Inflation, Managing Finance - myBskool | Online Mini MBA (Free)


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Inflation, Managing Finance
- Shekar Kupperi
Online MBA - Managing Finance -

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Inflation, Managing Finance - myBskool | Online Mini MBA (Free)

  1. 1. What is InflationWhat is Inflation  A rise in the general level of prices of goods and services in an economy  Measured over a period of time.  When the price level rises, each unit of currency buys fewer goods and services i.e. decreased purchasing power  When Prices rise, the Value of Money falls.  A chief measure of price inflation is the inflation rate.
  2. 2. Effects of InflationEffects of Inflation  Inflation can have positive and negative effects on an economy.  Negative effects of inflation include:  loss in stability in the real value of money and other monetary items over time;  uncertainty about future inflationary conditions may discourage investment and saving, and  high inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future.  Positive effects include:  mitigation of economic recession and  debt relief by reducing the real level of debt.
  3. 3. Stages of InflationStages of Inflation 1. Creeping inflation (0%-3%) 2. Walking inflation (3% - 7%) 3. Running inflation (10% - 20%) 4. Hyper inflation ( 20% and above)
  4. 4. Types of Inflation : Demand PullTypes of Inflation : Demand Pull  Places responsibility for inflation squarely on the shoulders of increases in aggregate demand.  Increasing aggregate demand means buyers want more production than the economy is able to provide i.e. buyers bidding up the price of existing production. Too much money chasing too few goods!  This type of inflation results when the four macroeconomic sectors (household, business, government, and foreign) collectively try to purchase more output than the economy is capable of producing.  The extra demand "pulls" the price level higher.
  5. 5. Causes of Demand Pull InflationCauses of Demand Pull Inflation a) Depreciation of exchange rate, making exports more competitive in overseas market b) Fiscal stimulus e.g. reduction in direct or indirect taxes or higher government borrowing or spending on defence, health, education and so on…. c) Monetary stimulus to economy e.g. reduction in interest rates may lead to demand d) Improved business confidence, hence more spending propensity
  6. 6. Types of Inflation: Cost PushTypes of Inflation: Cost Push  Inflation of the economy's average price level induced by decreases in aggregate supply that result from increases in production cost.  This type of inflation occurs when the cost of using any of the four factors of production (labour, capital, land, or entrepreneurship) increases.  In general, higher production cost means the economy simply cannot continue to supply the same production at the same price level. If buyers want the production, they must pay higher prices.  The higher cost "pushes" the price level higher.
  7. 7. a) Increase in cost of raw materials b) Rising labour costs - if wages account for 25% of a firm's total costs then a 10% increase in the total wage bill will cause the firm's total costs to rise by 2.5%. c) Increase in transportation costs d) Higher taxes imposed by the Government - for example an increase in fuel duties or a rise in the standard rate of Value Added Tax. e) External shocks - this could be either for natural reasons or because a particular group or country has gained more economic power (eg. OAPEC) Causes of Cost Push InflationCauses of Cost Push Inflation
  8. 8. Deflation and ReflationDeflation and Reflation  Deflation  Deflation is the opposite of Inflation.  Deflation is a state of disequilibria in which a contraction of purchasing power results in a decline of the price level.  It is a process of reversing inflation without creating unemployment or reducing the output in the economy.  Reflation  Reflation is defined as inflation deliberately undertaken to relieve a depression.  In other words, reflation is a type of controlled inflation.  When deflation is carried to an extreme limit and the prices of goods and services fall to extremely low levels, then reflation is employed to protect the economy.
  9. 9. Inflation and India!Inflation and India! “In other countries, the growth rate is low, but at the same time inflation is also low. Whereas in our country, while growth is slowing, inflation remains at a high level.” Dr Rangarajan, Economic Advisor to the Prime Minister Inflation Rate WPI (May 2013) : 4.7% Inflation Rate CPI (May 2013) : 9.31% All time high (Sept 1974) : 34.7% Record low (May 1976) : -11.3%
  10. 10. WPIWPI  In India, the wholesale price index (WPI) is the main measure of inflation.  The WPI measures the price of a representative basket of wholesale goods.  In India, wholesale price index is divided into three groups: Primary Articles (20.1% of total weight), Fuel and Power (14.9%) and Manufactured Products (65%).  Food Articles from the Primary Articles Group account for 14.3% of the total weight.  The most important components of the Manufactured Products Group are: Chemicals and Chemical products (12% of the total weight); Basic Metals, Alloys and Metal Products (10.8%); Machinery and Machine Tools (8.9%); Textiles (7.3%) and Transport, Equipment and Parts
  11. 11. CPICPI  CPI stands for Consumer Price Index  It is an index which takes into account the standard cost of living (which includes the weighted average of both commodities and services).  Also, called Retail Inflation  The CPI has much larger weightage of primary articles which implies that impact of food inflation is reflected much more prominently in CPI than in WPI.  CPI is computed under 3 categories, namely, Industrial Worker (IW), Agricultural Labourer (AL) and Urban Non- Manual Employees (UNME).  As their names suggest, CPI (IW, AL, UNME) is essentially a reflector of the standard cost of living of people belonging to these categories i.e. the majority of India.
  12. 12. Let the truth be told!Let the truth be told!
  13. 13. Let the truth be told!Let the truth be told!
  14. 14. Let the truth be told!Let the truth be told!
  15. 15. Comparison with Emerging MarketsComparison with Emerging Markets
  16. 16. Controlling persistent inflationControlling persistent inflation  Agricultural production in India has not grown in proportion to the growth in population, thus creating a supply shortage.  India has seen a rise in prices of raw materials and wage rates and a shortage of natural resources - has caused the price level (cost of goods) to increase.  High fiscal deficit  Change in dietary habits with focus on proteins  Inefficient supply chain management
  17. 17. Where is the real issue?Where is the real issue?
  18. 18. The challenge:The challenge: Food inflationFood inflation  Food inflation persisting despite large buffer stocks  upward pressure reinforced with significant increase in the Minimum Support Price (MSP) of most cereals and pulses  cost of agriculture has been going up sharply  Volatility in prices of vegetables and fruits  Significant price increase in protein rich food items, such as, eggs, fish and meat  The persistence of food inflation calls for:  a relook at the agriculture price policy of the country  revisit of the buffer stock policy
  19. 19. How to combat?How to combat? Need for policy action on several fronts:  Supply-demand imbalance in the agricultural sector and modernizing the supply chain  Market related pricing of petroleum products required to reduce the subsidy burden  Reliability of power supply and availability of necessary industrial raw materials are important  Stability of exchange rate to cushion transmission of international price pressures in commodities, particularly crude oil  Fiscal consolidation is important for maintaining both domestic and external balance
  20. 20. Final words…Final words…  The threshold level of inflation in India is about five per cent beyond which inflation harms growth by putting sands on the wheels of commerce  We are a country with vast labor supply, hence potential for growth is limitless…….but only in an environment of price stability, any positive step can bolster growth.
  21. 21. Shekar Kupperi
  22. 22. For More details Visit Email us – Call us - +91-44-4269 1990 87545 99122