Imported inflation rises after months of negative trends

In recent months, imported inflation in India has started to rise after being negative for several months. According to a recent report from the Reserve Bank of India (RBI), the contribution of imported inflation to the headline consumer price index (CPI) has also risen by 0.5% points since April of this year. 

What is Imported Inflation?

Imported inflation is caused by a decline in the value of a country's currency. The more the currency depreciates on the foreign exchange market the higher the price of imports. Effectively, more money is needed to buy goods and services outside the country.

With imported inflation, production costs are higher for companies. These companies most often reflect this increase in the selling price of the goods and services sold. As a result, prices within the country rise. Imported inflation causes inflation.

In India, this rise has been primarily influenced by several key global commodities, such as petroleum products, coal, gold and silver, textiles, cereals and dairy products, and vegetable oils. These items make up about 36.4% of the CPI basket, meaning they clearly impact consumer prices.

Recent trends

In August 2024, the overall CPI inflation rate in India was 3.7%. Out of this, 3.5% was driven by domestic factors, while the remaining 0.2% was due to imported factors. Notably, the contribution of imported inflation had been negative since December 2022 but turned positive in April 2024.

Rahul Bajoria of Bank of America, quoted in an ET report, explains that the rise in imported inflation comes from a very low starting point, with some adjustments in customs duties for commodities like gold and crude palm oil.

Currency impact on inflation

Imported inflation typically increases when the value of the Indian rupee falls against the US dollar. The RBI is closely monitoring currency fluctuations to ensure that the rupee remains stable, as a weaker rupee would make imports more expensive. 

According to RBI data, the rupee was overvalued by 4.7% as of the end of September, suggesting there is room for adjustments without drastic impacts on inflation.

Managing forex reserves

India's foreign exchange reserves have reached a record high of over $700 billion, mainly due to increased foreign portfolio investment (FPI) following the inclusion of Indian government bonds in the JP Morgan Emerging Market Bond Index. Foreign exchange reserves are the total amount of foreign currencies held by a country's central bank. These reserves are crucial for managing the country's currency value, stabilizing the economy, and facilitating international trade.

Gaura Sengupta of IDFC Bank says that with the balance of payments expected to improve, there will be limited pressure for the rupee to depreciate further.

As imported inflation rises, it's essential for the RBI to carefully manage the value of the rupee while ensuring that inflation remains under control. The overall economic outlook suggests a cautious approach, with expectations that capital inflows will continue, further stabilizing the rupee.

Understanding these dynamics can help consumers grasp how global events and currency fluctuations affect their everyday expenses.