ASSIGNMENT-III

INFLATION: CPI USED TO SET INLATION TARGET

year-WPI in same month of previous year)
------------------------------------------------------------------------------------- X 100
WPI in same month of previous year
Every week the wholesale price of nearly 435 goods are calculated by the Indian government. As 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 taes on products. !hen economy eperiences 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 ependiture 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. An inflation rate of ( or 3) 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 ecessive
growth of prices to a minimum.
Causes of Inflation
%emand$*ull inflation
"he %emand$*ull 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.
other countries.
Histor an! 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.
,n -ay .5, (/.4 0eserve 1ank of India, 2overner, %r.0aghuram 0a3an was talking to reporters after the 01I4s
board meeting updated that,5 Interest rate is the best tool for 0eserve 1ank to control inflation4, he said the 6best
tool4 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.
71oth need to work together and will work together. !e were epecting some increase in the &*I number because
of the seasonal effects from vegetable prices, but it came more than anticipated by the consensus forecast. !e will
study them in greater detail. !hat does it suggest is that inflation is high as far as food prices go,5 he added.
#owever, he said the core inflation had been coming down but though 6very very gently4. 0etail or consumer price
inde 8&*I9 inflation rose to a three$month high of :.5; per cent in April. %r. 0a3an euded confidence that retail
inflation would come down to < per cent by -arch, (/.<. 7!e are very comfortable with the fact that we can
achieve what the =r3it *atel committee suggested of : per cent inflation at the end of the year and < per cent at the
end of net year.5
"he !*I based inflation has eased to 5.( per cent, while the retail inflation was still high at :.5; per cent in April.
Inflation fi"ures #ertainin" to $%&'
"his involves inflation based on the &*I 8consumer price inde9 and the #I&* 8harmonised consumer price
inde9 . "he &*I is often considered a country4s most important inflation figure.
Inflation development during (/.3
A graph and a table with additional information about the development of inflation during (/.3 can be found
below. !hen you select a country and a type of inflation in the selection bo, the page will automatically change
and show the development of the inflation figure which you have selected in (/.3.
C(art CPI In!ia $%&'
>ource ?2lobal rates.com8.(./<..49
Ta)le CPI In!ia $%&'
-onths in (/.3 inflation 8yearly basis9
@anuary ...<.< )
Aebruary .(./</ )
-arch ...443 )
April ./.(44 )
-ay ./.<:/ )
@une .../5: )
@uly ./.:4; )
August ./.B4: )
>eptember ./.<;: )
,ctober .../</ )
Covember ...4<: )
%ecember ;..3( )

-ain drivers of food and non$food inflation in &*I new series















>ource? -inistry of Ainance D-id$Eear Economic Analysis8(/.3$(/.49F
IMPACT OF INFLATION ON INDIA*S ECONOMIC DE+ELOPMENT
"he Indian economy recovered in the second Guarter 8H(9 of (/.3$.4 recording a growth of 4.: per cent. "his
follows a growth rate of 4.4 per cent in the first Guarter 8H.9 of the current financial yearI the lowest in .<
Guarters. !hile the 2overnment delivered on the announced fiscal targets in (/.($.3, current account deficit
8&A%9 continued to remain elevated in H. of (/.3$.4 and in tandem with market misperception of an imminence
of the rollback of Guantitative easing in =>, assumed a serious dimension with the sharp depreciation of the rupee.
"he 2overnment put in place a series of measures and there has been a significant let$up in the challenges on the
trade and balance of payments front, particularly in the H( (/.3$.4. %omestic impediments like elevated levels of
food and retail inflation, high input costs and pressure on profit margins and infrastructural bottlenecks continued,
with the 2overnment addressing them through appropriate calibration of fiscal policy, administrative measures
and institutional mechanisms like &abinet &ommittee on Investment to fast track pro3ects.
"he recovery in growth, although weak, is epected to gather pace in the coming Guarters. !hile there are some
concerns about renewed price pressure in ,ctober (/.3 and the services sector, the driver of growth, is still to pick
up, there are indications to the effect that these could be reversed going forward. "he analyses in various sections
of this chapter would provide the analytical basis for the above assessment. !ith recent improvements in growth
of some sectors, better performance of eports and measures taken by the 2overnment, the year (/.3$.4 can be
epected to end with a growth of 5 per cent.
"he Indian economy weathered the global financial crisis rather well and Guickly recovered from the decline in
growth rate in (//:$/; to a healthy growth that averaged around ; per cent annually in (//;$./ and (/./$...
#owever, this recovery was short$lived and growth rate declined to <.( per cent in (/..$.( and 5./ per cent in
(/.($.3, on account of both domestic and eternal factors. %espite some recovery in the growth of agriculture and
industry sector, particularly in H( of the current financial year, the overall growth of the economy has been a
modest 4.< per cent in the first half of the year. "he growth rate of the economy improved from 4.4 per cent in H.
(/.3$ .4 to 4.: per cent in H(. &ompared to H. (/.3$.4, H( has evidenced a robust pick$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 $
ehibited 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
eports making an impressive turnaround in H( (/.3$.4. "he confluence of these factors has resulted in a growth
of 4.< per cent during the first half 8#.9 of (/.3$.4, roughly the same level of 4.B per cent achieved during the
second half 8#(9 of (/.($.3.
,n the eternal front, the crisis of (//:, the subseGuent sovereign debt crisis and the recession in the Euro$area
had moderated the average growth rate of the global economy to less than 3 per cent over the period (//:$(/.( as
compared to 5 per cent during (//4$(//B. %ata from I-A indicate that several emerging market economies
including &hina and India Guickly rebounded to high growth in the aftermath of the crisis. In fact, in terms of
market price 2%*, India4s growth eceeded that of &hina in (/./. Apart from emerging economies, advanced
economies also eperienced significant recovery in (/./ with both the => and the Euro$area registered distinctly
higher growth rates. A series of subseGuent events, including the uncertainty surrounding Euro$area sovereign debt
crisis, hampered sustained economic recovery in advanced economies with adverse conseGuences for growth and
challenges for macroeconomic management in emerging market economies. !ith the intensification of the
sovereign debt crisis, the decline in real 2%* growth rates starting (/.. has been witnessed across advanced and
emerging market economies. Economic growth has again started looking up in advanced economies, especially in
the =>, alleviating the eternal constraint on India4s recovery to some etent.
"he slowdown in real 2%* growth in India during (/..$.( and (/.($.3 is the trends in similar emerging
economies. "he downturn has been more pronounced in the Indian case, owing to domestic and structural factors.
"he growth of real 2%* has generally shown a declining trend since the first Guarter of (/..$.(. An upward
movement in some of the Guarters in between raised the hope for a turnaround that was belied .&orresponding to
this, the industrial sector witnessed a long, steep decline. "he service sector also witnessed growth moderation,
which has been gradual and less steep than the industrial sector, and its growth remained more or less constant
during H3 (/.($.3 to H. (/.3$.4. As panel . of Aigure ... shows, the declining trend in 2%* growth has
reversed in H( (/.3$.4, on the back of higher growth in agriculture and industry vis$J$vis H. (/.3$.4.
,KE0KIE! ,A "#E E&,C,-E
















>ource? -inistry of Ainance D-id$Eear Economic Analysis8(/.3$(/.49F
Re,e!ial Measures to Control Inflation:
According to "rading Economics on the benchmark interest rate in India was last recorded at : percent. Interest
0ate in India averaged <.<4 *ercent from (/// until (/.4, reaching an all time high of .4.5/ *ercent in August of
(/// and a record low of 4.(5 *ercent in April of (//;. Interest 0ate in India is reported by the 0eserve 1ank of
India.
"he -inistry of Ainance and the 01I 80eserve 1ank of India9 always strive to control inflation. "hey control
inflation by directly affecting the demand pull inflation by changing the amount of liGuidity circulating in the
economy. "he 01I can change the liGuidity by its various tools vi'. &00, 1ank$0ate 80E*, and 0everse$0E*,9,
>L0, etc.
&00 8&ash 0eserve 0atio9 is the proportion of amount which each commercial bank 8like >1I, I&I&I, etc.9 has to
maintain in the form of hard cash. All commercial banks accept deposits from individuals and lend it to borrowers
at a higher interest rate. "he difference between the interest rate which they collect from borrowers and which they
pay to their depositors is their profit. Caturally, each bank will try to lend all the money they collect from
depositors. #owever, banks can4t lend all the money they have. =nder law, each bank has to maintain a certain
proportion of cash as reserve. "his is known as &00. !hen 01I increases the &00, the bank4s lending power
decreases. Less lending means less borrowing, this in turn means less money in the economy. Last month, the 01I
increased the &00 from :.B5) to ;) to control inflation. >L0 8>tatutory LiGuidity 0atio9 is also similar to &00.
1ut in case of >L0, 2overnment$>ecurities need to be maintained by the commercial banks instead of cash.
In its (:th @anuary (/.4 meeting, 0eserve 1ank of India decided to raise the policy repo rate by (5 bps to :
percent to handle currency pressure and curb persistently high inflation.
1ank$0ate is basically the interest rate at which the &entral 1ank borrows from the other scheduled commercial
banks. "his rate is directly linked to the interest rates charged in turn by all the commercial banks to its customers.
All these other interest rates on #ome$loans, *ersonal$loans, etc. also increase with the increase in bank$rate.
"hus, by raising the 1ank$0ate and in turn all other Interest 0ates, the 01I makes borrowing money from banks a
very costly affair. *eople are thus discouraged to borrow more money and total amount of liGuidity decreases in
the economy. Last month, the 01I increased the 1ank 0ate from :.5) to ;.5). "his was an increase of 5/ basis$
points 8/.5)9 to control inflation.
"he above mentioned measures vi'. &00, >L0, 1ank$0ate are called -onetary *olicy tools. Apart from these,
there are certain Aiscal *olicy tools which the 2overnment can use. ,ne recent eample of fiscal tool is the recent
ban placed on the eport of 1asmati rice by the Ainance -inister. 1y banning the eport of rice, the supply of rice
will increase in the home country relative to its demand. "his will naturally bring down the price of rice which is a
ma3or component of !*I. "he price$rise in 1asmati rice is an eample of %emand$pull inflation because demand
has increased relative to supply. Although, it could be said that demand for rice is not related to liGuidity but is
inelastic 8where demand is autonomous and not related to increase in price or income9.
"he rise in interest rates initially makes life difficult for people who have taken loans on floating interest rates, it is
a reGuired step to bring down inflation which is a larger evil. It might also be noted that 01I, by making the policy
changes can control only one type of inflation i.e. demand$pull inflation. It cannot affect the other type of inflation
i.e. cost$push inflation which is caused by rise in prices of raw$materials and other factors of production. "hat is
why the rate of inflation is increasing continuously since last si months although the 01I 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. 1ut the prices of none
of them can be controlled by the government.
-une 'r!. $%&/ ,eetin". Reser0e 1an2 of In!ia left t(e re#o rate at 3 #er4ent. )ut 4ut t(e a,ount of
"o0ern,ent )on!s )an2s ,ust (ol! 5it( t(e 4entral )an2 - t(e statutor li6ui!it ratio - ) 7% )#s to $$87
#er4ent. ai,in" to in4rease )an2 4re!it8
"he cut in statutory liGuidity ratio will take effect from the fortnight beginning @une .4, (/.4. "he central bank
also decided to reduce the liGuidity provided under the eport credit refinance facility from 5/ per cent of eligible
eport credit outstanding to 3( per cent with immediate effect. *olicymakers introduced a special term repo
facility of /.(5 per cent of net demand and time liabilities to compensate fully for the reduction in access to
liGuidity under the E&0 with immediate effect.
In -arch and April, &*I headline inflation has risen on the back of a sharp increase in food prices. >ome of this
price pressure will continue into -ay, but it is largely seasonal. -oreover, &*I inflation ecluding food and fuel
has been edging down. "he risks to the central forecast of : per cent &*I inflation by @anuary (/.5 remain broadly
balanced. =pside risks in the form of a sub$normalMdelayed monsoon on account of possible El Cino effects, geo$
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 2overnment action on food supply and better
fiscal consolidation as well as the pass through of recent echange rate appreciation. Accordingly, at this 3uncture,
it is appropriate to leave the policy rate unchanged, and to allow the disinflationary effects of rate increases
undertaken during >eptember (/.3$@anuary (/.4 to mitigate inflationary pressures in the economy.
"he 0eserve 1ank remains committed to keeping the economy on a disinflationary course, taking &*I inflation to
: per cent by @anuary (/.5 and < per cent by @anuary (/.<. If the economy stays on this course, further policy
tightening will not be warranted. ,n the other hand, if disinflation, ad3usting for base effects, is faster than
currently anticipated, it will provide headroom for an easing of the policy stance.
In pursuance of the %r. =r3it 0. *atel &ommittee4s recommendation to move away from sector$specific refinance
towards a more generali'ed provision of system liGuidity without preferential access to any particular sector or
entity, the 0eserve 1ank has decided to limit access to eport credit refinance while compensating fully with a
commensurate epansion of the market4s access to liGuidity through a special term repo facility from the 0eserve
1ank 8eGuivalent to /.(5 per cent of C%"L9. "his should improve access to liGuidity from the 0eserve 1ank for
the system as a whole without the procedural formalities relating to documentary evidence, authori'ation and
verification associated with the E&0. "his should also improve the transmission of policy impulses across the
interest rate spectrum and engender efficiency in cashMtreasury management.
As the economy recovers, investment demand and the need for credit will pick up. "o the etent that this
contributes eventually to supply, it is important that banks have the room to finance it. A reduction in the reGuired
>L0 will give banks more freedom to epand credit to the non$2overnment sector. #owever, the 0eserve 1ank is
also cogni'ant of the significant on$going financing needs of the 2overnment. "herefore, the >L0 is reduced by
/.5/ per cent of C%"L, with any further change dependent on the likely path of fiscal consolidation.
CPI s(oul! )e use! to set inflation tar"et: R1I #anel
Inflation based on &onsumer *rice Inde 8&*I9
A 0eserve 1ank of India 801I9 panel on "uesday recommended that monetary policy be set by a committee and
that consumer price inde 8&*I9 inflation be used to set an inflation target, eventually of 4 percent.
"he panelNs report also said it should be made clear that managing inflation is the central bankNs primary ob3ective.
"he recommendations of the panel, which was established by 01I 2ov. 0aghuram 0a3an when he took office in
early >eptember, are widely epected to be adopted by the Indian central bank.
=nder current 01I practice, the power to make policy decisions is held solely by the governor. "he 01I, unlike
many central banks, has long used wholesale price inde 8!*I9 inflation as its primary guage.
0eserve 1ank of India 801I9 2overnor 0aghuram 0a3an 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.
A 0eserve 1ank of India 801I9 panel on "uesday recommended that monetary policy be set by a committee and
that consumer price inde 8&*I9 inflation be used to set an inflation target, eventually of 4 percent."he panelNs
report also said it should be made clear that managing inflation is the central bankNs primary ob3ective."he
recommendations of the panel, which was established by 01I 2overnor 0aghuram 0a3an when he took office in
early >eptember, are widely epected to be adopted by the Indian central bank.=nder current 01I practice, the
power to make policy decisions is held solely by the governor. "he 01I, unlike many central banks, has long used
wholesale price inde 8!*I9 inflation as its primary guage
Here are
.. 0epo or short$term lending rate hiked by /.(5 per cent to B.B5 per cent
(. -arginal standing facility 8->A9 rate or overnight lending rate cut by /.(5 per cent to :.B5 per cent
3. 2rowth forecast for the current fiscal slashed to 5 per cent from 5.B per cent earlier
4. &ash reserve ratio 8&009$ the portion of a bankNs deposit that it must mandatorily park with 01I, unchanged
at 4 per cent. "he minimum daily maintenance of the &00 has been reduced from ;; per cent of the
reGuirement to ;5 per cent effective from the fortnight beginning >eptember (.. (/.3.
5. &ash provided to banks through term repo increased to /.5/ per cent of net demand and time liability from
/.(5 per cent earlier
<. %ifference between repo and ->A rate narrows to . per cent
B. !holesale inflation epected to be higher than current levelsO warranting Nappropriate policy responseN
:. 0etail 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
./. Aood price pressures may ease with the arrival of summer crop harvest and seasonal moderation
Con4lusion:
Inflation is not harmful at all times. In fact only when there is a sustained increase above B) to :), there is cause
for worry. In fact a low level of inflation between () and 5) is a sign of prosperity. It is reGuired for growth.
"hat4s 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 reGuired. Inflation is also closely linked to
employment but that is the topic of discussion for another day.
0eference?
Economic Liberali'ation in India 8n.d.9, 0etrieved from
http?MMen.wikipedia.orgMwikiMEconomicPliberalisationPinPIndia
-id$Eear Economic Analysis8(/.3$.49 0etrieved from
http?MMwww.finmin.nic.inMreportsM-E0(/.3.4English.pdf
Inflation, 0etrieved from
http?MMen.wikipedia.orgMwikiMInflation
&*I should be used to set inflation target? 01I panel8@an. (.,(/.49 0etrieved from
http?MMin.reuters.comMarticleM(/.4M/.M(.Mindia$rbi$monetarypolicy$inflation$idIC%EEA/Q/E((/.4/.(.
01I will need to keep raising policy interest rate R I-A 0etrieved from
http?MMin.reuters.comMarticleM(/.4M/(M(.Mindia$economy$policy$imf$idIC%EEA.@/&S(/.4/((.