The Indian Economy: Dealing with Inflation
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Case Code: ECON020 Case Length: 12 Pages Period: 2006-2007 Pub Date: 2007 Teaching Note: Not Available |
Price: Rs.200 Organization : - Industry : - Countries : India Themes: - |
Abstract Case Intro 1 Case Intro 2 Excerpts
"As far as inflation is concerned, we are adopting a multi-prolonged strategy that will yield results soon."
- Dr. Manmohan Singh, Prime Minister of India, in February 2007.
"The main instrument that the Finance Minister has used in the budget is fiscal controls which will show results in three months. Fiscal deficit at 3.3% of GDP is the lowest in 25 years. But price controls are measures which should be left to the market to decide."
- Dr. Amit Mitra, Secretary General, FICCI, in March 2007.
"The current rate of inflation is not as high as 2000-01. The (then) Government took 12-18 months to moderate inflation rate in 2000-01. Inflation spurts in the past have been moderated and we are confident of moderating the current rise. We will continue to take fiscal, monetary and supply side steps to moderate inflation rate."
- P. Chidambaram, Finance Minister of India, in March 2007.
Introduction
In early 2007, in India, the inflation rate, as measured by the wholesale price index (WPI), hovered around 6-6.8%, well above the level of 5-5.5% that would have been acceptable to the Reserve Bank of India (RBI), the country's central bank. On February 15, 2007, the inflation rate reached a two-year high of 6.73%. In the past, the main cause of high inflation in India used to be rises in global oil prices. However, in early 2007, the chief component of the inflation was the increase in the prices of food articles - caused by increased demand as well as supply constraints. According to analysts, the increased demand was due to high economic growth and increased money supply, while stagnant agricultural productivity was behind the supply constraints.
Apart from the rise in prices of food articles, fuel and cement prices too recorded high increases. The Government of India (GoI), together with the RBI, took several measures to contain inflation. For example, the RBI increased the Cash Reserve Ratio (CRR) and repo rates9 in an effort to check money supply; the GoI reduced import duties on several food products and cut the price of diesel and petrol.
The RBI also chose not to intervene when the Indian Rupee rallied against the US Dollar between March 2007 and May 2007. The decision not to intervene was based on the idea that a stronger Rupee would bring down the cost of imports, which, in turn, would help reduce domestic prices of goods. Though the measures taken by the GoI were targeted at inflation, some analysts feared that some of these measures, especially the ones leading to higher interest rates, might induce recession in the Indian economy. There were others who felt that letting the Rupee rise would not only have a negative effect on the bottom lines of companies that earn a substantial percent of their profits from exports, but also impact the long-term competitiveness of Indian exports.
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