Inflation in India, Monetary and Fiscal Policy

By
Vaibhav Choudhry
BFIA 1B
75057
 INFLATION
• When prices rise, each rupee buys less goods and
services than it had been before.

• Erodes purchasing power of money

• It is measured through inflation rate- the annualized

percentage change in a general price index (Consumer
Price Index and Wholesale Price Index) over time.
 How is it Measured?

•Consumer Price Index

•Wholesale Price Index

 Wholesale Price Index (435 commodities)

WPI is the index that is used to measure the change in

the average price level of goods traded in wholesale
market.

Limitation :-
WPI is supposed to measure impact of prices on business. “But we use it to measure
the impact on consumers. Many commodities not consumed by consumers get
calculated in the index.
Consumer Price Index

• Estimates average price of consumer goods and services

purchased by households.

•Considers basket of goods and services from one period to

the next within the same area.

Definition : It is a price index determined by measuring the

price of a standard group of goods meant to represent the
typical market basket of a typical urban consumer. The
percent change in the CPI is a measure estimating inflation.
 Simple formula of Inflation Rate

PI for a certain year - PI for a comparative year X 100

PI for a comparative year
 Consequences of Inflation

1. Add uncertainty and make it difficult for companies to budget

or plan long-term.

2. Uncertainty about the future purchasing power of money

discourages investment and saving.

3. There can also be negative impacts to trade from an increased

instability in currency exchange prices.

4. The above further leads to Imbalance in BOP.

5. Higher income tax rates.

• India food inflation declines to 13.07 percent on February 10, 2011  
   
  
•India food inflation rose at 17.05 percent on February 3, 2011  
   
  
•India food inflation rose at 15.57 percent on January 27, 2011  
   
  
•India's food inflation rate eases to 15.52% on January 20, 2011  
   
  
•India's food inflation rate eases to 16.91% on January 13, 2011  
HOW TO CONTROL INFLATION

1. MONETARY POLICY

2. FISCAL POLICY
What is Monetary Policy?
 The term monetary policy refers to actions taken by
central banks to affect monetary magnitudes or
other financial conditions.
 variables such as money supply, interest rates and
availability of credit.
 affects liquidity
 By affecting liquidity affects credit,
 it affects total demand in the economy.
Price Stability: The Dominant
Objective

 There is convergence of views in developed and

developing economies, that price stability is the
dominant objective of monetary policy.
 Price stability does not mean complete year-to-year

price stability which is difficult to attain.

 Price stability refers to the long run average stability

of prices.
 Price stability involves avoidance of both

inflationary and deflationary pressures.

What is Bank Rate ?
6.00%
(w.e.f.
Bank Rate  
29/04/20
03)

1.  This is the rate at which central bank (RBI)  lends money to other banks
or financial institutions.  

2. If the bank rate goes up, long-term interest rates also tend to move up,
and vice-versa.

3. Thus, it can said that in case bank rate  is hiked,  in all likelihood banks
will hikes their own lending rates to ensure and they continue to make a
profit.
•Repo is the rate at which banks borrow from RBI

•Reverse Repo is the rate at which banks deploy their surplus funds with RBI.

•Both usedfor overnight lending and borrowing purposes.

•An increase in these policy rates imply borrowing and lending costs for banks would
increase and this should lead to overall increase in interest rates like credit, deposit etc.
The higher interest rates will in turn lead to lower demand and thereby lower inflation.
The move was in line with market expectations
5.50% Increased from 5.25%
Reverse Repo Rate (w.e.f. which was continuing
25/01/2011) since 02/11/2010

Increased from 6.25%

6.50% (w.e.f.
Repo Rate which was continuing
25/01/2011)
since 02/11/2010
 When banks raise demand and time deposits, they are required to keep a certain
percent with RBI. This percent is called CRR.

1. An increase in CRR implies banks would be required to keep higher percentage of

fresh deposits with RBI.
2. This will lead to lower liquidity in the system.
3. Higher liquidity leads to asset price inflation and also leads to build up of
inflationary expectations.

BY increasing the rate by 25 bps, RBI has signalled that though it wants to tighten
liquidity it also wants to keep ample liquidity to meet the outflows.

Increased from 5.00% to

5.50% wef 13/02/2010;
6.00% (w.e.f.
Cash Reserve Ratio (CRR) and then again to 5.75%
24/04/2010)
wef 27/02/2010; and now
to 6.00% wef 24/04/2010
 Decreased from 25%
24%(w.e.f.
Statutory Liquidity Ratio (SLR) which was continuing
18/12/2010)
since 07/11/2009 

What is SLR ? This term is used by bankers and indicates  the minimum
percentage of deposits that the bank has to maintain in form of gold,
cash or other approved securities. 

Thus, we can say that it is ratio of cash and some other approved to
liabilities (deposits) It regulates the credit growth in India. 
Demonetization of Currency. 

However, one of the monetary measures is to

demonetize currency of higher denominations. Such a measure is usually adopted
when there is abundance of black money in the country.

Issue of New Currency. The most extreme monetary measure is the issue of new
currency in place of the old currency. Under this system, one new note is exchanged
for a number of notes of the old currency. The value of bank deposits is also fixed
accordingly. Such a measure is adopted when there is an excessive issue of notes and
there is hyperinflation in the country. It is very effective measure. But is inequitable
forits hurts the small depositors the most.
NEW DELHI: Attributing rising inflation partly to stimulus and increasing global commodity prices ,
Finance Minister Pranab Mukherjee today said the government was committed to take all steps to
moderate price rise . 

"We have to take all the necessary steps to keep inflation at moderate levels", he said while speaking at
the 9th Pravasi Bhartiya Divas here. 

The government had already taken tough action against hoarding to check rising prices, especially of
onions. 

To help the economy combat the impact of global financial crisis in 2008, the Reserve Bank as well as
the government had provided several stimulus packages. 

These measures mainly included increasing money supply, lowering tax rates and hiking public
expenditure. 

While asking the Indian diaspora to invest and contribute to country's growth and prosperity,
Mukherjee said the government was making efforts to achieve double-digit growth rate. 

"These policy measures are directed towards two major objectives. The first is to grow the economic
pie in a sustained manner and boost GDP growth to a long-term path of over ten per cent per annum. 

"The second is to take concrete steps in order to ensure equitable and inclusive distribution of the fruits
from this growth process", he added.
FISCAL POLICY
Monetary policy alone is incapable of
controlling inflation. It should, therefore,
besupplemented by fiscal measures. Fiscal
measures are highly effective for
controllinggovernment expenditure, personal
consumption expenditure, and private and
publicinvestment. The principal fiscal
measures are the following:
(a) Reduction in Unnecessary
Expenditure. The government should reduce
unnecessary expenditure on non-development
activities in order to curb inflation. This will
also put a check on private expenditure which
is dependent upon government demand for
goods and services. But it is not easy to cut
government expenditure. Though economy
measures are always welcome but it becomes
difficult to distinguish between essential and
non-essential expenditure. Therefore, this
measure should be
supplemented by taxation
b) Increase in Taxes.To cut personal
consumption expenditure, the rates of
personal, corporate and commodity taxes
should be raised and even new taxes should be
levied, but the rates of taxes should not be so
high as to discourage saving, investment
and production. Rather, the tax system should
provide larger incentives to those who
save, invest and produce more. Further, to
bring more revenue into the tax-net, the
government should penalize the tax evaders
by imposing heavy fines. Such measures are
bound to be effective in controlling inflation.
To increase the supply of goods within the
country, the government should reduce
import duties and increase export duties.
c) Increase in Savings. Another measure is to
increase savings on the part of the people.
This will tend to reduce disposable income
with the people, and hence personal
consumptionexpenditure. But due to the rising
cost of living, people are not in a position to
save muchvoluntarily. Keynes, therefore,
advocated compulsory savings or what he
called `deferredpayment' where the saver gets
his money back after some years. For this
purpose, thegovernment should float public
loans carrying high rates of interest, start
saving schemeswith prize money, or lottery
for long periods, etc. It should also introduce
compulsoryprovident fund, provident fund-
cum-pension schemes, etc. compulsorily. All
such measuresto increase savings are likely to
be effective in controlling inflation
d) Surplus Budgets. An important measure is
to adopt anti-inflationary budgetary policy.
For this purpose, the government should give
up deficit financing and instead have surplus
budgets. It means collecting more in revenues
and spending less.
(e) Public Debt. At the same time, it should
stop repayment of public debt and postpone it
to some future date till inflationary pressures
are controlled within the economy. Instead,
the
government should borrow more to reduce
money supply with the public
Thank you 