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Photo: Mint

High food prices at heart of India’s inflation problem

India’s CPI has been above the RBI-mandated 2-6% for 8 out of the 9 previous prints. Rising inflation predated the lockdowns and supply distortions. However, inflation continues to remain high despite weak economic activity. Mint explores.

India’s Consumer Price Inflation has been above the RBI-mandated 2-6% for 8 out of the 9 previous prints. Rising inflation predated the lockdowns and supply distortions. However, inflation continues to remain high despite weak economic activity. Mint explores.

How is inflation estimated?

Consumer Price Inflation is estimated, first of all, by constructing a representative ‘basket’ of goods and services. The share of consumption expenditure for each of the items is then calculated. The cost of purchasing the basket is estimated monthly. The change in the cost of the basket is essentially inflation. There are two important consumption baskets—one measures the consumption of a typical consumer while the other measures the basket of a producer. These give us the Consumer Price and Producer Price inflation. In India, we call the producer price inflation wholesale price inflation.

Why is India’s inflation rate historically so high?

As expected, inflation is sensitive to the weights in the basket of goods and services. In India, the weight for food and beverage in the CPI basket is 54.18% for rural, 36.29% for Urban and 45.86% for combined as per the Consumption Expenditure Survey in 2011. According to the National Accounts of India 2017, the share of food in total expenditure was 28.5% that year and 30.38% in 2011. The corresponding weight of food and beverages for the US is 14-15%. India’s inflation is thus more sensitive to food inflation which is why it continues to resist monetary policy.

Stubbornly high
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Stubbornly high

Why is India’s inflation so high amid the pandemic?

Many may argue that the spike in inflation could be an outcome of proactive policy response. However, India’s inflation has historically been driven by high food prices. A major reason, for post-lockdown high inflation is supply disruptions along with spike in MSPs. In the medium-term, new agri reforms will limit government’s role in determining agricultural prices.

Do emerging markets have higher inflation?

EMs experience periods of high inflation because of volatility due to agricultural shocks and output gaps, prompting expansionary fiscal policy. However, since the mid-1990s, EMs have experienced substantial moderation in inflation—from triple-digit figures to low single-digits by the end of 2001. A reason for this is favourable external factors. Conventional theory states that higher wage growth pushes inflation and EMs experience higher wage growth as labour markets tighten due to expansion of economic activity.

How do wages relate to inflation?

Wages are intricately linked with inflation as wages are a cost of production. Therefore, wages have the potential to push inflation via ‘wage push inflation’ effects. This occurs as higher wages result in businesses incurring higher cost of production which results in a higher price for goods. Thus, an overheating labour market tends to have an impact on inflation, and an increase in prices results in workers demanding another wage increase to compensate for the increase in the cost of living.

Karan Bhasin is a policy researcher.

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