The recent surge in the price of primary food items including cereals, pulses, and a host of vegetables is making headlines. The attribution for the spike is seen as emanating from the weather disturbances and the associated reduction in acreage. But that is only a part of the story.
The decline in headline retail inflation to 4.8% in May 2023 from 6.2% in December 2022 was on account of the base effect of high inflation last year, seasonal decline in vegetable prices during the winters, and easing of imported edible oil prices from the shortage-led surge in the aftermath of the Russia-Ukraine war.
But, despite the recent deceleration, the four-year CAGR headline and core CPI inflation are over 6% and the latest surge in food inflation is accentuating the impact on households. A situation of low-income growth and elevated unemployment with high inflation has a greater debilitating impact compared to a situation of high inflation, strong income, and lower unemployment.
The real private final consumption expenditure has decelerated sharply to an average of 2.5% in the second half of FY23, lower than the four-year CAGR of 4%, and it is less than half of the pre-Covid average of 7% (December 2019). The unemployment rate for June 2023 rose again to 8.5%, up from 7.7% a month back and 7.8% a year back (Source: CMIE).
So, high inflation is impacting the spending power of common households and is creating two distinct price trends.
The Two-Track Inflation
On the one hand, there has been a steep rise in the prices of vegetables, cereals, and pulses, and on the other hand, the organised staples and retail segments have to offer early discounts or promotions as they face lackluster demand situations.
The steep rise in prices of tomatoes (up 700% since March 2023), cauliflower (up 300%), chilly (up 66%), ginger (150%), coriander (up 700%), carrot (up 60%), etc., reflects a disproportionate rise as compared with the usual post-winter seasonal rise.
There has been persistence in inflation for cereals and pulses as well. The price of rice has climbed up by 11% YoY, while on a three-year basis, it has compounded by 9%. And despite the easing of wheat prices by 11% since February 2023 due to government interventions, it is still higher by 8.4% on a three-year CAGR basis. Prices of pulses are also on the boil with a three-year CAGR of 14% with the sharpest rise in Tur, which is up 27% YoY.
Conversely, consumer companies are facing a soft demand trend even in Q1 FY24. Contrary to the initial optimism, companies have sounded less sanguine, and following a period of steep price-led profit expansion in the post-Covid era, they have now relied on price cuts to shore up volumes or protect market share gains. As a corollary, the two-track inflation would mean gains in terms of trade for the agricultural sector.
Thus, beyond the weather anomalies impacting food prices, the big picture points towards some noticeable structural trends.
Spending Has Slowed But 60% Still Going Into Inflation
Real spending growth of households has decelerated to 4% on a four-year CAGR (2.8% in Q4 FY23) from a peak of 8.5% (old GDP series peak of 10% in Q4 FY08) but the nominal spending has decelerated to 9.3% four-year CAGR (7% YoY in Q4 FY23) from 17% in 2013 when inflation was high.
So, the proportion of nominal spending going into inflation has risen to a high of 60%; only the remaining 40% went into real spending. Contrastingly, during the period of high inflation of 2013-14 when spending was growing at 17%, the proportion going into inflation was lower at 50%.
Income Recovery Is Crucial
Our estimates show positive responsiveness of real consumption spending to inflation at 0.58 (sample period 2004-2023) instead of the negative as one would normally expect. The elasticity and R-square jumped up to 1.8 and 0.87 during the high growth era of 2003-2008, which was also associated with the doubling of inflation from 3% to 6%. This is because the positive income effect from higher growth outweighs its associated rise in inflation. As a corollary, the low-income effect from a prolonged phase of low growth and persistent high food inflation can overwhelm the positive influence of moderating product inflation due to intensifying competition. It could very well be the case of product substitution within the budgetary constraints of households.
Structural Factors
The persistently high inflation for primary food items may look ironic to the fact that real agriculture output growth at 3.8% CARG (three years) has been higher than the overall GDP growth of 3.3%; IIP data shows an even higher pace of rice production of 11% (March-April 2023) on four-year CAGR. In addition, the vulnerability of India’s agricultural production to deficient rains reduced notably due to rising reservoir capacity and irrigated areas.
In the ongoing kharif season, despite the monsoon anomalies, the sown area at 598 lac hectares is only 1.6% lower than last year, with 16% YoY rise under coarse cereal induced by the millet year initiative, mostly compensating for declines under paddy, pulses, and oilseeds (-16%, -9.8%, and -10.4% YoY, respectively).
Thus, high food inflation has less to do with overall supply shortages. Rather, it is associated with the distributional aspect of rising ruralisation triggering higher food consumption and is accentuated by the above substitution within the cropped area. As a result, even a small negative shock on the supply side, say from weather disturbances, can trigger a disproportionate price surge. A recent RBI study indicates sequential transmission from tomato to potato and onion.
High Inflation, Slackening Savings Impacting Growth Potential
The sharp deceleration in PFCE is due to significant lagging of household real income growth (estimated as PFCE plus household savings), particularly after FY12. In FY23 it decelerated to a 27-year low of 3.5% on a four-year CAGR (5.4% YoY, 7.3% in FY22, and 9% in FY10), pushing households to rely on leveraged spending.
Since FY12, household savings have continued to slacken resulting in a continued lack of private capex and the associated decline in potential growth. Thus, higher rises in inflation even with a modest rise in consumption.
Modigliani’s consumption smoothening thesis (1950s) has it that people follow an income-spending adjustment process over their lifetime with higher savings and constrained consumption during rising incomes to provide for dis-savings during their post-retirement. In the recent Indian context, this process is pushed back due to persistent shocks impacting income situations, more than the drag on consumption and its concentration on basic items like food.
Thus, it would be fallacious to consider the recent surge in inflation as a fallout of short-term disturbances. There are deeper structural imbalances that imply that even with moderating household spending, rising proportion is feeding into elevated inflation than real spending. Post-pandemic high inflation has benefited corporate profit and tax collection at the cost of the household situation without creating sustainable supply-side impulses. This reinforces the criticality of private capex revival. The redressal of this structural logjam hence requires a policy facelift that addresses employment and income generation concerns and catalyses positive supply impulses that keep inflation tamed.
Dhananjay Sinha is co-head of equities and head of research, strategy and economics, Systematix Group.
The views expressed here are those of the author and do not necessarily represent the views of BQ Prime or its editorial team.
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