PRICES AND INFLATION

INTRODUCTION

 The global economy has been witnessing a steep decline in inflation over the
past five decades (World Bank, 2019). Inflation has declined in almost all the
countries around the world. Emerging market economies have also
experienced a remarkable decline in inflation over the same period. Inflation
peaked in 1993 at 118.7 percent and then declined to 4.8 per cent in 2018 in
emerging market and developing economies (World Economic Outlook,
October 2019).
 There can be many reasons that could have contributed to the steep decline in
inflation in the emerging market economies like the adoption of a more
resilient monetary and fiscal policy frameworks, structural reforms of labour
and product markets that strengthen competition, and adoption of monetary
policy framework for inflation targeting. India introduced inflation targeting
on 5th August, 2016 for a period of five years ending on 31st March, 2021.
 In India, inflation has been witnessing moderation since 2014. However,
recently inflation has shown an uptick. Headline Consumer Price Index-
Combined (CPI-C) inflation increased to 4.1 per cent in 2019-20 as compared
to 3.7 per cent in 2018-19. Though, Wholesale Price Index (WPI) inflation has
seen an increase between 2015-16 and 2018-19, it fell from 4.7 per cent in
2018-19 to 1.5 per cent during 2019-20. Fall in food inflation has been a major
contributing factor in the drastic reductions observed in inflation between
2014-15 and 2018-19. Also, it has been observed that there has been a shift in
inflation dynamics. The average and peak levels of inflation have fallen
considerably since 2013-14. Not only have the average levels of inflation come
down, the peak levels of inflation during the financial year are now much
lower.

CURRENT TRENDS IN INFLATION

 Headline inflation based on CPI-C has been sliding on a downward path since
2014. The average CPI-C headline inflation, which was 5.9 per cent in 2014-
15, has fallen continuously to around 3.4 per cent in 2018-19. This has been
led by a drastic fall in food inflation, which has fallen from 6.4 per cent in
2014-15 to 0.1 per cent in 2018-19.
 Overall, CPI-C headline inflation in December, 2019 stood at 7.4 per cent, while
CPI-food inflation increased to 14.1 per cent mainly driven by the rise in
vegetable prices. Core (non-food non-fuel) inflation has also increased to 3.8
per cent in December, 2019.
 During 2019-20, WPI based inflation has been on a continuous fall declining
from 3.2 per cent in April 2019 to 0.6 per cent in November 2019, but
increased to 2.6 per cent in December 2019.
 Since July 2018, CPI-Urban inflation, has been consistently above CPI-Rural
inflation. This is in contrast to earlier experience where rural inflation has
been mostly higher than urban inflation. The divergence has been mainly on
account of the differential rates of food inflation between rural and urban
areas witnessed during this period.
 In 2019-20, there has been sudden change in the trend. Since July 2019, urban
areas have registered much higher food inflation when compared to rural
areas. Divergence in rural-urban food inflation in 2019-20 was mainly led by
cereals, eggs, fruits, vegetables etc. The slide in rural inflation could be because
of fall in the growth of real rural wages.
 The divergence in rural-urban inflation is not just observed in the food
component but in other components also. The decline in rural inflation in
items like clothing and footwear, fuel and light could be due to fall in growth of
real rural wages, while rise in rural price index for items like education, health,
personal care etc. also raises the question of affordability of these items to the
rural segment.

INFLATION IN STATES

 CPI-C inflation has continued to be highly variable across States. Inflation

ranged between (-)0.04 per cent to 8.1 per cent across States/UTs in financial
year (FY) 2019-20 compared to (-)1.3 per cent to 9.1 per cent in FY 2018-19.
However, the overall inflation rate has been quite low in almost all the States.
 For FY 2019-20, Daman & Diu had the lowest inflation followed by Bihar and
Chhattisgarh.
 Though in most of the states the overall inflation rate in rural areas is lower
than the overall inflation rate in urban areas, the overall variability of rural
inflation in a particular month across States was higher than the variability of
urban inflation across states.
 Though the overall inflation in rural areas is lower at an All India level but due
to the high variability across states, some states might actually have inflation
in rural areas higher than inflation in urban areas. In Punjab, Haryana,
Uttarakhand, Delhi, Rajasthan, Uttar Pradesh, Madhya Pradesh, Nagaland,
Tripura and Kerala rural inflation was indeed higher than urban inflation
during April-December, 2019.

DRIVERS OF INFLATION

 During 2018-19, the major driver of CPI-C inflation was the miscellaneous
group. Compared to 2017-18, the contribution of food and beverages to total
inflation was lower in 2018-19. However, during 2019-20 (April- December),
food and beverages emerged as the main contributor to CPI-C inflation, with
54 per cent of the inflation during this period attributable to this group.
Miscellaneous group was the second largest contributor to inflation during
this period.
CRUDE OIL AND FUEL INFLATION

 During April-December 2019, world crude oil prices declined owing to weak
global demand. As oil has a major share in the country’s import basket, it
impacts considerably domestic prices of petroleum products. The mineral oils
group in WPI saw an inflation of 5.8 per cent in April 2019, thereafter saw
continuous decline to end at (-)3.2 per cent in December 2019.

DRUG PRICING

 Out of the total out of pocket expenditure of individuals on health, the major
portion is that of medicines. This makes the provision of affordable drugs an
imperative. Indian pharmaceutical sector is an important sector not only
because of the welfare implications it has, but also because of its economic
importance as a sector with a proven record of technical capability and global
standing. The sector has grown considerably in the recent years and has
potential for further development in the coming years.
 The Government came out with National Pharmaceutical Pricing Policy, 2012
with an objective to put in place a regulatory framework for pricing of drugs so
as to ensure availability of required medicines – “essential medicines” – at
reasonable prices even while providing sufficient opportunity for innovation
and competition to support the growth of industry, thereby meeting the goals
of employment and shared economic well-being for all.
 The fixation of ceiling prices/Maximum Retail Price (MRP) has resulted in a
total saving of Rs 12,447 crores to the public after implementation of DPCO,
2013.
 In case of cardiac stents, in the post price capping period (2017) over the
period of two years, it has been observed that there is 26 per cent increase in
the sales of the cardiac stents in the Indian market. It has also been observed
that indigenous manufacturers have benefited from the price capping of the
cardiac stents as their share in the production has increased by 10 per cent in
post price capping period.

FOOD INFLATION

 Food inflation has been the major driver of inflation during the current
financial year, 2019-20. Some commodities such as onion, tomato and pulses
have shown high inflation since August 2019. Untimely rains have caused
lower production as well as constricted the movement of onion and tomato to
the markets. In the case of pulses, the progress in sowing has been at much
lower levels than in the previous year.

(a) Onion

 CPI based Inflation rate of onion showed an increasing trend since April, 2019
and rose up by 328.0 per cent during the month of December, 2019. The WPI
 based inflation rate of onion during the month of December, 2019 also
increased to 455.8 per cent as compared to a decline of (-) 63.8 per cent in
December, 2018 on a Year on Year (YoY) basis.
 There can be many reasons for the rise in onion prices. One of the primary
reasons that is observed every year is driven by demand-supply mismatch
which can be primarily attributed to the seasonal factors. Other reasons that
further exacerbated this demand supply mismatch are the fall in area sown
and damage to Kharif onion due to rain.

(b) Tomato

 CPI based Inflation rate of Tomato showed an increasing trend since July, 2019
and rose up by 35.2 per cent during the month of December, 2019 as
compared to December, 2018 on a Year on Year (YoY basis).
 The current spike in the tomato prices in 2019 is mainly due to the excess
rains in Maharashtra and Karnataka etc. which are major producers of tomato
thus disrupting the supply of tomato.

(c) Pulses

 The CPI inflation rate of pulses increased from -20.2 per cent in January 2018
to 15.4 per cent in December 2019. The overall rate of inflation, based on CPI,
for Pulses during the month of December 2019 stood at 15.4 per cent as
compared to -7.2 per cent during December 2018.
 However, a comparison of the inflation trend of pulses item-wise reveals that
the current hike in prices of various pulses compared to their long-term trends
is not very high.
 The phase of price rise during 2019 could be due to fall in acreage resulting
from rains in the growing states and also because of low price realisation due
to glut in the market following increased production of earlier years. Low
market prices during 2018-19 may have resulted in significant reduction in
acreage of some pulses.

VOLATILITY IN ESSENTIAL COMMODITY PRICES

 Prices of rice and wheat remained stable since 2014 due to adequate supply
arising out of sufficient domestic production and also due to maintenance of
adequate buffer stock of rice and wheat for meeting the food security
requirements. As a result, the price volatility was lower in the case of rice and
wheat.
 The overall price volatility was highest for vegetables and lowest for rice,
wheat and palm oil. There was a significant rise in volatility for pulses, sugar
and tomatoes during 2014 - 2019.
 The extent to which given production and consumption shocks translate into
price volatility depends on supply and demand elasticities. Stockholding and
 speculation can have major impact on price variability, either stabilising or
destabilising. Perishability of the commodities also adds to price volatility.
Presence of marketing channels, storage facilities, effective MSP system can
help limit price volatility.

DIVERGENCE IN RETAIL AND WHOLESALE PRICES FOR ESSENTIAL

AGRICULTURAL COMMODITIES

 A divergence between the retail and wholesale price of various essential

commodities was observed in the four metropolitan cities of the country over
the period 2014 to 2019. A price wedge of 10 to 15 per cent per kg is not
excessive if one compares this with the marketing costs and margins.
 In 2019 the margins are excessive for some of the commodities, and for all the
commodities the margins are highest in Delhi and Mumbai. In the case of
vegetables, onion and tomato are analysed. For both price wedge was
excessive especially in Delhi and Mumbai. In Delhi, the price margin was 51
per cent for onion and in the case of tomatoes it was 59 per cent. The vertical
spreads in prices is maximum for vegetables that are perishable, then for
pulses and the least for edible oils.
 The reasons for such a high spread between the wholesale and retail prices
could be due to several reasons such as high transaction costs, weak
infrastructure and information systems, poor marketing facilities, huge
margins of middleman etc. It is a fact that transaction costs in the northern
states of the country are high compared to other States. The market structure
is also different across States. If there is a fair amount of competition in the
market between traders, price wedge will not be very high. On the other hand,
if traders collude, price wedge will be much higher. Another possible reason
for this could be asymmetry in the transmission of price signals from
wholesale to retail prices and vice versa, this can happen due to action of
intermediaries. Therefore, to reduce the wedge it is important that market
barriers and structural rigidities in the system that lead to higher transaction
costs are removed.

HAS THERE BEEN A SHIFT IN INFLATION DYNAMICS?

 Given the falling trend in inflation in the recent years, it is pertinent to ask
whether there has been a shift in the inflationary process. The average and
peak levels of inflation have fallen considerably during 2012-13 and 2019-20.
 It has been generally believed that, food and fuel inflation in India have had
strong secondary effects leading to persistence in household inflation
expectations. This feeds into core inflation and therefore prolongs the effects
on headline inflation. One way to check for the presence of secondary effects of
food and fuel inflation is to look at the swiftness with which headline inflation
converges to core inflation after the occurrence of a food or fuel price shock. If
headline inflation does not completely revert to core inflation within a
 reasonably short span of time, it may indicate the presence of strong
secondary effects. The reversion of headline inflation to core inflation has
considerable implications for the conduct of monetary policy in an inflation
targeting framework. In an economy with strong secondary effects, monetary
policy may have to be tighter in an event of a food or fuel price shock
compared to an economy where such effects are minimal.
 It was observed that from 2012, there is convergence of headline towards core
inflation as per the CPI-C data. In the period under consideration there is
evidence of strong reversion of headline inflation to core inflation.
 Two major factors could have contributed to the changing dynamics of
inflation in India. First, it was observed that food inflation has seen a declining
trend during the period under consideration. The decline in inflation has been
witnessed in most categories of food group including those with a high
weightage such as cereals and products, fruits, vegetables and pulses and
products. Second, inflation expectations have been declining since 2015. This
could be partly because of the success of inflation targeting approach of
monetary policy adopted by RBI in anchoring inflation expectations. On the
other hand, household inflation expectations are known to move closely with
food inflation. The fall in food inflation during this period could have had the
effect of reducing the overall inflation expectations of the households.

TRENDS IN GLOBAL COMMODITY PRICES

 As per the commodity prices published by the World Bank, energy commodity
prices have shown a decreasing trend in 2019-20 (April- November). They
recorded average inflation of (-)16.8 per cent in 2019-20 as compared to 35.5
per cent in 2018-19.
 In terms of food prices, the deflationary trend continued with inflation of
(-)4.3 per cent in 2019-20 compared to 0.3 per cent in 2018-19.
 The metals and minerals index also showed a deflationary trend, indicative of
the gloomy global economic scenario prevalent during the year.

MEASURES TO CONTAIN PRICE RISE OF ESSENTIAL COMMODITIES

 Government takes various measures from time to time to stabilize prices of

essential food items which, inter-alia, include utilizing trade and fiscal policy
instruments like import duty, Minimum Export Price, export restrictions,
imposition of stock limits and advising States for effective action against
hoarders & black marketers etc. to regulate domestic availability and
moderate prices.
 Also, Government incentivizes farmers by announcing Minimum Support
Prices for increasing production and is implementing Schemes which, inter
alia, include Mission for Integrated Development of Horticulture (MIDH),
National Food Security Mission (NFSM), National Mission on Oilseeds and Oil
 Palm (NMOOP), etc. for increasing production and productivity through
appropriate interventions.
 Besides, Government is also implementing Price Stabilization Fund (PSF) to
help moderate the volatility in prices of agri-horticultural commodities like
pulses, onion, and potato. Onion prices saw a hike during 2019-20 starting
from August, 2019, and various measures were taken by the Government to
ease the situation which included:
o During 2019-20, buffer stock of Rabi onion was created under Price
Stabilization Fund (PSF) which was distributed to various State
Governments, other agencies and sold in various mandis.
o Onions were supplied to State Governments at no-profit no-loss basis to
improve prices and availability situation.
o The benefit to exporters of onions under Merchandise Exports from India
Scheme (MEIS) was withdrawn w.e.f. 11th June 2019.
o Minimum Export Price (MEP) of $850/ MT was imposed on onion on
13th September 2019, and subsequently its export was banned by
Government on 29th September 2019 in view of its continued high
prices.
o Government, on 29th September 2019, imposed stock limits on traders
across the country. Further, Government of India urged State
Governments to prevent hoarding, speculative trading and profiteering,
unfair and illegal trade practices like cartelling, etc.
o Facilitated private imports of onions by relaxing its fumigation norms
and exempting importers from stock limits.
o Government imported onions through MMTC from countries like Egypt
and Turkey and directed NAFED to procure surplus Kharif onion and
undertake distribution in deficit States.

CONCLUSION

Overall, while the WPI inflation remained low during the financial year 2019- 20,
CPI-C inflation saw a slight uptick, driven mainly by food prices. Supply-side
shocks in agricultural commodities such as onion due to erratic rains led to the
sudden spike in the prices of these commodities. The volatility in inflation of
most of the essential agricultural commodities with the exception of pulses has
also come down over time. However, one major issue that still remains is the
high wedge between retail and wholesale prices of some of the commodities like
onion and tomato. Analysing inflation figures at State level, a divergence is
observed in inflation across the States and also between the rural and urban
areas within each state. The inflation dynamics have also been changing over
time. In the current period, there is evidence for a strong reversion of headline
inflation to core inflation. Future inflationary prospects and inflation dynamics
crucially depend on the overall macroeconomic scenario as well as the
containment of rising prices in certain agricultural commodities.