There are a
myriad of reasons for the rising inflation.Let us
first understand –what inflation actually is.
Simply put,
inflation is the increase in the prices of goods and services from their
previous level. Inflation erodes the purchasing power of the currency - this
means Rs. 100 shall now fetch you fewer goods and services than what it could
buy earlier.
What is
the basic theoretical cause of the inflation?
‘Demand and
Supply Rule’ explains the basic reason for the inflation. When demand for goods
and services increases and if this elevated demand is not counterbalanced by
the increased supply then the prices of goods or services are liable to rise.
There are a
score of reasons for the elevated demand but we shall restrict ourselves
to the vital-few.
·
The excess money in the economy: When this excess money chases available goods
and services in the system, inflation rises.
When money supply in the system increases RBI hikes the policy rates to suck the money (liquidity) from
the economy. But policy rates can’t be hiked beyond a limit as it unfavorably
hinders the growth of the economy.
·
Growing population of India: Burgeoning population of India keeps the demand high. Australia has
around double geographical area than India but strange thing is that India’s
population increases every year by about Australia’s total population.
Pragmatic
reasons responsible for rising inflation in India
(1) US Money Printing: To prop up the fledgling USA economy
US Federal Reserve opted for the Quantitative Easing or the money
printing. As interest rates in USA were hovering near zero level and significant
portion of this money was routed to India for better returns as Interest rates
in India were much higher than US rates and equity markets in India too were
more promising.
This money entered India at such a high speed which resulted in the
meteoric rise of the capital markets. Everybody was talking about 10 % GDP growth rate.
But 2008-crisis changed the situation and growth rate of Indian GDP slid
miserably.
Foreign money which entered India too started departing back.
But inflation once increased did not retrace and momentum of inflation
continued.
US quantitative easing spooked big investors and they became skeptical
about Fiat Money and raised their allocation in gold and this resulted in gold soaring new heights day
by day.
Soaring gold prices resulted in higher Indian gold import and subsequent
higher Current Account Deficit.
If in future too, if US goes for QE3 and part-proceeds comes to India,
inflation shall keep on rising.
(2) Chinese growth: Chinese export-oriented economy
which is driven by low-cost manufacturing fuelled the global commodity prices.
Barring Aluminium almost all commodities tripled or quadrupled in price. Even
though presently Chinese economy is slowing but commodities never landed to
their previous price level. Again if Chinese economy picks up, demand for the
commodities shall shoot up further pushing the inflation higher.
Cheap Chinese manufacturing badly affected the exports of Indian capital
goods companies and their export took a hit. Lesser exports meant lesser flow
of foreign currency (mainly dollar) and weaker rupee.
General inflation rises in a nation with the weaker local currency.
(3) Weaker Rupee: After 2008- crisis crude prices
bottomed around 35 US dollars per barrel and presently crude prices are
hovering around 91 dollars per barrel.
This means crude prices have risen by around 160 %- but wait are we
missing something?
Yes.
Crude is bought in dollars and therefore rupee-dollar exchange rates come
into play.
Let’s understand this-
Date
|
Crude prices
|
Dollar-rupee exchange rate
|
Feb 09
|
35 $/barrel
|
44 Rs.
|
May 12
|
91 $/barrel
|
56 Rs.
|
Simply put, in Feb 09, crude was 1540 Rs. per barrel while presently we
need 5096 Rs. for a barrel, this means in rupee terms crude oil has become
dearer by whopping 230 %.
In India petro-product prices are regulated by the government. On papers
only, petrol prices are not regulated by the government but in reality oil
marketing companies can’t hike petrol prices on their own.
Some of you may argue that if petrol prices are governed by the
government than how crude prices could increase the inflation?
Though prices are regulated by
the Indian government but government keeps on hiking the petro prices though
not proportionately with the rising international crude prices.
As dollar is the world’s reserve currency and a majority of global
financial transactions take place in dollar. Any currency depreciating against
the dollar makes the import costlier and trade deficit
of that nation widens. Recently dollar has appreciated against all major
currencies including Euro and Rupee.
Rupee depreciation has made imports costlier for India. 70% of
India’s oil need is catered through imports and in aforesaid point we have
already seen how depreciating rupee increments the trade deficit.
Europe’s debt crisis resulted in Euro depreciating against the dollar and subsequent rise in
the dollar index. This happened as investors
withdrew money from India to park their assets in dollar denominated safe
assets and to meet the financial obligations arising in the Euro region.
Weaker rupee not only affects crude only but imported fertilizers, steel
and coal too become costlier. As coal is
used in cement and steel manufacturing we see cascading inflation. Expensive
fertilizer prices, ultimately translates into dearer food items.
Higher crude price results in higher transportation costs and that makes
each and every commodity (that requires transportation) dearer.
(4) Food inflation: This is one of the vital policy-led reasons
responsible for the inflation. Recently food inflation has played a pivotal
role in boosting the overall inflation. A few of Government’s faulty policies
are responsible for the food item induced inflation-
·
MSP hike for political benefits: MSP or
Minimum Support Price is the minimum price at which government buys grains,
cereals and other agricultural produce from the farmers.
In India around 70 % of
the total wheat produced that comes to mandi
(trading arena) is bought by the government, so bread, biscuit and flour
makers can buy remaining 30 % of the wheat that too at higher prices. This is
why bread price has been doubled in the last 5 years.
Not only central
government but state-governments also buy the produce that too at even higher
prices.
If market price of wheat
is Rs. 10-12 per KG than government buys it at Rs. 14-16 thus incurring a loss
of Rs. 4 per kg.
Now the million
dollar question, what government will do with this wheat?
It distributes little
portion of it through rationalized shops at much subsidized rate and rest is simply
handed over to FCI (Food Corporation of India). As storing 6.3 crore tonne
wheat is not a simple job, this wheat rots/spoils as government can’t afford to
bear the storage cost.
Government should stop
buying agro-products directly from all the farmers to garner votes and instead
let this produce come in the market for the fair price discovery .Government
should buy from poor farmers only.
·
Decreasing acreage in the name of development
Visit any district
magistrate’s office and you shall find ‘Applications for the Land Diversion’
piled up. Diversion is the process of granting the permission to start
commercial operation on an agricultural land.
With real estate prices
skyrocketing, many farmers preferred to sell their land to commercial builders.
Recently in Singur (WB),
1000 acres of fertile land was seized from farmers for erecting the Tata’s Nano
plant. Though WB government was changed in the polls on this issue and TATA Motors
retreated but many farmers are still not in the possession of their land.
India’s population is
increasing by leaps and bounds while arable land is depleting. This is why food
item prices have an upwards bias.
·
Indian government’s populist policies
In India MNREGA (Mahatma
Gandhi Rural Employment Guarantee Scheme) was implemented with a holy purpose
of helping rural people with employment in their vicinity but this scheme was
implemented in damn hurry with political agenda in mind.
Under this scheme cash
was distributed as wage without ensuring the productivity. State governments too
were not prepared to effectively implement the MNREGA schemes.
How MNREGA helped
food inflation to soar
1. Under MNREGA wages offered were much
higher than what farmers paid to farm-labors so labors never turned up at
farms. This resulted in hiring of labors at higher wages which increased the
cost of grain production and ultimately which was passed on to the consumers.
MNREGA rates became the industry benchmark and with every rise in MNREGA rates,
prices of food items are bound to increase.
2. States like Punjab, which is called
‘Granary of India’, is already grappling with the scarcity of farm-labors and
implementation of MNREGA aggravated the situation. As a result farm wages were
increased discriminately and this increased cost of production was ultimately
passed on to the consumers, resulting in higher inflation.
3. Milk, poultry and other protein rich
food products which are predominantly supplied from rural areas. Higher wages in
the hands of rural workers resulted in higher local consumption and thus upward
pushing the prices of protein rich products.
(5) Commodity Market Manipulation: Theory says commodity markets ensure
the fair price discovery of the commodity items and helps farmers to come out
of the clutches of unscrupulous middlemen.
But as far as India is concerned, this theory is partially true.
Whenever price of a commodity surpasses comfort levels and enters into
much higher territories, government bans the trading of that commodity on
commodity exchanges.
We have seen, though not immediately but slowly prices start falling to
their justified levels. Market is abuzz with the flurry of news about artificial
price propping by few players- Guar gum price appreciation is the recent
example.
(6) Shortage of the coins/change in the
economy: This is not a silly reason but the most
overlooked reason and no major economic book or paper talks about this.
Coins up to 25 paisa denomination are
discontinued and in market there is increasing scarcity of Rs. 1 and Rs. 2
coins. Shopkeepers and traders are upward-revising prices in the name of
rounding the price. Price tag of a commodity/item worth Rs. 5 directly gets revised
to Rs. 10 with some increment in quantity which is more in favor of traders/shopkeepers.
Shortage of coins make non-branded items (which
have no printed price on it) dearer and causes overselling of low-priced
branded FMCG products.
(7) Increase in disposable income
Two decades of the liberalization resulted in higher deposable incomes
in the hands executives and businesses in the urban area. Government’s welfare
policies like MNREGA (Mahatma Gandhi Rural Employment Guarantee Scheme) resulted
in increased money in the rural area and consequent higher spending. Elevated
demand without compensating higher supply resulted in the inflation.
This programme has been implemented without ensuring the productive
output and has become just a cash distribution system, as quoted by Kiran Shah,
a famous businesswomen and the founder of Biocon. World Bank too viewed MNREGA
as a barrier to economic development.
(8) Availability of easy credit
Post-liberalization financial sector developed a lot owing to vital
reforms. Many private and players entered in the field and interest rates too
started falling. Easy credit boosted the demand and instead of saving people
started to splurge. Earlier, during last years of the service people used to
think about owning a house or property while presently just after couple of
years of the first job people are opting to own property.
Earlier people used to save to buy capital assets like house, car or
high value gadgets but now a day’s people get the same on easy credit.
Easy credit has boosted the consumption resulting in higher demand and
subsequent inflation.
(9) Deficit financing: Deficit financing is nothing but government
spending in excess of the revenue. Now the question is – from where this excess
money comes?
And you guessed right- Money Printing. Money
printing is a practice where money is created by an electronic credit entry
without backing of any security or gold. This is
generally used to boost the economy and when economy starts running well
another counter balancing electronic debit entry eliminates this false money
from the system.
It’s just like your saving balance in a bank
which is just Rs. 10 lakh (1 million) becomes Rs. 50 lakh (5 million) with a
credit entry of Rs. 4 million. Now you can expand your business with this extra
40 lakh (4 million) rupee. When your business turns profitable, a
counterbalancing debit entry of rupee 4 million wipes the Rs. 4 million from
your account.
You shall call it wonderful but impossible.
But this is not impossible in case of
governments across the world.
Bu wait- if this electronic entry is not wiped
from the system within time currency devaluates like
anything and inflation goes on fire.
Following pictures aptly tells what happened in
Zimbabwe!
Money printing is not always done with the electronic entry only but
issuing bonds which promises to pay in future is nothing but money printing.
Indian government usually issues oil bonds to downstreamcompanies to meet under recoveries. Be it in any form, money printing raises
the inflation.
(9) Black money
Black money that already flowing in
the nation is predominantly invested in Real estate and gold. And it is the
bitter truth that India survived the 2008’s global financial crisis due to this
parallel economy of black money. As black money can’t be parked in the main
system, it unofficially circulates among the few players at very higher
interest costs and this is the reason despite having seen real estate prices going
multifold no ‘Property Bubble’ took place in India like the one in the
USA.
Black money transactions ensures lesser money flowing into government’s
coffers and government is forced to borrow money
Not only money generated and circulating in the
Indian economy but the black money parked abroad is finding its way into the
nation through back door. P-notes or fake export transactions are the common
ways used to bring back black money into Indian shores. Sudden jump in transactions
with countries like Bahamas raises the suspicion.
(10)Hike in taxes
Barring a few services, almost all major services attracts the service
tax and hike in the service tax makes services expensive. In this budget
service tax was increased to 12% from earlier 10 %. Phone/mobile bills, cable bills, bank draft
fees, locker fees and all services which attract service tax became expensive.
Similarly hiking the excise duty or customs duty ads to the cost of the
products and service; Businesses and service providers when pass on this extra
burden on the consumers, general inflation rises.
There are
many other reasons responsible for the rising inflation but I discussed only a
vital few that can be understood easily without going into unnecessary details.
Many of the aforesaid mentioned reasons are interlinked and often work in
tandem.
NB: MNREGA
was discussed for the information purpose only and in no way this post
indicates author’s bias against it but he expects its effective and productive
implementation to needy people only.
3 Comments:
Awesome facts , real truth and a eye opening.
why one should stop using paper money and get back to the system of converting money in real gold . so its value keep rising rather than going down like a 100RS meant a lot 15 year back but now days it can not do nothing good rather than jumping red light and paying challan.
Wonderful Article. Please keep writing more of the kind.
HI,
Wonder full Article .. why don't you write about various step that a individual or a government should take ..
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