Making sense of inflation and the IIP numbers

It remains to be seen whether the wholesale price index (WPI) also shows a big increase when the data is released on April 18. WPI growth increased to 13.1% in February after falling in the months of December 2021 and January. A faster growth in prices is bound to harden inflation expectations going forward. This has the potential of creating a vicious cycle of inflation and inflationary expectations feeding into and off each other.

Surging food prices mean a bigger squeeze on the poor

Food inflation, which accounts for 39% of the CPI basket, is now ahead of the headline inflation number after November 2020. At 7.68%, food inflation in March 2022 is the highest since November 2020, when it reached 9.2%. Because food spending has a bigger share in the total spending of poorer households, it means that inflationary pain is going to be more for those at the bottom of the pyramid.

A Crisil research note corroborates this observation. “Using the National Sample Survey Organisation data, we estimate average expenditure across three broad income groups — the bottom 20%, the middle 60%, and the upper 20% of the population, and mapped them with the inflation trend…We find that the rural bottom 20% faced the highest inflation at 7.7% in March, compared with 7.7% for the middle 60%, and 7.6% for the upper 20% of income segment. In urban areas, too, it was the bottom 20% that faced the highest inflation (6.4%), followed by the middle 60% (6.3%) and the upper 20% (6.1%),” the note said.

This is bad news for already weak consumer demand

IIP data for the month of February shows that consumer demand continues to be an area of concern. A use-based classification of IIP shows that the consumer goods subcategory contracted for the fifth consecutive month in February. At 6.6%, the annual contraction was the most in the last five months. Thanks to a contraction in consumer goods category, manufacturing growth in February came at just 0.85%.

This statistic, when read with the fact that consumer confidence continues to remain significantly below pre-pandemic level in the March round of RBI’s Consumer Confidence Survey, is bad news on the aggregate demand front. Private Final Consumption Expenditure (PFCE) accounts for more than half of India’s GDP and unless the slack in consumer demand is reversed, tailwinds from export and capital spending from the government might not be enough to revive growth on a sustainable basis.

The terms of trade question will become critical now

To be sure, the exact impact of inflation on mass demand will be decided via a terms of trade adjustment between the farm and non-farm sectors of the economy. Given the fact that food prices, especially that of wheat, have risen sharply due to the Russian invasion of Ukraine, cereal prices are expected to remain high going forward. While this will generate pressure on food inflation, farmers who sell these crops are expected to experience some tailwinds to incomes. The cushioning of farm incomes on account of higher global prices and their spillover in the domestic market will compensate the potential squeeze on demand due to higher inflation to some extent. But the net terms of trade interplay between high food prices and overall demand will also be decided by what is happening to non-food prices, especially of those commodities which are used as inputs in farming. This will also bring critical choices for the government, which will have to maintain a fine balance between Minimum Support Prices, fertiliser subsidies, and food subsidies. The final choice will depend on both politics and economics.