Inflation generalisation: Why price pressures are spreading, and what it means for interest rates

In September, household inflation surged to 5.54%, up from 4.83% in August, according to data released on Monday. This development has led to the phrase "price pressures are generalising" becoming a common topic of conversation. The generalisation of inflation refers to the process where higher prices spread across various categories of household consumption, moving from essential items like food and fuel to consumer goods and services.

The Reserve Bank of India (RBI) acknowledged in a recent statement that there is "some evidence of elevated inflation expectations and generalisation of inflation," marking a shift from its earlier stance in August. Economists have criticized the RBI's initial approach of attributing inflation to supply shocks, arguing that this explanation lacks credibility.

The latest Consumer Price Index (CPI) inflation data for September supports the broader spread of inflation, with the RBI's concession on October 7 contributing to a consensus among analysts. The question then arises: how can one identify inflation generalisation, and what role does it play in determining interest rates?

Broadly, inflation generalisation can be identified by observing whether prices are rising across a larger portion of the CPI basket. This can be measured by tracking the number of items experiencing inflation rates above 4%, which is the RBI's medium-term target. In January, only 65 out of 358 items in the CPI basket had an inflation rate of 4% or higher. By September, this number had almost doubled to 129.

Another method to assess inflation generalisation is through the use of diffusion indices, which consider the weight each item has in the CPI basket. According to the RBI's diffusion index, 46% of the CPI basket registered 4%-plus inflation in September, up from 37% in August and 16% in January. However, some economists argue that this figure is low compared to historical standards, questioning the extent to which inflation pressures have truly broadened.