inflation report_final 27.03.2014

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Project Submitted By: 115 - Jinkal R Vyas 116 - Darshan Wadke 117 - Siddharth Ramachandran 118 - Denny Oommen 119 - Amala Selvaraj 120 - Kanwar Simar Singh 121 - Gauri Lad A Research Methodology Project Guide: Prof. Butani

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Inflation Research Methodology

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Project Submitted By:115 - Jinkal R Vyas116 - Darshan Wadke117 - Siddharth Ramachandran118 - Denny Oommen119 - Amala Selvaraj120 - Kanwar Simar Singh121 - Gauri Lad

A Research Methodology Project

Guide: Prof. Butani

Acknowledgements

We would take this opportunity to thank all the Economists, Bankers, Treasurers who

took time out of their busy schedule to answer our questionnaire and share their

invaluable insights on the current inflation and make the study fruitful. Also a sincere

thanks to all who has answered the questionnaire and helped us through the

fructification of this project

Questions will always remain unanswered unless we are curious! Therefore we would

like to extend our sincere thanks to Prof. Butani who gave us the opportunity to study

this subject and has also guided us through the development of this project.

Page 2 of 41

INDEX

Topics Page No.Introduction

Inflation : The Economic Curse 4

Research 5Defining the Research ProblemFormulation of Questionnaire and Pilot Study 7Sampling Technique and Sample size 8Hypothesis tested 9

Data Analysis and Interpretation

Section A: The CPI and WPI 15Section B: Food Articles 20Section C: Fuel and Electricity 23Section D: Services 27

RecomendationsEl Nino 39Conclusion 40

AnnexuresAnnexure 1 : CPI V/s WPI 10Annexure 2 : Urjit Patel Committee Recommendations 12Annexure 3 : Questionairre 35

References Glossary of Terms Used 14 Bibliography 30Literature review 32

Interview Extract 34

Page 3 of 41

Introduction : The Economic Curse

The term “inflation” is from the Latin term inflare, meaning to “blow up or inflate,” and it was first used in a monetary sense to describe “an increase in the amount of money”. In 1838 the concept of inflation was first used. Inflation can stifle economic growth and cause a rise in prevailing interest rates.

The challenges in developing economy are many, especially when in context of the monetary policy with the Central Bank, the inflation and price stability phenomenon. There has been a universal argument these days when monetary policy is determined to be a key element in depicting and controlling inflation. The Central Bank works on the objective to control and have a stable price for commodities. A good environment of price stability happens to create saving mobilization and a sustained economic growth. The former Governor of RBI C. Rangarajan points out that there is a long-term trade-off between output and inflation. He adds on that short-term trade-off happens to only introduce uncertainty about the price level in future. There is an agreement that the central banks have aimed to introduce the target of price stability while an argument supports it for what that means in practice.

Central banks strive to achieve a low and stable inflation rate in order to sustain a high level of growth and maximize social welfare. In the last decade we experienced a period of high growth and low inflation until the global financial crisis in 2008. The crisis adversely impacted the Indian economy given our increasing integration with the global economy. The Government and the Reserve Bank of India (RBI) took several policy measures to minimize the spillover of global crisis on our economy. In the process growth bounced back but inflation also increased. More recently while growth has moderated, inflation still remains above our comfort levels. In the post-global crisis period since 2008-09 inflation has emerged as a major public policy concern. A disturbing feature of the current episode of inflation is that it has been accompanied by high food inflation, which hurts most the poor and the low-income strata of our society.

Inflation management is one of the hardest tasks an economic policymaker has to undertake. It appears, at first sight, that one can rely entirely on commonsense to carry out this task. But that will be a cardinal mistake. While inflation policy does require judgment and intuition, it is essential that these be backed up with statistical information and an understanding of economic theory.

This paper tries to bring together the formal analytics that underlie inflation policy. It surveys some of the standard ideas and also questions some of these and, in the process, tries to push further outwards the frontiers of our understanding.

Page 4 of 41

Defining the Research Problem

Inflation is the gravest economic concern which has gripped India into its jagged tentacles. India has been plagued by the disease of inflation since the 1950s but it has started showing its prominently harmful symptoms and ill effects since 1991, post liberalization. Kick started by the fiscal crisis of 1991, marked by deficits in government finances and devaluation of the rupee, a whopping inflation of 13.66 per cent took its toll on the Indian economy.

For reasons of completeness it may be mentioned that independent India’s highest inflation occurred in September 1974, when inflation reached 33.3%. Arguably our worst inflationary episode was from November 1973 to December 1974, when inflation never dropped below 20% and was above 30% for four consecutive months starting June 1974.

What is the best inflation measure in India? What inflation measure is most relevant for monetary policy making in India? Questions of timeliness, weights in the price index, accuracy of food price measurement, and inclusion of services prices are relevant to the choice of measure. Though monetary policy in India is not explicitly charged with delivering low and stable inflation, it still needs to choose a measure of inflation as a reference. In this context, a major problem identified by the Reserve Bank of India (RBI) is the measurement of inflation in India:

Research Problem : To study whether the recommendations of the Urjit Patel Committee report are seen

as a realistic estimate To study the three main components of CPI (Food, Fuel and Services) To study the impact of inflation on spending

The research survey considers several parameters and areas that are affected by the switch from Wholesale Price Index (WPI) to Consumer Price Index (CPI). Few of the key considerations that are made while conducting the survey are:

CPI and its impact on the GDP

The GDP, is one of many economic indicators investors can use to gauge the growth rate and strength of an economy. The CPI plays a role in the determination of the real GDP; therefore, manipulation of the CPI could imply manipulation of the GDP because the CPI is used to deflate some of the nominal GDP components for the effects of inflation. CPI and GDP have an inverse relationship, so a lower CPI - and its inverse effect on GDP - could suggest to investors that the economy is stronger and healthier than it really is.

Should WPI be ruled out completely

According to the Wholesale Price Index, inflation picked up in the month of August to 6.1 per cent from 5.8 per cent in July. On the other hand, the (newer) Consumer Price Index

Page 5 of 41

indicates that inflation slowed in the same month, moderating from 9.6 per cent to 9.5 per cent.

Why the divergence? And which of these disparate measures should policy makers be looking at?

Indian policy makers currently pay most attention to wholesale prices – that’s what decisions are based on and linked to. But perhaps that seems a bit odd, given it is consumer price inflation that affects the Indian public. So the question that is left unanswered is should WPI be ruled out completely? Through this survey we have tried to touch this area to.

Facts of Urjit Patel Committee report impact inflation

The Urjit Patel committee report, which has recommended that the RBI should be a flexible inflation-addressing central bank that targets the CPI at 4 per cent, is considered a welcome step towards making it a modern central bank. Through this survey we have tried to understand what common man with his limited knowledge on the subject understand and has a takeaway from it.

End user impact due to shift from WPI to CPI considering consumables like food grain, fuel and electricity and services.

CPI would try to bring in facts of how consumer is affected due to his spending in several areas like food grain, electricity, services. It tries to capture the actual impact of inflation considering end users. In this survey we felt it was important to understand what the end users ‘Consumers’ had to say about it.

Is spending impacted due to increase in inflation

It is said that CPI reflects spending patterns of the population of the country. It is based on the expenditures of almost all residents of the country, including professionals, the self-employed, the poor, the unemployed, and retired people, as well as urban wage earners and clerical workers. Having said that, does the shift from WPI to CPI or an increase in inflation really stop the consumer from spending is one of the areas that we tried to touch upon in the survey.

While it is true that we do not fully understand inflation and, to that extent it remains a threat, what is comforting is that this exercise of data collection and theoretical research have given us deep insights into this troubling phenomenon. And even though we do not fully understand its origins, we have understood its impact on the economy.

It is therefore important to do fundamental analytical research on inflation where the backdrop is an emerging market economy such as India. That is the spirit in which the present paper is written. As such, it begins with a brief description of the inflationary experience of India with some comparative descriptions from other nations.

Page 6 of 41

Research Methodology: Formulation of Questionnaire and Pilot Study

The survey of literature provided a good background to formulate our questionnaire and also proved that a mix of quantitative and qualitative questions would prove effective in assessing sentiments on inflation.

We therefore five sections to the questionnaire: the first profiled the respondent. Given that inflation is an intense topic, our respondents comprised both experts (economists, bank treasury officials) and others (from a non-finance background). The second section contained questions to assess forecasts on CPI and WPI inflation for the coming month; expectations on GDP growth for 2014-15. In line with the literature reviewed we also added two questions, to assess the shift in India’s approach to inflation:

Do you think only CPI should be considered and WPI must be ruled out gradually? Is it feasible / essential for India to consider Head line Inflation when most countries

consider Core Inflation? As per the Urjit Patel Committee report the RBI should bring down CPI or retail inflation

to 8 per cent over the next 12 months, and to 6 per cent over the next 24 months. Is this a realistic estimate?

We have also assessed respondents expectations across three categories: Food Articles, Fuel & Electricity and Services. The questions are both quantitative and factor-based, the latter of which was evaluated using a 5-point Likert scale. We have also tried to identify the one single item in each of the above three categories, which has had the maximum impact on a respondent’s monthly expenditure.

In all, we have attempted to provide a holistic assessment of the impact of inflation on an individual (micro-level), while also ensuring the opinion that finally emerges provides a macro perspective.

Pilot Study:

The questionnaire was first administered to a group of 10 bankers/ treasurers to know the lacunae in the questionnaire and the areas of improvement. During the discussions with the experts we were briefed on the main factors that affect inflation and that must be considered in the ambit of our study.

The Pilot survey went a long way in shaping the questionnaire to be comprehensive from the point of view of our research problem

Page 7 of 41

Research Methodology: Sampling Technique and Sample size

For the purpose of our research we wanted to study experts and general respondents separately and combined. For this we used convenience sampling technique

Convenience Sampling: This is a type of non-probability sampling which involves the sample being drawn from that part of the population which is close to hand. That is, a sample population selected because it is readily available and convenient, as researchers are drawing on relationships or networks to which they have easy access.

Sample Size: Since we wanted to study a small subset and curb the study to a specific target group we restricted the respondents to 100. We closed the survey link as soon as the target number was achieved.

Main Demographics:

For the purpose of our study we have clubbed Banker – Treasurer and Economist / Academcians as experts and the rest as general polulace

Total Respondents : 100

Experts : 41

General : 59

Bank / Treasury30%

Economist / Academician

11%Non - Finance Sec-tor

29%

Other Financial Organisation

30%

Work Profile

Monthly Income

25,000-50,00050,001-75,00075,001- 1 lacLess than 25,000More than 1 lac(blank)

Page 8 of 41

Research Methodology: Hypothesis tested

The different hypothesis that are proposed to be tested using T -test are as below:

1. H0: The expectations of the Year on Year CPI of the experts is the same as that of the general public

H1: The expectations of the Year on Year CPI of the experts is not the same as that of the general public

2. H0: The expectations of the Year on Year WPI of the experts is the same as that of the general public

H1: The expectations of the Year on Year WPI of the experts is not the same as that of the general public

3. H0: The opinion of the experts and the general populace are the same on the recommendations of the Urjit Patel committee report

H1: The opinion of the experts and the general populace are not the same on the recommendations of the Urjit Patel committee report

The different hypothesis that are proposed to be tested using Chi-Square test are as below:

4. H0: Monthly salary of the individual and the cut down on spending of food are independent

H1: Monthly salary of the individual and the cut down on spending of food are dependent

5. H0: Monthly salary of the individual and the cut down on spending of fuel and electricity are independent

H1: Monthly salary of the individual and the cut down on spending of fuel and electricity are dependent

6. H0: Monthly salary of the individual and the cut down on spending of services are independent

H1: Monthly salary of the individual and the cut down on spending of services are dependent

Page 9 of 41

Annexure 1: CPI V/s WPI

India is one of the few countries where the WPI is considered as the headline inflation measure by the Central Bank. This preference over the CPI is often explained in terms of three criteria: national coverage, timeliness of release (now only limited to food products) and its availability in very disaggregate format (Mohanty, 2010)

“In India, we have one wholesale price index and four consumer price indices. There are ongoing efforts at a technical level to reduce the number of consumer price indices, and I believe the technical issues are not insurmountable. But that still will not give us a single representative inflation rate for an emerging market economy with market imperfections, diverse geography and 1.2 billion people." - Subbarao (2010)

Consumer Price Index (CPI)

A consumer price index measures changes in the price level of consumer goods and services purchased by households. A CPI can be used to index (i.e., adjust for the effect of inflation) the real value of wages, salaries, pensions, for regulating prices and for deflating monetary magnitudes to show changes in real values. The overall CPI is meant to represent the cost of a representative basket of goods and services consumed by an average household. However, in India, the existing CPIs refer to specific segments of the population.

In most countries, the Consumer Price Index is the most widely understood and recognised measure of inflation. It is available relatively frequently, and it is typically not subject to revisions. The overall CPI is meant to represent the cost of representative basket of goods and services consumed by an average urban/rural household.

CPI = (Updated cost / Base period cost )x 100

Wholesale Price Index (WPI)

The Wholesale Price Index or WPI is the price of a representative basket of wholesale goods. The Indian WPI figure is released every 10 days and influences stock and fixed price markets. The Wholesale Price Index focuses on the price of goods traded between corporations, rather than goods bought by consumers, which is measured by the Consumer Price Index. The purpose of the WPI is to monitor price movements that reflect supply and demand in industry, manufacturing and construction. In India WPI is the indicator for inflation rate. The use of the WPI in deciding on policy has often come under criticism (Patnaik, Shah and Veronese, 2011; Rakshit, 2011).

It is true that the WPI does not track the price of services, which is increasingly the major part of India’s value added in GDP. However, since services constitute an important input for manufacturing and agricultural products, it is arguable that the price of services gets indirectly reflected in the WPI.

Page 10 of 41

Wholesale Price Index Consumer Price IndexBase Year 2004-05 2010Weightage Primary Articles – 20.12% Food – 57%

Fuel & Power – 14.91% Pan,Supari, Tobacco – 3.15%Manufactured Products – 64.97% Fuel & Light – 6.28%

Housing – 8.67%Clothing,Bedding Footwear-8.54%Misc – 16.36%

Measurement Production stage at bulk price Consumption Stage at Retail PriceServices No weightage Considerable weightageRevision Frequent Revisions as based on

external shocksLess Frequent revisions in CPI(state level CPIs are Combined to derive all India Index (incl of state level taxes)

Items CPI Urban CPI – IW^ CPI – Rural CPI –RL* CPI - Combined

Food & Beverages 35.80 46.19 56.58 66.77 47.58Pan,tobacco 1.35 2.27 2.73 3.7 2.13Fuel & Light 8.40 6.43 10.42 7.9 9.49Housing 22.53 15.27 - - 9.77Clothing, Bedding, Footwear

3.91 6.57 5.36 9.76 4.73

Miscellaneos 28.00 23.27 24.91 11.87 26.31

From above synopsis it is clear that WPI covers more products than the one covered by CPI. But CPI focuses its attention on Domestic expenses and it also includes Services. Less weightage of Primary Articles is being observed in WPI whereas Food & Service sector price rise is clearly observed in CPI due to considerable weightage.

The honourable Governor Mr. Rajan is now more concerned with CPI as a primary indicator and he supposes that keeping a check on it will not only help the poor people to reduce their burden on spending but will also contribute to a great extent to tame the Core Inflation. WPI has considered due importance to Price changes in manufactured articles which can be kept under control as businesses might not increase product prices and will keep themselves satisfied with stable prices in case of a recessionary phase of economy.

Primary articles constitute only 20% weightage out of which only 14% weigtage is for food articles in overall WPI which is much below than what is considered in CPI i.e 57%

Page 11 of 41

Annexure 2: Urjit Patel Committee Report: Overview and Recommendations

Governor Dr. Raghuram G. Rajan, in a statement on September 4, 2013 observed that:

“The primary role of the central bank, as the RBI Act suggests, is monetary stability, that is, to sustain confidence in the value of the country’s money. Ultimately, this means low and stable expectations of inflation, whether that inflation stems from domestic sources or from changes in the value of the currency, from supply constraints or demand pressures. I have asked Deputy Governor Urjit Patel, together with a panel he will constitute of outside experts and RBI staff, to come up with suggestions in three months on what needs to be done to revise and strengthen our monetary policy framework. A number of past committees, including the FSLRC, have opined on this, and their views will also be considered carefully. “

Accordingly, an Expert Committee to Revise and Strengthen the Monetary Policy Framework was appointed on September 12, 2013. The main objective of the Committee is to recommend what needs to be done to revise and strengthen the current monetary policy framework with a view to, inter alia, making it transparent and predictable.

Recommendations:

The Choice of Nominal Anchor(1) Inflation should be the nominal anchor for the monetary policy framework. This nominal anchor should be set by the Reserve Bank as its predominant objective of monetary policy in its policy statements.

The Choice of Inflation Metric(2) The RBI should adopt the new CPI (combined) as the measure of the nominal anchor for policy communication. The nominal anchor should be defined in terms of headline CPI inflation, which closely reflects the cost of living and influences inflation expectations relative to other available metrics

Numerical Target and Precision(3) The nominal anchor or the target for inflation should be set at 4 per cent with a band of +/- 2 percent around it (a) in view of the vulnerability of the Indian economy to supply/external shocks and the relatively large weight of food in the CPI; and (b) the need to avoid a deflation bias in the conduct of monetary policy. This target should be set in the frame of a two-year horizon that is consistent with the need to balance the output costs of disinflation against the speed of entrenchment of credibility in policy commitment

Time Horizon for Attaining Price Stability(4) In view of the elevated level of current CPI inflation and hardened inflation expectations, supply constraints and weak output performance, the transition path to the target zone should

Page 12 of 41

be graduated to bringing down inflation from the current level of 10 per cent to 8 per cent over a period not exceeding the next 12 months and to 6 per cent over a period not exceeding the next 24 month period before formally adopting the recommended target of 4 percent inflation with a band of +/- 2 per cent. (5) Since food and fuel account for more than 57 per cent of the CPI on which the direct influence of monetary policy is limited, the commitment to the nominal anchor would need to be demonstrated by timely monetary policy response to risks from second round effects and inflation expectations in response to shocks to food and fuel

Institutional Requirements(6) Consistent with the Fiscal Responsibility and Budget Management (Amendment) Rules, 2013, the Central Government needs to ensure that its fiscal deficit as a ratio to GDP is brought down to 3.0 per cent by 2016-17 (7) Administered setting of prices, wages and interest rates are significant impediments to monetary policy transmission and achievement of the price stability objective, requiring a commitment from the Government towards their elimination

Organisational Structure for Monetary Policy Decisions(8) Monetary policy decision-making should be vested in a monetary policy committee (MPC)

Accountability of MPCThe MPC will be accountable for failure to establish and achieve the nominal anchor. Failure is defined as the inability to achieve the inflation target of 4 percent (+/- 2 per cent) for three successive quarters. Such failure will require the MPC to issue a public statement, signed by each member, stating the reason(s) for failure, remedial actions proposed and the likely period of time over which inflation will return to the centre of the inflation target zone

Page 13 of 41

Glossary of Terms used

CPI : Consumer Price Index

WPI : Wholesale Price Index

RBI : Reserve Bank of India

YOY : Year on Year

MPC : Monetary Policy Committee

CPI (IW) : Consumer Price Index (Industrial Workers)

d.f : Degrees of Freedom

GDP : Gross Domestic Product

IMF: International Monetary Fund

FRBM : Fiscal Responsibility and Budget Management

MPF : Monetary Policy Framework

Page 14 of 41

Data Analysis and Interpretatio

Section A: The CPI and the WPI

For the purpose of our study we administered the questionnaire to professionals from banks, treasury, and economists and academicians who could give us their expert opinion on the present CPI and WPI numbers. We have then compared the responses with those of the general populace to find out if the expectations/ outlook/ opinion on inflation are the same.

Total number of Respondents: 100

Number of Experts: 41 Number of General Respondents: 59

In this section the Hypothesis are tested using the T-Test for unequal sample sizes

A t-test is any statistical hypothesis test in which the test statistic follows a Student's t distribution if the null hypothesis is supported. It can be used to determine if two sets of data are significantly different from each other, and is most commonly applied when the test statistic would follow a normal distribution if the value of a scaling term in the test statistic were known

Equal or unequal sample sizes, unequal variances

This test, also known as Welch's t-test, is used only when the two population variances are not assumed to be equal (the two sample sizes may or may not be equal) and hence must be estimated separately. The t statistic to test whether the population means are different is calculated as:

where

Here s2 is the unbiased estimator of the variance of the two samples, ni = number of participants in

group i, i=1 or 2. Note that in this case   is not a pooled variance. For use in significance testing, the distribution of the test statistic is approximated as an ordinary Student's t distribution with the degrees of freedom calculated using

1. Expectations of the Year on Year (YOY) CPI for the upcoming month

Here we attempted to test our first hypothesis whether the Year on year CPI predicted by the experts are the same as that of the general public.

Page 15 of 41

H0: The expectations of the Year on Year CPI of the experts is the same as that of the general public

H1: The expectations of the Year on Year CPI of the experts is not the same as that of the general public

We have used the T-Test for unequal sample sizes to arrive at the P value at 5% level of significance for the above stated hypothesis and arrived at the values as below:

  Variable 1 Variable 2Mean 2.731707 2.694915Variance 0.70122 1.04325Observations 41 59Hypothesized Mean Difference 0  df 95  t Stat 0.197268  P(T<=t) two-tail 0.844039  t Critical two-tail 1.985251  

Since P value is greater than 0.05, we accept H0

Therefore we can prove that the opinion of the experts and the general respondents are the same.

2. Expectations of the Year on Year (YOY) WPI for the upcoming month

Here we attempted to test our second hypothesis whether the Year on year WPI predicted by the experts are the same as that of the general public.

H0: The expectations of the Year on Year WPI of the experts is the same as that of the general public

H1: The expectations of the Year on Year WPI of the experts is not the same as that of the general public

We have used the T-Test for unequal sample sizes to arrive at the P value at 5% level of significance for the above stated hypothesis and arrived at the values as below:

  Variable 1 Variable 2Mean 2.7804878 2.79661Variance 0.8756098 1.061368Observations 41 59Hypothesized Mean Difference 0  df 91  t Stat -0.081279  P(T<=t) two-tail 0.9353982  t Critical two-tail 1.9863772  

Page 16 of 41

Since P value is greater than 0.05, we accept H0

Therefore we can prove that the opinion of the experts and the general respondents are the same.

3. Do you think only CPI should be considered and WPI must be ruled out gradually?

Yes68%

No32%

Expert Opinion

Yes59%

No41%

General Opinion

More than 50% of the experts and the general public are of the opinion that the CPI must be considered and WPI must be ruled out gradually. From the numbers it is evident that Experts clearly prefer CPI to be used with a 68% of the respondents tilting towards that notion.

4. Is it feasible / essential for India to consider Head line Inflation when most countries consider Core Inflation?

Yes49%

No51%

Expert Opinion

Yes58%

No42%

General Opinion

We can see that the expert and the general opinion is mixed in case whether to consider Headline Inflation or CORE inflationThe opinion of the experts is divided and tilts neither in the favour of Headline inflation or Core inflation as almost 50%

Page 17 of 41

5. As per the Urjit Patel Committee report (See Annexure 2): Reserve Bank should bring down CPI or retail inflation to 8 per cent over the next 12 months, and to 6 per cent over the next 24months. Is this a realistic estimate?

Here we have tested our third hypothesis whether the opinion of the experts and the general populace are the same on the recommendations of the Urjit Patel committee report

H0: The opinion of the experts and the general populace are the same on the recommendations of the Urjit Patel committee report

H1: The opinion of the experts and the general populace are not the same on the recommendations of the Urjit Patel committee report

We have used the T-Test for unequal sample sizes to arrive at the t(calculated) for the above stated hypothesis and arrived at the values as below:

  Variable 1 Variable 2Mean 2.12195122 1.627118644Variance 1.159756098 0.858562244Observations 41 59Hypothesized Mean Difference 0  df 78  t Stat 2.390784669  P(T<=t) two-tail 0.019223325  t Critical two-tail 1.990847069  

Since P value is less than 0.05, we accept H0

Therefore we can prove that the opinion of the experts and the general respondents are the same.

Descriptive Statistics:

For the T – test we have used the data on responses on the 4 point Likert scale ranging from Highly unrealistic to Highly realistic. For the ease of graphical representation we have clubbed the responses of 4 scales to 2 i.e. Realistic and Unrealistic.

Given below is the graphical representation of the opinion of experts and the general public:

Page 18 of 41

Highly Realistic51%

Expert Opinion

Highly Realistic73%

General Opinion

From the graphs it is clearly visible that while the opinion of experts are divided, the general public strongly feels that the estimates of the Urjit Patel Committee report are highly realistic and can be achieved over the next 24 months. This is in strong contradiction to the fact that the committee comprising of expert bankers and economists have arrived at the conclusion that retail inflation can be brought down to 6% over the next 24 months and the sample comprising of their peers from the industry do not endorse this opinion. Now only time will tell that whether the RBI along with other government reforms is able to bring down inflation as stated.

5. Estimate GDP Growth for FY 2014-15

0-3% 3-4% 4-5% 5-6% Above 6%0

5

10

15

20

25

30

35

40

Estimated GDP growth rate for FY 14-15

From the above table it is evident that most respondents feel that the GDP will be in the rate of 5-6% in the next fiscal

Comprison of GDP and CPI of India, China and USA

Page 19 of 41

1 2 3 4

-4

-2

0

2

4

6

8

10

12

GDP Growth

INDIA CHINAUSA

1 2 3 40

2

4

6

8

10

12

CPI

INDIA CHINAUSA

From the above data of 4 years it is evident that more the CPI less the GDP growth

Data Analysis and Interpretation

Section B: Food ArticlesFor the purpose of this section we have now combined the two samples of experts and general respondents to study their mutual opinion on the inflation in food articles which is one of the principal components under CPI.

Total Sample Size: 100

1. Expectations on increase in food prices over the next one year

0 to 5%

5 to 10%

10 to 15%

15 to 20%

Above 20%

0 10 20 30 40 50 60

Dairy ProductsFruits and VegetablesFood grains

Page 20 of 41

2. Factors affecting inflation in food articles

Cli

ma

te a

nd

Ra

infa

ll

La

bo

ur

Su

bsi

die

s

De

ma

nd

an

d S

up

ply

iss

ue

s

Lo

ng

Su

pp

ly C

ha

in

Factors Affecting inflation

0

20

40

60

80

100

Very HighHighMediumLowVery Low

3. Percentage increase in the expenditure on food items

0-5% 5-10% 10-15% 15-20% Above 20%0

5

10

15

20

25

30

35

Increase in the expenditure on food items

4. Food items maximum affected by inflation

Page 21 of 41

Vegetables Fruits Milk Other Dairy Products

Cereals and Pulses

0

10

20

30

40

50

60

5. Effect of inflation on spending

Under this section we will now try to test our fourth hypothesis whether there is a dependence of monthly salary and the cut down on the expenses of food articles.

To test the independence we will use the Chi Square test

H0: Monthly salary of the individual and the cut down on spending of food items are independent

H1: Monthly salary of the individual and the cut down on spending of food items are dependent

The value of the test-statistic is

where

 = Pearson's cumulative test statistic, which asymptotically approaches a  distribution.

 = an observed frequency;

 = an expected (theoretical) frequency, asserted by the null hypothesis;

 = the number of cells in the table.

Page 22 of 41

Contingency Table:Salary Yes No TotalLess than 25000 13 4 1725000-50000 20 7 2750000-75000 21 10 31More than 75000 10 15 25Total 64 36 100

*Kindly note that the contingency table has been re-written since one of the cell frequencies were less than 5

Oi Ei Oi-Ei (Oi-Ei)2 (Oi-Ei)2/ Ei

13 10.88 2.12 4.49440.41308823

5

20 17.28 2.72 7.39840.42814814

8

21 19.84 1.16 1.34560.06782258

110 16 -6 36 2.25

4 6.12 -2.12 4.49440.73437908

5

7 9.72 -2.72 7.39840.76115226

3

10 11.16 -1.16 1.34560.12057347

715 9 6 36 4

=8.77516378

9

tab at 4 degrees of freedom and 5% level of significance is 11.1

Therefore cal < tab, Hence accept H0

Therefore we can prove that no matter what the monthly income of the household, the cut down on spending is independent of the same

Data Analysis and Interpretation

Section C: Fuel and ElectricityFor the purpose of this section we have now combined the two samples of experts and general respondents to study their mutual opinion on the inflation in fuel and electricity which is one of the components under CPI.

Total Sample Size: 100

1. Expectations on increase in fuel prices over the next one year

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0 to 5

5 to 10

10 to 15

15 to 20

Above 20

0 5 10 15 20 25 30 35 40 45

LPG and KerosenePetrol and DieselElectricity

2. Factors affecting inflation in fuel and electricity

Ex

cha

ng

e R

ate

Incr

ea

se in

In

tern

ati

on

al E

ne

rgy

De

ma

nd

Ind

ust

ria

l Co

nsu

mp

tio

n o

f E

lect

rici

ty

Su

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die

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LP

G a

nd

Ke

rose

ne

aff

ect

ing

p

rice

s o

f P

etr

ol D

iese

l

Fis

cal D

efi

cit

Factors Affecting inflation

020406080

100

Very High

High

Medium

Low

Very Low

3. Increase in monthly expenditure on fuel and electricity

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0-5% 5-10% 10-15% 15-20% Above 20%0

5

10

15

20

25

30

35

Increase in expenditure of fuel and electricity

Series1

4. Fuel and electricity items maximum affected by inflation

Electricity Petrol Diesel LPG Kerosene0

5

10

15

20

25

30

35

40

5. Effect of inflation on monthly spending on fuel and electricity

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Under this section we will now try to test our fourth hypothesis whether there is a dependence of monthly salary and the cut down on the expenses of food articles.

To test the independence we will use the Chi Square test

H0: Monthly salary of the individual and the cut down on spending of fuel and electricity are independent

H1: Monthly salary of the individual and the cut down on spending of fuel and electricity are dependent

Contingency Table:

Salary Yes No TotalLess than 25000 11 6 1725000-50000 19 8 2750000-75000 19 12 31More than 75000 10 15 25Total 59 41 100

*Kindly note that the contingency table has been re-written since one of the cell frequencies were less than 5

Oi Ei Oi-Ei (Oi-Ei)2 (Oi-Ei)2/ Ei11 10.03 0.97 0.9409 0.09380857419 15.93 3.07 9.4249 0.59164469619 18.29 0.71 0.5041 0.027561509

10 14.75 -4.7522.562

5 1.5296610176 6.97 -0.97 0.9409 0.1349928268 11.07 -3.07 9.4249 0.851391147

12 12.71 -0.71 0.5041 0.039661684

15 10.25 4.7522.562

5 2.201219512

= 5.469940965

tab at 4 degrees of freedom and 5% level of significance is 11.1

Therefore cal < tab, Hence accept H0

Therefore we can prove that no matter what the monthly income of the household, the cut down on spending is independent of the same

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Section D: ServicesFor the purpose of this section we have now combined the two samples of experts and general respondents to study their mutual opinion on the inflation in services which is one of the components under CPI but not WPI

Total Sample Size: 100

1. Expectations on increase in services over the next one year

0 to 5%

5 to 10%

10 to 15%

15 to 20%

Above 20%

0 5 10 15 20 25 30 35 40 45

Services Transport and Communication

Services Housing

Services Health care and Eductaion

2. Factors affecting inflation in Services

Lo

an

In

tere

st R

ate

s

Incr

ea

se i

n F

ue

l P

rice

s

Pri

va

tisa

tio

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f H

ea

lth

care

an

d E

d-

uca

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n

La

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f R

eg

ula

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ov

ern

me

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gra

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an

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sub

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020406080

100

Very HighHighMediumLowVery Low

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3. Increase in monthly expenditure on Services

0-5% 5-10% 10-15% 15-20% Above 20%0

5

10

15

20

25

30

35

40

Increase in the expenditure of Services

4. Services maximum affected by inflation

Housing Healthcare Education Transport Communication0

5

10

15

20

25

30

35

40

45

50

Servcies affected by Inflation

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5. Effect of monthly income on monthly spending on fuel and electricity

Under this section we will now try to test our fifth hypothesis whether there is a dependence of monthly salary and the cut down on the expenses of services.

To test the independence we will use the Chi Square test

H0: Monthly salary of the individual and the cut down on spending of Services are independent

H1: Monthly salary of the individual and the cut down on spending of Services are dependent

Contingency Table:

Oi Ei Oi-Ei (Oi-Ei)2 (Oi-Ei)2/ Ei11 9.35 1.65 2.7225 0.29117615 14.85 0.15 0.0225 0.00151521 17.05 3.95 15.6025 0.915103

8 13.75 -5.75 33.0625 2.4045456 7.65 -1.65 2.7225 0.355882

12 12.15 -0.15 0.0225 0.00185210 13.95 -3.95 15.6025 1.11845917 11.25 5.75 33.0625 2.938889

= 8.027422

tab at 4 degrees of freedom and 5% level of significance is 11.1

Therefore cal < tab, Hence accept H0

Therefore we can prove that no matter what the monthly income of the household, the cut down on spending is independent of the same

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Salary Yes No TotalLess than 25000 11 6 1725000-50000 15 12 2750000-75000 21 10 31More than 75000 8 17 25Total 55 45 100

References

Anand R, Prasad ES (2010). \Optimal Price Indices for Targeting Ina-tion under Incomplete Markets." (16290).

Aoki K (2001). \Optimal Monetary Policy Responses to Relative Price Changes. " Journal of Monetary Economics, 48(3), 55{80. Benigno P, Woodford M (2005). ,Ination Stabilization and Welfare: TheCase of a Distorted Steady State." Journal of the European Economic Association, 3(6), 1185{1236.}

Blinder AS (1982). \Inventories and Sticky Prices: More on the Micro- foundations of Macroeconomics." The American Economic Review, 72(3), 334{348}.

Chang R, Catao L (2010). \World Food Prices and Monetary Policy." (16563).

CSO (2008). Manual on Index of Industrial Production (IIP).

Dhyne E, Alvarez LJ, Bihan HL, Veronese G, Dias D, Ho_mann J, Jonker N, Lunnemann P, Rumler F, Vilmunen J (2006). \Price Changes in the Euro Area and the United States: Some Facts from Individual Consumer

Price Data." Journal of Economic Perspectives, 20(2), 171{192. LB (2009). \Report of the Index Review Committee." Technical report, Labor Bureau, New Delhi.

Mankiw NG, Reis R (2007). \Sticky Information in General Equilibrium."Journal of the European Economic Association, 5(2-3), 603{613.

Mishkin FS (2007). \Headline versus Core Ination in the Conduct of Monetary Policy, At the Business Cycles, International Transmission and Macroeconomic Policies Conference, HEC Montreal, Montreal, Canada

Mohanty D (2010). \Measures of ination - issues and perspectives

Nadhanael GV, Pattnaik S (2010). \Measurement of Ination in India: Issues 25and associated challenges for the conduct of monetary policy." In \RBI Sta_ Papers," Reserve Bank of India.

Nakamura E, Steinssonn J (2008). \Five Facts About Prices: A Reevaluation of Menu Cost Models." Quarterly Journal of Economics, 123(4), 1415{1464.

OEA MoC (2008). Manual on compilation of index numbers of Wholesale prices in India.

OEA-DIPP (2008). \Technical Report of the working group, revision of Index numbers of wholesale prices in India from the base -94 to 2004-05."

Technical report of the Economic Adviser, Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, New Delhi. RBI (2009-10). \Annual Report." Technical report, Reserve Bank of India, Mumbai.

S Eusepi BH, Tambalotti A (2009). \CONDI: A Cost-of-Nominal-Distortions Index." In \Sta_ Papers," 367. Federal Reserve Bank of New York.

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Subbarao D (2010a). \Financial Crisis - Some Old Questions and Maybe Some New Answers, Tenth C.D. Deshmukh Memorial Lecture delivered at Council for Social Development, Southern Regional Centre, Hyderabad."

Subbarao D (2010b). \India and the global _nancial crisis transcending from recovery to growth, at the Peterson Institute for International Economics, Washington DC."

Zhang W, Law D (2010). \What drives China's food-price ination and how does it a_ect the aggregate ination?" HKMA working paper, Hong Kong Monetary Authority.

The relationship between El Niño, inflation and GDP growthFIRST PUBLISHED: WED, MAR 26 2014. 06 27 PM IST Live Mint & the Wall street Journal

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Literature Review

Though for a subject as an intense subject like inflation makes news headlines every other day, we had to delve into past research studies to validate our choice of topic. The first and obvious point of reference was the Reserve Bank of India (RBI), which as the country’s apex body for formulating monetary policy, largely shapes the growth path for the Indian economy. We have also referred to empirical research studies made by individual experts, external agencies such as the International Monetary Fund and by publications like the Economic and Political Weekly (EPW) and Economist.

The primary theme that we chose as the focal point of our study was: Do the RBI and inflation theorists in India have to shift their focus from headline inflation (or wholesale price index inflation – WPI) to consumer price index inflation (CPI) as most developed economies are doing?

The answer came in the form of the release of the Urjit Patel committee’s report (See Annexure 2 for the recommendations). The report recommends that the RBI should gradually shift its focus to CPI inflation (be made the new nominal anchor for monetary policy). The report also states that under this model, the central bank can aim to reduce consumer price inflation to 8-8.5% in 2014-15 and further to 6% by January 2016.

Given the robustness of the above recommendations, we decided to test our respondents’ reaction to the same. Surprisingly, our respondents from the expert category (comprising bank treasury officials and economists) are equally split on the issue (See the Data Analysis Section). Respondents from the general populace (from a non-finance background) were more positive on the recommendations.

Another theme that we examined via secondary literature was the relation between inflation and real GDP growth: Is there a cogent relationship between inflation and GDP growth and if so, are the effects adverse to the economy’s improvement?

The above points are validated by various studies, including by RBI officials themselves. Take for instance the study titled: Inflation Threshold in India: an Empirical Investigation, by ‘Deepak Mohanty, A B Chakraborty, Abhiman Das and Joice John’ (2011).

The study examines the existence of ‘threshold effects’ in the relationship between inflation and real GDP growth in India using 3 different approaches. In view of the structural changes of the economy, the empirical analysis uses RBI data between 1996-97 and 2010-11 to capture the more recent picture of the growth-inflation nexus.

The study concludes that when inflation trends in the range of 4% to 5.5%, inflation has positive and negative effect on real GDP growth, respectively. In other words, inflation and growth can co-exist and move upwards up to a certain range within this level. If inflation rises above a certain level (5.5% in this study) it retards the growth rate of GDP, while below the threshold

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(below 4%) there is a statistically significant positive relationship between inflation rate and growth.

The study also clearly outlined two clear viewpoints in the debate of growth-inflation trade-off and the role of monetary policy. One is the short-term conventional viewpoint, which opines that that higher inflation tolerance could yield higher growth against the view that inflation itself is a risk to growth beyond a level. However, such a viewpoint seems myopic in considering the long-term effect of rising inflation on growth.

A major shift in the growth inflation nexus in India came with the advent of the global financial crisis. Quoting from the above report, “From 1996 to 2002, GDP growth was hovering around 6%, while y-o-y average Wholesale Price Index-inflation was close to 5%. Subsequently, growth traversed much higher trajectory and inflation remained relatively low in the range 5-6% till global financial crisis adversely affected growth-inflation dynamics. After the recent global crisis in 2008, growth rate of India bounced back much quicker than anticipated and at the same time inflation went up significantly. Therefore, the dynamics of growth-inflation nexus in India is not straightforward.”The above study concludes that the relationship between inflation and GDP growth is non-linear and that inflation must be controlled at a certain level for it to positively affect GDP growth in the long run.

Echoing with this sentiment, another study titled, “Inflation and Economic Growth in India –An Empirical Analysis”, by Prasanna V Salian and Gopakumar K, is more blatant. It says that inflation is more than helpful to real GDP growth, owing to a ‘cyclical effect’. The study explains that there are two schools of thought: one that reasons that if actual output rises above potential output, this will create an upward pressure on wages in the labour market. Higher wages, in turn, will lead to higher production costs and hence higher prices. This means that economic output growth will drive up inflation in the future. Here growth is seen as driving up inflation in the long run, indicating a positive correlation between inflation and GDP growth. However, what if the cycle turns and inflation begins to put pressure on GDP growth. The reverse process is quite simple: if a rise in prices drives up future inflation, then it will obviously harm productivity and investments, especially in developing economies like India. Developing countries are more vulnerable to supply shocks causing high variability in inflation and disturb the consumption, investment and production behaviour.

To conclude, the above survey of literature provided a good background to formulate our questionnaire and also proved that a quantitative questionnaire model would prove more effective rather than qualitatively assessing sentiments on inflation.

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Interview: Extract

As a part of our study we also asked the expert respondents their opinion on current inflation. Their responses are quoted verbatim below:

Inflation will remain around 8% in 2014-15, as the economy remains weak. Global crude & commodity prices stay soft. A weak monsoon next year could lead to high inflation next year.

- DK Joshi (Chief Economist – CRISIL)

Inflation control should be responsibility of the government and not RBI, which is not the case in India. It's unfair for RBI to set a target for CPI as it by itself can hardly control any of the inflation related factors.

- Hitesh Thakkar (Citibank)

The reducing inflation sustainably will require the RBI to make containing inflation its primary objective, with headline CPI as the nominal factor for monetary policy. Considering the ingrained nature of inflation and inflation expectations, reducing inflation may require the RBI to raise rates decisively and maintain higher rates for a prolonged period of time. Low and stable inflation is the best way for monetary policy to support robust and inclusive growth in the medium-term. Headline CPI inflation should be the focus of monetary policy. It plays a key role in influencing both inflation expectations and wage formation in India, and it represents the true cost of living for the average Indian. Over the years, RBI surveys have consistently documented that food inflation is a key driver of households’ inflation expectations, which is hardly surprising given the large share of food in households’ consumption in India

-Abin Mathew (Dubai First PJSC)

The current inflation is under control. However that can be considered as a yardstick unless it continues for a period of time and only under pewllar circumstances it should increase manifold. Otherwise it should be within a range.

-V Murali (Hindustan Petroleum)

Inflation can never be stopped but can be always controlled. As global economies changes there will be effect on inflation rate going higher or lower.Few things to control inflation in india. Government should immediately stop /ban exports of daily consumer goods which are

required as a basic need of common man and have scarcity in country but yet exported. Biggest reason of inflation is corruption. There should be a single government and all

political parties should be dissolved. All candidates should be elected basis on their credential, skills and not which

party/race/colour they belong. This will reduce the collection of huge party funds n their promotion expenses.

-Rajeev Nirmal (Citibank)Page 34 of 41

Headed, down for now. But prone to sudden shocks-Vidya M (Economist – CRISIL)

Annexure 3 : Questionnaire

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El Nino

Fears have surfaced about another El Nino, a weather phenomenon that occurs when the Pacific Ocean heats up abnormally. In India, it would drive away rain clouds and put the monsoon and kharif harvest at risk. Bank of America Merrill Lynch, for instance, has put out a report saying there’s a 50-75 basis point risk to their gross domestic product (GDP) growth forecast of 5.4% for FY15 because of El Nino.

But will the El Nino phenomenon actually occur? According to the US’s National Oceanic and Atmospheric Administration (NOAA) update of 24 March, the Oceanic Nino Index (ONI) was at -0.7 degrees Celsius from December 2013 to February 2014. El Nino is characterized by positive ONI greater than or equal to 0.5 degree Celsius. This threshold must be exceeded for a period of at least five consecutive overlapping three-month seasons for a full-fledged El Nino to occur. In recent weeks, however, the sea has warmed up and the agency says there’s a 50% chance of El Nino developing during the summer or fall of 2014, which corresponds to the rainy season in India.

What was the ONI during earlier drought years in India? Well, in the period December to February 2009 it was -0.8 degrees Celsius and during December to February 2002 it was -0.2 Celsius. Later on in 2002, the ONI was as high as 1.3 Celsius, while in 2009 it went as high as 1.6 Celsius. So it’s perfectly possible for the current -0.7 Celsius reading to turn positive and lead to a drought.

The important question is: even if the monsoon fails, will it necessarily stoke inflation and lower GDP growth? In 2002-03, which was a drought year for India, Wholesale Price Index headline inflation was low at around 3.4% and agriculture growth was -6.6% with overall GDP growing at 3.9% year-on-year. Remember the world economy was just recovering from the wreckage of the dot-com bubble. In 2009-10, when the world economy was recovering from the Lehman crisis in the US and El Nino conditions were prevailing, headline inflation was low at 3.8%, agricultural growth was 0.8% and overall GDP grew at 8.6%. Even food inflation was very low in 2002, although it was high in 2009.

On the other hand, inflation rose very sharply in 2010 because of government stimulus and administered minimum support prices that increased the prices of food grains. Historical data indicate that there is no direct correlation between El Nino, inflation and GDP growth. Another good thing is that the contribution of “agriculture, forestry and fishing” to the GDP has shrunk from 21.4% in 2002-03 to around 14% so far in FY14.

Moreover, there are several mitigating factors this year, according to a CitiResearch note dated 24 March—water reservoir levels are comfortable and excess foodgrain stocks could offset the inflationary impact from El-Nino to some extent. Also, the contribution of summer crops (kharif) in agriculture production has been declining while the contribution of winter crops (rabi) has been on a rise. The sowing of the rabi crop is not directly impacted by less rainfall. However, the problem this time is that the industrial economy is in a recession and investment demand is very low. If rainfall is drastically lower than expected, there could be a drag on agricultural output, which might pull down rural consumption.

The Indian market is on a roll because of Modi mania, but fears of crop damage because of the recent hailstorms in Maharashtra and the spectre of drought due to the El Nino phenomenon could act as party-poopers."The hailstorm is likely to result in an estimated crop failure of about Rs 12,000 crore (0.1% of the full year GDP) and this could reverse the recent downtrend in retail price inflation," said Jyotivardhan Jaipuria, managing director and head of research at Bank of America Merrill Lynch (BoA-ML), in a report. Every 10% increase in vegetable prices pushes CPI inflation up by 54 basis points.

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Conclusion

The research methodology we used was insightful. Data and findings from the research papers and survey of other people was selected and reviewed. Brief review of all the survey and papers studied has been given in the Review of Literature. These were studied deeply to gather maximum knowledge of the Report on the topic Inflationary incidence on consumer equilibrium.

Our study from the consumer perspective brought light to the fact that the inflation effect the consumer decisions like their consumption decision, saving decision and it effects the future expectation of buying.Inflation always hurts our standard of living. Rising prices means we have to pay more for the same goods and services. If our income increases at a slower rate as inflation, our standard of living declines even if we are making more. Its main consequence is a subtle reduction in our standard of living.It doesn't affect everything equally. Gas prices can double while our home loses value. This makes financial planning more difficult.Further, it is really bad for our retirement planning because our target has to keep getting higher and higher to pay for the same quality of life. In other words, our savings will buy less. As a result, we will need to save more today to pay for higher priced goods and services in the future. Since everything we buy today costs more, so we have less left-over income available to save.

We also understand that India is moving aggressively to get prices under control, and that is likely to mean lower economic growth for the near future.If the central bank does so, which seems likely, that will likely mean higher interest rates and slower growth.That’s because India until now has used wholesale prices as its benchmark inflation gauge. This measure, which excludes the massive service sector, has typically been much lower than consumer prices.

Some economists say focusing on inflation isn't the best approach for a developing country like India. Worrying too much about inflation forces central banks to raise interest rates, which raises borrowing costs and hurts economic expansion. It is also said that a dead economy with zero inflation is not benefitting anybody.

Having sad that the question raised is, what approach a developing country like India should take in curbing and controlling inflation. Historically, the Indian central bank has followed a multifocal approach to monetary policy, setting interest rates based on how it sees inflation, growth and currency stability. It usually didn't have an official inflation target, which often left markets surprised by its moves.

One of the best recommendations made available to us was made by the Urjit Patel Committee Report. It said that the Consumer-price index is currently hovering near 10%, compared with about 6% for wholesale prices. The central bank must aim to reduce CPI to 8% by 2015 and 6% within two years before adopting a target range around a 4% anchor as described in the committee report. If this is done, this will bring India in line with global norms by placing less emphasis on wholesale price inflation, which India has used until now as its main indicator of price movements.

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In order to achieve what the Urjit Patel Committee Report recommended the government should adopt all fiscal, monetary measures simultaneously. Monetary measures that work in our favor are credit control, demonization of currency, Issue of new currency. Fiscal measures like reduction in unnecessary expenditure, increase in taxes, increase in savings, surplus budgets, and public debt.

Inflation is like a hydra-headed monster which should be fought by using allthe weapons at the command of the government however a close eye must also be kept on ensuring that we don’t bring it down to such an extent that it affects the GDP which is the true picture of our economic growth.

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