Inflation in India

SYLLABUS

GS 3 >> Indian Economy and issues

REFERENCE NEWS

• Recently, the Reserve Bank of India Monetary Policy Committee (MPC) has released the projection of retail Inflation in India for FY 25. RBI’s MPC projects Inflation in India to be 4.9% in Q1, 3.8% in Q2, 4.6% in Q3 and 4.5% in Q4 of FY25.
• Inflation in India is now showing a decreasing trend, after its upsurge in the aftermath of the COVID-19 pandemic and Russia’s invasion of Ukraine. However, the retail food inflation in India has been posing challenges for the final descent of inflation to the target of 4%.

ABOUT INFLATION

Inflation is the increase in the prices of widely used goods and services like food, clothing, housing, transportation, and consumer staples. It represents the average change in the prices of a selected group of goods and services over time.

Types of Inflation:

• Demand-Side Inflation: This occurs when demand outstrips supply, creating a gap that drives up prices as consumption increases.
• Cost-Push Inflation: This type of inflation arises from shortages in production factors such as labor, land, and capital, or through deliberate scarcity due to hoarding.
• Structural Inflation: This occurs when there are structural rigidities and inefficiencies in the economy, leading to a rise in prices. This can be caused by factors such as poor infrastructure, supply chain disruptions, market imperfections, institutional bottlenecks etc.
• Imported Inflation: This occurs when the prices of imported goods and services increase due to external factors, leading to a rise in domestic prices. This can be caused by factors such as global commodity prices, international trade policies, exchange rate fluctuations etc.

Inflation Indices in India:

• WPI (Wholesale Price Index) Inflation: WPI tracks the movement of wholesale prices, primarily influencing GDP calculations. Key components include manufactured goods (64.23%), primary articles (22.62%), and fuel and power (13.15%).
• CPI (Consumer Price Index) Inflation: CPI measures changes in the retail prices of goods and services used by households, and is crucial for RBI's inflation targeting and determining employees' Dearness Allowance (DA). Major components include food and beverages (45.86%), housing (10.07%), and transport and communication (8.59%).

Inflation Targeting in India: Under the RBI Act of 1934, the Reserve Bank of India manages inflation. Starting in 2016, the Indian government sets a five-year inflation target for the RBI's Monetary Policy Committee. Currently, the RBI aims to maintain inflation at 4%, with a tolerance range of +/- 2% until March 2026.

REASONS BEHIND RISING INFLATION

• Reduced Agricultural Output Due to Weather Anomalies: In India, adverse weather conditions like insufficient monsoon rains and unexpected seasonal changes have led to reduced crop yields. This scarcity has driven up the prices of basic food staples such as wheat, rice, pulses, vegetables, and edible oils.
• Rising Costs of Agricultural Inputs: The escalation in the prices of essential farming inputs like seeds, fertilizers, and labor has increased the cost of farming. This increment in production costs has directly impacted the retail prices, making cereals and pulses more expensive for consumers.
• Surge in Global Fuel Prices: India heavily relies on imports for its fuel needs, with about 80% dependency. A $10 rise in the price of crude oil can lead to a 0.40% to 0.60% increase in inflation. This linkage shows the significant impact of global fuel price fluctuations on India's domestic inflation rates.
• Geopolitical Conflicts and Tensions: International conflicts, such as the Russia-Ukraine conflict and the tensions between Israel and Hamas, have led to instability in global markets, particularly affecting crude oil prices. This instability also impacts the cost of commodities like wheat and sunflower oil, which are crucial imports for India.
• COVID-19 Pandemic Effects: The pandemic caused widespread disruptions in global supply chains, leading to increased commodity prices. Additionally, the economic rebound post-pandemic ignited a surge in demand for various goods, contributing to demand-pull inflation as markets struggled to meet the rapid increase in consumption.
• Inadequate Government Measures: There has been criticism regarding the government's response to controlling the prices of essential commodities. Measures against hoarding and speculative stockpiling have been seen as insufficient. Furthermore, the export of non-basmati rice significantly increased the prices(due to supply shortage in the market) exacerbating the situation of food inflation in the country.

POSITIVE IMPACTS OF MODERATE INFLATION (AROUND 4% ± 2%):

• Economic Growth Stimulation: Moderate inflation can stimulate economic growth by encouraging consumers to buy and invest sooner rather than later, which can lead to increased employment and economic activity.
• Enhanced Profits and Production: For manufacturers and businesses, inflation can lead to higher profits as prices for goods increase. This, in turn, can motivate an increase in production.
• Improved Investment Returns: During periods of inflation, investments in profitable ventures can yield higher returns, benefiting entrepreneurs and investors.
• Wage Increases: As the cost of living rises, wages typically increase, helping workers manage the higher costs of goods and services.
• Debt Relief: Inflation can effectively reduce the real burden of debt, as the nominal value of money owed remains unchanged while its real value decreases, benefiting those with existing debts.

NEGATIVE IMPACTS OF HIGH INFLATION (6% OR MORE):

• Inflation Tax: When inflation is high, it diminishes the purchasing power of money, meaning people can afford fewer goods and services with the same amount of money, which can lower their standard of living.
• Widening Socio-Economic Disparities: Higher inflation rates can have a disproportionate impact on the economically vulnerable, including the poor, the unemployed, those on fixed incomes, and retirees.
• Dampening Economic Activities: High inflation introduces uncertainty in the economy, leading to higher borrowing costs for businesses as the central bank typically raises interest rates to control inflation.
• Loss of International Competitiveness: High inflation can make a country’s goods and services more expensive internationally, reducing competitiveness and affecting the balance of trade.
• Currency Depreciation: Persistent high inflation can lead to the depreciation of the national currency, which may undermine economic stability and confidence in the country's financial systems.

TOOLS FOR INFLATION MANAGEMENT:

• Monetary Policy: The Reserve Bank of India (RBI) utilizes monetary policy as a critical tool to regulate the money supply in the economy. By adjusting the repo rate, which is the rate at which banks borrow from the RBI, it can influence overall economic activity. An increase in the repo rate typically cools down inflationary pressures by making borrowing more expensive and reducing spending and investment.
• Fiscal Policy: The government employs fiscal policy to manage inflation through adjustments in public spending and taxation. By increasing taxes and reducing government expenditure, the government can curb the aggregate demand in the economy, which in turn helps in lowering inflation.
• Export Policy: To ensure domestic availability of essential commodities and curb inflation, the government might impose export restrictions or set minimum export prices. Examples include the temporary bans on rice and onion exports.
• Price Control Policy: Under the Essential Commodities Act of 1955, the government has the authority to designate certain goods as essential, ensuring their availability at fair prices to mitigate the impact of inflation.
• Anti-Hoarding and Anti-Speculation Measures: The Prevention of Black Marketing and Maintenance of Supplies of Essential Commodities Act of 1980 is aimed at combating the hoarding and speculative pricing of essential goods, which can exacerbate inflationary pressures.

CHALLENGES IN MANAGING INFLATION IN INDIA:

• Volatility in Food and Fuel Prices: Food and fuel, which significantly impact the Consumer Price Index (CPI), are susceptible to external shocks and climatic variations. The RBI has limited control over these sectors, which are influenced by global events and natural conditions, such as the Ukraine-Russia conflict.
• Government's Response to Supply Shocks: The government's occasional use of export bans on agricultural products can induce panic and speculative behavior in the markets, leading to increased hoarding and higher prices.
• Focus of Monetary Policy: The RBI's monetary policy primarily targets demand-side constraints but struggles with supply-side shocks, particularly in the food and oil sectors.
• Inflation Targeting Model: The current model of inflation targeting in India assumes that inflation signifies an overheating economy—an increase in output beyond its natural level. This model may not be entirely applicable in India, where measuring actual output levels precisely is challenging, making the setting of policy rates based on assumed economic conditions problematic.

WAY FORWARD

• Enhanced Renewable Energy Use: By accelerating the integration of renewable energy sources into the national energy mix, India can decrease its reliance on imported fuels. This shift not only mitigates the price volatility associated with foreign oil markets but also supports environmental sustainability.
• Revising the CPI Basket Weights: Updating the weights of food and beverages within the Consumer Price Index (CPI) basket is crucial. The current weights are based on a consumption survey from 2011, and adjusting these to reflect more recent consumption patterns can provide a more accurate measure of inflation.
• Release of Buffer Stocks: To address food inflation, the government, through the Food Corporation of India, could release part of its excess buffer stocks into the market. Currently holding over 40 million tonnes of rice, far exceeding the buffer norm of 13.5 million tonnes, releasing these stocks could help stabilize food prices.
• Adjustment of Import Duties: Lowering import duties on essential commodities such as wheat can make imports cheaper, helping to stabilize domestic prices. This measure can be particularly effective during periods of low domestic production or supply disruptions.
• Implementing Agricultural Reforms: Agricultural reforms aimed at boosting production and productivity are vital. Alongside, there should be an emphasis on enhancing the processing capabilities for perishables like onions and tomatoes to reduce wastage and price fluctuations, providing more stability in prices.

PRACTICE QUESTION

Q: Discuss the various types of inflation in India. How does inflation affect the growth and development prospects of India? Suggest some policy measures to achieve price stability and low inflation in India. (15M, 250W)