“What’s Driving Inflation in India: Understanding the Factors Behind Rising Prices” A Comprehensive Analysis

With or without a successful winter crop, the disinflation process is expected to be sluggish as recovering informal sector demand helps to restore manufacturers’ profit margins. RBI has its hands full.


Inflation in India

There is a puzzle here. The inflation rate for products is declining globally as input costs and demand decline. However the cost of things is increasing in India. Inflation in the services sector is still significant globally as there is still unmet demand for high-touch services. Inflation for services is declining in India. What is happening? We think a very Indian tale is about to emerge and has to be shared.

The beginning of it all was the decline in rural consumer expenditure in the latter half of 2021. During 2022, the monsoon rains proved unreliable, inflation picked up speed, and the March heatwave spread, resulting in a subpar harvest and a severe hit to rural earnings. Through the year, two-wheeler and consumer non-durables sales declined. Demand in cities increased throughout this period. Lockdowns ended, and urban jobs returned. Workers who had left for home during the pandemic era came back to the major cities. Wages increased by 2.5 times for every worker who relocated from rural to urban India. Stronger consumption was a result of higher incomes. In light of this, the rural demand deficit became even more apparent.

the climate changed. The reservoirs started to fill up in the final few months of 2022, and winter farm sowing increased. Agricultural salaries increased as more workers were required on the ground. In fact, once inflation was taken into account, they surpassed pre-pandemic levels. Other rural indicators also indicated higher revenues, such as the manufacturing of consumer non-durables, which increased quickly from October levels.

By the end of 2022, the change in labourers returning to the cities and the resulting growth stimulation were practically ended. After that, indices of urban demand, such the manufacturing of durable goods for consumers, started to decline. Fair enough, rural demand is just marginally increasing while urban demand is a little bit declining. Both are hardly dramatic. But it’s obvious that the cards are turning more slowly.

Similar developments are taking place in India’s informal economy, which employs around 80% of the country’s labour force, evenly split between agricultural and non-agricultural employees. The lockdowns and the rise in commodity prices were two consecutive economic shocks that affected businesses in the informal sector. We discover that small businesses underperformed large businesses during the epidemic, losing market share, turning a loss, and paying their employees less.

The informal small businesses suffered the most. The prospects for small businesses have been better in recent months as a result of ending the lockdowns and the spike in commodity prices from a year ago. High input costs are no longer as burdensome, and worker compensation at these companies are gradually increasing.

The production of non-durable consumer products is one evidence that suggests that informal sector incomes are rising. In one sense, we use the terms nearly interchangeably since there are substantial connections between the rural and informal sectors. First, around three-fourths of the informal sector employees in the nation reside in rural India. Second, a large portion of the food that rural Indians eat is made in the unofficial economy. But, it’s also crucial to remember that 25% of informal labourers are located in metropolitan areas of India, where their living standards are also rising.

How will the patterns of demand for goods and services in the rural and unorganised sectors change?

In rural areas, 20% of households are landowners (own more than one hectare of land). They rely heavily on agriculture for their livelihood. On the other hand, wages account for a large portion of the income for the 80% of households with landless status (holding less than one hectare of land). Their salaries are divided between agricultural work (which accounts for about 40% of households) and non-agricultural work (the remaining 40 per cent of households).

Every one of these groups was performing poorly up until six months ago. The 40% of households with agricultural wage earners are currently doing well. The 20% of landowners’ incomes will increase if the winter crop performs well and they sell their produce in the coming months for prices that are generally higher than the government’s minimum support prices (MSPs).

What will these households purchase, then? We discover that consumption in the rural and informal sectors is more heavily weighted towards commodities than services, as well as consumer non-durables over consumer durables. The primary cause of the overall products demand exceeding the demand for services is the rise in more goods-heavy demand from the rural and unorganised sectors.

Also, manufacturers are utilising this chance to increase profit margins following last year’s significant losses. This explains why retail inflation hasn’t decreased as much as wholesale inflation and why manufacturing profit margins are increasing more quickly than service provider profit margins. Most notably, it explains why the inflation rate for products is higher than that for services.

Many were shocked by the strong inflation reading for January of 6.5%. Food costs will probably continue to rise, especially for milk and wheat, as we wait for the winter crop, which is expected in March or April. But, even if the winter crop is successful, we are more concerned that the rural demand it fuels will prevent disinflation as producers continue to increase their margins, pushing core inflation.

However, even if rural incomes and core inflation decline, food inflation could remain high if the winter crop is weak as a result of last-minute weather interruptions, particularly now that temperatures have started to increase swiftly.

In any case, we anticipate inflation in FY24 to be greater than most people currently anticipate (the consensus of estimates). The rate-setting strategy of the RBI may be affected by this. We predict that the Fed’s activities, global inflation, and any potential pressure on the rupee will have a significant impact on the RBI’s rates during the next sessions. Moreover, domestic inflation may not offer much breathing room either, in our opinion. The point is well-made. Prepare for additional RBI rate increases over the upcoming months.

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