Governments manage inflation by monitoring the supply of money through financial policies. To do this, they change the Statutory Liquidity Ratio (SLR) and Current Reserve Ratio (CRR), as well as bank rates, whenever necessary.
What Is the Impact of Inflation on the Indian Economy?
You should have observed how the price of products and services escalates gradually over time. Well, its key reason is none other than inflation, a monetary phenomenon that lessens the relative value of a currency. Inflation signifies a rate by which prices of goods upsurge over time in an economy.
This phenomenon affects various aspects of an economy, including consumer spending, employment rates, business investment, tax policies, interest rates, etc. To know more about the impact of inflation on the Indian economy, keep reading.
What Are the Effects of Inflation on the Indian Economy?
The occurrence of inflation has resulted in higher costs of regular products such as food, shelter, and medicines, as well as want-based products such as jewellery or vehicles. Being an underdeveloped country, India suffers from various factors that affect its core economy, out of which inflation is one. Take a look at inflation’s impact on various sectors of India.
- Effect on Agricultural Sector: Agriculture is among the main occupations of India, and in recent years more than half of the entire country's population has been engaged in it. Inflation also has a big effect on the agricultural sector of India. It reduces agricultural product profitability and purchasing power, increasing risks and debts, thereby declining the country's economy and agricultural competition on international markets. Input cost inflation has created cash flow problems for farmers and increased the need for high-level operational management and conventional financial strategies.
- Effect on Healthcare: During inflation, the irregular rise of prices unavoidably diminishes the purchasing power of several consumers. When it comes to medical inflation is a situation when the average cost and per-unit costs of healthcare services increase down the line. It comprises the price of new and modernised treatments and their extensive availability and services. The upward rising trend in the cost of medical treatments, supplies, and medications than the cost of other products and services causes it. Since a substantial amount of money is invested in discovering new treatment methods, the medical charges in India increase by a considerable margin. In addition, therapies and treatments for ailments like cancer, transplants, etc., grow costlier with additional research and increased cost of raw materials. Furthermore, the COVID-19 pandemic was a turning point in the medical field that made doctors and medical specialists work round-the-clock to cater for the needs of COVID patients. During this period, there was a steep rise in hospitalisation charges.
- Effect on Tourism: Inflation is a problem in India and worldwide. The tourism industry also experiences a price rise. The increasing cost of tourism is due to increased production costs or tourism demand. The tourism-pull inflation is caused due to an escalation in aggregate demand owing to the financial resources brought to the country by foreign tourists.
Furthermore, during the COVID-19 pandemic, the tourism industry faced a tremendous challenge due to the intense increase in global inflation. Overall, these situations caused an increase in travel-related costs and lowered the purchasing power of travellers.
Now after understanding the impact of inflation on the Indian economy, take a look at the methods of its calculation.
How to Calculate the Inflation Rate?
A simple formula that helps calculate the inflation rate is as follows:
(B - A)/A x 100.
Here, A is the starting number, and B is the ending number.
The Consumer Price Index or CPI is used to measure the inflation rate that determines the rate of price change within a particular period based on goods. This inflation rate is calculated by Consumer Price Index (CPI) and Wholesale Price Index (WPI). Mentioned below is how inflation is computed in India:
1. Calculation of Inflation Using the Consumer Price Index (CPI)
Consumer Price Index (CPI) calculates the average selling price of goods and services at the customer level. It comprises the cost of food items, clothes, and other merchandise, along with electricity, transport, and so on. The inflation rate is the change in CPI in a year in respect of the base year.
In India, the government departments gather the price data from 1114 and 1181 urban and rural markets, respectively. By collecting the necessary data, the rate of CPI is determined from the average prices of goods and services. In India, the Ministry of Statistics and Programme Implementation maintains the records of CPI changes via the Central Statistics Office.
2. Calculation of Inflation Using Wholesale Price Index (WPI)
Wholesale Price Index (WPI) is the average value of products at the wholesale level. If there is a fluctuation WPI index percentage contrary to the base year, it demonstrates the rate of inflation within the nation.
In India, the Reserve Bank of India (RBI) formerly applied the Wholesale Price Index (WPI) to compute an inflation rate up to 2014. Additionally, the Ministry of Commerce and Industry measured WPI from the average prices of 697 different items at a wholesale level. Subsequently, the base index for inflation calculation was switched to CPI from WPI in April 2014 by the then-governor of the Reserve Bank of India.
Contrary to Consumer Price Inflation (CPI), Wholesale Price Index (WPI) considers services that observe lower inflation than goods. For instance, fuel has a much higher value in WPI than compared to CPI.
What Are the Causes of Inflation in India?
Let us take a look at the causes of inflation in the Indian economy:
- Built-In Inflation: In general, built-in inflation occurs when many people start predicting that inflation will continue for a long time in future. Owing to this guesswork, workers and employees demand their respective firms or employers to increase their income to accomplish their goals and maintain their standard of living. As a result, with the increase in workers' earnings, goods' price starts to increase, leading to inflation.
- Cost-Push Inflation: When it comes to cost-push inflation, it takes place as the cost upsurges owing to the increase in the cost of production, such as costly raw materials, greater wages, etc. Often, these costs are passed down to customers via higher prices of products and services. Here the demand rate remains constant while the supply of goods reduces, resulting in higher production costs. Thus, these additional production prices are added to the price of finished products, which a consumer must endure.
- Demand-Pull Inflation: While speaking about demand-pull inflation, it takes place with the increase in demand for any particular product or service. Precisely, in this type of inflation, the demand towards commodities surges beyond their supply in an economy. Thus, owing to a shortage in supply, manufacturers have to increase the selling prices of their merchandise to manage the growing demands of consumers.
Inflation is the general trend of escalation in prices over time. With its occurrence, purchasing power declines, i.e. you have to bear extra costs to purchase the same product. Having this crystal-clear idea about the impact of inflation on the Indian economy will help you adopt the precautionary measures as per necessity.
FAQs on the Impact of Inflation on the Indian Economy
Inflation is the general increase in the costs of products and services within an economy over time. In contrast, stagflation is an economic phenomenon that exhibits slow economic growth, huge inflation, and enlarged unemployment. Even though inflation can benefit the economy sometimes, stagflation is not.
The inflation rate in India was 6.04% on average from the year 2012 up to 2022. It reached its peak in November 2013 at 12.17%. On the other hand, it recorded the lowest in June 2017 at only 1.54%.
In general, inflation is classified into four types:
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