The problem of inflation can no longer be ignored. Price pressures have spread across the economy – and there are still some signs they will end soon. The Reserve Bank of India (RBI) has started tightening monetary policy without explicitly saying so. Several companies have indicated that they will increase the prices of their products. The government’s decision to provide free food for the next six months can be explained at least partly by the need to protect the purchasing power of households.
Beyond the headlines, it is useful to take a closer look at Indian inflation right now. There are five issues worth noting.
Firstly, inflationary pressures are long awaited, which most people feel. The sharp fall in headline inflation in September 2021 may also have created a false sense of security. The ascent started soon after. Average figures for the past one year tell an even more worrying story. Headline inflation has averaged 5.5% since April 2021. Average core inflation—excluding volatile food and fuel prices—has been more than 6%. Other measures of core inflation, which do not include prices of petrol, diesel, gold and silver, are also shining. So, even though the discussion after every monthly data release looks at the impact of certain individual items in the consumer price index, the broader story is that inflation has been sticky. Why core inflation has remained consistently high despite weak demand is an analytical puzzle that economists have yet to give a concrete answer to.
Second, inflation is not limited to a few commodities. In the US, those who argued that price pressures in that country were temporary because they were concentrated in certain sectors, such as used cars and lumber, now have spread inflation. It is more or less the same story in India as well. There are various measures to show the widespread price pressure in the Indian economy. One such solution is the truncated mean. Outliers in the price index, or the items that have seen the largest and lowest price increases, are removed from the calculation. Various trimmed instruments in India show that price pressures are not concentrated in a handful of commodities that have been hit by specific demand or supply shocks. It is very similar with the diffusion index, which calculates the proportion of commodities promoting growth in any given index, such as consumer prices.
Third, the drivers of inflation in India must be investigated. Recent inflation has generally been fueled by goods inflation rather than services inflation. This is true for many other countries where demand for goods has improved faster than demand for services, and this may change as consumers begin to walk out with more confidence. A sharp rise in hotel prices is an early sign. Another way to look at inflation factors is to see whether pressures are coming from the supply or demand side. In its latest monetary policy report released earlier this month, the Indian central bank used a statistical technique called vector auto regression to show that consumer prices are driven by oil prices, higher money supply, rural wages, domestic supply constraints. being pushed by factors such as and devaluation of Rs. Weak demand is working in the opposite direction to keep inflation down. Finally, the role of imported inflation is increasing in importance, which is no surprise given the resurgence of inflation in the most advanced economies and the sharp rise in global commodity prices.
Fourth, where does India stand in comparison to other major economies on the inflation front? Much has been made of the fact that US inflation is now higher than Indian inflation, but a broader look tells us a more grim story. The Economist tracks the latest data for 42 major economies every week. There are 17 countries whose inflation is higher than ours, but 24 countries are low inflation. So while India is not global inflationary as it was a decade ago, it is not a safe zone either. However, each country has its own macro fundamentals, and a more useful measure that I like is how far inflation has moved from its formal or informal inflation target in any given country. This exercise can only be done with data from countries where central banks have numerical inflation targets, but it shows India in a better light. As this column reported two weeks ago, there are three groups of countries. The first group includes countries such as the US, Brazil, Germany, Mexico and the UK, where the most recent inflation readings are well above targets. In the second group are countries such as France, South Korea, Taiwan and South Africa, where inflation is slightly above comfort levels. And then there are countries where inflation is still below target. These countries include Japan, China, Indonesia and the Philippines.
Fifth, Indian monetary policy makers also need to look at two other measures of inflation: inflation expectations and forecasts of future inflation. Inflation expectations in India have been rising for some time now. Think of it as inflationary psychology in the country. The central bank has also increased its inflation forecast for the new financial year beginning April 1. RBI said in February that it expects inflation to average 4.5% in FY 2022-23; That forecast has now been sharply raised to 5.7%, although the central bank still expects quarterly inflation to be sequentially lower over the course of the year.
Inflation forecasting is important because a central bank has to formulate policy by looking at the windshield rather than the rear-view mirror. Reason: Monetary policy operates with a lag of three or four months, so what RBI does now will have its effect only in a year or so. So our central bank being behind the curve is now risky.
Niranjan Rajadhyaksha is CEO and Senior Fellow at Earth India Research Advisors, and a member of the Academic Advisory Board of the Meghnad Desai Academy of Economics.