What is Inflation?

Imagine you had Rs. 7 in 2003. You could've purchased a 300 ml Pepsi from the store
and gone home happy (excluding the Rs. 2 that shopkeepers charge for refrigerating it).
Fast forward 10 years and you would have to shell out R. 12 to purchase the same 300ml
Pepsi bottle. What happened?
You would think Indra Nooyi has fleeced you, but in reality, the value of money has
reduced. This is attributable to inflation.
Inflation is defined as a sustained increase in the general level of prices for goods and
services.
Consider the annual inflation rate to be 5%.
Now, if Rs. 100 can buy you a pint in 2014, it would cost you Rs. 105 in 2015.
Quite literally, the beast of inflation reduces the purchasing power of your money.

So you'd think that Inflation is a bad thing, but it isn't so bad after all.
Few terms that you would also like to know about:

Disinflation: A decrease in the rate of inflation, say, from 3% in 2013 to 2% in

2014. Here, if a good costs you Rs. 100 in 2013, it'd cost you Rs. 103 in 2014 and Rs.
105.06 in 2015.

Deflation: Also known as negative inflation. it is a decrease in the general price

level of goods and services. If the deflation rate is 2% for 2014, a good costing Rs.
100 in 2014 would cost Rs. 98 in 2015.
Deflation must be sounding rather good to your wallet, but it isn't. Ask your
Japanese friends about it, or imagine being the Oil Mafia in Russia, when the prices
of oil have fallen so dramatically in the recent past.

Hyperinflation: An extreme case when a country experiences very high and

rapidly accelerating rates of inflation. This rapidly erodes the real value of the
nation's currency. People resort to holding relatively stable foreign currencies at
such times, since the local currency would be used to make pyramids or be swept off
the streets.
I am not kidding:

Also note that inflation is measured by a variety of indices, like the Consumer Price
Index (CPI) and the Wholesale Price Index (WPI).
1.

CPI: The Consumer Price Index expresses the current price of a basket of
goods and services (say July 2014) in terms of prices during the same period in the
previous year (July 2013).
Most countries, including India, use the CPI as their measure of inflation, which is
measured from the consumer's perspective.

2.

WPI: The Wholesale Price Index shows the rise (or fall) of prices of
manufactured goods as they leave the factory.
Until recently, the Reserve Bank of India (RBI) used the WPI as their measure of
inflation.

Under Raghuram Rajan's governance, the RBI has now adopted the CPI as their measure
of inflation, as sugegsted by the Urjit Patel Committee report, in April 2014.
(Just so that you and many others here know, Mr. Urjit Patel is the Deputy Governor of
the RBI)
Which is better?
Case in point: The WPI in India used to produce relatively real-time statistic of inflation
that the CPI, which is also why the CPI is known as the "lagging indicator" of inflation.
However, most (rather all) developed countries use the CPI.
There are a million other things that relate to inflation, like unemployment, hoarding,
etc., almost like a well-connected web. My objective here is to provide you with a broad
overview of inflation.
So next time when you vent your surprise at your sabzi waale bhaiyya(vegetable seller)
asking, "Aloo itna mehenga kyun hai bhaiyya?", and if he answers, "Kya kare madam,
mehengaai maar rahi hai", trust me, he's talking about inflation!

2. What are the trends in inflation?

Just like any other indicator, there are fluctuations, and therefore, trends in the CPI (or
WPI). Generally, an inflation rate of 1-3% is considered to be healthy, although that
would depend upon the nature of the economy. the resources it has it's disposal, the
political climate engulfing the economy and a gazillion other reasons that need to be
accounted for here.
(Don't take the rate window to heart. You will get 3 different answers from 2 different
people if you ask them about the acceptable rate window)
Historically, India was (and is) a developing country. If you see the data from the last 4
months (Aug 14- Nov 14), the inflation rate has been in a record decline. Here are the
inflation rates:
CPI Aug 2014: 7.73%
CPI Sep 2014: 6.46%
CPI Oct 2014: 5.52%
CPI Nov 2014: 4.38%
The CPI for Nov 2014 is the record lowest inflation rate recorded in the period 20122015. You could say we are going through a period of disiflation.
If you see the data for the period dated 2012-2015, there have been many extreme
fluctuations in the inflation rate.
At the beginning of 2012, the inflation index measured 7.55% (Jan 2012), and shot up to
in 11.16% in Nov 2013, before diving to 4.38% in Nov 2014.
For an in-depth month-wise inflation index, you could visit 300.000 INDICATORS
FROM 196 COUNTRIES and see for yourself the various inflation rate data of other
countries. What do you see when you compare the inflation rates of developed and
under-developed countries to those of India's? Do you see a trend?

3. What is the impact of inflation on the Indian economy and the

Indian individual?
This is a fascinating question, one that has a plethora of answers, some of them
completely antagonistic to one another, depending upon the person's domain.
There is a reason why India's central bank, the Reserve Bank of India (RBI) is
autonomous, aloof from the outreached hands of the Central Government.
There is a two-pronged approach towards controlling the economy, namely, the Fiscal
Policy and the Monetary Policy.
Fiscal Policy: Fiscal policy is the means by which a government adjusts its spending
levels and tax rates to monitor and influence a nation's economy. The tax and
expenditure programs levied and undertaken by the government are the drivers of the
fiscal policy.
Monetary Policy: The Monetary Policy is governed by the nation's central bank (in this
instance, the RBI) to control the money supply in the economy to maintain price stability
and attain high economic growth. The central bank achieves this by controlling the
interest rates.
Now, you have surely picked up the word inflation because of it being increasingly
thrown around these days, in policy debates or hogging the headlines in those pinkcolored newspapers.
"Does the monetary policy alone wag the tail of inflation?"
If the RBI decides to opt for low interest rates, then the money supply would grow
fast, and people will have more money to spend. Consequently, there will be a greater
demand for goods and services for consumption, thereby exerting an upward push on
the total demand (called Aggregate Demand), resulting in inflation, as producers will
charge more for a commodity beacuse of it's sheer demand.
Conversely, if the RBI opts for high interest rates, then the money supply will shrink,
and people would consume (thereby demand) less. Consequesntly, there will be a
downward pull on the total demand, on virtue of which producers would charge less for
the same commodity in order to clear their inventories, resulting in deflation.
(thise were big sentences, take breaths in between!)
The reason why the central government and the finance ministry are pushing for lower
interest rates is because they wish for the economy to grow quickly, or rather, to get the
air of respect from the populace with the added bonus of bragging rights in the
Parliament. In fairness, a low interest rate in the times of disinflation and stable
currency would be the go-to solution for spurring economic growth.

However, the RBI, under Raghuram Rajan, believes that the Government needs to invest
heavily in economic assests as well, under the umbrella of an expansionary fiscal policy.
Fiscal policy could also mean hiking of income taxes, but we surely don't want that to
happen! There are prevailing anaemic disorders in Indian policies that prevent this.
The argument is to lower the interest rates, so that EMIs be lowered; the operating costs
of companies will reduce resulting in increased investment, and encourage the people to
consume more. Simple right?
There are multiple reasons stating why the interest rates are not being lowered:
1. The Base Effect: The disinflation that is currently prevalent is down to the base
effect, which might show signs of reversal in the future, but not currently. For starters,
the base effect reflects the inflation in the corresponding period of the previous year. If
the inlfation increased handsomely (from 100 to 150) in Nov 13, a similar such increase
(150 to 200) in Nov 14 would show a low inflation rate in Nov 14, as the base on which
the percentage is calculated has increased from 100 to 150, showing a mere 33.33%
increase in Nov 14 as compared to an 50% increase in Nov 13.
Eg: Recall that onion prices were Rs. 80 during this time in 2013, as opposed to
howering around Rs. 40 now. (100% fall)
The Indian economy, has it's roots in agriculture, and much is made of the predictions
and forecasts of the Ministry of Agriculture and the Monsoons. The MoA have predicted
a lower output for some monsoon crops, called Khariff crops, like oilseeds, pulses and
cereals. This will increase the inflation by itself.
2. The US Federal Reserve (the central bank of the United States) is expected to raise
rates next year. If the RBI cuts its interest rates, there would be a reduced Interest Rate
Differential with the US. For e.g., if the US Dollar has a 5% interest rate, and the Indian
Rupee has a 2% interest rate, the Interest Rate Differential of the two countries would be
3%. Quite naturally, one would be paid this 3% and capital outflows will increase.
4. Oil and the falling INR: The Oil prices have plumetted to record lows,
approximately 40% from $115 to $70.15 in recent months. Juxtaposingly, the Indian
Rupee has depreciated by close to 6% from 58.34 to 63.03 in the same period. This has
negated the good effects the low oil prices have cast on the oil imports of India.
Furthermore, since the Fed is in most likelihood, going to increase the interest rates, the
US Dollar will appreciate more against the Indian Rupee. Consequently, imports such as
oil, gadgets and your swanky iPhone would be costlier, resulting in inflation.
5. Inadequate demand: If interest rates are kept low, they would attract higher
investment, or so is believed, as loans would come cheaper. But firms are bulking up on
their investments as they are sceptical of the consumer demand, which is low, and
warding off any plans of further investment.

6. Raghuram Rajan is the Rahul Dravid of India's economy: Calm under pressure,
calculated, classy, gritty and he knows what he's doing, for he was amongst the select few
(0.000001% of world population) who predicted the 2008 Financial Crisis correctly.
An alternative take to this would be to eventually lower the interest rates in the face of
easing inflation, therby spurring manufacturing activity and contributing towards faster
economic growth.
What would be it's impact on you, the vegetable buyer: You'll be happier if disinflation
continues, and if your sole motto in life is to eat yor Aloo Patty.
What would be it's impact on you, if you're Anand Mahindra: You'll be happier if
interest rates are cut, and inflation rises from it's slumber to aid economic growth.