There are several aspects of the latest retail inflation numbers for July that need to be dissected – besides the obvious fact that it is driven by food prices and that the reading of 7.44 per cent is the highest since April 2022. The inflation is genuinely high because it comes on a high base — the reading for the same month last year was 6.7 per cent. The inflation projections of the Monetary Policy Committee for the second quarter and the entire fiscal could be overshot. Indeed, for Q2 estimates of 6.2 per cent to come true, the months of August and September will have to report an average reading of 5.6 per cent, a tall order given that a weak monsoon in many parts of the country is likely to exert pressure on food prices. However, core inflation (excluding food and fuel) is at 5.1 per cent, an indication that inflation expectations have been curtailed.
The MPC is right in choosing to ‘look through’ food inflation as a transient phenomenon, since interest rates are no answer to a supply-side problem. However, if an adverse monsoon raises expectations of inflation on the whole, the MPC will be constrained to keep liquidity tight this fiscal.
Food inflation has diverse drivers. Tomato, potato and onion inflation have played an outsized role in driving food inflation, owing to the extraordinary volatility in their prices, despite the fact that they account for a weight of just 2.2 per cent in the overall index and over a third of the vegetables index. Tomato prices are on the decline, owing to fresh arrivals, while a buffer in onions seems to have staved off high prices this time. However, there can be no getting away from the fact that cereals inflation is far from ‘transient’, having shown a consistent increase over the last year. Cereals account for 12.35 per cent of the overall basket or over a quarter of the food basket in the CPI; prices are up 13 per cent in July. There are many factors at work here, including the political economy compulsion to shore up market prices. The weak monsoon so far is expected to impact rice output. Pulses inflation (a weight of 2.95 per cent in CPI) too has been more endemic than transient, despite the recent overall rise in pulses acreage and output. Acreage under arhar, urad and moong are sharply down from last year. While edible oil prices have fallen 17 per cent, dairy inflation at 8.34 per cent (again high, for at least a year) is in large measure due to the lack of fodder availability, besides the impact of lumpy skin disease. The Centre must recognise that certain structural factors too could be pushing up food prices.
Meanwhile, the CPI is in dire need of overhaul. Its weights are derived from the consumer expenditure survey of 2011-12. A weight of 47 per cent assigned to food items may not be in sync with the prevailing consumption basket. The basket also underplays services such as entertainment and telecom. A fresh consumer expenditure survey is needed, as policymakers are working on imperfect price data.