Inflation

INTRODUCTION #

Inflation is defined as a situation in which there is a gradual rise in the general price level and a fall in the value purchasing power of any observed over a period of time which may generate expecta- tions of a further rise. Inflation implies a sustained, unchecked rise in the general price level observed over a period of time rather than a one-time rise.

VARIOUS FORMS OF INFLATION #

There are various forms of inflation depending upon its severity, causal factors and the kind of sectors it is related to. These are as follows:

• Galloping Inflation: Also known as hopping inflation/jumping inflation/ runaway inflation characterized by double or triple digit rise in the general price level which could be as high as 10 to 900 percent.
• Hyper Inflation: This implies a very rapid rate of increase up to a million percentage an- nual rise which results in a rapid fall in the purchasing power of money so much that people lose faith in the domestic currency and start opting for physical assets, gold and foreign currency. This may force the policy- makers to use an alternate currency or switch over to barter. The most prominent example of hyperinflation is the post First World War Germany (1920 – 23) when at the end of 1923.
• Core Inflation: It is defined on the basis of goods and services which may be excluded while calculating inflation. It is a popular concept used in western economics which ex- clude energy and food articles while calculat- ing inflation. Thus, core inflation is inflation

confined to non-energy and non-food article. In India non-food manufacturing inflation is defined as ‘core inflation’ by the RBI Within the non-food manufacturing group are com- modities like beverages, tobacco products, wood and wood products, chemicals and chemical products, machinery and transport equipment, capital goods and consumer dura- bles. Core inflation is also called Underlying inflation.

• Stagflation: This is a typical situation in which inflation coexists with recession and unemployment. It is essentially a combina- tion of high inflation and low growth.
• Deflation: This implies a sustained and wide- spread all in the general price level observed over a period of time. It is just the opposite of inflation.
• Disinflation: This implies a reduction in the rate of inflation. For example, if the rate of inflation falls from 8 per cent to 6 per cent to 4 per cent, we can call it disinflation.
• Reflation: It is a deliberate policy adopted by the government and monetary authorities to counter deflationary situation. This is done by higher public expenditure, tax cuts, interest rate reduction, etc.

Depending upon causal factors, inflation is cat- egorized into Demand-Pull inflation and Cost-Push inflation. The former sets of factors are those due to which there is an overall rise in the demand for goods and services in general. On the other hand, the latter set of factors are those due to which there is either a scarcity or shortfall in the supply of goods and services or/and an increase in the cost of pro-

duction and distribution of goods and services. A detailed explanation of these factors is given below, particularly how these factors manifest themselves in the Indian economy. In fact, causes of inflation in any economy can be explained only on the basis of Demand-Pull causes and Cost-Push causes.

A.   Demand-Pull Factors #

Mounting Government expenditure: Govern- ment expenditure has been rising steadily over the years. It implies a rising demand for goods and ser- vices. Moreover, continuous increase in government expenditure has the effect of putting in large money income in the hands of the general public thereby raising their purchase power and stoking the fire of inflation. In India, it is the non-plan expenditure, which is mainly responsible because most of the non-plan expenditure is non-productive and hence only added to purchasing power and demand without adding to production. Thus, too much money starts chasing too few goods.

1. Deficit Financing and increase in Money Supply: Mounting government expenditure financed through deficit financing i.e. print- ing of fresh currency directly pushes up mon- ey supply, increases purchasing power and breeds inflation without a corresponding rise in the supply of goods and services.
   1. Black Money: Unaccounted or black money plays an important role in pushing up prices by pushing up demand and conspicuous con- sumption. Black money estimated to be close to 50 percent of India’s GDP has a major role in fueling demand and leading to rise in prices.
   1. Population Pressure: Growing population also puts pressure on aggregate demand and on the price level. Indian Economy is partic- ularly affected due to pressure of population which results in expansion in demand for goods and services in general and results in inflationary pressures if supply falls to match demand.
   1. Forex Reserves: Rise in forex reserves leads to corresponding increase in domestic money supply and fuels inflation. As more foreign exchange comes into the country, RBI has to create corresponding domestic money.

• Excess liquidity created in the system due to

monetary and fiscal stimulus packages.

• Rising incomes and wages in India have also pushed up demand.

B.  Cost-Push and Supply-Related Factors #

1. Fluctuations in output and supply – Prices tend to rise when there occurs violent fluc- tuation in output or when there occurs specu- lative hoarding of the available output in the Indian context shortfalls in agricultural and industrial production are more often ob- served, leading to scarcity of goods and rise in price Level. Seasonal factors play a very important role in creating shortages of agri- cultural goods like fruits, vegetables, food grains from time to time.
   1. Rise in wages, which is greater than the rise in productivity, pushes up costs thereby push- es up the prices too This also acts on the De- mand-Pull side because rising wages lead to rising demand also.
   1. Indirect taxes are known to have cost-cas- cading effects. These taxes, like excise and custom duties, raise the cost of production as these taxes are on commodities. Also, State level taxes like VAT, Entry Tax, Octroi lead to rise final prices of goods and services.
   1. Infrastructural bottlenecks like shortage of power, transportation etc. raise per unit cost of production and hence the price level in- creases. These have played a very important role in fueling inflation in a country like India as these shortages raise per unit cost of both production and distribution.
   1. Increase in administered prices like procure- ment prices of food grains, petroleum prices and such other prices which are arbitrarily fixed by the government tend to push up the price level, as they have a high weightage in the price index.
   1. Rise in import prices pushes up domestic price level and leads to what is called import Cost-Push inflation. This factor is becoming increasingly important in a globalized scenario.

While the above Cost-Push factors are general- ized set of factors built into the Indian Economy,

there are other important factors causing distortions in the entire supply chain from time to time and creating artificial scarcity as well as critical supply bottleneck.

These are as follows:

1. Cartelisation practices adopted by traders of essential commodities particularly manufac- tured goods like cement, steel.
2. Entry barriers along the supply chain includ- ing high fees charged by State Governments under the APMC Act which proves prohibi- tive for new entrants to trade their products in the regulated markets.
3. Sudden flow of speculative capital into thin commodity futures markets, which has some impact on the spot market also.
4. High margins appropriated by middlemen all across the supply chain.
5. Costlier imports of some food items like edi- ble oils.
6. Rise in international prices of crude oil.
7. Speculation, hoarding, black marketing prac- tice of Indian traders to take advantage of ris- ing prices.
8. Depreciation of the rupee making imports costlier.

CONSEQUENCES OF INFLATION #

Apart from uncertainties in production, inflation causes certain serious imbalances in the economy. Price relationships are badly distorted and production pattern goes out of line with demand. As a result, there is misallocation of resources. Capital resources available in the country get diverted from long-term to short-term uses and production shifts from essen- tial to non-essential goods. For example, if prices of non-essential goods are rising and those of essential goods are not, it will be more profitable to invest resources for the production of non-essential goods.

Inflation leads to recession in many sectors of the economy. For example, as a result of inflation, prices of certain articles of consumption in India have increased to very high levels forcing demand for such goods to decline. Similarly inflation brings about a squeeze in purchasing power so that people incur increasing expenditure on essential goods

while expenditure on the other goods declines and causes recession in industries producing these goods.

Rise in price level has eroded the volume of investment in real terms in India on many occa- sions and has led to distortions in cost calculations. Inflation also leads to rise in interest rates as interest rates move ‘in tandem to keep abreast of inflation to put a curb on rise in demand for loans from banks.

The most serious effect of inflation is on distri- bution of incomes which makes better off and poor worse off. Profit earners gain because of inflation while people with fixed incomes tend to lose. Inflation has thus brought about shifts in distribu- tion of income in favor of the rich and perpetuated inequalities.

Inflation also breeds corruption black-marketing and speculation and is responsible for generation of black money.

Inflation mars incentive for hard work because common man cannot meet his ends with limited income.

Inflation also makes exports costlier and to that extent may impact balance of payments and exchange rate.

Rise in interest rates due to inflation can also make borrowing by the government costly and thereby raise fiscal deficit.

Measurement of Inflation #

In India inflation is measured on the basis of both the wholesale price index (WPI) and the consumer price index for Industrial Workers called the (CPI-lW). There are three distinct series of Consumer Price Index (CPI) used for monitoring retail price movements on a monthly basis. These are CPI (IW), CPI (AL) i.e. agricultural laborers and CPI (UNME) i.e. Urban Non-Manual Employees’ of these, CPI (IW) is the most popular and is also used for grant of Dearness Allowance to Central Government employees.

Consumer Price Index #

Consumer Price Index is a measure of change in retail prices of goods and services consumed by defined population group in a given area with reference to a base year. This basket of goods and

services represents the level of living or the utility derived by the consumers at given levels of their income, prices and tastes. The consumer price index number measures changes only in one of the factors; prices. This index is an important economic indicator and is widely considered as a barometer of inflation, a tool for monitoring price stability and as a deflator in national accounts. Consumer price index is used as a measure of inflation in around 157 countries. The dearness allowance of Government employees and wage contracts between labour and employer is based on this index.

Presently the consumer price indices compiled in India are CPI for Industrial workers CPI(IW), CPI for Agricultural Labourers CPI(AL) and; Rural Labour- ers CPI(RL) and (Urban) and CPI(Rural). Consumer Price Index for Urban Non Manual Employees was earlier computed by Central Statistical Organisation. However this index has been discontinued since April 2008.The CPI(IW) and CPI(AL& RL) compiled are occupation specific and centre specific and are compiled by Labour Bureau. This means that these index numbers measure changes in the retail price of the basket of goods and services consumed by the specific occupational groups in the specific centres. CPI (Urban) and CPI (Rural) are new indices in the group of Consumer price index and has a wider coverage of population. This index compiled by Central Statistical Organisation tries to encompass the entire population and is likely to replace all the other indices presently compiled. In addition to this, Consumer Food Price Indices (CFPI) for all India for rural, urban and combined separately are also released w.e.f May, 2014.

Price data are collected from selected towns by the Field Operations Division of NSSO and from selected villages by the Department of Posts. Price data are received through web portals being main- tained by the National Informatics Centre (NIC).

The Reserve Bank of India (RBI) has started using CPI-combined as the sole inflation measure for the purpose of monetary policy. As per the agreement on Monetary Policy Framework between the Government and the RBI dated February 20, 2015 the sole of objective of RBI is price stability and a target is set for inflation as measured by the Consumer Price Index-Combined.

RECENT DEVELOPMENT #

The government on May 2017, has revised the wholesale price index (WPI) by shifting to a new base year of 2011-12 from 2004-05 and added a new WPI food index to capture the rate of inflation in food items. Revision of macroeconomic data is undertaken to reflect changes in the economy. The WPI series had undergone six revisions in the past. Apart from a new base year, the revision also includes change in the basket of commodities and assigning of new weights. Under the revamped data series, the number of items have gone up to 697 from 676.The data now has 199 new items and

146 items have been deleted and has quotations from 8,331 sources compared with 5.482 in the old series. In the new WPI series, prices used for compilation do not include indirect taxes in order to remove the impact of fiscal policy. This is in line with international practices and moves the WPI closer to the producer price index. Seasonality of fruits and vegetables has been updated to account for more months as these are now available for longer duration. The government has also set up a technical review committee, which will ensure that the product mix keeps pace with changing structure of the economy. Under primary articles, new veg- etables and fruits such as radish, carrot, cucumber, bitter gourd, mosambi, pomegranate, jack fruit, pear have been added. Around 173 new items have been added under the manufactured products category, while 135 items have been dropped. The new WPI food index will be compiled by combining food articles under primary articles and food products under manufactured products.

Wholesale Price Index (WPI) #

Wholesale Price Index (WPI) measures the average change in the prices of commodities for bulk sale at the level of early stage of transactions. The index basket of the WPI covers commodities falling under the three major groups namely Pri- mary Articles, Fuel and Power and Manufactured products. (The index basket of the present 2011-12 series has a total of 697 items including 117 items for Primary Articles, 16 items for Fuel & Power and 564 items for Manufactured Products.) The prices tracked are ex- factory price for manufactured products, mandi price for agricultural commodities

and ex-mines prices for minerals. Weights given to each commodity covered in the WPI basket is based on the value of production adjusted for net imports. WPI basket does not cover services.

In India WPI is also known as the headline inflation rate.

In India, Office of Economic Advisor (OEA), Department of Industrial Policy and Promotion, Min- istry of Commerce and Industry calculates the WPI.

The main uses of WPI are the following: #

1. To provide estimates of inflation at the whole- sale transaction level for the economy as a whole. This helps in timely intervention by the Government to check inflation in particu- lar, in essential commodities, before the price increase spill over to retail prices.
2. WPI is used as deflator for many sectors of the economy including for estimating GDP by Central Statistical Organisation (CSO).
3. WPI is also used for indexation by users in business contracts.
4. Global investors also track WPI as one of the key macro indicators for their investment de- cisions.

The Government periodically reviews and revises the base year of the WPI as a regular exercise to capture structural changes in the economy and improve the quality, coverage and representativeness of the indices. The Wholesale Price Index (WPI) series in India has undergone six revisions in 1952- 53, 1961-62, 1970-71, 1981-82, 1993-94 and 2004-

05 so far. The base year of All-India WPI has been revised from 2004-05 to 2011-12 on 12 May 2017 to align it with the base year of other macroeconomic indicators like the Gross Domestic Product (GDP) and Index of Industrial Production (IIP). The current series is the seventh revision.

The revision entails not just shifting the base year to 2011-12 from 2004-05, but also changing the basket of commodities and assigning new weights to the commodities.

The new series with base 2011-12=100, was based on the recommendations of the Working Group which was constituted on 19th March 2012 under the chairmanship of Late Dr. Saumitra Chaud-

huri, Member, erstwhile Planning Commission. The committee submitted its report in March 2014.

Wholesale price index calculated with 2011-12 base year does not include taxes in order to remove the impact of fiscal policy. This also brings the pres- ent WPI series closer to Producer Price Index, as is practised globally. A Producer Price Index reflects the change in average prices that producers get. The exclusion of indirect taxes would also ensure the continuity and compatibility of new WPI series as and when Goods and Services Tax (GST) is introduced.WPI is used as a deflator for nominal macroeconomic aggregates like GDP and IIP. Since the nominal estimates are computed at basic price which does not include product taxes, excluding indirect taxes from WPI makes it a compatible and appropriate deflator.

Wholesale Price Index (WPI) Vs Consumer Price Index (CPI)

WPI reflects the change in average prices for bulk sale of commodities at the first stage of transac- tion while CPI reflects the average change in prices at retail level paid by the consumer.

The prices used for compilation of WPI are col- lected at ex-factory level for manufactured products, at ex-mine level for mineral products and mandi level for agricultural products. In contrast, retail prices applicable to consumers and collected from various markets are used to compile CPI.

The reasons for the divergence between the two indices can also be partly attributed to the difference in the weight of food group in the two baskets. CPI Food group has a weight of 39.1 per cent as compared to the combined weight of 24.4 per cent (Food articles and Manufactured Food products) in WPI basket.

The CPI basket consists of services like housing, education, medical care, recreation etc. which are not part of WPI basket. A significant proportion of WPI item basket represents manufacturing inputs and intermediate goods like minerals, basic metals, machinery etc. whose prices are influenced by global factors but these are not directly consumed by the households and are not part of the CPI item basket.

Thus even significant price movements in items included in WPI basket need not necessarily trans-

late into movements in CPI in the short run. The rise or fall in prices at wholesale level spill over to the retail level after a lag.

Similarly, the movement in prices of non-trad- able items included in the CPI basket widens the gap between WPI and CPI movements. The relative price trends of tradable vis a vis non-tradable is an important explanatory factor for divergence in the two indices in the short term.

Key Highlights of WPI with 2011-12 as base year

In the new and presently running WPI series, significant improvement in concept, coverage and methodology has been made. In the updated WPI basket, the number of items has been increased from 676 to 697. In all 199 new items have been added and 146 old items have been dropped . Efforts have been made to enhance the number of quotations from 5482 to 8331, an increase by 2849 quotations (52%) . The increase in number of quotations has been done across the major groups to ensure com- prehensive coverage and representativeness. New definition of wholesale price index does not include taxes in order to remove impact of fiscal policy. This also brings new WPI series closer to Producer Price Index and is in consonance with the global practices. The item level indices are being compiled based on statistically robust Geometric mean as compared to Arithmetic mean used in the WPI 2004-05 series. (The formula geometric mean is used for calculation of elementary indices by CSO in its CPI series. Prior to independence, the WPI was computed using Geometric Mean. The weighted arithmetic mean was adopted in preference to weighted geometric mean since independence, due to increase in num- ber of commodities and consequent computational complexities.) Further for the first time a Technical Review Committee has been set up to recommend appropriate methodological intervention to contin- uously improve coverage, quality and timeliness of the WPI. The new series also present separate ‘WPI Food Index’ which along with CPI Food Price Index published by CSO would help monitor the food inflation effectively. Further, seasonality of fruits and vegetables has been updated to account for more months as these are now available for longer duration. (For example, tomato price index will now

be available around the year as against eight months in the current series of WPI (base 2004-05). Cauli- flower was earlier available only for six months but now it will be available for eight month in the year.)

The major changes in weights, number of items and quotations between WPI 2004-05 and WPI 2011-12 are given in the table below:

Major Group	Weights		No. of Items		No. of Quotations
	2004-05	2011-12	2004-05	2011-12	2004-05	2011-12
All Commod- ities	100.00	100.00	676	697	5482	8331
Primary Articles	20.12	22.62	102	117	579	983
Fuel & Power	14.91	13.15	19	16	72	442
Manufactured Products	64.97	64.23	555	564	4831	6906

The inflation for “All Commodities” in the new series of WPI (2011-12) is, in general, lower than 2004-05 series due to shift to latest base year. The minor variation in rate of inflation estimates can be attributed to the changes in weighting structure, increase in number of quotations, inclusion of new items and exclusion of obsolete items, exclusion of indirect taxes and use of geometric mean instead of arithmetic mean in the new series.

Changes in Commodity basket under WPI (2011-12 = 100) #

In the revised WPI basket, total of 199 new items have been added and 146 items have been deleted. In all 498 items are common between the 2004 -05 and 2011-12 series.

Primary Articles #

In the Primary Articles, new vegetables and fruits such as Radish, Carrot, Cucumber, Bitter Gourd, Mosambi, Pomegranate, Jack Fruit, and Pear etc have been added. In the mineral group items like Copper Concentrate, Lead Concentrate and Garnet have been added whereas Copper Ore, Gypsum, Kaolin, Dolomite, Magnesite have been deleted. Natural Gas has been added as a new item.

Fuel and Power #

In the Fuel and Power Major Group, the index for non-coking coal will also be available at a disaggregated level based on Gross Calorific Value (GCV) to cater to the requirements of diverse user groups. The item coke has been dropped.

The electricity sector is now a single item group that includes data relating to average rate of sale of power by generating stations to distributors. In contrast, in WPI (Base 2004-05) retail level tariffs applicable to different sectors such as agriculture, industry, domestic, commercial and railways were used for compilation of WPI for electricity. In the new series, monthly average rate of sale of power of 49 selected generating stations covering Hydro and Thermal sectors is being used to compile the index for electricity.

In the Mineral oil sub-group, Light Diesel Oil has been deleted in view of its decreasing impor- tance while Petroleum coke has been added as a new item owing to its growing importance. There have been some changes in weights of the retained mineral fuels. The number of quotations has been increased significantly to give wider geographical coverage.

Also the number of quotations for Fuel & Power has increased from 72 in WPI (2004-05) to 442 in WPI (2011-12) as per the details given below:

Coal: In new series, pithead run of mine notified prices for both regulated and unregulated sectors from all mines and for all grades is being used. This change has increased the number of quotations for coal from 20 in current series to 127 in new series.

Electricity: There is a change in the definition of prices for computation of price index for electricity from considering use based retail prices in the WPI (2004-05) to using average rate of sale of power of selected generating stations in the new series WPI (2011-12). There is a substantial increase in number of quotations from 5 in 2004-05 series to 49 in new series covering Hydro; Thermal (coal and gas) based plants.

Mineral Oil: Number of quotations under min- eral oil has increased from 47 in current series to 266 in new series due to increased coverage of refineries and varieties.

Manufactured Products #

A major review of manufactured products has been carried out. Accordingly, the number of 2 digit groups has been increased from 12 to 22 in the new series in keeping with National Industrial Classifi- cation (NIC) of 2008. Around 173 new items like

Conveyer Belt, Rubber Tread, Steel Cables, Tissue Paper, Wooden Splint, XLPE Compound have been added while 135 items like Khandsari, Papad, Video CD-Players, etc., have been dropped.

Assigning weights to commodities constituting WPI #

The weight of an item in the WPI basket is based on the net traded value of the item in the base year i.e. 2011-12. The net traded value is the value of output of the item in the year 2011-12 adjusted for net imports. Thus, net traded value represents the total transactions of each product in the economy during the base year. However the weight assigned to crude petroleum is based on the value of domestic production only as crude petroleum is not directly traded in the market and its derivatives ( petroleum products ) are assigned due weight based on net traded value.

Weights can change from series to series depend- ing on addition /deletion of items or regrouping of commodities etc. Some real examples are given below.

The weight of the Primary Article has increased from 20.1 % in WPI (2004-05) to 22.6% in WPI

(2011-12). This increase is primarily attributed to the increase in the weight of “Crude Petroleum” from 0.90% in 2004-05 series to 1.94% in 2011-12 series and addition of one new item “Natural gas” with 0.46% weight. It may be noted that the average price of crude oil (Indian basket) was at peak in 2011-12.

In the 2004-05 series, Manufacture of textiles had a weight of 7.33%. This has now been bifurcated into 2 sub-groups in 2011-12 namely Manufacture of Textiles and Manufacture of Wearing Apparel. The combined weight of these groups is 5.69% in 2011-12 series. The decrease in this Group’s weight is due to some items which were earlier classified under textile such as polyster staple fibre, viscose staple fibre, viscose staple fibre and acrylic fibre have now been put under the chemical group given their widespread applicability, not restricted to tex- tile sector.

Weights of major groups in WPI may also be at variance with their share in GDP.This is because the Wholesale Price Index (WPI) is an index covering prices of products/commodities only pertaining to

four sectors comprising agriculture, mining, manu- facturing and electricity. The other sectors of GDP, in particular, services sector are not covered under WPI. The share of these four sectors in GDP at current prices in 2011-12 was 41.4%. The weighting diagram of WPI is not drawn on the basis of gross value added which is a concept in GDP. The weights are derived on the basis of turnover or value of output adjusted for net imports. The ratio of gross value added to value of output differs significantly in the sectors covered under WPI.

Impact of the Revision in base year #

WPI is used as the main deflator in estimating many macro-economic variables including for deflat- ing the core ingredients in the annual and quarterly national accounts and forecasts of GDP. The impact of revision in WPI would thus get reflected in all those variables which uses WPI as a deflator.

For instance, when WPI is lower, as is the case with the revision to 2011-12 series, real gross value added (GVA) would increase, thereby showing an increase in GDP. The downward revision in WPI may enhance the divergence with consumer price index..

Broadly, two sets of measures are ado ted to curb inflation as follows:

1. Monetary Policy: This policy adopts quanti- tative: and qualitative credit control measures to address inflation, by and large the RBI use Repo Rate and Cash Reserve Ratio to tame inflation from time to time.
2. Fiscal Policy: This is used mainly by way of reduction of import duties on essential items as well as selective reduction of excise duties.

However, both these policies may have limited impact on controlling inflation. As such, more often the government adopts several administrative meas- ures to control inflation which are as follows:

1. Levy obligation in respect of all imported raw

sugar and white/refined sugar removed.

• Export of non-basmati rice, edible oils (ex- cept coconut oil and forest based oil) and pulses (except Kabuli chana) banned.
  • Minimum export price (used to regulate ex- ports of onion and basmati rice.

• Futures trading in rice, urad and tur suspend- ed by the Forward Market Commission.

Producer Price Index –

A Producer Price Index (PPI) measures price change from producers’ perspective as against the Consumer Price Index (CPI), which measures price change from consumers’ perspective. Most of the countries have switched over to PPI from WPI. In PPI, only basic prices are used for compilation, while taxes, trade margins and transport costs are excluded. PPI is considered to be a better measure of inflation as price changes at crude and interme- diate stages can be tracked before it creeps into the finished goods stage.

The government has set up a committee to devise an all-new barometer called the Producer Price Index as it is readying to consign the Whole- sale Price Index to history; months after Reserve Bank of India started giving more importance to the upgraded Consumer Price Index as a gauge of infla- tion. The proposed Index will seek to bring India’s inflation gauge on a par with international standards, with PPI tracking changes at the producer level for both goods and services and CPI providing details of retail prices. The 13 member committee is headed by Professor BN Goldar and has representation from various central ministries and departments.

PPI is a totally new concept for India. It involves a lot of work. WPI includes taxes while PPI tracks inflation minus tax component. The most important part of PPI will be services as currently there is no index tracking inflation in the sector that contributes about 55% to India’s GDP.

PPI will track average change over time in sell- ing prices received by domestic producers for their output for both goods and services while WPI tracks transaction only at the wholesale level for goods.

Prices included in PPI are from the first com- mercial transaction for many products and some services. The committee will outline methodology and timelines for launch of PPI series to initially run parallel to WPI and later replace it.

Inflation Targeting #

Inflation Targeting implies that the principal objective of monetary policy of the central bank is

to achieve rice stability by setting a certain numeri- cal target of inflation or range of inflation within a particular time frame. Some countries have adopted point targets while others are following a more flexible target of inflation within a band/range.

New Zealand was the first country to adopt infla- tion targeting in 1989 and at present most advanced nations as well as some developing nations adopt inflation targeting. A Committee was headed by Urjit Patel which recommended inflation targeting.

Inflation Targeting In India #

Inflation targeting is a monetary policy strategy used by Central Banks for maintaining price level at a certain level or within a range. It indicates the primacy of price stability as the key objective of monetary policy. The argument for price stability stems from the fact that rising prices create uncer- tainties in decision making, adversely affecting savings and encouraging speculative investments. Inflation targeting brings in more predictability and transparency in deciding monetary policy. If the cen- tral banks could ensure price stability, households and companies can plan ahead, negotiating wages on the basis of expecting low and stable inflation. Various advanced economies including United States, Canada and Australia have been using infla- tion targeting as a strategy in their monetary policy framework. The case for inflation targeting has been made in India as the country has been experiencing a high level of inflation till recently.

The Reserve Bank of India and Government of India signed a Monetary Policy Framework Agree- ment on 20th February 2015. As per terms of the agreement, the objective of monetary policy frame- work would be primarily to maintain price stability, while keeping in mind the objective of growth. The monetary policy framework would be operated by the RBI. RBI would aim to contain consumer price inflation within 6 percent by January 2016 and within 4 percent with a band of (+/-) 2 percent for all subsequent years.

The central bank would be seen as failing to meet the targets, if retail inflation is more than 6 per cent for three consecutive quarters from 2015- 16 and less than 2 per cent for three consecutive quarters from 2016-17. If this happens, RBI will

have to explain the reason for its failure to meet as well as give a timeframe within which it will achieve it. RBI will publish the operating targets as well as operating procedure for the monetary policy though which the target for the monetary policy will be achieved. The RBI will also be required to bring a document every six months to explain the sources of inflation and forecast for inflation for next 6-18 months.

RBI has been using headline CPI (Combined) inflation as the nominal anchor for monetary policy stance from April 2014 onwards.

RBI in its Monetary Policy Report in April 2015 stated that this flexible inflation targeting (FIT) framework greatly enhances the credibility and effectiveness of monetary policy, and particularly, the pursuit of the inflation targets that have been set. The commitment of the Government to this framework enhances credibility significantly since it indicates that the Government will do its part on the fiscal side and on supply constraints to reduce the burden on monetary policy in achieving price stability.

Management of monetary policy and the express objective of inflation targeting has been enshrined as the responsibility of RBI by amending the preamble of the RBI Act, 1934 through the Finance Act 2016 (Chapter XII). Thus, ensuring price stability through inflation targeting is a legal responsibility of RBI since 2016. A new Chapter (Chapter IIIF, Section 45Z) was introduced in the RBI Act, through this Finance Bill, 2016, for detailing the operation of a Monetary Policy Committee (MPC), which would be the institutional arrangement at the disposal of RBI for targeting inflation.

Under Section 45ZA(1) of the RBI Act, 1934, the Central Government determines the inflation target in terms of the Consumer Price Index, once in every five years in consultation with the RBI. This target would be notified in the Official Gazette. Amongst other measures, RBI targets inflation primarily by changing the “Policy Rate” which means the rate for repo-transactions as defined under sub-section (12AB) of section 17 of the RBI Act.

Factors constituting failure to meet inflation target under the MPC Framework was notified on 27 June 2016. In exercise of the powers conferred

by section 45ZN of the RBI Act, 1934, the Central Government notified the following as factors that con- stitute failure to achieve the inflation target, namely:

• the average inflation is more than the upper tolerance level of the inflation target notified under section 45ZA of the RBI Act for any three consecutive quarters; or
• the average inflation is less than the lower tolerance level of the inflation target notified under section 45ZA of the RBI Act for any three consecutive quarters.

The provisions of the RBI Act relating to the chapter on Monetary Policy have been brought into force through a Notification in the Gazette of India on 27.6.2016. The Rules governing the Procedure for Selection of Members of Monetary Policy Committee and Terms and Conditions of their Appointment and factors constituting failure to meet inflation target under the MPC Framework have also been notified in the Gazette on 27.6.2016. The Government, in consultation with the RBI, has notified the inflation target in the Gazette of India dated 5th August 2016, for the five year period beginning from the date of publication of this notification

SERVICES PRICE INDEX #

Given the importance of the service sector, there is need to develop service price indices for selected service sectors, particularly in the National Accounts framework. Accordingly, the Office of the Economic Advisor, Department of Industrial Policy and Pro- motion, Ministry of commerce and industry has been in the process of developing Service Sector price indices as per international best practices. Studies are being commissioned for selected services like road transport, railways, air transport, port, bank- ing, insurance, posts, telecommunications, business services and trade services to develop service price index. The need for a services sector price index in India is warranted by the growing dominance of the sector in the economy.

REAL ESTATE/HOUSING PRICE INDEX #

Rapid urbanisation and high economic growth experienced by the urban centers in the last few

years has resulted in an upsurge in property values. The importance of facilitating supply of affordable housing to the people and the necessity of designing a right mix of policy initiatives to encourage house acquisition highlights the necessity of tracking the movement of residential house prices. Moreover, the real estate assets are a significant component of the wealth of the private sector and financial freedom allowed for acquiring this wealth is one of the important financial obligations of this sector. The authentic data on the real estate sector in the country, development of a credible database on market driven price trends and price index of market-segments have, therefore, emerged as a crucial elements of market development and for enhancing the effi- ciency of market processes. The NHB RESIDEX is an initiative of the National Housing Bank (NHB) to provide an index of residential prices in India across cities and overtime. The NHB RESIDEX now covers 15 cities and is updated and released on a quarterly basis with 2007 as base year.

BASE EFFECT #

This is defined on the basis of the impact of rise in price level in the previous year over the corresponding rise in the price level in the current year. It is calculated by dividing the rise in price index in the current year (numerator) byprice index in the previous year. For example, price index may be 100, 130, 160 and 190 in 2010, 2011, 2012 and

2013 respectively.

Inflation rate in 2011 will be 30/1 00 x 100 = 30 per cent

Inflation rate in 2012 will be 30/1 30 x 100 = 23 per cent

Inflation rate in 2013 will be 30/160 x 100 =

18.75 per cent

PHILLIPS CURVE #

The curve given by A.W. Phillip of New Zealand establishes relationship between rate of inflation and rate of unemployment. It state that there is an inverse relationship between the two in the sense that if a nation wants low rate of inflation it must be prepared for a high rate of unemployment and vice versa.