History of Inflation in India
India has been traditionally a low inflation country. Barring a few years of high inflation driven by supply shocks, inflation has remained benign throughout the period since independence. For example, in the 62 years since 1950-51 average annual inflation rate as measured by changes in the wholesale price index (WPI) increased at a rate of 6.7 per cent per annum. During the period 1951-52 to 2004-05, in 28 years inflation was below 6 per cent and in 40 years it was below 9 per cent. There are only four years in the entire period, when inflation was above 15 per cent. These years of high inflation basically reflect the impact of supply shocks, primarily due to setbacks in domestic agricultural production and external oil price hikes. That is not a very high rate considering that many countries, both developed and developing, experienced very high inflation in their modern development history. In fact, more recently in the 1980s and 1990s the world inflation averaged around 17 per cent per annum. In the 2000s there was a sharp all round moderation in global inflation.
Frequency Distribution of WPI Inflation
Graph 1 depicts the frequency distribution of inflation in India across different ranges during the period 1951 -52 to 2004-05. The modal range of inflation in the entire period consists of 3 per cent to 6 per cent. Furthermore, out of 54 years, 32 years are placed in the range of 3 per cent to 9 per cent of inflation.
Inflation during pre-reform period (1951-52 to 1991-92) In the pre-reform period, inflation had accelerated during the 1960s partly induced by the two wars in 1962 and 1965 and the crop failure of 1965-66 when agricultural production fell by more than 16 per cent. It became a matter of serious concern when it exceeded 20 per cent in the early 1970s led by a setback in agricultural production and an unprecedented hike in international oil prices. Prior to that, the 1950s witnessed average inflation of less than 2 per cent, but with considerable variation in yearly inflation. The percentage change in prices varied from a negative value of 12.8 per cent in 1952-53 to the highest inflation of 13.8 per cent in 1956-57.
The deflation of 1952-53 is mainly attributed to the higher agricultural production in that year, whereas high inflation of 1 956-57 was mainly due to demand pressures, particularly investment demand in the light of the thrust on industrialization in the second five-year plan. During the 1950s, two more years, viz. 1954-55 (ï¿½6.71 per cent) and 1955-56 (ï¿½5.23 per cent) also witnessed negative price changes. Thus, notwithstanding low average inflation during 1950s, there was considerable volatility in the price movement. However, inflation was in the range of 3 to 7 per cent during the last four years of this decade (1957-58 to 1960-61).
In the following decade, average inflation increased to 6.2 per cent. Price changes were the lowest at a negative of 0.91 per cent in 1968-69 as a result of bumper agricultural production in the previous year. It was highest at 13.95 per cent in 1966-67, followed by inflation of 11.56 per cent in the following year. High inflation during these two years can largely be attributed to impact of the Pakistan war in 1965 and the famine experienced during 1965-66. During this decade, average inflation was higher vis-ï¿½-vis the previous decade, but the variation subsided.
The decade of the 1970s stands out as the most tumultuous period in India in terms of inflationary uncertainty, witnessing very high inflation mainly driven by the supply shocks emanating from agricultural and oil prices. For the first time since independence, inflation overshot the level of 20 per cent in 1973-74 (20.2 per cent) and 1974-75 (25.2 per cent). Reflecting the first oil shock of 1973, the import price deflator (measured as year-on-year changes in the unit value index of imports) surged by 43.0 per cent and 72.8 per cent during 1973-74 and 1974-75, respectively. In line with the sharp increase in average international crude oil prices by over 250 per cent in 1974, domestic fuel prices increased sharply from an annual average of about 4.7 per cent during the three years preceding the first oil crisis to about 26.5 per cent on average during the three years beginning 1973-74.
Referring to the severity in inflation, particularly that of agricultural commodities in 1972-73 and 1973-74, the RBI Annual Report 1974-75 observed that ï¿½even the seasonal decline in prices, particularly agricultural commodity prices, to which the Indian economy is traditionally accustomed, did not take place during the last two yearsï¿½. A hike in oil prices and poor agricultural production led to reappearance of high inflation in 1979-80 (17.1 per cent) and 1980-81 (18 .2 per cent).
Making a comparison of the two events of high inflation in the 1970s, the RBI Annual Report, 1979-80 observed that, ï¿½Agricultural supplies were affected in both years; but while 1973-74 had been preceded by successive poor harvests and sizeable food imports became necessary, in 1979 substantial and readily available food stocks served to mitigate the scarcity.
Hence, the influence on the price level of primary commodities in general and of food articles in particular was lower in 1979-80. Although the impact of the external influence of oil price hikes was experienced even during 1973-74, it was of far greater significance in the price rise in 1979-8 0.ï¿½ us, higher fuel prices and agricultural commodity prices got reflected in overall inflation and the average inflation during the 1970s is estimated to be 10.3 per cent. It can also be noted that demand factors in terms of a sharp increases in money supply vis-ï¿½-vis output growth also aggravated the inflationary problem in 1970s.
While the average output growth of GDP during this period stood at 3.2 per cent, the average growth of broad money (M3) at 17.7 per cent added to demand pressures. Demand pressures emanating from an expansionary fiscal policy and its monetisation, coupled with intermittent supply shocks, continued inflationary pressure during the 1980s but its severity was lower than the previous decade. Inflation averaged 7.2 per cent per annum during the 1980s with a noteworthy reduction in inflation variability. Inflation varied between 4.4 per cent in 1985-86 and 10.1 per cent in 1990-91. The scale deficit of the centre widened from 3.8 per cent of GDP during the 1970s to 6.8 per cent during the 1980s. Close to one-third of this burden was borne by the RBI during the 1980s (close to a quarter during the 1970s). Rapid expansion of RBI credit to the government led to an acceleration in reserve money growth.
However, broad money growth was contained at 16.9 per cent with increases in cash reserve requirements. The experience of the 1980s has a noteworthy contribution in highlighting the inflation-fiscal-monetary nexus. Empirical evidence confirmed the adverse effects of excessive monetary expansion, emanating from the monetisation of the fiscal deficit, on inflation [Rangarajan and Arif 1990; Jadhav and Singh 1990].
Because of higher elasticity of government expenditure with respect to inflation relative to that of government receipts, higher inflation meant an enlarged scale deficit which, in turn, necessitated increased monetisation. This led to a further increase in inflation, starting a vicious circle of high inflation, high deficits and high monetisation.
Written by princy