REASONS AND IMPACT (INDIA)
The term “inflation” is from the
Latin term inflare, meaning to
“blow up or inflate,” and it was first
used in a monetary sense to
describe “an increase in the
amount of money”.
In1838 the concept of inflation
was first used.
Inflation can be defined as the rise in
overall price level in the economy, i.e.
rise in prices of all the goods and
prices rise,it erodes the
purchasing power of money.
Inflation is a situation in which there is
a persistent and appreciable increase
in general level of prices.
Inflation is the gravest economic concern
which has gripped India into its jagged
India has been plagued by the disease of
inflation since the 1950s but it has started
showing its prominently harmful symptoms
and ill effects since 1991, post liberalization.
Kick started by the fiscal crisis of 1991,
marked by deficits in government finances
and devaluation of the rupee, a whopping
inflation of 13.66 per cent took its toll on the
A chief measure of price inflation is
the inflation rate. It is measured by:
1.Change in price index
a)Consumer Price Index(CPI)
b) Wholesale Price Index (WPI)
2. Gross National Product Deflator
Change in price index
Rate of change in inflation can be
measured through change in price
where,P0 is current average price level
P-1 is the price level a year ago
Consumer Price Index(CPI)
A consumer price index measures
changes in the price level of consumer
goods and services purchased by
A CPI can be used to index (i.e., adjust for
the effect of inflation) the real value of
wages, salaries, pensions, for regulating
prices and for deflating monetary
magnitudes to show changes in real values.
Wholesale Price Index(WPI)
The Wholesale Price Index or WPI is the price of a
representative basket of wholesale goods.
The Indian WPI figure is released every 10 days
and influences stock and fixed price markets.
The Wholesale Price Index focuses on the price of
goods traded between corporations, rather than
goods bought by consumers, which is measured
by the Consumer Price Index.
The purpose of the WPI is to monitor price
movements that reflect supply and demand in
industry, manufacturing and construction.
In India WPI is the indicator for inflation rate.
GNP deflator is not obtained directly
like CPI and WPI. It is measured as
where, nominal GNP= GNP at current
Real GNP= GNP at constant prices
There are different types inflation which are explained below:
Creeping Inflation: This is also known as mild inflation or
moderate inflation. This type of inflation occurs when the
price level persistently rises over a period of time at a mild
Galloping Inflation: If mild inflation is not checked and if it is
uncontrollable, it may assume the character of galloping
inflation. Inflation in the double or triple digit .Indian
economy has witnessed a galloping inflation .It causes
economic distortion and disturbances.
Hyperinflation: It is a stage of very high rate of inflation. While
economies seem to survive under galloping inflation, a third and
deadly strain takes hold when the cancer of hyperinflation strikes.
Nothing good can be said about a market economy in which prices
are rising .
Stagflation: It is an economic situation in which inflation and
economic stagnation or recession occur simultaneously and remain
unchecked for a period of time. Stagflation was witnessed by
developed countries in 1970s, when world oil prices rose
Deflation: Deflation is the reverse of inflation. It refers to a sustained
decline in the price level of goods and services. It occurs when the
annual inflation rate falls below zero percent (a negative inflation
rate), resulting in an increase in the real value of money.
The rate at which the prices of everything go up is called the "rate of
inflation". For example, if the price of something is Rs.100 this year
and next year the price becomes approximately Rs.104 then the rate
of inflation is 4%. If the price of something is Rs.80 then after a year
with a rate of inflation of 4% the price go up to (80 x 1.04) = 83.2.
So, when you make an investment, make sure that your rate of return
on the investment is higher than the rate of inflation in your country.
In our county India, for the year 2005-2006 the rate of inflation was
REASONS OF INFLATION IN
The 1990s is widely described in general as
a price stability era all over the globe,
barring some external factors like bouts of:
Increase in international oil price and
Natural disasters like drought or flood
showed an ebbing trend.
The main problem of inflation came to head in
When Iraq invaded Kuwait the prices of oil
doubled in international market.
Trade deficit (import exceeding exports) in 1991
rose to 15600 cores therefore,
India borrowed funds from International
REASONS FOR INFALTION IN
EARLY 20TH CENTURY
The first half of India's fiscal 2002-03 (beginning
April 1, 2002) witnessed uptrend in inflation
largely due to:
Increase in oil prices twice during the period.
Adverse impact of drought on Agricultural
products leading to increase in prices –
Oilseeds and Edible oils.
At the end of the fiscal 2002-03 inflation was up
3.3 percentage points. In the light of overall
variation in wholesale price inflation, the inflation
in fiscal 2002-03 was dominated by non-food
items unlike preceding years, as per a RBI
Defence expenditures (official) skyrocketed, also
four times, from Rs 16,347 cores to Rs 65,000
cores in the budget of 2002/03.
Food inflation can be defined as a consistent rise in
the price level of all agricultural food items. This
rise in price level is neither seasonal nor sudden, it
keeps on increasing over a period of time. This is
one of the biggest problem faced by the economy.
Prices of close substitutes for rice are rising sharply
as well: wheat, maize, and soybeans are all at
The nature of India's current bout of inflation is also
a pointer to the fact that it is not a product of
growth. It is largely driven by a rise in prices of
food items. Wholesale prices of all commodities
have risen by about 38% between 2005 and 2010,
but prices of food items have jumped by over 77%.
Some food items have seen even bigger hikes like
vegetables (101%), milk, eggs, meat and fish (80%).
In 2009-2010 the country faced worst situation in
food inflation which was the major cause of
UPDATE ON FOOD INFLATION
India's food inflation plunged sharply to 4.3 per cent for
the week ended December 15 as compared to 8 per cent
in the previous month as onions, potatoes and wheat
became cheaper and the rise in the prices of other items
moderated on the back of a good monsoon.
Food inflation has dropped sharply in the last four weeks.
It had come down in single digit for the week ended
November 12 from 12.21 percent. The headline inflation
based on the wholesale price index was recorded at 9.73
The Reserve Bank of India (RBI) has hiked key policy
rates 13 times since the beginning of 2010 to control the
Causes of inflation
1-Cost push inflation.
2-Rising imported raw materials costs.
3-Rising labor costs.
4-Higher indirect taxes imposed by the government.
5-Demand pull inflation.
Effects of inflation on prices
1. Over-expansion of money supply i.e. excess liquidity in the
economy leads to inflation .
-- Expansion of Bank Credit .
-- Deficit Financing: The high doses of deficit financing which
may cause reckless spending.
-- A high population growth leads to increase in demand and
money income and cause a high price rise.
-- Excessive increase in the price of fuel or food products due to
political, economic or natural reasons
2. Western economies like us are consuming on a massive scale
leading to huge trade imbalance.
3. As government has reduced protection and subsidies on
agriculture that results into high cost of energy which directly
translates into high cost of cultivation and therefore high prices
4. The problem of inflation is directly linked to the price of
crude oil imported by our country. India’s 70% oil needs are
fulfilled through imports.
Effect of inflation on different
Effect on bank
1-The RBI may go for further monetary tightening in the light of rising
2-Yields are rising, compelling the banks to raise interest rates, which will
hamper their business growth .
3-Inflation concerns remain high with finance ministry officials indicating
the rate could go up to 13 per cent in the near term.
Effect on airline industry
1-One major issue is cost of Aviation Turbine Fuel
2-Job cuts in airline industries on a rise
Effect on automobile industries in india
1-The automobile sector is also suffering because of soaring raw
2-The two-wheeler sector is especially suffering, as banks are not
willing to lend fearing delinquency.
Effect on IT companies
1-Patni computers has handed the pink slip to over 400 employees
for non performance.
2-TCS other companies warns its employees that non
performance wont be tolerated.
3-Companies like wipro and sutherland may cut down on
incentives and other perks
EFFECTS ON STOCK MARKET
1-A huge 6.5 % fall in Reliance Industries & 4.5 %
fall in Bharti Airtel was responsible for the
Sensex to close at 14590.16 points, down 498
2-For the first time in 2008, the Sensex dipped
from the psychological level of 15,000 point.
3-Investors confidence is dented by the rising
Inflation widening gap between rich and
Inflation in country creates a breeding
ground for social upheavals .Inflation
redistributes income and wealth in favor of
rich and black marketers .
The rich and business class get ample
chances of making profit while poor
indirectly suffer the social sins done by
Here are broadly two ways of controlling inflation in an
economy – Monetary measures and fiscal measures.
1). Monetary measures
2). Fiscal measures
The most important and commonly used method to
control inflation is monetary policy of the Central Bank.
Most central banks use high interest rates as the
traditional way to fight or prevent inflation.
Monetary measures used to control inflation include:
(i) bank rate policy
(ii) cash reserve ratio and
(iii) open market operations.
(i) Bank rate policy is used as the main instrument of
monetary control during the period of inflation. The
central bank raises the bank rate. The increase in bank
rate increases the cost of borrowing which reduces
commercial banks borrowing from the central bank.
Consequently, the flow of money from the commercial
banks to the public gets reduced. Therefore, inflation is
controlled to the extent it is caused by the bank credit.
(ii) Cash Reserve Ratio (CRR) : To control inflation, the
central bank raises the CRR which reduces the lending
capacity of the commercial banks. Consequently, flow of
money from commercial banks to public decreases. In
the process, it halts the rise in prices.
(iii) Open Market Operations: Open market operations
refer to sale and purchase of government securities and
bonds by the central bank. To control inflation, central
bank sells the government securities to the public through
2) Fiscal Measures
measures to control inflation include
decrease in government expenditure and delay in
payment of old debts and taxation.
The government can also take some protectionist
measures (such as banning the export of essential
items such as pulses, cereals and oils to support
the domestic consumption, encourage imports by
lowering duties on import items etc.)
(a)Increase in production
(b) Provision of subsidies
(c) Proper commercial polices
(d) Imposing direct control on prices of
(e) Encouragement to savings
MEASURES TAKEN BY
Government has reduced import duty on skimmed milk
powder, petrol and diesel and customs duty on crude oil.
“As part of the monetary policy review stance, the RBI has
taken suitable steps to maintain its growth without provoking
Headline inflation, as measured by Wholesale Price Index
(WPI), has been above the 9 per cent mark since December,
2010, and stood at 9.22 per cent in July . Food inflation
stood at 9.80 per cent in mid-Year.
The government has been under attack from various
quarters over sustained inflationary pressure.
In its Annual Report the RBI said inflation is likely to stay
elevated at least till the third quarter of the current fiscal,
before falling to 7 per cent by March, 2012.
Reserve Bank of India (RBI) Governor D Subbarao has
said that inflation will come down by March on the back of
strengthening agro-based economy in the country.
"Inflation will come down because the production and
agriculture sectors will boost up the rural agro-based
economy of the country," Subbarao said at a RBI Financial
Outreach Programme in Dungabori in central Assam's
According to the RBI Governor, the Indian economy is
stable and will grow despite the global economic slow
The Reserve Bank of India has tightened liquidity by raising the
interest rate. It currently stands at 8.5 per cent.
In India RBI uses repo technique for increasing or decreasing
liquidity in market.
The RBI takes into account the important concern of balancing the
targets of controlling inflation and keeping up growth and
The fiscal deficit as a percentage of GDP was 6.4 per cent in 2009-10.
In 2010-11 this was brought down to 4.7 per cent. This year a target
of 4.6 per cent has been set. This is a difficult target, given the
deterioration in the global economy and its impact on India over the
last 3 to 4 months.
Liberalization of imports and cutting of
excise and custom duties
Has directed RBI to take monetary
measures and to put down interest rates to
State governments have taken initiative to
provide lower priced ration goods for the
BPL (below poverty line).
On alternative source of fuel!
In some countries biodiesel is less
expensive than conventional diesel.
More usage of bio fuels.
Need for focus on the crops that will yield
The problem of huge oil import bill and
price uncertainty can be mitigated by
cultivating bio fuel crops on over 60
million hectares of waste land available in