Five charts that explain the inflation situation in India

As far as retail inflation goes, India has seen worse even in the current CPI series which starts from January 2011. However, WPI has been in its highest ever territory in the past few months; it had never breached the double-digit barrier until April 2021.

But CPI and WPI measure different set of prices

Lest one assumes that the difference between CPI and WPI is the former measuring retail and the latter wholesale prices, it is important to clarify that the CPI and WPI commodity baskets differ significantly. The difference is on two counts: weight of different commodities in the two indices and the kind of commodities which are included in each basket. For example, food items have a share of 39% in the CPI basket. For food and beverages combined, this share is 46%. In contrast, food items account for just 24% of the WPI basket. Price of housing, which accounts for 22% of the CPI basket, is not present in WPI at all. Then there are items such as fertilisers and synthetic rubber in the WPI, which are not present in the CPI. This difference is on account of the purposes of the two indices. CPI seeks to measure the price change facing a household’s budget; WPI is the best proxy for producer prices in India.

There is more to inflation than fuel prices

Headline inflation numbers would have been higher had it not been the recent moderation in food prices. And, fuel prices have been an important source of tailwinds for both retail and wholesale inflation. The fuel sub-category of both CPI and WPI is at an all-time high at the moment. However, fuel is not the only source of inflation at the moment. Prices of non-food non-fuel goods and services have also been rising at a fast pace. Trends in the CPI sub-categories of clothing and footwear and miscellaneous (it mostly includes consumer services) and WPI sub-category of manufacturing goods clearly shows that inflation is pretty broad based in nature at the moment.

Is it a case of imported inflation?

International prices have definitely played a role. And it is not just an increase in crude oil prices. The Bloomberg Commodity Index – it is a weighted average of prices of energy, grains, industrial and precious metals, cotton and livestock – has increased significantly in the post-pandemic period. To be sure, it is still way below its all-time high and the trend has flattened in the past few weeks. Some independent economists have been arguing that the post-pandemic surge in international commodity prices – it was the result of twin shocks of disrupted value chains and sudden spike in pent-up demand – might have peaked already. If this is indeed the case, price pressures should ease going forward.

But there is also a profiteering angle to current inflation story

Whether or not, and to what extent producers raise prices for consumers is among the most important bargains in economies. Producers are more confident of raising prices when they expect demand to be price inelastic i.e. less sensitive to change in prices. This is likely to be the case when consumer incomes are robust (higher prices do not hurt) or when producers do not fear being outcompeted by someone offering lower prices. Economic inequality, both among producers and consumers, plays an important role in this bargain.

In a research note dated August 2, Pranjul Bhandari, Chief India economist at HSBC had underlined this possibility. “A key structural shift over the last year has been the rise in inequality. At the firm level, there is evidence that the pricing power of large firms has risen over the last year. At the individual level, higher demand for services could distort prices. The rich tend to consume more services than the poor, and the disproportionate rise in demand could stoke services inflation (which can’t be traded away like goods)”, the note said. In her note after the latest CPI numbers were released, Bhandari has reiterated this argument. “This component (core inflation or non-food non-fuel component of CPI basket) is most at risk over the foreseeable future as producers start to pass on higher input costs to consumers and services demand rises as vaccination rates pick up”, the note said.

An HT analysis of data from the Centre for Monitoring Indian Economy’s Prowess database – it is among the most comprehensive corporate database in India – supports Bhandari’s argument. The ratio of corporate profits to raw material costs – other things remaining the same, it would tell us whether firms are passing a greater or smaller share of input costs to consumers – has increased significantly in the post-pandemic period.

It might be tempting to call for anti-profiteering actions to control such tailwinds to inflation. However, this is an option where a policy intervention carries a big risk of subverting market signals in the name of correcting them. A better way to look at this problem is to ask what has led to the rise in economic power of large corporations or the formal sector which has bestowed it with asymmetric pricing power in the economy. The answer to this question must confront the larger realm of political economy rather than tracking the intersection of demand and supply of individual commodities.

(Vineet Sachdev contributed to this story for analysis of the CMIE Prowess data)