What does 12-year-low core inflation say about India's growth story?

Core inflation is seen as a proxy for demand in the economy as it excludes the volatile price changes seen in food and fuel items and thus provides a better understanding of underlying inflation developments.

As was expected, India's headline retail inflation rate remained steady in February, coming in at 5.09 percent as against 5.10 percent the previous month. However, core inflation – inflation excluding food items and fuel  – continued its downward trend and fell to 3.3 percent, as per Moneycontrol calculations. This, economists say, is the lowest core inflation has been since January 2012.

Of course, ways to measure core inflation can differ. In essence, core inflation strips out the volatile food and fuel items and focuses on the price changes of other items. Some economists like to go one step further and remove certain fuel and metal items from the 'miscellaneous' category of the Consumer Price Index (CPI) that includes household goods and services, transport and communication, and health and education related items, among others.

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"Weak core inflation at a time of strong growth is a conundrum," economists Paras Jasrai and Sunil Kumar Sinha of India Ratings and Research noted.

Growth has indeed been strong. The statistics ministry surprised everyone when it said on February 29 that India's GDP growth in the last quarter of 2023 was a blockbuster 8.4 percent, significantly higher than all forecasts.

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Jasrai and Sinha point at the "weak input price growth" for the falling core inflation, with wholesale inflation being in the negative for much of 2023-24.

To be sure, a favourable base effect has also helped drag down core inflation. But one must also consider what core inflation purportedly reflects: demand.

"The sustained moderation in core inflation indicates that despite strong growth conditions, there are no signs of overheating," said Gaura Sen Gupta, India economist at IDFC First Bank. According to Sen Gupta, the lack of overheating – which refers to the rise in prices when an economy's production capacity is exceeded by demand – despite the high GDP growth is on account of the "type of growth", which has been led by investments rather than consumption.

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Economists from QuantEco Research agree, saying that while the improvement in supply chains post Covid and low input price inflation are playing a role, "soft domestic consumption demand has been providing an additional downward bias".

"Growth dynamics reflect an investment led momentum (predominantly led by the government) and the relentless push for heavy lifting by public capex has ensured a softer bias for core inflation in 2024-25," they added.

For others, the demand angle is "misleading".

"Since the decline in core (inflation) is visible in both rural and urban areas and in goods and services that are quintessential to the day-to-day living, to confer that core decline is a proxy for decline in demand or rural slowdown is misleading," Soumya Kanti Ghosh, State Bank of India's group chief economic adviser, said in a report.

According to Ghosh, changes in how households make their purchases is the only explanation for the fall in core inflation.

"We believe that peoples are actively using e-commerce websites to buy these essentials (preferably at discounted price) and hence demand is migrating from offline to online mode."