Inflation and Its Effects On The Indian Economy: March 2017

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INFLATION AND ITS EFFECTS ON THE INDIAN ECONOMY
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INFLATION AND ITS EFFECTS ON THE INDIAN ECONOMY
Dr. Anjala Kalsie * & Ms. Shikha Mittal Shrivastav **
ABSTRACT
India is going through a phase of declining growth and investor condence, depreciating
currency and rising ination. All the government efforts to revive growth have so far failed
miserably. From 2010, India has witnessed high and persistent ination which did decline in the
end of 2012 but it increased further, thanks to massive depreciation in India rupee. This paper
discusses the inationary experience of India from 1950-2013 and evaluated the causes of
ination and its effects on Balance of Payment, Consumer, Industries, Investment, Poverty and
Currency Depreciation. The paper also empirically analyzed the signicance & impact of Repo
Rate, CRR, Exchange Rate and Petrol Prices on Ination measured by natural logarithm of
Consumer Price Index. In the end, the paper comes out with certain recommendations such as
better management of monetary policy, increase in productivity and scal consolidation in order
to save the faltering economy.
Keywords: Ination, Balance of Payment, Consumer Price Index (CPI), Repo Rate, Exchange
Rate
1. INTRODUCTION
“I don't mind going back to daylight saving time. With ination, the hour will be the only thing
I've saved all year.”
-Victor Borge
Ination refers to a signicant rise in the general price level in a country over a long period of
time. It is the opposite of price stability. In economics, price stability is not used in a rigid sense to
mean price xity. A modest increase of 2 to 3 per cent per annum in the price level is a compatible,
sometimes even desirable, in the context of economic development. However, when the general
price rise appreciates (say in double-digit gure) and is experienced over a long period of time, it
gets the dreaded name of ination. For the common person, there is something threatening about
the phenomenon of ination, especially on those occasions when the rise in prices of goods is not
matched by an equivalent rise in the prices of labor.
Ination is usually measured based on certain indices. An Index number is a single gure that
shows how the whole set of related variables has changed over time or from one place to another.
In India, we use two major indices for measuring ination or price levels.
1.1 Wholesale Price Index

In India, the wholesale price index (WPI) is the main measure of ination. The WPI measures the
price of a representative basket of wholesale goods. It is an index that measures and tracks the
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*Dr. Anjala Kalsie, Asst. Professor, Faculty of Management Studies, University of Delhi Management Perspective
Email : kalsieanjala@gmail.com
**Ms. Shikha Mittal Shrivastav, (Corresponding Author) Asst. Professor, IILM, Gr. Noida Volume 3, Issue 1, October – March 2017
Email : shikhamit20@gmail.com
changes in price of goods in the stages before the retail level. In India, wholesale price index is
divided into three groups: Primary Articles (20.1 percent of total weight), Fuel and Power (14.9
percent) and Manufactured Products (65 percent). Food Articles from the Primary Articles Group
account for 14.3 percent of the total weight.
The most important components of the Manufactured Products Group are Chemicals and
Chemical products (12 percent of the total weight); Basic Metals, Alloys and Metal Products
(10.8 percent); Machinery and Machine Tools (8.9 percent); Textiles (7.3 percent) and Transport,
Equipment and Parts (5.2 percent)
WPI has several critical limitations. Some of them are:
· Non-inclusion of services.
· Following a xed weighting scheme when economy is undergoing major structural changes.
· Use of gross transactions data rather than data on nal purchases.
1.2 Consumer Price Index

The CPI measures price changes from the perspective of the retail buyer. It is the real index for the
common man. It reects the actual ination that is borne by the individual. CPI is designed to
measure changes over time in the level of retail prices of selected goods and services on which
consumers of a dened group spend their incomes. In India, till January 2012, there were only
following four CPIs compiled and released on the national level:
(1) Industrial Workers (IW) (base 2001),
(2) Agricultural Labourer (AL) (base 1986-87) and
(3) Rural Labourer (RL) (base 1986-87)
(4) Urban Non-Manual Employees (UNME) (base 1984-85)
A new series of CPI was started in 2012. In this series, Central Statistics Ofce (CSO) of the
Ministry of Statistics and Programme Implementation has started compiling a series of CPI for
the
(a) Entire urban population viz CPI (Urban);
(b) Entire rural population viz CPI (Rural)
(c) Urban + Rural population will also be compiled based on above two CPIs.
There is no clear cut answer as to what should be the tolerable limit to ination but The Indian
Committee to Review the Working of the Monetary System (S. Chakravarty Committee)
recommended, as a general guideline, an increase in price of not more than 4 per cent. Rangarajan
regarded 6 per cent of ination to be the outer limit. Tarapore Committee recommended 3 per cent
level of ination rate. Thus the acceptable range of ination rate in India lies between 3-7 per cent.
A constantly high ination can have serious consequences on the functioning of the economy. In
the past few years, India has faced a constantly high ination. This high ination has been
accompanied by a decline in growth. Now, whether ination has played any part in faltering
33
growth or not is an open question. If yes, then how much is the contribution of ination in declined
growth? There are also a lot of discussions going on about the ability of the Government and the
RBI to tackle ination. And RBI has come under a lot of criticism for constantly increasing
interest rates and hampering investment and thus, growth.
2. LITERATURE REVIEW
In the past few years, the Indian economy has witnessed a period of high ination and declining
growth. On one hand, prices of a number of goods have increased exponentially and, on the other
hand, industrial production is at an all-time low. Though this period can still not be classied as
'stagation' but we can denitely say that if the situation worsens, then Indian economy can move
to this dreadful phase. There have been a lot of discussions on the kind of ination, demand pull or
cost push, that India is facing and also on its effects on Indian economy. There is a burning debate
on whether ination is the result of over expansionary scal policy followed by the Government
of India or it is a supply side phenomenon basically resulting from structural problems of the
country.
A lot of studies have also tried to ascertain the validity of the Phillips curve in India's case and
validity of the trade-off between ination and growth theory but nothing concrete has come out
yet. And this provided us with the very motivation of doing a project on 'Ination and its effect on
Indian economy'.
Economists often distinguish between two types of ination: Demand-Pull Ination and Cost-
Push Ination. Both the type of Ination causes an increase in the overall price level within an
economy. The RBI's most important goal is to moderate and stable ination in order to maintain
monetary stability in India. The RBI uses monetary policy to maintain price stability and an
adequate ow of credit.
Joshi V. K. (2012) in his study based on the impact of monetary policy of India in ination found
that the thrust of monetary policy was on reducing the annual ination rate. In the study period
from 2009-11, he found that the ination has crossed the historical records reached upto a level of
14%. Based on the study he concluded that CRR is most important measure by which RBI can
combat ination. In the last six months the ination has dropped from a level of 7.17 in January
2015 to 4.36 in July 2015. In the last decade Ination range between 4-14% with highest in 2009.
The RBI revises CRR and the repo rate in their quarterly and mid-quarter policy reviews to
maintain a balance between growth and ination.
Bhattacharya K. and Bhattarcharyya I. (2001) in their paper examined the transmission
mechanism of an increase in oil prices on prices of other commodities and output in India using
monthly data from April 1994 to December 2000. The paper specied a four equation VAR model
to study the interaction of ination in oil with non-oil ination and growth in money and output.
34
The paper also analysed the nature and extent of feedback in such transmission and found that
there exists a board independence-directional causality between oil and non-oil ination in India.
The study concluded that this board independence-directional causality is pertinent as
policymakers had had typically increased the administered prices of petroleum products when
the overall inationary environment had been favourable. The results of VAR model revealed
that 20% point shock increase in oil prices lead to 1.3% point increase in ination in other
commodities. In earlier studies on Oil shock in India, Rangarajan et. al. (1981) and Sastry (1982)
used input-output analysis to estimate the cost-push effect of a hike. However their method is not
useful in estimating the shock over a long period of time given static nature. The IMF (2000)
report indicated that a sustained US $ 5 per barrel increase in the price of oil leads to 1.3 % point
increase in ination after a year and it also reduces the annual GDP growth by 0.1% point.
However, the report acknowledges that the magnitude of such an impact crucially depends on the
monetary policy followed.
Exchange rate stability is crucial for ination management as a stable rate is expected to reduce
domestic ination pressures through a 'policy discipline effect'- restricting money supply
growth, and a 'credibility effect'- inducing higher money demand and reduced velocity of money
(Mohanty and Bhanumurthy, 2014). Using a monetary model of Ination, Mohanty and
Bhanumurthy, 2014 investigated the impact of stable exchange rate regime on ination in India
during different episodes of exchange rate stability. The results showed that the impact of
exchange rate regime on ination is not visible in Indian case may be due to the large scale
intervention by RBI to even out exchange rate volatility. The literature on the assessment of the
optimal exchange rate regime favours stable exchange rate regime for ination consequences; a
stable exchange rate is considered less inationary than a more exible regime as it has a
restrictive impact on the determinants of ination such as, money supply and money demand.
Barro and Gordon (1983) developed the idea that a xed or stable exchange rate policy could help
impart credibility of low ination policies of a central bank. The main argument in favour of
stable exchange rate regimes is the ability of such regimes to induce price discipline and
commitment to monetary policy efciency. A number of other studies in the recent past followed
the idea coined by them.
3. OBJECTIVE
The objective of this paper is to do an in depth analysis of factors that have fuelled ination in
India in the past few years.
1. To provide a theoretical background of Ination and to discuss the historical experience
of India with respect to ination.
2. To ascertain the causes and the effect of ination on Indian economy.
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3. To analyze the signicance & impact of Repo Rate, CRR, Exchange Rate and petrol
prices on Ination.
4. INDIA'S INFLATIONARY EXPERIENCES

India's inationary experiences can broadly be divided into two periods: Pre-reform Period and
Post reform period.
4.1 Pre-Reform Period (1950-51 to 1990-91)
Ination during the pre-reform period was generally on an upward trend with few years of
negative ination in between. Both domestic and foreign factors played a crucial role in
determining ination rates over these years. Some of the major events that affected ination
during this period were wars of 1962 and 1965, low agricultural production in 1965-66, and oil
price shocks in early and late 1970s.
Period: 1953-54 to 1961-62
The average ination during this period was 2.69, but it showed signicant variations annually.
During this period, India witnessed negative ination of -6.8 and -5.2 percent in 1954-55 and
1955-56 respectively. This was followed by highest ination recorded during this period of
about 14 percent in 1956-57. This was observed mainly due to increase in demand pressures,
particularly investment demand in light of the thrust on industrialization in second ve-year
plan. Post this, ination lied between 3 to 7 percent in the next four years.
Period: 1961-62 to 1970-71
Average ination jumped to 6.9 percent during this period and annual variations were lesser than
the previous period. It varied from -1.1 to 13.9 percent. Years 1966-67 and 1967-68 witnessed
high ination of 13.9 and 11.6 percent respectively. This was primarily seen as the impact of
impact of the Pakistan war in 1965 and the famine experienced during 1965-66. 1968-69
experienced deation of around 1 percent due to great harvest in the previous year. In the
following two years, ination was between 3 to 6 percent.
Period: 1970-71 to 1981-82
This period was marked by extreme uctuations in ination. The average ination was 10.1,
ranging from -1.1 to 25 percent. Early 1970s experienced high rates of ination with years 1973-
74 and 1974-75 witnessing above 20 percent ination in India for the rst time since
independence. In fact, 1974-75 recorded 25 percent ination which is the highest ever till date
for India. This was seen as a result of supply shock originating from poor agricultural production
and increase in oil prices. The following year witnessed slight deation. This was followed by in
low ination periods till 1978-79. Ination was again high at 17.1 and 18.2 percent in the next
two years. This was again due to low agricultural productivity and rise in oil prices. Referring to
the severity in ination, particularly that of agricultural commodities in 1972-73 and 1973-74,
the RBI Annual Report 1974-75 observed that “even the seasonal decline in prices, particularly
36
agricultural commodity prices, to which the Indian economy is traditionally accustomed, did not
take place during the last two years”.
Period: 1981-82 to 1990-91
Average ination during this period was 7.2 percent. Variations were less relative to previous
periods. Ination varied between 4.4 per cent in 1985-86 and 10.1 per cent in 1990-9112.
Table 1: WPI Ination in India: Periodic Averages
Sources
(i) Economic Survey 2001-2002
(ii) Indian Experience of Ination: A Review of the Evolving Process,
EPW, January 2006
4.2 Post-Reform period (1991-92 to 2012-13)
Price levels have been persistently rising in the post-reform period with no year experiencing
deation.
Period: 1991-92 to 2000-01
By March, 1991 rupee depreciated by nearly 37 percent with respect to dollar and this added to
the inationary pressures in the economy. Sustained rise in fuel prices combined with the phased
opening of Indian economy during this period also added to the ination. As a result a sharp
increase in ination was witnessed during 1992-96. From 1995-96 onwards, there has been a
continuous deceleration and the average ination for the period 1996-97 to 2000-01 was the
lowest since the mid 1950s in terms of the 52 week average.
Period 2000-01 to 2009-10
During this period ination varied from as low as 3.3 percent in 1999-2000 to as high as 7.2
percent in 2000-01. However, after this ination witnessed a decelerating trend and remained at
about 3.4 percent in 2002-03. In 2004-05, spurt in domestic food prices due to decient monsoon
coupled a spurt in the international oil prices again drove up domestic prices. Ination began to
ease in the second half of 2004-05 under the impact of a combination of scal and monetary
measures. In 2005-06, WPI ination eased to 4.3 per cent as compared to 6.5 per cent a year
earlier.
In this decade 2000-01, 2003-04, 2004-05, 2006- 07, and 2008-09 had higher ination relative to
the decadal average of 5.4 percent. The years 2003-04, 2004-05, 2006-07, and 2008-09 also
37
witnessed high ination in manufactured products mainly on account of high prices of raw
materials. Major drivers of ination in 2008-09 were high international fuel and commodity
prices. Year 2009-10 was marked by global slowdown and unfavorable monsoon, average
ination during this period was 3.6 percent.
Period 2010-13
This period is very peculiar in India's experiences of ination. This is period is marked by high
ination resulting from elevated inationary expectations, hike in vegetable prices due to
unseasonal rains post monsoon and rising global commodity prices. Food products have been the
major drivers of ination during this period. The nancial year started with a headline ination of
9.7 per cent which briey touched double digit in September 2011 before coming down to 6.6 per
cent in January 2012. It was expected that decline in growth during the period 2011-12 will ease
the pressure on core ination but the extent of moderation was constrained by depreciating rupee
and high global commodity prices.
Primary food articles ination declined sharply during November 2011–January 2012, largely
reecting a seasonal decline in the prices of vegetables. However, prices rebounded signicantly
subsequently, resulting in food ination reverting to double-digit levels by April 2012. As per
mid-year analysis 2012-13, ination as measured by WPI averaged 8.9 per cent for 2011-12. In
the rst half of 2012-13, it decelerated to 7.7 percent. It fall to 7.32 per cent in October 2012, 7.24
per cent in November, 7.18 per cent December 2012 and stood at 6.62 (provisional) for the month
of January 2013.
4.3 Recent Trends
The Economic Survey 2016-2017 highlighted that the retail ination is likely to be below 5% in
the current scal year as demonetisation would discourage ant price headwind. According to the
survey the new ination targeting approach by the Monetary Policy Committee (MPC) and gains
from macro-economic stability will help India consolidate gains on price control, meaning prices
will be less susceptible of individual whims and caprice of governments. In the year 2016, retail
ination stabilised around 5 per cent, while wholesale price-based ination averaged around 2.9
per cent during April-December, 2016.
Ination in the scal year 2016-17 has been characterized by two distinctive features. The
Consumer Price Index during April-December, 2016, averaged 4.9 per cent and displayed a
downward trend since July when it became apparent that kharif agricultural production in
general, and pulses in particular would be bountiful. The decline in pulses prices has contributed
substantially to the decline in CPI ination which reached 3.4 percent at end-December. On the
On wholesale-price front, a reversal trend was observed from a trough of (-) 5.1 per cent in August
2015 to 3.4 per cent at the end of December 2016 due to rising international crude prices. The
average ination based on the wholesale price index (WPI) also declined to (-) 2.5 per cent in
2015-16 from 2.0 per cent in 2014- 15. The downward trend however reversed during the current
38
nancial year partly due to impact of rise in global commodity prices and partly owing to adverse
base effect. The global commodity and energy prices have increased by 18 per cent and 23 per cent
respectively in the rst eleven months of 2016 as per IMF price indices. The wedge between CPI
and WPI ination, which had serious implications for the measurement of GDP has narrowed
considerably. Core ination has, however, been more stable, hovering around 4.5 percent to 5
percent for the year so far. India has managed to maintain export competitiveness despite capital
inows and ination that has been greater than in trading partners. Reecting this, India's global
market share in manufacturing exports has risen between 2010 and 2015. Ination hardened
during the rst few months of 2016-17, mainly due to upward pressure on the prices of pulses and
vegetables. It dipped to two-year low of 3.4 per cent in December 2016 as a result of lower prices
especially of food items.
Table 2: Annual Average Ination Rate based on WPI
5. CAUSES & EFFECTS OF FLATION IN INDIA

5.1 CAUSES OF INFLATION
There are a number of factors that might impact ination in India. One of them is supply factors.
India is an agrarian society with close to 52% of the workforce employed in agriculture. Droughts,
oods, inadequate methods for the storage of grains lead to a lower amount of output being
produced. This decreases the supply at each price level, but the demand remains the same. Thus
excess demand leads to increase in price level. Since 2006-07 there have been a series of adverse
supply shocks. The shocks arose from a shortfall in food-grain and non-food grain commodities
(vegetables, fruits, protein-based foods - pulses, milk, eggs, meat).
39
Another factor might be demand factors as rising incomes have drastically increased the
purchasing power of the population, further increasing consumption demand. This surge in
demand has triggered inationary pressures, particularly in sectors where supply has lagged
behind. As public policy continued to spur growth in consumption demand and wages, ination
became a common phenomenon. Supply shocks can trigger sudden and sharp inationary
pressures, but the pressures diminish when supplies revive. In India, the constant ination stems,
instead, from government policies that spurred consumption demand by increasing wages and
salaries but did not do enough to remove supply-side bottlenecks. Within the framework of such
scal policies that boosted consumption, supply shocks had a larger effect on inationary
pressures. In India, an expansionary scal policy has boosted consumption demand in recent
years. A sharp increase in the international prices of fuels has also acted as a trigger for ination.
(Figure 1)
Figure 1:
Petrol & Diesel Prices
Source: www.capitalmind.in
There are domestic factors that have a role to play. India is a developing country where the
markets and the inter linkages between markets are not perfectly established and are
underdeveloped. This means that when there is an increase in money supply, there is no
corresponding change in production of goods. The supply of goods takes a longer time to adjust
and hence it leads to ination. Other important domestic factors include the practice of hoarding.
40
Hoarding is stockpiling of items when a shortage is expected or it may be strategic in order to
decrease supply and hence increase the market price
Figure 2:
Annual CPI Ination VS Annual Wage Increases
Source: CARPE DIEM, Professor Mark J. Perry's Blof for Economics & Finance
There have been wage increases by the government, which more than compensated for ination,
but had no established link to productivity improvement. Such a growth in wages without an
improvement in productivity is a source of ination. The wages of a large section of workers in the
economy rise in line with ination as they may be linked to ination like the linking of wages to
ination under NREGA. This linkage between wages and ination through MGNREGA has the
potential to spread a wage-price spiral across various sections of the economy. It is important to
link wage increases to productivity, to increase supply in line with rising demand. Despite
monetary tightening, inationary pressures have continued. The RBI has attempted to reign in
demand, which the higher scal decit red by consumption-oriented spending, through interest
rate hikes. The nature and quantum of scal spending has thus muted the effectiveness of the
monetary policy. Political instability in the country makes investors wary of investing in India.
This reduced investment decreases growth opportunities and causes supply bottlenecks thus
further fuelling supply shortage and price increase.
Figure 3:
Ination Components
Source: www.livemint.com
41
By virtue of being an open economy, the Indian macroeconomic variables including ination will
be inuenced by external factors. Suppose there is an increase in the prices of goods produced in
USA due to increasing costs resulting from new labour laws or taxation policies. This would
increase the price of imports from USA and thus an increase in the domestic price level of the
commodity. Also, if these goods happen to be used as inputs in some manufacturing process, the
cost of production increases. Another factor for ination is the depreciation of the Rupee which
has the same impact as an increase in prices of foreign goods as the Rupee becomes relatively
cheaper and now 1 Rupee is able to buy a lesser amount of foreign goods. The impact is modest but
signicant. Controlling for lagged ination, global commodity prices, and the output gap, which
are all statistically signicant, a 10% depreciation of the currency raises quarterly headline and
core ination by 1% and 0.8% respectively. For comparison, 10% higher global commodity prices
raises India's headline and core ination by 1% and 0.5% respectively in the same quarter.
Figure 4: Imported Ination and WPI Ination
Source: Ofce of the Economic Advisor and FICCI research
5.2. EFFECTS OF INFLATION

High and persistent ination is bound to have certain adverse effects on the economy and the
major casualty of ination is growth. Some part the recent decline in growth rate and a massive
decline in industrial production can be attributed to high ination India has faced in the last 3-4
years.
Balance of Payments
India for long has been facing an import-export mismatch. As the prices of goods in India have
increased, their relative cost for international customers have increased as a result of which there
has been a decline in exports. On the other hand, since imports have become relatively cheaper,
demand of imports have increased, further worsening the current account of the country. As we
can see from the gure that this ratio has continually been increasing and it is expected to increase
further this nancial year. As of June, 2013 India's current account decit already stands at
staggering $ -18.1 B.
42
Figure 5: CAD TO GDP RATIO
Source: RBI
Industries
Industries and economic activity all over India has also been adversely affected. Ination has led
to the increase in the costs of inputs such as raw materials and labor to some extent. This increase
in costs has led to the decline in margins. There is some extent up to which industries can bear
these added expenses resulting from ination, once these increased prices are passed on to the
customers, it further adds to ination. According to a CRISIL research, EBITDA margins, which
touched 5-year lows in 2012-13, are expected to remain under pressure, as input costs escalate and
demand remains weak (gure-6).
Figure 6: Effect of Ination on Economic Growth
Source: CRISIL Research
Consumer
The section of the society that is most affected by ination is the consumer. As the salaries and
income of the individual's increases with a lag, there is always a time when prices of good are
increasing and they are becoming less and less affordable because income is stagnant. Fixed
wage earners are most affected by it as it takes more time for their wages to adjust to rising
ination. If the ination is high and persistent, the lag between price rise and wage rise increases.
Population at the lower end on the spectrum is most affected by ination.
43
Investment
Ination has distorted the nancial system of the country. In its initial stages, the system was able
to withstand its adverse effect because the nancial institutions by their very nature tend to ignore
the purchasing power of money and operate with reference to interest rates and maturity of
nancial instruments. However, as ination has gathered strength, the nancial system is not able
to withstand it. As the ination has crossed its earlier phases, strain on the nancial system,
speculation, and expectations of further price rise and similar other forces have lead to an increase
in unemployment and a fall in output. Eventually, in the nal phase of ination, the output and
employment levels may fall to abysmally low levels. Fluctuating prices generate opposite effects
on debtors and creditors. Rising prices have proved benecial for debtors at the expense of
creditors. Thus, ination has discouraged people to invest in nancial assets. All this has been
coupled by the decline in foreign investment in the country because of decline in investor
condence. Overseas investors have pulled out a massive Rs 44,162 crores from the Indian capital
market in the month of June, 2013 itself.
Equality and Poverty
Although ination erodes the wealth of each and every individual equally, its effects are more
pronounced on poor people rather than rich. The people that are already living at subsistence level
are most affected by it. In terms of capability deprivation, ination has not only led to an increase
in inequality but also to increase in poverty.
Currency depreciation
Figure 7: Rupee/USD Exchange Rate
Source: RBI
Weakening of Indian rupee is both the cause and effect of ination. As the domestic ination has
increased, imports have become cheaper leading to the increased demand of dollars, thus
depreciation the currency. A depreciated currency, on the other hand, has now increased the cost
of imported goods too further fuelling ination. A weak Indian rupee has increased the cost of oil
and petroleum which is a major input in many industries and seriously affected the protability of
many industries.
44
From the above discussion, we can easily make out the effect of ination on the overall growth of
the economy. As shown in the gure India's GDP growth has declined from 9.4% to 4.7% in 2013
and much of the can be attributed to the adverse effects of ination on economic growth.
Figure 8: India GDP Growth
Source: www.tradungeconomist.com
6. MEASURING THE IMPACT OF REPO RATE, CRR, EXCHANGE

RATE AND PETROL PRICES ON INFLATION
Regression Analysis:
Using historical data for the various variables that affect ination, we use regression analysis to
check the signicance and impact of each of them. The dependent variables considered are Repo
Rate, CRR, Exchange Rate and petrol prices (See Annexure 1). Consumer Price Index (CPI) is
used to measure the Ination and is the independent variable.
We have used the Lin-Log method so that we can directly calculate the absolute impact of a
percentage change in the independent variables on the dependent variable.
Expected Results:
A negative relationship between Repo Rate and Ination
A negative relationship between CRR and Ination
A positive relationship between Exchange rate and Ination
A positive relationship between Petrol Prices and Ination.
45
Equation:
The regression equation thus developed would be:
Y= -3.057895 – 1.094898 X1+ 0.9160321 X2 + 1.7735266 X3 + 0.7396423 X4
Interpretation of the results:
The intercept term represents the rate of ination when all the variables are equal to 0. It is equal to
-3.057895 and has no economic interpretation. The coefcient of X1 has the expected negative
sign. It is equal to -1.094898. It implies that for every 1% increase in repo rate, there is a
1.094898% decrease in ination. The coefcient of X2 was expected to have a negative sign. But
the analysis shows that there is a positive sign. This might be due to sample errors like
multicollinearity. The coefcient of X3 has the expected positive sign. It is equal to 1.7735266.
This implies that for every 1% increase in depreciation of the Rupee, the ination increases by
1.7735266 %. The coefcient of X4 has the expected positive sign. It is equal to 0.7396423. This
implies that for every 1% increase in petrol prices, ination increases by 0.7396423%.
The R square value signies that 52.71373% of variation in ination can be explained by the
above mentioned factors.
Signicance of Variables:
Take a level of signicance of 5% (=0.05)
Null hypothesis: Coefcient is 0
Alternate Hypothesis: Coefcient is not 0
If the p value is less than the level of signicance, we reject the null hypothesis.
Thus the all variables i.e. intercept, X1, X2, X3 and X4 are statistically signicant. They have an
individual impact on ination in India.
Reasons for variable X2 having a sign opposite to what is expected include the possibility of
multicollinearity.
There is an 82.52% negative linear relationship between X2 and X3. This might be the reason for
the coefcient of variable X2 turning out to be positive rather than negative.
F-Test:
Degrees of freedom of numerator= 3
Degrees of freedom of denominator= 26
At 5% level of signicance, FTabulated= 2.9752
FCalculated = 7.246063
46
Since Fcalculated>FTabulated, the null is rejected and this means that the variables are jointly
signicant.
As per the data collected for Indian ination and its various factors, it can be seen that repo rate,
CRR, exchange rate and petrol prices are factors that denitely have an impact on ination in the
country. They have an impact individually and are also jointly signicant as shown by the F-test.
These factors are able to explain about 53% of the factors affecting ination. Other non-
quantiable factors as discussed include political instability, supply bottlenecks and excessive
demand.
7. CONCLUSION AND RECOMMENDATIONS

There might be positive relation between growth and ination in the short run because as the
demand of goods and services increases with economic growth, ination is bound to increase. But
in the longer run, relation between ination and growth turns negative. As shown and discussed,
long and persistent ination reduces the economic growth. Thus, there is an urgent need to address
these issues of Ination. RBI and government are very much aware of all these effects have taken
certain measure to tackle ination. But what effect these measures will have on growth is a
contentious issue. For example, increase in interest rates may reduce ination but will also reduce
investment and thus, growth.
There are various measures that can help in removing or reducing ination without having a much
adverse impact on economic growth such as:
Cut on expenditures
An effective way of reducing ination is to shift the demand curve towards the left and this can be
done by cutting on expenditures by the government. However, this is likely to have some serious
consequences on growth. There will denitely be some tradeoff between growth and ination.
However, scal consolidation can, on a whole, help in the long run.
Change in Tax Structure
Supply side bottlenecks have played a major role in fuelling ination. A change in tax structure
will certainly help in expanding the output of industries and tackle ination. Tax holidays should
be provided to encourage the private sector and expand production. There is a need to make entire
business environment more liberal.
Save the currency
One major factor that has fuelled in ination in recent times is depreciation of Indian currency.
There is an urgent need to arrest the free fall of Indian rupee. RBI has to actively monitor the forex
market and government also has to take certain steps to increase the capital inows and restore the
foreign investor condence.
Improve productivity
There is a need to improve productivity. This can be done by implement policies to improve farm
47
productivity and reducing infrastructural bottlenecks. Government should step up efforts at skill
development in sectors that face acute skill shortages and devise mechanisms to link wages to
productivity in the public sector and in government safety-net programs such as the Mahatma
Gandhi National Rural Employment Guarantee Scheme (MGNREGS).
Effective monetary policy
RBI monetary policy has come under lot of criticism for reducing the liquidity in the system and
increasing interest rate, to tackle ination. While in the short run, it may help in avoiding in
building up of inationary expectations but in the long run it is seriously going to hamper the
growth of Indian economy. RBI should refrain from permanently using it as a tool to tackle
ination.
References
· Aleem, A. (2010). Transmission mechanism of monetary policy in India. Journal of Asian
Economics, 21(2), 186-197.
· Barro, R. J., & Gordon, D. B. (1983). Rules, discretion and reputation in a model of
monetary policy. Journal of monetary economics, 12(1), 101-121.
· Basu, K. (2011). Understanding ination and controlling it. Paper. Available at:
http://nmin.nic.in/WorkingPaper/understanding_ination_controlling. pdf,(accessed
14 November 2011).
· Bhattacharya, K., & Bhattacharyya, I. (2001). Impact of increase in oil prices on ination
and output in India. Economic and Political weekly, 4735-4741.
· Gupta, P., & Goyal, A. (2015). Impact of oil price uctuations on Indian economy. OPEC
Energy
· Jha, R. (2008). Ination targeting in India: issues and prospects. International Review of
Applied Economics, 22(2), 259-270.
· Joshi, V. K. (2013). Impact of monetary policy of India with special reference to CRR,
repo & reverse repo rate in curbing ination: an econometric study. Management
Insight,8(2).
· Mohanty, B., & Bhanumurthy, N. R. (2014). Exchange rate regimes and ination:
Evidence from India. International Economic Journal, 28(2), 311-332.
· Mohanty, M. S., & Klau, M. (2001). What determines ination in emerging market
economies?. BIS Papers, 8, 1-38.
· Mussa, M. (2000). The impact of higher oil prices on the global economy.International
Monetary Fund, 8.
· Patnaik, A. (2010). Study of Ination in India: A Cointegrated Vector Autoregression
Approach. Journal of Quantitative Economics, 8(1), 118-129.
· Patnaik, I., Shah, A., & Veronese, G. (2011). How to measure ination in India?(No.
11/83).
· Pattnaik, R. K., & Samantaraya, A. (2006). Indian experience of ination: A review of the
evolving process. Economic and Political weekly, 349-357.Review, 39(2), 141-161.
· Rangarajan, C., Sah, R. K., & Reddy, K. S. (1981). Impact of hike in prices of coal and
petrolium products on the othe sectors of the economy: An application of input-output
technique.
· RVSS, N. R., Reddy, P. C., Basha, A. M., Srinivasulu, P., & Pranav, K. S. (2013). A Study
on Ination in India. International Research Journal of Social Sciences Vol, 2, 51-55.
48
· Salian, P., & Gopakumar, K. (2008). Ination and Economic Growth in India–An
Empirical Analysis. Indian Economic Service, New Delhi and Gopakumar. K, Faculty,
BIET-MBA Programme, Davangere, Karnataka.
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Price Level - 1970-71 to 1980-81, Reserve Bank of India Occasional Paper, 3, pp 68-93.
ANNEXURE
Annexure 1: The Data for regression analysis
X 1 =Log(Repo X 2 =Log(CRR) X 3 =Log(Exchange X 4 =Log(Petrol Y=Log(CPI)

Rate) Rate) Price)
0.812913357 0.698970004 1.644340099 1.638389408 0.6766936
0.84509804 0.698970004 1.668479103 1.67678503 0.7993405
0.875061263 0.698970004 1.649140064 1.651762447 0.8273693
0.889301703 0.812913357 1.610127613 1.631950826 0.8241258
0.889301703 0.84509804 1.614686342 1.638688887 0.8609366
0.889301703 0.875061263 1.599883072 1.638688887 0.7411516
0.929418926 0.916453949 1.63124078 1.703807065 0.8859263
0.954242509 0.942008053 1.624900602 1.704322141 0.920645
0.954242509 0.954242509 1.641077313 1.704322141 0.9552065
0.903089987 0.77815125 1.692670699 1.704322141 1.0191163
0.875061263 0.740362689 1.688419822 1.704322141 1.0191163
0.812913357 0.740362689 1.685204134 1.659155281 0.9867717
0.740362689 0.698970004 1.690373307 1.608739919 1.0191163
0.698970004 0.698970004 1.703463342 1.608739919 0.9047155
0.67669361 0.698970004 1.695569227 1.608739919 0.9395193
0.67669361 0.759667845 1.666330744 1.676053125 1.1720188
0.698970004 0.759667845 1.654272827 1.676053125 1.1720188
0.759667845 0.77815125 1.667733053 1.711385379 1.0511525
0.77815125 0.77815125 1.654176542 1.714581209 0.9921115
0.829303773 0.77815125 1.651084089 1.766189693 0.9454686
0.860338007 0.77815125 1.656098202 1.801883707 0.9405165
0.903089987 0.77815125 1.645422269 1.804139432 0.9258276
0.916453949 0.77815125 1.690018781 1.825036441 1.002598
0.929418926 0.740362689 1.693023068 1.817168572 0.7259116
0.929418926 0.67669361 1.705692697 1.817168572 0.9370161
0.903089987 0.67669361 1.719579858 1.817168572 1.0094509
0.903089987 0.653212514 1.728353782 1.835436895 0.9609462
0.860338007 0.62838893 1.731749884 1.827756863 1.0652061
0.875061263 0.602059991 1.734639839 1.834674974 1.058426
0.860338007 0.602059991 1.746712023 1.799960527 1.0285713
0.860338007 0.602059991 1.785329835 1.847819347 0.984077
49
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INFLATION AND ITS EFFECTS ON THE INDIAN ECONOMY

Article · March 2017

Anjala Kalsie Shikha Mittal Shrivastav

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1.1 Wholesale Price Index

1.2 Consumer Price Index

4. INDIA'S INFLATIONARY EXPERIENCES

5. CAUSES & EFFECTS OF FLATION IN INDIA

Figure 4: Imported Ination and WPI Ination

Source: Ofce of the Economic Advisor and FICCI research

5.2. EFFECTS OF INFLATION

Figure 6: Effect of Ination on Economic Growth

Source: CRISIL Research

6. MEASURING THE IMPACT OF REPO RATE, CRR, EXCHANGE

7. CONCLUSION AND RECOMMENDATIONS

Annexure 1: The Data for regression analysis

X 1 =Log(Repo X 2 =Log(CRR) X 3 =Log(Exchange X 4 =Log(Petrol Y=Log(CPI)

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