ACKNOWLEDGEMENT

I would like to put forth my gratitude, indebtness, and thankfulness to the authorities of Sbodh Institute of Management and Career studied, Jaipur for giving me the opportunity to do a project report on INFLATION . I would like to thank Prof. Sharmila mam for his constant guidance, advice, suggestions and for his encouragement, to complete the project successfully.

DECLARATION

We hereby declare that all the information that has been collected, analyzed, and provided for the purpose of this project is entirely true and factual. We would also like to mention that the work here has neither purchased nor acquired by any other unfair means .and it has not been submitted to other universities or published any time before. The information presented in the report is accurate and updated to the best of our capabilities and knowledge. ABHISHEK JOSHI

CONTENTS

Overview of inflation Definition Types of Inflation Measures of inflation Issues in Measuring Inflation Causes of Inflation Effect of Inflation Control of Inflation Inflation in India Calculation of Inflation in India Rate of Inflation in Indian Whom does inflation hit the most Analysis Report Conclusion and recommendation

4 5 7 14 16 17 20 23 26 27 31 35 45 48

OVERVIEW OF INFLATION
Everyone is familiar with the term Inflation as rising prices. This means the same thing as fall in the value of money. For example, a person would like to buy 5kgsof apple with Rs. 100, at the present rate of inflation, say, zero. Now when the inflation rate is 5%, then the person would require Rs. 105 to buy the same quantity of apples. This is because there is more money chasing the same produce. Thus, Inflation is a monetary aliment in an economy and it has been defined in so many ways, which can be defined as the change in purchasing power in a currency from period to period relative to some basket of goods and services. Inflation is a rise in general level of prices of goods and services over time. Although "inflation" is sometimes used to refer to a rise in the prices of a specific set of goods or services, a rise in prices of one set (such as food) without a rise in others (such as wages) is not included in the original meaning of the word. Inflation can be thought of as a decrease in the value of the unit of currency. It is measured as the percentage rate of change of a price index but it is not uniquely defined because there are various price indices that can be used. Many economists believe that high rates of inflation are caused by high rates of growth of the money supply. Views on the factors that determine moderate rates of inflation are more varied: changes in inflation are sometimes attributed to fluctuations in real demand for goods and services or in available supplies (i.e. changes There are many measures of inflation. For example, different price indices can be used to measure changes in prices that affect different people. Two widely known indices for which inflation rates are reported in many countries are the Consumer Price Index (CPI), which measures consumer prices, and the GDP deflator, which measures price variations associated with domestic production of goods and services.

DEFINITION
Inflation is a general and progressive increase in prices; "in inflation everything gets more valuable except money" .It can be either an increase in money supply or a decrease in available goods and services. A simple commonly used definition of the word inflation is simply "an increase in the price you pay or a decline in the purchasing power of money". In other words, Price Inflation is when prices get higher or it takes more money to buy the same item. Inflation is the rise in the general price level in demand without corresponding rise in supply According to Webster's Dictionary However, The American Heritage Dictionary of the English Language, Fourth Edition, and Copyright 2000 Published by Houghton Mifflin Company says: Inflation is a persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services. Crowther, similarly defines inflation as the state in which value of money is falling, i.e.prices are rising Authors like Torp and Quant, however opine that it is of great help to define the term inflation in observable phenomenon and for this reason the process of rising prices is inflation .

TYPES OF INFLATION
The various types of inflation are classified as follows (a) . RATE OF INFLATION According to the rate of inflation, there are three types of inflation, 1. Moderate inflation (a) Creeping (b) Walking 2. Running inflation 3. Galloping Inflation 4. Hyper Inflation

1. Moderate, Galloping and Hyperinflation: The severity of inflation is often measured in terms of the rapidity of price rise. On the basis, a quantitative distinction of inflation may be made into three categories, viz: Moderate inflation; Running and galloping inflation; and Hyperinflation. a. Moderate Inflation It is a mild and tolerable form of inflation. It occurs when prices are rising slowly when the rate of inflation is less than 10 per cent annually, or it is a single digit int1ation rate, it is considered to be a moderate inflation in the present the economy. The following are the major characteristics of moderate inflation: i. There is a single digit inflation rate (less than 10 per cent) annually. ii. It does not disrupt the economic balance. iii. It is regarded as stable inflation in which the relative prices do not get far out of line. iv. Peoples expectations remain more or less stable under moderate inflation. v. Under a low inflation rate, the real interest rate is not too low or negative, so money can serve its role as a store of value without difficulty. vi. There are modest inefficiencies associated with moderate inflation.

Economists have arbitrarily laid down that a 3-4 per cent price rise per annum is a tolerable rate of inflation in modern economies. Even the Chakravarthi Report of the Reserve Bank of India has accepted 3-4 per cent rate of inflation annually to be an efficient and tolerable norm for the Indian economy. Incidentally, some economists have described up to 3 per cent annual rate of inflation as creeping inflation and if it exceeds 10 per cent, it is called walking inflation. This means, Samuelson has clubbed creeping and walking inflation intoModerate inflation. Samuelsons opinion, moderate inflation is not a serious problem. While some economists feel that even a walking inflation should make us more cautious, as it represents a warning signal for the occurrence of running or double digit and eventually a galloping inflation, if it is not checked in time. 2. Running and Galloping Inflation: When the movement of price accelerates rapidly, running inflation emerges. Running inflation may record more than 100 per cent rise in prices over a decade. Thus, when prices rise by more than 10 per cent a year, running inflation occurs. Economists have not described the range of running inflation. But, we may say that a double digit inflation of 10-20 percent per annum is a running inflation. If it exceeds that figure, it may be called galloping inflation. According to Samuelson, when prices are rising at double or triple digit rates of 20, 100 or 200 per cent a year, the situation is described as galloping inflation. Indian economy has witnessed a sort of running and galloping inflation to some extent (not exceeding 25 per cent per annum) during the planning era, since the Second Plan period. Argentina, Brazil and Israel, for instance, have experienced inflation rates over 100 per cent in the eighties. Galloping inflation is really a serious problem. It causes economic distortions and disturbances. 3. Hyper Inflation In the case of hyperinflation, prices rise every movement, and there is no limit to the height to which prices might rise. Therefore, it is difficult to measure its magnitude, as prices rise by fits and starts. . In quantitative terms, when prices rise over 1000 per cent in a year, it is called a hyperinflation. Austria, Hungary, Germany, Poland and Russia witnessed

Hyperinflation in the wake of World War I. Hyperinflation notably took place in Germany in 1920-1923. The German price index rose from 1 to 10, 00,000,000 % during January 1922 to November 1923. Believe it or not, it is a fact! In the year 2007-08 due to poitical and economic disturbances the African nation Zimbabwe experienced the the rate of inflation as high as 35,0000% The Main Features of Hyperinflation are i. During hyperinflation, the price rise is severe. The price index moves up by leaps and bounds. It is over 1000 per cent per year. There is at least a 50 per cent price rise in a month, so that in a year it rises to about 130 times. ii. It represents the deterioration in purchasing power of public . iii. It is apparently generated by a massive fiscal dislocation. iv. It is amplified by wage-price spiral. v. Hyperinflation is a monetary disease. vi. The velocity of circulation of money increases very fast. vii. The structure of the relative prices of goods becomes highly unstable. viii. The real wages tend to decline fast. (b.) TIME PERIOD According to the nature of time period of occurrence, inflation is classified into three types, 1. War-time Inflation 2. Post-war Inflation 3. Peace-time Inflation War, Post-War and Peace-Time Inflation On the basis of the nature of time-period of occurrence, we have: War-time inflation; Post-war inflation; and Peace-time inflation. 1. War-Time Inflation It is the outcome of certain exigencies of war, on account of increased government expenditure on defence which is of an unproductive nature. By such public expenditure, the government apportions a substantial production of goods and services out of total availability for war which
8

causes a downward shift in the supply; as a result, an inflationary gap may develop. 2. Post-war Inflation It is a legacy of war. In the immediate post-war period, it is usually experienced. This may happen when the disposable income of the community increases, when war-time taxation is withdrawn or public debt is repaid in the post-war period. 3. Peace-time Inflation By this is meant the rise in prices during the normal period of peace. Peacetime inflation is often a result of increased government outlays on capital projects having a long gestation period; so a gap between money income and real wage goods develops. In a planning era, thus, when governments expenditure increases, prices may rise. (c) GOVERNMENT REACTION According to government there are two types of inflations 1. Open inflation 2. Repressed inflation

Open and Repressed Inflation Inflation is open or repressed according to the governments reaction to the prevalence of inflationary forces in the economy. a. Open Inflation When the government does not attempt to prevent a price rise, inflation is said to be open. Thus, inflation is open when prices rise without any interruption. In open inflation, the free market mechanism is permitted to fulfill its historic function of rationing the short supply of goods and distribute them according to consumers ability to pay. Therefore, the essential characteristics of an open inflation lie in the operation of the price mechanism as the sole distributing agent. The post-war hyperinflation during the twenties in Germany is a living example of open inflation. b. Repressed Inflation

When the government interrupts a price there is a repressed or suppressed inflation.. Thus, suppressed inflation refers to those conditions in which price increases are prevented at the present time through an adoption of certain measures like price controls and rationing by the government, but they rise on the removal of such controls and rationing. The essential characteristic of repressed inflation, in contrast to open inflation, is that the former seeks to prevent distribution through price rise under free market mechanism and substitutes instead a distribution system based on controls. Thus, the administration of controls is an important feature of suppressed inflation. Types of Inflation Based on the Causes Inducing Inflation According to the cause of rising prices, one can consider several types of inflation as follows: 1. Credit-inflation 2. Deficit inflation 3. Scarcity inflation 4. Profit-inflation 5. Foreign trade inflation 6. Tax-inflation 7. Cost or wage inflation 8. Demand inflation 1. Credit Inflation Inflation which is caused by excessive expansion of bank credit or money supply is referred to as credit or money inflation. 2. Deficit Inflation It is the inflation caused by deficit financing. When the government budgets contain heavy deficit financing, through creating new money, the purchasing power in the community increases and prices rise. This may be referred as to As deficit-induced inflation. During a planning era, when government launches upon heavy investment, it usually resorts to deficit financing, when adequate resources are not found. An inflationary spiral develops due to deficit financing, when adequate resources are not found and the consumption of goods fails to keep pace with the increased money expenditure.
10

3. Scarcity Inflation Whenever scarcity of real goods occurs or may be artificially created by the hoarding activities of unscrupulous traders and speculators which may result into black-marketing, thereby causing prices to go up, such type of inflation may be described as scarcity inflation. 4. Profit Inflation . The concept of profit inflation was originated by Keynes in his Treatise on Money. According to Keynes, the price level of consumption goods is a function of the investment exceeding savings. He considered the investment Boom as a reflection of profit boom. Inflation is unjust in its distribution effect. It redistributes income in favor of profiteers and against the wageearning class. During inflation, thus, the entrepreneur class may tend to expect an upward shifting of the marginal efficiency of capital (MEC); hence entrepreneurs are induced to invest more even by borrowing at higher interest rates. Eventually, investment exceeds savings and economy tends to reach a higher level of money income equilibrium. If economy is operating at full employment level or if there are bottlenecks of market imperfections, real output will not rise proportionately, so the imbalance between money Income and real income is corrected through rising prices. 5. Foreign-Trade Induced Inflation For an international economy, we may categories the following Two types of inflation as being caused by factors pertaining to The balance of payments. i. Export-Boom Inflation; and ii. Import Price-hike Inflation. a. Export-Boom Inflation When a country having a sizeable export component in its foreign trade experiences a sudden rise in the demand for its exportable against the inelastic supply of exportable in the domestic market, it obviously implies an excessive pressure of demand which is revealed in terms of persistent inflation at Home. Again, trade gains and sudden influx of exchange remittances may lead to an increase in monetary liabilities which is further reflected in the rising pressure of demand for domestic output causing an inflationary spiral to get further momentum. Such a permanent case for export-boom inflation is, however, ruled out in the Indian economy, because neither export trade is a significant portion of
11

Domestic National Product nor is there a continuous boom of exportdemand, causing tenus of trade to move up favorably all the time. b. Import Price-hike Inflation When prices of import components rise due to inflation abroad, the domestic costs and prices of goods using these imported parts vill tend to rise. Such an int1ation is referred to as imported intluion. For instance, hike in oil prices by the Arab countries was responsible for accelerating. Inflationary price rise in many oil-importing countries, including India to some extent. 6. Tax Inflation Year to year increase in commodity taxation such as excise duties and sales tax may lead to rise in prices of taxed goods. Such inflation is termed as tax inflation or tax-induced inflation. 7. Cost Inflation When inflation emerges on account of a rise in cost factor, it is called cost inflation. It occurs when money incomes (wage rate, particularly) expand more than real productivity. Cost inflation has its course through the level of money costs of the factors of production and in particular through the level of wage rates. Due to a rising cost of living index, workers demand hitch wages, and higher wages in their turn increase the cost of production, which a producer generally meets by raising prices. This process of spiraling may each higher and higher level. In this case, however, cyclical anti-inflation remedies of monetary Controls are not relative effective. Wage inflation is an important variant of cost inflation. Wage push inflation occurs when money wages are raised without Corresponding improvement in the productivity of the workers. 8. Demand Inflation When there is an excess of aggregate, detrland against the available aggregate supply of goods and services, prices tend to rise. It is called demand-induced inflation. Population-growth, rising money income, etc. forces playa significant role in generating demand inflation. There are three major types of inflation,

Demand-pull inflation: inflation caused by increases in aggregate demand due to increased private and government spending, etc. Demand inflation is constructive to a faster rate of economic growth since the excess demand and favorable market conditions
12

will stimulate investment and expansion. The failing value of money, however, may encourage spending rather than saving and so reduce the funds available for investment. Cost-push inflation: presently termed "supply shock inflation," caused by drops in aggregate supply due to increased prices of inputs, for example. Take for instance a sudden decrease in the supply of oil, which would increase oil prices. Producers for whom oil is a part of their costs could then pass this on to consumers in the form of increased prices. Built-in inflation: induced by adaptive expectations, often linked to the "price/wage spiral" because it involves workers trying to keep their wages up (gross wages have to increase above the CPI rate to net to CPI after-tax) with prices and then employers passing higher costs on to consumers as higher prices as part of a "vicious circle." Built-in inflation reflects events in the past, and so might be seen as hangover inflation.

A major demand-pull theory centers on the supply of money: inflation may be caused by an increase in the quantity of money in circulation relative to the ability of the economy to supply (its potential output). This is most obvious when governments finance spending in a crisis, such as a civil war, by printing money excessively, often leading to hyperinflation, a condition where prices can double in a month or less. Another cause can be a rapid decline in the demand for money, as happened in Europe during the Black Plague. The money supply is also thought to play a major role in determining moderate levels of inflation, although there are differences of opinion on how important it is.

HOW TO CALCULATE INFLATION?

Inflation can be measured by calculating the rate of change in a price index. Inflation is measured by observing the change in the price of a large number of goods and services in an economy, usually based on data collected by government agencies. The prices of goods and services are combined to give a price index or average price level, the average price of the basket of products. The inflation rate is the rate of increase in this index

13

Measuring the size of a balloon, inflation refers to the increase in its size. There is no single true measure of inflation. The rate can be calculated for many different price indices, including:
1. Consumer price index:

A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance. Changes in CPI are used to assess price changes associated with the cost of living. CPI is one of the most frequently used statistics for identifying periods of inflation or deflation. This is because large rises in CPI during a short period of time typically denote periods of inflation and large drops in CPI during a short period of time usually mark periods of deflation. In case of Indian economy the CPI is calculated for the rural and urban areas separately.

the new press release by central GOVERNMENT OF INDIA, april 2011

statistical

department,

14

Groups/sub groups

Rural

Urban

Combined (rural+urban) 14.59 2.65

Cereals Pulses

19.08 3.25

8.03 1.87

Milk & milkproducts

8.59

6.61

7.73

Oil and fats

4.67

2.89

3.90

Egg,fish & meat

3.38

2.26

2.89

Vegetables

6.57

3.96

5.44

Fruits

1.90

1.88

1.89

Sugar etc.

2.41

1.26

1.91

Condiments and spices

2.13

1.16

1.71

Non-alcoholic beverages

2.04

2.02

2.03

Prepared meals etc.

2.57

3.17

2.83

Pan, tobacco and intoxicants

2.73

1.35

2.13

FOOD BEVERAGES and TOBACCO

59.31

37.15

49.71

FUEL and LIGHT

10.42

8.40

9.49

clothing and bedding

4.60

3.34

4.05

15

Footwear

0.77

0.57

0.68

CLOTHING BEDDING and FOOTWEAR

5.36

3.91

4.73

HOUSING

22.53

9.77

Education

2.71

4.18

3.15

Medical care

6.72

4.34

5.69

Recreatment and amusemesnt

1.00

1.99

1.43

Transport and communication

5.83

9.84

7.57

Personal care and effects

3.05

2.74

2.92

Household requisits

4.84

3.92

4.30

Others

1.12

0.99

1.06

Miscellaneous

24.91

28.00

26.31

All groups

100.00

100.00

100.00

16

2.Cost of living indices (COLI): are indices similar to the CPI which are often used to adjust fixed incomes and contractual incomes to maintain the real value of those incomes. 3.Producer price indices PPIs which measures the prices received by producers. This differs from the CPI in that price subsidization, profits, and taxes may cause the amount received by the producer to differ from what the consumer paid. There is also typically a delay between an increase in the PPI and any resulting increase in the CPI. Producer price inflation measures the pressure being put on producers by the costs of their raw materials. This could be "passed on" as consumer inflation, or it could be absorbed by profits, or offset by increasing productivity. In India and the United States, an earlier version of the PPI was called the Wholesale Price Index. 4.Commodity price indices, Commodity price indices measure the price of a selection of commodities. In the present commodity price indices are weighted by the relative importance of the components to the "all in" cost of an employee.

17

The GDP Deflator is a measure of the price of all the goods and services included in Gross Domestic Product (GDP). The US Commerce Department publishes a deflator series for US GDP, defined as its nominal GDP measure divided by its real GDP measure. Capital goods price Index, although so far no attempt at building such an index has been made, several economists have recently pointed out the necessity of measuring capital goods inflation (inflation in the price of stocks, real estate, and other assets) separately. Indeed a given increase in the supply of money can lead to a rise in inflation (consumption goods inflation) and or to a rise in capital goods price inflation. The growth in money supply has remained fairly constant through since the 1970s however consumption goods price inflation has been reduced because most of the inflation has happened in the capital goods prices. Wholesale price index: An index that measures and tracks the changes in price of goods in the stages before the retail level. Wholesale price indexes (WPIs) report monthly to show the average price changes of goods sold in bulk, and they are a group of the indicators that follow growth in the economy.

ISSUES IN MEASURING INFLATION

Measuring inflation requires finding objective ways of separating out changes in nominal prices from other influences related to real activity. In the simplest possible case, if the price of a 10 oz. can of corn changes from $0.90 to $1.00 over the course of a year, with no change in quality, then this price change represents inflation. But we are usually more interested in knowing how the overall cost of living changes, and therefore instead of looking at the change in price of one good, we want to know how the price of a large 'basket' of goods and services changes. This is the purpose of looking at a price index, which is a weighted average of many prices. The weights in the Consumer Price Index, for example, represent the fraction of spending that typical consumers spend on each type of goods (using data collected by surveying households).
18

Inflation measures are often modified over time, either for the relative weight of goods in the basket, or in the way in which goods from the present are compared with goods from the past. This includes hedonic adjustments and reweighing as well as using chained measures of inflation. As with many economic numbers, inflation numbers are often seasonally adjusted in order to differentiate expected cyclical cost increases, versus changes in the economy. Inflation numbers are averaged or otherwise subjected to statistical techniques in order to remove statistical noise and volatility of individual prices. Finally, when looking at inflation, economic institutions sometimes only look at subsets or special indices. One common set is inflation excluding food and energy, which is often called core inflation.

CAUSES OF INFLATION
Some of the Causes of Inflation Inflation is a complex phenomenon which cannot be attributed to a single factor. We may summaries the major causes of inflation thus: 1. Over-expansion of Money Supply Many a times, a remarkable degree of correlation between the increase in money supply and the rise in the price level may be observed. 2. Expansion of Bank Credit Rapid expansion of bank credit is also responsible for the inflationary trend in a country. 3. Deficit Financing The high doses of deficit financing which may cause reckless spending, may also contribute to the growth of the inflationary spiral in a country. 4. Ordinary Monetary Factors Among other monetary factors influencing the price trend in an economy, the major ones are listed here: a. High Non-development Expenditure . The continuous increase in public expenditure, and especially the growth of defence and non-development expenditure. b. Huge Plan Investment.

19

The huge planned investment and its high rate of growth in every plan may lead to an excess demand in the capital goods sector, so that industrial prices may rise. c. Black Money . Some economists have condemned black money in the hands of tax evaders and black marketers as an important source of inflation in a country. Black money encourages lavish spending, which causes excess demand And a rise in price d. High Indirect Taxes. Incidence of high commodity taxation. Prices tend to rise on account of high excise duties imposed by the Government on raw materials and essential goods. Non-Monetary Factors There are various non-monetary and structural factors that may Cause a rising price trend in a country. These are: a. A high Population Growth. Undoubtedly, the rising pressure of demand resulting from of population and money income, will cause a high price rise in an over populated country. b. Natural Calamities and Bad Weather Conditions. Vagaries of monsoon, bad weather conditions, droughts and failure of agricultural crops have been responsible for price spurts, from time to time, in many underdeveloped countries. Agricultural prices are most sensitive to inflationary forces in India. Natural calamities also contribute occasionally to the inflationary boost in a country. Events such as cyclones and floods, which destroy village economies, also aggravate the inflationary pressure. c. Speculation and Hoarding . Hoarding and speculative activities, corruption at every level, in both private and public sectors, etc., are also responsible to some extent for aggravating inflation in a: country. d. High Prices of Imports. Inflation has also been inflicted on some countries through the import content used by their industries. Prices of petroleum products have been increased in many countries due to price hikes by the oil producing countries. e. Monopolies.
20

Monopoly profits and unfair trade practices by big industrial houses are also responsible for the price rise in countries like India. f. Underutilization of Resources. Non-utilization of installed capacities in large industries is also a contributory factor to inflation. Inflation in the country may be regarded as a symptom of a Deep-seated malady, born of structural deficiencies involved in the functioning of its economic system, which is characterized by inherent weaknesses, wastages, and imbalances. GAPS AND BOTTLE NECK To understand the true nature of inflation in an underdeveloped country, one has to examine the bottlenecks and gaps of various types which obstruct the normal growth process, causing prices to rise with the generation of money income without an appropriate rise in real income. These gaps or bottlenecks may be enlisted as to follows: 2. Market imperfections. Market imperfections like factor immobility, price rigidity, ignorance of market conditions, rigid social and institutional structures, and lack of specialization and training in underdeveloped economies do not allow an optimum allocation and utilization of resources. Hence, increase in money supply and increased money income remains unaccompanied by increased supply of real output, causing a net price rise of an inflationary nature in these economies. a. Capital Bottleneck. On account of a very low rate of capital formation and consequent capital deficiency, a poor country is caught in a vicious circle of poverty, and any excessive money supply instead of breaking this vicious circle, tends to create a chronic inflationary spiral. Thus, in a poor country, there is inflation because by virtue of its internal backwardness, it is prone to chronic inflation. b. Entrepreneurial Bottleneck. Entrepreneurs in underdeveloped countries lack skill, spirit of boldness and adventure. They prefer trading or safer traditional investments rather than attempt risky innovations. Absence of adequate industrial capital, prevalence of merchant capital and a colossal amount of private investments in such Unproductive fields as land, jewellery, gold, etc., which is a gross socio economic waste, starves the developing economy of its much needed
21

capital resources. Thus, increased money supply or savings in terms of money makes little impact on real output and monetary equilibrium is just attained through a galloping price rise in the various sectors of the economy. c. Food Bottleneck. Due to slow growth of agriculture, overpressure of growing population on land, primitive methods of cultivation, defective land tenure system, lack of adequate irrigation facilities and many other reasons, agriculture output, especially food supply which constitutes a large part of wagegoods, has failed to keep pace with the growing demand for it from the growing population and. Increased rural employment in the rural industrilsation process in these countries. This food bottleneck has created the problem of price rise in food grains, and it has become the cornerstone in the whole of pricestructure in the developing economies. d. Infrastructural Bottleneck. These refer to power shortages and inadequacies of transport facilities in underdeveloped economies. Infrastructural bottlenecks obviously restrict the Growth process in industrial, agricultural and commercial sectors and cause under-utilization of capacity in the economy as a whole. Underutilization of resources does not absorb the full increase in money supply and reflects upon the rising prices. f. Foreign Exchange Bottleneck. Developing economies suffer from a fundamental structural disequilibrium in the balance of payments due to high imports and low exports on unfavorable terms of trade; hence, they usually suffer from foreign exchange scarcity problem. In recent years, day to day, rising imports bills due to high oil prices have aggravated the problem further. This foreign exchange bottleneck comes in the way of necessary imports to check domestic inflation. Again, the need to boost exports to meet the growing deficits in the balance of payments puts an extra pressure on the marketable surplus meant for domestic requirements. This eventually leads to a heavy rise to exportable commodities in the domestic market. g. Resources Gap. When the public sector is widely expanded for industrial development in these countries, the government aggravates the problem of resources gap. Owing to the backward socio-economic political structure of the less developed country, its government always fmds it difficult to raise
22

sufficient resources through taxation, public borrowings and profit of State enterprises, to meet the ever-increasing public expenditure in intensive and extensive dimensions. As such, under the pressure of the resources gap, the government has to resort to a heavy does of deficit flanking, despite knowing its dangers. This makes the economy inflation prone. Similarly, the resource gap in the private sector, caused by low voluntary savings and high-cost economy, presses for over-expansion of money supply through bank credit which, by and large, Results in the acceleration of inflationary spiral in the economy.

EFFECTS OF INFLATION
A controlled rise in the level of inflation can be viewed as having a beneficial effect on the economy. One reason for this is that it can be difficult to renegotiate prices and wages. With generally increasing prices it is easier for relative prices to adjust. Many prices are "sticky downward" and tend to creep upward, so that efforts to attain a zero inflation rate (a constant price level) punish other sectors with falling prices, profits, and employment. Efforts to attain complete price stability can also lead to deflation, which is generally viewed as a negative by Keynesians because of the downward adjustments in wages and output that are associated with it. With inflation, the price of any given good is likely to increase over time, therefore both consumers and businesses may choose to make purchases sooner rather than later. This effect tends to keep an economy active in the short term by encouraging spending and borrowing and in the long term by encouraging investments. But inflation can also reduce incentives to save, so the effect on gross capital formation in the long run is ambiguous. Inflation is also viewed as a hidden risk pressure that provides an incentive for those with savings to invest them, rather than have the purchasing power of those savings erode through inflation. In investing, inflation risks often cause investors to take on more systematic risk, in order to gain returns that will stay ahead of expected inflation.

23

Inflation also gives central banks room to maneuver, since their primary tool for controlling the money supply and velocity of money is by setting the lowest interest rate in an economy - the discount rate at which banks can borrow from the central bank. Since borrowing at negative interest is generally ineffective, a positive inflation rate gives central bankers "ammunition", as it is sometimes called, to stimulate the economy. As central banks are controlled by governments, there is also often political pressure to increase the money supply to pay government services; this has the added effect of creating inflation and decreasing the net money owed by the government in previously negotiated contractual agreements and in debt. For these reasons, many economists see moderate inflation as a benefit; some business executives see mild inflation as "greasing the wheels of commerce." But other economists have advocated reducing inflation to zero as a monetary policy goal - particularly in the late 1990s at the end of a long disinflation period, when the policy seemed within reach; and some have even advocated deflation instead of inflation. In general, high or unpredictable inflation rates are regarded as bad:

Uncertainty about future inflation may discourage investment and saving. Redistribution o Rent Seeking - happens when resources are used to merely transfer wealth rather than produce it. E.g. a company tries to gauge and combat the costs of inflation. o Inflation redistributes income from those on fixed incomes, such as pensioners, and shifts it to those who draw a variable income, for example from wages and profits which may keep pace with inflation. o Debtors may be helped by inflation due to reduction of the real value of debt burden. o Inflation redistributes wealth from those who lend a fixed amount of money to those who borrow. For example, where the government is a net debtor, as is usually the case, it will reduce this debt redistributing money towards the government. Thus inflation is sometimes viewed as similar to a hidden tax.

24

A particular form of inflation as a tax is Bracket Creep (also called fiscal drag). By allowing inflation to move upwards, certain sticky aspects of the tax code are met by more and more people. For example, income tax brackets, where the next dollar of income is taxed at a higher rate than previous dollars, tend to become distorted. Governments that allow inflation to "bump" people over these thresholds are, in effect, allowing a tax increase because the same real purchasing power is being taxed at a higher rate. International trade: Where fixed exchange rates are imposed, higher inflation than in trading partners' economies will make exports more expensive and tend toward a weakening balance of trade. Shoe leather costs: Because the value of cash is eroded by inflation, people will tend to hold less cash during times of inflation. This imposes real costs, for example in more frequent trips to the bank. (The term is a humorous reference to the cost of replacing shoe leather worn out when walking to the bank.) Menu costs: Firms must change their prices more frequently, which impose costs, for example with restaurants having to reprint menus. Relative Price Distortions: Firms do not generally synchronize adjustment in prices. If there is higher inflation, firms that do not adjust their prices will have much lower prices relative to firms that do adjust them. This will distort economic decisions, since relative prices will not be reflecting relative scarcity of different goods. Rising inflation can prompt trade unions to demand higher wages, to keep up with consumer prices. Rising wages in turn can help fuel inflation. In the case of collective bargaining, wages will be set as a factor of price expectations, which will be higher when inflation has an upward trend. This can cause a wage spiral. In a sense, inflation begets further inflationary expectations. Hoarding: people buy consumer durables as stores of wealth in the absence of viable alternatives as a means of getting rid of excess cash before it is devalued, creating shortages of the hoarded objects. Hyperinflation: if inflation gets totally out of control (in the upward direction), it can grossly interfere with the normal workings of the economy, hurting its ability to supply.
o

25

HOW TO CONTROL INFLATION?

A healthy rise in the general price level (up to 10%) shows the growth of the economy, but if it rises with uncontrolled rate it is an alarming situation for the economy and may cause many economic and social damages to the country. Inflation is complex phenomenon. It should be attacked from various angles. The following are the broad categories of instruments commonly used in order to control inflation in modern economy:

(1) Monetary policy, (2) Fiscal policy, (3)Direct control, and (4) Miscellaneous measures.
1. Monetary Policy Inflation is primarily a monetary phenomenon. Hence, the most logical solution to check inflation is to check the flow of money supply by devising appropriate monetary policy and carefully implementing monetary measures. Broadly speaking, to control inflation, it is necessary to control total outlays because under conditions of full employment, increase in total outlays will be reflected in a general rise in prices, that is, inflation. Monetary policy used to control inflation is based on the assumption that a rise in prices (inflation) is due to excess of monetary demand for goods and services by the people because easy bank credit is available to them. Monetary policy, thus, pertains to banking and credit availability of loans to firms and households, interest rates, public debt and its management, and the monetary standard. Monetary management is aimed at the commercial banking system, and through this action, its effects are primarily felt in the economy as a whole. Monetary management, by directly affecting the volume of cash reserves of the banks, can regulate the supply of money and credit in the economy, thereby influencing the structure of interest rates and the availability of credit. Both these, factors affect the components of
26

aggregate demand (consumption plus investment) and the flow of expenditure in the economy. The central banks monetary management methods, the devices for decreasing or increasing the supply of money and credit for monetary stability is called monetary policy. Central banks generally use the three quantitative weapons, namely: (i) bank rate policy, (ii) Open market operations, and (iii) Variable reserve ratio to control the volume of credit in an economy. To curb inflationary pressures, a dear money policy is usually followed by using the quantitative methods; the total volume of credit is depleted. In this regard, (i) bank rate may be raised; (ii) Open market sales operation may be wldertaken; and (iii) In severe cases, the reserve requirement ratio may be increased. In a developing economy there is always an increasing need for credit. Growth requires credit expansion but to check inflation, there is need to contract credit. In such a conflict, the best course is to resort to credit control, restricting the flow of credit into the unproductive, inflationinfected sectors and speculative activities and diversifying the flow of credit towards the most desirable needs of productive and growthinducing sector.

Fiscal Policy
Fiscal policy is budgetary policy in relation to taxation, public borrowing, and public expenditure. Changes in the total expenditure can be effected by fiscal measures. To combat inflation, fiscal measures would involve increase in taxation and decrease in government spending. During inflation the government is supposed to counteract an increase in private spending. Obviously, during a period of full employment inflation, the aggregate demand in relation to the limited supply of goods and services is reduced to the extent that government expenditures is curtailed. A curtain public expenditure along is not sufficient. Government must simultaneously increase taxes to affect a cut in private expenditure also, -

27

in order to minimize inflationary pressures. As we know, when more taxes are imposed, the size of the disposable income diminishes, as also the magnitude of the inflationary gap, given the available supply of goods and services. Inflationary pressure is significantly weakened by the simultaneous curtailment of government expenditure and an increase in taxation because, more resources are released for expanding the productive capacity in the private sector; the Supply curve of aggregate goods and services shifts upwards with a contraction of monetary demand due to a decline in disposable income with people. It has been argued that a tax policy can be directed towards restricting demand without restricting production. For instance, excise duties or sales tax on various commodities take away the buying power from the consumer goods market without discouraging the expansion of production capacity. However, some economists point out that this is not a correct way of combating inflation becomes of its regressive nature. On the other hand, this may lead to a further rise in prices of such commodities, and inflation can spread from one sector to Another and from one commodity to another. But, during inflation, a progressive direct tax is considered best; it is also justified in the interest of social equity. .

Direct Controls
Direct controls refer to the regulatory measures undertaken to convert an open inflation into a repressed one. Such regulatory measures involve the use of direct control on prices and rationing of scarce goods. The function of price control is a fix a legal ceiling, beyond which prices of particular goods may not increase. When ceiling prices are fixed and enforced, it means prices are not allowed to rise further and so, inflation is suppressed. Under price control, producers cannot raise the price beyond a prevailing level, even though there may be a pressure of excessive demand forcing it up. Wartime price control is an example of such attempts to suppress inflation. In view of the severe scarcity of certain goods, particularly, food grains, government may have to enforce rationing, along with price control. The main function of rationing is to divert consumption from those commodities whose supply needs to be restricted for some special reasons, say, in order to make the commodity available to a larger number of people as possible. Thus, rationing

28

becomes essential when necessities, such as food grains, are relatively scarce. Rationing has the effect of limiting the variety of quantity of goods available for the good Cause of price stability and distributive justice. However, rationing is criticized on the ground that it restricts consumers sovereignty. According to Keynes, rationing involves a great deal of waste, both of resources and of employment. Prof.Kurihara, however, suggests that a sensible progress of rationing should aim at diverting consumption from particular articles whose supply is below normal rather than at controlling aggregate consumption. In short, monetary fiscal controls may be used to repress excess demand, in general, but direct controls can be more useful when they are applied to CALCULATION OF INFLATION IN INDIA Rising inflation was the most recent ticklish political issue that hit the Manmohan Singh government. But was inflation rising because of price rise in essential commodities? Or was it because of the 'erroneous method' of calculating inflation? Some economists assert that India's method of calculating inflation is wrong as there are serious flaws in the methodologies used by the government. Economists V Shunmugam and D G Prasad working with India's largest commodity bourse -- the Multi Commodity Exchange -- have come out with a research paper arguing that the government urgently needs to shift the method of calculating inflation. Saying that there are serious flaws in the present method of calculating inflation, the paper India should adopt methodologies in developed economies.

India uses the Wholesale Price Index (WPI) to calculate and then decide the inflation rate in the economy. Most developed countries use the Consumer Price Index (CPI) to calculate inflation.

29

Wholesale Price Index (WPI) WPI was first published in 1902, and was one of the more economic indicators available to policy makers until it was replaced by most developed countries by the Consumer Price Index in the 1970s. WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market. In India, a total of 435 commodities data on price level is tracked through WPI which is an indicator of movement in prices of commodities in all trade and transactions. It is also the price index which is available on a weekly basis with the shortest possible time lag only two weeks. The Indian government has taken WPI as an indicator of the rate of inflation in the economy. Consumer Price Index (CPI) CPI is a statistical time-series measure of a weighted average of prices of a specified set of goods and services purchased by consumers. It is a price index that tracks the prices of a specified basket of consumer goods and services, providing a measure of inflation. \CPI is a fixed quantity price index and considered by some a cost of living index. Under CPI, an index is scaled so that it is equal to 100 at a chosen point in time, so that all other values of the index are a percentage relative to this one. Economists Shunmugam and Prasad say it is high time that India abandoned WPI and adopted CPI to calculate inflation. India is the only major country that uses a wholesale index to measure inflation. Most countries use the CPI as a measure of inflation, as this actually measures the increase in price that a consumer will ultimately have to pay for. "CPI is the official barometer of inflation in many countries such as the United States, the United Kingdom, Japan, France, Canada, Singapore and China. The governments there review the commodity basket of CPI every 4-5 years to factor in changes in consumption pattern," says their research paper.

30

It pointed out that WPI does not properly measure the exact price rise an end-consumer will experience because, as the same suggests, it is at the wholesale level. The paper says the main problem with WPI calculation is that more than 100 out of the 435 commodities included in the Index have ceased to be important from the consumption point of view. Take, for example, a commodity like coarse grains that go into making of livestock feed. This commodity is insignificant, but continues to be considered while measuring inflation. India constituted the last WPI series of commodities in 1993-94; but has not updated it till now that economists argue the Index has lost relevance and can not be the barometer to calculate inflation. Shunmugam says WPI is supposed to measure impact of prices on business. "But we use it to measure the impact on consumers. Many commodities not consumed by consumers get calculated in the index. And it does not factor in services which have assumed so much importance in the economy," he pointed out. But why is India not switching over to the CPI method of calculating inflation? Finance ministry officials point out that there are many intricate problems from shifting from WPI to CPI model. First of all, they say, in India, there are four different types of CPI indices, and that makes switching over to the Index from WPI fairly 'risky and unwieldy.' The four CPI series are: CPI Industrial Workers; CPI Urban Non-Manual Employees; CPI Agricultural laborers; and CPI Rural labour. Secondly, officials say the CPI cannot be used in India because there is too much of a lag in reporting CPI numbers. In fact, as of May 21, the latest CPI number reported is for March 2006. The WPI is published on a weekly basis and the CPI, on a monthly basis. And in India, inflation is calculated on a weekly basis.
31

India Inflation Rate The Indian economy has been registering stupendous growth after the liberalization of Indian economy. The opening up of the Indian economy in the early 1990s had increased India's industrial output and consequently has raised the India Inflation Rate. The stupendous growth rate of industrial output and employment has created enormous pressure on the inflation rate. The Reserve Bank of India (the central bank) and the Ministry of Finance, Government of India are concerned about the prevalent and intermittent rise of the inflation rate. The present rise of India Inflation Rate can be detrimental to the projected growth of Indian economy. Thus, the Reserve Bank of India is devising methods to arrest the rise of inflation by putting checks and measures in place. The main cause of rise of India Inflation Rate is the pricing disparity of agricultural products between the producer and end-consumer. Moreover, the meteoric rise of prices of food products, manufacturing products, and essential commodities has also catapulted the India Inflation Rate. As a result of this, the Wholesale Prices Index (WPI) of India increased to the level of 20.12% as on 9th april 2011( as per data released by CSO, GOI) . Moreover, the Cash Reserve Ratio touched 6.00% (as per RBI 9/04/2011) To arrest the panic and discomfort amongst the Indian business circles, the Reserve Bank of India, in its recently drafted monetary policy, had given top priority to price stability. It also sought to sustain the stupendous rate of economic growth of India. The Reserve Bank of India has raised the Cash Reserve Ratio in a continuous manner to arrest the rise of Inflation Rate in India . The solution to this problem lies in rationalizing the pricing disparity between the producer and the consumer. Only this will ensure inflation stabilization and thus sustainable economic growth of India.

32

WHOM DOES INFLATION HURT THE MOST

When we first think of inflation we assume that it will affect all people equally. After all if everyone is using the same dollars wouldn't everyone be affected equally? The fact of course is that everyone isn't affected equally. Our second assumption might be that the poor would be hurt the worst because they earn minimum wage and everything they buy is getting more expensive. However, if the minimum wage is indexed to inflation they would about break even. So interestingly if the minimum wage earners are also deep in debt inflation actually helps them. The reason for this is that debtors borrow valuable money and the number of dollars they must repay is fixed. So over time the value of the dollars they must repay is less and less (so they are easier to obtain than if the value of the dollar wasn't inflated away.) This is called repaying with "cheaper dollars". However, bigger beneficiaries would be the average middle class person with a large mortgage because the debt is for a longer term so inflation has longer to work its "magic". On the other hand, the biggest losers due to inflation are those willing to loan money. An extreme example would be during the hyper-inflation of 1923 in Germany. If you had loaned a friend enough money to buy a car in early 1923 and he had repaid it at the end of 1923 you might have been able to buy a box of matches with it. So it is easy to see that the borrower got a car and he was able to repay it with pocket change. The lender of course was the big loser.

33

At first this looks like the ultimate Robin Hood scheme, robbing from the rich bankers and giving to the poor borrowers. However, the other big losers those on fixed incomes like the elderly and anyone whose income isn't indexed to inflation. Inflation affects them especially hard because the prices of things they buy go up while their income stays the same. In addition, the poor are generally renters so they don't even benefit from a "cheaper" mortgage while they are paying higher prices for their groceries. Also even though their wages may be indexed to inflation there is a time lag since it is usually only re-indexed once a year. During this time they are on the old wages while prices for things they buy have already gone up. Interestingly the biggest debtor in the world is the US government and thus it is also the biggest beneficiary of inflation. And not coincidentally the Government is also the one who controls the money supply and thus inflation. In a way, inflation works as a hidden tax because the government borrows money from investors. It spends this valuable money and then gets to pay back its debt with cheaper dollars. The poor unsuspecting investor who is convinced that Government notes, bonds and T-Bills are "Low-Risk investments" accepts these dollars at face value but before long realizes that they won't buy as much as the dollars they loaned to the government in the first place. Generally, the Government walks a tightrope though; it can't inflate all its debt away too quickly, without destroying the economy, so it faces a constant balancing act. One big disadvantage of inflation is the fact that it discourages lending (smart banks need more interest to make up for the lost value). This prices some borrowers out of the market making loans too expensive. Inflation also makes planning for the future more difficult, so businesses are less likely to take risks. No risk no growth which stifles the entire economy.
34

On a small scale lenders are the losers from inflation and borrowers are the winners but on a bigger scale the biggest beneficiary is the Government and the overall economy is the biggest loser. Other losers are those on fixed incomes and those who are priced out of the loan market.

HOW DOES INFLATION AFFECT THE INDIVIDUAL?

When people go the grocery store and see ever higher prices they know how inflation affects them. But when they are feeling more philosophical they might reason that if all wages and prices increased at the same rate it would all balance out in the end right? Well theoretically yes but in reality it never works that way. Prices of various items all increase at different rates so some people are benefiting while others suffer. Those on fixed incomes suffer the most because the cost of things they are buying increases but their income stays the same. This is where COLA or "Cost Of Living Allowance" comes in it is an adjustment that is made to compensate for the increase in prices due to inflation. But even if costs are adjusted they are adjusted after the fact so that you have already been paying the higher prices for a year before your income is adjusted. One side of inflation that most consumers appreciate is the fact that they can pay off their debts with "cheaper dollars". So as you borrow the value of the money you borrowed goes down so it takes fewer hours of work to pay back the lender. This is one reason why debt is so prevalent today. Unfortunately, this is a subtle but insidious poison because it trains us to feel good about cheating others. In the past a man's honor was tied to his ability to repay
35

his debts but today inflation has taught us that it is good to try to cheat lenders out of their due. This has led to a higher rate of bankruptcies and if the trend continues it could lead to the breakdown of commerce. Once lenders can't be assured of getting repaid they will stop lending (or have to charge exorbitant interest rates) and as interest rates increase the economy grinds to a halt. So even the "good" side of inflation is really "bad" for the economy in the long run.

Hard times for India as inflation surges again

After a three-week respite, food inflation is back to haunt us. Data released on Thursday show food inflation measured by wholesale prices at 8.76 per cent for the week ended April 16 Any hope that the spike is a one-off development and inflation will soon resume its downward trajectory is belied by two factors. One is the largescale disruption in rail and road traffic caused by the on-going agitation by Jats seeking caste-based reservation in north India. The other is higher global commodity - especially fuel prices. While the pass-through on account of higher fuel prices may not happen immediately, given impending elections in five states and the already high inflation, the impact on prices cannot be suppressed for long. During the week under review, on an yearly basis, fruits became expensive by 28.43 per cent year-on-year, while egg, meat and fish prices went up by 12.14 per cent. Onions became expensive by 10.96 per cent. The moderate fiscal deficit budgeted for 2011-12 gave some momentary comfort on the demand front. But the increase in subsidies on petroleum products and fertilisers as a result of high crude prices coupled with the prospect of expenditure overshooting Budget estimates suggests the fisc is unlikely to lend a helping hand in demand-side inflation management. With the fisc unwilling to chip in and the RBI unable to do much more, where does that leave the aam aadmi? As always, at the receiving end.

36

India's inflationary pressure due to supply bottlenecks: World Bank

PTI, Jan 14, 2011, 06.20pm IST NEW DELHI: The World Bank today attributed high inflation in India to supply bottlenecks, and assured support to the country to improve agriculture productivity, which will go a long way to stabilise food prices. "My own sense in the case of the Indian economy is that some of the inflationary pressures are more likely a function of some of the bottleneck on the supply side than they are from the demand side," World Bank President Robert B Zoellick said at a joint press conference with Indian Finance Minister Pranab Mukherjee. Expensive food items pushed overall wholesale price inflation to 8.43 per cent in December from 7.48 per cent in the previous month. Zoellick further said the World Bank would try to help India to overcome obstacles to improve agricultural productivity and production. "This will be very key priority over the next three years," he added. He said that World Bank is ready to be a partner to help India by sharing the institution's development knowledge and expertise, adding that it is ready to share India's development expertise to other countries, which in itself makes India a true global player. After a meeting with Zoellick, Mukherjee said India see an increased role for the World Bank in recycling global savings to developing countries and emerging markets as one of the approaches to resolve global imbalances. The two leaders also discussed global economic situation, rise in commodity prices worldwide, unemployment in advance economies, inflationary conditions in emerging economies and India's increasing in the global affairs, including G20.

37

Praising India's "prudent" handling of the fallout of the global crisis, Zoellick said New Delhi is addressing how economic growth can be used to overcome poverty and meet the growing aspirations of its people. The World Bank President said that during his meetings with policy makers and government officials he learnt how India was accelerating its response to these development challenges. "The Bank is pleased to support the governments efforts not just with finance, but by offering the development experience and technical knowledge the World Bank has gained around the world," he said. Zoellick also called on Prime Minister Manmohan Singh to learn more about how India is sustaining high growth while simultaneously striving to ensure that the most vulnerable people avail the opportunities afforded by increased growth.

Fiscal policy responsible for India's inflation: StanChart

Published on Fri, Mar 04, 2011 at 15:23 | Source : CNBC-TV18 Updated at Wed, Mar 09, 2011 at 14:53

Gerard Lyons, chief economist and group head of global research at Standard Chartered Bank, in an interview on CNBC-TV18 speaks about the turmoil in West Asia and where Asian markets, including, India are headed on the back of the crisis. He doesn't see crude going below the USD 100 a barrel and finds it highly unlikely to happen anytime soon. With the situation in Libya and neighbouring gulf countries becoming a heated topic, he believes oil prices will hover around current levels. With the commencement of the Indian budget, he says he sees India growing at 8-8.5% with the fiscal policy adding to the country's inflation woes. He also sees a need for further montary tightening by the RBI.

38

Inflation to bog down India growth, push lakhs into poverty: ADB
ET Bureau, Apr 27, 2011 NEW DELHI: Rising food and fuel prices could hurt growth in India and push millions of countrymen into extreme poverty, Asian Development Bank said on Tuesday.

India will be badly affected by high food prices as a 10% increase could push close to 30 million Indians below the poverty line, said an ADB study titled 'Global Food Price Inflation and Developing Asia'.

The findings could raise alarm bells in the policymaking circles of Asia's third-largest economy. ThePlanning Commission estimates that close to a third of India's 1.21 billion people are poor. "The government is taking all measures to keep food prices under check," said Finance Minister Pranab Mukherjee. "I will respond to the ADB report at its forthcoming annual meeting," he said.

A persistent rise in food prices had burned a hole in the wallets of most consumers. Annual inflation in food articles, which rose to 22.9% in June 2010, stood at 9.47% in March this year, driven by a 23% increase in the prices of fruit and a 13.6% rise in prices of eggs, meat and fish. Prices of cereals rose 3.96% while those of pulses declined 4.17%.

Domestic food inflation in developing Asia averaged at about 10% in the first two months of 2011 while international prices rose more than 30%. A sustained 10% increase in domestic food prices could push an additional 64 million people, or almost 2% of Asia's 3.3 billion people, below the poverty line of $1.25 a day, the study warned.

39

Left unchecked, the food crisis will badly undermine recent gains in poverty reduction made in Asia," said ADB Chief Economist Changyong Rhee. "For poor families in developing Asia which already spend more than 60% of their income on food, higher prices will further reduce their ability to pay for medical care and their children's education," he said.

ADB advised countries to refrain from export bans on food items and to strengthen social safety nets. If the trend in global food and oil prices persists for the rest of the year, economic growth in Asia could be lower by up to 1.5%, said the ADB study. India could see close to 1% lower growth in 2011.

"Food inflation is the worst kind of tax, affecting the poor much more as they spend most of their income on food. The government has to take a long-term view of the problem and insure the poor against food inflation," said Ashok Gulati, chairman of the Commission for Agricultural Costs and Prices, which fixes the support prices of agricultural commodities.

Some economists said inflation has already started impacting growth in India. "The GDP growth would be lower in 2011-12 than last year's official forecast of 8.6%," said Sunil Sinha, senior economist at rating agency Crisil.

India recovered from the global economic downturn quickly, growing at 8% in 2009-10. The Indian economy is estimated to have grown 8.6% in the fiscal year ended March. The government expects the economy to expand 9% in the current fiscal year.

40

Inflation based on wholesale price index hovered around 8.9% in March, almost one percentage point above the Reserve Bank of India forecast of 8%. The central bank's efforts to tame inflation through eight back-toback rate hikes last year did not make much impact. Most economists expect the RBI to raise key policy rates by another 75-100 basis points this year.

In 2011, inflation was boosted by large increases in the prices of cereals, edible oils and meat, triggered by shortfalls. A sustained increase in oil prices due to political unrest in West Asia has also added to the pressures. The pattern of higher and more volatile food prices is likely to continue in the short-term, the report said.

Efforts to stabilise food production should take centre-stage, with greater investments in agricultural infrastructure to increase crop production and expand storage facilities to ensure grain is not wasted, Rhee said.

The report said many people who were poor before would now be on the verge of hunger and malnutrition and those close to the poverty line would have been pushed below it. Earlier in the month, the International Monetary Fund had cautioned the fast-growing Asian economies of overheating.

The ADB report said structural factors such as ballooning demand due to rising populations, higher incomes from emerging economies and changing diet, which were responsible for the food crisis in 2007-08, continues to be relevant in the current scenario.

41

HOW DOES INFLATION AFFECT THE INDIAN MARKET:

STOCK

Amit Dalal of Amit Nalin Securities feels that there is definitely going to be more of a negative impact on interest rate sensitive stocks. Companies that have gone into a mode of high capital employed capex programmers will have high cost of productions. Those sectors are real estate, auto, where we have to be very concerned, he said. According to Dalal, if one looks at the volatility that has been seeing during the last ten days, it is obviously impossible for one to forecast how the market trend can be, in terms of looking at price of oil. The fall in the market that has come in the last two weeks which is down to 3,000 points from where we were. It has taken into account the fact that earnings are going to be impacted by this high inflationary period ahead of us. Therefore, we are now discounting earnings at a much lower level for FY09 and even FY10. The positive lining in the cloud is that we have now completely differentiated our investment opportunities from investment laggards. There are certain sectors, which are dependent on borrowings like infrastructure, auto companies are dependent on consumer borrowings and these are going to be laggards for a long time to come, Dalal added

ANALYSIS REPORT 1. Expenditure pattern amongst people? price awareness food rent health education transport clothes entertainment 60 2500 5000 500 10000 2000 5000 800

42

phone bill vehicle (inc fuel) electricity servant

1500 2000 600 500

2.peoples view on government handling inflation? measures taken by GOVT increase in bank interest rates measures are taken by GOVT govt control over steel and cement price 12 as told by people 25 23

43

3. suggestions from survey ? suggestions to control prices do not buy luxury during inflation govt should control all sectors import duty should be increased taxes should be increased on liquor

18 20 12 10

44

CONCLUSION AND RECOMMENDATION

1.HOW TO TACKLE INFLATION IN INDIA Inflation is no stranger to the Indian economy. In fact, till the early nineties Indians were used to double-digit inflation and its attendant consequences. But, since the mid-nineties controlling inflation has become a priority for policy framers. The natural fallout of this has been that we, as a nation, have become virtually intolerant to inflation. While inflation till the early nineties was primarily caused by domestic factors (supply usually was unable to meet demand, resulting in the classical definition of inflation of too much money chasing too few goods), today the situation has changed significantly.

45

Inflation today is caused more by global rather than by domestic factors. Naturally, as the Indian economy undergoes structural changes, the causes of domestic inflation too have undergone tectonic changes. Needless to emphasize, causes of today's inflation are complicated. However, it is indeed intriguing that the policy response even to this day unfortunately has been fixated on the traditional anti-inflation instruments of the pre-liberalization era. Global imbalance the cause for global liquidity To understand the text of the present bout of inflation, let us at the outset understand the context: the functioning of the global economy, which is in a state of extreme imbalance. This is simply because developed western economies, particularly the United States, are consuming on a massive scale leading to gargantuan trade deficits. Crucially their extreme levels of consumption and imports are matched by the proclivity, nay fetish, of the developing countries in having an export-driven economic model. Thus while a set of developing countries produces, exports and also saves the proceeds by investing their forex reserves back in these countries, developed countries are consuming both the production and investment originating from the developing countries. In effect, developing countries are building their foreign exchange reserves while the developed countries are accumulating the corresponding debt. After all, it takes two to a tango. For instance, the US current account deficit is estimated to be 7 per cent of GDP in 2006 and stood at approximately $900 billion. Obviously, the current account deficit of the US becomes the current account surplus of other exporting countries, viz. China, Japan and other oil producing and exporting countries. The reason for this imbalance in the global economy is the fact that after the Asian currency crisis; many countries found the virtues of a weak currency and engaged in 'competitive devaluation.' Under this scenario, many countries simply leveraged their weak currency wise versa the US dollar to gain to the global (read US) markets. This mercantilist policy to maintain their competitiveness is
46

achieved when their central banks intervenes in the currency markets leading to accumulation of foreign exchange, notably the US dollar, against their own currency. Implicitly it means that the developing world is subsidizing the rich developed world. Put more bluntly, it would mean that the US has outsourced even defending the dollar to these countries, as a collapse of the US currency would hurt these countries holding more dollars in reserves than perhaps the US itself! . Rather than demand pushing the value of commodities higher in the past 18 months, it has been the (impending) dollar's devaluation against commodities that has pushed commodity prices to record highs." Naturally, as the players fear a fall in the value of the dollar and reach out to various assets and commodities, the prices of these commodities and assets too will rise. But as the imbalance shows no sign of correcting, players seek to shift to commodities and assets across continents to hedge against the impending fall in the US dollar. Thus, it is a fight between central banks and the psychology of market players across continents. As a corrective measure, economists are coming to the conclusion that most of the currencies across the globe are highly undervalued wise versa the dollar, which, in turn, requires a significant dose of devaluation. For instance, a consensus exists amongst economists and currency traders that the Yen is one of the most highly undervalued currencies (estimated at around 60%) along with the Chinese Yuan (estimated at 50%) followed by other countries in Asia. This artificial undervaluation of currencies is another fundamental cause for increasing global liquidity. To get an idea of the enormity of the aggregation of these two factors on the world's supply of dollars, Jephraim P. Gundzik calculates the dollar value of rising prices of just one commodity -- crude oil. In 2004, global demand for crude oil grew by a mere four per cent. Nevertheless higher oil prices advanced by as much as 34 per cent.

47

Consequently, it is this factor that significantly contributed to increase the world's dollar supply by about $330 billion. In 2005, international crude oil prices gained another 35 per cent and global demand for oil grew by only 1.6 per cent. Nonetheless, the world's supply of dollars increased by a further $460 billion. Naturally, with all currencies refusing to be revalued, this leads to increased global liquidity. While one is not sure as to whether the increase in the prices of crude led to the increase of other commodities or vice versa, the fact of the matter is that, in the aggregate, increased liquidity has led to the increase in commodity prices as a whole. Although some of this increase in the world's supply of dollars has been reabsorbed into US economy by the twin American deficits -- current as well as budgetary -- it is estimated that as much as $600 billion remains outside the US. What has further compounded the problem is the near-zero interest rate regime in Japan. With almost $905 billion forex reserves, it makes sense to borrow in Japan at such low rates and invest elsewhere for higher returns. Obviously, some of this money -- estimated by experts to be approximately $200 billion -- has undoubtedly found its way into the asset markets of other countries. Most of it has been parked in alternative investments such as commodities, stocks, real estates and other markets across continents, leveraged many times over. Needless to reiterate, the excessive dollar supply too has fuelled the property and commodity boom across markets and continents. The twin causes -- excessive liquidity due to undervaluation of various currencies (technical) and fear of the US dollar collapse leading to increased purchase of various commodities to hedge against a fall in US dollar (psychological) -- needs to be tackled upfront if inflation has to be confronted globally. What actually compounds the problem for India is the fact that lower harvest worldwide, specifically in Australia and Brazil, and the overall strength of demand wise versa supply and low stock positions world over, global wheat prices have continued to rise.
48

Wheat demand is expected to rise, while world production is expected to decline further in the coming months, as a result of which global stocks, already at historically low levels, may fall further by 20 per cent. These global trends have put upward pressure on domestic prices of wheat and are expected to continue to do so during the course of this year. No wonder, despite the government lowering the import tariffs on wheat to zero, there has been no significant quantity of wheat imports as the international prices of wheat are higher than the domestic prices. Growth and forex flows Another cause for the increase in the prices of these commodities has been due to the fact that both India and China have been recording excellent growth in recent years. It has to be noted that China and India have a combined population of 2.5 billion people. Given this size of population even a modest $100 increase in the per capita income of these two countries would translate into approximately $250 billion in additional demand for commodities. This has put an extraordinary highly demand on various commodities. Surely growth will come at a cost. The excessive global liquidity as explained above has facilitated buoyant growth of money and credit in 2005-06 and 2006-07. For instance, the net accretion to the foreign exchange reserves aggregates to in excess of $50 billion (about Rs 225,000 crore) in 2006-07. Crucially, this incremental flow of foreign exchange into the country has resulted in increased credit flow by our banks. Naturally this is another fuel for growth and crucially, inflation. This Reserve Bank of India's strategy of dealing with excessive liquidity through the Market Stabilization Scheme (MSS) has its own limitations. Similarly, the increase in repo rates (ostensibly to make credit overextension costly) and increase in CRR rates (to restrict excessive money supply) are policy interventions with serious limitations in the Indian context with such huge forex inflows. How about the revaluation of the Indian Rupee?

49

To conclude, all these are pointers to a need for a different strategy. The current bout of inflation is caused by a multiplicity of factors, mostly global and is structural. Monetary as well as trade policy responses, as has been attempted till date, would be inadequate to deal with the extant issue effectively. Crucially, a stock market boom, a real estate boom and a benign inflation in the food grains market is an economic impossibility. It has to be noted that the Indian market is structurally suited for leveraging shortages rather effectively. Added to this is the information asymmetry among various class of consumers as well as between consumers, on the one hand, and producers and consumers, on the other. Further, the sustained flow of foreign money, thanks to the excessive global liquidity in the world, has fuelled the rise of the stock markets and real estate prices in India to unprecedented levels. This boom has naturally led to corresponding booms in various related markets as much as the increased credit flow has in a way resulted in overall inflation. Economic policy rests in the triumvirate of fiscal, monetary and trade policies. Theoretical understanding of economics meant that these policies are interdependent. Also, one needs to understand that growth naturally comes with its attendant costs and consequences. While these policies are usually intertwined and typically compensatory, one has to understand that the issues with respect to inflation cannot be subjected to conventional wisdom in the era of globalization. One policy route yet unexamined in the Indian context by the government is the exchange rate policy, especially revaluation of the Rupee as an instrument to control inflation. It is time that we think about a revaluation of the Indian Rupee as a policy response to the complex issue of managing inflation; while simultaneously address the constraints on the supply side on food grains through increase in domestic production.

50

A higher Rupee value vice-versa the dollar would mean lower purchase price of commodities in Rupee terms. The Indian economy has undergone significant changes in the past decade and a half. With increased linkages to the global economy, it cannot duck the negatives of globalization. Quite the contrary, it needs to come with appropriate policy responses for the same, which cannot be of the 1960s vintage. Allowing Rupee to appreciate is surely one of them. The time for a rethink on our exchange rate policy to tackle inflation is now. Are we ready? 2.SridharKrishnaswami Washington, July 2 (PTI) The impact of surging food and fuel prices being felt globally is "not so big" in India but it needs to tighten its monetary policy, the IMF has said as it warned that some countries will not be able to feed their people and maintain economic stability if the hike continues. "Some countries are at a tipping point," said International Monetary Fund Managing Director Dominique Strauss-Kahn at the release of a new IMF study which says the effect of price hike is most acute for importdependent poor and middle-income countries confronted by balance of payments problems, higher inflation and worsening poverty. "If food prices rise further and oil prices stay the same, some governments will no longer be able to feed their people and at the same time maintain stability in their economies," he said. Kahn said such countries needed help from the international community for good policy options. "Their challenge is ours. It is to ensure adequate food supplies while preserving the poverty-reducing benefits derived in recent years from faster growth, low inflation, and better budget and balance of payments positions," he added. But a senior official of the IMF told PTI that although India has not been flagged in the latest report because of many "mitigating factors", the broad general policy implications apply. "India is a large country and it has USD 312 billions in reserves. The fact
51

that you had a near doubling of oil prices over a period of year is going to impact the current account and you are seeing it," said Kalpana Kochhar, Senior Advisor in the Asia Pacific Department of the Fund. "You would not have seen Indian highlighted.... The impacts are big but not so big. There are positive inflows and the results are still large," she said. P.Chidambaram. REFERENCES: 1. Inflationdata.com 2. www.investopedia.com 3. Geoffrey T Mills (1996), The impact of inflation on Capital Budgeting and Working capital, Journal of financial and Strategic Decisions, vol.9, No.1, Spring, pp 79-87.

52