December 2011

CRISIL EconomyFirstCut
Inflation:
Falling rupee limits inflation descent
Overview WPI rose by 9.1 per cent in November as against 9.6 per cent a month earlier. Looking ahead, inflation will fall further as food inflation declines due to good arvest and slowing demand lowers core inflation. The pace of fuel inflation will depend on the impact of global slowdown on oil and other commodity prices. The continued depreciation of the rupee, however, will push up the imported component of inflation, at least temporarily. Overall, we believe, with a reasonable degree of confidence that WPI inflation will fall around RBIs projection of 7.0 per cent by March 2012. Nonetheless, despite slowing demand, inflation will remain above the RBIs tolerance limit of 5 per cent for some months to come. We therefore, do not expect a cut in CRR or repo rate in the monetary policy announcement on Friday this week. To alleviate liquidity shortage RBI would continue with open market operations (OMOs), if necessary.
Continued weakness in the currency is pushing up the cost of imports (edible oil, fuels and metals). For example, while the global crude oil prices rose by nearly 20.0 per cent in November 2011 compared to a year earlier, the rupee price of oil shot up by around 40.0 per cent due to currency depreciation. The fall in rupee is also responsible for an upward revision in CRISIL Researchs average inflation forecast to 9.2 per cent in 2011-12, from 9.1 per cent estimated earlier. Inflation in the fiscal year so far (April to November 2011) stands at 9.1 per cent compared to 9.6 per cent during the same period of 2010. Inflation for September 2011 was revised up to 10.0 per cent compared to 9.7 reported earlier. Food (primary plus processed) inflation fell to 7.9 per cent in November 2011 from 9.8 per cent in October. Normal monsoons and a good harvest have kept food inflation in check. A steep fall in inflation was recorded in fruits, vegetables and poultry. Food inflation, at 8.6 per cent average in the year so far, is also lower than 12.7 per cent in the same period a year ago. Fuel inflation at 15.5 per cent in November compared to 14.8 per cent in October, largely reflecting the combined impact of higher international prices compared to a year earlier and a sharp depreciation of rupee on internationally-linked prices of aviation turbine fuel, furnace oil and naptha and bitumen. Despite slowing growth, core (non-food manufacturing) inflation is still to show signs of decline. During November 2011, it was recorded at 7.9 per cent relative to 7.7 per cent in October. However, any hike in interest rates first reduces demand before curbing inflation. We expect the second-leg of policy-rate transmission to play out over the coming months.

Inflation pressures remain high

% 14.0 11.0 8.0 5.0 2.0 -1.0 Mar-10 Nov-09 Nov-10 Mar-11 Nov-11 Jul-10 Jul-11

Price Movements, y-o-y growth

% yoy 50.0 40.0 30.0 20.0 10.0 0.0 -10.0 -20.0 Apr-11 Oct-11 Apr-11 Aug-11 Dec-11 Aug-11 Oct-11 Dec-11 Jun-11 Jun-11 International Rupee

WPI yoy

SA, q-o-q annualised 3 MA

Oil

Metal

Source: Ministry of Industry and Commerce, CRISIL Research

The seasonally-adjusted q-o-q annualized (SA) inflation is again reflecting some sequential decline. It stood at 8.3 per cent in November, compared to an average of 8.8 per cent between April and October 2011.

Falling rupee appears to have resulted in a higher increase in domestic prices of commodities and metals than in global markets.

CRISIL EconomyFirstCut - Inflation

Inflation in major inflation groups (2004-05 base) General Primary - Food articles - Non-Food articles - Minerals Fuel - Petrol - Diesel Manufacturing - Food - Non Food
Source: Ministry of Industry, CRISIL Research

Weight 100.0 20.1 14.3 4.3 1.5 14.9 1.1 4.7 64.9 9.9 55.0

Aug-11 9.8 12.6 9.6 17.8 23.4 12.8 23.2 9.3 7.8 9.1 7.7

Sep-11 10.0 11.8 9.2 14.8 24.8 14.1 26.3 9.3 7.7 8.8 7.6

Oct-11 9.7 11.4 11.1 7.7 20.4 14.8 27.9 9.3 7.7 9.8 7.7

Nov-11 9.1 8.5 8.5 3.2 18.0 15.5 27.6 9.2 7.7 7.9 7.9

Apr-Oct FY11 FY12 9.6 18.4 17.0 19.0 27.8 12.5 17.0 15.2 5.5 12.5 5.5 9.6 11.9 9.1 15.4 23.5 13.4 26.0 8.1 7.6 8.6 7.6

Moderating growth, sticky inflation

% yoy (3 month

Expectations about income, 1-year ahead

WPI inflation % of respondents 80.0 70.0 60.0 50.0 40.0 30.0 20.0 Dec-11 Sep-11

Domestic demand growth

12.00 10.00 8.00 6.00 4.00 2.00 0.00 Sep-09 Sep-10 Dec-09 Dec-10 Mar-09 Mar-10 Mar-11 Sep-11 Jun-09 Jun-10 Jun-11

10.0 0.0 increase remain the same decrease

Note: Domestic demand includes private final consumption expenditure and gross fixed capital formation.
Source: CSO, Ministry of Industry, RBI Consumer Confidence Survey, Sep 2011, CRISIL Research

Despite domestic demand growth posting a marked decline in the past two quarters, WPI inflation has remained high and stubborn reflecting price stickiness as well as impact of continued depreciation in rupee.

Expansion in domestic demand is expected to slow down further going forward. RBIs Consumer Confidence Survey suggests that while percentage of people expecting an increase in future income remains high, it has fallen over the last four quarters. This, in turn, will lead to lower consumption growth and help control inflationary pressures from the wage-price spiral.

About CRISIL Limited

CRISIL is a global analytical company providing ratings, research, and risk and policy advisory services. We are India's leading ratings agency. We are also the foremost provider of high-end research to the world's largest banks and leading corporations.

About CRISIL Research

CRISIL Research is the countrys largest independent and integrated research house with strong domain expertise on Indian economy, industries and capital markets. We leverage our unique research platform and capabilities to deliver superior perspectives and insights to over 1200 domestic and global clients, through a range of research reports, analytical tools, subscription products and customised solutions.

Disclaimer
CRISIL Limited has taken due care and caution in preparing this Report. Information has been obtained by CRISIL from sources, which it considers reliable. However, CRISIL does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. CRISIL Limited has no financial liability whatsoever to the subscribers / users / transmitters / distributors of this Report. The Centre for Economic Research, CRISIL (C-CER) operates independently of and does not have access to information obtained by CRISIL's Ratings Division, which may in its regular operations obtain information of a confidential nature that is not available to C-CER. No part of this Report may be published / reproduced in any form without CRISIL's prior written approval.

CRISIL Privacy Notice

CRISIL respects your privacy. We use your contact information, such as your name, address, and email id, to fulfill your request and service your account and to provide you with additional information from CRISIL and other parts of The McGraw-Hill Companies, Inc. you may find of interest. For further information, or to let us know your preferences with respect to receiving marketing materials, please visit www.crisil.com/privacy. You can view McGraw-Hills Customer Privacy Policy at http://www.mcgrawhill.com/site/tools/privacy/privacy_english

Last updated: 31 March, 2011

Analytical Contacts: Vidya Mahambare Senior Economist Email: vmahambare@crisil.com Media Contacts: Mitu Samar Head, Communications and Brand Management Email: msamar@crisil.com Phone: +91 22 3342 1838 Priyadarshini Roy Communications and Brand Management Email: proy@crisil.com Phone: +91 22 3342 1812 Dipti Saletore Economist Email: dsaletore@crisil.com

CRISIL Limited CRISIL House, Central Avenue, Hiranandani Business Park, Powai, Mumbai- 400 076, India Tel: +91 22 3342 3000 Fax: +91 22 3342 8088 www.crisil.com CRISIL Ltd is a Standard & Poor's company