Under the shadow of Covid-19 pandemic, inflation bites India the hardest

Though inflation levels in India are incomparable with developed countries and emerging peers, the noticeable dip during lockdown that happened in most countries eluded India

Among the many ways in which Covid-19 has affected the economy, the most tangible outcome, the one that affects each and every person, is the impact on inflation. 

Even before the pandemic struck, consumer inflation had crossed the upper tolerance level of six per cent in December 2019. India was in a tight situation with inflation higher than the mandate, but economic growth falling fast to levels of three per cent, a rare low. 

But even into the pandemic, when inflation numbers in most countries eased, Indians did not see it going below six per cent, apart from the two months of April and May when the consumer price index was imputed from limited data. 

The chart below compares movement in monthly inflation numbers for nine countries including India, a few advanced economies (US, UK, Germany, and Japan), Asian and other emerging markets (China, Vietnam, Brazil, and Mexico). 

The intent here is to observe two things: one, the movement in inflation across the pandemic year through the lockdown and relaxation phases, and two, inflation in 2020 vis-a-vis the 2019 average in the respective country. The intent is not to compare inflation in India with that with other countries. 

Note that in each chart, the solid line represents monthly consumer inflation in that country in 2020, while the dotted line denotes the average monthly inflation in 2019. 

What we observe is that in most countries, the pandemic pulled inflation down for a short period, after which, it firmed up again in varying degrees across the nine countries. Only in Germany and Japan, deflationary conditions have sustained for a longer period, nonetheless meaning low inflation. 

India went through a different path. The dip in inflation in the initial months of lockdown (through imputed values) was minor, and the curve mostly appears flat rather than a partial 'V' or a smooth 'U'. 

Secondly, for most countries, the dip in inflation was such that inflation touched or went below the last year’s average inflation level. On this aspect, too, the Indian situation was different. In the entire year, Indians faced considerably higher inflation than in the previous year. 

According to Asian Development Bank’s analysis, the average inflation in developing economies in Asia would be around 2.9 per cent, quite lower than the range in which India’s inflation has hovered in 2020. 

Experts think that the lacunae in measurement of inflation, and the unknown or unexplained variables behind the supply constraints have kept inflation high. On the contrary, inflation in advanced economies has been “underestimated.”

Due to excessive weight to food products, the measurement of CPI is faulty if we account the changes in consumption pattern in the last decade, said Soumya Kanti Ghosh, chief economist at the State Bank of India.

“There has been no change in the CPI methodology as the consumer spending survey is not available after the 2011-12 version. Food products still command 46 per cent of the CPI basket, whereas it has been rightly revised to about 35 per cent in the new CPI-Industrial Workers series,” he said. 

As a result, the rise in food prices affects headline inflation disproportionately. 

“Even if we consider the current method as sacrosanct, a drop in consumption of services disturbs the balance in favour of food inflation, due to the model used to determine inflation,” said Ghosh. 

Sreejith Balasubramanian, economist at IDFC First Bank, said that apart from fuel prices and cost-push pressures, the crisis in the informal sector has probably a reason for high headline inflation. 

“Rather than supply bottlenecks, it is possible that the production itself has come down, especially those items manufactured and serviced by small informal enterprises,” he told Business Standard. 

Typically, these are the low value-adding items consumed daily by the majority of the populace. 

“Our analysis underlines high inflation in India, not just on a year-on-year basis, but also on a sequential, or month-on-month basis. Except for Brazil, and that too only in recent months, no other comparable country had a higher sequential growth in inflation than India,” said Balasubramanian.

Contemporary research has flagged the reasons for low inflation globally. 

In advanced economies, inflation during the pandemic has been underestimated, a research paper by Marshall Reinsdorf for the International Monetary Fund noted. 

“A price index will understate inflation if the items whose weights are too small have rapid price growth and the items whose weights are too large have below-average price growth,” it said. 

It said that rising food inflation has been under-measured, while falling transportation costs have been over-measured in some countries. 

So effectively, while changes in spending patterns resulted in low inflation rates in advanced economies, they resulted in high inflation numbers for India. 

The interesting bit is that inflation has stayed low or comparable to the 2019 average even as lockdown restrictions began easing towards the end of 2020. 

A special note for the IMF by Ehsan Ebrahimy and others finds that globally, measures of inflation “show no obvious pattern of an upward move.”

It found that headline as well as core inflation declined in advanced economies in the initial months of lockdown, after which, it recovered to a lower normal. 

Meat and dairy, which have shown a persistent high inflation in India in the pandemic period, have remained pricey after initial spikes in advanced economies as well. 

It also contends that inflationary pressures during a pandemic are more “manageable” as little physical capital gets destroyed, and demand improves only gradually, thus acting as a drag on any supply led inflationary pressures. 

But in India's case, supply pressures are so strong that inflation has remained high across the spectrum: muted demand during initial lockdown, pent-up demand during festive season, and even on the leeward side of the slight decline in pent-up demand.