Inflation is always a hot topic in a developing country like India. Different people look at inflation data differently. The upper class looks at the inflation data to see whether the central bank will go for a rate cut or not. Middle class looks at the inflation data to check how it will affect their returns on investments or savings. But it’s poor to whom the inflation affects the most. Even the smallest change in the prices affects his overall monthly or weekly budget. Lower income group spends the majority of their income on food items and it is very natural that they will always care about the food prices.
Last year India witnessed historic elections where inflation was one of the central issues. Of course, inflation has been a prime topic for elections right from the first elections held in the country. The current government is about to complete their first year after taking the charge with a complete majority in the parliament. Now people have started raising questions about the performance of the government in dealing with the inflation and they are right in doing so. Let’s try to look at what exactly this inflation means and how to assess the performance of the government.
“Inflation is a general increase in the overall price level of goods and services in an economy in a given period of time.”
The question is why the prices go up? There are two reasons for the increase in the prices, either due to rise in demand which forces prices to go up or fall in supply which also forces prices to go up. There can be many reasons for the rise in the demand or fall in the supply. To state a few, the overall rise in the income of people may lead to a rise in the demand or rise in the population will lead to a rise in the demand, a fall in the rainfall may lead to a decrease in the supply of agriculture commodities or an improper supply chain may lead to a fall in the supply. In the technical terms, these are called “Demand Pull” effect on inflation or “Supply Shock” effect on inflation.
Now the other question is how do you calculate the inflation? There are various ways to calculate inflation but let’s discuss the major two methods. These methods are calculating the inflation on wholesale prices through Wholesale Price Index (WPI) and calculating the inflation on retail prices through Consumer Price Index (CPI). Retail price inflation is more important to people since it affects their day to day life and especially the food component which is known as the food inflation.
In India, till February 2013 we were using wholesale inflation index for taking policy decisions but now we focus on the retail inflation index. To calculate inflation government creates a basket of goods and services which people use in their day to day life. The basket is different for calculating the wholesale inflation and the retail inflation. They give weights to goods and services on the basis of their usage by people. Let’s focus on consumer inflation and see which all goods and services are included in the basket and what are the weights given. Please check the table given below for the weights.
|Goods and services||Rural Weights||Urban Weights||Combined Weights|
|Cereals and products||12.35||6.59||9.67|
|Meat and fish||4.38||2.73||3.61|
|Milk and products||7.72||5.33||6.61|
|Oils and fats||4.21||2.81||3.56|
|Pulses and products||2.95||1.73||2.38|
|Sugar and Confectionery||1.70||0.97||1.36|
|Prepared meals, snacks, sweets etc.||5.56||5.54||5.55|
|Food and beverages||54.18||36.29||45.86|
|Pan, tobacco and intoxicants||3.26||1.36||2.38|
|Clothing and footwear||7.36||5.57||6.53|
|Fuel and light||7.94||5.58||6.84|
|Household goods and services||3.75||3.87||3.80|
|Transport and communication||7.60||9.73||8.59|
|Recreation and amusement||1.37||2.04||1.68|
|Personal care and effects||4.25||3.47||3.89|
The above weights are nothing but the proportion of expenditure we spend on a particular product. For last many years inflation has been a major issue which Indian economy is facing. India is facing the problem of inflation due to both the causes i.e. demand pull and supply shock effect. Let’s try to see the performance of the new government. The following three graphs will give you a picture of inflation in India from May 2014 to April 2015.
If we look at the above graphs then it is clearly visible that the current government is been fairly successful in curbing the wholesale and the retail inflation. Food inflation has also come down but at a moderate rate.
Generally, people say that they don’t understand these inflation figures and they only know that the prices in the market are not coming down. They are right also. Yes, the prices in the market are not coming down because the inflation rate is falling which means the rate at which the prices increase is falling. For an example if a commodity is Rs.100 per kg now and if the inflation rate falls from 8% to 4% means the commodity will cost Rs.104 per kg instead of Rs.108 per kg which is actually an improvement but if we look at the absolute prices then we will see the price rise and we will feel that there is no change in the inflation. This is not true. We need to understand if we want to see a fall in the absolute prices of the commodities then the inflation rate should become negative like what you can see in the case of wholesale inflation. The wholesale inflation rate is been negative for last five months. If the consumer inflation becomes negative then one can see a decrease in the absolute prices.
The second misinterpretation generally people have is when inflation rate goes down it indicates the fall in the overall price-rise which may not be true for all the goods and services. Since inflation rate is calculated on an average basis of all the goods and services some commodities may see a price-rise though the overall inflation rate is falling. People say the price of a particular commodity has increased from so to so, where the inflation rate is falling? But we need to understand that inflation rate is an overall aggregate and it may not be experienced in some commodities for the commodity-specific reasons.
As a fair student of economics, I see the performance of the current government is really outstanding in dealing with the inflation though there are many things in which the government will have to look into. Infrastructure development and agriculture sector reforms are very important to solve the supply side bottlenecks. One year is not a sufficient time to solve the supply side bottlenecks and we will have to wait for another year or two to see the improvement in the same. I personally feel it will be an injustice if we don’t acknowledge the efforts taken by the current government in dealing with the problem of inflation. People may feel that I am a supporter of the current government and trying to justify their position but I have honestly tried to analyze the overall issue with the pure lenses of economics. I am following the inflation data at least for last 6 years and this government’s performance is really commendable. Rest is up to your judgment!