Inflation situation in the country explained through four charts
The RBI published the minutes of the Monetary Policy Committee (MPC) meeting held on September 28-30 last Friday.
RBI published the minutes of the Monetary Policy Committee (MPC) meeting held on September 28-30 last Friday. The minutes suggest that opinions are beginning to diverge within MPC on the best way forward for monetary policy interventions. While J R Varma and Ashima Goyal have opined against an aggressive frontloading of rate hikes from now on, internal (RBI) members of MPC have spoken in favour of what can be described as a more hawkish policy stance. India’s benchmark inflation rate, as measured by the Consumer Price Index (CPI) climbed to 7.4% in the month of September, a forty basis point hike compared to the 7% print in August. What exactly is the inflation scenario and best possible policy outcome in the Indian economy? Here are four charts which explain this in detail.
With inflation rising, inflation expectations have reversed their declining trajectory as well
Headline CPI has increased for two consecutive months now and its effects seem to be showing in inflation expectations of households. The latest RBI survey on household inflation expectations shows that inflation expectations reversed their declining trajectory between the May and July rounds and are rising again in the September round. While three-month ahead expectations were back to May levels, the one-year ahead value is slightly lower than what it was in May . Because monetary policy interventions target future inflation, rising inflation expectations are a matter of concern for MPC.
But a break-up of headline inflation number underlines the limits of rate-hike interventions
In a textbook world, inflation targeting works by administering a demand shock to the economy by raising the cost of borrowing through interest rate hikes. This textbook model can run into problems when inflation drivers are not exactly driven by “excess demand” . A supply-side shock to fuel prices or hike in food prices (where deflating demand is not very desirable) are some such examples. Breaking up the headline CPI number into food, fuel and core inflation (the last excludes the food and fuel components) shows that the recent surge in inflation is driven mainly by food and fuel components and core inflation has been relatively sticky for a long time.
To be sure, drivers of food inflation seem to have changed in the past few months
This is perhaps the most critical issue confronting the food economy now. Until a few months ago, a significant part of food inflation was actually imported in nature via the edible oil route. This seems to have changed with edible oil prices coming down in the global market. However, food inflation has found a new tailwind in cereal prices which saw a double digit inflation in the month of September. An HT analysis shows that the contribution of cereal and product sub-category to annual growth in the food and beverages category (45.9% share in CPI basket) increased from 14.2% in April to 25.9% in September . The contribution of oil and fats sub-category fell from 17.8% in April to just 0.4% in September . Given the fact that cereals sub-category the biggest share in food and beverages inflation (21%), strengthening grain prices can emerge as a problem for the headline inflation number.
But India might have a cushion against the calorie impact of cereal price spike
This is perhaps the most interesting and also underappreciated aspect of the current surge in cereal prices. Under normal circumstances, a surge in prices of staple food can lead to a serious food security crisis. While India has its share of problems in terms of large parts of its population being able to access balanced diets – this shows in lower levels of protein and fat as well as the intake of other micronutrients – there has been remarkable progress in insuring the calorie intake of the poor against the impact of price hikes.
The first route through which this has happened is the extension of the food security net under, first the National Food Security Act (NFSA) and then the provision of extra five kg of food grains (rice and wheat) under the PMGKY scheme to almost 800 million people. It is obvious that these schemes have reduced the impact of increase in cereal prices on a large part of the population. Another development, through the market route, might also have played a role in reducing the calorie burden of cereal price inflation in India even for those who are not under the food security net. If one looks at the ability of average daily rural wage – it is often taken as the benchmark for blue collar manual work – to buy basic staples such as rice and wheat, then the purchasing power seem to have increased significantly over the past few years including the period of recent inflation.
The improvement in affordability of basic staples perhaps explains why inflation has not led to the kind of political anger which was seen in the last decade. However, this data needs to be read with an important caveat. Because the CPI basket itself is obsolete in nature – it is based on 2011-12 Consumption Expenditure Survey – the inflation cushion of cheaper staples might be smaller than what the current basket suggests. In this case, a hawkish policy stance to tackle inflation which is driven by higher food especially cereal prices, might be comparable to throwing punches at the enemy in the dark.