Why is Inflation at record high levels now?

Blinders on to COVID figures, and what’s the other thing going up? Inflation, sure it is. And it’s incumbent on us to talk about it…

It’s official: Wholesale Price Index (WPI) for March 2021 shoots up to 7.39% from March 2020, a scene that hasn’t been witnessed for almost a decade! Last time we were close to this perhaps in 2012. It wouldn’t be wrong to say that this is a record 8-years-high Inflation level!

And naturally, it’s already rife in the news. But we feel there isn’t much people know about what the hell WPI is, the reasons for this price rise, its impact and the nitty-gritty of the matter. On that account, while news articles will tell you the ‘what’, today we’ll tell you the ‘why what’ & ‘so what’ ;-)

At the outset, here’s a primer on Inflation and WPI.

Inflation: in layman’s terms

Well, for the layman, Inflation is the increase in the price of an average shopping basket. It makes goods and services costlier for you and thus, reduces the purchasing power of your money. Remember our grandparents boasting about having bought a pyjama for Rs 100 in those times? Well, what do you think a hundred can fetch you now? Not even a pizza! That’s Inflation for you, guys. If you managed your monthly expenditure with Rs 50,000 last year, a 10% inflation could force you to cough up Rs 5,000 extra this month! And if your paycheck hasn’t increased in proportion, you’ll realise why it is indeed an issue, isn’t it?

Just so you know, Inflation can be measured with the help of two indices: CPI (Consumer Price Index) and WPI (Wholesale Price Index). As the name suggests, CPI peeps into consumers’ baskets, whereas WPI talks of wholesalers and manufacturers. Pertaining to its large-scale impact, the rate of change in CPI is considered synonymous to Inflation. However, today, we’ll talk about the elephant in the room, WPI.

So, basically, WPI is the mandi or factory-gate level price benchmark. If you’re a manufacturer or a wholesaler, it’ll be of paramount importance to you. You’ll purchase a lot of stuff, as in fuel for machinery and transport, metals as raw materials and other goods for distributing them to retailers. A spike in the price of these inputs will make you either cut down your business or pass the burden of price-hike to the end-consumer. Either way, it’s awful!

Anyway, what led us to this mishap?

Why is WPI Inflation so high?

It’s a no brainer that inflation spikes when too much money is chasing too less buyables. Of course, that could either be due to a pull by consumer demand or a push from input costs. This time, it’s more of a cost-push inflation kind of a thing. And what’s it that we attribute this tragedy to, you ask? Well…

• Fuel cost on a rise

Fuel is crucial to the operations of any economy. From running factory machinery to the nationwide supply of goods and services to personal vehicles to domestic and commercial cooking purposes, fuel is the quintessential lifeblood of any nation. Needless to say, when fuel prices rise, running machines become expensive, transportation and other costs follow, and this obviously reflects in the price of goods and services. And that brought us to this mess! The entire fuel and power basket cost has witnessed an uptick of over 10.25%, mainly on account of the rising cost of petrol and diesel.

The price rise is an offshoot of last year’s steep drop in oil production among OPEC countries. You see, with factories shut and vehicles parked at home, the demand for oil was very low; hence it made no economic sense for oil-producing nations to go on producing when none was willing to purchase. Thus, they cut down on its production and supply, which led to an increase in international oil prices.

A major impetus was a domestic factor as well, thanks to the taxman! At a time when the economy was in turmoil, the central and state governments were badly in need of funds to fight the pandemic. How do they create revenue? Well, smokers, drunkards and machines have to bear the burden. Excise duty was hiked on sin goods and fuel, which has risen by more than 65% in the last year. And as diesel is the prerequisite for big machines to run, now you know why manufacturing prices have also shot up more than 7.3%! Comprising about two-third of the index, manufacturing price hike is the main villain; you could say, with the uptick in food prices as its henchman!

• Metal prices surge

Apart from a trigger from the rising fuel price, manufacturing prices have also been influenced by increases in the price of metals like iron, copper, steel, etc., which are essential inputs in factories. And you could ascribe two reasons to this. The first being, the growing interest among global investors in buying these metal commodities. And the second reason is that many rich countries have been investing heavily in infrastructure in a bid to revive their economy. And naturally, metals being the bedrock of infrastructural development, have witnessed a push in prices as much as 16.6% over a year!

• Statistical flaws

Inflation is calculated year-on-year. Meaning how much prices have risen since the same month a year ago. In this same quarter last year, you can notice in the attached chart, inflation rates were in the red. As a result of this low base, the inflation rate this quarter will obviously witness a little bit of exaggeration. No wonder why the chart clearly suggests, inflation rates could even touch double digits in the coming May.

Apart from this base effect, there is also the impact of response rates on Inflation. You see, March 2020 was the time India acknowledged the virus. The nation went into lockdown, and business activity came to a halt. Naturally, conducting any economic or statistical survey in those times would be a gruesome task! As the economy had moved indoors, the response rate would be very low.

While the response rate for inflation figures in March 2021 was about 90%, it was less than 75% a year ago, meaning a significant portion of last year’s inputs was based on other metrics. Thus, last year’s prices wouldn’t have depicted their true picture as such. So now you know what made Inflation figures a bit overstated now.

Well, now that you’re aware of the ‘why what’, let’s understand the ‘so what’ of these inflation highs.

Will consumer prices increase?

To us, the end-users, this is of the essence… Will a rise in manufacturing and wholesale prices spill over to the retail level? While you can’t be sure about this, it totally makes sense to presume that it will. After all, why would the manufacturers and wholesalers take the haircut entirely by themselves? No business sense in that! At least some impact could be felt in consumer prices (CPI) as well.

Add to this the probable rise in import bills if the rupee keeps dropping further, and this does tell a lot about what may be coming! God forbid, but if the supply chains disrupt this time around due to these new waves of the virus, prices could skyrocket like anything!

The Bottom Line

By any chance, if the wholesale price rise percolates to the consumer level, the RBI might face a catch-22 situation! In the recent monetary policy discussion, it has maintained its accommodative stance of keeping interest rates low to boost the economy. But lower interest rates means more money with people, more demand and thus increase in prices, ultimately higher Inflation! It can’t increase the interest rates either, as that would mean giving up on its economic revival dreams! Thus, that could really be a tough nut to crack for the RBI.

Anyway, the onus is on our superhero to turn the corner. And we know it will. Hopefully so…

All hail the RBI lord.