Recent Double Digit Inflation in India: causes and consequences and its Mathematical Modulation.

Semester I
Submitted to: Prof. Yadav

By: Stuti Haldar

Recent double digit inflation in India: causes and consequences, and its mathematical modulation.
INTRODUCTION:
Before stepping toward Double-digit inflation it is very crucial to take an insight into what is Inflation? Inflation means a persistent rise in the price levels of commodities and services, leading to a fall in the currencys purchasing power. The problem of inflation used to be confined to national boundaries, and was caused by domestic money supply and price rises. In this era of globalization, the effect of economic inflation crosses borders and percolates to both developing and developed nations. Double digit inflation can be defined as a rate of inflation between 10% and 99%, usually calculated on an annual basis. Inflation is spoiling the government's celebration of India's quick recovery from the effects of the global crisis. The Wholesale Price Index (WPI) figures for May point to three worrying trends. First, for the fifth month now, the aggregate annual rate of inflation as reflected in the month-on-month increase in the WPI has been near or well above double-digit levels. The figures for May put inflation at 10.2 per cent over the year. Secondly, the current inflation is particularly sharp in the case of some essential commodities, as a result of which the prices of food articles as a group have risen by 16.5 per cent and of food grain by close to 10 per cent. Finally, there are clear signs that what was largely an inflation in food prices is now more generalized, with fuel prices rising by 13 per cent and manufactured goods prices by 6-7 per cent.

Causes:
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. Thus, in this paper we would try to develop a better understanding of the factors responsible for double digit inflation in India. And also analyze how these factors affect inflation.

OBJECTIVE:
In this paper we would study the trends of Inflation in India. Our basic objective is to identify the variables responsible for Double- digit inflation in India. And analyze their affects on inflation. Hereafter, we would make efforts to derive a mathematical formulation of the relationship between these variables and inflation.

METHODOLOGY:
Theories of Inflation and its economic consequences (a short review): High levels of inflation distort economic performance, making it mandatory to identify the causing factors. Several internal and external factors such as printing of more money by the government, a rise in production and labour costs, high lending levels, a drop in the exchange rates, decreased taxes or wars can cause inflation. There is a general agreement amongst economists that economic inflation may be caused either by an increase in money supply or decrease in quantity of goods being supplied. Demand pull theory Cost push theory Since its specifically difficult to identify the reasons for or factors that contribute to inflation, many theories and concepts have been introduced for this purpose. Each theory tries to clarify the supply and demand factors that result in the creation of an inflationary situation. The main theories of inflation are as follows, Quantity Theory of Money Keynesian Theory Monetarism Structuralism Central bankers believe that mild inflation, in the 1 to 2 per cent range, is the most benign for a countrys economy. High inflation, stagflation or deflations are all considered to be serious economic threats. Identification of variables that caused recent double digit inflation in India Collection of data Analysis of the trends in inflation Study of relationship between these variables and inflation Mathematical modulation Conclusion

ANALYSIS: Theoretical interpretation: Demand Pull Theory

Increase in quantity of money in circulation relative to ability of economy to supply leads to increased demand, thereby fueling prices. This case is of too much money chasing too less goods. Increase in demand could also be a result of declining interest rates, a cut in tax rates or increased consumer confidence. 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, as the economy moves along the Phillips curve. This would not be
expected to persist over time due to increases in supply, unless the economy is already at a full employment level.

The term demand-pull inflation is mostly associated with Keynesian economics. According to Keynesian theory, the more firms will employ people, the more people are employed, and the higher aggregate demand (AD) will become. This greater demand will make firms employ more people in order to output more. Due to capacity constraints, this increase in output will eventually become so small that the price of the good will rise. At first, unemployment will go down, shifting AD1 to AD2, which increases demand (noted as "Y") by (Y2 - Y1). This increase in demand means more workers are needed, and then AD will be shifted from AD2 to AD3, but this time much less is produced than in the previous shift, but the price level has risen from P2 to P3, a much higher increase in price than in the previous shift. This increase in price is called inflation.

Cost push theory:

Inflation occurs when the cost of producing rises and increase is passed on to consumers. Cost of production can rise because of rising labour costs or when the producing firm is a monopoly or oligopoly and raises prices, cost of imported raw material rises due to exchange

rate changes and external factors, such as natural calamities or an increase in the economic power of a certain country. Increase in indirect taxes can also lead to increased production costs. A classic example of cost push or supply shock inflation is the oil crisis that occurred in 1970s after the OPEC raised oil prices. The U.S saw double digit inflation levels. Since oil is used in every industry, sharp rise in price of oil leads to increase in prices of all other commodities. While Money Growth is considered to be a principal long-term determinant of inflation, non-monetary sources, such as increase in commodity prices, have played a key role in triggering inflation in the past 4 decades. Inflation has become a major concern worldwide in 2008, with global prices rising in food, oil, steel and other commodities being the culprit.

Quantity Theory of Money:

This refers to the identical or equal relationship between national income estimated at market prices and the velocity of circulation of the money supply. Based on this theory, there is a positive relationship between price levels and the money supply. This relationship is presented using the quantity equation (MV=PY) which was observed under the study on money supply. MV = PY Where: M is the stock of money in circulation V is the velocity of circulation P is the general price level Y is the total income. Accordingly there will be a proportionate positive relationship between the money supply and the price levels of a given economy. That is, when the money supply increases by a certain percentage the price levels will also increase by an equal percentage. According to this theory it is believed that inflation is caused by an expansion in the money supply of a given economy. It is under the view that inflationary situations caused due to an increase in money supply which is not followed by or supported by an increase in output levels of an economy.

Keynesian Theory:
The Keynesian view on inflation initially introduced in a book titled The General Theory of Employment, Interest and Money published in 1940.

According to Keynes an increase in general price levels or inflation is created by an increase in the aggregate demand which is over and above the increase in aggregate supply. If a given economy is at its full employment output level, an increase in government expenditure (G), an increase in private consumption (C) and an increase in private investment (I) will create an increase in aggregate demand; Leading towards an increase in general price levels. Such an inflationary situation is created due to the fact that at optimum or full employment of output (maximum utilization of scarce resources) a given economy is unable to increase its output or aggregate supply in response to an increase in aggregate demand.

According to the graph, when the government uses monetary and fiscal policies to improve full employment of production levels, there will be an increase in aggregate demand level of the economy from AD0 toAD1 which would result in the creation of full employment level of equilibrium output represented at the point E. If the aggregate demand level increases further from AD1 to AD2 the general price levels shall increase since the full employment of production level will remain unchanged at Yf. The output level will not change since all resources are fully employed at the point of Yf. An Aggregate demand level over and above the full employment of production level will create an inflationary gap of EF. In addition, an aggregate demand below the full employment of production level will create deflationary gap of ED.

Monetarism:
The monetarists theory states that when the money supply is increased in order to grow or increase production and employment, creating an inflationary situation within an economy. A monetarist believes increases in the money supply will only influence or increase production and employment levels in the short run and not in the long run. Accordingly, there

will be a positive relationship between inflation levels and money supply. The monetarists explain this relationship using the theory of natural rate of unemployment. The theory of natural rate of unemployment suggests that there will be a level of equilibrium output, employment, and corresponding level of unemployment naturally decided based on features such as resources employment, technology used and the number of firms in the country etc, the unemployment level decided in this manner will be identified as natural rate of unemployment. In the short run, expansionary monetary policies will result in the decline in the natural rate of unemployment and increase the production but the effectiveness of the expansionary policies will be limited in the long run and lead to an Inflationary situation.

Structuralism:
This theory states that the main reason for inflation is the in-elasticity in the structures of the economy. This theory is mainly used to explain the nature and basis of inflation in developing countries. Originating in Latin America, this theory states that the inflation rates in developing countries are affected by the in-elasticity of the following reasons;

Production level and capacity Capital formulation Institutional framework High in-elasticity in the agricultural sector In-elasticity of the labour force and employment structures.

Thus, to analyze and identify the variables which determine double-digit inflation figures in India, we first review the trends of inflation in India. Inflation seems to be all important for the Indian economy as well as the stock markets. There is misplaced hope that inflation will slow in 2011 and growth can resume. We, however, believe we are headed into a sustained period of slow growth and high inflation. The government's response is that while this is a matter for concern, the trend is likely to reverse itself with the onset of the monsoon. To the extent that any policy response is being spoken of, the reference is mainly to a tightening of credit and an increase in interest rates by the Reserve Bank of India. This ignores important structural influences on the pace of price increase in the current conjuncture. One is the long-term neglect of agriculture, which has affected the level and pattern of agricultural production to an extent where supply-side constraints are leading to inflation every time growth picks up. The sudden and sharp hike in the support prices for pulses announced recently is an acknowledgement of this problem by the government. However, given the likely lag in output responses, the immediate fallout of that price increase could be an aggravation of inflationary trends. A second structural influence is the effect the policy of reducing subsidies, raising administered prices, and dismantling price controls has on the costs of production. Even when inflation is ruling high, the government is contemplating deregulation of the pricing of universal intermediates such as petroleum products. Finally, inflation is high and persistent, despite expectations of a normal or good monsoon, because the decision to give private trade a greater role in the markets for essentials has provided the basis for a new bout of speculation, which the government seems unable or unwilling to control. It is to corrections in these areas that it must turn when looking for a solution to the inflation problem rather than merely look for relief from monetary policy adjustments.

Determinants of inflation:
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 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--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 subsidizing 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--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--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. Thus, from the above theories and trends, we can state the variables that determined recent double digit inflation in India. We can categorize the factors determining inflation under demand pull and cost push inflation. The variables under demand pull inflation are: government expenditure(G) direct or indirect tax(T) Exchange rates(Ex) Money supply(Ms) Fiscal deficit(Fs) Disposable income.(Yd) Whereas the factors on the supply side, i.e. cost push inflation are: Oil prices(O) rate of wage inflation(w) food prices(Fp) cost of raw materials(R) population(P)

In India, the method generally used to measure inflation is computation of Whole Sale Price Index. (W.P.I) So according to the W.P.I data, we try to study the trends and causes of recent double digit inflation in India. If we have the WPI values of two time zones, say, beginning and end of year, the inflation rate for the year will be, (WPI of end of year WPI of beginning of year)/WPI of beginning of year x 100

WHOLESALE PRICE INDEX MONTHLY - ANNUAL VARIATION All commodities

year /month Apr. May. June. July. Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. 2005-06 5.3 4.6 4.7 4.8 3.5 4.4 4.7 3.9 4.4 4.4 4.5 4.2 2006-07 5 6 6.8 6.5 7.1 7 6.9 6.7 7 6.6 6.6 6.7 2007-08 6.2 5.5 4.5 4.4 4 3.4 3.2 3.7 4 4.5 5.7 7.7 2008-09 7.9 8.2 10.9 11.1 11.1 10.8 10.7 8.6 6.7 5.9 3.6 1.6 2009-10 1.2 1.5 -0.4 -0.3 0.5 1.4 1.8 4.7 7.1 8.7 9.7 10.4 2010-11 10.9 10.5 10.3 10 8.9 9 9.1 8.2 9.4 9.5 9.5 9.7 2011-12 9.7 9.6 9.4 9.2

12 10 8 6 4 2 0 Apr. -2 May. June. July. Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12

WHOLESALE PRICE INDEX MONTHLY - ANNUAL VARIATION FOR ALL COMMODITIES

Here we can clearly make out that inflation in India was in double digits from 2008 to 2011. As there was rise in the overall prices of the commodities. This can be well expressed by the following graph.

The inflation rate in India was last reported at 9 percent in August of 2011. Looking at the causes from the demand side, we observe:
Various central government plans like the national minimum wages guarantee program and other constructive work in the rural India has also meant money in the hands of the poor. It caused inflation. Now let us remember what happened in the Budget 2008. Our Finance Minister did a poll gimmick and waived loans up to Rs. 60K crore. To think of the after effects, the farmers who would have saved money to pay back the loans are free to use the money as they wish. It is used up to buy things. Demand increases.

By the above analysis we can conclude that disposable income is a main reason for rise in rate of inflation in the recent years. Due to an increase in disposable income, Yd the purchasing power increases which in turn leads to an increase in demand and hence rise in prices of commodities.
To look at the supply side: We sure did not have very good monsoons in last few years. Further more and more farmers are cultivating cash crops to make money. This means we have less food to eat. Crude is on a mountain climbing expedition and petroleum products prices are at all time highs all most every day. Though the government is cushioning the domestic prices the world market prices are not controlled. This results in higher transportation cost at the least and the imports become expensive. On the topic of petroleum prices, we all know that government is giving huge subsidies on the petroleum products. Government will some way or other have to raise the money and probably will impose new taxes direct and indirect. So the discount we now get on the petrol and cooking gas, we will pay back as taxes. What actually causes discomfort is the fact that later when they will impose taxes, it affects the poor by increasing the prices of the manufactured goods.

It would be rather helpful to see the money given as subsidies on petroleum products invested in infrastructure and making the public transport more useable by public. Further the subsidies are working towards subsidizing pollution.

By studying the supply side, we can conclude that recent double digit inflation has been brought about by food prices, government expenditure, direct and indirect taxes, crude oil prices and population pressure. As there was shortage in food production. The prices of food grains swelled, leading to inflation. Hereafter, government subsidized the petroleum products which further lead to rise in taxes. Thus, leading to a rise in prices of manufactured products. Moreover, since crude oil is used in almost all spheres of the economy i.e. transport, industries etc, again causing inflation. Lastly, the growing population leads to shortages in supply and thus causing inflation. Now we analyze the trends in the change in WPI for primary articles.

Primary articles:
year /month 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 Apr. May. June. July. Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. 2.2 0.4 2.1 3.6 1.6 3.5 4.5 4.3 6.8 8.6 8.2 6.3 7.7 9.6 10.1 7.6 8.8 9.3 9.3 8.7 11.1 9.5 10.9 12.8 13.2 11.8 8.8 10.4 9.3 8.4 6.1 6.8 5.3 4.3 6.7 9.6 9.4 10.7 14.2 13.6 11.2 10.4 12.9 12.6 11.6 13.2 7.7 5.4 6.6 6.8 5.9 5.8 9.8 10.6 10.3 14.3 18 20.2 21.7 22.2 21.4 20.4 20.1 19.1 16 18.2 18.1 14.7 18.4 18.4 15.9 13.4 15.1 12.9 12.2 11.3

25

20 2005-06 15 2006-07 2007-08 2008-09 10 2009-10 2010-11 5 2011-12

0 Apr. May. June. July. Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar.

WHOLESALE PRICE INDEX MONTHLY - ANNUAL VARIATION FOR PRIMARY ARICLES

Here we notice, that inflation rates for primary goods have been high since December 2006 till date. However the WPI went down after June 2007, it again increased from may 2008.since October 2009 India witnessed very high inflation in primary articles, which continued to remain in double digits in 2010 to 2011. The inflation rate has been to a height of 22.2% in march 2010.

Food articles:
year /month Apr. May. June. July. Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. 2005-06 3 1.8 3.5 5.8 3.1 5.5 6.4 4.5 6.1 9.2 8.7 7.3 2006-07 6 8 9.3 5.4 8.2 10.7 9.9 9.1 11.7 11.4 12.3 13.2 2007-08 14.2 12.9 8.9 11.2 9.7 6.3 5.2 4.4 3.2 0.8 2.8 5.6 2008-09 6.1 6.5 7 6.9 6.6 8.2 11.3 12.7 12.1 14.4 9.5 8 2009-10 8.7 8.9 11.3 12.7 14.4 13.9 12.5 16.7 20.8 20.2 21.8 20.6 2010-11 20.5 21.4 21 18.5 15 16.3 14.6 10.1 15.1 16.7 11 9.4 2011-12 10.7 8.3 8.4 8.2

25

20 2005-06 15 2006-07 2007-08 2008-09 10 2009-10 2010-11 5 2011-12

0 Apr. May. June. July. Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar.

WHOLESALE PRICE INDEX MONTHLY - ANNUAL VARIATION FOR FOOD ARTICLES

From the above chart, we can clearly notice that inflation rates were in double digits since the year 2006. April 2010 witnessed a very high rate of inflation in food items, and same was the scenario in 2009. The main factors driving the food inflation in the economy is basically a prolonged neglect of Indian agriculture, whereby the growth rate of agriculture has come down, so much so that the growth rate of food grains during 1993-94 to 2003-04 was only 0.69% which further reduced to 0.32% during 2004-05 to 2009-10. Such a slowdown in the growth rate of food grain production is a result of two decades of following neo-liberal policies of decreasing public investment in agriculture, a drying up of agricultural credit, withdrawal of

extension services of the government, etc. It is this decline in the production of food-grains which is the real driving force of the inflationary tendencies in the economy. This tendency is further strengthened by speculation through forward trading in food-grains and liberalization of the agricultural sector to world price fluctuations. In other words, the prevailing high food inflation in India is a structural problem and hence will continue unless these problems are overcome.

Fuel and Power:

year /month Apr. May. June. July. Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. 2005-06 15.4 15.3 14.9 16.5 13 15.9 17.1 12.2 12.7 9.6 9.9 10.2 2006-07 9.8 10.5 11.6 9.2 9.6 6.8 5.8 5.2 3.4 3.6 2 1.1 2007-08 1 0.3 -2.1 -2.8 -2.8 -3.4 -2.9 -1.5 1.5 2.1 4 7.4 2008-09 9.6 10.5 19.2 20.2 21.8 21.1 19.4 12.7 5.7 3.6 0 -3.4 2009-10 -4.6 -5 -11.3 -8.9 -9.7 -8.1 -6.8 -1.1 4.6 6.8 10.2 13.8 2010-11 13.6 14.4 13.9 13.3 12.5 11.1 11 10.3 11.3 11.4 12.4 12.5 2011-12 13 12.3 12.8 12

25 20 15 10 5 0 Apr. -5 -10 -15 May. June. July. Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12

WHOLESALE PRICE INDEX MONTHLY - ANNUAL VARIATION FOR FUEL AND POWER

The other issue with regard to inflation, as repeatedly pointed out by the government is the issue of higher crude prices in the international market, because of which it has to increase the domestic prices of petroleum products. Again, it is true that there has been an increase in the prices of crude oil in the international market. But to deregulate the prices of petroleum products was incorrect for at least two reasons. First, any increase in the international price of oil is basically like a tax levied on the domestic economy by outsiders. The government does not want this extra levy to be imposed on the country. This can be done by keeping the import bill constant, through a reduction in the demand of oil. The price of petroleum products is increased, assuming that the demand for oil is a negative function of price. This is

however not the case because oil being a necessary commodity of immense importance, the demand for oil is price inelastic. What essentially results with increasing the price of oil is cost-push inflation, which further adds to the already existing inflationary situation in the country. Moreover, the victims of such inflation are those whose wages do not rise with a rise in inflation, who are essentially the unorganized workers and the poor. In other words, the marginalized section of the poor becomes adversely affected. Thus with price deregulation, neither will the import bill of the government decrease, nor will it lead to any decrease in inflationary pressures. Secondly, the entire argument of under-recoveries of the oilcompanies because of which the prices are increased is again a lie. The fact of the matter is that the total revenue collected from the government in 2008-09 from petroleum sector is Rs 161798 crore, while the total subsidy and under-recovery from this sector was Rs 105980 crore, which is less than the total revenue collected.

Manufactured products:
year /month Apr. May. June. July. Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. 2005-06 4.3 3.4 3.2 2.6 2 2 1.8 1.9 1.7 1.8 2.2 2.2 2006-07 3 4 4.6 5.4 6 6.2 6.4 6.4 6.7 6.7 6.4 6.3 2007-08 5.4 4.9 4.8 4.4 3.9 3.7 4.1 4.1 4.2 5.1 5.7 7.1 2008-09 6.8 6.7 7.9 8.2 8.5 8.4 7.6 6.2 5.1 4.1 3.2 1.7 2009-10 0.8 1.3 0.2 -0.2 0.2 0.7 1.1 2.8 4.1 5.1 5.3 5.3 2010-11 6.4 5.9 5.6 5.8 5.2 5 5.1 5 5.4 5.3 6.3 7.4 2011-12 6.8 7.4 7.4 7.5

9 8 7 2005-06 6 5 4 3 2 1 0 -1 Apr. May. June. July. Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12

WHOLESALE PRICE INDEX MONTHLY - ANNUAL VARIATION FOR MANUFACTURED PRODUCTS

Rising labor and production costs - Any costs associated with manufacturing that rise will definitely raise the price of the end products. The rising price of raw materials usually

results in manufactured goods costing more. As workers demand wage increases, companies that grant them pass these costs onto their customers.

MATHEMATICAL FORMULATION:
ASSUMPTIONS:
Here we have identified the variables that effect inflation. And we have assigned them certain symbols. They are as follows: government expenditure (G) direct or indirect tax (T) Exchange rates (Ex) Money supply (Ms) Fiscal deficit (Fs) Disposable income (Yd) Oil prices (O) rate of wage inflation (w) food prices (Fp) cost of raw materials (R) population (P) Further we try to establish a mathematical relationship between these variables and inflation. This has been done by mainly considering G, Yd, Fp, and O. We denote Inflation by I This has been represented with the help of graphs...

DESCRIPTION:
Let us first analyze the relationship between these variables and inflation. Yd Fs G T I I I 1/ I

Ex I Ms=K.I Fp R P I I I

Now we derive a relationship between inflation and few of these variables which lead to recent double digit inflation in India.

I= K1 .(Yd/G).(Fp/Fp).(O/O)*1002 Hence, I .(Yd/G).(dFp/Fp).(dO/O).(1) In equation 1, is the constant. dFp/Fp WPI of food products dO/O WPI of fuel prices p- p p -O)/O] p p -1 . -1] p p*O)]+[1-( p p p p 1-[( p p + Here we assume that (dFp/Fp).(dO/O)= {1-[ p p+ ]} 1 ]+1 a is
1.13 1.08 0.95 1.01 0.89 0.88 1.07 0.69 0.64 0.91 1.49 1.64 0.99 1.1 1.11 0.92 0.66 0.72 0.99 0.85 0.84

]}

Now we get, (dFp/Fp).(dO/O)= [ p p Let, We plot a graph.. Taking p p on the a is ,and on For the year 2010-11
(x) p p (y) y/x 0 0 0 0.94 1.04 1.11 1.03 0.98 0.95 1.05 0.88 0.84 1.06 0.81 0.76

F'/F
1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0

food vs oil prices

food vs oil prices

0 0.94 1.03 1.05 1.06 1.13 1.01 1.07 0.91 0.99 0.92 0.99

o/o'

Let p p Now we plot a graph of the slope of the above curve w.r.t time(t),
year /month Apr. May. June. July. Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar y/x 0 1.11 0.95 0.84 0.76 0.95 0.88 0.64 1.64 1.11 0.72 0.84

y/x
1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 Apr. May. June. July. Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar y/x

Therefore, in equation (1) .(Yd/G). 1 After comparing this graph with the inflation curve for the same year i.e. 2010-2011 We can now state that K(d/dt) I

2010-11
WPI for all commodities 12 10 8 6 4 2 0 2010-11, 9.7

Inflation for All commodities

Now substituting all the values in equation 1
d /G).

dt dt

et K

Thus, I=(Yd

G. d

CONCLUSION
Thus we conclude that,by finding the relationship between the WPI for fuel and Food prices. And taking government expenditure and disposable income we can estimate the rate of inflation. Moreover, the other factors such as direct or indirect tax,Exchange rates,Money supply,Fiscal deficit,,rate of wage inflation,cost of raw materials,population also determine inflation.

Thus we conclude that, The main factors driving the food inflation in the economy is basically a prolonged neglect of Indian agriculture, whereby the growth rate of agriculture has come down, so much so that the growth rate of food grains during 1993-94 to 2003-04 was only 0.69% which further reduced to 0.32% during 2004-05 to 2009-10. Such a slowdown in the growth rate of food grain production, is a result of two decades of following neo-liberal policies of decreasing public investment in agriculture, a drying up of agricultural credit,1 withdrawal of extension services of the government, etc. It is this decline in the production of food-grains which is the real driving force of the inflationary tendencies in the economy. This tendency is further strengthened by speculation through forward trading in food-grains and liberalization of the agricultural sector to world price fluctuations. In other words, the prevailing high food inflation in India is a structural problem and hence will continue unless these problems are overcome.
The other issue with regard to inflation, as repeatedly pointed out by the government is the issue of higher crude prices in the international market, because of which it has to increase the domestic prices of petroleum products. Again, it is true that there has been an increase in the prices of crude oil in the international market. But to deregulate the prices of petroleum products was incorrect. As, any increase in the international price of oil is basically like a tax levied on the domestic economy by outsiders. The government does not want this extra levy to be imposed on the country. This can be done by keeping the import bill constant, through a reduction in the demand of oil. The price of petroleum products is increased, assuming that the demand for oil is a negative function of price. This is however not the case because oil being a necessary commodity of immense importance, the demand for oil is price inelastic. What essentially results with increasing the price of oil is cost-push inflation, which further adds to the already existing inflationary situation in the country. Moreover, the victims of such inflation are those whose wages do not rise with a rise in inflation, who are essentially the unorganized workers and the poor. In other words, the marginalized section of the poor becomes adversely affected. Thus with price deregulation, neither will the import bill of the government decrease, nor will it lead to any decrease in inflationary pressures.