If we break down the headline inflation number into its micro-components, we find that the current spike is solely due to volatile prices of vegetables, while the core components of inflation are still closer to the ground, suggesting that this phase is transitory at best. The chief reason for this is that while both food and core inflation were high back then, only food inflation is high right now, with core at a near-record low.
To begin with, inflation has just entered the “high” territory by crossing six per cent for just one month. In 2012, when it went above six per cent in January, remained above that level till as long as August 2014, and had an impact that catalysed a political transition in Delhi.
Back then, inflation in villages had generally remained higher than in cities, owing mostly to the construction sector. This sector kept providing informal sector jobs to new rural workers, raising their wages, and consequently, prices. This fact has been corroborated by the Reserve Bank of India’s research, which establishes a direct link between higher wages and rising prices.
However, in 2019, the scene was different. Rural inflation remained lower than urban for almost the entire year, in line with the fall in real wages in the farm and construction sector.
Now, suddenly in December 2019, both rural and urban inflation have risen above seven per cent, bucking the temporary trend and raising eyebrows.
But a closer look at the broad components of inflation, core inflation and food inflation, shows us that the entire rise in inflation this time is due to rising food prices. Core inflation, in fact, has remained near three per cent, the lowest since February 2015.
The magnanimity of high food inflation, however, hasn't crossed the monstrous proportion it had assumed in 2012-2014.
Instead, if we remove only three daily consumption items, headline inflation drops to 4.48 per cent from 7.35 per cent, Soumya Kanti Ghosh, chief economist at State Bank of India wrote in a note.
Further, this upsurge could be partially due to a “low-base” effect, as food inflation was negative a year ago.
However, Ghosh also warned about the probable upside to inflation. “The uptick in global food prices through the import channel will have some bearing on the headline inflation,” he wrote in his Ecowrap report dated January 14.
S Mahendra Dev, director at the Indira Gandhi Institute of Development Research (IGIDR) said that the high inflation in the 2012-14 period had two strong reasons: the setting of a wage floor for NREGA workers, and the boom in construction activity.
“These two activities raised wages faster than ever, which raised prices as demand increased,” he said.
Cut to 2019, some economists are applying a similar reasoning to say that high food inflation—both at the retail and wholesale level—would mean that farmers’ incomes are rising. However, there are limitations to this argument, as inflation has risen because of supply constraints due to reduced production caused by untimely rains, and not due to high demand.
“After demonetisation, construction sector has been particularly affected, and the demand for labour has declined. Due to farm mechanisation, demand for agricultural labour too has diminished. And in this situation of negative real wage growth, supply disruption has affected the purchasing power of the rural folk adversely,” said Dev.
“Further, this suggests that the shares of wholesalers and retailers in the rise in wholesale prices could be higher than the share of farmers,” he added.
Tepid core inflation
Stable core inflation, on the other hand, represents stable demand in the economy. A higher core inflation either shows higher demand and the inability of the economy to supply that demand, or worse, a lack of demand itself. The current low core inflation is sadly due to the latter.
The 2012-2014 period, however, was characterised by high food inflation coupled with high core inflation, as opposed to high-food-low-core at the moment. As both the components were treading on a high note, there was no respite for a long time. As we enter 2020, economic slowdown due to demand and supply constraints would keep it low for a considerable time.
“In the 2012-14 period, the growth stimulus had resulted in high inflation in all core components. Right now, core inflation is unlikely to move up considerably from current levels, and thus unlikely to push headline inflation beyond the upper comfort limit of 6 per cent, as volatile food inflation subsides,” said DK Joshi, chief economist at CRISIL, a ratings agency.
There was a considerable rise in core inflation in 2018 especially due to rising health and education costs, which has moderated now, trouncing core inflation to 3.5-3.8 per cent. There was a similar drop in core inflation in 2015, but that was due to the crash in oil prices, and drop in telecom tariffs.
“If core inflation rises above 5 per cent, it is a worry. But apart from telecom tariffs, weak demand situation will keep core inflation low,” said Joshi.
As for the permanence of high food inflation, experts underline its transitory nature.
Former agriculture secretary to the union government, Siraj Hussain, told Business Standard that while inflation in milk, pulses and maize would stay high for some time, that for vegetables would come down in the coming months after fresh vegetables flood the market. But he also said that the rising stock of rice and wheat with the government would result in lower prices in 2020.
“Grain inflation—rice and wheat—would subside from current levels, especially due to the fact that the more than 70 million tonnes of rice and wheat with the government would need to be marketed or offloaded. This would create excess supply and reduce prices,” he said.
Traders are too not buying these staples at the moment, anticipating an imminent price collapse in the coming months due to excess availability.
Veggies are the root cause
A look at the five key components of food inflation shows where the devil lies. The two most volatile are vegetables and pulses. vegetable prices, chiefly responsible for the current spike, rose 60 per cent in December. Inflation in pulses stood at 14 per cent. Both of them have a high bandwidth—both have moved from minus 30 (-30) per cent to more than 50 per cent in the past eight years.
It is this part that is responsible for the current inflation spike, while all other components are dimmed.
On the contrary, the less volatile components, namely cereals, milk and fruits, show a clear trend. In 2012-14 period, all three exhibited high inflation, while currently, all of them have just sprung near 4 per cent from a year-long phase of consistent fall in prices, or deflation.
It now depends on how much milk, maize and pulses contribute to overall food inflation in the coming months. These are particularly vulnerable at the moment, said Hussain.
A bigger worry, though, could come from core inflation, which seems to be a sleeping horse at the moment.
While in the 2012-14 period, almost all of its important components—health and education, household goods and services and clothing—exhibited high inflation, their trend was very peculiar in 2019. Inflation in these remained high for most of the year, falling to near-record lows in the last few months.
Joshi of Crisil maintains that the rise in telecom tariffs could push core inflation up to some extent in the coming months. If other components exhibit similar characteristics, a rise in core inflation can turn out to be a graver concern than food inflation, which is transitory at best.