India’s great inflation decline—a whodunit

It is not the oil price decline, nor decline in metals prices, nor decline in food prices. So what explains India’s great inflation decline?

A sustained inflation decline is in the air. In November 2013, year-on-year CPI inflation was 11.2%. In November 2014, the level declined to 4.3%. The decline in inflation rate for the WPI has been even larger for the same period: 7.6 percentage points (ppt) to a level of zero percent. This is one of the largest one-year declines ever observed for India and, excluding hyper inflation economies, for most countries. This article attempts to explain the factors behind the India’s Great Inflation Decline or GID.

Over the past one year, many explanations have been offered. One consistent, and common, explanation has been “base effects”. Some call it a voodoo explanation, and some might be correct in doing so. But no sooner was the base effect discredited (at best it can account for 1 to 2 ppt of decline and that too temporarily for a few months) that the experts had a new explanation for GID—it is the decline in international food, oil and commodity prices. The oil decline, steep as it has been, has only been there since the intra-year peak of $105/barrel in June 2014. Today the price is close to $50, but the discussion, and data, for inflation are till November 2014 when the oil price averaged $76.

Let us look at possible causes for the observed inflation decline between November 2013 and November 2014. International and domestic inflation will be compared; fortunately, for this comparison, the rupee/dollar exchange rate was near unchanged—R62.5 to a dollar in November 2013 and R61.5 in November 2014.



This is the big story and a very likely contributor, according to many experts, for India’s GID. In November 2013, the international crude oil price was at $94. In November 2014 (hereafter today), it was $76, a 19% decline. The wholesale price of petrol, in rupees, has declined by a smaller amount, 10%, over the same period. Petrol has only a 1% weight, but petrol-related products have a 15% weight in the WPI. So fuel should have brought the aggregate WPI down by 1.5 ppt or from 7.6% in November 2013 to 6.1% in November 2014.


Metals and mineral products have close to a 11% weight in the WPI. International metal prices (Goldman Sachs Index, S&P GSCI Industrial Metals) actually increased over the last year by 4.3%. Domestic metal prices over the last year have been flat (only a 0.3% increase)—again suggesting a loose correlation with trends in international prices.


There is a general impression that international food prices have declined substantially, and that this has contributed in large part to the decline in headline CPI inflation. (Food accounts for nearly 50% weight in the CPI.) But this story is flawed on at least two counts. First, that domestic food prices have not followed international food prices (in rupees) for several years. For example, between November 2011 and November 2014, international (FAO) food prices, in rupees, have increased by 7%; since November 2013, FAO food prices have declined by 8%. However, domestic food prices increased by 3% according to CPI, and 0.6%, WPI, in the last 12 months.

Inflation expectations

RBI, and several economists, put a lot of store in the concept of “household inflation expectations” as measured by RBI, i.e. such expectations should decline before one can feel safe that inflation is under control. In September 2013, the 12-month ahead inflation expectations were 11.8%, according to the RBI survey; in September 2014, such expectations were higher at 12.7%. So if this is any guide, inflation should have persisted in double digits, and increased! But we know the opposite happened.

However, Zyfin, a financial information company (I am on their advisory board), has been conducting a consumer confidence survey for the last several years. According to this survey, 16% of the respondents felt, in November 2013, that inflation will decline over the next year. This fraction increased to almost a quarter of the population (24.3%) in November 2014.

So none of the popularly mentioned factors for India’s great inflation decline add up to any sort of explanation. It is not the oil price decline, nor decline in metals prices, nor decline in food prices. So what explains GID? There are conjectures. First, that world and monetary policy operates in strange and mysterious ways so we are not observing, as yet, the full effects of international food, oil and commodity price decline. But then one has to conclude that inflation in 2015 in India will trend lower still!

Second, there is a novel and radical explanation for GID by Jahangir Aziz. In an article titled “UPA by another name?” (Indian Express, January 5, 2015;, Aziz states that “with some help from the better supply management of the new government, the shift to inflation targeting finally ended four years of rabid inflation.” Other inflation experts (nee hawks) have also chimed in over the last few weeks about what a wonderful thing the new inflation targeting framework would be for low and stable inflation. However, and this is important to note, the new targeting framework has yet to be formulated and decided upon. If Aziz is right, that just the mere mention of inflation targeting can bring inflation down by 700 basis points, think of the wonders that are in store for India’s macro-economy when inflation targeting is finally accepted! If the mere talk of inflation targeting can have a larger effect than metal, oil, food, expectations, etc, then who knows, with actual inflation targeting, and a little bit of ill-luck, we will soon face the ECB problem of desperately trying to get the inflation rate to increase!

So what does explain the great Indian inflation decline? Buried in the table is a line which states “weighted MSP change, lagged one year”. As discussed so many times in these columns, I have argued that with domestic control barriers, the dominant determinant of Indian inflation is the procurement price (minimum support prices) for food. The government does not set the price of meat, or eggs, or fruits or vegetables. However, the prices of these food items are affected by the same factors that affect the prices of cereals, pulses, cotton, oilseeds and sugar. The MSP indirectly affects the price of land and labour, the two principal factors in agricultural production. Hence, MSP inflation affects inflation in milk, and fruits, and vegetables. A long historical analysis (since the late 1970s) suggests that each 10% increase in MSP increases headline inflation by 3 percentage points. The decline in MSP inflation between 2013 and 2014 was 10.2 percentage points. And 30% of this decline is 3.1 ppt, i.e. on the basis of MSP alone, headline inflation should have declined to 10.1-3.1 or 7.0%. Actual observed year-on-year inflation January to November 2013 was 7.4%!

It is time that RBI declared victory on inflation. To be sure, there will be blips along the way, but most expectations are that CPI inflation for 2015 will be well below the RBI target of 6%. Perhaps it is the talk of inflation targeting that is doing the trick. (It can’t be the fiscal deficit that is causing inflation to decline because that is up!) Whatever the favoured explanation may be, it is time for RBI to follow through on the reality of India’s Great Inflation Decline.

Surjit S Bhalla is chairman of Oxus Investments, an emerging market advisory firm, and a senior advisor to Zyfin, a leading financial information company. He can be followed on Twitter, @surjitbhalla

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