In India, inflation is not just an economic concept but a political weapon where political parties had often used it to attack the government quite effectively. People belonging to poor income group are most severely affected by inflation as it reduces their real income. Successive government have promised to control the inflation but have failed consistently in reining in the inflation. Particularly in the last four years, inflation remained above the comfortable levels eroding the savings of middle class while hurting the poor most.

 

In order to find the correct cure of inflation, it is important to understand the factors responsible for its rise. Some major reasons of inflation in India are –

 

Adverse monsoon season as happened in 2014 negatively affects the agricultural productivity. It creates shortage of food grains giving upward push to the prices. Also, Minimum Support Price (MSP) declared by government is increased every year due to political pressure. Higher level of MSP increases the base price of food grains in open market.

 

Social schemes like Mahatma Gandhi National Rural Employment Guarantee Act (MNREGA) provide additional income in the hands of people giving upward push to the prices.

 

Additionally, MNREGA also increases wages in rural areas and creates scarcity of labour.

Increase in population itself leads to increase in demand.

 

Increase in the prices of crude oil imports leads to price rise in all those industries which use it as raw material. Increase in petroleum prices also increases the transportation cost which is an important input in almost all industries.

 

During the United Progressive Alliance (UPA) rule, government social spending was extensively increased without finding additional resources for funding. This widened the fiscal gap. In order to increase funds, government increased indirect taxes which ultimately increases the price of final product.

 

Large number of intermediaries exists in distribution chain in India who does not contribute in value addition but takes commission and contributes in price rise.

 

Apart from aforesaid measures, in India, a complex cause and effect relationship between wages and prices keeps inflation at self sustaining levels. Increase in nominal wages creates additional income in the hands of the people. Rise in additional income leads to rise in demand increasing the prices. Increase in prices induces labour to push for further increase in wages. This spiral relationship between wages and prices is called as wage-price spiral and makes inflation self-sustaining.

 

Most noticeable measures so far undertaken Reserve Bank of India (RBI) to control inflation is to increase interest rates to reduce the additional liquidity from the market. When the surplus cash is reduced from the market, theoretically, prices should exhibit a fall.

 

Government on its parts often subsidises the essential commodities to safe guard the interest of the vulnerable sections of the population. As far as monetary policy is concerned, so far, it has not been able to curb the prices in India. The most important reason for the failure of monetary policy in curbing inflation in India is the existence of vast black economy over which RBI’s policies have no control. Another reason for ineffectiveness of monetary policy is the nature of Indian economy. Historically, monetary policy is more effective in developed countries where both money and commodity markets are fully developed. The monetary measures on controlling inflation will succeed only if full employment level is achieved.

 

On the government’s part, subsidies will never provide a permanent solution to inflation as they distort the market structure.

 

When India is transforming into a market based economy, solution must also be the market based. In a market economy, prices are determined by interaction of demand and supply. In order to move down the prices, either demand should be reduced or supply must be increased. Demand can be reduced by reducing income which is practically impossible in India. Presence of black economy will make the job tougher. RBI often increases interest rates in an attempt to curb the money supply in order to curd demand. This has also failed as most essential commodities have inelastic demand.

 

If authorities are unable to reduce demand, they can assist in increasing the supply. Supply can be increased by improving infrastructure, increasing investment rate etc. Agricultural price fluctuations can be curbed by increasing capital formation and making it less dependent on the vagaries of monsoon. In gist efforts should be made to make the supply growth rate in synergy with the rise in demand to keep the prices stable. If market forces can make the prices of electronic goods fall, why not in other sectors.

  

There are other factors as well which are beyond our control like international oil prices. Subsidies will not provide permanent solution. To give a cushion from external oil shocks, a buffer pool of crude can be maintained. However, life of the people of Indian cannot be made fully dependent on the market forces. Therefore a safety net for them in the form of public distribution should not be taken away. Indeed inflation can be checked in India, but an economic phenomenon cannot be controlled by political solutions.