What December inflation data tells us, what it means for budget, monetary policy
Context- The most recent official announcement reveals that India’s inflation rate, based on the Consumer Price Index (CPI), reached 5.7% in December. Although this is a standard monthly update, its timing is crucial for several reasons.
Firstly, in terms of fiscal policy, this is the final inflation data published before the Union Budget is presented on February 1. Secondly, regarding monetary policy, this will be the latest data that the Reserve Bank of India’s Monetary Policy Committee has at its disposal before it reconvenes later in February. Finally, as this is the inaugural release in an election year, it may carry more political weight than usual.
What is CPI inflation?
- The Consumer Price Index (CPI) inflation is the rate of inflation experienced by consumers. It differs from the primary inflation indicator, the Wholesale Price Index-based inflation rate.
- The CPI measures changes in the general price level of a basket of selected goods and services that households consume, as per the Ministry of Statistics and Programme Implementation (MoSPI). The current CPI basket at the all-India level includes 299 items. In addition to an overall index, separate consumer price indices are also compiled for rural and urban consumers.
How is it calculated?
- The current series of indices uses 2012 as the “base year”, meaning the price index is set at 100 for this year, and subsequent changes in price levels are calculated from this base to determine inflation rates for each product or service.
- The National Statistical Office, part of the MoSPI, gathers monthly price data from 1181 villages and 1114 urban markets across the country. This data is collected weekly by the NSO’s field staff.
What are its components?
- The Consumer Price Index (CPI) is composed of six main categories, each with different weights and numerous sub-components. These categories are: Food and beverages, Pan, tobacco and intoxicants, Clothing and footwear, Housing, Fuel and light, and Miscellaneous services such as education and healthcare.
- Food articles, which make up 54% of the total index, have the most significant weight. Within the food category, cereal prices are the most influential, accounting for 12.4% of the total CPI.
- Therefore, a rise in food prices, especially cereals, vegetables, milk, and pulses, can significantly increase consumer inflation. This high weighting for food articles is due to the substantial portion of income that most Indian consumers spend on food.
What does the data show?
- The inflation rate can be analyzed in two ways. The first method is the year-on-year increase, which compares the price level of a particular month (like December) with the price level of the same month in the previous year.
- This is the most commonly used inflation rate. The second method is the month-on-month change, which compares the prices of a particular month with the prices of the preceding month.
- The data indicates that the Year-on-Year (YoY) inflation rate began to rise towards the end of 2023, while the Month-on-Month (MoM) data showed deflation in December, meaning prices fell from one period to another. This is different from disinflation, which is a slowdown in the inflation rate.
- The YoY inflation increase in December was largely due to a spike in food prices. Specifically, vegetable prices rose by nearly 28%, pulses by 21%, spices by 20%, and cereals by 10%.
- These four food groups, which make up 23% of the total index weight, significantly contributed to the overall inflation rate. However, inflation rates varied across the country, with Odisha recording the highest at 8.7% and Delhi the lowest at 2.9%.
What is the significance?
- Looking forward, most analysts, including Dipti Deshpande of CRISIL, anticipate a decrease in the inflation rate in the upcoming months due to the Kharif harvest and government interventions reducing food inflation.
- Overall, the inflation for the entire financial year is projected to be 5.5%, with the inflation rate in March 2024 expected to be at 5%.
- Moreover, despite the changes in headline inflation, the core inflation rate, which excludes food and fuel inflation, has been on a downward trend.
- The recent inflation data is likely to postpone the reduction in interest rates, affecting EMIs. While there were expectations of the Reserve Bank of India (RBI) cutting rates as early as April, the rise in inflation in November and December makes it unlikely for the RBI to cut rates before August.
- The RBI believes that food shocks can have secondary effects that hinder policy goals, leading to a potential minor rate cut only from August 2024, according to Indranil Pan, Chief Economist of Yes Bank.
- Higher inflation is unfavorable for fiscal policymakers due to its political implications close to elections and the uncertainty it brings to budget planning.
Conclusion- The recent rise in India’s inflation rate, driven primarily by an increase in food prices, has significant implications for both monetary and fiscal policies. The anticipated reduction in interest rates may be delayed, and the uncertainty surrounding inflation poses challenges for budget planning.
While analysts predict a decrease in inflation in the coming months due to factors like the Kharif harvest and government interventions, the exact trajectory remains uncertain. As such, the inflation rate continues to be a critical economic indicator to monitor, particularly in an election year.