CHAPTER III INFLATION RECORD OF INDIA 3.1 History of inflation in India 3.2 Measurement of Inflation in India 3.3 Inflation based on WPI 3.4 Alternative indicators of inflation in India 3.5 Historical Analysis of Inflation in India 3.6 Phase I: 1935-1949 3.6.1 Pre-War inflation (1935-1939) 3.6.2 Wartime inflation (1939-1945) 3.6.3 Post War Inflation (1945-1949) 3.7 Phase II: 1949-1969 3.8 Phase III: 1969-1991 3.9 Phase IV: 1991 to 2009 3.10 Disaggregated view of the WPI inflation
Transcript
CHAPTER III
INFLATION RECORD OF INDIA
3.1 History of inflation in India
3.2 Measurement of Inflation in India
3.3 Inflation based on WPI
3.4 Alternative indicators of inflation in India
3.5 Historical Analysis of Inflation in India
3.6 Phase I: 1935-1949
3.6.1 Pre-War inflation (1935-1939)
3.6.2 Wartime inflation (1939-1945)
3.6.3 Post War Inflation (1945-1949)
3.7 Phase II: 1949-1969
3.8 Phase III: 1969-1991
3.9 Phase IV: 1991 to 2009
3.10 Disaggregated view of the WPI inflation
49
CHAPTER III
INFLATION RECORD OF INDIA
3.1 History of inflation in India
India’s track record of inflation is good in the sense that it has
never had to face the terror of hyper inflation. ‘The highest inflation
that India has ever seen in the past two centuries is 53.8%, in the
famine year of 1943. Amartya Sen has often written about the havoc
wreaked by that inflation in his part of the country. Satyajit Ray
captured the sufferings in Ashani Sanket, a film he made in 1973.
Those were terrible times, but nothing like what Germany faced in the
early 1920’s or what Zimbabwe has to deal with today.1
India’s experience of inflation has been a mixed bag. There were
years when the annual rate of inflation was as high as 40%, while in
other years it was in the negative. During last 70 years, beginning with
1939-40, inflation rate was below 6% for 34 years and for remaining
years it was above 6%. If the tolerable rate of inflation is assumed to
be 6% and below, then India appears to have fared badly in terms of
control over inflation, as for 36 years the rate of inflation was above
6%. For about 9 years, the rate of inflation was above 15%. Therefore,
there are many who believe India to be an inflation ridden country.
They consider the inflation as a permanent characteristic of Indian
economy. A strong inflationary pressure has been built into the Indian
economy for a long time, precisely from the start of the Second World
War, partly through ever mounting demand on the one side and
inadequately rising supply on the other. The expanding demand is due
to the rapid multiplication of our population, rising money incomes,
expansion in money supply and liquidity in the country, rising volume
50
of black money and continuous rise in demand for goods and services
due to rapid economic development. Supply of goods and services too
has been rising but the rise in supply has not been proportionate to and
matching with the rise in demand. This is due to monsoon tied
agriculture, use of backward technology, bottlenecks in transport and
power, and shortages of various inputs.2
3.2 Measurement of Inflation in India:
Inflation is the rate of change of general price level. For
measuring the general price level, index numbers are constructed by
taking weighted average of prices of individual goods and services.
The weight assigned to each good or service reflects the relative
importance of that good or service in the economy or in the
consumption basket of consumers and producers. The general price
index so constructed indicates the overall magnitude of prices of goods
and services. The comparison of general price index over a period of
time gives us the variation in the general price level, which is nothing
but the rate of inflation. In India, there are mainly three types of
measures of general price level namely (i) wholesale price index (WPI),
(ii) consumer price index (CPI), and (iii) Implicit GDP deflator3. The
rate of inflation can be measured in terms of any one of these three
measures.
The WPI is the main measure of the rate of inflation often used
in India. The WPI is available for all commodities, and for major
groups, sub-groups and individual commodities. The basic advantage
of this measure of inflation is its availability at high frequency, i.e. on
a weekly basis, with a gap of about two weeks; thereby enabling
continuous monitoring of the price situation for policy purposes.4 The
51
major defect of this measure of inflation is that it does not cover the
services and non tradable commodities.
The two most popular price indices that are used for measuring
change in price level are the Paasche Index and the Laspeyres Index.
The Paasche Index is calculated using following formula.
),,(
),,(
0 nCC
nCnC
PtQtP
tQtPP
⋅Σ
⋅Σ=
The Laspeyres Index on the other hand is calculated with the
help of following formula.
),,(
),,(
00
0
tQtP
tQtPP
CC
CnC
L⋅Σ
⋅Σ=
The P in the formula refers to the price level, while Q to the
quantities of commodity. t0 and tn denote base and current periods
respectively.
In India the process of WPI construction begins with the
calculation of price relative (i.e. 1000
1×
P
P) for each price quote of a
commodity. For obtaining commodity/item level index, simple
arithmetic average of the price relatives of all the varieties (each quote)
is taken. Next aggregation method based on Laspeyres formula is used
to arrive at indices for the sub groups/groups/major groups of WPI.
The aggregation method used is as below:
I = S (Ii x Wi)/S Wi
Where,
I = Index number of wholesale prices of a sub group/ group/major group/all commodities.
S = Stands for the summation operation Ii = Index of the ith item/sub-group/group/major group. Wi = Weight assigned to the ith item of sub-group/ group /
major group
52
The aggregation method is first applied to sub-groups, then to
groups, and major groups. Finally, the all commodity index is
constructed by aggregating major group indices. The weights assigned
are value weights.
CPI reflects the cost of living conditions of a homogenous group
of consumers for which it is constructed and based on retail prices of
commodities generally consumed by the group. Currently, four
categories of CPI are available in India. They are CPI for industrial
workers (CPI-IW), CPI for agricultural labourers (CPI-AL), CPI for
rural labourers (CPI-RL) and CPI for urban non-manual employees
(CPI-UE). Among the four CPI-IW is very popular with better
coverage, whereas CPI-AL and CPI-UE are designed to measure the
impact of inflation on rural and urban poverty respectively.5 The third
measure of inflation, GDP deflator is derived from the national income
accounts as a ratio of GDP at current prices to GDP at constant prices.
The scope and coverage of the GDP deflator is wider than any other
measure, for it encompasses the entire spectrum of economic activities
including services. At present, the GDP deflator is available only
annually with a long lag of over one year and hence has very limited
use for the conduct of policy. 6
We will analyze the trend in inflation based on three indices
namely WPI, CPI-IW & GDP deflator, beginning with WPI.
3.3 Inflation based on WPI:
The following table takes us in to the history so as to give us a
perspective on inflation in India. The data presented is for last 70 years,
beginning with 1939-40, and is based on different wholesale price
1. Vakil,C.N. (1978) War Against Inflation The Story of the Falling Rupee : 1947-77, The Macmillan Company of India Ltd., pp.4-5 2. Handbook of Statistics on Indian Economy, RBI 3. Office of the Economic Adviser, Ministry of Commerce & Industry, GOI
Graph 3.1
Annual Rate of Inflation (in %)
-20
-10
0
10
20
30
40
50
19
39
19
41
-42
19
44
-45
19
47
-48
19
50
-51
19
52
-53
19
55
-56
19
58
-59
19
61
-62
19
63
-64
19
66
-67
19
69
-70
19
71
-72
19
74
-75
19
77
-78
19
80
-81
19
82
-83
19
85
-86
19
88
-89
19
91
-92
19
93
-94
19
96
-97
19
99
-00
20
02
-03
20
05
-06
20
08
-09
W
PI
Infl
ati
on
ra
te
Year
INFLATION RATE
Source: Based on Table No. 3.1
From the above table and graph, it appears that inflation, based
on wholesale price index, has varied in a wide range of -12.5% and
38.3%. The lowest figure of -12.5% was recorded for the ear 1952-53,
while the highest one of 38.3% for the year 1943-44, the final year of
World War-II. As can be seen from the graph, there are three peaks in
the years 1943-44, 1948-49, and 1974-75 with the inflation rates of
38.3%, 22.6% and 25.1% respectively. These years of high inflation
56
basically reflect the impact of war, supply shocks resulting from
setbacks in domestic agricultural production and external oil price
hikes. The average inflation for the entire period of 70 years works out
to be 7.6 %.
The frequency distribution of inflation in India across different
ranges during the period 1939-40 to 2008-09 is presented in the
following table and graph.
Table No. 3.2
FREQUENCY DISTRIBUTION OF WPI INFLATION
(1939-40 to 2008-09)
Range of Inflation (in %) Frequency Below 0 06
0 – 3 06 3 – 6 22 6 – 9 15
9 – 12 07 12 – 15 05 Above 15 09
Source: Compiled from table No. 1
Graph 3.2
Frequency Distribution of WPI inflation
0
5
10
15
20
25
Below
0
0 – 3 3 – 6 6 – 9 9 – 12 12 – 15 Above
15
Infl
ati
on
Ra
te
Range of Inflation (in %)
Source: Based on Table No. 3.2
57
The range with highest frequency, that is, modal range of
inflation, during the entire period is the one of 3% to 6%. The range of
second highest frequency is that of 6% to 9%. Out of 70 years, it was
only for 12 years that inflation remained below 3%. The notion that
inflation has been a chronic problem in India is indicated by the fact
that it remained above 6% for about 36 years in a period of 70 years.
If decadal inflation rates are considered, then it appears that the
average for the decade of 1940’s was the highest at 12.63%. The
lowest average inflation rate was recorded for the immediate decade of
1950’s and it was just 1.73%. From the low of 1.73% during 1950’s,
the average inflation rate climbed to 6.34% during 1960’s and 8.99%
during 1970’s. During the following decades of 1980’s & 1990’s, it
remained close to 8%, while in the 2000’s it has been found subdued at
5.43%.
Table No. 3.3
DECADAL WPI INFLATION RATE (ANNUAL AVERAGE)
(In Percent)
Period Inflation rate
1940-41 to 1949-50 12.63
1950-51 to 1959-60 1.73
1960-61 to 1969-70 6.34
1970-71 to 1979-80 8.99
1980-81 to 1989-90 7.97
1990-91 to 1999-2000 8.12
2000-01 to 2008-09 5.43
Source: Based on Table No. 1
58
Graph No. 3.3
Decadal WPI Inflation Rate
0
2
4
6
8
10
12
14
1940's 1950's 1960's 1970's 1980's 1990's 2000-01 to 2008-
09
Infl
ati
on
ra
te
Decade
Inflation rate
Source: Based on Table No. 3.3
3.4 Alternative indicators of inflation in India:
As said earlier, apart from the WPI, there are two more inflation
indices that are constructed and used in India. Though, the WPI is the
preferred choice of both policymakers and academicians, for its
advantages such as wide coverage, high frequency & data availability
with a lag of just two weeks, the other two indices, namely CPI-IW and
GDP deflator are no less important. Here a comparison of inflation
based on all the three indices is attempted for a period of 70 years. For
CPI-IW and GDP deflator, the data available is for last 58 years
1951-2009 0.85 0.85 0.91 * 1951-1969 WPI = Wholesale Price Index, CPI-IW = Consumer Price Index for Industrial Workers, GDPd = GDP deflator Source : 1. Same as Table No. 3.4
Graph No. 3.5
Phasewise Average Inflation Rates
0
2
4
6
8
10
12
14
16
39-49 49-69 69-91 91-2009 39-2009
Infl
ati
on
ra
te
Period/Phase
WPI
CPI- IW
GDPd
Source: Based on Table No. 3. 5
It can be seen from the above table that WPI inflation was
highest in average terms, during the first phase, that is during 1935 and
1949. It was 15% and was primarily the consequence of Second World
War. During the second phase, inflation based on all the three indices
WPI, CPI-IW and GDP deflator moderated considerably and remained
around 4% in annual average terms. The third phase (1969-1991),
68
which experienced two oil price shocks from OPEC countries and
unrestricted deficit financing by the Indian govt., recorded a higher
average inflation in terms of all the three indices of around 8%, nearly
double the one found for the earlier phase. During the fourth phase
(1991-2009), inflation based on all the three indices, is found to have
moderated somewhat to the level of around 7% in average terms.
If a comparison is made of inflation rate based on all the three
indices (averages for the period for which data is available), then it is
the GDP deflator inflation that is found lowest. This is perhaps because
of wide coverage of GDP deflator, having included in to it the services,
whose prices tend to be relatively stable. Average inflation based on
CPI-IW was the second highest at 6.7%, marginally higher than the
average inflation based on GDP deflator. However, for a uniform
period ranging from 1970 to 2009, average inflation derived from CPI-
IW is found to be higher (7.9%) than the ones based on WPI (7.7%)
and GDP deflator (7.6%).
As far as the variation in inflation rate is concerned, WPI
inflation appears to have varied too much during the study period,
particularly during the first phase as reflected in higher standard
deviation of 14. Volatility or variation in the inflation rate based on
GDP deflator is found to be the lowest, with the standard deviation of
4.8 worked out for the period 1951 to 2009. Even the CPI-IW based
inflation is found to be less volatile than the one based on WPI.
Volatility appears to have moderated for inflation based on all the three
indices over the years.
A close association is found between the WPI inflation and GDP
deflator inflation, as implied in the correlation co-efficient of 0.91. The
association between WPI and CPI-IW and between CPI-IW and GDP
69
deflator is found to be relatively weak as given by the co-efficient of
correlation of 0.85 and 0.85 respectively for the period 1951 to 2009.
Though the inflation rates based on all the three indices have
some distinguishing features, they are found to be close to each other
over a long period.
It is to be noted that all the three price indices have their merits
and demerits. However, WPI has been the preferred choice of policy
makers and academicians in India. WPI has emerged as the most
suitable general price index due to its wide coverage of commodities,
availability at a high frequency (weekly basis) with a lag of just two
weeks, etc. 7
For the analysis of study from a historical perspective, we will
keep to the tradition and use WPI inflation for the discussion. What
follows is the analysis of inflation divided into earlier mentioned four
historical phases.
3.6 Phase I: 1935-1949
This phase begins with the establishment of Reserve Bank of
India in 1935 and ends with its nationalization. The period of this
phase is important from another point of view as it was the period
immediately preceding independence, 8 during which there was too
much chaos, as the freedom fight was at its culmination and we had to
support the war efforts of allies. Analysis of inflation during this phase
will also reveal the success of RBI as an inflation fighter during early
years of its existence.
3.6.1 Pre-War inflation (1935-1939):
Reserve bank of India (RBI) assumed the reigns as the central
bank of India in 1935 and the challenge before it was not the one of
70
controlling price rise, but that of reviving the falling prices. At the time
of its establishment, the Indian economy, like other economies of the
world, was gradually recovering from the great depression of the
1930’s. Since the commencement of the depression, the price level had
steadily declined to its lowest level in March 1933, when the Calcutta
index of wholesale prices (base: July 1914=100) touched 83 as against
the average level of 141 for 1929, representing a fall of 41.1 %.9
A look at the following table gives us an idea about the
behaviour of prices during the immediate post-depression period or the
pre-war period.
Table No. 3.6
BEHAVIOUR OF PRICES DURING 1935 TO 1939
As on the last friday of the calendar year
April
5, 1935 1935 1936 1937 1938 1939
Aug. 25
1939 (i.e.
eve of world war II)
1 2 3 4 5 6 7
Index number of wholesale Prices- Calcutta (July 1914=100) Monthly – December index for column
2 to 6
88 (April)
93
(5)
(5.7)
94
(1)
(1.07)
102
(8)
(8.5)
95
(-7)
(-6.9)
137
(42)
(44.2)
100 (Aug.)
(5)*
(5.3)*
Note: Figures in bracket indicate absolute and percentage variation over previous period. * Variation over December 1938. Source: Simha S.L.N. History of the Reserve Bank of India: 1935-51 (volume I), RBI, Bombay, 1970.
71
After reaching its low level in March 1933, the Calcutta index of
wholesale prices began its upward march to clock its post-depression
high of 105 in August, 1937. Recovery of prices during this period was
due to increasing demand for agricultural raw material in the wake of
world wide rearmament efforts and the emergence of speculative
hoarding of commodities.10
The process of gradual recovery in prices got reversed with the
U.S.A. and other countries of the world knocking the door of recession
by about the middle of 1937. The continuance of Sino-Japanese
hostilities further aggravated the situation. These two adverse
developments reduced the demand for cotton, the most important item
of export, particularly from Japan, the principal customer for India’s
raw cotton.11 The Calcutta prices index, consequently, started moving
southward to touch a low of 94 in April, 1938, representing a fall of
10.5%.
The impact of depression abated by the end of 1938 and prices
began moving up gradually with the index surging northward to 101.5
in May 1939. The recovery in prices could not be sustained due to
growing uncertainties of the international situation. Besides, the cotton
textile industry saw one of the worst slumps in its history during this
period. Consequently, the raw cotton suffered a sharp decline.12 The
outbreak of war in September 1939 very immediately altered the
situation and caused a sharp rise in commodity prices. A comparison of
index number for August 1939 and December 1939 shows a rise of
37% in prices. The sharp increase in price level of a little under 40%
during first few months was mainly due to the exaggerated fears of
acute shortage consequent on the outbreak of war and the resulting
panic buying, financed by bank credit.13
72
3.6.2 Wartime inflation (1939-1945):
During the war period India suffered a greater magnitude of
inflation in comparison with other non-devastated countries. The
severity of inflation varied across the war hit countries, but it was the
people living near the subsistence, who suffered a lot every where.
During the early years of war, price increases were fairly moderate, but
a sharp rise took place in 1942 and 1943. From the end of 1943 to the
end of 1945, prices were relatively stable at a very high level, but in
1946 there was again a marked increase14 as can be seen from the table
No. 3.5.
The general index of wholesale prices, which was 100 on August
25, 1939, the eve of World War II, went up to 254 at the end of March
1946, representing a rise of 154% during the war period. It is also true
that the official index underestimated the extent of the price rise as
limited success was achieved in administering the price controls.
Consequently, the prices used for the compilation of the index did not
fully reflect the true level of prices which had to be paid.15
This period contained an inflationary price spiral of serious
proportions, spanning over three consecutive years of 1941-42, 1942-
43 and 1943-44. Prices rose at an alarming rate during these three years
with respective inflation rates of 19.3%, 24.8 and 38.3%. At no other
time in the known history of India, prices rose at such an alarming
rates for three consecutive years. There were times, for example, 1946-
47 to 1948-49, 1972-73 to 1974-75 and 1979-80 to 1981-82, when the
prices increased very fast for three or more consecutive years, but the
rates were not as high as they were during the period 1941-42 to 1943-
44.
73
The prime reason behind the run away inflation recorded during
this period was undoubtedly the war and the way it was financed.
Being ruled by Britishers, India was called upon to make a substantial
contribution to the war effort of U.K. and her Allies. Low per capita
income, the lack of enthusiasm for the war on the part of the country as
a whole, non co-operation from the leading political party and the
inadequacy of the administrative machinery for collecting taxes set a
serious limit to govt.’s ability in raising resources in the form of
taxation and non-inflationary borrowing from the public.16
So war efforts were financed by substantially stepping up the
expenditure on govt. of India’s own account as well as on the account
of the Allies. The combined expenditure more than doubled in just two
years of 1941-42 and 1942-43 from Rs. 342 crores to Rs. 693 crores.17
The substantial increase in expenditure was inevitably financed
through recourse to deficit financing, that is creation of new money,
causing the demand for everything to exceed the supply by a
considerable margin and thereby putting upward pressure on prices. A
clear description of the situation is given in the ‘manifesto’ issued
jointly by a number of Indian economists on 12th April, 1943. The
relevant part is reproduced below18
“The rapid rise in the general price level during the past two
years and the enormous expansion of currency in India are, we feel,
causally related. The unprecedented expansion of currency since the
war began is due chiefly to the system adopted for financing the large
British and other Allied purchases in India, under which the govt. of
India accepts payments in sterling and provides rupees in exchange.
For all these purchases, India acquires under present arrangements,
sterling assets in London and against these there occurs an expansion
74
of currency in India…………… The govt. seems to act as if it is
enough for it to take care of its own budget deficit while meeting the
needs of the British Govt. by printing more notes. This is a grave
misreading of the whole situation and has resulted in an ever increasing
expansion of currency unrelated to the needs of internal production and
trade. As a result, the inflationary spiral is already at work in
India………....... The inflation in India is, therefore, a deficit induced
fiat-money inflation. It is the most disastrous type of inflation.”
So it was the unrestricted deficit financing during the war years
that appears to be responsible for the catastrophic inflation during this
period. Besides, exports of consumer goods leading to fall in supplies
to domestic market, reduced imports, relatively small increases in the
production of basic commodities, difficulties of transport and
distribution, artificial shortages created through speculation and
hoardings and failure of price controls were also responsible for the
price rise accentuation.
After the middle of 1943, considerable moderation in the rate of
price rise was seen. It was mainly because of two reasons; first the
budget deficits after peaking in 1943-44, remained more or less stable
during next two years. The second reason which helped in moderation
of price rise was the introduction of partial rationing. 19
3.6.3 Post War Inflation (1945-1949)
The post-war period from 1945 up till 1949 was as chaotic as the
war period. It saw the prolonged political crisis, culminating in the
transfer of power and the partition of the county, with its aftermath of
vast social upheavals and huge massacres. It was in such a complex
75
situation that there was an inflationary trend which had remained
repressed during 1944-45 and 1945-46.
During the immediate post-war period, there was an
apprehension that a depression was very much likely due to the abrupt
contraction of pubic expenditure. It was in line with the view also held
by the developed countries.20 With the strong influence of Keynesian
ideology over its mind, the govt. of India thought it necessary to
practice an expansionary fiscal policy and cheapen the money. In an
attempt to protect the economy from deflationary tendencies, a plethora
of measures were undertaken. The budget for 1946-47 provided
various tax reliefs, including the abolition of the excess profits tax and
introduced special initial depreciation allowance in respect of new
buildings and plant and machinery so as promote investment in the
economy.21 The govt. also followed a policy of gradually withdrawing
controls, with controls pertaining to essential commodities being
removed in December 1947. Following the withdrawal of controls,
there was marked rise in commodity speculation leading to sudden rise
in price index in December 1947.22
The situation was further aggravated by industrial unrest and a
trend towards upward adjustment of wages and prices to compensate
for the rise in the cost of living that had already taken place.23 On the
supply front, there was also reduction in it owing to loss of
predominantly agricultural regions, consequent on partition and decline
in agricultural production on account of the dislocation caused by
communal disorders and the failure of crops in some parts of the
country.24
Another important reason behind the inflationary price rise
during this period was a substantial expansion in money supply
76
resulting from the substantial deficit in govt. budget on account of the
large expenditure on the relief and rehabilitation of the displaced
persons.25
The emergence of the extensive pent.-up demand of the war
period further added fuel to the fire. Continuously rising prices
intensified the people’s urge to spend. Besides, people lost the
incentive to save with the returns on savings going down as a
consequence of the post-war cheap money policy.26
All the above mentioned factors worked in pushing the price
level to an intolerably high level. The WPI inflation jumped from a low
of 0.3% in 1945-46 to 12.5% in 1946-47. With a marginal fall of 1% in
1947-48, it again sprung to 22.6% in 1948-49. This was for the second
time during this historical phase (1935-1949) that inflation ruled at a
very high level for three years in row.
Overall, the first phase, which began with the establishment of
RBI in 1935 up till its nationalization in 1949, saw little or no success
in terms of control over inflation. The average inflation rate during this
period was the highest in comparison with the ones recorded for other
subsequent phases. Further, it was this phase, which saw highest
volatility as implied in the high level of standard deviation of 14. The
inflation rate during this phase varied from a low level of -8.6% in
1940-41 to a high level of 38.3% in 1943-44.
It is undisputedly clear that it was world war II and the way it
was financed along with some other reasons like wrong interpretation
of the situation by the govt. and the adoption of measures which
propelled inflation, instead of arresting it, as also social tensions born
out of the partition, which were responsible for the unpleasant inflation
scenario during this phase. It is thus apparent that the wartime inflation,
77
and even the inflation during post-war period, was primarily caused by
the too much creation of money to finance the military expenses. RBI
as a central bank, was aware of the seriousness of this way of financing
the war and it was at several times that it communicated its concern to
the finance department of Govt. of India, which under the pressure
from British govt. could not avoid recourse to deficit financing as a
way of financing war. The RBI, thus, remained subservient to the
finance department during the pre-independence period and followed
an accommodative policy.
3.7 Phase II: 1949-1969
The nationalization of Reserve Bank of India marks the
beginning of this phase. The phase ends with nationalization of 14
commercial banks in 1969. This phase inherited a strong inflationary
pressure developed during the Second World War and the subsequent
years. The devaluation of rupee in 1949, following the devaluation of
pound sterling by U.K. and of other currencies, in the very beginning
of this phase, did not sound well from the point of view of keeping the
inflation in check in the forthcoming years. It is on this background
and also on the background of nationalization of RBI in 1949, which
followed the nationalization of central banks in other countries that we,
in this section, propose to study the trend in inflation in India and the
factors that caused fluctuations in it during this phase.
The first year of this phase 1949-50, witnessed govt.’s endeavour
to realise the benefits of devaluation and to suppress the inflationary
impact of the measure. The important steps initiated for cooling the
inflationary pressure were cut in the prices of controlled commodities
like food grains, cloth, yarn, pig iron and steel, prohibition of futures
78
trading in several commodities to check the speculation, imposition of
export duties on some of the articles exported, reduction in govt.
expenditure, regulation of credit facilities so as to discourage
speculative hoarding of stock of essential commodities, introduction of
national savings campaign as also substantial tax reliefs and other
concessions to individuals and industries with a view to encourage
investment.27 It was perhaps because of these measures adopted by the
govt. that inflation rate remained at low level of 2.4% in 1949-50.
The following two years, viz. 1950-51 and 1951-52, however
saw the inflation inching up to around 6% primarily because of an
external cause, i.e. Korean War boom. The outbreak of hostilities in
Korea in June 1950 led to a worldwide inflation situation. The Korean
boom, which was essentially a raw material boom, created a huge stock
piling demand, pushing the prices of several internationally traded
strategic materials to abnormally high levels.28 The index of industrial
raw materials sprang by nearly 40% from 490 on the eve of the Korean
war to 689 by the middle of 1951, pushing the general index of
wholesale prices up from 393 in May 1950 to 458 in April, 1951.29
The year 1952-53 brought with it a big surprise of prices
entering into the negative territory. It was the higher agricultural
production that was behind the deflation of 1952-53.30 Two more years,
which witnessed negative inflation rates during the decade of 1950’s
and during the second phase of our study were 1954-55 (-6.8%) and
1955-56 (-5.2%). The main factors responsible for the habitation of
inflation rate in the negative zone were the increase in supplies
stemming not only from the bumper production of agricultural and
industrial sectors but also from larger volume of imports and
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dishoarding resulting from the relaxation of controls over a wide
sector.31
If the period of first five year plan (1951-52 to 1995-56) is
considered, then the average inflation comes to -2.74%. The first plan,
which was essentially an agricultural plan, emphasizing the
development of agricultural sector, succeeded not only in achieving its
growth target of 2.1% per annum (actual growth rate per annum –
3.6%), but also in keeping the inflation under control. This plan
showed the importance of increase in agricultural production in
keeping the price rise under check, but during the subsequent plans,
unfortunately, it was the industrialization that received the policy
priority and we were doomed to live with high inflation in the
following years.
The latter half of the fifties presented a vastly more complicated
environment in the monetary sphere. This was the period of second
five year plan, which was much more ambitious than its predecessor,
involving a planned public sector investment outlay of Rs. 4800 crores,
a quarter of which was to be met through deficit financing.32 The first
year of the second plan, viz. 1956-57, began with an inflation rate of
14% which was the result of huge demand pressure emanating
particularly from the investment demand in the light of the thrust on
industrialization in the second five year plan.33 During the latter years
of the second plan, though the inflation rate declined, inflationary
threat prevailed. The average inflation rate for the second plan turned
out to be 6.28%, nearly 8% higher than the one recorded during the
first plan. Apart from the large size of the second plan and the manner
of financing it, the other factors that can be held responsible for the
relatively higher inflation during this period were harvest shortfalls and
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a sharp fall in foreign exchange reserves due to large imports
particularly of capital goods and consequent imposition of controls on
imports of many consumer and intermediate goods.34
The first half of the 1960’s that is the period of third five year
plan (1961-66), experienced considerable price instability, with the rate
of inflation rising sharply from around 3% in average terms during the
first three years of the third plan to about 11% in 1964-65, 7.6% In
1965-66 and to a post-war high of close to 14% in 1966-67.35 The main
contributing factors to the significant rise in inflation towards the end
of third five year plan were two wars, a series of poor harvests
including two droughts, leading to near stagnation in agricultural
production, unimpressive industrial growth, no perceptible increase in
savings rate and unstable external environment.36 Agricultural
production did not increase much above the 1960-61 level until 1964-
65 and in fact declined by about 10% in 1965-66, which was first of
two drought years.37 The story with food production was no different.
It was below 72 million tonnes per year, a level reached in 1960-61, up
to 1964-65, when it rose to 78 million tones but dropped nearly a fifth
next year to reach 63 million tonnes.38
The last three years of this phase, viz. 1966-67, 1967-68 and
1968-69 saw inflation rates of 13.9%, 11.6% and -1.1% respectively,
with the average working out to be fairly high at 8.1%. The higher
inflation of 13.9% in 1966-67, followed by 11.6% in the following year
can largely be attributed to the impact of the Pakistan war in 1965 and
the famine experienced during 1965-66.39
Taking the decade of the 1960’s as a whole, the average decadal
inflation edged up to 6.4%40 from a low level of just 1.7% recorded for
the previous decade. The inflationary pressure started mounting from
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1962-63, on account of the Chinese war in 1962 and unsatisfactory
supply position. The war with Pakistan in 1965 and the famine
conditions during 1965-66 added fuel to the fire and the situation got
aggravated. The higher inflation of 13.9% was recorded for the year
1966-67, with the lowest (-1.1%) for the year 1968-69, which was
primarily the result of bumper agricultural production of the previous
year.41
Overall, this phase spanning over 20 years from 1949 to 1969,
saw the inflation rate moderating in annual average terms. The average
inflation rate during this phase remained subdued at 4% per annum,
compared to a high of 15% experienced for the first phase of 1935 to
1949.
Not only did the average inflation rate moderate during this
phase, but the variation in it also subsided. The standard deviation of
6.7 during this phase, in comparison with the one of 14 during the first
phase certainly represents an improvement in the situation. The GDP
deflator inflation too was close to 4% during this phase. The lowest
inflation, during this phase, was recorded for the year 1952-53 (-12.5)
while the highest for the year 1966-67 (13.9%). The former was on
account of higher agricultural production, whereas the latter was
primarily the result of war with Pakistan in 1965 and famine of 1965-
66.
The main factors that can be held responsible for the higher
inflation during some of the years of this phase were shortfall in
agricultural production, adoption of a strategy of economic planning
(Nehru-Mahalnobis strategy) which emphasized industrialization and
thus entailed huge increase in demand, particularly investment demand,
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financed through deficit financing, two wars with China and Pakistan
and the increase in money supply.
The Reserve Bank of India did attempt to cool prices by
deploying instruments of monetary policy like the bank rate, open
market operation and selective credit controls. Some tightening of
monetary policy did happen during this phase and therefore the policy
of Reserve bank during this phase was termed as the policy of
controlled expansion. The end result, the inflation rate remained within
the acceptable limit.
3.8 Phase III: 1969-1991
This phase spanning over 22 years from 1969 to 1991, turns out
to be the most tumultuous period in India in terms of fluctuations in
inflation, witnessing relatively high rates inflation on account of the
supply shocks emanating mainly from agricultural and oil prices. The
beginning of this phase coincides with the biggest economic event of
not just the 1960’s but the next three decades. Nationalization of
fourteen private sector banks on July 20, 1969 was the single most
important economic decision taken by the govt. since 1947. Even the
economic reforms of 1991 are not comparable in their consequences-
political, social and economic with the nationalization decision.42 The
end of this phase in 1991 is also important from the historical point of
view. It saw the Indian economy landing into a balance of payments
crisis and forced to adopt far reaching economic reforms covering
various sectors of the economy. It is the inflation experienced during
this phase, resulting from the policy mistakes, which took India
towards the 1991 crisis and therefore study of inflation during this
83
phase becomes important as it will help us understand the link between
the crisis and inflation.
The first year of this phase 1969-70, which was also the first
year of fourth five year plan saw the wholesale price inflation to rise
very modestly by 3.7%. Even during the subsequent two years (i.e.
1970-71 and 1971-72) not only the increase in wholesale prices indeed
was modest at 5.5% and 5.6 respectively, the increase in consumer
price index (CPI-IW) also was slightly lower.43 This modest growth in
both WPI and CPI-IW inflation during these two years was achieved
mainly because of the better availability of goods of mass consumption,
especially of food grains carried forward from the exceptionally good
harvest of 1970-71 and also due to good procurement, not withstanding
the larger increases in money supply at 11.3% and 14.0% respectively
in these two years.44 The inflation rate almost doubled in the year
1972-73, reflecting the demand pressure emanating from increased
money supply in the earlier years, decline in agricultural production,
especially of food grains in 1972-73 and further sharp increase in
money supply by 15.7% in that year.45 The years of 1973-74 and 1974-
75 were exceptional, as it was for the first time since independence that
inflation during these two years crossed the 20% mark. 46 The inflation
recorded during these two years at 20.2% and 25.2% respectively was
mainly due to the failure of Kharif crops in 1972-73 as also to the hike
in crude oil prices in 1973.47 Another important reason that high
inflation of this period can be attributed to, was the massive influx of
refugees from Bangladesh following the Indo-Pak war of December
1971. It led to considerable increase in demand for funds by the govt.
compelling it to draw heavily on credit from the Reserve Bank of India
thus causing heavy inflation in the economy.48
84
The period of four years from 1971-72 to 1974-75 saw the
country passing through a phase of hyper-inflation, with the average
inflation rate touching a high of 15.25% during this period.49 It was for
the third time in India’s history from 1935 that price rise had assumed
such an alarming proportions. The worsening situation on the inflation
front forced the govt. to deploy all possible instruments in arresting the
price rise. In the early years of 1970’s govt. relied entirely on monetary
and fiscal measures, but realizing their inadequacy, began its
operations against hoarders, black marketers and smugglers.50 In
response to the substantive anti-inflationary measures, particularly
against the hoarding of essential commodities, the inflation rate
moderated from a high 25.2% in 1974-75 to -1.1% in 1975-76, the
lowest level recorded for the decade of 1970’s. Next two years did not
see inflation raising its head much and in the third year (1978-79) it
touched 0%. The year 1979-80, however, witnessed a strong
resurgence of inflationary pressure, resulting mainly from the poor
agricultural output and the second oil shock, raising the prices of crude
oil.51 The average inflation during the 1970’s was 9.0%, higher than
the one worked out for the decade of 1960’s. Alongside the increase in
average inflation, this decade also witnessed increase in volatility in
inflation. The standard deviation of 4.9 worked out for the decade of
1960’s, jumped up to 9.0 during the 1970’s.
The decade of 1980’s began its journey with the highest inflation
rate of 18.2% in 1980-81, carrying the influence of oil price hike.
Among the two oil price hikes of 1970’s, it was the oil price hike of
1979-80 that had larger influence on price level in India. Although the
wholesale price inflation following the first oil price hike was higher
than the one following the second oil price hike, it was the latter that
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had larger influence of increase in crude oil price. The relatively lower
inflation that followed the second oil shock was the result of
substantial and readily available food stocks, which helped mitigate the
scarcity.52
The inflation during the whole decade of 1980’s remained steady
with the actual inflation rate staying above 7.0% for six years out of
ten. It was below 5% only during two years of 1982-83 and 1985-86.
For the entire decade, the average inflation turned out to be 8.0%,
marginally lower than the one for the previous decade. What is
interesting to note about this decade is the fall in inflation variability as
implied in standard deviation of just under 4. Inflation varied between
18.2% in 1980-81 and 4.4% in 1985-86.
The steady and higher inflation during this decade was to a great
extent the result of automatic monetisaion of the fiscal deficit of govt.
of India. The fiscal deficit of the central govt. increased to 6.8% of
GDP during the 1980’s from 3.8% during the previous decade. While
the monetization of the same (that is, the part financed by the RBI
though creation of money) increased close to one-third during the
1980’s from close to a quarter during the 1970’s.53 It was thus the
automatic monetization of fiscal deficit through RBI credit to the govt.
that caused the money supply to grow faster and the inflation to stay
higher during this decade.
The experience of the 1980’s has a noteworthy contribution in
highlighting the nexus between inflation, fiscal policy and monetary
policy.54 It showed that as the resource gap in govt.’s budget (i.e. fiscal
deficit) met by borrowing from the Reserve Bank increases, the
inflationary situation worsens, for the price effects of an increase in
money supply are stronger than the output effects.55 Further once the
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inflation occurs due to increase in money supply (resulting from
monetization of fiscal deficit), govt. expenditure rises much faster than
the revenue, further widening the fiscal deficit and necessitating
increased monetization. Thus a vicious circle of high inflation, high
deficits and high monetization sets in motion.56
The last year of the third phase, i.e. 1990-91 saw the inflation
rate rise above 10% from 7.5% recorded for the previous year. The
main contributing factor was the gulf war and its adverse impact
necessitating imposition of gulf war cess on petroleum products and
other imports.57
The third phase (1969 to 1991) did not see much pleasant picture
on the inflation front. The average inflation during this phase increased
to 8.3% from a low of 4% recorded for the previous phase (1949-1969).
The inflation measured on the basis of CPI-IW and GDP deflator was
also close to 8%. The cross correlation between all the three indices
based inflation comes close to 0.8 or 0.9 reflecting the fact that
inflation based on all the three indices had strong association in them.
Though the average inflation surged during this phase to close to 8%,
variation in it subsided marginally to 6.5 from the 6.7 observed for the
second phase.
This phase, it can be argued, experienced strong inflationary
pressure as is clear from the higher average inflation rate. The main
culprits for the worsened inflationary situation during this phase were
the intermittent falls in agricultural production, two oil price shocks
delivered by the OPEC countries and the unbridled growth in public
expenditure financed through creation of new money by the RBI. The
inflation that followed the two oil price hikes had a major influence
over average inflation during this phase.
87
Reserve bank of India, playing its part, made the use of all
instruments in its arsenal, to combat the inflationary rise in prices. The
bank rate, CRR and SLR were taken to their highest levels so as to
tame the price rise, but unfortunately not much success came to its
door. The automatic monetization of fiscal deficit sabotaged every
effort of RBI at inflation control.
3.9 Phase IV: 1991 to 2009
The balance of payments crisis, resulting from the underlying
imbalances in the form of high inflation, high fiscal and current
account deficits during the 1980’s marks the beginning of this phase in
1991. The nature of the crisis was so grave that it warranted immediate
correction of the situation. A series of reforms, in the name of
Macroeconomic Stabilization Programme and Structural Adjustment
Programme, covering the industrial, financial, fiscal and external
sectors were introduced. Liberalization of the imports, adoption of the
flexible exchange rate system, convertibility of the rupee, deregulation
of interest rates, dereservation of the public sector, abolition of the
industrial licensing and the restrictive provision of the MRTP Act,
marked reduction in fiscal and revenue deficit, abandonment of the
practice of automatic monetization of the fiscal deficit, etc. are some of
the important reforms introduced since 1991 and they have changed the
entire landscape of the Indian economy. It is on this background that an
attempt is made, in the following section, to study the behaviour of
inflation and the impact of economic reforms, positive or otherwise, on
it during the post reform period.
This phase spans over 18 post reform years starting from 1991-
92 to 2008-09. The first half of the 1990’s witnessed a resurgence of
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inflationary tendencies with the inflation rate averaging just above 10%
during 1991-92 to 1995-96. The economic survey58 (1991-92), in this
respect, stated that “the build up of inflationary pressure is mainly
attributable to excess demand arising from the large and persistent
fiscal deficits over the years, resulting in excessive growth in money
supply and a liquidity overhang. There have also been supply and
demand imbalances in sensitive commodities like pulses, edible oils,
etc. due to shortfalls in domestic production and constraints in
importing desired quantities due to the severe foreign exchange crunch.
A sharp increase in procurement prices of cereals, and consequent rise
in issue prices, has set the trend for open market prices. Exchange rate
adjustment in early July, 1991, led to increase in import costs which
contributed to some cost pressure in import intensive industries. The
uneven progress of monsoon until the end of August, 1991 also
generated some inflationary expectations in the economy, exacerbating
the pressure on prices”.
The causal explanation of the build up of inflationary pressure
around 1990-92, offered in the economic survey of 1991-92 also holds
true for the subsequent years until 1995-96. Apart from the above
mentioned causes, the inflationary price rise of the first half of the
1990’s was also attributable to the increase in the prices of fuel and
administered prices of other items. The continuous rise in the prices of
fuel items at a double digit rate (of about 13%) during the first half of
the 1990’s contributed to inflationary pressure, not only directly but
also through the second round effects.59 The inflationary pressure also
emanated from the unprecedented capital inflows and the consequent
higher monetary expansion.60
89
The second half of the 1990’s saw a significant turnaround in the
inflation outcome.61 The average inflation rate during this period
declined from around 10% in the first half to 5.08%. A number of
factors contributed towards the lowering of inflation during the second
half of 1990’s.62 First, the RBI could largely contain money supply to
levels consistent with its indicative inflation projections. This was done
with the sterilization of capital flows through open market sales of govt.
securities and judicious use of liquidity adjustment facility (LAF) and
greater emphasis on market borrowing leading to a lower degree of
monetization of fiscal deficit. Second, supply pressure emanating from
food prices eased with the fall in food articles inflation from around
12.0% to around 6.0%. This was mainly attributable to the deceleration
in procurement price increases. Third, cooling of global inflation
reduced external pressure on domestic prices. Fourth, the extent of
depreciation of rupee slowed considerably from around 11% per
annum in the first half to around 4% in the second half. Fifth, large
buffer stocks of food grains provided a cushion against undue pressure
on food prices through timely release of stocks. Sixth, the high level of
foreign exchange reserves added comfort to supply management
through imports of essential commodities. This not only helped in
reducing inflation but contributed to lowering of inflation expectations
on a sustainable basis.
Further, the distinct decelerating trend in inflation during the
post reform period has also been attributable to the liberalization of
both internal and external trade and continual reduction and
rationalization of taxes leading to greater competition and cost
efficiency.63
90
The decade of 1990’s saw two distinct halfs, first characterized
by a high rate inflation in annual average terms, while the second
witnessed significant fall in inflation. For the decade as a whole, the
average inflation rate comes to just above 8%. The variation in the
inflation rate, as given by the standard deviation, showed a marginal
moderation from 3.9 during the previous decade to 3.6 during the
1990’s. The consumer price inflation (CPI-IW) as also the GDP
deflator inflation stayed higher than the inflation based on WPI. The
divergence between the inflation based on three indices, particularly
WPI and CPI is also visible in the lower co-efficient of correlation
implying a weakening association.
The southward march of inflation continued even in the early
part of new century, with only a marginal increase in the latter part.
The average inflation during 2000-01 to 2008-09 works out to 5.4%,
representing nearly 3% decline from the average inflation recorded for
the decade of 1990’s. The inflation rate varied from a low of 3.4% in
2002-03 to a high of 8.3% in 2008-09.
The year 2000-01 saw the inflation rate jumping to 7.27% from a
low of 3.3% for the previous year, despite the good performance on the
agricultural front in 1999-2000, adequate buffer stocks of food grains
and improved supply of essential commodities, helping contain the
prices of primary articles. It was the increases in the administered
prices of petroleum products, first in March 2000 and second in
September 2000, following the international crude oil price escalation,
that pushed the inflation rate up.64 The years 2001-02 and 2002-03
witnessed moderation in inflation to 3.6% and 3.4% respectively. The
evening out of the impact of increases in administrated prices of fuel
products and record public stocks of food grains with the Food
91
Corporation of India (58 million tones in January 2002), together with
active private trade accorded stability to food grain prices and thus to
the overall inflation.65 The year 2002-03 stood out exceptional with a
moderate inflation of 3.4%, notwithstanding the severe drought and
several other adverse developments such as border tensions (in the gulf
region) and high international crude oil prices.66 Adequate release of
surplus stocks of food grains helped in keeping the inflation as also the
undercurrents of inflationary expectations low.67
The acceleration in inflation in 2003-04 and 2004-05, though on
modest scale, represents a fallout of hardening of international prices
of crude oil, minerals and metal related products as also the deficient
monsoon of 2004-05, fueling the inflation of agricultural and some
agro based products.68 The softening of inflation to 4.4% in 2005-06
largely owes to monetary tightening measures (hike in CRR, reverse
repo and repo rates) adopted by the RBI. The inflation based on WPI,
however, firmed up again in 2006-07, as a result of the hike in the
prices of petrol and diesel by Rs. 4 per litre and Rs. 2 per litre
respectively on July 6, 2006, following the upsurge in the price of
crude (Brent*) to an average of US $ 70 per barrel from US $ 54 per
barrel in 2005.69
The WPI inflation cooled marginally to 4.7% in 2007-08 on
account of the reduction in the prices of petrol and diesel following the
softening of the international prices of crude oil in the later months of
2006 and early 2007. Besides, the fiscal, administrative and monetary
measures adopted since June 2006 together with the improved
* Brent crude: it is a classification of oil and represents a benchmark, which is used to price two thirds of the world's internationally traded crude oil supplies.
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availability of wheat, pulses and edible oil had the sobering effect on
inflation during 2007-08.70 The year 2008-09 turned out to be a very
unusual year, marked by extremes in price movements and recording
the highest inflation in the current decade (2000’s). The 8.4% inflation
recorded for this year was mainly influenced by the high inflation in
first three quarters, as inflation began cooling from the last quarter in
the aftermath of global financial problems and recession.
Over a five year period, 2004-05 to 2008-09, inflation remained
below 7%, except for two breaches.71 The first breach occurred in the
second half of 2004-05, as a fallout of increase in the price of crude oil
per barrel (Brent) from US $ 38 in 2004 to US $ 54 in 2005 and also of
the erratic, delayed and uneven spatially spread monsoon. March 2008
witnessed the second breach as the crude oil price started sky rocketing
to hit a level of US $ 147 per barrel in July 2008. On both the
occasions, inflation in the domestic economy mirrored the global
development, that is, a spurt in the prices of crude oil, minerals and
metal related products, indicating the growing integration of the Indian
economy with the world economy.72
The average decadal inflation rate for the current decade (2000-
01 to 2008-09) at 5.4% appears significantly below the previous
decade average of 8.1%. An important distinguishing feature of this
decade vis. a vis. the decades of 1980’s and 1990’s is that the
consumer price inflation as also the GDP deflator inflation stayed
below the WPI inflation. As far as the variation in inflation is
concerned, it has gone down to 1.6, 1.9 and 1.1 for WPI, CPI-IW and
GDP deflator inflations respectively. The association between the three
inflation indices appears to have further weakened during the current
decade as reflected in the cross correlations.
93
The last phase of this study period throws out a mixed picture of
inflation with both glitter and gloom. The beginning period comprising
five years from 1991-92 to 1995-96 presented a gloomy picture with
the inflation rate averaging 10% per annum during this period.
Monetary expansion of the preceding period, fall in the value of rupee,
problems with the production of agricultural commodities, a sharp
increase in the procurement prices and hardening of the international
price of crude oil were the main villains in the inflation story of this
period.
The period from 1996-97 onwards up till 2008-09 added glitter
to the inflation picture. It witnessed the inflation drifting down to just
over 5%, reflecting the concerted policy efforts.73
For the whole period of the forth phase (1991-2009), the average
inflation works out to be 6.7%, 1.6% lower than the one for the
previous phase. The inflation based on CPI-IW and GDP deflator was
close to the WPI inflation, but CPI-IW inflation was higher at 7.2% in
average terms. The volatility in inflation, as given by the standard
deviation value, moderated in case of inflation based on all the three
indices. The WPI inflation moved in between a low of 3.3% in 1999-
2000 and a high of 13.7% in 1991-92.
In comparison with the previous phase, the cross-correlations
between inflation rates based on all the three indices are found to have
weakened. This is largely true in case of WPI inflation and inflation
based on CPI-IW.
The Indian experience, as is evident from the record of inflation
and the analysis of the same presented in this chapter, has been both
good and bad, with both alternating each other during the study period
of 75 years, starting from 1935 up till 2009. The first phase (1939-
94
1949) saw the highest inflation of 15% in average terms, mainly on
account of the World War II and the way of financing it. The second
phase (1949-1969) witnessed considerable moderation in average
inflation to 4% in the absence of any adverse international
development. The third phase (1969-1991) experienced reversal in
inflation trend of the previous phase and the inflation edged up to 8.3%
in average terms. Two oil price hikes as also the continuous recourse to
deficit financing were the main reasons behind the upturn in inflation
trend. The fourth and the last phase (1991-2009) once again saw the
good times returning and the inflation, in average terms, coming down
to 6.7%, reflecting the proper assessment and control of the
inflationary situation and timely steps from the RBI and the
government.
Over the entire period of 70 years (1939-2009), the inflation
averages 7.6% and exhibits the variability of 8.1. At the end, the
important thing to note is the downward drift in inflation observed
during last 13 years beginning with 1996-97.
3.10 Disaggregated view of the WPI inflation:
The widely held opinion in India is that, the general inflation is
driven mostly by the inflation in primary/food articles. This view over
the years has become so strong that it has become a new theory of
inflation called structural theory of inflation. According to this theory,
which has been developed in the context of developing countries, the
inflation in developing countries is different and can not be explained
either with the demand-pull theory or with the cost-push theory of
inflation, both well documented in economic literature. The proponents
of structural theory of inflation argue that developing countries are
95
characterized by some structural rigidities and imbalances, which are
responsible for the large part of inflation experienced by them. They,
therefore, argue for disaggregate analysis of inflation in developing
countries.
It is said that inflation in India is a structural inflation and has,
most of the times, resulted from problems in agriculture. Monsoon
dependent nature of agriculture, stagnant production, low productivity,
inefficient markets with dominance of speculators and hoarders, etc.
are some of the factors that are responsible for inadequate supplies of
agricultural and particularly of food articles in relation to increasing
demand for them arising from increase in people’s income, growth in
population and urbanization.
Studies relating to the Indian economy reveal that the
inflationary pressures have emanated from the agricultural and
particularly the food grains sector.74 The inflation in the category of
food articles has a tendency of spreading to other categories and
therefore causing inflationary price spiral in the economy. In case of
India, where large number of people live in poverty and a large part of
income is devoted to food grains,75 a crop failure in agriculture causes
what is called as food-shortage inflation.76 Higher food grains prices
get reflected in higher wages in industrial sector, causing the cost of
production in industrial sector and consequently the prices of industrial
products to go up.77 In the government sector of developing country
like India, rising prices and wages mean additional non-developmental
public expenditure, and if revenues do not keep pace, inducing budget
deficits and deficit financing through central bank credit to the govt.78
96
Hence, a chain of causation sets in to the motion whereby rising
food grains prices feed other prices in the economy and cause a
inflationary price spiral.
So, it makes perfect sense to look in to the inside of WPI
inflation and see whether food grains prices have grown faster than the
price rise in other categories of WPI and the contribution of food
inflation in overall inflation.
The wholesale price index, which is used to measure headline /
overall inflation in India, has undergone several changes over the years,
with the number of major sub-groups it comprised falling, due to
merging, to just three at present. The main three sub-groups which the
WPI consist of are 1) primary articles 2) fuel, power, light and
lubricants and 3) manufactured goods. The primary articles category
introduced in 1970-71 series, comprises food articles, non food articles
and minerals. It is to be noted that the WPI is a weighted price index
with the respective weights being 22.03%, 14.23% and 63.75% in the
present WPI series with 1993-94 as the base. With the structural
change in the economy, the weights have also been changed in
accordance. The weight of food/primary articles group has declined
from 50.4% in the 1952-53 series to 22.03% in the 1993-94 series,
while that of manufactured products has gone up from 46.6% to
63.75%. The weight of fuel category increased from 3% to 14.2% over
the same period.
Having underscored the importance of studying the inside of the
WPI inflation, an attempt is made in the next part to analyze the
inflation in major sub-groups of WPI.
The following tables present before us the WPI in a decomposed
form. First an attempt is made to compare the inflation rates in sub-
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groups of WPI and then relative contribution of each group in WPI
AC : All commodities. PA:Primary articles. FA:Food articles. NF : Non-food articles. FPL&L:Fuel, power, light & lubricants. MP: Manufactured products. Note :1.Major groups/sub-groups under the various series are not strictly comparable on account of changes in classification of commodities over time.
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2.In the series (Base: 1961-62=100), MP comprises sub-groups chemicals, machinery and transport equipment and manufactures. 3.Columns with Heads a,b,c,d,e & f indicate variation in %
Source: 1. Handbook of Monetary Statistics of Indian Economy,RBI 2. Office of the Economic Adviser, Ministry of Commerce and Industry, Government of India.
Table No. 3.8
INFLATION IN THE SUB-GROUPS OF WHOLESALE
PRICE INDEX (in %) 1952-53 to 2008-09
Year AC PA OF WHICH FPL&L MP
FA NF
a b c d e f g
1952-53
1953-54 4.6 6.7 -0.8 -1
1954-55 -6.8 -11.3 -2.1 1.6
1955-56 -5.2 -8.5 -2 -0.9
1956-57 14 18.1 9.5 6.6
1957-58 2.9 4.1 8.8 1.7
1958-59 4.1 8.2 1.8 0.3
1959-60 3.8 3.3 1 3
1960-61 6.6 0.8 3 10.9
1961-62 0.2 0.1 1.8 2.2
1962-63 3.8 6.5 3.2 3.1
1963-64 6.2 8.4 14.4 2.5
1964-65 11 17.3 1.9 3.9
1965-66 7.6 6.8 3.2 7.7
1966-67 13.9 18.3 8.4 8
1967-68 11.6 21.4 5.6 3.2
1968-69 -1.1 -5.2 4.6 2.3
1969-70 3.7 -0.1 4.4 6
1970-71 5.5 3.6 4.3 7.9
1971-72 5.6 0.9 1.1 -1.4 5.9 9.5
1972-73 10 9.7 10.1 9 4 11.3
1973-74 20.2 28.1 22.7 36.4 18.6 14.4
1974-75 25.2 25.2 26 11.7 51.8 21
1975-76 -1.1 -6.6 -4.9 -14.6 10.5 1.4
1976-77 2.1 0.8 -5.1 19.7 5.3 2.3
1977-78 5.2 9.9 11.8 6.3 1.5 2.3
1978-79 0 -1.3 -0.7 -4.3 4.4 0.2
1979-80 17.1 13.8 8.2 14.2 15.7 20.2
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1980-81 18.2 15 11.4 11.9 25.2 19.2
1981-82 9.3 11.3 13.1 10.5 20.7 5.2
1982-83 4.9 6.7 11.1 0.8 6.5 3.5
1983-84 7.5 10.8 13.9 11.5 5.6 6.1
1984-85 6.5 6.2 4.2 10.9 4.3 7
1985-86 4.4 0.2 1.7 -3.4 10.7 6
1986-87 5.8 9.1 10.2 11.4 6.8 3.8
1987-88 8.1 11.3 9 21.6 3.4 7.2
1988-89 7.5 4.9 9.9 -1.7 5.5 9.4
1989-90 7.5 2.2 1.2 3.6 3.6 11.3
1990-91 10.3 13 11.9 17 12.3 8.4
1991-92 13.7 18.1 20.2 18 13.2 11.3
1992-93 10.1 7.5 12.4 -0.2 14.1 10.9
1993-94 8.4 6.9 4.9 8.9 15.5 7.8
1994-95 12.6 15.8 12.8 24.2 8.9 12.3
1995-96 8 8.2 8.3 9 5.1 8.5
1996-97 4.6 8.4 12.4 -0.9 10.4 2.1
1997-98 4.4 2.7 3 2.5 13.8 2.9
1998-99 5.9 12.1 12.7 10.4 3.3 4.4
1999-00 3.3 1.2 3.8 -5.8 9.1 2.7
2000-01 7.2 2.8 3 2.4 28.5 3.3
2001-02 3.6 3.6 3.3 4.4 8.9 1.8
2002-03 3.4 3.3 1.8 8.2 5.5 2.6
2003-04 5.5 4.3 1.3 6.4 5.7
2004-05 6.5 3.6 2.6 0.7 10.1 6.3
2005-06 4.4 2.9 4.8 -4.5 9.5 3.1
2006-07 5.4 7.8 7.8 5.1 5.6 4.4
2007-08 4.7 7.5 5.5 12.6 1 4.9
2008-09 8.3 10.2 8 11.3 7.5 8.1
Averages
1953-69 4.8 5.9 3.9 3.4
1969-91 8.3 8.6* 7.7 8.6* 10.5 8.3
1991-2009 6.7 7.1 7.1 6.6 9.8 5.7
1953-2009 6.8 7.8** 7 7.3** 8.4 6.1
* 1971-91 ** 1971-2009 AC : All commodities. PA:Primary articles. FA:Food articles. NF : Non-food articles. FPL&L:Fuel, power, light & lubricants. MP: Manufactured products. Note : 1.Major groups/sub-groups under the various series are not strictly comparable on account of changes in classification of commodities overtime 2.In the series (Base: 1961-62=100), MP comprises sub-groups chemicals, machinery and transport equipment and manufactures. Source : 1. Same as Table No. 3.7
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Graph No. 3. 6
Phasewise Average Inflation in the Sub-groups of WPI
0
2
4
6
8
10
12
AC PA FA NF FPL&L MP
Infl
ati
on
ra
te
Sub-groups
1953-69
1969-91
1991-2009
1953-2009
Source: Based on Table No. 3.8
The above table juxtaposes the annual WPI inflation with the
inflation in the major sub-groups of WPI. Simple averages have also
been worked out at the end of the table for the three historical phases
used in this study.
For the second phase (1953 to 1969), for which required data is
available, the WPI inflation in average terms is found to be 4.8% per
annum. In comparison, the inflation in the food articles category was
higher at 5.9%, while that in fuel and manufactured goods categories
was lower at 3.9% and 3.4% respectively. It means, during 1953-1969,
food articles prices rose much faster (nearly 2% faster) than the prices
of fuel and manufacturing goods. Even the overall inflation trailed the
inflation in food articles category by a percentage point.
The third phase (1969-1991), which witnessed two oil price
hikes saw not only a big jump up in overall inflation, but a lead taken
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by fuel category in the inflation race. All the major sub groups of WPI
exhibited relatively higher inflation during this phase than during the
previous phase. An internal comparison however shows that it was the
fuel sub-group that registered the highest price rise of 10.5% as a
natural corollary of artificial hikes in crude oil prices during this period.
Inflation in the food category was relatively lower during this period. It
was however only marginally lower at 7.7% than the overall and
manufactured goods category inflation of 8.3%.
The fourth phase (1991-2009) saw the overall inflation and the
inflation in sub-groups cooling, with the maximum cooling happening
in the sub-group of manufactured goods. The inflation in the food
articles category at 7% though lower than in fuel category (9.8%), is
found to be higher than the overall inflation (6.7%) and manufactured
goods category inflation (5.7%).
If a long term view is taken and inflation rates are worked out for
the period of 1953 to 2009, then the food inflation appears to be
slightly higher (7%) than the overall inflation (6.8%) and also the
inflation in the sub group of manufactured goods (6.1). For the same
period, the highest rise is seen to have occurred in the prices of fuel
commodities (8.4%).
So it comes out that two categories of WPI, viz. fuel and food,
have seen relatively higher price rise during the study period. This
however doesn’t mean that a large part of inflation which India
experienced was contributed by the fuel category of WPI. Due to lower
weightage in WPI, higher rate of price rise in fuel category does not
get translated much in overall inflation. This is what has happened in
India. The following table presents the relative contribution of each
