Triggers and Effects of High Inflation Rate in India

Panduranga Naidu Patrick Baretto Prakash Shringeri

INFLATION
Sustained increase in the general level of prices for goods and services.
As inflation rises, the value of currency goes down. Thus the purchasing power of the currency, i.e. the goods and services that can be bought in a unit of currency, too goes down.

Other terms
Deflation is when the general level of prices is falling. This is the opposite of inflation. Hyperinflation is unusually rapid inflation. In extreme cases, this can lead to the breakdown of a nation's monetary system. Stagflation is the combination of high unemployment and economic stagnation with inflation.

Inflation and Price Level

The inflation rate is the percentage change in the price level. That is, where P1 is the current price level and P0 is last years price level, the inflation rate is [(P1 P0)/P0] 100 Inflation can result from either an increase in aggregate demand or a decrease in aggregate supply.

Types of Inflation
Demand-pull inflation
"Too much money chasing too few goods. In other words, demand is growing faster than supply.

Cost-push inflation
Cost-push inflation is an inflation that results from an initial increase in costs.

Causes of Inflation
Increase in money supply Increase in disposable income Increase in exports Existence of black money High rates of indirect taxes Shortage in the supply of factors of production Hoarding by traders and speculators Role of natural calamities

Problems arise when there is unanticipated inflation:

Creditors lose and debtors gain if the lender does not anticipate inflation correctly. For those who borrow, this is similar to getting an interest-free loan. Uncertainty about what will happen next makes corporations and consumers less likely to spend. This hurts economic output in the long run. People living off a fixed-income, such as retirees, see a decline in their purchasing power and, consequently, their standard of living. If the inflation rate is greater than that of other countries, domestic products become less competitive.

Effects of High Inflation Rates

Increase in costs Loans becoming costlier Decrease in returns from investments Decrease in total portfolio value High taxes Cut down in working costs by companies Slow infrastructure growth

Inflation and Unemployment: The Phillips Curve

A Phillips curve is a curve that shows the relationship between the inflation rate and the unemployment rate.

Monetary Measures
Bank Rate retained at 6.0 per cent. Repo rate under the LAF increased by 50 basis points from 7.5 per cent to 8.0 per cent. Reverse repo rate under the LAF, automatically adjusted to 7.0 per cent. The Marginal Standing Facility (MSF) rate, determined with a spread of 100 basis points above the repo rate, recalibrated at 9.0 per cent. Cash reserve ratio (CRR) of scheduled banks retained at 6.0 per cent of their net demand and time liabilities (NDTL).

Projections
Real GDP growth for 2011-12 retained at 8.0 per cent. Baseline projection for wholesale price index (WPI) inflation for March 2012 revised to 7.0 per cent.

INDEX NUMBERS OF INDUSTRIAL PRODUCTION - GROWTH RATES

Month

Change in repo rate (bps) 25 25 25 25 25

Repo Rate

Change in reverse repo rate (bps) 25 50 25 50 50

Reverse repo rate 3.25% 3.75% 4% 4.50% 5.00%

inflation

Core Inflation

March 2010 April 2010 2 July 2010 27 July 2010 Sept 2010

5% 5.25% 5.50% 5.75% 6%

10.36% 10.88% --9.98% 8.98%

3.5% 5.9% --5.50% 5.30%

Nov. 2010
Dec.2010 Jan.2011 Mar 2011 May 2011

25
No change 25 25 50

6.25%
6.25% 6.50% 6.75% 7.25%

25
No change 25 25 50

5.25%
5.25% 5.50% 5.75% 6.25%

8.20%
9.45% 9.47% 9.68% 9.56%

5.84%
6.21% 6.53% 8.48% 7.26%

Jun 2011
Jul 2011 Sept. 2011

25
50 25

7.50%
8 8.25

25
50 25

6.50%
7% 7.25

9.44%
9.22% 9.78%

7.31%
7.53% 7.8%

DOMESTIC ECONOMY
GDP growth
Year
2010-11 (Q2) 2011-12 (Q1) 2011-12 (Q2)

Growth %
8.8 7.8 7.7

% change
----

Agricultural growth has accelerated, but industry and services have decelerated. The index of industrial production (IIP) slowed from 8.8 per cent year-on-year in June to 3.3 per cent in July.

Inflation
Wholesale price index (WPI) inflation rose from 9.2 per cent in July to 9.8 per cent in August 2011. Non-food manufactured products inflation rose from 7.5 per cent in July to 7.7 per cent in August 2011. The oil marketing companies raised the price of petrol by ` 3.14 per litre with effect from September 16, 2011. This will have a direct impact of 7 basis points to WPI inflation. The new combined (rural and urban) consumer price index (base: 2010=100) rose to 110.4 in July from 108.8 in June. Other consumer price indices registered inflation rates in the range of 8.4 to 9.0 per cent in July.

Inflation
July August % change

Wholesale price index

9.2

9.8
7.7

Non food manufactured 7.5 products

The new combined (rural and urban) consumer price index (base: 2010=100) rose to 110.4 in July from 108.8 in June. Other consumer price indices registered inflation rates in the range of 8.4 to 9.0 per cent in July.

Weight edge to CPI & WPI

Monetary, Credit and Liquidity Conditions

Year-on-year money supply (M3) growth at 16.7 per cent in August was higher than the projection of 15.5 per cent for the year reflecting higher growth in term deposits and moderation in currency growth. Liquidity has remained in deficit, consistent with the stance of monetary policy. The daily average borrowings under the liquidity adjustment facility (LAF) were around ` 40,000 crore in September (up to September 15, 2011). on in currency growth. as a result of global risk aversion, the rupee has depreciated, which may have adverse implications for inflation.

Fiscal Conditions
The central governments fiscal imbalances widened during April-July of 2011,
the impact of decline in revenue receipts coupled with pressures from non-plan revenue expenditures on account of higher petroleum and fertiliser subsidies.

Fiscal deficit at 55.4 per cent of the budget estimates in the first four months of the current fiscal was significantly higher than that of 42.5 per cent during the corresponding period last year (when adjusted for the more than budgeted spectrum proceeds).

Food Inflation
Month Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec. 2008 5.51 5.47 7.87 7.81 7.75 7.69 8.33 9.02 9.77 10.45 10.45 9.70 2009 10.45 9.63 8.03 8.70 8.63 9.29 11.89 11.72 11.64 11.49 13.51 14.97 2010 16.22 14.86 14.86 13.33 13.91 13.73 11.25 9.88 9.82 9.70 8.33 9.47 2011 9.35 9.54 9.68 9.70 9.06 7.57 7.33 9.80 9.47