Government manages to keep inflation in check

I think we are all a little terrified by the word inflation!

Inflation is simply the rise in price of goods and services. Inflation is indicative of the decrease in the purchasing power of a unit of a country’s currency and is expressed as a percentage. Higher inflation leads to an increase in the cost of living and ultimately a slump in economic growth.

A certain level of inflation is required in an economy so as to promote investments and demotivate hoarding of money.

In India, the Ministry of Statistics and Programme Implementation measures inflation using two indices –

Consumer Price Index (CPI)

Consumer Price Index, India 2020 (Source: MoSPI)

CPI measures changes in price of daily goods and services.

Wholesale Price Index (WPI)

Wholesale Price Index India 2020 (Source: CEIC Data)

WPI measures the change in prices of goods sold by manufacturers.

Some of the major reasons for increase in inflation are:

• Increase in demand and low supply creates a demand supply gap leading to an increase in prices. 

• Increase in prices of inputs drives prices of commodities upwards.

• Excess circulation of money leads to inflation as money loses some of its purchasing power. Also people will have more money to spend thereby increasing demand.

Inflation is perceived differently by consumers and depends on the nature of the assets possessed by them. A person with real assets like property, equipment, etc will benefit from the increase in prices whereas someone with cash will be negatively affected as the cash they hold will lose value. 

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In 2016, the Reserve Bank Of India established a target inflation between 2% and 6% for the country.

CPI increased 6.69 percent year-on-year in August of 2020 (Source: MoSPI)

The inflation target is up for review next year.

India experienced a period of high inflation from 2008-2013. As per IMF data, on average, CPI inflation rate in those years in India were 9.1%, 12.3%, 10.5%, 9.5% 10% and 9.4%, respectively. 

Since 2016, the current Modi Government has managed to keep the inflation well within the targeted range of 2 to 6 per cent

The coronavirus pandemic has obviously slowed down the economy and has caused a huge gap between supply and demand owing to the restrictions on certain activities which has led to a medium high inflation in the country. Even though India’s economy is in dire need of rescue, the Modi government has managed to keep a check on the rising inflation numbers.

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The pandemic came as a shock to the world in early 2020.

The virus had caused a global economic standstill with strict lockdowns in place in most of the countries. Along with the pandemic India also faced a few minor border disputes with China that disrupted trade and harmony between the two nations to some extent. The RBI had to revise the key policy rates in May to facilitate borrowers for the slump in the economy. The rate cut worked in the opposite way for depositors as they now earned a lower interest on their fixed deposits. The RBI cut the repo rate by 40 basis points to 4% and the reverse repo rate to 3.335%. The RBI has since then not made any changes to the policy rates as they believe a further decrease in rates will reduce lending further. As the effects of the lockdown started to surface PM Narendra Modi announced a Rs.10 Lakh Crore stimulus focused on providing relief to MSMEs and other small scale labourers. The stimulus was a way to infuse some liquidity into the economy to delay a recessionary environment. 

Even though inflation is in control, India’s economic growth has taken a toll over the past few years. The coronavirus pandemic has had a much larger effect on India than anticipated and the government along with the central bank need to rescue the country from this situation.

In November of 2016 PM Narendra Modi announced the demonetisation scheme, reducing liquidity drastically.

The central banks had to increase the interest rates to support the target inflation after demonetisation. 

The pandemic has cost more than 10 million salaried jobs in India, reducing the purchasing power and demand in the economy. The lockdown reduced the supply of goods and services into the economy.

Fragmented and fragile recovery, ahead.

The economy is now slowly recovering as the government has eased restrictions on movement and also opened up many of the services. With the festival season coming up, we can expect a further improvement in the economic conditions, but to bring the economy back to pre-covid levels will be a daunting task for the government. In RBI’s most recent meeting they have decided to keep the policy rates unchanged and adopt a more accommodative stance.

The Indian Government plans to roll out another round of stimulus, but this time the stimulus will lay more emphasis on creating jobs . The government has also understood the plight of borrowers and allowed an extension to the loan repayment along with restructuring of larger corporate loans.

Experts believe that RBI should be given permission to use and monitor funds borrowed by government

Government deficit is bound to widen this year as they will have to resort to excess capital expenditure and borrowing to fuel the economy. The pandemic is going to create a long lasting effect on the inflation numbers of the country and continuous changes in the monetary policy is one of the major ways that the central bank can keep the economy in control.