The task of managing inflation is difficult during the best of times. In a supply-constrained economy as the one India faces today, with almost all states going through a lockdown, the task can be expected to be even more difficult. Yet the latest inflation numbers, released on May 12, seem to suggest that the headline inflation is well within the inflation tolerance band that the central bank, the Reserve Bank of India, has set out for itself. After hovering close to the upper tolerance limit of 6% for March 2021 (at 5.52%), the April 2021 numbers, with a reduced headline inflation of 4.29%, are a welcome change. Yet, a careful perusal of the inflation and associated numbers shows multiple fault lines.
The first concern is qualitative and has to do with how one assesses such tempering of inflation. With food and beverages carrying a weight of 45.85 in the overall Consumer Price Index (Combined), the fate of inflation gets determined primarily through this component. Food inflation has been an important driver of inflation for the past several years. However, while the dozen components constituting food inflation, in the aggregate, have moved towards some taming, it is the individual trends that remain worrisome. More specifically, a reduction in food inflation from 5.24% in March 2021 to 2.66% in April 2021 hides certain anomalies that point to poor inflation management and an inability to address the structural issues at a granular level. Thus, the inflation in oils and fats (weight = 3.56), which has remained high throughout the last six months (especially in the Calendar Year 2021), has increased from 24.92% to 25.91% between March to April 2021. Such inflation has risen from 20.05% in December 2020 to 25.91% for April 2021. However, inflation in vegetables has not only been negative (and hence actually constituting deflation), but such deflation has also increased over the period. From a -4.83% inflation for vegetables in March 2021, the inflation figure for vegetables has grown to -14.18% in April 2021. Such deflationary trends are witnessed for vegetables throughout the calendar year so far. Besides vegetables, cereals, sugar and confectionery have also demonstrated negative trends, while meat and fish, eggs, pulses and non-alcoholic beverages have all shown very high positive upward trends.
The rural-urban divide with respect to these trends is far starker. In April 2021, inflation in oils and fats in rural areas was 27.79% compared to 22.64% in urban India. Vegetable deflation at -16.47% in rural India was far greater than the -10.11% deflation in urban India. The overall rural food inflation was at 1.96% compared to 3.78% urban inflation.
The divergence in the price trends indicates all is not well with food inflation management. On the one hand, proteins are becoming more expensive, putting them out of reach of most Indian consumers, already reeling under job cuts and unemployment; on the other hand, small farmers and cultivators of vegetables may not get the right deal for their products. Such divergences are seen in the case of the non-food components as well. Thus, inflation in the fuel and light and health components have increased over March-April 2021. The rural-urban divide in inflationary trends also masks the sizeable burden placed on rural areas by inflation in the case of essentials such as oils and fats.
A second concern is to do with the differential performance of states with regard to inflation on the one hand and a large urban-rural divide on the other. We again see huge discrepancies among states, with nine of the 22 states exhibiting greater than the 6% tolerance band in March 2021. Southern states, especially Andhra Pradesh and Tamil Nadu, have very high inflation rates at 8.88% and 7.7%, while northern states such as Delhi, Rajasthan and Uttar Pradesh have been able to keep inflation rates well within control in the 3-4% band. Such high differentials may also be explained by the high inflation in transportation at 11.04%, which may prevent price equalisation across states.
A final concern has to do with managing inflationary expectations. It is such expectations that are crucial to actual inflation in the next period. To understand this, if we all expect prices of oil to rise, we will go out and buy oil today, causing oil prices to rise. Despite the CPI headline inflation being well within the inflation tolerance band of 2-6%, household inflationary expectations data for the period of May 2020 to March 2021 reveals that the proportion of respondents who believe that prices will increase at either the same rate or a greater rate one year ahead is above 80% in March 2021. Moreover, the mean and median one-year ahead as well as the three months-ahead (short-term) inflationary expectations are above 10%—well above the RBI’s inflation tolerance band, indicating that people expect inflation to rise, both in the short and medium term.
In sum, while the reduction in headline inflation is good, inflation management would need to go beyond just the aggregate numbers. A greater attention to managing both inflation and inflationary expectations, both at an aggregate and granular level, is the need of the hour.
Tulsi Jayakumar
Professor, Economics and Chairperson, Family Managed Business at Bhavans SPJIMR.
(tulsi.jayakumar@spjimr.org) (Views are personal)