Inflation has been on a volatile journey since the onset of the pandemic. In fiscal 2021 – the first year of the pandemic – Consumer Price Index (CPI)-linked inflation rose to 6.2% from 4.8% the previous year, despite a steep collapse in demand. Interestingly, global consumer inflation fell in 2020 and rose in 2021. In contrast, in the current fiscal, despite recovering demand and significantly higher global commodity prices, CPI inflation has averaged 5.2% so far. This is higher than the 4% that the Reserve Bank of India (RBI) wants it to settle at, but within its tolerance band of 2-6%.

While headline inflation during April-December at 5.2% was lower than during the same period last fiscal, core inflation at 5.9% was higher. As input cost increases are yet to be fully passed on to the end-consumer, the pressure on core inflation will continue in the coming fiscal as input costs continue to rise. During the first nine months of current fiscal, urban inflation at 5.5% was 50 basis points (bps) higher than rural inflation. The urban poor (bottom 20%) faced the highest inflation, at 5.6%. This is because fuel, with the highest inflation, has a larger share in consumption for the bottom 20% than other income classes in urban areas. Meanwhile, inflation for producers – measured by the Wholesale Price Index (WPI) – has been in double digits this fiscal and scaled a record high in November, led by the low base of fiscal 2021 and sharp increase in commodity prices.

We expect CPI inflation to moderate to 5% in fiscal 2023 as global commodity prices soften and the reduction in excise duty on petroleum products tempers fuel inflation. That said, this would be the third consecutive year with inflation above 4%. The inflation outlook is still subject to uncertainty. As seen in the current fiscal, unpredictable movements in food can sway the overall inflation reading. In particular, vegetables, with 6% weight in consumer basket, is notorious for volatile price movements, being subject to unseasonal rain patterns. Pass-through of broad-based input-cost increases to retail prices continues and can gain pace as demand improves. Elevated inflation has also led to a rise in household inflation expectations, which remain above pre-pandemic rates. Further increase in prices can raise inflation expectations, adding to the persistence of elevated inflation. Another factor to watchout for is supply disruption. In this fiscal, supply disruptions have risen significantly on account of the uneven nature of global recovery and sporadic lockdowns globally. Broadening global recovery and easing Covid-19 restrictions should address supply bottlenecks going forward. However, any large Covid-19 waves that disrupt recovery and bring back restrictions can again put pressure on global supply chains. This is especially relevant for China – the global manufacturing powerhouse – which continues to follow a zero-Covid policy and implement strict restrictions.