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Inflation in India

Inflation is defined as a situation in which there is a gradual rise in the general price level and a fall in the value / purchasing power of money observed over a period of time which may generate expectations of a further rise. Inflation implies a sustained, unchecked rise in the general price level observed over a period of time rather than a one-time rise. Inflationary pressures have continued to build in the Indian economy since 2011-12 suggesting that inflation has become structural in nature. These pressures are mainly from the food and energy sectors both at global and domestic levels. Food inflation particularly continues to be high and alarming causing overall inflation to rise.


There are various forms of inflation depending upon its severity, causal factors and the kind of sectors it is related to. These are as follows:

  • Galloping Inflation: Also known as hopping inflation/jumping inflation/ runaway inflation characterized by double or triple digit rise in the general price level which could be as high as 10 to 900 percent.
  • Hyper Inflation: This implies a very rapid rate of increase up to a million percentage annual rise which results in a rapid fall in the purchasing power of money so much that people lose faith in the domestic currency and start opting for physical assets, gold and foreign currency which are inflation proof. This may force the policy makers to use an alternate currency or switch over to barter. The most prominent example of hyperinflation is the post first world war Germany (1920 – 23) when at the end of 1923, prices were nearly 35 billion times higher than 1920.
  • Core Inflation: This is defined on the basis of goods and services which may be excluded while calculating inflation’. It is a popular concept used in western economics which exclude energy and food articles while calculating inflation. Thus, core inflation is inflation confined to non-energy and non-food articles. In India, non-food manufacturing inflation is defined as ‘core inflation’ by the RBI. Within the non-food manufacturing group are commodities like beverages, tobacco products, wood and wood products, chemicals and chemical products, machinery and transport equipment, capital goods and consumer durables.
  • Stagflation: This is a typical situation in which inflation coexists with recession and unemployment. It is essentially a combination of high inflation and low growth.

Depending upon causal factors, inflation is categorized into Demand-Pull inflation and Cost-Push inflation. The former set of factors are those due to which there is an overall rise in the demand for goods and services in general. On the other hand, the latter set of factors are those due to which there is either a scarcity or shortfall in the supply of goods and services or/and an increase in the cost of production and distribution of goods and services. A detailed explanation of these factors is given below, particularly how these factors manifest themselves in the Indian economy. In fact, causes of inflation in any economy can be explained only on the basis of Demand-Pull causes and Cost-Push causes.

  1. Demand-Pull Factors:
  2. Mounting Government expenditure – Government expenditure has been rising steadily over the years. It implies a rising demand for goods and services. Moreover, continuous increase in government expenditure has the effect of putting in large money income in the hands of the general public thereby raising their purchase power and stoking the fire of inflation. In India, it is the non-plan expenditure, which is mainly responsible because most of the non-plan expenditure is non-productive and hence only adds to purchasing power and demand without adding to production. Thus, too much money starts chasing too few goods.
  3. Deficit Financing and increase in Money Supply – Mounting government expenditure financed through deficit financing i.e. printing of fresh currency directly pushes up money supply, increases purchasing power and breeds inflation without a corresponding rise in the supply of goods and services.
  4. Black Money – Unaccounted or black money plays an important role in pushing up prices by pushing up demand and conspicuous consumption. Black money estimated to be close to 50 percent of India’s GDP has a major role in fuelling demand and leading to rise in prices.
  5. Population Pressure – Growing population also puts pressure on aggregate demand and on the price level. Indian Economy is particularly affected due to pressure of population which results in expansion in demand for goods and services in general and results in inflationary pressures if supply fails to match demand.
  6. Forex Reserves – Rise in forex reserves leads to corresponding increase in domestic money supply and fuels inflation. As more foreign exchange comes into the country, RBI has to create corresponding domestic money.
  7. Excess liquidity created in the system due to monetary and fiscal stimulus packages.
  8. Rising incomes and wages in India have also pushed up demand.
  9. Cost-Push and Supply-Related Factors
  10. Fluctuations in output and supply – Prices tend to rise when there occurs violent fluctuation in output or when there occurs speculative hoarding of the available output. In the Indian context, shortfalls in agricultural and industrial production are more often observed, leading to scarcity of goods and rise in price level. Seasonal factors play a very important role in creating shortages of agricultural goods like fruits, vegetables, food grains from time to time.
  11. Rise in wages, which is greater than the rise in productivity, pushes up costs and thereby pushes up the prices too. This also acts on the Demand-Pull side because rising wages lead to rising demand also.
  12. Indirect taxes are known to have cost-cascading effects. These taxes, like excise and custom duties, raise the cost of production as these taxes are on commodities. Also, State level taxes like VAT, Entry Tax, Octroi lead to rise in final prices of goods and services.
  13. Infrastructural bottlenecks like shortage of power, transportation etc. raise per unit cost of production and hence the price level in general. These have played a very important role in fuelling inflation in a country like India as these shortages raise per unit cost of both production and distribution.
  14. Increase in administered prices like procurement prices of food grains, petroleum prices and such other prices which are arbitrarily fixed by the government tend to push up the price level, as they have a high weightage in the price index.
  15. Rise in import prices pushes up domestic price level and leads to what is called import Cost-Push inflation. This factor is becoming increasingly important in a globalised scenario.

While the above Cost-Push factors are generalised set of factors built into the Indian Economy, there are other important factors causing distortions in the entire supply chain from time to time and creating artificial scarcity as well. as critical supply bottleneck. These are as follows:

  1. Cartelisation practices adopted by traders of essential commodities, particularly manufactured goods like cement, steel.
  2. Entry barriers along the supply chain including high fees charged by State Governments under the APMC Act which proves prohibitive for new entrants to trade their products in the regulated markets.
  3. Sudden flow of speculative capital into thin commodity futures markets, which has some impact on the spot market also.
  4. High margins appropriated by middlemen all across the supply chain.
  5. Costlier imports of some food items like edible oils.
  6. Rise in international prices of crude oil.
  7. Speculation, hoarding, black marketing practices of Indian traders to take advantage of rising prices.
  8. Depreciation of the rupee making imports costlier. This has been a very important factor in the last one year as the rupee depreciated to a record low level.


  1. Apart from uncertainties in production, inflation causes certain serious imbalances in the economy. Price relationships are badly distorted and production pattern goes out of line with demand. As a result, there is misallocation of resources. Capital resources available in the country get diverted from long-term to short-term uses and production shifts from essential to non-essential goods. For example, if prices of non-essential goods are rising and those of essential goods are not, it will be more profitable to invest resources for the production of non-essential goods.
  2. Inflation leads to recession in many sectors of the economy. For example, as a result of inflation, prices of certain articles of consumption in India have increased to very high levels forcing demand for such goods to decline. Similarly, inflation brings about a squeeze in purchasing power so that people incur increasing expenditure on essential goods, while expenditure on the other goods declines and causes recession in industries producing these goods.
  3. Rise in price level has eroded the volume of investment in real terms in India on many occasions and has led to distortions in cost calculations. Inflation also leads to rise in interest rates as interest rates move in tandem to keep abreast of inflation to put a curb on rise in demand for loans from banks.
  4. The most serious effect of inflation is on distribution of incomes which makes rich better off and poor worse off. Profit earners gain because of inflation while people with fixed incomes tend to lose. Inflation has thus brought about shifts in the distribution of income in favour of the rich and perpetuated inequalities.
  5. Inflation also breeds corruption, black-marketing and speculation and is responsible for generation of black money.
  6. Inflation mars incentive for hard work because common man cannot meet his ends with limited income.
  7. Inflation also makes exports costlier and to that extent may impact balance of payments and exchange rate.
  8. Rise in interest rates due to inflation can also make borrowing by the government costly and thereby raise fiscal deficit.

Measurement of Inflation

In India, inflation is measured on the basis of both the Wholesale Price Index (WPI) and the, Consumer Price Index for Industrial Workers called the (CPI-IW). There are three distinct series of Consumer Price Index (CPI) used for monitoring retail price movements on a monthly basis. These are CPI (IW), CPI (AL) i.e. Agricultural labourers and CPI (UNME) i.e. Urban Non-Manual Employees. Of these, CPI (IW) is the most popular and is also used for grant of Dearness Allowance to Central Government employees. The base year for CPI (IW) is 2001. The CPI (IW) is used for measuring the cost of living of a common man as influenced by inflation, while the WPI is used for measuring the rate of inflation. An interesting distinction between the two is that the WPI is purely a commodity index and does not take into account services for measuring inflation, whereas CPI (IW) includes both commodities and services, though the number of commodities covered by it is much smaller as compared to the WPI. Besides, the CPI (IW) is based on retail prices and hence captures the impact of prices of selected essential goods and services on the household budget.

Inflation based on WPI is called ‘Headline Inflation’. WPI was being prepared on a weekly basis for many years. However, from November 2009, it is being prepared on a monthly basis. Even for ‘food articles’ group and ‘fuel’ and ‘energy’ it is being prepared on monthly basis since January 2012. Construction of the Wholesale Price Index has undergone a change w.e.f. September 2010. These changes are as follows:

  1. Base year has been shifted from 1993-94 to 2004-05.
  2. Number of commodities has gone up from 435 to 676.
  3. Number of commodities comprising the manufactured commodities group has gone up from 318 to 555.
  4. As many as 400 new items have been added mostly in the manufactured commodities group, by phasing out 200 old items and by adding 200 new items.
  5. Weightage of manufactured commodities in the Index has gone up from 63.75 percent to nearly 65 percent.
  6. Weightage of primary articles, including food articles, has come down from 22 percent to a little over 20 percent.
  7. Weightage of fuel, light and electricity has gone up marginally from 14 percent to 15 percent.
  8. Number of manufactured commodities in the new index has gone up from 318 to 555 and the number of primary articles has gone up from 98 to 102.The number of items in the Fuel, light and electricity group remains the same at 19.

Some of the important items included in the new series are flowers, lemons, ice-cream, canned meat, mineral water, gold and silver, etc. As compared to the WPI, the CPI has much larger weightage of primary articles, which is as high as 50 percent. This implies that impact of food inflation is reflected much more prominently in CPI than in WPI as WPI gives just 24 percent weight to these articles. Moreover, seasonal fluctuations in the prices of these commodities have a relatively lesser influence on WPI.

A new WPI is on the anvil which will have a stronger focus on manufactures and track prices of about 1200 items and will have an expanded basket of food items. Prices of fruits, vegetables, eggs etc. would be sourced from several urban centres and towns as against the current practice of getting price quotes from only a few different places.

Also notable in the new WPI will be a provision of a mechanism for factoring in the effect of the government’s procurement prices of cereals which will discourage politically mandated increase in procurement prices that merely add to inflationary spiral. The base year for the new WPI would shift to 2009-10.

New Consumer Price Index (base 2010):

A new CPI was launched in January, 2011 called CPI (N) with base year 2010. CPI (N) is the average of CPI (R) and CPI (U) – Rural and Urban which is also prepared separately. The CPI (N) is based on five major commodity groups at present. The new series has a wide geographical spread and covers 310 towns and nearly 1200 villages, it is based on a weighting scheme derived from Consumer Expenditure Survey Data and has an all India character.

Inflation in India is a structural as well as a monetary phenomenon. In the short term, localised demand-supply imbalances in wage goods, often due to seasonal variations in production – coupled with market rigidities and regulatory failures have supported inflationary expectations that have resulted in a more widespread impact on the consumers than the initial inflationary impulse.

In the medium to long-term, the movement and outcome of monetary aggregates such as the money supply and reference interest rates of the financial systems have influenced aggregate demand and consequently changes in price levels in the economy. The latter considerations and the influence of global commodity prices on the domestic prices have become more important with the opening and growing integration of the Indian economy with the rest of the world.

Food inflation in WPI

The food index consists of two sub components, namely primary food articles and manufactured food products. The overall weight of the composite food index in the WPI is 24.31 percent, comprising primary food articles with a weight of 14.34 percent and manufactured food products with a weight of 9.97 percent. A major concern in the domestic economy has been a sharp rise in food price inflation in recent years. Inflation in primary food articles has mainly been driven by rice, vegetables, potatoes, onions, fruits, milk, eggs, meat and fish, condiments and spices, and tea while in manufactured groups it has been vanaspati oil, groundnut oil, sunflower oil, etc. Main items of concern in non-food inflation are raw cotton, raw jute, raw silk, copra, castor seed, sunflower, raw rubber, copper ore, zinc, iron ore, cotton textiles, petrochemicals, intermediate and industrial machinery and machine tools. In the fuel and power group the major contribution to inflation is from mineral oils accounting for over 90 percent.

Inflation has been a major cause of concern for both the government and the RBI. A number of measures have been adopted to contain inflation. Measures like higher interest rates to contain demand on the one hand and incentives to producers to improve supply on the other. Also, certain other measures have been taken that shield vulnerable consumers (such as targeted subsidies for below poverty line (BPL) families), those that protect all against a price rise (such as subsidizing diesel prices), and those that shut down markets so as to suppress price signals (such as shutting down commodity futures markets) or to quell price increases (such as export bans).

Given that inflation has been persistent, it suggests a significant mismatch between demand and supply. In the short run, curbing demand moderately so as to allow supply to catch up can be an effective tool, while in the long run, measures to increase supply are the only way to have non-inflationary growth. For some articles such as food, where demand is hard and probably unwise to curb, supply increases have to be the primary solution. The government can curb demand through fiscal consolidation, while the RBI does so through high policy rates and tight liquidity. These measures may have an adverse effect on growth, but that is precisely how they curb inflation.

Given that India faces a number of constraints on supply, such as low agricultural productivity, poor infrastructure, and a limited skill base, the growth-friendly way to deal with inflation is to focus on boosting the supply side, as a number of government initiatives are attempting. And because the vulnerable segments of society may be adversely affected before supply side measures kick in, some targeted support is reasonable. However, broader support (such as a diesel subsidy) tends to suppress price signals, boosts demand excessively, expands the fiscal deficit, and makes the fight against inflation harder. Such short term palliatives need to be avoided.

Equally counterproductive are periodic bans of exports, imposition and removal of tariffs, and repeated closure of futures markets. These tend to make it harder tor producers to plan, reduce their incentives to produce by limiting their remuneration, and inhibit the production increases that are needed to bring prices under more sustained control. Other measures to control inflation have been as follows:

Monetary Measures

As part of the monetary policy review, the RBI has taken suitable measures to moderate demand to levels consistent with the capacity of the economy to maintain its -growth without provoking price rise. It has already raised its key policy rates several times and has narrowed the liquidity adjustment facility (LAF) corridor to reduce volatility of rates. The economy has witnessed aggressive tightening of liquidity under which the repo rate and reverse repo rate have been raised to 8 and 7 percent respectively.

Fiscal Measures

  1. Import duties reduced to zero on rice, wheat, pulses, edible oils (crude), butter, and ghee and to 7.5 percent on refined and hydro generated oils and vegetable oils.
  2. Import of raw sugar allowed at zero duty under open general licence (OGL).


Administrative Measures

  1. Levy obligation in respect of all imported raw sugar and white/refined sugar removed.
  2. Export of non-basmati rice, edible oils (except coconut oil and forest based oil) and pulses (except Kabuli Ghana) banned.
  3. Minimum export price (MEP) used to regulate exports of onion and basmati rice.
  4. Futures trading in rice, urad and tur suspended by the Forward Market Commission.
  5. Export of Onions (all varieties) not permitted with effect. from 22 December 2010 until further orders.
  6. Full exemption from basic custom duty, special additional duty and education cess provided to onions and shallots.
  7. NAFED and NCCF have undertaken sale of onions at subsidised prices from their retail outlets at various locations, with suitable budgetary support being provided to them for this purpose.

Measures with a wider horizon include the following:

  • A scheme to support the State Governments in the setting up of farmers’ mandis and mobile bazaars and improve the functioning of civil supplies corporations and cooperatives will be finalised urgently.
  • The existing PDS to be suitably strengthened through computerization and other steps, including opening more procurement windows across the country. The government has identified 22 essential commodities whose prices are being monitored to contain food inflation.
  • State Governments urged to review the APMC Acts and, in particular, consider exempting horticultural products from their purview thereby mitigating marketing and distribution bottlenecks in this crucial sector. State Governments will also be urged to consider waiving mandi tax, octroi and other local levies which impede smooth movement of essential commodities, as well as to reduce commission agent charges.
  • Investment to be encouraged in supply chains, including provisions for cold storages, which will be dovetailed with organised retail chains for quicker and more efficient distribution of farm products, minimising wastages. The DIPP, Department of Food and Public Distribution, Ministry of Food Processing Industries and the Planning Commission will jointly work out schemes for this purpose.
  • Build an institutional machinery to read warning signals, assess international trends, recommend action on the fiscal, monetary, production, marketing, distribution, and infrastructure fronts to prevent price spikes, and suggest measures to strengthen collection and analysis of data and forecasting.
  • Maintain close coordination with State agencies to get direct feedback with a view to taking suitable remedial measures on a fast track.

Despite these measures, inflationary pressures did not subside and instead food inflation raced to double digits throughout 2013. However, for the first time since January 2012, CPI based inflation slumped to 5 year low of 4 percent in November, 2014, while WPI based inflation came down to zero. This was mainly due to steep fall in global oil prices to US $ 60 per barrel.

INFLATION INDEXED BONDS: The government launched certificates/ bonds to protect peoples’ savings against price rise. These bonds called Inflation linked bonds were opened for subscription from 23rd December 2013.

The closure date was extended due to poor initial response. These are popularly called Inflation indexed Bonds/ inflation indexed National Savings Securities. Sale of these bonds was through SBI, nationalised banks and three private sector banks viz. HDFC, ICICI and Axis Bank. The interest rate on these bonds is linked to the Consumer Price index (CPI). The bonds will pay 1.5 percent more than the inflation recorded in the CPI. The interest rate will comprise of two parts – a fixed rate of 1.5 percent per annum and inflation rate based on CPI with a lag of three months. It would be compounded on the principal at half yearly basis and paid at the time of maturity. The bonds have 10-year tenure. For example, if retail inflation (CPI) is at 9 percent, one will earn interest at 10.5 percent (9 plus .1.5), the minimum limit for investment is Rs. 5,000 and the maximum is Rs. 5 lakhs per applicant per year.

While for senior citizens, early redemption would be allowed after one year from the date of issue, other investors can redeem them after three years but with penalty of 50 percent of the last coupon paid. Productivity increases to match demand with supply, minimising wastage ratio of fruits and vegetables, robust procurement and distribution, private sector participation in building the required storage and transportation infrastructure, streamlining supply chain from farm to market, developing an alternate mechanism to PDS and experimenting with releasing smaller quantities by FCI at multiple locations instead of bulk sales are some of the important policy measures that need to be adopted with strong political will to tame inflation.

Producer Price Index

A Producer Price Index (PPI) measures price change from producers’ perspective as against the Consumer Price Index (CPI), which measures price change from consumers’ perspective. Most of the countries have switched over to PPI from WPI. In PPI, only basic prices are used for compilation, while taxes, trade margins and transport costs are excluded. PPIs, apart from measuring inflation, are used as deflators in the compilation of GDP. PPI is considered to be a better measure of inflation as price changes at crude and intermediate stages can be tracked before it creeps into the finished goods stage.

Panel Setup to Devise New PPI as WPI Replacement

The government has set up a committee to devise an all-new barometer called the Producer Price Index as it is readying to consign the Wholesale Price Index to history; months after Reserve Bank of India started giving more importance to the upgraded Consumer Price Index as a gauge of inflation. The proposed Index will seek to bring India’s inflation gauge on a par with international standards, with PPI tracking changes at the producer level for both goods and services and CPI providing details of retail prices. The 13 member committee is headed by Professor BN Golder and has representation from various central ministries and departments.

PPI is a totally new concept for India. It involves a lot of work. WPI includes taxes while PPI tracks inflation minus tax component. The most important part of PPI will be services, as currently there is no index tracking inflation in the sector that contributes about 55% to India’s GDP.

PPI will track average change over time in selling prices received by domestic producers for their output for both goods and services while WPI tracks transaction only at the wholesale level for goods.

Prices included in PPI are from the first commercial transaction for many products and some services. The committee will outline methodology and timelines, for launch of PPI series to initially run parallel to WPI and later replace it.

Data is likely to prove a key constraint for the committee since services sector data is not collected on a regular basis.

An experimental services price index is already in place for four services-railways, banking, postal and telecom. However the challenge will be to get regular timely data to formalize the index.

Chaudhury, who headed the panel on WPI revision, recommended doing away with the excise duty component on manufactured goods while computing WPI to track pure price changes. This will keep inflation free of effects of tax fluctuations and bring it closer to PPI.

But PPI is much more than that and is a better indicator of price changes. PPI will track average change over time in selling prices received by domestic producers for their output for both goods and services.

Some of the challenges in computing PPI may be as follows:

  • Though it contributes about 55% to economy, there is no services sector database. Government has, on an experimental basis, come out with a services price index for railways, postal, banking and telecom.
  • Agriculture data: Most transactions happen at the mandi so tracking producer level prices is a challenge.
  • Historical data: WPI has been around for decades, with a large historical database, and will be difficult to replace.

Inflation Targeting

In recent years, there is increasing debate on the role of inflation targeting as a framework for implementing monetary policy. Inflation targeting may be defined as a framework for policy decisions in which the central bank makes an explicit commitment to conduct policy to meet a publicly announced numerical inflation target within a particular time frame. Some countries have adopted point targets, while others are following a more flexible approach on targeting inflation within a band. A Committee headed by Urjit Patel, Deputy Governor, (RBI), has recommended inflation targeting in India at 4 percent with 2 percent plus or minus band.

Services Price Index

Given the importance of the service sector, there is need to develop service price indices for selected service sectors, particularly in the National Accounts framework. Accordingly, the Office of the Economic Advisor, Department of Industrial Policy and Promotion, Ministry of Commerce and Industry has been in the process of developing Service Sector price indices as per international best practices. Studies are being commissioned for selected services like road transport, railways, air transport, port, banking, insurance, posts, telecommunications, business services and trade services to develop service price index. The need for a services sector price index in India is warranted by the growing dominance of the sector in the economy. The WPI covers only commodities.

Real Estate/Housing Price Index

Rapid urbanisation and high economic growth experienced by the urban centres in the last few years has resulted in an upsurge in property values. The importance of facilitating supply of affordable housing to the people and the necessity of designing a right mix of policy initiatives to encourage house acquisition highlights the necessity of tracking the movement of residential house prices. Moreover, the real estate assets are a significant component of the wealth of the private sector and financial freedom allowed for acquiring this wealth is one of the important financial obligations of this sector. For the financial intermediaries also, lending for residential houses has been a significant component of their credit portfolio. The authentic data on the real estate sector in the country, development of a credible database on market driven price trends and price index of market-segments have, therefore, emerged as a crucial elements of market development and for enhancing the efficiency of market processes. The NHB RESIDEX is an initiative of the National Housing Bank (NHB) to provide an index of residential prices in India across cities and over time. The NHB RESIDEX now covers 15 cities and is updated and released on a quarterly basis with 2007 as base year.

Indian Economy

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