Inflation Needs Better Targetting : Daily Current Affairs

Relevance: GS-3: Indian Economy and issues relating to planning, mobilization of resources, growth and development.

Key Phrases: Consumer price inflation, RBI, Global commodity, Wholesale price index, National Statistical Organization, Price Controls, Contractionary Monetary Policy, Open Market Operations, and Reserve Requirements.

Why in News?

The targeted rate for consumer price inflation set by the RBI is 4 per cent, with 2 per cent leeway on either side; the fitment band is, therefore, between 2 and 6 per cent. Panic has been building up about rising inflation because the upper limit of 6 per cent has been breached for four consecutive months now, and the April reading of 7.79 per cent is at an eight-year high.

What are the reasons behind inflation rises in India?

Global commodity price inflation has been building up since the last quarter of 2021 due to rising demand, as consumption increases with declining Covid cases. The Russian invasion of Ukraine has worsened the situation, with Brent crude oil prices crossing $120 per barrel in March. Crude oil prices have been holding above $100 per barrel since then, sending fuel costs shooting higher.
Disturbed Global supply: With the US and its allies making it difficult to access exports from Russia, prices of agriculture commodities such as wheat and edible oil as well as metals have also surged. The situation has worsened with China imposing lockdowns in April to control Covid-19 cases. This affected global supply further. The rupee hitting an all-time low against the dollar has increased the cost of imported goods further.

Inflation measurement in India

The two main indicators of inflation in India are the wholesale price index (WPI) and the consumer price index (CPI). The wholesale price index is considered as the primary inflation measure in India. The Reserve Bank of India had adopted the consumer price index as its key measure of inflation in India since 2014.

Consumer Price Index

The consumer price index is the measure of the average change over time in the prices of consumer goods and services purchased by households. The percentage change in the consumer price index over a period of time gives the amount of inflation over that specific period.
Consumer Price Index in India is published by the National Statistical Organization (CSO). It is published monthly in India.

Wholesale Price Index

The Wholesale Price Index measures the average change in the prices of commodities for bulk sale at the level of the early stage of transactions.
Countries like the Philippines use wholesale price index changes as a central measure of inflation.
The wholesale price index is published by the office of economic adviser, Ministry Of Commerce And Industry.

Inflation on Global Level:

All countries are in the same boat since the pandemic has impacted supply in all countries and the disruption caused by the Russia-Ukraine conflict and China’s lockdown has led to severe shortages in agri and other commodities globally.
CPI inflation in the US, at 8.5 per cent in March, was at a 40-year high. It’s due to the higher degree of uncertainties caused by recent global events that the IMF has revised the inflation projection for 2022 to 5.7 per cent for advanced economies and 8.7 per cent for developing economies in the April World Economic Outlook.

Tool to control Inflation:

Price Controls: Price controls are price caps or floors mandated by the government and applied to specific goods. Wage controls can be implemented in tandem with price controls to suppress wage push inflation.
Despite a number of intervening factors (e.g., the end of the Bretton Woods System, poor harvests, the Arab oil embargo, and the complexity of the 1970s price control system), most economists view the 1970s as evidence enough that price controls are an ineffective tool for managing inflation.
Contractionary Monetary Policy: Today, contractionary monetary policy is a more popular method of controlling inflation. The goal of a contractionary policy is to reduce the money supply within an economy by increasing interest rates. This helps slow economic growth by making credit more expensive, which reduces consumer and business spending.
Open Market Operations: Reverse repurchase agreements are an example of open market operations (OMOs), which refers to the buying and selling of Treasury securities. OMOs are a tool with which the Central bank increases (by buying Treasuries) or decreases (by selling Treasuries) the money supply and adjusts interest rates.
Reserve Requirements: The central bank also managed the money supply through reserve requirements, or the amount of money banks were legally required to keep on hand to cover withdrawals. The more money banks were required to hold back, the less they had to lend to consumers.

How are RBI and other central banks reacting to this situation?

Global central banks are on the war-path to control inflation now; for, a sustained increase in price increases the risk of stagflation wherein there is an extended period of high inflation and low growth in the economy.
While there is little that can be done to ease the supply-led inflation by central banks, they are trying to control demand and thus cool prices. Demand has been boosted by the easy monetary policies adopted by central banks to fight the pandemic-led slowdown in 2020. These easy policies include excessive money pumped into the system by global central banks and ultra-low interest rates since April 2020.
Central banks, including the US Federal Reserve, RBI and Bank of England, are now beginning to increase interest rates and reduce liquidity in the system by reducing the bonds issued by them.

Will tightening monetary policy across the world smother economic growth?

There is certainly a risk that some near-term growth will be sacrificed due to liquidity tightening and interest rate hikes. Companies that were beginning to plan for capital expansion will postpone their plans and wait for better visibility on the rate hike cycle now.
Consumers will also postpone their discretionary spends as their outgo on essentials such as food and commute increases. Real estate, consumer durables, travel, etc, may get impacted as interest rates on loans begin moving higher.
GDP growth projections for India as well as other countries have been revised lower for 2022 as the world grapples with high inflation.

Source: The Hindu BL

Mains Question:

Q. Discuss the reasons behind inflation rise in India? What are the different tool to control Inflation? Examine.