What's pushing the inflation rate up?  

Posted by NoeL in ,

Inflation is a measure of rise in general price levels of goods and services. Inflation is measured by taking a set (Consumer Price Index!) of goods and services, and then the prices of the items in the set are compared to prices one time period ago.

In India, inflation is measured based on the wholesale price index (WPI) which measures the change in prices of a selection of goods at wholesale prices. Inflation is primarily of two types - inflation due to cost push and inflation due to demand pull (supply side). Cost push inflation is due to rise in costs of input materials or labour, whereas demand pull inflation is due to increase in demand beyond installed capacity.

Controlled inflation is good for the economy as it increases motivation levels of people. The government, in consultation with the Reserve Bank of India, decides the inflation threshold in the country (current inflation threshold range in India is 4-5 per cent). The inflation target is one of the key parameters that go into determining fiscal and monetary policies. Inflation went up quite a bit in the beginning of last year (around seven percent) on the back of high liquidity in the markets (huge funds inflows in the form of FII and FDI). The RBI controlled inflation by tightening the monetary policy (raising cash reserve ratio and interest rates) and letting the rupee appreciate against foreign currencies. Inflation came well within the control limits in the second half of last year. However, inflation is going up again this year from the last few weeks. Last week, it has gone above 7 percent. And this week it has peaked at 7.57percent. Highest in the last 4 years. The reasons of rising inflation this time are quite different from those last year.

Here are some of the main reasons behind rising inflation:

Price rise of essential commodities
The prices of the basic commodities - milk, vegetables, cereals, dairy products, cement, steel, edible oil etc - have gone up quite significantly, especially in the last few weeks. This is due to supply concerns. There is fear in the market that the supply of basic commodities is not increasing in proportion to population growth. This has triggered a wave of speculation in commodities and hence the prices are going up rapidly.

Commodity prices rise at global level
Rise in commodity prices at the global level is another factor that contributes to higher inflation in the country. The correction in global stock markets resulted in a rise of commodity prices all over the world as investors are using commodities, especially precious metals, to hedge their risk.

Rising oil prices
Crude oil prices have gone up significantly in the last few weeks. Although the government is controlling fuel prices in the country, rising crude oil prices plays a crucial role in general price rise.

Increasing demand
India's economy is growing at around 7-8 per cent per annum over the last few years. The per capita income levels have gone up and as a result, the demand for many commodities has increased significantly.

Basically, inflation does not have any direct relation to a fall or rise in the stock markets in the short term. However, when inflation goes up beyond the comfortable limit of the RBI and government, they take some strong policy measures such as tightening of monetary policies, regulatory controls, subsidy etc.

This entry was posted on Saturday, May 3, 2008 at Saturday, May 03, 2008 and is filed under , . You can follow any responses to this entry through the comments feed .


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I study at European Business School, Oestrich-Winkel. The opinions expressed here are my own, and neither European Business School, Oestrich-Winkel nor any other party necessarily agrees with them.