Inflation in India
Inflation has emerged as a global phenomenon in 2008 posing the biggest risk for the economies of both major
industrial nations as well as the relatively faster-growing emerging market economies like India and other low-income
developing countries. It is a consequence of the continuous surge in international commodity prices, especially of
crude oil whose prices were edging toward 145 dollars a barrel in July, more than double its 2007 average, as well
as of food and basic metals.
Double-digit inflation now rages across several Asian and other developing economies, which are hard pressed in
controlling prices through both monetary and supply-demand management measures. Governments are running
bigger fiscal burdens in trying to enlarge the social security net for the poor. India’s current battle against the double
digit inflation close to 12 per cent in July must be seen in this perspective.
Global institutions like the International Monetary Fund are telling nations that they must give the highest priority to
fighting inflation, which had accelerated in leading developing countries including China and India, by tightening
monetary policies and moderating demand.. The world economy is already slowing down in the midst of continuing
financial turmoils, credit crunch and weakening business confidence. Over and above this, inflation has become
a bigger danger for macro-economic stability.
Price pressures emerged in India at the beginning of 2008 mainly due to the soaring international oil and food prices. Between March and May, Government mounted an array of fiscal measures by slashing import and excise duties to help lower domestic price level. Administrative measures were taken to regulate exports including ban on non-basmati rice exports and steel items in order to improve domestic availability. These measures were expected to have a moderating impact in the following months.
However, according to revised data, the wholesale price index had already moved up to 7.75 per cent by the end of March 2008 as against the normal 4.5 to 5 per cent range, and since then inflation has been on an uptrend moving into double digit in June. The Reserve Bank of India has been gradually tightening its benchmark rates (interest and cash reserve ratios) in order to contain excessive liquidity and control growth in aggregate demand which exert upward pressures on prices.
The timely arrival of monsoon in June had raised hopes of bringing down the rate of inflation to some extent in the near future. However, unrelenting pressures of surge in international oil and food prices were raising inflation expectations everywhere. In June, Government were forced to effect what it called a moderate rise in petrol and diesel prices but the annual rate of inflation was already worryingly high at 8 per cent. The oil product price revision gave a boost to the headline inflation.
While food prices have somewhat eased in recent weeks with the record foodgrain production of 230 million tonnes in 2007-08, maximum wheat procurement at 22 million tonnes and rise in grain stocks at Government’s disposal, other basic food items have seen an uptrend. Government is trying to strengthen the public distribution system with imported edible oil at subsidised rates in order to help the low-income groups.
The overall outlook for prices continues to be one of serious concern and though there is some noticeable moderation in money supply and deposit accretion, non-food credit growth is higher on a year-to-year basis as on July 4. In combating inflation at the national level, the totality of the global situation and its possible spill-overs into emerging economies with all the risks on the downside have to be taken into account.
Faced with an “intolerable” level of inflation of close to 12 per cent, demand pressures and global commodity prices at elevated levels, the Reserve Bank of India further tightened its policy instruments on July 29 according high priority to price stability and anchoring inflation expectations.
The Repo Rate (the rate at which RBI lends to commercial banks) has been raised to 9 per cent with immediate effect, while leaving the bank rate and Reverse Repo Rates unchanged at 6 per cent. The Cash Reserve Ratio, which helps to impound a part of bank funds for controlling liquidity, has been increased by another quarter per cent to 9 per cent with effect from August 30. Both these rates had been revised in June in two phases to 8.5 per cent (Repo) and 8.75 per cent (CRR) respectively.
RBI had earlier given itself an objective of ensuring that inflation is kept around 5 to 5.5 per cent for an economy assumed to grow at 8 to 8.5 per cent in 2008-09. The developments since RBI announced its monetary and credit policy for the year on April 29 appear to rule out the prospects of higher growth with price stability in the current year. In view of the global slowdown, especially a decline in demand from USA, and global oil and food prices, IMF and the World Bank have lowered growth estimates for emerging economies and have projected growth for China and India at less than 10 and 8 per cent respectively in 2008.
The Reserve Bank has also revised down its earlier growth estimate to 8 per cent in 2008-09 if there are no further domestic or external shocks. While its policy actions are aimed at bringing down inflation to a tolerable level of 5 per cent, it feels the realistic endeavour at this juncture would be to lower it to close to 7 per cent by March 31, 2009 from the present 11-12 per cent range.
The Finance Ministry has welcomed the latest tightening of monetary policy and says it is a signal to banks for moderating credit growth, having regard to the need to moderate aggregate demand. Banks should be able to meet credit demands for productive sectors if loans are carefully appraised and credit is allocated prudently. Government expects all measures taken over the last two months including the Reserve Bank’s announcements on July 29 to help in moderating and containing inflation.
At the same time, RBI in its statement has also emphasized the importance of “close and careful” monitoring of fiscal developments in view of growing enhanced subsidy expenditures and off-budget liabilities (like bonds for oil companies), farmer loan waivers and salary revisions under the sixth pay commission report during the year. Increases in non-plan spending adds to demand pressures, apart from widening budget deficits.
industrial nations as well as the relatively faster-growing emerging market economies like India and other low-income
developing countries. It is a consequence of the continuous surge in international commodity prices, especially of
crude oil whose prices were edging toward 145 dollars a barrel in July, more than double its 2007 average, as well
as of food and basic metals.
Double-digit inflation now rages across several Asian and other developing economies, which are hard pressed in
controlling prices through both monetary and supply-demand management measures. Governments are running
bigger fiscal burdens in trying to enlarge the social security net for the poor. India’s current battle against the double
digit inflation close to 12 per cent in July must be seen in this perspective.
Global institutions like the International Monetary Fund are telling nations that they must give the highest priority to
fighting inflation, which had accelerated in leading developing countries including China and India, by tightening
monetary policies and moderating demand.. The world economy is already slowing down in the midst of continuing
financial turmoils, credit crunch and weakening business confidence. Over and above this, inflation has become
a bigger danger for macro-economic stability.
Price pressures emerged in India at the beginning of 2008 mainly due to the soaring international oil and food prices. Between March and May, Government mounted an array of fiscal measures by slashing import and excise duties to help lower domestic price level. Administrative measures were taken to regulate exports including ban on non-basmati rice exports and steel items in order to improve domestic availability. These measures were expected to have a moderating impact in the following months.
However, according to revised data, the wholesale price index had already moved up to 7.75 per cent by the end of March 2008 as against the normal 4.5 to 5 per cent range, and since then inflation has been on an uptrend moving into double digit in June. The Reserve Bank of India has been gradually tightening its benchmark rates (interest and cash reserve ratios) in order to contain excessive liquidity and control growth in aggregate demand which exert upward pressures on prices.
The timely arrival of monsoon in June had raised hopes of bringing down the rate of inflation to some extent in the near future. However, unrelenting pressures of surge in international oil and food prices were raising inflation expectations everywhere. In June, Government were forced to effect what it called a moderate rise in petrol and diesel prices but the annual rate of inflation was already worryingly high at 8 per cent. The oil product price revision gave a boost to the headline inflation.
While food prices have somewhat eased in recent weeks with the record foodgrain production of 230 million tonnes in 2007-08, maximum wheat procurement at 22 million tonnes and rise in grain stocks at Government’s disposal, other basic food items have seen an uptrend. Government is trying to strengthen the public distribution system with imported edible oil at subsidised rates in order to help the low-income groups.
The overall outlook for prices continues to be one of serious concern and though there is some noticeable moderation in money supply and deposit accretion, non-food credit growth is higher on a year-to-year basis as on July 4. In combating inflation at the national level, the totality of the global situation and its possible spill-overs into emerging economies with all the risks on the downside have to be taken into account.
Faced with an “intolerable” level of inflation of close to 12 per cent, demand pressures and global commodity prices at elevated levels, the Reserve Bank of India further tightened its policy instruments on July 29 according high priority to price stability and anchoring inflation expectations.
The Repo Rate (the rate at which RBI lends to commercial banks) has been raised to 9 per cent with immediate effect, while leaving the bank rate and Reverse Repo Rates unchanged at 6 per cent. The Cash Reserve Ratio, which helps to impound a part of bank funds for controlling liquidity, has been increased by another quarter per cent to 9 per cent with effect from August 30. Both these rates had been revised in June in two phases to 8.5 per cent (Repo) and 8.75 per cent (CRR) respectively.
RBI had earlier given itself an objective of ensuring that inflation is kept around 5 to 5.5 per cent for an economy assumed to grow at 8 to 8.5 per cent in 2008-09. The developments since RBI announced its monetary and credit policy for the year on April 29 appear to rule out the prospects of higher growth with price stability in the current year. In view of the global slowdown, especially a decline in demand from USA, and global oil and food prices, IMF and the World Bank have lowered growth estimates for emerging economies and have projected growth for China and India at less than 10 and 8 per cent respectively in 2008.
The Reserve Bank has also revised down its earlier growth estimate to 8 per cent in 2008-09 if there are no further domestic or external shocks. While its policy actions are aimed at bringing down inflation to a tolerable level of 5 per cent, it feels the realistic endeavour at this juncture would be to lower it to close to 7 per cent by March 31, 2009 from the present 11-12 per cent range.
The Finance Ministry has welcomed the latest tightening of monetary policy and says it is a signal to banks for moderating credit growth, having regard to the need to moderate aggregate demand. Banks should be able to meet credit demands for productive sectors if loans are carefully appraised and credit is allocated prudently. Government expects all measures taken over the last two months including the Reserve Bank’s announcements on July 29 to help in moderating and containing inflation.
At the same time, RBI in its statement has also emphasized the importance of “close and careful” monitoring of fiscal developments in view of growing enhanced subsidy expenditures and off-budget liabilities (like bonds for oil companies), farmer loan waivers and salary revisions under the sixth pay commission report during the year. Increases in non-plan spending adds to demand pressures, apart from widening budget deficits.
Controlling Inflation Without Hurting Growth
Has the inflation peaked in India? Well, if the international credit rating agency Moody is to be believed it “may have”. But there is no occasion to be euphoric as, it says, the internal situation will continue to be difficult for some time. That explains why both the Central government and the Reserve Bank of India continue to be firm in dealing with both the supply side and the liquidity side.
When the RBI recently raised the Repo Rate (the rate at which it lends money to the banks) by 50 basis points and the Cash Reserve Ratio, CRR, (the percentage of money that the banks are mandatorily required to keep with the Reserve Bank) by 25 basis points- taking it to as much as 9 percent -many of us did not like it because it in turn led to further increase in the already high interest rates. But if the bull of rising inflation, which has crossed the psychological barrier of 12 percent, has to be taken by its horns, drastic steps can not be avoided. The prescription is to reduce liquidity through monetary measures on the one hand and increase the supply of goods on the other, through fiscal and other measures.
Money supply in the country has been increasing at the rate of 20 percent a year, consistently for the last 3 years. This in turn leads to increase in demand for goods and commodities which forces the prices to go up. Thus, the need for curbing money supply for the time being.
But the real thrust has to be on the supply side because unless we increase the supply of goods, the always existing demand will keep on pushing the prices upwards. Besides, restricting the flow of funds beyond a point is bound to affect the growth rate as well. Already, economists have started admitting that the hard steps being taken by the government to tackle inflation will reduce the growth rate this year to some extent. But this may still hover around 7.5 to 8 percent against the backdrop of 9.1 percent growth the country witnessed last year.
It is in this background that the Prime Minister during the recent debate in Parliament emphasized that the government’s two top priorities are tackling inflation without hurting growth and revitalizing the farm sector to increase the agricultural output.
One of the latest economists to join those predicting an early control on inflation is the Planning Commission Deputy Chairman Shri Montek Singh Ahluwalia. He believes that the inflation rate will come down to single digit in a few months The RBI puts it at 7 percent by the end of this fiscal. Shri C Rangarajan, who has just resigned as Chairman of the Prime Minister’s Economic Advisory Council, believes it may be in the range of 8 to 9 percent by the year end.
Perhaps what makes them optimistic is the hope of a good monsoon this year that can boost agricultural production. Despite it being erratic in July and below average in critical states like Gujarat, Maharashtra and Andhra Pradesh, which could affect the production of ground nuts and cotton prices, it is expected to pick up in the current month. The falling crude oil prices, which have already come down to $118 per barrel from $143 a barrel only a few weeks ago is another indication of better days ahead. The international crude prices are expected to fall further due to moderation of demand in the developed countries, increase in the value of dollar and pressures from the developing countries that speculators should not be allowed to raise oil prices artificially. If the Monsoon really behaves and oil prices continue to fall to a reasonable level the country can make a turn around on the inflation front.
As a short term measure, the government has already banned the export of sensitive commodities like cement and non-basmati rice and reduced substantially import duties on a number of other commodities like steel, cement, pulses and other goods to increase their domestic supply. The cost of inputs has also been reduced to help the farmers grow more. There is however a limit to which the government can go in reducing duties. Beyond that point, reduction of duties can be counter-productive since loss of revenue can lead to fiscal deficit and consequently inflation. The government has also persuaded steel manufacturers to keep the prices of steel in check as it is a key component in the list of commodities that determine the wholesale price index.
The Government did well in deferring the decision on decontrolling sugar. It is widely believed that despite a good stocks position of 110 lakh tonnes and an expected good sugarcane crop this year, decontrolling it would lead to increase in its price. In the previous two years also successive glut in sugarcane crop could not prevent increase in sugar prices as the demand always outstrips its supply.
The government also plans to boost the flow of essential commodities by strengthening the state-run agencies and consumer federations. It will involve providing non- plan assistance to these agencies subject to certain eligibility conditions.
Thus while inflation continues to be a major concern there are indications to have almost peaked and would begin to subside in a few months. How soon can that happen will depend on how merciful is the rain God, how international crude oil prices behave and how good is the agriculture production in the country.
When the RBI recently raised the Repo Rate (the rate at which it lends money to the banks) by 50 basis points and the Cash Reserve Ratio, CRR, (the percentage of money that the banks are mandatorily required to keep with the Reserve Bank) by 25 basis points- taking it to as much as 9 percent -many of us did not like it because it in turn led to further increase in the already high interest rates. But if the bull of rising inflation, which has crossed the psychological barrier of 12 percent, has to be taken by its horns, drastic steps can not be avoided. The prescription is to reduce liquidity through monetary measures on the one hand and increase the supply of goods on the other, through fiscal and other measures.
Money supply in the country has been increasing at the rate of 20 percent a year, consistently for the last 3 years. This in turn leads to increase in demand for goods and commodities which forces the prices to go up. Thus, the need for curbing money supply for the time being.
But the real thrust has to be on the supply side because unless we increase the supply of goods, the always existing demand will keep on pushing the prices upwards. Besides, restricting the flow of funds beyond a point is bound to affect the growth rate as well. Already, economists have started admitting that the hard steps being taken by the government to tackle inflation will reduce the growth rate this year to some extent. But this may still hover around 7.5 to 8 percent against the backdrop of 9.1 percent growth the country witnessed last year.
It is in this background that the Prime Minister during the recent debate in Parliament emphasized that the government’s two top priorities are tackling inflation without hurting growth and revitalizing the farm sector to increase the agricultural output.
One of the latest economists to join those predicting an early control on inflation is the Planning Commission Deputy Chairman Shri Montek Singh Ahluwalia. He believes that the inflation rate will come down to single digit in a few months The RBI puts it at 7 percent by the end of this fiscal. Shri C Rangarajan, who has just resigned as Chairman of the Prime Minister’s Economic Advisory Council, believes it may be in the range of 8 to 9 percent by the year end.
Perhaps what makes them optimistic is the hope of a good monsoon this year that can boost agricultural production. Despite it being erratic in July and below average in critical states like Gujarat, Maharashtra and Andhra Pradesh, which could affect the production of ground nuts and cotton prices, it is expected to pick up in the current month. The falling crude oil prices, which have already come down to $118 per barrel from $143 a barrel only a few weeks ago is another indication of better days ahead. The international crude prices are expected to fall further due to moderation of demand in the developed countries, increase in the value of dollar and pressures from the developing countries that speculators should not be allowed to raise oil prices artificially. If the Monsoon really behaves and oil prices continue to fall to a reasonable level the country can make a turn around on the inflation front.
As a short term measure, the government has already banned the export of sensitive commodities like cement and non-basmati rice and reduced substantially import duties on a number of other commodities like steel, cement, pulses and other goods to increase their domestic supply. The cost of inputs has also been reduced to help the farmers grow more. There is however a limit to which the government can go in reducing duties. Beyond that point, reduction of duties can be counter-productive since loss of revenue can lead to fiscal deficit and consequently inflation. The government has also persuaded steel manufacturers to keep the prices of steel in check as it is a key component in the list of commodities that determine the wholesale price index.
The Government did well in deferring the decision on decontrolling sugar. It is widely believed that despite a good stocks position of 110 lakh tonnes and an expected good sugarcane crop this year, decontrolling it would lead to increase in its price. In the previous two years also successive glut in sugarcane crop could not prevent increase in sugar prices as the demand always outstrips its supply.
The government also plans to boost the flow of essential commodities by strengthening the state-run agencies and consumer federations. It will involve providing non- plan assistance to these agencies subject to certain eligibility conditions.
Thus while inflation continues to be a major concern there are indications to have almost peaked and would begin to subside in a few months. How soon can that happen will depend on how merciful is the rain God, how international crude oil prices behave and how good is the agriculture production in the country.
Monetary Policy and Inflation
In Developed countries Monetary policy which is unveiled by the central bank periodically is mainly aimed at keeping inflation low. In India as well as many other developing economies central banks have twin objective of controlling inflation and pushing growth.
It is therefore a balancing act always for Reserve Bank of India, which has to contain inflation without impeding growth momentum, every three months monetary policy review takes place. Of course, central bank can intervene in between if an unusual situation arises warranting policy action.
In the face of global currency crisis in 2008 which blew over into a recession, unprecedented since the great depression of 1928, central banks world over including India had to take swift monetary action to get out of the monumental crisis.
With severe liquidity crunch in the banking system and collapse of several top global banks due to mounting bad debts, policy actions were required to pump-in money into the system so that demand picks up and thereby the plummeting growth, crucial for the health of the economy.
Instead of keeping tight control of money supply and interest rates, central bank adopted easy monetary policy by injecting more money into the system and lowering interest rates which fell to near zero in developed countries to prop up growth that became negative in some countries.
Conservative Approach By RBI
Unlike in many other countries, Reserve Bank of India has been conservative in its monetary policy and the Government very cautious in moving towards full float of rupee, that is total capital account convertibility. This approach helped India to ward off a major crisis and economic recovery from the global recession faster.During the crisis the Government and Reserve Bank had to come out with fiscal stimulus and monetary stimulus packages to revive the economy. This pushed the Government’s fiscal deficit up to 6.7% of GDP (2009-10) due to increased spending, leading to high borrowing.
Reserve Bank’s Monetary policy became very accommodative releasing more cash into the system and lowering key policy rates to reduce interest rates so as to ensure that cost of borrowing is less. The monetary instruments that the central bank used for this purpose are Cash Reserve Ratio (CRR), the percentage of money, the slice of deposit that banks have to park with the central bank and the key short-term policy rates, Repo and Reverse Repo rates. (Repo is the rate at which banks borrow overnight or short-term from the Reserve Bank. Reverse Repo rate is the rate at which banks deploy surplus funds with the central bank.)
With large capital flows from abroad and increasing domestic demand for investment funds, there was increased borrowing before the global crisis and the central bank had increased Cash Reserve Ratio to as high as 9% in a grade manner to suck out excess liquidity in the banking system so that there was no overheating of the economy, particularly through increased lending to real estate sector where a bubble was in the making. Likewise it increased repo and reverse repo rates in stages and repo rate was as high as 6% to ensure cost of funds for lending become expensive for banks.
Easy Monetary Policy During Global Crisis
When the global recession started, central bank started adopting accommodative monetary policy, making available more liquidity in stages and reduced the cost of borrowing. CRR came down to as low as three per cent and Repo rate to nearly 4 per cent. This released more than 3 lakh crore into the banking system so that there was ample liquidity available to prop up growth. With the economic recovery and surging inflation, unwinding of the easy monetary policy and fiscal stimulus began in a calibrated manner in the last few months. Monetary tightening began in January to ensure excess liquidity is sucked out in a graded manner to contain inflation without impeding growth momentum as economic recovery is still fragile.Exit From Easy Policy Began With Recovery And Inflation Surging
To tackle rising inflation, the central bank in its annual monetary policy statement for 2010-11 unveiled on April 20 raised key policy rates – repo and reverse repo rates for second time in as many months and CRR to squeeze out excess liquidity from the banking system. The Repo and Reverse Repo rates were hiked by 0.25 % and CRR too by 0.25% to take away Rs 12,500 crore from the system. An increase in policy rates signals a rise in interest rates. Repo rate will now be 5.25% while Reverse Repo rate will be 3.76%.The CRR hike which will come into effect on April 24 will now be 6%. Earlier in January during the quarterly policy review, the central bank had raised CRR by 0.75% to 5.75% to suck out Rs 37,500 crore liquidity from the banking system. Reserve Bank Governor, Dr. D Subbarao rightly said after the policy announcement that he would like to take “baby steps” which was better for the economy as drastic hike in policy rates and CRR might have helped in bringing down rapidly but would hit hard the growth that is beginning to look up.Inflation Still A Matter Of Concern
Inflation no doubt is a matter of concern as food inflation has started spilling over to non-food areas. But a small dose of inflation is good for the economy as it has multiplier effect thus helping the pace of recovery. “We believe that taking several baby steps towards normalisation is better for the economy to adjust with the pre-crisis growth level,” Dr. Subbarao said. These baby steps might not immediately affect lending rates of banks as there is still enough liquidity in the system as demand for credit is picking up slowly.Dr. D Subbarao said he would not like to take mid-policy action before July end, when the quarterly policy review will be unveiled. He pegged the inflation to be at 5.5% in 2010-11 and the growth to pick up to 8% in the financial year.He said it was therefore important to calibrate the exit from the easy policy stance, given the revival in demand for credit and the large Government borrowing programme. He expected credit growth of 20% this year.Endorsing the measure, the Finance Minister Shri. Pranab Mukherjee described it as “well-balanced and mature” and this “gentle’ and “small tightening of credit” will dampen further inflationary pressures. He even disagreed with Reserve Bank forecast of 5.5% inflation this year saying analysis showed that the Inflation may come down further and it could be even close to 4%.
No comments:
Post a Comment