Type: op-ed snap

Central Idea

• India’s post-pandemic economic recovery has hit a roadblock with the resurgence of inflation, hindering progress despite three consecutive months of softening. Recent significant spike in inflation, leading the Reserve Bank of India to adopt an inflation-targeting stance by raising interest rates. However, the battle to curb inflation is still ongoing, and the latest data raises doubts about whether the RBI’s efforts are sufficient.

What is 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).

Consumer Price Index (CPI)

• CPI is used to monitor changes in the cost of living over time.
• When the CPI rises, the average Indian family has to spend more on goods and services to maintain the same standard of living.
• The economic term used to define such a rising prices of goods and services is Inflation.

Inflation outlook

• RBI’s Inflation target: The inflation targeting framework mandates the RBI to achieve a CPI consumer price index inflation target of 4 per cent.
• Inflation during the pandemic was still within the target band: During the pandemic period of March 2020 to September 2021, CPI inflation averaged 5.9 per cent. This was higher than the point target of 4 per cent but still within the inflation targeting band of 2-6 per cent.
• Inflation outlook has been worsening: In 2022, CPI inflation was above the upper threshold of the RBI’s targeting band for 10 consecutive months, which meant the target was not achieved for three quarters in a row.
• Optimism that the Inflation began softening: By December 2022, CPI inflation was down to 5.7 per cent. This led many to believe that the inflation peak had passed, and that inflation was on its way to the official target.
• This optimism was misplaced: Underlying inflationary pressures still persist. The softening of inflation in November and December 2022 was largely driven by a steep fall in vegetable prices. Excluding vegetables, CPI inflation was in fact more than 7 per cent.
• The misplaced optimism has now become evident: The January 2023 CPI inflation came out to be 6.5 per cent, once again crossing the upper threshold of the RBI’s inflation targeting band.

Back to basics: Core Inflation

• The core inflation rate measures rising prices in everything except food and energy.
• That’s because gas prices tend to escalate now and then. Higher gas costs increase the price of food and anything else that has large transportation costs.

What contributed to the latest spike in inflation?

• Rise in food prices: With food accounting for 46 per cent of the overall CPI basket, a rise in food inflation from roughly 4 per cent in December 2022 to almost 6 per cent in January 2023 has played an important role in overall inflation going up.
• Cereal inflation is soaring high: Within food, one component that has proved rather stubborn is cereal inflation. Between May and December 2022, year-on-year cereal inflation nearly doubled from 5 per cent to 14 per cent. In January 2023, this increased to 16 per cent. Within cereals, inflation in wheat has been steadily going up. Between May and December 2022, wheat inflation increased from 9 per cent to 22 per cent. It increased even further to 25 per cent in January 2023.
• The steep rise in wheat prices reflects shortages: Data from the Food Corporation of India shows that stocks in government warehouses declined. The government has recently approved a release of three million tonnes in the open market. However, this is insufficient to restore market supplies.
• Persistently high core inflation: Second, core (non-food, non-fuel) inflation in January came out to be 6.2 percent. This is consistent with the unyielding core inflation of 6 per cent for nearly three years now. A persistently high core inflation implies that price pressures have become entrenched in the system.
• External factors also play a role: Inflation in developed countries continues to be high (6.4 per cent in the US; 8.5 per cent in the EU; 10.5 per cent in the UK). India is importing some of this elevated inflation through international trade in goods and services. Moreover, with China gradually opening up its economy after nearly three years of zero-Covid restrictions, commodity prices are likely to go up, which could exert renewed pressures on India’s inflation.

What have the policymakers been doing to address the inflationary concerns?

• The government has done its bit by announcing a conservative Union budget for 2023-24: It has accorded primacy to much needed fiscal consolidation, and has refrained from announcing populist measures that could have arguably fuelled demand, and hence inflation.
• The RBI has been doing its job as well: It increased the policy repo rate from a pandemic low of 4 per cent to 6.5 per cent in a span of 10 months. Unlike last year, when despite rising inflation, the monetary policy statements did not contain any forward guidance, the RBI, in its February 2023 statement, emphasised the importance to remain alert on inflation, thereby hinting that the monetary tightening cycle is not over yet.

Conclusion

• Inflation has been a challenge for India’s economy post-pandemic, despite the RBI’s attempt to control it by raising interest rates. A credible glide path to bring inflation down is essential today.

Mains question

Q. Despite of RBI’s efforts there is significant spike in inflation In India. Discuss the factors that contributed to the latest spike in inflation in India and what are the policymakers doing to address inflationary concerns?

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Context

• On 25 January, US-based Hindenburg Research put out a tweet, talking about a negative report on the Adani Group that it had published. The report made many allegations against the group which triggered a fall in the price of their listed stocks.

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Just think of this situation

• A research report is released by a global firm that is also a short seller (that is, one who sells shares that it does not own, but buys them back at a lower price once the price falls).
• The report outlines areas of concern in a company that is listed in another jurisdiction. The issues raised could relate to the firm’s accounting or market practices.
• The report is released, quite curiously, before the company is going in for an equity issuance.

What happens after the news?

• Panic sale: As equity markets run on sentiments, such news leads to a panic sale and the share price of the company comes down sharply.
• Widespread uncertainty: The market sees investor wealth eroding sharply, leading to widespread uncertainty, as this is how contagions progress.
• Outrage: Denials are issued by the concerned company while the short seller stands firm on its views. However, shareholders have seen an erosion in their wealth and there is outrage everywhere.

In such a situation, what can the regulator do?

• Policies and system in place to put verified facts in public domain: It is for regulators in other jurisdictions to have policies/systems in place for verified facts to be put in the public domain.
• In the current context: The Securities and Exchange Commission of the US would matter and if the broker complied with its rules, then there is nothing to stop their views from being aired in a globalised world. This is why it is said that if any company opts for listing in overseas markets, there is more reason to ensure that its accounts are in place and there are no deviations from best practices.

What can regulators do to protect investors?

• It is necessary to understand that when share prices tumble: Only when someone sells the shares that have declined in value will a loss be actually incurred. This is the first point that ordinary investors need to keep in mind. While the media will talk of the loss of value and wealth, it is notional for those shareholders who don’t sell. And stock prices will return to their equilibrium once the storm passes.
• There is a need to have a wide market intelligence network: A special division that continuously analyses the messaging about Indian companies across the world. Given that such reports do not come up without signals being sent along the way, monitoring of views on companies listed overseas would be essential.
• While citing financial accounting irregularities need to be looked into: the accounting and auditing firms need to take on more responsibility to ensure that the Generally Accepted Accounting Practices (GAAP) are followed for overseas-listed firms. They will have to be made partners in any such crisis in terms of taking ownership and clarifying the same.
• Detecting price manipulation: Price manipulation, for instance, is one practice that has always been a concern for regulators. And it takes a lot of experience to detect it. Thus exchanges need to ensure that their market watch and surveillance practices are robust. This is where trading patterns can show if there has been market manipulation.
• Restoring assurance and sanity in the market: It is necessary that investors have some assurance from the regulator, which may be needed to restore sanity in the markets. However, this should be an immediate and time-bound investigation which looks at the allegations or the shortcomings of the report.
• Investing derivative segments too: As a corollary, the regulator needs to investigate the derivative segment too and probably talk to other regulators to analyse how the short positions have been created and whether they were in order. This will mean being in touch with other regulators, especially the SEC which regulates the jurisdiction for most overseas listings.
• Audit firms can be employed to flag off the concerns: The regulator should insist that all overseas listed companies have regular investor calls with stakeholders where meetings are recorded and transmitted back home for special teams to examine so that there is a sense of how potential investors feel about the companies.

Conclusion

• In the cases of overseas reports, investors must have some assurance from the regulator, which can restore sanity in the markets. But investors also need to be proactive when investing. Those who are more active investors would perhaps need to be aware of developments in the companies that they have invested in.

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