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Shifting Dynamics in Indian Inflation

Context:

The Reserve Bank of India’s recent observations reveal a noteworthy shift in the dynamics of inflation in India, with supply and demand factors playing crucial roles. Over the period from January 2019 to May 2023, approximately 55% of the Consumer Price Index (CPI) headline inflation is attributed to supply-side factors, while demand drivers contributed 31%.

Relevance:

GS III: Indian Economy

Dimensions of the Article:

  1. Causes of Inflation in Recent Years in India
  2. Methodology for Assessing Inflation Causes
  3. Understanding Inflation: Definition and Impact

Causes of Inflation in Recent Years in India

Impact of Covid-19 Waves:
  • Supply disruptions during both Covid-19 waves were the primary contributors to inflation.
  • Pandemic-induced lockdowns led to a significant drop in production and demand, causing a sharp decline in economic growth.
  • Weakened demand during this phase also led to a reduction in commodity prices.
Reopening Challenges:
  • The reopening of the economy, coupled with vaccine distribution and pent-up demand release, resulted in a faster recovery of demand compared to supply.
  • This imbalance exerted upward pressure on commodity prices.
  • The Russia-Ukraine conflict in 2022 intensified supply chain challenges, compounding commodity price pressures.

Methodology for Assessing Inflation Causes

Monthly Shifts in Prices and Quantities:

  • Inflation’s nature is determined by unforeseen shifts in prices and quantities within a month.
  • Demand-driven inflation occurs when prices and quantities move in the same direction, while supply-driven inflation sees prices and quantities moving in opposite directions.

Supply-Driven Inflation Indicators:

  • Unexpected changes in prices and quantities moving in opposite directions indicate supply-driven inflation.
  • A decrease in supply linked with a lower volume but increased prices, and vice versa, characterizes supply-driven inflation.

Combining Demand and Supply Factors:

  • Assessing overall headline inflation involves combining demand and supply factors at the sub-group level using CPI weights.

Headline Inflation Measurement:

  • Headline inflation is a comprehensive measure of total inflation within an economy, encompassing volatile commodities like food and energy.
  • Calculated through the Consumer Price Index (CPI), it determines inflation by assessing the cost of purchasing a fixed basket of goods.

Understanding Inflation: Definition and Impact

Definition of Inflation:
  • Inflation, according to the International Monetary Fund, is the rate of increase in prices over a specified period, encompassing a broad measure of overall price increases or specific goods and services.
  • It signifies the rising cost of living, indicating the increase in the expense of a set of goods and/or services over a defined period, typically a year.
Impact of Inflation in India:
  • In India, the impact of inflation is particularly significant, given economic disparities and a large population.
Causes of Inflation:
  • Demand-Pull Inflation:
    • Occurs when the demand for goods and services surpasses their supply.
    • High overall demand in the economy prompts consumers to pay more for available goods and services, resulting in a general price increase.
    • A booming economy with substantial consumer spending can create excess demand, exerting upward pressure on prices.
  • Cost-Push Inflation:
    • Driven by an increase in the production costs for goods and services.
    • Factors such as increased incomes, rising costs of raw materials, or disruptions in the supply chain contribute to this type of inflation.
  • Built-In or Wage-Price Inflation:
    • Described as a feedback loop between wages and prices.
    • When workers demand higher wages, businesses may raise prices to cover increased labor costs.
    • Collective bargaining by labor unions can lead to higher wages, escalating production costs and subsequently causing higher prices for goods and services.

-Source: The Hindu


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