What is inflation?
Inflation is a general increase in the price of products and services with the fall in the purchasing value of money. It is an important factor to assess the economy of any nation.
How inflation is calculated in India?
In India inflation is calculated by using the Wholesale Price Index (WPI). But this system is considered backward as compared to the Consumer Price Index (CPI), a method that is used by the developed countries to calculate inflation.
The Wholesale Price Index or WPI is the price of certain wholesale goods. Any change in this index, points towards inflation. Earlier WPI figures used to be released on every Thursday but now these figures are updated on monthly basis. The main focus is on goods traded between corporations. These figures affect the stock exchange and fixed price market in India.
Different commodities for calculating WPI are chosen on the basis of their importance in a region. Then the wholesale price of these commodities is taken up to calculate the Wholesale Price Index. In1993-94 there were 435 items but at present there are about 676 items in the list of WPI.
In India, there are three groups of Wholesale Price Index
– Primary Articles (20.1 percent of total weight),
– Fuel and Power (14.9 percent) and
– Manufactured Products (65 percent).
What leads to inflation?
Inflation is also determined by demand and supply factor. Inflation is accelerated in case demand is more than supply. India has the capacity to produce 550 units of major commodities but the demand for the same is 700 units. If both demand and supply are considered, then supply is more important from inflation point of view.
India is basically an agrarian country where grains are produced in an enormous quantity. But lack of proper storage facilities and their damage in transit lead to the scarcity of food grains. Production cost is also high as the cost of labour is more. All this results in low supply leading to inflation.
Domestic factors like under developed economies because of lesser developed financial market also cause inflation.
Inflation in India is also affected by the exchange rate. When the price of goods in United States of America increases, inflation in India increases as commodities are imported at a higher price.
In May 2013 the inflation rate in India was 4.70%, in July it was 4.86% and in August inflation rate was 5.79%.
Why India is not using advance method of calculating inflation?
Economists V Shunmugam and D G Prasad who are working with India’s largest commodity bourse — the Multi Commodity Exchange argued that government should immediately shift to another method of calculating inflation as present method has many flaws. Many commodities that are not even used by the end consumer are used to calculate inflation in WPI.
But demographic and structure of India does not allow it to use the advance method. Consumer Price Index in India is difficult to adopt as four types of CPI indices are there in India:
- CPI Industrial Workers
- CPI Urban Non-Manual Employees
- CPI Agricultural labourers
- CPI Rural labour
Then lag in reporting makes it difficult to use CPI method for calculating inflation.
Impact of Inflation
In inflation money supply increases that impact both economy as well as social life of the nation.
Value of money is eroded by inflation that we are seeing at present. There comes a decline in worth and purchasing power of Rupee.
Controlling inflation is highly important for a balanced progress in India. India has huge population of poor. They bear the impact of inflation greater than any other segment of society. So keeping inflation low is the need of the day.
High inflation adversely affects the trade.
Common man suffers the most due to inflation as general price of all the essential commodities gets hiked. His monthly income becomes less than expenditure leading to burden and pressure to earn more. Also fall in household savings have been observed at the time of inflation.
In present inflation state, cost of daily usable items like food and milk has gone up by 12% that constitute about 30-40% of monthly expenditure. After spending so much on these items he is left with very little money for other things.
There is an increase in home loan rates by 1-2%. This has a direct impact on EMI.
Hike in petrol and diesel prices.
All this leads to a decline in the standard of living.
How to control inflation in India?
In order to control inflation in India, work needs to be done on several fronts. Major reason of inflation in India is the ever increasing difference between Aggregate Demand and Aggregate Supply. In India supply is almost constant where as demand is increasing. So if India wants to control inflation then this gap has to be reduced. India must focus on demand and supply of goods and commodities. To achieve this either we have to increase the capacity of present production units or build new one.
India must work on its infrastructure to improve the efficiency that will ultimately bring down the price. Like transporting goods via rail is a cheaper option than road. But as compared to rail our road network is much developed so we are using the costlier option leading to more cost.
India must structure its domestic economy as there is no control on external economic conditions of the world. Exchange rate stability is must to achieve so that international price pressure can be controlled to an extent.
Bulk of fuel requirement is met by imports in India. An alternative to this must be implemented to reduce inflation.