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RISING INFLATION

RISING INFLATION

  • Inflation has assumed a menacing proportion in almost all countries. The situation is the worst in the United States where the consumer price inflation stood at 8.56%, a level not reached for several decades. Consumer price index (CPI) inflation in India stood (in March 2022) at 6.95%. It is expected to rise further in the coming months.
  • On the other hand, the Wholesale Price Index (WPI) inflation had remained in double digits since April 2021. The GDP implicit price deflator-based inflation rate for 2021-22 is 9.6%.
  • In this context, it is imperative to understand the issue of inflation and measures that need to be taken in order to contain inflation.

Reasons for Inflation

  • Inflation in India cannot be described just as ‘cost-push’. Abundance of liquidity has been an important factor.
  • The April Monetary Policy statement talked of a liquidity overhang of the order of ₹8.5 lakh crore.
  • Beyond a point, inflation itself can hinder growth. Negative real rates of interest on savings are not conducive to growth. If we want to control inflation, action on liquidity is very much needed with a concomitant rise in the interest rate on deposits and loans.
  • The high rate of inflation in March 2022 is primarily due to rise in prices of crude petroleum and natural gas, mineral oils, basic metals, etc. owing to disruption in the global supply chain caused by the Russia-Ukraine conflict.
  • On the other hand, the retail inflation rose mainly on account of rising prices of essential food items like 'oils and fats', vegetables and protein-rich items such as 'meat and fish'.
  • As per the CPI data, inflation in 'oils and fats' in March soared to 18.79% as the geopolitical crisis due to the Russia-Ukraine war pushed edible oil prices higher.
  • Ukraine is a major exporter of sunflower oil. In vegetables, inflation quickened to 11.64% in March, while in 'meat and fish' the rate of price rise stood at 9.63 compared to February 2022.
  • The sharp rise in commodity prices across the world is a major reason behind the inflation spike in India. This is increasing the import cost for some of the crucial consumables, pushing inflation higher.

Impact of Inflation in India

  • Repo Rate - It is expected to push up interest rates in the banking system. Equated Monthly Installments (EMIs) on home, vehicle and other personal and corporate loans are likely to go up. Deposit rates, mainly fixed term rates, are also set to rise. Consumption and demand can be impacted by the Repo rate hike
  • CRR - The hike in CRR will suck out Rs 87,000 crore from the banking system. The lendable resources of banks will come down accordingly. It also means the cost of funds will go up and banks’ net interest margins could get adversely impacted. Net interest margin (NIM) is a measure of the difference between the interest income earned by a bank or other financial institution and the interest it pays out to its lenders (for example, depositors), relative to the amount of their assets that earn interest.

Challenges in Tackling Increasing Inflation

  • In the current situation, it is argued that inflation will come down, if some part of the increase in crude prices is absorbed by the government. There may be a case for reducing the duties on petroleum products for the simple reason that one segment of the population should not bear excessive burden. The same consideration applies to food prices.
  • But to think that it is a magic wand through which inflation can be avoided is wrong. If the additional burden borne by the government (through loss of revenue) is not offset by expenditures, the overall deficit will widen.
  • The borrowing programme will increase, and additional liquidity support may be required.
  • Central banks cannot order interest rates. For a rise in the interest rate to stick, appropriate actions must be taken to contract liquidity. That is what the rise in CRR will do. In the absence of a rise in CRR, liquidity will have to be sucked by open market operations.
  • As the RBI Governor put it in his statement, “Liquidity conditions need to be modulated in line with the policy action and stance to ensure their full and efficient transmission to the rest of the economy.”

Inflation directly affected to consumer equilibrium. At the time of inflation increases the prices of commodities increases which reduce the purchasing power of the consumers, and consumers have to reduce the consumption. Inflation has another bad side-effect…once people start to expect inflation, they will spend now rather than later. That’s because they know things will only cost more later. This consumer spending heats up the economy even more, leading to further inflation. This situation is known as spiraling inflation because it spirals out of control.