What is Inflation: Meaning, Types, Definition & Causes @ INDMoney

What is Inflation?

Inflation refers to the sustained increase in the prices of goods and services produced in a nation over a given period of time. In the Indian context, inflation is measured based on the Consumer Price Index (CPI), the price of the goods and services we consume, and the Wholesale Price Index (WPI), the bulk price of goods, before they reach consumers. 

The Wholesale Price inflation surged to a new high of 15.9% in May 2022. The CPI headline inflation decreased from the eight-year high of 7.79% in April 2022 to 7% in May 2022. Even though it eased up to 7%, it still remains over the RBI’s target band of 4% with an upside or downside of 2%. 

Headline inflation is used by the central banks as their target variable. This helps them regulate interest rates in the economic order to control the demand for goods and services. The Reserve bank of India has defined the range of accepted inflation as 2% to 6%.
 

Inflation: Understanding the CPI and WPI

Breaking down the CPI: CPI (Consumer Price Index) measures how much households have to pay for goods and services. Below is the category-wise breakdown of CPI basket for the year 2022:
 

*miscellaneous- education, health care, recreation, transportation, etc. 

Breaking down the WPI: WPI (Wholesale Price Index) measures the price of the goods before they reach the hands of the consumers - basically the prices of the goods at the wholesaler/distributor.

* Primary articles include food articles (wheat, milk, meat, eggs, etc.) and nonfood articles ( oil seeds, minerals, etc.)
 

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Inflation Rate Is Soaring, But Where? 

Food and beverages have the highest weight of 45.9% in the CPI, thus any changes in the food basket will directly impact the headline inflation number. On the other hand, manufactured products, such as apparel, textiles, pharmaceuticals, and so on hold the highest weight of 64% in the WPI. Therefore, a rise in these prices has a large bearing on the WPI.

As part of the impact of the Russia and Ukraine war, oil prices have heightened. While India was spending $11 billion to purchase oil in December of 2021, the same amount of oil cost $17 billion in March of 2022. This impacted edible oil as 60% of raw materials required by India from edible oils is imported from Ukraine and Russia. 

India has also witnessed a tremendous rise in food inflation. The elevated prices of wheat flour, rice, milk, and so on are contributing to the state of inflation in the country. 

Consumer Inflation - Where is it hurting? 

It is the CPI inflation rate of the food and beverage industry that has contributed most to the hike in inflation. The WPI inflation rate for Fuel and Power has not increased drastically but has consistently remained at a high. Although the WPI inflation of manufactured products has decreased slightly, it is a contributor due to the large weightage it holds in the breakdown of WPI. 
 

Inflation Rate: Segment-wise analysis

CPI Breakdown (2022)

*miscellaneous- education, health care, recreation, transportation, etc. 

WPI Breakdown (2022)

* Primary articles include food articles (wheat, milk, meat, eggs, etc.) and nonfood articles ( oil seeds, minerals etc.)

Inflation Rate Analysis

• In the CPI and WPI breakdown, the most considerable increase has been the Food industry and the Fuel and Power sector. 
• Food inflation has recently been the biggest policy worry in India. According to the Food and Agricultural organization, food prices are 30% higher globally compared to May of 2021. 
• Cereals like maize and wheat are up 34% and cooking oils are up 46%. The absence of Ukraine and Russia's edible oil and wheat is one reason. Another reason is the curb that 26 countries including India have put on the exports of various food products to fight domestic inflation. 
• Cotton exports are also said to be curbing soon, which is why there was increased inflation in the clothing and footwear sector as well. 
• Oil prices are also hiking. Petroleum prices went up by 10 rupees just between April and May of 2022. As Russia invaded Ukraine, the global price of crude oil shot up. Since India imports nearly 85% of its oil, such a price rise contributes to Indian inflation. 
   

Inflation Rate: Impact on the common man

• The rising food inflation in the past year has left the common man troubled. The middle class has been badly hit as the prices of essential commodities such as petrol, dal, and vegetable oil are exceeding their budget. The price of petroleum has increased by ₹30 per liter, while the price of edible oils has increased by 20-40% in one year.
• The cost of living has been shooting up and essentials are more expensive than they were even a month prior. Oil has touched record high prices. The cost of Wheat flour has increased by 14%, salt by 4%, and milk by 7% to name a few.
• While those who are compensated by their employers to combat inflation, might maintain their lifestyle, those who are not in organized employment are forced to reduce consumption or adopt alternative methods.
• The value of money in one’s savings account is impacted by inflation. The value of savings will decrease as one will be able to buy less with their money. For instance, if there is 7% inflation growth for the next 1 year, what originally cost 10,000 rupees would cost 10,700 rupees. 
   

Inflation Rate: Impact on the economy

• The government is planning to spend an additional 2 lakh crores in the coming fiscal years to protect consumers and combat inflation. They could possibly use an amount of the money to subsidize fertilizers and provide tax cuts on petroleum and diesel if crude oil prices continue to rise.
• For the years 2022-2023, the RBI has kept the Gross Domestic Product (GDP) growth at 7.2%, while it has increased its inflation forecast to 6.2% for the current fiscal year. It had raised its interest rate to a two-year high of 4.9%. Inflation is a major factor in this RBI action.
• In order to improve the welfare of the citizens of a country, the government needs more money than they earn through taxes. Since inflation causes higher prices, the demand for credit by the government increases, and interest rates are raised. In such cases, only the lenders of the money benefit, while the capacity of the government to borrow decreases. 

Inflation Rate: Impact on Industries

• Inflation has an adverse effect on the industrial sector. A rise in price in turn leads to increased prices of the factors of production such as labor and raw materials. Profit margins of companies also decrease and the burden of additional expenses falls on consumers.
• In April 2022, retail inflation for the agricultural and rural laborers increased by 6.44% and 6.67% respectively. This increase was primarily due to the rise in the price of wheat flour, rice, vegetables, and so on.
• Since India is dependent on oil imports, it faced a surge in oil prices due to the war in Ukraine. Fuel and power inflation, which was on a declining streak in February 2022, was said to increase to 38.66% in April 2022. This can be attributed to increased prices of petrol and diesel. The increase in the price of commodities such as petrol affects other industries such as transportation as well.
• The impact of inflation in the import industry falls on the WPI inflation of fuels and manufactured items. The WPI of fuel rose 7% and that of manufactured items rose 3%.
• Due to the rising costs of cotton and decreasing stocks of raw materials, textile mills are looking to secure any available cotton stocks. This creates a negative impact on the cotton-producing industries. 

Inflation Rate: Impact on Stock Market

• A decrease in the net profits of a company leads to a decrease in its stock price. In June 2022, the RBI increased its key interest rate by 0.5%. When interest rates increase in order to control inflation, demand for products and services goes down. As a result, the company’s revenue and profit-making will lower. The company’s ability to take loans also decreases because of hiked interest rates. 
• Since inflation leads to the decreased value of money, the purchasing power of investors will decrease. Therefore, the investors can only purchase fewer stocks at the same amount. 

Hurt By The Rise In Inflation Rate? What Should You Do?

• To fight inflation, one should avoid storing idle cash in their savings account which hardly offers any interest, since the inflation rate is higher than the returns you would get. One should invest in areas where the returns from investments exceed the inflation rate. 
• One option would be to put money in a sweep bank account which is linked to an investment account. Excess cash will automatically be put into the money market fund, resulting in higher interest than a savings account or a fixed deposit.
• Involvement in mutual fund schemes will also provide stable returns with little risk. 
• Even as a low risk-taking individual, investment of a small share of about 10-15% in stocks, real estate, or even gold can help battle inflation. 
• An important step would also be retirement planning. Tracking one's average monthly expenditure can help calculate the amount needed for retirement. This should be done by keeping the current inflation rate in mind.