Low inflation, but goods still expensive? Here's why.

The calculation of CPI inflation is based on a statistical method called indexing. Here, you consider a particular year as a base year and current index values are calculated based on that. CPI inflation is always calculated on a year-on-year (yoy) basis.

Jan 04, 2019 07:01 IST India Infoline News Service

A cursory glance at the monthly CPI (consumer price index) inflation chart below would look like a reason for celebration. CPI inflation appears to have come down sharply and the trend has only gotten more pronounced in the last few months.

Monthly CPI (consumer price index) inflation chart | IndiaInfoline
(Source: Trading Economics)

If you were to ask a random group of shoppers if they are feeling the fall in inflation, the most likely answer would be “no”. Why does it happen so often that the rate of inflation shows a declining trend but consumers do not really see a fall in prices? At the very least, their budgets continue to be stretched. There are five possible reasons behind this dichotomy.

1.      CPI inflation is a year-on-year index number
The calculation of CPI inflation is based on a statistical method called indexing. Here, you consider a particular year as a base year and current index values are calculated based on that. CPI inflation is always calculated on a year-on-year (yoy) basis. So inflation of 2.33% in November 2018 means that the index number for November 2018 was 2.33% higher than the index number for November 2017. For the purpose of CPI inflation, the year 2012 is taken as the base year with the value at 100.

Base Index (Nov 2017) Latest Index (Nov 2018) Calculation CPI Inflation
137.60 140.80 {(140.8 - 137.6) / 137.6} 2.33%
(Data Source: MOSPI)

The table shows how the 2.33% inflation was arrived at. When we intuitively look at inflation, we compare it with the previous month. It is hard to remember what happened in November last year. This is one of the reasons why CPI inflation looks out of sync with respect to your household budget.

2.      Inflation is falling, but it is still inflation after all
What the 2.33% inflation for November means is that prices are still on their way up, albeit at a lower rate. That means that the prices are rising but the momentum of inflation is coming down. Price levels in November 2018 are still 2.33% higher than in November 2017. Compared to the month of October 2018, prices are marginally higher by 0.07%. That means the pressure on your household budget is still on, although it is exerting pressure at a slower rate.

3.      Gap between rural and urban inflation is widening

All India inflation rates based on CPI and CFPI. | IndiaInfoline
(Source: MOSPI)

This is an interesting table which tells you why exactly you are not able to feel the impact of inflation. The CPI inflation number is normally broken up into rural inflation and urban inflation. Staying in Mumbai, Delhi, Bengaluru, Chennai, Kolkata, or any of the urban centers, you will experience urban inflation and not rural inflation. In November 2017, urban and rural inflation were almost at par.

In November 2018, the average CPI inflation of 2.33% is misleading because rural inflation is at 1.71% and urban inflation is at 3.12%. Why this dichotomy? Rural inflation is lower because of distress and the marginal support price (MSP) not exactly being instrumental in improving farm incomes. This has led to lower demand and hence lower prices in rural areas. The irony is that food deflation is more acute in urban areas and despite that urban inflation is higher. That means core inflation (excluding food and fuel) is substantially higher in urban India, which is what most of you are experiencing.

4.     There are state-level variations in inflation
The 2.33% CPI inflation for November 2018 is a national average. But behind these numbers, there are a plethora of states and union territories with vast dichotomies in price inflation. Consider the analytical summary of states below to get a better understanding of the state-level disparities in inflation.
Number of States / UTs Lowest Inflation (November 2018) Highest Inflation (November 2018) Average
Range of
22 (-2.38%) 6.25% 2.33% 8.63%
(Source: MOSPI)

What emerges from the above table is that inflation is a highly state-centric subject. The national average inflation of 2.33% is misleading because it ranges from 6.25% in Jammu & Kashmir to (-)2.38% in Himachal Pradesh. Such disparities arise due to various reasons like transport cost, state taxes, cropping patterns, income cycles, etc. In the above case, there is a huge variance range of 8.63% and the CPI inflation does not really tell you the full story. A person in J&K will have an entirely different experience of inflation compared to a person in Himachal Pradesh.

5.      Spending expands to accommodate cost savings
Let us look at some serious statistics in the inflation numbers. For example, urban India reported 3.12% inflation despite a (-)3.04% deflation in food, which is the largest component. That means fuel and core inflation has been really big. Then why are you not feeling the impact of negative food inflation? There could be two possible reasons behind this. Firstly, retail prices don’t always react to a fall in base prices, and hence, the price you pay for pulses and vegetables may be the same. That is due to logistical inefficiencies. Secondly, most people tend to pay for groceries with their credit card, and hence, your consumption is always expanding to accommodate new goods. You may be buying more without actually realizing it.

The moral of the story is that inflation is still positive, and hence, prices are higher. Retailers are required to pass on GST cuts but not all of input cost cuts. You may be paying for your retailer to save for a rainy day. Above all, like in most cases, inflation is an average and can be statistically misleading!

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