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BBA-2nd SEMESTER
Inflation
rate in
India
ASSINGMENT -1
What was the dilemma faced by the RBI & the government in adopting strong measures for
inflation.
RECENT TRENDS
Before we look into the recent trends in the inflation rates, we need to understand the existing measures of inflation. As in any economy, India also has two broad estimates that cover the prices in whole sale market (which is called Wholesale Price Index (WPI)) and the retail market (Consumer Price Index (CPI)). Within CPI there are three sub indices that cover three groups namely industrial workers, urban non-manual employees and agricultural laborers. But there is no consolidated CPI for the whole economy. In the case of WPI, the index covers only the prices of goods and not the services, thus, making difficult for the policy makers and researchers in choosing the appropriate price index for target and also for research. However, WPI is the one that is tracked by the analysts and policy makers as the information flow is faster with WPI compared to CPI, which comes with a lag of two months. It is also generally assumed that any changes in the prices in wholesale market would eventually transmit (or pass-through) to the retail market. Hence, WPI might be a better indicator for tracking the general price level in the economy. However, a look at the graph below shows that the convergence between WPI and CPI inflation is quite weak, particularly during the high
inflationary periods, and also takes a long lag. Thus, this divergence in price indices also results in divergence in the policy impacts as well. The recent trends in the inflation numbers show that India is experiencing high inflation situation since the end of 2009 and currently it is at an uncomfortable level of 10.16% in May 2010 and there are expectations that this would increase further. At the disaggregated level, one may note that the prices of both food and non-food and the fuel group are increasing sharply since the middle of 2009, while the inflation rate in the manufacturing sector was almost subdued at around 6% for a long time. As minimum rise in the inflation rate acts as an important incentive for the production activity, this could have adverse impact on the consumption and could particularly affect the poor who are largely not indexed in India. Based on this, our own studies in the past have shown that the threshold (or the optimal or tolerant) inflation for India is at around 4 to 4.5%. Policy makers (particularly the monetary authorities) would try to contain the inflation at around this range. Although India does not follow the inflation targeting regime (where the inflation rate should be controlled at a level fixed by the legislation. For instance, UK has fixed the inflation target at 2%), it is generally clear from the policy statements (such as manual Credit policy) that the Central Bank would try to control the inflation once it crosses the comfortable level.
electricity and steel - which has a 26.7% weight age in the overall IIP fell from 4.2%in January, compared to 8.3% in January 2007. Wholesale Price Index (WPI) had already begun to breach the self-imposed year-on-year 5% tolerance level in the third week of February and continues to rise. WPI based inflation rate breached the critical 5% mark to close at 5.11% for the week ended March 1, 2008, the highest in over nine months. It further rose to 5.92% when the latest figures were released for the week ended March 8, 2008, to reach the highest figure since May 7, 2007. The prices for cereals increased 6.28%, for milk 9.71%, vegetables 9.79%, dairy products 9.31%, cement 5.13%, iron and steel 20.87%, and edible oils 17.52%.
There are many reasons to doubt that the drop in capital goods is not part of any long term trend. For a start, statistically 2006-07 was an year of extraordinary industrial growth, with the final quarter growth being 12.5%. Sustaining this was not realistic and maybe not even desirable, given the strains it would place on an already stretched out economy. Investments in the main consumers of capital goods like infrastructure have been growing and shows no signs of slackening. The order books of the main capital goods manufacturers remain buoyant and their sales numbers have shown robust growth. In fact, the key listed capital goods companies grew by about 33 per cent in the last quarter of 2007, in comparison to the same period last year.
The already committed investments in these sectors may be enough to sustain the present capital goods growth trends in the near future. The projected expenditures in these non tradable services like ports, airports, highways, power, urban infrastructure, telecommunications etc is massive, are by themselves capable of sustaining very high growth rates. The Government's own flagship programs like the Golden Quadrilateral and other National Highway projects, PMGSY, JNNURM, and the programs to promote PPP in core infrastructure, should provide more than adequate demand side stimulus to sustain high rates of growth for sectors like capital goods. The demand for both residential and commercial real estate is both massive and ever growing, and has not shown any signs of slackening. The critical inputs to infrastructure sector like steel and cement, after a blip in January, exhibited robust growth in February. The construction sector, which encompasses all these infrastructure investments, exhibited one of the lowest sectoral ICORs in the Tenth Plan period at a very low 1.2. It has also been shown that construction sector generates one of the highest employment rates for every rupee investment. All this will ensure that the economic multiplier will be significant from these committed and projected investments. So any talk of a major slowdown may be not based on any logical foundations. The recent budget cut CENVAT on all goods from 16% to 14%, excise duties on automobiles from 16% to 12%, excise duties on drugs and diagnostic equipments, and some packaged food items from 16% to 8%. These rates were cut with the objective of lowering prices and thereby spurring consumption and boosting industrial and business activity. The consumer durables sector, especially two-wheelers and automobiles, is expected to be one of the largest beneficiaries of this. The Sixth Pay Commission is expected to put nearly Rs 350 billion in the hands of consumers, thereby providing a major fillip to manufacturing demand. These are all
strong stimulus measures that are expected to keep aggregate demand high, and thereby keep the corporate investment climate healthy.
This needs to be addressed immediately on the highest priority, especially given the large share of population dependent on agriculture. The external sector has also been a significant determinant on price increases. Since 2004, import prices of oil have soared from $34 to $110, palm oil from $471 to $1177, and Thailand rice from $225 per tones to $510 per tones. Our import basket has taken an enormous hit, and naturally inflationary pressures have been building up. Commodity prices worldwide - food grains, cash crops, energy and metals - have been growing at an alarming rate. Over the six years to February 2008, the Goldman Sachs broad commodity index jumped by 288 per cent, the energy price index by 358 per cent, the non-energy index by 178 per cent, the industrial metals index by 263 per cent and the agricultural index by 220 per cent. All this will also reduce the demand for oil and other energy supplies. Economic growth in the merging economies too will drop, though not sharply, thereby further reducing domestic demand in these markets. All this is likely to result in lower commodity prices, which will benefit large domestic market and commodity import dependent economies like India and China.
ACKNOWLEDGEMENT
I express my sincere gratitude and thanks to DR.NIDHI GUPTA for his valuable and unmatched guidance and sincere efforts in trying to make us not just familiar but well equipped with the
fundamentals and building stones of the research work. The efforts put up by us during the development of this project would not have been fruitful, if it were not the people around us, who encouraged us at all times. Taking this opportunity, further we would like to thank the staff and the faculty members of the institution for being there whenever we need their help. We are also grateful to Prof. Col. Mahander Singh Director General, RDIAS for his expert guidance and cooperation in making our project learning and worthwhile experience.