Reason behind Indian Inflation

While discussing about petrol price hike (Truth Behind Petrol Price Hike) , I mentioned that the major reason behind price hike and inflation is the governmental policy of economic stimulus for the defaulting sectors during the economic crisis of 2008. I was asked if I can offer an analysis to prove my point.

Here is an explanation of Indian inflation rate going sky high.

It is important to understand that inflation and price rise are two different phenomenons. Henry Hazlitt, a renowned Austrian economist explained the process of inflation in following words:

Inflation is an increase in the quantity of money and credit. Its chief consequence is soaring prices. Therefore inflation — if we misuse the term to mean the rising prices themselves — is caused solely by printing more money. For this the government’s monetary policies are entirely responsible¹ .

Ludwig Von Mises also explained inflation when he commented,

What people today call inflation is not inflation, i.e., the increase in the quantity of money and money substitutes, but the general rise in commodity prices and wage rates which is the inevitable consequence of inflation² .

Price hike is just a consequence of inflation. As the available currency in market increases, the face value of currency decrease and hence prices rise. Inflation as mentioned by Hazlitt is solely caused by printing new money and this money is often printed for providing economic stimulus to save the big corporate which in return offer money for politicians during elections. Obviously, inflation is actually the result of immoral trade between corporates and politicians and we the common people suffer the consequences of this immorality in form of price rise whose direct consequence is poverty and increasing economic difference.

Thus, while government fools us by suggesting that it will work to decrease the yawning economic difference, the result of having a government is just opposite, it increases poverty and economic difference.

The figure for Indian inflation rate (Consumer Price Index) changes since Jan 2008 to July 2011 explains the reality. Inflation was quite low (around 5.5%) during January 2008. But then, government announced economic stimulus and RBI printed loads of money, the consequence was a steep increasing in inflation that reached above 10 by the end of 2008 and beginning of 2009. In 2009 again, Indian government announced a new stimulus package and result was again same as inflation rose again to reach around 12%, in 2010, Indian government offered third stimulus package and result again was same as inflation reached above 16% by the first quarter of 2010. Even after that, the ill policies of government and the inefficiency of central bank RBI failed to keep a check on inflation and price rise as the government kept pumping money in the market.

How Government and Federal Reserve Bank of India (RBI) Causes Inflation:

Here are the reports on how and when Government and RBI infused currency in the market:

First Stimulus Package: Indian Newspaper The Hindu reported that the economic stimulus has been offered to various economic sectors of Indian economy to help them against the global downturn. The housing and infrastructure sector, automobile companies, textiles, cement and other sectors were provided an additional Rs 20,000 crore³ .

Second Stimulus Package: Government announced Rs32, 000 crore stimulus package to boost Indian economy. Montek Singh Ahluwalia, then Deputy Chairman of Planning Commission announced a stimulus package of over Rs 20,000 crore for the “Round II Package” that was meant to reduce stress on financial companies, real estate, infrastructure and small and medium businesses⁴ .

Third Stimulus Package: In order to offer a boost again, Indian government announced a new stimulus and offered a two percent cut in excise duty and service tax, that is, government offered free floating fiat currency of measure around Rs 30, 000 crore in market. This cut was above the four percent cut in CENVAT announced in December 2008, which was extended to beyond March 31⁵ .

Economic stimulus is often provided by government in forms of cess cuts. This cuts in excise duties, sales tax and others similar reliefs cause a significant reduction in money for the government and its budget. However, government never reduces their expenditures to maintain these cuts in balance. Rather, government borrows money from RBI that offers new printed money to the government.

The excessive money printing process of RBI started in 2008 and it is still going on. In October 2010, RBI bought up to Rs 12, 000 crore of government securities in order to help government in managing cash⁶ . Soon after that in December, 2010, RBI again bought government securities of worth Rs 48, 000 crore⁷ .

While it is a good step to reduce taxes on various economic sectors, but if the RBI buys government securities while offering the newly printed money to provide enough cash for government to pursue their irrational policies, then the burden is actually loaded on the common poor man.

Since November 2010, Indian government and banks kept borrowing money at an average of one trillion rupees everyday from RBI⁸ . Will the government and banks ever return this borrowed money? No, it is national debt that will always keep going on. While in 2008, Indian government tried to present itself as one of the most stable economies of the world that remained unaffected by the global economic crisis, government is pumping crores of rupees for bailing out bankrupt public sector units. In 2010, Air India was at the verge of bankruptcy and government offered a loan of Rs 12 billion to AIR⁹ . Obviously, government didn’t reduce its expenditure but borrowed from RBI which printed new money so that government could expend.

This increase in Indian currency INR is actually debasing Rupee by decreasing its value in internal and external market and hence, rupee is constantly getting weaker against dollar. This is again causing price rise as all exports product are now costlier because of weak rupee.

The United States FED’s policy of debasing dollar by similar means of offering economic stimulus to rescue American economy is also causing inflation in Indian markets. As the US government and FED prints new dollar, the investors find it easy to invest these newly introduced dollars in emerging market such as India and it again causes inflation.

Conclusion: Economic stimulus by government can only be offered if RBI prints out new currency because government in no way adheres to a fine monetary policy and never reduces its own expenditure rather, it always keep increasing governmental expenditure. As a result, the common men not only suffer the burden of national debt, they also suffer higher rate of inflation which soon affect the poor section of Indian society in form of price rise. Ron Paul defined inflation as tax on poor citizens¹⁰ . Whenever government introduces the newly printed money by RBI, it actually taxes the poorest section of Indian society without their consent making them poorer. On the other hand, these smart crook politicians keep promising that they will work for reducing poverty and economic difference.

And before Indians could get accustomed to increasing prices, our Keynesian Economist Prime Minister Manmohan Singh declared a $10 Billion stimulus package for Eurozone. True to say, politicians don’t know the limits of insanity.

1. Inflation in One Page, Henry Hazlitt, Freeman 2004 [↩]
2. Planning for Freedom, Ludwig Von Mises on Inflation, Page 79 [↩]
3. Government unveils Stimulus Package, A Dasgupta, The Hindu, Dec 08, 2008 [↩]
4. Government-RBI delivers Second Stimulus, 2009, Indiaserver [↩]
5. 3rd Stimulus: 2 pc cuts in excise duty & service tax, Narayan, 2009, Finance Buzz [↩]
6. RBI to buy bonds to infuse liquidity in cash-starved system, Roy, 2010, Mint Lounge, Wall Street Journal [↩]
7. RBI to buy securities worth Rs 12,000 crore from the government, Sampat, 2011, Invest India [↩]
8. Monetary conditions too tight for RBI rate hike, D’Silva, 2010, Reuters [↩]
9. Cabinet OKs 12-bln-rupee infusion into Air India, Reuter, 2010 [↩]
10. The Inflation Tax, Ron Paul, 2006, Lew Rockwell.com [↩]