[Editorial Analysis] Dizzying climb: On retail inflation

Mains Paper 3: Economy
Prelims level: Retail Inflation
Mains level: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

Context:

• The statistics department showed that food inflation fell to a 20-month low of 1.89% as vegetable prices slumped 15.84% last month. Retail inflation in rural and urban India stood at 3.23% and 5.06%, respectively.

• The latest retail inflation, the Consumer Price Index (CPI) rose by 4.06% in January, marking a deceleration for a second straight month to a 16-month low. However Inflation must not be allowed to pose a threat to macro-economic stability.

What is Retail Inflation?

• Retail inflation means the increase in prices of certain products or commodities compared to a base price. In India, retail inflation is linked to Consumer Price Index.

• When goods and services cost more than the CPI will rise over a period of time. If the CPI drops, that means there is deflation, or a steady reduction in the prices of goods and services.

It’s justifying the central bank’s accommodative monetary policy:

• Inflation appears to have cooled after having stayed stubbornly stuck above the Reserve Bank of India’s upper tolerance threshold of 6% for six months through November, helped by an appreciable softening in food prices.

• The Reserve Bank of India (RBI) in its latest monetary policy statement had said with the larger-than-anticipated deflation in vegetable prices in December bringing down headline inflation closer to the target, it is likely that the food inflation trajectory will shape the near-term outlook

• the Consumer Food Price Index reflected a gain of a mere 1.89% last month as vegetable prices saw a disinflation of 15.8% and cereal prices eased considerably for a second month in the wake of kharif crop arrivals.

• The RBI in its monetary policy statement this month, cited “the bumper kharif crop, rising prospects of a good rabi harvest, larger winter arrivals of key vegetables and softer egg and poultry demand on avian flu fears” as factors that augured well for the months ahead.

• The central bank was mindful of the risks too, especially with regard to food costs where the latest data had brought to the fore concerns over the prices of pulses and edible oils.

• While inflation in pulses and products was at 13.4%, that for oils and fats stood at 19.7%. Eggs and meat and fish two other key sources of protein both posted double-digit rates of 12.9% and 12.5%, respectively, with price gains in the former barely registering any telling impact from the avian flu outbreak.

What are the main causes of inflation?

• Inflation is a sustained rise in the general price level. Inflation can come from both the demand and the supply-side of an economy.

• It is two type, Demand-pull inflation and Cost-push inflation depend up on aggregate demand (AD and the aggregate Supply (AS) side of an economy.

• Demand-pull inflation occurs when aggregate demand (AD)is growing at an unsustainable rate leading to increased pressure on scarce resources and a positive output gap, when there is excess demand, producers can raise their prices and achieve bigger profit margins.

• Cost-push inflation occurs when firms respond to rising costs by increasing prices in order to protect their profit margins like, increase in the prices of raw materials, caused by wage increases, higher indirect taxes, Monopoly employers/profit-push inflation etc.

The worry/Challenge is the trend in input costs for multiple sectors:

• The base effect beginning to wane inflation moderated by more than 100 basis points in February 2020 to 6.58% before slowing to 5.84% in March the outlook is far from reassuring.

• The particular worry is the trend in input costs (Cost-push inflation) for multiple sectors in the real economy, including manufacturing.

• Which include from automobile manufacturers to builders, rising raw material costs are beginning to force them to pass on the impact to the end consumers, and this at a time when demand is still to gain a firm footing.

• The latest IHS Market India Manufacturing Purchasing Managers’ Index (PMI) points to the sharpest increase in purchasing costs for more than two years as ‘a lingering supply-side squeeze’ fanned inflationary pressures and manufacturers raised their product prices at the fastest pace in over a year.

• To the mix the unrelenting and dizzying climb in transportation fuel prices to newer and newer record highs in recent days and the outlook for inflation becomes distinctly darker.

• Diesel, the main fuel for freight carriage, has now exceeded ?80 per litre and is bound to feed into prices of almost everything being transported across distances from fresh produce to intermediate and finished industrial goods.

• With banks still flush with liquidity, policymakers need to maintain a strict vigil to keep inflation from resurging and posing a threat to macro-economic stability.

Conclusion:

• The experience with successfully maintaining price stability and the gains in credibility for monetary policy since the institution of the inflation targeting framework, barring the COVID-19 period, needs to be reinforced in the coming years.

• The outlook for core inflation is likely to be impacted by further easing in supply chains; however, broad-based escalation in cost-push pressures in services and manufacturing prices due to increase in industrial raw material prices could impart upward pressure

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