DEFINITION OF INFLATION

In economics, 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; consequently, inflation is also an erosion in the purchasing power of
money – a loss of real value in the internal medium of exchange and unit of account in the
economy. A chief measure of price inflation is the inflaction, the annualized percentage change in a
general price index over time.

Inflation's effects on an economy are manifold and can be simultaneously positive and negative.

Negative effects of inflation include a decrease in the real value of money and other monetary items
over time, uncertainty over future inflation may discourage investment and savings, and high
inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will
increase in the future. Positive effects include a mitigation of economic recessions and debt
relief by reducing the real level of debt.

Economists generally agree that high rates of inflation and hyperinflation are caused by an

excessive growth of the money supply. Views on which factors determine low to moderate rates of
inflation are more varied. Low or moderate inflation may be attributed to fluctuations
in realdemand for goods and services, or changes in available supplies such as during scarcities, as
well as to growth in the money supply. However, the consensus view is that a long sustained period
of inflation is caused by money supply growing faster than the rate of economic growth.

Today, most mainstream economists favor a low steady rate of inflation Low (as opposed to zero
or negative) inflation may reduce the severity of economic recessions by enabling the labor market
to adjust more quickly in a downturn, and reduce the risk that a liquidity trapprevents monetary
policy from stabilizing the economy. The task of keeping the rate of inflation low and stable is
usually given to monetary authorities. Generally, these monetary authorities are the central
banks that control the size of the money supply through the setting ofinterest rates, through open
market operations, and through the setting of banking reserve requirements.
IN ANOTHER WAY

The term "inflation" originally referred to increases in the amount of money in circulation, and
some economists still use the word in this way. However, most economists today call an increase in
the money supply monetary inflation, to distinguish it from rising prices, which may also for clarity
be called 'price inflation' Economists generally agree that monetary inflation is one of the main
causes of price inflation.

Other economic concepts related to inflation include: deflation – a fall in the general price
level; disinflation – a decrease in the rate of hyper inflation;  – an out-of-control inflationary
spiral; stagflation – a combination of inflation, slow economic growth and high unemployment;
and reflation – an attempt to raise the general level of prices to counteract deflationary pressures.

Since there are many possible measures of the price level, there are many possible measures of
price inflation. Most frequently, the term "inflation" refers to a rise in a broad price index
representing the overall price level for goods and services in the economy.The consumer Price
Index(CPI), the Personal Consumption Expenditure Price Index(PCEPI) and the GDP are some
examples of broad price indices. However, "inflation" may also be used to describe a rising price
level within a narrower set of assets, goods or services within the economy, such
as commodities (including food, fuel, metals), financial assets (such as stocks, bonds and real
estate), services (such as entertainment and health care), or labor. The Reuters-CRB Index (CCI),
the Producer Price Index, and Employment price index (ECI) are examples of narrow price indices
used to measure price inflation in particular sectors of the economy. Core inflation is a measure of
inflation for a subset of consumer prices that excludes food and energy prices, which rise and fall
more than other prices in the short term. The Federal Reserve Board pays particular attention to the
core inflation rate to get a better estimate of long-term future inflation trends overall

MEASURE

Inflation is usually estimated by calculating the inflation rate of a price index, usually the Consumer
Price Index. The Consumer Price Index measures prices of a selection of goods and services
purchased by a "typical consumer". The inflation rate is the percentage rate of change of a price
index over time.
For instance, in January 2007, the U.S. Consumer Price Index was 202.416, and in January 2008 it
was 211.080. The formula for calculating the annual percentage rate inflation in the CPI over the
course of 2007 is

The resulting inflation rate for the CPI in this one year period is 4.28%, meaning the general level
of prices for typical U.S. consumers rose by approximately four percent in 2007.

Other widely used price indices for calculating price inflation include the following:

 Producer Price Index  (PPIs) which measures average changes in prices received by
domestic producers for their output. This differs from the CPI in that price subsidization,
profits, and taxes may cause the amount received by the producer to differ from what the
consumer paid. There is also typically a delay between an increase in the PPI and any
eventual increase in the CPI. Producer price index measures the pressure being put on
producers by the costs of their raw materials. This could be "passed on" to consumers, or it
could be absorbed by profits, or offset by increasing productivity. In India and the United
States, an earlier version of the PPI was called the Wholesale Price Index.
 Commodity Price Index  , which 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 Index   because 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.

Other common measures of inflation are:

  GDP deflator  is a measure of the price of all the goods and services included in Gross
Domestic Product (GDP). The US Commerce Department publishes a deflator series for
US GDP, defined as its nominal GDP measure divided by its real GDP measure.
 Regional inflation The Bureau of Labor Statistics breaks down CPI-U calculations
down to different regions of the US.
 Historical inflation Before collecting consistent econometric data became standard for
governments, and for the purpose of comparing absolute, rather than relative standards of
living, various economists have calculated imputed inflation figures. Most inflation data
before the early 20th century is imputed based on the known costs of goods, rather than
compiled at the time. It is also used to adjust for the differences in real standard of living
for the presence of technology.
 Asset price Inflection: is an undue increase in the prices of real or financial assets, such
as stock (equity) and real estate. While there is no widely accepted index of this type, some
central bankers have suggested that it would be better to aim at stabilizing a wider general
price level inflation measure that includes some asset prices, instead of stabilizing CPI or
core inflation only. The reason is that by raising interest rates when stock prices or real
estate prices rise, and lowering them when these asset prices fall, central banks might be
more successful in avoiding bubbles and crashes in asset prices.

Issues in measuring
Measuring inflation in an economy requires objective means of differentiating changes in nominal
prices on a common set of goods and services, and distinguishing them from those price shifts
resulting from changes in value such as volume, quality, or performance. For example, if the price
of a 10 oz. can of corn changes from $0.90 to $1.00 over the course of a year, with no change in
quality, then this price difference represents inflation. This single price change would not, however,
represent general inflation in an overall economy. To measure overall inflation, the price change of
a large "basket" of representative goods and services is measured. This is the purpose of a price
index, which is the combined price of a "basket" of many goods and services. The combined price
is the sum of the weighted average prices of items in the "basket". A weighted price is calculated by
multiplying the unit price of an item to the number of those items the average consumer purchases.
Weighted pricing is a necessary means to measuring the impact of individual unit price changes on
the economy's overall inflation. The Consumer Price Index, for example, uses data collected by
surveying households to determine what proportion of the typical consumer's overall spending is
spent on specific goods and services, and weights the average prices of those items accordingly.
Those weighted average prices are combined to calculate the overall price. To better relate price
changes over time, indexes typically choose a "base year" price and assign it a value of 100. Index
prices in subsequent years are then expressed in relation to the base year price Inflation measures
are often modified over time, either for the relative weight of goods in the basket, or in the way in
which goods and services from the present are compared with goods and services from the past.
Over time adjustments are made to the type of goods and services selected in order to reflect
changes in the sorts of goods and services purchased by 'typical consumers'. New products may be
introduced, older products disappear, the quality of existing products may change, and consumer
preferences can shift. Both the sorts of goods and services which are included in the "basket" and
the weighted price used in inflation measures will be changed over time in order to keep pace with
the changing marketplace. Inflation numbers are often seasonally adjusted in order to differentiate
expected cyclical cost shifts. For example, home heating costs are expected to rise in colder months,
and seasonal adjustments are often used when measuring for inflation to compensate for cyclical
spikes in energy or fuel demand. Inflation numbers may be averaged or otherwise subjected to
statistical techniques in order to remove statistical noise and volatility of individual prices. When
looking at inflation economic institutions may focus only on certain kinds of prices, or special
indices, such as the core inflation index which is used by central banks to formulate monetary
policy. Most inflation indices are calculated from weighted averages of selected price changes. This
necessarily introduces distortion, and can lead to legitimate disputes about what the true inflation
rate is. This problem can be overcome by including all available price changes in the calculation,
and then choosing the median value.

EFFECTS

Negative
High or unpredictable inflation rates are regarded as harmful to an overall economy. They add
inefficiencies in the market, and make it difficult for companies to budget or plan long-term.
Inflation can act as a drag on productivity as companies are forced to shift resources away from
products and services in order to focus on profit and losses from currency inflation. Uncertainty
about the future purchasing power of money discourages investment and saving. And inflation can
impose hidden tax increases, as inflated earnings push taxpayers into higher income tax rates unless
the tax brackets are indexed to inflation.

With high inflation, purchasing power is redistributed from those on fixed nominal incomes, such
as some pensioners whose pensions are not indexed to the price level, towards those with variable
incomes whose earnings may better keep pace with the inflation. This redistribution of purchasing
power will also occur between international trading partners. Where fixed exchange rate are
imposed, higher inflation in one economy than another will cause the first economy's exports to
become more expensive and affect the balance of trade. There can also be negative impacts to trade
from an increased instability in currency exchange prices caused by unpredictable inflation.

Cost-push inflation
High inflation can prompt employees to demand rapid wage increases, to keep up with consumer
prices. Rising wages in turn can help fuel inflation. In the case of collective bargaining, wage
growth will be set as a function of inflationary expectations, which will be higher when inflation is
high. This can cause a wage spiral. In a sense, inflation begets further inflationary expectations,
which beget further inflation.
Hoarding
People buy consumer durables as stores of wealth in the absence of viable alternatives as a means of
getting rid of excess cash before it is devalued, creating shortages of the hoarded objects.

Hyperinflation
If inflation gets totally out of control (in the upward direction), it can grossly interfere with the
normal workings of the economy, hurting its ability to supply goods. Hyperinflation can lead to the
abandonment of the use of the country's currency, leading to the Inefficiencies of barter.
Allocative Efficiency
A change in the supply or demand for a good will normally cause its relative price to change,
signalling to buyers and sellers that they should re-allocate resources in response to the new market
conditions. But when prices are constantly changing due to inflation, price changes due to genuine
relative price signals are difficult to distinguish from price changes due to general inflation, so
agents are slow to respond to them. The result is a loss of allocative efficiency.
Shoe Leather Cost
High inflation increases the opportunity cost of holding cash balances and can induce people to hold
a greater portion of their assets in interest paying accounts. However, since cash is still needed in
order to carry out transactions this means that more "trips to the bank" are necessary in order to
make withdrawals, proverbially wearing out the "shoe leather" with each trip.
Menu costs
With high inflation, firms must change their prices often in order to keep up with economy-wide
changes. But often changing prices is itself a costly activity whether explicitly, as with the need to
print new menus, or implicitly.
Business Cycle
According to the Austrian business Cycle Theory inflation sets off the business cycle. Austrian
economists hold this to be the most damaging effect of inflation. According to Austrian theory,
artificially low interest rates and the associated increase in the money supply lead to reckless,
speculative borrowing, resulting in clusters of malinvestments, which eventually have to be
liquidated as they become unsustainable.

Positive
Labor-market adjustments
Keynesians believe that nominal wages are slow to adjust downwards. This can lead to prolonged
disequilibrium and high unemployment in the labor market. Since inflation would lower the real
wage if nominal wages are kept constant, Keynesians argue that some inflation is good for the
economy, as it would allow labor markets to reach equilibrium faster.

Debt relief
Debtors who have debts with a fixed nominal rate of interest will see a reduction in the "real"
interest rate as the inflation rate rises. The “real” interest on a loan is the nominal rate minus the
inflation rate.(R=n-i) For example if you take a loan where the stated interest rate is 6% and the
inflation rate is at 3%, the real interest rate that you are paying for the loan is 3%. It would also hold
true that if you had a loan at a fixed interest rate of 6% and the inflation rate jumped to 20% you
would have a real interest rate of -14%. Banks and other lenders adjust for this inflation risk either
by including an inflation premium in the costs of lending the money by creating a higher initial
stated interest rate or by setting the interest at a variable rate.

Room to maneuver
The primary tools for controlling the money supply are the ability to set the discount rate,the rate at
which banks can borrow from the central bank, and open market operation are the central bank's
interventions into the bonds market with the aim of affecting the nominal interest rate. If an
economy finds itself in a recession with already low, or even zero, nominal interest rates, then the
bank cannot cut these rates further (since negative nominal interest rates are impossible) in order to
stimulate the economy - this situation is known as a liquidity trap. A moderate level of inflation
tends to ensure that nominal interest rates stay sufficiently above zero so that if the need arises the
bank can cut the nominal interest rate.
Tobin effect
The Noble Price winning economist James tobin at one point argued that a moderate level of
inflation can increase investment in an economy leading to faster growth or at least a higher steady
state level of income. This is because inflation lowers the Real Return on monetory  relative to real
assets, such as Physical Capital. To avoid this effect of inflation, investors would switch from
holding their assets as money (or a similar, susceptible-to-inflation, form) to investing in real
capital projects. See Tobin monetary model

HISTORY OF INFLATION IN INDIA

A peek into the past shows that prices have never really fallen in our country. From the 1950s, most
spurts in inflation have been triggered by setbacks in agricultural production due to poor monsoons.
Things have worsened when prices of industrial raw materials have increased. Since the 1960s,
large fiscal deficits, the subsequent injection of money into the economy, and the hoarding of
essential commodities by speculators, have been other factors causing inflation.

Bad monsoons and harvests triggered inflation in the mid-'50s. In the mid-'60s, decelerating
industrial output, setbacks in agricultural production, and the devaluation of the rupee were
responsible for high inflation from 1964-65 to 1967-68. The international oil crisis of 1973
coincided with inflation above 16 per cent. It was only during the Emergency inflation came down
to zero (in 1975-76) because of good agricultural production and a crackdown on speculation in
commodities.

But the trend was reversed with Charan Singh's 1979 budget, which fuelled price hikes through
higher indirect taxes on some essential commodities. This eased a bit in 1985-86, when foodgrain
production was a record 150 million tonnes. But it was back to square one the following year and in
subsequent years, as agricultural production suffered.

The '90s have been marked by high inflation. The tone was set by the fiscal crisis of 1991, when
high deficits in government finances and devaluation of the rupee caused galloping inflation of
13.66 per cent. It was later controlled, but the average rate of inflation over seven years of
liberalisation has been a substantial 9.3 per cent per year.

ACCEPTABILITY OF INFLATION IN INDIA

Inflation in India is at an acceptable level and remains much lower than in many other developing
countries. But off late prices of essential commodities such as food grain, edible oil, vegetables etc
have risen sharply and in the process driving up the inflation rate. 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, the value of currency goes down. Thus the purchasing power of the
currency, i.e. the goods and services that can be bought in a unit of currency, too goes down. 

Measuring inflation is a difficult task. To do so a number of goods that are representative of the
economy are put together into what is referred as a "market basket." The cost of this basket is then
compared over time. This results in a price index, which is the cost of the market basket today as a
percentage of the cost of that identical basket in the starting year. In India two types of index:
Consumer Price Index (CPI) and Wholesale Price Index (WPI) are used to monitor inflation. Off
the two, Wholesale Price Index (WPI) is the most widely used price index in India. It is used to
measure the change in the average price level of goods traded in wholesale market and is available
on a weekly basis with the shortest possible time lag only two weeks. 

The current rise in inflation has its roots in supply-side factors. There was shortfall in domestic
production vis-a-vis domestic demand and hardening of international prices, prices of primary
commodities, mainly food items. Wheat, pulses, edible oils, fruits and vegetables, and condiments
and spices have been the major contributors to the higher inflation rate of primary articles. The
inflation was also accompanied by buoyant growth of money and credit. While the GDP growth
zoomed to 9.0 per cent per annum, the broad money (M3) grew by more than 20 per cent. Demand
for nearly everything from housing to fast moving consumer goods is outpacing supply in part
because white-collar salaries are rising faster in India than anywhere else in Asia. One of the
daunting tasks before the government is to reconcile the twin needs of facilitating credit for growth
on the one hand and containing liquidity to tame inflation on the other.

CAUSE FACTORS

The puzzle haunting the Indian economists is simply this- Why is inflation rate in India so high as
compared to the other emerging and overheating market economies, like China, Korea and
Indonesia where inflation just touches a mere 3 per cent?There are a couple of explanations for this-
Firstly, India has been very much underinvested as compared to China whose rate of investment for
the year 2009 was 45 per cent as compared to India’s 37 per cent. This has been the key to China’s
development, (currently fastest in the world) free from all scars of inflationary pressure.India has
always been subject to uncertainty of the monsoons, particularly last year, which led to a sharp fall
in agricultural produce, declining supply and thus shooting up the prices. This is called the Supply
shock factor or the cost push inflation.Another reason, intuitively named as the Policy Shock is
responsible for inflation. Hike in fuel prices, subject to the discretion of OPEC, increases the
manufacturing cost of a number of industries, which in turn shoots up the prices of their respective
commodities.Apart from the above, there is another explanation, namely overheating: the supply
capacity falls short of demand. Now, overheating in India is a serious cause of worry because it
certainly implies that the economy’s current growth rate of 8.4 per cent surpasses its potential or
trend growth rate. In this scenario, how can anyone in India dream of China-type-double-figure
growth rates unless and until infrastructure development is given some serious thought?
Microeconomic distortions causing an increase in land prices accompanied by various
macroeconomic factors such as surging capital inflows in the real estate and housing sector are very
much responsible for the rising cost of production in the economy. Apart from agriculture and
manufacturing, service sector which contributes the highest (54 per cent for 2009-2010) also bears
dire consequences of galloping prices of land.Excess of short-term borrowings and speculative
activities are majorly responsible for a steady inflation in the Indian economy. Highly volatile, these
short term borrowings lead to a vicious cycle of speculation, which ends up causing serious
depression in the economy, sometimes insolvency.  Increase in speculative activities leads to a rise
in domestic price, thus making the exports expensive. This ensues in the deficit in the balance of
payments which forces the government to pump in money into the economy by printing currency
notes. This, along with the adjustment of the BOP, plays havoc with the demand capacity of the
economy. Since people own more money now, their demand for goods and services accelerates like
anything and this further leads to a rise in prices.
Consequences:
The dire consequences of this phenomenon are levied upon the aam admi.  Of course somebody like
you and me, or someone less well off than us cannot be considered as aam aadmi. Aam aadmi clan
is that 70 per cent of the population of India who spend less than Rs 20 on themselves every day.
Right from the rickshawallas in Delhi, to the daily wage earners in Bihar, these people struggle to
make ends meet. Prices of food items like vegetables, fruits, pulses, oil, wheat, rice, etc,
conveyance, education and healthcare have soared up to no extent, thus causing the cost of living
to increase.
The RBI has been implementing the only monetary strategy it knows, increasing the interest rates to
squeeze liquidity. According to the forecasts of the Bloomerag News survey, the RBI will increase
both the repurchase and the reverse repurchase rates by a quarter points each. This has led to an
upsurge in agitation among the opposition parties who are stubborn against any rise in interest rates.
However, the government needs be careful lest it ends up hampering the growth of the economy
with such a tight credit policy. A balance needs to be maintained between the credit liberty for
growth on one hand and tightening liquidity for tackling inflation on the other.Wages, in the
country are on a high rise these days. World leading mobile phone supplier Nokia Pvt Limited and
IT companies such as Wipro and Infosys have taken a step ahead and raised the wages of their
employees to retain them.
Future Predictions:
The RBI predicts that it will be able to pull down inflation rate up to 6 per cent by the end of this
year.If in future inflation is not curbed, it will not only deprive the aam admi of basic amenities but
along with it, also deprive the Indian economy of its growth of all the sectors.

Inflation in India: How to tackle it

Inflation is no stranger to the Indian economy. In fact, till the early nineties Indians were used to
double-digit inflation and its attendant consequences. But, since the mid-nineties controlling
inflation has become a priority for policy framers . The natural fallout of this has been that we, as a
nation, have become virtually intolerant to inflation. While inflation till the early nineties was
primarily caused by domestic factors (supply usually was unable to meet demand, resulting in the
classical definition of inflation of too much money chasing too few goods), today the situation has
changed significantly.Inflation today is caused more by global rather than by domestic factors.
Naturally, as the Indian economy undergoes structural changes, the causes of domestic inflation too
have undergone tectonic changes.Needless to emphasise, causes of today's inflation are
complicated. However, it is indeed intriguing that the policy response even to this day unfortunately
has been fixated on the traditional anti-inflation instruments of the pre-liberalisation era.

Global imbalance the cause for global liquidity

To understand the text of the present bout of inflation, let us at the outset understand the context:
the functioning of the global economy, which is in a state of extreme imbalance. This is simply
because developed western economies, particularly the United States, are consuming on a massive
scale leading to gargantuan trade deficits.Crucially their extreme levels of consumption and imports
are matched by the proclivity, nay fetish, of the developing countries in having an export-driven
economic model. Thus while a set of developing countries produces, exports and also saves the
proceeds by investing their forex reserves back in these countries, developed countries are
consuming both the production and investment originating from the developing countries.In effect,
developing countries are building their foreign exchange reserves while the developed countries are
accumulating the corresponding debt. After all, it takes two to a tango.For instance, the US current
account deficit is estimated to be 7 per cent of GDP in 2006 and stood at approximately $900
billion. Obviously, the current account deficit of the US becomes the current account surplus of
other exporting countries, viz. China, Japan [ Images ] and other oil producing and exporting
countries.The reason for this imbalance in the global economy is the fact that after the Asian
currency crisis; many countries found the virtues of a weak currency and engaged in 'competitive
devaluation.'Under this scenario, many countries simply leveraged their weak currency vis-à-vis the
US dollar to gain to the global (read US) markets. This mercantilist policy to maintain their
competitiveness is achieved when their central banks intervenes in the currency markets leading to
accumulation of foreign exchange, notably the US dollar, against their own currency.Implicitly it
means that the developing world is subsidising the rich developed world. Put more bluntly, it would
mean that the US has outsourced even defending the dollar to these countries, as a collapse of the
US currency would hurt these countries holding more dollars in reserves than perhaps the US itself!

In this connection, commenting on the above phenomenon in the Power and Interest News Report,
Jephraim P Gundzik wrote that the world growth "was hardly sufficient to be behind the further rise
of commodity prices in the first five months of this year (i.e. in 2006). Rather than demand pushing
the value of commodities higher in the past 18 months, it has been the (impending) dollar's
devaluation against commodities that has pushed commodity prices to record highs."Naturally, as
the players fear a fall in the value of the dollar and reach out to various assets and commodities, the
prices of these commodities and assets too will rise.

The psychological dimension

But as the imbalance shows no sign of correcting, players seek to shift to commodities and assets
across continents to hedge against the impending fall in the US dollar. Thus, it is a fight between
central banks and the psychology of market players across continents. As a corrective measure,
economists are coming to the conclusion that most of the currencies across the globe are highly
undervalued vis-à-vis the dollar, which, in turn, requires a significant dose of devaluation. For
instance, a consensus exists amongst economists and currency traders that the Yen is one of the
most highly undervalued currencies (estimated at around 60%) along with the Chinese Yuan
(estimated at 50%) followed by other countries in Asia.This artificial undervaluation of currencies
is another fundamental cause for increasing global liquidity.

To get an idea of the enormity of the aggregation of these two factors on the world's supply of
dollars, Jephraim P. Gundzik calculates the dollar value of rising prices of just one commodity --
crude oil.

In 2004, global demand for crude oil grew by a mere four per cent. Nevertheless higher oil prices
advanced by as much as 34 per cent. Consequently, it is this factor that significantly contributed to
increase the world's dollar supply by about $330 billion.

In 2005, international crude oil prices gained another 35 per cent and global demand for oil grew by
only 1.6 per cent. Nonetheless, the world's supply of dollars increased by a further $460 billion.

Naturally, with all currencies refusing to be revalued, this leads to increased global liquidity. While
one is not sure as to whether the increase in the prices of crude led to the increase of other
commodities or vice versa, the fact of the matter is that, in the aggregate, increased liquidity has led
to the increase in commodity prices as a whole.

Although some of this increase in the world's supply of dollars has been reabsorbed into US
economy by the twin American deficits -- current as well as budgetary -- it is estimated that as
much as $600 billion remains outside the US.

What has further compounded the problem is the near-zero interest rate regime in Japan. With
almost $905 billion forex reserves, it makes sense to borrow in Japan at such low rates and invest
elsewhere for higher returns. Obviously, some of this money -- estimated by experts to be
approximately $200 billion -- has undoubtedly found its way into the asset markets of other
countries.
Most of it has been parked in alternative investments such as commodities, stocks, real estates and
other markets across continents, leveraged many times over. Needless to reiterate, the excessive
dollar supply too has fuelled the property and commodity boom across markets and continents.

The twin causes -- excessive liquidity due to undervaluation of various currencies (technical) and
fear of the US dollar collapse leading to increased purchase of various commodities to hedge
against a fall in US dollar (psychological) -- needs to be tackled upfront if inflation has to be
confronted globally.

Higher international farm prices impact Indian farm prices

What actually compounds the problem for India is the fact that lower harvest worldwide,
specifically in Australia and Brazil and the overall strength of demand vis-à-vis supply and low
stock positions world over, global wheat prices have continued to rise.

Wheat demand is expected to rise, while world production is expected to decline further in the
coming months, as a result of which global stocks, already at historically low levels, may fall
further by 20 per cent. These global trends have put upward pressure on domestic prices of wheat
and are expected to continue to do so during the course of this year.

No wonder, despite the government lowering the import tariffs on wheat to zero, there has been no
significant quantity of wheat imports as the international prices of wheat are higher than the
domestic prices.

Growth and forex flows

Another cause for the increase in the prices of these commodities has been due to the fact that both
India and China have been recording excellent growth in recent years. It has to be noted that China
and India have a combined population of 2.5 billion people.

Given this size of population even a modest $100 increase in the per capita income of these two
countries would translate into approximately $250 billion in additional demand for commodities.
This has put an extraordinary highly demand on various commodities. Surely growth will come at a
cost. The excessive global liquidity as explained above has facilitated buoyant growth of money and
credit in 2005-06 and 2006-07. For instance, the net accretion to the foreign exchange reserves
aggregates to in excess of $50 billion (about Rs 225,000 crore) in 2006-07. Crucially, this
incremental flow of foreign exchange into the country has resulted in increased credit flow by our
banks. Naturally this is another fuel for growth and crucially, inflation.

This Reserve Bank of India's strategy of dealing with excessive liquidity through the Market
Stabilization Scheme (MSS) has its own limitations. Similarly, the increase in repo rates (ostensibly
to make credit overextension costly) and increase in CRR rates (to restrict excessive money supply)
are policy interventions with serious limitations in the Indian context with such huge forex inflows.

How about the revaluation of the Indian Rupee?

To conclude, all these are pointers to a need for a different strategy. The current bout of inflation is
caused by a multiplicity of factors, mostly global and is structural. Monetary as well as trade policy
responses, as has been attempted till date, would be inadequate to deal with the extant issue
effectively.

Crucially, a stock market boom, a real estate boom and a benign inflation in the foodgrains market
is an economic impossibility.

It has to be noted that the Indian market is structurally suited for leveraging shortages rather
effectively. Added to this is the information asymmetry among various class of consumers as well
as between consumers, on the one hand, and producers and consumers, on the other.

Further, the sustained flow of foreign money, thanks to the excessive global liquidity in the world,
has fuelled the rise of the stock markets and real estate prices in India to unprecedented levels.

This boom has naturally led to corresponding booms in various related markets as much as the
increased credit flow has in a way resulted in overall inflation.

Economic policy rests in the triumvirate of fiscal, monetary and trade policies. Theoretical
understanding of economics meant that these policies are interdependent.

Also, one needs to understand that growth naturally comes with its attendant costs and
consequences. While these policies are usually intertwined and typically compensatory, one has to
understand that the issues with respect to inflation cannot be subjected to conventional wisdom in
the era of globalisation.
One policy route yet unexamined in the Indian context by the government is the exchange rate
policy, especially revaluation of the Rupee as an instrument to control inflation.

It is time that we think about a revaluation of the Indian Rupee as a policy response to the complex
issue of managing inflation, while simultaneously address the constraints on the supply side on food
grains through increase in domestic production.

A higher Rupee value vis-à-vis the dollar would mean lower purchase price of commodities in
Rupee terms. The Indian economy has undergone significant changes in the past decade and a half.
With increased linkages to the global economy, it cannot duck the negatives of globalisation.

Quite the contrary, it needs to come with appropriate policy responses for the same, which cannot
be of the 1960s vintage. Allowing Rupee to appreciate is surely one of them. The time for a rethink
on our exchange rate policy to tackle inflation is now. Are we ready?

Inflation in India statistics

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2009 10.45 9.63 8.03 8.70 8.63 9.29 11.89 11.72 11.64 11.49 - -

2008 5.51 5.47 7.87 7.81 7.75 7.69 8.33 9.02 9.77 10.45 10.45 9.70

2007 6.72 7.56 6.72 6.67 6.61 5.69 6.45 7.26 6.40 5.51 5.51 5.51

2006 4.39 5.31 5.31 5.26 6.14 7.89 6.90 5.98 6.84 7.63 6.72 6.72

QUANTITATIVE MEASURES: 
Measures which aim to control the quantity of money supply directly such as CashReserve Ratio
(CRR), Statutory Liquidity Ratio (SLR), and Open Market Operations (OMO)
Cash Reserve Ratio:
 It is a quantitative tool of monetary and credit policy to regulate the money supply in the economy.
Cash reserve ratio (CRR) is that slice of a bank's deposits, which the bank has to compulsorily
deposit with RBI.A CRR of six per cent means that out of every Rs 100, bank has to deposit Rs. 6
with RBI. Interestingly, RBI does not pay anyinterest on this money to banks. When RBI wants to
reduce liquidity from the system, like in times of high inflation, it increasesthe CRR.RBI by varying
the CRR regulates the lendable funds of commercial banks.An increase in CRR would also mean
that money is being sucked out of the system. This would mean that funds are hard tocome by and
hence banks will have to pay more to depositors in order to induce them to keep their funds with
banks. This willpush up cost of funds for banks. The banks therefore will also have to raise lending
rates in order to meet the increased costwhile maintaining their margins. For exampleRBI has
increased the CRR of scheduled banks by 6% of their Net Demand and Time Liabilities (NDTL).
As a result of thisincrease in the CRR, about 12,500 crore of excess liquidity will be absorbed
from the system.
Statutory Liquidity Ratio:
 It is a quantitative tool of monetary and credit policy to regulate the money supply in theeconomy.
Under the provision of Banking Regulation Act governing the banking operations, banks are
required to hold liquidassets such as government securities, or other unencumbered approved
securities, cash or gold, against their demand and timeliabilities as on the last Friday of second
preceding fortnight in India. This is known as supplementary reserve requirement orsecondary
reserve requirement. The main objective of this monetary policy instrument is to ensure solvency of
commercialbanks by compelling them to hold low risk assets up to a stipulated extent. It also helps
to regulate the pace of credit expansionto commercial sector. SLR refers to the ratio of holdings of
the prescribed liquid assets to total time and demand liabilities. Atpresent, SLR is 25%, means 25
out of 100 are invested in prescribed liquid assets.
The objectives of SLR are:
1.To restrict the expansion of bank credit.
2.To augment the investment of the banks in Government securities.
3.To ensure solvency of banks. A reduction of SLR rates looks eminent to support the credit growth
in India.
Open Market Operations:
A monetary policy instrument which is used by the Reserve Bank mainly with a view to affect the
reserve base of the banks and thereby the extent of monetary expansion. It also, in the process,
helps to create and maintaina desired pattern of yield on government securities (G-Sec) and to assist
the government in raising resources from the capitalmarket. Under the RBI Act, the RBI is
authorized to purchase and sell the securities of the Union Government and StateGovernments of
any maturity and the security specified by the Central Government on the recommendation of
Bank's CentralBoard. Presently the RBI deals only in the securities issued by the Union
Government. Open market operations are by wayoutright sale and purchase of securities through
the Securities Department and repo and reverse repo transactions.When RBI buys the securities in
the open market, It increases the liquidity and reserves of commercial banks, making itpossible for
banks to expand their loans and investments. If RBI sells the securities, the effects are reversed.
QUALITATIVE MEASURES: 

They aim to control the quantity of money supply indirectly through cost of credit. These
measures are Bank Rate, Repo & Reverse Repo Rates, and Interest Rates etc.
Bank Rate:
An instrument of general credit control and represents the standard rate at which the RBI is
prepared to buy orrediscount bills of exchange or other commercial paper eligible for purchase
under the provisions of the Act. In short, Bank rateis the minimum rate at which the central bank
provides loans to the commercial banks. It is also called the discount rate.Usually, an increase in
bank rate results in commercial banks increasing their lending rates. Changes in bank rate affect the
lending rates through altering the cost of credit. At present Bank rate is 6%.
Repo Rate:
 Repo and Reverse Repo Rates are Liquidity adjustment Facility (LAF) tools used by RBI. Repo is
an instrumentmeant for injecting the funds required and Reverse Repo for absorbing the excess
liquidity out of system.In bond markets, interest rates are the most important factor, and the RBI
controls interest rates. RBI uses various rates likerepo, reverse repo and CRR to give direction to
interest rates in the country. Take an example
Repo refers to 'repurchase obligation'. In case of tight liquidity conditions (as you saw in 2008),
when banks need funding forthe short term, they approach the RBI and ask for a temporary loan.
RBI gives them a loan only after taking some collateral
STEP HAS BEEN TAKEN BY RBI OVER CURVING INFLATION 2010

The Reserve Bank released its Second quarter review of monetary policy for 2010-11

 At the heart of the policy was a further increase in the repo and reverse repo rates by 25
basis points each. Accordingly, the repo rate stands raised to 6.25 per cent and the reverse
repo rate to 5.25 per cent. The cash reserve ratio (CRR) has been left unchanged at 6 per
cent of net demand and time liabilities (NDTL) of banks.

 With this increase, since we started reversing the monetary policy stance in March 2010,
the repo rate has increased by 150 basis points and the reverse repo by 200 basis points.

Considerations Behind Policy Move

Second Quarter Review of Monetary Policy 2010-11 Press Statement by Dr. D. Subbarao,
Governor

As always, we had taken into account both global and domestic macroeconomic situation in
calibrating this policy move. In particular, we were guided by three considerations.

i. Domestic growth drivers are robust which should help absorb to a large extent the negative
impact of any slowdown in global recovery.

ii. Inflation and inflationary expectations remain high as both demand de and supply side
factors are at play. Given the spread and persistence of inflation, demand-side inflationary
pressures need to be contained and inflationary expectations anchored.

iii. Even though a liquidity deficit is consistent with our anti-inflation stance, it needs to be
contained within a reasonable limit to ensure that economic activity is not disrupted.

Inflation

Let me now move to the vital issue of inflation conditions. Notwithstanding some moderation in
recent months, headline inflation remains significantly above its medium-term trend, and well
above the comfort zone of the Reserve Bank. Food inflation has not shown the expected post-
monsoon moderation and has remained persistently elevated for over an year now, reflecting in part
the structural demand-supply mismatches in several commodities. This has elevated inflation
expectations. The risks of expectations spilling over into prices of other commodities are significant
when the economy is growing close to trend. That could potentially offset the recent moderation.

Even as non-food manufacturing inflation has moderated, it remains above its medium-term trend.
The new WPI series released in September 2010 is a better representative of commodity price levels
with an updated base (2004-05=100) and wider coverage of commodities. When we compare the
old and new WPI series, inflation at the aggregate level over the medium-term is similar under both
series, but there are differences at a disaggregated level. Inflation in primary articles, especially
food articles, in the new series has been significantly higher than in the old series, whereas for
manufactured products, it has been somewhat lower.

Going forward, the inflation outlook will be shaped by three factors: (i) the evolution of food price
inflation; (ii) global commodity prices; and (iii) demand pressures stemming from sustained growth
amidst tightening capacity constraints in many industries.

On balance, inflation is expected to moderate from the present elevated level, reflecting in part,
some easing of supply constraints and concerted policy action. In its July Review, the Reserve Bank
made a baseline projection of WPI inflation for March 2011 of 6 per cent under the old series of
WPI. The baseline projection of WPI inflation for March 2011 has been placed at 5.5 per cent under
the new series. This is equivalent to 6 per cent under the old series. Effectively, this means that the
Reserve Bank’s inflation projection remains unchanged from that made in its July 2010 Review.

Macroeconomic and Monetary Developments in the Second Quarter of 2010-11

The Reserve Bank of India today released its Macroeconomic and Monetory Devleopment of
Second Quarter Review 2010-11document.The document serves as a background to the Second
Quarter Review of Monetary Policy 2010-11 to be announced on November 02, 2010.

Inflation
  The headline inflation has started to soften after staying in double digit for five months up to
July 2010.

 Inflation in non-food manufactured products, though remains above its medium-term trend,
has shown some moderation.

 But food inflation remains disconcertingly high despite a normal monsoon. This can be
attributed partly to a change in the consumption pattern in favour of protein-rich items, such
as, egg, milk, fish and meat where price increases have been high.
 Despite moderation in recent months, elevated inflation remains a challenge for monetary
policy.

Mid-Quarter Monetary Policy Review: September 2010

On the basis of the Reserve Bank’s assessment of macroeconomic situation, it has been decided to:

 increase the repo rate under the Liquidity Adjustment Facility (LAF) by 25 basis points
from 5.75 per cent to 6.0 per cent with immediate effect.

 increase the reverse repo rate under the LAF by 50 basis points from 4.5 per cent to 5.0 per
cent with immediate effect.

Expected Outcome

The measures undertaken in this review should:

 contain inflation and anchor inflationary expectations without disrupting growth.

 reduce the volatility in overnight call money rates, thereby strengthening the monetary
transmission mechanism.

 continue the process of normalisation of the monetary policy instruments.  

The Reserve Bank’s rate and liquidity actions since October 2009 have been driven by two
considerations: normalisation of the monetary policy stance as the crisis abated and inflation
management. The Reserve Bank believes that the tightening that has been carried out over this
period has taken the monetary situation close to normal. Consequently, the role of normalisation as
a motivation for further actions is likely to be less important. Current and expected macroeconomic
conditions will be the more important considerations going forward. The Reserve Bank will
continue to monitor these conditions, particularly the price situation, and take further action as
warranted.

First Quarter Review of Statement on Monetary Policy for the Year 2010-11

"This morning, the Reserve Bank released the First Quarter Review of Monetary Policy for 2010-11
at a meeting of the chief executives of major banks. The important decisions contained in the
review were to raise the repo rate from 5.5 per cent to 5.75 per cent and the reverse repo rate from 4
per cent to 4.50 per cent.  This asymmetric raise in rates narrows the LAF corridor from 150 basis
points to 125 basis points.

Inflation

The developments on the inflation front are, however, worrisome. Let me explain. WPI inflation
has been in double digits since February 2010. Primary food articles inflation, despite some
moderation, continues to be in double digits. Between November 2009 and June 2010, non-food
inflation rose from zero to 10.6 per cent and non-food manufactured inflation from zero to 7.3 per
cent. Significantly, non-food items contributed over 70 per cent to WPI inflation in June 2010,
suggesting that inflation is now very much generalised. Inflation in terms of all four consumer price
indices remains in double digits notwithstanding some decline in recent months.

Going forward, the outlook on inflation will be shaped by: (i) the monsoon performance for the
remaining period; (ii) movements in global energy and commodity prices, which have been
showing distinct signs of softening over the past few weeks; and (iii) potential build-up in demand-
side pressures with the strengthening of domestic growth drivers.
Taking into account the emerging domestic and external scenario, the baseline projection for WPI
inflation for March 2011 has been raised to 6.0 per cent from our April policy projection of 5.5 per
cent.

 Our monetary policy actions are expected to:

i) Moderate inflation by reining in demand pressures and inflationary expectations.

ii) Maintain financial conditions conducive to sustaining growth.

iii) Generate liquidity conditions consistent with more effective transmission of policy actions.

iv) Restrict the volatility of short-term rates to a narrower corridor.

Macroeconomic and Monetary Developments in the First Quarter of 2010-11

The Reserve Bank of India today released the document Monetory Devleopment of First Quarter
Review 2010-11 which serves as a background to the First Quarter Review of Monetary Policy
2010-11 to be announced on July 27, 2010.

Overall Assessment

 The normalisation of monetary policy of the Reserve Bank in 2010-11 so far has been
conditioned by the changing growth-inflation dynamics characterised by robust acceleration
in growth and increasing generalisation of inflation.

 With concerns about the recovery receding, increasing risks of generalised inflation indicate
that monetary policy has to continue the calibrated normalisation process.

Annual Policy Statement for the Year 2010-1

"This morning, I had a meeting with the chiefs of major banks where we announced the Reserve
Bank’s monetary policy for 2010-11. We had consulted with a wide array of stakeholders in the run
up to this policy and took their views on board. Let me briefly summarise the main points of our
discussion with the banks before I spell out the Reserve Banks’ policy stance.

Inflation

The developments on the inflation front are, however, worrisome. Headline wholesale price index
(WPI) inflation accelerated from 1.5 per cent in October 2009 to 9.9 per cent by March 2010. There
has been a significant change in the drivers of inflation in recent months. What was initially a
process driven by food prices has now become more generalised. This is reflected in non-food
manufactured products inflation rising from (-) 0.4 per cent in November 2009 to 4.7 per cent in
March 2010.

Going forward, three major uncertainties cloud the outlook for inflation. First, the prospects of the
monsoon in 2010-11 are not yet clear. Second, crude prices continue to be volatile. Third, there is
evidence of demand side pressures building up. On balance, keeping in view domestic demand-
supply balance and the global trend in commodity prices, the baseline projection for WPI inflation
for March 2011 is placed at 5.5 per cent.

Monetary Policy Measures

Our Monetary Policy Statement 2010-11 specifies the following monetary measures:

i) The repo rate has been raised by 25 basis points from 5.0 per cent to 5.25 per cent with immediate
effect.

ii) The reverse repo rate has been raised by 25 basis points from 3.5 per cent to 3.75 per cent with
immediate effect.

iii) The cash reserve ratio (CRR) of scheduled banks has been raised by 25 basis points from 5.75
per cent to 6.0 per cent of their net demand and time liabilities (NDTL) effective the fortnight
beginning April 24, 2010.
Expected Outcome

We expect four major outcomes from the above policy action:

i) Inflation will be contained and inflationary expectations will be anchored.

ii) The recovery process will be sustained.

iii) Government borrowing requirements and the private credit demand will be met.

iv) Policy instruments will be further aligned in a manner consistent with the evolving state of the
economy.

Inflation Situation

 Headline WPI inflation has been in double digits since February 2010 and   has also become
increasingly generalised in every successive month.

 Non-food manufacturing inflation accelerated from near zero in November 2009 to 7.3 per
cent in June 2010, reflecting the impact of rising input costs, recovering private demand and
associated return of pricing power.

 Since November 2009, 42 per cent of the overall increase in WPI has resulted from
revisions in administered prices and lagged reporting of past increases in prices.
 Given the risks to inclusive growth from high inflation, the monetary unwinding that started
in October 2009 should continue till inflation expectations are firmly anchored and inflation
is brought down.

Macroeconomic and Monetary Developments in 2009-10

The Reserve Bank of India today released the document Monetory Devleopment of Second Quarter
Review 2009-10 which serves as a background to the Monetary Policy Statement 2010-11 to be
announced on April 20, 2010.
Overall Assessment

 With the improving growth outlook, monetary and fiscal exit measures have started.

 While recovery in private demand needs to be stronger to reinforce the growth momentum,
already elevated headline inflation suggests that the weight of policy balance may have to
shift to containing inflation, since high inflation itself will dampen recovery in growth.

 In the emerging macroeconomic scenario, monetary policy management in 2010-11 will be

dominated by the challenge of moderating inflation and anchoring inflation expectations,
while remaining supportive of growth impulses.

inflation Situation

 Headline WPI inflation firmed up significantly during the fourth quarter of 2009-10.

 The initial inflationary pressure was predominantly conditioned by rising food and fuel
prices, reflecting the impact of a deficient monsoon on agricultural output and the increase
in international crude prices.  In the second half of the year, with persistent supply side
pressures, inflation became increasingly generalised.

 This is evident from the acceleration of inflation in non-food manufactured products from
-0.4 per cent in November 2009 to 4.7 per cent in March 2010.

 Inflation, as measured by consumer price indices (CPIs) also remained high, though there
was some moderation in February 2010.

 These inflationary conditions, coupled with the stronger momentum seen in the pace of
economic recovery, created the compelling ground for altering the Reserve Bank’s policy
focus to anchoring inflation expectations.

inflation Outlook
  Inflation can be expected to moderate over the next few months, from the peak levels seen
in recent months. There are, however, upside risks to inflation:

First, international commodity prices, particularly oil, have started to increase again. In several
commodities, the import option for India to contain domestic inflation is limited, because of higher
international prices.

Second, the revival in private consumption demand and the bridging of the output-gap will add to
inflationary pressures.

Finally, it is important to guard against the risk of hardening of inflation expectations conditioned
by near double digit headline WPI inflation.