Imported inflation: how import costs can increase the prices of goods and services

• Imported inflation refers to the rise in the prices of goods and services in a country that is caused by an increase in the price or the cost of imports into the country.
• It is believed that a rise in input costs pushes producers to raise the price they charge from their local customers, thus boosting inflation.

A fall in the rupee

• A depreciation in the value of a country’s currency is generally seen as the most important reason behind imported inflation in an economy.
• This is because when a country’s currency depreciates, people in the country
  • Will have to shell out more of their local currency to purchase the necessary foreign currency required to buy any foreign goods or services
  • Which in turn means that they will effectively be paying more for anything that they import.
• The Asian Development Bank recently warned that India could face imported inflation as the rupee could depreciate amid the rise in interest rates in the West.
• A rise in interest rates in the West tends to cause the currencies of developing countries to depreciate against western currencies
  • Which in turns can lead to higher import costs for these countries.
• It can be further argued that even when import costs rise due to a depreciating currency, the rise in costs is still ultimately driven by the demand for the final output among consumers.
• In other words, the exchange rate of a currency depreciates to reflect the greater demand for the foreign currency in terms of the local currency.
• So, the resulting rise in import costs due to depreciation itself can be seen simply as a reflection of a change in the nominal demand for inputs.
• Stated simply, it is not currency depreciation that is causing input costs and the prices of final goods to rise
  • Rather, the currency depreciation is simply a reflection of higher nominal demand for imported goods from final consumers.

Prelims takeaway

• Inflation
• Deflation