Covid-19’s initial economic shock was on the supply side while its second-round effect is likely to be on demand across India
The bean counters working for the government usually calculate monthly inflation by collecting prices from 1,114 urban markets as well as 1,181 rural markets. The severe lockdown brought about by the covid pandemic meant that the data collectors at the front line could not visit these markets. Also, many items that are part of the consumer price index were not traded at all. No prices were available for them.
India thus did not release the official consumer price inflation estimates for April and May in accordance with the scheduled calendar. That is why the government has recently announced inflation estimates for three months at one go—7.2% in April, 6.3% in May and 6.1% in June. The declining trend is obvious, as supply constraints eased in tandem with the gradual easing of the national lockdown. However, the numbers took economists by surprise. Inflation in each month was around 80 basis points higher than the consensus estimate of private-sector economists. The coverage for data collection in June was 1,030 urban markets and 998 rural markets, quite close to the usual figures.
The fact that inflation is above the upper end of the target band given by the government to the Reserve Bank of India in a quarter of economic contraction could be a potential cause for worry. It shows that the initial covid shock was to the supply side of the economy. Demand, though, is likely to suffer its second-round effects. A lot thus hinges on the inflation trajectory in the months ahead, for policymakers as well as the private sector.
Every country has its own way of calculating inflation, and the weights assigned to each item in the price index depend on the structure of consumption in that country. For example, food accounts for nearly half of the consumer price index in India, about a third in China, and less than a tenth in the US. Yet, a quick look at some global inflation data shows that the price trends in India are not out of the ordinary.
Over the past five months, most countries show a similar trend as in India. Inflation in June is lower than it was in February (the last full month before the pandemic brought the world economy to a standstill). There is one important difference, however. No other major economy saw a sharp spike in inflation for April. Indian inflation shot up from 5.8% in March to 7.2% in April. Even countries such as Argentina, Turkey and Pakistan, which have higher inflation than India, reported lower price increases in April compared to March.
Why did India see a sharp increase in inflation after the pandemic struck? Three possible explanations come to mind. First, India had one of the most severe lockdowns in the world, so the disruption in its supply chains was worse than in other major economies. Core inflation has been climbing. Second, food constitutes a bigger part of the Indian food basket, so a rise in food prices hit Indian consumers harder than their peers in many other countries. Third, the way the April consumer price index has been retrospectively calculated leaves room for doubt.
There are some other conundrums as well. Soaring gold prices have played a part in pushing up our inflation numbers. HSBC India chief economist Pranjul Bhandari says in a recent report that gold prices added 70 basis points to core inflation. Headline inflation for June would have been in the range of 5.5-6% without the rally in gold prices. Food prices have also been buoyant, and a recent report by Harish Damodaran in the Indian Express says that tomatoes and potatoes have been rising sharply in agricultural markets in July. Indian inflation is too high, given the fact that the economy is expected to contract this year. However, inflation pressures should begin to ease in the third quarter of the current financial year. The spread of the monsoon over the entire country thus far, as well as an increase in the area under various kharif crops augurs well for food production.
Supply chains will be hopefully repaired as more economic activity gets normalized, though there will be the omnipresent risk of fresh shutdowns in areas where the number of infections are shooting up once again. There has been a surge in the purchases of certain consumer goods after the lockdown was lifted. Such pent-up demand is likely to ease, and the desire to hold more precautionary savings after the traumatic income shock to millions will keep consumer demand under check. In other words, a demand shock could follow the supply shock.
The six members of the central bank’s Monetary Policy Committee will have to take a tricky call when they meet in August, perhaps the last meeting for the three external members whose tenure comes to an end, unless the government takes the extraordinary step of asking them to continue till the economic stress eases. Monetary policy should look ahead through the windshield rather than back through the rear-view mirror. There is, thus, still a compelling case for a rate cut next month.
Niranjan Rajadhyaksha is a member of the academic board of the Meghnad Desai Academy of Economics