What is India’s track record of inflation management? Have things improved after inflation targeting was introduced? Before we answer these questions, it may be useful to identify an inflation measure which has lesser volatility and captures the underlying direction of inflation. In an economy, the prices of food and fuel tend to be somewhat volatile, and by excluding them from the overall price increase process one can get a more stable indicator of inflation. This measure is popularly known as core inflation.
There is little doubt that the core inflation has come down after inflation targeting was introduced in 2016. The average core inflation was 6.7 percent between 2012-13 (the base year of the current consumer price index) and 2015-16, this came down to an average of 5.25 percent during the 2016-17 to 2022-23 period. Without getting into any brouhaha about anchoring inflationary expectations or managing the output gap, suffice it to say core inflation has come down after adopting inflation targeting. Structuralists have a different perspective, according to them, relative prices of agricultural goods or commodity prices have a key role in the inflationary process. However, nobody, irrespective of his or her theoretical underpinnings, can deny that average core inflation has come down after 2016-17.
Role of market structure
Nevertheless, there is an issue. During the last two years core inflation has moved up and is veering around 6 percent. This has the potential to feed into headline inflation and get it elevated. What is behind the stickiness of core inflation is the key question. One of the plausible reasons could be that the pass-through of higher input and services prices was happening with a lag. Secondly, higher import prices too could be providing elbow room for inflation persistence in selected cases.
It is indeed true that core inflation and its persistence can also be affected by market structure, which includes market size, concentration and pricing power. Some attempts have been made in recent months by the former deputy governor of the Reserve Bank of India Viral Acharya to relate the persistence in core inflation with the pricing power of firms and industrial groups supposedly thriving in an oligopolistic market with tacit support from policymakers. The focus is on five big industrial houses of India for this purpose. But, one has not come across supportive empirical evidence from Acharya as yet.
However, some questions can be justifiably raised about his observations. Firstly, the five business houses he mentions have not transcended to the chaebol or zaibatsu stage as yet. Further, none of the mentioned houses seems to be too big to fail as yet and is not showing any signs of becoming systematic risks for the financial system.
Overestimating pricing power
The concentration of economic power has to be seen in relation to the market, all horizontal merger studies have to define what is the market and what are the substitutes. For example, is a watch meant to show time or is it an ornament, if the motive is to keep track of time, then mobiles perfectly serve the purpose of indicating the time. Next arises the question of market share, for this, the denominator has to be the total market - should it include only watch or watch and mobile? Further with changes in technology and innovation, the nature of product offering and competition changes too. Mobiles were supposed to be instruments of communication; however, they have become an integral part of the entertainment industry.
Coming back to concentration, the traditional logic runs as follows: concentration leads to market power which can lead to higher prices for the consumer that provides higher profit for the seller at the individual consumer’s expense. The current reality is different, one of the most concentrated markets is the search engine industry, which is led by Google. None of us pays Google anything for all the searches it does for us. The traditional concentration-pricing power relationship does not work. Possibly for social media and search engines, we ourselves are the products!
The concept of industrial groups or lead firms setting prices on their own or as an oligopolistic combine is valid, if product innovations don't happen, substitutes don’t appear and technology remains staid. During the Covid pandemic, one saw how quickly a part of the retail industry got substituted or complemented by e-commerce suppliers.
We do not have clear empirical evidence establishing the relation between the stickiness of core inflation and market concentration. There could be some methodological issues, it has to be done sector-wise or segment-wise. Secondly, the explanatory power of concentration could get subsumed by factors like the output gap in the sector or segment, the previous period’s price (inertia effect) and inflationary expectation.
Siddhartha Roy is the former Economic Advisor of the Tata Group. Views are personal, and do not represent the stand of this publication.
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