“Poor man’s tax” -Is inflation here to stay?

The word that’s buzzing around: Inflation

Everyone seems to be talking about it. It has been making headlines for quite some time now. So what exactly does an increased rate of inflation in a country imply?

Inflation, like friction, is a necessary evil, required to balance the government’s public expenditures.  It’s a matter of concern when the rates are high and for a prolonged period of time.

Inflation in simple terms is a rise in the price of commodities. When this hike hits consumer goods, the common man’s purchasing power gets affected. When there are fewer commodities and more people who are capable of buying them, the end result is inflation. This is when the demand grows faster than the supply. Inflation can also be cost-pushed, i.e. when a company’s cost, like the wages of labourers, import expenses or taxes, increase, they automatically have to increase the price on products to make a profit.

Where does India stand today in this regard?

India’s Economic Survey Report, 2009-2010, reveals a double digit increase in food inflation, currently standing at a staggering 16.12%.  Inflation has spread to other sectors as well. It is not one cause, but a sum of many events that has led to this. In 2008, the Finance Minister waived loans up to sixty thousand crores! A benevolent gesture, but as a result of having more money in hand, demand for commodities increases. We have not been witnessing very good monsoons in the last few years. If the crop yield isn’t good, then the demand clearly exceeds supply. The global economy, as a whole, is in a state of imbalance. With major nations in the world experiencing an economic setback, the import expenses are rising too. Not to mention, the ever rising costs of petroleum and crude oil have a direct impact on transportation charges.

As many people live below or close to poverty line in India, the poor pay a heavy price. With the increasing wholesale and retail margins, the farmers do not benefit from the rise in prices that consumers in rural and urban areas are forced to pay.

Money meanders…

The Government lays down the fiscal policies, while the central bank lays down the monetary policies. A bank may deposit a part of the costumer’s money with the government.  This is known as ‘reserve ratio’. This is how the banks get involved during inflation. The Indian bank dictates other commercial banks to increase the rate of interest, by increasing the cash reserve ratio.  For the common man, the cost of borrowing increases. As a result, the demand for commodities will decrease. Hence the country’s economy will gradually stabilise.

However, if the government spends excessively, it’ll lead to fiscal inflation. The government may then instruct the banks to print extra currencies.  Inflation destabilises a country’s currency value.

A chain reaction

It is evident that inflation or deflation is caused by various sequences of events over a period of time. It is affected by not only the country’s economy, but also by the economic status in the rest of the world. Inflation isn’t inevitable, but slight variation in rates is permissible and sometimes unavoidable. The central bank and the government have intervened to prevent the rates from soaring any higher. The banks have adopted a tight monetary policy. It is anticipated that the situation will stabilise towards the end of the year.

Deepashri Varadarajan