The Inflation Problem

—By Charu Latha

By definition, inflation is the rate of increase in prices over a given period. Inflation generally represents how much more expensive a good or service has become or how much more a person has to spend on a set of goods or services in a year. It leads to a decrease in the purchasing power of people in the economy, i.e., people get less number of goods or services for the same amount of money. There are three types of inflation based on the causes—demand-pull inflation, cost-push inflation, and built-in inflation. Demand-pull inflation is caused when there is a rise in aggregate demand and exceeds the supply of goods at current prices. Cost-push inflation occurs when the cost of production rises, it could be due to an increase in the price of inputs of production (labour, raw materials, etc.). Built-in inflation is due to the expectation of future inflation in the economy. An increase in wages due to a rise in prices increases the cost of production which in turn increases prices. The rate of inflation is measured with the help of price indices, majorly, the Wholesale Price Index (WPI) which measures inflation at the level of producers, and the Consumer Price Index (CPI) measures the change in prices from a retail consumer’s perspective. Other measures of inflation are the Producer Price Index, Commodity Prices Index, Core Price Index, and GDP Deflator.

In India, the inflation hydra is on the horizon now. According to the official data, the WPI inflation in February 2022 was 13.11 per cent while in March 2021, it was 7.89 per cent. In April 2022, retail inflation was 7.79 per cent while in April 2021, it was 4.2 per cent. Food is an important and most volatile component of CPI inflation. WPI in March 2022 was 14.55 per cent which is the second-highest since 2012. Inflation in food items surged even higher, 8.38 per cent in April 2022. There has been a significant rise in the inflation rate from the last year. Some of the major reasons are a rise in prices of commodities, rise in oil prices, interest rate rise in the United States on account of monetary tightening by the Federal Reserve, increase in import cost of some of the commodities as well as supply-side factors due to the recent outbreak of COVID-19 pandemic in China and the lockdowns imposed and the disruption of global supply chain due to Russia-Ukraine war.

Causes of Surging Inflation in India

1. Increase in money supply: Increase in government expenditure that exceeds the revenue leads to deficit financing. The RBI has to lend to the government which increases the money supply in the economy. The money supply in March 2022 was 53,029 billion rupees which is an all-time high. According to the Monetary Policy Statement of April, there is a liquidity overhang of about 8,500 billion rupees. Increase in liquidity in the economy contributes to increasing the aggregate demand for goods and services in the economy and pushing up prices in this process. This causes inflationary situation in the economy.
2. Deficit financing: When the Government is unable to meet its expenditure, it resorts to deficit financing. When the Government borrows money from the RBI, it increases the money supply in the economy and creates upward inflationary pressure.
3. External factors: Due to the Ukraine-Russia war, the oil and fertiliser prices have risen. Ukraine is one of the largest sunflower oil producers in the world and India imports a major part of its oil from Ukraine. Ukraine is also one of the important suppliers of fertiliser to India. Due to the war, the supply of both these commodities has come to a halt. Due to low supply, the prices of these commodities have shot up and also had a cascading effect on all the other commodities. Indonesia has recently banned exports of palm oil which could make edible oil even costlier. The export ban on palm oil, imposed on April 28, was later reversed on May 23, giving India big relief, a big importer of edible oil. Even the food prices are hugely affected due to the increase in crude oil prices, rising costs of production, surging international crop prices, and extreme weather-related disruptions. Due to the lockdown in China, there are shortages of coal for power as well as semiconductor chips for industries (especially cars). Due to high demand and low supply, the prices have risen. Some of the other factors which impact the prices of agricultural produce are sudden changes and disruptions in the weather patterns such as increased instances of heatwaves in the country.
4. Rise in import prices: Due to the export ban in Indonesia, the war in Ukraine, and the lockdown in China, the import prices have been hugely affected.
5. Rise in taxes: The increase in tax rates leads to an increase in the prices of many commodities. The GST rates on finished goods such as clothes, footwear, and textiles have been raised from 5 per cent to 12 per cent. GST of 5 per cent has been levied on rides booked through online apps. The food delivery apps will also have to pay a tax of 5 per cent apart from the restaurants. All these increases in tax rates and the imposition of new taxes have increased the prices of goods and services which also contributed to inflation.
6. Expectations of consumers: The expectations of consumers play a key role in determining inflation. Expectations result in inflation spiralling. Due to the present global scenario and the existing conditions in the country, the majority of the consumers expect the prices to rise shortly. These expectations lead to wage negotiations and price adjustments. When the negotiations and adjustments are fulfilled, the cost of production rises and inflation follows the path of expectation.

Why Inflation should be Controlled

The effect of inflation is not evenly distributed in the economy. Some sectors and some sections of the people bear the majority of its burden. People with lower incomes are the ones who are affected the most. One of the important and immediate effects of inflation is the reduction in purchasing power of people. Due to inflation, people adjust their income in such a way as to cut their expenditure to balance the rise in prices, which reduces the demand. High inflation rates will also worsen the exchange rate. The Indian rupee is stooped to a lifetime low of Rs 77 for one US dollar on May 31, 2022. Due to the worsening of the exchange rate, imports become costlier, adding to inflationary woes in the economy.

High inflation rates lead to market instability making it difficult for long-term planning. Inflation can also have an impact on productivity due to an increase in the cost of production. Inflation redistributes wealth from creditors to debtors; lenders suffer as the purchasing power of the amount of money reduces and the interest rate at which they lend does not include the fluctuations in the price level. Inflation also hurts saving. People save less as the purchasing power of money reduces with time, and the saving rate in the economy decreases over time.

Measures Taken to Tackle Inflation

• The government announced an excise tax cut of Rs 8 per litre on petrol and Rs 6 per litre on diesel.
• Inflation targeting: It is the policy to control inflation by using the monetary instruments which the Central Bank can use to check inflation. RBI has raised the policy repo rate by another 50 basis points—for second time in over a month, from 4.40 per cent to 4.90 per cent to reduce inflation.
• The government has levied export duty on some steel products and reduced import duty which will result in the reduction of the price of steel.
• The government also reduced the import duty on key raw materials and inputs for the plastic and steel industry.
• The government granted a subsidy of Rs 200 per cylinder (up to 12 cylinders per year) under the Pradhan Mantri Ujjawala Yojana.
•  A limit was imposed on sugar exports (up to 100 lakh tonnes) to ensure that there is enough supply of sugar to prevent the price rise.
• The government has permitted duty-free imports of soyabean and crude sunflower oil in the current and next financial years.

More Ways to Tackle the Situation

There are a few other ways in which inflation can be controlled. To curb the rise in food prices, the government has to ease import limits on pulses and other commodities. The hoarding of grains and other food supplies should also be checked to prevent demand-pull inflation. There should be duty cuts on oil imports. A reduction in the prices of oil will have a positive impact on the other goods as well. The government should also take measures to boost growth and address supply side bottlenecks as an increase in output and growth can ease retail inflation. As far as taxes are concerned the indirect taxes should be reduced to control the price rise. The government could also implement policies or schemes to boost the incomes of low and middle-income households to reduce the burden of inflation.

Conclusion

A particular level of inflation is good for any economy. This particular level of inflation that is healthy for the economy is called the ‘ideal rate’ of inflation and every economy must maintain its inflation within this range. For India, this range is 2 to 6 per cent (CPI). When this limit is crossed, inflation starts negatively impacting the economy. Inflation results in a loss of real value of the medium of exchange in the economy. For every additional burden borne by the Government by reducing taxes, import duties, and thus loss of revenue, if the deficit is not offset by an increase in expenditure and output, it will lead to further widening of the overall deficit. One of the major reasons for the rise in inflation is due to present liquidity conditions. The RBI increases interest rates to curb the liquidity in the economy, but if increasing the repo rate does not absorb the liquidity, then it has to contract liquidity through open market operations.

The present situation in the economy is not only due to a rise in prices of inputs of production but also due to a rise in prices of agricultural prices. The agricultural price-driven inflation would require improvement of the farm policy and increase in productivity and also stabilisation of procurement prices of all the grains. With the measure taken by the Government as well as the Central Bank, RBI has predicted the inflation rate to rise to 6.7 per cent for the full financial year, sharply up from the 5.7 per cent it had projected in April for the full year and well above its 6 per cent upper tolerance level. But there is uncertainty due to supply-side disruptions, after the effect of the pandemic and an uncertain global situation which would keep the inflation trajectory volatile.

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