Home > Finance > Decoding high inflation: Use supply side measures, not interest rates, to cool consumer prices

Decoding high inflation: Use supply side measures, not interest rates, to cool consumer prices


First, a little bit of background.

Inflation measures the rate of increase in the level of absolute prices. So, high prices don’t necessarily mean inflation, if those price levels are stable.

There are two measures of inflation in India, Wholesale Price Index (WPI) and the Consumer Price Index (CPI). CPI is tracked by RBI and it measures the changes over time in general level of retail prices of selected goods and services that households purchase for consumption.

CPI measures price changes by comparing through time the cost of a fixed basket of commodities (Current Base: 2012 = 100). At present, data for CPI measurement are collected from representative and selected 1,114 urban markets and 1,181 villages covering all states/ UTs through personal visits by field staff on a weekly roster.

So, what is worrying about recent CPI inflation?

CPI inflation has increased to 6.30% on yearly basis in May’21 as compared to 4.23% in Apr’21. For policy makers, what is also important is core CPI inflation, as it excludes the more volatile component of food and fuel prices and is a clear gauge of demand supply mismatch of goods and services. Even the core CPI (ie CPI ex food and fuel) has increased to almost a seven-year high at 6.55%.

What’s driving this sharp rise?

One of the factors leading to higher inflation is the rising food prices. Protein items, cereals and even vegetables have all witnessed increase in prices. Localised lockdowns by various states have possibly disrupted supply chains. However, supply side disruptions are not the only factor. The pandemic has resulted in significant increase in health expenses, consumption of household non-durable goods important for domestic hygiene and even intoxicants.

As expected, the relentless surge in fuel prices has translated into higher prices for transportation (local conveyance) and fuel (electricity and even firewood chips). Global increase in raw material prices of cotton has also pushed up prices for clothing. Labour shortages are also resulting in steep increase in prices of labour for household services.

Interestingly, the pandemic and the resultant lockdown and working from home have clearly resulted in rapid price surges in hitherto stable categories that include cable television, hobby goods and of course, mobile data, and laptops.

Will a good monsoon lead to decline in food inflation?

The south-west monsoon irrigates over half of India’s crop land. Its arrival marks the beginning of the cultivation of rain-fed kharif crops. The quantity and distribution of rainfall determines agricultural production and subsequently foodgrain prices. A good monsoon is sine qua non for lower foodgrain prices, particularly for staple crops like tomato, onion and potato (TOP) that have always been the bane of inflation in India.

What is the inflation outlook?

The current situation of high and persistent inflation may remain for next couple of months, as international factors (like high crude oil and edible oil prices, which we import mostly) will also impact the inflation trajectory going forward. We thus have to be patient.

What should RBI/ government do?

Maintaining price stability is the foremost objective of the monetary policy committee of RBI. However, during the pandemic, growth has taken centre stage and RBI has rightly cut interest rates.

With the rise in inflation amidst a second wave, the balancing acumen of the MPC will now be sorely tested. Factors like rising commodity prices, supply chain disruptions are expected to raise overall domestic inflation. Traditionally, raising interest rates can lead to decline in prices by making credit more expensive and this is the tool that RBI employs. However, just raising interest rates to combat inflation may kill any incipient signs of recovery. So, RBI may prefer a wait-and-watch mode at least for now.

On the other hand, repairing the supply chain remains the top priority – and on this RBI has little control. GoI needs to remove supply side bottlenecks. For example, GoI can immediately offload 10-20% of its pulses stock with NAFED in the open market. Stocks are currently at 14.6 lakh MT. This may immediately cool down pulses’ price. Measures like this across commodity classes are the best response right now.

Source link

TAGS , , , , ,
Hi guys, this is Kimmy, I started LicensetoBlog to help you with the latest updated news about the world with daily updates from all leading news sources. Beside, I love to write about several niches like health, business, finance, travel, automation, parenting and about other useful topics to keep you find the the original information on any particular topic. Hope you will find LicensetoBlog helpful in various ways. Keep blogging and help us grow as a community for internet lovers.