(IGP) IAS Pre: GS - Indian Economy - Economy Concepts: Inflation Concepts, Facts & Policy

Inflation means a persistent rise in the price of goods and service? (Inflation reduces the purchasing power of money). It hurts the poor more as a greater proportion of their incomes are needed to pay for their consumption. Inflation reduces savings; pushes up interest rates; dampens investment; leads to depreciation of currencythus making imports costlier.

Depending upon the rate of growth of prices, inflation can be of the following types
(Creeping is a rate of general price increase of 1 to 5 percent a year?
Creeping inflation of 3 to 5 percent erodes the purchasing power of money when continued over many years, but it is "Manageable.") Furthermore, (a-low creeping inflation could be good for the economy as producers and traders make reasonable profits encouraging them to invest.)

(Trotting inflation is usually defined as a 5 to 10 percent annual rate of increase in the general level of that, if not controlled, might accelerate into a galloping inflation of 10-20 percent a year). If it aggravates, galloping inflation can worsen to (“runaway” inflation which may change into a hyperinflation). (Hyperinflation is inflation that is “out of control” a condition in which prices increase rapidly as a currency loses its value). No definition of hyperinflation's universally accepted. One simple definition requires a monthly inflation rate of 20 or 30% or more- 'an inflationary cycle without any tendency toward equilibrium'. The worst is a monetary collapse, if prices are not reined in, in time.

Other related concepts are

• (deflation when there is a general fall in the level of prices
• disinflation which is the reduction of the rate of inflation
• stagflation which is a combination of inflation and rising unemployment due to recession and)

Measures of inflation

GDP deflator

GDP stands for gross domestic product, the total value of all final goods and services produced within that economy during a specified period. (GDP deflator is a measure of the change in prices of all new, domestically produced, final' goods and services in an economy). (The GDP deflator is not based on a fixed market basket of goods and services but applies to all goods and service domestically produced.’

Cost of living index

(The cost of living is the of maintaining a certain standard of living. It is defined with reference to a basket of goods and service). When their cost goes the base year. An index value of 105 indicates that the cost of living is five percent higher than in the base year.

PPI

(Producer price index (PPIs) measures the change in the prices received by a producer). The difference with the WPJ is accounted for by logistics, profits and taxes, mainly Producer price inflation measures the price pressure due to increase in the cost of raw material. It may be absorbed by them or made up by increases in productivity or passed on to the consumers. It depends on the market conditions.

WPI

Wholesale price indices, (which measure the change in price of a selection of goods at wholesale; prior to retail sales thus excluding sales taxes.) These arc very similar to the Producer Price Indexes.

CPI

Consumer price index measure the change in price paid by the consumer at the retail level. I can be for the whole community or group-specific-for example, CFI for industrial workers etc as in India.

Type of inflation based on causes

There are four major types of inflation

• (Demand pull inflation, inflation caused by increases in demand due to increased private and government spending, etc.) It involves inflation rising as real gross domestic product rises and unemployment falls. (This is commonly described as "too much money chasing too few goods”.) For example" India in 2010 when the economy is said to have overheated and demand outstripped supply and prices rose. Since supplies will be augmented to adjust to demand, prices will come down. It may be referred to as growth inflation too. Demand-pull inflation can be caused by money supply increasing. for example, the expansionary monetary policy of the RBI in 2009 saw rates come down and easy and cheap credit pushed up prices as demand grew. In 2010, repo rates went up by 6 times and thus RBI sought to control prices.

• (Cost-push inflation: It is also referred to as “Supply shock inflation”) (caused by reduced supplies due to increased price of inputs), for example, crude prices globally have gone up causing supply constraints which means higher costs of production and so higher prices. Crude and food prices shot up in 2008 July. Other examples are, higher cost of capital, increases in prices of imported raw materials. Just as a shortage of goods tends to push prices up, an oversupply of commodities tends to induce the opposite effect on prices.

• (Structural inflation): A type of persistent caused by deficiencies in certain conditions in the economy such as a backward agricultural sector that is unable to respond to people’s increased demand for food inefficient distribution and storage facilities leading to artificial shortages of goods, and production of some goods controlled by some people. Food inflation currently being witnessed (2011) is structural in nature as the preference for protein foods is far ahead of its supplies and this is a phenomenon driven by income rise.

• Speculation
• Cartelization
• Hording

High Inflation hurts

If inflation is high in an economy, the following problems can arise

• low income groups are particularly hurt
•  people on a fixed income (e.g. pensioners, students) will be worse off in real terms due to higher prices and equal income as before; this (will lead to a reduction in the purchasing power of then income).
• inflation discourages exports as domestic sales are attractive and BPO problems can be caused. Inflation may erode the external competitiveness of domestic products if it leads to higher production costs such as wages increase, higher interest rate and currency deprecation.

• Increasing uncertainty may discourage investment and saving. The saving pattern is affected thus: With the declining value of money, people would be more inclined to spend than save anticipating that their money can buy even less in the future. Therefore, with its adverse effect on savings, inflation can also discourage investment.

• Inflation tax happens. When a government borrows and spends, the cash held by people erodes in value due toinflation.
• It will redistribution income from those on fixed income; such as pensioners, and shifts it to those who draw an inflation-linked income and business.

• strikes can take place for higher wages which can cause a wage spiral. Also if strikes occur in an important industry which has a comparative advantage the nation may see a decrease in productivity, exports and growth.

Small amount of inflation can be good

(It can be argued that a low level of inflation can be good if it is result of innovation new products are launched at high prices, which quickly come down through competition). Therefore, there is encouragement for innovation and the problem is short lived. Also, a small price rise is necessary for wages to go up. It further helps the economy keep off deflation which can otherwise set off a recession. Besides, inflation at a moderate level, is an incentive to the producer. At any rate, small price rises are inevitable in a growing economy. (Some see mild inflation as "greasing the wheels of commerce.") To control inflation There are fiscal, monetary, supply-side and administrative measures to control inflation to ideal/optimal rates though zero rate of inflation is never preferred for the reasons cited elsewhere in the lesson.

• Fiscal measures include reduction in indirect taxes
• Dual pricing like an sugar
• Monetary measures include rate and reserve requirement changes. Open market operation can stabilize prices under normal conditions. Also, sterilization through Government bund transaction as in the case of MSBs
• Supply side factors include making goods available- import of wheat in India. Administrative measures include implementation of dehoarding and anti-black-marketing measures. Wage arid price controls cap also be used

Changes in the price levels at the wholesale and retail level are tracked by various price indices in India- WPI and CPI. 3 CPls exist for different consumer group each of which is homogenous.

All price indices use a particular year as a “base year”. That means that rises on falls in price are measured with reference to the price in that year. For example, (the base year used for the Wholesale Price Index is 2004 is 2005 from September 2010) Wholesale prices of all products in the basket with their respective "weightages in that year add upto "100”. If, in 04-05, the wholesale price of gur was Rs 2 a kg, and rose by 50 paise the following year, it would mean that the wholesale price index for gur would rise to 125 in 2005-06. But the movement of an index is based on the average of price movement of all the goods in the basket and not just one article. Different base years are used for different price indices due to convenience, data availability, logistics etc.

WPI

The Wholesale Price Index

Government launched a new series of wholesale price index (WPI) with 2005-05 base from September 2010. Earlier, 1993-94 was used as base year to calculate WPI. The new series of WPI has 676 items in the previous series. Consumer items widely used by the middle class like ice-cream, mineral water, flowers, microwave oven, washing machine, gold and silver are reflected in the new series of WPI. This would give better picture of the price variation. Readymade food, computer stationary, refrigerators, dish antenna, VCD, petroleum products and computers will also be part of the new series.

(Under primary article group of the new WPI, there are 102 items) against earlier 98, while fuel and power category remains static at 19. In the new series, there are 555 items of manufactured products compared to 318 items earlier.

241 new items are there in the basket of commodities making up the official wholesale price index in a bid to reflect changes in India's price line and consumption pattern better.

(The new series is based on the recommendation of a working group that was set up under Plan Commission Member Abhijit Sen, which in its technical report submitted in May 2008) recommended the change the base year to 2004-05.) The new series has also altered the weight attached to each commodity group.
(Manufactured items now have a higher weight) of 64.972 as against 63.749 earlier. The weight for fuels has also increased to 14.910 against 14.226. But for primary articles, the weight is down at 20.118 against 22.025. In a bid to reflect the actual consumption pattern, the new series drops as many as 200 items sach as typewriters, video cassette recorders, to make a room for items like computers, refrigerators, televisions and video disc players.

Government is also working on a two new indices to reflect the changes in the cost of services — one on financial services and the other on trade and transport.
(The WPI, published weekly by the Economic Advisor in the Ministry of Commerce and Industry, with a two week lag, tracks the wholesale traded price of 676 items that include agricultural commodities) (such as rice, tea, raw cotton, groundnut oil seed), industrial commodities) (such as iron ore, bauxite, coking coal), intermediate products for industry (such as cotton yam, polyester fiber, synthetic resins, iron & steel, sheet glass), products for consumers (atta, sugar, paper, electricity, ceiling fans) and energy items (petrol, kerosene, electricity for commercial use). The weight attached to each item in the index is meant to reflect the volume (by value) of wholesale trade in that item in the Indian market.

The wholesale price index (WPI) is an indicator designed to measure the changes in the price levels of commodities that flow into the wholesale trade). The index is a vital guide in economic analysis and policy formulation . (WPI covers primary goods, power/fuel and manufactured goods).

(The WPI is not intended to capture the effect of price rise on the consumer though it generally and broadly indicates it).

(WPI is the only price index in India which is available on a weekly basis with basis with the shortest possible time lag of two weeks). It has an All India character. It is due to these attributes that (it is widely used in business and industry circles and in Government and is generally taken as an indicator of the rate of inflation in the economy).

To reflect the structural changes in the economy that have taken place over a decade, a large number of commodities have been added and a few with diminished importance have been dropped.

WPI is compiled on weekly basis with a time lag of two weeks. This provisional weekly index is made final after a period of 8 weeks.
(The inflation rate is calculated on point to point basis) i.e. on the basis of the, variation between the index of the current year and for the corresponding week of the previous year).

There are a number of agricultural commodities, especially, some fruits and vegetables, which are of a seasonal nature. Such seasonal items are handled in the index in a special manner. When a particular seasonal item disappears from the market and its prices are not quoted, the index of such an item ceases to get compiled and its weight is distributed over the remaining items and new seasonal items, if any, in the concerned sub-group.

(The advantage of the WPI is that it covers more goods; is available with relatively small time lag of fortnight; is convenient to compile). Disadvantages are that it does not include services like transport, health, education etc.

Comparative Stateme of Commodities and price quotations

No. of Price Commodities Quotation			No. of Price Commodities Quotation
1993-94		2004-05	1993-94	2004-05
All Commodities	435	676	918	5482
Primary Articles	98	102	155	579
Fuel and Power	19	19	72	72
Manufactured Products	318	555	1391	4831

Weightage of the Sub Indices

	1993-94	2004-05
All Commodities	100%	100%
Primary Articles	22.025%	20.118%
Fuel and Power	14.226%	14.910%
Manufactured	63.749%	94.972%

Limitations on WPI

(The accuracy of WPI is unsatisfactory even after the introduction of the revised series in 2010). Services such as rail and road transport, health care, postal, banking and insurance, for example, are not part of the WPI basket. Neither are the products of the unorganized sector that are estimated to constitute about 35 per cent of the total manufactured output of the country. The index thus falls well short of being a broad based indicator of the price level even in its construction.

Government set up Abhijit Sen committee on revising the WPI and the revised series was introduced in 2010 to broadbase the basket and update the goods.
WPI: new reporting method From late -2009, India presented inflation figures on a monthly basis instead of weekly system Analysts say since weekly data on wholesale price index-based inflation do not adequately capture the movement of prices of manufactured goods, government has to often revise the figures later. Therefore, the government decided to have weekly release of inflation data on food and fuel prices and monthly data on WPI.

However, inflation of primary goods within the WPI is reported on a weekly basis.
The earlier system was to release the wholesale price index every week and consumer price index, where food items have greater weightage, every month.

CPI

There are three. Consumer Price Indices in India. Each tracks the retail prices of goods and service for specific group of people, because the consumption patterns of different groups differ.

For (Industrial Workers (CPI-IW), a basket of 370 commodities is tracked; (for Urban Non-Manual Employees (CPI-UNME), 180 commodities; for Agricultural Laborers (CPI-AL), 60 commodities). (The respective base years are 2001, 1984-85 and 1986-87). The first two indices haveservices in them. These baskets and the weightages to each item have been determined on the basis of surveys of consumption patterns. Information also differs from centre to centre around the country; the all-India figures declared are averages.

(Mahatma Gandhi NREGA wages are to be indexed to the CPI(AL) 6m the beginning of the year 2011).

CSO decided to discontinue CPI(UNME) 2008.

Each commodity is given a specific weightage, which differs from one index to another index. For example, the CPI-AL would give a greater weightage to foodgrains than the CPI-UNME, since a greater proportion of the agricultural labourer's expenditure would go toward foodgrains, and he would be unlikely to buy the sort of items the office-goer would buy.

The coverage of CPIIW is broader than the other indices of CPI like the CPI for agricultural laborers (AL) and the GPI for urban non-manual employees (UNME).
(In the organised sector, CPI-IW is used as a cost of living index).

(CPI-AL and CPI-UNME are not considered as robust national inflation measures because they are designed for specific groups of population) with the main purpose of measuring the impact of price rise on rural and urban poverty.

In accordance with the Government of India (Allocation of Business) Rules, 1961, as amended from time to time, (it is the responsibility of the Ministry of Labour to compile and release the data on the CPI for Industrial Workers and the data on the CPI for Rural Labourers). (It is the responsibility of the Ministry of Statistics and Programme Implementation to compile and release the data on the CPl for Urban Non-Manual Employees).

The Government of India (Allocation of Business) Rules, 1961, with subsequent amendments, assigns (the responsibility for compiling the WPI to the Office of the Economic Adviser in the Department of Industrial Policy and Promotion under the Ministry of Commerce and Industry). (The Economic Adviser holds the final authority for all decisions regarding the WPI).

(The national income deflator (GDP deflator) is a comprehensive measure statistically derived from national accounts data released by the Central 'Statistical Organization (CSO).) Since it encompasses the entire spectrum of economic activities including services, the scope and coverage of national income deflator is wider than any other measure. Al present, the GDP deflator is available only annually with a long lag of over one year and hence has very limited use for the conduct of policy

Difference between wholesale price and consumer prices

WPI measures price rise at the wholesale level. (Wholesale means sale in large quantities and meant for resale). It cover a certain set of goods that are traded at the wholesale level. CPI on the other hand measures price rise at the level. There is a difference between the two. The difference is due to a number of factors. A substantial portion of the differential is accounted for by the retailers' margins which are built into what the consumer pays. Besides, the way the two indices are calculated both in terms of weightage assigned to products as well as the kind of items included in the basket of products.

(While wholesale prices are more or less the same throughout the country, consumer prices or retail prices vary across regions (rural and urban) and also across cities according to the consumer preferences for certain products, supplies and purchasing power). Besides, taxes levied by states comprise an important component of the variation in prices of many products. Therefore, give WPI an important place in government policy as it is more representative; figures come quickly relatively; and has an all India character.

Divergence between WPI and CPI

Why do WPI and CPIs differ? (They differ in terms of their weighting pattern). First, food has a larger weight in CPI ranging from 46 per cent in CPI-IW to 69 per cent in CPI-AL whereas it has a weight of only 27 per cent in WPI. The CPIs are, therefore, more sensitive \o changes in prices of food items. Second, the fuel group has a much higher weight in the WPI (14.2 per cent) than the CPIs (5.5 to 8.4per cent). As a result, movement in international crude prices has a greater bearing on WPI than on the CPIs. Third, services are riot covered under WPI while they are, to different degrees, covered under CPIs. Consequently, service price inflation has a greater influence on CPIs.

Which index should one use?

The WPI is useful in certain contexts. For example, for industrialists, the costs of setting up a factory over the course of several years; and further to calculate the costs of production and returns over several years. (The basket of items in the CPI does not include machinery, chemicals, and so on;) secondly, (the price of electricity in the CPI is the consumer tariffs, not the industrial tariffs;) and so on.

Figures for inflation in the WPI are on the average much lower than those in the CPI indices. There could be two reasons for this difference in rates between the WPI and CPI: first, prices of the items in the CPI basket might have risen more sharply than items excluded from it — this would mean that prices of mass consumption goods have risen more sharply than inputs for production; secondly, the retail prices of commodities might have grown more sharply than the wholesale prices, indicating that middlemen have taken a bigger share.

Services and price index

While the WPI now does not include services, the two consumer price indices (CPI) meant for Turban non-manual employee and industrial workers, do include certain service's such as medical care, education, recreation and amusement, transport and communication. On the other hand, some of the other major services such as trade, hotels, financing, insurance, real estate and business services do not find a mention either in the WPI or in the CPIs.

In India, the services sector accounts for about 55 per cent of the GDP In August 2010, Department of Industrial Policy Promotion (DIPP), Ministry of Commerce & Industry constituted an Expert Committee to render technical advice for development of Service Price Index (SPI) and its related issues. The Committee is chaired by Prof.C.P.Chandrasekhar.

Producer price index

The process of introducing the (producer price index) (PPI) is also underway in India, according to Dr. Abhijit Sen, Member of Planning Commission. It (means prices of goods as they are sold to the wholesalers by the producers). The difference between WPI and PPI is accounted for by the margins and other transport and distribution costs.

Core or Underlying Inflation (Core or underlying inflation measures the long-run trend in the general price level.) Temporary effects on inflation are factored out to calculate core inflation. For this purpose, certain items are usually excluded from the computation of core inflation. These items include: changes in the price of fuel and food which are volatile or subject to short-term fluctuations and/or seasonal in nature like food items. In other words, core or underlying inflation is an alternative measure of inflation that eliminates transitory effects. These price changes are not within the control of monetary policy inasmuch as these are supply shocks.
The main argument here is that the central bank should effectively be responding to the movements in permanent component of the price level rather than temporary deviations.

Inflation Targeting

(Inflation targeting focuses mainly on achieving price stability as the ultimate objective of monetary policy). This approach entails the announcement of an inflation target- either a number or a range, that the central bank promises to achieve over a given time period. The targeted inflation rate will be set jointly by the RBI and the government, although the responsibility of achieving the target would rest primarily on the RBI. This would reflect an active government participation in achieving the goal of price stability with fiscal discipline by way of a rational borrowing programme (not borrowing in excess).

(Monetary policy and fiscal policy have to converge for achievement of inflation targeting). Advantage is that it promotes transparency in the conduct of monetary policy. Further it increases the accountability of monetary authorities to the inflation objective.

Prices impact on the macro economy in many ways - welfare of people, growth and stability of the economy in a globalised order.

Ideal level of inflation

(Ideal inflation rate is one that takes into consideration human, social and economic impact is the level of inflation beyond which the adverse consequences are strong). (Chakravarty Committee (1985) had indicated 4 per cent as an acceptable level of inflation on a long-term basis). However, such a level of inflation cannot be fixed at one level for all times. It depends on growth rate. It also depends on what the global levels are RBI sees about 5.5%_ rate of inflation as 'comfortable'- neither does it hurt in human terms nor in growth terms.

Collection of Statistics Act, 2008

Collection of Statistics Act, 2008 was made to bring in new rules aimed at (improving data collection. (Government will levy higher penalty for not sharing data and tougher punishment will be imposed in cases where manipulation of data is involved, they say).

Under the new Act, people or companies not divulging data would have to pay a fine of Rs 1,000 and they would be given a 14-day notice period to comply. If the information is not provided even after two weeks, the penalty will rise to Rs 5,000 per day.

Under the old Act, which was passed in 1953, the penalty was only Rs 500 for the first default and Rs 200 per day thereafter. The new penalty scheme will ensure that data collection is done on time. It will increase the accuracy of the data The Act also makes willful manipulation or omission of data a criminal offence, punishable by a prison term that may extend up to 6 months. This penalty will also apply if a company prevents or obstructs any employee from collecting data.
The Collection of Statistics Act, 2008, gives powers to the government to classify any statistics as "core statistics" and also determine the method to collect and disseminate the same.

Philips’s curve

(The inverse relationship between inflation and rate of unemployment is shown in the Phillips curve:) price stability has a trade-off against employment. Some level of inflation could be considered desirable in order to minimize unemployment.

(Potential output (sometimes called the "natural gross domestic product") is an important concept in relation to inflation). It is the level of GDP where the economy is at its optimal level of production, given various constraints-institutional and natural.

This level of output corresponds to the Non-Accelerating Inflation Rate of Unemployment, NA1RU. (If GDP exceeds its potential, inflation will accelerate and if GDP falls below its potential level, inflation will decelerate) as suppliers attempt to use excess capacity by cutting prices.

Deflation

Deflation is a prolonged and widespread decline in prices that causes consumers and businesses to curb spending as they wait for prices to fall further. It is the opposite of inflation, when prices rise, and should not be confused with, disinflation, which merely describes a slowdown in the rate of inflation.

(Deflation occurs when an economy's annual headline inflation indicator -- typically the consumer price index --enters negative territory).

Deflation is hard to deal with because it is self-reinforcing. Put simply, unless it is stopped early, (deflation can breed deflation, leading to what is known as a deflationary spiral).

(When an economy has fallen into deflation, demand from businesses and consumers to buy products falls because they expect to pay less later as prices fall). But as producer struggle to sell and go bankrupt, unemployment rises, reducing demand further. That causes deflation to become more pronounced.
It makes it more expensive to service existing debts. This is as true of governments, who have borrowed trillions of dollars globally to prop up the financial sector, as it is for consumers.

As debt becomes more expensive to pay off, the risk of default and bankruptcy rises too, making banks more wary of lending. This reduces demand and further exacerbates the deflationary problem.

Remedy

• Tax cuts to boost demand from consumers and businesses
• Lowering central bank interest rates to encourage economic activity
•  Printing more currency to boost money supply
• Capital injections into the banking system
• Increase government spending on projects that boost the return on private investment India did not face the threat of deflation as demand has not dropped so much. Also, food scarcity meant food prices did not fall. In fact they rose.

India and deflation

(On the WPI, we faced disinflation- rate of growth of prices fell but not prices themselves till the first quarter of 2009. In the second quarter and later, there was deflation on the WPI. This negative inflation is due to higher base as inflation peaked in July 2008 due to international energy and food price rises because of speculation.

The deflationary phase was short lived for a few weeks as the fiscal as well monetary measures of the government started showing results and demand and growth returned.

Growth–inflation trade off

With high growth, economy overheats as in India from today (2011) Overheating of the economy means demand overshoots supply and there is pressure on prices. As growth creates more employment and incomes rise, demands rises pushing up prices.

As prices rise, the central bank intervenes and raises rates to cool consumption and so prices fall relatively. Rep and reverse repo rates- the policy rates- are the tools available to the central bank as signals to the economy that it is ready to act to soften prices -partly because the poor suffer disproportionately and partly because inflation can derail the medium and longer growth.

Such intervention by the central bank has a dampening impact on growth as higher interest rates prevent easy borrowing and thus demand slackens.
We witnessed the same in India with CRR and repo rates going up consistently peaking in 2008 July- aimed at balancing growth and inflation. It led to deceleration of growth rate. We thus see growth being 'softened' to ease inflation in the country. It is a trade off between growth and inflation.
It was reversed when growth fell sharply due to global meltdown since 2008 when the RBI dropped policy rates- repo and reverse, repo and also the reserve ratios- SLR and CRR to make easy credit available to boost demand and supply.

Since early 2010, however, when Indian economy bounced back and inflation is rising, RBI has been raising the policy rates and CRR was also raised to 6% to manage the inflationary expectations.

Thus, growth and inflation are intimately connected- one being traded for the other depending upon where the growth situation stands.

As prices stabilise, growth resumes and a new and higher base is set for the growth process.

Growth and inflation do have a trade off but that is only in the short term. (As Dr. C. Rangarajan says, growth is a marathon while overheating and slow down are a temporary pause to gain greater strength).

Fiscal drag operates in an overheated economy. That is the tax liability increases as wages rise. That leaves less purchasing power in the hands of the people and so demands drops automatically. It acts as an automatic stabilizer.

Inflation in India

(India's inflation rate went into negative figures and India entered into deflation for the first time in 30 years in June 2009). It is the continuation of the trend that started in August 2008 when inflation peaked at 13% on the WPI. However, it is a statistical deflation as the high base on 2008 makes the price rise look negative. Also, average price rise is negative due to preponderance of industrial goods in WPI. But food prices rose and the CPI was above 10%. Thus, the drop in the demand for industrial goods is captured by the WPI but not wage goods and food.

The drop in prices is attributed to

• Slackening demand globally and nationally
• Commodity prices fell since last year- crude etc
• Excise duty and service tax rates came down
• Job losses and decline in demand

Reasons for the current inflation

In spite of the steps of the government, prices are relentlessly on rise. Food inflation was 18.32% in late December, 2010. General inflation on WPI was 7.5% for November 2010. The reasons for the rise in prices are the following

• Low base effect (for non-food inflation)
• Growth
• The bad monsoons and the decline in production raised inflationary expectations
• Even as the buffer stocks accumulated to huge surplus, governance problems and the fiscal pressures of the states prevented them from being distributed.
• Narega, loan waiver, and 6th Pay Commission award led to increased demand
• Fuel price deregulation for petrol in June 2010 and upward revisions since then.
•  Raising petrol, diesel, kerosene and LPG prices
• Easy monetary policy till the earlier part of 2010
• Hoarding and cartelization as in the case of onions
• Huge FII inflows creating asset price rise
• Rise in the MSP for agri products annually
• Middle men
• Excess of money supply due to the RBI entering the forex market and acquiring dollars. The excess has not been fully absorbed(sterilized)

Government steps to control inflation

The Government has taken a number of short term and medium term measures to improve domestic availability of essential commodities and moderate inflation.
It has procured record food grains. Even after keeping the minimum buffer stock, there is enough food grains to intervene in the market to keep the prices at reasonable level.

A Strategic Reserve of 5 million tonnes of wheat and rice has also been created to offload n the open market when prices are high.. This is in addition to the buffer stock held by FCI every year.

Issue price of grains supplied through PDS outlets are frozen.
The price situation is reviewed periodically at high-level meetings such as the Cabinet Committee on Prices (CCP).

Fiscal Measures

• Reducing import duties to zero - for rice, wheat, pulses, edible oils and sugar
• Allowed import of raw sugar at zero duty under O.G.L
• Reduced the fiscal deficit

Administrative Measures

• Banning export of edible oils, onions and pulses (except kabuli chana).
•  Imposition of stock limit orders in the case of rice, paddy, pulses, sugar, edible oils and oilseeds;
• Using Minimum Export Price (MEP) to regulate exports
• Distribution of one million tons of imported edible oils to States/UTs at a subsidy

• To augment availability of pulses, the Public Sector Undertakings (namely, STC, MMTC, and PEC) and NAFED were permitted to import and sell pulses under a scheme and losses, if any, up to 15% are reimbursed by the Government. Distribution of imported pulses to State Governments for supply through PDS at a subsidy of Rs.10 per kg..

•  Banning of futures trade in key essential commodities.
•  In addition to the above, Government has also taken medium initiatives such as the National Rural Employment Guarantee Programme (NREGP), Integrated Scheme of Oilseeds, Pulses, Oil Palm and Maize(ISOPOM), National Food Security Mission (NFSM) and Rashtriya Krishi Vikas Yojna (RKVY) to improve production and productivity in agriculture.

Monetary Policy and inflation

a. RBI increased CRR and repo and reverse repo rates(repo and reverse repo rates are 6.25% and 5.25% respectively. CRR is at 6%.)
b. RBI allowed the rupee to appreciate to some extent.

Open inflation

(When the government does not attempt to prevent a price rise, inflation is said to be open). Thus, inflation is open when prices rise without any interruption. In open inflation, the free market mechanism is permitted to fulfill its historic function of rationing the short supply of goods and distribute them according to consumer's ability to pay. "Therefore, the essential characteristics of an open inflation lie in the operation of the price mechanism as the sole distributing agent.

Repressed inflation

(When the government interrupts a price rise, there is a repressed or suppressed' inflation). Thus, it refers to those conditions in which price increases are prevented at the present time through an adoption of certain measures like price control and rationing by the government, but they rise on the removal of such controls and rationing. The essential characteristic of repressed inflation, in contrast to open inflation, is that the former seeks to prevent distribution through price rise under free market mechanism and substitutes instead a distribution system based on controls.

Thus, the administration of controls is an important feature of suppressed Inflation. Repressed inflation is criticized as it breeds number of evils like black market and uneconomic diversion of productive resources from essential industries to non-essential or less essential goods industries since there is a free price movement in the latter and hence are more profitable to investors.

Inflation Tax

(Price rise means more money being paid by the consumers for what they buy). Thus, it is a type of tax.

PPI from ET

(30/12/2010)
India will have another gauge of price changes, the producer price index (PPI), completing the bouquet of indices needed for a holistic picture of inflation in the economy.

The ministry of industry has set up an internal committee to prepare a framework for the new index. The committee has commissioned studies to arrive at a commodity basket for the PPI.

The producer price index would help us in looking at the margins.
The PPI measures changes in prices received by domestic producers of goods and services over time. This is different from the retail price paid by consumers that include logistics costs, taxes and other levies. It will give an account of the economy's efficiency in transferring goods and services from the producer to the consumer.

India has five gauges of inflation, measuring prices from the wholesale level to the retail level. The WPI is the most widely followed index for inflation and there are four consumer price indices. The WPI measures prices recorded in bulk transactions, while the consumer price indices measure prices paid by the consumer .The current WPI series was launched in September 2010 with 2004-05 as the; base year.

The WPI would typically have some taxes such as excise levies and logistics costs already bundled in. Once the PPI is in place, there would not be any need for the WPI.

The working group report further said the WPI could eventually be discounted. (The US had converted its wholesale price index into a producer price index in 1978).

PRICE GAUGE

How are price measured in India?
Prices measured Prices are measured at wholesale and retail levels.
What is the global best practice?
Most advanced economies have a producer price index and a set of retail price indices.
What is producer price index, or PPI?
It is a selling price for producers. It is usually the first commercial transaction in goods and Services produced.
How does PPI differ from WPI?
WPI measures prices at the wholesale level and includes certain taxes and costs. PPI is a measure of what the producer gets and not what buyer pays, which includes taxes.
Why is a PPI needed?
Together with the retail price indices, it gives an idea of margins on different products and incidence of taxes. It indicates the cost pressures in an economy.
Fiscal reforms for stabile economic growth.

• Banking sector is deregulated and made to conform to stringent reforms for higher competitive strength and performance globally.
•  move towards free float of rupee and relaxation of controls on convertibility; aggressive export promotion; FDI and FII inflows etc.
  Reforms were prioritized and sequenced in such a way as to make them sustainable and render further reforms feasible. For example, first generation reforms involved essentially non-legislative government initiatives- reduce SLR and CRR banking sector. Disinvestment of the PSEs. Deregulation of the rupee gradually and later make exchange rate of the rupee market-driven and so on. The second generation reforms involve legislative reforms and touch a wider section of the society-labour reforms; GST, FDI expansion etc. The former prepares the economy for the latter.
  Above all, a reform with human face was the goal, unlike elsewhere in the world like in South America in the 1980's. It yielded results- the social effect of the reforms in India is seen in the flagships schemes making an impact on health, education, social protection etc. The reforms gained consensus and showed positive results as can be seen below.
• Rates of growth went up
• BOP crisis has been solved in the first few years and today the country has about $300b forex reserves (2011 January).

• Services sector (tertiary sector) has grown in importance and today 4 contributes almost 51% of GDP (2010) emerging as a global player-India being the global back office.

• Exports have performed well and have recovered handsomely even while the world continues to be trapped in near recession conditions. It accounting for many jobs and quality Indian products
• Resilience of the economy in the face of Great Recession which is still no resolved
• Consumer choice has increased
• Tax-GDP ratio is at JJ % of GDP(2010)
• Nature of external debt has changed and the short term component is less
• Indian companies are listed on Nasdaq and New York Stock Exchange and raised billions of dollars for investment
• FIIs and FDI has picked up.

• Indian corporates have acquired global majors like Jaguar and Anglo-Dutch steel maker Corus; Bharati bought Zain’s African telecom operations (2010)
  While the above facts paint a positive picture of reforms, there are deficiencies as well

• poverty is a challenge and reforms with a human face is the need of the hour
• jobless growth is worrying the policy makers
• regional economic imbalances are intensifying
• While foodgrains production is at 233mtt(2010), there is still pressure on food security
•  farmers are feeling rectionless under the WTO regime Globalization threatens to destabilize agriculture with cheaper imports and questionable provisions related to intellectual property rights impacting negatively on availability of medicines etc.
• Infrastructure so far received inadequate attention except telecom, roads and ports
• PSU reforms have not made progress and disinvestment and privatization are still to see substantial movement
• Globalization has exposed India to imported inflation due to commodity price rise- 14.4% food inflation in December 2010.

Second Generation Reforms

Having begun with the reforms in all the above sectors and seen the economy benefit from them, the second generation reforms were initiated by the end of 1990's. The reason for calling the latter set of reforms SGR is that they followed the initial reforms which laid the foundation for the reform process to deepen. It is a matter of sequencing in line with prioritization; economic preparation; consensus-building and so on. In fact, unless the success in material and human terms of the initial reforms was demonstrated, the next round of 'difficult' reforms would not be possible.

In 2001 the Economic Advisory Council of the Prime Minister advised on the second generation reforms- labour flexibility, pension reforms based on employee contribution and the pension funds being developed in the stock market; value added tax and GST; liberalized FDI including FDI in retail etc.
Second generation reforms are difficult as they are directly involved with the daily lives of people like

• User charges need to be rationalized to make these utilities viable but there are bound to be protests.
• Man power rationalization in banks and PSUs through VRS faced resistance.
• Labour law flexibility will make TUs agitate.
• Interest rate cut, for example, for small savings will mean less returns for the middle class etc
• Agroreforms may mean small and marginal farmers' resistance
  However, unless the SGRs are carried out, investment and growth will suffer with long term adverse consequences for poverty alleviation and employment generation. As the long term benefits of the reforms are bound to show in terms of higher growth rates and more social welfare, consensus needs to be built for successful legislation and implementation of SGRs. 11th Five Year Plan (2007-2012).

11th Five Year Plan (2007-2012)

(The eleventh plan has the following objectives):

1. Income & Poverty

• Accelerate GDP growth from 8% to 10% and then maintain at 10% in the 12th Plan in order to double per capita income by 2016-17
• Rs.36,44,000 lakh crores ($910 billion) is the investment
• gross budgetary support (GBS) is Rs 14,21,711 crore, double of the last plan
• (Increase agricultural growth rate to 4% per year to ensure broad-based development)
•  Create 70 million new work opportunities.
•  Reduce educated unemployment to below 5%.
• Raise real wage rate of unskilled workers by 20 percent.
• Reduce poverty by 10 percentage points
• industrial and services sector growth to 9-11 per cent
• investment rate to be at 36.7 per cent

2. Education

• (Reduce dropout rates of children from elementary school from 52.2% in 2003-04 to 20% by 2011-12).
• Develop minimum standards of educational attainment in elementary school, and by regular testing monitor effectiveness of education to ensure quality.
•  Increase literacy rate for persons of age 7 years or more to 85%.
• Lower gender gap in literacy to 10 percentage points.

3. Health

•  Reduce infant mortality rate to 28 and maternal mortality ratio to 1 per 1000 live births
• Reduce Total Fertility Rate to 2.1.
• Provide clean drinking water for all by 2009 and ensure that there are no slip-backs.
• Reduce malnutrition among children of age group 0-3 to half its present level.
• Reduce anaemia among women and girls by 50% by the end of the plan.

4. Women and Children

•  Raise the sex ratio for age group 0-6 to 935 by 2011-12 and to 950 by 2016-17
• Ensure that at least 33 percent of the direct and indirect beneficiaries of all government schemes are women and girl children
• Ensure that all children enjoy a safe childhood, without any compulsion to work

5. Infrastructure

• Ensure electricity connection to all villages and BPL households by 2009 and round-the-clock power.
• Ensure all-weather road connection to all habitation with population 1000 and above (500 in hilly and tribal areas) by 2009, and ensure coverage of all significant habitation by 2015
• Connect every village by telephone by November 2007 and (provide broadband connectivity to all villages by 2012)
• Provide homestead sites to all by 2012 and step up the pace of house construction for rural poor to coverall the poor by 2016-17

6. Environment

• (Increase forest and tree cover by 5 percentage points).
• (Attain WHO standards of air quality in all major cities by 2011-12).
• Treat all urban waste water by 2011-12 to clean river waters.
•  Increase energy efficiency by 20 percentage points by 2016-17.

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