Inflation Shock After GDP Slump

Inflation Shock After GDP Slump

Updated on 14 January, 2020

GS3 Economy
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Inflation Shock After GDP Slump - Retail inflation shot to a five-and-a-half-year high of 7.35% in December, breaching the central bank’s tolerance limit of 6%.

  • CPI inflation is also known as retail inflation. Its basket comprises items of consumption including food, fuels, services like education, health, housing among others.
  • Core inflation is Retail inflation minus food and fuel.

Background: 

  • Under the flexible inflation targeting framework adopted in 2016, RBI accords primacy to the objective of price stability, while simultaneously focusing on growth when inflation is under control.
  • The amended RBI Act, 1934 also provides for an empowered six-member monetary policy committee (MPC) to be constituted by the Central Government. The MPC determines the policy interest rate required to achieve the inflation target.
  • Inflation targets: India adopted the ‘Consumer Price inflation target’ of 4% in 2016 for the next five years under the monetary policy framework. The consumer inflation target for RBI until March 31, 2021, is 4% with an upper tolerance level of 6% and a lower limit of 2%.

What the data says:

  • Consumer food price inflation has hit 14.12 percent year-on-year in December 2019, the highest after it touched 17.89 percent reached more than six years ago in November 2013.
  • The central bank’s forecast is that inflation will be 4.7-5.1% during October-March.
  • It was expected given the seasonality of vegetable prices, rising prices of meat and fish (9.57%), egg (8.79%), milk (4.2%) and spices (5.76%) also contributed to the acceleration in retail inflation.
  • December inflation was the fastest increase since July 2014. 
  • India’s economic growth slowed to a six-and-a-half-year low of 4.5% in the September quarter.
  • The gross savings rate in India has declined sharply from 34.65% in 2011-12 to 30.54% in 2017-18, led by the household sector.

Reasons behind high inflation: The rise in food inflation is driven largely by the damage to the Kharif crop from prolonged unseasonal rains from September to early November. These excess rains have, however, helped recharge groundwater aquifers and fill the country’s major dams to near-full reservoir levels, thereby boosting plantings of the winter/ spring rabi crop due for harvesting from end-March.

Inflation may stay above the target for a long period, the following are the reasons:

  • Prices of pulses may remain elevated in the coming months: Prices of pulses depend not just on the rabi output, but also on how deftly the government manages its food stocks.
  • Mismanagement: The government took time to import onions shows it has been slipping on its food management off late. 
  • Infrastructural inflation: Telecom tariff hikes, cement price increases and the fired-up global crude oil prices will keep up the pressure.
  • The global upswing in food prices: The UN Food and Agricultural Organisation’s Food Price Index (base year: 2002-04 = 100) averaged 181.7 points in December 2019, the highest since the 185.8 level of December 2014.
  • The inflationary pressure caused by escalating trade wars around the globe is driving global prices up.

Govt. steps:

  • Onion import: Public sector trading firm MMTC has contracted to import 6,090 tonnes of onion to boost domestic supply and ease prices
  • Repo rate cut: For the fifth consecutive time this calendar year, the central bank cut the repo rate by 25 bps and the reverse repo by 25 bps to boost investments. (100 bps = 1 per cent).
  • Palm oil import ban: The government banned the import of RBD (refined, bleached and deodorized) palm olein and palm oil by moving these from the “free” to the “restricted” category. 
  • The government is also under pressure to open up imports of skimmed milk powder, following a more than doubling of domestic prices to Rs 300-320 per kg in the last one year.

Concerns

  • Stagflation fears: Along with slowing growth, more-than-desirable inflation raises the specter of stagflation (where inflation rises even as output and employment fall)
  • Challenge for monetary policy committee (MPC): Galloping inflation could not only constrain the Reserve Bank of India (RBI) from further monetary easing but may also force it to rethink its accommodative policy stance. If RBI raises rates in the backdrop of lower savings, then it is a serious situation.

 

Way forward

  • MPC will have to protect its 4% inflation target: A breach of inflation target necessitates a policy rate hike, but in the current context—of the slowest economic growth in six years—this will be dangerous. 
    • Higher Interest rates increase the cost of borrowing and this will reduce aggregate demand (AD). This will be effective for reducing inflation, but, it will cause a bigger fall in GDP.
  • A long pause on interest rates: MPC will have to watch onions, garlic, and potato prices, besides hoping that past policy rate cuts will somehow reignite the dying embers of investment. Till then it may not tinker with the interest rates.
  • Redistribution of weightages in CPI basket: the food basket is relatively overweight in the current economic context given increasing consumer spending on discretionary items, healthcare, and education. A redistribution of the weightages may need to be considered for a better reflection of the consumption basket and the inflation trajectory.

‘Consumer Price Inflation’ (CPI) or retail inflation: This index is linked to consumer prices or prices of retail goods. The CPI is like your shopping basket.

  • It is calculated by the Central Statistics Office (CSO), Ministry of Statistics and Programme Implementation (MOSPI).
  • The Base Year of the Consumer Price Index (CPI) 2012.
  • It is now compiled as urban households and rural households linked CPI. This is relevant because the consumption patterns vary vastly in urban and rural India. 
  • The new CPI has five sub-groups including food and beverages, fuel and light, housing and clothing, bedding and footwear. 
  • The weightages differ for the rural and urban baskets. For example, the urban basket has a much higher weightage to housing-related items. 
  • Unlike the WPI, this is more relevant to an individual’s daily expenditure. 
  • There are some common components in both baskets—such as fuel and food articles—but here as well, the CPI focuses mainly on end consumption linked articles whereas the WPI as a mix of both.

Category wise weights in CPI and comparison with some BRICS nations



Wholesale Price Index: this index looks at the change in wholesale prices. Changes in bulk prices of items in the WPI basket may not affect you or your spending directly but ultimately this trickles down to retail prices as well.

  • It is published by the Office of the Economic Adviser in the Department of Industrial Policy and Promotion, Ministry of Commerce & Industry.
  • The base year for the Wholesale Price Index (WPI) is 2011-12
  • The biggest group in the WPI basket is manufactured goods (64.9%). There are many sub-groups in this category; some of the main ones are chemical and chemical products, basic metals, alloys, and metal products, food products, machinery, and machine tools and textiles. 
  • Around 20.12% of the basket consists of primary articles; this includes food articles such as cereals, meat, fish, fruits and vegetables. It also includes non-food articles such as cooking oil, cotton, jute, and minerals. 
  • The next big group is fuel and power (14.91%) and this includes elements such as electricity, mineral oils and coal. Items such as kerosene, diesel, liquefied petroleum gas, and petrol also fall into this category.

A new “WPI Food Index” is being compiled by combining the “Food Articles” under “Primary Articles” in WPI and “Food Products” under “Manufactured Products” in WPI.

Globally, the food price index is being released by the Food and Agriculture Organization of the United Nations. 

  • The FAO Food Price Index is a measure of the monthly change in international prices of a basket of food commodities. 
  • It consists of the average of five commodity group price indices (Cereal, Vegetable Oil, Dairy, Meat, and Sugar) weighted with the average export shares of each of the groups for 2002-2004.

Also read: Rebasing The GDP Of India

Concerns Due To Low Nominal GDP Growth Rate

 


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