Inflation hits tier II cities harder

By Anto Antony

Tier II cities are feeling the pinch of inflation more than the metros. For six months up to February, retail inflation as measured by the consumer price index for industrial workers (CPI-IW) had been hardening, but at a much lesser pace in the eight major metros than the tier II cities a phenomenon that economists attribute to the fact that supply mechanisms of smaller towns are less elastic to demand variations.

The rate of inflation was on the decline in March and April, but still at double-digit levels. Again, the moderation is more in metros than in other cities-- the difference between the rate of retail inflation in metros and tier II cities was close to 4 percentage points, when the country-wide inflation stood at 13.33% in April.

While the retail inflation has been running at double digits across almost all cities in India, it was from second half of 2009 that the smaller cities started heating up much faster.

The fuel price hike, which is expected by next month, would lead to further acceleration in the pace of increase in prices in smaller cities. As these cities are witnessing much higher capacity utilisation compared to metros, the fuel price hike would work through them fast to show up in retail inflation numbers.

Says country's chief statistician Pronab Sen, "The smaller cities have a supply mechanism which is less elastic to demand variations than those in major metros. Hence as the demand went up with resurgence in the economy, these towns witnessed sharper spike in prices".

No wonder, CPI-IW data shows pace of inflation in smaller towns was way below that in metros when the economy saw a fall in demand in the aftermath of Lehman collapse.

Higher inflation in smaller cities compared to the larger ones is due to both higher tradable and non-tradable inflation, points out Goldman Sachs economists Pranjul Bhandari and Tushar Poddar. "The recovery since the crisis seems broad-based across both tiers of cities and the strong recovery and growth momentum for the smaller cities and not just the main metros signal their rising importance as activity hubs as India continues to grow," Goldman Sachs said in a research note. The difference in inflation rate between the two classes of cities is sharper in respect of tradeable items. Tradable items in the consumption basket includes food, fuel and durable and non-durable goods while non-tradable items include housing costs and services such as medical care and domestic services.

The spike in fuel prices will have a larger impact on non-food items than food items, planning commission member Abhijit Sen said. "Petrol price hike will no be having any impact on food items while a 10% hike in diesel price will see food inflation moving up by 20 to 30 basis points at the most," Abhijit Sen told FE in an interview. "It will have a much higher impact on headline inflation figures," he added.

Meanwhile, policymakers and analysts are closely watching the headline inflation numbers that will be released on Monday. An FE poll of economists showed the consensus estimate of headline inflation for month of May at 9.13%.

If the inflation numbers overshoot the projections to move into double digit territory RBI will be forced to go for a hike in policy rates before the monetary policy review in July. Retail inflation as measured by CPI-IW was 13.33% in April while the headline inflation as measured by the wholesale price index was at 9.59% in the same month.