Rising Inflation In India: Reasons, Impact And RBI Measures

Source: Indian Express
GS III: Indian Economy and issues relating to planning, mobilisation of resources, growth, development and employment.

Overview

1. News in Brief
2. Inflation
3. Reasons for Rising Inflation
4. Impact of Rising Inflation
5. Challenges Before the RBI
6. How RBI is Responding

Why in the News?

Retail inflation (CPI) rose from 3.93% in May to 4.38% in June, primarily driven by higher food, transport, and restaurant prices.

News in Brief

• Food inflation increased to 5.32%, led by rising vegetable and spice prices, while weak monsoon conditions and lower kharif sowing raised concerns over future price pressures.
• Fuel price hikes and rising global crude oil prices, amid West Asia tensions, added to transport and services inflation, increasing overall inflationary risks.
• The RBI faces the challenge of balancing inflation control with economic growth as it prepares for its upcoming Monetary Policy Committee (MPC) meeting.

Inflation

• Inflation is the sustained rise in the general price level of goods and services over time, reducing the purchasing power of money.

Types of Inflation

• Demand-pull- Occurs when aggregate demand for goods and services outpaces aggregate supply, often described as “too much money chasing too few goods”.
• Cost-push – Driven by an increase in the cost of production (wages, raw materials), suppliers “push” the higher costs onto consumers.
• Core – Calculated by excluding highly volatile items (usually food and fuel) from the headline figure to reflect the long-term trend in price changes.
• Headline-  The total inflation within an economy, including all commodities in the price index, even volatile items like food and energy.
• In India, inflation is measured using the Consumer Price Index (CPI), Wholesale Price Index (WPI), and GDP Deflator.
• While CPI reflects retail prices and guides monetary policy, WPI tracks wholesale prices and excludes services.

Inflation Targeting in India

• India follows a Flexible Inflation Targeting (FIT) framework under the RBI Act, 1934 (amended in 2016).
  • Historically, when domestic consumption demand pushes inflation up, the RBI raises the repo rate.
  • This makes borrowing costlier for commercial banks, subsequently raising interest rates for car, home, and business loans.
  • Cooling Demand: By making loans more expensive, consumer spending and business investments moderate, which brings down aggregate demand and helps lower inflation
• The Reserve Bank of India aims to maintain inflation at 4% with a tolerance band of ±2%.
• Role of Government and RBI- The RBI uses monetary policy tools to achieve price stability, while the Government supports inflation management through fiscal measures, supply-side interventions, and food management policies.

Reasons for Rising Inflation

• Adverse weather, including heatwaves, an uneven monsoon, and El Niño,  severely impacted domestic agricultural output.
• Prices for cereals, pulses, dairy, and perishables (like onions, tomatoes, and capsicum) spiked sharply, making food inflation the primary catalyst.
• Global geopolitical tensions in West Asia have driven up crude petroleum and input costs, which directly hit retail transport and energy prices, leading to imported inflation.
• WPI pressures from higher raw material and transportation costs gradually passed through to CPI inflation.

Impact of Rising Inflation

• Economic
  • Reduces purchasing power.
  • Increases cost of living.
  • Lowers household savings.
  • Raises business input costs.
  • Creates investment uncertainty.
• Fiscal
  • Increases subsidy burden.
  • Raises government expenditure.
• Monetary
  • Limits RBI’s scope for interest rate cuts.
  • Tightens liquidity conditions.
• Social
  • Disproportionately affects poor households.
  • Increases food insecurity.
  • Widens income inequality.

Challenges Before the RBI

• Balancing inflation control with economic growth.
• Uncertain monsoon and agricultural output.
• Volatility in global crude oil prices.
• Geopolitical uncertainties.
• Evolving inflation expectations.
• Spillover effects of monetary policy decisions by the US Federal Reserve and European Central Bank (ECB).

How RBI is Responding

• Maintaining the Status Quo
  • Instead of immediately raising interest rates, the Monetary Policy Committee (MPC) has chosen to hold the repo rate steady.
  • This allows the central bank to avoid choking economic growth while treating the recent spikes as temporary supply shocks.
• Liquidity Management
  • The RBI uses tools like the Standing Deposit Facility (SDF) to encourage banks to park excess funds directly with the central bank.
  • This absorbs surplus cash from the system without needing to formally hike benchmark borrowing rates.
• Forex Interventions
  • To support the rupee and manage imported inflation, the RBI utilizes its foreign exchange reserves and introduces measures designed to attract foreign capital inflows

Way Forward and Conclusion

• Strengthen agricultural resilience, improve food supply chains, and reduce dependence on imported crude through renewable energy and ethanol blending to address structural drivers of inflation.
• Ensure coordinated monetary and fiscal policies, supported by better inflation forecasting and timely interventions, to maintain price stability and sustain long-term economic growth.

Key Takeaways

UPSC Prelims and Mains Practice Question

With reference to inflation and the Reserve Bank of India’s Monetary Policy Committee (MPC), consider the following statements:

1. The RBI follows a Flexible Inflation Targeting framework with a target of 4% inflation, with a tolerance band of ±2%.
2. Food inflation is measured using the Wholesale Price Index (WPI).
3. The Monetary Policy Committee consists of six members, with the RBI Governor serving as its Chairperson.
4. A rise in crude oil prices can contribute to inflation by increasing transport and production costs.

Which of the statements given above are correct?

(a) 1, 3 and 4 only
(b) 1 and 2 only
(c) 2, 3 and 4 only
(d) 1, 2, 3 and 4

Answer: (a) 1, 3 and 4 only

Mains Practice Question

Q. Food inflation and global crude oil price volatility continue to influence India’s inflation trajectory. Analyse their impact on monetary policy and suggest measures to ensure sustainable price stability and economic growth. (15 Marks , 250 Words)

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