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What’s Feeding Inflation in India

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What’s Feeding Inflation in India

  • As input prices and demand soften, goods inflation, globally, is falling. But in India, goods inflation is rising.
  • With rise in demand for high-touch services still having some way to go, services inflation, globally, remains elevated. In India, services inflation is falling.

Rise in Urban demand: A cause of Inflation

  • In late 2021 when consumer spending in rural areas weakened.
  • Through 2022, inflation accelerated, the March heatwave took hold, and monsoon rains proved erratic, leading to a poor harvest and a battering of rural incomes.
  • As lockdowns ended, urban jobs came back. Workers who had gone home during the pandemic period returned to the big urban centres.
  • Every time a worker moved from rural to urban India, result in rise of wages. Higher incomes meant strong consumption. Against this backdrop, the rural demand weakness showed up all the more starkly.
  • In the last few months of 2022, winter farm sowing picked up.
  • With more hands needed on the ground, agricultural wages rose.
  • By end-2022, the shift in labourers moving back to the cities was almost over, as was the growth stimulus powered by it.
  • After that, indicators of urban demand, such as consumer durables production, began to weaken.
  • To be fair, rural demand is still barely rising, while urban demand is slightly softening. Neither is dramatic. But it is clear that the tables are slowly turning.

Situation in Informal Sector

  • The Sector employs about 80% of India’s labour force, divided equally between agricultural and non-agricultural workers.
  • Informal-sector firms have faced back-to-back economic shocks:
    • The lockdowns,
    • The commodity price hike.
  • Small firms underperformed large firms through the pandemic, losing market share, becoming less profitable, and paying their staff less.
  • Over the past few months, coming out of the lockdowns and last year’s commodity price jump, the prospects for small firms have improved.
  • The burden of high input costs has fallen, and the salaries of these firms’ staff are gradually rising.
  • Informal sector incomes appear to be rising, again showing up in indicators such as improving the production of non-durable consumer goods.

Interlinkages between the rural and the informal sector:

  • There are strong interlinkages between the rural and the informal sector – so, in one sense, we use the two terms almost interchangeably.
  • First, about three-fourths of the country’s informal sector workers live in rural India.
  • Second, much of what rural Indians consume is produced in the informal sector.
  • But it is also important to note that a quarter of informal-sector workers live in urban India, where they are also seeing improvement in incomes.

Evolution of informal and rural sector demand trends for goods and services

  • About 20% of rural households are landed (own more than one hectare of land). Much of their income comes from cultivation.
  • Much of the income of the 80% of households that are landless (owning less than one hectare of land) comes from wages.
  • These wages are split between agricultural and non-agricultural activity.
  • It is observed that rural and informal sector consumption is skewed more towards goods rather than services, and there too, more towards consumer non-durables rather than consumer durables.
  • Manufacturers are taking this opportunity to build back profit margins, after sharp losses last year.
  • This explains why retail inflation hasn’t fallen as much as wholesale inflation and why the margins of manufacturers are rising faster than the margins of service providers.
  • It also explains why goods inflation is outpacing services inflation.
  • The rise in the more goods-heavy demand from the rural and informal sectors is the key reason why overall goods demand is outpacing services demand.

Conclusion

  • Either way, It is expected inflation in FY24 to tread higher than what most are now expecting (the consensus of estimates).
  • This has implications for the RBI’s rates policy. Over the next few meetings, we believe the RBI’s rates will be strongly impacted by the Fed’s actions, global inflation, and any likely pressure on the rupee.
  • Based on assessment, domestic inflation may not provide much breathing space, either.
  • The message is clear. Brace for further RBI rate hikes over the next few months.

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