Inflation has been at a worryingly high level for the last four months- wholesale price index (WPI) has been above 10% and the Consumer Price Index (CPI) crossed the 6% mark in June, well above the Reserve Bank of India’s (RBI) tolerance band. This is happening at a time when demand is low, unemployment is high, many people have lost their income and poverty has increased. So, why is there high inflation and do the official figures capture the real picture?
data issues
The production and price data could not be collected due to the strict lockdown in April and May 2020. The unlock started gradually in June and July 2020 but normalcy did not return. Therefore, the current data on prices for April to July 2021 are not comparable with the same months of 2020. As such, the official inflation figures for these months in 2021 do not reflect the true picture.
Anyway, the same number for inflation aggregates across different goods and services – the price increases for different items of consumption are different. Therefore, a single number is obtained by weighting the various goods and services. For WPI, weighting is used in production; For CPI, the consumption basket is used. But people are not identical. The consumption basket is very different for the poor, middle classes and rich. Therefore, the CPI is different for each of these classes and a composite index requires the average of the baskets. So, in a sense, it does not represent any category.
During the lockdown and unlock in 2020, people consumed essential things on a large scale. RBI data show consumer confidence fell from 105 in January 2020 to 55.5 by January 2021. This means that even when the economy officially began to grow, consumer confidence had not returned. Employment and income were still low and according to one report 23 crore people have slipped below the poverty line. This means that the consumption basket for different sections of the population has changed. Even if there is little change in the consumption patterns of the affluent classes, the poor and middle classes, especially those who have lost jobs and income, will have to cut back on their consumption. Thus, the weighting in the CPI would have changed and inflation would need to be recalculated, but this has not been done. Consumer confidence declined to 48.6 in July 2021 due to the impact of the second wave of COVID-19.
Additionally, inflation figures under-represent services in the consumption basket. In production, services account for about 55% of GDP but have no representation in the WPI and about 40% in the CPI. We know that health costs have increased during the pandemic, but is it recorded in the inflation data? Similarly, the cost of education has also increased with the need for mobile phones, laptops and Wi-Fi. Many services were not used. Eating out and traveling, for example, should have been outside.
In short, the shock of the lockdown not only made data collection difficult, but the consumption basket should have been changed to calculate the CPI.
Inflation has loosened the pockets of the consumers. If the rate of inflation is 10%, then a person has to spend 10% more to buy the same quantity of things as compared to the previous year. If a person’s income also increases by 10%, inflation doesn’t matter. But if a person’s income increases by less than 10%, their budget is adversely affected. For the middle class, both consumption and savings of less essential goods are reduced. But the poor, who barely save, have to cut back on essential consumption.
In India, 94% work in the unorganized sector and mostly earn low income and save very little. By definition, they cannot bargain for higher incomes as prices rise, and become vulnerable to inflation. Moreover, due to the lockdown, the wages of many people in both the unorganized and organized sectors have declined. This has had an impact on his family budget.
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As a result, there has been a fall in demand not only for non-essentials but also for essentials. In a vicious circle, it is slowing economic recovery and job creation. Moreover, it affects the revenue of the government and increases the budgetary deficit. This puts pressure on the government to cut budgetary expenditure, especially on the social sector. This increases poverty and further reduces demand. Thus, inflation in times of low demand and low income leads to a vicious cycle of slowing down the economy and increasing distress in the lives of the poor and unemployed, most of whom belong to the unorganized sector and some to the organized sector.
Inflation Underlying Factors
The government has increased taxation on energy to mobilize resources. As energy is used for all production, the prices of all goods and services rise and increase the rate of inflation. Moreover, it is an indirect tax, it is regressive and affects the poor more. It also makes the RBI’s task of controlling inflation difficult.
The lockdown disrupted supplies and led to shortages and price rise. The prices of drugs and medical equipment increased dramatically. The prices of items of daily consumption also rose. The prices of fruits and vegetables increased because these commodities did not reach the urban markets. Their prices fell in rural areas but rose sharply in urban areas. Since the competition from the unorganized sector reduced, the big traders raised the prices. And despite the lower wage bill, they raised prices, as reflected in a sharp increase in corporate sector profits.
International factors have influenced the prices. Most major economies have recovered and demand for inputs has increased while supply has remained constrained (such as chips for automobiles). Therefore, commodity and input prices have risen (as in the case of metals). The business claims that the increase in input cost reduces the price increase. Due to the depreciation of rupee, inflation also increased.
In short, the current official inflation rate does not accurately measure price growth as the lockdown has dealt a blow to the economy. It required modification in the method of calculation. Loss of income and rise in prices have dealt a double blow to many non-rich. This is slowing down the growth spurt due to a decrease in demand.
Arun Kumar is the Malcolm Adisheya Chair Professor, Institute of Social Sciences, and author of IThe biggest crisis of the Indian economy: The impact of coronavirus and the way forward
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