GS paper 3: Issues related to planning, Mobilization of resources, Growth and Development
Prelims level exam: Inflation, CPI, WPI
Mains level exam: RBI efforts to contain inflation
The CPI-based inflation is above 7 per cent for the third consecutive month and above the RBI’s 6 percent upper tolerance target for the sixth month.
What does recent retail inflation data shows
• The concerted efforts made by the Reserve Bank and the Union government to contain inﬂation appear to be having some impact, albeit marginal, in slowing the pace of price gains, the latest retail inflation data show.
• Price gains as measured by the Consumer Price Index (CPI) eased almost imperceptibly to 7.01% in June, from May’s 7.04%, with food price inﬂation slowing by a distinct 22 basis points to 7.75%.
o Of the 12 items comprising the food and beverages basket, almost half the weight of the CPI, the prices of pulses and edible oils both shrank from a month earlier.
o Prices of the key cooking medium, which had been on a boil amid a supply shock (from Ukraine and Indonesia), have cooled, helped by import duty reductions.
• Year on year inﬂation in oils and fats decelerated last month by a whopping 390 basis points to 9.4%, with the index shrinking 0.7% on a sequential basis.
o And prices of pulses contracted both from a year earlier and the preceding month.
• The other major positive sign of a policy measure translating to softer prices was with transportation fuels.
o The Centre’s reduction of excise duty on petrol and diesel in May manifested in a signiﬁcant easing in inﬂation in the transport and communication index: year on year, the rate slowed by 260 basis points to 6.9%, while sequentially it shrank by 120 basis points.
Case of USA
• U.S. consumer prices surged 9.1% in June, the largest increase in more than four decades amid stubbornly high costs for gasoline, food and rent, cementing the case for another 75 basis point interest rate increase by the Federal Reserve this month.
• The larger than expected increase in the year on year consumer price index reported by the Labor Department also reflected higher prices for healthcare, motor vehicles, apparel as well as household furniture.
• Many experts have also said that high inflation in the US has warranted another rate hike at the upcoming Federal Open Market Committee (FOMC) meeting. FOMC is a Federal Reserve committee that decides US interest rates.
• Its effect on india: This will impact India in three possible ways:
o Firstly, India would become a less attractive destination for the currency carry trade as the differential interest rate between India and US is narrowing.
o Second, higher returns in the US debt markets could also trigger a churn in emerging market equities, which will dampen the spirit of foreign investors’ from investing in India.
o Third, this will have a potential impact on currency markets, because of the outflows from Indian equity and debt markets.
• Already, in the case of India, nine consecutive months of selling by FPIs is weighing upon the Indian rupee amidst expectation of widening of CAD to $105 billion in FY23 from $39 billion in FY22. Overall, a bullish dollar backdrop and expectation of a BoP deficit of 1 percent of GDP could continue to keep rupee under moderate pressure. Experts expect the rupee to depreciate towards 81 levels before the end of FY23.
What lies ahead
• It would be way too premature for policymakers to drop their guard.
o With nine of the 12 items in the food and beverages basket, representing almost 80% of the sub index and spanning cereals, milk and meat to vegetables, sugar and spices, experiencing sequential price gains, the Government would need to maintain vigil to ward oﬀ any buildup of inﬂationary pressures in consumers’ kitchens.
• Year on year inﬂation in cereals, meat and milk all accelerated in June from May’s pace, and price gains in vegetables still remained in double digits at 17.4%.
• The progress of monsoon rains give hope that the prices of farm produce may moderate in the coming months, provided the extreme rainfall and flooding seen in some States does not adversely hit crop growing regions.
• And while an appreciable softening in global crude oil prices in recent sessions oﬀers some respite, the rupee’s sharp depreciation against the dollar means India will continue to face the spectre of ‘imported inﬂation’ as the bill for imports, including crude, keeps rising.
• The decision of the GST Council to raise tariﬀs on a range of goods including some items of mass consumption is also bound to add upward pressure on prices.
• Finance Minister Nirmala Sitharaman’s remarks reﬂect authorities’ recognition that any let up in the ﬁght against inﬂation risks undermining growth and broader macroeconomic stability.
Imported inflation may be set off by foreign price increases, or by depreciation of a country’s exchange rate.
• Imported inflation is a general and sustainable price increase due to an increase in costs of imported products. This price increase concerns the price of raw materials and all imported products or services used by companies in a country. Imported inflation is also referred to as cost inflation.
• Imported inflation is also caused by a decline in the value of a country’s currency. The more the currency depreciates on the foreign exchange market the higher the price of imports. Effectively, more money is needed to buy goods and services outside the country.
• With imported inflation, production costs are higher for companies. These companies most often reflect this increase in the selling price of the goods and services sold. As a result, prices within the country rise. Imported inflation causes inflation.
• Let’s take the example of a French company that manufactures cotton clothing. To be able to manufacture these garments, the company must buy cotton from abroad, as France is not a cotton producer. It therefore imports cotton paying with Euros. If the value of the euro falls against the currency of the cotton exporting country, it must pay more euros to obtain supplies. To keep its margins, the company then decides to increase the selling price of its clothing in France. This is then imported inflation, as the selling prices of clothing sold in France have increased due to an increase in production costs.