1. 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.

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 2012-2015.
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 pink-
colored 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, thereby 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.

Inflation has long been the common man's concern about economy. In regular
social discourse and everyday conversation inflation is commonly referred as the
synonymous index for the price hike of daily commodities. Though inflation is the
most immediate economic parameter to be associated with the hike of price, it
has its long and far reaching effects on the society and social concerns. Globally
the strong currencies those control the monetary strategies in the international
level are less vulnerable to the effects of global inflation than the currencies of
the poorer and developing nations. So in respect of obtaining a better view of the
effects and influence of inflation on the society we need to take mainly the
experience of poor and developing nations which are commonly termed as Third
World. This paper analyses the effects of inflation on our country’s economy that
emerged in the recent past.
INFLATION AND ITS IMPACT ON INDIAN
ECONOMY
CAUSES OF INFLATON
Inflation refers to a rise in prices that causes the purchasing power of a nation to fall.
Inflation is a normal economic development as long as the annual percentage remains
low; once the percentage rises over a pre-determined level, it is considered an inflation
crisis. There are many causes for inflation, depending on a number of factors.

Excess printing of money

Inflation can happen when governments print an excess of money to deal with a crisis. As
a result, prices end up rising at an extremely high speed to keep up with the currency
surplus. This is called the demand-pull, in which prices are forced upwards because of a
high demand.

Rise in production costs

Another common cause of inflation is a rise in production costs, which leads to an increase
in the price of the final product. For example, if raw materials increase in price, this leads
to the cost of production increasing, this in turn leads to the company increasing prices to
maintain steady profits. Rising labour costs can also lead to inflation. As workers demand
wage increases, companies usually chose to pass on those costs to their customers.

International lending and national debts

Inflation can also be caused by international lending and national debts. As nations borrow
money, they have to deal with interests, which in the end cause prices to rise as a way of
keeping up with their debts. A deep drop of the exchange rate can also result in inflation,
as governments will have to deal with differences in import/export level.

Rise in tax and duties

Finally, inflation can be caused by federal taxes put on consumer products such as
cigarettes or fuel. As the taxes rise, suppliers often pass on the burden to the consumer;
the catch, however, is that once prices have increased, they rarely go back, even if the
taxes are later reduced. Wars are often cause for inflation, as governments must both
recoup the money spent and repay the funds borrowed from the central bank. War often
affects everything from international trading to labour costs to product demand, so in the
end it always produces a rise in prices.

EFFECT OF INFLATION
As we know Inflation is the increase in the price of general goods and service. Thus, food,
commodities and other services become expensive for consumption. Inflation can cause
both short-term and long-term damages to the economy; most importantly it causes
slowdown in the economy.

1. People start consuming or buying less of these goods and services as their income is
limited. This leads to slowdown not only in consumption but also production. This is
because manufactures will produce fewer goods due to high costs and anticipated lower
demand.
2. Banks will increase interest rates as inflation increases otherwise real interest rate will
be negative. (Real interest = Nominal interest rate – inflation). This makes borrowing
costly for both consumers and corporate. Thus people will buy fewer automobiles, houses
and other goods. Industries will not borrow money from banks to invest in capacity
expansion because borrowing rates are high.
3. Higher interest rates lead to slowdown in the economy. This leads to increase in
unemployment because companies start focusing on cost cutting and reduces hiring.
Remember Jet Airways lay off over 1000 employees to save cost.
4. Rising inflation can prompt trade unions to demand higher wages, to keep up with
consumer prices. Rising wages in turn can help fuel inflation.
5. Inflation affects the productivity of companies. 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.

METHODOLOGY
The study is based on secondary data. Inflation and growth rate is collected from World
Economic Outlook for the period of thirteen years from 1999 to 2011.

Tools Used
Karl Pearson’s Correlation Coefficient is used to study the relationship between inflation
and growth. Trend Analysis is used to predict the trend for 4 years from 2012 to 2015.

CONTROLING MEASURES
There are broadly two ways of controlling inflation in an economy:
1. Monetary measures and
2. Fiscal measures

Monetary Measures
The most important and commonly used method to control inflation is monetary policy of
the Central Bank. Most central banks use high interest rates as the traditional way to fight
or prevent inflation.

Monetary measures used to control inflation include:

(i) Bank rate policy
(ii) Cash reserve ratio and
(iii) Open market operations.

Bank Rate Policy: This policy is used as the main instrument of monetary control during
the period of inflation. When the central bank raises the bank rate, it is said to have
adopted a dear money policy. The increase in bank rate increases the cost of borrowing
which reduces commercial banks borrowing from the central bank. Consequently, the flow
of money from the commercial banks to the public gets reduced. Therefore, inflation is
controlled to the extent it is caused by the bank credit.

Cash Reserve Ratio (CRR): To control inflation, the central bank raises the CRR which
reduces the lending capacity of the commercial banks. Consequently, flow of money from
commercial banks to public decreases. In the process, it halts the rise in prices to the
extent it is caused by banks credits to the public.

Open Market Operations: Open market operations refer to sale and purchase of
government securities and bonds by the central bank. To control inflation, central bank
sells the government securities to the public through the banks. This result in transfer of
a part of bank deposits to central bank account and reduces credit creation capacity of the
commercial banks.

Fiscal Measures: Fiscal measures to control inflation include taxation, government

expenditure and public borrowings. The government can also take some protectionist
measures such as banning the export of essential items like pulses, cereals and oils to
support the domestic consumption encourage imports by lowering duties on import items
etc.