Number theory: Is inflation surge different this time?
India’s benchmark inflation rate, as measured by the Consumer Price Index (CPI), was 7.79% in April. This is the highest inflation has been since the current government assumed office in May 2014. To be sure, CPI was higher than its April level in April 2014 and peaked at 11.5% in November 2013. While most analysts do not expect inflation to reach double digit levels at the moment, they also underline the inherent volatilities given the shock to food and fuel prices because of the ongoing geopolitical crisis in Europe.
How different is the inflationary situation today than it was in 2013-14? A holistic answer to this question must look at statistics beyond price levels to get an idea about the larger balance on forces in the economy. Here are three charts which explain this.
Wholesale prices are a bigger worry at the moment than retail prices
The Wholesale Price Index (WPI) grew at 15.1% in the month of April, as per data released by the Ministry of Commerce and Industry on May 17. This is the highest ever monthly WPI reading since March 1995, if a long-term comparison is made with the spliced WPI series in the Centre for Monitoring Indian Economy (CMIE) database. April is the 13th consecutive month when WPI has grown at a double-digit rate.
To be sure, WPI and CPI do not measure similar sets of prices in wholesale and retail markets in India. Because the former is used as a proxy for producer prices and the latter is supposed to represent an average household’s consumption basket, the composition of CPI and WPI baskets is very different. For example, CPI includes such things as housing and personal services whereas WPI includes metals and fertilizers. While CPI growth has been higher in the past, WPI is showing unprecedented momentum at the moment. Broadly speaking, this suggests that a lot of the inflation is actually cost-push in nature where producers are passing on higher commodity prices to consumers. The fact that CPI is still lagging WPI also suggests that weak demand conditions might be holding back producers, or at least a section of them, from passing on the entire effect of the increase in input prices. Economists such as Pranjul Bhandari at HSBC have been making this point for quite some time.
What can we say about a demand-supply mismatch in the Indian economy?
In the sanitised world of economics textbooks, inflation is mostly a result of demand overshooting supply in the short run. The international commodity price shock notwithstanding, how much of a factor is excess demand in driving inflation at the moment in India? Lack of high frequency data makes this a difficult question to answer. However, one can try and triangulate on the probable situation with some statistics.
Parts of formal sector seem to be experiencing a strong recovery
The Purchasing Managers’ Indices (PMI) for both manufacturing and services have been in the expansion zone since July and August 2021 respectively. The latest data on capacity utilisation levels from RBI’s OBICUS Survey shows that it was the highest since June 2019 in the quarter ending December 2021. While these numbers are based on small samples and are likely to have a strong formal sector bias, they do suggest that at least a part of the Indian economy has seen a sharp restoration of demand in the recent past.
Cut mass demand is still scarred
Index of Industrial Production (IIP) data for the month of March shows a divergent trend in the consumer goods sub-component and the rest of the IIP basket. While the former continues to contract, the latter has been showing expansion. This basically suggests that a large section of the consumer base continues to see demand destruction. What more can be said about this situation? Data from RBI’s Consumer Confidence Survey (CCS) can offer some insight into this question.
While the level of net consumer sentiment vis-à-vis general economic situation and prices is at a similar level (latest data is for March ) to where it was when inflation peaked (September 2013 and December 2013) in the last cycle, perception around income and employment is much worse for the present period. This suggests that the purchasing power of a larger part of the urban population – this CCS is only done in cities – could be lower today than what it was when prices peaked in 2013.
Which only complicates the economic policy challenge
One of the biggest arguments in favour of India not giving a large fiscal package to cushion the pandemic’s impact was that it could pose risks to macroeconomic stability. Government officials have often cited runaway inflation in advanced countries, which gave large fiscal stimuli, as a vindication of India’s official policy response. Had international commodity prices not seen a spike, the strategy could have paid off to some extent. However, the price disruption after the Russia-Ukraine war has left the Indian economy vulnerable to high rates of inflation without having indulged in so-called fiscal profligacy. While monetary policy will face little pressure against unleashing interest rate hikes and sucking back liquidity, it is the fiscal arm which will face the bigger dilemma, especially on the question of sharing the burden of higher petroleum prices between consumers and the government; and taking pre-emptive strikes against food price inflation, which could hurt farmers’ incomes. The first such pre-emptive strike, the ban on wheat exports, has already taken place.