Inflation Dynamics in India During the Twin Shocks of COVID-19 and Ukraine War

The COVID-19 pandemic, described as a ‘once in a century’ shock, caused India to experience one of the deepest economic contractions globally. As the economy began to recover through various fiscal stimulus measures, significant public capital expenditure, and traditional and unconventional fiscal and monetary policies, the outbreak of the Ukraine war disrupted the recovery and altered the global economic trajectory. International commodity prices, particularly crude oil, surged dramatically. This, coupled with heightened supply chain pressures, both globally and domestically, led to rising input costs and increased consumer price index (CPI) inflation. In this rapidly shifting macroeconomic landscape, we analyse whether the inflation dynamics have changed course. First, we examine the empirical patterns of CPI inflation by examining structural changes in the inflation process and its potential drivers before and after the pandemic and war periods. Next, we attempt to explain the evolving nature of inflation using a small open economy New Keynesian dynamic stochastic general equilibrium model. Our results reveal that (a) real and nominal frictions, as well as structural shocks, have become more pronounced and (b) inflation is now being driven more significantly by cost-push and demand shocks in the aftermath of the pandemic and the war. JEL Classification: C32, E10, E12, E31