I’ve been wondering, why do we have 12%+ inflation in India. What are the reasons for it?
Is it because of the weakening US dollar, which happens to be India’s chief reserve curency?
Is it the price of Crude Oil and other commodities in the international markets?
Is t because of the monetary policies of the Reserve Bank of India?
What could be the possible solutions? Can we avoid this brewing crisis? People are extremely poor, and can hardly afford this price-rise in basic commodities like food. What could the government do differently to calm the inflation?
Really sorry to be responding so late that the questions has almost become irrelevant. Inflation is back down to sub 6% levels and looks to be headed lower in coming days. but the questions are still pertinent in my view, because the tools used to bring inflation down have had a long lasting impact on economic activity in India.
Inflation in India had risen due to a combination of the factors you mention. High commodity prices were a reality, but monetary measures that accompanied these were what actually caused a bulk of the pain. RBI intervention in the FX market through 2007 was of a magnitude that was both unprecedented and unwarranted. in the course of a year, the RBI bought close to USD 100 bln, a whopping 10% of GDP, to stop the rupee from appreciating. This had a twofold impact. The artificially weak INR caused a flow through of high global commodity prices to the domestic economy and huge liquidity injection caused secondary inflation in consumer prices. It can be argued that this excess liquidity also contributed to asset price inflation impacting both equities and real estate.
Realising this, the RBI resorted to tightening monetary policy, by intervening in the moeny markets to suck liquidity out through CRR increases and MSS bonds and hiked interest rates. However, since inflation was caused by factors which could not be influenced by domestic monetary policy, these measures ended up hurting economic activity causing a temporary liquidity freeze in the domestic money markets in October 2008. these measures, a large part of which have been reversed since, have caused a loss of confidence in businesses and consumers and slowed economic activity to a crawl.
Inflation has reduced, but this has been primarily driven by the collapse in commodity prices than by any measures undertaken by the RBI. In fact, despite a reversal of the earlier policies, the RBI and the Government are now faced with the task of reviving the economy.
The emergng challenge before the RBI is now deflation. In coming days, if commodity prices were to remain benign, decreased consumption levels due to depressed confidence can cause the economy to get into a deflationary spiral. this would be a virtual repeat of what was experienced in the 2000 - 2004 period. The problem is, we are already near the 2004 lows in terms of interest rates and the crisis is only just beginning.
sorry once again for the delay. I plan to dedicate at least an hour a day to this group and look forward to hering from you soon.
Good analysis. However, I don’t think we are going to see deflation problem in anytime in near future. Deflation doesn’t necessarily always equate to lower prices. To be more accurate, deflation is the contraction of money supply and that is not going to happen with RBI printing press pumping all the money to “stimulate” the credit market.
We will continue to have economic problems and they are going to get worse as the fundamentals of our economy are not improving.