Kalika Bansal

especially for the Reserve Bank as the key objective of monetary policy is price stability.  It has. posed a major challenge for policymakers. This spell of high inflation has been the longest since the mid-1990s. therefore. .

Why do we need to worry about inflation?  the burden of inflation is disproportionately large on the poor. high inflation by itself can lead to distributional inequality.  high inflation distorts economic incentives by diverting resources away from productive investment to speculative activities. .

nominal interest rates tend to be higher than they would have been under low and stable inflation. it raises the inflation risk premia in financial transactions. • Hence.• inflation reduces households saving. • Consequent fall in overall investment in the economy reduces its potential growth. . • As inflation rises and turns volatile.

 The Reserve Bank’s current assessment suggests that the threshold level of inflation for India is in the range of 4-6 %. if domestic inflation remains persistently higher than those of the trading partners. .  If inflation persists beyond this level. it affects external competitiveness. it could lower economic growth. Fifth.

How did the inflation dynamics change? • The current phase of high inflation followed the global financial crisis. which affected the India’s economy. though not with the same intensity as advanced countries. • Managing inflation in an economy which is recovering from a downturn is much more complex because of associated uncertainties than managing inflation under normal conditions .

EMEs were also adversely affected by the spillover effects: first through contraction in world trade and then from reversal in capital flows.• In the initial phase of the crisis. . it appeared that emerging market economies (EMEs) were better positioned to weather the storm created by the global financial meltdown on the back of • their substantial foreign exchange reserve cushion. improved policy frameworks and generally robust banking sector and corporate balance sheets. • Eventually. • However. any hope about EMEs escaping unscathed could not be sustained after the failure of Lehman Brothers in September 2008 which triggered global deleveraging and heightened risk aversion.

. The Reserve Bank.  In a span of seven months. and sharply reduced the policy rates. took a number of measures to augment domestic and foreign currency liquidity. there was unprecedented policy activism. like most central banks.  between October 2008 and April 2009.

(ii) the reverse repo rate was reduced by 275 basis points to 3.• (i) the repo rate was reduced by 425 basis points to • • • • 4.25 per cent. The Government also come up with various fiscal stimulus measures. (iii) the cash reserve ratio (CRR) of banks was reduced by 400 basis points of their demand and time liabilities (NDTL) to 5. . and (iv) the total amount of primary liquidity potentially made available to the financial system was over 5.75 per cent.6 trillion or over 10 per cent of GDP.0 per cent.

Hence. • Second. recovery was not assured. households’ inflation expectations were rising. . • Industrial production had started to pick up but exports were still declining.• In October 2009. domestically. consumer price inflation was high. it was not easy to exit from the excessively accommodative monetary policy stance. globally. On the other hand. most central banks were in favour of continuing stimulus.

6 9.9 9.* in Inflation BRICS Countries  Country 2010 (Average) 2011 (Latest)@  Brazil 5.0  India 9.3 5.3 6.0  * WPI for India and CPI for other countries.4  China 3.0 6. .5  South Africa 4.9  Russia 6.

domestic factors have had a significant influence on the inflation. . Inflation in India has been high compared to those in many EMEs.  apart from global factors.  In India changes in the WPI is taken as the headline inflation for policy articulation.

8  Energy 91.6 216.4  Food 119.9 Dec-10 140.4 190. Global Commodity Prices  (IMF Primary Commodity Index: 2005 = 100)  Dec-08 Dec-09  All Commodities 98.5  Beverage 132.7 .5 176.1 212.0 171.6 Apr-11 Jul-11 209.2 146.3 210.5 176.7  AgriRaw Mtls 87.2 200.5 242.6  Metals 107.6 250.6 111.9 198.6 139.1 167.9 233.6 137.6 161.7 176.9 192.9 174.9 180.

the adverse impact on domestic inflation has been stronger. .  India being a net importer of commodities. The increase in commodity prices has affected different countries differently depending on whether they are net importers or exporters of commodities.