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Inflation

  • IASbaba
  • May 20, 2022
  • 0
Economics
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Context: Since the start of the inflation-targeting regime of RBI, most of the focus has been on consumer price inflation. That’s because that is the inflation rate that RBI seeks to target and keep at the 4% mark. But over the past year, the inflation in wholesale prices has been surging in a rather unprecedented manner.

  • Since April last year, WPI (wholesale price index) based inflation has been above 10% in every single month.
  • In April 2022, WPI inflation crossed another psychological mark: it went beyond 15%.

With such high levels of headline inflation, it is clear that most components of WPI are witnessing high inflation.

What’s fuelling WPI inflation?

  • While the highest inflation has been in fuel prices, it is the smallest contributor to the overall index (Much before the Ukrainian crisis).
  • While manufactured product inflation is the least, it is likely to have had almost six times the impact on the overall inflation because of the weight.
  • The heatwave led to a spike in prices of perishables such as fruits, vegetables and milk, which along with a spike in tea prices pushed up the primary food inflation.
  • Much of the inflation spike is being seen as a result of the Russia-Ukraine conflict, with the contribution in retail inflation being seen at three-fourths of the index.

What next?

An increase in WPI-food inflation leads to higher food prices for consumers as well. With WPI inflation remaining in double-digits, the probability of a repo hike in the June monetary policy has risen further.

  • One can expect retail food prices to possibly increase further simply on account of higher food inflation in the wholesale market.
  • Higher retail prices of food tend to spike wholesale food prices in turn. In other words, one can get into a vicious cycle if inflation is left unaddressed.
  • Imported inflation in the form of high energy and commodity prices is a fact of life, and it will continue to force RBI to take action. High WPI inflation will further convince RBI to raise interest rates and do so urgently.
  • Tough Act for RBI:
  • The flip-side of raising interest rates sharply, however, is that they will dampen the overall demand in the Indian economy at a time when overall consumer demand is still fledgling.
  • The RBI, thus, has a tough balancing act to perform: contain inflation (especially from sources over which it has no control, such as high fuel prices) while ensuring not snuffing out domestic economic recovery.

Some of the likely impacts of inflation:

  • Reduces people’s purchasing power: Restrict people’s ability to purchase things, but coupled with reduced incomes and job losses, households would struggle even more. The poor are the worst affected because they have little buffer to sustain through long periods of high inflation.
  • Reduces overall demand: The eventual fallout of reduced purchasing power is that consumers demand fewer goods and services. Typically, non-essential demands such as a vacation get curtailed while households focus on the essentials.
  • Harms savers and helps borrowers: High inflation eats away the real interest earned from keeping one’s money in the bank or similar savings instruments. Earning a 6% nominal interest from a savings deposit effectively means earning no interest if inflation is at 6%. By the reverse logic, borrowers are better off when inflation rises because they end up paying a lower “real” interest rate.
  • Helps the government meet debt obligations: In the short term, the government, which is the single largest borrower in the economy, benefits from high inflation. Inflation also allows the government to meet its fiscal deficit targets. Fiscal deficit limits are is expressed as a percentage of the nominal GDP. As the nominal GDP rises because of inflation (without necessarily implying an increase in overall production), the same amount of fiscal deficit (borrowing) becomes a smaller percentage of the GDP.
  • Mixed results for corporate profitability. In the short term, corporates, especially the large and dominant ones, could enjoy higher profitability because they might be in a position to pass on the prices to consumers. But for many companies, especially smaller ones, persistently higher inflation will reduce sales and profitability because of lower demand.
  • Worsens the exchange rate: High inflation means the rupee is losing its power and, if the RBI doesn’t raise interest rates fast enough, investors will increasingly stay away because of reduced returns.
  • Leads to expectations of higher inflation: Persistently high inflation changes the psychology of people. People expect future prices to be higher and demand higher wages. But this, in turn, creates its own spiral of inflation as companies try to price goods and services even higher.

Consumer Price Index

  • A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care.
    • FOOD ITEMS, which account for 46% of the index;
    • FUEL & LIGHT, with a weight of 7%;
    • CORE, all other items, which make up the remaining 47%.
  • It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them.
  • Changes in the CPI are used to assess price changes associated with the cost of living;
  • The CPI is one of the most frequently used statistics for identifying periods of inflation or deflation.
  • Headline inflation is calculated using the Consumer Price Index.

In the current financial year, it is estimated that all three components will experience an inflation rate of 6% or more.

Wholesale Price Index (WPI)

  • WPI measures the changes in the prices of goods sold and traded in bulk by wholesale businesses to other businesses. In other words, WPI tracks prices at the factory gate before the retail level.
  • The numbers are released by the Ministry of Commerce and Industry
  • Even as the WPI is used as a key measure of inflation in some economies, the RBI no longer uses it for policy purposes, including setting repo rates.

Difference between WPI & CPI?

  • WPI, tracks inflation at the producer level and CPI captures changes in prices levels at the consumer level.
  • Both baskets measure inflationary trends (the movement of price signals) within the broader economy, the two indices differ in which weightages are assigned to food, fuel and manufactured items.
  • WPI does not capture changes in the prices of services, which CPI does.

Headline Retail Inflation vs Core Inflation

  • Headline inflation is the raw inflation figure reported through the Consumer Price Index (CPI) that is released by CSO. The headline figure is not adjusted for seasonality or for the often-volatile elements
  • Core inflation removes the CPI components that can exhibit large amounts of volatility from month to month, which can cause unwanted distortion to the headline figure. The most commonly removed factors are those relating to the cost of food and energy.

Previous Year Questions (PYQs)

Q.1) Consider the following statements in respect of the Laureus World Sports Award which was instituted in the year 2000:

  1. American golfer Tiger Woods was the first winner of this award.
  2. The award has been received mostly by ‘Formula One’ players so far.
  3. Roger Federer received this award the maximum number of times compared to others.

Select the correct code:

  1. 1 and 2 Only
  2. 2 and 3 Only
  3. 1 and 3 Only
  4. 1, 2 and 3

Source: Indian Express

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