How To Bottle Inflation Genie

Source: The post is based on the article “How To Bottle Inflation Genie” published in “Times of India” on 17th August 2023.

Syllabus: GS3 – Indian Economy

Relevance: Inflation

News: Consumer price index (CPI)-based inflation, which appeared to have peaked at the beginning this fiscal, spiked to 7. 4% in July, decisively above the Reserve Bank of India’s upper tolerance limit of 6%. The reason was food inflation, over which RBI’s monetary policy has limited influence.

How is the food inflation driving CPI?

CPI has three components: ‘food and beverages’, ‘fuel’ and ‘core’.

Food has 45.9% weightage in the index, fuel 6. 8% and core 47. 3%. Core inflation is arrived at by removing data of the other two.

Of the three, food inflation is the most volatile, and has a disproportionate impact on the overall CPI movement.

In July, food inflation increased to 11. 5% from 4. 5% in June, whereas fuel and core fell 3. 6% and 4. 9%, respectively. If we took food out, inflation in July was only 4. 8%.

If sustained, food inflation can spill over to other components and steer the CPI inflation above RBI’s target.

Is this surge in food inflation transient, or can it create sustained pressure?

Inflation in vegetables, the key driver of food inflation, flared up to 37% in July compared with 0. 9% in June. This is not a cause of concern because vegetables have a short crop cycle and prices increase and correct quickly.

Vegetable prices are cyclical in nature and experience what is called “Cobweb Phenomenon”.

Cobweb Phenomenon: This refers to a phenomenon where the prices of certain goods witness fluctuations that are cyclical in nature. It happens due to faulty producer expectations. The producers of tomatoes, for instance, might decide to increase their output in one year because their product commanded a very high price the previous year. This, however, might lead to overproduction and cause prices to slump that year, thus leading to losses.

The worrying constituents of food inflation are ‘cereals’, ‘spices’, and ‘pulses’, where inflation continues to rise.

Spices inflation has averaged 18% over the past year because supply has been hit due to pest attacks and lower production. Cereals inflation has averaged 13% since August 2022.

El Nino’s potential to disrupt palm oil production in Indonesia and Malaysia may drive prices upward, affecting India, a significant palm oil importer. Despite current lower edible oil prices compared to last year, the risk of a global shock could reverse this trend.

Prices of pulses have also been increasing. In June and July, pulses inflation averaged 11%, and sowing continues to lag.

What are the steps taken by the government?

Food prices are tamed by increasing supply and the government has taken steps to boost supplies.

The government has imposed stocking limit on wheat, removed the 40% procurement ceiling on pulses, and raised their minimum support prices to incentivize farmers.

To check the rise in domestic prices due to exports, government has banned some varieties of non-basmati rice for export and is intervening in the market by selling rice from its stock at lower prices.

Why will core inflation remain low?

Firstly, the goods part of core CPI inflation is falling and will benefit from a sharp decline in input costs as reflected in the negative Wholesale Price Index (WPI) for non-food prices.

Secondly, slow GDP growth in the second half will alleviate inflationary pressures. This will coincide with the peak impact of a global growth slowdown and the delayed effects of interest rate increases.