Inflation in India in Recent Times - Report Example

Article: India Inflation up 7.31% on year. Table of Contents Article: India Inflation up 7.31% on year Source of the Article: http online.wsj.com/article/SB126345256624628581.html?mod=googlenews_wsj 1 Introduction 2 Inflation in India in the recent times 2 The Impact of High Inflation 4 Some highlights of the unemployment figures in India. 5 Steps that should be taken by the Government 6 Conclusion 7 References 8 Source of the Article: http://online.wsj.com/article/SB126345256624628581.html?mod=googlenews_wsj Publication Date: 15th January 2010. Introduction The numbers of the companies released in 2010 is a clear indication that the worst of the financial crisis is over. Countries like India and China have relatively been less affected by the financial crisis. These two countries have emerged as the drivers of the world economic growth during the financial crisis. The GDP growth rate of India during Q2, 2009-10 stood at a healthy 7.9%. At the same time, the threat of high inflation has been a cause of significant worry amongst the Indian policy makers. With recovery in sight, the global prices are showing signs of going up. Moreover, the prices of important food items are also indicating signs of firming up driven by two reasons: Increase in demand and asset motive. It shall be noted that inflation was reigning in the negative territory during the last year. At the same time, the employment figures in the country are showing some encouraging signs. Companies are back on the hiring spree and with the expected increase in demand, companies are increasing their workforce. Inflation in India in the recent times The FY 2009-10 has been a very volatile period as far as the inflation is concerned. The Wholesale Price Index which was in the negative territory during June -August 2009 increased sharply to 7.3% by December 2009. The graph below shows the Wholesale Price Inflation on Year-on-Year Basis. Figure 1: Wholesale Price Inflation: Year-on-Year (Source: RBI) As can be seen from the graph above, the highest growth in WPI is in the Essential Commodities group. The increase in the WPI rate during the period can be attributed to the following factors: Waning of the base effect of sharp increases in prices during the first half of 2008-09 The upward revision of prices of petrol and diesel Increase in the prices of sugar, vegetables, drugs and medicines during the recent times. The price rise has been primarily because of increase in few commodities such as sugar, oil cakes, food-grains, eggs, meat, fish and drugs and medicines. The WPI inflation excluding the food items was 2.1% indicating the concentrated nature of the inflation. The graph below shows the contribution of the major groups towards the WPI. Figure 2: The Contribution of the major groups towards the WPI (Source: RBI). On a macroeconomic front, the price rise can be attributed to an increase in the growth rate of the country. Unlike China, the growth in India has been because of self-generated demand rather than export driven. With the high growth rates, people have more money. The expansionary monetary policy implies that the system will have more liquidity and people will have more money to spend. With the growth rate increasing, the employment is also increasing implying that more people will have more money to spend. As a result of all these factors, the spending power of the population increased thereby leading to an increase in the prices. This demand pull inflation with too much money chasing too few goods can be explained using diagram Figure 3. Figure 3: Demand-Pull Inflation and Real GDP As can be seen from the graph, as Aggregate Demand (AD) grows faster as compared to the Aggregate Supply (AS), the AD shifts towards right. As a result, prices are forced up thereby leading to inflation. Another reason that has been attributed to the high increase in the food item prices during the recent times has been the weak monsoon in the year 2009. The weak monsoon resulted in an increase in the prices of dairy products and oil cakes. Besides the above cited reasons, black-marketering and hoarding have also emerged as a major concern leading to price rises. This has been cited as the major reason for the increase in the prices of sugar. The Impact of High Inflation The impact of high inflation on the Indian economy has many facets. In the simplest of concepts, the high inflation leads to a direct erosion of wealth of the population. High prices imply that people have to spend more on their living, which will have an adverse impact on their savings. The reduction in the savings will have a much larger impact on the growth of the country. Besides, high inflation also results in the reduction of investments. Moreover, high inflation makes the real return on investments smaller. Research has shown that periods where WPI has been higher than 8%, the markets have significantly underperformed. The graph below shows the movement of the BSE Sensex with respect to the WPI. Figure 4: The movement of BSE Sensex viz-z-viz the WPI (Source: Seeking Alpha) As can be seen from the graph, periods with WPI >8.0% have been marked with significant under-performance of the BSE Sensex. Another impact of the high inflation may be the development of the dangerous Achilles heal where the federal government is unable to tackle the supply-side deficiencies in the Public Distribution System of India. Economists are also of the opinion that the inflation may reach a high 10% by the end of this fiscal year. This may put a cloud on the recovery of the countrys economy from the financial crisis. In order to decrease the inflation, the government may take certain steps like squeezing the liquidity in the market. This may result in the decrease in the spending and hence the growth of the country. Some highlights of the unemployment figures in India. The financial crisis of 2008-09 did have a considerable impact on the employment in the country. Most of the companies freezed hiring in the 2 years. There were no major layoffs but organizations like the Jet Airways which were finding it difficult to operate profitably did steps towards reducing manpower costs. Companies also reduced the variable pay of their employees. The campus placements from the colleges dried thereby leaving a large numbers of educated youth being unemployed. This type of unemployment is called the Keynesian Unemployment. This type of unemployment is because of inadequate aggregate demand. Graphically, this concept can be explained using figure3. However, the recent times have seen an increase in the job offers being made. The pay packages have increased and so have the number of jobs on offer. The official unemployment in the middle of the financial crisis (during June 2009) was more than 9%. About 30% of the workers are casual workers and are unpaid for a significant part of the year. In order to remove the problem of unemployment, the Prime Minister of India has emphasized that the country achieves a growth rate between the range of 9-10% (DNA India). Steps that should be taken by the Government In such a situation of High Growth and High Inflation, the Governments role becomes very important. The Government needs to ensure that the prices of the essential commodities are controlled without sacrificing the growth trajectory of the countrys economy. Along with the Government, the Central Bank (RBI) also has an important part to play here. One of the steps that the Government can take in order to reduce inflation is to move from its expansionary fiscal policy set up in order to face the economic slowdown. The Government however needs to be very intelligent here so that it does not affect the growth process in order to curb inflation. The government can increase taxes and reduce its spending in order to squeeze liquidity in the market, but this has to be done slowly and intelligently. The Government shall also work on some other reasons that lead to inflation such as the Public Distribution System. The system is anarchic and needs to be overhauled in order to remove black-marketers and others from the chain. The Government also need to invest in modernization of the agricultural sector. This sector is still heavily dependent on the monsoons in the country and need to be made such that this dependency is no longer there. Another area where the Government needs to take serious action is that of fake currency. Besides these steps, the Central Bank can follow a contractionary monetary policy by increasing the CRR and the repo rates. This will in a way dry up the excess liquidity from the market and will help reduce the spiraling prices. The lending rates can be increased in a gradual manner in order to reduce the inflation rates. Conclusion The Indian economy is at major cross-heads. At one end, it is spearheading the worlds recovery from the economic crisis. At the same time it is experiencing near double digit inflationary pressures. The role of the Government and the Central Bank here is to ensure that the inflation is brought under control without affecting the growth rate. This is a challenging task. At the same time, in order to reduce the unemployment, the Government needs to focus on the educational sector and impart vocational trainings. The Government need to encourage the culture of entrepreneurship and self-employment. References DNA India. 9-10% economic growth needed to remove unemployment: PM. Dated 15th February 2010. [Online]. Available at: http://www.dnaindia.com/india/report_9-10pct-economic-growth-needed-to-remove-unemployment-pm_1348294 [Last Visited on 20th February 2010]. RBI. Monetary Policy Statement 2009-10. Macroeconomic and Monetary Developments Third Quarter Review 2009-10. [Online]. Available at: http://www.rbi.org.in/scripts/AnnualPublications.aspx?head=Macroeconomic and Monetary Developments [Last visited on 20th February 2010]. Seeking Alpha. Inflation in India- Cant Ignore It Anymore. Dated 3rd February 2010. [Online]. Available at: http://seekingalpha.com/article/186279-inflation-in-india-cant-ignore-it-anymore [Last visited on: 20th February 2010]. Read More