In October 2018, the Reserve Bank of India (RBI) changed its policy stance to calibrated tightening. This effectively ruled out any possibility of a rate cut in the near future. Back then, the central bank cited risks to inflation from higher MSPs, high oil prices and rising input costs. Then followed the talks of a rate hike to support the weak rupee before the December 2018 policy. Moving on since then, the rupee has strengthened, oil prices have fallen and inflation prints have been the lowest in over a year. The broad expectation on the street from RBI is to hold rates steady in its February policy.
RBI’s upper bound of acceptable headline number is 6%. The latest CPI inflation for December came in at 2.2%. The month’s trend was no different—being driven by fall in food inflation. Food inflation has made almost a complete about-turn from 2.9% in the first quarter of the fiscal to -2.0% in the third quarter, to average 0.5% in the fiscal so far. Vegetables, pulses and sugars have witnessed a deflation in this year so far. Core inflation (as measured by various metrics) has not followed a similar path and has remained consistent around 6%. Within core, housing, health and education have witnessed the fastest rates of inflation. Housing inflation is still bearing the impact of the increased HRA under the recommendations of Seventh Pay Commission.
The miscellaneous category has a weight of 28.32% in the CPI basket—over 60% weight in the core CPI basket. Inflation in this category has averaged 5.8%, during the first three quarters of the fiscal. Within this category, items like metal utensils, cookware, electrical appliances and electrical fittings and fixtures have experienced high rates of inflation. Such categories have around 10% weight in the miscellaneous category. One possible explanation for this could be the high inflation in WPI Base Metals. This could be an outcome of an increase in global metal prices and a weak rupee.
Another group within miscellaneous that has reported high inflation is the charges for domestic help and cleanliness workers. More often than not, people working on these jobs usually ask for a salary/wage hike to meet their non-subsistence expenses like kids’ education, medical care, hike in kerosene/gas prices, or to meet their conveyance expenses. In a practical scenario, their demand for a hike is often justified and is often met. From a consumer (people availing their services) point of view, it seems only just to pay higher price for their services on moral grounds as well. In addition, the increased outflow on their services usually constitutes a very small portion of the overall household expenditure. What also comes into play is the inflation the consumer itself perceives in the normal, day-to-day life.
Health-related items have around 21% weight in the miscellaneous category. Items like hospital charges, doctors’ fees and medicines have seen quite high inflation. The situation of our healthcare sector is very well known. Public healthcare facilities in most places are inadequate both in terms of availability and capability, forcing people to resort to private healthcare. More often than not, people would like to avail the services of the best doctor, sometimes even when the doctor fees might be straining their budgets. Fees and charges of private doctors and hospitals are not regulated. Given the shortage of good public medical facilities, private healthcare has significant pricing power. India’s healthcare market is imperfect—oligopolistic pricing can be rather irrational and arbitrary. It also not uncommon for medical practitioners to prescribe such medication to their patients that is often branded and quite expensive, and that fetches them the highest margins from pharmaceutical companies. Yes, we can definitely ask for a cheaper generic with the same formulation, but many of us still want to go with the prescribed medicines and not take any chances.
Transportation fuels (diesel and petrol) account for around 8.2% weight in the miscellaneous category. Changes in these fuel prices are a direct function of global crude oil prices and our exchange rate. The movement in crude oil price impacts inflation directly via the weight of fuel components in the CPI basket and indirectly via second round impact on other items of the CPI basket. Government taxation, too, has some bearing on retail fuel price inflation. Between April to December 2018, Brent crude price has moved in the range $50-86 per barrel.
A recent RBI Mint Street Memo by Saurabh Ghosh and Shekhar Tomar quantifies the impact of crude price movement on domestic inflation. Under their conservative estimate, a $10 per barrel increase in crude price at the price of $65 per barrel will lead to a 49 basis points (bps) increase in headline inflation. A similar increase at $55 per barrel gives around a 58bps increase in headline inflation. Other fuel items like kerosene, LPG and coal (under fuel and light category) too have seen double-digit or close to double-digit inflation during the first three quarters.
Inflation in tuition and college fees (having 10% weight in the miscellaneous category) has also averaged 6.8% in the fiscal so far. Inflation in this category has averaged 6.1% since the start of the new CPI series. School and college fees also take a substantial share of households’ income. Government schools account for 41.2% of the total secondary schools and 73.1% of the total elementary schools in India. According to the latest ministry of education data, mean achievement score of students at national level (Class 10) for private schools is at least 10% higher than that of government schools across subjects—English, mathematics, science and social sciences. According to a research paper by Geeta Gandhi Kingdon, between 2010-11 and 2015-16, student enrolment in government schools across 20 Indian states fell by 13 million, while private schools acquired 17.5 million new students. Private tuitions and coaching institutes have become too common, formal and commercialised.
Parents would like to get their kids educated in the best schools with whole gamut of activities and facilities, even it if means higher cost of a private school as opposed to a cheaper government school. Increased adoption of international educational boards and standards has further pushed up the cost of education. Exorbitant fees and donation in medical and engineering colleges is not unheard of. In the absence of any strong regulation governing the fees charged by private unaided institutes, parents have no option but to pay the high fees.
Theoretically, the monetary policy is targeted at demand-side inflation. Hence, food and fuel fall outside the purview of target of the central bank’s policy. Food constitutes 39.06% of the basket and fuel 6.84%. Diesel and petrol under the miscellaneous category is another 2.3%.
When money becomes dearer, the demand for certain discretionary items/services should fall and, hence, keep their prices in check. Core inflation (demand-side inflation, computed as inflation excluding food and fuel) is what the monetary policy aims to tackle. As discussed above, certain categories within core inflation seem to have dominance of supply-side factors. Demand in such categories is relatively inelastic and fails to respond effectively to price increases. In other cases, the market structure allows for an imperfect competition and arbitrary pricing. Consumers are left with no choice but to pay the higher price. This makes around 30% of the core inflation relatively ineffective to monetary policy. High inflation in these categories could also be one of the reasons for household inflation expectations remaining high. While the stance and actions of RBI remain very important for the broad economy, it is also worthwhile to keep in mind what portion of its target variable is it actually able to impact, and to what extent.
