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Not All States Are Benefiting Equally From India’s Low Inflation

Retail inflation in India has fallen sharply over the past five years. From a period of double digit inflation, India has seen annual price increases moderate to a pace below 4 percent at present. Relatively low oil prices, a sharp fall in food costs and periods of weak demand have kept inflation in check.

But the low inflation has not benefited all parts of the country equally. In fact, the divergence of inflation across states has actually risen even as the headline national-level inflation has fallen, shows a BloombergQuint analysis.

Variance, a measure of the spread between inflation rates across major Indian states, was nearly twice as high for February 2019, as compared to a year ago, showed the BloombergQuint analysis. This variance is calculated by computing the average of the squared difference from the mean.

While all-India CPI inflation was at 2.57 percent in February 2019, inflation across states ranged from -2 percent in Himachal Pradesh to over 6 percent in Nagaland and 7 percent in Andamans. Geographically, the North Eastern states saw the maximum divergence in inflation with states such as Nagaland recording among the highest inflation rates.

As noted in a recent RBI paper, while average inflation has come down across all states, volatility in inflation has risen. That, in turn, has been caused by volatility in food inflation, said DK Joshi, chief economist at Crisil. The RBI paper, published in its November 2018 bulletin, had noted that while there is significant divergence in state level inflation, over time this converges to the national average.

Analysis of the regional inflation dynamics in India reveals the presence of wide dispersion in inflation across states, largely driven by food price inflation. State level inflation tends to converge to the national average overtime, however, validating the choice of national level consumer price inflation as the nominal anchor for monetary policy in India.  
RBI Paper - November 2018 Bulletin

Lowest And Highest Inflation

Among major Indian states, Andhra Pradesh, Chattisgarh, Haryana, Himachal Pradesh and Telangana recorded the lowest inflation readings of under one percent in February 2019, as a result of a consistent drop in inflation over the past twelve months.

Based on the average of the last twelve months, the national average inflation stands at 3.7 percent. In comparison, Himachal Pradesh, Andhra Pradesh, Rajasthan, Gujarat and Delhi recorded the lowest average CPI inflation.

Assam and Kerala continued to record the highest inflation rate among major Indian states in February 2019, even though the pace of price increases has moderated in keeping with the trend in all-India CPI. Karnataka was the only major Indian state to see a rise in inflation in the course of the last one year.

On an average basis,over one year, West Bengal, Jammu and Kashmir, Kerala, Bihar and Uttarakhand recorded the highest inflation rate of over four percent.

Indian states are dynamic and inflation in every state varies on account of the diversity of the state’s economy and a range of other factors endemic to each state, said Devendra Pant, chief economist at India Ratings. Inflation, which is also a measure of purchasing power, may also vary on account of factors such as the wide variation in per capita income, he added.

However, state wise inflation trends are often counter-intuitive, Pant said. Ideally, agricultural producing states are should have lower inflation as the inflation decline has been led by food prices. However, preliminary analysis does not depict a clear correlation between agrarian states and their inflation rates even when analysed across rural and urban areas, Pant said.

The RBI analysis, however, had concluded that food prices continue to be the major cause of divergence. The food inflation spread turns out to be the primary driver of the overall inflation spread across states in our findings, said the study.

Why Inflation Divergence Matters

The divergence in state level inflation matters more in an inflation targeting regime. Since the central bank targets to bring all-India inflation down to 4 (+/-2) percent, a wide divergence in state inflation could have consequences for aggregate demand in these regions.

“In the Indian context, ensuring that the benefits of low and stable inflation accrue across regions and states is critical for anchoring the credibility of the new monetary policy framework and for incentivising buy-in by the widest sections of society,” the RBI study said while concluding at that the present juncture targeting of national level inflation remains appropriate since the two converge over time.

In theory, prices should converge across states, said SoumyaKanti Ghosh, chief economic advisor of the State Bank of India. However, localised divergences may prevent that from occurring. A persistent rise in divergence may defeat the purpose of inflation targeting while price convergence simplifies that objective, he added.