Context

Inflation for the last four months has been worryingly high. This is happening at a time when demand has been down, unemployment has been high, many have lost incomes and poverty has aggravated.

Issues with the recent inflation data

• The shock of lockdowns not only made data collection difficult but the consumption basket for calculating CPI should have been changed.
• Issue with the base: In April and May 2020, data on production and prices could not be collected due to the strict lockdown.
• As such, the official inflation figures for these months in 2021 do not reflect the true picture.
• For calculating inflation, a single number is arrived at by assigning weights to different commodities and services.
• Issue due to different consumption baskets: For WPI, the weights in production are used; for CPI, the consumption basket is used.
• The consumption basket is vastly different for the poor, the middle classes, and the rich.
• Hence, the CPI is different for each of these classes and a composite index requires averaging the baskets.
• So, in a sense, it represents none of the categories.
• Changed consumption pattern: During lockdown and unlock in 2020, people largely consumed essentials.
•  RBI data show that consumer confidence fell drastically from 105 in January 2020 to 55.5 by January 2021.
• While the consumption pattern of the well-off sections may have changed little, the poor and middle classes, especially those who lost jobs and incomes, would have had to cut back on their consumption.
• Thus, the weights in the CPI would have changed and inflation required recalculation, but this has not been done.
• Under-representation of services: Inflation data under-represents services in the consumption basket.
• In production, services are about 55% of the GDP but have no representation in WPI and about 40% in CPI.
• Increased health and education cost not captured: Health costs and education costs shot up during the pandemic, but this is not captured in inflation figures.
• Many services were not used. Eating out and travel, for instance, should have been factored out.

Impact of the inflation

• If the income does not increase in proportion to inflation, for the middle classes, both consumption of less essential items and savings get reduced.
• But the poor, who hardly save, have to curtail essential consumption.
• Decline in demand: In India, 94% work in the unorganised sector and mostly earn low incomes and have little savings.
• By definition, they cannot bargain for higher incomes as prices rise, further, due to lockdowns, the wages of many declined, both in the unorganised and organised sectors.
• Consequently, demand has declined not only for non-essentials but even for essentials.
• Impact on employment generation: In a vicious cycle, this is slowing down economic recovery and employment generation.
•  Further, this impacts the government’s revenues and tends to increase the budgetary deficit.
• This puts pressure on the government to cut back budgetary expenditures, especially on the social sector.
• That aggravates poverty and reduces demand further.

Factors leading to inflation

• Tax on fuels: Increase in tax on fuel push up the prices of all goods and services.
• This is an indirect tax, it is regressive and impacts the poor disproportionately more.
• It also makes the RBI’s task of controlling inflation difficult.
• Supply bottlenecks: The lockdowns disrupted supplies and that added to shortages and price rise.
• Prices of medicines and medical equipment rose dramatically.
• Prices of items of day-to-day consumption also rose.
• International factors: Most major economies have recovered and demand for inputs has increased while supplies have remained disrupted (like chips for automobiles).

Consider the question “What are the issues with measurement of inflation data in India? How inflation in times of low demand and reduced incomes leads to a vicious cycle?”

Conclusion

The current official inflation rate does not correctly measure price rise since the lockdown administered a shock to the economy. The method of calculating it needed modification.

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