Inflation during post-reform period (since 1992-93)

The Indian economy underwent a severe economic crisis in 1991. The year 1991-92 registered low economic growth of 1.3 per cent and foreign currency assets at around US $ 1 billion were barely two weeks of imports in July 1990. During the crisis year of 1991-92, inflation was 13.7 per cent. As part of the macroeconomic stabilization programme and structural reforms undertaken in the aftermath of the crisis, the exchange rate depreciated substantially. Between end-March 1991 and end-March 1992, the Indian rupee depreciated by nearly 37 per cent with respect to the US dollar. Notwithstanding the limited openness of the Indian economy, this order of depreciation added to inflationary pressures during the first half of the 1990s [RBI 2004].

Hikes in procurement prices as well as supply-demand imbalances in essential commodities like pulses, oilseeds and edible oils further added to inflation. The average inflation was around 9.8 per cent during the period 1992-96, which came down by half (4.9 per cent) during the period 1996-2005.

In the eight year period from 2000 to 2007, India�s inflation performance was even better at 5.2 per cent as measured by WPI and 4.6 per cent measured by the consumer price index (CPI-IW). In 2008 the global financial crisis struck following which inflation rose sharply both in advanced countries and EDEs as commodity and oil prices rebounded ahead of a sharp �V� shaped recovery. Thereafter, inflation rate moderated both in advanced economies and EDEs. In India too the inflation rate rose from 4.7 per cent in 2007-08 to 8.1 per cent in 2008-09 and fell to 3.8 per cent in 2009-10. However, the inflation rate backed up and stayed near double digits during 2010-11 and 2011-12 before showing some moderation in 2012-13. Given India�s good track record of inflation management, the persistence of elevated inflation for over two years is apparently puzzling.

Inflation in India has remained persistently high influence early 2010, with headline WPI moving in a range of 9-10 per cent till October 2011, significantly above its average of around 5 per cent recorded during the 2000s. Non-food manufactured products inflation, a measure of underlying inflation, has also increased over the course of 2011 and has moved in a range of 7-8 per cent during 2011. India is a moderate inflation country.

Second, the deceleration of growth and emergence of a significant negative output gap has failed to contain inflation. It is understandable if inflation goes up in an environment of accelerating economic growth. There could be a situation when the real economy is growing above its potential growth that could trigger inflation what economists call an overheating situation. It is like an electric cable exploding if we overload it with appliances beyond its capacity. But, that is not the case. The Reserve Bank estimates suggest that the potential output growth of the Indian economy dropped from 8.5 per cent pre-crisis to 8.0 per cent post-crisis and it may have further fallen to around 7.0 per cent in the recent period. Even against this scaled down estimate of potential growth, actual year-on-year GDP growth has decelerated significantly from 9.2 per cent in the fourth quarter of 2010-11 to 5.3 per cent in the second quarter of 2012-13. The loss of growth momentum that started in 2011-12 got extended into 2012-13.

Headline versus Core Inflation

Two concepts of inflation which have become popular among policy makers are �headline inflation� and �core inflation�. While �headline inflation� covers the entire set of goods and services included in the general index, �core inflation� otherwise known as �underlying inflation� ignores the volatile items in the general index. Headline inflation reflects not only the effect of demand pressures but also supply shocks which impart transitory fluctuation to the index. Thus, a supply shock arising from crop failures or the international oil price hike will have the effect of raising the headline inflation. On the other hand, a positive supply shock such as a good harvest may reduce the headline inflation for some time even if underlying inflationary pressures are building up.

The term core inflation was coined by Eckstein (1981) who deed it as �the trend increase of the cost of factors of production� that �originates in the long-term expectations of inflation in the minds of households and businesses, in the contractual arrangements which sustain the wage-price momentum, and in the tax system�. The concept of core inflation became popular in the 1970s during periods of high inflation and now normally refers to that component of inflation that is likely to persist for a long period, say, for several years and, therefore, useful for near-term and medium-term inflation forecasting.

Most countries use CPI as a measure of headline inflation. Therefore, core inflation measure in most countries are based on CPI. However, in India, there is no single measure of inflation which captures economy-wide inflationary pressures in the economy. It is the year on year percentage change in wholesale price index (WPI), which is used as an indicator of headline inflation. Although there are four consumer price in dices (CPIs), they are targeted at different population groups and none of them captures economy-wide inflationary pressures. CPI (Rural), CPI (Urban) and CPI (All India) have been launched recently, yet time series data in respect of new CPI series are not available. In view of these constraints, therefore, the Reserve Bank monitors an array of measures of inflation, both overall and disaggregated components, in the context of the evolving macroeconomic situation to assess the underlying inflationary pressures (RBI, 2010).

Written by princy

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