Weak demand may prove to be a bigger and stickier problem than inflation

There can’t be a more trying phase for economic policy makers than one where the economy is stagnant but prices are shooting up. That’s what emerged this week after the wholesale price index in April increased by 10.49%, the highest in 11 years. The headline however doesn’t convey a clear picture of the underlying situation; we are not in the midst of an overheating economy. The surge in WPI is because of a rise in global energy and commodity prices which are benchmarked against a phase last year when they were falling.

In April 2020, the Indian basket crude had collapsed to $19.90 a barrel in the shadow of worldwide lockdowns. By last month, the price of the Indian basket had risen to $63.40, an increase of 319% in a year. Global price trends in key industrial commodities are showing a similar pattern. Iron ore’s average price in February was $163.8 per dry metric ton. By April, it had risen to $179.8 per ton. This combination is feeding into prices across manufactured products. This does not mean that RBI should reorient its priorities to place inflation ahead of economic growth. That will be counterproductive.

RBI’s inflation-fighting tools largely centre on squeezing demand to cool the economy. Therein lies the problem. Demand’s already weakening in the wake of the second wave of Covid-19. RBI’s latest analysis on the state of the economy observes that the biggest toll of the second wave is a demand shock. Here it’s important to be mindful of the dissimilarities between the first and second waves. There’s evidence that this wave is penetrating rural India and it’s not clear yet what the full impact will be. This time rural demand may not act as a countervailing force to the urban impact of lockdowns.

Another early sign that weakness of demand may persist shows up in corporate results. RBI’s analysis of the financial results of 288 non-financial companies for January-March quarter shows that they registered an increase in sales and net profit despite a rise in raw material costs. That’s because of a lower growth in salaries and other expenses. Many developments suggest that consumer demand will slacken. Weak demand may then be a bigger and stickier problem than inflation. That’s what needs to be prioritised but through fiscal policies. It’s a clever fiscal policy that India needs to offset the economic impact of the second wave.


This piece appeared as an editorial opinion in the print edition of The Times of India.


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