Here’s How Cost of Services is Rising Faster Than Goods in India

While the higher GST could be one reason, increase in incomes could also be leading to higher demand for services.

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A rise in so-called ‘core inflation’ in India has led to the assumption that the demand-supply gap in India is closing. That rising core inflation, which also feeds into headline inflation, has been cited as key justification for higher interest rates in the economy.

But what if the inflationary pressures are emerging more from the increased cost of services than the increased cost of goods? Is the assumption that the output gap is closing then flawed, asks Soumya Kanti Ghosh, chief economist at State Bank of India.

Indeed, a services CPI index constructed by BloombergQuint consisting of health, education, personal care, recreation and amusement services shows that these components have seen a higher level of inflation than the overall index over the last four months.

Ghosh, in his report, pointed out that services inflation has been rising since December. In contrast, goods inflation has only started to pick-up from about March. “We believe, in the coming months the services CPI inflation may cross the Goods CPI inflation,” he said.

Recent Inflationary Pressure Led by Services

While the higher Goods and Services Tax (GST) could be one reason, increase in incomes could also be leading to higher demand for services, say economists.

Shubhada Rao, chief economist at Yes Bank said that higher tax rates have certainly had an impact on services inflation. However, if you look at the components that have seen an increase from personal care to health and education, all of these have seen demand conditions remain robust as well, Rao told BloombergQuint.

Services inflation is particularly being seen in segments like personal care, health, education, entertainment...This is something we need to keep a watch on. Other segments like housing have actually seen lower momentum than we typically see seasonally.

Shubhada Rao, Chief Economist, Yes Bank

Ghosh agrees that there has been an increase in the demand for services relative to the demand for goods.

He, however, questions whether higher interest rates can do much to bring down inflation driven by rising incomes. He adds that services inflation measured by government data may not take into effect the impact of technology-based platforms.

Services Inflation Led by Rising Cost of Health Care

Sonal Varma, chief India economist at Nomura sees it differently.

According to her, while goods inflation could be explained by higher input costs, services inflation is a more direct indicator of strengthening domestic demand.

“If you are seeing inflation in the non-tradables services, then it is clearly an indicator of domestic demand being strong,” Varma said. She added that even after the impact of GST was built-in, services inflation has continued to rise. “That is a bit concerning,” Varma said.

The belief that inflation is on the rise has prompted the Monetary Policy Committee to raise rates at two consecutive meetings. The benchmark repo rate has been hiked cumulatively by 50 basis points since June.

(This story was originally published on BloombergQuint.)