Is inflation in India headed for a ‘new normal’ that’s lower?

At an eight-year low in July and the first sub-2% reading in more than six years, headline consumer price index (CPI)-based inflation is now even below the lower threshold of RBI’s target inflation band.

Notably, looking beyond the headline numbers, there are several more reasons to cheer. The easing of price pressures in recent months has largely been broad-based. While much of the decline in headline inflation is attributed to a sharp dip in food prices, the upside in other major CPI sub-indices has remained capped too. Fuel inflation, albeit with a marginal uptick, is hovering below 3% and transport and communication inflation is easing thanks to moderate international crude oil prices.

Further, core inflation (CPI excluding food and fuel) has remained sticky at about 4%, reflecting a comforting lid on demand-side price pressures even in an environment of monetary accommodation, with 100 basis points of repo rate cuts having been delivered this year. Offering a clear sign of confidence, household inflation expectations, which remained in double-digits through mid-2020 to 2023, have also been on a downtrend in recent months.

There are more encouraging signals and nuances hidden in the inflation dynamics.

First, July’s sharp decline in on-year inflation was not an outcome of a favourable base effect. Headline inflation in July 2024 was below 4%, suggesting very little contribution from an unusually inflated base. This is in contrast with June 2017, the last time CPI inflation was below 2%, when its trajectory gained sizeably from a favourable 2016 base.

Second, there has been a sizeable moderation in the sequential momentum in both June and July despite adverse seasonality. Price pressures typically see a sequential upside during the monsoon months, owing to erratic rains, crop damage and supply disruptions. Putting this in numbers, headline inflation rose 0.9% month-on-month in July, compared to an average of 2.2% during the same month in the last two years.

A favourable monsoon with steady progress so far this year and robust crop production have driven a decline in food inflation. Contained global commodity prices, especially of crude oil, with the benchmark Brent contract trading below $70 a barrel, have helped cap fuel inflation as well as any second-round effects on broader inflation in India.

However, beyond these cyclical factors, there are likely structural factors at play too. Supply-side measures, especially the government’s astute food supply management in recent years, have been crucial in managing food inflation. Steps such as the augmentation of buffer stocks for essential food grains, stock limits to prevent hoarding and strategic open-market sales of procured grains have helped ease supply concerns.

This was further aided by prudent trade policies and facilitation of imports, along with export curbs for critical food items during periods of scarcity. Such measures include placing the export of some food items under the prohibited category, imposing higher export duties and promptly increasing imports in the event of short supply.

Finally, improving agricultural productivity and higher government capital expenditure in rural infrastructure have addressed logistical bottlenecks, eased supply constraints and aided farmers’ access to markets, thus helping keep food inflation under check.

These structural supply-side measures, complemented by favourable global and domestic factors, have led to a decline in inflation to a multi-year low in India.

Tailwinds need not continue to favour price stability. Global commodity prices, in particular, are exogenous and cyclical and may not always be as supportive. Thus, during periods of exogenous price shocks, it would be crucial to watch how the impact of structural supply-side measures plays out.

While several favourable factors working in tandem have led the country’s inflation trajectory to pivot towards a potential new lower bound, more data is needed to determine if the economy has indeed graduated to a new equilibrium of lower inflation that is sustainable and could endure.

It’s worth noting that in the last decade, headline CPI inflation has never touched double-digits, a phenomenon that was evident in the years preceding this decade.

More importantly, at this juncture, with the global economy facing unprecedented uncertainty, a sharp decline in price pressures has given RBI’s monetary policy committee significant rate-setting headroom. Even as it maintains a neutral policy stance, headline inflation below the lower bound of India’s target band, capped demand-side price pressures and comfortably positive real rates of interest all add up to grant the central bank ammunition in support of an economy that faces external headwinds.

For now, various economic signs point to India steadily moving towards a lower-inflation economy. If that’s achieved, it would lay a strong foundation for sustainable growth over the long-term.

The authors are, respectively, partner and lead; and senior economist, economics practice, PwC India