Inflation in India

Many developing countries use changes in the consumer price index (CPI) as their central measure of inflation. In India, CPI (combined) was declared as the new standard for measuring inflation in April 2014. CPI numbers are typically measured monthly, and with a significant lag, making them unsuitable for policy use. India uses changes in the CPI to measure its rate of inflation.

The WPI measures the price of a representative basket of wholesale goods. In India, this basket is composed of three groups: Primary Articles (22.62% of total weight), Fuel and Power (13.15%) and Manufactured Products (64.23%). Food Articles from the Primary Articles Group account for 15.26% of the total weight. The most important components of the Manufactured Products Group are Food products (19.12%); Chemicals and Chemical products (12%); Basic Metals, Alloys, and Metal Products (10.8%); Machinery and Machine Tools (8.9%); Textiles (7.3%) and Transport, Equipment and Parts (5.2%).

WPI numbers were typically measured weekly by the Ministry of Commerce and Industry. This makes it more timely than the lagging and infrequent CPI statistic. However, since 2009 it has been measured monthly instead of weekly.

Issues

The challenges in a developing economy are many, especially in the context of monetary policy, the Central Bank, and the phenomena of inflation and price stability. There has been a universal argument recently that monetary policy is a key element in depicting and controlling inflation. The Central Bank works on the objective to control and have a stable price for commodities. A good environment of price stability creates saving mobilisation and sustained economic growth. The former Governor of RBI C. Rangarajan points out that there is a long-term trade-off between output and inflation. He adds that short-term trade-off happens to only introduce uncertainty about the price level in future. There is an agreement that the central banks have aimed to introduce the target of price stability while an argument supports it for what that means in practice.

Optimal inflation rate

It arises as the basic theme in deciding an adequate monetary policy. There are two debatable proportions for an effective inflation: whether it should be in the range of 1-3 per cent as the inflation rate that persists in the industrialized economy or should it be in the range of 6-7 per cent. While deciding on the elaborate inflation rate certain problems occur regarding its measurement. The measurement bias has often calculated an inflation rate that is comparatively more than actual. Secondly, there typically arises an issue when the quality improvements in the product need to be captured out. Hence, it affects the price index. The consumer preference for cheaper goods affects the consumption basket at costs, for the increased expenditure on the cheaper goods takes time for the increased weight and measuring inflation. The Boskin Commission has measured 1.1 per cent of the increased inflation in the USA per annum. The commission points out that comprehensive studies on inflation in developed countries appear to be fairly low.

Money supply and inflation

Quantitative easing by the central banks with the effect of an increased money supply in an economy typically helps to increase or moderate inflationary targets. There is a puzzle formation between low-rate inflation and a high growth of money supply. When the current rate of inflation is low, a high worth of money supply warrants the tightening of liquidity and an increased interest rate for a moderate aggregate demand and the avoidance of any potential problems. Further, in case of a low output, a tightened monetary policy would affect the production in a much more severe manner. Supply shocks are known to play a dominant role in regard to monetary policy. The bumper harvest in 1998-99 with a buffer yield in wheat, sugarcane, and pulses led to an early supply condition further driving their prices from what they were in the previous year. The increased import competition since 1991 with the trade liberalisation in place has widely contributed to the reduced manufacturing competition with cheaper agricultural raw materials and the fabric industry. These cost-saving-driven technologies have often helped to drive a low inflation rate. The normal growth cycles accompanied by international price pressures have several times been characterized by domestic uncertainties.

Global trade

Inflation in India generally occurs due to global traded commodities and the several efforts made by the Reserve Bank of India (RBI) to weaken the rupee against the dollar. This was done after the Pokhran Blasts in 1998. This has been regarded as the root cause of the inflation crisis rather than domestic inflation. According to some experts, the policy of the RBI to absorb all dollars coming into the Indian economy contributes to the appreciation of the rupee. When the U.S. dollar depreciated by a margin of 30%, the RBI made a massive injection of dollars into the economy making it highly liquid; this further triggered off inflation in non-traded goods. The RBI picture clearly portrays subsidising exports with a weak dollar-exchange rate. Critics argue that these account for dangerous inflationary policies being followed by the central bank of the country. Further, on account of cheap products being imported in the country which are made on high technological and capital intensive techniques, domestic raw materials in the global market either increase in price or are forced to sell at a cheaper price, hence incurring heavy losses.