The Indian Economy: Dealing with Inflation
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Case Details:
Case Code : ECON020
Case Length : 12 Pages
Period : 2006-2007
Pub Date : 2007
Teaching Note :Not Available
Organization : -
Industry : -
Countries : India
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"As far as inflation is concerned, we are adopting a multi-prolonged
strategy that will yield results soon."1
- 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."2
- Dr. Amit Mitra, Secretary General, FICCI 3, 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."4
- P. Chidambaram, Finance Minister of India, in March 2007.
Introduction
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In early 2007, in India, the inflation rate, as
measured by the wholesale price index (WPI)5,
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.6 On February 15, 2007, the
inflation rate reached a two-year high of 6.73%. In the past7,
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. |
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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)8 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.
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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. |
The Indian Economy: Dealing with Inflation
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