This is best shown with an example, like the recent heat waves that engulfed large parts of the country for a few months this year. It can be argued that the resulting crop damage and livestock mortality led to K-shaped inflation. And this is visible across all different slices of price data.
One, even as core inflation (which is the cost of all goods and services that households buy, except food and fuel) is falling, food inflation is on the rise.
Let’s dig into core inflation more. Some new drivers seem to be keeping core inflation low. During the last bout of core disinflation in 2012, the main driver was a weakness in growth. This time, the dominant driver seems to be imported disinflation from China.
Furthermore, previously, past inflation was a driver of future inflation. If inflation was high, it would remain high for a long time. Now, the belief that the Reserve Bank of India’s (RBI) efforts will bring inflation down to the 4% target has played a role in driving down core prices. In other words, inflation targeting seems to have had some of the desired results.
Food inflation, however, remains a big worry. It has, in our view, been stoked by the changing nature of weather events. In the past, El Niño came with low rainfall. But now, it is not just about rains, but also high temperatures. This has not just increased the price of vegetables, wheat and pulses, but is also hurting the production of eggs, meat and milk.
Two, food inflation is elevated, but not as widespread as in previous shocks. Where imports of food were possible (as with oilseeds), prices did not go up much. Our diffusion index, which picks up the proportion of items where food inflation is elevated, has been lower than past trends. On the margin, this is good news. Rapid inflation across many more food items would have been harder to solve.
Three, urban inflation is falling, but rural inflation remains high and sticky. Much of this is driven by a wide difference between food and fuel prices. In fact, food inflation dynamics seem mysterious. One would think rural food inflation should be lower than urban food inflation, given that rural India grows the food.
There are two hypotheses as to why rural food prices remain much higher. One, with incomes hurt, farmers are making more of an effort to sell food to urban procurers where returns are higher, leaving less supply for rural areas. Two, a higher proportion of food was imported this time around, with port-to-fork infrastructure likely to be more efficient in urban India.
Diverging fuel inflation dynamics are more straightforward. The government cut prices of petrol, diesel and LPG. With all three consumed more in urban India, urban energy inflation fell more quickly than rural inflation.
Four, goods inflation is rising, while services inflation is falling, looking like a perfect K. It is worth noting that India is among the world’s few large economies where services inflation did not take off post-pandemic. Again, it all seems to be interlinked.
Supply shocks like the heatwave that kept incomes weak likely led to a situation where incomes across certain groups were just about enough to afford the ‘necessary’ goods. Demand for services, which tend to rise mostly when incomes do, remained weak, keeping a lid on prices.
Five, input prices are rising faster than output prices. Rising food, oil and industrial metal prices have stoked input price inflation this year. But corporates, facing weak demand from some groups, such as rural Indians, are not raising prices. Instead, they are taking a hit to their margins.
All of these recent K-shaped inflation dynamics have, in one way or another, been triggered by climate events. But other supply side shocks, like the pandemic and global commodity price shocks, can have similar K-shaped growth and inflation consequences. Such supply-side shocks that impact incomes and inflation variously for different groups are becoming more frequent. And this will likely complicate policy-making.
For instance, should RBI, ruminating its next move, worry about the 5 percentage-point wedge between food and core inflation, or should it take solace that headline inflation is the closest to its target in several months?
There are no simple answers. Eventually, RBI may have to focus on the expected direction of change in the short run. June was brutal, with rains 11% below normal levels. But July rains are forecast to be above average as El Niño abates and its contrasting weather phenomenon, La Niña, associated with stronger rains and lower temperatures, picks up. If this progresses well, reservoirs fill back up and sowing rises, eventually food inflation will soften.
RBI may find a little bit of room to ease later in the year, even if medium-term pressures from “recurring and overlapping” climate-related events, as RBI Governor Shaktikanta Das called them recently, remain.
Meanwhile the government, too, may need to be more sensitive to the impact of policy changes across different groups already reeling from supply-side shocks. Reforms may need careful explaining and planning.
Welcome to a world of unexpected shocks with K-shaped consequences.