A REPORT ON

CRABGRASS ON OUR NATION’S SAVINGS

(INFLATION)

Submitted By:
HARSHEET KEDIA
SUBIGYA POUDEL
PRATICHYA GAUTAM
RON SHRESTHA
BISHAL JUNG KHADKA
SIMON KC
AAWAZ KATTEL
SANDESH GURUNG

Submitted To:
ROSHAN BARDEWA
FACULTY OF MACROECONOMICS
Ace Institute of Management
Pokhara University

In partial fulfillment of the requirements for the class internal evaluation

For course Macroeconomics
17th febraury, 2020

DECLARATION
We hereby, declare that this report entitled “CRABGRASS ON OUR NATION’S SAVINGS” has
been carried out under the guidance of Mr.Roshan Bardewa, faculty of Macroeconomics in Ace
Institute of Management, which is submitted in the partial fulfillment of the requirement for the
CIE of Macroeconomics comprises only our original work and due acknowledgment have been
made to materials used in the report.
We further declare that this report is the result of our own efforts and that it has not been
submitted in the part of any other universities or institutions for any kind of project.

HARSHEET KEDIA
SUBIGYA POUDEL
PRATICHYA GAUTAM
RON SHRESTHA
BISHAL JUNG KHADKA
SIMON KC
AAWAZ KATTEL
SANDESH GURUNG
BBA – 3rd Semester
Ace Institute of Management

ACKNOWLEDGEMENT
In today’s rapidly changing world, inflation plays an important role in the economic development
of the country, more in the context of developing nations. Hence, we’re thankful to Pokhara
University for providing us the opportunity to allow us to perform practical field work.
We would like to thank every individual for their cooperation. Our special thanks to Mr.Roshan
Bardewa, for providing us supervision and teaching us about the workings of inflation.
We would like to thank all the concerned people, my supervisors, family members and colleagues
for their precious time, valuable suggestion and their countless support during our activity. We
perceive this opportunity as a big milestone in our career development. We will strive to use skills
and knowledge in the best possible way which we gained by working on this project.

INTRODUCTION

“Too much money chasing too few goods”, Inflation refers to the persistent or continuous rise in
the general price level. It is simply a rise in the average price of goods and services in an economy
over a period of time. Inflation reduces the purchasing power of each unit of currency, which
leads to increases in the prices of goods and services over time. In other words, it increases your
cost of living.
It has been experienced that a rise in GDP (Gross Domestic Product) has generally been
accompanied by an increase in the General Price Level. Normally a moderate inflation has been
considered a necessary condition for economic growth. But, frequently rising general price level
went out of control and reached to astonishing limit. The phenomenon of Inflation (and its
converse deflation) is conventionally analyzed in macroeconomics.
As, Inflation is basic issues in macroeconomics measurement of it is necessary. So, it is measured
by the percentage change in price indices:
● Consumer Price Index (CPI): Calculated by pricing a basket of goods and services
purchased by typical household. Includes prices of items like food, clothing,
shelter, fuel, transportation, and college tuition.
● Producer Price Index (PPI): Based on a number of important raw materials.
● GDP Deflator
The degrees of inflation are given below;
● Very Mild Inflation i.e. 0-4%
● Mild Inflation i.e. 4-10%
● Inflationary Inflation i.e. 10-20%
● Serious Inflation i.e. 20-50%
● Hyper Inflation i.e. 50% and above
So, as an economist’s point of view very mild inflation can be taken as a normal condition i.e.
0-4%.

Inflation has often been described as the cruelest tax because it eats away our savings and our
paychecks. For instance, if the rate of inflation exceeds the rate of growth in our paychecks that
means our real incomes or purchasing power is declining even though our wages are going up.
However, that not everyone loses from inflation. Unanticipated inflation can actually benefit
borrowers at the expense of lenders. For example, suppose you borrow $1000 from a bank and
promise to repay it in two years. And if during that time the price level doubles because of
inflation, the $1000 which you repay will have only half of the purchasing power of the $1000
originally borrowed. Hence, borrowers can win from inflation whereas lenders can lose.

TYPES OF INFLATION
At its most basic level, inflation is a general increase in prices across the economy and is well-
known to all of us. After all, who among us has not reminisced about how little lunch used to
cost? And who has not noticed prices on everything from milk to movie tickets creeping upward?
In this topic, we explore the major types of inflation and touch upon the competing explanations
offered by different economic schools.
 � Wage Push Inflation
-Wage push inflation is an overall rise in the cost of goods that results from a rise in
wages. To maintain corporate profits after an increase in wages, employers must
increase the prices they charge for the goods and services they provide. The overall
increased cost of goods and services has a circular effect on the wage increase;
eventually, as goods and services in the market overall increase, higher wages will
be needed to compensate for the increased prices of consumer goods.

� Imported Inflation
- Inflation due to an increase in the price of imports. As the price of imports increase, prices
of domestic goods using imports as raw materials also increase, causing an increase in the
general prices of all goods and services. Imported inflation may be caused by foreign price
increases or depreciation of a country's exchange rate. A depreciation in the exchange rate
will make imports more expensive. Therefore, the prices will increase solely due to this
exchange rate effect. A depreciation will also make exports more competitive so will
increase demand.
� Core Inflation
- Core inflation is the change in the costs of goods and services but does not
include those from the food and energy sectors. This measure of inflation excludes these items
because their prices are much more volatile. It is most often calculated using the consumer price
index (CPI), which is a measure of prices for goods and services.
� Temporary Factor
- The inflation rate can also increase due to temporary factors such as increasing indirect
taxes. If you increase VAT rate from 17.5% to 20%, all goods which are VAT applicable will be
2.5% more expensive. However, this price rise will only last a year. It is not a permanent effect.

� Hyperinflation

- This is reserved for extreme forms of inflation – usually over 1,000% though there is no specific
definition. Hyperinflation usually involves prices changing so fast, that it becomes a daily
occurrence, and under hyperinflation, the value of money will rapidly decline. During this period,
people carried basket load of money to the market and brought goods in the pocket.

� Stagflation

- Stagflation is when economic growth is stagnant but there still is price inflation. This seems
contradictory, if not impossible. Why would prices go up when there isn't enough demand to
stoke economic growth? It happened in the 1970s when the United States abandoned the gold
standard. Once the dollar's value was no longer tied to gold, it plummeted. At the same time, the
price of gold skyrocketed.

� Asset inflation

-An asset bubble, or asset inflation, occurs in one asset class. Good examples are housing, oil and
gold. It is often overlooked by the Federal Reserve and other inflation-watchers when the overall
rate of inflation is low. But the subprime mortgage crisis and subsequent global financial crisis
demonstrated how damaging unchecked asset inflation can be.

� Type of Inflation by Rate of Increase

- On the basis of the rate of change in the price level, inflation can be of four types. They are as
follows:

Creeping Inflation
When the rate of inflation slowly increases over time. Creeping inflation may not be immediately
noticeable, but if the creeping rate of inflation continues, it can become an increasing problem.
This is the mildest type of inflation. In this situation price level rises within a range of 10% per
decade or 1% per annum. It lubricatesthe wheel of trade and industry. In other words, it creates
positive effect on investment, production and employment.

Walking Inflation
When inflation is in single digits – less than 10%. At this rate –inflation is not a major problem,
but when it rises over 4%, Central Banks will be increasingly concerned. Walking inflation may
simply be referred to as moderate inflation. It is a warning signal to the economy.

Running Inflation
When inflation starts to rise at a significant rate. It is usually defined as a rate between 10% and
20% a year. At this rate, inflation is imposing significant costs on the economy and could easily
start to creep higher. Running inflation may record more than 100% rise in prices over a decade.
In this type of inflation, prices rise rapidly.

Galloping Information
This is an inflation rate of between 20% up to 1000%. At this rapid rate of price increases,
inflation is a serious problem and will be challenging to bring under control. Some definitions of
 galloping inflation may be between 20% and 100%. There is no universally agreed definition, but
hyperinflation usually implies over 1,000% a year. It is a period of rapid increase in the overall
price level.
Deflation
-Deflation is the opposite of inflation. It's when prices fall. It's caused when an asset bubble bursts
that’s what happened in housing in 2006. Deflation in housing prices trapped those who bought
their homes in 2005. In fact, the Fed was worried about overall deflation during the recession.
That's because deflation can turn a recession into a depression. During the Great Depression of
1929, prices dropped 10% a year. Once deflation starts, it is harder to stop than inflation.

On the basis of the government reaction (or control)

On the basis of the government reaction (or control), inflation can be of two types. They are as
follows:

Open Inflation
- Inflation is open when “markets for goods or factors of production are allowed to function freely,
setting prices of goods and factors without normal interference by the authorities.” Thus open
inflation is the result of the uninterrupted operation of the market mechanism.

There are no checks or controls on the distribution of commodities by the government. Increase in
demand and shortage of supplies persists which tend to lead to open inflation. Unchecked open
inflation ultimately leads to hyper-inflation.

Suppressed Inflation
On the contrary when the government imposes physical and monetary controls to check open
inflation, it is known as repressed or suppressed inflation. The market mechanism is not allowed
to function normally by the use of licensing, price controls and rationing in order to suppress
extensive rise in prices.

According to Friedman, governments themselves are often producers and sellers of wide range of
commodities and they want to keep their own prices low by price restrictions and controls. This
leads to the breakdown of the free price system.

Further, suppressed inflation also results when efforts are made to increase domestic production
and reduce import demand by tariffs, import restrictions, limits on foreign loans, voluntary import
agreements, etc. So long as such controls exist, the present demand is postponed and there is
diversion of demand from controlled to uncontrolled commodities. But as soon as these controls
are removed, there is open inflation.

Demand Pull Inflation

 Demand-pull inflation is the upward pressure on prices that follows a shortage in supply.
Economists describe it as "too many dollars chasing too few goods." Demand-pull inflation is a
tenet of Keynesian economics that describes the effects of an imbalance in aggregate supply and
demand. When the aggregate demand in an economy strongly outweighs the aggregate supply,
prices go up. This is the most common cause of inflation.

Understanding Demand-Pull Inflation

The term demand-pull inflation usually describes a widespread phenomenon. That is, when
consumer demand outpaces the available supply of many types of consumer goods, demand-pull
inflation sets in, forcing an overall increase in the cost of living.

KEY TAKEAWAYS
When demand surpasses supply, higher prices are the result. This is demand-pull inflation.
A low unemployment rate is unquestionably good in general, but it can cause inflation because
more people have more disposable income.
Increased government spending is good for the economy, too, but it can lead to scarcity in some
goods and inflation will follow.
In Keynesian economic theory, an increase in employment leads to an increase in aggregate
demand for consumer goods. In response to the demand, companies hire more people so that they
can increase their output. The more people firms hire, the more employment increases.
Eventually, the demand for consumer goods outpaces the ability of manufacturers to supply them.

Example of Demand-Pull Inflation

-Say the economy is in a boom period, and the unemployment rate falls to a new low. Interest
rates are at a low point, too. The federal government, seeking to get more gas-guzzling cars off
the road, initiates a special tax credit for buyers of fuel-efficient cars. The big auto companies are
thrilled, although they didn't anticipate such a confluence of upbeat factors all at once. Demand
for many models of cars goes through the roof, but the manufacturers literally can't make them
fast enough. The prices of the most popular models rise, and bargains are rare. The result is an
increase in the average price of a new car. It's not just cars that are affected, though. With almost
everyone gainfully employed and borrowing rates at a low, consumer spending on many goods
increases beyond the available supply. That's demand-pull inflation in action.
▪ Cost Push Inflation
- Cost-push inflation occurs when overall prices increase (inflation) due to increases in the cost of
wages and raw materials. Higher costs of production can decrease the aggregate supply (the
amount of total production) in the economy. Since the demand for goods hasn't changed, the price
increases from production are passed onto consumers creating cost-push inflation.
Understanding Cost-Push Inflation

Most common use of cost-push inflation starts with an increase in the cost of production which
may be expected or unexpected. For example, the cost of raw materials or inventory used in
production might increase, leading to higher costs. Inflation is a measure of the rate of price
increases in an economy for a basket of selected goods and services. Inflation can erode a
consumer's purchasing power if wages haven't increased enough or kept up with rising prices. If
a company's production costs rise, the company's executive management might try to pass the
additional costs onto consumers by raising the prices for their products. If the company doesn't
raise prices, while production costs increase, the company's profits will decrease. For cost-push
inflation to take place, demand for the affected product must remain constant during the time the
production cost changes are occurring. To compensate for the increased cost of production,
producers raise the price to the consumer to maintain profit levels while keeping pace with
expected demand.
KEY TAKEAWAYS
Cost-push inflation occurs when overall prices increase (inflation) due to increases in the cost of
wages and raw materials. Cost-push inflation can occur when higher costs of production decrease
the aggregate supply (the amount of total production) in the economy. Since the demand for
goods hasn't changed, the price increases from production are passed onto consumers creating
cost-push inflation.
Example of Cost-Push Inflation
The Organization of the Petroleum Exporting Countries (OPEC) is a cartel that consists of 14
member countries that both produce and export oil. In the early 1970s, due to geopolitical events,
OPEC imposed an oil embargo on the United States and other countries. OPEC banned oil
exports to targeted countries and also imposed oil production cuts.
What followed was a supply shock and a quadrupling of the price of oil from approximately $3 to
$12 per barrel. Cost-push inflation ensued since there was no increase in demand for the
commodity. The impact of the supply cut led to a surge in gas prices as well as higher production
costs for companies that used petroleum products.
CAUSES OF INFLATION

Demand Pull Inflation

 Demand-pull inflation is asserted to arise when aggregate demand in an economy outpaces
aggregate supply. It involves inflation rising as real gross domestic product rises and
unemployment falls.

1. Money supply: Inflation is primarily caused by an increase in the money supply that
outpaces economic growth.When a government decides to print new currency, they
essentially water down the value of the money already in circulation. A more
macroeconomic way of looking at the negative effects of an increased money supply is
that there will be more dollars chasing the same amount of goods in an economy, which
will inevitably lead to increased demand and therefore higher prices.
2. A depreciation of the exchange rate increases the price of imports and reduces the
foreign price of a country's exports. If consumers buy fewer imports, while exports grow,
AD in will rise – and there may be a multiplier effect on the level of demand and output
3. Higher demand from a fiscal stimulus e.g. lower direct or indirect taxes or higher
government spending. If direct taxes are reduced, consumers have more disposable
income causing demand to rise. Higher government spending and increased borrowing
creates extra demand in the circular flow
4. Monetary stimulus to the economy: A fall in interest rates may stimulate too much
demand – for example in raising demand for loans or in leading to house price inflation.
Monetarist economists believe that inflation is caused by “too much money chasing too
few goods" and that governments can lose control of inflation if they allow the financial
system to expand the money supply too quickly.
5. Fast growth in other countries – providing a boost to Nepal exports overseas. Export
sales provide an extra flow of income and spending into the Nepal circular flow – so what
is happening to the economic cycles of other countries definitely affects the Nepal.
 Cost Push Inflation
Cost-push inflation occurs when firms respond to rising costs by increasing prices in order
to protect their profit margins.

1. Component costs: e.g. an increase in the prices of raw materials and other components.
This might be because of a rise in commodity prices such as oil, copper and agricultural
products used in food processing. A recent example has been a surge in the world price of
wheat.
2. Rising labour costs - caused by wage increases, which are greater than improvements in
productivity. Wage costs often rise when unemployment is low because skilled workers
become scarce and this can drive pay levels higher. Wages might increase when
people expect higher inflation so they ask for more pay in order to protect their real
incomes. Trade unions may use their bargaining power to bid for and achieve increasing
wages, this could be a cause of cost-push inflation
3. Expectations of inflation are important in shaping what actually happens to inflation.
When people see prices are rising for everyday items they get concerned about the effects
of inflation on their real standard of living. One of the dangers of a pick-up in inflation is
what the Bank of England calls “second-round effects" i.e. an initial rise in prices triggers
a burst of higher pay claims as workers look to protect their way of life. This is also
known as a “wage-price effect"
4. Higher indirect taxes – for example a rise in the duty on alcohol, fuels and cigarettes, or
a rise in Value Added Tax. Depending on the price elasticity of demand and supply for
their products, suppliers may choose to pass on the burden of the tax onto consumers.
5. A fall in the exchange rate – this can cause cost push inflation because it leads to an
increase in the prices of imported products such as essential raw materials, components
and finished products
1. Effects on Redistribution of Income and Wealth:
There are two ways to measure the effects of inflation on the redistribution of income and wealth
in a society. First, on the basis of the change in the real value of such factor incomes as wages,
salaries, rents, interest, dividends and profits.
Second, on the basis of the size distribution of income over time as a result of inflation, i.e.
whether the incomes of the rich have increased and that of the middle and poor classes have
declined with inflation. Inflation brings about shifts in the distribution of real income from those
whose money incomes are relatively inflexible to those whose money incomes are relatively
flexible.
The poor and middle classes suffer because their wages and salaries are more or less fixed but the
prices of commodities continue to rise. They become more impoverished. On the other hand,
businessmen, industrialists, traders, real estate holders, speculators, and others with variable
incomes gain during rising prices.
The latter category of persons becomes rich at the cost of the former group. There is unjustified
transfer of income and wealth from the poor to the rich. As a result, the rich roll in wealth and
indulge in conspicuous consumption, while the poor and middle classes live in abject misery and
poverty.
But which income group of society gains or losses from inflation depends on who anticipates
inflation and who does not. Those who correctly anticipate inflation, they can adjust their present
earnings, buying, borrowing, and lending activities against the loss of income and wealth due to
inflation.
They, therefore, do not get hurt by the inflation. Failure to anticipate inflation correctly leads to
redistribution of income and wealth. In practice, all persons are unable to anticipate and predict
the rate of inflation correctly so that they cannot adjust their economic behaviour accordingly. As
a result, some persons gain while others lose. The net result is redistribution of income and
wealth.
The effects of inflation on different groups of society are discussed below:
(1) Debtors and Creditors:
During periods of rising prices, debtors gain and creditors lose. When prices rise, the value of
money falls. Though debtors return the same amount of money, but they pay less in terms of
goods and services. This is because the value of money is less than when they borrowed the
money. Thus the burden of the debt is reduced and debtors gain.
On the other hand, creditors lose. Although they get back the same amount of money which they
lent, they receive less in real terms because the value of money falls. Thus inflation brings about a
redistribution of real wealth in favour of debtors at the cost of creditors.
(2) Salaried Persons:
Salaried workers such as clerks, teachers, and other white collar persons lose when there is
inflation. The reason is that their salaries are slow to adjust when prices are rising.
(3) Wage Earners:
Wage earners may gain or lose depending upon the speed with which their wages adjust to rising
prices. If their unions are strong, they may get their wages linked to the cost of living index. In
this way, they may be able to protect themselves from the bad effects of inflation.
But the problem is that there is often a time lag between the raising of wages by employees and
the rise in prices. So workers lose because by the time wages are raised, the cost of living index
may have increased further. But where the unions have entered into contractual wages for a fixed
period, the workers lose when prices continue to rise during the period of contract. On the whole,
the wage earners are in the same position as the white collar persons.
(4) Fixed Income Group:
The recipients of transfer payments such as pensions, unemployment insurance, social security,
etc. and recipients of interest and rent live on fixed incomes. Pensioners get fixed pensions.
Similarly the rentier class consisting of interest and rent receivers get fixed payments.
The same is the case with the holders of fixed interest bearing securities, debentures and deposits.
All such persons lose because they receive fixed payments, while the value of money continues to
fall with rising prices.
Among these groups, the recipients of transfer payments belong to the lower income group and
the rentier class to the upper income group. Inflation redistributes income from these two groups
toward the middle income group comprising traders and businessmen.
(5) Equity Holders or Investors:
Persons who hold shares or stocks of companies gain during inflation. For when prices are rising,
business activities expand which increase profits of companies. As profits increase, dividends on
equities also increase at a faster rate than prices. But those who invest in debentures, securities,
bonds, etc. which carry a fixed interest rate lose during inflation because they receive a fixed sum
while the purchasing power is falling.
(6) Businessmen:
Businessmen of all types, such as producers, traders and real estate holders gain during periods of
rising prices. Take producers first. When prices are rising, the value of their inventories (goods in
stock) rise in the same proportion. So they profit more when they sell their stored commodities.
The same is the case with traders in the short run. But producers profit more in another way. Their
costs do not rise to the extent of the rise in the prices of their goods. This is because prices of raw
materials and other inputs and wages do not rise immediately to the level of the price rise. The
holders of real estate’s also profit during inflation because the prices of landed property increase
much faster than the general price level.
(7) Agriculturists:
Agriculturists are of three types, landlords, peasant proprietors, and landless agricultural workers.
Landlords lose during rising prices because they get fixed rents. But peasant proprietors who own
and cultivate their farms gain. Prices of farm products increase more than the cost of production.
For prices of inputs and land revenue do not rise to the same extent as the rise in the prices of
farm products. On the other hand, the landless agricultural workers are hit hard by rising prices.
Their wages are not raised by the farm owners, because trade unionism is absent among them. But
the prices of consumer goods rise rapidly. So landless agricultural workers are losers.
(8) Government:
The government as a debtor gains at the expense of households who are its principal creditors.
This is because interest rates on government bonds are fixed and are not raised to offset expected
rise in prices. The government, in turn, levies less taxes to service and retire its debt.
With inflation, even the real value of taxes is reduced. Thus redistribution of wealth in favour of
the government accrues as a benefit to the tax-payers. Since the tax-payers of the government are
high-income groups, they are also the creditors of the government because it is they who hold
government bonds.
As creditors, the real value of their assets decline and as tax-payers, the real value of their
liabilities also declines during inflation. The extent to which they will be gainers or losers on the
whole is a very complicated calculation.
Conclusion:
Thus inflation redistributes income from wage earners and fixed income groups to profit
recipients, and from creditors to debtors. So far as wealth redistributions are concerned, the very
poor and the very rich are more likely to lose than middle income groups.
This is because the poor hold what little wealth they have in monetary form and has few debts,
whereas the very rich hold a substantial part of their wealth in bonds and have relatively few
debts. On the other hand, the middle income groups are likely to be heavily in debt and hold some
wealth in common stocks as well as in real assets.
2. Effects on Production:
When prices start rising production is encouraged. Producers earn wind-fall profits in the future.
They invest more in anticipation of higher profits in the future. This tends to increase
employment, production and income. But this is only possible up to the full employment level.
Further increase in investment beyond this level will lead to severe inflationary pressures within
the economy because prices rise more than production as the resources are fully employed. So
inflation adversely affects production after the level of full employment.
The adverse effects of inflation on production are discussed below:
(1) Misallocation of Resources:
Inflation causes misallocation of resources when producers divert resources from the production
of essential to non-essential goods from which they expect higher profits.
(2) Changes in the System of Transactions:
Inflation leads to changes in transactions pattern of producers. They hold a smaller stock of real
money holdings against unexpected contingencies than before. They devote more time and
attention to converting money into inventories or other financial or real assets. It means that time
and energy are diverted from the production of goods and services and some resources are used
wastefully.
(3) Reduction in Production:
Inflation adversely affects the volume of production because the expectation of rising prices
along-with rising costs of inputs bring uncertainty. This reduces production.
(4) Fall in Quality:
Continuous rise in prices creates a seller’s market. In such a situation, producers produce and sell
sub-standard commodities in order to earn higher profits. They also indulge in adulteration of
commodities.
(5) Hoarding and Black marketing:
To profit more from rising prices, producers hoard stocks of their commodities. Consequently, an
artificial scarcity of commodities is created in the market. Then the producers sell their products
in the black market which increases inflationary pressures.
(6) Reduction in Saving:
When prices rise rapidly, the propensity to save declines because more money is needed to buy
goods and services than before. Reduced saving adversely affects investment and capital
formation. As a result, production is hindered.
(7) Hinders Foreign Capital:
Inflation hinders the inflow of foreign capital because the rising costs of materials and other
inputs make foreign investment less profitable.
(8) Encourages Speculation:
Rapidly rising prices create uncertainty among producers who indulge in speculative activities in
order to make quick profits. Instead of engaging themselves in productive activities, they
speculate in various types of raw materials required in production.

SITUATION BEFORE AND AFTER EARTHQUAKE

Nepal Suffered from a huge earthquake and a blockade from India. These impacted the economy
of Nepal in various ways. There was a drastic inflation and had a great impact on the society and
the nation itself. Nepal being a poor country had a difficult time after these disasters. And this was
the situation before earthquake:

Liquidity Management
In the ten months of 2014/15, the NRB mopped up liquidity of Rs. 105.0 billion through deposit
auctions, Rs. 279.80 billion through reverse repo auction on cumulative basis and Rs. 6.0 billion
through outright sale auction. In the corresponding period of the previous year, Rs. 426.00 billion
was mopped up through reverse repo and Rs. 8.50 billion through outright sale auction. As
mentioned in the monetary policy statement for 2014/15, the deposit auction has been introduced
to mop up liquidity since the second month of current fiscal year.

Interest Rates
Both the weighted average of 91-days Treasury Bill rate and inter-bank transaction rates have
increased in the tenth month of 2014/15 compared to a year ago. The weighted average 91-days
Treasury Bill rate increased to 0.5904 percent in the review month from 0.04 percent a year ago.
The weighted average inter-bank transaction rate among commercial banks that was 0.19 percent
a year ago reached 0.44 percent in the review month.
Likewise, the weighted average inter-bank rate among other financial institutions increased to
3.91 percent from 2.11 percent a year ago.
Weighted average interest rate spread of commercial banks inched up to 4.62 percent from 4.39
percent a month ago and the average base rate came down to 7.76 percent from 8.31 percent a
year ago.

Securities Market
NEPSE index increased by 10.1 percent to 938.2 points in mid-May 2015 on y-o-y basis. This
index had increased by 73.7 points to 852.1 points a year ago.
The y-o-y stock market capitalization increased by 10.9 percent to Rs. 963.53 billion in mid-May
2015. The ratio of market capitalization to GDP stood at 45.4 percent in mid-May 2015 compared
to 44.8 percent a year ago.

Consumer Price Inflation

The y-o-y inflation as measured by the consumer price index increased by 7.1 percent in mid-May
2015. The CPI based inflation was 9.7 percent in the corresponding period of the previous year.
The indices of food and beverage group and non-food and services group increased by 8.9 percent
and 5.4 percent respectively during the review period. Such indices had increased by 12.9 percent
and 7.0 percent respectively in the corresponding period of the previous year.

Wholesale Price Inflation

The y-o-y wholesale price index increased by 5.1 percent during the review period compared to a
rise of 9.1 percent in the corresponding period of the previous year. The wholesale price indices
of agricultural commodities and domestic manufactured commodities increased by 8.8 percent
and 4.5 percent respectively, whereas such index of imported commodities decreased by 2.1
percent in the review period. The increments in agricultural commodities, domestic manufactured
commodities and imported commodities were 11.9 percent, 7.3 percent and 4.9 percent
respectively in the corresponding period of the previous year.
National Salary and Wage Rate
The y-o-y salary and wage rate index increased by 7.2 percent during the review period
compared to an increase of 15.4 percent in the corresponding period of the previous year. Within
the salary and wage rate index, the salary index increased by 7.5 percent and the wage rate index
increased by 7.1 percent compared to an increase of 26.5 percent and 12.9 percent respectively in
the corresponding period of the previous year.

Budget Deficit / Surplus

During the ten months of 2014/15, government budget on cash basis remained at a surplus of Rs.
53.90 billion. Such budget surplus was Rs. 58.57 billion in the corresponding period of the
previous year.

Government Expenditure
During the review period, total government expenditures on cash basis increased by 16.2 percent
to Rs. 308.35 billion. Such expenditures had increased by 22.5 percent to Rs. 265.41 billion in the
corresponding period of the previous year.

Government Revenue
During the review period, revenue mobilization of the Government of Nepal (GoN) grew by 11.7
percent to Rs. 312.94 billion. Such revenue had risen by 19.4 percent to Rs. 280.04 billion in the
corresponding period of the previous year.

Situation After the Earthquake:

Consumer Price Inflation

Consumer price inflation has further moderated to 2.9 percent in mid-March 2017 from the point
of 10.2 percent in mid-March 2016. The y-o-y inflation has been decelerating in recent months
due mainly to the previous year's base price effect and improved supply situation.

Wholesale Price Inflation

The y-o-y wholesale price inflation dropped to 1.0 percent in the review period from 5.5 percent a
year ago. The wholesale price indices of agricultural commodities declined by 0.2 percent
whereas domestic manufactured commodities and imported commodities showed a growth of 4.2
percent and 1.8 percent respectively in the review period. In the corresponding period of the
previous year, the increments in wholesale price indices of agricultural commodities and domestic
manufactured commodities were 9.1 percent and 6.3 percent respectively, whereas the price index
of imported commodities had declined by 2.8 percent.

National Salary and Wage Rate

The y-o-y salary and wage rate inflation rose to 14.1 percent in the review period from 4.6 percent
in the corresponding period of the previous year. In the review period, the salary index increased
18.9 percent, while the wage rate index grew 13.0 percent. The hike in pay scale of civil service
drove up the salary and wage rate index in the review period. The salary indices of civil service,
army and police forces and public corporation sub-groups increased 24.2 percent, Box 1M Y-O
-Y Food Inflation (Eight Months) Particulars Inflation (Percent) 2015/16 2016/17 Food Inflation
10.3 (0.4) 1 Pulses and Legumes 31.6 (11.2) 2 Ghee and Oil 18.8 (5.8) 3 Spices 16.6 2.4 4 Milk
products and Eggs 11.9 3.9 5 Cereal Grains and their Products 9.2 (0.1) 6 Fruit 9.2 0.9 7
Vegetable 6.8 (8.3) Source: National Consumer Price Index, Mid-March 2017 3 23.6 percent and
21.7 percent respectively in the review period. Likewise, wage rate indices of agricultural laborer,
construction laborer and industrial laborer witnessed a growth of 13.5 percent, 13.0 percent and
11.6 percent respectively in the review period.

Budget Deficit / Surplus

In the first eight months of 2016/17, the Government of Nepal (GoN) was at a surplus of Rs.
42.45 billion in its budget. Such surplus was Rs. 31.75 billion in the corresponding period of the
previous year.

Government Expenditure
In the review period, total government expenditure on a cash basis increased 57.5 percent to Rs.
374.96 billion. Such expenditure had increased just 6.5 percent to Rs. 238.11 billion in the
corresponding period of the previous year.

Government Revenue
In the review period, the government revenue collection increased 51.9 percent to Rs. 354.16
billion. Such revenue had decreased 3.4 percent in the corresponding period of the previous year.
Higher growth rate of major tax heads such as value added tax, income tax, customs, excise duty
and others tax heads contributed to the overall rise in revenue collection in the review period.

Liquidity Management
In the first eight months of 2016/17, the NRB injected liquidity of Rs. 33.21 billion through repo
auction including Rs. 5.4 billion under the corridor system. Likewise, the BFIs used Rs. 58.17
billion standing liquidity facility (SLF) in the review period.

Interest Rates
The weighted average 91-day Treasury Bill rate increased to 0.74 percent in the eighth month of
2016/17 from 0.53 percent a year ago. Likewise, the weighted average inter-bank transaction rate
among commercial banks, which was 0.42 percent a year ago, increased to 0.90 percent in the
review month. The weighted average inter-bank rate among other financial institutions increased
to 7.96 percent from 0.98 percent a year ago.
The weighted average interest rate spread between deposit and lending rate of commercial banks
decreased to 5.6 percent in the review month from 6.1 percent a year ago. The average base rate
of commercial banks increased to 8.3 percent in the review month from 6.5 percent a year ago.

Capital Market
The NEPSE index which was 1,318.9 points in mid-March 2016 increased 2.8 percent to 1,355.2
points in mid-March 2017. However, the index which was 1,718.2 points in mid-July 2016 has
decreased by 21.1 percent during the review period.

Current Situation:

Consumer Price Inflation

The y-o-y consumer price inflation stood at 6.82 percent in mid-January 2020 compared to 4.58
percent a year ago. Food and beverage inflation stood at 10.21 percent whereas non-food and
service inflation stood at 4.25 percent in the review month.

Wholesale Price Inflation

The y-o-y wholesale price inflation stood at 7.88 percent in the review month compared to 6.04
percent a year ago. In the review month, price of food under primary group and prices of food,
beverage and tobacco, and leather and leather products under manufactured group rose
significantly.
The y-o-y prices of consumption goods, intermediate goods and capital goods increased 10.20
percent, 7.58 percent and 2.50 percent respectively. The wholesale price of construction materials
dropped 5.06 percent in the review month.

Salary and Wage Rate Index

The y-o-y salary and wage rate index increased 10.04 percent in the review month compared to
9.30 percent a year ago. In the review month, salary index and wage rate index increased 13.56
percent and 9.06 percent respectively.

Fiscal Deficit/Surplus
During six months of 2019/20, fiscal position of the Government, based on banking transactions,
remained at a surplus of Rs.119.31 billion compared to a surplus of Rs.82.06 billion in the
corresponding period of the previous year.

Expenditure and Revenue

In the review period, total expenditure of the federal government based on banking transactions
(excluding direct payments and unrealized cheques) stood at Rs.378.17 billion. Such expenditure
was Rs.339.29 billion in the corresponding period of the previous year.
In the review period, revenue collection based on banking transactions (including the amount to
be transferred to provincial and local governments) stood at Rs.483.72 billion. Total government
revenue was Rs. 414.27 billion in the corresponding period of the previous year

Liquidity Management
In the review period, NRB mopped up Rs.58 billion liquidity through open market operations.
Rs.100.35 billion liquidity was mopped up in the corresponding period of the previous year.

Interest Rates:
The weighted average 91-day Treasury bills rate increased to 3.17 percent in the sixth month of
2019/20 from 0.86 percent a year ago. The weighted average inter-bank transaction rate among
commercial banks, which was 2.84 percent a year ago, decreased to 1.76 percent in the review
month.
The average base rate of commercial banks decreased to 9.45 percent in the review month from
9.80 percent a year ago. Weighted average deposit rate and lending rate of commercial banks
stood at 6.79 percent and 11.94 percent respectively in the review month. Such rates were 6.72
percent and 12.29 percent respectively in the corresponding month of the previous year.

Capital Market
The NEPSE index stood at 1263.4 points in mid-January 2020 compared to 1178 points in mid-
January 2019. The increase in points is 7.2% in the fiscal year.
NEPAL’S DEPENDENCE ON INDIA AND CHINA

Nepal’s economy has failed to withstand the shock of the third Indian blockade that is now
running in the third month—previous blockades were imposed in 1988 -89 and in 1970—due to
the country’s excessive dependence on the southern neighbor.

According to Nepal Rastra Bank’ study report titled ‘Impact of Unofficial Indian Embargo on
Nepal’, Nepal did not learn lessons from the past two blockades by the southern neighbour and
failed to develop a self-reliant economy capable of bearing such shocks.

The central bank has said that Nepal’s dependence on India continued to grow considerably since
the second embargo in 1989 as Nepal failed to assess the possibility of such an embargo by India.

According to the NRB, Nepal’s trade with India was 34.3 percent in 1988-89, which reached 63.7
percent in the last fiscal year (2014-15).

In view of the ongoing unofficial blockade by India this time, the NRB has projected that the
country’s economy could witness a negative growth (-0.9 percent) this fiscal (2015-16). The last
time Nepal witnessed a negative growth was in 1982-83.

Nepal is reeling from the unofficial blockade by India since September 23.

Earlier, India had imposed a blockade in 1970 for building the Araniko Highway to a Chinese
border point. India imposed a trade embargo second time in 1989 for purchasing arms from
China.
But, Nepal’s economy in the past two events did not suffer as much as it is now. As the impact of
the blockade in 1989, Nepal’s economic growth decreased to 4.5 percent in 1990-91 from 5.2
percent the previous fiscal. Likewise, as a result of the blockade in 1970, economic growth was
limited to 1.7 percent in fiscal 1970-71 from previous year’s 9.8 percent. “Nepal’s dependence on
foreign products grew after 1990s as Nepal adopted liberal economy without enhancing domestic
capacity to export and proper market inspection mechanism,” said Posh Raj Pandey, a trade
expert. “So, Nepali products failed to compete when foreign products flooded the domestic
market.”

While country’s overall dependence on foreign countries increased after 1990s, reliance on India
grew exponentially. “It is also due to the fact the Nepal didn’t review the exchange rate regime
with India time to time,” said Pandey. “Even if peg with Indian currency was maintained, there
should have been a periodic review on pegged rate.”

According to the NRB, as Nepal’s economy turned more consumption-driven as a result of liberal
economic policy, Nepal’s dependence on foreign goods surged. There were only 74,000 vehicles
plying the road in 1990, which has now crossed two million. Annual import of fuel was worth less
than Rs 1 billion then, which now has reached Rs 111 billion. Cooking gas was virtually not used
until 1989 and share of traditional energy source such as firewood was 95 percent against 77
percent now.

“The hydropower production was sustaining the domestic demand of energy to a large extent,”
said the NRB. But, now, energy supply is only 780MW against the total demand of 1300MW.

As Nepal is dependent on these products on foreign countries, mostly India, the economy has now
faced the impact of the blockade.

“The country is currently witnessing fuel and medicine crisis due to the blockade. If the current
situation continues, we will also see a crisis in food availability,” said Pandey. “This shows that
we should urgently adopt a state policy by keeping energy and food security as a part of national
security.”

In this context, the central bank has suggested maintaining buffer stock of essential goods such as
fuel, food and agriculture products, opening all nine border points with China for bilateral trade
and upgrading existing two routes connecting China—Rasuwagadhi and Tatopani.

The central bank has also suggested Bilateral Investment Protection and Promotion Agreement
(Bippa), Project Development Agreement and Power Trade Agreement with China. Promoting
export and food security and focusing on producing raw materials for industries within the
country are other suggestions.

The central bank has also suggested that the country should declare energy crisis and adopt a fast-
track mechanism to develop hydropower projects.

Nepal sees connectivity with China both as a measure of stepping up business opportunities as
well as the one which would bring ‘independence’ in her own decision-making. Economic
reasons are of course highlighted. But the underlying reasons are far more important, which
outweigh — in view of what Nepal experienced throughout the constitution making process
during 2015 autumn and subsequent five months in the form of the border blockade — the
economic options alone. A closer relationship with China rules the average Nepali mindset as an
existential lifeline, for which no price appears to be too expensive, at least at the moment. But
Nepal is equally sensitive to the fact that she cannot afford to jeopardize relations with India. It is
a delicate balancing act the country is out to play.

This is going to be an uphill task. If there is one thing the strategic community needs to take into
account as regards Nepal, it is to understand Nepal’s sensitive positioning. Nepal is certainly
closer to India from cultural, linguistic, civilizational and geographical points of view. Relations
with India, therefore, are irreplaceable.

This dependence on India, at the same time, has had both pluses and minuses. On the plus side,
Nepali political leaders have looked at India for support at difficult times. First generation of
Nepali leaders like Mananmohan Adhikari and BP Koirala actively participated in India’s
independence movement. On the minus, what has gone wrong on the side of Nepalese leadership
since 1950s is that they depended too much on India’s leverage for effecting domestic political
changes, which naturally made India take Nepal for granted. To overcome resultant trust deficit,
both countries must interact intensively at three different levels: government, political leadership
and most importantly academic. A narrative of economic interdependence may be developed. For
example, it would be good if an increasing number of Indians recognizes that Nepal, a small
economy in itself, is the seventh largest remittance provider to India. The number of rational
Nepal and India experts in each other countries seems to be thinning, which then points to the
need of investment in human resources. Top politicians jumping from one summit to another will
not be sufficient. Having said this, Nepal is still likely to keep her possibilities with China open,
which should not be seen otherwise as the two countries do share a 1,400 km long border.
CONTROL OF INFLATION

CONCLUSION

Inflation is one of the obstacles on the way of development. In reality low inflation rate and an
upward economic growth is never possible. Nevertheless, low inflation rate means slow economic
growth. Whenever, money is in excess, there is bidding by the consumers due to which the cost of
goods increases.
The main objective of this study was to examine the impact of inflation on the life Nepalese
middle class people and to people who are below the poverty line.
The inflation rate must be at moderate level, for developing countries like Nepal3% to 4% raise of
inflation could be acceptable