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3/26/13 Mrunal [Economic Survey Ch4] Inflation, WPI, CPI, monetary policy, RESIDEX gist of Print

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[Economic Survey Ch4] Inflation, WPI, CPI, monetary policy, RESIDEX gist
of
1. Prerequisite
2. How to measure inflation?
WPI
CPI
WPI vs CPI difference?
GDP deflator
3. Steps taken by Government to curb inflation
Via import
Via bans / coercive measures
Via schemes
Via Policy/Act
4. Why Govt could not control inflation?
Export bans = uncertainty
Export bans = CAD
Black money and gold purchase
FDI and infra= No quick results
Environmental clearances
5. Steps taken by RBI to curb inflation
CRR rates
SLR rates
Why RBI couldnt control inflation?
6. Way ahead
7. RESIDEX
8. Mock questions
Prerequisite
To understand this article better, first go through earlier articles on following topics
(click on the topic name)
1. WPI calculation
2. GDP deflator
3. CRR, SLR, Repo, reverse repo, LAF and MSF
How to measure inflation?
There are three ways
3/26/13 Mrunal [Economic Survey Ch4] Inflation, WPI, CPI, monetary policy, RESIDEX gist of Print
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1. WPI
2. CPI
3. GDP deflator
WPI
Wholesale price index
Compiled by Office of Economic Adviser ->Ministry of Commerce and
Industry.
Base year 2004
Doesnt cover services.
its calculated using Laspeyres formula.
Items are classified into three categories
1. Primary articles
2. Fuel, power, light, lubricants
3. Manufactured products.
Earlier Government used to give weekly primary and food inflation data based on the
Wholesale Price Index. But this practice has been discontinued since 2012.
CPI
Consumer price index
In 2012, the CPI system was reformed
Before 2012 After
Subtypes
There were four subtypes of CPI
1. Agricultural Labourer (AL)
2. Rural Labourer (RL)
3. Industrial Workers (IW)
4. Urban Non-Manual Employees
(UNME)
Now only three subtypes of CPI
1. Entire urban population
2. Entire rural population
3. Urban + Rural (consolidate
from above two)
Prepared
by
First three subtypes of CPI were
prepared by Labour Bureau ->
Ministry of Labour and
Employment
Last subtype was prepared by
Central Statistical Organisation
(CSO) -> Ministry of Statistics and
Programme Implementation.
All prepared by Central Statistical
Organisation (CSO) -> Ministry of
Statistics and Programme
Implementation
Different years for different subtypes.
3/26/13 Mrunal [Economic Survey Ch4] Inflation, WPI, CPI, monetary policy, RESIDEX gist of Print
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Baseyear
1. Agri labour=1986
2. rural labour=1986
3. Industrial workers=2001
4. Urban non-manual=1984
Common base year ( 2010) for all
three subtypes.
WPI vs CPI difference?
WPI
CPI (reformed
in 2012)
Compiled by Economic advisor CSO
Ministry Commerce ministry
Statistics
ministry
Includes services? No Yes
Baseyear 2004 2010
Items included 676 200
Known as
Headline
inflation?
Yes no
Importance
When RBI and Government make policies, they
mainly pay attention to this number.
Not much
GDP deflator
How and why GDP deflator is calculated? Already explained in earlier article,
click me So not going into details in the current article.
GDP deflator is calculated by Central Statistical Organisation (CSO)-> Ministry
of Statistics and program implementation.
GDP deflator =GDP @current price divided by GDP @constant price
GDP deflator is the most comprehensive number to measure inflation, but RBI
/Government doesnt use it much for policy making because GDP deflator data
comes quarterly (and not weekly/monthly basis).
Measures to contain inflation
By How?
Government Taxation, Expenditure, export bans etc.
RBI Repo, SLR, CRR
Steps taken by Government to curb inflation
Via import
1. Govt reduced import duties for wheat, onions, pulses, and crude palmolein were
reduced to zero
3/26/13 Mrunal [Economic Survey Ch4] Inflation, WPI, CPI, monetary policy, RESIDEX gist of Print
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2. Govt. allowed duty-free import of white/raw sugar.
3. Govt. imported pulses and edible oils and distributed them at subsidized rate.
Via bans / coercive measures
4. Govt. put ban on onion export for short periods of time whenever required
5. Govt. suspended futures trading in rice, urad, tur, guar gum and guar seed.
6. Govt. banned exports of edible oils (except coconut oil and forest-based oil) and
edible oils.
7. Govt. imposed stock limits on certain essential commodities such as pulses,
edible oil, and edible oilseeds and rice.
8. Increased excise duty on gold.
Via schemes
9. Govt. has been giving rice and wheat to poor families at very cheap rate under the
Antodyaya Anna Yojana.
10. Govt. allocated huge amount of foodgrain under the targeted PDS (TPDS).
11. government has allocated rice and wheat under the Open Market Sales Scheme
(OMSS)
12. direct cash transfer.
13. Introduced Rajiv Gandhi Equity Saving scheme (with tax benefits) to make
people invest money in it, rather than in gold.
Via Policy/Act
14. Recently the government permitted FDI in multi-brand retail trading. This will
improve logistical facilities connecting farmers with the final consumers and cut
down the middlemen.
15. The States of Madhya Pradesh and West Bengal have recently waived the market
fee on fruits and vegetables. Such waivers are expected to promote investment
private sector in the infrastructure necessary for transports and processing of
fruits and vegetables.
16. Budgetary provisions for improving storage and warehousing facilities, creating
infrastructure for aquaculture etc.
Why Govt could not control inflation?
From above points, it seems Government did lot of things to reduce inflation.
Then why are we not seeing any good results?
Export bans = uncertainty
Because, to fight food inflation, govt. started imposing ban on exporting some
food commodities, increased and decreased the duties on import/export as
necessary.
3/26/13 Mrunal [Economic Survey Ch4] Inflation, WPI, CPI, monetary policy, RESIDEX gist of Print
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While this may look a good solution for the short term but in long term, this
creates uncertainty for businessmen, farmers.
It reduces their incentive to produce more, because theyre not certain whether
govt. will allow them to export or not? (for example Sugarcane->sugar, onion
etc.)
So indirectly, this affects employment and income of people => leads to more
inflation.
Export bans = CAD
When Government puts ban on export of xyz item, that means India receives that
much less foreign exchange (dollars). So this increases the Current Account
deficit (CAD).
When CAD increases = rupee weakens against dollar = crude oil become
expensive for us = inflation in everything.
Therefore, export bans are like firefighting / short term quickfix solutions. They donot
solve the fundamental problems of Indian economy, infact they worsen it in long run.
Black money and gold purchase
All Government schemes = leakage, corruption. And corruption =black money.
And black money is mostly invested in gold and real estate.
So demand of gold forever high= high current account deficit = rupee weakens
against dollar= crude oil price increases = petrol/diesel price increases = even
more inflation.
Government did try to hike excise duty, make PAN cards mandatory for high
value gold purchase and even thought of putting bans on gold import. But these
moves have been heavily opposed by the jeweler lobby, hence Government has
shied away from doing anything radical to stop the gold consumption.
Besides a small hike of 2-3% in gold excise duty doesnt prevent those bad guys
with black money from buying gold! And Government hasnt done much to stop
the Black money / corruption either.
FDI and infra= No quick results
You have read and heard this ten thousand times that FDI in multibrand retail = no
middlemen = less inflation in food. And similarly cold storage, and food
processing infrastructure= less wastage.
But, suppose Government allows wallmart on Monday, that doesnt mean from
Tuesday Wallmart will start running and from Wednesday inflation will be gone.
All these things take months and years to get file permission, construction, hiring
and training employees, setting up supply lines etc.
Environmental clearances
3/26/13 Mrunal [Economic Survey Ch4] Inflation, WPI, CPI, monetary policy, RESIDEX gist of Print
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Many coal and mining projects are not cleared due to environmental issues.
This has affected the electricity and raw material supply = input cost increased in
manufacturing sector=inflation.
Fiscal consolidation
Government is on the path of fiscal consolidation so it increased the prices of petrol,
diesel and reduced the number of subsidized LPG cylinders. These moves have
increased the inflation.
Steps taken by RBI to curb inflation
Lets do a recap: from SBI manangers point of view
CRR
Ive to keep this much cash aside. I cannot loan it to people. I donot earn
any interest on this.
SLR
Ive to invest this much cash in govt. securities, gold and reliable corporate
bonds.
Repo Ive to pay this much interest rate, IF I take short term loans from RBI.
Reverse
Repo
I earn this much interest rate, IF I deposit my money in RBI for short term.
So what will be the impact on liquidity when RBI changes these rates?
Rate When rate is increasedWhen rate is decreased
CRR Liquidity decreases Liquidity increases
SLR Liquidity decreases Liquidity increases
Repo Rate Liquidity decreases Liquidity increases
Note: RBI doesnt need to change reverse repo rate, because they automatically
keep it 1% less than repo rate. (1%= 100 basis points).
In winter, the supply of green vegetables is high so their price goes down. But in
summer, their supply is low, so price goes high. Same is the link between
liquidity and interest rates.
When liquidity increases = loan interest rate decreases.
When liquidity decreases = loan interest rate increases = harder to get loans for
home, car, bike, business.
RBI focused its monetary policy on two objectives
1. Control inflation.
2. Facilitate growth.
But It has been very difficult to do both these things at the same time. Because if
RBI wants to control inflation, then it needed to reduce the liquidity= RBI had to
increase repo rate, CRR. But this type of tight monetary policy badly affects
3/26/13 Mrunal [Economic Survey Ch4] Inflation, WPI, CPI, monetary policy, RESIDEX gist of Print
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both producers (businessmen) and consumers. Why?
But when repo rate is increased= liquidity decreased= difficult to get loans for
home, car, bike etc.= demand down + difficult for businessmen to get loans =
this hurts the businessman and whatever hurts the businessmen also hurt the
GDP and employment.
To put this in refined words: the tight monetary policy of RBI decreased the flow of
credit (loan) to productive sectors of Economy and hence negatively affected the
growth.
But due to inflationary pressures, RBI followed tight monetary policy during
2010-11.
During this period, RBI raised policy rate (repo rate) by 3.75%= repo rate was
increased from 4.75 per cent to 8.5 per cent. Check the following chart.
But this move has backfired: global economy was progressing slow (due to
problems in EU, and USA not yet fully recovered) => so, this tight monetary
policy actually contributed to a sharper slowdown of Indian economy than
anticipated.
GDP growth rate fell down from good 9+% to around 5-6%.
CRR rates
3/26/13 Mrunal [Economic Survey Ch4] Inflation, WPI, CPI, monetary policy, RESIDEX gist of Print
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Check the chart
As you can see, between 2010-11, here too, RBI kept increasing CRR rates to curb
inflation. But from 2012 onwards, RBI has started decreasing the CRR.
SLR rates
As you can see, RBI hasnt changed SLR much in last three years.
Why RBI couldnt control inflation?
Were facing inflation because there is mismatch between supply and demand.
Supply (of food, gold, houses, everything) is low
3/26/13 Mrunal [Economic Survey Ch4] Inflation, WPI, CPI, monetary policy, RESIDEX gist of Print
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While demand of those items (particularly food) is high (because population is
high, the income levels of public has increased).
Now think about this: What can RBI do? It can only increase the interest rates.
While increased interest rates may decrease the demand of houses, cars, bikes
but it cannot directly decrease the demand of food, milk and other essential
commodities.
In other words, Interest rates cannot change the dietary habits of people, not at
least in the short term.
Besides, high interest rates make it difficult for businessmen to borrow = less
new projects = less new employment, less GDP.
Therefore primary solution to fight Indias inflation =Increase the supply of food
items.
But this will requie thorough revision of the way govt. treats agriculture, allied
activities, food processing and infrastructure. Small farms, disguised
unemployment, heavy reliance on monsoon : all these issues must be addressed
in comprehensive manner.
Way ahead
For RBI
World Banks report (January 2013) says prices of most of the global
commodity prices are expected decrease in 2013 and 14 (except for metals.)
However, as per the assessment of RBI, global economic and financial
conditions are still fragile. So theyre not providing any growth stimulus to the
economy. (for example, if situation in Europe and America was good, theyd have
been importing a lot more goods and services from India= Indias GDP could
increase.)
So in that context, even if RBI drastically reduces repo or CRR, that wont do
much good to economy.
For Government
tackling the supply side bottlenecks take months and years.
So in the mean time poor people must be protected from the inflation.
Thats why govt. needs to continue giving welfare schemes and subsidies.
But such support must be targeted to the right beneficiaries: thats where
UID/Aadhar, Direct cash transfer comes into picture.
Other than that, Government needs to continue pushing for fiscal consolidation,
deregulation of sugar pricing (as per Rangarajans recommendations), and other
policy initiatives.
On a side note:
RESIDEX
3/26/13 Mrunal [Economic Survey Ch4] Inflation, WPI, CPI, monetary policy, RESIDEX gist of Print
mrunal.org/2013/03/economic-survey-ch4-inflation-wpi-cpi-monetary-policy-residex-gist-of.html/print/ 10/11
Rural to urban migration is an inevitable part of economic growth.
But when people migrate from rural areas to urban areas, it creates pressure on
civic amenities and housing (slums).
Year % of Indian population living in Urban areas
195117
201130
204050 (expected)
Until recently, we did not have an index to capture the prices of residential
buildings in urban areas.
Hence Residex index was launched in 2007.
This index records the changes in the prices of residential buildings.
According to the RESIDEX, the housing prices have declined in Hyderabad,
Banglore and Jaipur (from 2007 to 2012) but they have increased by more than
100% in Pune, Bhopal and Chennai.
Mock questions
1. Correct statements about WPI?
a. It is released by finance ministry
b. It classifies items into three categories 1) primary 2) fuel and fodder 3)
Manufactured products and services.
c. It is calculated using Laspeyres formula.
d. None of above
2. Incorrect statements about CPI
a. The base year is 2004-05
b. It is calculated by Labour Bureau with the help of NSSO
c. Both A and B
d. Neither A or B.
3. Correct statements
a. CPI measures price change in both goods and services.
b. WPI measures price change in only in goods but not in services.
c. Both A and B
d. Neither A or B.
4. What is the formula for GDP deflator?
a. GDP at constant price divided by current price
b. GDP at current price divided by annual WPI
c. WPI divided by CPI
d. GDP at current price divided by constant price
5. What is RESIDEX?
a. It is a drug to combat swine flu.
b. It is a new vaccine for rabies.
c. It is an index to capture the prices of residential buildings in urban areas.
d. It is an index to capture the prices of residential buildings in both rural and
3/26/13 Mrunal [Economic Survey Ch4] Inflation, WPI, CPI, monetary policy, RESIDEX gist of Print
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urban areas.
6. Between March 2011 to March 2013, what was the highest Repo rate?
a. 9.00
b. 7.25
c. 8.50
d. None of Above
7. Which of the following can be used to measure inflation directly?
a. Current Account deficit
b. GDP deflator
c. Fiscal deficit
d. Purchasing power parity
for more articles on economy: visit Mrunal.org/economy
URL to article: http://mrunal.org/2013/03/economic-survey-ch4-inflation-wpi-cpi-
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