The National Statistical Office, this February 14th, released data on the Consumer Price Index (CPI) based inflation rate that rose to 6.01% in January 2022, whereas it was 5.66% in December 2021. This was also the highest recorded in the last seven months. Food inflation went up to 5.43% from 4.05% in January. Though this may not be alarming, it does indicate that the common man could be hit harder in times to come.
The rise in inflation rate appears to be a Global phenomenon. In the United States, it rose by 7.5% and in Europe, to 5% in December 2021.
So, what exactly is CPI? It generally indicates how the prices of the consumer goods and services have been varying and hence the inflation. First a sample of representative items are taken whose prices are collected periodically. Sub-indices are computed for different categories and sub-categories of goods and services such as transportation, food, and medical care. They are combined to produce the overall index with weights reflecting their shares in the total consumer expenditures covered by the index. Whereas it also accounts for the real value of wages, salaries and pensions, its annual percentage change is used to measure inflation.
It is important to estimate the inflation rate as it indicates the increase in the cost of living. The RBI said it was more due to unfavourable base effect. The base effect comes in focus when different reference points are chosen for comparison between two data points. However, it also may be due to an unwillingness to see more closely the happenings on the ground.
Still, should we be concerned about the rising prices? Will they further rise to our discomfort? Our household budgets have been impacted. We have been paying higher utility bills and higher prices for vegetables. It also means we are saving less.
Are there some real reasons for the rise in inflation? The increase that we are seeing has been in the entire globe. It must be attributed to the expansionary fiscal and monetary policies of almost all the governments of the world, in the wake of the Covid 19 Pandemic. Big stimulus packages probably are driving the inflation.
To set the context, India allocated 1.7 trillion rupees or $22.5 billion towards an economic stimulus package. This would be disbursed through food security measures for poor households and through direct cash transfers. Daily wage earners, small business owners, low-income households like the small farmers, rural workers, poor pensioners, construction workers, low-income widowers were the most vulnerable during the lockdown.
The current inflation may also be driven by supply bottlenecks due to the unprecedented pandemic curbs as our factories were closed with workers unable to report for work. The shutdowns led to shortfalls in raw materials, impacting other industries. We all know how the semiconductor shortages affected the production of automobiles raising their prices. Even the freight rates increased due to port disruptions and unavailability of shipping containers. All this led to rise in production costs and a consequent rise in prices.
It was prudent that the government adopted an expansionary fiscal policy that included tax cuts, transfer payments, rebates and increased government spending on projects such as infrastructure improvements. Fundamentally there was lowering of short-term interest rates and expansion of money supply. However, expansionary fiscal policy can result in rising interest rates, growing trade deficits, and accelerated inflation due to higher demand. Still the government has done well to contain the fiscal deficit in FY22 to 6.6% of GDP even as it manged to keep the interest rates fairly low. Consequently, households and SMEs were incentivised to borrow freely and invest in expansion.
Hence, what the pandemic has done is to see that a lot of money and liquidity was flowing worldwide. This has allowed investors to search proactively for good yields and income which led to huge capital inflows in many countries. It is projected that the India Capital Flows will be around 110.00 USD Million in 2023 and 7.93 USD Million in 2024 as per a few global econometric models.
The construction industry that grew 11% in 2010-15 and 9% in 2015-20, and thriving, was in the dumps due to the pandemic. The real estate sector was hit very badly in the last couple of years. High interest rates and low economic growth of the past decade saw that the once booming sector declined and fell to new lows. This saw many, even the large players sit on large piles of inventories. Construction made when the going was good resulted in excess supply. With the pandemic now turning endemic and the economy picking up, we will once again see these assets surge in demand with an increase in their prices. Demand for houses will always rise if property is seen as a stable, appreciating asset. The phenomena is expected to have a domino effect on other aspects of the economy. To offset such happenings, measures such as a higher additional buyer’s stamp duties on subsequent property after the first, and tighter limits on loans may be required. Probably over time the RBI may need to bring in rates and policies to slowdown the asset price inflation.
Will we see GST rates rising amid inflation and rising costs of living? What are our inflation expectations? Will we see more price rises in the future? Will we buy more and spend more? The Pandemic has certainly changed our consumption patterns. We shopped online and used all those food delivery apps which we never used in the past. We are now more conscious of our personal well-being and spend more money to purchase items like the face masks and hand sanitisers. We spent money on electronic devices and comfortable chairs as we worked from home. As we move into a new norm post pandemic, our expectations may change once again pushing the inflationary trends.
A research study reports that when households are exposed to better quality products, they report higher inflation expectations. Would our inflation expectations result in even higher inflation rate? Our workers may ask for higher wages and industries may increase their prices. All this would raise the inflation rate further.
Though the RBI and the government are doing a great job containing inflation, managing inflation may be more challenging this time round with a large amount of cash and small supply of goods.