Resurgence of Inflation: Explained, pointwise

Introduction

India went through a significant inflationary phase last year. Prices of food, especially tomatoes and cereals, are rising again. Recent inflation figures have also raised concerns regarding the resurgence of high inflation. 

What are the recent trends in inflation? 

The recent Consumer Price Index (CPI) data shows a rise in inflation with June’s CPI reaching a three-month high of 4.81 percent. But it is still below RBI’s upper tolerance limit of 6 percent.  

Food prices are leading this surge, especially in the food and beverages sector, which makes up almost 46% of the CPI’s weight. 

The food price inflation was broad-based with 10 of the 12 sub-groups witnessing year-on-year increases. 

Specifically, cereals witnessed a 12.7 percent price gain, eggs rose by 7 percent, dairy by 8.56 percent, pulses by 10.5 percent, and spices by a sharp 19 percent. 

Vegetable prices rose significantly in June, with tomatoes increasing by 64% from May. 

What are the signs of resurgence of high inflation? 

The year-on-year price rise happened in spite of a high base (June 2022 saw inflation at 7.01 percent) which is a clear sign of resurgence of high inflation.  

Another sign is core inflation. It is calculated by excluding the more volatile components like food and fuel from CPI. It remained at 5.16 percent, barely moving from May’s 5.17 percent. 

What are the reasons for the recent inflationary trend? 

Erratic weather conditions: While the late arrival of the monsoon led to a large rain deficit till mid-June, heavy rains since the last week of June have caused significant damage to crops, primarily in Punjab and Haryana. 

Weight of food and beverages in the CPI basket: This weight currently is 45.9 percent, and food alone is 39 percent. This is outdated and based on the 2011 consumption survey. Also, as per Engel’s law, with rising per capita income, people will spend less on food. Therefore, with the old weights, there is overestimation of CPI inflation. 

Disease and Feed Costs: Milk production faced challenges from rising feed costs and lumpy skin disease. 

Reduced Production: Tur inflation soared because of lower acreage and production. Weather conditions might further reduce pulse outputs in regions that depend on rainfall. 

What are the government policies to control inflation? 

Inflation is a complex phenomenon caused by several factors such as demand-pull factors, cost push factors and structural factors. Therefore, a mix of macro-economic policies are needed to manage the inflation in the economy.  

Following are some policies governments use to deal with inflation: 

Monetary Policy:  

Limiting the money supply may help reduce inflation since the money supply and inflation are closely linked.  

In 2016, Parliament amended the RBI Act, 1934 to change the monetary policy, and introduce an inflation targeting framework.  

As per the new framework, the central government, in consultation with RBI sets: (i) an inflation target, and (ii) an upper and lower tolerance level for retail inflation. The target has been set at 4%, with an upper tolerance limit of 6% and a lower tolerance limit of 2%. 

RBI adjusts its policy instruments, mainly the repo rate, to achieve this target. 

Repo rate is the interest rate at which the RBI lends money to the banks. As such, it changes the interest rates in the whole economy. 

Fiscal Policy: 

The government can manage inflation through public expenditure and taxation.  

The government can reduce inflation by raising the tax rates and thereby decreasing expenditure, demand, and inflationary pressures. 

When inflation is high, the government reduces public expenditure. Decline in public expenditure affects private investment and results in decline of aggregate demand. 

Other Measures: 

Price controls: Under the Essential Commodity Act 1955, the government can declare a commodity as an essential commodity to ensure supplies to people at fair prices. 

Export policy: The government can temporarily ban the export of certain items to improve their supply in the domestic market. The government also imposes Minimum Export Price (MIP) to discourage exports of commodities to ensure their availability in the domestic markets. Governments also allow duty-free imports of certain items to improve domestic supply.  

Check over Speculation and Hoarding: The Prevention of Black Marketing and Maintenance of Supplies of Essential Commodities Act, 1980 allows for detention of persons engaged in activities like hoarding, creating artificial scarcities of essential commodities in the market and rigging up of the prices. 

Ban on Futures Trading of Commodities: To reduce speculation – driven appreciation in prices, the government often bans futures trading of the commodities. 

What are the recent government initiatives? 

The government has recently banned the export of non-basmati white rice.  

Earlier, the government banned the export of wheat and introduced stocking limits. 

The government has directed two cooperatives — National Cooperative Consumers’ Federation of India (NCCF) and National Agricultural Cooperative Marketing Federation of India (NAFED) — to sell tomatoes. 

How effective are the policies to control inflation? 

Monetary policy: Monetary policy is effective in controlling inflation when there is excess demand, and the economy is overheating (demand-pull inflation). Higher interest rates lower inflation because loans become costlier.  

But in India’s case it is the supply costs and bottlenecks that have created inflation (cost-push inflation). In such a scenario monetary policy is not very effective in taming inflation. In fact, a tighter monetary policy drags down GDP and pushes people out of employment, harming the real economy. 

Fiscal policy: If government spending and taxation are used to enhance the productive capacity and efficiency of the economy, they can help mitigate cost-push inflation. Investments in infrastructure, education, and technology can improve productivity and reduce inflationary pressures. 

Reducing government expenditure during periods of high inflation can help to dampen demand pressures in the economy, as less money is pumped into circulation. 

Export Bans and Stocking Limits: India banned wheat exports in May 2022 and imposed stocking limits on traders. An export ban was also placed on white rice. Policymakers are using older strategies from the 1960s, which might not be suitable for current market dynamics. For example, despite the wheat export ban and stocking limits, wheat inflation is at 12.37 percent.  

But the ban on rice exports may bring relief to Indian consumers because a shortfall in production is expected. Due to extreme flooding in the north and relatively poor rainfall elsewhere, rice sowing has declined this year.

What alternative measures should be taken? 

Adjust Import Duties: Import duties on items like wheat should be reduced as cheaper imports can help control domestic prices. 

Release Excess Stocks: The government holds more than 40 million tonnes of rice, much above the buffer stock norms of 13.5 MT. This excess stock should be unloaded by Food Corporation of India in the open market at reasonable prices. 

Update the CPI Basket Weights: The weight of food and beverages in the CPI basket should be adjusted to reflect current realities as the weights are based on the 2011 consumption survey.  

Enhance Processing Capacity: About 10-15 percent of perishable items like tomatoes and onions should be processed. The availability of alternatives like tomato paste and onion powder will help to stabilize prices.  

Conclusion 

Fiscal policy and monetary policy must work in tandem and be well-coordinated because sometimes one policy alone might not be sufficient to manage inflation effectively. These two policy tools are the primary components of a country’s macroeconomic policy framework, and their combined efforts can help achieve stable economic growth and price stability. 

Sources: The Hindu, Indian Express