Subject: Economics

 Context

• It seems that inflation may hover around 7 per cent despite RBI’s tightening of monetary policy in the months to come.

What is a simple definition for inflation?

• Inflation is an increase in the level of prices of the goods and services that households buy. It is measured as the rate of change of those prices. Typically, prices rise over time, but prices can also fall (a situation called deflation).

Inflation Rate

• Inflation Rate is the percentage change in the price level from the previous period. If a normal basket of goods was priced at Rupee 100 last year and the same basket of goods now cost Rupee 120, then the rate of inflation this year is 20%.
• Inflation Rate= {(Price in year 2 – Price in year 1)/ Price in year 1} *100

Types of Inflation

Creeping Inflation

• Creeping or mild inflation is when prices rise 3% a year or less. This kind of mild inflation makes consumers expect that prices will keep going up. That boosts demand. Consumers buy now to beat higher future prices. That’s how mild inflation drives economic expansion.

Walking Inflation

• This type of strong, or pernicious, inflation is between 3-10% a year. It is harmful to the economy because it heats up economic growth too fast. People start to buy more than they need, just to avoid tomorrow’s much higher prices. This drives demand even further so that suppliers can’t keep up. More important, neither can wages. As a result, common goods and services are priced out of the reach of most people.

Galloping Inflation

• When inflation rises to 10% or more, it wreaks absolute havoc on the economy. Money loses value so fast that business and employee income can’t keep up with costs and prices. Foreign investors avoid the country, depriving it of needed capital. The economy becomes unstable, and government leaders lose credibility. Galloping inflation must be prevented at all costs.

Hyperinflation

• Hyperinflation is when prices skyrocket more than 50% a month. It is very rare. In fact, most examples of hyperinflation have occurred only when governments printed money to pay for wars. Examples of hyperinflation include Germanyin the 1920s, Zimbabwe in the 2000s, and Venezuela in the 2010s. The last time America experienced hyperinflation was during its civil war.

Core Inflation

• The core inflation rate measures rising prices in everything except food and energy. That’s because gas prices tend to escalate now and then. Higher gas costs increase the price of food and anything else that has large transportation costs.

 

Consumer Price Index

• CPI is used to monitor changes in the cost of living over time. When the CPI rises, the average Indian family has to spend more on goods and services to maintain the same standard of living. The economic term used to define such a rising prices of goods and services is Inflation.

Whole sale Price Index

• WPI is used to monitor the cost of goods and services bought by producer and firms rather than final consumers. The WPI inflation captures price changes at the factory/wholesale level.

GDP Deflator

• Another important measure of calculating standard of living of people is GDP Deflator. GDP Deflator is the ratio of nominal GDP to real GDP. The nominal GDP is measured at the current prices whereas the real GDP is measured at the base year prices. Therefore, GDP Deflator reflects the current level of prices relative to prices in a base year. Example, In India the base year of calculating deflator is 2011-12.

Factors fuelling inflation in India

• Falling rupee: Inflation is here to stay because it has much to do with the decline in value of the rupee that has fallen to its lowest, which makes imports of oil and gas more expensive.
• Ukraine crisis: The war in Ukraine has the same effect and pushes the price of some food items upward.
• Poor inflation management: With inflation, as measured by the consumer price index, in August going back to 7 per cent, and the wholesale price index coming in at 12.4 per cent, one thing is clear India is not out of the woods on inflation management.

Rising inflation have these implications

• Impact on the poor: This upsurge of inflation is affecting the poor more because some of the commodities whose prices are increasing the most represent a larger fraction of the budget of the most vulnerable sections of society.
• Rising inequality: As a result, inequalities which were already on the rise are increasing further. Recently, the State of Inequality in India report showed that an Indian making Rs 3 lakh a year belonged to the top 10 per cent of the country’s wage earners. 

• Inequality in healthcare: India’s spending on healthcare is among the lowest in the world. Decent level of healthcare is available only to the ones who can afford it because of increasing out-of-pocket expenditure the payment made directly by individuals for the health service, not covered under any financial protection scheme. Overall, these out-of-pocket expenses on healthcare are 60 per cent of the total expenditure on public health in India, which is one of the highest in the world.

 

Need for bold steps on three fronts to tackle inflation

• Unless bold and innovative steps are taken at least on three fronts, GDP growth and inflation both are likely to be in the range of 6.5 to 7.5 per cent in 2022-23.

1] Tightening of loose monetary policy: The Reserve Bank of India (RBI) is mandated to keep inflation at 4 per cent, plus-minus 2 per cent.

• The RBI has already started the process of tightening monetary policy by raising the repo rate, albeit a bit late.
• It is expected that by the end of 2022-3, the repo rate will be at least 5.5 per cent, if not more.
• It will still stay below the likely inflation rate and therefore depositors will still lose the real value of their money in banks with negative real interest rates.
• That only reflects an inbuilt bias in the system — in favour of entrepreneurs in the name of growth and against depositors, which ultimately results in increasing inequality in the system.

2] Prudent fiscal policy: Fiscal policy has been running loose in the wake of Covid-19 that saw the fiscal deficit of the Union government soar to more than 9 per cent in 2020-21 and 6.7 per cent in 2021-22, but now needs to be tightened.

• Government needs to reduce its fiscal deficit to less than 5 per cent, never mind the FRMB Act’s advice to bring it to 3 per cent of GDP.
• However, it is difficult to achieve when enhanced food and fertiliser subsidies, and cuts in duties of petrol and diesel will cost the government at least Rs 3 trillion more than what was provisioned in the budget.

3] Rational trade policy: Export restrictions/bans go beyond agri-commodities, even to iron ore and steel, etc. in the name of taming inflation.

• But abrupt export bans are poor trade policy and reflect only the panic-stricken face of the government.
• A more mature approach to filter exports would be through a gradual process of minimum export prices and transparent export duties for short periods of time, rather than abrupt bans, if at all these are desperately needed to favour consumers.

Conclusion

• Though the government is opting for market-based economics, currently, India needs a mixed solution that comprises price stability via government channels and subsidies.

Mains question

Q.What are the fuelling factors for inflation? Discuss what steps should be taken to tackle inflation.

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