October , 2021
More uncertainties before policy makers
17:46 pm

T. K. Jayaraman

In the midst of uncertainties on many fronts, including those presented by the August take-over of Afghanistan by Talibans casting a shadow on the future of international petroleum crude prices with likely involvement of Iran, Indian economy received some comforting news on inflation for yet another month - August 2021.

Both consumer price index (CPI) and wholesale price index (WPI) for the month of August were released in mid-September. The Reserve Bank of India, which has been mandated to maintain price stability, has been targeting retail inflation at 4% with an allowable margin of 2%. The targeted inflation, which is the rate of change in consumer price index (CPI) of all consumer products (the calculation of CPI being the responsibility of Ministry of Statistics and Programme Implementation), does not take into account food, fruits and vegetables as well as fuel and power on grounds of their volatility. The volatility in case of food items is due to vagaries in nature (drought or excess rain or natural disasters including floods). In case of fuel (petrol, diesel and liquefied petroleum gas), their prices are based on fluctuating international prices of the petroleum crude and natural gas over which India has no control as in the case of nature. India is dependent for its requirements on imports of crude to the extent of 85% from the expanded Organization of Petroleum Exporting Countries (OPEC 2.0). 

The WPI takes into account all commodities regardless of volatility, the responsible ministry being the Ministry of Commerce and Industry. The commodities included are broadly categorised into primary articles including food grains, vegetables and fruits, oilseeds; minerals; petroleum crude and natural gas; manufactured products. The monthly CPI based inflation (known as retail price inflation), ignoring currently volatile items, is calculated as change in percent of CPI on a year to year (YtoY) basis, which is also the same procedure for calculating WPI inflation.

However, WPI records rise in prices of a single point of sale (primary commodities, including food grains or non-food; and fuel and finished products and manufactured products, including their transportation costs from farms and points of production to final sales points. The CPI inflation without current month volatility seeps in soon next month.

The trends in CPI and WPI show that as WPI inflation once rises, CPI inflation follows. For example, when WPI inflation began to increase in January 2021 to February and then on to March, CPI inflation also began to rise. Internationally traded petroleum crude price began to rise in March and April, due to signs of economic recovery from Covid-19 pandemic, WPI rose in March and April; and so too CPI inflation followed by increasing to 6.30% in May and 6.26% June, as manufactured and processed food products goods have also risen, which are duly reflected.

Premature recovery signs

Once the new Covid-19 variant Delta began to emerge, optimism based on prospects of economic recovery was proved to be premature. As hopes of sustained recovery crashed, the crude price fell, giving some relief to crude oil importing countries. CPI inflation fell from the dangerous levels, 6% in June to 5.59% in July and then on to 5.3% in August. Although in the comfort zone of being below 6$, it was above the mandated target of 4%.  

The bimonthly MPC, which is scheduled to meet on October 6-8 would refer to the “comforting developments” on petroleum crude price front with no further indications of any fresh rises in price above US$ 70 per barrel despite the “the stunningly swift collapse of the U.S.-backed Afghan government.”.

With President Biden of the United States declaring on September 21 before the United Nations General Assembly that his country would now prefer “ceaseless diplomacy over relentless wars” has raised hopes of peace in the Middle East. Iran would have heaved a sigh of relief. Writing in Wall Street Journal on August 18, 2021, Randall Forsyth observed the US preference for diplomatic negotiations

with Iran, would contribute to softening of any likely aggressive military measures by Iran, including vigorously supporting China-Pakistan-Taliban axis. It was also expected that as the Wall Street Journal article indicated that OPEC 2.0 has “regained discipline after last year’s market-share wars”, indicating the group would not like crude prices “to rise too high”, which would accelerate global green efforts. However, the most likely outcome would be increased volatility in oil prices. 

Once again the volatility in oil prices In fact, what was feared, the oil price started to be volatile again. On Friday, September 24 there were signs of developing volatility after a gap of near stagnant prices over weeks. In April this year, price of benchmark Brent was US$64.41 per barrel. It rose to US68.53 in May and it

touched US$ 75.16; and in June it was 75.17. In August, it came down to US$ 70.75. On September 24, Brent crude began to shoot up to reach the highest at US$ 77.47. The reasons given were output disruptions. The September 24 price is the highest since June 2021. It was also close to its highest since October 2018. Consequently, petrol price rose on September 24 to Rs.101.19 per litre in Delhi; and Rs.107.26 in Mumbai. Diesel price in Delhi was ` 88.82; and in Mumbai was Rs.96.41.

As I update this before it went to press, the petroleum crude benchmark Brent is close to US$ 80 per barrel on September 28. As a result, the price of petrol rose to Rs.101.39 a litre in Delhi and Rs.107.47 per litre in Mumbai. Diesel prices went up to Rs. 89.57 a litre in Delhi and Rs.97.21 in Mumbai.This is the first price increase in petrol in more than two months and the fourth in case of diesel. The increase followed international oil prices rising for the fifth consecutive day and global benchmark Brent heading for $80 per barrel.

The reasons put forward are that global demand for crude oil has been rising, consequent to  easing of pandemic restrictions and improving vaccination rates; and of course, on the supply front OPEC 2.0 is slow “has been slow in easing output restrictions”. They want to make up for the loss of revenue in the past! 

The central government placed the subject of bringing petroleum products under the tax system in the agenda of GST Council Meeting on September 17, in deference to Kerala High Court’s advice. As there was opposition from State Governments, the Finance Minister announced that Kerala HC would be informed that matter has been discussed and that the Council felt “it was not the time to bring petroleum products under GST”. 

Edible oil prices: failure of domestic policies? 

The August 2021 CPI core inflation, though in the tolerant zone, is more than the target of 4%. It is due to rising edible oil price, rather than petroleum crude price. The failure of poor domestic policies to augment domestic production of edible oil seeds is yet another reminder to policy makers on the need for a strategy. There is lack of incentives towards increased acreage and yield per hectare; and further “policy goofs up” including wrong timing of imports when there is already surplus domestic production. They do not like fall in prices. In his article in the hindu Business Line article, Radheshyam Jadav wrote in early September 2021 that the policy failures have resulted in the oil seeds production, “falling way short of needs in domestic demand for edible oil”. The result is as we note, a big volume of edible oils, dominated by palm oil, has to be imported every year. 

A suggestion for revision of weights in CPI

A review of CPI headline inflation shows that although it has remained at a high level in 2020-21, CPI core inflation has been low in better times with favorable arrivals of fruits, vegetables and fruits as well as when fuel and energy, are also equally low and favourable. When food inflation is high, that is when consumer food price index (CFPI) is high , it is mainly attributed to scarcity of vegetables in the initial months and to pulses and edible oils in the latter part of the year. Two economists, A. Sirija and S. Bajaj rightly observed in their article in The Hindu Business Line a tighter monetary policy would be appropriate only when there is excess aggregate demand. But when CFPI inflation is high due to supply factors, a restrictive monetary policy would only hurt growth. A rise in repo is called for only when core inflation is seen above 6 per cent for three consecutive quarters. The two authors, who are officials in the Department of Economic Affairs, Ministry of Finance note that Economic Survey 2019-20 ruled out the possibility of strong secondary effects from food inflation to core components. 

It is widely expected that October 6-8 MPC meeting would continue maintaining the accommodative stance for a while and wait for new CPI data in mid October. A suggestion made by Srija and Bajaj in their contribution deserves consideration.  Tables 2 and 3 present weights assigned to commodities for WPI and CPI (base year 2011-12). These weights were assigned ten years ago. The weights for CPI need a re-look, as food habits have changed; and further lifestyle of the population has also undergone radical transformation. A rising middle class buys far more manufactured goods, with increased use of internet shopping in the context of Covid-19, the suggestion from two government economists that increase in the household consumption of manufactured goods needs to be reflected in the CPI and their weights to be increased, thereby enabling “RBI to better target the non-volatile segment (core inflation)” .

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