Yogesh Patil

IIPM 12-14

Index

INTRODUCTION

OBJECTIVES

OVERVIEW OF THE INDIAN ECONOMY

METHODS FOR CONTROLLING INFLATION

RISING INFLATION IN INDIA

GLOBAL INFLATION AND INDIA

CONCLUSION

BIBLIOGRAPHY

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IIPM 12-14

LIST OF TABLES

INDIA WHOLESALE PRISE INFLATION

INDIA GDP GROWTH

INDIA FOREIGN EXCHANGE RESERVES

USD RUPEE DAILY RATES

MOVEMENT IN INTERNATIONAL OIL PRICES

INDICES OF WORLD COMMODITY PRICES

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OBJECTIVES OF STUDY
1. TO UNDERSTAND THE INDIAN ECONOMY
2. TO STUDY THE EFFECT OF RISING INFLATION IN INDIA
3. TO ANALYSE THE RESPONSE OF THE INDIAN
GOVERNMENT REGARDING RISING INFLATIONARY RATE

INTRODUCTION

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In our economy, most prices tend to rise over time. This increase in the overall
level of prices is called inflation. The economists all over the world measures
the inflation rate as the percentage change in the consumer price index(CPI),the
GDP deflator, or some other index of the overall price level. These price indexes
show that, over the past 70 years, prices have risen on average about 4 percent
per year. Accumulated over so many years, a 4 percent annual inflation rate
leads to a 16-fold increase in the price level.
Although inflation has been the norm in more recent history, there has been
substantial variation in the rate at which prices rise. During the 1990s prices
rose at an average rate of about 2 percent per year. By contrast, in the 1970s,
prices rose by 7 percent per year, which meant a doubling of the price level over
the decade. The public often view such high rates of inflation as a major
economic problem.
International data shows even broader range of inflation experiences.
Prices rise when the government prints too much money. This insight has a long
and venerable trend among the economists. The quantity theory explains all
moderate inflations. This theory was been discussed by the famous 18 th century
philosopher and economist David Hume and was later advocated by the
prominent economist Milton Friedman.
After developing a theory of inflation we turn to a related question: WHY IS
INFLATION A PROBLEM?
At first glance the answer to this question may
seem obvious: INFLATION IS A PROBLEM BECAUSE PEOPLEDONT
LIKE IT.
But what exactly, are the costs that inflation imposes on a society?
is surprising.........

The answer

IDENTIFYING THE VARIOUS COSTS OF INFLATION IS NOT AS

STRIGHTFORWARD AS IT FIRST APPEARS. As a result, although all
economists decry hyperinflation, some economists argue that the cost of
moderate inflation are not nearly as large as the general public believes.

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AN OVERVIEW OF THE INDIAN ECONOMY

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The Tenth Five Year Plan (2002-07) has been prepared against a backdrop of
high expectations
arising from some aspects of the recent performance. GDP growth in the post
reforms period has improved
from an average of about 5.7 per cent in the 1980s to an average of about 6.1
per cent in the Eighth and Ninth
Plan periods, making India one of the ten fastest growing countries in the world.
The Tenth Five Year Plan aims
at achieving an average growth rate of the Gross Domestic Product (GDP) of 8
per cent per annum over the
period 2002 to 2007. It also seeks to create the conditions for a further
acceleration in the growth rate over the
Eleventh Plan period (2007-12) in order to achieve a doubling of per capita
income of the country over the
next ten years.
The strategy for the Tenth Plan include redefining the role of Government, a
Statewise breakdown of growth and social development targets, extending
reforms into the agricultural sector, emphasis on employment-generating sectors
and poverty alleviation. Simultaneously, the Tenth Plan has specific focus on
key indicators of human development. Accordingly, the Plan seeks to establish,
in addition to the target rate

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of real growth of 8 per cent, specific and monitorable targets measuring

human well being, in terms of :
(1)Reduction of poverty ratio by 5 per centage points by 2007, (2) Providing
gainful and high-quality employment
atleast in addition to the labour force over the Tenth Plan period,
(3) All children to complete 5 years of
schooling by 2007,
(4) Reduction in gender gaps in literacy and wage rates by at least 50 per cent
by 2007,
(5) Reduction in the decadal rate of population growth between 2001 and 2011
to 16.2 per cent,
(6)Increase in Literacy rates to 75 per cent within the plan period,
(7) Reduction of Infant Mortality Rate (IMR)
to 45 per 1000 live births by 2007,
( 8) Reduction of Maternal Mortality Rate (MMR) to 2 per 1000 live births by
2007,
(9) Increase in forest and tree cover to 25 per cent by 2007, (10) All villages to
have sustained access to potable drinking water within the Plan period and
registered
(11) Cleaning of major polluted rivers by 2007.

HOW INDIA MEASURES INFLATION

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India uses the Wholesale Price Index (WPI) to calculate and then decide
the rate of inflation in the economy. Most developed countries use the
Consumer Price Index (CPI) to calculate inflation.
WPI was first published in 1902, and was one of the major economic
indicators available to policy makers until it was replaced by the
Consumer Price Index in most developed countries by 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, price data for 435
commodities is tracked through WPI which is an indicator of movement in
prices of commodities in all trades and transactions. It is also the price
index which is available on a weekly basis with the shortest possible time
lag -- two weeks. The Indian government has taken WPI as an indicator of
the rate of inflation in the economy.

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.

Some economists argue that 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.

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 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.

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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.

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 and announced on
every Friday.

METHODS FOR CONTROLLING INFLATION

1. Monetary policy
Today the primary tool for controlling inflation is monetary policy. Most central
banks are tasked with keeping inflation at a low level, normally to a target rate
around 2% to 3% per annum, and within a targeted low inflation range,
somewhere from about 2% to 6% per annum.

There are a number of methods that have been suggested to control inflation.
Central banks can affect inflation to a significant extent through setting interest
rates and through other operations. High interest rates and slow growth of the
money supply are the traditional ways through which central banks fight or
prevent inflation, though they have different approaches. For instance, some
follow a symmetrical inflation target while others only control inflation when it
rises above a target, whether express or implied.

Monetarists emphasize increasing interest rates (slowing the rise in the money
supply, monetary policy) to fight inflation. Keynesians emphasize reducing
demand in general, often through fiscal policy, using increased taxation or
reduced government spending to reduce demand as well as by using monetary
policy. Supply-side economists advocate fighting inflation by fixing the
exchange rate between the currency and some reference currency such as gold.
This would be a return to the gold standard. All of these policies are achieved in
practice through a process of open market operations.

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2. Fixed exchange rates

Under a fixed exchange rate currency regime, a country's currency is tied in
value to another single currency or to a basket of other currencies (or sometimes
to another measure of value, such as gold). A fixed exchange rate is usually used
to stabilize the value of a currency, vis-a-vis the currency it is pegged to. It can
also used as a means to control inflation. However, as the reference value rises
and falls, so does the currency pegged to it. This essentially means that the
inflation rate in the country is determined by the inflation rate of the country the
currency is pegged to. In addition, a fixed exchange rate prevents a government
from using domestic monetary policy in order to achieve macroeconomic
stability.
3. Gold standard

The gold standard is a monetary system in which a region's common media of

exchange are paper notes that are normally freely convertible into pre-set, fixed
quantities of gold. The standard specifies how the gold backing would be
implemented, including the amount of specie per currency unit. The currency
itself has no innate value, but is accepted by traders because it can be redeemed
for the equivalent specie. A U.S. silver certificate, for example, could be
redeemed for an actual piece of silver.
Gold was a common form of representative money due to its rarity, durability,
divisibility, fungibility, and ease of identification. Representative money and the
gold standard were used to protect citizens from hyperinflation and other abuses
of monetary policy, as were seen in some countries during the Great Depression.
However, they were not without their problems and critics, and so were partially
abandoned via the international adoption of the Bretton Woods System. That
system eventually collapsed in 1971, at which time all nations had switched to

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full fiat money. Austrian economists strongly favor a return to a 100 percent
gold standard.
Under a gold standard, the long term rate of inflation (or deflation) would be
determined by the growth rate of the supply of gold relative to total output.
Critics argue that this will cause arbitrary fluctuations in the inflation rate, and
that monetary policy would essentially be determined by gold mining, which
some believe contributed to the Great Depression.
4. Wage and price controls
Another method attempted in the past have been wage and price controls
("incomes policies"). Wage and price controls have been successful in wartime
environments in combination with rationing. However, their use in other
contexts is far more mixed. Notable failures of their use include the 1972
imposition of wage and price controls by Richard Nixon. More successful
examples include the Prices and Incomes Accord in Australia and the Wassenaar
Agreement in the Netherlands.
In general wage and price controls are regarded as a temporary and exceptional
measure, only effective when coupled with policies designed to reduce the
underlying causes of inflation during the wage and price control regime, for
example, winning the war being fought. They often have perverse effects, due to
the distorted signals they send to the market. Artificially low prices often cause
rationing and shortages and discourage future investment, resulting in yet
further shortages. The usual economic analysis is that any product or service
that is under-priced is overconsumed. For example, if the official price of bread
is too low, there will be too little bread at official prices, and too little
investment in bread making by the market to satisfy future needs, thereby
exacerbating the problem in the long term.
Temporary controls may complement a recession as a way to fight inflation: the
controls make the recession more efficient as a way to fight inflation (reducing
the need to increase unemployment), while the recession prevents the kinds of
distortions that controls cause when demand is high. However, in general the
advice of economists is not to impose price controls but to liberalize prices by
assuming that the economy will adjust and abandon unprofitable economic
activity. The lower activity will place fewer demands on whatever commodities
were driving inflation, whether labor or resources, and inflation will fall with
total economic output. This often produces a severe recession, as productive

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capacity is reallocated and is thus often very unpopular with the people whose
livelihoods are destroyed.

RISING INFLATION IN INDIA

Inflation growth rate

Inflation growth rate in india for the year 2008:

INFLATION
RATES (%)
Czech Republic
Lithuania
Latvia
Ukraine
Thailand
South Korea
India
China
Argentina
Brazil
Chile
Venezuela
Turkey
South Africa
Egypt
Jordan

SEP AUG JUL JUN MAY APR MAR FEB JAN

2.8 2.4
7.1 5.5
11.4 10.1
14.4 14.3
2.1 1.1
2.3 2.0
n.a. 7.3
n.a 6.7
8.6 8.7
n.a 4.8
5.9 4.7
15.3 15.9
7.1 7.4
n.a 6.7
n.a 8.5
n.a 3.9

N.A. = NOT AVAILABLE

2.3 2.5
4.1 4.9
9.5 8.8
13.5 12.9
1.2 1.9
2.5 2.6
6.4 5.7
4.7 4.5
8.6 8.8
4.2 4.0
3.8 3.2
17.2 19.4
6.9 8.6
7.0 7.0
8.0 8.5
3.7 3.9

2.4
2.5
4.9
4.8
8.2
8.9
10.7 10.5
1.9 1.8
2.4 2.4
6.6 6.8
3.4
3.0
8.8
8.9
3.6
3.4
2.9
2.5
19.5 19.4
9.2 10.7
6.9
7.0
10.0 11.7
3.6
5.6

1.9 1.5 1.3

4.6 4.3 4.0
8.5 7.3 7.1
10.1 9.5 10.8
2.0 2.3 3.1
2.2 2.2 1.7
6.7 7.6 6.7
3.3 2.8 2.2
9.1 9.6 9.7
3.3 3.1 2.9
2.6 2.7 2.8
18.5 20.4 18.4
10.9 10.2 9.9
6.1 5.8 6.0
12.8 12.6 12.4
6.7 8.4 7.6

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It is clearly observable that the increase rate of inflation in INDIA is much

higher than other countries.

What is obvious from the above chart is that the steady uptick inflation since
last autumn. Rising energy and food costs are likely to continue, and These will
only add to the problems facing the administration. Crude oil jumped to an alltime high of $111 last week, putting pressure on India's government to continue
increasing prices following February's initial increase in the cost of retail
gasoline and diesel. Central bank Governor Yaga Venugopal Reddy last week
said rising food and energy prices pose "acute policy dilemmas". Reddy also
indicated that India's benchmark interest rates, currently at a six-year high,
wont be coming down in a hurry, due to the current inflation and the difficulties
arising from uncertainty in the global financial markets.

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"The large segments of the poor tend to reap the benefits of high growth with a
time lag while the rise in prices affects them instantly.....Considerable weight is
currently accorded by the Reserve Bank of India to price and financial stability
while recognizing its twin objectives of growth and stability."

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Bank lending continues to rise, and was up 21.88% year-on-year in the two
weeks to February 29, 2008, as compared with the 21.84% growth rate logged
in the fortnight ended February 15, according to Reserve Bank of India data
released last Friday. Outstanding loans rose by Rs 41,481 crore to Rs 22.51 lakh
crore in the two weeks to February 29. Non-food credit rose by Rs 39,988 crore
to Rs 22.07 lakh crore over the two weeks, while food credit rose by Rs 1,493
crore to Rs 44,311 crore in the same period. Deposits were up 23.7% in the two
weeks to February 29 from a year earlier. Banks' deposits rose by Rs 43,539
lakh crore to Rs 30.81 lakh crore.
At the same time the country's foreign-exchange reserves continued their
upward march and increased by $2.2 billion in the week ended March 7 to
$303.5 billion, according to the RBI.

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The rupee really started to drop significantly in February following the

withdrawal by the Indian unit of Emaar Properties of its $1.8 billion initial
public offer (IPO) due to the volatile situation in the Indian stock market.
Foreign investment in IPOs had constituted a major support for the rupee in
January, ever since Reliance Power raised $3 billion within a minute of opening
for sale. India's trade deficit, which has suffered on the back of the rise in the
rupee - and which swelled to $9.4 billion in January, more than three times
larger than in the same month a year earlier - clearly hasn't help underpin
expectations that the Indian monetary authorities will feel comfortable
accepting the continuing rise in the currency.

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Inflation too mild to account for stagnant agriculture

A study of agricultural growth in reform years (Agricultural
Growth in India since 1991) by the Development Research
Group of the RBI has thrown up some interesting findings. It
argues, the recent history of Indian agriculture reveals no
uni-directional link between growth and relative prices.
The study concludes that the evidence of price shift is too
mild to account for the observed slowing(in agricultural
growth).
Instead, the study points out a host of structural factors
including fragmentation of land holdings, stagnant public
investment and slowing of irrigation expansion since 1991
that have in general led to poorer production conditions in
Indian agriculture.
The study estimates growth rate for all crops in the period
1991-92 to 2006-07 at 1.3% and yield improvement at 1.2%,
far below the compounded annual growth rates in the
preceding years. Since the bulk of Indias population is
engaged in agriculture, this slowing down of growth has
implications for poverty alleviation.

Minimum Support Price for Farmers

ANOTHER problem which has affected agriculture is the Minimum Support
Price (MSP) for farmers. Since the cost of production in agriculture is
increasing, there is a need to increase the MSP for farmers. Till 2007-08 it was
Rs 850 per quintal in case of wheat and Rs 745 per quintal for rice. It was
alleged that the government is paying more for imports in the international
market, but is not paying a higher MSP to its own farmers so that it can have
more foodgrains for its buffer stocks. Only recently, the government has revised
the MSP for wheat to Rs 1000 per quintal, but has not done so for rice so far.

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Inflation in Fuels, Cement and Steel

BESIDES foodgrains, other commodities which are exercising an upward
pressure on the WPI are fuels, cement and steel. The price of petrol in the
international market has reached an unprecedented level of $ 114 per barrel. Via
the rise in transport cost, it pushes up the price level. But this is an exogenous
factor on which the government has no control. Recently, there has been a
diversion of certain foodgrains towards the manufacture of bio-fuels. This has
resulted in pushing up the international prices of foodgrains by over 80 per cent,
thus raising the cost of imported food grains. The diversion of foodgrains to biofuels is aggravating the supply constraint in the domestic economy as well. To
mitigate the situation, the government should impose severe restrictions on the
use of foodgrains for bio-fuels as a temporary measure till such period that
foodgrains output growth is accelerated by the measures initiated to reach the
target of agricultural growth four per cent per annum.
Grilled by the Opposition, Finance Minister P. Chidambaram stated in the Lok
Sabha on April 16, 2008: I have no hesitation in repeating that cement
manufacturers are behaving like a cartel. There are signs that even steel
manufactures are behaving like a cartel If they do not understand the gravity
of the situation and behave responsibly, the government will not hesitate to take
tough administrative measures.
There appears to be divergence of views within the government. As against the
Finance Ministers strong view warning of tough measures against cartel-like
behaviour by the steel and cement manufacturers, the Minister of State for Steel,
Jitin Prasad, in a written reply to a query in the Lok Sabha stated:
The steel prices are determined by market forces, such as demand and supply
and international prices. However, no evidence on cartelisation by steel
companies in determining steel prices has been brought to the notice of the
Ministry of Steel.

GLOBAL INFLATION AND INDIA

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Most analyses of accelerating inflation in India emphasise the role

of imported inflation in driving Indian prices upwards. In this
edition of Macro scan, C. P. Chandrasekhar and Jayati Gosh
examine the trends in global markets that influence domestic price
movements and their implications.

With the annual rate of inflation in India having touched 7 per cent on a pointto-point basis during the week-ending March 22, 2008, the search for policies to
combat the price rise has begun. One factor seen as making that search difficult
is the ostensible role of imported inflation in driving the rise in domestic
prices.
There is an obvious reason why such an argument arises. Among the products
primarily responsible for the current inflation are food products of different
kinds, including cereals, intermediates like metals and the universal
intermediate, oil.

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Of these, the difficulties that high and rising levels of oil prices pose have been
known for some time now. Price movements for the two varieties of crude that
enter Indias import basket (Chart 1) show that since May 2003 international
prices have, despite fluctuations, been on a continuous rise. In the event the
prices per barrel of these varieties have moved from less than $25 in May 2003
to close to or well above $100 today.
Real price of oil

This has changed one feature of the oil price scenario that held during much of
the last two decades. During those years, despite high nominal prices, the real
price of oil (adjusted for increases in the general price level) was far lower than
that which prevailed during the 1970s. As Chart 2 shows, when measured by the

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price-deflated refiner acquisition cost of imported oil in the US, in the years
since 1974 the real price of oil was higher than that in 2006 only during a brief
period between 1980 and 1982. Since 2006, nominal oil prices having risen
further at rates much higher than the average level of prices.
As a result, oil producers are regaining the real price benefits they garnered
during the 1979-81 shock. According to one estimate, in terms of current prices,
the late 1970s-early 1980s peak in oil prices works out to $100-110 a barrel.
That is a figure that we are fast approaching.

While the disruption caused by the US occupation of Iraq, other geopolitical

factors and the speculation that followed have played a role in the case of oil,
what explains the recent increase in other global commodity prices, especially
food articles and metals? Chart 3 (based on IMF data) shows that, except for
agricultural raw materials whose prices have increased very little, all the other
commodity groups have shown sharp rises in price.
The rise in price levels for metals was the earliest in the recent surge, with the
weighted average of metals prices increasing sharply from the last quarter of
2005, and almost doubling in the two-year period to February 2008. Coal prices
more than doubled last year, thereby showing a faster rise than even the oil
price. Food prices, like agricultural raw materials, had shown only a modest
increase until early 2007. But since then they have zoomed, such that the IMF
data show more than 40 per cent increase in world food prices over 2007.

Food price index

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The FAO food price index, which includes national prices as well as those in
cross-border trade, suggests that the average index for 2007 was nearly 25 per
cent above the average for 2006. Apart from sugar, nearly every other food crop
has shown very significant increases in price in world trade over 2007, and the
latest evidence suggests that this trend has continued and even accelerated in the
first few months of 2008. The net result is that globally the prices of many basic
commodities have been rising faster than they ever did during the last three
decades.
It has been argued that these developments are largely demand driven, being the
result of several years of rapid global growth and the voracious demand from
some fast-growing countries such as China. Certainly there is some element of
truth in this. And to the extent that this is true, it implies that the world economy
is heading back to the late-1960s and early-1970s scenario wherein rapid and
prolonged growth came up against an inflationary barrier. Capitalisms success
over the last two decades was its ability to prevent such an outcome, political
economy processes that restrained the wage and income demands of workers
and primary producers. But clearly there are limits to such a process, and these
limits are now being reached.
If this were the only cause of the recent commodity price inflation, it would not
necessarily be of such concern to policymakers, because it could then be
expected that a slowing down of overall growth would simultaneously reduce
inflation. It would also reflect some recovery of the drastically reduced
bargaining power of workers and primary producers. But there are other, more
worrying tendencies in operation, that suggest that the current global
inflationary process has other factors pushing it which will not be so easily
controlled.
Forces behind the rise
To understand this, it is necessary to examine the forces behind the price rises
for different commodities. In the case of food, there are more than just demand
forces at work, although it is certainly true that rising incomes in Asia and other
parts of the developing world have led to increased demand for food. Five major
aspects affecting supply conditions have been crucial in changing global market
conditions for food crops.
First, there is the impact of high oil prices, which affect agricultural costs
directly because of the significance of energy as an input in the cultivation
process itself (through fertiliser and irrigation costs) as well as in transporting
food. Across the world, governments have reduced protection and subsidies on
agriculture, which means that high costs of energy directly translate into higher
costs of cultivation, and therefore higher prices of output.

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Policy neglect
Third, the impact of policy neglect of agriculture over the past two decades is
finally being felt. The prolonged agrarian crisis in many parts of the developing
world; the shifts in acreage from food crops to cash crops relying on purchased
inputs; the excessive use of groundwater and inadequate attention to preserving
or regenerating land and soil quality; the lack of attention to relevant
agricultural research and extension; the overuse of chemical inputs that have
long-run implications for both safety and productivity; the ecological
implications of both pollution and climate change, including desertification and
loss of cultivable land: all these are issues that have been highlighted by
analysts but largely ignored by policymakers in most countries.
Reversing these processes is possible but will take time and substantial public
investment, so until then global supply conditions will remain problematic.
Fourth, there is the impact of changes in market structure, which allow for
greater international speculation in commodities. It is often assumed that rising
food prices automatically benefit farmers, but this is far from the case,
especially as the global food trade has become more concentrated and vertically
integrated.
A small number of agribusiness companies worldwide increasingly control all
aspects of cultivation and distribution, from supplying inputs to farmers to
buying crops and even in some cases to retail food distribution. This means that
marketing margins are large and increasing, so that direct producers do not get
the benefits of increases expect with a time lag and even then not to the full
extent. This concentration also enables greater speculation in food, with more
centralised storage.
Financial speculators
Finally, primary commodity markets are also attracting financial speculators. As
the global financial system remains fragile with the continuing implosion of the
US housing finance market, commodity speculation is increasingly emerging as
an important alternative investment market. Such speculation by large banks
and financial companies is in both agricultural and non-agricultural
commodities, and explains at least partly why the very recent period has seen
such sharp hikes in price.
Commodity speculation has also affected the minerals and metals sector. For
these commodities, it is evident that recent price increases have been largely the
result of increased demand, especially from China and other rapidly growing
developing countries, but also from the US and European Union.

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A positive fallout of the recent growth in demand and diversification of sources

of demand is that it has allowed primary metals producing countries, especially
in Africa, to benefit from competition to extract better prices and conditions for
their mined products. But there is also the unfortunate reality that higher
mineral prices have rarely if ever translated into better incomes and living
conditions of the local people, even if they may benefit the aggregate economy
of the country concerned.
At any rate, metal prices are high and likely to remain so because of the
growing imbalance between world supply and demand. A reduction in global
output growth rates would definitely have some dampening effect on prices
from their current highs, but the basic imbalance is likely to continue for some
time. This is also because there has been a neglect of investment in this sector as
well, so that building up new capacity will take time given the long gestation
period involved in investments for metal production.
Implications for India
So the medium-term outlook for global commodity prices, while uncertain, is
that they are likely to remain high even if the world economy slows down in
terms of output growth. What does this mean for India? Until the 1990s, both
producers and consumers in India were relatively sheltered from the impact of
such global tendencies because of a complex system of trade restrictions, public
procurement and distribution and policy emphasis on at least food selfsufficiency.
The liberalising policies that began in the early 1990s have rendered all of that
history, since one explicit aim of the reform strategy was to bring Indian prices
closer in line to world prices. Countries like India seeking to manage this effect
of global speculation on the prices of a universal intermediate like oil have to
decide how important it is to insulate the domestic economy and the domestic
consumer from its effect.
Given the huge revenues being derived from duties on oil products, one way
this can be done is to forego duty while holding oil prices. This would require
compensating for revenue losses with taxes in other areas which a growing
economy can contemplate. But the Government appears unwilling to take this
route, increasing pressure to hike oil prices further and aggravate an inflationary
tendency that is already proving to be economically and politically damaging.

Yogesh Patil
IIPM 12-14

Ineffective strategy
This reticence till recently to proactively insulate the domestic economy has
meant, that both producers and consumers are now more or less directly affected
adversely by global trends.
The Governments response to the domestic price rise, which is already creating
panic in official corridors in an election year, has been to reduce or eliminate
import duties on several food items such as edible oils, so as to allow imports to
bring the price down.
But that is a short-sighted and probably ineffective strategy. It provides direct
competition to Indian farmers producing oilseeds, even as they suffer rapidly
rising costs. It sends confused signals not only to farmers for the next sowing
season, but also to consumers, and leaves the field open for domestic
speculators as well because the imports are not under public supervision but left
to private traders.
Most of all, given the tendency of international commodity prices noted here, it
will not solve the basic problem of rising inflation in such commodities. Instead,
it will make the Indian economy even more prone to the volatility and
inflationary pressure of world markets. In fact, the increases in prices in India
have not been as sharp for some commodities largely because of the vestiges of
the intervention era.
Thus, prices of some commodities, like rice for example, have gone up less than
world prices only because exports have been prohibited. This does suggest that
the Indian economy cannot hope to remain insulated from these global trends
without much more proactive policies that rely substantially on government
intervention in several areas.
In the case of food, this essentially requires a more determined effort to increase
the viability of food cultivation, to improve the productivity of agriculture
through public measures, and to expand and strengthen the public system of
procurement and distribution.
For other commodities too, it is now evident that a laissez faire system is simply
not good enough and public intervention and regulation of markets is essential.

Yogesh Patil
IIPM 12-14

Inflation: through RBI lens

INDIA's central banking authorities Reserve Bank of India maintains that
zooming inflation that the country witnessed in the first quarter of the current
fiscal 2008-09 and beyond - from 7.7 per cent at end-March 2008 to 11.9 per
cent by July 12, 2008- cane be attributed to the impact of some pass-through
of higher international crude oil prices to domestic prices as well as continued
increase in the prices of iron and steel, basic heavy inorganic chemicals,
machinery and machinery tools, oilseeds/edible oils/oil cakes and raw cotton
on account of strong demand, international commodity price pressures and
lower domestic 2007-08 rabi production of oilseeds. The seasonal hardening
of vegetables prices as well as increase in the prices of textiles have also
contributed to the rising inflation during 2008-09 so far. Inflation in India is
estimated on the basis of fluctuations in the wholesale price index (WPI).

Macroeconomic and Monetary Developments: RBI First Quarter Review

2008-09 *
Headline inflation firmed up further in major economies, during the first
quarter of 2008-09, reflecting the combined impact of higher food and fuel
prices as well as strong demand conditions, especially in emerging markets.
Notwithstanding inflation remaining above the targets/comfort zones, the
monetary policy responses during the quarter were mixed in view of growth
implications of the persistence of financial market turmoil following the US
sub-prime crisis. While many central banks in developed countries such as the
US, the UK and Canada, which had reduced policy rate up to April 2008, have
paused subsequently, many central banks in emerging economies continued
with pre-emptive monetary tightening to contain inflation and inflationary
expectations on account of excess supply of global liquidity. Apart from
independent actions, the co-ordinated move by major advanced country
central banks in terms of injection of short-term liquidity aimed at easing
strains on the money markets continued during the quarter.
Mirroring inflation trends in many advanced as well as emerging economies,
various measures of inflation in India have also risen significantly since the
beginning of this calender year. In India, inflation based on the wholesale
price index (WPI) increased from 7.7 per cent at end-March 2008 to 11.9 per
cent by July 12, 2008, reflecting the impact of some pass-through of higher
international crude oil prices to domestic prices as well as continued increase
in the prices of iron and steel, basic heavy inorganic chemicals, machinery and

Yogesh Patil
IIPM 12-14

machinery tools, oilseeds/edible oils/oil cakes and raw cotton on account of

strong demand, international commodity price pressures and lower domestic
2007-08 rabi production of oilseeds. The seasonal hardening of vegetables
prices as well as increase in the prices of textiles have also contributed to
inflation during 2008-09 so far. Consumer price inflation also edged up
generally during the first quarter of 2008-09, reflecting increase in the prices
of food items and services, represented by the miscellaneous group. Various
measures of consumer price inflation were placed in the range of 6.8-8.8 per
cent during May/June 2008 as compared with 6.0-7.9 per cent in March 2008
and 5.7-7.8 per cent in June 2007.
Primary articles prices, y-o-y, increased by 10.1 per cent on July 12, 2008 on
top of 11.1 per cent a year ago (it was 9.7 per cent at end-March 2008),
reflecting increase in prices of food articles, especially rice, wheat, fruits and
milk, and non-food articles such as oilseeds and raw cotton.
Fuel group inflation increased to 16.9 per cent on July 12, 2008 from 6.8 per
cent at end-March 2008 (and a decline of 1.4 per cent a year ago), mainly
reflecting the effect of some hikes in the prices of petrol, diesel and LPG in
June 2008 as well as continued increase (15-51 per cent) in the prices of freely
priced petroleum products such as naphtha, furnace oil, aviation turbine fuel,
bitumen and lubricants over end-March 2008.
Manufactured products inflation, year-on-year, rose further to 10.7 per cent on
July 12, 2008 from 7.3 per cent at end-March 2008 (and 4.8 per cent a year
ago), reflecting increase in the prices of edible oils, oil cakes, textiles,
chemicals, basic metals, alloys and products, and machinery and machine
tools. Prices of sugar and grain mill products, however, eased somewhat from
end-March 2008.
Consumer price inflation increased further during the first quarter of 2008-09
mainly due to increase in food prices and services (represented by the
miscellaneous group) prices. Various measures of consumer price inflation
were placed in the range of 6.8-8.8 per cent during May/June 2008 as
compared with 6.0-7.9 per cent in March 2008 and 5.7-7.8 per cent in June
2007.

Recent Measures by the Government to Control Inflation in India

Yogesh Patil
IIPM 12-14

In order to contain inflationary pressures, the monetary measures undertaken

by the Reserve Bank were supplemented by a number of fiscal and supply
augmenting measures undertaken by the Government. These include:
(i) Measures relating to Imports
Pulses: Customs duty on import of pulses was reduced to zero on June 8,
2006 and the period of validity of import of pulses at zero duty, which was
initially available up to March 2007, was first extended to August 2007 and
further to March 2009.
Wheat: Import of wheat at zero duty, which was available up to endDecember 2006, was extended further to end-December 2007.
Edible oils: Customs duty on palm oils was reduced by 10 percentage points
across the board in April 2007 and import duty on various edible oils was
reduced in a range of 5-10 percentage points in July 2007. The 4 per cent
additional countervailing duty on all edible oils was also withdrawn. Customs
duties on crude and refined edible oil were reduced from a range of 40-75 per
cent to 20.0-27.5 per cent in March 2008. Import of crude form of edible oil at
zero duty and refined form of edible oil at a duty of 7.5 per cent was allowed.
Rice: In March 2008, the customs duty on semi-milled or wholly-milled rice
was reduced from 70 per cent to zero per cent up to March 2009.
Maize: Customs duty on maize imported under a Tariff Rate Quota of five
lakh metric tonnes was also decreased from 15 per cent to Nil in April 2008.
Milk: In order to ensure adequate availability of milk in lean summer months,
basic customs duty on skimmed milk powder was proposed to be reduced
from 15 per cent to 5 per cent for a Tariff Rate Quota of 10,000 metric tonnes
per annum in April 2008. Similarly, on butter oil, which is used for
reconstituting liquid milk, customs duty was reduced from 40 per cent to 30
per cent.
Cement: On April 3, 2007, import of portland cement other than white cement
was exempted from countervailing duty (CVD) and special additional customs
duty; it was earlier exempted from basic customs duty in January 2007.
Exports of cement was prohibited with effect from April 11, 2008.
Iron & Steel: In order to augment the domestic availability of steel products as
well as to soften prices, the following measures were announced:
a) reduction in the basic customs duty on pig iron and mild steel products viz.,
sponge iron, granules and powders; ingots, billets, semi-finished products, hot

Yogesh Patil
IIPM 12-14

rolled coils, cold rolled coils, coated coils/sheets, bars and rods, angle shapes
and sections and wires from 5 per cent to Nil;
b) Full exemption of the import of TMT bars and structurals from CVD,
which is currently at 14 per cent;
c) reduction in the basic customs duty on three critical inputs for manufacture
of steel, i.e. metallurgical coke, ferro alloys and zinc from 5 per cent to Nil.
Cotton: The 10 per cent customs duty on cotton imports along with 4 per cent
special additional duty was abolished with effect from July 8, 2008.
Crude Oil & Petroleum products: Customs duty on crude oil was reduced
from 5 per cent to nil as well as on diesel and petrol from 7.5 per cent to 2.5
per cent each, and on other petroleum products from 10.0 per cent to 5.0 per
cent. Excise duty on petrol and diesel was reduced by Re. 1 per litre.
(ii) Measures relating to Exports
Pulses: A ban was imposed on export of pulses with effect from June 22, 2006
and the period of validity of prohibition on exports of pulses, which was
initially applied up to end-March 2007, was further extended first up to endMarch 2008 and then for one more year beginning April 1, 2008.
Onion: The minimum export price (MEP) was increased by the National
Agricultural Cooperative Marketing Federation of India Ltd. (NAFED) by US
$ 100 per tonne for all destinations from August 20, 2007 and by another US $
50 per tonne with effect from October 2007 for restricting exports and
augmenting availability in the domestic market.
Edible Oils: The export of all edible oils was prohibited with immediate effect
from April 1, 2008.
Rice: On April 1, 2008, export of non-basmati rice was banned and the
minimum export price (MEP) was raised to US $ 1,200 per tonne in respect of
basmati rice. On April 29, 2008, an export duty of Rs.8,000 per tonne was
imposed on basmati rice along with a commensurate reduction in its minimum
export price and thereby re-fixed the MEP at US$ 1,000 per tonne.
Iron & Steel: On April 29, 2008, export duty was imposed on steel items at
the following three different rates:
15 per cent on specified primary forms and semi-finished products, and hot
rolled coils/sheet,

Yogesh Patil
IIPM 12-14

10 per cent on specified rolled products including cold-rolled coils/sheets and

pipes and tubes,
5 per cent on galvanized steel in coil/sheet form.
For this purpose, a uniform statutory rate of 20 per cent has been incorporated
in the Export Schedule. These measures are expected to disincentives the
export of steel and augment domestic supply.
Cotton: One per cent drawback benefits (refund of local taxes) on exports of
raw cotton were withdrawn with effect from July 8, 2008.
(iii) Other Measures
a) The minimum support price (MSP) for paddy was raised by Rs. 125 per
tonne for 2007-08 and for wheat by Rs. 150 for 2007-08 and further by Rs.
150 for 2008-09.
b) Issuance of oil bonds to State-run oil marketing companies.
* Following are extracts of the The Reserve Bank of India document
was released on July 28, 2008

Yogesh Patil
IIPM 12-14

Is India, the world's second most populous nation, facing a

food crisis?

This question is vexing policy makers and analysts alike even as creeping
inflation - around 7% now - is sending jitters through the Congress party-led
ruling coalition.
To be sure, India has not yet experienced riots over rising food prices that have
hit other countries like Zimbabwe or Argentina.
But what is worrying everybody is that the current rise in inflation is driven by
high food prices.
In the capital, Delhi, milk costs 11% more than last year. Edible oil prices have
climbed by a whopping 40% over the same period.
More crucially, rice prices have risen by 20% and prices of certain lentils by
18%. Rice and lentils comprise the staple diet for many Indians.
Tax on the poor
Inflation, economists say, is akin to a tax on the poor since food accounts for a
relatively high proportion of their expenses.
All of which is bad news for ruling politicians because the poor in India vote in
much larger numbers than the affluent.
Roughly one out of four Indians lives on less
than $1 a day and three out of four earn $2 or
less.
The rise in food prices, the government says, is
an international phenomenon.
But this argument is unlikely to cut much ice
with the people.
At the crux of the crisis is the tardy pace at which
farm output has been growing in recent years.
Food prices have risen sharply in
the past year

Yogesh Patil
IIPM 12-14

The Indian economy has been growing rapidly at an average of 8.5% over the
last five years.
This growth has been mainly confined to manufacturing industry and the
burgeoning services sector.
Agriculture, on the other hand, has grown by barely 2.5% over the last five
years and the trend rate of growth is even lower if the past decade and a half is
considered.
Consequently, per capita output of cereals (wheat and rice) at present is more or
less at the level that prevailed in the 1970s.
The problem acquires a serious dimension since farming provides livelihood to
around 60% of India's 1.1 billion people even though farm produce comprises
only 18% of the country's current gross domestic product (GDP).
On the other hand, the services sector - that includes the fast-growing computer
software and business process outsourcing industries - constitutes over 55% of
GDP with the remainder being taken up by industry.
The crisis in farms is exemplified by the state of the country's cereal stocks.

Vulnerable farmers

Yogesh Patil
IIPM 12-14

Six years ago, the stocks were at record levels.

Nobel laureate economist Amartya Sen had said if all the bags of wheat and rice
with the state-owned Food Corporation of India were placed end to end, they
would go all the way to the moon and back.
Stocks have come down over the past three years because of low production and
exports.
The problem has been compounded by the fact that whenever India has
imported wheat in recent months, world prices of wheat There is also
considerable resentment over the fact that the price of wheat that the
government imports is often twice as high as the minimum price the
government pay its own farmers for domestically grown wheat.
Indian farmers are particularly vulnerable since 60% per cent of the country's
total cropped area is not irrigated.
They are also dependent on the four-month-long monsoon during which period
80% of the year's total rainfall takes place.
The crisis in agriculture has been manifest in the growing incidence of farmers
taking their own lives.
At least 10,000 farmers have committed suicide each year over the last decade
because of their inability of repay loans taken at usurious rates of interest from
local moneylenders.

Yogesh Patil
IIPM 12-14

Populist moves
There has never been an acute shortage of food in
India, not even during the infamous famine in
Bengal in 1943 in which more than 1.5 million
people are estimated to have died of starvation.
The problem then - and now - is entitlement or
access to food at affordable prices.
Given the low purchasing power of India's poor,
even a small increase in food prices contributes to a
sharp fall in real
incomes.
Growth in the farm sector has
The current crisis in
been sluggish
Indian agriculture is a
consequence of many
factors - low rise in
farm
productivity,
unremunerative prices
for cultivators, poor food
storage
facilities
resulting in high levels of
wastage.
Fragmentation of land Rising food prices has made the holdings and a fall in
public investments in government jittery
rural areas, especially in
irrigation
facilities,
are also to blame.
The government has
announced a $15bn waiver
of farmer loans and extended a jobs scheme - ensuring 100 days of work in a
year entailing manual labour to every family demanding such work at the
official minimum wages giving its ignored farms the importance they deserve.
But that alone may not help, as the study notes low correlation between
expansion in area irrigated and expenditure. This suggests the need for better
governance to improve the usage of funds allocated to the sector. The study
flags the shrinking public support for expanding the knowledge base for
agriculture. From a high of 0.54% of total revenue spending in 1990-91, the
public spending on research and extension has fallen to 0.45% by 2005-06.
However, this can be addressed through a greater involvement of the private
sector. In the case of contract farming, the private sector purchasers usually help
make available to farmers the best practices and domain knowledge. The study
also cites credit issues with farming but that has been a concern for a while.
Clearly, boosting agricultural growth would require a multi-pronged effort.
Better prices for farm produce alone would not suffice.

Yogesh Patil
IIPM 12-14

VIEW OF INDIAN
INFLATIONARY RATE

GOVERNMENT

REGARDING

RISING

There are more bad news coming on the economy front. After car sales and
industrial growth revealed disappointing figures, Prime Minister's Economic
Advisory Council (PMEAC) came out with a grim picture of Indian economy.
In its outlook for 2008-09, the high-powered body revised the economic growth
downward to 7.7%, agriculture growth projection to 2% and said inflation will
continue its upward march to touch 13%. However, FM P Chidambaram was
bullish that growth figure will touch 8% in the current financial year. "If the
PMEAC pegs GDP growth at 7.7%, I can confidently say it will be close to 8%,"
he said, adding that the credit requirements of productive sector will be met.
Outgoing chairman of PMEAC, C Rangarajan said, "For some more time,
inflation can increase. It could touch 13%. But by December it will start
declining." The panel hoped that "inflation could be brought down to 8-9% by
March
2009
through
coordinated
policy
action."
PMEAC lowered the economic growth projection for 2008-09 to 7.7% from
8.5% forecast in January. Rangarajan said that downward revision of GDP
growth was mainly on account of lower agriculture and industrial growth, and
adverse fallout of global developments. RBI has forecast a growth rate of 8%.
As per the PMEAC projection, agriculture production is likely to decline to 2%
from 4.5% in the last fiscal, industrial production to 7.5% from 8.5% and
services
sector
output
to
9.6%
from
10.8%.

Yogesh Patil
IIPM 12-14

In 2008-09, the PM panel said while the investment momentum will continue as
it was in 2007-08, savings would decline. It said public sector savings will be
adversely affected by the increase in the subsidy burden. Erosion of corporate
margins
would
also
hit
private
sector
savings.
PMEAC said because of rising crude prices, the current account deficit in 200809 would go up to 3.2% of GDP in 2008-09 from 1.5% in 2007-08.
Rangarajan attributed the slowing down of economy to factors like rising oil and
food prices in international market and global slowdown triggered by US
subprime
crisis.
Stating that the surge in inflation was mostly on account of surging global
commodity prices, the PMEAC said there were serious fiscal risks arising from
growing off-budget liabilities on account of fertilizer, food and oil, along with
unbudgeted liabilities arising out of the farm loan waiver and National Rural
Employment Guarantee (NREG) scheme. It said that these schemes would create
a liability of 5% of GDP, which is double the budgeted fiscal deficit at 2.5%.
PMEAC's new chairman Suresh Tendulkar said 7.7% economic growth rate will
not be "unrespectable and would be the second highest growth rate by any
country."
Meanwhile, Chidambaram reiterated the view that there is no slowdown in the
demand for credit, though there is indeed some slowdown in demand for
personal loans. In the real estate sector, however, he said, banks have imposed
certain restrains but the demand for credit in this sector continues to be very
high.
Chidambaram added that many banks have not increased the interest rate on
home loan up to Rs 30 lakh. Therefore, he said any rise in the interest rate would
not unduly impact the sector.

To douse the anger of the common man, the government adopted the fire
fighting approach to tackle inflation. The following measures were
announced:
1.Scrapped import duties on edible oils.
2. Banned export of basmati rice.
3. Reduced duty on maize imports from 15 per cent to zero.
4. Extended ban on export of pulses for one year.

Yogesh Patil
IIPM 12-14

5. Banned export of edible oils.

6. Withdrew export incentives in steel and cement.
The principal objective of the government was to make available supply of
foodgrains, pulses, edible oils for domestic use and to facilitate the import of
these commodities to reduce the impact of supply constraint. But these
measures did not produce the desired effect.
Another problem is the wide gap in the prices of food items in the wholesale
mandis as revealed by the figures of the Agricultural Produce Marketing
Committee and those charged by retailers. The government should have set up
distribution centres or used the PDS shops after making bulk purchases from
wholesale markets and thus provided a competitive and countervailing structure
to offer relief to the consumers but it has failed to do so. Such a fire fighting
measure would have mitigated the hardship for the consumers and tamed the
middlemen who are making huge profits taking advantage of the prevailing
scarcity.
Failure to Improve Growth Rate in Agriculture
BASICALLY, the present inflation, which is driven by the prices of foodgrains,
pulses, vegetables and fruits, is not a demand-driven inflation, but is the result
of the failure of the government policy on the agricultural front to raise output.
It is the supply constraint that has fuelled inflation.

Yogesh Patil
IIPM 12-14

CONCLUSION
India inflation rate rises to 11%

Year Jan Feb Mar Apr May Jun

2008 4.84 5.23 6.02 7.95

Jul Aug Sep Oct Nov Dec

8.24 11.05

2007 7.36 7.81 7.56 7.74 6.79 6.08 6.86 6.41 5.74 5.48 5.10 5.07
2006 5.00 4.80 5.00 4.97 5.84 6.47 5.71 6.14 7.02 7.17 6.70 6.94
FIG : INFLATION CHART

Wholesale price inflation rose by 11%. The inflation rate is now at its highest since
1995.
Inflation is being driven higher by the rising cost of fuel and food, and is well above
the governments target of between 5% and 5.5%.

Unlike most countries, India calculates inflation on the wholesale price of a basket of
435 commodities, which means actual prices paid by the consumer are much higher.

Cooking gas prices have risen by 20% and diesel is up 21%.

Although an election must be held by May 2009, our correspondent says there is some
suggestion it may be held later this year.

Yogesh Patil
IIPM 12-14

With the central bank expected to increase interest rates to try to control inflation,
Indias economic growth is expected to slow down and combined with rising prices,
this may translate into voter anger.

BIBLIOGRAPHY

For our study of increasing inflationary trend in India we have taken reference
of the following:

WEBSITES:
www.rbi.co.in
www.bbc.co.in
www.theeconomicstime.com
www.managementparadise.com
www.htindia.com

MAGAZINES:
INDIA TODAY
OUTLOOK
BUSINESS TODAY

We had also taken reference of newspapers such as:

HINDUSTAN TIMES
TIMES OF INDIA
DECCAN CHRONICLE

Yogesh Patil
IIPM 12-14

THE ECONOMICS TIMES