10 Things You Need to Know About India’s High-Inflation

In September, inflation as measured by the consumer price index continued to remain in elevated territory at 7.34%. Inflation is the rate of price rise in comparison to the same period last year.

Let’s take a look at this relatively high inflation of 7.34%, pointwise.

1) Only twice in the last five years has the monthly inflation figure been higher than that in September 2020. This was in January 2020 and December 2019, at 7.59% and 7.35%, respectively. The December 2019 inflation figure was more or less similar to the September 2020 number.

2) Interestingly, eight out of the ten highest inflation months in the last five years have been in 2020. What this clearly tells us is that 2020 has been a year of high inflation. Alongside this consumer demand has collapsed and there is stagnation in the economy. Hence, 2020 has been the year of stagflation (stagnation + inflation) as well. While, this wasn’t clear at the beginning of 2020 when covid hadn’t made an appearance (and I had said so), it is very clear by now (and I am saying so).

3) In an environment where consumer demand has collapsed, prices should be falling and not going up. What’s the logic here? When consumer demand collapses, firms in order to get people to consume, cut prices. This leads to lower inflation or even deflation (in worst cases, when prices fall).

But that hasn’t happened in the Indian context. The question is why? The following chart plots food inflation (using data from the consumer price index) over the last five years and possibly has the answer.

High food inflation

Source: Centre for Monitoring Indian Economy.

 Food inflation in India has been rising since early 2019 and it has continued to remain high in the post-covid environment. The inflation of vegetables, pulses, oils and fats and egg, meat and fish, was in double digits in September. Vegetable prices led the way and rose at the rate of 20.73% during the course of the month, with potato prices rising 101.98%.

4) Food carries a weight of 39.06% in the overall consumer price index. In the rural part, it carries a weight of 47.25%. Hence, elevated food inflation pushes up overall inflation. Also, the thing to notice here is that food prices were high even before the covid-pandemic struck. This was due to weather disruptions among other things. The trend of high food prices has continued post-covid.

5) Take a look at the following chart. It plots the difference in food inflation as measured by the consumer price index and as measured by the wholesale price index.

The Farmer Doesn’t Benefit 

 Source: Author calculations on data from Centre for Monitoring Indian Economy.

What does this chart tell us? It tells us that post-covid, the food prices at the consumer level have been growing at a much faster rate than food prices at the wholesale level. The average difference between April and August was 610 basis points. One basis point is one hundredth of a percentage. The wholesale price index data for September is yet to come in (It will be published tomorrow).

What this means is that, despite the end consumers of food paying a higher price, the farmers are largely not benefitting from this rise in food prices, given that they sell their produce at the wholesale level.
This difference can be because of a few reasons.

a) A collapse in supply chains has led to what is being sold at the wholesale level not reaching the consumers at the retail level, thus, leading to higher prices for the consumer.

b) This could also mean those running the supply chains hoarding stuff, in order to increase their profit.

Having said that, the former reason makes more sense given that stuff like vegetables, egg, fish and meat, etc., cannot really be hoarded. Also, hoarding stuff like pulses, needs a specialized storage environment which India largely lacks.

6) The difference in food inflation as measured by the consumer price index and as measured by the wholesale price index peaked in April at 790 basis points. This makes complete sense given the lockdown was at its peak during the month. As the economy has opened up, the difference has come down.

Nevertheless, in August the difference was at 521 basis points. This is still high given that the average of the difference over the last five years is 38 basis points. Also, with the food inflation as measured by the consumer price index going up by 163 basis points to 10.68% in September 2020, in comparison to August 2020, chances are that the difference in food inflation as measured by the consumer price index and as measured by the wholesale price index, might go up in September.

7) So, what does this mean for food inflation in the second half of this financial year? The monetary policy committee of the RBI projects that the inflation will be between 4.5-5.4% during the second half of this financial year. This can only be if food inflation comes down and also, it does not seep into overall inflation.

In the past, high food inflation has seeped into wage inflation and overall food inflation. It remains to be seen whether this happens this time around as well. The monetary policy committee doesn’t think so, but then it has as much control over food prices as it has over the finance ministry.

Interestingly, in the monetary policy report released a few days back, the RBI says in this context:

“Food inflation has remained elevated in recent months driven by price pressures in vegetables, cereals and protein items such as pulses, eggs and meat. The normal south-west monsoon, increased sowing of kharif crops, moderate MSP hikes, and high reservoir storage are expected to soften food inflation going forward.”

It goes on to say:

“However, a delayed normalisation of supply chains, heavy rains and floods in some states and demand-supply imbalances in key items such as pulses could exert further upward pressure on the headline inflation and keep it higher by around 50 basis points. On the other hand, an accelerated softening of food inflation due to an early restoration of supply chains, ample buffer stocks and efficient food stock management by the Government could bring headline inflation below the baseline by up to 50 basis points.”

So, the RBI in the monetary policy report is basically saying it could go either ways. In the process, it has hedged itself well, either ways.

8) Until the dynamic of whether food inflation is seeping into overall inflation becomes clear, it will be very difficult for the RBI to cut the repo rate any further than 4%, where it currently stands. The repo rate is the interest rate at which the RBI lends to banks.

Also, if the food inflation starts seeping into the overall inflation, the easy money policy of the RBI, where it has been printing and pumping money into the economy to drive down the interest rates, will have to take a backseat.

The RBI has pumped a lot of money into the financial system since February. Some of it has been done by buying bonds from financial institutions. But a lot of it has been done by defending the rupee.  When a lot of foreign money comes into India, the demand for rupee increases and it tends to appreciate against the dollar. This hurts exporters as well as domestic producers.

To prevent this from happening the RBI intervenes in the foreign exchange market by selling rupees and buying dollars. When the RBI sells rupees the money supply in the economy goes up. The RBI has an option of sterilising this rupee inflow by selling government bonds and sucking out the excess money. But it has chosen not to do this, which is in line with its easy money policy.

In the recent past, the RBI has allowed the rupee to appreciate against the dollar, by not buying dollars, and not adding rupees to the money supply through this route. This is primarily because there is already too much easy money floating around in the financial system.

This easy money hasn’t led to inflation because banks are going slow on lending and borrowers are being very careful before borrowing. This has ensured that the dynamic of too much money following the same amount of goods and services hasn’t played out and hasn’t created an even higher inflation.

Nevertheless, as the economy continues to recover there is a chance of this happening. Hence, the RBI needs to be careful with its easy money policy, especially if food inflation starts seeping into the overall inflation.

In the latest monetary policy, the monetary policy committee had said: “The MPC also decided to continue with the accommodative stance as long as necessary – at least during the current financial year and into the next financial year – to revive growth on a durable basis and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward [italics added].”

In simple English, this means that the RBI will keep driving lower interest rates to create growth. Up until now it doesn’t seem to be worried about its inflation mandate (to maintain the inflation as measured by the consumer price index between the range of 2-6%). But if food inflation remains high and seeps into overall inflation, the RBI will have a major problem at its hand, with all the liquidity it has pumped into the financial system.

9) Even if inflation falls to 4.5-5.4% as the RBI expects it to, the real return on fixed deposits after adjusting for inflation and taxes paid on the interest earned, will continue to remain in negative territory. And that’s not good news for savers as their savings will lose purchasing power. It’s great news for borrowers because inflation means they are repaying their loans in money which is worth less than it was at the time it was borrowed.

10) As much as economists might want us to believe, economics is no science. There are too many ifs and buts and maybes to the predictions that are made. And this is something that every reader needs to be aware of. This is true as much of this situation as it is of others.

What the latest WPI number tells us about the Indian economic story

InflationVivek Kaul

Inflation as measured by the wholesale price index(WPI) fell to a eight month low of 5.05% in January 2014. On the face of it, it might seem like a reason to rejoice, but the devil as they say always lies in the detail.
Around 65% of the wholesale price index is made up of manufactured products. The rate of inflation for manufactured products stood at 2.76%. In comparison, this had stood at 4.96% in January 2013.
On the other hand the price of food articles which constitute around http://teekhapan.wordpress.com/2014/02/14/food-inflation-is-down-but-the-figure-raghuram-rajan-is-watching-hasnt-even-budged/14.3% of the index rose by around 8.9%. In comparison, the rise had been at 12.4% in January 2013.
Vegetable prices went up by 16.60% (in comparison to over 30% during the same period last year). The price of rice was up by 13.4% (in comparison to 17.8% during the same period last year). The price of Egg, Meat and Fish went up by 10.9% (in comparison to 11.2% during the same period last year).
If India has to get economic growth going again, the manufacturing inflation needs to rise from its current level and the food inflation needs to fall further.
For more than five years, food inflation has been very high. High inflation has eaten into the incomes of people and led to a scenario where their expenditure has gone up faster than their income. This has led to people cutting down on expenditure which is not immediately necessary.
When people cut down on expenditure, the demand for manufactured products falls as well. This is reflected in the rate of inflation for manufactured products which stood at 2.76% in January 2014. Interestingly, this is also reflected in the consumer durable number( a part of the index industrial production from a use based point of view), which fell by 16.2% in December 2013.
At a more practical level it is reflected in the falling car sales numbers. The domestic car sales number stood at 1,60,289 units in January 2014, falling from 173,449 units in January 2013. The two wheeler sales went up by just 5% to 179,576 units in January 2014 over January 2013.
With high inflation eating into the incomes of people it is not surprising that they are cutting down on their expenditure. Also, high inflation has prevailed for close to five years now. Given this, a fall in overall inflation, as it has over the last couple of months, will not immediately lead to increased consumption. People need a little more evidence of falling inflation before they decide to open up their purses. This means, that overall inflation (as measured through the wholesale price index or the consumer price index for that matter) needs to continue to fall over the next few months, for consumer demand to return. Whether that happens remains to be seen.
While food inflation has been falling, the inflation at the retail level still continues to be strong. If one looks at core retail inflation (i.e. non food non fuel inflation which forms around 40% of the consumer price inflation index) it continues remains to be high at 8%
.
The core inflation contains measures of housing, medical care, education, recreation, transport, personal care etc, basically, everything that is required for a reasonably comfortable living.
If consumer demand has to return, the core retail inflation needs to come down from a level of 8% to close to 5-6%.
What makes a fall in core retail inflation even more important is the fact that the items that constitute it (i.e. housing, medical care, education, recreation, transport, personal care etc) are the ones that consumers deal with on an almost daily basis. And they will not feel inflation has come down, unless the price rise of these items starts to slow down.
This number is closely tracked by the Reserve Bank of India(RBI) as well. The RBI governor Raghuram Rajan had said on January 29, 2014, “that he would have liked to see a greater reduction in core inflation.”
Also, f
ood inflation needs to continue to fall. Its the high price of food that feeds into wages and thus leads to high levels of core retail inflation. Once that is brought under control, consumer demand will return, and will start to reflect in higher manufactured products inflation and a better index of industrial production number (which stood at -0.6% in December 2013).
And that, in turn, is likely to show up in higher economic growth.

The article originally appeared on www.FirstBiz.com on February 14, 2014

(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Food inflation is down but the figure Raghuram Rajan is watching hasn’t even budged

ARTS RAJANVivek Kaul  

As soon as some new economic data is declared by the government, the business lobbies demand that the Reserve Bank of India(RBI) should cut interest rates. The response is almost Pavlovian. Something similar happened yesterday as well. The index of industrial production(IIP) shrunk by 0.6% for the month of December 2013.
The manufacturing sector which constitutes close to three fourths of the index declined by 1.6% during the month. In comparison, it had declined by 0.8% during December 2012. The IIP is a measure of the industrial activity within the country and given that the number is in negative territory, what it tells us is that all is not well with the Indian businesses.
No sooner had the number been declared, the Confederation of Indian Industry I(CII), a leading business lobby in the country demanded that interest rates be cut. “We are especially concerned about the performance of the manufacturing sector, which continues to be in the red,” 
CII Director General Chandrajit Banerjee said. “We look forward for an accommodative monetary policy to spur demand and revive investment activity especially as inflation has started receding,” he added. Accommodative monetary policy essentially refers to the RBI cutting the repo rate, the rate at which it lends to banks.
The logic is that if the RBI cuts the repo rate, the banks will cut the interest rates at which they lend. This will ensure that people will borrow and spend more, which will translate into greater revenue and profit for businesses. Once businesses start making more money, they are likely to invest more as well. All this will lead to a higher economic growth, which for this financial year is likely to be at or around 5%. Or so goes the argument.
Another reason why business lobbies feel that the RBI should be cutting interest rates is the fact that the consumer price index(CPI) inflation in January 2014 fell to a two year low of 8.79%. This was on the back of food inflation falling to a 22 month low of 9.9%. Food products constitute nearly half of the consumer price index. Food inflation was at 12.2% in December 2013.
Food inflation came down because of the vegetable prices falling by 13.2% between December and January. This was primarily on account of greater supply of vegetables hitting the market. During the period August-September 2013, farmers made significantly better returns on their produce. This led to them planting more vegetables, leading to an oversupply in the recent months.
So with the consumer price inflation falling to a two year low, the business lobbies want the RBI to start cutting interest rates in order to revive consumer demand, which has been stagnating for a while. The IIP data when looked from a use based point of view, indicates towards the same. The consumer durables measure fell by 16.2% during December 2013.
But the question is will a cut in interest rates revive consumer demand? While in theory the link appears to be fairly straightforward, that is really not the case. Let’s consider a case where an individual takes a three year two wheeler loan of Rs 40,000 from the State Bank of India to be repaid over a period of 36 months at an interest of 18.25%. The EMI for this comes to around Rs 1451.
Now lets assume that interest rates crash dramatically by one third from their current levels and the rate of interest on a two wheeler loan from the State Bank of India falls to 12.25%. In this case, the EMI falls to Rs 1333 or around Rs 118 lower. Hence, even if interest rates come down by a third, the EMI falls only by around Rs 118 or a little over 8%.
Someone who wants to buy a two-wheeler will definitely not be influenced by it. As John Kenneth Galbraith writes in 
The Affluent Society, first published in the 1950s, “The customer, in contemplating the purchase, is less aware of the interest rate than of the monthly charge…There is, in fact, considerable agreement that monetary policy does not make any effective contact with consumer borrowing and spending. During periods of active monetary policy, increased finance charges have regularly been followed by large increases in consumer loans.”
Given this, the customer who wants to purchase a consumer good by taking on a loan should be comfortable with the idea of paying an ‘x’ amount of money every month as an EMI, irrespective of what the interest rate is.
In this scenario, what becomes very important is the rate of inflation. For more than five years, inflation as measured by the consumer price index has been very high. This has largely been on account of food prices having gone up at a very fast rate. High inflation has eaten into the incomes of people and led to a scenario where their expenditure has gone up faster than their income. This has led to people cutting down on expenditure which is not immediately necessary. This is reflected in the consumer durable number which fell by 16.2% in December 2013.
Food prices have now started to come down and that is some good news for the Indian consumer. But if one looks at what economists call core inflation (i.e. non food non fuel inflation which forms around 40% of the consumer price inflation index) that remains to be high at 8%, as it has over the last few months. The core inflation contains measures of housing, medical care, education, recreation, transport, personal care etc, basically, everything that is required for a reasonably comfortable living.
Interestingly, this number is closely tracked by the RBI governor Raghuram Rajan. 
He had said on January 29, 2014, “that he would have liked to see a greater reduction in core inflation.” A day earlier in an interaction with the media he had said that “. Core (inflation) tells us something about the second round effects. Even within core, there are some which we need to pay attention to like some aspects of services like education, which have been going up quite strongly.” Given this, it is unlikely that the RBI will cut the repo rate anytime soon.
If the consumer demand story is to be revived again, the core inflation needs to be brought down, so that consumers feel comfortable in spending money. The ironical part here is that despite the economic growth falling from more than 10% to less than 5%, over the last few years, core inflation continues to remain high. The explanation for this lies in the fact that the high price of food, leads to a demand for higher wages and that leads a higher core inflation. When businesses have to pay higher wages, they, in turn, demand a higher price from consumers. And this in turn impacts consumer demand.
The government can definitely play a role here by cracking down on hoarders of food and at the same ensure that there is no shortage of wheat and rice in the market, of which it has enormous stocks.
As far as businesses lobbies are concerned it is worth looking at what Galbraith said in that context. “To restrict consumer borrowing by increasing the interest cost on instalment and other loans collides abruptly with the process of consumer-demand creation…Any step to discourage borrowing and buying will be automatically opposed by the machinery for consumer-demand creation.”

 The article originally appeared on www.FirstBiz.com on February 13, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)