India's inflation continued to rise across all sectors in August

India has published the latest retail inflation data. Consumer price index (CPI) in August increased 4.82% year-on-year, marginally higher than the market's previous estimate of 4.80%. The inflation trend has been more aggressive compared to 4.45% growth rate in July. At present, inflation is still within the target tolerance range of 2% to 6% set by the Reserve Bank of India, and has not yet touched the regulatory red line. However, the upward trend in prices has rapidly raised market concerns about inflation getting out of control.

India has kept its monetary policy fairly easy. Neighboring countries like Indonesia and Philippines have already begun to raise interest rates with the spurt in energy prices and wild gyrations in exchange rates making it all the more imperative for India to change its monetary policy. India has not hiked interest rates since February 2023. Its key interest rate has stayed at 5.25%. After three years, inflation has picked up across the board. The market expects India will soon end this long period of easy monetary policy.

Inflation in India was mainly driven by the food and fuel sectors. Now, prices have risen across various sectors such as services, daily necessities and clothing. The base for price increases has expanded. Due to the insufficient rainfall during the summer monsoon season, domestic agricultural production in India has been affected. Food inflation rose to 5.95% in August from 5.52% in July. The cost of living for residents has increased as prices of essential food items like onions and garlic have skyrocketed.

India is as dependent as 85% on imported oil and more than 50% of its crude oil imports are from the Middle East. Now, the geopolitical situation in the Middle East is tense, and the supply of crude oil has been disrupted. The Brent oil price has approached $108 per barrel. Even though domestic state-owned oil companies have not adjusted the prices of refined oil products, the transportation inflation in August rose from 4.43% to 4.60%. The inflation in catering services soared to 8.41% in August, far exceeding 7.75% in July. The inflation in the clothing, daily necessities and education sectors has all approached or exceeded 4%.

After excluding the highly volatile food and fuel prices, the core inflation data, which better reflects the real domestic demand, has risen largely. In August, India's core inflation rose to 4.2%, a substantial increase from 3.86% in July. The rise in core inflation is the most closely watched signal by the market. Many overseas institutions predict that the upward trend of inflation in India has not ended. According to the current price trend, India's inflation is likely to exceed 5% in the fourth quarter and gradually approach the tolerance limit of 6% set by the central bank.

At its August interest rate meeting, the Reserve Bank of India kept the interest rate unchanged, but the meeting minutes released a clear signal of tightening. If inflationary pressure continues to spread and affect all categories, an interest rate hike will be initiated immediately. Major rating agencies have also revised their interest rate predictions.The mainstream view in the market was that India would not raise interest rates until December 2026. Now, with the impact of unexpected inflation data and high oil prices, the possibility of an interest rate hike at the October meeting has increased.

Before the official interest rate hike, the Reserve Bank of India has already taken actions to regulate market liquidity in advance. Within two weeks starting from September 16th, the central bank will sell a total of 1 trillion rupees ($10.47 billion) worth of bonds. By recouping market liquidity and reducing the volume of circulating funds, it aims to cool down the enthusiasm for consumption and investment and alleviate the upward pressure on inflation. This measure can avoid a sudden and excessive interest rate hike that shocks the economy and can also curb the spread of inflation in advance.