Understanding India’s Inflation: Causes and Consequences You Need to Know

Inflation in India is a topic that affects everyone, from the consumer buying groceries to the entrepreneur building a business.Inflation in India, has been a significant economic concern, impacting the cost of living, savings, and overall financial well-being. For anyone looking to understand India’s economy or manage their finances, knowing about inflation, its causes, effects, and how it is measured can provide valuable insights. In this blog, we will explore the essentials of inflation in India, making the concept easy to grasp for anyone interested in the country’s economic landscape.

What is Inflation?

Inflation in India refers to the increase in the general price level of goods and services over a period of time. When inflation rises, each unit of currency buys fewer goods and services, resulting in a decrease in the purchasing power of money. For instance, if you notice that groceries, fuel, or electricity bills are getting more expensive over time, that’s the impact of inflation in action.

Inflation in India is typically measured through two primary indices:

• Consumer Price Index (CPI) – This measures changes in the prices of essential consumer goods and services.
• Wholesale Price Index (WPI) – This measures the price of goods at the wholesale level before they reach consumers.

Together, these indices give an overview of price changes at both the retail and wholesale levels.

Types of Inflation

Understanding the different types of inflation helps us comprehend the causes and their effects on the economy:

• Demand-Pull Inflation: This occurs when demand for goods and services exceeds supply. In other words, more people want to buy products than there are available, pushing prices up.
• Cost-Push Inflation: When the production costs of goods rise (due to factors like higher raw material costs or wage increases), companies pass these costs to consumers, resulting in higher prices.
• Built-In Inflation: This form of inflation arises when workers demand higher wages to keep up with increased living costs. In turn, businesses raise prices to cover higher wage costs, creating a feedback loop of rising prices and wages.

Causes of Inflation in India

Several factors contribute to inflation in India. The reasons can vary, but some of the primary causes include:

• Supply Chain Disruptions: Natural disasters, international trade issues, or supply chain breakdowns can restrict the availability of goods, causing price increases.
• Rising Fuel Prices: India relies heavily on imports for its energy needs. Any increase in global oil prices directly affects the cost of fuel, which cascades into other sectors, raising transportation and manufacturing costs.
• Demand-Side Factors: During periods of economic growth, consumer demand often rises, which can lead to demand-pull Inflation in India. Government spending, especially on large-scale projects or subsidies, also contributes to demand-side inflation.
• Global Factors: India is not isolated from global economic events. Trade policies, import-export restrictions, and geopolitical events can impact prices in India. For instance, global crises affecting food supply, such as disruptions in wheat or oil production, often lead to price hikes domestically.
• Currency Depreciation: When the value of the Indian Rupee falls compared to other major currencies, importing goods becomes more expensive. This is especially important for a country like India that imports significant amounts of fuel and raw materials.

Impact of Inflation on the Indian Economy

Inflation in India affects various sectors of the economy in several ways. Here are some key impacts:

• Cost of Living: The most immediate impact of inflation is felt in the cost of living. Essential items like food, fuel, housing, and healthcare become more expensive, impacting household budgets.
• Savings and Investments: Higher inflation rates erode the purchasing power of money, which can reduce the real value of savings over time. Investors often look to assets that hedge against inflation, such as gold or real estate, to maintain their wealth.
• Interest Rates: To curb inflation, the Reserve Bank of India (RBI) often raises interest rates. While this helps control inflation, it also increases borrowing costs, which can dampen consumer spending and slow down economic growth.
• Business Profitability: For businesses, inflation increases the costs of raw materials, labor, and logistics. Small businesses, in particular, may find it challenging to absorb these costs, potentially leading to layoffs or even closures.
• Exports and Imports: High inflation in Indian goods more expensive on the global market, which can affect exports. Conversely, imports may become more costly if the rupee is weaker, leading to a trade imbalance.

How Inflation is Managed in India

The Reserve Bank of India (RBI) plays a central role in managing inflation. Using monetary policy tools, the RBI regulates the money supply to stabilize prices:

• Interest Rate Adjustments: By raising or lowering interest rates, the RBI can influence borrowing and spending patterns. Higher interest rates tend to reduce inflation by decreasing spending and investment.
• Open Market Operations (OMO): The RBI can buy or sell government securities in the market to control the money supply. Selling securities reduces liquidity in the economy, which can help lower inflation.
• CRR and SLR Requirements: The Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) are tools used by the RBI to control the amount of money banks have available to lend. Adjusting these ratios can affect inflation by influencing the money supply.
• Regulation of Food Prices: Food prices contribute significantly to Inflation in India. The government, in collaboration with the RBI, may release stockpiled food grains during times of shortage to stabilize food prices.

Inflation’s Impact on Everyday Life

For individuals, inflation impacts daily life in various ways. Essential items like groceries, utilities, and fuel may take up a larger portion of the monthly budget. Inflation can also influence lifestyle choices, from housing and schooling to healthcare. Managing finances carefully, setting aside an emergency fund, and investing in assets that can outpace inflation are essential strategies for coping with rising prices.

India’s past 30 years annual inflation rates (1994 to 2023)

Notes:

• High Inflation Periods: India experienced high inflation during the late 1990s and early 2010s, particularly during 2008-2012 due to global economic factors and high commodity prices.
• Recent Trends: Post-2014, inflation has generally stabilized around 3-6% due to inflation-targeting policies by the Reserve Bank of India (RBI). However, the COVID-19 pandemic caused disruptions, leading to slightly elevated rates from 2020 onward.
• This table provides a useful historical perspective, showing how inflation in India has evolved, influenced by both domestic and international economic events.