Context
- The recent data seems to indicate that retail inflation has possibly peaked and is now likely to trend downwards. But, it would be wise to exercise caution. The latest data, while providing useful nuggets of information about price trends in the economy, challenges some of the widely held conceptions about inflation, and gives mixed signals about its trajectory.
What is a simple definition for inflation?
- Inflation is an increase in the level of prices of the goods and services that households buy. It is measured as the rate of change of those prices. Typically, prices rise over time, but prices can also fall (a situation called deflation).
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Inflation Rate
- Inflation Rate is the percentage change in the price level from the previous period. If a normal basket of goods was priced at Rupee 100 last year and the same basket of goods now cost Rupee 120, then the rate of inflation this year is 20%.
- Inflation Rate= {(Price in year 2 – Price in year 1)/ Price in year 1} *100
Five broad trends emerge to consider as reasons behind high inflation.
- Russia- Ukraine war:
- The sharp rise in commodity prices as a consequence of the war is considered to have been largely responsible for the spurt in inflation this year, pushing it beyond the upper threshold of the RBI’s inflation-targeting framework.
- For instance, India’s crude oil import price rose from $84.67 per barrel in January to $112.87 in March, and further to $116.01 in June. The ripple effects of higher commodity prices have been felt across the economy.
- Inflation generalized in formal and informal sectors:
- There are indications that inflation is getting more generalized across both the formal and informal segments of the economy.
- One indication of this comes from the clothing and footwear category, a highly fragmented industry with the presence of both formal and informal segments. Another possible indication comes from rentals.
- Rental inflation in India had tended to remain largely range-bound over much of the past few years. But as this category has the highest individual item-wise weight in the inflation index, any movement in either direction, however small, would have a large impact on core inflation.
- Supply side disruptions during the pandemic: During the pandemic, supply-side disruptions had caused goods inflation to rise, even as services inflation remained relatively muted owing to risk-averse behaviour by consumers and restrictions on high-contact intensive sectors.
- Competition and the pricing mechanism in the economy:
- Prices are rigid on the downside will depend not only on how demand fares now with monetary conditions having been tightened, but also on the extent of competition in the economy, among others.
- After all, greater market concentration creates conditions for greater pricing power. A badly damaged non-corporate sector (MSMEs) would have led to ruptures in the low-cost economy, increasing the pricing power of the corporate sector during this period.
- Wage- price spiral:
- Inflation in India is not a consequence of a strong economy. Wage growth in the large informal rural economy has been lower than inflation.
- While some skill-intensive segments of the urban formal labour force may be able to exercise some bargaining power, the labour force participation rates suggest continuing slack in urban labour markets.
What are the concerns?
- Commodity should have come down over the period: If high core inflation in the months after the beginning of hostilities was an outcome of the passthrough, either in part or completely, of the Ukrainewar, then the decline in commodity prices since then should have led to a moderation in core inflation
- Services inflation vs goods inflation: But as activities normalised, there was an expectation that services inflation would see a strong pick-up. The recent data indicates that this has not been the case. While services inflation has risen, it remains considerably lower than goods inflation, perhaps owing to a combination of lower cost-push pressures, more slack and less demand.
Conclusion
- While inflation may have peaked, it is far from being quashed. The RBI expects inflation to edge downwards from 6.5 per to 5 per cent in the first quarter of the next financial year (2023-24). But RBI ca not afford to underestimate the price pressures in the economy.
Mains Question
Q. What is inflation? Some of the new emerging trends are considered while measuring rising inflation in the current scenario. Discuss.
