India's headline inflation has been above 9 percent nearly every month for two years, prompting the central bank to hike interest rates 13 times in a row.
While Monday's data may bring some relief to central bankers — and business people concerned about the hit to growth from high interest rates — economists warn the decline was dramatized due to high prices this time last year, when the price of onions spiked.
Jay Shankar, chief economist at Religare Capital Markets, called the data a "statistical mirage." He said the central bank is unlikely to cut rates until the base effect fades, in May.
In the meantime, supply constraints remain, and in some cases are getting worse, even as demand remains relatively robust.
India has done little to address supply bottlenecks — by, for instance, building food warehouses, irrigation systems and power plants — that have driven prices up. Slowing capital expenditure, policy inaction and corruption scandals have also helped to push prices up.
"Investment and capacity addition haven't been significant in the last one and a half to two years, and demand has not slowed," Shankar said. "The demand supply gap may be accentuated and that may further push up prices."
Problems are brewing in the politically sensitive area of food prices, he said.
Even as demand for protein increases as incomes rise, milk and egg production has been flat and the area of land used to grow pulses like lentils — a key protein in this largely vegetarian nation — has actually decreased this year, he said.
The unseasonable rains that last year drove price spikes in onions and other vegetables haven't been repeated this year. Instead, some states are already showing signs of inadequate rainfall, he said.
"Inflation pressures are not going to go away fast," he said.
Core inflation, which is thought to be responsive to monetary policy, also remained firm, suggesting that the central bank may hold back from lowering interest rates when it meets later this month, analysts said.
"Core inflation, which is inflation stripped of agriculture and fuel, is still fairly high — close to 8 percent," said HDFC Bank Chief Economist Abheek Barua. "That might hold them back."
He said that in the best case, the bank may reduce cash reserve requirements in January, to help ease tight liquidity, but hold off on a rate cut until it gets more evidence that inflation is in check, perhaps in March or April.
Food prices softened in December but the cost of manufactured products held steady.
December food prices rose just 0.7 percent from a year ago, thanks to plunging prices of potatoes and onions. That is a huge improvement — food inflation averaged 9.2 percent a month from July to November, the data showed.
The cost of manufactured products rose 7.4 percent from a year ago, versus a July-November average rise of 7.8 percent a month, the data showed.
The result was roughly in line with expectations. A CNBC-TV18 poll predicted that headline December inflation would be 7.4 percent.
