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Business News/ Market / Mark-to-market/  What makes core inflation sticky?
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What makes core inflation sticky?

As the economy gets remonetised, the pressure on services inflation will continue, which should give enough stickiness to core inflation

Recall that during the high inflation period of 2011-2013, much of the food inflation was blamed on the structural shift in preference for protein-rich food items. Photo: APPremium
Recall that during the high inflation period of 2011-2013, much of the food inflation was blamed on the structural shift in preference for protein-rich food items. Photo: AP

The answer to this question was actually given by former governor of Reserve Bank of India (RBI) D. Subbarao four and a half years ago. Battling a runaway rise in prices at that time, Subbarao had said, “Twenty years ago, when I had a thick mop of hair, I used to pay Rs25 for a haircut. Ten years ago, after my hair started thinning, I was paying Rs50 for a haircut. And now, when I have virtually no hair left, I am paying Rs150 for a hair cut."

Not much has changed since then and the effects of a monetary shock such as demonetisation have begun to fade away as well.

An analysis of core inflation since its weakest point in August 2015 shows two things. Services inflation (with a 28% weightage in overall index) has gone up even as other items such as prices of clothing and beverages have come off. But what drove services inflation up is not health or education as one would believe. Inflation rate of personal services and effects such as Subbarao’s haircut have risen sharply.

Demonetisation had the obvious effect on every segment and discretionary spending wasn’t an outlier here. The inflation rate of personal services and effects fell sharply in December to 6.51% and further in January as Indians bereft of 86% of their cash postponed their spending.

What is interesting is that the inflation rate of personal services and also overall services is higher in rural areas which are more dependent on cash than urban areas.

Recall that during the high inflation period of 2011-2013, much of the food inflation was blamed on the structural shift in preference for protein-rich food items. Growing affluence certainly drove up the demand for protein rich food but it also understandably spurred discretionary spending. Rising rural wages have meant that villagers have arrived on the demand scene.

Economists and even the RBI have flagged off the stickiness in core inflation again. The message was that a floor has formed and it would be challenging to bring down the core inflation further which was at that time around 5.5%.

Core inflation has never gone below 4.5% in the new series and the pressure from rural wages is still on. For the past four years, inflation rate for education has remained near 5% and for healthcare around 4%.

As the economy gets remonetised, the pressure on services inflation would continue. That should give enough stickiness to core inflation and will continue to be a source of concern for RBI.

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Published: 27 Feb 2017, 11:54 AM IST
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