ASSIGNMENT-III

INFLATION: CPI USED TO SET INLATION TARGET

Introduction:
Inflation means the general level of prices is going up. Economists measure inflation regularly to know an
economy's state. Inflation changes the ratio of money towards goods or services; more money is needed to get the
same amount of a good or service, or the same amount of money will get a lower amount of a good or service.
Consequently, inflation also reflects erosion in the purchasing power of money.
In India the method of calculation of inflation is by the holesale !rice Inde". Inflation is the percentage change
in the value of the holesale !rice Inde" #!I$ on a year%on year basis. In India, inflation is calculated by taking
the !I as base.
Formula for calculating Inflation=
(WPI in month of current year-WPI in same month of previous year)
------------------------------------------------------------------------------------- X 100
WPI in same month of previous year
Every week the wholesale price of nearly &'( goods are calculated by the Indian government. )s these are
wholesale prices, the actual prices paid by the customer is far higher.
Inflation occurs due to an imbalance between demand and supply of money, changes in production and
distribution cost or increase in ta"es on products. hen economy e"periences inflation, i.e. when the price level of
goods and services rises, the value of currency reduces. *his means now each unit of currency buys fewer goods
and services.It has its worst impact on consumers. +igh prices of day%to%day goods make it difficult for consumers
to afford even the basic commodities in life.
In times of rising inflation, this also means that the cost of living increases. ,ue to increased prices, people have to
spend more to maintain the standard of living. *hus, inflation is eating up the savings of an average man. *hus the
effect is amplified when food rises, since food represents more than half of the e"penditure of the individual.
+ence the government tries to keep inflation under control.Contrary to its negative effects, a moderate level of
inflation characteri-es a good economy. )n inflation rate of . or '/ is beneficial for an economy as it encourages
people to buy more and borrow more, because during times of lower inflation, the level of interest rate also
remains low. +ence the government as well as the central bank always strive to achieve a limited level of inflation.
Central banks attempt to stop severe inflation, along with severe deflation, in an attempt to keep the e"cessive
growth of prices to a minimum.
Causes of Infation
,emand%!ull inflation
*he ,emand%!ull inflation theory can be said simply as 0too much money chasing too few goods.0 In other words,
if the will of buying goods is growing faster than amount of goods that have been made, then prices will go up.
other countries.
!istor" and Current Status
For 2009, Indian inflation stood at 11.49%. According to the Economic Survey Report for 2009-10, economic
growth decelerated to 6,7% in 2008-09 from 9% in 2007-08.
Indias 2009-10 Economic Survey Report suggested a high double-digit increase in food inflation, with signs of
inflation spreading to various other sectors as well. The Deputy Governor of the Reserve Bank of India, however,
expressed his optimism in March 2010 about an imminent easing of Indian wholesale price index-based inflation,
on the back of falling oil and food prices.
On March 19, 2010, the Reserve Bank of India raised its benchmark reverse repurchase rate to 3.5% percent, after
this rate touched record lows of 3.25%. The repurchase rate was raised to 5% from 4.75% as well, in an attempt to
curb inflation.
In its Annual Monetary Policy Statement, RBI had said the firming up of global commodity prices poses upside
risks to inflation. The central banks industrial outlook survey shows companies are increasingly regaining their
pricing power in many sectors, and as the recovery gains momentum, the demand pressures are expected to
accenture.
1n 2ay 3(, .43& 5eserve 6ank of India, 7overner, ,r.5aghuram 5a8an was talking to reporters after the 56I9s
board meeting updated that,: Interest rate is the best tool for 5eserve 6ank to control inflation9, he said the ;best
tool9 available with the central bank to control price rise was interest rate and adding that the government too had
tools such as increasing agricultural production and improving supply.
<6oth need to work together and will work together. e were e"pecting some increase in the C!I number because
of the seasonal effects from vegetable prices, but it came more than anticipated by the consensus forecast. e will
study them in greater detail. hat does it suggest is that inflation is high as far as food prices go,: he added.
+owever, he said the core inflation had been coming down but though ;very very gently9. 5etail or consumer price
inde" #C!I$ inflation rose to a three%month high of =.(> per cent in )pril. ,r. 5a8an e"uded confidence that retail
inflation would come down to ? per cent by 2arch, .43?. <e are very comfortable with the fact that we can
achieve what the @r8it !atel committee suggested of = per cent inflation at the end of the year and ? per cent at the
end of ne"t year.:
*he !I based inflation has eased to (.. per cent, while the retail inflation was still high at =.(> per cent in )pril.
Infation fi#ures $ertainin# to %&'(
*his involves inflation based on the C!I #consumer price inde"$ and the +IC! #harmonised consumer price
inde"$ . *he C!I is often considered a country9s most important inflation figure.
Inflation development during .43'
) graph and a table with additional information about the development of inflation during .43' can be found
below. hen you select a country and a type of inflation in the selection bo", the page will automatically change
and show the development of the inflation figure which you have selected in .43'.
C)art CPI India %&'(
Aource B7lobal rates.com#3..4?.3&$
Ta*e CPI India %&'(
2onths in .43' inflation #yearly basis$
Canuary 33.?3? /
Debruary 3..4?4 /
2arch 33.&&' /
)pril 34..&& /
2ay 34.?=4 /
Cune 33.4(= /
Culy 34.=&> /
)ugust 34.E&= /
Aeptember 34.?>= /
1ctober 33.4?4 /
Fovember 33.&?= /
,ecember >.3'. /

2ain drivers of food and non%food inflation in C!I new series















AourceB 2inistry of Dinance G2id%Hear Economic )nalysis#.43'%.43&$I
IMPACT OF INFLATION ON INDIA+S ECONOMIC DE,ELOPMENT
*he Indian economy recovered in the second quarter #J.$ of .43'%3& recording a growth of &.= per cent. *his
follows a growth rate of &.& per cent in the first quarter #J3$ of the current financial yearK the lowest in 3?
quarters. hile the 7overnment delivered on the announced fiscal targets in .43.%3', current account deficit
#C),$ continued to remain elevated in J3 of .43'%3& and in tandem with market misperception of an imminence
of the rollback of quantitative easing in @A, assumed a serious dimension with the sharp depreciation of the rupee.
*he 7overnment put in place a series of measures and there has been a significant let%up in the challenges on the
trade and balance of payments front, particularly in the J. .43'%3&. ,omestic impediments like elevated levels of
food and retail inflation, high input costs and pressure on profit margins and infrastructural bottlenecks continued,
with the 7overnment addressing them through appropriate calibration of fiscal policy, administrative measures
and institutional mechanisms like Cabinet Committee on Investment to fast track pro8ects.
*he recovery in growth, although weak, is e"pected to gather pace in the coming quarters. hile there are some
concerns about renewed price pressure in 1ctober .43' and the services sector, the driver of growth, is still to pick
up, there are indications to the effect that these could be reversed going forward. *he analyses in various sections
of this chapter would provide the analytical basis for the above assessment. ith recent improvements in growth
of some sectors, better performance of e"ports and measures taken by the 7overnment, the year .43'%3& can be
e"pected to end with a growth of ( per cent.
*he Indian economy weathered the global financial crisis rather well and quickly recovered from the decline in
growth rate in .44=%4> to a healthy growth that averaged around > per cent annually in .44>%34 and .434%33.
+owever, this recovery was short%lived and growth rate declined to ?.. per cent in .433%3. and (.4 per cent in
.43.%3', on account of both domestic and e"ternal factors. ,espite some recovery in the growth of agriculture and
industry sector, particularly in J. of the current financial year, the overall growth of the economy has been a
modest &.? per cent in the first half of the year. *he growth rate of the economy improved from &.& per cent in J3
.43'% 3& to &.= per cent in J.. Compared to J3 .43'%3&, J. has evidenced a robust pick%up in the growth of the
agricultural sector and a gradual recovery in the industrial sector. *he growth in economic services also got
strengthened, while the community, social and personal services% a sector with substantial public sector presence %
e"hibited a significant fall in growth, pointing towards efforts at fiscal consolidation. *he demand side impetus to
growth is gradually gaining momentum with the strengthening of private consumption and investment and with
e"ports making an impressive turnaround in J. .43'%3&. *he confluence of these factors has resulted in a growth
of &.? per cent during the first half #+3$ of .43'%3&, roughly the same level of &.E per cent achieved during the
second half #+.$ of .43.%3'.
1n the e"ternal front, the crisis of .44=, the subsequent sovereign debt crisis and the recession in the Euro%area
had moderated the average growth rate of the global economy to less than ' per cent over the period .44=%.43. as
compared to ( per cent during .44&%.44E. ,ata from I2D indicate that several emerging market economies
including China and India quickly rebounded to high growth in the aftermath of the crisis. In fact, in terms of
market price 7,!, India9s growth e"ceeded that of China in .434. )part from emerging economies, advanced
economies also e"perienced significant recovery in .434 with both the @A and the Euro%area registered distinctly
higher growth rates. ) series of subsequent events, including the uncertainty surrounding Euro%area sovereign debt
crisis, hampered sustained economic recovery in advanced economies with adverse consequences for growth and
challenges for macroeconomic management in emerging market economies. ith the intensification of the
sovereign debt crisis, the decline in real 7,! growth rates starting .433 has been witnessed across advanced and
emerging market economies. Economic growth has again started looking up in advanced economies, especially in
the @A, alleviating the e"ternal constraint on India9s recovery to some e"tent.
*he slowdown in real 7,! growth in India during .433%3. and .43.%3' is the trends in similar emerging
economies. *he downturn has been more pronounced in the Indian case, owing to domestic and structural factors.
*he growth of real 7,! has generally shown a declining trend since the first quarter of .433%3.. )n upward
movement in some of the quarters in between raised the hope for a turnaround that was belied .Corresponding to
this, the industrial sector witnessed a long, steep decline. *he service sector also witnessed growth moderation,
which has been gradual and less steep than the industrial sector, and its growth remained more or less constant
during J' .43.%3' to J3 .43'%3&. )s panel 3 of Digure 3.3 shows, the declining trend in 7,! growth has
reversed in J. .43'%3&, on the back of higher growth in agriculture and industry vis%L%vis J3 .43'%3&.
1ME5MIE 1D *+E EC1F12H
















AourceB 2inistry of Dinance G2id%Hear Economic )nalysis#.43'%.43&$I
Re-edia Measures to Contro Infation:
)ccording to *rading Economics on the benchmark interest rate in India was last recorded at = percent. Interest
5ate in India averaged ?.?& !ercent from .444 until .43&, reaching an all time high of 3&.(4 !ercent in )ugust of
.444 and a record low of &..( !ercent in )pril of .44>. Interest 5ate in India is reported by the 5eserve 6ank of
India.
*he 2inistry of Dinance and the 56I #5eserve 6ank of India$ always strive to control inflation. *hey control
inflation by directly affecting the demand pull inflation by changing the amount of liquidity circulating in the
economy. *he 56I can change the liquidity by its various tools vi-. C55, 6ank%5ate #5E!1 and 5everse%5E!1$,
AN5, etc.
C55 #Cash 5eserve 5atio$ is the proportion of amount which each commercial bank #like A6I, ICICI, etc.$ has to
maintain in the form of hard cash. )ll commercial banks accept deposits from individuals and lend it to borrowers
at a higher interest rate. *he difference between the interest rate which they collect from borrowers and which they
pay to their depositors is their profit. Faturally, each bank will try to lend all the money they collect from
depositors. +owever, banks can9t lend all the money they have. @nder law, each bank has to maintain a certain
proportion of cash as reserve. *his is known as C55. hen 56I increases the C55, the bank9s lending power
decreases. Ness lending means less borrowing, this in turn means less money in the economy. Nast month, the 56I
increased the C55 from =.E(/ to >/ to control inflation. AN5 #Atatutory Niquidity 5atio$ is also similar to C55.
6ut in case of AN5, 7overnment%Aecurities need to be maintained by the commercial banks instead of cash.
In its .=th Canuary .43& meeting, 5eserve 6ank of India decided to raise the policy repo rate by .( bps to =
percent to handle currency pressure and curb persistently high inflation.
6ank%5ate is basically the interest rate at which the Central 6ank borrows from the other scheduled commercial
banks. *his rate is directly linked to the interest rates charged in turn by all the commercial banks to its customers.
)ll these other interest rates on +ome%loans, !ersonal%loans, etc. also increase with the increase in bank%rate.
*hus, by raising the 6ank%5ate and in turn all other Interest 5ates, the 56I makes borrowing money from banks a
very costly affair. !eople are thus discouraged to borrow more money and total amount of liquidity decreases in
the economy. Nast month, the 56I increased the 6ank 5ate from =.(/ to >.(/. *his was an increase of (4 basis%
points #4.(/$ to control inflation.
*he above mentioned measures vi-. C55, AN5, 6ank%5ate are called 2onetary !olicy tools. )part from these,
there are certain Discal !olicy tools which the 7overnment can use. 1ne recent e"ample of fiscal tool is the recent
ban placed on the e"port of 6asmati rice by the Dinance 2inister. 6y banning the e"port of rice, the supply of rice
will increase in the home country relative to its demand. *his will naturally bring down the price of rice which is a
ma8or component of !I. *he price%rise in 6asmati rice is an e"ample of ,emand%pull inflation because demand
has increased relative to supply. )lthough, it could be said that demand for rice is not related to liquidity but is
inelastic #where demand is autonomous and not related to increase in price or income$.
*he rise in interest rates initially makes life difficult for people who have taken loans on floating interest rates, it is
a required step to bring down inflation which is a larger evil. It might also be noted that 56I, by making the policy
changes can control only one type of inflation i.e. demand%pull inflation. It cannot affect the other type of inflation
i.e. cost%push inflation which is caused by rise in prices of raw%materials and other factors of production. *hat is
why the rate of inflation is increasing continuously since last si" months although the 56I is trying to control it. In
fact, only the cost%push component of inflation is rising which consists of increase in prices of steel, cement,
petroleum, etc. Aome of these factors are produced in our country and others are imported. 6ut the prices of none
of them can be controlled by the government.
.une (rd/ %&'0 -eetin#/ Reser1e 2an3 of India eft t)e re$o rate at 4 $ercent/ *ut cut t)e a-ount of
#o1ern-ent *onds *an3s -ust )od 5it) t)e centra *an3 - t)e statutor" i6uidit" ratio - *" 7& *$s to %%87
$ercent/ ai-in# to increase *an3 credit8
*he cut in statutory liquidity ratio will take effect from the fortnight beginning Cune 3&, .43&. *he central bank
also decided to reduce the liquidity provided under the e"port credit refinance facility from (4 per cent of eligible
e"port credit outstanding to '. per cent with immediate effect. !olicymakers introduced a special term repo
facility of 4..( per cent of net demand and time liabilities to compensate fully for the reduction in access to
liquidity under the EC5 with immediate effect.
In 2arch and )pril, C!I headline inflation has risen on the back of a sharp increase in food prices. Aome of this
price pressure will continue into 2ay, but it is largely seasonal. 2oreover, C!I inflation e"cluding food and fuel
has been edging down. *he risks to the central forecast of = per cent C!I inflation by Canuary .43( remain broadly
balanced. @pside risks in the form of a sub%normalOdelayed monsoon on account of possible El Fino effects, geo%
political tensions and their impact on fuel prices, and uncertainties surrounding the setting of administered prices
appear at this stage to be balanced by the possibility of stronger 7overnment action on food supply and better
fiscal consolidation as well as the pass through of recent e"change rate appreciation. )ccordingly, at this 8uncture,
it is appropriate to leave the policy rate unchanged, and to allow the disinflationary effects of rate increases
undertaken during Aeptember .43'%Canuary .43& to mitigate inflationary pressures in the economy.
*he 5eserve 6ank remains committed to keeping the economy on a disinflationary course, taking C!I inflation to
= per cent by Canuary .43( and ? per cent by Canuary .43?. If the economy stays on this course, further policy
tightening will not be warranted. 1n the other hand, if disinflation, ad8usting for base effects, is faster than
currently anticipated, it will provide headroom for an easing of the policy stance.
In pursuance of the ,r. @r8it 5. !atel Committee9s recommendation to move away from sector%specific refinance
towards a more generali-ed provision of system liquidity without preferential access to any particular sector or
entity, the 5eserve 6ank has decided to limit access to e"port credit refinance while compensating fully with a
commensurate e"pansion of the market9s access to liquidity through a special term repo facility from the 5eserve
6ank #equivalent to 4..( per cent of F,*N$. *his should improve access to liquidity from the 5eserve 6ank for
the system as a whole without the procedural formalities relating to documentary evidence, authori-ation and
verification associated with the EC5. *his should also improve the transmission of policy impulses across the
interest rate spectrum and engender efficiency in cashOtreasury management.
)s the economy recovers, investment demand and the need for credit will pick up. *o the e"tent that this
contributes eventually to supply, it is important that banks have the room to finance it. ) reduction in the required
AN5 will give banks more freedom to e"pand credit to the non%7overnment sector. +owever, the 5eserve 6ank is
also cogni-ant of the significant on%going financing needs of the 7overnment. *herefore, the AN5 is reduced by
4.(4 per cent of F,*N, with any further change dependent on the likely path of fiscal consolidation.
CPI s)oud *e used to set infation tar#et: R2I $ane
Inflation based on Consumer !rice Inde" #C!I$
) 5eserve 6ank of India #56I$ panel on *uesday recommended that monetary policy be set by a committee and
that consumer price inde" #C!I$ inflation be used to set an inflation target, eventually of & percent.
*he panel's report also said it should be made clear that managing inflation is the central bank's primary ob8ective.
*he recommendations of the panel, which was established by 56I 7ov. 5aghuram 5a8an when he took office in
early Aeptember, are widely e"pected to be adopted by the Indian central bank.
@nder current 56I practice, the power to make policy decisions is held solely by the governor. *he 56I, unlike
many central banks, has long used wholesale price inde" #!I$ inflation as its primary guage.
5eserve 6ank of India #56I$ 7overnor 5aghuram 5a8an today hiked repo rate% the rate at which the central bank
lends short term money to banks% for the second time in as many months, citing inflationary concerns.
) 5eserve 6ank of India #56I$ panel on *uesday recommended that monetary policy be set by a committee and
that consumer price inde" #C!I$ inflation be used to set an inflation target, eventually of & percent.*he panel's
report also said it should be made clear that managing inflation is the central bank's primary ob8ective.*he
recommendations of the panel, which was established by 56I 7overnor 5aghuram 5a8an when he took office in
early Aeptember, are widely e"pected to be adopted by the Indian central bank.@nder current 56I practice, the
power to make policy decisions is held solely by the governor. *he 56I, unlike many central banks, has long used
wholesale price inde" #!I$ inflation as its primary guage
!ere are
3. 5epo or short%term lending rate hiked by 4..( per cent to E.E( per cent
.. 2arginal standing facility #2AD$ rate or overnight lending rate cut by 4..( per cent to =.E( per cent
'. 7rowth forecast for the current fiscal slashed to ( per cent from (.E per cent earlier
&. Cash reserve ratio #C55$% the portion of a bank's deposit that it must mandatorily park with 56I, unchanged
at & per cent. *he minimum daily maintenance of the C55 has been reduced from >> per cent of the
requirement to >( per cent effective from the fortnight beginning Aeptember .3. .43'.
(. Cash provided to banks through term repo increased to 4.(4 per cent of net demand and time liability from
4..( per cent earlier
?. ,ifference between repo and 2AD rate narrows to 3 per cent
E. holesale inflation e"pected to be higher than current levels; warranting 'appropriate policy response'
=. 5etail inflation to remain around > per cent or even higher without policy action
>. *o closely monitor inflation risks while being mindful of the evolving growth dynamics
34. Dood price pressures may ease with the arrival of summer crop harvest and seasonal moderation
Concusion:
Inflation is not harmful at all times. In fact only when there is a sustained increase above E/ to =/, there is cause
for worry. In fact a low level of inflation between ./ and (/ is a sign of prosperity. It is required for growth.
*hat9s because it gives the producer of goods and services a certain impetus to stay in the market. *his in turn
gives rise to growth, development and employment which is very much required. Inflation is also closely linked to
employment but that is the topic of discussion for another day.
5eferenceB
Economic Niberali-ation in India #n.d.$, 5etrieved from
httpBOOen.wikipedia.orgOwikiOEconomicPliberalisationPinPIndia
2id%Hear Economic )nalysis#.43'%3&$ 5etrieved from
httpBOOwww.finmin.nic.inOreportsO2H5.43'3&English.pdf
Inflation, 5etrieved from
httpBOOen.wikipedia.orgOwikiOInflation
C!I should be used to set inflation targetB 56I panel#Can. .3,.43&$ 5etrieved from
httpBOOin.reuters.comOarticleO.43&O43O.3Oindia%rbi%monetarypolicy%inflation%idIF,EE)4Q4E..43&43.3
56I will need to keep raising policy interest rate R I2D 5etrieved from
httpBOOin.reuters.comOarticleO.43&O4.O.3Oindia%economy%policy%imf%idIF,EE)3C4CS.43&4..3