a.

What, in your opinion, were the factors, both domestic and global, that led to the
inflationary trend in India in early 2007?

Inflation is a situation where too much money chases too few goods. India faced such an
inflationary situation in 2006-07. It was 6-6.8% as measured by WPI Wholesale price
index quite above the acceptable level of 5-5.5%.

Various economists held distinct factors responsible for the inflation

Due to increased demand and supply constraints, prices of food articles have increased
exponentially, turning attention towards them as cause of inflation. Demand increase was
due to high economic growth (GDP Gross domestic product increased to 9.2% from 6%)
and increased money supply. Supply constraints were due to stagnant agricultural
productivity.

The average annual GDP growth in the 2000s was about 6% and during the second
quarter (July-September) of fiscal 2006-2007, the growth rate was as high as 9.2%. All this
growth was bound to lead to higher demand for goods.

Food Articles

Domestic factors
Despite being one of the worlds largest producers of food grains, the growth in the
supply of goods, especially food articles such as wheat and pulses, did not keep pace with
the growth in demand. As a result, the prices of food articles increased. The factors causing
supply side constraints of food articles was also food grains wastage due to
Slow agricultural growth
Inadequate distribution links
Poor storage
Processing capacity
Global factors
Lower harvest of wheat in Australia and Brazil had resulted in lower supply of wheat
in international market raising price of wheat in world market that in turn raised domestic
price of wheat as GoI was unable to build up enough buffer stocks for other reasons.

Edible oil by 43%

India imported around 3.8 million tons of palm oil annually to meet one fourth of its edible
oil requirements. Due to increase in international prices of palm oil, domestic prices too
must have increased.

Pulses price by 25.4%

Due to stagnant production and productivity of pulses, its price raised exponentially.

Money supply

Annual growth rate of money supply was 22.1% as opposed to 15.5% as projected by RBI.
Reason was, RBI had purchased $12.6 billion that added INR 565.43 billion to domestic
monetary base. It immediately increased liquidity.

Other reasons quoted were

Economic growth
Manufactured products
Cement
Fuel

In India, the wholesale price index (WPI), which was the main measure of the
inflation rate consisted of three main components - primary articles, which included food
articles, constituting 22% of the index; fuel, constituting 14% of the index; and
manufactured goods, which accounted for the remaining 64% of the index.

b. Critically analyze the measures taken by the Indian Government and the RBI to
control inflation. What impact does the tackling of inflation through monetary means
have an economic growth?

GoI Government of India and countrys central bank RBI Reserve bank of India
took various measures to subside the inflation. The steps taken were strong enough to invite
criticism that the side effects could have been long term and worse like recession or long
term export competitiveness.

Increased CRR - Cash reserved ratio
To check money supply, RBI increased CRR (percentage of depositors balance
banks must have on hand) and repo rates (rate of interest applicable on securities bought
from RBI). This could have induced recession in Indian economy. With the increase in the
repo rates and bank rates, banks had to pay a higher interest rate for the money they
borrowed from the RBI. Consequently, the banks increased the rate at which they lent to
their customers. The increase in the CRR reduced the money supply in the system because
banks now had to keep more money as reserves.

INR v/s Dollars
RBI did not intervene when INR rallied against USD US dollar between Mar May 2007
considering stronger INR would bring down cost of imports and reduce domestic prices of
goods. Letting rupee rise like this could have a negative effect on companies earning profit
from exports. It in turn would have resulted in long term competitiveness of Indian exports.

Reduced the rate of interest on cash deposited by banks with the RBI.

Reduced import duties
GoI reduced import duties on several food products

Reduced fuel Price
GoI cut the price of diesel and petrol.

Raised Taxes
GoI raised taxes like education cess from 2% to 3%

Cement
Import tariff of cement was reduced and incentives were introduced on use of fly ash,
limestone in production of cement. GoI also assured long term coal supply to cement
manufacturers to help control the cost.

Duty cuts
Import duty on non-agricultural products was brought down to 10% from 12.5%.

As opposed to critics there were no big adverse effects of these reforms.