Economy - State-wise inflation analysis shows demand shock is outweighing supply shock in geographies with higher spread of Covid-19

Anagha Deodhar - ICICI Securities

CPI inflation in Sep '20 came in at 8-month high of 7.3%. With this number, Q2FY21 inflation averaged 6.9%, the highest quarterly average since Q1FY15. Persistently high inflation even during the times of weak aggregate demand has led to concerns that supply shock is outweighing demand shock in the economy.

While this may be true for the country as a whole, it is not true for all states. Our analysis of state-wise inflation shows the following:

- We classify states based on confirmed Covid-19 cases per thousand into three groups: Group 1 consists of states/UTs with relatively high spread of Covid-19 such as Delhi, Maharashtra, and Karnataka. Group 2 consists of states/UTs with moderate spread of Covid-19 including Telangana, Haryana and Punjab. Lastly, Group 3 consists of states with states/UTs with relatively low spread of Covid-19 including West Bengal, Rajasthan and Uttar Pradesh.

- In Q2FY21 the share of Group 1 in national CPI fell to 37% from 46% in Q2FY20. This shows that states with higher spread of Covid-19 are recording much lower inflation compared to the rest of the country, possibly indicating that demand shock in these states is outweighing supply shock.

- On the other hand, states/UTs with relatively moderate and low spreads of Covid-19 are witnessing faster pick-up in inflation compared to the national average. In Q2FY21, the share of states/UTs in Groups 2 and 3 in national CPI increased to 20% (up from 15% in Q2FY20) and 44% (up from 39% in Q2FY20), respectively. This shows that in geographies where the spread of Covid-19 is relatively lower, supply shock is possibly outweighing demand shock.

- This holds true for core inflation as well. In Q2FY21, the share of Group 1 in national core inflation fell to ~38% from ~43% in Q2FY20. On the other hand, the share of Group 2 in national core inflation increased to ~20% from ~15% while the share of Group 3 remained broadly unchanged.

- Our analysis of mobility indicators further confirms this finding. Google mobility data shows that states in Group 1 are lagging behind the rest of the country when it comes to reopening of the economy. Since Jun '20, when the Unlock process began, their mobility indicators have been lagging 3 to 4 percentage points behind the national average. On the other hand, mobility indicators for states/UTs in Group 2 and Group 3 are ~2 percentage points and ~6 percentage points above the national average, respectively.

- This shows that in states/UTs with relatively higher spread of Covid-19, return to normalcy has been slower and aggregate demand is weaker compared to rest of the country.

Source : Equity Bulls

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