Inflation in India

INDIAN INSTITUTE OF PLANNING AND MANAGEMENT (ERR (E RRAM AMAN ANZI ZIL, L, BE BESI SIDE DE TAJ TAJ KRIS KRISHN HNA, A, BANJ BANJAR ARA A HILL HILLS, S, HYDERABAD)

A REPORT ON INFLATION IN INDIA

UNDER GUIDANCE OF PROF.PRABHAKAR REDDY

CHANDRA SEKHAR  AJAY KUMAR  MANIK REDDY KRISHNA KEERTHANA UDAY SHREE BHARGAVI

FALL WINTER BATCH 2007-09 Trimester 3

1

ACKNOWLEDGEMENT

I would like to put forth my gratitude, indebtness, and thankfulness to the authorities of Indian institute of planning and management Hyderabad for for givi giving ng us the the op oppo port rtun unit ity y to do a proj projec ectt repo report rt on GENE GENERA RAL L INSURA INSURANCE NCE(HE (HEALT ALTH H INSURA INSURANCE NCE). ). We would would like like to thank thank Prof. Prof. Prabhakar Prabhakar Reddy sir for his constant constant guidance, advice, suggestions suggestions and for  his encouragement, to complete the project successfully. Lastly we would thank our family members without whose blessings and support we wouldn’t have made it so far.

2

DECLARATION

We hereby declare that all the information that has been collected, analyzed, and provided for the purpose of this project is entirely true and factual. We would also like to mention that the work here has neither purchased nor  acquired by any other unfair means .and it has not been submitted to other  universities or published any time before. The information presented in the report is accurate and updated to the best of our capabilities and knowledge.

CHANDRA SEKHAR  AJAY KUMAR  MANIK REDDY KRISHNA KEERTHANA UDAY SHREE BHARGAVI Trimester-3 (fall winter batch 2007-09)

CONTENTS 3

Overview of inflation Definition Types of Inflation Measures of inflation Issues in Measuring Inflation Causes of Inflation Effect of Inflation Control of Inflation Inflation in India Calculation of Inflation in India Rate of Inflation in Indian Whom does inflation hit the most How does Inflation Affect the Individual “Rising Inflation Hit Business Confident” FICCI Indian Stocks Plunge Due to Political Turmoil And Inflation Fears How does Inflation affect the Indian Market Food prices drive Indian Inflation Analysis Report Conclusion and recommendation

5 6 7 14 16 17 20 23 26 27 31 35 37 38 41 43 44 45 48

4

OVERVIEW OF INFLATION Everyone is familiar with the term ‘Inflation’ as rising prices. This means the same thing as fall in the value of money. For example, a person would like to buy 5kgsof apple with Rs. 100, at the present rate of inflation, say, zero. Now when the inflation rate is 5%, then the person would require Rs. 105 to buy the same quantity of apples. This is because there is more money chasing the same produce. Thus, Inflation is a monetary aliment in an economy and it has been defined in so many ways, which can be defined as “the change in purchasing power in a currency from period to period relative to some basket of goods and services.” Inflation is a rise in general level of prices of goods and services over time. Although "inflation" is sometimes used to refer to a rise in the prices of a specific set of goods or services, a rise in prices of one set (such as food) without a rise in others (such as wages) is not included in the original meaning of the word. Inflation can be thought of as a decrease in the value of the unit of currency. It is measured as the percentage rate of change of a  price index but it is not uniquely defined because there are various price indices that can be used. Many economists believe that high rates of inflation are caused by high rates of grow growth th of the the money money supply supply.. View Viewss on the the fact factor orss that that dete determ rmin inee mode modera rate te rate ratess of infl inflat atio ion n are are more more vari varied ed:: chan change gess in infl inflat atio ion n are are sometimes attributed to fluctuations in real demand for goods and services or in available supplies (i.e. changes There are many measures of inflation. For example, different price indices can be used to measure changes in prices that affect different people. Two wide widely ly kn know own n indi indice cess for for whic which h infl inflat atio ion n rate ratess are are repo report rted ed in many many countries are the Consumer Price Index (CPI), which measures consumer    prices, and the GDP deflator , which measures price variations associated with domestic production of goods and services.

5

DEFINITION Inflation is a gene genera rall and and prog progre ress ssiv ivee incr increa ease se in pric prices es;; "in "in infl inflat atio ion n everything gets more valuable except money" .It can be either an increase in money supply or a decrease in available goods and services.

A simple commonly used definition of the word inflation is simply "an increase in the price you pay or a decline in the purchasing power of  money". In other words, Price Inflation is when prices get higher or it takes more money to buy the same item. Webster's 1983 Definition of Inflation

According to Webster's New Universal Unabridged Dictionary published in 1983 the second definition of "inflation" is: "An "An incr increa ease se in the the amou amount nt of  currency in circul circulati ation, on, result resulting ing in a relatively sharp and sudden fall in its value and rise in prices: it may be caused by an increase in the volume of paper money issued or of gold mined, or a relative increase in expenditures as when the supply of goods fails to meet the demand. This definition includes some of the basic economics of inflation and would seem to indicate that inflation is not defined as the increase in prices but as the increase in the supply of money that causes the increase in prices i.e. inflation is a cause rather than an effect. Webster's 2000 Definition of Inflation

However, However, The American American Heritage® Dictionary Dictionary of the English English Language, Language, Fourth Fourth Editio Edition, n, and Copyri Copyright ght © 200 2000 0 Publis Published hed by Hought Houghton on Miffli Mifflin n Company says: “Inf “Infla lati tion on is a pers persis iste tent nt incr increa ease se in the the leve levell of cons consum umer er pric prices es or a  persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services.” In this definition, inflation would appear to be the consequence or result (rising prices) rather than the cause.

6

TYPES OF INFLATION The various types of inflation are classified as follows (a) . RATE OF INFLATION According to the rate of inflation, there are three types of inflation, 1. Moderate inflation (a) Creeping (b) Walking 2. Running inflation 3. Galloping Inflation 4. Hyper Inflation

1. Moderate, Gal1oping and Hyperinflation The severity of inflation is ofte often n meas measur ured ed in term termss of the the rapi rapidi dity ty of pric pricee rise rise.. On the the basi basis, s, a quantitative distinction of inflation may be nude into three categories, viz: Moderate inflation; Running and galloping inflation; and Hyperinflation. a. Moderate Inflation It is a mild and tolerable form of inflation. It occurs when prices are rising slowly when the rate of inflation is less than 10 per cent annually, or it is a single digit int1ation rate, it is considered to be a moderate inflation in the  present the economy.

The following are the major characteristics of moderate inflation: i. There is a single digit inflation rate (less than 10 per cent) annually. ii. It does not disrupt the economic balance. iii. It is regarded as stable Inflation in which the relative prices do not get far  out of line. iv. iv. Peop People le’s ’s expe expect ctat atio ions ns rema remain in more more or less less stab stable le un unde derr mode modera rate te inflation. v. Under a low inflation rate, the real interest rate is not too low or negative, so money can serve its role as a store of value without difficulty. vi. There are modest inefficiencies associated with moderate inflation. Economists have arbitrarily laid down that a 3-4 per cent price rise per  annu annum m is a tole tolera rabl blee rate rate of infl inflat atio ion n in mode modern rn econ econom omie ies. s. Ev Even en the the Chakravarthi Report of the Reserve Bank of India has accepted 3-4 per cent rate of inflation annually to be an efficient and tolerable norm for the Indian economy. Incidentally, some economists have described up to 3 per cent 7

annual rate of inflation as ‘creeping inflation’ and if it exceeds 10 per cent, it is called ‘walking inflation.’ This means, Samuelson has clubbed ‘creeping’ and ‘walking’ inflation into ‘Moder ‘Moderate ate’’ infla inflatio tion. n. Samuel Samuelson son’s ’s opinio opinion, n, moder moderate ate inflat inflation ion is no nott a serious Problem. While some economists feel that even a walking inflation should make us more cautious, as it represents a warning signal for the occurrence of running or double digit and eventually a galloping inflation, if it is not checked in time. 2. Running and Galloping Inflation When the movement of price accelerates rapidly, running inflation emerges. Running inflation may record more than 100 per cent rise in prices over a decade. Thus, when prices rise by more than 10 per cent a year, running infl inflat atio ion n occu occurs rs.. Econ Econom omis ists ts have have no nott desc descri ribe bed d the the rang rangee of runn runnin ing g inflation. But, we may say that a double double digit inflation of 10-20 10-20 percent per annum is a running inflation. If it exceeds that figure, it may be called ‘galloping’ inflation. According to Samuelson, when prices are rising at double or triple digit rates of 20, 100 or 200 per cent a year, the situation is described as ‘galloping’ inflation. Indian economy has witnessed a sort of ‘running’ and ‘galloping’ inflation to some extent (not exceeding 25 per cent per annum) during the planning era, since the Second Plan period. Argentina, Brazil and Israel, for instance, have experienced inflation rates over 100 per cent in the eighties. Galloping inflation is really a serious problem. It causes economic distortions and disturbances. 3. Hyper Inflation In the case of hyperinflation, prices rise every movement, and there is no limit to the height to which prices might rise. Therefore, it is difficult to measure its magnitude, as prices rise by fits and starts. . In quantitative terms, when prices rise over 1000 per cent in a year, it is called called a hyp hyper erinf inflat lation ion.. Austr Austria, ia, Hungar Hungary, y, German Germany, y, Poland Poland and Russia Russia witnessed Hyperinflation in the wake of World War I. Hyperinflation notably took   place in Germany in 1920-1923. The German price index rose from 1 to 10, 00,000,000 during January 1922 to November 1923. Believe it or not, it is a fact!

8

The Main Features of Hyperinflation are i. During During hyperinflatio hyperinflation, n, the price rise is severe. severe. The price index index moves up  by leaps and bounds. It is over 1000 per cent per year. There is at least a 50  per cent price rise in a month, so that in a year it rises to about 130 times. ii. It represents the most pathetic deterioration in people Purchasing power. iii. It is apparently generated by a massive fiscal dislocation. iv. It is amplified by wage-price spiral. v. Hyperinflation is a monetary disease. vi. The velocity of circulation of money increases very fast. vii. The structure of the relative prices of goods becomes highly lU1stable. viii. The real wages tend to decline fast.

(b.) TIME PERIOD According to the nature of time period of occurrence, inflation is classified into three types, 1. War-time Inflation 2. Post-war Inflation 3. Peace-time Inflation War, Post-War and Peace-Time Inflation On the basis of the nature of time-period of occurrence, occurrence, we have: • War-time inflation; • Post-war inflation; and • Peace-time inflation. 1. War-Time Inflation It is the outcome of certain exigencies of war, on account of increased government expenditure on defence which is of an unproductive nature. By such public expenditure, the government apportions a substantial production of go good odss and and serv servic ices es ou outt of tota totall avai availa labi bili lity ty for for war war whic which h caus causes es a downward shift in the supply; as a result, an inflationary gap may develop. 2. Post-war Inflation It is a lega legacy cy of war. war. In the the imme immedi diat atee po post st-w -war ar peri period od,, it is usua usuall lly y expe experi rien ence ced. d. Th This is may may happ happen en when when the the disp dispos osab able le inco income me of the the community increases, when war-time taxation is withdrawn or public debt is repaid in the post-war period.

9

3. Peace-time Inflation By this is meant the rise in prices during the normal period of peace. Peacetime inflation is often a result of increased government outlays on capital projects having a long gestation period; so a gap between money inco income me and and real real wage wage go good odss deve develo lops ps.. In a plan planni ning ng era, era, thus thus,, when when government’s expenditure increases, prices may rise.

(c) GOVERNMENT REACTION According to government there are two types of inflations 1. Open inflation 2. Repressed inflation

Open and Repressed Inflation Inflation is open or repressed according to the government’s reaction to the  prevalence of inflationary forces in the economy. a. Open Inflation When the government does not attempt to prevent a price rise, inflation is said said to be op open en.. Th Thus us,, infl inflat atio ion n is op open en when when pric prices es rise rise with withou outt any any interruption. In open inflation, the free market mechanism is permitted to fulf fulfil illl its its hist histor oric ic func functi tion on of rati ration onin ing g the the shor shortt supp supply ly of go good odss and and distri distribut butee them them accord according ing to consum consumer’ er’ss abilit ability y to pay. pay. Theref Therefore ore,, the essential characteristics of an open inflation lie in the operation of the price mechanism as the sole distributing agent. The post-war hyperinflation during the twenties in Germany is a living example of open inflation. b. Repressed Inflation When the government interrupts a price there is a repressed or suppressed inflation.. Thus, suppressed inflation refers to those conditions in which  price increases are prevented at the present time through an adoption of  certain measures like price controls and rationing by the government, but they they rise rise on the the remo remova vall of such such cont contro rols ls and and rati ration onin ing. g. Th Thee esse essent ntia iall characteristic of repressed inflation, in contrast to open inflation, is that the former seeks to prevent distribution through price rise under free market mechanism mechanism and substitute substitutess instead instead a distribut distribution ion system system based on controls. controls. Thus, the administration of controls is an important feature of suppressed inflation.

10

Types of Inflation Based on the Causes Inducing Inflation According to the cause of rising prices, one can consider several types of  inflation as follows: 1. Credit-inflation 2. Deficit inflation 3. Scarcity inflation 4. Profit-inflation Profit-inflation 5. Foreign trade inflation 6. Tax-inflation 7. Cost or wage inflation 8. Demand inflation

1. Credit Inflation Inflation which is caused by excessive expansion of bank credit or money supply is referred to as credit or money inflation. 2. Deficit Inflation It is the inflation caused by deficit financing. When the government budgets contain heavy deficit financing, through creating new money, the purchasing  power in the community increases and prices rise. This may be referred as to As defici deficit-i t-indu nduced ced inflat inflation ion.. Durin During g a plann planning ing era, era, when when gov govern ernmen mentt launches upon heavy investment, it usually resorts to deficit financing, when adequate resources are not found. An inflationary spiral develops due to deficit financing, when adequate resources are not found. An inflationary spiral Develops due to deficit financing, when the production of consumption goods fails to keep. Pace with the increased money expenditure. 3. Scarcity Inflation Whenever scarcity of real goods occurs or may be artificially created by the hoarding activities of unscrupulous traders and speculators which may result into black-marketing, thereby causing prices to go up, such type of inflation may be described as scarcity inflation. 4. Profit Inflation . The concept of profit inflation was originated by Keynes in his Treatise on Money. According to Keynes, the price level of consumption goods is a function of the investment exceeding savings. He considered the investment 11

Boom as a reflection of profit boom. Inflation is unjust in its distribution effect. It redistributes income in favor of profiteers and against the wageearning class. During inflation, thus, the entrepreneur class may tend to expect an upward shifting of the marginal efficiency of capital (MEC); hence entrepreneurs are induced to invest more even by borrowing at higher  interest rates. Eventually, investment exceeds savings and economy tends to reach a higher level of money income equilibrium. If economy is operating at full employment level or if there are bottlenecks of market imperfections, real output will not rise proportionately, so the imbalance between money Income and real income is corrected through rising prices. 5. Foreign-Trade Induced Inflation For an international economy, we may categories the following Two types of inflation as being caused by factors pertaining to The balance of payments. i. Export-Boom Inflation; and ii. Import Price-hike Inflation. a. Export-Boom Inflation When a country having a sizeable export component in its foreign trade experiences a sudden rise in the demand for it’s exportable against the inelastic supply of exportable in the domestic market, it obviously implies an excess excessive ive pressu pressure re of demand demand which which is reveal revealed ed in terms terms of persi persiste stent nt infl inflat atio ion n at Home Home.. Agai Again, n, trad tradee gain gainss and and sudd sudden en infl influx ux of exch exchan ange ge remittances may lead to an increase in monetary liabilities which is further  reflected in the rising pressure of demand for domestic output causing an inflationary spiral to get further momentum. Such a permanent case for  export-boom inflation is, however, ruled out in the Indian economy, because neither export trade is a significant portion of Domestic National Product nor  is there a continuous boom of export-demand, causing tenus of trade to move up favorably all the time. b. Import Price-hike Inflation When prices of import components rise due to inflation abroad, the domestic costs and prices of goods using these imported parts vill tend to rise. Such an int1ation int1ation is referred referred to as imported imported intluion. intluion. For instance, instance, hike in oil prices  by the Arab countries was responsible for accelerating. Inflationary price rise in many oil-importing countries, including India to some extent. 6. Tax Inflation Year to year increase in commodity taxation such as excise duties and sales tax may lead to rise in prices of taxed goods. Such inflation is termed as tax inflation or tax-induced inflation. 12

7. Cost Inflation When inflation emerges on account of a rise in cost factor, it is called cost inflation. It occurs when money incomes (wage rate, particularly) expand more than real productivity. Cost inflation has its course through the level of  money costs of the factors of production and in particular through the level of wage rates. Due to a rising cost of living index, workers demand hitch’ wages, and higher wages in their turn increase the cost of production, which a producer generally meets by raising prices. This process of spiraling may each higher and higher level. In this case, however, cyclical anti-inflation remedies of monetary Controls are not relative effective. Wage inflation is an important variant of  cost inflation. Wage push inflation occurs when money wages are raised without Corresponding improvement improvement in the productivity of the workers. 8. Demand Inflation When When ther theree is an exce excess ss of aggr aggreg egat ate, e, detr detrla land nd agai agains nstt the the avai availa labl blee aggregate supply of goods and services, prices tend to rise. It is called demand-ind demand-induced uced inflatio inflation. n. Populatio Population-gr n-growth owth,, rising rising money money income, income, etc. forces playa significant role in generating demand inflation.

There are three major types of inflation, •

•

•

Demand-pull Demand-pull inflation: inflation caused by increases in aggregate demand demand due to increa increased sed privat privatee and gov govern ernmen mentt spendi spending, ng, etc. etc. Demand inflation is constructive to a faster rate of economic growth sinc sincee the the exce excess ss dema demand nd and and favo favora rabl blee mark market et cond condit itio ions ns will will stimul stimulate ate invest investmen mentt and expans expansion ion.. The faili failing ng value value of money, money, however, may encourage spending rather than saving and so reduce the funds available for investment. Cost-pus Cost-push h inflatio inflation n: pres presen entl tly y term termed ed "sup "suppl ply y shoc shock k infl inflat atio ion, n,"" caused by drops in aggregate supply due to increased prices of inputs, for example. Take for instance a sudden decrease in the supply of oil, which would increase oil prices. Producers for whom oil is a part of  thei theirr cost costss coul could d then then pass pass this this on to cons consum umer erss in the the form form of  increased prices. Built-in inflation: induced by adaptive expectations, expectations, often linked to the "  price/wage spiral" spiral" because it involves workers trying to keep their wages up (gross wages have to increase above the CPI rate to net to CPI after-tax) with prices and then employers passing higher costs on to consumers as higher prices as part of a "vicious circle." Built-in 13

inflation reflects events in the past, and so might be seen as hangover  inflation. inflation. A major demand-pull theory centers on the supply of money: inflation may  be caused by an increase in the quantity of  money in circulation relative to the ability of the economy to supply (its   potential output). output). This is most obvious when governments finance spending in a crisis, such as a civil war,  by printing money excessively, often leading to hyperinflation, hyperinflation, a condition where prices can double in a month or less. Another cause can be a rapid decline in the demand for money, as happened in Europe during the Black  Plague. The money supply is also thought to play a major role in determining moderate levels of inflation, although there are differences of opinion on how important it is.

MEASURES OF INFLATION Inflation is measured by calculating the percentage rate of change of a price index, which is called the inflation rate. rate. Inflation is measured by observing the change in the price of a large number of goods and services in an economy, usually based on data collected by government agencies. The  prices  prices of goods goods and services services are combined combined to give a price index index or average  price level, the average price of the basket of products. The inflation rate is the rate of increase in this index; while the price level might be seen as Measuring the size of a balloon, inflation refers to the increase in its size. There is no single true measure of inflation, The rate can be calculated for many different price different price indices, indices , including: 1.Consumer 1.Consumer price indices

(CPIs) which measure the price of a selection of goods purchased by a "typical consumer." In the UK , an alternative index called the Retail Price Index (RPI) uses a slightly different market basket. 2.Cost-of-livin 2.Cost-of-living g indices (COLI) are indices similar to the CPI which are often used to adjust fixed incomes and contractual incomes to maintain the real value of those incomes. 14

3.Producer 3.Producer price indices

(PPIs) which measure the prices received by producers. This differs from the CPI in that price subsidization, profits, and taxes may cause the amount received by the producer to differ from what the consumer paid. There is also typically a delay between an increase in the PPI and any result resulting ing increa increase se in the CPI. CPI. Produc Producer er price price inflat inflation ion measur measures es the  pressure being put on producers by the costs of their raw materials. This could be "passed on" as consumer inflation, or it could be absorbed by  profi  profits, ts, or offset offset by increa increasin sing g produc productiv tivity ity.. In India and the United States, States, an earlier version of the PPI was called the Wholesale Price Index. Index. 4.Commodity 4.Commodity price indices,

Comm Commod odit ity y pric rice ind indice ices meas measur uree the the pric pricee of a selec electi tion on of  commodities. In the present commodity price indices are weighted by the relative importance of the components to the "all in" cost of an employee. •

•

The GDP Deflator  is a measure of the price of all the goods and serv servic ices es incl includ uded ed in Gross Gross Domest Domestic ic Produ Product ct (GDP (GDP)). Th Thee US Comm Commer erce ce Depa Depart rtme ment nt pu publ blis ishe hess a defl deflat ator or seri series es for for US GDP, GDP, defined as its nominal GDP measure divided by its real GDP measure. Capital goods price Index, Index , although so far no attempt at building such an index has been made, several economists have recently pointed out the necessity of measuring capital goods inflation (inflation in the  price of stocks, real estate, and other assets) separately. Indeed a given incr increa ease se in the the supp supply ly of mone money y can can lead lead to a rise rise in infl inflat atio ion n (consumption goods inflation) and or to a rise in capital goods price inflation. The growth in money supply has remained fairly constant through since the 1970s however consumption goods price inflation has been reduced because most of the inflation has happened in the capital goods prices.

ISSUES IN MEASURING INFLATION Measur Measuring ing inflat inflation ion requir requires es findin finding g object objective ive ways ways of separa separatin ting g out changes in nominal prices from other influences related to real activity. In 15

the simplest possible case, if the price of a 10 oz. can of corn changes from $0.90 to $1.00 over the course of a year, with no change in quality, then this   price change represents inflation. But we are usually more interested in knowing how the overall cost of living changes, and therefore instead of  looking at the change in price of one good, we want to know how the price of a large 'basket' of goods and services changes. This is the purpose of  looking at a  price index, index, which is a weighted average of many prices. The weights in the Consumer Price Index, Index, for example, represent the fraction of  spending that typical consumers spend on each type of goods (using data collected by surveying households). Inflat Inflation ion measur measures es are often often modif modified ied over over time, time, eithe eitherr for the the relati relative ve weight of goods in the basket, or in the way in which goods from the present are compared with goods from the past. This includes hedonic adjustments and “reweighing” as well as using chained measures of inflation. As with many economic numbers, inflation numbers are often seasonally adjusted in order to differentiate expected cyclical cost increases, versus changes in the econ econom omy. y. Infl Inflat atio ion n nu numb mber erss are are aver averag aged ed or othe otherw rwis isee subj subjec ecte ted d to statistical techniques in order to remove statistical noise and volatility of  individual prices. Finally, when looking at inflation, economic institutions sometimes only look at subsets or   special special indices indices. One common set is inflation excluding food and energy, which is often called “core “ core inflation”. inflation”.

CAUSES OF INFLATION Some of the Causes of Inflation Inflation is a complex phenomenon which cannot be attributed to a single factor. We may summaries the major causes of inflation thus: 1. Over-expansion of Money Supply Many a times, a remarkable degree of correlation between the increase in money supply and the rise in the price level may be observed. 2. Expansion of Bank Credit Rapid expansion of bank credit is also responsible for the inflationary trend in a country. 3. Deficit Financing The high doses of deficit financing which may cause reckless spending, may also contribute to the growth of the inflationary spiral in a country. 4. Ordinary Monetary Factors Among other monetary factors influencing the price trend in an economy, the major ones are listed here: 16

a. High Non-development Non-development Expenditure . The continuous increase in public expenditure, and especially the growth of  defence and non-development non-development expenditure. b. Huge Plan Investment. The huge planned investment and its high rate of growth in every plan may lead to an excess demand in the capital goods sector, so that industrial prices may rise. c. Black Money . Some Some econ econom omis ists ts have have cond condem emne ned d blac black k mone money y in the the hand handss of tax tax evaders and black marketers as an important source of inflation in a country. Black money encourages lavish spending, which causes excess demand And a rise in price d. High Indirect Taxes. Incidence of high commodity taxation. Prices tend to rise on account of  high high exci excise se du duti ties es impo impose sed d by the the Gove Govern rnme ment nt on raw raw mate materi rial alss and and essential goods. Non-Monetary Factors There are various non-monetary and structural factors that may Cause a rising price trend in a country. These are: a. A high Population Growth. Undoubtedly, the rising pressure of demand resulting from of population and money income, will cause a high price rise in an over populated country. b. Natural Calamities and Bad Weather Conditions. Vagari Vagaries es of monsoo monsoon, n, bad weathe weatherr condit condition ions, s, droug droughts hts and failu failure re of  agricultural crops have been responsible for price spurts, from time to time, in many underdeveloped countries. Agricultural prices are most sensitive to inflationary forces in India. Natural calamities also contribute occasionally to the inflationary boost in a country. Events such as cyclones and floods, which destroy village economies, also aggravate the inflationary pressure. c. Speculation and Hoarding . Hoardi Hoarding ng and specul speculati ative ve activi activitie ties, s, corrup corruptio tion n at every every level, level, in both both   private and public sectors, etc., are also responsible to some extent for  aggravating inflation in a: country. d. High Prices of Imports . Inflation has also been inflicted on some countries through the import content used by their industries. Prices of petroleum products have been incr increa ease sed d in many many coun countr trie iess du duee to pric pricee hike hikess by the the oil oil prod produc ucin ing g countries. e. Monopolies.

17

Monopoly profits and unfair trade practices by big industrial houses are also responsible for the price rise in countries like India. f. Underutilization of Resources. NonNon-ut util iliz izat atio ion n of inst instal alle led d capa capaci citi ties es in larg largee indu indust stri ries es is also also a contributory factor to inflation. Inflation in the country may be regarded as a symptom of a Deep Deep-s -sea eate ted d mala malady dy,, bo born rn of stru struct ctur ural al defi defici cien enci cies es invo involv lved ed in the the functi functioni oning ng of its econom economic ic system system,, which which is charac character terize ized d by inhere inherent nt weaknesses, wastages, and imbalances. GAPS AND BOTTLE NECK  To understand the true nature of inflation in an underdeveloped country, one has to examine the bottlenecks and gaps of various types which obstruct the normal growth process, causing prices to rise with the generation of money income without an appropriate rise in real income. These gaps or bottlenecks may be enlisted as to follows: a. Market imperfections. Market imperfections like factor immobility, price rigidity, ignorance of  market conditions, rigid social and institutional structures, and lack of  specialization and training in underdeveloped economies do not allow an optimu optimum m alloca allocatio tion n and utiliz utilizati ation on of resou resource rces. s. Hence, Hence, increa increase se in money supply and increased money income remains unaccompanied by increased supply of real output, causing a net price rise of an inflationary nature in these economies.  b. Capital Bottleneck . On account of a very low rate of capital formation and consequent capital deficiency, a poor country is caught in a vicious circle of poverty, and any excessive money supply instead of breaking this vicious circle, tends to create a chronic inflationary spiral. Thus, in a poor country, there is inflation because by virtue of its internal backwardness, it is prone to chronic inflation. c. Entrepreneurial Entrepreneurial Bottleneck . Entrepreneurs in underdeveloped countries lack skill, spirit of boldness and adventure. They prefer trading or safer traditional investments rather  than attempt risky innovations. Absence of adequate industrial capital,   pre preva vale lenc ncee of merc mercha hant nt capi capita tall and and a colo coloss ssal al amou amount nt of priv privat atee investments in such Unproductive fields as land, jewellery, gold, etc., which is a gross socio economic waste, starves the developing economy of its much needed capital resources. Thus, increased money supply or savings in terms of money 18

makes little impact on real output and monetary equilibrium is just attained through a galloping price rise in the various sectors of the economy. d. Food Food Bott Bottle lene neck ck.. Due to slow growth of agriculture, overpressure of growing population on land, primitive methods of cultivation, defective land tenure system, lack  of adequate irrigation facilities and many other reasons, agriculture output, especially food supply which constitutes a large part of wage-goods, has fail failed ed to keep keep pace pace with with the the grow growin ing g dema demand nd for for it from from the the grow growin ing g  population and. Increased’ rural employment in the rural industrilsation process in these countries. This food bottleneck has created the problem of price rise in food grains, and it has become the cornerstone in the whole of price-structure in the developing economies. e. Infrastructural Infrastructural Bottleneck . These refer to power shortages and inadequacies of transport facilities in underdeveloped economies. Infrastructural bottlenecks obviously restrict the Growth process in industrial, agricultural and commercial sectors and cause under-utilization of capacity in the economy as a whole. Underutilization of  resources does not absorb the full increase in money supply and reflects upon the rising prices. f. Foreign Exchange Bottleneck . Developing economies suffer from a fundamental structural disequilibrium in the the bala balanc ncee of paym paymen ents ts du duee to high high impo import rtss and and low low expo export rtss on unfavorable terms of trade; hence, they usually suffer from foreign exchange scarcity problem. In recent years, day to day, rising imports bills due to high oil prices have aggravated the problem further. This foreign exchange bottleneck comes in the way of necessary imports to check domestic inflation. Again, the need to boost exports to meet the growing deficits in the balance of payments puts an extra pressure on the marketable surplus meant for domestic requirements. This eventually leads to a heavy rise to exportable commodities commodities in the domestic market. g. Resources Gap. When the public sector is widely expanded for industrial development in these countries, the government aggravates the problem of resources gap. Owin Owing g to the the back backwa ward rd soci socioo-ec econ onom omic ic po poli liti tica call stru struct ctur uree of the the less less developed country, its government always fmds it difficult to raise sufficient resources through taxation, public borrowings and profit of State enterprises, to meet the ever-increasing public expenditure in intensive and extensive dime dimens nsio ions ns.. As such such,, un unde derr the the pres pressu sure re of the the reso resour urce cess gap, gap, the the gove go vern rnme ment nt has has to reso resort rt to a heav heavy y do does es of defi defici citt fman fmanci cing ng,, desp despit itee 19

knowing its dangers. This makes the economy inflation prone. Similarly, the resource gap in the private sector, caused by low voluntary savings and highcost economy, presses for over-expansion of money supply through bank  credit which, by and large, Results in the acceleration of inflationary spiral in the economy.

 EFFECTS OF INFLATION  A small small amount amount of inflation inflation can be viewed viewed as having a beneficia beneficiall effect effect on the economy. One reason for this is that it can be difficult to renegotiate  prices and wages. With generally increasing prices it is easier for relative  prices to adjust. Many prices are "sticky "sticky downward" downward" and tend to creep upward, so that efforts to attain a zero inflation rate (a constant price level) punish other sectors with falling prices, profits, and employment. Efforts to attain complete price stability can also lead to deflation, deflation, which is generally viewed as a negative  by Keynesians because of the downward adjustments in wages and output that are associated with it. With inflation, the price of any given good is likely to increase over time, therefore both consumers and businesses may choose to make purchases sooner sooner rather rather than later. later. This effect effect tends to keep an economy active in the short term by encouraging spending and borrowing and in the long term by encouraging investments. investments. But inflation can also reduce incentives to save, so the effect on gross capital formation in the long run is ambiguous. Inflation is also viewed as a hidden risk pressure that provides an incentive for those with savings to invest them, rather than have the purchasing power  of those savings erode through inflation. In investing, inflation risks often cause investors to take on more systematic risk , in order to gain returns that will stay ahead of expected inflation. Inflation also gives central banks room to maneuver, since their primary tool for controlling the money supply and velocity of money is by setting the lowest interest rate in an economy - the discount rate at which banks can   borr borrow ow from from the centra centrall bank. bank. Since Since bo borro rrowin wing g at negati negative ve intere interest st is gene genera rall lly y inef ineffe fect ctiv ive, e, a po posi siti tive ve infl inflat atio ion n rate rate give givess cent centra rall bank banker erss "ammu "ammunit nition ion", ", as it is someti sometimes mes called called,, to stimul stimulate ate the econom economy. y. As 20

central banks are controlled by governments, governments, there is also often political  pressure to increase the money supply to pay government services; this has the added effect of creating inflation and decreasing the net money owed by the government in previously negotiated contractual agreements and in debt. For these reasons, many economists see moderate inflation as a benefit; some some busine business ss execut executive ivess see mild mild inflat inflation ion as "greas "greasing ing the wheels wheels of  commerce." But other economists have advocated reducing inflation to zero as a monetary policy goal - particularly in the late 1990s at the end of a long disinflation period, when the policy seemed within reach; and some have even advocated deflation instead of inflation. In general, high or unpredictable inflation rates are regarded as bad: •

•

Uncertainty about future inflation may discourage investment and saving. Redistribution Rent Seeking - happens when resources are used to merely transfer wealth rather than produce it. E.g. a company tries to gauge and combat the costs of inflation. Inflat Inflation ion redist redistrib ribute utess incom incomee from from those those on fixed fixed income incomes, s, such as pensioners, and shifts it to those who draw a variable income, for example from wages and profits which may keep  pace with inflation. Debtors may be helped by inflation due to reduction of the real value of debt burden. Inflat Inflation ion redist redistrib ribute utess wealth wealth from from those those who lend lend a fixed fixed amount of money to those who borrow. For example, where the government is a net debtor, as is usually the case, it will reduce this debt redistributing money towards the government. Thus inflation is sometimes viewed as similar to a hidden tax. tax. A particular particular form of inflation as a tax is Bracket Bracket Creep (also called fiscal fiscal drag). drag). By allowing inflation to move upwards, certain sticky aspects of the tax code are met by more and more  people. For example, income tax brackets, where the next dollar  of income is taxed at a higher rate than previous dollars, tend to  become distorted. Governments that allow inflation to "bump"  p peo eopl plee ov over er thes thesee thre thresh shol olds ds are, are, in effe effect ct,, allo allowi wing ng a tax tax increase because the same real purchasing power is being taxed at a higher rate. o

o

o

o

o

21

•

•

•

•

•

•

•

International International trade: Where fixed exchange rates are imposed, higher  inflation than in trading partners' economies will make exports more expensive and tend toward a weakening balance weakening balance of trade. trade .  s: Because the value of cash is eroded by inflation, Shoe leather cost s   people will tend to hold less cash during times of inflation. This imposes real costs, for example in more frequent trips to the bank. (The term is a humorous reference to the cost of replacing shoe leather  worn out when walking to the bank.) Menu costs : Firms must change their prices more frequently, which impose costs, for example with restaurants having to reprint menus. Relati Relative ve Price Price Distor Distortio tions ns: Firms Firms do not genera generally lly synchr synchroni onize ze adjustment in prices. If there is higher inflation, firms that do not adjust their prices will have much lower prices relative to firms that do adjust them. This will distort economic decisions, since relative  prices will not be reflecting relative scarcity of different goods. Rising inflation can prompt trade unions to demand higher wages, to keep up with consumer prices. Rising wages in turn can help fuel inflation. In the case of collective bargaining, wages will be set as a factor of price expectations, which will be higher when inflation has an upward trend. This can cause a wage spiral. spiral. In a sense, inflation  begets further inflationary expectations. Hoarding Hoarding: people people buy consumer consumer durables as stores stores of wealth wealth in the absence of viable alternatives as a means of getting rid of excess cash  before it is devalued, creating shortages of the hoarded objects. Hyperinflation: Hyperinflation: if inflation gets totally out of control (in the upward direction), it can grossly interfere with the normal workings of the economy, hurting its ability to supply.

CRUBING INFLATION Inflation is complex phenomenon. It should be attacked from various angles. The following are the broad categories of instruments commonly used in order to control inflation in modern economy: (1) Monetary policy, (2) Fiscal policy,

22

(3)Direct control, and (4) Miscellaneous measures.

1. Monetary Policy Inflat Inflation ion is prima primaril rily y a moneta monetary ry phenom phenomeno enon. n. Hence, Hence, the most most logica logicall solution to check inflation is to check the flow of money supply by devising appr approp opri riat atee mone moneta tary ry po poli licy cy and and care carefu full lly y impl implem emen enti ting ng mone moneta tary ry measures. Broadly speaking, to control inflation, it is necessary to control total outlays  because under conditions of full employment, increase in total outlays will  be reflected in a general rise in prices, that is, inflation. Monetary policy used to ‘control inflation is based on the assumption that a rise in prices (inflation) is due to excess of monetary demand for goods and services by the people because easy bank credit is available to them. Monetary policy, thus thus,, pert pertai ains ns to bank bankin ing g and and cred credit it avai availa labi bili lity ty of loan loanss to firm firmss and and households, interest rates, public debt and its management, and the monetary standard. Monetary management is aimed at the commercial banking system, and through this action, its effects are primarily felt in the economy as a whole. Monetary management, by directly affecting the volume of cash reserves of  the banks, can regulate the supply of money and credit in the economy, thereby Influencing the structure of interest rates and the availability of credit. Both these, factors affect the components of aggregate demand (consumption plus investment) and the flow of expenditure in the economy. Thee cent Th centra rall bank bank’s ’s mone moneta tary ry mana manage geme ment nt meth method ods, s, the the devi device cess for  for  decrea decreasin sing g or increa increasin sing g the supply supply of money money and credit credit for for moneta monetary ry stability is called monetary policy. Central banks generally use the three quantitative weapons, namely: (i) bank rate policy, (ii) Open market operations, and (iii) Variable reserve ratio to control the volume of credit in an economy. To curb inflationary pressures, a dear money policy is usually followed by using the quantitative methods; the total volume of credit is depleted. In this regard, (i) bank rate may be raised; (ii) Open market sales operation may be wldertaken; and (iii) In severe cases, the reserve requirement ratio may be increased.

23

In a developing economy there is always an increasing need for credit. Growth requires credit expansion but to check inflation, there is need to contract credit. In such a conflict, the best course is to resort to credit control, restricting the flow of credit into the unproductive, inflation-infected sectors and speculative Activities and diversifying the flow of credit towards the most desirable needs of productive and growth-inducing sector. Fiscal Policy Fiscal policy is budgetary policy in relation to taxation, public borrowing, and public expenditure. Changes in the total expenditure can be effected by fiscal measures. To combat inflation, fiscal measures would involve increase in taxati taxation on and decrea decrease se in gov govern ernmen mentt spendi spending. ng. During During inflat inflation ion the government is supposed to counteract an increase in private spending. Obviou Obviously sly,, during during a period period of full full employ employmen mentt infla inflatio tion, n, the aggreg aggregate ate demand in relation to the limited supply of i goods and services is reduced to the extent that government expenditures expenditures is curtailed. A curtai curtain n pub public lic expend expenditu iture re along along is not suffic sufficien ient. t. Govern Governmen mentt must must simultaneously increase taxes to affect a cut in private expenditure also, - in order to minimize inflationary pressures. As we know, when more taxes are impo impose sed, d, the the size size of the the disp dispos osab able le inco income me dimi dimini nish shes es,, as also also the the magnitude of the inflationary gap, given the available supply of goods and services. Inflationary pressure is significantly weakened by the simultaneous curtailment of government expenditure and an increase in taxation because, more resources are released for expanding the productive capacity in the  private sector; the Supp Supply ly curv curvee of aggr aggreg egat atee go good odss and and serv servic ices es shif shifts ts up upwa ward rdss with with a contraction of monetary demand due to a decline in disposable income with  people. It has been argued that a tax policy can be directed towards restricting demand without restricting production. For instance, excise duties or sales tax on various commodities take away the buying power from the consumer  goods market without discouraging the expansion of production capacity. However, Some economists point out that this is not a correct way of combating inflation becomes of its regressive nature. On the other hand, this may lead to a further rise in prices of such commodities, and inflation can spread from one sector to Anot Anothe herr and and from from on onee comm commod odit ity y to anot anothe her. r. But, But, du duri ring ng infl inflat atio ion, n, a  progressive direct tax is considered best; it is also justified in the interest of  social equity. . 24

Direct Controls Direct controls refer to the regulatory measures undertaken to convert an open inflation into a repressed one. Such regulatory measures involve the use of direct control on prices and rationing of scarce goods. The function of   price control is a fix a legal ceiling, beyond which prices of particular goods may not Increase. When ceiling prices are fixed and enforced, it means prices are not allowed to rise further and so, inflation is suppressed. Under price control,  producers cannot raise the price beyond a prevailing level, even though there may be a pressure of excessive demand forcing it up. Wartime price control is an example of such attempts to suppress inflation. In view of the severe scarcity of certain goods, particularly, food grains, government may have to enforce rationing, along with price control. The main function of rationing is to divert consumption from those commodities whose supply needs to be restricted for some special reasons, say, in order to make the commodity available to a larger number of people as possible. Thus, rationing becomes esse essent ntia iall when when nece necess ssit itie ies, s, such such as food food grai grains ns,, are are rela relati tive vely ly scar scarce ce.. Rationing has the effect of limiting the variety of quantity of goods available for the goo good d Cause Cause of price price stabil stability ity and distri distribut butive ive justic justice. e. Howeve However, r, rationing is criticized on the ground that it restricts consumer’s sovereignty. According to Keynes, “rationing involves a great deal of waste, both of  resources and of employment.” Prof.Kurihara, however, suggests that “a sensible progress of rationing should aim at diverting consumption from  particular articles whose supply is below normal rather than at controlling aggregate consumption. ” In short, monetary fiscal controls may be used to repress excess demand, in general, but direct controls can be more useful when they are applied to specific scarcity areas.

25

INFLATION IN INDIA

Indian economy has been registering a mammoth GDP growth postliberalization. The opening up of the Indian economy after the 1990s increased India's industrial output, which in turn raised the inflation India rate significantly. The stupendous growth rate of industrial output and employment created an enormous pressure on the inflation rate and pushed it further. The Reserve Bank of India (the central bank) and the Ministry of Finance, Government of India is concerned about the present upswing of inflation India. The present rise of inflation India rate could be detrimental to the projected growth and aims of the Indian economy. The main cause of rise in the rate of  inflation India is the pricing disparity of agricultural products between the producer and consumers in the the Indi Indian an mark market et.. Mo More reov over er,, the the skysky-ro rock cket etin ing g of pric prices es of food food  products, manufacturing products, and essential commodities have also cata catapu pult lted ed the the infl inflat atio ion n rate rate in Indi India. a. Furth urther ermo more re,, the the un unst stab able le international crude oil prices have worsened the situation. As a result of  this, the Wholesale Prices Index (WPI) of India touched 6.1% as on January 6, 2007 and the Cash Reserve Ratio (CRR) touched 5.5% on the same day. Reserve Bank of India - the central bank of India, has assured the Indian  business community and the general public about the harmless rise in the CRR but apprehensions still exist amongst business circles in India. The Reserve Bank of India is devising methods and financial models to arrest the the rise rise in the the rate rate of infl inflat atio ion n in Indi India. a. Th This is insu insurg rgen ency cy fina financ ncia iall modeling may arrest the immediate crisis but the long-term concerns are yet yet to be alla allaye yed d or addr addres esse sed. d. To arre arrest st the the dist distur urbi bing ng sent sentim imen ents ts amongst the Indian business circles, the Reserve Bank of India had given top priority to price stability and economic growth sustenance in India, in its recently drafted monetary policy. The Reserve Bank of India has raised the Cash Reserve Ratio in a continuous manner to arrest the rise in inflation. Most developed nations across the world have devised several methods to arrest inflation and bring in stability to its economy. In India, the solution to this problem lies in rationalizing the pricing disparity between the 26

  pro produ duce cers rs and and the the endend-co cons nsum umer erss alon along g with with incr increa easi sing ng Indi India' a'ss agricultural produce. This will not only ensure inflation stabilization but also sustain the present economic growth rate of India.

CALCULATION OF INFLATION IN INDIA

Rising Rising inflat inflation ion was the most most recent recent tickl ticklish ish politi political cal issue issue that that hit the Manmohan Singh government. But was inflation rising because of price rise in essential commodities? Or was it because of the 'erroneous method' of  calculating inflation? Some economists assert that India's method of calculating inflation is wrong as there are serious flaws in the methodologies used by the government. Economists V Shunmugam and D G Prasad working with India's largest commodity bourse -- the Multi Commodity Exchange -- have come out with a research paper arguing that the government urgently needs to shift the method of calculating inflation. Saying that there are serious flaws in the present method of calculating infl inflat atio ion, n, the the pape paperr Indi Indiaa shou should ld adop adoptt meth method odol olog ogie iess in deve develo lope ped d economies.

•

•

India uses the Wholesale Price Index (WPI) to calculate and then decide the inflation rate in the economy. Most developed countries use the Consumer Price Index (CPI) to calculate inflation.

Wholesale Price Index (WPI)

WPI WPI was was firs firstt pu publ blis ishe hed d in 19 1902 02,, and and was was on onee of the the more more econ econom omic ic indi indica cato tors rs avai availa labl blee to po poli licy cy make makers rs un unti till it was was repl replac aced ed by most most developed countries by the Consumer Price Index in the 1970s. WPI is the index that is used to measure the change in the average price leve levell of go good odss trad traded ed in whol wholes esal alee mark market et.. In Indi India, a, a tota totall of 43 435 5

27

comm commod odit itie iess data data on pric pricee leve levell is trac tracke ked d thro throug ugh h WPI WPI whic which h is an indicator of movement in prices of commodities in all trade and transactions. It is also the price index which is available on a weekly basis with the shortest possible time lag only two weeks. The Indian government has taken WPI as an indicator of the rate of inflation in the economy. Consumer Price Index (CPI)

CPI is a statistical time-series measure of a weighted average of prices of a specified set of goods and services purchased by consumers. It is a price index that tracks the prices of a specified basket of consumer goods and services, providing a measure of inflation. \CPI is a fixed quantity price index and considered by some a cost of living index. Under CPI, an index is scaled so that it is equal to 100 at a chosen  point in time, so that all other values of the index are a percentage relative to this one. Economists Shunmugam and Prasad say it is high time that India abandoned WPI and adopted CPI to calculate inflation. India is the only major country that uses a wholesale index to measure inflation. Most countries use the CPI as a measure of inflation, as this actually measures the increase in price that a consumer will ultimately have to pay for. "CPI is the official barometer of inflation in many countries such as the United States, the United Kingdom, Japan, France, Canada, Singapore and China. The governments there review the commodity basket of CPI every 45 years to factor in changes in consumption pattern," says their research  paper. It pointed out that WPI does not properly measure the exact price rise an end-consumer will experience because, as the same suggests, it is at the wholesale level. The paper says the main problem with WPI calculation is that more than 100 outt of the ou the 43 435 5 comm commod odit itie iess incl includ uded ed in the the Inde Index x have have ceas ceased ed to be important from the consumption point of view.

28

Take, for example, a commodity like coarse grains that go into making of  live livest stoc ock k feed feed.. Th This is comm commod odit ity y is insi insign gnif ific ican ant, t, bu butt cont contin inue uess to be considered while measuring inflation. India constituted the last WPI series of commodities in 1993-94; but has not updated it till now that economists argue the Index has lost relevance and can not be the barometer to calculate inflation. Shunmugam says WPI is supposed to measure impact of prices on business. "But we use it to measure the impact on consumers. Many commodities not consumed by consumers get calculated in the index. And it does not factor in services which have assumed so much importance in the economy," he  pointed out. But why is India not switching over to the CPI method of calculating inflation? Finance ministry officials point out that there are many intricate problems from shifting from WPI to CPI model. First of all, they say, in India, India, there are four different different types of CPI indices, indices, and that makes switching over to the Index from WPI fairly 'risky and unwieldy.' The four CPI series are: CPI Industrial Workers; CPI Urban NonManual Employees; CPI Agricultural laborers; and CPI Rural labour. Secondly, officials say the CPI cannot be used in India because there is too much of a lag in reporting CPI numbers. In fact, as of May 21, the latest CPI number reported is for March 2006. The WPI is published on a weekly basis and the CPI, on a monthly basis. And in India, inflation is calculated on a weekly basis. India Inflation Rate

The Indian economy has been registering stupendous growth after the liberalization of Indian economy. The opening up of the Indian economy in the the early arly 19 1990 90ss had had incr increa eassed Ind ndiia's a's ind indust ustrial rial ou outp tpu ut and and consequently has raised the India Inflation Rate . The stupendous growth rate of industrial output and employment has

29

created enormous pressure on the inflation rate. The Reserve Bank of  India (the central bank) and the Ministry of Finance, Government of  India India are concer concerned ned about about the preval prevalent ent and inter intermit mitten tentt rise rise of the inflation rate. The present rise of  India Inflation Rate can be detrimental to the projected growth of Indian economy. Thus, the Reserve Bank of  India is devising methods to arrest the rise of inflation by putting checks and measures in place. Although the central bank has assured the Indian   bus busin ines esss comm commun unit ity y and and the the gene genera rall pu publ blic ic abou aboutt the the harm harmle less ss inflationary rise, apprehensions still exist among the business circles of  India. The main cause of rise of India Inflation Inflation Rate is the pricing pricing disparity disparity of  agricultural products between the producer and end-consumer. Moreover, the meteoric rise of prices of food products, manufacturing products, and essential commodities has also catapulted the India Inflation Rate. As a result of this, the Wholesale Prices Index (WPI) of India touched 6.1% as on 6th January, 2007. Moreover, the Cash Reserve Ratio touched 5.5% on the same day. To arrest the panic and discomfort amongst the Indian business circles, the Reserve Bank of India, in its recently drafted monetary policy, had give given n top top prio priori rity ty to pric pricee stab stabil ilit ity. y. It also also soug sought ht to sust sustai ain n the the stupendous rate of economic growth of India. The Reserve Bank of India has raised the Cash Reserve Ratio in a continuous manner to arrest the rise of   India Inflation Rate. The solution to this problem lies in rationalizing the pricing disparity  between the producer and the consumer. Only this will ensure inflation stabilization and thus sustainable economic growth of India.

30

RATE OF INFLATION IN INDIA SINCE (1995-2003)..,

India Inflation Rate 2006

India inflation rate 2006 had been lower towards the beginning of the year. The inflation rate in India in 2006 grew towards the middle of the year and rose again higher towards the end of the year. In an economic context, the term 'inflation' pertains to the sustained increase in the prices of goods and services. The increase needs to be sust sustai aine ned d and and also also sign signif ific ican antl tly y more more than than the the mean mean pric prices es,, for for the the economic condition to be defined as inflation. It is always the aim of the Indi Indian an go gove vern rnme ment nt to keep keep the the rate rate of infl inflat atio ion n in Indi Indiaa belo below w 4%   because the more higher the rate of inflation, the more expensive life  becomes for the people of the country. The government of India, along with the Reserve bank of India monitors and controls the inflation rate in India. In February 2006, the rate of inflation in India stood at 4.02% but it has since then lowered due to the decrease in  prices of groundnut seed, cotton seed, and raw cotton. In April, 2006 the inflation rate in India was pegged at 3.96%. However, in June, the rate of 

31

inflation in India in 2006 grew to 5.24%, which is the highest inflation rate in India in the last 13 months. The rise in inflation has taken place due to the Indian government's decision to increase petrol and diesel prices. The depreciation of the rupee and the increase in global rates made the inflation rate in India 2006 rise. This rise in the India inflation rate 2006 led to the increase in interest rates, which in turn increased the cost of living for the citizens of  the country. In July, 2006 the India inflation rate stood at 5.21%. The rise in the inflation inflation rates has taken place due to the increase increase of wholesale wholesale prices prices in food and energy. Due to the rise in the prices of manufactured and mineral products, the inflation rate in India stood at 5.45% in November, 2006. India inflation rate 2006 was a function of several factors and led to an uncomf uncomfor ortab table le rise rise in the price pricess of commod commoditi ities es and servic services, es, which which inconvenienced people from all walks of life.

Indian Inflation 2007

Indian Inflation 2007 has been reflecting a 4.05 percent decline during the month of August. Rate of inflation in India is decreasing due to lowering of   prices of vegetables, poultry chicken, fruits, lentils, and a few manufactured items. The Indian Inflation Inflation rate in July was 4.45 percent percent and it has been observed observed that the month of August has experienced a decline in inflation. However, the RBI is not keen on relaxing its policies. Only a few manufactured goods have experienced reduction in prices in the process. The rate of inflation for wholesale goods was 6.69 percent in the month of  January, which later came down to 4.28 percent by 1st June and further  reduced to 4.03 percent towards the end of the month, thus adding to the lowering of Indian Inflation 2007. RBI has been firm in its policy for data revision and firm manufactured  product prices. Economists consider the manufacturing inflation as the key inflation in the Indian economy and are expecting relaxation in policies from

32

the RBI. Interestingly, the annual inflation up to 21st April was 5.77 percent which went up to 6.07 percent thereafter. Acco Accord rdin ing g to RBI RBI go gove vern rnor or Venu Venugo gopa pall Redd Reddy, y, the the RBI RBI is keen keen on containing inflation at 5 percent this FY begun in April, 2007. However, the onset of the monsoons in July has resulted in better crops and other farm items, leading to a reduction in their prices. Few manufacturing products that have become cheaper now are imported  basic pig iron edible oil, methanol, bakery products, and foundry pig iron. A rising trend has been seen in prices of milk, tea, at the rate of 4 percent. The trends in Indian Inflation 2007 are given below: •

•

•

•

•

•

•

•

•

•

March 10 - (week ending 24 Feb) 6.10 percent March 16 - 6.46 percent April 6 - 6.39 percent April 14 - 5.74 percent April 20 - (week ended 7 April) 6.09 percent May 4 - 5.77 percent May 10 - 5.25 percent June 23 - (week ending 9 Jun) 4.38 percent July 13 - 4.27 percent August 11 - (week ending 28 July) 4.45 percent

Indian Inflation 2007 is definitely on the wane and has been observed to have been influenced by global factors. The domestic inflation is expected to undergo tectonic changes and is possibly becoming a victim of outdated anti-inflationary measures. INDIA INFLATION 2008

India's inflation remained below the RBI's year-end target for the eighth month in a row as the government continued to maintain a cap on retail fuel  prices, making it more likely the central bank will maintain interest rates at a 5 1/2 year high. Wholesale Wholesale prices prices rose 3.83 percent in the week ended Jan. 12 from a year earlier, faster than the previous week's 3.79 percent, the Ministry of Commerce and Industry said today in New Delhi

33

The Reserve Bank of India - which aims to keep inflation below 5 percent is due to meet on Jan. 29 to review rates. It has raised its benchmark interest rate nine times since October 2004 in order to keep a tight rein on prices and as a result has succeeded in dragging down inflation from a two-year high of  13.1%reached in January 2007. The Reserve Bank is expected to come under pressure after the U.S. Federal Reserve cut the target overnight lending rate on Jan. 22 by three quarters of a   per perce cent ntag agee po poin intt to 3.5 3.5 perc percen ent. t. Th Thee Fed Fed rate rate cut cut wide widene ned d the the spre spread ad   betwe between en two-ye two-year ar Indian Indian gov govern ernmen mentt bon bonds ds and simila similarr maturi maturity ty U.S. U.S. Treasury notes to 5.40 percentage points from 5.01 percentage points a week  earlier. Finance Minister Palaniappan Chidambaram noted in Davos that the unexpected cut in the U.S. interest rates may increase capital flows to India and the central bank would have to respond appropriately to tackle inflows. Pressure may also mount on the Rupee, which rose 12.3 percent in 2007, leading it to appreciate further on higher overseas inflows as investors try to take take advant advantage age of high-y high-yiel ieldin ding g emergi emerging ng market market assets assets.. The rupee rupee has gained 0.2 percent after the Federal Reserve cut its key interest rate to the lowest since 2005

34

WHOM DOES INFLATION HURT THE MOST

When we first think of inflation we assume that it will affect all people equally. After all if everyone is using the same dollars wouldn't everyone be affected equally? The fact of course is that everyone isn't affected equally. Our second assumption might be that the poor would be hurt the worst  because they earn minimum wage and everything they buy is getting more expensive. However, if the minimum wage is indexed to inflation they would about break even. So interestingly if the minimum wage earners are also deep in debt inflation actually helps them. The reason for this is that debtors borrow valuable money and the number of  dollars they must repay is fixed. So over time the value of the dollars they must repay is less and less (so they are easier to obtain than if the value of  the dolla dollarr wasn't wasn't inflat inflated ed away.) away.) This This is called called repayi repaying ng with with "cheap "cheaper  er  dollars". However, bigger beneficiaries would be the average middle class person with a large mortgage because the debt is for a longer term so inflation has longer to work its "magic". On the other hand, the biggest losers due to inflation are those willing to loan money. An extreme example would be during the hyper-inflation of  1923 in Germany. If you had loaned a friend enough money to buy a car in 35

early 1923 and he had repaid it at the end of 1923 you might have been able to buy a box of matches with it. So it is easy to see that the borrower got a car and he was able to repay it with pocket change. The lender  lender of of course was the big loser. At first this looks like the ultimate Robin Hood scheme, robbing from the rich bankers and giving to the poor borrowers. However, the other big losers those on fixed incomes like the elderly and anyone whose income isn't indexed to inflation. Inflation affects them especially hard because the prices of things they buy go up while their income stays the same. In addition, the poor are generally renters so they don't even benefit from a "cheaper" mortgage while they are  paying higher prices for their groceries. Also even though their wages may be indexed to inflation there is a time lag since it is usually only re-indexed once a year. During this time they are on the old wages while prices for things they buy have already gone up. Interestingly the biggest debtor in the world is the US government and thus it is also the biggest beneficiary of inflation. And not coincidentally the Government is also the one who controls the money supply and thus inflation. In a way, inflation works as a hidden tax because the government borrows money from investors. It spends this valuable money and then gets to pay  back its debt with cheaper dollars. The poor unsuspecting investor who is convinced that Government notes,  bonds and T-Bills are "Low-Risk investments "Low-Risk  investments"" accepts these dollars at face value but before long realizes that they won't buy as much as the dollars they loaned to the government in the first place. Generally, the Government walks a tightrope though; it can't inflate all its debt debt away away too too qu quic ickl kly, y, with withou outt dest destro royi ying ng the the econ econom omy, y, so it face facess a constant balancing act. One big disadvantage of inflation is the fact that it discourages lending (smart banks (smart  banks need more interest to make up for the lost value). This prices some borrowers out of the market making loans too expensive. 36

Inflation also makes planning for the future more difficult, so businesses are less likely to take risks. No risk means no advancement which stifles the entire economy. On a small scale lenders are the losers from inflation and borrowers are the winners but on a bigger scale the biggest beneficiary is the Government and the overall economy is the biggest loser. Other losers are those on fixed incomes and those who are priced out of the loan market.

HOW DOES INFLATION AFFECT THE INDIVIDUAL

When people go the grocery store and see ever higher prices they know how inflation affects them. But when they are feeling more philosophical they might reason that if all wages and prices increased at the same rate it would all balance out in the end right? Well theoretically yes but in reality it never works that way. Prices of  various items all increase at different rates so some people are benefiting while others suffer. Those on fixed incomes suffer the most because the cost of things they are buying increases but their income stays the same. This is where COLA or "Cost Of Living Allowance" comes in it is an adjustment that is made to compensate for the increase in prices due to inflation. But even if costs are adjusted they are adjusted after the fact so that you have already been paying the higher prices for a year before your income is adjusted. One side of inflation that most consumers appreciate is the fact that they can  pay off their debts their  debts with "cheaper dollars". dollars". So as you borrow the value of the money you borrowed goes down so it takes fewer hours of work to pay back  the lender .

37

This is one reason why debt is so prevalent today. Unfortunately, this is a subtle but insidious poison because it trains us to feel good about cheating others. In the past a man's honor was tied to his ability to repay his debts but today inflation has taught us that it is good to try to cheat lenders out of their  due. This has led to a higher rate of  bankruptcies  bankruptcies and if the trend continues it could lead to the breakdown of commerce. Once lenders can't be assured of getting repaid they will stop lending (or  have to charge exorbitant interest rates) rates) and as interest rates increase the economy grinds to a halt. So even the "good" side of inflation is really "bad" for the economy in the long run. “RISING INFLATION HITS BUSINESS CONFIDENCE”, says FICCI SUVERY

Runaway inflation, combined with high interest rates, has further dented the  business confidence of Indian industry, a survey by the Federation of Indian Chambers of Commerce and Industry (Ficci) for the fourth quarter of 200708 has revealed. As many as 64 per cent of the 413 companies surveyed said that the economic conditions had worsened, compared with the past six months. In the previous survey, for the third quarter (October-December) of 2007-08, 50 per cent of the respondents had expressed a similar view. In the survey for the fourth quarter of 2006-07, only 14 per cent of the respondents said that the economic conditions had worsened. The latest survey also reveals that the outlook on parameters like sales, investments and employment took a dip, while that on profits remained flat, compared with the third quarter survey. A larger number of companies expect weak demand. As many as 37 per cent of the respondents mentioned weak market demand as a factor adversely affecting their business performance, as against 20 per cent in the same quarter of 2006-07. As many as 95 per cent of the respondents pointed towards the rising cost of  raw materials and inputs as the key constraint to their performance, as against 70 per cent in the fourth quarter of 2006-07.

38

Moreover, 61 per cent of the companies surveyed cited rising wages as a cause for concern, while a higher number of respondents reported high cost of credit as a cause for worry. The only silver lining in the survey was in the form of expectations of better  econom economic ic condit condition ionss later later during during the year. year. "In their their assess assessmen mentt of the the econom economic ic situat situation ion,, member memberss of corpor corporate ate India India have have report reported ed that that the economic trends may have reached their worst levels and from now on one can expect some improvement," a FICCI release said. The survey found that 44 per cent of the companies companies covered by it expected expected thei theirr perf perfor orma manc ncee woul would d impr improv ovee in Q1 (Apr (April il-J -Jun une) e) and and Q2 (Jul (JulyySeptember) in 2008-09. "Manufacturing inflation will go up in the months ahead and it would be a   persistent trend throughout 2008," the Federation of Indian Chamber of  Commerce and Industry (FICCI) said after conducting a survey of business confidence which has deteriorated in the last six months. Manufacturing has a weight age of 63.75 per cent in the whole price index. Inflation touched a 13-year high of 11.42 per cent for the week ended June 14. The results of the survey conducted between May and June showed that   performance of the economy, industry and at the firm level has further  weakened. "The Current Conditions Conditions Index is at its lowest level because because of moderation moderation in growth, rise in inflation and input costs," the chamber said. The pressure on industry on account of rising interest and input costs has breached the absorptive capacity for many companies that are being forced to revise  prices upward. "Ind "India ia Inc Inc has has stru struck ck a no note te of nerv nervou ouss op opti timi mism sm and and expr expres esse sed d deep deep concern at the current state of the economy," it said. Assessment of current indu indust stry ry perf perfor orma manc ncee show showss that that near nearly ly 38 per per cent cent of the the comp compan anie iess witnessed deterioration in performance over the last six months. This figure stood at 29 per cent in t he last survey. The industry is however keeping its fingers crossed for recovery in the

39

medium term. About 37 per cent of the companies have expressed optimism that economic conditions would improve in the near term as "economic trends may have reached their worst levels and one can now expect some improvement". About 32 per cent feel the situation would further deteriorate over the next six months. Apart from heavy and light industry, where performance has declined, the services sector too is showing signs of moderation. "While the situation may improve somewhat in the near future, we will still fall short of the strong performance that was witnessed till about a year ago," the chamber said. The relentless increase in prices since early 2008 has clouded the economic environment. With RBI further tightening the monetary policy, interest rates have have starte started d harden hardening ing and this this would would impact impact the countr country's y's econom economic ic growth. In addition, global factors such as rising crude oil and commodity prices continue to remain a cause of concern. With the Current Conditions Index and Expectations Index moving in the opposite direction, the Overall Business Confidence Index value has not seen any lateral movement and maintained its level at 55.3 as seen in the previous survey. While outlook  outlook for for investments, sales and employment in the next six months has modera moderated ted,, there there is margin marginal al improv improveme ement nt in outloo outlook k for export exports. s. While depreciation of the rupee against the dollar has eased the situation for  exporters, companies maintain that the effect of the rupee rise still continues.

Indian Stocks Plunge Due to Political Turmoil and Inflation Fears: India's key stock market index has fallen more than 3.5 percent because of  concerns about rising inflation and political instability.

40

Mumbai's Sensex index lost 500 points Tuesday to close at 12,962, its lowest in more than a year. Indian banks were among the hardest hit in the sell-off, including State Bank  of Indi India, a, whic which h lost lost 7.8 7.8 perc percen ent, t, and and ICIC ICICII Bank Bank,, whic which h decl declin ined ed 6.5 6.5  percent. The surging price of crude oil worldwide has added to concerns about India's inflation rate, which is at a 13-year high. In June, the Indian government raised the price of gasoline and diesel fuel to help state oil companies stay  profitable. Analysts say tensions between India's ruling coalition and the communist  parties over a proposed nuclear pact with the United States also contributed to Tuesda Tuesday's y's stock stock sell-o sell-off. ff. The commun communist ist partie partiess have have threa threaten tened ed to withdraw support for the ruling coalition and force early elections if the pact is passed.

INFLATION AT 11.63%; FM SEES 13% IN NEAR TERMS

Inflation for the week week ended June 21 is at 11.63% versus versus 11.42%. A CNBCTV18 poll had seen inflation for the week ended June 21 at 11.44%. Finance Minister P Chida Finance Chidambar mbaram am said the main drive drivers rs will cont continue inue to be  petroleum, iron and steel products, reports CNBC-TV18. He also said that fuel and power prices have stabilised after a sharp rise. “There is a rise in prices of manufactured products, despite a year-on-year  (YoY) drop in commodities. The pace in price rise of essential commodities is slower than last week.” The Fin Financ ancee Min Minist ister er see seess inf inflat lation ion tou touchi ching ng 13% in nea near-t r-term erm rep report ortss CNBC-TV18 quoting Newswire18.

41

Indranil Pan of  of Kotak Kotak Mahindra Bank sees Bank sees a 25bps repo arte hike by the RBI on July 29 and an overall 50 bps hike in this financial year. He also sees a CRR hike in the days ahead given the liquidity in the economy. He expects inflation to touch 13% going forward. He sees GDP at 7.5 to 7.8% this year. Gaurav Kapur  of  ABN Am Gaurav Amro ro Ban Bank  k  feels that over the next couple of  months, things can only worsen from hereon. So by the time we reach the monetary policy, we could still pretty much have the number in the vicinity of 12.5-13%. Sh ubha Shub ha Ra Rao o, Chief Economist,Yes Economist,Yes Bank has Bank  has said that the inflation numbers are not a comforting number looking at the index week-on-week. She said that since early May, the average number that has been going up is by 0.8 ticks. "Going forward, we are not really optimistic about any lowering of  this kind of a trend." According the Rao, in couple of weeks from now inflation could possibly be seen cross well over 12%, given this trend and the news flows in terms of  aviation turbine fuel (ATF), steel prices or even the second order impact in terms of primary articles fruits, vegetables, transportation cost being built in and the cement prices being marginally hiked in the south all these news flows do not add to comfort. Speaking to CNBC-TV18, Rao said that the Reserve Bank  of India (RBI) will walk into the monetary policy on July 29 with inflation ruling well over  12%. She believes that means RBI will review its fixed rate once again,  perhaps 50 bps was taking the cue that inflation will be between 11.5% to 12.5% but between these weeks if there are a few more nasty surprises like this then in just a couple of weeks it would have crossed well over 12.5%. "We cannot really rule out a repo rate hike but at this point in time RBI may look at inflation crossing well over 13% or so."

INDI INDIAN AN OFFI OFFICI CIAL AL INFL INFLAT ATIO ION N IS AT 12% 12% BUT BUT IN REAL REALIT ITY Y COMMON PEOPLE ARE FACING HYPER INFLATION OF 30% 42

Indian inflation rose to a new 13-year high of 11.42 per cent for the week  ended June 14, vastly higher than the 4.13 per cent in the corresponding week a year ago. That is what the Indian Government is telling the media. But Indian main streets are upset with the onslaught of inflation and Indian fiscal mismanagement. According to sources, the commodities and services that affect common  people in India is rising at a whopping rate of 30%. The Government keeps quiet. But the common people are suffering badly. Many Indian middle class household household is deep in debt as they bought bought two or three cars, new apartment apartment,, furniture and so on loan. They never realized what it will mean when food  prices go up at a rate higher than 30% per year. Even the data released by the Central Statistical Organization (CSO) was accompanied by a steep revision of the provisional inflation figure of 7.57  per cent reported earlier earlier for the week ended April 19. The final figure now stands at 8.23 per cent, once again underscoring the fact that inflation has  been under reported throughout the recent months. The biggest problem for India is subsidized petroleum products. When that subsidy is gone, the real inflation for the common people will be above 50%  per year. That will crumble the financial infrastructure in the country. Most middle class Indians depend on life insurance, bank deposits and so on. Risi Rising ng infl inflat atio ion n will will make make thes thesee ho hous useh ehol old d wort worth h much much less less they they can can imagine create massive negative sentiment. HOW DOES INFLATION AFFECT THE INDIAN MARKET: MARKET:

Amit Dalal of Amit Nalin Securities feels that there is definitely going to be more of a negative impact on interest rate sensitive stocks. “Companies that have gone into a mode of high capital employed capex programmers will have high cost of productions. Those sectors are real estate, auto, where we have to be very concerned,” he said. According to Dalal, if one looks at the volatility that has been seeing during the last ten days, it is obviously impossible for one to forecast how the market trend can be, in terms of looking at price of oil. “The fall in the market that has come in the last two weeks which is down to 3,000 points from where we were. It has taken into account the fact that earnings are

43

going to be impacted by this high inflationary period ahead of us. Therefore, we are now discounting earnings at a much lower level for FY09 and even FY10. The positive lining in the cloud is that we have now completely differentiated our investment opportunities from investment laggards. There are certain sectors, which are dependent on  borrowings like infrastructure, auto companies are dependent on consumer borrowings and these are going to be laggards for a long time to come,” Dalal added

FOOD PRICES DRIVE INDIA INFLATION

Inflation in India has hit a three-year high as a result of spiraling food and energy costs, official figures show. India's wholesale price index, released weekly, hit 7% for the year up to 22 March, the highest since December 2004. The government has been taking steps to control prices, banning exports of  non-basmati rice and scrapping import duties on cooking oils and maize. Economists said the data could trigger a rise in interest rates this month, earlier than many had expected. India's India's Economic Economic Times says the governme government nt is consideri considering ng a price ceiling on commodities if all other measures fail to bring down inflation - a law last used in the 1970s. In India, the wholesale price index, which measures inflation at the "factory gate", is more closely watched than the consumer   price index because it tracks a wider range of goods. The consumer price index reflects shop and market prices. "Inflation is beyond anybody's expectations and I expect further firefighting measures from the government," said D K Joshi, principal economist at Crisis. "One can forget lowering of interest rates for some time to come." Record prices of rice, wheat and other foodstuff, along with the sky-high oil  price, have fanned inflation worldwide. This has prompted many governments to impose price controls and curb exports of essential goods. India has raised the cost of borrowing nine times since October 2004.

44

Growth is expected to slow this coming financial year to about 8%, its weakest rate of expansion since 2005, but still a robust rate of growth. In the year ending 31 March 2008, the economy grew 8.7%.

ANALYSIS REPORT

1. Expenditure pattern amongst people?  price awareness food rent health education transport clothes ent entert ertainm ainmen entt   phone bill vehi vehicl clee (inc (inc fuel) electricity servant

60 2500 5000 500 10000 2000 5000 800 80 0 1500 2000 600 500

45

2.people’s view on government handling inflation? as told by  people 25 23

measures taken by GOVT increase in bank interest rates measures are taken by GOVT govt go vt con ontr tro ol over ver ste steel and cement price 12

46

3. suggestions from survey ?

suggestions to control  prices do no nott bu buy y luxu luxury ry du duri ring ng inflation govt should control all sectors import duty should be increased taxe taxess shou should ld be incr increa ease sed d on liquor

18 20 12 10

47

CONCLUSION AND RECOMMENDATION RECOMMENDATION 1.HOW TO TACKLE INFLATION IN INDIA

Inflation is no stranger to the Indian economy. In fact, till the early nineties Indians were used to double-digit inflation and its attendant consequences. But, since the mid-nineties controlling inflation has become a priority for   policy framers. The natural fallout of this has been that we, as a nation, have become virtually intolerant to inflation. While inflation till the early nineties was   primarily caused by domestic factors (supply usually was unable to meet demand, resulting in the classical definition of inflation of too much money chasing too few goods), today the situation has changed significantly.

48

Inflation today is caused more by global rather than by domestic factors.  Naturally, as the Indian economy undergoes structural changes, the causes of  domestic inflation too have undergone tectonic changes.   Nee Needl dles esss to emph emphas asiz ize, e, caus causes es of toda today' y'ss infl inflat atio ion n are are comp compli lica cate ted. d. However, it is indeed intriguing that the policy response even to this day unfortunately has been fixated on the traditional anti-inflation instruments of  the pre-liberalization era. Global imbalance the cause for global liquidity

To understand the text of the present bout of inflation, let us at the outset understand the context: the functioning of the global economy, which is in a state state of extrem extremee imbala imbalance nce.. This This is simply simply becaus becausee develo developed ped wester western n economies, particularly the United States, are consuming on a massive scale leading to gargantuan trade deficits. Crucially their extreme levels of consumption and imports are matched by the proclivity, nay fetish, of the developing countries in having an exportdriven economic model. Thus while a set of developing countries produces, exports and also saves the proceeds by investing their forex reserves back in these countries, developed countries are consuming both the production and investment originating from the developing countries. In effect, developing countries are building their foreign exchange reserves while while the develo developed ped countr countries ies are accumu accumulat lating ing the corres correspon pondin ding g debt. debt. After all, it takes two to a tango. For instance, the US current account deficit is estimated to be 7 per cent of  GDP in 200 2006 6 and stood stood at approx approxim imate ately ly $90 $900 0 billi billion. on. Obviou Obviously sly,, the current account deficit of the US becomes the current account surplus of  other exporting countries, viz. China, Japan and other oil producing and exporting countries. The reason for this imbalance in the global economy is the fact that after the Asian currency crisis; many countries found the virtues of a weak currency and engaged in 'competitive devaluation.' Under this scenario, many countries simply leveraged their weak currency wise versa the US dollar to gain to the global (read US) markets. This mercantilist policy to maintain their competitiveness is achieved when their  49

central banks intervenes in the currency markets leading to accumulation of  foreign exchange, notably the US dollar, against their own currency. Impl Implic icit itly ly it mean meanss that that the the deve develo lopi ping ng worl world d is subs subsid idiz izin ing g the the rich rich deve develo lope ped d worl world. d. Put Put more more blun bluntl tly, y, it woul would d mean mean that that the the US has has outsourced even defending the dollar to these countries, as a collapse of the US currency would hurt these countries holding more dollars in reserves than perhaps the US itself! . Rather than demand pushing the value of commodities higher in the past 18 mont month hs, it has has bee been the the (impen mpend ding) ing) do dolllar lar's deva evalua luatio tion aga against inst commodities that has pushed commodity prices to record highs."  Naturally, as the players fear a fall in the value of the dollar and reach out to various assets and commodities, the prices of these commodities and assets too will rise. But as the imbalance shows no sign of correcting, players seek to shift to commodities and assets across continents to hedge against the impending fall in the US dollar. Thus, it is a fight between central banks and the  psychology of market players across continents. As a corrective measure, economists are coming to the conclusion that most of the currencies across the globe are highly undervalued wise versa the doll do llar ar,, whic which, h, in turn turn,, requ requir ires es a sign signif ific ican antt do dose se of deva devalu luat atio ion. n. For  For  instance, a consensus exists amongst economists and currency traders that the Yen is one of the most highly undervalued currencies (estimated at around around 60%) along with the Chinese Chinese Yuan (estimated (estimated at 50%) followed followed by other countries in Asia. This artificial undervaluation of currencies is another fundamental cause for  increasing global liquidity. To get an idea of the enormity of the aggregation of these two factors on the world's supply of dollars, Jephraim P. Gundzik calculates the dollar value of  rising prices of just one commodity -- crude oil. In 20 2004 04,, glob global al dema demand nd for for crud crudee oil oil grew grew by a mere mere four four per per cent cent..   Nev Never erth thel eles esss high higher er oil oil pric prices es adva advanc nced ed by as much much as 34 per per cent cent.. Consequently, it is this factor that significantly contributed to increase the world's dollar supply by about $330 billion. 50

In 2005, international crude oil prices gained another 35 per cent and global demand for oil grew by only 1.6 per cent. Nonetheless, the world's supply of  dollars increased by a further $460 billion.  Naturally, with all currencies refusing to be revalued, this leads to increased global liquidity. While one is not sure as to whether the increase in the  prices of crude led to the increase of other commodities or vice versa, the fact of the matter is that, in the aggregate, increased liquidity has led to the increase in commodity prices as a whole. Although some of this increase in the world's supply of dollars has been reabsorbed into US economy by the twin American deficits -- current as well as budgetary -- it is estimated that as much as $600 billion remains outside the US. What has further compounded the problem is the near-zero interest rate regime in Japan. With almost $905 billion forex reserves, it makes sense to  borrow in Japan at such low rates and invest elsewhere for higher returns. Obviously, some of this money -- estimated by experts to be approximately $200 billion -- has undoubtedly found its way into the asset markets of other  countries. Most of it has been parked in alternative investments such as commodities, stocks, real estates and other markets across continents, leveraged many times over. Needless to reiterate, the excessive dollar supply too has fuelled the property and commodity boom across markets and continents. The twin causes -- excessive liquidity due to undervaluation of various currencies (technical) and fear of the US dollar collapse leading to increased  p pur urch chas asee of vari variou ouss comm commod odit itie iess to hedg hedgee agai agains nstt a fall fall in US do doll llar  ar  (psy (psych chol olog ogic ical al)) -- need needss to be tack tackle led d up upfr fron ontt if infl inflat atio ion n has has to be confronted globally. What actually compounds the problem for India is the fact that lower harvest worldwide, specifically in Australia and Brazil, and the overall strength of  demand wise versa supply and low stock positions world over, global wheat  prices have continued to rise. Wheat demand is expected to rise, while world production is expected to decline further in the coming months, as a result of which global stocks, already at historically low levels, may fall further by 20 per cent. These 51

global trends have put upward pressure on domestic prices of wheat and are expected to continue to do so during the course of this year.  No wonder, despite the government lowering the import tariffs on wheat to zero zero,, ther theree has has been been no sign signif ific ican antt qu quan anti tity ty of whea wheatt impo import rtss as the the international prices of wheat are higher than the domestic prices. Growth and forex flows Another cause for the increase in the prices of these commodities has been due to the fact that both India and China have been recording excellent growth in recent years. It has to be noted that China and India have a combined population of 2.5 billion people. Given this size of population even a modest $100 increase in the per capita income income of these these two count countrie riess would would transl translate ate into into approx approxima imatel tely y $25 $250 0  billion in additional demand for commodities. This has put an extraordinary highly demand on various commodities. Surely growth will come at a cost. The excessive global liquidity as explained above has facilitated buoyant growth of money and credit in 2005-06 and 2006-07. For instance, the net accretion to the foreign exchange reserves aggregates to in excess of $50  billion (about Rs 225,000 crore) in 2006-07. Crucially, this incremental flow of foreign exchange into the country has resulted in increased credit flow by our banks. Naturally this is another fuel for growth and crucially, inflation. This Reserve Bank of India's strategy of dealing with excessive liquidity through the Market Stabilization Scheme (MSS) has its own limitations. Similarly, the increase in repo rates (ostensibly to make credit overextension costly) and increase in CRR rates (to restrict excessive money supply) are  policy interventions with serious limitations in the Indian context with such huge forex inflows. How about the revaluation of the Indian Rupee?

To conclude, all these are pointers to a need for a different strategy. The current bout of inflation is caused by a multiplicity of factors, mostly global and is structural. Monetary as well as trade policy responses, as has been atte attemp mpte ted d till till date date,, woul would d be inad inadeq equa uate te to deal deal with with the the exta extant nt issu issuee effectively.

52

Crucially, a stock market boom, a real estate boom and a benign inflation in the food grains market is an economic impossibility. It has to be noted that the Indian market is structurally suited for leveraging shortages rather effectively. Added to this is the information asymmetry among various class of consumers as well as between consumers, on the one hand, and producers and consumers, on the other. Further, the sustained flow of foreign money, thanks to the excessive global liquidity in the world, has fuelled the rise of the stock markets and real estate  prices in India to unprecedented levels. This boom has naturally led to corresponding booms in various related markets as much as the increased credit flow has in a way resulted in overall inflation. Econom Economic ic policy policy rests rests in the triumv triumvira irate te of fiscal fiscal,, monet monetary ary and trade trade  policies. Theoretical understanding of economics meant that these policies are interdependent. Also, one needs to understand that growth naturally comes with its attendant costs and consequences. While these policies are usually intertwined and typically compensatory, one has to understand that the issues with respect to infl inflat atio ion n cann cannot ot be subj subjec ecte ted d to conv conven enti tion onal al wisd wisdom om in the the era era of  globalization. One policy route yet unexamined in the Indian context by the government is the the exch exchan ange ge rate rate po poli licy cy,, espe especi cial ally ly reva revalu luat atio ion n of the the Rupe Rupeee as an instrument to control inflation. It is time that we think about a revaluation of the Indian Rupee as a policy response to the complex issue of managing inflation; while simultaneously address the constraints on the supply side on food grains through increase in domestic production. A higher Rupee value vice-versa the dollar would mean lower purchase  price of commodities in Rupee terms. The Indian economy has undergone significant changes in the past decade and a half. With increased linkages to the global economy, it cannot duck the negatives of globalization.

53

Quite the contrary, it needs to come with appropriate policy responses for  the the same same,, whic which h cann cannot ot be of the the 19 1960 60ss vint vintag age. e. Allo Allowi wing ng Rupe Rupeee to appreciate is surely one of them. The time for a rethink on our exchange rate  policy to tackle inflation is now. Are we ready? 2.SridharKrishnaswami Washington, July 2 (PTI) The impact of surging food and fuel prices being felt globally is "not so big" in India but it needs to tighten its monetary  policy, the IMF has said as it warned that some countries will not be able to feed their people and maintain economic stability if the hike continues. "Some countries are at a tipping point," said International Monetary Fund Managing Director Dominique Strauss-Kahn at the release of a new IMF study which says the effect of price hike is most acute for import-dependent   poor poor and middle middle-in -incom comee countr countries ies confro confronte nted d by balanc balancee of paymen payments ts problems, higher inflation and worsening poverty. "If food prices rise further and oil prices stay the same, some governments will no longer be able to feed their people and at the same time maintain stability in their economies," he said. Kahn said such countries needed help from the international community for  good policy options. "Their challenge is ours. It is to ensure adequate food supplies while preserving the poverty-reducing benefits derived in recent years from faster growth, low inflation, and better budget and balance of  payments positions," he added. But a senior official of the IMF told PTI that although India has not been flagged in the latest report because of many "mitigating factors", the broad general policy implications apply. "India is a large country and it has USD 312 billions in reserves. The fact that you had a near doubling of oil prices over a period of year is going to impact the current account and you are seeing it," said Kalpana Kochhar, Senior Advisor in the Asia Pacific Department of the Fund. "You would not have seen Indian highlighted.... The impacts are big but not so big. There are positive inflows and the results are still large," she said. P.Chidambaram. 54

REFERENCES :

1. Inflationdata.com Inflationdata.com 2. Inflation wikipedia 3. www.investopdedia.com 4. Geoffrey T Mills Mills (1996), “The impact of inflation on Capital Capital Budgeting and Working capital”, Journal of financial and Strategic Decisions, vol.9, No.1, Spring, pp 79-87.

55