Inflation and its Trend in India
Inflation is an economic phenomenon originating in the economic system due to the interaction of various economic forces. It is commonly understood to be a situation in which prices of goods and services persistently rise rapidly. To put it in layman’s terms, inflation is a situation of rising prices in the economy for a long time. This constant increase in prices of goods and services results in a simultaneous, steady increase in the cost of living. Inflation poses an exponential threat to anyone and everyone who isn’t a businessman and has devastating impacts on the economy for years to come. Essentially, making the rich richer and the poor poorer is the crux of inflation.
As we can witness in India these days, inflation devalues the units of currency, which is merely a loss in the trading power of a currency. Such loss in value of the legal tender means that you can buy fewer commodities with that legal tender. And this is the most immediate way in which inflation affects us all. It’s as straightforward as your money won’t buy as much as it could the day before. Hence, it is advisable to invest it somewhere useful.
Inflation can have two major reasons — Demand Pull and Cost Push Inflation. Demand-Pull Inflation is caused by the aggregate demand for goods and services exceeding their aggregate supply at existing prices. We are likely to get it if economic growth is above the long-run trend rate of growth. This rate is the average sustainable rate of growth, determined by the growth in productivity. Its immediate causes are an increase in money supply, a high rate of investment, declining productivity of firms, etc.
On the other hand, Cost Push Inflation is a situation in which prices rise as a result of a rise in the cost of production. We can say that it is caused by cost factors. When additions to the supply of money and credit are channeled into a commodity or other asset markets, especially when accompanied by a negative economic shock to the supply of critical commodities, costs for all kinds of intermediate goods rise. It is mainly caused by rising wages, higher taxes, an increase in prices of raw materials, etc.
There are broadly two indices related to inflation. They are the Wholesale Price Index and Consumer Price Index. Wholesale Price Index, or WPI, measures the changes in the prices of goods sold and traded in bulk by wholesale businesses to other businesses. To put it simply, the WPI tracks prices at the factory gate before the retail level. The index is based on the wholesale prices of a few relevant commodities available. The commodities are chosen based on their significance in the region. These represent different strata of the economy and are expected to provide a comprehensive WPI value. The total costs of the goods being considered in one year are then compared with the total costs of goods in the base year. The total prices for the base year are equal to 100 on the scale. Prices from another year are compared to that total and expressed as a percentage of change.
Consumer Price Index (CPI) is an index measuring retail inflation in the economy by collecting the change in prices of the most common goods and services used by consumers. It is a measure that examines the weighted average of prices of a market basket of consumer goods and services. Market basket is a fixed list of items including food, housing, apparel, transportation, electronics, medical care, education, etc. The price data is collected periodically, and thus, the CPI is used to calculate the inflation levels in an economy. It can be further used to compute the cost of living and also provides insights as to how much a consumer can spend to be on par with the price change.
However, almost a decade back, the BJP government which came into power in 2014, shortly after India’s financial nightmare, changed the methodology for calculating inflation. In 2017, the base year for calculating the CPI and WPI was changed from 2010 to 2012. The change in the methodology aimed to add to the GDP, making the then fiscal target easier and at least negating the adverse impact of lower than expected growth in the then fiscal year. The lower inflation and the lower than anticipated growth had put downward pressure on the national income, but the revision in the base year was expected to more than make up for this potential decline.
Inflation can be classified into four types. The first is Creeping Inflation, where prices rise 3% a year or less. When prices increase by 2% or less, it benefits economic growth. This kind of mild inflation makes consumers expect that prices will keep going up, boosting demand. Consumers buy now to beat higher future prices and economic expansion occurs. Next is Walking/Trotting Inflation, which is between 3–10% a year. It is harmful to the economy as it heats economic growth too fast. People start to buy more than they need to avoid tomorrow’s much higher prices. This increased buying drives demand even further so that suppliers and wages can’t keep up. Hence, common goods and services are priced out of the reach of most people. It severely harms the poorest class the most, as they are unable to afford the most basic necessities.
The third type is Running Inflation, a situation in which inflation rises to 10% or more, wreaking havoc on the economy. Money loses value so fast that business and employee income can’t keep up with costs and prices. Foreign investors avoid the country, depriving it of needed capital. The economy becomes unstable, and government leaders lose credibility. It is a warning to control inflation before it rises further. Finally, the last one is Hyperinflation. It is when inflation increases to excessively high and accelerating rates. Prices skyrocket more than 50% a month. Extremely rare, most examples of hyperinflation occur when governments print money to pay for wars. With hyperinflation, money loses its value so rapidly that nobody wants to use it as a medium of exchange. For eg: Zimbabwe between 2008 and 2009.
It is a very recent instance of hyperinflation. In November of 2008, Zimbabwe had an inflation rate of 79.6 billion percent. To put it into contrast, the United States had an average annual rate of inflation of 2.1% in 2012. Zimbabwe’s inflation rate was so high it is difficult to comprehend. Putting it into context, it is equivalent to price increases of 98% per day. This means that, from one day to the next, prices essentially double. Prices for commodities in Zimbabwean dollars were adjusted several times each day. People traded in millions and trillions of Zimbabwean dollars every day. However, at its height, it took 621,984,228 Zimbabwean dollars to purchase one U.S. dollar. Finally, in 2009, the country abandoned its currency and allowed foreign currencies to be used for purchases.
The following graph shows the inflation rates in India since 2010:
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