ASSIGNMENT-III

INFLATION: CPI USED TO SET INLATION TARGET

Introduction:
Inflation means the general level of prices is going up. Economists measure inflation regularly to know an
economy's state. Inflation changes the ratio of money towards goods or services; more money is needed to get the
same amount of a power of money.
In India the method of calculation of inflation is by the Wholesale Price Index. Inflation is the percentage change
in the value of the Wholesale Price Index WPI! on a year"on year basis. In India# inflation is calculated by taking
the WPI 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 taxes on products. When economy experiences 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 expenditure of the individual.
)ence the government tries to keep inflation under control.+ontrary 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.
+entral banks attempt to stop severe inflation# along with severe deflation# in an attempt to keep the excessive
growth of prices to a minimum.
Causes of Infation
*emand"Pull inflation
(he *emand"Pull inflation theory can be said simply as /too much money chasing too few goods./ In other words#
if the will of buying goods is growing faster than amount of goods that have been made# then prices will go up.
(his most likely happens in economies that are growing fast. Whenever a product is bought or sold beyond its real
price for its worth# then Inflation of money occurs.
+ost"Push inflation
(he +ost"Push inflation theory says that when the cost of making goods which are paid by the company! go up#
they have to make prices higher to still make profit out of selling that very product. (he higher costs of making
goods can include things like workers wages# taxes to be paid to the government or bigger costs of getting raw
materials from other countries.
!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.
0n 1ay 2&# -32$ 4eserve 5ank of India# 6overner# *r.4aghuram 4a7an was talking to reporters after the 45I8s
board meeting updated that#9 Interest rate is the best tool for 4eserve 5ank to control inflation8# he said the :best
tool8 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.
;5oth need to work together and will work together. We were expecting some increase in the +PI number because
of the seasonal effects from vegetable prices# but it came more than anticipated by the consensus forecast. We will
study them in greater detail. What does it suggest is that inflation is high as far as food prices go#9 he added.
)owever# he said the core inflation had been coming down but though :very very gently8. 4etail or consumer price
index +PI! inflation rose to a three"month high of <.&= per cent in 'pril. *r. 4a7an exuded confidence that retail
inflation would come down to > per cent by 1arch# -32>. ;We are very comfortable with the fact that we can
achieve what the ?r7it Patel committee suggested of < per cent inflation at the end of the year and > per cent at the
end of next year.9
(he WPI based inflation has eased to &.- per cent# while the retail inflation was still high at <.&= per cent in 'pril.
Infation fi#ures $ertainin# to %&'(
(his involves inflation based on the +PI consumer price index! and the )I+P harmonised consumer price
index! . (he +PI is often considered a country8s most important inflation figure.
Inflation development during -32%
' graph and a table with additional information about the development of inflation during -32% can be found
below. When you select a country and a type of inflation in the selection box# the page will automatically change
and show the development of the inflation figure which you have selected in -32%.
C)art CPI India %&'(
@ource A6lobal rates.com2-.3>.2$!
Ta*e CPI India %&'(
1onths in -32% inflation yearly basis!
Banuary 22.>2> .
Cebruary 2-.3>3 .
1arch 22.$$% .
'pril 23.-$$ .
1ay 23.><3 .
Bune 22.3&< .
Buly 23.<$= .
'ugust 23.D$< .
@eptember 23.>=< .
0ctober 22.3>3 .
Eovember 22.$>< .
*ecember =.2%- .

1ain drivers of food and non"food inflation in +PI new series
@ourceA 1inistry of Cinance F1id"Gear Economic 'nalysis-32%"-32$!H
IMPACT OF INFLATION ON INDIA+S ECONOMIC DE,ELOPMENT
(he Indian economy recovered in the second Iuarter J-! of -32%"2$ recording a growth of $.< per cent. (his
follows a growth rate of $.$ per cent in the first Iuarter J2! of the current financial yearK the lowest in 2>
Iuarters. While the 6overnment delivered on the announced fiscal targets in -32-"2%# current account deficit
+'*! continued to remain elevated in J2 of -32%"2$ and in tandem with market misperception of an imminence
of the rollback of Iuantitative easing in ?@# assumed a serious dimension with the sharp depreciation of the rupee.
(he 6overnment 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- -32%"2$. *omestic impediments like elevated levels of
food and retail inflation# high input costs and pressure on profit margins and infrastructural bottlenecks continued#
with the 6overnment addressing them through appropriate calibration of fiscal policy# administrative measures and
institutional mechanisms like +abinet +ommittee on Investment to fast track pro7ects.
(he recovery in growth# although weak# is expected to gather pace in the coming Iuarters. While there are some
concerns about renewed price pressure in 0ctober -32% and the services sector# the driver of growth# is still to pick
up# there are indications to the effect that these could be reversed going forward. (he analyses in various sections
of this chapter would provide the analytical basis for the above assessment. With recent improvements in growth
of some sectors# better performance of exports and measures taken by the 6overnment# the year -32%"2$ can be
expected to end with a growth of & per cent.
(he Indian economy weathered the global financial crisis rather well and Iuickly recovered from the decline in
growth rate in -33<"3= to a healthy growth that averaged around = per cent annually in -33="23 and -323"22.
)owever# this recovery was short"lived and growth rate declined to >.- per cent in -322"2- and &.3 per cent in
-32-"2%# on account of both domestic and external 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 J2
-32%" 2$ to $.< per cent in J-. +ompared to J2 -32%"2$# 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 "
exhibited a significant fall in growth# pointing towards efforts at fiscal consolidation. (he demand side impetus to
growth is gradually gaining momentum with the strengthening of private consumption and investment and with
exports making an impressive turnaround in J- -32%"2$. (he confluence of these factors has resulted in a growth
of $.> per cent during the first half )2! of -32%"2$# roughly the same level of $.D per cent achieved during the
second half )-! of -32-"2%.
0n the external front# the crisis of -33<# the subseIuent sovereign debt crisis and the recession in the Euro"area
had moderated the average growth rate of the global economy to less than % per cent over the period -33<"-32- as
compared to & per cent during -33$"-33D. *ata from I1C indicate that several emerging market economies
including +hina and India Iuickly rebounded to high growth in the aftermath of the crisis. In fact# in terms of
market price 6*P# India8s growth exceeded that of +hina in -323. 'part from emerging economies# advanced
economies also experienced significant recovery in -323 with both the ?@ and the Euro"area registered distinctly
higher growth rates. ' series of subseIuent events# including the uncertainty surrounding Euro"area sovereign debt
crisis# hampered sustained economic recovery in advanced economies with adverse conseIuences for growth and
challenges for macroeconomic management in emerging market economies. With the intensification of the
sovereign debt crisis# the decline in real 6*P growth rates starting -322 has been witnessed across advanced and
emerging market economies. Economic growth has again started looking up in advanced economies# especially in
the ?@# alleviating the external constraint on India8s recovery to some extent.
(he slowdown in real 6*P growth in India during -322"2- and -32-"2% 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 6*P has generally shown a declining trend since the first Iuarter of -322"2-. 'n upward
movement in some of the Iuarters in between raised the hope for a turnaround that was belied .+orresponding to
this# the industrial sector witnessed a long# steep decline. (he service sector also witnessed growth moderation#
which has been gradual and less steep than the industrial sector# and its growth remained more or less constant
during J% -32-"2% to J2 -32%"2$. 's panel 2 of Cigure 2.2 shows# the declining trend in 6*P growth has
reversed in J- -32%"2$# on the back of higher growth in agriculture and industry vis"L"vis J2 -32%"2$.
0ME4MIEW 0C ()E E+0E01G
@ourceA 1inistry of Cinance F1id"Gear Economic 'nalysis-32%"-32$!H
Re-edia Measures to Contro Infation:
'ccording to (rading Economics on the benchmark interest rate in India was last recorded at < percent. Interest
4ate in India averaged >.>$ Percent from -333 until -32$# reaching an all time high of 2$.&3 Percent in 'ugust of
-333 and a record low of $.-& Percent in 'pril of -33=. Interest 4ate in India is reported by the 4eserve 5ank of
India.
(he 1inistry of Cinance and the 45I 4eserve 5ank of India! always strive to control inflation. (hey control
inflation by directly affecting the demand pull inflation by changing the amount of liIuidity circulating in the
economy. (he 45I can change the liIuidity by its various tools vi,. +44# 5ank"4ate 4EP0 and 4everse"4EP0!#
@N4# etc.
+44 +ash 4eserve 4atio! is the proportion of amount which each commercial bank like @5I# I+I+I# etc.! has to
maintain in the form of hard cash. 'll commercial banks accept deposits from individuals and lend it to borrowers
at a higher interest rate. (he difference between the interest rate which they collect from borrowers and which they
pay to their depositors is their profit. Eaturally# each bank will try to lend all the money they collect from
depositors. )owever# banks can8t lend all the money they have. ?nder law# each bank has to maintain a certain
proportion of cash as reserve. (his is known as +44. When 45I increases the +44# the bank8s lending power
decreases. Ness lending means less borrowing# this in turn means less money in the economy. Nast month# the 45I
increased the +44 from <.D&. to =. to control inflation. @N4 @tatutory NiIuidity 4atio! is also similar to +44.
5ut in case of @N4# 6overnment"@ecurities need to be maintained by the commercial banks instead of cash.
In its -<th Banuary -32$ meeting# 4eserve 5ank of India decided to raise the policy repo rate by -& bps to <
percent to handle currency pressure and curb persistently high inflation.
5ank"4ate is basically the interest rate at which the +entral 5ank 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# Personal"loans# etc. also increase with the increase in bank"rate.
(hus# by raising the 5ank"4ate and in turn all other Interest 4ates# the 45I makes borrowing money from banks a
very costly affair. People are thus discouraged to borrow more money and total amount of liIuidity decreases in
the economy. Nast month# the 45I increased the 5ank 4ate from <.&. to =.&.. (his was an increase of &3 basis"
points 3.&.! to control inflation.
(he above mentioned measures vi,. +44# @N4# 5ank"4ate are called 1onetary Policy tools. 'part from these#
there are certain Ciscal Policy tools which the 6overnment can use. 0ne recent example of fiscal tool is the recent
ban placed on the export of 5asmati rice by the Cinance 1inister. 5y banning the export of rice# the supply of rice
will increase in the home country relative to its demand. (his will naturally bring down the price of rice which is a
ma7or component of WPI. (he price"rise in 5asmati rice is an example of *emand"pull inflation because demand
has increased relative to supply. 'lthough# it could be said that demand for rice is not related to liIuidity 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 reIuired step to bring down inflation which is a larger evil. It might also be noted that 45I# by making the policy
changes can control only one type of inflation i.e. demand"pull inflation. It cannot affect the other type of inflation
i.e. cost"push inflation which is caused by rise in prices of raw"materials and other factors of production. (hat is
why the rate of inflation is increasing continuously since last six months although the 45I is trying to control it. In
fact# only the cost"push component of inflation is rising which consists of increase in prices of steel# cement#
petroleum# etc. @ome of these factors are produced in our country and others are imported. 5ut 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
$ercent/ ai-in# to increase *an3 credit8
(he cut in statutory liIuidity ratio will take effect from the fortnight beginning Bune 2$# -32$. (he central bank
also decided to reduce the liIuidity provided under the export credit refinance facility from &3 per cent of eligible
export credit outstanding to %- per cent with immediate effect. Policymakers introduced a special term repo
facility of 3.-& per cent of net demand and time liabilities to compensate fully for the reduction in access to
liIuidity under the E+4 with immediate effect.
In 1arch and 'pril# +PI headline inflation has risen on the back of a sharp increase in food prices. @ome of this
price pressure will continue into 1ay# but it is largely seasonal. 1oreover# +PI inflation excluding food and fuel
has been edging down. (he risks to the central forecast of < per cent +PI inflation by Banuary -32& remain broadly
balanced. ?pside risks in the form of a sub"normalOdelayed monsoon on account of possible El Eino effects# geo"
political tensions and their impact on fuel prices# and uncertainties surrounding the setting of administered prices
appear at this stage to be balanced by the possibility of stronger 6overnment action on food supply and better
fiscal consolidation as well as the pass through of recent exchange rate appreciation. 'ccordingly# at this 7uncture#
it is appropriate to leave the policy rate unchanged# and to allow the disinflationary effects of rate increases
undertaken during @eptember -32%"Banuary -32$ to mitigate inflationary pressures in the economy.
(he 4eserve 5ank remains committed to keeping the economy on a disinflationary course# taking +PI inflation to
< per cent by Banuary -32& and > per cent by Banuary -32>. If the economy stays on this course# further policy
tightening will not be warranted. 0n the other hand# if disinflation# ad7usting for base effects# is faster than
currently anticipated# it will provide headroom for an easing of the policy stance.
In pursuance of the *r. ?r7it 4. Patel +ommittee8s recommendation to move away from sector"specific refinance
towards a more generali,ed provision of system liIuidity without preferential access to any particular sector or
entity# the 4eserve 5ank has decided to limit access to export credit refinance while compensating fully with a
commensurate expansion of the market8s access to liIuidity through a special term repo facility from the 4eserve
5ank eIuivalent to 3.-& per cent of E*(N!. (his should improve access to liIuidity from the 4eserve 5ank for
the system as a whole without the procedural formalities relating to documentary evidence# authori,ation and
verification associated with the E+4. (his should also improve the transmission of policy impulses across the
interest rate spectrum and engender efficiency in cashOtreasury management.
's the economy recovers# investment demand and the need for credit will pick up. (o the extent that this
contributes eventually to supply# it is important that banks have the room to finance it. ' reduction in the reIuired
@N4 will give banks more freedom to expand credit to the non"6overnment sector. )owever# the 4eserve 5ank is
also cogni,ant of the significant on"going financing needs of the 6overnment. (herefore# the @N4 is reduced by
3.&3 per cent of E*(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 +onsumer Price Index +PI!
' 4eserve 5ank of India 45I! panel on (uesday recommended that monetary policy be set by a committee and
that consumer price index +PI! inflation be used to set an inflation target# eventually of $ percent.
(he panel's report also said it should be made clear that managing inflation is the central bank's primary ob7ective.
(he recommendations of the panel# which was established by 45I 6ov. 4aghuram 4a7an when he took office in
early @eptember# are widely expected to be adopted by the Indian central bank.
?nder current 45I practice# the power to make policy decisions is held solely by the governor. (he 45I# unlike
many central banks# has long used wholesale price index WPI! inflation as its primary guage.
4eserve 5ank of India 45I! 6overnor 4aghuram 4a7an 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.
' 4eserve 5ank of India 45I! panel on (uesday recommended that monetary policy be set by a committee and
that consumer price index +PI! inflation be used to set an inflation target# eventually of $ percent.(he panel's
report also said it should be made clear that managing inflation is the central bank's primary ob7ective.(he
recommendations of the panel# which was established by 45I 6overnor 4aghuram 4a7an when he took office in
early @eptember# are widely expected to be adopted by the Indian central bank.?nder current 45I practice# the
power to make policy decisions is held solely by the governor. (he 45I# unlike many central banks# has long used
wholesale price index WPI! inflation as its primary guage
!ere are
2. 4epo or short"term lending rate hiked by 3.-& per cent to D.D& per cent
-. 1arginal standing facility 1@C! rate or overnight lending rate cut by 3.-& per cent to <.D& per cent
%. 6rowth forecast for the current fiscal slashed to & per cent from &.D per cent earlier
$. +ash reserve ratio +44!" the portion of a bank's deposit that it must mandatorily park with 45I#
unchanged at $ per cent. (he minimum daily maintenance of the +44 has been reduced from == per cent
of the reIuirement to =& per cent effective from the fortnight beginning @eptember -2. -32%.
&. +ash provided to banks through term repo increased to 3.&3 per cent of net demand and time liability
from 3.-& per cent earlier
>. *ifference between repo and 1@C rate narrows to 2 per cent
D. Wholesale inflation expected to be higher than current levels; warranting 'appropriate policy response'
<. 4etail 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
23. Cood 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 D. to <.# there is cause
for worry. In fact a low level of inflation between -. and &. is a sign of prosperity. It is reIuired for growth.
(hat8s 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 reIuired. Inflation is also closely linked to
employment but that is the topic of discussion for another day.
4eferenceA
Economic Niberali,ation in India n.d.!# 4etrieved from
httpAOOen.wikipedia.orgOwikiOEconomicPliberalisationPinPIndia
1id"Gear Economic 'nalysis-32%"2$! 4etrieved from
httpAOOwww.finmin.nic.inOreportsO1G4-32%2$English.pdf
Inflation# 4etrieved from
httpAOOen.wikipedia.orgOwikiOInflation
+PI should be used to set inflation targetA 45I panelBan. -2#-32$! 4etrieved from
httpAOOin.reuters.comOarticleO-32$O32O-2Oindia"rbi"monetarypolicy"inflation"idIE*EE'3Q3E--32$32-2
45I will need to keep raising policy interest rate R I1C 4etrieved from
httpAOOin.reuters.comOarticleO-32$O3-O-2Oindia"economy"policy"imf"idIE*EE'2B3+S-32$3--2