Reining in Inflation in India: Options for a Developing Economy

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"The price buoyancy has persisted since 2008-09. In fact, the level of inflation observed in the economy has been a matter of great concern. Fast increasing food prices are denting family budgets across the country, especially of people in the low-income brackets." ¹

-Commission for Agricultural Costs and Prices, in 2011.

"We are not sure whether we have all the tools in our hands to control food inflation." ²

-P. Chidambaram, home minister (former finance minister), Government of India, in 2011.

"I get less perturbed by inflation; I would be [perturbed] if it goes beyond 15%. Obviously, hyper inflation will impact growth, but we are nowhere near that." ³

-Prof. Arvind Panagariya, the Jagdish Bhagwati professor of Indian political economy at Columbia University, in 2011.

India, an economy which consistently posted a GDP growth rate of over 8% since 2005, was battling high inflation in mid-2011. Only during 2008-2009 was the GDP growth rate less than 8% in the face of an acute global recession. Headline inflation (measured in India through the Wholesale Price Index (WPI))4, which includes both food and non-food primary articles besides manufactured items, was above 8% during the whole calendar year of 2010.5 It was constantly above 9% from December 2010 to June 2011. In July 2011, it stood at 9.22%, more than two times the RBI's threshold level6 of 4-6%7 and was expected to stay high in the short- to mid-term.8

With inflation hovering at over 9%, the Reserve Bank of India (RBI), India's central bank, followed a tight monetary policy regime. Between March 2010 and January 2012, RBI hiked interest rates 13 times consecutively to limit liquidity in the economy and curb demand and thereby control the growing inflation. Consequently, the repo rate⁹ stood at 8% in July 2011, up from 4.75% before March 2010.¹⁰ Though, the demand in interest rate sensitive sectors such as automobiles and consumer electronics moderated, the demand for food and non-food primary articles still remained high. Economists, while expecting another rate increase from RBI by the end of October 2011, maintained that monetary tightening alone might not be enough to control inflation and that government should complement RBI's rate hikes with tight fiscal policies.

Spiralling Food Inflation: Getting out of Control? - Next Page>>

1] Report on Price Policy For Kharif Crops of 2011-2012 Season, Commission For Agricultural Costs And Prices, Government of India, March 31, 2011
2] Jason Overdorf, "Food Crisis Threatens India," www.globalpost.com, January 7, 2011
3] "India's Delicate Dance: Containing Inflation While Ensuring Growth," http://knowledge.wharton.upenn.edu, February 10, 2011
4] WPI is an index to measure and track the changes in the price of goods at the wholesale level or before retail level. Some countries (like India and the Philippines) use WPI changes as a central measure of inflation. In India, WPI is measured based on weekly changes in the wholesale price of 676 items with 2004-05 being used as the base year. The indicator tracks the price movement of each commodity individually and determines WPI using the averaging principle.
5] Fiscal Year in India is different from the calendar year. Fiscal year represents the 12-month period from April 1st to March 31st. For instance, fiscal 2010 – 2011 means April 2010 to March 2011.
6] Various studies market the threshold inflation level at 4 to 6% for RBI. For instance, Rangarajan in 1998 suggested a threshold level of 6%; Kannan and Joshi (1998) - 6-7%; Vasudevan, Bhoi, and Dhal (1998) - 5-7%; Samantaraya and Prasad (2001) - 6.5%; Report on Currency and Finance (2001) - 5% etc,. However, the RBI annual report in 2011 had suggested a 4 to 6% inflation rate would be the tolerable level, beyond which it would prove regressive for economic growth.
7] Deepak Mohanty, "Monetary Policy Response to Recent Inflation in India," www.rbi.org.in, October 10, 2011
8] Niraj Kumar, "July WPI: India's July Inflation Eases to 9.22% From 9.44% in June," http://goindocal.com, August 16, 2011
9] The rate at which the RBI lends money for the short term to commercial banks is called the repo rate. This is also called the Official Bank Rate or Benchmark Lending rate as all the commercial banks will adjust their lending rate according to the repo rate. Thus a lower repo rate results in high liquidity in the economy and a high repo rate leasds to the opposite.
10] "Inflation Cost us Rs 5.8 Lakh Cr More in 3 Years," http://businesstoday.intoday.in, June 28, 2011

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