The rise in retail inflation in September was anticipated by both the markets and the authorities.
Ergo, an uncomfortably high title impression of 7.34% didn’t faze anyone. After all, the surge came from the usual suspects: vegetable prices and sticky core inflation. Yet India’s retail inflation, when broken down into parts, tells a story that policy makers should focus on if they want a smooth recovery.
If the trend can be followed month-over-month, Indian villages experienced higher inflation increases than urban centers in September. This was to be expected, considering that rural centers have shown more resilience than urban India in terms of demand. However, that’s only part of the big picture.
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Since the start of the COVID-19 pandemic in February, urban centers have driven price pressures that form stiff core inflation. As such, core inflation, which includes most of the service sector, has remained an urban phenomenon of late. The pandemic appears to have exacerbated the problem.
Urban retail inflation in services was 7.74% in September, while the rural one was 6.12% lower. Core inflation has seen a steeper rise in urban centers since July. The more volatile fuel inflation has also been largely driven by urban centers.
There are many reasons why urban areas are driving inflation lately. Smaller cities and urban centers were hit the hardest by the closures. The progressive relaxation has meant that business activity has resumed rapidly. Additionally, service providers were able to pass the additional cost of social distancing and hygiene onto consumers through a small tax. “What keeps core inflation high are increases in telecommunications prices last year and a second-round impact from the large increase in retail fuel prices on bus fares, taxi, etc. demand pressures,” analysts at Edelweiss Securities Ltd wrote in a note to clients.
That said, consumer demand has yet to fully revive in urban centers and hopes are based on the holiday season. Core inflation as a whole has moderated over the past six months, showing a lack of demand.
As such, the September inflation surge was driven primarily by vegetable prices. Economists expect these to cool down in the coming months. As food inflation is expected to decline, the Reserve Bank of India (RBI) did well to analyze the short-term rise in retail inflation.
However, the old enemy of the central bank, India’s core inflation, has yet to be tamed. For that to happen, city-driven pressures should ease.
In its monetary policy report, the RBI has said that divergent trends in rural and urban inflation tend to converge over time. The key question for monetary policy now is whether urban inflation would drop to meet the rural curve, or vice versa.
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