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Last fiscal year, India experienced its sharpest economic contraction ever as the covid-19 pandemic hit demand. Counterintuitively, there was also a surge in inflation. Retail inflation, based on the consumer price index (CPI), averaged 6.2%, a good 140 basis points higher than in 2019-20. Though demand-pull factors were missing, supply disruptions and cost-push factors (such as high gold and petrol and diesel prices) guided the inflation trajectory. Among categories, food and beverages— with a 54.8% contribution to CPI inflation last fiscal year—was the main culprit, followed by core with a 42.3% contribution, and fuel and light the rest.

This fiscal, the economy has been battered by the pandemic again, with a much stronger wave of infections going deep into the hinterland. While there is no nationwide lockdown, almost all major states have adopted some form of localized lockdowns and imposed other curbs.

So what are the implications of the pandemic redux for inflation in 2021-22, amid high commodity prices globally?

Crisil’s forecast of 5% CPI inflation for the fiscal is premised largely on expectations of softer food inflation. However, upside risks to this have emerged, not only from food but also the other two major categories—fuel and light, and core. Put another way, the hydra has reared its head.

Data of the past decade shows food has disproportionate heft to move the retail-inflation needle. It is also the most volatile component of the gauge, with a standard deviation (a measure of volatility) of 4.0, compared with 3.0 for fuel and light and 1.7 for core inflation. Within food, vegetable inflation plays a dominant role, given its heavy weight and large swings. Greater spread of food inflation into rural areas could lead to a disruption in production and transportation of food to wholesale markets or mandis.

Data for April, when several states began imposing restrictions again in a bid to contain covid, shows some disruption in food arrival at mandis. The arrival of vegetables fell 10.4% month-on-month on a seasonally adjusted basis , compared with a 13.6% increase in March. Likewise, the mandi arrival of fruits was down 11.1% after rising 4.0% in March.

Rising rural caseloads could further decelerate arrivals at mandis. Both the wholesale price index (WPI) and CPI-based food prices rose month-on-month in April and could rise more on supply disruption.

The pass-through of high global food prices is another potential worry. Global food prices have risen for 12 straight months now, the longest such stretch in almost a decade, and may stay elevated on surging global demand (especially from China) amid subdued supply because of inclement weather in key agri-producer nations such as Brazil, the US and Australia.

While India is not a ‘price taker’ in most food commodities, there is still some pass-through to the CPI food basket from high global food prices, especially in commodities such as edible oils and sugar, whose domestic prices are strongly correlated with international prices. On average, global food prices have risen about 30% year-on-year till April this year (with edible oil and sugar prices rising 49% and 27%, respectively). Should this trend continue, the pass-through could crank up food inflation.

A faster global recovery is increasing cost pressures. Crude oil prices crossed the $65 per barrel mark in May, doubling on-year. This not only raises fuel inflation, but also puts pressure on the core via higher transport costs. Prices of metals and minerals have also surged to decadal highs, materially increasing manufacturing cost. Global transportation costs are also at decadal highs, as indicated by the Baltic Dry Index.

Even as prices have risen in the wholesale market, a commensurate pass-through to retail or end-consumer prices has not happened yet.

An analysis of the monthly changes in wholesale and retail prices on a seasonally adjusted basis (as on-year numbers may not reflect accurate trends, given last year’s disruption in data collection) shows the WPI has seen a broad-based sequential rise across all items. As expected, the sharpest rise is in items directly linked to crude oil, edible oils and metals. That said, WPI has also meaningfully risen for other manufacturing items, including chemicals, paper and textile sectors.

However, the pressure on CPI inflation has come primarily from rising fuel inflation so far. The sequential rise in core CPI (i.e. CPI excluding food and fuel) has been relatively low. Within the core, consumer durables, which use metals as inputs, have seen a consistent rise in prices since January. But this segment accounts for a relatively small share of the CPI (0.9% weight). In comparison, fast-moving consumer goods, which account for a larger share (9.0%), have seen a relatively moderate rise in prices during the period, indicating some pass through of input costs.

That said, the recent rise in manufacturing costs presents an upside risk—and could be passed on to retail prices once demand rebounds. The path of retail inflation thus remains fraught with upside risks. Uncertainty remains on several counts, especially supply-related disruptions, because of pandemic management and the pass-through of high global commodity prices, which would keep the inflation trajectory volatile.

Mint Road has an unenviable task ahead of taming hydra-headed inflation.

Pankhuri Tandon, economist at Crisil, contributed to this article.

Dharmakirti Joshi and Adhish Verma are, respectively, chief economist and senior economist at Crisil

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