Inflation In India- Reasons and Solutions- Explained Pointwise

Recently, the Reserve Bank of India Monetary Policy Committee (MPC) has released the projection of retail Inflation in India for FY 25. RBI’s MPC projects Inflation in India to be 4.9% in Q1, 3.8% in Q2, 4.6% in Q3 and 4.5% in Q4 of FY25. Inflation in India is now showing decreasing trend, after its upsurge in the aftermath of the COVID-19 pandemic and Russia’s invasion in Ukraine.

However, the retail food inflation in India has been posing challenges for the final descent of inflation to the target of 4%. But there is hope, for softening of food inflation softening in the months ahead, due to easing global food prices and the onset of La Nina in India. This would provide the much needed leeway for the MPC to consider cutting the central bank’s benchmark interest rates.

What is Inflation? What are its different types?

Inflation- Inflation refers to the rise in the prices of most goods and services of daily or common use such as food, clothing, housing, recreation, transport, consumer goods. Inflation measures the average price change in a basket of commodities and services over a period of time.

Types of Inflation

Different Inflation indices used in India

WPI Inflation- WPI captures the average movement of wholesale prices of goods only. Its major components are- Manufactured goods (64.23%) > Primary articles (22.62%)> Fuel and Power (13.15%). It is primarily used for ascertaining GDP Deflator in the economy.

CPI Inflation- CPI captures the movement in prices of goods and services that are acquired by the households for consumption purposes. Its major components are- Food and Beverages (45.86%) >Housing (10.07%)> Transport and communication (8.59%)> Fuel and Light (6.84%). It is primarily used for RBI’s Inflation targeting and measurement of DA for employees.

Inflation Targeting in India

The Reserve Bank of India is the authority to control inflation under RBI Act 1934.

What are the reasons behind the recently Increasing Inflation in India?

1. Decreased food production due to erratic weather- The prices of food commodities has increased, on account of decreased production due to deficient monsoon and unseasonal rains. This had caused a spike in the prices of wheat, rice, pulses, vegetables and edible oils.

2. Increasing cost of agricultural inputs- The increase in the cost of inputs such as seeds, fertilizers, and labour has raised the production costs for farmers in India. This, in turn, has led to higher prices for cereals and pulses.

3. Increase in Global Fuel prices- India has import dependency of around 80% for its fuel demands. For ex- A $10 increase in crude oil price increases inflation in India by 40-60 bps.

4. Geopolitical Conflicts and tensions- The Russia-Ukraine crisis  and Israel-Hamas wars have resulted in the increase of crude oil prices and have contributed to soaring food and commodity prices (wheat and sunflower oil) .

5. Impact of COVID-19 pandemic- COVID-induced lockdowns caused supply chain disruptions across the world, pushing up the commodity prices. Post COVID economic rebound led to a drastic increase in demand for goods causing demand pull inflation in India.

6. Lack of Government Interventions- The lackadaisical approach government in actively controlling prices of the essential commodities like lax action on hoarders and stockpilers and exports at prices lower than MSP (Non-basmati rice exports surged from 1.38 MT in 2019-20 to 6.4 MT in 2022-23, at prices lower than (MSP), causing high food inflation).

What are the impacts of Inflation in India?

Moderate inflation in the range of 4%+/- 2%, has its positive impacts on the economy-

1. Increased economic growth- Increasing prices encourages consumers to spend and invest, which gives a boost to the economy and job creation.

2. Higher Profits and Boost to production- Inflation is advantageous to product manufacturers as it enables them to make more money because of Increased Prices. This also boosts to the production of more goods and services.

3. Better returns to the investors- Entrepreneurs and investors get better returns on investments made in profitable ventures during periods of inflation.

4. Increase in worker’s wages- Inflation results in increased wages for the workers as they need more money to keep up with rising costs of products.

5. Reduction in debt burden- Inflation reduces the real burden of debt as the amount of money owed remains constant while the value of money decreases over time. This is particularly helpful for borrowers who are struggling to repay their debts.

However, high and soaring inflation rates (6% or more in India) has seriously negative impacts on the economy-

1. Inflation tax- High rate of Inflation erodes the purchasing power of money. People can buy less with the same amount of money, resulting in decreased standard of living.

2. Exacerbates socio-economic inequality- High inflation rates disproportionately impacts the poor, unemployed, people with fixed incomes and retired workers.

3. Reduced economic activities-  High inflation increases the economic and financial uncertainties by resulting in increased borrowing cost of businesses(as RBI increases Repo rate).

4. Reduced international competitiveness- High Inflation makes a country’s goods and services more expensive relative to other countries, thereby reducing its international competitiveness.

5. Currency depreciation- Inflation in India leads to depreciation of currency which can impact economic stability.

What are the measures employed in India to control inflation?

Inflation management is a complex task as inflation is caused by several factors such as demand-pull factors, cost push factors and structural factors. Therefore a mix of macro-economic policies are needed to manage the inflation in the economy.

What are the challenges with Inflation Management in India?

1. Rising Food Prices- India’s food and oil components of the consumer price index CPI are about 50%. The RBI has no control over the prices of food and oil, as these are driven by natural climatic factors as well as global uncertainties like Ukraine-Russia war. Therefore, it is left to squeeze less than 50% of the domestic economy to lower inflation.

2. Govt Failure in addressing supply shocks- Govt’s myopic policies of export ban of agricultural products (like wheat, rice, onions) induces fear and panic in the domestic market, leading to rise in stock holdings which ultimately resulted in price rise.

3. Monetary Policy’s singular focus on demand side- RBI’s monetary policy targets only demand constraints. It faces the problem of tackling Supply shocks originating from food and oil.

4. Flawed Model of Inflation targeting- The current model of Inflation targeting is based on the assumption that inflation means overheating of the economy-that is increased output greater than natural level output. However, In India it is impossible to observe the actual level of output in an economy. Hence, setting policy rates based on the assumption that the economy has overheated is unscientific.

What should be the solutions for reducing inflation?

1. Implementing Farm Reforms- Farm reforms which aim to raise agricultural production and productivity must be implemented at the earliest. Also, measures to enhance the processing of perishables like Onion and tomato must be undertaken.

2. Adjustment of Import Duties- Import duties on items like wheat should be reduced as cheaper imports can help control domestic prices.

3. Release Excess Buffer Stocks- The government holds more than 40 million tonnes of rice, much above the buffer stock norms of 13.5 MT. This excess stock should be unloaded by Food Corporation of India in the open market at reasonable prices. This will cool down the food inflation.

4. Reduced dependence on fuels- We must aim to increase our renewable energy share in energy mix at the earliest, so as to reduce the burden on imported fuels, which induce price volatility.

5. Updation of the CPI Basket Weights- The weight of food and beverages in the CPI basket should be adjusted to reflect current realities as the weights are based on the 2011 consumption survey.