[Economic Survey Ch4] Inflation, WPI, CPI, monetary policy, RESIDEX gist of Mr...

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MARCH 26TH, 2013

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[Economic Survey Ch4] Inflation, WPI, CPI, monetary policy, RESIDEX gist of
Prerequisite How to measure inflation? WPI CPI WPI vs CPI difference? GDP deflator Steps taken by Government to curb inflation Via import Via bans / coercive measures Via schemes Via Policy/Act Why Govt could not control inflation? Export bans = uncertainty Export bans = CAD Black money and gold purchase FDI and infra= No quick results Environmental clearances Steps taken by RBI to curb inflation CRR rates SLR rates Why RBI couldnt control inflation? Way ahead RESIDEX Mock questions

Prerequisite
To understand this article better, first go through earlier articles on following topics (click on the topic name) 1. WPI calculation 2. GDP deflator 3. CRR, SLR, Repo, reverse repo, LAF and MSF

How to measure inflation?

There are three ways 1. WPI 2. CPI 3. GDP deflator

WPI
Wholesale price index Compiled by Office of Economic Adviser ->Ministry of Commerce and Industry. Base year 2004 Doesnt cover services. its calculated using Laspeyres formula. Items are classified into three categories

1. Primary articles 2. Fuel, power, light, lubricants 3. Manufactured products. Earlier Government used to give weekly primary and food inflation data based on the Wholesale Price Index. But this practice has been discontinued since 2012.

CPI
Consumer price index In 2011, the CPI system was reformed Before 2011 There were four subtypes of CPI Subtypes 1. 2. 3. 4. Agricultural Labourer (AL) Rural Labourer (RL) Industrial Workers (IW) Urban Non-Manual Employees (UNME) After Now only three subtypes of CPI 1. Entire urban population 2. Entire rural population 3. Urban + Rural (consolidate from above two)

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Prepared by

First three subtypes of CPI were prepared by Labour Bureau -> Ministry of Labour and Employment Last subtype was prepared by Central Statistical Organisation (CSO) -> Ministry of Statistics and Programme Implementation. Different years for different subtypes.

All prepared by Central Statistical Organisation (CSO) -> Ministry of Statistics and Programme Implementation

Baseyear

1. 2. 3. 4.

Agri labour=1986 rural labour=1986 Industrial workers=2001 Urban non-manual=1984

Common base year ( 2010) for all three subtypes.

WPI vs CPI difference?

WPI Compiled by Ministry Includes services? Baseyear Items included Known as Headline inflation? Importance Economic advisor Commerce ministry No 2004 676 Yes When RBI and Government make policies, they mainly pay attention to this number. CPI (reformed in 2012) CSO Statistics ministry Yes 2010 200 no Not much

GDP deflator
How and why GDP deflator is calculated? Already explained in earlier article, click me So not going into details in the current article. GDP deflator is calculated by Central Statistical Organisation (CSO)-> Ministry of Statistics and program implementation. GDP deflator =GDP @current price divided by GDP @constant price GDP deflator is the most comprehensive number to measure inflation, but RBI /Government doesnt use it much for policy making because GDP deflator data comes quarterly (and not weekly/monthly basis).

Measures to contain inflation

By RBI How? Repo, SLR, CRR Government Taxation, Expenditure, export bans etc.

Steps taken by Government to curb inflation

Via import

1. Govt reduced import duties for wheat, onions, pulses, and crude palmolein were reduced to zero 2. Govt. allowed duty-free import of white/raw sugar. 3. Govt. imported pulses and edible oils and distributed them at subsidized rate.
Via bans / coercive measures

4. 5. 6. 7. 8. 9. 10. 11. 12. 13.

Govt. put ban on onion export for short periods of time whenever required Govt. suspended futures trading in rice, urad, tur, guar gum and guar seed. Govt. banned exports of edible oils (except coconut oil and forest-based oil) and edible oils. Govt. imposed stock limits on certain essential commodities such as pulses, edible oil, and edible oilseeds and rice. Increased excise duty on gold.
Via schemes

Govt. has been giving rice and wheat to poor families at very cheap rate under the Antodyaya Anna Yojana. Govt. allocated huge amount of foodgrain under the targeted PDS (TPDS). government has allocated rice and wheat under the Open Market Sales Scheme (OMSS) direct cash transfer. Introduced Rajiv Gandhi Equity Saving scheme (with tax benefits) to make people invest money in it, rather than in gold.
Via Policy/Act

14. Recently the government permitted FDI in multi-brand retail trading. This will improve logistical facilities connecting farmers with the final consumers and cut down the middlemen. 15. The States of Madhya Pradesh and West Bengal have recently waived the market fee on fruits and vegetables. Such waivers are expected to promote investment private sector in the infrastructure necessary for transports and processing of fruits and vegetables. 16. Budgetary provisions for improving storage and warehousing facilities, creating infrastructure for aquaculture etc.

Why Govt could not control inflation?

From above points, it seems Government did lot of things to reduce inflation. Then why are we not seeing any good results?

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Export bans = uncertainty

Because, to fight food inflation, govt. started imposing ban on exporting some food commodities, increased and decreased the duties on import/export as necessary. While this may look a good solution for the short term but in long term, this creates uncertainty for businessmen, farmers. It reduces their incentive to produce more, because theyre not certain whether govt. will allow them to export or not? (for example Sugarcane->sugar, onion etc.) So indirectly, this affects employment and income of people => leads to more inflation.
Export bans = CAD

When Government puts ban on export of xyz item, that means India receives that much less foreign exchange (dollars). So this increases the Current Account deficit (CAD). When CAD increases = rupee weakens against dollar = crude oil become expensive for us = inflation in everything. Therefore, export bans are like firefighting / short term quickfix solutions. They donot solve the fundamental problems of Indian economy, infact they worsen it in long run.
Black money and gold purchase

All Government schemes = leakage, corruption. And corruption =black money. And black money is mostly invested in gold and real estate. So demand of gold forever high= high current account deficit = rupee weakens against dollar= crude oil price increases = petrol/diesel price increases = even more inflation. Government did try to hike excise duty, make PAN cards mandatory for high value gold purchase and even thought of putting bans on gold import. But these moves have been heavily opposed by the jeweler lobby, hence Government has shied away from doing anything radical to stop the gold consumption. Besides a small hike of 2-3% in gold excise duty doesnt prevent those bad guys with black money from buying gold! And Government hasnt done much to stop the Black money / corruption either.
FDI and infra= No quick results

You have read and heard this ten thousand times that FDI in multibrand retail = no middlemen = less inflation in food. And similarly cold storage, and food processing infrastructure= less wastage. But, suppose Government allows wallmart on Monday, that doesnt mean from Tuesday Wallmart will start running and from Wednesday inflation will be gone. All these things take months and years to get file permission, construction, hiring and training employees, setting up supply lines etc.
Environmental clearances

Many coal and mining projects are not cleared due to environmental issues. This has affected the electricity and raw material supply = input cost increased in manufacturing sector=inflation.
Fiscal consolidation

Government is on the path of fiscal consolidation so it increased the prices of petrol, diesel and reduced the number of subsidized LPG cylinders. These moves have increased the inflation.

Steps taken by RBI to curb inflation

Lets do a recap: from SBI manangers point of view CRR SLR Repo Ive to keep this much cash aside. I cannot loan it to people. I donot earn any interest on this. Ive to invest this much cash in govt. securities, gold and reliable corporate bonds. Ive to pay this much interest rate, IF I take short term loans from RBI.

Reverse Repo I earn this much interest rate, IF I deposit my money in RBI for short term. So what will be the impact on liquidity when RBI changes these rates? Rate CRR SLR When rate is increased When rate is decreased Liquidity decreases Liquidity decreases Liquidity increases Liquidity increases Liquidity increases

Repo Rate Liquidity decreases

Note: RBI doesnt need to change reverse repo rate, because they automatically keep it 1% less than repo rate. (1%= 100 basis points). In winter, the supply of green vegetables is high so their price goes down. But in summer, their supply is low, so price goes high. Same is the link between liquidity and interest rates. When liquidity increases = loan interest rate decreases. When liquidity decreases = loan interest rate increases = harder to get loans for home, car, bike, business. RBI focused its monetary policy on two objectives 1. Control inflation. 2. Facilitate growth.

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But It has been very difficult to do both these things at the same time. Because if RBI wants to control inflation, then it needed to reduce the liquidity= RBI had to increase repo rate, CRR. But this type of tight monetary policy badly affects both producers (businessmen) and consumers. Why? But when repo rate is increased= liquidity decreased= difficult to get loans for home, car, bike etc.= demand down + difficult for businessmen to get loans = this hurts the businessman and whatever hurts the businessmen also hurt the GDP and employment. To put this in refined words: the tight monetary policy of RBI decreased the flow of credit (loan) to productive sectors of Economy and hence negatively affected the growth. But due to inflationary pressures, RBI followed tight monetary policy during 2010-11. During this period, RBI raised policy rate (repo rate) by 3.75%= repo rate was increased from 4.75 per cent to 8.5 per cent. Check the following chart.

But this move has backfired: global economy was progressing slow (due to problems in EU, and USA not yet fully recovered) => so, this tight monetary policy actually contributed to a sharper slowdown of Indian economy than anticipated. GDP growth rate fell down from good 9+% to around 5-6%.

CRR rates
Check the chart

As you can see, between 2010-11, here too, RBI kept increasing CRR rates to curb inflation. But from 2012 onwards, RBI has started decreasing the CRR.

SLR rates

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As you can see, RBI hasnt changed SLR much in last three years.

Why RBI couldnt control inflation?

Were facing inflation because there is mismatch between supply and demand. Supply (of food, gold, houses, everything) is low While demand of those items (particularly food) is high (because population is high, the income levels of public has increased). Now think about this: What can RBI do? It can only increase the interest rates. While increased interest rates may decrease the demand of houses, cars, bikes but it cannot directly decrease the demand of food, milk and other essential commodities. In other words, Interest rates cannot change the dietary habits of people, not at least in the short term. Besides, high interest rates make it difficult for businessmen to borrow = less new projects = less new employment, less GDP. Therefore primary solution to fight Indias inflation =Increase the supply of food items. But this will requie thorough revision of the way govt. treats agriculture, allied activities, food processing and infrastructure. Small farms, disguised unemployment, heavy reliance on monsoon : all these issues must be addressed in comprehensive manner.

Way ahead
For RBI

World Banks report (January 2013) says prices of most of the global commodity prices are expected decrease in 2013 and 14 (except for metals.) However, as per the assessment of RBI, global economic and financial conditions are still fragile. So theyre not providing any growth stimulus to the economy. (for example, if situation in Europe and America was good, theyd have been importing a lot more goods and services from India= Indias GDP could increase.) So in that context, even if RBI drastically reduces repo or CRR, that wont do much good to economy.
For Government

tackling the supply side bottlenecks take months and years. So in the mean time poor people must be protected from the inflation. Thats why govt. needs to continue giving welfare schemes and subsidies. But such support must be targeted to the right beneficiaries: thats where UID/Aadhar, Direct cash transfer comes into picture. Other than that, Government needs to continue pushing for fiscal consolidation, deregulation of sugar pricing (as per Rangarajans recommendations), and other policy initiatives.

On a side note:

RESIDEX
Rural to urban migration is an inevitable part of economic growth. But when people migrate from rural areas to urban areas, it creates pressure on civic amenities and housing (slums). Year % of Indian population living in Urban areas 1951 17 2011 30 2040 50 (expected) Until recently, we did not have an index to capture the prices of residential buildings in urban areas. Hence Residex index was launched in 2007. This index records the changes in the prices of residential buildings. According to the RESIDEX, the housing prices have declined in Hyderabad, Banglore and Jaipur (from 2007 to 2012) but they have increased by more than 100% in Pune, Bhopal and Chennai.

Mock questions
1. Correct statements about WPI? a. It is released by finance ministry b. It classifies items into three categories 1) primary 2) fuel and fodder 3) Manufactured products and services. c. It is calculated using Laspeyres formula. d. None of above 2. Incorrect statements about CPI a. The base year is 2004-05 b. It is calculated by Labour Bureau with the help of NSSO c. Both A and B d. Neither A or B. 3. Correct statements a. CPI measures price change in both goods and services. b. WPI measures price change in only in goods but not in services. c. Both A and B d. Neither A or B. 4. What is the formula for GDP deflator? a. GDP at constant price divided by current price

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b. GDP at current price divided by annual WPI c. WPI divided by CPI d. GDP at current price divided by constant price 5. What is RESIDEX? a. It is a drug to combat swine flu. b. It is a new vaccine for rabies. c. It is an index to capture the prices of residential buildings in urban areas. d. It is an index to capture the prices of residential buildings in both rural and urban areas. 6. Between March 2011 to March 2013, what was the highest Repo rate? a. 9.00 b. 7.25 c. 8.50 d. None of Above 7. Which of the following can be used to measure inflation directly? a. Current Account deficit b. GDP deflator c. Fiscal deficit d. Purchasing power parity for more articles on economy: visit Mrunal.org/economy
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132 comments to [Economic Survey Ch4] Inflation, WPI, CPI, monetary policy, RESIDEX gist of

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Priyanka
Reply to this comment Please reply I have not recieved the confirmation mail from upsc for the successful submission of form Do i need to fill the form again?

Rajpal
Reply to this comment Try to fill part II of the registration process again with RID. Website will guid you accordingly.

Priyanka
Reply to this comment When i fill my RID it says that your form has been successfully submitted.. I evn tried calling upsc but they are not taking up calls

karan
Reply to this comment hey u sure it saying submitted, i tried the same i.e. filling part 2, it says its completed.

deepak
same problem wid me..no mail confirmation but part 2 registration says your form has been completed

Nik
Dear xxxxxxxxx,

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You have successfully submitted your form for Civil Services (Preliminary) Examination 2013. Your Registration ID: 0000000. Your candidature is further subject to the acceptability of your photo & signature as well as verification of payment in case you are not a fee exempted candidate. Dear All, this is the format of the mail which I have received. More important is transaction id which might have been generated immediately after completing part II of the form.

Prashant
Reply to this comment Please Confirm before last date. May be , you can check with UPSC. Last time one of acquaintances got some problem with form filling so could not appear.

Priyanka
Reply to this comment Please reply

Amruth
Reply to this comment Hello priyanka, dont worry mate everything will be alryt and as it said it is successfully completed, why r u bothering.. hope u got the confirmation mail by now, if u havent then just try one more time if u cant get UPSC just fill it for second time. With best wishes, Amruth.

anks
Reply to this comment Hey , same thing has happened to me, i dint get the 2nd confirmation mail, and isnt fillinf it for the second time makes it invalid?

RAKESH
Reply to this comment can anyone please suggest me which is right? thanks Consider the following 1. Market borrowing 2. Treasury bills 3. Special securities issued to RBI Which of these is/are components(s) of internal debt? (a) 1 only (b) 1 and 2 (c) 2 only (d) 1, 2 and 3

nisha
Reply to this comment I think a

vids
Reply to this comment d. All three are form of internal debt.

anks
Reply to this comment D. All three are internal debts however treasury bills are also issued for FIIs in such a case the debts are not internal.

anks
Reply to this comment in addition like the limit for the FII incesting in G sec(T bills) is 25 billion thus they can be bothways.

rakesh
Reply to this comment all a,b,c

Karthikeyan
Reply to this comment

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[Economic Survey Ch4] Inflation, WPI, CPI, monetary policy, RESIDEX gist of Mr... Page 8 of 12

Sir, can U please put up an article on NCTC.

Vicky
Reply to this comment http://mrunal.org/2012/09/polity-nctc.html

geetikasg
Reply to this comment Dear Mrunal sir, I really appreciate your effort for making it all so comprehensible. I am addicted to your blog. A big fan! Warm regards. Thank u so much. Geetika

jeeet
Reply to this comment good one article on economy

jeeet
Reply to this comment thanks sir

KUMAR
Reply to this comment Its B B C A C C A

harshwardhan
Reply to this comment THERE IS NO OTHER WAY TO UNDERSTAND ALL THESE ECONOMY BOUTS WITHOUT HELP OF YOUR ARTICLES .. GREAT WORK

brijit
Reply to this comment hi, mrunal when r u putting an article for DI and ENGLISH for SBI PO? waiting eagerly thanks

Tarun
Reply to this comment Hi can anyone please reply On which of the following rates reserve bank of india purchase the other commercial paper and rediscounts bills of exchange from the banks? 1-Repo rate 2-Reserve Repo rate 3-bank rate 4-base rate

Tarun
Reply to this comment On which of the following rates reserve bank of india purchase the other commercial paper and rediscounts bills of exchange from the banks? 1-Repo rate 2-Reserve Repo rate 3-bank rate 4-base rate Anyone reply please

Divya
Reply to this comment

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According to me it should be BANK RATE as RBI lends money to commercial bank on repo rate by keeping their security paper and according to question RBI PURCHASE THE OTHER COMMERCIAL PAPER and its not security paper so it should be bank rate. what say??????????/

Darshan Thakker
Reply to this comment You are right. In bank rate commercial bill are given by bank to rbi and in repo and reverse repo, govt securities.

Vijay
Reply to this comment Its Reverse repo rate..

piyush
Reply to this comment its: c a c d c c b

jitendra
Reply to this comment Thanks again for such a valuable knowledge, I am highly inspired by you. The way you are helping the students is unmatched to any other services. Sir i have a question to you? Sir i want to know that do you think upsc really requires optional subject in order to select deserving candidates. Dont you think that upsc should keep gs only

PRINCE TOMAR
Reply to this comment Mock questions answer as follow:1.C 2.B 3.C 4.D 5.C 6.C 7.B A line of confirmation will be highly appreciated. Regards.

vishvender rana
Reply to this comment cpi revised base year is 2010 so ans of 2. c

vinayak
Reply to this comment when will the fifth chapter of economic survey be uploaded?????

daya
Reply to this comment 1. b,c 2. c 3. c 4. d 5. c 6. c 7. b

Mohit
Reply to this comment In question 1. option b fuel and fodder . is it correct?

hanish
Reply to this comment

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ans for 1 is c. option b contains manufactured goods and services.but wpi wont count services.

Ash
Reply to this comment Hello Mrunal Thanx for your wonderful efforts. I am preparing for Upsc and have some doubts regarding economy for prelims. Economy is my weakest link and as u can see not much time left to improve. I have Ramesh Singh book but to cover the basics and then the current would take hell lot of time. So what I want to ask is about your economy notes or PDFsare they alone good enough for answering economy in pre??? It would be great if somehow I could attempt even 40-45% of economy questions askesd in pre. Please guide

mohan
Reply to this comment Kindly suggest best books for following syllabus of Ap state service. LAND REFORMS & SOCIAL CHANGES IN A.P. AFTER INDEPENDENCE 1. Historical background of land reforms and the change in laws from time to time Intermediaries abolition, tenancy reforms, ceilingson holdings and land issues in A.P. 2. Structure of the Andhra Pradesh economy its sectoral and regional distribution and the extent of poverty. Agricultural inputs and technology. 3. Demographic features and social backwardness, literacy and occupation structure; changes in the sectoral distribution of income and employment. Socio-political and economic empowerment of women. 4. State finances and budgetary policy tax structure, sharing central taxes, expenditure pattern in revenue and capital account as well as plan and non-plan accounts. Public debt composition internal and external debt including World Bank loans. 5. Five year plans of AP Outlays, financing public sector plan and resource allocation pattern in the recent 5 year plan. PLANNING IN INDIA & INDIAN ECONOMY 1. National and per capita income and human development Sectoral changes in the Indian Economy (GDP and work force). 2. Indian Planning Objectives, priorities, specific aims of the recent 5 year plan experience and problems. Changes in the role of public-Private Sectors and their shares in the total plan outlay before and after economic reforms. 3. Poverty and unemployment problems magnitude and measures initiated to ameliorate them. 4. Monetary policy Structure of Indian Banking and non-banking financial institutions and reforms in them since the 1990sregulation of credit by RBI. 5. Pattern of revenue, expenditure and public debt and effects on the economy. ANDHRA PRADESHS ECONOMY, PRESENT STATUS, ITS STRENGTHS AND WEAKNESSES 1. Growth and structure of industries in AP; Factories, small and tiny sectors, their comparison, growth, weaknesses and problems. 2. Structure of agricultural outputs. Administratedprices including support and procurement prices Public Distribution System in Andhra Pradesh. 3. Regional disparities in income, industrial output, rainfall, irrigation, health and education in AP. 4. Institutional and non-institutional sources of rural credit in AP structure and growth cooperatives and their share in total credit adequacy and problems. 5. Service Sector of AP Importance, composition and growth with special reference to transport and communication, tourism and information technology.

hanish
Reply to this comment 1)c 2)c 3)c 4)d 5)c 6)c 7)b

Santosh Behera
Reply to this comment 1-c 2-d 3-c 4-d 5-c 6-c 7-b

Kumar
Reply to this comment

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finally i saw someone with whom my answers matched :)

sunil
Reply to this comment ans of 2) should be (c) both statement incorrect new cpi index all are prepared by cso with base year 2010

Vijay
Reply to this comment Bro you rock man..seriously Been suffering to do the survey myself due to time constraint. Browse up and I find this!!! Now its gonna be an easy game Thank you so much..

Sonal
Reply to this comment This is by far the best educational blog I have ever come acrossIts a talent to make things so comprehensiblekeep up the good workyou are a true genius

Aakansha
Reply to this comment Thanx Mrunal. U rock !!

Vikas Tomar
Reply to this comment correct Answer Keys c,c,c,d,c,c,b Ignore Above faulty Keys.

sunil
Reply to this comment c c c d c c b

praveen
Reply to this comment thanks sir

praveen
Reply to this comment hats off

SAGAR
Reply to this comment When liquidity increases = loan interest rate decreases. When liquidity decreases = loan interest rate increases = harder to get loans for home, car, bike, business. COULD YOU PLEASE EXPLAIN IT IN BRIEF

Ranjith
Reply to this comment Hi, LIQUIDITY INCREASES: When liquidity increase -> more money is available in the market(for ex: Bank). Banks run business mainly by earnings from interests. If a bank keeps their interest rate very high, customers wont approach it(because more money in market, they can get for less interest from some money lenders). So the banks are forced to keep the interest rates low. <> LIQUIDITY DECREASES: When liquidity decreases -> less money is available in the market(for ex: Bank). Money availability is less, so customers wont have various means to get money(money lenders wont have money to lend :-)). Banks cant lend all the money with less interest (everyone will take the least available money and bank will with no money). so the Banks will increase the interest rate, which is not good for doing business, so customers taking loan will decrease. <> Hope it helps.. :)

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Sudeep
Reply to this comment Mrunal, please correct this statement In 2012, the CPI system was reformed and Before 2012 . The correct year is 2011.

nocturnal
Reply to this comment About the new CPI http://pib.nic.in/newsite/erelease.aspx?relid=69636

Kinshuk
Reply to this comment This chapter said that exempting vegetables and fruits from mandi fees will encourage development of backend infrastructure by private traders. Can you please explain how?

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