Context: Recently, Finance Minister stated that states which have not cut-down taxes on Oil are experiencing high Inflation. 

Concern associated with Inflation: 

1. Decreased purchasing power: The increase in prices of essential commodities such as milk, bread or edible oils decreases the overall purchasing power of common man which further decreases consumption. According to Consumer Price Index Data, Inflation in March-April 2022 touched 18% in edible oils. 


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2. Decline in Production: Increase in cost of primary products pushes the final cost of production which makes good costlier and faces decline in demand and subsequently results in decline in production due to increase in supply. 

Inflation quickens to an almost 8-year high, less impact on low income  households says Finance Ministry - The Hindu

3. Increase in Repo Rate: Increase in inflations compels Reserve Bank of India to increase the cost of borrowing, in this case, (Repurchase Rate/Repo Rate) to bring down prices of essential goods. 

Note: When Reserve Bank of India increases the (Repo rate/Repurchase Rate), say, from 4% to 4.5%, it increases the cost of borrowing for Banks which means banks must pay more interest now (.5% more) to borrow funds from RBI. In order to shift increased cost of borrowings, Banks increase the rates of various financial products subscribed by customers such as Home Loans, Vehicle Loans, Personal Loans. 

Owing to the increased interest rates, the consumers are less likely to borrow more, which decreases the demand of products and results in decline in Inflation. 

Causes of Increased Inflation: 

  1. Abundant Liquidity: India’s inflation has climbed due to adoption of “stretched expansive monetary policy” adopted to recover market demand injected more than 8.5 Lakh Crore. 
  2. Russia-Ukraine Conflict: Black swan event like Russia’s attack on Ukraine has sent supply shockwaves across the world in commodities sector such as (Crude Oil, Coal, Wheat, Rice, Edible Oil) where Crude Oil prices have climbed from $60 to $120, Prices of Natural Gas has almost doubled from 4$/MMBtu to $8/MMBtu. 
  3. Demand: Owing to easy monetary policy, low-cost of borrowing has increased the demand of the product which results into shortage of supplies and results in increase in prices of products. 

Measures taken to contain inflation: 

  1. Increase in Repo Rate: (Already Explained Above)
  2. Fiscal Policy: Government has rationalized the GST structure to bring down prices of essential commodities to accommodate with increased inflation. Along with that, government has cut down on excise duty levied on Crude Oil by substantial percentage. 
  3. Oil Imports from Russia: Government has diversified the oil imports such as Russia which has offered Crude Oil at Pre-war rate. 

Challenges in tackling Inflation: 

  1. Recessionary: There has been a fear of recession which grew simultaneously with rapid increase of repo rates as it leads to immediate suction of liquidity from market. 
  2. Weak Growth: Tackling inflation could trigger weak growth as it decreases the purchasing power which further declines productivity.

Maintaining price stability is essential in market which takes some time and requires using tool to bring demand and supply into better balance.