Bornali Bhandari and Ajaya K Sahu
Headline inflation as measured by the year-on-year (y-o-y) change in the Consumer Price Index (Base Year 2012=100) remained above the Reserve Bank of India inflation band of 4%±2% for a whole year between December 2019 & November 2020 (Figure 1). This high inflation was primarily driven by Consumer food price inflation which had remained in double digit for six months. CPI headline inflation experienced a sharp fall in December 2020 and stayed within the band for the next few months till May 2020 (green line). While the inflation episode in 2020-21:Q1 was driven by food prices, it was more broad-based in 2021-22:Q1 (NCAER QRE June 2021).
The CPI inflation is consistent of five categories – food & beverages; pan, tobacco & intoxicants; clothing & footwear; housing; fuel & light; and miscellaneous category. The CPI core inflation is traditionally computed by taking out food & beverages and fuel & light components, labelled as CPI Core Inflation, non-food non-fuel. The red-dashed line in Figure 1 shows that it has stayed elevated and close to 6% since July 2020.
However, there is a problem with this traditional measure of core inflation. The measure of fuel inflation is incomplete as it leaves out a key indicator, ‘fuel for transport’ which is actually included in the sub-category of transport & communication in the miscellaneous category. There is nothing novel about this and many analysts have computed alternative measures of core inflation taking into account this anomaly. Further, if one takes out gold inflation from the miscellaneous category, one computes a version of core inflation labelled as core-core inflation.
Instead of the above methods, we compute an alternative measure of fuel inflation to compute a measure of core inflation (non-food non-revised fuel). We leave out the ‘light’ part of fuel & light inflation and include the transport components of fuel inflation (Table 1).
Table 1: Components of Fuel Inflation
|Fuel & light inflation||Revised fuel inflation|
|Electricity||LPG (excluding conveyance)|
|LPG (excluding conveyance)||Kerosene|
|Kerosene||Diesel (excluding conveyance)|
|Diesel (excluding conveyance)||Petrol for vehicle|
|Other fuel||Diesel for vehicle|
|Coke||Lubricants & other fuel for vehicle|
|Firewood & chips|
Source: Ministry of Statistics and Programme Implementation.
It is very clear that that the modified fuel inflation has been higher than fuel & light between January 2020 and July 2021 (Figure 2) and that gap has widened since December 2020. Modified fuel inflation is more than double that of fuel & light inflation. The modified core inflation (non-food non-modified fuel) is significantly lower and has stayed well within the RBI target band (blue dotted line in Figure 1).
The LPG and petrol for vehicle together contributed 88% to revised fuel inflation, on average, between January 2020 and July 2021 (Figure 3). The pricing of petroleum products benefited from the fall in crude oil prices. The Brent Crude Oil Price had fallen to US$23 per barrel in March 2020 from US$65.2 in December 2019. It had stayed below US$50 till November 2020. It jumped up from US$54.6 in January 2021 to US$62 in February 2021 and in July 2021 had reached US$ 74.4 (IMF Commodity Price Index).
LPG inflation had stayed elevated in 2020 but experienced double-digit inflation, above 20%, from March to July 2021. The central taxes on petrol and diesel have been increased three times during the period January 2019 to January 2021. There has been no increase in central tax on LPG during the same period (Lok Sabha Unstarred Question No. 2124). Specifically, the Centre increased the special additional excise duty and Road Infrastructure Cess on petrol and diesel twice during March-May 2020 (RBI Bulletin Dec 24, 2020). ‘Petrol for transport’ inflation has been in double digits since July 2020 and had progressively gone up. It averaged around 24% in June and July 2021. The Union Budget 2021-22 shows that the Revised Estimates of Union Excise duties were Rs 3.6 trillion in 2020-21 versus Rs 2.7 trillion Budget Estimates.
The traditional measure of core inflation is elevated due to not accounting ‘fuel for vehicle’ inflation. Once that is accounted for, core inflation is well within the RBI target band. And the revised fuel inflation is mainly being driven by LPG and ‘petrol for vehicle’. While crude oil prices remained benign, the GoI could keep prices same while appropriating the revenue. The challenge arose when crude oil prices rose along with non-reversal of excise duties (RBI Monetary Policy Report April 2021).
What does that mean for public policy? The policymakers need to weigh in the impact of their policies from both efficiency and equity purposes. They need to do a cost-benefit analysis for the Indian macro economy– high inflation versus low government revenue with all its multiplier impact in various time horizons. Secondly, any inflation on transport is regressive in nature as it is an indirect tax on poorer households. Further, large rise in fuel prices (particularly diesel) will have large cascading effect on prices of other commodities. This is coupled with reduction in Direct Benefit Transfers for LPG (DBTL) between 2019-20 and 2020-21 (Petroleum, Pricing, Analysis and Cell data). Therefore households in India are suffering from a double whammy of loss in real incomes where they are either losing jobs or experiencing pay cuts coupled with higher inflation on key products.
Bornali Bhandari is a Senior Fellow and Ajaya K Sahu is a Senior Research Analyst at NCAER.
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