Indian inflation is bubbling up

Liseth Galvis-Corfe - 12 April 2018

Inflationary pressures are building in India. Despite the recent decline in headline CPI inflation from 5.1 per cent in January 2018 to 4.4 per cent in February 2018 (figure 1), the Reserve Bank of India (RBI) in its first bi-monthly policy statement stated that “there are several uncertainties surrounding the baseline inflation path”, casting doubt on a continuation of the decreasing trend. The February decrease derives mainly from the reduction of food prices, specifically vegetables, which were higher in the previous months due to seasonal factors.

Looking at the CPI excluding food and fuel, it can be seen that the inflation rate has remained around 5 per cent since November 2017 to the present, a reason why we should be cautious in interpreting the recent reduction in headline inflation. Figure 1 also shows that while this is a reduction of 0.6 percentage points compared with the previous month, the February 2018 figure represents an increase of 0.8 percentage points with respect to the same month in 2017.

One of the potential sources of future inflation in India is the fiscal expansion plan announced by the Minister of Finance in the 2018 Union Budget. This is the last budget before the 2019 election and includes substantial spending increases in areas such as rural development, agriculture, and healthcare. The objective of these measures is increasing living standards for the poorest and also to increase popular support for the re-election of Narendra Modi next year. For example, the Government announced a National Health Protection Scheme “Modicare” that will cover vulnerable families and it will cost 110bn Rupees (US$1.7bn) a year. This will add pressure to the public finances especially as this is “the world’s largest government funded healthcare programme” according to the Minister of Finance.

House price inflation increased from 7.7 per cent to 8.7 per cent between November 2017 and February 2018. The rates have been growing due to increases in House Rent Allowances (HRAs) for government employees established in July 2017. According to the RBI, it is estimated that the effect of the HRA in the inflation rate is around 0.3 per cent. Which leave us with an inflation rate of 4.1 per cent in February, discounting HRA effects.

Other factors that can trigger higher inflation in 2018 are the increase in oil prices, the implementation of goods and sales tax (GST) tax reform, input price pressures in the manufacturing sector and export price inflation. Looking at the export price deflator of non-fuel goods (figure 2) the annual growth rate has increased from -1.17 per cent to 2.89 per cent between Q3 2017 and Q2 2018, suggesting that pressures such as higher costs of raw materials have translated into higher prices of Indian export goods.

Figure 3 shows the evolution of inflation expectations according to the household inflation expectations survey from the RBI (based on 5,150 urban households in 18 cities). The results for March 2018 reveal that the proportion of respondents expecting prices to increase in the next three months is 80.2 per cent. By contrast, just 2 per cent of the correspondents expect a decline in prices.

India has long been susceptible to inflation and the administration’s desire for faster growth and complex reforms have opened the door to a new inflationary episode. After a decline in the CPI headline rate in 2016, the tide turned last summer. The Indian economy is projected to grow by 7.4 per cent in 2018 (the highest among the emerging economies), and the production of goods and services will reflect the new inflationary pressures.


Figure 1

Data source: CEIC

Figure 2

Data source: Thomson Reuters Datastream

Figure 3

Source: Reserve Bank of India (RBI)



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