Inflation in India

Inflation happens to be a key determinant in the functioning of any economy. India is a country with a mixed economy model that comprises of both capitalism and socialism hence the challenges faced are vital for its growth model. The recent rise in inflation has been found to consist of several political and economic crisis with Dr Manmohan Singh the Prime minister often being under the ambit of it.

Contesting on the challenges faced, several economists have questioned the method of measuring inflation to be faulty. The present day process being used in India has been The Wholesale Price Index while several other developed countries adopt the Consumer price index to calculate inflation.

Measurement Challenge

There are two basis system of measuring inflation present today. While India adopts the prior method which is considered to be lesser advanced. The demographics and structures of India don't permit it to adopt the second basis system of measuring inflation.

Wholesale Price Index

It first came in 1902 and being replaced by 1970 with the Consumer Price Index globally. Around 435 commodities data are being tracked through it that captures the movement of commodities hence measuring the inflation for the country. The drawback of the system that widely challenges is the ignorance of the service sector. But when compared with the Consumer Price Index it covers a more wide range of commodities. ^[1]The problem that occurs with Wholesale Price Index, it occurs on a weekly basis. The prices of the different commodities may rise at different rates. Hence if the prices of high weighted index cost less while for lower weighted index cost more, the inflation in the economy would be reflected as low.The rational consumer happens to pay more for commodities like vegetable( weight less but high cost).^[2]

Consumer Price Index

Though Consumer price index happens to be a more advanced instrument for the measurement of inflation. There occurs several problems for India to shift from the current Wholesale Price Index. The Consumer Price Index is not viable to be used in India because there happens to be too much of a lag in reporting the Consumer Price Index numbers. Another debate points that contradicts the application of Consumer Price Index is the fact that it is calculated on a monthly basis while the Wholesale Price Index is calculated on a weekly basis. A system which India adopts at present. However when the index for consumers are to be recorded than the wholesalers this system should be adopted.

Issues

The challenges faced by a developing economy are many, especially when in context of the Monetary Policy with the Central Bank, the inflation and price stability phenomenon. There has been a universal argument these days when monetary policy is determined to be a key element in depicting and controlling inflation. The Central Bank works on the objective to control and have a stable price for commodities. A good environment of price stability happens to create saving mobilization and a sustained economic growth. The former Governor of RBI C. Rangarajan points out that there happens to be a long-term tradeoff between output and inflation. He adds on that short-term trade-off happens to only introduce uncertainty about the price level in future. There happens to be an agreement that the central banks have aimed to introduce the target of price stability while an argument supports it for what that means in practice.

The Optimal Inflation Rate

It arises as the basis theme in deciding an adequate monetary policy. There are two debatable proportions for an affective inflation, whether it should be in the range of 1-3 per-cent as the inflation rate that persists in the industrialized economy or should it be in the range of 6-7 per-cents. While deciding on the elaborate inflation rate certain problems occur regarding its measurement. The measurement bias has often calculated an inflation rate that is comparatively more than in nature. Secondly, there often arises a problem when the quality improvements in the product are in need to be captured out, hence it affects the price index. The consumer preference for a cheaper goods affects the consumption basket at costs, for the increased expenditure on the cheaper goods takes time for the increased weight and measuring inflation. The Boskin_Commission has measured 1.1 per cent of the increased inflation in USA every-annum. The commission points out for the developed countries comprehensive study on inflation to be fairly low. The Reserve Bank of India clearly mentions for the future underlining rate of inflation as a prior phenomenon that the current inflation rate for an effective monetary policy in India.

Money Supply and Inflation

^[3] The Quantitative Easing by the central banks with the effect of an increased money supply in an economy often helps to increase or moderate inflationary targets. There happens to be a puzzle formation between low-rate of inflation and a high growth of money supply. When the current rate of inflation is low, a high worth of money supply warrants the tightening of liquidity and an increased interest rate for a moderate aggregate demand and the avoidance of any potential problems. Further, in case of a low output a tightened monetary policy would affect the production in a much more severe manner. The supply shocks have known to play a dominant role in the regard of monetary policy. The bumper harvest in 1998-99 with a buffer yield in wheat, oilseeds, sugarcane, and pulses had led to an early supply condition further driving their prices from what were they in the last year. The increased import competition since 1991 with the trade liberation in place have widely contributed to the reduced manufacturing competition with a cheaper agricultural raw materials and the fabric industry. These cost-saving driven technologies have often helped to drive a low-inflation rate. The normal growth cycles accompanied with the international price pressures has several times being characterized by domestic uncertainties.

Global Trade

Inflation in India generally occurs as a consequence of global traded commodities and the several efforts made by The Reserve Bank of India to weaken rupee against dollar. This has been regarded as the root cause of inflation crisis rather than the domestic inflation. When the US dollar has shrieked by a margin of 30%, RBI had made a massive injection of dollar in the economy make it highly liquid and this further triggered off inflation in non-traded goods. The RBI picture clearly portrays for subsidizing exports with a weak dollar-exchange rate.All these account for a dangerous inflationary policies being followed by the central bank of the country.^[4] Further, on account of cheap products being imported in the country which are made on a high technological and capital intensive techniques happen to either increase the price of domestic raw materials in the global market or are they forced to sell at a cheaper price, hence fetching heavy losses.

Factors

There are several factors which help to determine the inflationary impact in the country and further help in making a comparative analysis of the policies for the same.The major determinant of the inflation in regard to the employment generation and growth is depicted by the Phillips curve.

Demand Factors

It basically occurs in a situation when the aggregate demand in the economy has exceeded the aggregate supply. It could further be described as a situation where too much money chases just few goods. A country has a capacity of producing just 550 units of a commodity but the actual demand in the country happens to be 700 units. Hence, as a result of which due to scarcity in demand the prices of the commodity rises. This has generally been seen in India in context with the agrarian society where due to droughts and floods or inadequate methods for the storage of grains leads to lesser or deteriorated output hence increasing the prices for the commodities as the demand remains the same.

Supply Factors

The supply side inflation happens to be a key ingredient for the rising inflation in India. The agricultural scarcity or the damage in transit creates a scarcity causing high inflationary pressures. Similarly, the high cost of labor eventually increases the production cost and leads to a high price for the commodity.The energies issues regarding the cost of production often increases the value of the final output produced. These supply driven factors have basically have a fiscal tool for regulation and moderation. Further, the global level impacts of price rise often impacts inflation from the supply side of the economy.

Domestic Factors

The underdeveloped economies like India have generally a lesser developed financial market which creates a weak bonding between the interest rates and the aggregate demand. This accounts for the real money gap that could be determined as the potential determinant for the price rise and inflation in India. There happens to be a gap in India for both the output and the real money gap. The supply of money grows rapidly while the supply of goods takes due time which causes increased inflation. Similarly Hoarding has been a problem of major concern in India where onions prices have shot high in the sky. There are several other stances for the gold and silver commodities and their price hike.^[5]

External Factors

The exchange rate determination happens to be an important component for the inflationary pressures that arises in the India. The liberal economic perspectives in India affects the domestic markets. As the prices in United States Of America rises it impacts India where the commodities are now imported at a higher price impacting the price rise. Hence, the nominal exchange rate and the import inflation are a measures that depict the competitiveness and challenges for the economy.^[6]

References

1. ^ How India calculates inflation
2. ^ Making the CPI changeover | mydigitalfc.com
3. ^ "Central Banking In New Millennium- Andrew Crockett". http://rbidocs.rbi.org.in/rdocs/Speeches/PDFs/8431.pdf. 
4. ^ From fiscal dominance to currency dominance: diagonosing and addressing India's inflation crisis of 2008
5. ^ HOARDING IN INDIA. - View Article - NYTimes.com
6. ^ Inflation Determination in Open Economy Phillips Curve