Where is inflation heading?

Friday, March 24th, 2017

Over the last few years we have seen that inflation has been structurally moving down. This trend is slowly changing with a number of countries now showing higher prints every month. Where is inflation heading now? And what does it mean for the Indian economy?

 

We can look at the inflation print of some of the major economies in the chart below, using data from the  OECD website.

 

 

The data shows the inflation trend from January 2011 till February 2017. After years of inflation trending down, we see that Interest Rates in the US, UK and EU region are now climbing higher. Even Japan, which has historically been known for its deflationary conditions, is now showing signs of a pickup in the inflation environment.

On the other hand, India has seen a sharp fall in its CPI in its recent past. Part of this can be attributed to demonetisation. Because currency was sucked out of the system, there were fewer transactions happening leading to fall in prices. But if we look at WPI, the inflation print was at 5.25 per cent in January and 6.55 per cent in February. WPI is used more as a measure for input prices, therefore it could either mean that output prices remain low, putting a squeeze on company’s margins, or  be that price rises are passed on to the end consumer. We think the latter is the more likely scenario and therefore we could see global inflation feed back into the domestic economy.

What does this mean for the Indian economy? Higher inflation, especially if it moves out of RBI’s comfort zone, could lead to higher interest rates. Higher inflation though also means higher nominal growth which is a boost to the underlying earnings growth of companies. There are also macroeconomic implications of higher inflation as it will feed into out exchange rates and also affect our fiscal deficit numbers.


About the author

Rishad is the founder of Kairos Capital. He started his career with Standard Chartered Wealth Management and has extensive experience in markets, particularly in terms of mutual funds and stocks.

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