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India: Inflation Decoded

, November 21, 2013, 0 Comments

Inflation Decoded- Marketexpress
Inflation is one criterion which is closely monitored by Central Bank for its Monetary Policy and also by individuals to match their returns to be above the Inflation rate.  In this Decoding Series, we decode the related topics connected with Inflation.

Is inflation an untamable  problem in the true sense?

What types of inflation causes can be curtailed  by  Monetary Policy?

Like Monetary Targeting of Money Supply, can Inflation Level also be targeted?

If inflation is a precursor to growth, who looses the maximum with high growth but high inflation alongside?

All these questions do leave an average citizen puzzled every time he has to pay an additional sum for the daily food bill or the frequently rising price of petrol or diesel on the pretext of better growth. Even the Central Bank with multiple objectives to cater to like Monetary Targeting, Exchange-Rate Targeting and Growth promoting strategies concentrates on just inflation targeting by raising the interest rates many a times when the Inflation level gets really out of hand.

Though,the mentioned adopted measure to tackle inflation(raised interest rates) reduces the Growth Rates by reduced Domestic Investment  in the economy. A hawkish stance like this is accepted every time WPI Inflation Rate or CPI Inflation Rate or the GDP Deflator value shoots up.

Even if the Equated Monthly Installments provided on floating rates rise of the average citizen on the grounds of Targeting of Inflation by the Central Bank, he with a confused scenario about inflation fails to understand the aggregate impact in totality!

It is common knowledge that a certain amount of inflation is a by-product of a good growth rate. The reason is very basic.Higher demand for goods (caused by better growth rates in the economy)  but with limited supply  raises the prices of those products. The problem exists when the amount of inflation crosses a tolerable benchmark. Amongst the various causes, food inflation caused by structural bottlenecks on the supply-side is the most difficult to tackle and usually has a long gestation period to sort out the cause.

Hoarders and middlemen also add on to the burden of food inflation. Cost-Push Inflation is also difficult to be curtailed eg. The cost price(in dollars) per barrel of oil usually raises the input prices in various industries via higher payment  for transportation costs.Demand-Pull caused when higher demand of a particular product raises its price can only be subdued when matched by additional supply of the product.

Demand Side Inflation can be curtailed by Monetary Policy tools of the Central Bank. RBI when raises the interest rates, then the supply of money is controlled in the economy and Demand – Pull Inflation can be controlled.

The high fiscal deficit also fuels inflation in the economy. Also, if the high fiscal deficit is complemented by high interest rates, then the exchequer has a greater additional burden on the borrowed debt which raises the price levels in the country further. Another cause  is the high amount of foreign institutional investment in the economy.

Higher the portfolio investment in the economy, more is the supply of dollars in the economy. RBI then intervenes by buying dollars to prevent appreciation of domestic currency which might harm the exporters. The supply of money then increases in the economy  when RBI buys Dollars in exchange of Rupee and when too much money follow too few goods, inflation increases. Higher Minimum Support Prices (MSP)offered for agricultural products also raises the Cost-Push Inflation in the country.

Also, more are the bank credit instruments in the country, greater is the money creation by banks and due to the increased money supply more is the inflation in the country.

Concentrating on who looses the maximum due to this , its the fixed wage earners whose salary is fixed due to the high price level who loose the maximum due to inflation.Also, the debtors loose if their loans are adjusted to this and creditors gain due to inflation.The government also increases its deficits further due to the high interest rates payments on borrowed funds due to Inflation Targeting in the first stance!

The Central Bank through its Monetary Policy tools like CRR, SLR, Repo Rate , Reverse Repo Rate, MSF Rate changes tackles Inflation level. Also, with greater Fiscal Prudence, by controlling the Non-Plan Government Expenditure , the government can contribute in better Fiscal Policy Management and eventually by cutting down on wasteful expenditure, the Government can curtail deficits in a better fashion and thus avoid Inflation.

The high Inflation Level though might create short -term happiness by better Dearness Allowance announcement for the Government employees, but after understanding the full impact of the trickle-down effect of inflation, even they may vouch for a controlled Inflation rate of 5 percent (WPI) for developing countries as a better option than high Core Inflation!