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Understanding Inflation in India: Causes, Impact, and Solutions

PWOnlyIAS October 16, 2023 07:30 2859 0

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Understanding Inflation in India: Measurement, Causes, Impacts & Solutions. Learn about CPI, core inflation, and policy measures to control inflation.

Understanding Inflation in India: Causes, Impact, and Solutions

Context:

  • Consumer Price Index (CPI) Inflation in India dropped to 5.02% in September from a high of 7.79% in April 2022 and is now within RBI’s Inflation tolerance limit of 4 ±2%.

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  • Definition: Inflation is the rate of change in the general price level of commodities.
  • Measurement:  It is measured using  indices measuring the change in prices of a predetermined set of items. 
  • Prominent Indices used: Inflation in India is officially measured through the Consumer Price Index (CPI) and Wholesale Price Index (WPI).  At present, based on the recommendation of the Urjit Patel Committee, CPI is used by RBI for inflation targeting. 

Managing Monetary Policy in India: Regulating Inflation In India 

  • Objective: It aims to tighten or relax monetary policy based on divergence of inflation forecasts determined  from inflation target fixed.
  • Reason for adoption: Urjit Patel Committee had recommended inflation targeting to be the “predominant objective of monetary policy in its policy statement.”
  • Target: Central bank is mandated by the government to  maintain inflation in India at 4 ±2%

Difference between CPI and WPI: Two component to measure inflation in India

Parameters CPI WPI
Base Year
  • 2012 (From January, 2015)
  • 2011-12
Scope
  • Includes Goods and Services
  • Includes only Goods
Released by
  • National Statistical Office (NSO), Ministry of Statistics and Programme Implementation (MoSPI)
  • Office of Economic Adviser, Ministry of Commerce and Industry
Major components
  • Food and Beverages (45.86%) >Housing(10.07%)> Transport and communication (8.59%)>Fuel and Light 6.84%
  • Manufactured goods (64.23%) > Primary article(22.62%)> Fuel and Power (13.15%)
Purpose
  • It captures movement in prices of goods and services that households acquire for the purpose of consumption.
  • WPI captures the average movement of wholesale prices of goods.
Uses
  • RBI’s Inflation targeting, Measuring DA for employees
  • GDP Deflator
Relevance
  • They better encapsulate the demand side pressures in the economy.
  • Monetary policy cannot control food or fuel inflation in India.

 

Core Inflation in India

  • Definition: Core inflation is the persistent component of inflation in India.
  • Purpose: It attempts to remove the volatile, transitory movements from the CPI. 
  • Measurement: In India it is measured by removing Food and Fuel categories from CPI.

Analysing Recent Factors Contributing to High Inflation in India: A Multifaceted Perspective

  • High Food Inflation in India: Deficit monsoon along with erratic weather patterns– unseasonal rain and flooding in certain regions has caused a spike in wheat, tomato, edible oils, and egg prices.
  • Volatile Fuel prices: A $10 increase in crude oil price increases inflation in India by 40-60 bps as India is dependent on imports for 80% of its fuel demand.
  • COVID-induced lockdowns: It caused supply chain disruptions across the world pushing up prices.
  • Post-Covid rebound: It led to a drastic increase in demand for goods causing demand pull inflation in India.
  • Russia-Ukraine Crisis: It caused not only an increase in crude oil prices but also soaring food (wheat and sunflower) and commodity prices.

Impact of Persistent High Inflation: Unpacking Economic Consequences and Social Implications

A moderate amount of inflation in India  is generally considered to be a sign of a healthy economy because as the economy grows, demand for stuff increases. However persistent high inflation can have many negative consequences like the following:

  1. ‘Inflation tax’: Inflation in India erodes the purchasing power of money, which means people can buy less with the same amount of money.
  2. Exacerbates inequality: It disproportionately impacts the poor, unemployed, people with fixed incomes and retired workers.
  3. Reduces economic activity: Inflation increases the cost of borrowing for businesses and also makes them less competitive against international peers.
  4. Currency depreciation: Inflation in India leads to depreciation of currency which can impact economic stability.
  5. “Spillover Effect”: Sustained inflation in india  in some categories of goods eventually leads to inflation in other categories and if not contained may become structural.

Combating Inflation in India: Analysing Strategic Monetary, Fiscal, and Trade Measures

  • Monetary Policy: RBI has been continuously increasing the repo rate under the Liquidity Adjustment Facility (LAF) to decrease the money supply. It went from 4% in April 2022 to 6.50% in February 2023. It also introduced the Incremental Cash Reserve Ratio (ICRR).
  • Fiscal Measures: The Central Government has undertaken fiscal measures like reduction in excise duty on petrol and diesel, and rationalisation of import duties on raw materials used in the manufactured products.
  • Trade Measure: Prohibition of the export of wheat products, imposition of export duty on rice, reduction in import duties and cess on pulses, rationalisation of tariffs and imposition of stock limits on edible oils and oil seeds, maintenance of buffer stock for onion and pulses.

Way Forward: Enhancing Economic Resilience

  • Monetary Transmission: Make it more efficient so that RBI can manage inflation more effectively.
  • Improve Data Collection: Update CPI basket including changing relevant weightage to reflect contemporary consumer demands.
  • Aatmanirbhar Bharat: Reduce dependence on imported fuel and other essential commodities.
  • Farm Reforms: Introduce Farm reforms and improve farm logistics for stable output and prices.

Conclusion 

  • Managing inflation in India requires a comprehensive approach encompassing strategic monetary policies, fiscal measures, and trade interventions. Upholding the recommendations of the Urjit Patel Committee for inflation targeting, enhancing economic resilience through efficient monetary transmission and improved data collection, reducing dependency on imports, and implementing farm reforms are crucial for maintaining a stable and robust economic environment.
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Inflation in India FAQs

Urijit Panel Committee

Consumer Price Index

It attempts to remove the volatile, transitory movements from the CPI

They better encapsulate the demand side pressures in the economy; monetary policy cannot control food or fuel inflation in India.

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