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Unpacking inflation in India today: A necessary evil in the modern economy?

Unpacking inflation in India today: A necessary evil in the modern economy?

By Jatin Bavishi

The famous economist John Maynard Keynes once remarked that “Inflation is unfair, but deflation is inexpedient”. Several economists agree that positive inflation is better than zero and negative inflation or, deflation. Though it might appear counter-intuitive, the concept can be appreciated if we demarcate the economy into two segments, namely, buyers and sellers. It must be kept in mind that the boundary between the two segments is highly fluid. This means that gains for one results in losses for the other.

CPI and WPI: Same objective but different results?

In India, the most widely accepted indices to check inflationary trends are the Wholesale Price Index (WPI) and the Consumer Price Index (CPI). Despite measuring the same aspect, these indices have displayed diverging trends. There are two main reasons for this divergence. The first being that while the WPI is calculated before the product reaches the market, CPI is calculated from the final price paid by the consumer. The second reason is that both the indices use different commodity bundles with different weights assigned to same commodities. Recently, the government changed the base year to measure WPI to 2011-12 to bring it in line with CPI measures.

According to data from the Ministry of Commerce and Industry, the Wholesale Price Index, calculated based on the revised base year of 2011-12, decelerated in May 2017 to 2.17 percent from 3.85 percent in April 2017. This was preceded by a decline in WPI to (-) 0.09 percent in May 2016. The CPI also stands at a four-year low of 2.18 percent for the month of May 2017, down from 2.99 percent a month ago. In comparison, the CPI for the same month in the last financial year stood at 5.76 percent.

Food for thought

Following two failed South-West monsoons, the year 2016 finally saw good rains and plentiful harvest in most parts of the country, barring Tamil Nadu where subdued North-East monsoons led to drought-like conditions. However, this bumper harvest spelt misery for farmers as prices of their produce were adversely hit. Despite provisions like the Minimum Support Price (MSP) and public procurement by the Food Corporation of India (FCI), most farmers resorted to stress sales at throw away prices. This was witnessed mostly in Maharashtra and Madhya Pradesh where cultivation is largely for the market.

A decline in food prices was also a major reason behind the fall in the WPI and CPI. This is because both indices give substantial weight to the category of food. The current agitation by farmers raises a fundamental question- are we paying a very high price for maintaining low food inflation? The answer to this depends on which side we are on.

Demonetisation and energy woes continue

Demonetisation, that occurred in November 2016, might also be a contributing factor. It is a known fact that the informal sector constitutes a large part of the Indian economy. Since the sector is heavily dependent on cash transactions, the effect of a sudden withdrawal of notes was brutal. Cumulatively, it led to a reduction in the aggregate demand which consequently pushed down sales, output and most importantly, jobs. Though the event occurred six months ago, we must understand that the effects typically show after a lag. The spectre of demonetisation is probably still haunting the economy and will have implications in the future as well.

Drops in the prices of commodities such as energy also have some positive effects on consumer spending, which in turn impacts the CPI. The overall index in this category showed a fall, largely on account of LPG and electricity. This is, however, not true in the case of petroleum, coke, and lignite (coal) which saw an increase of 7 and 6 percent respectively. This may cause a spike in inflation indicators in the future. Additionally, a large chunk of our petroleum requirements is met by imports from the Gulf countries. The present stand-off between Qatar and Saudi Arabia might push up oil prices. This may lead to a burgeoning Current Account Deficit (CAD) and also trigger a speculative capital flight from India.

RBI has the last word

In the recently concluded bi-monthly meeting of the Monetary Policy Committee (MPC), the repo or policy rates were kept unchanged. The Committee cited inflationary tendencies for their decision. Most analysts, however, expected a rate cut and the Chief Economic Advisor even went to the extent of questioning the methodology of RBI’s inflation forecasting. This accusation stems from the fact that the RBI relies on official data which is released after a lapse of time. Most think-tanks, however, form expectations based on industry level surveys. Nonetheless, they hope that the RBI would be more considerate in its next bi-monthly meeting. According to them, a lower rate of interest would decrease the cost of borrowing and investment. Indian stocks and bonds have already witnessed an influx of capital after the inflation numbers were released and these might play a crucial role in the coming quarters.

To conclude, it may be useful to draw attention to some basics. While both rising and falling inflation have costs, what makes the whole picture fuzzy is inflation volatility. This volatility increases uncertainty, resulting in an accumulation of inventories and holding up both consumption and investment decisions. With the macro conditions mostly stable, it is imperative for policymakers to spur the economy.

Featured Image Credits: Pixabay

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