Explaining inflation to your boyfriend
9 min read 19 Jun 2022, 10:03 PM ISTIn times of ‘shrinkflation’, our guide on what has been and what can be doneIn May, urban inflation in India came in at 7.1% and rural inflation at 7%. Kerala had the lowest inflation at 4.8% while the highest was in Telangana—9.5%
PremiumMUMBAI : The sun began to set over the Juhu beach. She waited for him at a café overlooking the Arabian Sea, sipping cold coffee, looking at the rare, totally pollution free blue Mumbai sky.
He arrived dot at 6pm and as usual was in a grumpy mood.
“For someone who works from home, he is rather irritable most of the time," she thought. “What if he had to deal with bosses?"
“Hello," he said, almost throwing his phone on to the table.
“So, what happened?" she asked.
“Oh, this taxi I came in, the driver just went on and on."
“About what?"
“How everything has become so expensive. Tomatoes are selling at ₹80-100 a kg. And petrol is selling at more than ₹100 a litre. CNG prices have gone up."
“You mean inflation?"
“If that is what you economists call it," he said, trying to suddenly seem all uninterested.
“Yes. Inflation is the rate of price rise."
“Price rise?"
“Yes. Like the retail inflation in May stood at 7%. This meant that overall prices in May 2022 were 7% higher than the prices in May 2021."
“Ah, like that," he replied, with a glow on his face that can be often seen when one figures out something new.
“Indeed."
“So, tell me something, how is retail inflation calculated?" he asked.
“There are different goods and services which form a part of what is known as the consumer price index. Each item has a different weight in the index and their prices are tracked all across the country. While calculating inflation for May 2022, prices in May 2022 were compared with prices in May 2021 and the rate of increase was calculated."
“Sounds quite complicated."
“Which it is."
“But 7% inflation doesn’t sound much," he said.
“Ah, you entitled lot!"
“Me?"
“For a taxi driver, food and fuel prices are the most important. Food prices went up by 8% in May, whereas petrol, diesel and CNG prices have gone up quite a bit over the last one year. At the same time, the taxi fares in Mumbai haven’t been increased. So, while the expenses of taxi drivers have gone up, their income hasn’t, unless it’s possible for them to work longer hours."
Shrinkflation
Inflation must also be because of companies increasing the price of their products?" he asked.
“Not always, she replied. “Many companies simply reduce the size of the product while maintaining the same price."
“But why do they do that?"
“One, because the customer feels he is paying the same price. Two, many companies sell products like shampoos, biscuits, eatables, etc., at magic price points like ₹1, ₹5 or ₹10—essentially price points where consumers can use coins to pay for products."
“Interesting."
“A company like Hindustan Unilever Ltd, one of the biggest fast moving consumer goods companies in the country, gets almost 30% of its business from such price points. In this scenario, even if the cost of materials that goes into making of their products goes up, companies prefer to maintain the same price point while reducing the grammage of the product."
“We can call this shrinkflation!"
“Well, you are late on that front. The media has already coined that term."
“Oh!"
“Sometime in May, I read a Bloomberg news report which talked about this phenomenon. One price point at which Hindustan Unilever sells Vim, a very popular soap bar to wash utensils, is ₹10. It used to weigh 155 grams earlier and was down to 135 grams in May. Along similar lines, a ₹10 pack of Haldiram’s aloo bhujia, a salty snack, used to weigh 55 grams earlier and was down to 42 grams in May."
“But tell me something… the companies cannot endlessly keep shrinking sizes and maintain prices…" he said.
“Indeed. In fact, a recent report in The Times of India quoted Ritesh Tiwari, the chief financial officer of Hindustan Unilever, as saying: “You cannot go down beyond a point. If a ₹1 Clinic Plus shampoo volume falls below a certain threshold, it will not allow for a full hair wash.""
“You know, I recently realised that the two brands of bread I buy both cost the same. But one weighs 400 grams and the other weighs 450 grams. Clearly, inflation presents itself in different forms," he said.
“That it does."
Controlling price rises
So, what can be done to control inflation?" he asked.
“The government has banned the export of wheat and set a limit on the export of sugar. When it comes to steel exports, a duty of 15% has been levied in order to try and increase the domestic supply of steel and lower high steel prices."
“Okay."
“But then the government can’t do much on other fronts. Take the case of crude oil and petroleum products. In 2021-22, the last financial year, we imported close to 86% of what we consumed. Oil price continues to remain high due to the war in Ukraine. The same is true for commodities like coal and fertilizer. India imports a substantial part of these and has no control over the price that it pays," she explained, while realizing that all the ice in the cold coffee had melted.
“Any other reasons?"
“The rupee has been losing value against the dollar. The more value the rupee loses, the more expensive the imports become and this feeds into retail inflation."
“Can’t anything be done to prevent the rupee from losing value?" he asked.
“See, one reason for the rupee losing value is foreign investors selling out of the Indian stock market. Between October and now, they have sold stocks worth ₹2.4 trillion. When they repatriate this money out of India, they largely convert it into dollars. This leads to the demand for the dollar soaring and the rupee loses value. In order to slow down the fall, the Reserve Bank of India (RBI) has been intervening in the foreign exchange market."
“Intervening?"
“Yes. It sells dollars from its reserves and buys rupees. This leads to the supply of dollars going up and that of the rupee going down. In the process, the value of the rupee does not fall as fast as it otherwise would have. At the beginning of October, one dollar was worth a little over ₹74. Currently, it is worth around ₹78. If the RBI hadn’t intervened, the rupee would have lost more value and the dollar could have been possibly worth ₹80," she explained.
“And that would have meant more inflation?"
“Yes, higher imported inflation, as importers would have to pay more in rupees to buy dollars to pay for the imports. Also, this has come at the cost of the foreign currency reserves of the RBI falling from $575 billion in October to around $532 billion now."
“Why can’t the RBI just keep selling dollars and help increase the value of the rupee against the dollar?" he asked.
“The RBI cannot create dollars out of thin air. If it keeps selling, its foreign currency reserves will deplete at a fast pace."
The repo hikes
What else is being done?" he asked, taking a sip from her glass of melted cold coffee.
“The RBI has started raising the repo rate…"
“Repo rate?" he interrupted again.
“It’s the rate at which the RBI lends to banks."
“And how does raising the rate help?"
“As RBI raises the repo rate, the banks also start raising interest rates. The idea is to raise EMIs and discourage people from borrowing and spending money, rein in consumer demand and in the process, control inflation, as lesser money chases the same set of goods and services."
“But this has created a problem for me," he said, as he stared across to the sea.
“Why?"
“Oh, I was thinking of buying a small car. I am tired of waiting endlessly for app cabs."
“What’s stopping you?"
“You just said RBI is raising interest rates," he said. “Won’t EMIs go up?"
“Yes, they will. But it won’t matter."
“Sorry?"
“Let’s say you take a car loan of ₹4 lakh to be repaid over 4 years at an interest rate of 8%. The EMI for this works out to ₹9,765 per month. Now let’s say the rate goes up to 9% with everything else staying the same. What do you think the EMI will be?"
“Don’t do this. You know I barely managed to pass maths in my class tenth," he pleaded comically.
“Well, the EMI will go up by ₹189 to ₹9,954."
“That’s it?"
“Yes. So, are you not going to buy a car just because the EMI will go up by ₹189?"
“Yipee, I am buying a car," he said excitedly. “So, tell me something…the difference in EMIs for a two-wheeler loan would be even lower?"
“Yes, you are right."
Inflation maths
You know, now that we are talking, I had another doubt."
“Tell me."
“How can there be one rate of inflation for the whole nation?"
“Interesting question."
“Oh, I don’t ask dull questions, my dear," he said in a slightly flirty tone, on what was originally supposed to be a romantic date by the sea.
“Well, you are right. All of us have our own rate of inflation given what we consume on a regular basis."
“So?"
“But the government cannot calculate a rate of inflation for all of us individually. One, that is not possible. Two, it won’t be of any use."
“Hmmm."
“The government tries to calculate the rate of inflation of what it thinks is the consumption basket of an average Indian. It tries to arrive at this by carrying out surveys. Like in the current consumer price index used to calculate retail inflation, food has a weightage of 39%. So, nearly two-fifths of an average Indian’s spending is on food. If food prices go up, retail inflation tends to rise at a fast pace."
“39%? Isn’t that very high?" he asked.
“Yes, by yours and my standard. As incomes go up, we spend a lesser proportion of our overall spending on food."
“Hmmm."
“Nonetheless, while the media tends to report the overall retail inflation figure, there are other figures which are also available. Like, urban and rural retail inflation figures are separately available. In May, urban inflation was 7.1% and rural inflation was 7%. Further, separate inflation figures are available state-wise."
“Oh really?"
“Yes. In May 2022, Kerala had the lowest inflation at 4.8% and the highest inflation was in Telangana at 9.5%. The inflation in Maharashtra and Andhra Pradesh was at around 8.5%," she said.
“So, inflation in Telangana is actually double that of Kerala."
“Yes."
“Final question," he said, with a twinkle in his eyes. “How do I figure out the exact inflation in my life?"
“There are two ways. The difficult way and the slightly less difficult way."
“Tell me both."
“The difficult way is to keep an exact record of every expenditure you make. Over a period of time, you will figure out the stuff that you consume on a regular basis. Given that you will maintain the exact price data at different points of time, you should be able to calculate the exact rate of inflation," she explained.
“That’s not happening."
“The other way is to keep track of your overall expenditure every month. After a year, you will have enough data to know by how much your expenses have gone up. This should give you a good rough cut rate of inflation. Of course, if you make a big one-off purchase during a particular month, you will have to leave that out of the calculation."
“This is doable."
“Good for you," she said. “No more questions."
“Of, course."
Then they ordered for two more cold coffees and turned their heads around to take one last look at the setting sun. In their heads, they were holding hands and walking into the sunset.
(The example is hypothetical).
Vivek Kaul is the author of Bad Money.
