Inflation

Annual consumer inflation in India declined to 2.33 percent in November, 2018 from an upwardly revised 3.38 percent in October, 2018 and below market expectations of 2.8 percent. This is the lowest inflation rate since June, 2017 as food prices fell the most since the series began in 2012. In 2013, the Consumer Price Index (CPI) replaced the wholesale price index (WPI) as the main measure of inflation.

Recent Developments

Government changes the base years for GDP and retail inflation calculation

  • The Ministry of Statistics and Programme Implementation (MoSPI) changed the base year for calculation of GDP to 2017-18 and retail inflation (CPI-Consumer Price Index) to 2018 from its earlier base year of 2011-12 and 2012 respectively, which is likely to come to effect by 2019-20.
  • For the revised GDP calculations, the Indian statisticians have changed the base year from 2011-12 to 2017-18. This means that the ‘real’ GDP will be counted by keeping the prices of 2017-18 as the base prices instead of referring to the prices of 2011-12. This change alone will play an important part in shooting up the GDP and related number while (may result to) decline of inflation rate (CPI, WPI etc.) overall and also the revisions facilitates more accurate assessment of the progress of the economy and the society.
  • A base year is the first of a series of years in an economic or financial index from which the predictions are to be performed. New, up-to-date base years are periodically introduced to keep data current in a particular index. The growth rate equation is: (Current Year - Base Year) / Base Year.

Urjit Patel Committee on Inflation

The ‘Expert Committee to Revise and Strengthen the Monetary Policy Framework’, headed by RBI Deputy Governor Urjit R Patel submitted its report to RBI Governor Dr. Raghuram Rajan.

The main objective of the committee was to recommend what needs to be done to revise and strengthen the current monetary policy framework with a view to making it transparent and predictable.

Some of the major recommendations of the Urjit Patel committee were-

  • RBI should adopt the new Consumer Price Index (CPI) for anchoring the monetary policy.
  • Set the inflation target at 4% with a band of +/- 2% around it.
  • Monetary policy decision making should be vested in a Monetary Policy Committee (MPC) that should be headed by the Governor.
  • Eliminate administered prices (MSP on food grains, LPG cylinders)
  • Eliminate administered wages (MNREGA)
  • Eliminate administered interest rates (interest subvention given to farmers)
  • Implement Vijay Kelkar Committee’s recommendations on fiscal consolidation.
  • Religiously follow the guidelines & targets of FRBM
  • The two schemes- Dependence on Market Stabilisation Scheme (MSS) and Cash Management Bills (CMBs) may be discontinue and the government debt and cash management must be taken over by the government’s Debt Management Office.
  • All fixed income financial products should be treated on par with the bank deposits for the purposes of taxation and TDS. Detachment of Open Market Operations (OMOs) from the fiscal operations and instead linked solely to the liquidity management. OMOs should not be used for managing yields on government on government securities.

Inflation: Basics

Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. This implies that:

  • The purchasing power of money gets eroded.
  • There is a loss in real value of money as medium of exchange and unit account in the economy.
  • Usually Inflation has adverse impacts on the economy, often it has positive impacts.

Adverse Impacts of Inflation

Favourable Impacts of Inflation

Inflation causes decrease in the real value of money and other monetary items over time.

Inflation ensures that the central banks adjust the interest rates.

Inflation causes uncertainty over future; this may discourage investment and savings.

Inflation encourages non-monetary investment.

High inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future.

During very low inflation, an economy may be stuck in a recession. Arguably targeting a higher rate of inflation can enable a boost in economic growth.

Indices of Inflation

There are several ways to measure inflation such as on the basis of population coverage, the inflation indices are developed to understand the levels of inflation for certain sets of population such as consumers, producers, retailers, wholesalers, etc.

There are several popular inflation index reports that investors and economists follow:

  • Consumer Price Index (CPI): CPI is a price index which represents the average price of a basket of goods over time. CPI calculates the average price paid by the consumer to the shopkeepers. Education, communication, transportation, recreation, apparel, foods and beverages, housing and medical care are the 8 groups for which the CPI is measured.
  • Wholesale Price Index (WPI): WPI is an indicator of price changes in the wholesale market.WPI calculates the price paid by the manufacturers and wholesalers in the market. WPI measure the changes in commodity price at selected stages before goods reach to the retail level.
  • Producer Price Index (PPI): This inflation index measures the change in prices manufacturers and producers experience on materials necessary for conducting their business. The price of steel and aluminum for automobile manufacturers would be tracked by the PPI.
  • Employment Cost Index (ECI): This inflation index measures the rising cost of hiring employees in various fields.
  • Commodity Price Indices: This Index measure the price of a selection of commodities. In the present commodity price indices are weighted by the relative importance of the components to the “all in” cost of an employee.
  • Core Price Indices: Commodities such as food and oil prices can change quickly due to changes in supply and demand conditions in the food and oil markets, it can be difficult to detect the long run trend in price levels when those prices are included. Therefore, most statistical agencies also report a measure of ‘core inflation’, which removes the most volatile components (such as food and oil) from a broad price index like the CPI. Because core inflation is less affected by short run supply and demand conditions in specific markets, central banks rely on it to better measure the inflationary impact of current monetary policy.
  • Gross Domestic Product Deflator (GDP Deflator): This inflation index measures the rise in costs experienced by end consumers as well as the government or institution providing goods and services to those consumers.

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