Inflation in India: the biggest cause of worry

Inflation: Meaning Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every rupee you own buys a smaller percentage of a good or service. There are several variations on inflation:

Deflation is when the general level of prices is falling. This is the opposite of inflation. Hyperinflation is unusually rapid inflation. In extreme cases, this can lead to the breakdown of a nation's monetary system. Stagflation is the combination of high unemployment and economic stagnation with inflation. This happened in industrialized countries during the 1970s, when a bad economy was combined with OPEC raising oil prices.

Causes of Inflation There are 2 primary theories which explain the causes of inflation. These are as follows:

Demand-Pull Inflation According to this theory, if demand is growing faster than supply, prices increase. This usually occurs in growing (developing) economies. Cost-Push Inflation - When companies' costs go up, they need to increase prices to maintain their profit margins. Increased costs can include things such as wages, taxes, or increased costs of imports.

Costs of Inflation Almost everyone thinks inflation is evil, but it isn't necessarily so. Inflation affects different people in different ways. It also depends on whether inflation is anticipated or unanticipated. If the inflation rate corresponds to what the majority of people are expecting (anticipated inflation), then we can compensate and the cost isn't high. For example, banks can vary their interest rates and workers can negotiate contracts that include automatic wage hikes as the price level goes up. Problems arise when there is unanticipated inflation:

Creditors lose and debtors gain if the lender does not anticipate inflation correctly. Uncertainty about what will happen next makes corporations and consumers less likely to spend. This hurts economic output in the long run. People living off a fixed-income, such as retirees, see a decline in their purchasing power and, consequently, their standard of living. If the inflation rate is greater than that of other countries, domestic products become less competitive.

Instances of Inflation in India

Source: RBI website The above graph depicts that one of the key features of Indian Inflation is Volatility. As depicted, inflation has been the most variable in case of Primary Articles (such as food, groceries etc) and Fuel. The average WPI (Wholesale Price Index) inflation had been ranging between 47%, during the past. However, the inflation trend in recent years has been catching a lot of consumers attention, since it has been soaring high at 8.5% in August 2010 and 9.78% in August 2011. The Prices of onion and petrol (particularly) have been the primary causes of worry for every Indian citizen, due to which Inflation has managed to secure the designation of the biggest economic issue in India, today. It should be noted that curbing the inflation situation would have not one, but multiple positive effects, as follows:

Reduction in poverty Lesser economic inequality and better standard of living Lesser reliance on cheap or inferior imported products (for instance, Chinese goods) Lower interest rates encouraging more lending Lower layoffs and retrenchment.

Today, attaining a lower inflation rate is a serious cause of concern to India and if properly addressed would encourage us to become a developed nation from being a third world country.

Why does India face chronically high inflation? As a matter of fact, the overall inflation has not spiked all of a sudden. The recent inflation figures are in fact relatively low, at least compared with the rest of last year. For instance, December 2010 had 8.4% WPI inflation which was the secondlowest of last year; from March to July inflation was over 10%. Thus, the real question ought not to be why inflation is high now, but why India seems to have chronically high inflation. Kalpana Kochhar, a senior official at the IMFs Asia desk argues that India is a chronically supply-constrained economy, with chronically excess demand (demand pull theory). In the course of the economic cycle, therefore, price pressures tend to be exaggerated. Ironically, in the middle of 2009, Indian policymakers were debating whether the country was likely to fall into persistent deflation. WPI inflation was in fact negative year-on-year in June and July last year, and below 2% for every month between March and September. Thus, as already observed, it may be better to think of India as a country where inflation is relatively more volatile through the business cycle than in other countries. The Indian agricultural output is very volatile, partly because of poor infrastructure, bad supply chains, poor storage facilities etc. This means that changes in weather conditions or other factors affecting output can lead to really large price fluctuations. In the case of onions, unseasonal rain in October that destroyed crops in Maharashtra appears to be the main culprit. Negative Effects of Inflation (rising cost of living):

Ever widening gap between the standard of living for the rich and the poor in a country like India where economic inequality persists. The rich get richer and the poor get poorer

Decline in the value of Rupee since the demand for Indian products would be lower in the international market due to its high prices. The Indian rupee has declined 5.4 percent this quarter as investors shunned emerging markets on concern the world economy is weakening.

Rising loan-to-deposit ratios as savers move their money into perceived inflation hedges like gold and property. Bank deposits increased by 16.5% in the two weeks ended December 31 from a year earlier, lagging a 24.4% increase in lending, according to RBI data. "The shift of the Indian household sector from deposits to inflation hedges such as property and gold is creating a liquidity crunch in the banking sector thats unlikely to be solved in the near future, Kristine Li, senior director of Asia-Pacific credit strategy at Royal Bank of Scotland Group Plc, told Bloomberg.

Slow and limited hiring (even layoffs) in most of the Indian organizations especially IT sector to reduce the manufacturing cost.

To sum up, I would say that before countering issues such as poverty, gender discrimination, crime, inequality, illiteracy, corruption and the like, we as a country need to resolve the issue of unusually high inflation in India. If thought carefully, the root cause of all the above mentioned worries is the rising high prices. And to do that, we need to become more dynamic, as a country. Thus, the solution is continuous revision and upgradation in methodologies. Every process has its due life and when exploited beyond that time frame it becomes obsolete. Obsolescence is, perhaps the biggest weakness of India (demonstrated in its inflation calculation method, agriculture technology, education system, to name a few).