RESERVE BANK OF INDIA (RBI) kept repo rate unchanged at 6.5% in its latest monetary policy despite consumer price inflation (CPI) staying above its 6% target in January and February, even though March CPI came in at 5.6%. RBI's logic: Inflation is expected to moderate in FY24 and monetary policy actions it has already taken are "still working through the system." RBI governor Shaktikanta Das explained: "It's a pause for now, to assess the progress so far, and MPC wouldn't hesitate to raise the rate if and when required."
RBI, in fact, stood out among world's major central banks in announcing a pause in the rate hike cycle. U.S. Fed (despite bank runs) and European central banks increased rates by 25-50 basis points recently to control four-decade-high inflation rates. In India, RBI's assumptions have gone wrong for years, with January and February inflation (6.5% and 6.4%, respectively) coming in higher than its estimate of 5.8-5.9% for Q4 of FY23.
However, the fight against inflation has taken a twist in U.S. and Europe. More and more economists are calling it a "sellers’ inflation" — caused not by rising input costs like wage-price spirals of 1970s but companies using market dominance to increase prices. As this blunts the impact of rate hikes, RBI may have to tweak its strategy of increasing the repo rate to bring inflation under control.
The development is so unusual that a study by University of Massachusetts Amherst titled "Sellers' Inflation, Profits and Conflict: Why Can Large Firms Hike Prices In An Emergency?," published in February 2023, says that even suggesting a possible link between corporate profits and high inflation would have been considered "heretical" until 2022.
The reasons are simple. Since 1970s, the two dominant inflation triggers have been excess aggregate demand in relation to capacity (Keynesian) and too much money chasing too few goods (monetarist or neoliberal), says the paper. Under these theories, high inflation is purely a matter of inflated wages and there is no role for profits or power of firms to set prices. This is wrong, says the paper, concluding that U.S. is predominantly seeing a sellers' inflation that started in second quarter of 2021 and continued in 2022. During this period, profit (after tax) of non-financial U.S. corporations broke a new record, surpassing previous highs of the period after World War-II, says the paper. Wages didn't contribute as they "have consistently failed to keep pace with inflation and most workers have faced declining real wages," it adds. Instead, this inflation is driven by "ability of firms with market heft to hike prices." The four sources of this ability are — monopolies or market concentration in hands of a few price makers; compromised competition; versatile product portfolio and good revenue management; and access to diverse markets for money (making rate hikes ineffective) as well as consumers (finding people to sell at a high price). Since sellers' inflation is not demand-driven, it cannot be brought down by raising interest rates which, in fact, will hit smaller firms. Tackling this requires "price gouging" laws backed by close monitoring, windfall profit taxes and price controls for significant sectors where competitive markets are compromised, says the paper.
Eurozone and U.K.
The first sentence of a research paper by French bank Natixis, "Euro Area: Wages, Profits And Inflation," released on March 27, 2023, reads: "One factor behind stickiness of core inflation in euro area has been ability of companies to sustain high margins."
It doesn’t talk about sellers' inflation but says corporate profits were "excessive" in 2021 and "re-accelerated throughout 2022," driven by mark-up, which continued to grow strongly. Wage share has declined sharply over last two years, it says. The high mark-up was possible because "pent-up demand during pandemic meant people were less price-sensitive as they came out of lockdowns," says Dirk Schumacher, who heads the European research unit of Natixis.
U.K. is also going through a "cost of living crisis." A study by its trade union Unite titled "Profiteering Across The Economy – It’s Systemic," published in March 2023, found sellers' inflation at work as many companies pushed up prices through price gouging. It found wages fell sharply in U.K. in 2022 and had no role in keeping inflation high. Now, workers are facing a difficult choice. They risk wage-driven inflation too if they demand higher wages to overcome their cost-of-living crisis.
The surge in price mark-up has come after the unprecedented stock market boom in 2020 and 2021 amid millions losing their lives and livelihoods to the pandemic. The global economy shrunk by 3.1% in 2020 before growing 6% in 2021. A study by Swiss bank UBS and PwC says billionaire wealth went to "a new high"— from $8 trillion at beginning of April 2020 to $10.2 trillion by end-July — in just four months. The trigger was huge fiscal and quantitative easing by governments and central banks, it says.
Central Bank Action
Central banks of U.S. and Europe have been flagging the problem since 2022. For example, vice chair of U.S. Fed, Lael Brainard, pointed out in September 2022 that "reductions in mark-ups could make an important contribution to reduced pricing pressures." Isabel Schnabel, member of European Central Bank's executive board, said in May 2022 that "profits have recently been a key contributor to total domestic inflation."
Now, pressure to act is mounting. On March 7, US Fed chair Jay Powell was rebuked for ignoring sellers' inflation during his testimony to Congress, with Sherrod Brown, chair of the Senate Banking Committee, telling him: "The Fed can't force corporations to change their ways or rewrite the Wall Street business model on its own. But you could talk about it. High interest rates, falling wages and increasing unemployment are hallmarks of failed policies that end up helping Wall Street, large corporations and the wealthy."
On March 24, Andrew Bailey, governor of Bank of England, urged companies to refrain from price increases with a veiled warning: "And I would say to people who are setting prices, please understand that if we get inflation embedded, interest rates will have to go up further."
India's Big 5
RBI and Central government have not yet acknowledged sellers' inflation in India even though RBI has noticed an unusual phenomenon. Its March 2023 bulletin expressed concern that while CPI remained high, core inflation (excluding food and fuel) "continues to defy the distinct softening of input costs." One would expect RBI to probe further but it did nothing more than mentioning the problem.
Viral Acharya, former RBI deputy governor who teaches at New York University's Stern School, has raised a red flag while explaining this anomaly. "When input prices rise, if market power in an industry is high, wholesale price inflation in that sector rises a lot more. And that feeds into CPI," he says.
He, in fact, blames Big Five — Reliance, Tata, Birla, Adani and Bharti groups— for driving inflation because "the Big Five are able to charge product prices that are substantially higher than other competitors." Helping them are "sky-high tariffs" shielding them from competition by foreign firms. He said these conglomerates wield immense pricing power in retail, resources and telecommunication sectors and should be broken up.
Acharya also questions the "national champions" policy. "Creating national champions, which is considered by many as the industrial policy of new India, appears to be feeding directly into keeping prices at a high level."
In a just published paper, "India at 75: Replete With Contradictions, Brimming With Opportunities, Saddled With Challenges," he writes that post-1991 liberalisation, these Big Five have not only expanded footprint in more and more sectors but also increased their share in assets of non-financial sectors from 10% in 1991 to nearly 18% in 2021. At the same time, the share of the next big five business groups fell from 18% in 1992 to less than 9%. "In other words, Big Five grew not just at the expense of the smallest firms but also of the next largest firms," says the paper.
That wages are not contributing to inflation is evident. In FY21, corporate profits soared to historic high, partly due to job and wage cuts, says CMIE. PLFS (periodic labour force survey) data also confirms that post-pandemic recovery is profit-led rather than wage-led. Acharya says real wages have risen in urban areas but fallen in rural areas, where most of the jobs are.
RBI and finance ministry often blame external factors for inflation, calling it a "spillover from geopolitical shocks." The role of domestic factors such as fuel costs, tariff and non-tariff import barriers, extreme weather conditions causing crop loss and pass-through of input costs are either ignored or soft-peddled. A big reason for this is propensity for "positivity" in public narrations. The finance ministry's Monthly Economic Report of April 2022, released in May 2022, claimed inflation doesn't hit the poor but the rich and thus, when inflation moderates, there is "redistribution of income." It used 2011-12 household consumption expenditure but excluded critical elements that reflect impact of inflation on households: (a) income levels (b) expenditure on luxury goods and (c) savings.
One can hope for a reality check by RBI when it next looks at inflation and interest rates, keeping in mind that disciplining inflation calls for measures other than interest rates, too — like U.S. and Europe are realising now.