EFFECTS
OF INFLATION ON INDIAN ECONOMY – ECONOMY
News: Fear factor: On the inflation battle
What's
in the news?
●
Inflation faced by consumers eased to 5%
in September, bringing some relief after a sharp rally in prices that began
with July’s 15-month high inflation rate of 7.44%.
Inflation:
●
Inflation measures the change in prices of
a basket of goods and services over the course of a year.
●
It occurs as a result of a mismatch
between the supply and demand for money, changes in production and distribution
costs or an increase in product taxes.
●
Inflation is measured by the Consumer
Price Index (CPI) in India.
Reasons
for recent Inflation:
●
El Niño Impact on monsoon- below average
monsoon rainfall
●
Disruptions in the global supply chain
e.g. Fertilizer price raise due to Ukraine war
●
Geopolitical tensions led price raise like
Israel- Hamas conflict
●
Rising crude oil prices due to production
cut decision by OPEC plus
Positive
Impacts of Inflation:
●
Increased
Profits for Producers:
○
In most cases, inflation benefits the
producers of goods. They make more money because they can sell their products
at higher prices.
●
Increased
Investment Returns:
○
During periods of inflation, investors and
entrepreneurs are given additional incentives to invest in productive
activities. As a result, they benefit from higher returns.
●
Increase
in production output:
○
When producers receive the appropriate
investment, they produce more goods and services. As a result, inflation causes
an increase in product/service production.
●
Increased
Employment and Earnings:
○
As output rises, so does the demand for
the various production factors, including labour. As a result, employment and
income rise in response to inflation.
●
Shareholders
income increases:
○
If a company's profits increase as a
result of inflation, it can pay out dividends to its shareholders. As a result,
during inflationary periods, shareholders' dividend income may increase.
●
Borrowers'
Advantages:
○
Inflation reduces the purchasing power of
money. As a result, if the borrower pays an interest rate that is lower than
the inflation rate, he benefits from the process. This is due to the fact that
the real value of the money returned by the borrower is less than the value of
the money borrowed.
●
Governments
tax revenue improves:
○
As the cost of goods and services rises,
people must pay more indirect taxes, known as ad valorem (on value)
○
Direct taxes rise as people move into
higher tax brackets (but not in real terms), a phenomenon known as bracket
creep.
○
Tax revenue increases for the government,
but the real value does not keep pace with the current rate of inflation due to
a lag in tax collection.
Negative
Impacts of Inflation:
●
Real-Income
falls for groups with fixed income:
○
An individual's true income is the
purchasing power of his income money. To put it another way, Real Income=Money
Income/Price Level.
○
This means that people on fixed incomes,
such as salaried workers, pensioners and the like, will see a drop in real
income. To put it another way, their purchasing power will reduce.
●
Income
Distribution Inequality Rises:
○
Profits for business owners and
entrepreneurs rise as a result of inflation.
○
People in fixed-income groups, on the
other hand, see a decrease in their real income.
○
As a result, income inequality becomes
more pronounced during this time period.
●
Disturbs
the Planning Process:
○
Inflation raises the prices of goods, raw
materials and factor services. As a result, the government must spend more
money to complete any investment project initiated during the planning period.
○
If the government fails to raise more
financial resources through savings or taxation, the entire planning process is
thrown off.
●
Increased
Speculative Investment:
○
Assume that prices are increasing at an
alarming rate. People are unsure how much prices will rise in the coming weeks
or months. Many people begin speculative investments in such cases.
○
For example, they may begin purchasing
shares, gems, land and so on solely for speculative purposes.
○
This is done with the intention of making
quick money. Such investments do not contribute to the creation of productive
capital in the economy.
●
Negative
Impacts on Capital Accumulation:
○
Assume that rising prices become a
recurring feature of an economy. People begin to prefer goods over money during
such times because the real value of money will fall in the future. In
addition, people begin to prefer immediate consumption to future consumption.
○
As a result, the general desire to save
begins to wane. As people's willingness and ability to save decreases, so does
the amount of money available for further investment.
○
As a result, the overall impact on the
economy's capital accumulation is negative, because capital accumulation in an
economy is dependent on investment growth.
●
Lenders
Will Sustain Losses:
○
As mentioned before, borrowers benefit
from inflation when it has a positive impact.
○
As a result, lenders risk losing money
during such times. This is due to the fact that they receive a sum with less
purchasing power than the amount loaned.
●
Rupee
may depreciate:
○
Due to less purchasing power parity, the
demand for the dollar increases, depreciating the Indian rupee.
○
This benefits the exporters and will
burden the importers.
●
Export
Earnings Suffer as a Result:
○
Because the prices of raw materials and
factors of production rise during inflation, the prices of export items rise as
well.
○
As a result, their demand in foreign
markets may fall, resulting in a decrease in the country's export income.
○
Though the rupee depreciates, lack of
demand due to high prices nullifies the exchange rate benefit.
Steps
to control recent inflation:
1.
Tightening monetary policy:
●
The recent action of the RBI to raise the
repo rate by 40 basis points and cash reserve ratio (CRR) by 50 basis points is
to curtail the demand-pull inflation in the economy. This was the first Repo
rate hike by the central bank since August 2018.
2.
Curtailing indirect taxes:
●
Government can reduce central excise duty
rates on petroleum products owing to higher GST collections and 49% uptick
registered in direct tax collections in 2021-22 with a view to contain
inflation. It can also rationalise duties on raw materials.
3.
Sharing the burden:
●
Government can also transfer part of the
commodity price burden on itself. This could primarily be through higher food
and fertiliser subsidy, excise duty cut on petrol and diesel, custom duty cuts
in import-dependent products such as edible oil and intervening in agriculture
markets through open market sales and stocking norms etc.
4.
Increasing Minimum Support Price (MSP):
●
Government can consider raising MSP to
adjust for the cost of production (Fertilizer, electricity, raw material,
transport, logistics etc) of farmers.
5.
Check rupee volatility:
●
The RBI has also been intervening in the
forex market to check rupee volatility by selling more dollars in the market.
6.
Invest in long-term investments:
●
When it comes to long-term investments,
spending money now for investments can allow you to benefit from inflation in
the future.
Inflationary effects are
not uniformly dispersed throughout the economy. Inflation rates that are
unexpected or unanticipated are damaging to the economy. They contribute to
market volatility, making it difficult for businesses to set long-term budgets.
However, moderate inflation is good. It allows new employment and growth
opportunities to the economy.