The Manmohan Singh government went to the polls in the summer of 2014 against the backdrop of sustained high inflation over several years. The Narendra Modi government will face the electorate in the next few months with inflation well under control.

This column asks a slightly broader question. Has India finally succeeded in taming the inflation dragon? The answer has profound consequences for Indian macroeconomics. It is well known that headline inflation in India has nearly halved over the past five years. The most recent readings have been well below the central point of the target range given to the Reserve Bank of India by the government. The previous run of low inflation was in the six years to 2005, covering the tenure of the Atal Bihari Vajpayee government, as well as the first two years of the Manmohan Singh government.

That bout of low inflation was followed by nearly a decade of accelerating prices. India was a global inflation outlier and struggled with double-digit inflation even after the 2008 financial crisis when the rest of the world was battling deflation. Indian inflation has now moved closer to the average of developing peers in Asia. The narrowing inflation differential is welcome.

The trend in the three-month moving average of consumer price inflation for industrial workers shows the rise and fall in Indian inflation. The old inflation index provides a better picture as the new national consumer price index begins only in 2011 and thus cannot be used to trace price trends back to the turn of the century.

There are three possible explanations for the decline in price pressures in recent years. The question to ask is whether each of these factors is cyclical or structural. In other words, are they temporary or permanent? Three structural changes need to be highlighted.

First, global oil prices have collapsed. They have remained at moderate levels despite the synchronized recovery in the global economy since early 2017. Energy analysts believe that the entry of US shale into the global energy market has effectively capped crude oil prices.

Second, food price inflation has tumbled. Some economists argued during the episode of high inflation at the beginning of this decade, that India was facing the problem of protein inflation—as demand ran ahead of supply. Harish Damodaran has recently argued that India has now moved into an era of structural food surpluses.

Third, macro policy has been tighter in recent years. The Indian central bank is now legally committed to anchoring inflation around 4%. Inflation expectations have also drifted down. The initial record of the new inflation targeting regime has been a good one, though it has not yet been tested by a serious inflation shock.

There is thus a structural element in each of the three factors listed above. The new balance of power in the global energy market, the shift from food scarcity to food surpluses in India and the shift to a formal inflation target will act as a check on headline inflation.

Yet, there are certain concerns that also need to be articulated. The most immediate one is the persistence of higher core inflation. The gap between headline inflation and core inflation leaves scope for two competing possibilities as far as the inevitable convergence goes. First, core inflation will fall towards headline inflation. Second, headline inflation will rise towards core inflation. Sajjid Chinoy has shown in a recent research report for J.P. Morgan why the latter is more statistically likely.

There was a very similar analytical conundrum a few years ago. The collapse of global commodity prices in the second half of 2015 had pushed the wholesale price index (WPI) into deflation territory. The finance ministry had argued over the next year that the central bank should cut interest rates in response to this, though consumer price inflation was far higher than the eventual target. WPI eventually converged towards consumer price inflation. This column had argued in December 2015 that India was at the end of a disinflation cycle rather than the beginning of a deflation cycle.

The persistence in higher core inflation is a stumbling block in the larger narrative that India has moved into a structurally lower inflation range. There are two specific mysteries here. One, the monetary policy committee has said in its February statement, that a modest output gap has opened up despite the fact that core inflation has been sticky. Two, analysts have been struggling to figure out why rural medical and education costs—a component of core inflation—have spiked in recent months.

The earlier patch of low inflation began when economic growth was low. It continued as the economy began to pick up speed after 2003. The subsequent economic boom eventually led to high inflation, helped by the inability to withdraw the fiscal and monetary stimulus after 2011. It remains to be seen if Indian inflation will remain low if economic growth accelerates in the years ahead. That will be the acid test.

It is risky to say that India has decisively won the battle against high inflation. However, the structural changes in the food market, the energy market and the monetary policy framework offer reason for hope. The inflation dragon may not have been killed as yet, but it seems to have been tamed.

Niranjan Rajadhyaksha is research director and senior fellow at IDFC Institute. Read Niranjan’s previous Mint columns

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