Is Indian inflation a concern for our policy makers?

The key issue here is how core inflation is measured. The overall CPI gives us headline inflation—the average across everything in the consumer basket. But since the 1973 oil price hike, leaving the two classes of goods traded internationally, and subject to globally driven supply volatility due to weather (food), also looking at a subset of that basket considered prudent. Or cartel (fuel). The residual is called ‘core’ inflation, which captures the inflation-generating dynamics in the domestic economic system.

Headline and core inflation are not unrelated. An increase in food prices (for example due to the uncertainty of the weather currently in October) can lead to increased demand for wages and hence increase the core. These relationships are not stable or predictable. However, at any given time, title and original are different measures that give useful information.

The standard measure of basic inflation in India removes two sub-groups: food and beverages (with 45.86% weighting), and fuel and light (6.84%). This leaves the core with a residual weight of 47.3%. The core weight can be further increased by reducing the food sub-group, but I’ll deal with that in the end.

The physical result is what goes into the fuel and light subsamples. Its item-wise components include fuel used only for cooking and lighting (gas, kerosene). It does not include transport fuels (petrol, diesel), which therefore go to the origin through the transport segment of the diverse sub-group. Petrol and diesel should not have been included in the correctly calculated core. As of calendar 2021, international fuel prices were benign. Once international oil prices started rising, the recalculation of the core was not something I could really postpone.

In the four months of June to September 2021, petrol inflation averaged 23.63% annually and diesel inflation averaged 23.98%. The average for the same months in 2019 stood at -8.08% for petrol and -5.78% for diesel. These are wildly volatile, and this is why the push to measure headline inflation from these volatile products first gained global popularity. Yes, there is a huge tax element in the prices of petrol and diesel, but the point is that these fluctuations reflect what has happened to the international price of oil without any compensatory shortfall in domestic taxes.

The Reserve Bank of India has taken note of this, and the previous two monetary policy reports for April and October have provided alternative estimates of core inflation after excluding petrol and diesel from the core. However, there are some elements that must be connected to the core at the same time, and one such is electricity (from the fuel and light sub-groups). Unlike more developed countries, where the price of electricity can vary with the price of any fuel, and is therefore theoretically volatile, electricity prices in India are regulated and remain stable for long periods.

As shown above, from June to September 2021 when international fuel prices were boiling, electricity price inflation averaged 3.38% annually. From May to September 2019, electricity averaged -0.06%, when petrol and diesel were falling sharply. Of course, what is measured in CPI is electricity purchased through the grid. Small-scale diesel-generated power, an option used by mixed small enterprises when grid supply fails, will basically reflect the price of diesel, but requires a more complex estimation process to work out.

Excluding direct consumption of petrol and diesel, and including electricity, the core weight is 46.35%, while the adjusted load is 47.3%. Adjusted for September 2021, core inflation is 5.12% (versus 5.89% unadjusted), and has held steady at 5.09% on average during June to September.

Finally, the official CPI is accompanied by the Consumer Food Price Index (CFPI), which excludes prepared foods from the food sub-sector. If we include prepared foods with the fuel adjustments described above, its weight rises to 53.15%, and core inflation rises to 5.37% in September 2021 – and has remained stable there for four months. This is higher because prepared foods currently run at inflation rates close to 7%, reflecting the closure of the small-scale units that dominate the sector, as well as the cost-push effect of diesel-generated electricity. also shows. grid.

Improved grid supply through power sector reforms, and activating small units is the key to reducing core inflation, and will re-employ the skilled workforce already employed in those units.

As far as non-cores are concerned, inflation in oil and primary commodities is likely to remain subdued for some time due to shortage in shipping containers and several other global supply-side disruptions.

Indira Rajaraman is an economist