INFLATION BY SHYAM S KAGGOD
INTRODUCTION Inflation is the persistent increase in the price levels of basket of commodities Inflation is nothing more than a sharp upward rise in price level. Too much money chasing too fewer goods. Inflation is a state in which the value of money is falling i.e. prices are rising.
TYPES OF INFLATION-BASED ON RATE Moderate (Creeping and trotting-single digit) Galloping (two digits or three digits) Hyperinflation (astronomical rise)
TYPES OF INFLATION-BASED ON CAUSE Demand Pull Inflation Cost Push Inflation Structural Inflation Cartelization Hoarding
DEMAND PULL INFLATION Increasing government expenditure Increasing money supply (liberal monetary/fiscal policy) Parallel economy/black money Increasing forex reserves
COST PUSH INFLATION Increase in wages Increase in taxes Increase in prices of raw materials Supply shocks
STRUCTURAL INFLATION Food shortage Scarcity of resources Scarcity of foreign exchange reserves
TWO MEASURES OF INFLATION WPI CPI
HOW INFLATION IS CALCULATED Commodity Weightage Price (BY) Price (PY) Price Ratio Weighted ratio x 60% 20 24 1.2 72 y 30% 10 11 1.1 33 z 10% 500 600 1.2 12 Total 100 117
WPI Base year revised from 2004-05 to 2011-12 The number of items has been increased from 676 to 697 In all 199 new items have been added and 146 old items have been dropped Recommendations from Saumitra Chaudhuri working committee Given by Economic Advisor (commerce ministry) Published once a month
WPI REBASING
WPI REBASING
CPI Previously three different types-iw,unme and AL Changed to CPI (C) = CPI (U)+CPI (R) Base year was initially fixed at 2010 but again changed to 2012 CPI Before After Rural 437 448 Urban 450 460 Calculated by CSO
CPI Industrial Workers (IW) Urban Non- Manual Employees (UNME) Base year 2001 1984-85 1986-87 Agricultural Labourers (AL) Number of articles 370 180 60 Services included Yes Yes No Published by Ministry of Labour MoSPI Ministry of Labour
CPI- RURAL, URBAN & COMBINED Rural Urban Combined Food and beverages 54.18 36.29 45.86 Pan, tobacco and intoxicants 3.26 1.36 2.38 Clothing and footwear 7.36 5.57 6.53 Housing Not compiled 21.67 10.07 Fuel and light 7.94 5.58 6.84 Miscellaneous 27.26 29.53 28.32
COMPONENTS Inflation Main category Sub-category WPI Manufacturing (64%) Chemicals, textiles, wood and paper, metals and alloys, Beverages, tobacco etc Primary Articles (22%) Fuel (13%) Food articles, non-food articles, minerals (crude petroleum) Electricity, coal, mineral oils, LPG CPI Food & Beverages (45.86%) Cereals, meat, fish, egg, milk etc Miscellaneous (28.32%) Housing ((10.07%) Fuel & Light (6.84%) Clothing & Footwear (6.53%) Health, transport and communication, education, recreation etc Only in urban Fuel and light Clothing and footwear Pan Tobacco and Intoxicants (2.38%) Pan Tobacco and Intoxicants
EFFECTS OF INFLATION Reduces purchasing power Reduces real rate of returns Has an effect on exports Effects investment scenario
HOW TO CONTROL INFLATION Credit Control Reduction in Unnecessary Expenditure Increase in Taxes Increase in Savings Public Debt To Increase Production Rational Wage Policy Demonetization of Currency
OTHER CONCEPTS Deflation: Negative growth in the inflation rate Dis-inflation: the rate change of inflation is slower or not proportional Core inflation: what is the inflation rate when volatile commodities (such as food and energy items) are ignored Headline Inflation: measure of total inflation in the economy
INFLATION TARGETING Government has given the function of controlling inflation to RBI MPFA was signed between GoI and RBI As per this the RBI has to maintain Inflation at 4% (+/- 2%)
WPI AND CPI
PHILIPS CURVE Represents the inverse relationship between the inflation and unemployment rate
QUESTIONS Which reference to inflation in India, which of the following statements is correct? (2015) a. Controlling the inflation in India is the responsibility of the Government of India only b. The Reserve Bank of India has no role in controlling the inflation c. Decreased money circulation helps in controlling the inflation d. Increased money circulation helps in controlling the inflation
QUESTIONS Which of the following brings out the Consumer Price Index Number for the Industrial Workers? (2015) a) The Reserve Bank of India b) The Department of Economic Affairs c) The Labour Bureau d) The department of Personnel and Training
QUESTIONS Consider the following statements : (2013) 1. Inflation benefits the debtors. 2. Inflation benefits the bond-holders. Which of the statements given above is/are correct? (a) 1 only (b) 2 only (c) Both 1 and 2 (d) Neither 1 nor 2
Inflation Inflation is a persistent increase in the price levels of a basket of commodities Price and price levels are two different things- price refers to the monetary value that is paid/received for a good sold/bought respectively it is an individual concept; whereas price level is an aggregate concept which is the monetary value of basket/group of goods/services It is important because inflation is a measure of change in the price levels as the household buys a mix of goods and services and inflation tries to measure the impact on the household It is a macro-economic aggregate as it takes into consideration a basket of commodities Classification of inflation o Based on the rate Moderate-single digit inflation Galloping-double/triple digit Hyper-astronomical o Based on the cause Demand pull inflation Increasing government expenditure Increasing money supply (liberal monetary/fiscal policy) Parallel economy/black money Increasing forex reserves Because of the above reasons the demand will go up and in this situation there could be two outcomes- increase in the production or increase in the prices. Since in a short run production cannot be expanded, there will be increase in the prices. Cost push inflation Increase in wages Increase in taxes Increase in prices of raw materials Supply side shocks Structural inflation (is more a feature of a developing country as the resources availability is limited for them)
Food shortage Scarcity of resources Scarcity of foreign exchange reserves Reasons for inflation o Demand pull factors-higher expenditure by government, expansionary monetary/fiscal policy o Cost push factors- increase in wages, increase in taxes etc o Structural factors-lower investment, lower growth in agriculture, unscientific storage of food grains etc o Cartelization-suppliers come together and increase the price irrationally o Hoarding-the middlemen store part of the goods and create an artificial scarcity in the market Two measures of inflation o WPI o CPI WPI (Wholesale Price Index)- it measures the level of price changes at a wholesale market level It was reformed after the recommendations of Pronab Sen committee o Base year changed from 1993-94 to 2004-05 o Coverage increased from 435 commodities to 676 commodities o Published once a month o Published by Economic Advisor o Weightages also changed o All the commodities which were of no daily use were taken off and new commodities added to make it more representative In 2017, the government has rebased the WPI and IIP o The change of BY is from 2004-05 to 2011-12. The working committee that was set up by the government in this regard was headed by Dr Saumitra Chaudhuri o The revision is done to reflect the changes in the industrial sector, to align it with the base year of other macroeconomic indicators like the Gross Domestic Product (GDP), Consumer Price Index (CPI-BY 2012) o Under the new system
An institutional mechanism (Technical Review Committee) has been established For facilitating dynamic revision of the item list of products and the panel of factories It will be chaired by Secretary (Ministry of Statistics & PI) This Committee will meet at least once a year for identifying new items that need to be included in the item basket and removing those that have lost its relevance in the industrial sector or are no longer being produced The revised series will continue to represent the Mining, Manufacturing and Electricity sectors The revised series uses the National Industrial Classification (NIC) 2008 for the purpose of classification of industrial production The weightage given to the groups will be (for WPI will be) Primary articles 22.62% Manufacturing 64.233% Fuel and Power 13.15% Increase in number of items from 676 to 697. In all 199 new items have been added and 146 old items have been dropped The new series is more representative with increase in number of quotations from 5482 to 8331, an increase by 2849 quotations A new WPI Food Index will also be published (recommendation of Ministry of Finance). It will be compiled by taking aggregates of WPI for food products under manufactured goods and primary articles The practice of using Wholesale Price Index (WPI) to deflate items for which data is reported in value terms will continue In the new series of WPI, prices used for compilation do not include indirect taxes in order to remove impact of fiscal policy. This is in consonance with international practices and will make the new WPI conceptually closer to Producer Price Index o WPI and IIP is calculated by CSO o The unit coverage of IIP will, as before, cover entities in the organized sector units registered under the Factories Act, 1948 o The weightage given to the groups will be (for IIP will be) Mining 14.373% (previously it was 14.157%) Manufacturing 77.633% (previously it was 75.527%) Electricity 7.994% (previously it was 10.316%)
CPI (Consumer Price Index)- it measures the changes in the price levels at retail level. This inflation has the impact on the common man o CPI previously was calculated for various groups based on their consumption patterns Industrial Workers Urban Nonmanual Employees Agricultural Laborers Base year 2001 1984-85 1986-87 Number of articles Services included 370 180 60 Yes Yes No Published by Ministry of Labour MoSPI Ministry of Labour o Recently the CPI has been reformed-the base year has been shifted to 2012. Rather than having various CPIs, there are three CPIs now which are- CPI (Urban), CPI (Rural) and CPI (Combined). Rural Urban Combined Food and 54.18 36.29 45.86 beverages Pan, tobacco and 3.26 1.36 2.38 intoxicants Clothing and 7.36 5.57 6.53 footwear Housing Not compiled 21.67 10.07 Fuel and light 7.94 5.58 6.84 Miscellaneous 27.26 29.53 28.32
Impact of inflation o Reduces purchasing power o Reduces real rate of returns o Has an impact on exports o Impact on investment scenario How to control inflation o Credit Control-through contractionary monetary/fiscal policy o Demonetization of Currency-to control the black money o Reduction in Unnecessary Expenditure o Increase in Taxes o Increase in Savings-the government has to incentivize the savings so that expendable income reduces o Public Debt-government should not allow the public debt to go beyond the controllable limit o To Increase Production-thereby reducing/moderating the prices o Rational Wage Policy Inflation impacts the poor, fixed income class and people in unorganized sector as their purchasing power keeps on reducing and these groups do not have the savings to tap into. It has very less impact on the rich class hence it could be concluded that inflation leads to income redistribution in the favor of rich Inflation (manageable terms always works in favor of producers, as this extra price will act as an incentive for them to produce more Inflation Targetingo As per the recommendations of Urjit Patel Committee
CPI must be used as an anchor for monetary policy (adopted by RBI) Inflation must be maintained at 4% (+/-2%) (implemented through MPFA) The monetary policy decisions are to be taken my Monetary Policy Committee (in process) o RBI in 2015 has signed Monetary Policy Framework Agreement (MPFA) with the Government and as per this, it will bring down the inflation to lower than 6% by January 2016 (achieved) And from 2017-18 the target will be 4%(+/-2%) will publish a report every 6 months giving-reasons for inflation and forecasts of inflation it would have failed if inflation remains either higher than 6% or lower than 2% for three consecutive quarters in that case it will give a report to the government charting out the course and specify duration within which the inflation will be brought down Philips Curve- represents the relationship between the inflation and unemployment o Rate of unemployment and rate of wage inflation are inversely related (when there is low unemployment, the labour class is in a better position to bargain for higher wages) o Rate of inflation and wage inflation are directly related (higher the increase in wage, higher demand for goods leading to inflation) o Hence rate of unemployment and inflation are inversely related and the representation would be a downward sloping curve
Some terms Open Inflation- the prices of goods are allowed to fluctuate freely (or there is least interference of the government in deciding the prices of goods) Suppressed inflation- goods are sold at lower prices compared to the market prices (ex-food grains sold under NFSA) Stagflation- the period when there is inflation accompanied by increasing unemployment and lower productivity
National Income Aggregate Tries to measure what has been the growth in the production for comparison with other countries and with itself over the time (i.e. to comparison over space and time) For measuring the production various aggregates are used o GDP (Gross Domestic Product) o GNP (Gross National Product) o NDP (Net Domestic Product) o NNP (Net National Product) o National Income GDP o It is a geographic concept. It is the total monetary value of all the goods and services which have been manufactured in a country in a financial year o In calculation of GDP Intermediary goods will not be considered savings is not considered goods resold will not be considered (commission generated will be considered) social security transfers (eg-pensions) will not be considered o Three methods to calculate GDP Output/Product Value method=total output market price Income method=sum of all the factor incomes Expenditure method=c+i+g+(x-m) C= consumption expenditure by households I= Investment expenditure by firms G= Government expenditure X= Exports M= Imports
GNP o It is a nationality concept o Under this the production done by citizens of a country is considered o In a country there are inflows and outflows of foreign currency. The inflows are because some nationals are working outside but are sending back the remittances and outflows as foreign nationals are working within but are sending back the earnings. o Because there are such inflows and outflows, they need to be accounted o GNP=GDP+NFIFA (NFIFA=Net Factor Income From Abroad) o NFIFA=income earned by Indians living abroad-income earned by foreigners living in India NDP o Depreciation- whenever there is usage of machinery in manufacturing, they undergo wear and tear; and thereby lose value. This loss of value is considered as depreciation and has to be deducted from the total value of goods and services produced to give a better picture. o NDP=GDP-Depreciation NNP o Under NNP, the production of citizens of a country is adjusted for depreciation o NNP=GNP-Depreciation o NNP=GDP+NFIFA-Depreciation National Income o Is considered as the purest form of the income o It is the NI=NNPFC=NNPMC - Indirect Taxes + Subsidies o Factor cost=how much money is spent by manufacturer on all the factors of production Why GDP only? o The inflows and outflows of foreign currency can happen because of various reasons o Depreciation rates will vary across countries
o Taxation and subsidization will vary across countries Current prices and constant prices o The current prices will represent the prevailing prices. If GDP is calculated at these prices, then the inflation will not be discounted o Hence to discount for the inflation rate the GDP is calculated at constant prices o And to account for inflation, GDP deflator is used Limitation of NIA o Non-availability of data and data collection is a costly affair o Time lag-it takes time to collect data and arriving at numbers o Existence of non-monetized consumption (or barter system) o Parallel economy-the presence of black money in the economy may keep adding to the demand side o Lack of occupational specialization-many in India do multiple jobs rather than sticking to a single job Per Capita Income (PCI)-is the average income of every citizen of the country in a particular year PCI = National Income Population Some facts o 1 st estimate - Dadabhai Naoroji (1867-68) o 1 st scientific estimate - Prof V K R V Rao (1931-32) o 1 st official Estimate - Ministry of Commerce (1948-49) o Calculation done by CSO (MoSPI)
New GDP series The rebasing of the new GDP series is for the year 2011-12 rather than for 2009-10 as the data regarding employment is not fully available, there was drought, it wasn t a normal year as there was a recession during the year 2009-10 Why the need to rebase o The structural changes- such as technological changes leading to production changes, relative changes in the prices of the relative goods leading to changes in consumption side changes o This helps in judging the size of the economy o Which sectors are relatively important can be decided Whenever rebasing is done o accounting procedures change o price indices are changed o new estimations are used o new databases are used Till recently whenever the rebasing was done usually cosmetic or peripheral changes were done but in the new NAS (National Accounts Statistics) the changes have been comprehensive hence this has attracted a lot of attention and has led to discussion The Present rebasing has been done by CSO taking into consideration the recommendations given the SNA (System of National Accounts) published by UN in 2008. The changes introduced in the rebasing involve o GVA as a concept comes under SNA (System of National Accounts). SNA was prepared by UN in 1992-93, and has been ratified by WB, IMF, ADB etc o Replaced the old base year 2004-05 (decided in 2010) with 2011-12 (in 2015) o Along with this there have been changes even in the coverage. The old series covered 8 industries whereas the new covers 11 industries
o GDP at Factor Cost will be replaced with GVA at Basic Prices (The factor cost do not consider the indirect taxes and subsidies whereas both are considered under GVA at Basic Prices). o GDP at Market Costs henceforth will be referred to as GDP o Gross value added (GVA) is broadly defined as the value of output less the value of intermediate consumption. It measures the contribution to an economy of an individual producer, industry, sector or region o Production taxes and production subsidies are either paid/received and are independent of volume of any goods produced. Production taxes - land revenues, stamps and registration fees and professional tax etc Production Subsidies - subsidized to Railways transportation, input subsidies to farmers, subsidies given to small industries, subsidies given to companies etc Product taxes or subsidies are paid/received on per unit of product. Product taxes - excise tax, sales tax, service tax and import and export duties etc Product Subsidies - petroleum and fertilizer subsidies, interest subsidies given to farmers etc o The coverage has been increased (Previously RBI used to cover the data through ASI but has been shifted to MCA21) o The ASI used the concept of establishment (each unit s GVA was taken into consideration) whereas the new methodology uses enterprises (under this the parent company s GVA is taken into consideration which adds to services such as advertising, accounting, marketing etc) approach. Hence the size of GVA under the second method will be larger than the first o The calculation of labour in the previous methodology was based on Labour Input method (LI Method) wherein the marginal productivities of labour were not considered whereas in the new methodology Effective Labour Input (ELI) is used. Arguments - In 2015-16, India clocked a GDP growth rate of over 7.5% but the exports had fallen, investments were at the lowest ebb and IIP growth rate gave a completely different picture. One of the reasons for this diversion is considered to be the GDP deflator. In case of India, we use the WPI (along with CPI) as the
deflator to deflate the nominal numbers but the WPI does not consider the services and it is mainly oriented towards commodity prices Producer Price Index o PPI measures price changes from the perspective of the seller o Sellers and Purchasers prices vary as there are taxes and subsidies o The WPI does not cover services, whereas the PPI covers services o Many countries have adopted PPI o The government in 2014 has set up 12-member committee headed by B N Goldhar to recommend regarding forming a PPI for India (determining its methodology, data needed for its construction, and selecting a base year among other things). It s not the first time as even before two committees under the Planning commission have been set up to study regarding forming a PPI for India-one was headed by Abhijit Sen and the other by Saumitra Chaudhuri
NATIONAL INCOME AGGREGATES BY SHYAM S KAGGOD
POINTS TO BE COVERED Why Types New GDP Methodology Questions
AGGREGATES USED GDP (Gross Domestic Product) GNP (Gross National Product) NDP (Net Domestic Product) NNP (Net National Product) NI (National Income)
GDP Total monetary value of all the goods and services produced within a geographical area within a time period Three Methods Output/Product Value method=total output*market price Income method=sum of all the factor incomes Expenditure method=c+i+g+(x-m)
Calculation of National Income Cost on the company FoP Revenue to the providers Rent Land Rent Salary/wage/income Labour Salary/wage/income Interest Capital Interest Profit Entrepreneurship Profit Total cost of production goods Total income received expenditure
NEW METHOD OF MEASUREMENT The base year was changed from 2004-2005 to 2011-12 SNA-The SNA was prepared by UN, launched in 1992 and upgraded in 2008. ratified by WB, IMF, OECD etc Methodological changes Shifted from cost price to market price Coverage has shifted to MCA21 data (ASI to MCA21) New concept of GVA introduced New concept of Basic Prices introduced
GROSS VALUE ADDED Intermediate Goods Miner Steel Manufacturer Utensil Manufacturer 00 10 30 Market Prices 10 30 50 Value Added 10 20 20 Value Added=Total Consumption-consumption of Intermediate goods
GDP NEW SERIES GVABP = GVAFC + Production taxes Production Subsidies GDPMP = GVABP + Product Taxes Product Subsidies
CONCERNS Discrepancies The GDP numbers do not reflect the other realities (such as bank loans growth rate, corporate sector profitability, industrial growth etc)
GDP-DISCREPANCY
GDP DISCREPANCY
GDP DEFLATOR Used to adjust for inflation In case of India WPI is used (in developed countries PPI is used) GoI has set up a committee under B N Goldhar
GNP Total monetary value of all the goods and services by the normal residents of a country within a financial year GNP=GDP+NFIFA NFIFA=FIRILA-FIPFLI NFIFA=net factor income from abroad FIRILA=factor income paid to Indians living abroad FIPFLI=factor income paid to foreigners living in India
NDP Depreciation is the expenditure in the form of lower value of machinery, repairs etc Hence depreciation has to be accounted as it reduces the profit margins NDP = GDP - Depreciation
NNP Accounting for depreciation out of the total production done by Indians NNP = GNP - Depreciation
National Income or NNPFC NNPFC=NNPMC - Indirect Taxes + Subsidies It is the purest form of an income of a country as it takes into account depreciation, the indirect taxes as well as the subsidies
LIMITATIONS OF NIA Non-availability of data Time lag Existence of non-monetized consumption Parallel economy Doesn t consider development, environmental impact etc
PER CAPITA INCOME Is the average income of the citizen of a country in a year It is a representative number
PCI
SOME FACTS 1 st estimate-dadabhai Naoroji (1867-68) 1 st scientific estimate- Prof V K R V Rao (1931-32) 1 st official estimate-ministry of Commerce (1948-49) Calculation done by CSO (MoSPI) Base year used= 2011-12
QUESTIONS The national income of a country for a given period is equal to the (2013) (a) total value of goods and services produced by the nationals (b) sum of total consumption and investment expenditure (c) sum of personal income of all individuals (d) money value of final goods and services produced
CAPITAL, SAVINGS AND INVESTMENT BY SHYAM S KAGGOD
GROSS CAPITAL FORMATION Private Households (Financial and Physical) Gross Savings companies Public
GROSS CAPITAL FORMATION Of the total production, part is consumed and whatever is left out is referred to it as savings. This could be either in Public or Private sector. Whatever is invested back from this is referred to as capital formation This ratio is one of the indicators of health of the economy YEAR GCF 2012-13 38.6 2013-14 34.7 2014-15 34.2
GROSS CAPITAL FORMATION (GCF) GCF GFCF Stock Infrastructure such as building, machinery, means of transport, roads, canal etc Change in raw materials, inventories, finished/semifinished goods etc
GROSS FIXED CAPITAL FORMATION
SAVINGS AND INVESTMENT
SAVINGS AND INVESTMENT 2003 (% of GDP) 2007 (% of GDP) 2017 (% of GDP) GFCF 26.5% 35.6% 26.4% Domestic Savings 29.2% 38.3% 29% (for 2016)
SAVINGS & INVESTMENT
CHANGES IN SAVINGS/INVESTMENTS
CONNECTION BETWEEN INTEREST RATES AND INVESTMENTS Fisher Equation r=n-i r=real interest rate n=nominal rate of interest i=inflation rate
CONNECTION BETWEEN INTEREST RATES AND INVESTMENTS Projects Investment Project Returns Real Interest rates Total investment A 10 Cr 7% 5% 810 Cr (A+B+C+D) B 20 Cr 9% 8% 800 Cr (B+C+D) C 300 Cr 8% 9.5% 480 Cr (D) D 480 Cr 10% 11% 0 Cr The inflation rate between FY14 to FY16 has declined by 900 bps (WPI) or by 500 bps (CPI) whereas, the repo rate has been reduced by 125 bps This increase the cost of the borrowing for industries hence lesser borrowing r n i 3% 8% 5% 4% 7% 3%
QUESTIONS Economic growth in country X will necessarily have to occur if (2013) (a) there is technical progress in the world economy (b) there is population growth in X (c) there is capital formation in X (d) the volume of trade grows in the world economy