US Inflation and Impact on India

Context: Over the last few days, the retail inflation in the US has risen to 6.2%, the highest year-on-year jump in 3 decades. These rising prices have cornered a lot of attention, both globally and in India.

What has caused the inflation surge in the US?

• Usually, inflation spikes can be assigned to either an increase in demand or a decrease in supply. In the US, both factors seem to be responsible.

Reasons for Increase in Demand

• 1) Sharp recovery: Due to the Rapid rollout of the Covid-19 vaccination drive.
• 2) Social security Measures: Billions of dollars were pumped by the government to provide relief to consumers, those who lost their jobs, and to stimulate demand

Reasons for decrease in Supply
1). Decreased industrial production: due to widespread lockdowns and disruption caused by the pandemic. 2). The slow pace of supply chain recovery worsened the mismatch between demand and supply, thus triggering a sustained price rise.

• While the US has seen the sharpest increase in prices, inflation has affected policymakers across most of the major economies, be it Germany, China, or Japan.

What is happening in India?

• India was one of those rare major economies where high inflation was present before the pandemic. The pandemic made the matters worse because of supply constraints.
• As a consequence, India’s retail inflation has stayed above or near the RBI’s upper limit.
• However, in the last couple of months, the headline retail inflation rate has decreased down to below 5%.
• While the overall inflation average appears quite manageable at present, it is the “core” inflation that is worrying policymakers now that is now over 6%.

Why is US inflation a matter of concern for India?

• Imported inflation: When prices increase globally, everything that is imported will become costlier too.
• Indian firms trying to raise money outside India will find it costlier: Because to control inflation, the central banks of advanced economies will resort to a tight monetary policy, i.e. credit will become costlier due to higher interest rates.
• A further increase in inflation in India: RBI will also have to align its monetary policy at home by raising interest rates domestically. That, in turn, may further raise inflation because the production costs would go up.

Additional Information
Inflation: It is the rate at which prices increase over a given period. Typically, in India, the inflation rate is calculated on a year-on-year basis.
In other words, if the inflation rate for a particular month is 10%, it means that the prices in that month were 10% more than the prices in the same month a year earlier.

• In India, inflation is primarily measured by two main indices — WPI (Wholesale Price Index) and CPI (Consumer Price Index) which measure wholesale and retail-level price changes, respectively.
• India has adopted a flexible inflation targeting mandate of 4 (+/-2)%.