Inflation, except during the COVID-19 pandemic, has remained relatively low in India for over a decade. But it is back with a bang. Wholesale Price Index (WPI) inflation is hovering close to 10% in June (Chart 1a). After remaining low — negative, or close to 0 — until December last year, the climb started with a sharp jump since March this year.
Even those with only a fleeting connection to economics believe that prices rise when demand outpaces supply (overheating), and vice versa. But is that really the case?
Before we go into the causes, let us look at what contributed to this rise in WPI inflation in the first place. The WPI is a weighted average of three sub-categories of commodities: primary articles (food, minerals, etc.), fuel and power and manufactured products. Chart 1b shows the contribution of each to total WPI inflation. The latter two — the orange and the red bars — have contributed to this dramatic jump in recent months. Fuel and power prices require little explanation as they are determined by oil prices purchased from abroad and are essentially imported prices. However, primary commodity and manufactured product prices need to be understood.
Structural differences in pricing
The Polish economist Michal Kalecki argued that while primary commodity prices are demand-determined, industrial prices are cost-determined. In other words, inflation of industrial commodities is not determined by a demand and supply mismatch. Come to think of it, this is commonsensical if you leave aside the quintessential demand-supply curves out of your head. After all, prices of cars, cycles, or toothbrushes do not fluctuate with a change in their demand. If more cars are demanded, more are produced and supplied to the customer instead of increasing the price. Prices of tomatoes or mangoes, on the other hand, vary quite significantly with a mismatch between demand and supply.
Viewed this way, the demand and supply curves need to be reconstructed (Graph 1). For primary commodities (panel (a)), supply is virtually fixed, represented by a vertical curve on the quantity axis, whereas demand follows the usual downward sloping curve. A decline in supply (shifting of the supply curve in panel (a) to the left) will increase its prices. In the case of food, for example, a bad monsoon will affect production adversely, thereby decreasing supply and increasing its prices. A good monsoon, on the other hand, will bring the prices down. Inflation here is demand-pull.
For the manufactured commodities (panel (b)), the supply curve is flat, which means a rise or a fall in demand (shifting of the demand curve) will bring about an equivalent supply of such commodities with no change in their prices. Again, the reason is simple. Most such commodities, except in cases of supply constraints, are produced in factories that run below capacity, so an increase in their demand simply increases their production. Demand here, quite opposite to the earlier case, has no role to play in determining their prices. Prices are determined instead by the cost of production. The supply curve is nothing but a profit markup over the cost (the vertical difference between supply and cost is the profit markup). A rise in the costs would push the cost curve up, and, unless the capitalists want to absorb this rise in cost through a lower markup, this would get passed on as higher prices in the market. Inflation here is purely cost-push.
What happened in the Indian case?
Having seen this difference, let us apply this idea to the inflationary problem currently facing India. If manufactured prices are cost-determined, what do their costs depend on? While wage cost is an important component of total costs, it is usually not the factor that pushes prices up because Indian workers do not really have space to bargain for higher wages. In other words, Indian workers are mostly price-takers; they make do with what they get. It is the material costs instead, which create the inflationary impulse.
One of the most important materials used in the production of any industrial commodity is oil. If we plot the movement of fuel and power against the manufactured prices (Chart 2), we can see almost a one-to-one correspondence between the two. A rise in fuel and power prices raised the manufactured inflation as well.
Food prices, too, have risen. One likely reason is the adverse impact of an inadequate monsoon, as a result of the El Niño effect, on agricultural production this year. Chart 3 plots data on food price inflation with years in which the country experienced droughts. In every instance, drought conditions were accompanied by a significant rise in food inflation, much in line with the Kaleckian structuralist idea. To be sure, there have been instances in which food price inflation has taken place even in the absence of such supply shocks. These could perhaps be the years of high demand. Suffice to say that a drought is a sufficient, even if not a necessary, condition for food prices to soar.
What is to be done?
Given these structural differences, can something be done to control inflation? Let us start with the food prices. We believe food prices need to be decoupled from the vagaries of nature to the extent possible. That India solely depends on the rain gods to feed its population is in itself quite unscientific and an anachronism in the modern era of technology. The country must invest heavily in agriculture, particularly in irrigation infrastructure, which is not entirely dependent on the monsoon.
As for manufactured goods, controlling fuel and power costs, when crude oil prices are rising, may be difficult, but there are still ways that they can be controlled. Instead of the ill-thought-out inflation targeting framework, the government should apply a countercyclical indirect tax policy to keep fuel and power prices in check. If the government can reduce the customs and excise duties when crude prices soar, the cost at the pump can be controlled. In fact, this is exactly what the government did a few months ago, which is why pump prices were held constant despite soaring crude prices in the international markets. Unfortunately, the government has withdrawn this measure, which is one of the primary reasons WPI inflation has risen sharply.
(The authors are a part of the DevMac (Development Macroeconomics) network, which seeks pluralism in Economics)
Published – July 21, 2026 08:30 am IST
