Inflation: A New Battle

Annual inflation, measured in the WPI (Wholesale Price Index), jumped to a 13-year high of 11.05 per cent in the week ending 7 June 2008 from 8.75 per cent in the preceding week. Inflation has been rising rapidly since January 2008 and the weekly rise in inflation in the week ending on 7 June 2008 was the highest in the current calendar year.

This steep rise in inflation came mainly on account of the sharp jump in prices in the fuel group. Inflation in the fuel more than doubled to 16.25 per cent from 7.86 per cent in the week ending 31 March 2008. This was the highest rate of inflation in the fuel prices ever since 17 March 2001. The government had partially passed on the burden of the rising international crude oil prices to the Indian consumer by hiking the prices of petrol, diesel and LPG (liquid petroleum gas) by Rs.5 per litre, Rs.3 per litre and Rs.50 per 14.2 kg cylinder, respectively, with effect from 5 June 2008.

The rising inflation is due to the rising oil prices in the global markets which have increased to 135 dollars per barrel. The global demand for the oil is also on an increase with growing countries like China and India consuming more and more oil and the already developed economies not reducing their fuel demand. Every time the our country goes through a price hike in crude oil, there is an economic and political crisis. This time around as well, the government is under great pressure from the public at large and opposition parties. The Prime Minister Dr. Manmohan Singh and finance minister Mr P. Chidambaram are in a tight spot as the inflation seems to be uncontrollable, along with the fear of interim elections.

The inflation has not only hit hard the consumers but has also had an adverse effect on the stock market. Already week with wounds of U.S sub prime crisis, the stock market is on a bearish trend after the impact of inflation. The worst hit stocks are real estate stocks, with the likes of D.L.F going below their issue price as well. The market is sluggish and is showing no signs of recovery. Even an investment in bank deposits is running in to losses with respect to real interest rate. (Real interest rate is nominal interest rate adjusted for inflation). At nominal interest rate of 9% and inflation of 11.05%, the investor incurs a loss of 2.05% in terms of real interest. So an investment in fixed deposit is actually eating up your money.

The R.B.I has increased repo rate i.e. the rate at which it lends money to commercial banks and also raised the cash reserve ratio as part of its defence mechanism. But this is not enough as the base of monetary policy in India is still very weak. Efforts should be made to appreciate rupee so as to reduce the cost of imports of crude oil and reduce inflation. Hiking the interest rate is another option which will reduce the purchasing power of people and thus inflation. But the R.B.I cannot hike the interest rate beyond a certain level as it will hinder the growth of infrastructure which is essential to support the growth of the economy.

According to Robert Prior-Wandesforde, chief Indian economist at HSBC in Singapore inflation figures are likely to remain in double digits for the next nine months and peak at 15 percent by the end of 2008. But according to Chief Economic Advisor to the Finance Ministry Arvind Virmani inflation will have a clear downward trend in October-December this year. Whether any of these predictions will come true or not is still to be seen.

Nitish Kapoor

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