Other experts also point out the latest inflation numbers could prompt the central bank to leave the key policy rate untouched in its mid-quarterly policy review meeting despite the economic growth expected to slow down.
“Food inflation will be on the rise and coupled with this would be fuel inflation,” according to said Siddharth Shankar, director, KASSA group. “Going forward in third quarter of this year, food prices may moderate but I expect the fuel inflation to move up sharply,” he says. The changing food patterns are the cause of inflation and even fiscal measures cannot combat that, he adds. “It is only focus on agriculture that will reduce inflation.”
The Confederation of Indian Industry says the upturn in inflation spelt bad news for the industry at a time when the industry was reeling under the impact of an investment-led slowdown caused by a tight monetary policy and with manufacturing sector growing at a modest 4.4 per cent during April-January 2011-12.
Chandrajit Banerjee, director-general of the industry chamber, says an increase in food inflation called for adequate supply-side responses to address the structural bottlenecks facing agriculture production and distribution.
Some other economists, however, call for a rate cut by the RBI.
The finance minister is expected to announce some measures to tackle inflationary pressures in the Budget. RBI has already cut the cash reserve ratio by 75 basis points last week infusing Rs 48,000 crore into the system.
Earlier, official data showed a 6.8 per cent growth in the industrial output in January, against just 2.5 per cent in the previous month. However, except for consumer non-durable goods, other sectors did not show much upturn, again giving confused signals to the central bank.
Food prices push inflation to 6.95%
This article is about a rise in food prices causing inflation in India. Inflation is caused by a number of factors. This essay will determine the causes of inflation and evaluate the appropriate government responses including policies from the Reserve Bank of India (RBI).
Inflation is a continuing increase in the general price level. There are mainly two types of inflation: demand-pull and cost-push. Demand-pull inflation is caused by increases in aggregate demand (AD). AD is defined as the total quantity of goods and services spent in a period of time at a given price level. Cost-push inflation is caused by an increase in the costs of production.
Based on the article, it mentions both the demand-pull and cost-push inflation. Figure 1 shows the demand-pull inflation and is caused by changing food patterns in India. It can be seen in Figure 1 that an increase in AD shifts AD to the right from AD1 to AD2. This impacts the economy and causes the price level to increase from P1 to P2. AD (aggregate demand) is composed of 4 main components- consumption, investment, government spending and the net export. India’s country’s wealth is increasing, thus resulting in an increase in consumer wealth. This increases consumer confident; therefore they are more likely to spend more, causing the AD curve to shift to the right. If food patterns are changed, this could indicate that for a given level of income, consumption would increase causing AD to increase, ceteris paribus. All of these changes eventually lead to demand-pull inflation.
Figure 2 illustrates cost-push inflation. The economy experiences a rise in costs of production due to an increase in the costs of raw materials in the agriculture market creating cost-push pressures. This causes a leftward shift in the SRAS curve from SRAS 1 to SRAS 2, resulting in an increased price level from P1 to P2 and a fall in the level of real GDP from Y1 to Y2. A change in the price of raw materials of food would have an impact on the whole economy, as food is a necessity for everyone.
In theory, there are two macroeconomic policies designed to decrease and influence the inflation rate. The inflation rate, mentioned in the article in India is at 6.95%. Fiscal policy is changes in the government’s own expenditures and taxes while monetary policy is changes in changes in the supply of money and interest rates in the economy. To ease inflation, the government can to decrease AD by increasing taxation and decreasing government expenditure using fiscal policy or using a contractionary monetary policy and raise the interest rates. The article mentions that economists suggest the “RBI should not hasten to cut policy rates” as they are confident this food price inflation is temporary and will drop back to 6.5% by the end of the financial year. In this scenario, if the RBI cuts the cash reserve ratio (CRR) (the money that the commercial banks will have to keep with the RBI as reserves), it will mean that banks will have more money that can be lent causing the money supply to increase leading to more inflation, worsening the current situation.
However, a decrease in the supply of money is necessary to ease inflation. A contractionary policy, as represented in Figure 3, can be used to fill in the inflationary gap caused by the excessive AD in India. Figure 3 shows when the RBI attempting to reduce the money supply through higher interest rates aimed to discourage investment and consumption spending, shifting AD 1 to the left to AD 2. This is so the price level will drop as it intersects the AS curve at the full employment level at real GDP.
This contractionary policy has benefits and drawbacks, which affects a number of different people. For domestic firms, a rise in interest rates is disadvantageous as consumption and investment will likely decrease, meaning the demand for firms’ products and their efficiency can decrease leading to a decrease in profit in the long run. On the other hand, the contractionary policy will benefit foreign investors, as they are likely to increase the amount of funds into India because as the foreign currency falls, there is an increase in the exchange rate. A higher exchange rate will cause exports to decrease and imports to increase making foreign investors to gain more profit.
In conclusion, a balance of fiscal and monetary supply side policies is needed to ensure a steady economic growth in India.