>8% WPI inflation by end 2009/10? (HSBC)

• Wholesale price inflation, India’s key price measure, may jump to 5-6% by end of calendar 2009 and 7-8% by March 2010
• Reflects likely impact of strong rise in oil, food and metal commodity prices – the key determinants of WPI
• Increase in inflation will put paid to another RBI cut and could spook markets

First the good news. India’s key measure of inflation, the Wholesale Price Index (WPI), has slumped from a high of 12.9% in early August last year to 0.1% at the end of May. The latter is comfortably the lowest rate the country has seen since at least the late 1980s, which is as far back as we have data. It could also fall a little further in the short term.

The bad news is that we are approaching the bottom in this measure and are set to see a strong run-up in inflation before the year is out, probably to around 6%. If we are right then this will almost certainly put paid to any chances of a further rate cut, which had already diminished significantly given the prospect of an expansionary budget in July, and could provide a shock to markets.

So why are we concerned? It certainly doesn’t reflect our long-held, relatively strong GDP growth view of 6.2% for the current fiscal year. This is still below trend and, in any case, whole economy output growth has little or no impact on the WPI. Instead, commodity price developments and the movement of the rupee are the biggest influences.

Although the price of commodities such as oil, food and metals are still falling heavily in year-on-year percentage terms, as a matter of simple arithmetic this won’t be the case for much longer barring a huge, sudden and unexpected collapse in prices. On the basis of unchanged commodity prices and a stable USD-INR exchange rate, the year-on-year rate of oil price inflation will be 66% in December, food 24% and base metals 45%.

In practice, as the charts overleaf show, none of the three commodity price series have a perfect relationship with the corresponding components of the WPI (energy, primary articles and manufacturing) but they are not too bad and each point to significant upside risks. By the end of this calendar year, we could be looking at energy price inflation of about 15%, primary at 4% and manufacturing up 4%. Given their respective weights in the WPI, this works out to be a 5½% headline rate of inflation, a big upward revision from our previous 0% forecast and well above consensus expectations. It is also most unlikely to be the peak. We think WPI inflation could reach 7-8% by the end of fiscal 2009/10 – double the RBI’s 4% target and up from our previous 1.8% forecast.

To see full report: INDIA WATCH