 "vegetable, household income, price, inflation")
Four shocks in the past four financial years have driven up price levels for both consumers and producers. These were the coronavirus pandemic, adverse weather conditions (excess and deficient rains, and heat waves), and two wars. Supply disruptions in the aftermath of each shock have caused prices to react.
For consumers, the price level today is 2.5 per cent higher than it would have been without the shocks. Simply put, this is the gap between the actual price level (consumer price inflation index) for fiscal 2024 and the estimated price level had these shocks not occurred.
Here, fiscal 2020 is treated as a pre-shock year. The estimated price level is calculated using the average inflation rate between fiscals 2014 and 2020. Though global oil and commodity prices tumbled in 2023, they have not come down below 2019 levels.
The average Brent crude oil price fell to $82.6/barrel (bbl) in 2023 from $99.8/bbl in 2022, but now stands $18/bbl higher than in 2019. Likewise, global metal prices dropped in 2023 but are nearly 30 per cent higher than in 2019.
In response to the shocks, economies have stabilised at price levels higher than originally expected. In India, alongside the impact of higher global oil and commodity prices (albeit with some relief from buying Russian oil), incessant weather disturbances also pushed up food prices, driving the inflation index above its pre-shock path or trend.
Yet, India remains an exception as the actual consumer price index has exceeded the pre-shock path by a relatively small margin – only 2.5 per cent. In contrast, the consumer price index level in the United States (US) and Eurozone are 12-13 per cent higher than their pre-shock path.
Further, core inflation has decelerated sharply in India, while remaining sticky in the US and the European Union (EU). Core inflation is calculated by excluding volatile food and fuel components, providing an indication of price pressures arising from strong demand or demand-led inflation. This implies that prices accelerated despite sluggish demand, especially from consumers.
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The situation is different in the US and the EU, where substantial stimulative policy measures, including direct transfers, were employed during the pandemic. These interventions bolstered consumer demand, and their effects are now evident in sticky inflation, notably core inflation (headline excluding food and fuel).
In contrast, fiscal support in India has predominantly focused on boosting public investment.
By fiscal 2024, only fixed investment, led by the government, has exhibited full recovery among the components of gross domestic product. The emphasis on public investment, particularly in infrastructure, continues, and a gradual increase in private-sector investment over time should alleviate supply bottlenecks in the economy.
This approach of triggering an investment-led recovery, rather than one led by consumption push, has ensured that demand-driven inflation (or core inflation) stays under control.
For the latest reading, India’s core inflation stood at a 52-month low of 3.4 per cent in February. It has declined for 13 consecutive months now. In comparison, US core CPI inflation came in at 3.8 per cent for February, higher than headline inflation of 3.2 per cent. In India, a tighter monetary policy – since October 2021 when excess liquidity began draining out of the system, followed by rate hikes from April 2022 – has kept demand-side pressures on core inflation under check.
Without coordinated fiscal policy actions, core inflation could have posed a challenge for India as well. An article in the March 20+24 issue of the Reserve Bank of India (RBI) Bulletin by Nishant Singh and Binod Bhoi examined the potential relationship between the size of the fiscal stimulus and inflation.
The article investigated the impact across countries of varied pandemic-infused fiscal expansions on inflation, while adjusting for supply-side factors. It concludes that economies with larger fiscal expansions experienced higher post-pandemic inflation on average.
For India, the nature of fiscal expansion and the early adoption of fiscal consolidation alongside the RBI’s monetary policy actions have been key in managing core inflation.
India’s coordinated approach to policy actions has not only improved the predictability of monetary policy measures but also ensured financial stability. In fiscal 2024, had it not been for the food price shocks, headline inflation would have glided further down.
We believe the disinflation path will continue in fiscal 2025, such that CPI inflation could ease to an average of 4.5 per cent, from around 5.4 per cent this fiscal. Non-food inflation will remain benign due to low global prices and some softness in domestic demand. Meanwhile, food prices should moderate, supported by the assumption of normal monsoon, an expected downcycle in pulses inflation, and a high base effect.
Easing inflation, a smaller fiscal deficit and an imminent turn in the US Federal Reserve’s policy rates create grounds for policy rate cuts in India. That said, persistently high food inflation could delay the move until there is clarity on rabi output (harvested in April and May) and the signal on forthcoming southwest monsoons by June.
The writer is principal economist at CRISIL Limited.
These are the personal opinions of the writer. They do not necessarily reflect the views of www.business-standard.com or the Business Standard newspaper.
