CHAPTER III INFLATION RECORD OF INDIA

3.1 3.2 3.3 3.4 3.5 3.6

History of inflation in India Measurement of Inflation in India Inflation based on WPI Alternative indicators of inflation in India Historical Analysis of Inflation in India Phase I: 1935-1949 3.6.1 Pre-War inflation (1935-1939) 3.6.2 Wartime inflation (1939-1945) 3.6.3 Post War Inflation (1945-1949)

3.7 3.8 3.9

Phase II: 1949-1969 Phase III: 1969-1991 Phase IV: 1991 to 2009

3.10 Disaggregated view of the WPI inflation

49
CHAPTER III INFLATION RECORD OF INDIA 3.1 History of inflation in India Indias track record of inflation is good in the sense that it has never had to face the terror of hyper inflation. The highest inflation that India has ever seen in the past two centuries is 53.8%, in the famine year of 1943. Amartya Sen has often written about the havoc wreaked by that inflation in his part of the country. Satyajit Ray captured the sufferings in Ashani Sanket, a film he made in 1973. Those were terrible times, but nothing like what Germany faced in the early 1920s or what Zimbabwe has to deal with today.1 Indias experience of inflation has been a mixed bag. There were years when the annual rate of inflation was as high as 40%, while in other years it was in the negative. During last 70 years, beginning with 1939-40, inflation rate was below 6% for 34 years and for remaining years it was above 6%. If the tolerable rate of inflation is assumed to be 6% and below, then India appears to have fared badly in terms of control over inflation, as for 36 years the rate of inflation was above 6%. For about 9 years, the rate of inflation was above 15%. Therefore, there are many who believe India to be an inflation ridden country. They consider the inflation as a permanent characteristic of Indian economy. A strong inflationary pressure has been built into the Indian economy for a long time, precisely from the start of the Second World War, partly through ever mounting demand on the one side and inadequately rising supply on the other. The expanding demand is due to the rapid multiplication of our population, rising money incomes, expansion in money supply and liquidity in the country, rising volume

50
of black money and continuous rise in demand for goods and services due to rapid economic development. Supply of goods and services too has been rising but the rise in supply has not been proportionate to and matching with the rise in demand. This is due to monsoon tied agriculture, use of backward technology, bottlenecks in transport and power, and shortages of various inputs.2 3.2 Measurement of Inflation in India: Inflation is the rate of change of general price level. For measuring the general price level, index numbers are constructed by taking weighted average of prices of individual goods and services. The weight assigned to each good or service reflects the relative importance of that good or service in the economy or in the consumption basket of consumers and producers. The general price index so constructed indicates the overall magnitude of prices of goods and services. The comparison of general price index over a period of time gives us the variation in the general price level, which is nothing but the rate of inflation. In India, there are mainly three types of measures of general price level namely (i) wholesale price index (WPI), (ii) consumer price index (CPI), and (iii) Implicit GDP deflator3. The rate of inflation can be measured in terms of any one of these three measures. The WPI is the main measure of the rate of inflation often used in India. The WPI is available for all commodities, and for major groups, sub-groups and individual commodities. The basic advantage of this measure of inflation is its availability at high frequency, i.e. on a weekly basis, with a gap of about two weeks; thereby enabling continuous monitoring of the price situation for policy purposes.4 The

51
major defect of this measure of inflation is that it does not cover the services and non tradable commodities. The two most popular price indices that are used for measuring change in price level are the Paasche Index and the Laspeyres Index. The Paasche Index is calculated using following formula.
PP = ( PC , t n QC , t n ) ( PC , t0 QC , t n )

The Laspeyres Index on the other hand is calculated with the help of following formula.
PL = ( PC , t n QC , t0 ) ( PC , t0 QC , t0 )

The P in the formula refers to the price level, while Q to the quantities of commodity. t0 and tn denote base and current periods respectively. In India the process of WPI construction begins with the calculation of price relative (i.e.
P1 100 ) for each price quote of a P0

commodity. For obtaining commodity/item level index, simple arithmetic average of the price relatives of all the varieties (each quote) is taken. Next aggregation method based on Laspeyres formula is used to arrive at indices for the sub groups/groups/major groups of WPI. The aggregation method used is as below: I = S (Ii x Wi)/S Wi Where, I S Ii Wi = = = = Index number of wholesale prices of a sub group/ group/major group/all commodities. Stands for the summation operation Index of the ith item/sub-group/group/major group. Weight assigned to the ith item of sub-group/ group / major group

52
The aggregation method is first applied to sub-groups, then to groups, and major groups. Finally, the all commodity index is constructed by aggregating major group indices. The weights assigned are value weights. CPI reflects the cost of living conditions of a homogenous group of consumers for which it is constructed and based on retail prices of commodities generally consumed by the group. Currently, four categories of CPI are available in India. They are CPI for industrial workers (CPI-IW), CPI for agricultural labourers (CPI-AL), CPI for rural labourers (CPI-RL) and CPI for urban non-manual employees (CPI-UE). Among the four CPI-IW is very popular with better coverage, whereas CPI-AL and CPI-UE are designed to measure the impact of inflation on rural and urban poverty respectively.5 The third measure of inflation, GDP deflator is derived from the national income accounts as a ratio of GDP at current prices to GDP at constant prices. The scope and coverage of the GDP deflator is wider than any other measure, for it encompasses the entire spectrum of economic activities including services. At present, the GDP deflator is available only annually with a long lag of over one year and hence has very limited use for the conduct of policy.
6

We will analyze the trend in inflation based on three indices namely WPI, CPI-IW & GDP deflator, beginning with WPI. 3.3 Inflation based on WPI: The following table takes us in to the history so as to give us a perspective on inflation in India. The data presented is for last 70 years, beginning with 1939-40, and is based on different wholesale price index series, constructed from time to time.

53
Table No. 3.1 ANNUAL RATE OF INFLATION (IN %) 1939-40 to 2008-09 YEAR 1939 1939-40 1940-41 1941-42 1942-43 1943-44 1944-45 1945-46 1946-47 1947-48 1948-49 1949-50 1950-51 1951-52 1952-53 1952-53 1953-54 1954-55 1955-56 1956-57 1957-58 1958-59 1959-60 1960-61 1961-62 1961-62 1962-63 1963-64 1964-65 1965-66 1966-67 1967-68 WPI INDEX 100 125.6 114.8 137 171 236.5 244.2 244.9 275.4 307 376.5 385.4 409.8 435.1 380.6 100 104.6 97.5 92.4 105.3 108.4 112.8 117.1 124.8 125.1 100 103.8 110.2 122.3 131.6 149.9 167.3 INFLATION RATE 25.6 -8.6 19.3 24.8 38.3 3.3 0.3 12.5 11.5 22.6 2.4 6.3 6.2 -12.5 -12.5 4.6 -6.8 -5.2 14 2.9 4.1 3.8 6.6 0.2 0.2 3.8 6.2 11 7.6 13.9 11.6

54
1968-69 1969-70 1970-71 1970-71 1971-72 1972-73 1973-74 1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 1980-81 1981-82 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 165.4 171.6 188.4 100 105.6 116.2 139.7 174.9 173 176.6 185.8 185.8 217.6 257.3 281.2 100 104.9 112.8 120.1 125.4 132.7 143.5 154.2 165.7 182.7 207.8 228.7 247.91 100 112.6 121.6 127.2 132.8 140.7 145.3 155.7 161.3 166.8 -1.1 3.7 5.5 5.5 5.6 10 20.2 25.2 -1.1 2.1 5.2 0 17.1 18.2 9.3 9.3 4.9 7.5 6.5 4.4 5.8 8.1 7.5 7.5 10.3 13.7 10.1 8.4 8.4 12.6 8 4.6 4.4 5.9 3.3 7.2 3.6 3.4

55
2003-04 2004-05 2005-06 2006-07 2007-08 2008-09
Source : 1. Vakil,C.N. (1978) War Against Inflation The Story of the Falling Rupee : 1947-77, The Macmillan Company of India Ltd., pp.4-5 2. Handbook of Statistics on Indian Economy, RBI 3. Office of the Economic Adviser, Ministry of Commerce & Industry, GOI

175.9 187.3 195.5 206.2 215.7 233.9

5.5 6.5 4.4 5.5 4.6 8.4

Graph 3.1 Annual Rate of Inflation (in %)

50 40

WPI Inflation rate

30 20 INFLATION RATE 10 0
1939 1941-42 1944-45 1947-48 1950-51 1952-53 1955-56 1958-59 1961-62 1963-64 1966-67 1969-70 1971-72 1974-75 1977-78 1980-81 1982-83 1985-86 1988-89 1991-92 1993-94 1996-97 1999-00 2002-03 2005-06

-10 -20

Year

Source: Based on Table No. 3.1

From the above table and graph, it appears that inflation, based on wholesale price index, has varied in a wide range of -12.5% and 38.3%. The lowest figure of -12.5% was recorded for the ear 1952-53, while the highest one of 38.3% for the year 1943-44, the final year of World War-II. As can be seen from the graph, there are three peaks in the years 1943-44, 1948-49, and 1974-75 with the inflation rates of 38.3%, 22.6% and 25.1% respectively. These years of high inflation

2008-09

56
basically reflect the impact of war, supply shocks resulting from setbacks in domestic agricultural production and external oil price hikes. The average inflation for the entire period of 70 years works out to be 7.6 %. The frequency distribution of inflation in India across different ranges during the period 1939-40 to 2008-09 is presented in the following table and graph. Table No. 3.2 FREQUENCY DISTRIBUTION OF WPI INFLATION (1939-40 to 2008-09) Range of Inflation (in %) Below 0 03 36 69 9 12 12 15 Above 15 Source: Compiled from table No. 1 Frequency 06 06 22 15 07 05 09

Graph 3.2 Frequency Distribution of WPI inflation

25

Inflation Rate

20 15 10 5 0

Below 0 3 3 6 6 9 9 12 12 15 Above 0 15 Range of Inflation (in %)

Source: Based on Table No. 3.2

57
The range with highest frequency, that is, modal range of inflation, during the entire period is the one of 3% to 6%. The range of second highest frequency is that of 6% to 9%. Out of 70 years, it was only for 12 years that inflation remained below 3%. The notion that inflation has been a chronic problem in India is indicated by the fact that it remained above 6% for about 36 years in a period of 70 years. If decadal inflation rates are considered, then it appears that the average for the decade of 1940s was the highest at 12.63%. The lowest average inflation rate was recorded for the immediate decade of 1950s and it was just 1.73%. From the low of 1.73% during 1950s, the average inflation rate climbed to 6.34% during 1960s and 8.99% during 1970s. During the following decades of 1980s & 1990s, it remained close to 8%, while in the 2000s it has been found subdued at 5.43%. Table No. 3.3 DECADAL WPI INFLATION RATE (ANNUAL AVERAGE) (In Percent) Period 1940-41 to 1949-50 1950-51 to 1959-60 1960-61 to 1969-70 1970-71 to 1979-80 1980-81 to 1989-90 1990-91 to 1999-2000 2000-01 to 2008-09 Source: Based on Table No. 1 Inflation rate 12.63 1.73 6.34 8.99 7.97 8.12 5.43

58
Graph No. 3.3 Decadal WPI Inflation Rate
14 Inflation rate

12

10

Inflation rate

0
1940's 1950's 1960's 1970's 1980's 1990's 2000-01 to 200809

Decade

Source: Based on Table No. 3.3

3.4 Alternative indicators of inflation in India: As said earlier, apart from the WPI, there are two more inflation indices that are constructed and used in India. Though, the WPI is the preferred choice of both policymakers and academicians, for its advantages such as wide coverage, high frequency & data availability with a lag of just two weeks, the other two indices, namely CPI-IW and GDP deflator are no less important. Here a comparison of inflation based on all the three indices is attempted for a period of 70 years. For CPI-IW and GDP deflator, the data available is for last 58 years respectively.

59
Table 3.4 ALTERNATIVE INDICATORS OF INFLATION IN INDIA (IN %) Year 1939-40 1940-41 1941-42 1942-43 1943-44 1944-45 1945-46 1946-47 1947-48 1948-49 1949-50 1950-51 1951-52 1952-53 1953-54 1954-55 1955-56 1956-57 1957-58 1958-59 1959-60 1960-61 1961-62 1962-63 1963-64 1964-65 1965-66 1966-67 1967-68 1968-69 1969-70 1970-71 1971-72 1972-73 1973-74 WPI 25.6 -8.6 19.3 24.8 38.3 3.3 0.3 12.5 11.5 22.6 2.4 6.3 6.2 -12.5 4.6 -6.8 -5.2 14 2.9 4.1 3.8 6.6 0.2 3.8 6.2 11 7.6 13.9 11.6 -1.1 3.7 5.5 5.6 10 20.2 CPI-IW GDP deflator

4 -0.9 2 -6.6 -3 11.3 4.9 5.2 4.2 0.9 2.4 3.2 4.5 15.2 7.2 13 11.6 -0.5 1.4 5.1 3.2 7.8 20.8

3.3 -4.4 2.5 -9.7 -1.4 12.8 3.5 3.8 2.7 3.8 2.2 4.4 8.4 8.5 8.3 13.2 8.6 2.4 3.3 1.6 5.4 10.8 17.8

60
1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 1980-81 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 25.2 -1.1 2.1 5.2 0 17.1 18.2 9.3 4.9 7.5 6.5 4.4 5.8 8.1 7.5 7.5 10.3 13.7 10.1 8.4 12.6 8 4.6 4.4 5.9 3.3 7.2 3.6 3.4 5.5 6.5 4.4 5.4 4.7 8.3 26.8 -1.3 -3.8 7.6 2.2 8.8 11.4 12.5 7.8 12.6 6.3 6.8 8.7 8.8 9.4 6.1 11.6 13.5 9.6 7.5 10.1 10.2 9.4 6.8 13.1 3.4 3.8 4.3 4 3.9 3.8 3.5 6.7 6.2 9.1 16.7 -1.6 6 5.6 2.5 15.7 11.5 10.8 8.1 8.5 7.9 7.2 6.8 9.3 8.2 8.4 10.7 13.7 9 9.8 10 9.1 7.5 6.5 8 3.8 3.5 3 3.8 3.6 5.6 4.2 5 4.9 6.2

Period 40-50 50-60 60-70

Average Inflation Rates WPI CPI 12.6 1.7 2.3* 6.35 5.9

GDPdfl 1.5* 6.31

61
70-80 80-90 90-00 00-09 39-2009 70-2009 *1951-60 9 8 8.1 5.4 7.6 7.7 ** 1951-2009 7.7 9 9.5 5 6.7** 7.9 8.1 8.7 8.8 4.4 6.4** 7.6

Period 40-50 50-60 60-70 70-80 80-90 90-00 00-09 1939-2009 * 1951-60

Standard Deviation WPI CPI 13.9 7.7 5.2* 4.9 5.6 9 9.5 3.9 2.4 3.6 3 1.6 1.9 8.1 ** 1951-2009 Correlation WPI&CPI 0.86 0.88 0.93 0.53 0.63 0.49 0.85 5.6**

GDPdfl 6.2* 3.6 6.8 1.5 2.6 1.1 4.8**

Period 51-60 60-70 70-80 80-90 90-00 00-09 1951-2009

CPI&GDPd 0.96 0.84 0.81 0.64 0.78 0.7 0.85

GDPd&WPI 0.9 0.9 0.94 0.86 0.9 0.6 0.91

WPI = Wholesale Price Index, CPI-IW = Consumer Price Index for Industrial Workers, GDPd = GDP deflator Source : 1. Same as Table No. 3.1 2. Labour Bureau, GOI 3. Mithani, D.M. (1993) Dynamics of Monetary-Fiscal Policy: An Indian Perspective, Himalaya Publishing House, Bombay, p. 90.

62
Graph No. 3.4 Alternative Indicators of Inflation
50 WPI 40 CPI-IW GDP deflator 30

Inflation Rate

20

10

0
1939-40 1941-42 1943-44 1945-46 1947-48 1949-50 1951-52 1953-54 1955-56 1957-58 1959-60 1961-62 1963-64 1965-66 1967-68 1969-70 1971-72 1973-74 1975-76 1977-78 1979-80 1981-82 1983-84 1985-86 1987-88 1989-90 1991-92 1993-94 1995-96 1997-98 1999-00 2001-02 2003-04 2005-06 2007-08

-10

Year
-20

Source: Based on Table No. 3.4

A look at above table reveals that the inflation rate based on all the three indices has been volatile, particularly during the earlier decades. The WPI inflation, during the period of 70 years, has moved in the range of -12.5% and 38.3%. The volatility in WPI inflation was highest during the decade of 1940, as indicated by the standard deviation of 13.9. The fluctuations in WPI inflation have however moderated in the recent past, as is clear from the standard deviation of just 1.6 for the last 9 years. In case of CPI-IW the highest volatility recorded is for the decade of 1970s. The standard deviation for this decade has been worked out to be 9.5, which declined in the following decades to reach 1.9 during last 9 years of the new century. Two oil price shocks were primarily responsible for the fluctuation in inflation rate based on all the three indices during the decade of 1970.

63
For GDP deflator, similar trend is observed with standard deviation moving southward from 6.8 during 1970s to 1.1 during last 9 years, indicating moderation in inflation volatility. Due to unavailability of data, average inflation rates based on three indices have not been worked out for the whole period of 70 years. However, the average inflation rate derived from either of the indices comes close to 8%, if it is worked out for the period of 1970 to 2009. As far as the correlation is concerned, it is found at around 0.9 between WPI and GDP deflator, implying a close association between the two. The association between WPI and CPI-IW and between CPIIW and GDP deflator has been found to be 0.85, with signs of weakening during the recent past, on account of the differences in composition and weights.

3.5 Historical Analysis of Inflation in India: The main objective of this study is to analyze the inflation in India during the period from 1935 to 2009. The beginning of this period coincides with a historical event of establishment of Reserve Bank of India (RBI). The other important historical events that happened during the study period were nationalization of RBI in 1949, Nationalization of Commercial banks in 1969 and introduction of New Economic Policy in 1991. Taking these four historical events as demarcation criteria, the entire period of 70 years has been divided into following four historical phases so as to understand trend in inflation in the past and derive useful implications.

64
The four phases are: 1. Establishment of Reserve Bank of India (1935) to Nationalization of Reserve Bank of India (1949) 2. 3. Nationalization of Reserve bank of India (1949) to

Nationalization of commercial banks (1969) Nationalization of Commercial Banks (1969) to the Introduction of New Economic Policy (1991). 4. Introduction of New Economic Policy (1991) to till date (200809). The table given below presents before us the trend in inflation based on three indices during the above mentioned four stages, followed by the analysis of the same.

Table No. 3.5 ALTERNATIVE INDICATORS OF INFLATION (IN %) Year 1939-40 1940-41 1941-42 1942-43 1943-44 1944-45 1945-46 1946-47 1947-48 1948-49 1949-50 1950-51 1951-52 1952-53 1953-54 1954-55 1955-56 WPI 25.6 -8.6 19.3 24.8 38.3 3.3 0.3 12.5 11.5 22.6 2.4 6.3 6.2 -12.5 4.6 -6.8 -5.2 CPI-IW GDP d

4 -0.9 2 -6.6 -3

3.3 -4.4 2.5 -9.7 -1.4

65
1956-57 1957-58 1958-59 1959-60 1960-61 1961-62 1962-63 1963-64 1964-65 1965-66 1966-67 1967-68 1968-69 1969-70 1970-71 1971-72 1972-73 1973-74 1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 1980-81 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 14 2.9 4.1 3.8 6.6 0.2 3.8 6.2 11 7.6 13.9 11.6 -1.1 3.7 5.5 5.6 10 20.2 25.2 -1.1 2.1 5.2 0 17.1 18.2 9.3 4.9 7.5 6.5 4.4 5.8 8.1 7.5 7.5 10.3 13.7 10.1 8.4 12.6 11.3 4.9 5.2 4.2 0.9 2.4 3.2 4.5 15.2 7.2 13 11.6 -0.5 1.4 5.1 3.2 7.8 20.8 26.8 -1.3 -3.8 7.6 2.2 8.8 11.4 12.5 7.8 12.6 6.3 6.8 8.7 8.8 9.4 6.1 11.6 13.5 9.6 7.5 10.1 12.8 3.5 3.8 2.7 3.8 2.2 4.4 8.4 8.5 8.3 13.2 8.6 2.4 3.3 1.6 5.4 10.8 17.8 16.7 -1.6 6 5.6 2.5 15.7 11.5 10.8 8.1 8.5 7.9 7.2 6.8 9.3 8.2 8.4 10.7 13.7 9 9.8 10

66
1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 8 4.6 4.4 5.9 3.3 7.2 3.6 3.4 5.5 6.5 4.4 5.4 4.7 8.3 10.2 9.4 6.8 13.1 3.4 3.8 4.3 4 3.9 3.8 3.5 6.7 6.2 9.1 9.1 7.5 6.5 8 3.8 3.5 3 3.8 3.6 5.6 4.2 5 4.9 6.2

Period 39-49 49-69 69-91 91-2009 39-2009 *-1951-1969

Average Inflation Rate (in %) WPI CPI- IW 15 4 4.4* 8.3 8.2 6.7 7.2 7.6 6.7**

GDPd 4.1* 8.2 6.5 6.4**

** 1951-2009 Standard Deviation WPI CPI-IW 14 6.7 5.7* 6.5 6.6 3 3.3 8.1 5.6**

Period 39-49 49-69 69-91 91-2009 39-2009 *-1951-1969

GDPd 5.6* 4.7 2.9 4.8**

** 1951-2009 Correlation WPI&CPI CPI&GDPd GDPd&WPI 0.86* 0.89* 0.92*

Period 39-49 49-69

67
69-91 91-2009 1951-2009 * 1951-1969
WPI = Wholesale Price Index, CPI-IW = Consumer Price Index for Industrial Workers, GDPd = GDP deflator Source : 1. Same as Table No. 3.4

0.87 0.67 0.85

0.81 0.86 0.85

0.9 0.83 0.91

Graph No. 3.5 Phasewise Average Inflation Rates

16 14 12
Inflation rate

10 8 6 4 2 0 39-49 49-69 69-91 Period/Phase 91-2009 39-2009 WPI CPI- IW GDPd

Source: Based on Table No. 3. 5

It can be seen from the above table that WPI inflation was highest in average terms, during the first phase, that is during 1935 and 1949. It was 15% and was primarily the consequence of Second World War. During the second phase, inflation based on all the three indices WPI, CPI-IW and GDP deflator moderated considerably and remained around 4% in annual average terms. The third phase (1969-1991),

68
which experienced two oil price shocks from OPEC countries and unrestricted deficit financing by the Indian govt., recorded a higher average inflation in terms of all the three indices of around 8%, nearly double the one found for the earlier phase. During the fourth phase (1991-2009), inflation based on all the three indices, is found to have moderated somewhat to the level of around 7% in average terms. If a comparison is made of inflation rate based on all the three indices (averages for the period for which data is available), then it is the GDP deflator inflation that is found lowest. This is perhaps because of wide coverage of GDP deflator, having included in to it the services, whose prices tend to be relatively stable. Average inflation based on CPI-IW was the second highest at 6.7%, marginally higher than the average inflation based on GDP deflator. However, for a uniform period ranging from 1970 to 2009, average inflation derived from CPIIW is found to be higher (7.9%) than the ones based on WPI (7.7%) and GDP deflator (7.6%). As far as the variation in inflation rate is concerned, WPI inflation appears to have varied too much during the study period, particularly during the first phase as reflected in higher standard deviation of 14. Volatility or variation in the inflation rate based on GDP deflator is found to be the lowest, with the standard deviation of 4.8 worked out for the period 1951 to 2009. Even the CPI-IW based inflation is found to be less volatile than the one based on WPI. Volatility appears to have moderated for inflation based on all the three indices over the years. A close association is found between the WPI inflation and GDP deflator inflation, as implied in the correlation co-efficient of 0.91. The association between WPI and CPI-IW and between CPI-IW and GDP

69
deflator is found to be relatively weak as given by the co-efficient of correlation of 0.85 and 0.85 respectively for the period 1951 to 2009. Though the inflation rates based on all the three indices have some distinguishing features, they are found to be close to each other over a long period. It is to be noted that all the three price indices have their merits and demerits. However, WPI has been the preferred choice of policy makers and academicians in India. WPI has emerged as the most suitable general price index due to its wide coverage of commodities, availability at a high frequency (weekly basis) with a lag of just two weeks, etc. 7 For the analysis of study from a historical perspective, we will keep to the tradition and use WPI inflation for the discussion. What follows is the analysis of inflation divided into earlier mentioned four historical phases. 3.6 Phase I: 1935-1949 This phase begins with the establishment of Reserve Bank of India in 1935 and ends with its nationalization. The period of this phase is important from another point of view as it was the period immediately preceding independence,
8

during which there was too

much chaos, as the freedom fight was at its culmination and we had to support the war efforts of allies. Analysis of inflation during this phase will also reveal the success of RBI as an inflation fighter during early years of its existence. 3.6.1 Pre-War inflation (1935-1939): Reserve bank of India (RBI) assumed the reigns as the central bank of India in 1935 and the challenge before it was not the one of

70
controlling price rise, but that of reviving the falling prices. At the time of its establishment, the Indian economy, like other economies of the world, was gradually recovering from the great depression of the 1930s. Since the commencement of the depression, the price level had steadily declined to its lowest level in March 1933, when the Calcutta index of wholesale prices (base: July 1914=100) touched 83 as against the average level of 141 for 1929, representing a fall of 41.1 %.9 A look at the following table gives us an idea about the behaviour of prices during the immediate post-depression period or the pre-war period. Table No. 3.6 BEHAVIOUR OF PRICES DURING 1935 TO 1939
As on the last friday of the calendar year April 5, 1935 Aug. 25 1939 (i.e. eve of world war II) 7

1935

1936

1937

1938

1939

1 Index number of wholesale Prices88 Calcutta (April) (July 1914=100) Monthly December index for column 2 to 6

93 (5) (5.7)

94 (1) (1.07)

102 (8) (8.5)

95 (-7) (-6.9)

137 (42) (44.2)

100 (Aug.) (5)* (5.3)*

Note: Figures in bracket indicate absolute and percentage variation over previous period. * Variation over December 1938. Source: Simha S.L.N. History of the Reserve Bank of India: 1935-51 (volume I), RBI, Bombay, 1970.

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After reaching its low level in March 1933, the Calcutta index of wholesale prices began its upward march to clock its post-depression high of 105 in August, 1937. Recovery of prices during this period was due to increasing demand for agricultural raw material in the wake of world wide rearmament efforts and the emergence of speculative hoarding of commodities.10 The process of gradual recovery in prices got reversed with the U.S.A. and other countries of the world knocking the door of recession by about the middle of 1937. The continuance of Sino-Japanese hostilities further aggravated the situation. These two adverse developments reduced the demand for cotton, the most important item of export, particularly from Japan, the principal customer for Indias raw cotton.11 The Calcutta prices index, consequently, started moving southward to touch a low of 94 in April, 1938, representing a fall of 10.5%. The impact of depression abated by the end of 1938 and prices began moving up gradually with the index surging northward to 101.5 in May 1939. The recovery in prices could not be sustained due to growing uncertainties of the international situation. Besides, the cotton textile industry saw one of the worst slumps in its history during this period. Consequently, the raw cotton suffered a sharp decline.12 The outbreak of war in September 1939 very immediately altered the situation and caused a sharp rise in commodity prices. A comparison of index number for August 1939 and December 1939 shows a rise of 37% in prices. The sharp increase in price level of a little under 40% during first few months was mainly due to the exaggerated fears of acute shortage consequent on the outbreak of war and the resulting panic buying, financed by bank credit.13

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3.6.2 Wartime inflation (1939-1945): During the war period India suffered a greater magnitude of inflation in comparison with other non-devastated countries. The severity of inflation varied across the war hit countries, but it was the people living near the subsistence, who suffered a lot every where. During the early years of war, price increases were fairly moderate, but a sharp rise took place in 1942 and 1943. From the end of 1943 to the end of 1945, prices were relatively stable at a very high level, but in 1946 there was again a marked increase14 as can be seen from the table No. 3.5. The general index of wholesale prices, which was 100 on August 25, 1939, the eve of World War II, went up to 254 at the end of March 1946, representing a rise of 154% during the war period. It is also true that the official index underestimated the extent of the price rise as limited success was achieved in administering the price controls. Consequently, the prices used for the compilation of the index did not fully reflect the true level of prices which had to be paid.15 This period contained an inflationary price spiral of serious proportions, spanning over three consecutive years of 1941-42, 194243 and 1943-44. Prices rose at an alarming rate during these three years with respective inflation rates of 19.3%, 24.8 and 38.3%. At no other time in the known history of India, prices rose at such an alarming rates for three consecutive years. There were times, for example, 194647 to 1948-49, 1972-73 to 1974-75 and 1979-80 to 1981-82, when the prices increased very fast for three or more consecutive years, but the rates were not as high as they were during the period 1941-42 to 194344.

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The prime reason behind the run away inflation recorded during this period was undoubtedly the war and the way it was financed. Being ruled by Britishers, India was called upon to make a substantial contribution to the war effort of U.K. and her Allies. Low per capita income, the lack of enthusiasm for the war on the part of the country as a whole, non co-operation from the leading political party and the inadequacy of the administrative machinery for collecting taxes set a serious limit to govt.s ability in raising resources in the form of taxation and non-inflationary borrowing from the public.16 So war efforts were financed by substantially stepping up the expenditure on govt. of Indias own account as well as on the account of the Allies. The combined expenditure more than doubled in just two years of 1941-42 and 1942-43 from Rs. 342 crores to Rs. 693 crores.17 The substantial increase in expenditure was inevitably financed through recourse to deficit financing, that is creation of new money, causing the demand for everything to exceed the supply by a considerable margin and thereby putting upward pressure on prices. A clear description of the situation is given in the manifesto issued jointly by a number of Indian economists on 12th April, 1943. The relevant part is reproduced below18 The rapid rise in the general price level during the past two years and the enormous expansion of currency in India are, we feel, causally related. The unprecedented expansion of currency since the war began is due chiefly to the system adopted for financing the large British and other Allied purchases in India, under which the govt. of India accepts payments in sterling and provides rupees in exchange. For all these purchases, India acquires under present arrangements, sterling assets in London and against these there occurs an expansion

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of currency in India The govt. seems to act as if it is enough for it to take care of its own budget deficit while meeting the needs of the British Govt. by printing more notes. This is a grave misreading of the whole situation and has resulted in an ever increasing expansion of currency unrelated to the needs of internal production and trade. As a result, the inflationary spiral is already at work in India....... The inflation in India is, therefore, a deficit induced fiat-money inflation. It is the most disastrous type of inflation. So it was the unrestricted deficit financing during the war years that appears to be responsible for the catastrophic inflation during this period. Besides, exports of consumer goods leading to fall in supplies to domestic market, reduced imports, relatively small increases in the production of basic commodities, difficulties of transport and distribution, artificial shortages created through speculation and hoardings and failure of price controls were also responsible for the price rise accentuation. After the middle of 1943, considerable moderation in the rate of price rise was seen. It was mainly because of two reasons; first the budget deficits after peaking in 1943-44, remained more or less stable during next two years. The second reason which helped in moderation of price rise was the introduction of partial rationing. 19 3.6.3 Post War Inflation (1945-1949) The post-war period from 1945 up till 1949 was as chaotic as the war period. It saw the prolonged political crisis, culminating in the transfer of power and the partition of the county, with its aftermath of vast social upheavals and huge massacres. It was in such a complex

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situation that there was an inflationary trend which had remained repressed during 1944-45 and 1945-46. During the immediate post-war period, there was an

apprehension that a depression was very much likely due to the abrupt contraction of pubic expenditure. It was in line with the view also held by the developed countries.20 With the strong influence of Keynesian ideology over its mind, the govt. of India thought it necessary to practice an expansionary fiscal policy and cheapen the money. In an attempt to protect the economy from deflationary tendencies, a plethora of measures were undertaken. The budget for 1946-47 provided various tax reliefs, including the abolition of the excess profits tax and introduced special initial depreciation allowance in respect of new buildings and plant and machinery so as promote investment in the economy.21 The govt. also followed a policy of gradually withdrawing controls, with controls pertaining to essential commodities being removed in December 1947. Following the withdrawal of controls, there was marked rise in commodity speculation leading to sudden rise in price index in December 1947.22 The situation was further aggravated by industrial unrest and a trend towards upward adjustment of wages and prices to compensate for the rise in the cost of living that had already taken place.23 On the supply front, there was also reduction in it owing to loss of predominantly agricultural regions, consequent on partition and decline in agricultural production on account of the dislocation caused by communal disorders and the failure of crops in some parts of the country.24 Another important reason behind the inflationary price rise during this period was a substantial expansion in money supply

76
resulting from the substantial deficit in govt. budget on account of the large expenditure on the relief and rehabilitation of the displaced persons.25 The emergence of the extensive pent.-up demand of the war period further added fuel to the fire. Continuously rising prices intensified the peoples urge to spend. Besides, people lost the incentive to save with the returns on savings going down as a consequence of the post-war cheap money policy.26 All the above mentioned factors worked in pushing the price level to an intolerably high level. The WPI inflation jumped from a low of 0.3% in 1945-46 to 12.5% in 1946-47. With a marginal fall of 1% in 1947-48, it again sprung to 22.6% in 1948-49. This was for the second time during this historical phase (1935-1949) that inflation ruled at a very high level for three years in row. Overall, the first phase, which began with the establishment of RBI in 1935 up till its nationalization in 1949, saw little or no success in terms of control over inflation. The average inflation rate during this period was the highest in comparison with the ones recorded for other subsequent phases. Further, it was this phase, which saw highest volatility as implied in the high level of standard deviation of 14. The inflation rate during this phase varied from a low level of -8.6% in 1940-41 to a high level of 38.3% in 1943-44. It is undisputedly clear that it was world war II and the way it was financed along with some other reasons like wrong interpretation of the situation by the govt. and the adoption of measures which propelled inflation, instead of arresting it, as also social tensions born out of the partition, which were responsible for the unpleasant inflation scenario during this phase. It is thus apparent that the wartime inflation,

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and even the inflation during post-war period, was primarily caused by the too much creation of money to finance the military expenses. RBI as a central bank, was aware of the seriousness of this way of financing the war and it was at several times that it communicated its concern to the finance department of Govt. of India, which under the pressure from British govt. could not avoid recourse to deficit financing as a way of financing war. The RBI, thus, remained subservient to the finance department during the pre-independence period and followed an accommodative policy.

3.7 Phase II: 1949-1969 The nationalization of Reserve Bank of India marks the beginning of this phase. The phase ends with nationalization of 14 commercial banks in 1969. This phase inherited a strong inflationary pressure developed during the Second World War and the subsequent years. The devaluation of rupee in 1949, following the devaluation of pound sterling by U.K. and of other currencies, in the very beginning of this phase, did not sound well from the point of view of keeping the inflation in check in the forthcoming years. It is on this background and also on the background of nationalization of RBI in 1949, which followed the nationalization of central banks in other countries that we, in this section, propose to study the trend in inflation in India and the factors that caused fluctuations in it during this phase. The first year of this phase 1949-50, witnessed govt.s endeavour to realise the benefits of devaluation and to suppress the inflationary impact of the measure. The important steps initiated for cooling the inflationary pressure were cut in the prices of controlled commodities like food grains, cloth, yarn, pig iron and steel, prohibition of futures

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trading in several commodities to check the speculation, imposition of export duties on some of the articles exported, reduction in govt. expenditure, regulation of credit facilities so as to discourage speculative hoarding of stock of essential commodities, introduction of national savings campaign as also substantial tax reliefs and other concessions to individuals and industries with a view to encourage investment.27 It was perhaps because of these measures adopted by the govt. that inflation rate remained at low level of 2.4% in 1949-50. The following two years, viz. 1950-51 and 1951-52, however saw the inflation inching up to around 6% primarily because of an external cause, i.e. Korean War boom. The outbreak of hostilities in Korea in June 1950 led to a worldwide inflation situation. The Korean boom, which was essentially a raw material boom, created a huge stock piling demand, pushing the prices of several internationally traded strategic materials to abnormally high levels.28 The index of industrial raw materials sprang by nearly 40% from 490 on the eve of the Korean war to 689 by the middle of 1951, pushing the general index of wholesale prices up from 393 in May 1950 to 458 in April, 1951.29 The year 1952-53 brought with it a big surprise of prices entering into the negative territory. It was the higher agricultural production that was behind the deflation of 1952-53.30 Two more years, which witnessed negative inflation rates during the decade of 1950s and during the second phase of our study were 1954-55 (-6.8%) and 1955-56 (-5.2%). The main factors responsible for the habitation of inflation rate in the negative zone were the increase in supplies stemming not only from the bumper production of agricultural and industrial sectors but also from larger volume of imports and

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dishoarding resulting from the relaxation of controls over a wide sector.31 If the period of first five year plan (1951-52 to 1995-56) is considered, then the average inflation comes to -2.74%. The first plan, which was essentially an agricultural plan, emphasizing the development of agricultural sector, succeeded not only in achieving its growth target of 2.1% per annum (actual growth rate per annum 3.6%), but also in keeping the inflation under control. This plan showed the importance of increase in agricultural production in keeping the price rise under check, but during the subsequent plans, unfortunately, it was the industrialization that received the policy priority and we were doomed to live with high inflation in the following years. The latter half of the fifties presented a vastly more complicated environment in the monetary sphere. This was the period of second five year plan, which was much more ambitious than its predecessor, involving a planned public sector investment outlay of Rs. 4800 crores, a quarter of which was to be met through deficit financing.32 The first year of the second plan, viz. 1956-57, began with an inflation rate of 14% which was the result of huge demand pressure emanating particularly from the investment demand in the light of the thrust on industrialization in the second five year plan.33 During the latter years of the second plan, though the inflation rate declined, inflationary threat prevailed. The average inflation rate for the second plan turned out to be 6.28%, nearly 8% higher than the one recorded during the first plan. Apart from the large size of the second plan and the manner of financing it, the other factors that can be held responsible for the relatively higher inflation during this period were harvest shortfalls and

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a sharp fall in foreign exchange reserves due to large imports particularly of capital goods and consequent imposition of controls on imports of many consumer and intermediate goods.34 The first half of the 1960s that is the period of third five year plan (1961-66), experienced considerable price instability, with the rate of inflation rising sharply from around 3% in average terms during the first three years of the third plan to about 11% in 1964-65, 7.6% In 1965-66 and to a post-war high of close to 14% in 1966-67.35 The main contributing factors to the significant rise in inflation towards the end of third five year plan were two wars, a series of poor harvests including two droughts, leading to near stagnation in agricultural production, unimpressive industrial growth, no perceptible increase in savings rate and unstable external environment.36 Agricultural production did not increase much above the 1960-61 level until 196465 and in fact declined by about 10% in 1965-66, which was first of two drought years.37 The story with food production was no different. It was below 72 million tonnes per year, a level reached in 1960-61, up to 1964-65, when it rose to 78 million tones but dropped nearly a fifth next year to reach 63 million tonnes.38 The last three years of this phase, viz. 1966-67, 1967-68 and 1968-69 saw inflation rates of 13.9%, 11.6% and -1.1% respectively, with the average working out to be fairly high at 8.1%. The higher inflation of 13.9% in 1966-67, followed by 11.6% in the following year can largely be attributed to the impact of the Pakistan war in 1965 and the famine experienced during 1965-66.39 Taking the decade of the 1960s as a whole, the average decadal inflation edged up to 6.4%40 from a low level of just 1.7% recorded for the previous decade. The inflationary pressure started mounting from

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1962-63, on account of the Chinese war in 1962 and unsatisfactory supply position. The war with Pakistan in 1965 and the famine conditions during 1965-66 added fuel to the fire and the situation got aggravated. The higher inflation of 13.9% was recorded for the year 1966-67, with the lowest (-1.1%) for the year 1968-69, which was primarily the result of bumper agricultural production of the previous year.41 Overall, this phase spanning over 20 years from 1949 to 1969, saw the inflation rate moderating in annual average terms. The average inflation rate during this phase remained subdued at 4% per annum, compared to a high of 15% experienced for the first phase of 1935 to 1949. Not only did the average inflation rate moderate during this phase, but the variation in it also subsided. The standard deviation of 6.7 during this phase, in comparison with the one of 14 during the first phase certainly represents an improvement in the situation. The GDP deflator inflation too was close to 4% during this phase. The lowest inflation, during this phase, was recorded for the year 1952-53 (-12.5) while the highest for the year 1966-67 (13.9%). The former was on account of higher agricultural production, whereas the latter was primarily the result of war with Pakistan in 1965 and famine of 196566. The main factors that can be held responsible for the higher inflation during some of the years of this phase were shortfall in agricultural production, adoption of a strategy of economic planning (Nehru-Mahalnobis strategy) which emphasized industrialization and thus entailed huge increase in demand, particularly investment demand,

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financed through deficit financing, two wars with China and Pakistan and the increase in money supply. The Reserve Bank of India did attempt to cool prices by deploying instruments of monetary policy like the bank rate, open market operation and selective credit controls. Some tightening of monetary policy did happen during this phase and therefore the policy of Reserve bank during this phase was termed as the policy of controlled expansion. The end result, the inflation rate remained within the acceptable limit.

3.8 Phase III: 1969-1991 This phase spanning over 22 years from 1969 to 1991, turns out to be the most tumultuous period in India in terms of fluctuations in inflation, witnessing relatively high rates inflation on account of the supply shocks emanating mainly from agricultural and oil prices. The beginning of this phase coincides with the biggest economic event of not just the 1960s but the next three decades. Nationalization of fourteen private sector banks on July 20, 1969 was the single most important economic decision taken by the govt. since 1947. Even the economic reforms of 1991 are not comparable in their consequencespolitical, social and economic with the nationalization decision.42 The end of this phase in 1991 is also important from the historical point of view. It saw the Indian economy landing into a balance of payments crisis and forced to adopt far reaching economic reforms covering various sectors of the economy. It is the inflation experienced during this phase, resulting from the policy mistakes, which took India towards the 1991 crisis and therefore study of inflation during this

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phase becomes important as it will help us understand the link between the crisis and inflation. The first year of this phase 1969-70, which was also the first year of fourth five year plan saw the wholesale price inflation to rise very modestly by 3.7%. Even during the subsequent two years (i.e. 1970-71 and 1971-72) not only the increase in wholesale prices indeed was modest at 5.5% and 5.6 respectively, the increase in consumer price index (CPI-IW) also was slightly lower.43 This modest growth in both WPI and CPI-IW inflation during these two years was achieved mainly because of the better availability of goods of mass consumption, especially of food grains carried forward from the exceptionally good harvest of 1970-71 and also due to good procurement, not withstanding the larger increases in money supply at 11.3% and 14.0% respectively in these two years.44 The inflation rate almost doubled in the year 1972-73, reflecting the demand pressure emanating from increased money supply in the earlier years, decline in agricultural production, especially of food grains in 1972-73 and further sharp increase in money supply by 15.7% in that year.45 The years of 1973-74 and 197475 were exceptional, as it was for the first time since independence that inflation during these two years crossed the 20% mark.
46

The inflation

recorded during these two years at 20.2% and 25.2% respectively was mainly due to the failure of Kharif crops in 1972-73 as also to the hike in crude oil prices in 1973.47 Another important reason that high inflation of this period can be attributed to, was the massive influx of refugees from Bangladesh following the Indo-Pak war of December 1971. It led to considerable increase in demand for funds by the govt. compelling it to draw heavily on credit from the Reserve Bank of India thus causing heavy inflation in the economy.48

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The period of four years from 1971-72 to 1974-75 saw the country passing through a phase of hyper-inflation, with the average inflation rate touching a high of 15.25% during this period.49 It was for the third time in Indias history from 1935 that price rise had assumed such an alarming proportions. The worsening situation on the inflation front forced the govt. to deploy all possible instruments in arresting the price rise. In the early years of 1970s govt. relied entirely on monetary and fiscal measures, but realizing their inadequacy, began its operations against hoarders, black marketers and smugglers.50 In response to the substantive anti-inflationary measures, particularly against the hoarding of essential commodities, the inflation rate moderated from a high 25.2% in 1974-75 to -1.1% in 1975-76, the lowest level recorded for the decade of 1970s. Next two years did not see inflation raising its head much and in the third year (1978-79) it touched 0%. The year 1979-80, however, witnessed a strong resurgence of inflationary pressure, resulting mainly from the poor agricultural output and the second oil shock, raising the prices of crude oil.51 The average inflation during the 1970s was 9.0%, higher than the one worked out for the decade of 1960s. Alongside the increase in average inflation, this decade also witnessed increase in volatility in inflation. The standard deviation of 4.9 worked out for the decade of 1960s, jumped up to 9.0 during the 1970s. The decade of 1980s began its journey with the highest inflation rate of 18.2% in 1980-81, carrying the influence of oil price hike. Among the two oil price hikes of 1970s, it was the oil price hike of 1979-80 that had larger influence on price level in India. Although the wholesale price inflation following the first oil price hike was higher than the one following the second oil price hike, it was the latter that

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had larger influence of increase in crude oil price. The relatively lower inflation that followed the second oil shock was the result of substantial and readily available food stocks, which helped mitigate the scarcity.52 The inflation during the whole decade of 1980s remained steady with the actual inflation rate staying above 7.0% for six years out of ten. It was below 5% only during two years of 1982-83 and 1985-86. For the entire decade, the average inflation turned out to be 8.0%, marginally lower than the one for the previous decade. What is interesting to note about this decade is the fall in inflation variability as implied in standard deviation of just under 4. Inflation varied between 18.2% in 1980-81 and 4.4% in 1985-86. The steady and higher inflation during this decade was to a great extent the result of automatic monetisaion of the fiscal deficit of govt. of India. The fiscal deficit of the central govt. increased to 6.8% of GDP during the 1980s from 3.8% during the previous decade. While the monetization of the same (that is, the part financed by the RBI though creation of money) increased close to one-third during the 1980s from close to a quarter during the 1970s.53 It was thus the automatic monetization of fiscal deficit through RBI credit to the govt. that caused the money supply to grow faster and the inflation to stay higher during this decade. The experience of the 1980s has a noteworthy contribution in highlighting the nexus between inflation, fiscal policy and monetary policy.54 It showed that as the resource gap in govt.s budget (i.e. fiscal deficit) met by borrowing from the Reserve Bank increases, the inflationary situation worsens, for the price effects of an increase in money supply are stronger than the output effects.55 Further once the

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inflation occurs due to increase in money supply (resulting from monetization of fiscal deficit), govt. expenditure rises much faster than the revenue, further widening the fiscal deficit and necessitating increased monetization. Thus a vicious circle of high inflation, high deficits and high monetization sets in motion.56 The last year of the third phase, i.e. 1990-91 saw the inflation rate rise above 10% from 7.5% recorded for the previous year. The main contributing factor was the gulf war and its adverse impact necessitating imposition of gulf war cess on petroleum products and other imports.57 The third phase (1969 to 1991) did not see much pleasant picture on the inflation front. The average inflation during this phase increased to 8.3% from a low of 4% recorded for the previous phase (1949-1969). The inflation measured on the basis of CPI-IW and GDP deflator was also close to 8%. The cross correlation between all the three indices based inflation comes close to 0.8 or 0.9 reflecting the fact that inflation based on all the three indices had strong association in them. Though the average inflation surged during this phase to close to 8%, variation in it subsided marginally to 6.5 from the 6.7 observed for the second phase. This phase, it can be argued, experienced strong inflationary pressure as is clear from the higher average inflation rate. The main culprits for the worsened inflationary situation during this phase were the intermittent falls in agricultural production, two oil price shocks delivered by the OPEC countries and the unbridled growth in public expenditure financed through creation of new money by the RBI. The inflation that followed the two oil price hikes had a major influence over average inflation during this phase.

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Reserve bank of India, playing its part, made the use of all instruments in its arsenal, to combat the inflationary rise in prices. The bank rate, CRR and SLR were taken to their highest levels so as to tame the price rise, but unfortunately not much success came to its door. The automatic monetization of fiscal deficit sabotaged every effort of RBI at inflation control. 3.9 Phase IV: 1991 to 2009 The balance of payments crisis, resulting from the underlying imbalances in the form of high inflation, high fiscal and current account deficits during the 1980s marks the beginning of this phase in 1991. The nature of the crisis was so grave that it warranted immediate correction of the situation. A series of reforms, in the name of Macroeconomic Stabilization Programme and Structural Adjustment Programme, covering the industrial, financial, fiscal and external sectors were introduced. Liberalization of the imports, adoption of the flexible exchange rate system, convertibility of the rupee, deregulation of interest rates, dereservation of the public sector, abolition of the industrial licensing and the restrictive provision of the MRTP Act, marked reduction in fiscal and revenue deficit, abandonment of the practice of automatic monetization of the fiscal deficit, etc. are some of the important reforms introduced since 1991 and they have changed the entire landscape of the Indian economy. It is on this background that an attempt is made, in the following section, to study the behaviour of inflation and the impact of economic reforms, positive or otherwise, on it during the post reform period. This phase spans over 18 post reform years starting from 199192 to 2008-09. The first half of the 1990s witnessed a resurgence of

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inflationary tendencies with the inflation rate averaging just above 10% during 1991-92 to 1995-96. The economic survey58 (1991-92), in this respect, stated that the build up of inflationary pressure is mainly attributable to excess demand arising from the large and persistent fiscal deficits over the years, resulting in excessive growth in money supply and a liquidity overhang. There have also been supply and demand imbalances in sensitive commodities like pulses, edible oils, etc. due to shortfalls in domestic production and constraints in importing desired quantities due to the severe foreign exchange crunch. A sharp increase in procurement prices of cereals, and consequent rise in issue prices, has set the trend for open market prices. Exchange rate adjustment in early July, 1991, led to increase in import costs which contributed to some cost pressure in import intensive industries. The uneven progress of monsoon until the end of August, 1991 also generated some inflationary expectations in the economy, exacerbating the pressure on prices. The causal explanation of the build up of inflationary pressure around 1990-92, offered in the economic survey of 1991-92 also holds true for the subsequent years until 1995-96. Apart from the above mentioned causes, the inflationary price rise of the first half of the 1990s was also attributable to the increase in the prices of fuel and administered prices of other items. The continuous rise in the prices of fuel items at a double digit rate (of about 13%) during the first half of the 1990s contributed to inflationary pressure, not only directly but also through the second round effects.59 The inflationary pressure also emanated from the unprecedented capital inflows and the consequent higher monetary expansion.60

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The second half of the 1990s saw a significant turnaround in the inflation outcome.61 The average inflation rate during this period declined from around 10% in the first half to 5.08%. A number of factors contributed towards the lowering of inflation during the second half of 1990s.62 First, the RBI could largely contain money supply to levels consistent with its indicative inflation projections. This was done with the sterilization of capital flows through open market sales of govt. securities and judicious use of liquidity adjustment facility (LAF) and greater emphasis on market borrowing leading to a lower degree of monetization of fiscal deficit. Second, supply pressure emanating from food prices eased with the fall in food articles inflation from around 12.0% to around 6.0%. This was mainly attributable to the deceleration in procurement price increases. Third, cooling of global inflation reduced external pressure on domestic prices. Fourth, the extent of depreciation of rupee slowed considerably from around 11% per annum in the first half to around 4% in the second half. Fifth, large buffer stocks of food grains provided a cushion against undue pressure on food prices through timely release of stocks. Sixth, the high level of foreign exchange reserves added comfort to supply management through imports of essential commodities. This not only helped in reducing inflation but contributed to lowering of inflation expectations on a sustainable basis. Further, the distinct decelerating trend in inflation during the post reform period has also been attributable to the liberalization of both internal and external trade and continual reduction and rationalization of taxes leading to greater competition and cost efficiency. 63

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The decade of 1990s saw two distinct halfs, first characterized by a high rate inflation in annual average terms, while the second witnessed significant fall in inflation. For the decade as a whole, the average inflation rate comes to just above 8%. The variation in the inflation rate, as given by the standard deviation, showed a marginal moderation from 3.9 during the previous decade to 3.6 during the 1990s. The consumer price inflation (CPI-IW) as also the GDP deflator inflation stayed higher than the inflation based on WPI. The divergence between the inflation based on three indices, particularly WPI and CPI is also visible in the lower co-efficient of correlation implying a weakening association. The southward march of inflation continued even in the early part of new century, with only a marginal increase in the latter part. The average inflation during 2000-01 to 2008-09 works out to 5.4%, representing nearly 3% decline from the average inflation recorded for the decade of 1990s. The inflation rate varied from a low of 3.4% in 2002-03 to a high of 8.3% in 2008-09. The year 2000-01 saw the inflation rate jumping to 7.27% from a low of 3.3% for the previous year, despite the good performance on the agricultural front in 1999-2000, adequate buffer stocks of food grains and improved supply of essential commodities, helping contain the prices of primary articles. It was the increases in the administered prices of petroleum products, first in March 2000 and second in September 2000, following the international crude oil price escalation, that pushed the inflation rate up.64 The years 2001-02 and 2002-03 witnessed moderation in inflation to 3.6% and 3.4% respectively. The evening out of the impact of increases in administrated prices of fuel products and record public stocks of food grains with the Food

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Corporation of India (58 million tones in January 2002), together with active private trade accorded stability to food grain prices and thus to the overall inflation.65 The year 2002-03 stood out exceptional with a moderate inflation of 3.4%, notwithstanding the severe drought and several other adverse developments such as border tensions (in the gulf region) and high international crude oil prices.66 Adequate release of surplus stocks of food grains helped in keeping the inflation as also the undercurrents of inflationary expectations low.67 The acceleration in inflation in 2003-04 and 2004-05, though on modest scale, represents a fallout of hardening of international prices of crude oil, minerals and metal related products as also the deficient monsoon of 2004-05, fueling the inflation of agricultural and some agro based products.68 The softening of inflation to 4.4% in 2005-06 largely owes to monetary tightening measures (hike in CRR, reverse repo and repo rates) adopted by the RBI. The inflation based on WPI, however, firmed up again in 2006-07, as a result of the hike in the prices of petrol and diesel by Rs. 4 per litre and Rs. 2 per litre respectively on July 6, 2006, following the upsurge in the price of crude (Brent*) to an average of US $ 70 per barrel from US $ 54 per barrel in 2005.69 The WPI inflation cooled marginally to 4.7% in 2007-08 on account of the reduction in the prices of petrol and diesel following the softening of the international prices of crude oil in the later months of 2006 and early 2007. Besides, the fiscal, administrative and monetary measures adopted since June 2006 together with the improved

* Brent crude : it is a classification of oil and represents a benchmark, which is used to price two thirds of the world's internationally traded crude oil supplies.

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availability of wheat, pulses and edible oil had the sobering effect on inflation during 2007-08.70 The year 2008-09 turned out to be a very unusual year, marked by extremes in price movements and recording the highest inflation in the current decade (2000s). The 8.4% inflation recorded for this year was mainly influenced by the high inflation in first three quarters, as inflation began cooling from the last quarter in the aftermath of global financial problems and recession. Over a five year period, 2004-05 to 2008-09, inflation remained below 7%, except for two breaches.71 The first breach occurred in the second half of 2004-05, as a fallout of increase in the price of crude oil per barrel (Brent) from US $ 38 in 2004 to US $ 54 in 2005 and also of the erratic, delayed and uneven spatially spread monsoon. March 2008 witnessed the second breach as the crude oil price started sky rocketing to hit a level of US $ 147 per barrel in July 2008. On both the occasions, inflation in the domestic economy mirrored the global development, that is, a spurt in the prices of crude oil, minerals and metal related products, indicating the growing integration of the Indian economy with the world economy.72 The average decadal inflation rate for the current decade (200001 to 2008-09) at 5.4% appears significantly below the previous decade average of 8.1%. An important distinguishing feature of this decade vis. a vis. the decades of 1980s and 1990s is that the consumer price inflation as also the GDP deflator inflation stayed below the WPI inflation. As far as the variation in inflation is concerned, it has gone down to 1.6, 1.9 and 1.1 for WPI, CPI-IW and GDP deflator inflations respectively. The association between the three inflation indices appears to have further weakened during the current decade as reflected in the cross correlations.

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The last phase of this study period throws out a mixed picture of inflation with both glitter and gloom. The beginning period comprising five years from 1991-92 to 1995-96 presented a gloomy picture with the inflation rate averaging 10% per annum during this period. Monetary expansion of the preceding period, fall in the value of rupee, problems with the production of agricultural commodities, a sharp increase in the procurement prices and hardening of the international price of crude oil were the main villains in the inflation story of this period. The period from 1996-97 onwards up till 2008-09 added glitter to the inflation picture. It witnessed the inflation drifting down to just over 5%, reflecting the concerted policy efforts.73 For the whole period of the forth phase (1991-2009), the average inflation works out to be 6.7%, 1.6% lower than the one for the previous phase. The inflation based on CPI-IW and GDP deflator was close to the WPI inflation, but CPI-IW inflation was higher at 7.2% in average terms. The volatility in inflation, as given by the standard deviation value, moderated in case of inflation based on all the three indices. The WPI inflation moved in between a low of 3.3% in 19992000 and a high of 13.7% in 1991-92. In comparison with the previous phase, the cross-correlations between inflation rates based on all the three indices are found to have weakened. This is largely true in case of WPI inflation and inflation based on CPI-IW. The Indian experience, as is evident from the record of inflation and the analysis of the same presented in this chapter, has been both good and bad, with both alternating each other during the study period of 75 years, starting from 1935 up till 2009. The first phase (1939-

94
1949) saw the highest inflation of 15% in average terms, mainly on account of the World War II and the way of financing it. The second phase (1949-1969) witnessed considerable moderation in average inflation to 4% in the absence of any adverse international development. The third phase (1969-1991) experienced reversal in inflation trend of the previous phase and the inflation edged up to 8.3% in average terms. Two oil price hikes as also the continuous recourse to deficit financing were the main reasons behind the upturn in inflation trend. The fourth and the last phase (1991-2009) once again saw the good times returning and the inflation, in average terms, coming down to 6.7%, reflecting the proper assessment and control of the inflationary situation and timely steps from the RBI and the government. Over the entire period of 70 years (1939-2009), the inflation averages 7.6% and exhibits the variability of 8.1. At the end, the important thing to note is the downward drift in inflation observed during last 13 years beginning with 1996-97. 3.10 Disaggregated view of the WPI inflation: The widely held opinion in India is that, the general inflation is driven mostly by the inflation in primary/food articles. This view over the years has become so strong that it has become a new theory of inflation called structural theory of inflation. According to this theory, which has been developed in the context of developing countries, the inflation in developing countries is different and can not be explained either with the demand-pull theory or with the cost-push theory of inflation, both well documented in economic literature. The proponents of structural theory of inflation argue that developing countries are

95
characterized by some structural rigidities and imbalances, which are responsible for the large part of inflation experienced by them. They, therefore, argue for disaggregate analysis of inflation in developing countries. It is said that inflation in India is a structural inflation and has, most of the times, resulted from problems in agriculture. Monsoon dependent nature of agriculture, stagnant production, low productivity, inefficient markets with dominance of speculators and hoarders, etc. are some of the factors that are responsible for inadequate supplies of agricultural and particularly of food articles in relation to increasing demand for them arising from increase in peoples income, growth in population and urbanization. Studies relating to the Indian economy reveal that the inflationary pressures have emanated from the agricultural and particularly the food grains sector.74 The inflation in the category of food articles has a tendency of spreading to other categories and therefore causing inflationary price spiral in the economy. In case of India, where large number of people live in poverty and a large part of income is devoted to food grains,75 a crop failure in agriculture causes what is called as food-shortage inflation.76 Higher food grains prices get reflected in higher wages in industrial sector, causing the cost of production in industrial sector and consequently the prices of industrial products to go up.77 In the government sector of developing country like India, rising prices and wages mean additional non-developmental public expenditure, and if revenues do not keep pace, inducing budget deficits and deficit financing through central bank credit to the govt.78

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Hence, a chain of causation sets in to the motion whereby rising food grains prices feed other prices in the economy and cause a inflationary price spiral. So, it makes perfect sense to look in to the inside of WPI inflation and see whether food grains prices have grown faster than the price rise in other categories of WPI and the contribution of food inflation in overall inflation. The wholesale price index, which is used to measure headline / overall inflation in India, has undergone several changes over the years, with the number of major sub-groups it comprised falling, due to merging, to just three at present. The main three sub-groups which the WPI consist of are 1) primary articles 2) fuel, power, light and lubricants and 3) manufactured goods. The primary articles category introduced in 1970-71 series, comprises food articles, non food articles and minerals. It is to be noted that the WPI is a weighted price index with the respective weights being 22.03%, 14.23% and 63.75% in the present WPI series with 1993-94 as the base. With the structural change in the economy, the weights have also been changed in accordance. The weight of food/primary articles group has declined from 50.4% in the 1952-53 series to 22.03% in the 1993-94 series, while that of manufactured products has gone up from 46.6% to 63.75%. The weight of fuel category increased from 3% to 14.2% over the same period. Having underscored the importance of studying the inside of the WPI inflation, an attempt is made in the next part to analyze the inflation in major sub-groups of WPI. The following tables present before us the WPI in a decomposed form. First an attempt is made to compare the inflation rates in sub-

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groups of WPI and then relative contribution of each group in WPI inflation is presented. Table No. 3.7 WHOLESALE PRICE INDEX & ITS SUB-GROUPS 1952-53 to 2008-09
Year AC PA FA 1 2 a 3 b 4 c Index (Average of weeks) & Variation Of Which NF 5 d 6 e 7 f FPL&L MP

(Base : 1952-53 = 100) Weight 1952-53 1953-54 1954-55 1955-56 1956-57 1957-58 1958-59 1959-60 1960-61 1961-62 100 100 104.6 97.5 92.4 105.3 108.4 112.8 117.1 124.8 125.1 4.6 -6.8 -5.2 14 2.9 4.1 3.8 6.6 0.2 . . . . . . . . . . 50.4 100 106.7 94.6 86.6 102.3 106.5 115.2 119 120 120.1 6.7 -11.3 -8.5 18.1 4.1 8.2 3.3 0.8 0.1 . . . . . . . . . . 100 99.2 97.1 95.2 104.2 113.4 115.4 116.5 120 122.1 -0.8 -2.1 -2 9.5 8.8 1.8 1 3 1.8 3 46.6 100 99 100.6 99.7 106.3 108.1 108.4 111.7 123.9 126.6 -1 1.6 -0.9 6.6 1.7 0.3 3 10.9 2.2

(Base : 1961-62 = 100) Weight 1961-62 1962-63 1963-64 1964-65 1965-66 1966-67 1967-68 1968-69 1969-70 1970-71 100 100 103.8 110.2 122.3 131.6 149.9 167.3 165.4 171.6 181.1 3.8 6.2 11 7.6 13.9 11.6 -1.1 3.7 5.5 . . . . . . . . . . 41.3 100 106.5 115.4 135.4 144.6 171.1 207.8 196.9 196.8 203.9 6.5 8.4 17.3 6.8 18.3 21.4 -5.2 -0.1 3.6 . . . . . . . . . . 6.1 100 103.2 118.1 120.3 124.1 134.5 142 148.6 155.1 161.8 3.2 14.4 1.9 3.2 8.4 5.6 4.6 4.4 4.3 52.6 100 103.1 105.7 109.8 118.2 127.6 131.7 134.7 142.8 154.1 3.1 2.5 3.9 7.7 8 3.2 2.3 6 7.9

(Base : 1970-71 = 100) Weight 1970-71 1971-72 1972-73 1973-74 1974-75 100 100 105.6 116.2 139.7 174.9 5.6 10 20.2 25.2 41.7 100 100.9 110.7 141.8 177.5 0.9 9.7 28.1 25.2 29.8 100 101.1 111.3 136.6 172.1 1.1 10.1 22.7 26 10.6 100 98.6 107.5 146.6 163.7 -1.4 9 36.4 11.7 8.5 100 105.9 110.1 130.6 198.3 5.9 4 18.6 51.8 49.9 100 109.5 121.9 139.5 168.8 9.5 11.3 14.4 21

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1975-76 1976-77 1977-78 1978-79 1979-80 1980-81 1981-82 173 176.6 185.8 185.8 217.6 257.3 281.3 -1.1 2.1 5.2 0 17.1 18.2 9.3 165.8 167.2 183.8 181.4 206.5 237.5 264.4 -6.6 0.8 9.9 -1.3 13.8 15 11.3 163.6 155.3 173.6 172.4 186.6 207.9 235.1 -4.9 -5.1 11.8 -0.7 8.2 11.4 13.1 139.8 167.4 178 170.4 194.6 217.7 240.5 -14.6 19.7 6.3 -4.3 14.2 11.9 10.5 219.2 230.8 234.3 244.7 283.1 354.3 427.5 10.5 5.3 1.5 4.4 15.7 25.2 20.7 171.2 175.2 179.2 179.5 215.8 257.3 270.6 1.4 2.3 2.3 0.2 20.2 19.2 5.2

(Base : 1981-82 = 100) Weight 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 100 100 104.9 112.8 120.1 125.4 132.7 143.5 154.2 165.7 182.7 207.8 228.7 247.8 4.9 7.5 6.5 4.4 5.8 8.1 7.5 7.5 10.3 13.7 10.1 8.4 32 100 106.7 118.2 125.5 125.7 137.1 152.6 160.1 163.6 184.9 218.3 234.6 250.9 6.7 10.8 6.2 0.2 9.1 11.3 4.9 2.2 13 18.1 7.5 6.9 100 111.1 126.5 131.8 134.1 147.8 161.1 177.1 179.3 200.6 241.1 271 284.4 11.1 13.9 4.2 1.7 10.2 9 9.9 1.2 11.9 20.2 12.4 4.9 17 100 100.8 112.4 124.6 120.4 134.1 163 160.2 166 194.2 229.2 228.7 249.1 0.8 11.5 10.9 -3.4 11.4 21.6 -1.7 3.6 17 18 -0.2 8.9 10 11 100 106.5 112.5 117.3 129.8 138.6 143.3 151.2 156.6 175.8 199 227.1 262.4 6.5 5.6 4.3 10.7 6.8 3.4 5.5 3.6 12.3 13.2 14.1 15.5 57 100 103.5 109.8 117.5 124.5 129.2 138.5 151.5 168.6 182.8 203.4 225.6 243.2 3.5 6.1 7 6 3.8 7.2 9.4 11.3 8.4 11.3 10.9 7.8

(Base : 1993-94 = 100) Weight 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 100 100 112.6 121.6 127.2 132.8 140.7 145.3 155.7 161.3 166.8 175.9 187.3 195.6 206.2 215.7 233.9 12.6 8 4.6 4.4 5.9 3.3 7.2 3.6 3.4 5.5 6.5 4.4 5.4 4.7 22 100 115.8 125.3 135.8 139.4 156.2 158 162.5 168.4 174 181.5 188.1 193.6 208.7 224.4 247.3 15.8 8.2 8.4 2.7 12.1 1.2 2.8 3.6 3.3 4.3 3.6 2.9 7.8 7.5 10.2 15.4 100 112.8 122.2 137.3 141.4 159.4 165.5 170.5 176.1 179.2 181.5 186.3 195.3 210.5 222 239.8 12.8 8.3 12.4 3 12.7 3.8 3 3.3 1.8 1.3 2.6 4.8 7.8 5.5 8 6.1 100 124.2 135.4 134.2 137.5 151.8 143 146.5 152.9 165.4 186.3 187.6 179.1 188.2 211.9 235.8 24.2 9 -0.9 2.5 10.4 -5.8 2.4 4.4 8.2 12.6 0.7 -4.5 5.1 12.6 11.3 14.2 100 108.9 114.5 126.4 143.8 148.5 162 208.1 226.7 239.2 254.5 280.2 306.8 323.9 327 351.4 8.9 5.1 10.4 13.8 3.3 9.1 28.5 8.9 5.5 6.4 10.1 9.5 5.6 1 7.5 63.7 100 112.3 121.9 124.4 128 133.6 137.2 141.7 144.3 148.1 156.5 166.3 171.4 179 187.8 203.1 12.3 8.5 2.1 2.9 4.4 2.7 3.3 1.8 2.6 5.7 6.3 3.1 4.4 4.9 8.1

AC : All commodities. PA:Primary articles. FA:Food articles. NF : Non-food articles. FPL&L:Fuel, power, light & lubricants. MP: Manufactured products. Note :1.Major groups/sub-groups under the various series are not strictly comparable on account of changes in classification of commodities over time.

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2.In the series (Base: 1961-62=100), MP comprises sub-groups chemicals, machinery and transport equipment and manufactures. 3.Columns with Heads a,b,c,d,e & f indicate variation in %

Source:
1. Handbook of Monetary Statistics of Indian Economy,RBI 2. Office of the Economic Adviser, Ministry of Commerce and Industry, Government of India.

Table No. 3.8 INFLATION IN THE SUB-GROUPS OF WHOLESALE PRICE INDEX (in %) 1952-53 to 2008-09
Year a 1952-53 1953-54 1954-55 1955-56 1956-57 1957-58 1958-59 1959-60 1960-61 1961-62 1962-63 1963-64 1964-65 1965-66 1966-67 1967-68 1968-69 1969-70 1970-71 1971-72 1972-73 1973-74 1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 AC b PA c OF WHICH FA NF d e FPL&L f MP g

4.6 -6.8 -5.2 14 2.9 4.1 3.8 6.6 0.2 3.8 6.2 11 7.6 13.9 11.6 -1.1 3.7 5.5 5.6 10 20.2 25.2 -1.1 2.1 5.2 0 17.1

6.7 -11.3 -8.5 18.1 4.1 8.2 3.3 0.8 0.1 6.5 8.4 17.3 6.8 18.3 21.4 -5.2 -0.1 3.6 1.1 10.1 22.7 26 -4.9 -5.1 11.8 -0.7 8.2

-0.8 -2.1 -2 9.5 8.8 1.8 1 3 1.8 3.2 14.4 1.9 3.2 8.4 5.6 4.6 4.4 4.3 5.9 4 18.6 51.8 10.5 5.3 1.5 4.4 15.7

-1 1.6 -0.9 6.6 1.7 0.3 3 10.9 2.2 3.1 2.5 3.9 7.7 8 3.2 2.3 6 7.9 9.5 11.3 14.4 21 1.4 2.3 2.3 0.2 20.2

0.9 9.7 28.1 25.2 -6.6 0.8 9.9 -1.3 13.8

-1.4 9 36.4 11.7 -14.6 19.7 6.3 -4.3 14.2

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1980-81 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 Averages 1953-69 1969-91 1991-2009 1953-2009
* 1971-91

18.2 9.3 4.9 7.5 6.5 4.4 5.8 8.1 7.5 7.5 10.3 13.7 10.1 8.4 12.6 8 4.6 4.4 5.9 3.3 7.2 3.6 3.4 5.5 6.5 4.4 5.4 4.7 8.3 4.8 8.3 6.7 6.8

15 11.3 6.7 10.8 6.2 0.2 9.1 11.3 4.9 2.2 13 18.1 7.5 6.9 15.8 8.2 8.4 2.7 12.1 1.2 2.8 3.6 3.3 4.3 3.6 2.9 7.8 7.5 10.2

11.4 13.1 11.1 13.9 4.2 1.7 10.2 9 9.9 1.2 11.9 20.2 12.4 4.9 12.8 8.3 12.4 3 12.7 3.8 3 3.3 1.8 1.3 2.6 4.8 7.8 5.5 8 5.9 7.7 7.1 7

11.9 10.5 0.8 11.5 10.9 -3.4 11.4 21.6 -1.7 3.6 17 18 -0.2 8.9 24.2 9 -0.9 2.5 10.4 -5.8 2.4 4.4 8.2 0.7 -4.5 5.1 12.6 11.3

25.2 20.7 6.5 5.6 4.3 10.7 6.8 3.4 5.5 3.6 12.3 13.2 14.1 15.5 8.9 5.1 10.4 13.8 3.3 9.1 28.5 8.9 5.5 6.4 10.1 9.5 5.6 1 7.5 3.9 10.5 9.8 8.4

19.2 5.2 3.5 6.1 7 6 3.8 7.2 9.4 11.3 8.4 11.3 10.9 7.8 12.3 8.5 2.1 2.9 4.4 2.7 3.3 1.8 2.6 5.7 6.3 3.1 4.4 4.9 8.1 3.4 8.3 5.7 6.1

8.6* 7.1 7.8**

8.6* 6.6 7.3**

** 1971-2009 AC : All commodities. PA:Primary articles. FA:Food articles. NF : Non-food articles. FPL&L:Fuel, power, light & lubricants. MP: Manufactured products. Note : 1.Major groups/sub-groups under the various series are not strictly comparable on account of changes in classification of commodities overtime 2.In the series (Base: 1961-62=100), MP comprises sub-groups chemicals, machinery and transport equipment and manufactures. Source : 1. Same as Table No. 3.7

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Graph No. 3. 6 Phasewise Average Inflation in the Sub-groups of WPI

12 10
Inflation rate

8 6 4 2 0 AC PA FA NF Sub-groups FPL&L MP

1953-69 1969-91 1991-2009 1953-2009

Source: Based on Table No. 3.8

The above table juxtaposes the annual WPI inflation with the inflation in the major sub-groups of WPI. Simple averages have also been worked out at the end of the table for the three historical phases used in this study. For the second phase (1953 to 1969), for which required data is available, the WPI inflation in average terms is found to be 4.8% per annum. In comparison, the inflation in the food articles category was higher at 5.9%, while that in fuel and manufactured goods categories was lower at 3.9% and 3.4% respectively. It means, during 1953-1969, food articles prices rose much faster (nearly 2% faster) than the prices of fuel and manufacturing goods. Even the overall inflation trailed the inflation in food articles category by a percentage point. The third phase (1969-1991), which witnessed two oil price hikes saw not only a big jump up in overall inflation, but a lead taken

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by fuel category in the inflation race. All the major sub groups of WPI exhibited relatively higher inflation during this phase than during the previous phase. An internal comparison however shows that it was the fuel sub-group that registered the highest price rise of 10.5% as a natural corollary of artificial hikes in crude oil prices during this period. Inflation in the food category was relatively lower during this period. It was however only marginally lower at 7.7% than the overall and manufactured goods category inflation of 8.3%. The fourth phase (1991-2009) saw the overall inflation and the inflation in sub-groups cooling, with the maximum cooling happening in the sub-group of manufactured goods. The inflation in the food articles category at 7% though lower than in fuel category (9.8%), is found to be higher than the overall inflation (6.7%) and manufactured goods category inflation (5.7%). If a long term view is taken and inflation rates are worked out for the period of 1953 to 2009, then the food inflation appears to be slightly higher (7%) than the overall inflation (6.8%) and also the inflation in the sub group of manufactured goods (6.1). For the same period, the highest rise is seen to have occurred in the prices of fuel commodities (8.4%). So it comes out that two categories of WPI, viz. fuel and food, have seen relatively higher price rise during the study period. This however doesnt mean that a large part of inflation which India experienced was contributed by the fuel category of WPI. Due to lower weightage in WPI, higher rate of price rise in fuel category does not get translated much in overall inflation. This is what has happened in India. The following table presents the relative contribution of each sub-category of WPI in WPI inflation.

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Table 3.9 RELATIVE CONTRIBUTION OF SUB-GROUPS IN WPI INFLATION (in %) 1953-54 to 2008-09
Year 1
1953-54 1954-55 1955-56 1956-57 1957-58 1958-59 1959-60 1960-61 1961-62 1962-63 1963-64 1964-65 1965-66 1966-67 1967-68 1968-69 1969-70 1970-71 1971-72 1972-73 1973-74 1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 1980-81 1981-82 1982-83 1983-84

Food Primary Articles Articles 2 3 74.4 86.8 81.3 64.9 66 99.2 44.2 6.4 17.2 69.8 57.1 66.1 36.3 56.2 83.5 691.9 -0.5 25.7 6.7 40.3 57.1 41.4 240.4 17.9 76.6 650.8 33.6 34.8 52.1 44.6 46.1 5.8 30 33 30.5 128.7 -76.8 64.9 246.2 14.3 18.9 43 39.8 31.9

Fuel, Power , Light & Non-Food Manufactures All Articles Commodities Lubricant 4 5 6 7 (Base : 1952-53 = 100) -0.5 26.1 100 1 12.2 100 1.1 17.5 99.9 2 33.1 100 8.5 25.5 100 1.3 -0.5 100 0.8 55.1 100.1 1.4 92.2 100 21.5 61.3 100 (Base : 1961-62 = 100) 5.1 25.1 100 14.6 28.3 100 1 32.8 99.9 2.5 61.2 100 3.8 40 100 3.2 13.3 100 -90.6 -501.4 99.9 6.2 94.4 100.1 4.5 69.8 100 (Base : 1970-71 = 100) -2.6 8.9 84.4 100 9.5 3.4 56.3 100 18.8 7.7 35.1 100 4.9 17.4 41.3 100 135.4 -78.4 -62.1 100 106.3 22.9 59.2 100 12.4 2.4 21.1 100 540.9 -450.9 -99.8 100 8.8 7.8 58.7 100 7 11.9 53.3 100 12.3 19.4 28.5 100 (Base : 1981-82 = 100) 1.7 14.3 41.1 100 15.4 8 45.9 100

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1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96

30.9 1.1 50.4 45 21.1 9.4 40.8 42.7 23.8 26.9

11.3 6.6 30.6 19.3 23 2.9 20 25.7 21.3 10.3

27.6 15.7 22.6 16.1 1996-97 39.9 41.1 1997-98 13.3 10.5 1998-99 44.9 33.2 1999-00 7.8 18.1 2000-01 9.3 6.9 2001-02 24.7 15.6 2002-03 22.9 8.5 2003-04 17.3 3.6 2004-05 12.9 6.5 2005-06 16.3 18.9 2006-07 32.2 22.5 2007-08 33.6 17.1 2008-09 26.4 14.5 Note : Same as Table No. 3.8 Source : 1. Same as Table No. 3.7

17 7.1 -7.4 24.9 19.8 12.5 26.8 4.5 -2.3 7.8 4.9 5.1 16.6 12.7 13.3 10.3 -0.2 14.9 10.8 19.9 (Base : 1993-94 = 100) 11.7 10.1 6.9 9.1 -1.2 31.9 3.4 44.6 10.7 7.9 -10.8 39.6 2.2 59.8 8.2 39.2 15.6 24.5 14.1 16.6 0.7 23 -7 34.2 5.8 14.8 15.6 2.8 8.1 12.5

62 74 37.1 50.5 71.1 85.5 46.5 47 61.3 53.2 62.3 68.2 28.2 42.1 47.2 52.6 30.9 36.1 52.6 66.1 64.1 49.5 53 63.6 61.1

100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100

Table 3.10 RELATIVE CONTRIBUTION OF SUB-GROUPS IN WPI INFLATION (%in total) 1953-54 to 2008-09
Year 1
1953-54 1954-55 1955-56 1956-57 1957-58 1958-59 1959-60

Primary Articles 2

Food Articles 3 74.4 86.8 81.3 64.9 66 99.2 44.2

NonFood Articles 4

Fuel, Power , Light & Lubricant 5 -0.5 1 1.1 2 8.5 1.3 0.8

Manufactures 6 26.1 12.2 17.5 33.1 25.5 -0.5 55.1

All Commodities 7 100 100 99.9 100 100 100 100.1

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1960-61 1961-62 1962-63 1963-64 1964-65 1965-66 1966-67 1967-68 1968-69 1969-70 1970-71 1971-72 1972-73 1973-74 1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 1980-81 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01

6.4 17.2 69.8 57.1 66.1 36.3 56.2 83.5 691.9 -0.5 25.7 5.8 30 33 30.5 128.7 -76.8 64.9 246.2 14.3 18.9 43 39.8 31.9 11.3 6.6 30.6 19.3 23 2.9 20 25.7 21.3 10.3 15.7 16.1 41.1 10.5 33.2 18.1 6.9

1.4 21.5 5.1 14.6 1 2.5 3.8 3.2 -90.6 6.2 4.5 8.9 3.4 7.7 17.4 -78.4 22.9 2.4 -450.9 7.8 11.9 19.4 14.3 8 7.1 24.9 12.5 4.5 7.8 5.1 12.7 10.3 14.9 19.9 10.1 9.1 31.9 44.6 7.9 39.6 59.8

92.2 61.3 25.1 28.3 32.8 61.2 40 13.3 -501.4 94.4 69.8 84.4 56.3 35.1 41.3 -62.1 59.2 21.1 -99.8 58.7 53.3 28.5 41.1 45.9 62 74 37.1 50.5 71.1 85.5 46.5 47 61.3 53.2 62.3 68.2 28.2 42.1 47.2 52.6 30.9

100 100 100 100 99.9 100 100 100 99.9 100.1 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100

6.7 40.3 57.1 41.4 240.4 17.9 76.6 650.8 33.6 34.8 52.1 44.6 46.1 30.9 1.1 50.4 45 21.1 9.4 40.8 42.7 23.8 26.9 27.6 22.6 39.9 13.3 44.9 7.8 9.3

-2.6 9.5 18.8 4.9 135.4 106.3 12.4 540.9 8.8 7 12.3 1.7 15.4 17 -7.4 19.8 26.8 -2.3 4.9 16.6 13.3 -0.2 10.8 11.7 6.9 -1.2 3.4 10.7 -10.8 2.2

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2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 Averages

24.7 22.9 17.3 12.9 16.3 32.2 33.6 26.4

15.6 8.5 3.6 6.5 18.9 22.5 17.1 14.5

8.2 15.6 14.1 0.7 -7 5.8 15.6 8.1

39.2 24.5 16.6 23 34.2 14.8 2.8 12.5 -1.5 -16.5 23.1 1.3

36.1 52.6 66.1 64.1 49.5 53 63.6 61.1 1.4 39.5 52.2 34.2

100 100 100 100 100 100 100 100 100 100 100 100

1953-69 100.1 1971-91 77.1 36.2 1991-2009 24.7 17 1953-2009 52.3* 46.4 *1971-2009 Note : Same as Table No. 3.8 Source : 1. Same as Table No. 3.7

47.3 6 27.7*

Graph No. 3.7 Phasewise Average Relative Contribution of Sub-groups in WPI Inflation

120 100 80 Contribution in % 60 40 20 0 Fuel, Power, Light & Lubricant Non-Food Articles Manufactures Food Articles -20 -40 All Commodities Primary Articles

1953-69 1971-91 1991-2009 1953-2009

Sub-groups

Source: Based on Table No. 3.10

The above table makes it clear as to which categories of goods have contributed maximum to the overall inflation in India observed

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during the three phases from the second phase onwards and for the whole period of 56 years beginning with 1953-54 up till 2008-09. During the second phase (1953-1969), all the inflation was contributed by the food articles category. The contribution of this category to WPI inflation was 100.1%. The relative contribution of other two categories viz. fuel and manufactured goods, which cancels out each other, was 1.5% and 1.4% respectively. The results for this phase are largely influenced by the results for the year 1968-69, when the contribution of food category in deflation of that year was the highest. The third phase (1969-1991) saw considerable change in the relative contributions of sub-categories of WPI in WPI inflation. In average terms, the relative contribution of the food articles category was 36.2%, while that of manufactured goods was 39.5%. The primary articles category which consists of food, non-food articles and minerals contributed the maximum (77.1%) of the overall inflation during this phase. The fuel category, however, had the negative contribution (-16.5) in overall inflation, despite the maximum price rise registered in this category during this phase. It was perhaps the result of lower pass on of higher crude oil prices to the customers as also of the lower weightage enjoyed by this category in WPI. The fourth phase (1991-2009) saw the maximum inflation coming from the category of manufactured goods. The contribution of this category in overall inflation was about the half. The relative contributions of other two categories, viz. primary articles and fuel, were one fourth each. The noticeable feature of this phase has been the lower contribution of food articles category in overall inflation (17%).

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If the whole period of 56 years is considered (1953-2009), then it turns out that nearly half the inflation during this period came from food articles category. The second largest contributor towards inflation in this period was the sub-group of manufactured goods with its contribution at 34.2%. The fuel sub-group had very meager contribution of 1.3%. In conclusion, it can be said that the sub-group of food articles was the major contributor to the overall inflation in the past, with its contribution of 100% during 1953-1969. Over the years, its contribution in overall inflation has declined (17% during 1991-2009), while the contribution of other two categories, viz. fuel and manufactured goods has shown an upward tendency. Inflation in India is no larger a food shortage inflation. This suggests that progressively, over the period, the impact of monsoon conditions on volatility in prices is getting increasingly moderated perhaps owing to the expansion of irrigated agriculture and buffer stock operations79and increasing non-food expenditure in total budget.

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References: 1. Rajadhyaksha, Niranjan (June 10, 2008): Inflation: A short history, posted at Cafeeconomics@livemint.com Dr.P. Arunachalam and Dr. K.C. Sankaranarayanan (November, 1998): Liberalization and inflation in India, Yojana, Vol. 42, No. 11, p. 7. Pattanaik, R.K. and Samantaraya Ameresh (January 28, 2006): Indian Experience of Inflation A Review of the Evolving Process, Economic and Political Weekly, Vol.41, No. 4, P. 349. Reddy, Y.V. (1999): Inflation in India: Status and Issues in Y.V. Reddy (2000): Monetary and Financial Sector Reforms in India: A Central Bankers Perspective, UBS Publishers and Distributors Ltd., New Delhi, p. 46-47. Pattanaik, R.K. and Samantaraya Ameresh, Op. cit., p. 349. Reddy,Y.V., Op. cit., p. 47. Pattanaik R.K. and Samantaraya Amaresh, Op.cit., p. 349. Vakil, C.N. (1978): War Against Inflation The Story of the Falling Rupee: 194777, The Macmillan Company of India Ltd., Bombay, P. 2. Simha, S.L.N. (1970): History of the Reserve Bank of India: 1935-51, Volume 1, RBI, Bombay, p. 153. Ibid, p. 153. Ibid, pp. 153-154. Ibid, p. 154. Ibid, p. 290.

2.

3.

4.

5. 6. 7. 8.

9.

10. 11. 12. 13.

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14. Ghosh, Shantikumar, (1964): Inflation in an Underdeveloped Economy- A study of Inflation in India, The World Press Pvt. Ltd., Calcutta, p. 67. Simha, S.L.N., Op. cit., p. 307. Ibid, pp. 283 and 290. Ibid, p. 294. Vakil, C.N., Op. cit., p. 310. Ghosh, Shantikumar, Op. cit., p. 73. Simha, S.L.N., Op. Cit., p. 675. Ibid, p. 678. Vakil,C.N., Op.cit., p. 41. Simha, S.L.N., Op. cit., p. 679. Ibid, p. 680. Ibid, p. 680. Ghosh, Shantikumar, Op. cit., pp. 87-88. Simha, S.L.N., Op. cit., p. 682. Sir B. Rama Rau (1960): Evolution of Central Banking in India, Vora and Co. Publisher Pvt. Ltd., Bombay, pp. 45-46. Ibid, p. 46. Pattanaik, R.K. and Samantaraya Amaresh, Op. cit., p. 351. The Indian Merchants Chamber Economic Research and Training Foundation, Bombay (1960): Inflation in a developing economy, p. 21. Balachandran, G. (1997): History of the Reserve Bank of India: 1951-67, Volume 2, RBI, Bombay p. 64.

15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28.

29. 30. 31.

32.

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33. 34. 35. 36. 37. 38. 39. 40. 41. 42. Pattanaik, R.K. and Samantaraya Amaresh, Op. cit., p. 351. Balachandran, G., Op. cit., p. 65. Ibid, p. 87. Ibid, p. 87. Ibid, p. 87 Ibid, p. 87 Pattanaik, R.K. and Samantaraya Amaresh, Op. cit., pp. 351-352. Reddy, Y.V., Op. cit., p. 49. Ibid, p. 49. RBI (2005): History of the Reserve Bank of India: 1967-1981, Volume 3, RBI, Bombay, p. 13. Iyengar, A.V.N. (July 1, 1975): Inflation: The Indian Experience, Yojana, Vol. 19, No. 11, p. 15. Ibid, p. 15 Ibid., p. 15 Pattnaik, R.K. and Samataraya Amaresh, Op. cit., p. 352. Reddy, Y.V., Op. cit., p. 50. Gupta, R.N. (October 1, 1972): Can the Trend be Reversed?, Yojana, Vol. 15, No. 18, p. 759. Misra, S.K. and Puri,V.K. (2006): Price Trends and Inflation, in Indian Economy, Himalaya Publishing House, Mumbai, p. 687. Ibid, p. 687. Reddy, Y.V., Op. cit., p. 50.

43.

44. 45. 46. 47. 48.

49.

50. 51.

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52. Reserve Bank of India (1980): Annual Report-1979-80, RBI, Mumbai. Pattnaik, R.K. and Samantaraya, Amaresh, Op. cit., p. 352. Ibid, p. 352 Rangrajan, C. and Arif, R.R. (April 21, 1990): Money, Output and Prices: A Macro Econometric Model, Economic and Political Weekly, Vol. 25, No. 16, pp. 837 and 851. Ibid, pp. 837 and 851. Ghoshal, M.K. (January 15, 1993): Inflation: Review and Outlook, Yojana, Vol. 36, No. 24, p. 4 Government of India (1992): Economic Survey, 1991-92, Government of India, New Delhi, p. 43. Pattnaik, R.K. and Samantaraya Amaresh, Op. cit., p. 352. Reserve Bank of India (2003): Report on Currency and Finance, 2001-02, RBI, Mumbai, V-10. Ibid., V-10. Reserve Bank of India (2005): Report on Currency and Finance, 2003-04, RBI, Mumbai, pp. 134-135. Government of India (2005): Economic Survey, 2004-05, Government of India, New Delhi, p. 87. Government of India (2001): Economic Survey, 2000-01, Government of India, New Delhi, p. 87. Government of India (2002): Economic Survey, 2001-02, Government of India, New Delhi, p. Government of India (2003): Economic Survey, 2002-03, Government of India, New Delhi, p. Ibid, p.

53. 54. 55.

56. 57.

58.

59. 60.

61. 62.

63.

64.

65.

66.

67.

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68. 69. Government of India (2005), Op.cit., p. 87. Government of India (2008): Economic Survey, 2007-08, Government of India, New Delhi, p. 60-61. Ibid, p. 61-62. Government of India (2009): Economic Survey, 2008-09, Government of India, New Delhi, p. 63-64. Ibid, p. 64. Reserve Bank of India (2005), Op. cit., p. 132. Sengupta, Keya (October 15, 1991), Procurement Prices and Inflation, Yojana, Vol. 35, No. 18, p. 10. Ibid, p. 10. Gupta, Suraj B. (1974): Food-shortage, Demand Pull and in Inflation in India, edited by Simha S.L.N., Vora and Co. Publishers Pvt. Ltd., Mumbai, p. 155. Sengupta, Keya, Op. cit., p. 10. Mithani, D.M. (1993):: Dynamics of Monetary-Fiscal Policy An Indian Perspective, Himalaya Publishing House, Mumbai, pp. 121-122. Reddy, Y.V., Op. cit., p. 51.

70. 71.

72. 73. 74.

75. 76.

77. 78.

79.

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