We must not be beguiled by our deceptively low inflation prints

Estimates of inflation released last week may have given the Reserve Bank of India (RBI) some breathing space in its fight to contain inflation. Retail inflation based on the consumer price index (CPI) moderated to 6.77% in October, compared to 7.41% in September. Even inflation based on the wholesale price index (WPI) declined to 8.4% in October, snapping a double-digit inflationary spell that lasted 18 months. These estimates suggest that India’s fight against inflation may be on track. But a close look at the disaggregated data suggests that such euphoria may be misplaced.

Much of the decline is a result of a high base effect. The second factor that has contributed to our decline in inflation is a sharp fall in edible oil inflation, which turned negative. It was a major driver of inflation until May. There is also a deceleration in the prices of vegetables, leading to lower food inflation. Along with a moderation in fuel inflation, it is clear that the effect of global factors may have peaked. While this may be good news for the central bank, it also confirms fears of inflation being largely driven by domestic factors and going beyond food inflation. The data does confirm this with a sharp rise in cereal inflation to more than 12%. All the three major cereals are now witnessing a rapid rise; inflation in rice is at more than 10%, while that for wheat and maize is at more than 17%. Cereal inflation in India defies the trend globally, where it has moderated considerably. Domestic inflation is largely a result of supply shocks and partly due to policy mismanagement, particularly in the case of wheat. These trends are also confirmed from WPI inflation data, which also reports a sharp rise in fodder inflation. The rise in agricultural input prices has accelerated sharply with inflation staying at over 30% since June 2022. This has raised the likelihood of cost-push inflation in several agricultural commodities. Milk products are already showing signs of high inflation.

The second worry should be inflation spilling over to other commodities and services, all of which are showing signs of price pressures getting entrenched. Clothing and footwear inflation has crossed 10% since the last two months; services such as health are also at almost 10%. The burden of high inflation in essentials such as food, clothing and health falls disproportionately on the poorest households, primarily because households at the bottom of our income distribution spend a large part of their income on these, compared to better-off households. A simple calculation using the implicit weights of commodity groups for different population groups from the National Sample Survey of 2011-12 suggests that inflation for the poorest 20% is almost 1% higher than for the top 20% of households. This is true for rural and urban areas. High inflation is not just eroding the purchasing power of households at the bottom of the pyramid, they are also facing income uncertainty due to rising input prices. As inflation is unlikely to ease in the near future, unless the supply situation improves, the priority should be to insulate the poor from the inflationary shock.

This is necessary not just to provide them relief, but also to prevent any further decline in demand, which is already weak owing to a slowdown in our economy and pandemic-induced shocks. Rural areas have already been through a phase of distress, with real wages declining in the last two years and farm incomes getting squeezed. So, any further decline in rural demand will be a sure recipe for an agrarian sector crisis.

Given the complexity of Indian inflation, which is now driven by domestic concerns led by supply shocks, the task of containing inflation becomes all the more difficult. Monetary policy may not have much of a role to play and pre-emptive action by the government through fiscal means to protect the purchasing power of the poor is the only way of preserving growth and protecting the majority of our people from inflationary pressures. While it may not be easy to increase supply in the short run, an increase in fiscal transfers to rural areas will likely increase demand as well as reduce the pain of inflation. Fortunately, the basic infrastructure for such transfers through the National Rural Employment Guarantee Scheme and Public Distribution System has proven effective as a lifeline during the pandemic. Strengthening these by way of increased fiscal allocations and targeted interventions that use existing cash-transfer mechanisms would be the best way to contain inflation and revive growth.

Himanshu is associate professor at Jawaharlal Nehru University and visiting fellow at the Centre de Sciences Humaines, New Delhi