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Divergences in rural and urban inflation do not persist for long: RBI paper

Rural-urban inflation divergence does not persist in the long run and converges over time, and both exhibit a long-term equilibrium relationship, said an RBI article.

This convergence of rural-urban inflation supports the relevance of one inflation target as nominal anchor at the national level, said the article prepared by Binod B. Bhoi, Himani Shekhar and Ipsita Padhi, Department of Economic and Policy Research, RBI.

“Rural urban inflation dynamics in India reveals close co-movement, with episodic divergences driven by different components food, fuel or ex-food and fuel which do not persist long,” it said.

Empirical estimates, it said, revealed that the differentials between rural and urban inflation are transient and both exhibit a long-run equilibrium relationship, with a significant error correction in the short-run.

At the state level, urban and rural inflation rates converge over time, the article said, adding, “these findings support the relevance of one inflation target as the nominal anchor at the national level for both rural and urban areas as well as all states”.

The RBI said the views expressed in the article are those of the authors and do not represent the views of the central bank.

The article noted that headline Consumer Price Index (CPI) inflation witnessed significant and sustained moderation during 2012-13 to 2018-19, before rising thereafter. Both rural and urban inflation exhibited a similar trend with the only difference that urban inflation started rising from 2018-19.

Moreover, annual average urban inflation which was ruling below rural inflation till 2017-18, moved above it during 2018-19 and 2019-20. Both food and non-food inflation contributed to the divergence between urban and rural inflation.

The authors said contributions of major groups to annual inflation, however, mask intra-year movements in inflation in the rural and urban areas, given significant differences in the composition of the CPI baskets.

“It can be observed from monthly data that rural and urban all groups inflation have often diverged during 2012-2020, but the divergence has not persisted long, suggesting the existence of a long-run relationship between them,” the article said.

This is further corroborated by the fact that the divergence has been driven not by any single component over time but by different components of CPI food, fuel and excluding food and fuel items during different periods, it added.

It further said that in 2020-21 so far, headline inflation has firmed up further reflecting the impact of COVID-19 induced lockdown measures and associated supply chain disruptions. Rural and urban inflation, however, have displayed significant convergence, broadly mirroring the trends in food price inflation after April-May 2020.

This could be attributed to the nature of the spread of COVID-19 and imposition of various lockdown measures to contain the spread, which was initially confined to urban areas before eventually spreading to rural areas, it said.

The RBI has been tasked by the government to keep the retail inflation at 4 per cent (+,- 2 per cent).

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