Inflation
This article deals with the basics of inflation and it's impact on every day life.
What is inflation?
Inflation is termed as a general rise in the price level of goods and services. The developed world targets inflation below 2% to maintain price stability. The Inflation rate in Japan is even lower, with Japan suffering from Deflation - I.e., negative inflation (falling prices) since 1990s. In the developed world, inflation has not really been a problem in the last decade. It is mostly an issue for emerging economies. However, things are different this year, with most of the western economies facing high inflation (graphs below)
US inflation chart
Europe inflation chart
Japan inflation
Meanwhile, in emerging markets such as India, inflation is on the higher side. This phenomenon is due to multiple factors – younger demographics, higher economic growth rate (compared to the western world), higher growth in propensity to consume etc.
India inflation chart
Why high inflation is problematic?
The most prominent effect of high inflation is reduction in purchasing power of the consumer. A 5% inflation over a year for 5 years reduces the value of money by more than 22%. To simply put, 100 rupees earlier would be worth only 78 now. Inflation also reduces the value of your savings as the saved money is worth less in the future.
As high inflation reduces the purchasing power of workers, they demand higher wages. This in turn leads to higher costs for companies, which they transfer to the consumers as more expensive products. This basically leads to a cost-push spiral which can get very difficult to control.
What is the CPI?
Consumer Price Index (CPI) measures the change in the costs of products and services over a particular period of time. The CPI includes costs inclusive of taxes charged by the government.
The National Statistical Office breaks down CPI into 6 broad categories – Food and Beverages, Pan Tobacco and intoxicants, clothing and footwear, housing, fuel & light and miscellaneous. The weights for each depend on Rural or Urban.
Some of these categories are further divided into sub categories to give a more detailed breakdown of items being considered. E.g. The Miscellaneous section includes Household goods and services, Health Education, Transportation and Communication, recreation and amusement and personal care items.
What do Central Banks do to manage inflation?
The Reserve Bank of India manages the interest rate so as to control inflation and maintain price stability. Increase rates to curb inflation and decrease rates if inflation falls below the lower bound of the target range. Well, the idea is, that increasing interest rates increases the cost of borrowing, thereby reducing demand. Lower Demand leads to lower prices which helps to calm inflation. Similary, RBI (or other central banks) can reduce the interest rates in order to stimulate the economy. Lower borrowing costs increase demand, which leads to higher inflation levels.
The central government, in consultation with the RBI, determines the inflation target in terms of the Consumer Price Index, once in every five years. In 2016, the government, under the Reserve Bank of India Act, 1924, had given a mandate to the RBI to keep the retail inflation at 4 per cent with a margin of 2 per cent on either side for a five-year period ending March 31, 2021. This was again extended for a period of 5 years, from April 1, 2021, to March 31, 2026.
The RBI has raised interest rates in the last 4 consecutive meetings to 5.9%, a 50 BPS hike. I believe the rates might be going higher to 6-6.5% this year itself as RBI wages a battle against high inflation. This might also help with some recent capital outflows from the India markets.
What might be the CPI for September 2022?
We look into a very simple comparison of Inflation Data of the above months and we try to predict September 2022. While, this is a very basic analysis, further breakdowns and predictions would be produced in later reports.
The National Statistical Office (NSO) sets a Consumer Price Index (CPI) on a Base of year 2012 at 100. A value of 110 would mean the costs have risen 10% since Inception. A change from 110 to 115 over a year would indicate a change of 4.5%.
We calculate possible cases of monthly inflation growth and expected data for the month of September.
If we compare data for Sep 2021 (163.2) with 0.5% MoM growth (i.e., 175.13), inflation rate is around 7.6%, way above the target range of 2-6%. Even, if we expect a slight reduction over MoM inflation, CPI would clock at 6.7%.
However, it is unlikely that there will be a reduction as global fuel and food prices have settled at a higher level. And prices for goods in the miscellaneous and clothing section rarely do reduce. We might have to deal with higher inflation levels in the short-medium term.
Comments and suggestions are most welcome!
Manas Agarwal
AgarWallStreet