ASSIGNMENT-III

INFLATION: CPI USED TO SET INLATION TARGET

Introduction:
Inflation means the general level of prices is going up. Economists measure inflation regularly to know an
economy's state. Inflation changes the ratio of money towards goods or services; more money is needed to get the
same amount of a power of money.
In India the method of calculation of inflation is by the Wholesale Price Index. Inflation is the percentage change
in the value of the Wholesale Price Index WPI! on a year"on year basis. In India# inflation is calculated by taking
the
$emand"Pull inflation
%he $emand"Pull inflation theory can be said simply as &too much money chasing too few goods.& In other words#
if the will of buying goods is growing faster than amount of goods that have been made# then prices will go up.
%his most likely happens in economies that are growing fast. Whenever a product is bought or sold beyond its real
price for its worth# then Inflation of money occurs.
'ost"Push inflation
%he 'ost"Push inflation theory says that when the cost of making goods which are paid by the company! go up#
they have to make prices higher to still make profit out of selling that very product. %he higher costs of making
goods can include things like workers wages# taxes to be paid to the government or bigger costs of getting raw
materials from other countries.
History and Currnt Status
For 2009, Indian inflation stood at 11.49%. According to the Economic Survey Report for 2009-10, economic
growth decelerated to 6,7% in 2008-09 from 9% in 2007-08.
Indias 2009-10 Economic Survey Report suggested a high double-digit increase in food inflation, with signs of
inflation spreading to various other sectors as well. The Deputy Governor of the Reserve Bank of India, however,
expressed his optimism in March 2010 about an imminent easing of Indian wholesale price index-based inflation,
on the back of falling oil and food prices.
On March 19, 2010, the Reserve Bank of India raised its benchmark reverse repurchase rate to 3.5% percent, after
this rate touched record lows of 3.25%. The repurchase rate was raised to 5% from 4.75% as well, in an attempt to
curb inflation.
In its Annual Monetary Policy Statement, RBI had said the firming up of global commodity prices poses upside
risks to inflation. The central banks industrial outlook survey shows companies are increasingly regaining their
pricing power in many sectors, and as the recovery gains momentum, the demand pressures are expected to
accenture.
(n )ay *+# ,-*. /eserve 0ank of India# 1overner# $r./aghuram /a2an was talking to reporters after the /0I3s
board meeting updated that#4 Interest rate is the best tool for /eserve 0ank to control inflation3# he said the 5best
tool3 available with the central bank to control price rise was interest rate and adding that the government too had
tools such as increasing agricultural production and improving supply.
60oth need to work together and will work together. We were expecting some increase in the 'PI number because
of the seasonal effects from vegetable prices# but it came more than anticipated by the consensus forecast. We will
study them in greater detail. What does it suggest is that inflation is high as far as food prices go#4 he added.
7owever# he said the core inflation had been coming down but though 5very very gently3. /etail or consumer price
index 'PI! inflation rose to a three"month high of 8.+9 per cent in :pril. $r. /a2an exuded confidence that retail
inflation would come down to ; per cent by )arch# ,-*;. 6We are very comfortable with the fact that we can
achieve what the <r2it Patel committee suggested of 8 per cent inflation at the end of the year and ; per cent at the
end of next year.4
%he WPI based inflation has eased to +., per cent# while the retail inflation was still high at 8.+9 per cent in :pril.
In!"ation !i#urs $rtainin# to %&'(
%his involves inflation based on the 'PI consumer price index! and the 7I'P harmonised consumer price
index! . %he 'PI is often considered a country3s most important inflation figure.
Inflation development during ,-*=
: graph and a table with additional information about the development of inflation during ,-*= can be found
below. When you select a country and a type of inflation in the selection box# the page will automatically change
and show the development of the inflation figure which you have selected in ,-*=.
C)art CPI India %&'(
>ource ?1lobal rates.com*,.-;.*.!
Ta*" CPI India %&'(
)onths in ,-*= inflation yearly basis!
@anuary **.;*; A
Bebruary *,.-;- A
)arch **...= A
:pril *-.,.. A
)ay *-.;8- A
@une **.-+8 A
@uly *-.8.9 A
:ugust *-.C.8 A
>eptember *-.;98 A
(ctober **.-;- A
Dovember **..;8 A
$ecember 9.*=, A

)ain drivers of food and non"food inflation in 'PI new series
>ource? )inistry of Binance E)id"Fear Economic :nalysis,-*=",-*.!G
IMPACT OF INFLATION ON INDIA+S ECONOMIC DE,ELOPMENT
%he Indian economy recovered in the second Huarter I,! of ,-*="*. recording a growth of ..8 per cent. %his
follows a growth rate of ... per cent in the first Huarter I*! of the current financial yearJ the lowest in *;
Huarters. While the 1overnment delivered on the announced fiscal targets in ,-*,"*=# current account deficit
':$! continued to remain elevated in I* of ,-*="*. and in tandem with market misperception of an imminence
of the rollback of Huantitative easing in <># assumed a serious dimension with the sharp depreciation of the rupee.
%he 1overnment put in place a series of measures and there has been a significant let"up in the challenges on the
trade and balance of payments front# particularly in the I, ,-*="*.. $omestic impediments like elevated levels of
food and retail inflation# high input costs and pressure on profit margins and infrastructural bottlenecks continued#
with the 1overnment addressing them through appropriate calibration of fiscal policy# administrative measures and
institutional mechanisms like 'abinet 'ommittee on Investment to fast track pro2ects.
%he recovery in growth# although weak# is expected to gather pace in the coming Huarters. While there are some
concerns about renewed price pressure in (ctober ,-*= and the services sector# the driver of growth# is still to pick
up# there are indications to the effect that these could be reversed going forward. %he analyses in various sections
of this chapter would provide the analytical basis for the above assessment. With recent improvements in growth
of some sectors# better performance of exports and measures taken by the 1overnment# the year ,-*="*. can be
expected to end with a growth of + per cent.
%he Indian economy weathered the global financial crisis rather well and Huickly recovered from the decline in
growth rate in ,--8"-9 to a healthy growth that averaged around 9 per cent annually in ,--9"*- and ,-*-"**.
7owever# this recovery was short"lived and growth rate declined to ;., per cent in ,-**"*, and +.- per cent in
,-*,"*=# on account of both domestic and external factors. $espite some recovery in the growth of agriculture and
industry sector# particularly in I, of the current financial year# the overall growth of the economy has been a
modest ..; per cent in the first half of the year. %he growth rate of the economy improved from ... per cent in I*
,-*=" *. to ..8 per cent in I,. 'ompared to I* ,-*="*.# I, has evidenced a robust pick"up in the growth of the
agricultural sector and a gradual recovery in the industrial sector. %he growth in economic services also got
strengthened# while the community# social and personal services" a sector with substantial public sector presence "
exhibited a significant fall in growth# pointing towards efforts at fiscal consolidation. %he demand side impetus to
growth is gradually gaining momentum with the strengthening of private consumption and investment and with
exports making an impressive turnaround in I, ,-*="*.. %he confluence of these factors has resulted in a growth
of ..; per cent during the first half 7*! of ,-*="*.# roughly the same level of ..C per cent achieved during the
second half 7,! of ,-*,"*=.
(n the external front# the crisis of ,--8# the subseHuent sovereign debt crisis and the recession in the Euro"area
had moderated the average growth rate of the global economy to less than = per cent over the period ,--8",-*, as
compared to + per cent during ,--.",--C. $ata from I)B indicate that several emerging market economies
including 'hina and India Huickly rebounded to high growth in the aftermath of the crisis. In fact# in terms of
market price 1$P# India3s growth exceeded that of 'hina in ,-*-. :part from emerging economies# advanced
economies also experienced significant recovery in ,-*- with both the <> and the Euro"area registered distinctly
higher growth rates. : series of subseHuent events# including the uncertainty surrounding Euro"area sovereign debt
crisis# hampered sustained economic recovery in advanced economies with adverse conseHuences for growth and
challenges for macroeconomic management in emerging market economies. With the intensification of the
sovereign debt crisis# the decline in real 1$P growth rates starting ,-** has been witnessed across advanced and
emerging market economies. Economic growth has again started looking up in advanced economies# especially in
the <># alleviating the external constraint on India3s recovery to some extent.
%he slowdown in real 1$P growth in India during ,-**"*, and ,-*,"*= is the trends in similar emerging
economies. %he downturn has been more pronounced in the Indian case# owing to domestic and structural factors.
%he growth of real 1$P has generally shown a declining trend since the first Huarter of ,-**"*,. :n upward
movement in some of the Huarters in between raised the hope for a turnaround that was belied .'orresponding to
this# the industrial sector witnessed a long# steep decline. %he service sector also witnessed growth moderation#
which has been gradual and less steep than the industrial sector# and its growth remained more or less constant
during I= ,-*,"*= to I* ,-*="*.. :s panel * of Bigure *.* shows# the declining trend in 1$P growth has
reversed in I, ,-*="*.# on the back of higher growth in agriculture and industry vis"K"vis I* ,-*="*..
(LE/LIEW (B %7E E'(D()F
>ource? )inistry of Binance E)id"Fear Economic :nalysis,-*=",-*.!G
R-dia" Masurs to Contro" In!"ation:
:ccording to %rading Economics on the benchmark interest rate in India was last recorded at 8 percent. Interest
/ate in India averaged ;.;. Percent from ,--- until ,-*.# reaching an all time high of *..+- Percent in :ugust of
,--- and a record low of ..,+ Percent in :pril of ,--9. Interest /ate in India is reported by the /eserve 0ank of
India.
%he )inistry of Binance and the /0I /eserve 0ank of India! always strive to control inflation. %hey control
inflation by directly affecting the demand pull inflation by changing the amount of liHuidity circulating in the
economy. %he /0I can change the liHuidity by its various tools viM. '//# 0ank"/ate /EP( and /everse"/EP(!#
>N/# etc.
'// 'ash /eserve /atio! is the proportion of amount which each commercial bank like >0I# I'I'I# etc.! has to
maintain in the form of hard cash. :ll commercial banks accept deposits from individuals and lend it to borrowers
at a higher interest rate. %he difference between the interest rate which they collect from borrowers and which they
pay to their depositors is their profit. Daturally# each bank will try to lend all the money they collect from
depositors. 7owever# banks can3t lend all the money they have. <nder law# each bank has to maintain a certain
proportion of cash as reserve. %his is known as '//. When /0I increases the '//# the bank3s lending power
decreases. Ness lending means less borrowing# this in turn means less money in the economy. Nast month# the /0I
increased the '// from 8.C+A to 9A to control inflation. >N/ >tatutory NiHuidity /atio! is also similar to '//.
0ut in case of >N/# 1overnment">ecurities need to be maintained by the commercial banks instead of cash.
In its ,8th @anuary ,-*. meeting# /eserve 0ank of India decided to raise the policy repo rate by ,+ bps to 8
percent to handle currency pressure and curb persistently high inflation.
0ank"/ate is basically the interest rate at which the 'entral 0ank borrows from the other scheduled commercial
banks. %his rate is directly linked to the interest rates charged in turn by all the commercial banks to its customers.
:ll these other interest rates on 7ome"loans# Personal"loans# etc. also increase with the increase in bank"rate.
%hus# by raising the 0ank"/ate and in turn all other Interest /ates# the /0I makes borrowing money from banks a
very costly affair. People are thus discouraged to borrow more money and total amount of liHuidity decreases in
the economy. Nast month# the /0I increased the 0ank /ate from 8.+A to 9.+A. %his was an increase of +- basis"
points -.+A! to control inflation.
%he above mentioned measures viM. '//# >N/# 0ank"/ate are called )onetary Policy tools. :part from these#
there are certain Biscal Policy tools which the 1overnment can use. (ne recent example of fiscal tool is the recent
ban placed on the export of 0asmati rice by the Binance )inister. 0y banning the export of rice# the supply of rice
will increase in the home country relative to its demand. %his will naturally bring down the price of rice which is a
ma2or component of WPI. %he price"rise in 0asmati rice is an example of $emand"pull inflation because demand
has increased relative to supply. :lthough# it could be said that demand for rice is not related to liHuidity but is
inelastic where demand is autonomous and not related to increase in price or income!.
%he rise in interest rates initially makes life difficult for people who have taken loans on floating interest rates# it is
a reHuired step to bring down inflation which is a larger evil. It might also be noted that /0I# by making the policy
changes can control only one type of inflation i.e. demand"pull inflation. It cannot affect the other type of inflation
i.e. cost"push inflation which is caused by rise in prices of raw"materials and other factors of production. %hat is
why the rate of inflation is increasing continuously since last six months although the /0I is trying to control it. In
fact# only the cost"push component of inflation is rising which consists of increase in prices of steel# cement#
petroleum# etc. >ome of these factors are produced in our country and others are imported. 0ut the prices of none
of them can be controlled by the government.
.un (rd/ %&'0 -tin#/ Rsr1 2an3 o! India "!t t) r$o rat at 4 $rcnt/ *ut cut t) a-ount o!
#o1rn-nt *onds *an3s -ust )o"d 5it) t) cntra" *an3 - t) statutory "i6uidity ratio - *y 7& *$s to %%87
$rcnt/ ai-in# to incras *an3 crdit8
%he cut in statutory liHuidity ratio will take effect from the fortnight beginning @une *.# ,-*.. %he central bank
also decided to reduce the liHuidity provided under the export credit refinance facility from +- per cent of eligible
export credit outstanding to =, per cent with immediate effect. Policymakers introduced a special term repo
facility of -.,+ per cent of net demand and time liabilities to compensate fully for the reduction in access to
liHuidity under the E'/ with immediate effect.
In )arch and :pril# 'PI headline inflation has risen on the back of a sharp increase in food prices. >ome of this
price pressure will continue into )ay# but it is largely seasonal. )oreover# 'PI inflation excluding food and fuel
has been edging down. %he risks to the central forecast of 8 per cent 'PI inflation by @anuary ,-*+ remain broadly
balanced. <pside risks in the form of a sub"normalOdelayed monsoon on account of possible El Dino effects# geo"
political tensions and their impact on fuel prices# and uncertainties surrounding the setting of administered prices
appear at this stage to be balanced by the possibility of stronger 1overnment action on food supply and better
fiscal consolidation as well as the pass through of recent exchange rate appreciation. :ccordingly# at this 2uncture#
it is appropriate to leave the policy rate unchanged# and to allow the disinflationary effects of rate increases
undertaken during >eptember ,-*="@anuary ,-*. to mitigate inflationary pressures in the economy.
%he /eserve 0ank remains committed to keeping the economy on a disinflationary course# taking 'PI inflation to
8 per cent by @anuary ,-*+ and ; per cent by @anuary ,-*;. If the economy stays on this course# further policy
tightening will not be warranted. (n the other hand# if disinflation# ad2usting for base effects# is faster than
currently anticipated# it will provide headroom for an easing of the policy stance.
In pursuance of the $r. <r2it /. Patel 'ommittee3s recommendation to move away from sector"specific refinance
towards a more generaliMed provision of system liHuidity without preferential access to any particular sector or
entity# the /eserve 0ank has decided to limit access to export credit refinance while compensating fully with a
commensurate expansion of the market3s access to liHuidity through a special term repo facility from the /eserve
0ank eHuivalent to -.,+ per cent of D$%N!. %his should improve access to liHuidity from the /eserve 0ank for
the system as a whole without the procedural formalities relating to documentary evidence# authoriMation and
verification associated with the E'/. %his should also improve the transmission of policy impulses across the
interest rate spectrum and engender efficiency in cashOtreasury management.
:s the economy recovers# investment demand and the need for credit will pick up. %o the extent that this
contributes eventually to supply# it is important that banks have the room to finance it. : reduction in the reHuired
>N/ will give banks more freedom to expand credit to the non"1overnment sector. 7owever# the /eserve 0ank is
also cogniMant of the significant on"going financing needs of the 1overnment. %herefore# the >N/ is reduced by
-.+- per cent of D$%N# with any further change dependent on the likely path of fiscal consolidation.
CPI s)ou"d * usd to st in!"ation tar#t: R2I $an"
Inflation based on 'onsumer Price Index 'PI!
: /eserve 0ank of India /0I! panel on %uesday recommended that monetary policy be set by a committee and
that consumer price index 'PI! inflation be used to set an inflation target# eventually of . percent.
%he panel's report also said it should be made clear that managing inflation is the central bank's primary ob2ective.
%he recommendations of the panel# which was established by /0I 1ov. /aghuram /a2an when he took office in
early >eptember# are widely expected to be adopted by the Indian central bank.
<nder current /0I practice# the power to make policy decisions is held solely by the governor. %he /0I# unlike
many central banks# has long used wholesale price index WPI! inflation as its primary guage.
/eserve 0ank of India /0I! 1overnor /aghuram /a2an today hiked repo rate" the rate at which the central bank
lends short term money to banks" for the second time in as many months# citing inflationary concerns.
: /eserve 0ank of India /0I! panel on %uesday recommended that monetary policy be set by a committee and
that consumer price index 'PI! inflation be used to set an inflation target# eventually of . percent.%he panel's
report also said it should be made clear that managing inflation is the central bank's primary ob2ective.%he
recommendations of the panel# which was established by /0I 1overnor /aghuram /a2an when he took office in
early >eptember# are widely expected to be adopted by the Indian central bank.<nder current /0I practice# the
power to make policy decisions is held solely by the governor. %he /0I# unlike many central banks# has long used
wholesale price index WPI! inflation as its primary guage
Hr ar
*. /epo or short"term lending rate hiked by -.,+ per cent to C.C+ per cent
,. )arginal standing facility )>B! rate or overnight lending rate cut by -.,+ per cent to 8.C+ per cent
=. 1rowth forecast for the current fiscal slashed to + per cent from +.C per cent earlier
.. 'ash reserve ratio '//!" the portion of a bank's deposit that it must mandatorily park with /0I#
unchanged at . per cent. %he minimum daily maintenance of the '// has been reduced from 99 per cent
of the reHuirement to 9+ per cent effective from the fortnight beginning >eptember ,*. ,-*=.
+. 'ash provided to banks through term repo increased to -.+- per cent of net demand and time liability
from -.,+ per cent earlier
;. $ifference between repo and )>B rate narrows to * per cent
C. Wholesale inflation expected to be higher than current levels; warranting 'appropriate policy response'
8. /etail inflation to remain around 9 per cent or even higher without policy action
9. %o closely monitor inflation risks while being mindful of the evolving growth dynamics
*-. Bood price pressures may ease with the arrival of summer crop harvest and seasonal moderation
Conc"usion:
Inflation is not harmful at all times. In fact only when there is a sustained increase above CA to 8A# there is cause
for worry. In fact a low level of inflation between ,A and +A is a sign of prosperity. It is reHuired for growth.
%hat3s because it gives the producer of goods and services a certain impetus to stay in the market. %his in turn
gives rise to growth# development and employment which is very much reHuired. Inflation is also closely linked to
employment but that is the topic of discussion for another day.
/eference?
Economic NiberaliMation in India n.d.!# /etrieved from
http?OOen.wikipedia.orgOwikiOEconomicPliberalisationPinPIndia
)id"Fear Economic :nalysis,-*="*.! /etrieved from
http?OOwww.finmin.nic.inOreportsO)F/,-*=*.English.pdf
Inflation# /etrieved from
http?OOen.wikipedia.orgOwikiOInflation
'PI should be used to set inflation target? /0I panel@an. ,*#,-*.! /etrieved from
http?OOin.reuters.comOarticleO,-*.O-*O,*Oindia"rbi"monetarypolicy"inflation"idID$EE:-Q-E,,-*.-*,*
/0I will need to keep raising policy interest rate R I)B /etrieved from
http?OOin.reuters.comOarticleO,-*.O-,O,*Oindia"economy"policy"imf"idID$EE:*@-'S,-*.-,,*