Inflation in India cause and effect

Inflation in India cause and effect

Subject: Economy 

Section: Inflation

Context: The official data revealed that retail inflation had grown by 7.8% in April- the highest rate in the last 8 years.

Details:

Retail inflation has been high since October 2019 and has, in fact, touched the 4% mark just once since then. In all other months, it has been higher than 4% and regularly breached the 6% since February 2022.

Causes:

• Ukraine War- leading rise in price of crude oil and natural gas. India importing more than 80% of its domestic need of these goods imported inflation is one of the most important causes.
• Rise in Food Inflation
• Rise in price of core items-all other items excluding food and fuel, which makeup the remaining 47% of the headline inflation- the CPI.

Impact:

• Reduces purchasing power of money- it is the ability of money to buy a particular quantity of good and service. As price rise lower amount of goods purchased with same quantity of money.
• Reduce Aggregate Demand-as more money required for purchasing initial quantities of goods.
• Reduces real rate of interest – thus reduces productive savings and investments. Reduced real interest rate benefits borrowers and helps the government meet its debt obligations in an easier manner.
• Help achieve fiscal deficit target- Fiscal Deficit limits are expressed as a percentage of the nominal GDP.As the nominal GDP rises because of inflation (without necessarily implying an increase in overall production), the same amount of fiscal deficit (borrowing)becomes a smaller percentage of the GDP.
• Corporate profitability –rises in the short run as they have a large inventory of raw material thus able to pass the rising price to the consumers. However in the long run due to fall in aggregate demand and rise in cost of production profits decline.
• Currency depreciation- as rise in prices of exports and imports become relatively cheaper. Further, due to low real interest rate capital outflows leading to the overall BOP deficit and currency depreciation as demand for foreign currency rises relative to domestic currency.
• Wage price spiral-People expect future prices to be higher and demand higher wages. But this, in turn, creates its own spiral of inflation as companies try to price goods and services even higher due to rise in the cost of production.