How is one to view inflation today? Inflation coming down does not mean that prices are falling. It is just that prices are increasing at a lower rate. This has to be made clear because often there is jubilation that inflation has come down when households are still paying higher prices for their groceries. Therefore, when the RBI says that it is targeting an inflation rate of 4% or the Fed 2%, the implication is that there is some element of price increase which will happen every year and this number is considered to be acceptable.
In the last credit policy, the RBI had provided forecasts of inflation getting to less than 4% in the second quarter which is July to September. But it is expected to increase to the region of 4.5% in the next two quarters. How is one to read these numbers?
All models used in forecasts are based on past relations as well as assumptions made on certain variables for the forecast period. This is where the commonly used phrase ‘base effect’ comes in. When inflation in July-September 2023 was high at 6.4%, it provided a cushion for the present number. The other factor which is taken into account is the present state of prices. The persistent problem today is rising food prices which has kept food inflation elevated. It has averaged 8% for food and beverages group. Here too the base effect is there as it was 4.1% last year.
But the four products which are creating havoc in absolute terms are tomatoes, potatoes, onions and toor. They have a weight of around 3% in the index; and intuitively it can be seen that if these prices have moved up by 20-30%, the inflationary impact is between 0.6-0.9%. That’s the statistics part of the issue.
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The fundamental character of any crop is that it is seasonal in nature. Tur for example is normally harvested in October-November and the output has to be made available for the rest of the year. In case of any crop shortfall, there will be a supply shortage through the year which has to be made good by imports. Another facet is that while there are 7-8 states which produce the product, Maharashtra, Karnataka and Madhya Pradesh are the leading states. All of them are in the interiors of the country and heavily dependent on the monsoon. Last year, output was lower which triggered the price increase. Imports are reckoned from Africa, Canada, and Australia among others. Once the supply shortage was observed, the exporters raised their prices knowing that there was no choice for us.
For perishables like tomatoes, onions and potatoes there are typically 2-3 crops where the harvesting can last for 3-4 months. But this is spread across the country. Crop failure in any location due to low or excess rain or heatwave can have ripple effects on the rest of the crop that gets diverted from other regions. Therefore output as well as prices tend to be volatile here.
Along with these four food items, prices of spices, milk and meat products have also been witnessing increase in prices. For spices it is a case of lower production while for dairy products and animal-based commodities, prices are up mainly due to higher input costs. There have not been supply issues here but the higher cost of animal feed which includes maize, fodder, oil cakes among others has pushed up the cost of maintenance of the animals. Hence while there is always focus on supply side issues for crops and other products, the allied activities which includes animal husbandry and fodder, often miss attention.
The last factor on the food side which has pushed up prices is the policy of Minimum Support Prices. The government announced these prices for all kharif and rabi crops. The idea is twofold. The first is to encourage farmers to grow certain crops and the second is to ensure that procurement is reckoned at remunerative prices by the FCI (Food Corporation of India). But the unintended consequence is that benchmark prices of all products covered by the MSP tend to rise in the market once they are announced as they become the floor. This also has an inflation impact, which can be mild in normal year, but work to cascade the effect when the output falls short of target.
The silent inflation which keeps creeping upwards which often escapes notice is core inflation which is the non-food and non-fuel part of the basket. It has been at a comfortable level for long at around 3% though it tended to average closer to 4-5% in the past. This normally is a response to generalised inflation when input costs go up. Producers would tend to increase prices of readymade garments, cosmetics, automobiles etc. when the input costs go up. The significant development in the last couple of years is that manufacturers have tended to hold back on price increases as inflation was high. But this is changing and as we can experience when we go shopping, prices of toothpaste, soaps, utensils, clothes etc. have been rising.
A takeaway here is that the low core inflation of 3% cannot be sustained for long and will have to move towards the 4% mark soon this year. This is what will keep this part of inflation ticking for the rest of the months.
Therefore, while inflation is likely to average 4.5-5% this year even in case the monsoon remains good and well spread, it is the individual components that can hurt family budgets. The one part which has been administered for long is fuel prices where citizens neither got benefits from low global crude prices not paid higher prices when it rose considerably. This part, it may be assumed will remain sluggish in terms of movements while the other components will witness the volatility which goes with supply changes and adjustments made to rising input costs.
The author is Chief Economist, Bank of Baroda and author of ‘Corporate Quirks: The Darker Side of the Sun’. Views are personal
