What causes inflation in India: Demand or supply issues?
- According to a Reserve Bank of India (RBI), inflation in India is influenced by a combination of supply and demand factors.
- During the two waves of COVID-19, supply disruptions were the main cause of inflation.
- However, following the Russia-Ukraine conflict, the driving forces shifted predominantly to factors related to demand.
Influence of COVID-19 and the Russia-Ukraine conflict
- During the initial phases of the pandemic, lockdowns led to a decline in production and demand, causing a drop in economic growth and commodity prices.
- However, as the economy reopened with vaccination efforts, demand outpaced supply, leading to upward pressure on commodity prices.
- The onset of the Russia-Ukraine conflict further intensified supply chain challenges and added to commodity price pressures.
Methodology to Identify Factors
- The Centre for Monitoring Indian Economy’s consumer expenditure data has been used to categorize inflation as either demand-driven or supply-driven.
- A simultaneous shift in prices and quantities in the same direction indicates demand-driven inflation, while opposing movements suggest supply-driven factors.
Key Findings
- Categories with Supply-Side Constraints: Vegetables, oils and fats, milk, eggs, pulses, and sugar.
- Demand-Sensitive Categories: Non-alcoholic beverages, personal care products, and health-related goods.
Overall Inflation Trends
- Demand and supply factors at the sub-group level were combined using the CPI weights to assess overall headline inflation.
- Supply-Focused Periods
- Supply factors drove inflation during excess rainfall in October 2019-January 2020, various stages of pandemic and the onset of the Russia-Ukraine conflict.
- They contributed approximately 55% to Consumer Price Index (CPI) headline inflation from January 2019 to May 2023.
- Demand Impact during COVID-19
- The impact of demand-side factors on headline inflation decreased during the COVID-19 crisis, dropping to 27.1% in 2020 from 41.5% in 2019.
- However, demand-side factors intermittently increased post-COVID-19 waves and after the Russia-Ukraine conflict.
- This contributed to the peak in headline inflation in April 2022.
- Overall Demand Contribution: Over the period from January 2019 to May 2023, demand drivers contributed 31% to inflation.