According to a recent Economic Times report, India’s headline retail inflation is expected to decline below 6% by the end of this fiscal year. Another piece in Business Standard states that Foreign Portfolio Investors (FPIs) invested ₹22000 crores in Indian markets in August as inflation concerns softened.

 

However, all these reports do not answer anything beyond numbers. What is so special about inflation that the news channels cover it, economists discuss it, and political parties fight over it?

 

Inflation significantly influences each of us – our food, choices, jobs, and even our politics are affected by inflation. In layman’s terms, inflation is an increase in prices, but there is much more to it.

 

This article will explain inflation, its factors, and some significant financial terms associated with it.

 

What is Inflation?

 

As most know, inflation is an increase in the general price of goods and services in an economy. So, for example, if goods and services cost ₹100 today and cost ₹104 the following year, the economy has been experiencing a 4% inflation or 4% price rise of goods and services.

 

How Is Inflation Calculated?

 

In India, there are two types of inflation: wholesale price index (WPI) and consumer price index (CPI). The former is the price of goods and services based on the prices charged by wholesale dealers. WPI data is released by the Ministry of Commerce. The latter was calculated based on the value paid by a consumer. Since CPI also considers the consumer’s tax, it becomes a better indicator of inflation for the public. Moreover, CPI is also known as ‘headline inflation’ because this inflation number occupies the headlines of our newspapers. The official CPI numbers are released by Central Statistical Office.

 

However, have you ever thought about what precisely the figure, say, 5% inflation means? Well, the prices of goods and services increased by 5%, but 5% of which price? This 5% increase is on the base year’s price of the basket of goods and services. The year 2012 is the current base year in India. So, 5% inflation means if a basket of goods cost ₹100 in 2012, but it costs around ₹105 this year.

 

The Price Movers

 

Do you ever think about the factors that move the prices in an economy? The forces of demand and supply determine the prices of goods and services in an economy. If more consumers need a product or service, the supplier will increase the price for more profit. As a result, some consumers would pay a higher price for the products and services they need.

 

Conversely, if the supply of a product or service exceeds the demand, the supplier would reduce the price to attract more customers or boost the demand. In other words, if people find a product or service available in plenty, they would never pay more prices for it.

 

Many factors influence inflation. For example, increased income or cheap credit push up the demand because every person has money to buy the products and services they need. This is why the government cannot print banknotes without taking note of inflation, as it can end up in ‘Demand-Pull Inflation.’

 

Black marketing or unchecked exports transform supply dynamics in an economy. Hoarding brings down supply and pushes up the prices. If exports increase, Indian goods get out of the country, turning those goods expensive in India. This type of inflation is known as ‘export-boom inflation.’

 

On the other hand, if imports increase, more goods will come to India, causing lower prices. This inflation usually happens in India, primarily for food products, known as ‘imported inflation.’

 

Sometimes, owing to the above factors, production costs shoot up. For example, an increase in diesel price shoots up the transportation costs. In addition, paying more salaries or hiring better talent brings extra costs to the company. This also makes the final product expensive. Hence, such inflation is knowns as ‘Cost-Push Inflation.’

 

The Measures of The Government to Counter Inflation

 

The Monetary Policy Committee (MPC) was established under the Reserve Bank of India (RBI) in June 2016. MPC is responsible for keeping inflation between 2% to 6% until 2021. In addition, a Price Stabilization Fund with a corpus of ₹500 crores has been created under the Department of Agriculture, Cooperation and Farmer’s Welfare (DAC & FW). When the food products’ prices fall below a sustainable level, this fund is used to buy those goods. On the other hand, when prices rise beyond a level, they sell the goods so that prices may come down.

 

Is 0% Inflation Possible?

 

Inflation is inevitable. If inflation is too low, people do not have enough money to buy things they need, or the suppliers are not getting enough consumers. So, they have no option but to sell their goods at whatever price they get from the market. While an increase in prices is called ‘inflation,’ the fall in prices is known as ‘deflation.’

 

A classical deflation scenario happened in September 2014 when food inflation reached 1.3%, and the farmers could not recover their cost of production.

 

There is another term called ‘disinflation.’ This term describes a scenario when the inflation index falls below 0% and turns detrimental to the economy. Disinflation also means that there are no economic activity and people have no money in hand to buy anything.

 

Inflation Caused by Fiscal Policies

 

Several fiscal policies induce inflation in our country. For example, an increase in tax rates causes ‘tax inflation.’ Likewise, excessive credit is pumped into the economy and creates ‘credit inflation.’ Sometimes, to repay the debt, the government risks printing more money. Since more money would come into the market, prices would rise. This is known as ‘deficit-push inflation.’

 

Conclusion

 

Inflation dramatically influences our lives. Our awareness of this economic phenomenon can help us understand the price of the goods and services in our economy. In a democratic country like India, such information would allow citizens to keep track of government policies and hold leaders accountable for their decisions and actions.

 

Inflation exists in both developed and developing countries. Hence, you would not be able to purchase the same goods and services next year with the same amount of money you can spend on the same goods and services this year. One of the efficient ways to beat inflation is by investing your money rather than saving it. So, the returns on your investments should beat the inflation rate.

 

Justin Raj

 

Alpha Research Team