UNIT 4 INFLATION IN INDIA

Structure

Obj~ctives
Intdbction
Measurement of Inflation in India
Price Trends in India
4.3.1 Phase of 195 1-66
4.3.2 Phase of 1966-90
4.3.3 Phase of 1990 onwards
Causes of Inflation in India
4.4.1 Factors on the Demand Side
4.4.2 Factors on the Supply Side
Consequences of Inflation in India
Remedies
4.6.1 Monetary Policy
4.6.2 Fiscal Policy
4.6.3 Production and Distribution Pol~cy
4.6.4 Adm~nisteredPrice Policy
4.6.5 Conimercial Policy
4.6.6 Income Policy
A Note on New Wholesale Price Index (WPI) Series
Let Us Sum Up
Key Words
Same Useful Books
hswers/Hints to Check Your Progress Exercises

4.0 OBJECTIVES

The unit introduces you to the trends in the general price level in India since the
beginning of the First Five Year Plan in 1951. After going through this unit you will
be able to :
Explain the course of inflation in the Indian economy
Identify the causes of inflationary trends in the Indian economy
Understand the consequences of inflation on the development prices
Frame out a policy that can work to bring inflation under control.
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4.1 INTRODUCTION
A major objective of economic planning in India has been to promote economic
growth in an environment of price stability. Price stability implies an absence of
erratic and unplanned movements in the general price level, inflationary or
deflationary. A moderate inflation is generally believed to be a necessary co?dition
of ec~nornicgrowth. Moreover, a planned inflation of any degree may not be a
reason for concern as the respective plans also provide for the necessary correctives.

However, when the rate of inflation jumps the planned levels it has serious
consequences. It may distort the entire frame of the plan. It is therefore not unwarranted
to symbolise inflation with a state of crisis. India has been passing through this phase
almost for over four decades now. It would be pertinent to diagnose this disease and
prescribe suitable measures to correct it.
 Inflation in India
4.2 MEASUREMENT OF INFLATION IN INDIA
Inflation in India is measured with the help of the wholesale price indei (WPI) . The
WPI is con~piledby the Government of India. on a weekly basis. The WPI is a
composite index of 447 commodities; these commodities are divided in three
groups. viz., (i) primary articles, (ii) fuel group, and (iii) manufactured products.
Primary articles have a weightage of 32.3 per cent while fuel group and manufactured
products have 10.7 per cent and 57.0 per cent weights respectively. Currently, the
WPI is estimated on the base year prices of 1993-94.

4.3 PRICE TRENDS IN INDIA

Each plan documents in India has sought to ensure that there is no accentuation of
*
inflationary pressures in thc course of the plan and that the levels of living of the
morc vulnerable classes in society are safeguarded. However, even as overall price
stability has becn an avowcd objective of econon~icplanning, the goal has eluded us
almost persistently, as would be clear from a review below. .

l l ~ cwhole period 1951-99 can conveniently be broken into three phases, viz., (i)
195 1-66, (ii) 1966-1990. and (iii) 1990 onwards.

4.3.1 Phase o f 1951-66

Inflation. although moderate had its beginning in India with the onset of the heavy
invcstmci~tprogramme during the mid-fifties.

Thc WPI, which had gone down by about 22 per cent during the First Plan, went up
by about 30 per cent during the five years of the Second Plan. The WPI went up
by another 35 per cent during the Third Plan period.

The rising trend of the WPI during this period could be attributed both to inflationary
financing of the developmental programmes and shortfall in output, specially of
agricultud products. Diversion of resources from development to defence in wake
of external aggressions in sixties also contributed to the build-up of the inflationary
pressures.

4.3.2 Phase o f 1966-90

During this period, price variations cut across the plan periods and had shown
considerable volatility. In all, seven sub-phases of price movements can be observed
during the period 1966-90.

High rates of inflation were witnessed during the years 1966-67 (13.9 per cent, ) and
1967-68 (1 1.6 per cent ) followed by four years of declining or gently rising price
levels up to 1971-72.

A sudden spurt in the general price level was noticed in 1972-73 to 1974-75 (25.2
per cent ). This was. followed by a distinct phase of four years (1975-76 to 1978-79)
experiencing relative price st'ability. In 1979-80, again prices shot up by 17.1 per cent
and then by 18.2 per cent in 1980-81. The rate of increase though still high, decelerated
to 9.3 per cent in 1981.82.

Thereafter. for the years, from 1982-83 to 1986-87, price increases were moderate,
Main Features of Indian The foregoing review brings out on interesting aspect of the liatilre of inflation in
Economy
India. The periods of high inflation are soon followed by periods of relative price
stability. This deems to be the logical consequence of India's econom'~cstructure
and fairly sensitive policy responses by the authorities to specific disturbances
which give rise to macro economic and sectoral imbalances.

4.3.3 Phase of 1990 onwards

Inflation has shown a dogged persistence in tlie post reforms period. In 1990-91, the
year of macro economic chaos, there was a 12.1 per cent rise in the WPI. In the
following fiscal year, there was a two -step devaluation of the rupee, which stipulated
expectations; WPI went up by 13.6 per cent during the year 1991-92 . In 1992-
93 where there was a 6.9 per cent rise in foodgrains output and a 3.9 per cent rise
in overall agricultural production, the inflation rate did come down to 7 per cent. 4

During the two subsequent years, the inflation rate averaged 10.6 per cent.

As mentioned above the WPI has three parts- primary articles (weightage of 32.29
per cent ), fuel group (weightage of 10.66 per cent) and manufactured articles
(weightage of 57.04 per cent). Primary articles - meaning unprocessed crops of food
items and fibres plus livestock - are vulnerable to the vagaries of nature. The fuel
group comprises mineral oils, electricity and coal. Inflation in this segment always
tends to be high. In fact, in six of the last 10 years, inflation rate in the fuel group
has averaged more than 10 per cent. However, over the last two years it has
dropped. In '98-99, inflation rate averaged 4.3 per cent and in '99-00, it hovered at
8 per cent.

The largest contributor to the low inflation rate, as measured by the WPI, has been
the 'manufactured products' group, where prices rose just 0.4 per cent, during
1999-2000 compared to 4.6 per cent in '98-99. This represents a dramatic drop in
inflation rate. Manufactured products are also the area that is most significant among
the three aomponents of inflation. There are two reasons for this - the high weightage
and the fact that this group is vulnerable to structural changes in the economy. That
is, the graup is more influenced by policy than the primary articles group. What is
driving law inflation in the manufactured product items? As such. drawing
generalised conclusions is hazardous. If inflation rate in this group is low it's because
of certain definitive factors - low input prices, producers' effort to boost demand or
even competitive pressures.

The last factor is the most important because it has long term implications about
the behaviiour of inflation. Evidence suggests that competitive pressures. both internal
and external, could have played an important role in keeping manufacturing inflation
low. If so, manufacturing inflation is not likely to rise in a hi~rryin the near future.

Overall, the Indian manufacturing sector is under more competitive pressures, both
domestic and external. Categories contributing about 35 per cent of tlie WPI could
be exposed to international competition. And, if one includes donlestic conlpetition
in sectors like cement, consumer durables and automobiles too, the pricing power of
a substantial part of the manufacturing basket could be affected by competitive
pressures. Which direction will inflation take in the future? It is not possible to make
an accurate forecast for the primary goods category because this section is
unpredictable. In four of the last 10 years, inflation in this category exceeded 10
per cent and only in the last two years has it stabilised at less than 5 per cent, So,
.c . . I I- c a -a *I-*. - n - A * --. . --.----
:- I:I.-I-. A- -2--
Prices in the fuels category tend to rise religiously, and so inflation could hover at Inflation In India
8-10 per cent. That leaves the manufacturing sector, the big bogey. A large part of
this section is now aligned with global cycles. Therefore, while demand revival
should create conditions for manufacturing inflation to rise, it is likely that it may
remain at 4-5 per cent levels in 2000-2001, where it has been for the last four years.
Overall, therefore, the WPI should stay at 5-6 per cent for the next year. This will
be a low for India.

The mid-nineties have witnessed a slowing down the rate of inflation. Although, the
WPI has continued to move upwards, the rate of increase has been moderate, 7.7
per cent in 1995-96, 6.4 per cent in 1996-97, 4.8 per cent in 1997-98 and 6.9 per
cent in 1998-99.

It would be seen from the above review that India entered the age of rising prices
in the mid-fifties. The price level has since been continuously rising. What has
differed, however, is the rate at which prices have gone up at different stages. While
during the fifties and the sixties, inflation used to be moderate and phases of stable
prices intermingled with those of rising prices. The rate of inflation picked up fast
during the mid-seventies, and accelerated further during the eighties and the first half
of the nineties. The price line has been little smoother in the second half of the
nineties.

Check -Your Progress 1

1 ) Is inflation good or bad for economic growth?

7

2) How do we measure inflation in India?

3) Traqe the course of inflation in India during the decade of nineties.

4.4 CAUSES OF INFLATION IN INDIA

Inflation in India has been a mixture of both demand-pull and cost-push factors.

4.4.1 Factors on the Demand Side

Main Features of Indian I ) Inflnrlionnry finnrrcing of government deficits: The rising expend iti~reof the
Economy government, ever since the beginning of the First Five-year plan. has resulted
in fiscal deficits. A substantially large part of these deficits could be met by
taking resort to easy and soft borrowings. both external and internal. But an
equally substantial part had to be funded by printing new currency notes. The
inflow of new currency, at times out of proportion with increase in output,
fuelled demand for goods and services, resulting in an upward movement on the
general price level.

2 ) Large supply to bank credit: The credit had been required to meet the growing
needs of the production sector in the growth process. Likewise, in wake of
globalisation and deepening and disintermediation of the financial system, new
financial instruments outside the banking system are appearing at a fast pace. All
these we add to monetary expansion in the economy .

3) Lnrge inflow ofnon-debtforeign cnpital: Large inflows of foreign capital by

way of factor incomes from abroad, direct and portfolio investment add to the
available liquidity in the economy. This generates new demand for goods and
services.

4) Black money: The tern1 is used to refer to that money which is acquired after
evading taxes. Black money is used to finance largely the non-productive activities
like deals in real estate, gold smuggling, hoarding, luxury living etc. These types
of transactions divert resources from productive uses to unproductive uses, and
hence are responsible for not getting the supply of goods and services increase
to their maximum.

4.4.2 Factors on the Supply Side

The important factors on the supply side are as follows:

I ) Rise irr ndntinistered prices. In our economy a large part of the market is
influenced and regulated by government action. This is true both of the agricultural
and industrial sector. In the agricultural sector the government regulates the
market forces through such measures as minimum guaranteed support price,
proclurement price, etc. Similarly, the prices of a number of important basic
indulstrial intermediates and raw materials are fixed by the governments. A large
part of the inflation in lnaia is explained by a periodical rise in the administered
prices.

2) Dislbcutiun ofinfr~~structrrrnIfc~cilities.
Notwithstanding the fact that substantial
efforts have gone into building up the infrastructural support to the economy and
reasonable progress has been recorded a gap between demand and supply continues
to eptist, having dampening effects on overall production and supply of goods,
resulting in higher unemployment and a lower rate of real output.

3) Rising import prices of essential commodities. In the increasingly globalising

economy domestic price level cannot remain insulated from the international
price levels whenever the import prices go up. These leave an inflationary impact
on domestic cost and price structure.

4) Faulty nnd ineffective mnnngemsnt. The private entrepreneurs in their zeal for
higher profits have never shirked from indulging in such practices as hoarding,
 o11ly interfere with the fiee operation of the market forces. These only lead to Inflatian in India
the creation of artificial scarcities, from which nobody gains except the private
entreprzneurs. The working of the public distribution system, wherever it operates
has also been marked by inefficient and corrupt administration.

Check Your Progress 2

1) Inflation in India is a joint result of demand and supply forces. Comment

2) Mention three factors on demand side that are responsible for inflation in
India.

3) Mention three factors on supply side that are responsible for inflation in India.
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4.5 CONSEQUENCES OF INFLATION IN INDIA

The major consequences of inflation in India can be examined as follows,
One, the effects of rising prices on general consumption standard are usually serious
enough on fixed income groups, including the large class of landless agricultural
labourers who are remunerated in cash. The rich can always insulate themselves
against inflation - through various asset deals and by buying&i@s whose prices rise
,
along with inflation.

Two, inflation generates demand for positional goods. The adverse fallout of this
trend would be on articles of consumption of the poor strata as the middle classes
in the urban and rural sectors may put greater pressure for diversion of resources
towards the production and availability of the articles of their own consumption. In
a resource-starved economy of India, the poor may have to tighten their belts krther
in a situation of rising prices.

Three for a country like India, with the large mass of the people being net debtors,
a gradual rise in prices should in part alleviate the burden of debt. Given the
structure of production and marketing, however, only a small proportion of the
benefit of higher prices accrues to the agriculturist or artisan owing to interception
By middlemen and moneylenders.
Four the extent of stimulus to output as a result of high prices is limited by
Main Features of Indian Five, inflation by distorting the relative price and wage structure has made it difficult
Economy
for tax authorities to track down money incomes of the various sectors of the economy
and helped in the consolidation and expansion of a parallel economy .

Six, the rising levels of non-plan expenditure by the government may also largely be
due to inflation. This compels the government to resort to deficit funding by way of
printing new currency. This in turn further fuels inflation.

Seven, inflation results in creation of a high-cost economy, which is sapping our

competitive capacity in the world market.

Eight, inflation discourages exports and builds up measure for enlarged imports.
Overall, Weakening export-competitiveness, unproductive activities of business
preoccupied with inflationary gains, and the growing frustration of workers confronting
a widening disparity in the distribution of income and wealth, all these trends indicate
that growth potential of a developing economy like India is being desirously
undermined by chronic inflation.

Check Your Progress 3

1) Explain how inflation affects the poor section of the society.

2) Explain how inflation adversely affects our competitiveness in the export

markets.

3) Whht is the effect of inflation on self-employed persons?

I

4.6 REMEDIES

As we have seen above many factors contribute to inflation. Corrective measures,

thus, necessarily have to have a broad sweep.

4.6.1 . Monetary Policy

The basic task of monetary policy in a developing economy is to meet the credit
needs of the growth sectors on the one hand, and to curb the supply of money to be
used in non-productive activities like speculative dealings and hoarding, on the other.
Mone@y policy in India has been designed on the same principles and hence is
 The Reserve Bank has been manipulating various quantitative and qualitative controls Inflation in India
to make this policy effective. But in the circumstances prevailing presently in the
economy, the monetary policy is subject to the number of limitations.

The proportion of total credit provided by non-banking institutions and agencies is

much higher and the linkages between banks and these institutions are not so well
developed. The impulses generated by the Reserve Bank have thus limited impact in
relation to the totality of lransaction that need to be effected.

Credit restraints whenever they are imposed hit most adversely the priority sectors
of the economy. Given these considerations, it is almost certain that we cannot
depend upon monetary policy alone to contain inflation.

4.6.2 Fiscal Policy

There is a need to curb fiscal deficits. Recent experience has shown that a reduction
in fiscal deficit by axing development expenditure can lead to recession and lower
revenue yields. In fact, public expenditure on development, particularly on
infrastructure, will need to be raised appreciably to revive industrial activity. On the
other hand, there is limited scope to slack non-development expenditure. Any saving
on this count may be offset by increased requirements of funds for defence.

What is required is that either or both of the following must happen:

a) Government sharply reduces its expenditure by reorganising itself, improving its
efficiency, reducing subsidies and other infructuous expenditures; and
b) Government is able to get much higher returns on its investments in the public
enterprise system and other parts of the public sector, like railways, posts and
telegraphs etc.

4.6.3 Production and Distribution Policy

No scheme worth its name can be successful if it does not aim at increased production
and productivity both in the agricultural and industrial sectors of the economy.

Alongwith this there is need for a well conceived distribution policy, We have
already experimented with two extreme forms of distribution system, viz., total
. dependence on private entrepreneurs to undertake the distribution of goods throughout
the length and breadth of the country, and total nationalisation of wholesale trade in
fosdgrains. Our experience has been that both of these systems are fraught with
dangers. We would suggest that the distribution system should be left to private
enterprise, but at the same time its working should be closely monitored and supervised
by the state agencies to prevent malpractices.

4.6.4 Administered Price Policy

In the context of administered price policy it is pertineit to note that the objectives
of fiscal stability and price stability do not always coincide. Though the increases in
administered prices by the PSUs relieve the exchequer of its obligation to provide
budgetary support to them, price hike in key inputs like petroleum products have a
cascading effect on the general price situation. Therefore, the price policy to be -
followed by the government is to be such as to break the tendency to move the
administered prices upwards at regular intervals.
Main F n t u r c ~of Indian 4.6.5 Commercial Policy
Economy

The export orientation of commercial policy and encouragement to inward inflow of

foreign exchange in any forms has come to be clearly established in more recent
years. This concern for exports arises largely out of balance of payments
consideratbns. This is as it should be in the prevailing economic scenario.

But in our zeal to earn foreign exchange we cannot afford to let the price situation
go out of hand. Given the present level of foreign exchange reserves the domestic
supplies of at least essential gpods would have to be maintained at levels that do not
fuel inflationary expectations. This will require in turn (a) liberal imports of
commodities, and (b) export-controls on commodities in short supply domestically.

4.6.6 Income Policy

For maintaining price stability it is important that a proper relationship between
different prices, between different incomes and between price structure and income
structure be evolved. Given a proper price-income structure, any rise in the income
of any factor should be consistent with the rise in productivity. It is also necessary
that the ri$e in money supply should not be more than that required for the genuine
.needs of #ti community such as the rise in the volume of transactions associated with
an incpe'ke in production and increase in the monetisation of existing transactions.

Check Your Progress 4

1) What type of monetary policy would you recommend for price stability?
..................................................................................................................................

2) Outlirhe the components of fiscal policy for price stability. /

..................................................................................................................................
3) What type of administered price policy w ~ u l d - ~ recommend
ou for price stability?
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4.7 A NOTE ON NEW WHOLESALE PRICE INDEX

(WPI) SERIES
The introduction of the revised series of Index numbers of wholesale prices, with
1993-94 as the base year, is expected to provide a more realistic picture of inflation.
The new base year has been chosen based on the well-known criteria, the desired
 Inflation in India
properties being: (i) a norn~alyear for level of production and trade as also for price
variations: (ii) a year for which rcliable price and other data are available; and (iii)
a year as recent as possible.

With a vie\\>to rcflccting adequately the changes that have taken place in the structure
of thc ccononij sirice 1981-82 (the base year of the old series), almost all the
important itenis being transacted in the econoniy have been included in the revised
indcx. Tlic neu scries with 1993-94 as the base has as many as 435 items in the
comniodity basket. Thus, the nuinber of items included in the new series is, in fact,
smaller than tllc 447 itcins in the 1981-82 series. However, the composition of the
ncw series has becii rationalised by incorporating newly emerging and important
iterus, dcletion of unimportant ones, 'unalganlation of less important items with
siiililar ones and splitting of certain items.

In all. 136 distinctly new itails have been added i11 the revised series. Besides, a
number of varictieslgrades. which are nierely quotations of some items in the 1981-
82 series without having ally wcight, havc been upgraded to the level of commodities
in the series. Again. a f c items
~ of the earlier serics have been amalgamated because
of their sinlilarity in characteristics and for making their description more purposefbl.
As many as ! 5 0 items figuring in the 1981-82 series have been dropped due to their
insignificant contribution in tenns of their relative value of production in the economy.
Only 68 pcr cci~tof the iten~s/cornn~odities are coininon in the d d and new series.
Sonic of thc important itenis tliat have entered the WPI commodities basket for the
tirst time arc electricity for railway traction, purified tereptlialic acid (PTA), injection
niouldcd plastic items, oxygen gas cylinder, railway sleepers (cement), thinner ms/
ss ingots. cold rolled sheets. LPG cylinder, jelly filled telephone cables, colour TV
sets. colnputcr and coniputer based systems. Some of the dropped items are mica,
imported pctroleuln crude. illdigenous petroleuni crude, khadi handloom cloth, broad
gauge opcn \vagons, and wrist watches.

The weight of 'prima5 articles' has significantly declined while that of 'manufactured
products' has gonc up considerably in the revlsed series. This situation has arisen
as a consequence of the relatively slo\\.er gro\ith in tlie agricultural sector particularly
-food articles' and 'noii-food articles - in the mqior group, -priman articles.. The
\vciglit of primary articles gro~lphas declined to 22.02 per cent in the new series
fro11132.29 in the 1981-82 scrics. 011 the othcr Iiaiid. thc \\eight of 'fie1 power, light
& lubricants' group has gonc up to 14.23 per cent from 10.66 per cent and that of
nlanufacturcd products' group has gone up to 63.75 per cent fro111 57.04 per cent.
The nc\v \\clghts arc in conformit? with the structural changes that have taken place
in the econoiily since thc introductioll of 1981-82 series.

A comparative analysis of tlie general wholesale price ~ndesof the revised series and
the earlier 1981-82 series shifted to 1993-94 base shoivs that the revised series starts
off from a level higher than the old series for the !ear 1994-95 and thereafter. the
tno series are more in consonance with each other. In fact, tlie rate of change :en the
revised series after 1994-95 is sli&tly lower than the old series as the commodity
colnpositioii of the revised serles reflects better quality products sometimes a little
higher in absolute price level.

The Workins Group uiider the Chain~iansliipof Prof. S. R. Hashim. which finalised
tlie compositioii of tlie ne\v WPI series. has stressed the need for more frequent
revisions in the \vliolesalc price i~ldexbecause of the greater integration of our
Main Fcatulvs of Indian Working Group has also suggested that a serious attempt be made to incorporate
Economy
services in the index, which occupies nearly one half of incomc generated 111 the
economy. It has suaested that initially the effort should begin with a restricted
number relatively important service industries for wvl~ichthe data are available and
eventually a new series of WPI combining the cornniodities and services may be
.
brought out. (Source : Economy Diary by S.D. Naik Business Line, and April 25.
2000) . ,
I

4.8 LET US SUM UP

,
A major objective of econonlic planning in India has bccn to promote economic a

growth in an environment of price stability. But thls goal has largely eluded us. Thc
price level began to rise after the First Five Year Plan and has slilce been continuously
rising. What has diffcred. hocvever. is the rate at nrhich prices have gonc up at
different stages. While during thc fifties and the sixties. inflation used to be moderate
and pba~esof stable prices intermingled with thosc of rising prices. the rate of
inflation picked up fast during the mid-seventies, and accelerated hrther during the
eighties And the early nineties. Illflation in India has been the mixture of demand-pull
and cost - push factors. Therefore. a set of measures need to be taken to restore price
stability in the economy.

4.9 KEY WORDS

Inflation: A sustained rise in the general price level
5 .

Cost-Push Inflation: A sustained rise in the general price level arising fro111 an
autonoinous rise in costs.
Demand-pull inflation: A sustained rise in aggregated demand: which results in
sustained rise in the general price level.
Real Income: The value of total output measured in 'constant prices' i,e., with the
general rate of inflation deducted so as to record the real command over resources.
Adrnidistered Prices: Prices, which are established by the conscious decision of
some individual or agency rather than by the impersonal play of market forces.
Administered pricing is generally possible where a good is sold by a public autl~ority.

4.10 SOME USEFUL BOOKS

Dhingra I.C. (2000). The Indian Economy: Environment and Policy (Chapter-lo).
Sultan Chand & Sons, New Delhi,
Governlent of India (2000). Economic Survey; 1999-2000 (Annuag. New Delhi
Jindal, Ajay (2000). A caged tiger called inflntion, the Economic Times, April 18.
Naik, S.D. (2000). New WPI Series: A inore realistic picture of inflation, Bzisiness
Line, April 25.
Plaiaing C o l r n ~ ~ i s s i o i ~).~ Ninth
( l ~ Five-Year Plan 1997-2002, New Delhi
Reserve Bank of India (2000). Report on Currency and Finance, 1999 Mumbai
 Inflation in India
4.11 ANSWERS / HINTS TO CHECK YOUR PROGRESS
EXERCISES

Check Your Progress 1

1 ) See Section 4.1
2) See Section 4.2
3) See Sub-section 4.3.3

Check Your Progress 2

1) See Section 4.4
2) See Sub-section 4.4.1
b

3) See Sub-section 4.4.2

?
Check Your Progressr3
1 ) See Section 4.5
2) See Section 4.5
3) See Section 4.5

Check Your Progress 4

1) See Sub-section 4.6:l
2) See Sub-section 4.6.2
3) See Sub-section 4.6.4