MAE Term Paper Report Analysis of Prices and Inflation in the Indian Economy Submitted to: Professor Ananth

Panth

Submitted On: Date: 11-March-2014

Submitted By: Group 9, Section A Anna Kallukaren Deepak M Laxmi Narayan Nanda Nupoor Jain Siddarth Shetty Vivek Narayanan 13009 13019 13029 13039 13051 13061

Contents
Inflation ........................................................................................................................................... 2 Effects of Price Rise in India .......................................................................................................... 2 Effect of inflation and economic growth is manifested in the following cases: ............................. 4 I) Investment: .............................................................................................................................. 4 II) Interest rates: .......................................................................................................................... 5 III) Exchange rates: ..................................................................................................................... 5 IV) Unemployment: .................................................................................................................... 5 V) Stocks: .................................................................................................................................... 5 Impact on Household Sector: ...................................................................................................... 5 Impact on Business Sector: ......................................................................................................... 6 Average trends in inflation (2000-01 to 2011-12) .......................................................................... 6 Inflationary Experience of India in Comparison to World ............................................................. 8 Episodes of High Inflation in India: 1971 to 2012 ......................................................................... 9 Government Measures to Contain Inflation .................................................................................... 9 Fiscal & Administrative measures .............................................................................................. 9 Budgetary and other measures .................................................................................................. 10 Monetary measures ................................................................................................................... 10 Bibliography ................................................................................................................................. 11

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Inflation
In economics, inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation reflects a reduction in the purchasing power per unit of money a loss of real value in the medium of exchange and unit of account within the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the consumer price index) over time. Inflation's effects on an economy are various and can be simultaneously positive and negative. Negative effects of inflation include an increase in the opportunity cost of holding money, uncertainty over future inflation which may discourage investment and savings, and if inflation were rapid enough, shortages of goods as consumers begin hoarding out of concern that prices will increase in the future. Positive effects include ensuring that central banks can adjust real interest rates (to mitigate recessions), and encouraging investment in non-monetary capital projects. The annualized inflation rate in India is 8.9% as of June 2012, as per the Indian Ministry of Statistics and Program Implementation. This represents a modest reduction from the previous annual figure of 9.6% for June 2011. Inflation rates in India are usually quoted as changes in the Wholesale Price Index, for all commodities

Effects of Price Rise in India

Indian economy is one of the largest economies in the world. It isnt surprising that India rank 11th in terms of nominal GDP (Gross Domestic Product) and 3rd in terms of PPP (Purchasing Power Parity). But this stupendous growth is accompanied by the emergence of new problems and challenges. One of the most grave of them all is that of price rise. There has been widespread uproar regarding the skyrocketing prices of commodities of daily use. Both the government and the citizens have been facing a hard time due to its inability to put a check on the rising inflation rates.

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Causes To analyze the causes we need to look at the internal and external factors. External factors include global inflation. For example, if an item is imported to India from some foreign country and its price rises, it automatically results in increased production costs in the Indian market. External factors cant be controlled but internal factors can be. The economists hold the view that due to unprecedented growth in the purchasing power of the people the supply is unable to meet the demands, hence creating price rise in various sectors. Or in other words too much money is chasing few goods. Sometimes the cause may be natural. For example there is a steep rise in the prices of goods of agricultural sector whenever there are occurrences of droughts and floods which lead to shortage of food grains. The other factor responsible for price rise is increase in production costs. For example increased wages for the labor will result in increased price of production. Besides these there are other causes such as hoarding. Recently onion prices reached new heights owing to the large scale hoarding creating artificial shortage. Also increased population has also contributed significantly to increased price. More population means more mouths to feed and more mouths to feed means increased consumption which in turn results in price rise (inflation). A certain amount of price rise is inevitable in a developing economy because as income level rises due to newly created opportunities the demand increases. And since a large proportion of the people do not have basic necessities, so the money is spent rather than saved. This creates a direct pressure on the market to supply more goods. But above a threshold limit the price rise begins to have a negative impact on the economy. Another reason for inflation is continued negligence of agricultural sector. The Indian economy has emphasized Industrial sector for too long but agricultural sector has been ignored ever since independence. Due to this, the supply of raw materials has not kept pace with the consumption. The heavy taxation on industries has also added to the increase in inflation as the increased production cost reflects in the final price of the finished products.

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Consequences The increase in prices reflects directly in the lives of people. The increased price renders the poor unable to buy the goods of basic use .Indian economic model supports both capitalism and socialism. The increasing prices have a lasting impact on the lives of poor whereas the rich are usually unaffected by inflation. Especially those who have fixed incomes, for example, government employees are hit the hardest by inflation. The government provision of dearness allowances becomes insufficient for the new prices. The exports are also adversely affected resulting in imbalance in the foreign trade. The rise in prices of goods results in wage-price spiral. Due to increased price, the labor demands higher wage which in turn adds to the cost of goods and thus forming a loop. This can create uncontrolled rise in price. The business planning is also affected by the increased prices due to uncertainty in the costs and prices Remedies The foremost solution to stop price rise is increasing the supply. But sometimes increasing supply is not possible due to factors that cant be controlled. For example unavailability of raw materials for production due to natural causes like floods. The other solution is to stop money from entering the market. This can be achieved by making people spend money in bonds by increasing the interest rates. Banks may increase the interest rates for loans to restrict the flow of money into the system. The corrupt practices like hoarding must be stopped to maintain a continuous flow of products. The taxation on the industries and imports must be controlled and kept reasonable to keep the final price under radar.

Effect of inflation and economic growth is manifested in the following cases:

I) Investment: If the price of goods increases and people have to compensate for the increase in price, they usually make use of their savings. In the event when savings are depleted, fund for investment is no longer available. An individual tends to invest, only if savings of an individual is strong and has sufficient money to meet his daily needs.

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II) Interest rates: Whenever inflation reigns supreme, it is a well-known fact that the value of money goes down. This leads to decline in the purchasing power. In the event, when the rate of inflation is high, the interest rates also rise. With increase in both parameters, cost of goods will not remain the same and consequently people will have to shell out more money for the same goods.

III) Exchange rates: Inflation and economic growth are affected by exchange rates as well. Exchange rates denote the value of money prevailing in different countries. High rate of inflation causes severe fluctuations in exchange rates. This adversely affects trade (export and import), important business transaction across borders, and value of money also changes.

IV) Unemployment: Growth of a nation depends to a large extent on employment. If rate of inflation is high, unemployment rate is low and vice versa. This theory is propounded by economist William Philips and this gave rise to the Philips Curve.

V) Stocks: The returns a company offer, on investment fully depend on the performance of the company. Past performance, current position of the company and future trends decide how much (money, in form of bonus or dividend) is to be returned to the investors. Owing to inflation, several monetary as well as fiscal policies are impacted. Impact on Household Sector: Inflation directly reduces the purchasing power of the household sector First, non-essential/ luxury expenses cut. Real income falls Expenses on some essentials also cut. Lower standard of living. Cash saving discouraged, stocking physical goods (gold) Fixed income groups suffer the most.

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Impact on Business Sector:

Moderate inflation (2-3%) good, initially-Firms benefit from rising prices. Soon, demand falls as consumers reduce consumption. Fall different for different commodities depending on the price elasticity of demand. Production costs go up, especially if wages are linked to inflation indexCosts increase, squeezes profits. Remedy: cost cutting and efficiency building. New investment risky, realigned to shift in consumer patterns-Govt. policies important-Competitive environment changes-composition of industrial outputs change. Some firms make profits-Competitiveness in exports affected and possibility of depreciation and rise in costs of imported raw materials.

Impact on Debtors and Creditors: Redistribution of income from creditors to debtors-repaid debt in depreciated value as purchasing power has eroded to the extent of inflation.

Impact on Govt Govt. expense goes up in tandem with increase in price level-austerity measures. Fiscal deficit (gap between govt. revenue and exp.). Induction of more currency (to cut-deficit) may worsen inflator pressures. Govt. may initiate restrictive policies wage freeze, tight money policy (higher interest rate) etc.

Average trends in inflation (2000-01 to 2011-12)

The range of inflation varied from a low of 3.3 per cent in 1999-2000 to a high of 7.2 per cent in 2000-01. During this period, inflation has had a distinct decelerating trend. In fact, Indian Experience of Inflation, op.cit., pp. 349-357 op.cit., Economic Survey 2001-02 even in 2002-03 when the country faced a severe drought, inflation remained moderate at 3.4 per cent. Moreover, 2002-03 was also marked by the simultaneous impact of several others adverse developments such as border tensions and high international crude oil prices. A hardening of international oil prices as well as domestic food prices responding to a deficient monsoon in the previous year fuelled a spurt in inflation in India during the first half of 2004-05.

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Inflation began to ease in the second half of 2004-05 under the impact of a combination of fiscal and monetary measures and weakening of south-west monsoon. In 2005-06, WPI inflation eased to 4.3 per cent as compared to 6.5 per cent a year earlier. The year 2010-11 was marked by strong inflation exhibiting persistence on the back of elevated inflation expectations, hike in vegetable prices with unseasonal rains post-monsoon and rising global commodity prices that resulted in significant cost-push and demand-pull pressures since December 2010. Drivers of inflation changed during 2010-11.Food products were the main drivers of price rise during April-July 2010, accounting for about two-fifths of increase in WPI. However, these price pressures spilled over to manufacture non-food products during December 2010-March 2011, which accounted for 61 per cent of the price rise in this period20. The whole of 2010-11 was marked by inflation persisting with headline inflation averaging 9.6 per cent. During 2011-12, the WPI exhibited a sustained increase, even though the pace of increase somewhat slowed down during the latter half of the year. The financial year stared with a headline inflation of 9.7 per cent which briefly touched double digit in September 2011 before coming down to 6.6 per cent in January 2012. The increase in the WPI during the initial months of the year was driven by a host of factors that included an increase in food prices, a revision in the administered prices of fuel as well as an increase in manufactured product prices in the wake of significant pressure from high input costs as well as strong demand and pricing power. The decline in growth during 2011-12 was expected to ease the pressure on core inflation. However, the extent of moderation was constrained by further pressure from rupee depreciation and high global commodity prices. The phase of softening of inflation was marked by a decline in the contribution of food, which again increased from February 2012 as prices increased sharply after the seasonal decline. The contribution of non-food manufactured products remained strong despite the deceleration in growth momentum. The contribution of fuel group to overall inflation remained high and significant throughout the year despite suppressed inflation from the administered prices of some petro-products, coal and electricity.

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Primary food articles inflation declined sharply during November 2011January 2012, from above 10 per cent to negative territory, largely reflecting a seasonal decline in the prices of vegetables and a favorable base effect. However, prices rebounded significantly subsequently, resulting in food inflation reverting to double-digit levels by April 2012. The prices of protein-based food articles have remained persistently high since October 2011. As per mid-year analysis 2012-13, inflation as measured by WPI averaged 8.9 per cent for 201112. Inflation in 2012-13: The inflation decelerated to 7.7 per cent in first half of (April-September) of 2012-13. WPI inflation was 8.07 per cent in September 2012, which was 8.01 per cent in August 2012. It has fallen to 7.32 per cent in October 2012, 7.24 per cent in November, 7.18 per cent December 2012 and stood at 6.62 (provisional) for the month of January 2013.

Inflationary Experience of India in Comparison to World

India is a moderate inflation country. For example, in the 62 years since 1950-51 average annual inflation rate as measured by changes in the wholesale price index (WPI) increased at a rate of 6.7 per cent per annum. That is not a very high rate considering that many countries, both developed and developing, experienced very high inflation in their modern development history. In fact, more recently in the 1980s and 1990s, the world inflation averaged around 17 per cent per annum. In the 2000s, there was a sharp all round moderation in global inflation. In the eight year period from 2000 to 2007, the world inflation averaged 3.9 per cent per annum. Even the emerging and developing economies (EDEs) which traditionally had very high inflation showed an average annual inflation at 6.7 per cent. Indias inflation performance was even better at 5.2 per cent as measured by WPI and 4.6 per cent measured by the consumer price index (CPI-IW). In 2008 the global financial crisis struck following which inflation rose sharply both in advanced countries and EDEs as commodity and oil prices rebounded. Thereafter, inflation rate moderated both in advanced economies and EDEs. In India too, the inflation rate rose from 4.7 per cent in 2007-08 to 8.1 per cent in 2008-09 and fell to 3.8 per cent in 2009- 10. However, the inflation rate backed up and stayed near double digits during 2010-11 and 2011-12 before showing some moderation
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in 2012-13. The high inflation during 2010 and 2011 was a combination of both adverse global and domestic factors as well as supply and demand factors.

Episodes of High Inflation in India: 1971 to 2012

Since 1970s, there have been seven episodes of high and persistent inflation in India where the headline WPI inflation was above 8 per cent for more than six months on a sustained basis. Most of these episodes resulted in high inflation persisting for about 2-3 years. Even though these high inflation periods had different drivers like oil shocks, drought and currency devaluation, persistence of inflation seems to be a common pattern when inflation turns high. It may be

noted that all three major drivers of inflation, viz., food, fuel and core have been significantly contributing to the high and persistent inflation.

Government Measures to Contain Inflation

Inflation has been a major cause of concern for both the Government and Reserve Bank of India who are taking a number of measures to contain it. Fiscal & Administrative measures Reduced import duties to zero - for wheat, onion, pulses, crude palmolein and to 7.5 per cent for refined & hydrogenated oils & vegetable oils. Duty-free import of white and raw sugar was extended up to 30.6.2012; however, import duty of 10 per cent was instituted in June 2012. Banned export of edible oils (except coconut oil and forest based oil) and edible oils in blended consumer packs upto 5 kg with a capacity of 20,000 tons per annum and pulses (except Kabuli chana and organic pulses and lentils up to a maximum of 10000 tonnes per annum). Imposed stock limits from time to time in the case of select essential commodities such as pulses, edible oil, and edible oilseeds and in the case of paddy and rice for specific seven states upto 30.11.2012. Ban on export of onion was imposed for short period of time whenever required. Exports of Onion were calibrated through the mechanism of Minimum Export Prices (MEP).
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 Maintained the Central Issue Price (CIP) for rice (at Rs 5.65 per kg for BPL and Rs 3 per kg for AAY) and wheat (at Rs 4.15 per kg for BPL and Rs 2 per kg for AAY) since 2002. Suspended Futures trading in rice, urad, tur, guar gum and guar seed. To ensure adequate availability of sugar for the households covered under TPDS, the levy obligation on sugar factories was restored to 10 per cent for sugar season Government allocated rice and wheat under Open Market Sales Scheme. Resumed the scheme for subsidized imported pulses through PDS in a varied form with the nomenclature " Scheme for Supply of Imported Pulses at Subsidized rates to States/UTs for Distribution under PDS to BPL card holders" with a subsidy element of Rs. 20/- per kg to be paid to the designated importing agencies up to a maximum number of BPL card holders for the residual part of the current year and extended the scheme for subsidized imported edible oils w.e.f. 1.10.2012 to 30.9.2013 with subsidy of Rs. 15/- per kg for import of up to 10 Lakh tonnes of edible oils for this period27. 2011-12.

Budgetary and other measures A number of measures were announced in Union Budget 2012-13 to augment supply and improve storage and warehousing facilities. Government launched a National Mission for Protein supplements in 2011-12 with allocation of Rs 300 crore. To broaden the scope of production of fish to coastal aquaculture, apart from fresh water aquaculture, the outlay in 2012-13 was stepped up to Rs 500 crore. Recently, Government permitted Foreign Direct Investment (FDI) in multibrand retail trading. This will help consumers and farmers as it will improve the selling and purchasing facilities. Monetary measures

The Reserve Bank of India (RBI) had also taken suitable steps to contain inflation with 13 consecutive increases by 375 bps in policy rates from March 2010 to October 201128. We all know that sustained level of high inflation is bad for the economy as it imposes real costs which are borne disproportionately by the different segment of the economy. A low rate of

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inflation along with high growth is the ideal situation. The fight against inflation is a part of agenda of Government at the present hour.

Bibliography
Indian Inflation. (n.d.). Retrieved from http://www.rbi.org.in/scripts/BS_SpeechesView.aspx?Id=776 Inflation and Economic Growth. (n.d.). Retrieved from http://www.economywatch.com/inflation/economy/economic-growth.html Inflation in India. (n.d.). Retrieved from http://gsvassociates.com/index.php/articles/mrv-articles/49inflation-in-india-how-to-tackle-it

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