Inflation

Features of Indian Foreign

Trade
Inflation is when a country's economy sees an increase in the prices
of products and services due to a decline in purchasing power.

David Hume first proposed the concept in the 18th century.

Inflation types include demand pull, cost pull, creeping, galloping,

and hyperinflation.

Rate of Inflation = (Current period price index – Reference period

price index)/(Reference Period Price Index)×100
Inflation indicates the decrease in the purchasing power of a
unit of the currency in the country. It is measured in
percentages.
It is categorized into three types, that is, Demand-pull, Cost-
pull, and Built-in.
The most commonly used inflation indexes are the Consumer
Price Index (CPI) and Wholesale Price Index (WPI)
Inflation measures the average change in price in a basket of
commodities and services over a period of time. The opposite
and rare fall in the price index of this basket of items is termed
as “Deflation”
Causes of Inflation

Primary Causes –cost push and demand pull

Increase in Public Spending
Deficit Financing of Government Spending
Increased Velocity of Circulation
Population Growth
Hoarding
Genuine Shortage
Exports
Trade Unions
Tax Reduction
The imposition of Indirect Taxes
Price-rise in the International Markets
Demand-Pull Effect
Demand-pull inflation occurs when an increase in the supply of
money and credit stimulates the overall demand for goods and
services to increase more rapidly than the economy's production
capacity. This increases demand and leads to price rises.

When people have more money, it leads to positive consumer

sentiment. This, in turn, leads to higher spending, which pulls prices
higher.

It creates a demand-supply gap with higher demand and less flexible

supply, which results in higher prices.
Cost-Push Effect
Cost-push inflation is a result of the increase in prices working
through the production process inputs. When additions to the
supply of money and credit are channeled into a commodity or other
asset markets, costs for all kinds of intermediate goods rise.

This is especially evident when there's a negative economic shock to

the supply of key commodities.

These developments lead to higher costs for the finished product or

service and work their way into rising consumer prices. For
instance, when the money supply is expanded, it creates a speculative
boom in oil prices. This means that the cost of energy can rise and
contribute to rising consumer prices, which is reflected in various
measures of inflation.
Creeping or Mild Inflation
When the speed of upward thrust in prices is slow but small, it is known as
creeping inflation.
It is helpful for economic development.
Price rise at a very small rate (<3%).

Walking or Trotting Inflation

When prices rise moderately, and the annual inflation rate rises by a single
digit.
It is the time when government should focus on the issue.
Price rises at a moderate rate (3% to 10%).

Galloping and Hyperinflation:

When creeping and walking inflation are left unchecked, the rate will rise
above 10%, called galloping inflation.
This leads to instability of the economy.
Hyperinflation is when the prices of goods and services rise more than
50% per month.
It is the last stage of inflation.
Built-In Inflation
Built-in inflation is related to adaptive expectations or the idea
that people expect current inflation rates to continue in the
future.

As the price of goods and services rises, people may expect a

continuous rise in the future at a similar rate.
Hyperinflation
Hyperinflation is when there is rapid, excessive, and out-of-
control price rice in the economy. It typically increases at a
rate of 50% each month over time.
It can occur in times of war and economic tension in the
underlying production economy, along with a central bank
printing an excessive amount of money.
It can cause a surge in prices for basic goods like food and
fuel as they become very limited.
Stagflation:
It is a situation in which the rate is high, the economic growth rate slows,
and unemployment remains steadily high.
It is also known as recession inflation.
It is a dilemma for economic policy since actions intended to lower the rate
may worsen the unemployment situation.

Core Inflation
Price rise in all goods and services except food and energy due to high price
fluctuations is core inflation.
It is calculated as government needs a stable and true picture of the rate of
price rise.

Headline Inflation
This measure considers total inflation in an economy, including food and
energy prices, which are more volatile.
CPI Points of WPI
Difference
It is the average change in prices of the Meaning It measures the changes in the prices of
goods and/ or services over time that the goods sold and traded in bulk by the
consumer pays for a basket of goods wholesale businesses to other
and/ or services businesses.

The RBI and other statistical agencies Uses It is used to measure inflation. The rate
study the CPI in order to understand the of inflation is the difference between
price change of various commodities the WPI calculated at the start and end
and keep inflation under control. of a year.

Ministry of Statistics and Program Computed Ministry of Commerce & Industry

Implementation by
CPI = (Cost of basket divided by Cost Formula (WPI of end of year – WPI of
of basket in the base year) multiplied by beginning of year)/WPI of beginning
100 of year x 100
CPI Consumer Price Index
It is the average change in prices of the goods and/ or services over
time that the consumer pays for a basket of goods and/ or services

CPI = (Cost of basket divided by Cost of basket in the base year) multiplied by 100

WPI Wholesale Price Index

It measures the changes in the prices of goods sold and traded in
bulk by the wholesale businesses to other businesses.
(WPI of end of year – WPI of beginning of year) / WPI of beginning of year x 100
Advantages
It means the price levels increase, but for an economy to run
healthily, wages should also be rising. Inflation is a sign that an
economy is flourishing.

The Reserve Bank of India (RBI) considers the range of 4-5% as an

ideal situation for inflation in India.

Following are some of its advantages:

Slow inflation aids economic growth
Better than deflation as it does not lead to recession
Allows adjustment of prices
Helps in adjustment of real wages
Disadvantages
On the other hand, now let’s take a quick look at the disadvantages of
Inflation:

May lead to uncertainty and lower investments

Higher rate of inflation can lead to lower growth and instability
Reduces international competitiveness
Distorts the planning process
May also give rise to speculative investment
May result in a decline in the value of savings
May lead to inequality in the income distribution
How to Control Inflation?
Now, let’s have a quick look at some of the methods with which
inflation can be controlled:

Monetary Policy
The Central Bank can increase the interest rates, making borrowing
more expensive and savings more attractive. This would lead to a
lower growth of consumer spending and an increase in investment.

Controlling money supply

As part of the monetary policy, many countries have set up an
inflation target. The reason for this is if people believe the inflation
target is credible, then it will also help to decrease inflation
expectations. It will result in a controlled inflation.
Fiscal policy
The government can increase the rate of taxes and may also cut its spending. This will not
only improve the government’s budget situation but also help reduce demand in the
economy. Both these policies will help in reducing inflation by reducing the growth of total
demand.
Wage control

If inflation is caused due to wages, then limiting the growth of wages can also help to
control inflation. Lower wage growth will help in reducing cost-push inflation along with
moderating the demand-pull inflation.

Supply-side policies
Inflation is many times caused by lack of competitiveness and rising costs of raw materials.
Supply-side policies may enable the economy to become more competitive and it will also
help in controlling inflationary pressures.
Other methods to control inflation are:
Controlling population
Having a rational-wage policy
Price control
Rationing
Importing high-demand commodities
Controlling hoarding and speculation
Decreasing exports
According to the data released by the National Statistics Office
(NSO), India’s retail inflation rate dropped to 5.09 percent in
February 2024, the lowest in four months. The retail inflation rate
registered a slight drop of 0.01 percent in one month, standing at
5.10 percent in January 2024. The current retail inflation eases to
4.83 percent in April 2024 and remains in the Reserve Bank of
India (RBI) tolerance band, set at 2 to 6 percent.

The inflation rate increased due to higher prices of food,

electricity, crude petroleum and natural gas, food products and
other goods manufacturing.
Foreign trade plays an important role in the economic
development of country. It is said,

“Foreign trade is not simply a device for achieving productive

efficiency but is an engine of economic growth.”

Many reasons certify this statement.

(i) Nation can optimally use its resources.
(ii) Technical know-how can be imported.

(iii) Surplus production can be exported.

(iv) Machinery and raw materials can be imported as and when needed.
(v) Food grains and necessary help can be imported during natural calamities
like earthquake, & flood etc.
(i) Optimal use of natural resources: International trade helps
each country to make optimum use of its natural resources.
Each country can concentrate on production of those goods for
which its resources are best suited. Wastage of resources is
avoided.

(ii) Availability of all types of goods: It enables a country to

obtain goods which it cannot produce or which it is not
producing due to higher costs, by importing from other
countries at lower costs.

(iii) Specialisation: Foreign trade leads to specialisation and

encourages production of different goods in different countries.
Goods can be produced at a comparatively low cost due to
advantages of division of labour.
(iv) Advantages of large-scale production: Due to international trade, goods
are produced not only for home consumption but for export to other countries
also. Nations of the world can dispose of goods which they have in surplus in the
international markets. This leads to production at large scale and the advantages
of large scale production can be obtained by all the countries of the world.

(v) Stability in prices: International trade irons out wild fluctuations in prices. It
equalizes the prices of goods throughout the world (ignoring cost of
transportation, etc.)

(vi) Exchange of technical know-how and establishment of new industries:

Underdeveloped countries can establish and develop new industries with the
machinery, equipment and technical know-how imported from developed
countries. This helps in the development of these countries and the economy of
the world at large.
(vii) Increase in efficiency: Due to international competition, the producers in a
country attempt to produce better quality goods and at the minimum possible cost.
This increases the efficiency and benefits to the consumers all over the world.

(viii) Development of the means of transport and communication:

International trade requires the best means of transport and communication. For
the advantages of international trade, development in the means of transport and
communication is also made possible.

(ix) International co-operation and understanding: The people of different

countries come in contact with each other. Commercial intercourse amongst
nations of the world encourages exchange of ideas and culture. It creates
cooperation, understanding, cordial relations amongst various nations.
(x) Ability to face natural calamities: Natural calamities such as drought,
floods, famine, earthquake etc., affect the production of a country adversely.
Deficiency in the supply of goods at the time of such natural calamities can be
met by imports from other countries.

(xi) Other advantages: International trade helps in many other ways such as
benefits to consumers, international peace and better standard of living
Salient Features of Indian Foreign Trade:
The following are the features of foreign trade:
(i) Change in the composition of exports:
After independence many changes took place in export trade. India exported tea,
jute, cloth, iron, spices and leather before independence. Now chemicals,
readymade garments, gems, jewellery, electronic goods, processed foods, machines.
Computer software etc. are exported along with tea, jute and cotton textiles.

(ii) Change in the composition of imports:

India imported consumer goods, medicines, textiles, motor vehicles
and electrical goods before independence. After independence,
imports are fertilizers, petroleum, steel, machines, industrial raw
materials, edible oils and unfinished diamonds.
(iii) Direction of foreign trade:
Direction of foreign trade means those countries with which India has trade ties.
Before independence, India has trade relations with England and Commonwealth
Nations Now India has trade relations with U.S.A, Russia, Japan, European
Union and Organization of Petroleum Exporting Countries (OPEC).

(iv) Balance of trade:

Simply speaking balance of trade means the difference between value of exports
and imports. Balance of payments is favourable if exports exceed imports and un-
favourable if imports exceeds export. India’s balance of payment was favourable
before Independence. It was favourable to Rs. 42 crore, but after independence it
becomes un-favourable. It was Rs. 65741 crore adverse in 2003-04. India trade
balance for 2022 was $-124.91B, a 50.25% increase from 2021.
(v) Dependent trade:
Before independence, Indian foreign trade was dependent on foreign shipping,
insurance and banking companies. After independence, cargo ships are being built
in India. Banks and insurance companies have started taking interest in foreign
trade.
(vi) Trade through sea routes: India’s foreign trade is through sea routes. India
has very little trade relations with neighbouring countries like Nepal, Afghanistan,
Pakistan, Bhutan and Sri Lanka etc.

(vii) Dependence on a few Ports:

Indian foreign trade is through Chennai, Kolkata and Mumbai ports. These ports
are always over-crowded. After independence ports like Kandla, Cochin and
Vishakhapatnam have been developed.
(viii) Less percentage of world trade:
India’s share in world trade has been diminishing. It was 1.8% of world’s total
imports and 2% of world’s total exports in 1950-51. In 2003-04 India’s share in
total world imports was 1% and in total world exports was 0.8%.

(ix) Increased Share in Gross National Income:

Foreign trade has significant contribution in Indian national income. In 1950-
51, India’s foreign trade contribution into national income was 12% and rose is
29% in 2003-04.
(x) Increase in value and volume of trade:
The value and volume of imports and exports increased many fold. In 1950-51
imports were Rs. 608 crores and exports were Rs. 606 crores. So total value was
Rs. 1214 crores. In 2003-04, it increased to Rs. 6, 52,475 crore. Value of
exports 2, 93,367 crore and of imports 3, 59,108 crore. The value of international trade
is expected to moderately decline to around US$ 31 trillion in 2023, driven by lower global demand,
particularly for goods.
Overview In 2022, India was the number 5 economy in the world in
terms of GDP (current US$), the number 15 in total exports, the
number 8 in total imports, the number 140 economy in terms of
GDP per capita (current US$) and the number 40 most complex
economy according to the Economic Complexity Index (ECI) .
 India's trade performance in FY 2023-24

Export/import 2022-23
(US$ billion)

Export 325.33
Services
Import 182.05

Overall trade Export 776.40

(merchandise+ser
vices) * Import 898.01

India's share of global goods exports was 1.8% in 2023 and imports was
2.8%. In digitally delivered services, India's share rose to 6% in 2023 from
4.4% in 2019
Exports The top exports of India are
Refined Petroleum ($86.2B),
Diamonds ($25.9B),
Packaged Medicaments ($19.5B),
Jewellery ($12.6B), and
Rice ($11.1B),

exporting mostly to United States ($82.9B),

United Arab Emirates ($31.6B),
Netherlands ($17.6B),
China ($15.3B), and
Bangladesh ($13.8B).

In 2022, India was the world's biggest exporter of Diamonds ($25.9B), Rice
($11.1B), Non-Retail Pure Cotton Yarn ($3.23B), Synthetic Reconstructed
Jewellery Stones ($1.84B), and Other Pure Vegetable Oils ($1.28B)
Imports The top imports of India are
Crude Petroleum ($170B),
Coal Briquettes ($58.7B)
, Gold ($35.8B),
Petroleum Gas ($32B), and
Diamonds ($26.1B),

importing mostly from

China ($110B),
United Arab Emirates ($51B),
United States ($48.5B),
Saudi Arabia ($46.2B), and
Russia ($40.4B).

In 2022, India was the world's biggest importer of Coal Briquettes ($58.7B), Diamonds
($26.1B), Palm Oil ($11.1B), Mixed Mineral or Chemical Fertilizers ($7.88B), and
Nitrogenous Fertilizers ($7.37B)
 Black money is hidden from government authorities and is
not reflected in the GDP of India, national income, etc.

White money is money that is earned through legitimate means

and is accounted for, for which income or other tax is paid.

In an ideal economy, all money that is transacted should be

accounted for. This would help the government to collect taxes.

Cash transactions without proper accounting are known as black

money.

As per estimates of some economists, the black economy of India is estimated

to be at 62% of the GDP. It is more than the income generated by Agriculture
and Industry combined together. It is larger than the spending of Government
of India.
Black money is generated by any of the following three ways:

Illegitimate activities The illegal activities that can lead to black money
generation are:
1. Crime
2. Corruption
3. Non-compliance with tax requirements
4. Complex procedural regulations
5. Money laundering
6. Smuggling

Tax evasion This is where an entity willfully does not pay taxes that
are due to the government.

Tax avoidance This is where an entity takes advantage of the existing

loopholes in the system and avoids paying taxes. This is
not illegal though
Sources of Black Money in India
Some of the chief sources of black money are described below.
Sellers or traders who do not give bills or receipt creates black money.
Many people invest in bullion or jewellery to hide their actual income from the
authorities.
In the real estate sector, many people undervalue their real assets to refrain from
paying the rightful tax. They cheat the government of the correct amount of
property tax.
Some Self-Help Groups (SHGs) and trusts do not provide proper sources for
their funds and donations received.
Tax havens: Tax havens are generally small countries where foreigners don’t
have to pay taxes. These countries generally have very liberal regulatory
frameworks, which big corporations take advantage of. They set up shell
companies there and redirect all their profits to this entity, by which they can
reduce their tax liabilities by a huge margin.

Hawala: Hawala is an informal method by which money can change hands

without the use of banks. This works through codes, contacts and trust with no
paperwork at all.
Investments through innovative derivative instruments like participatory notes
also is a means to hide black money.
Size of the problem
A Bank of Italy calculation reveals India’s share in tax havens globally to be
$152-181 billion or Rs. 10 lakh crore.

India is ranked eighth in the world in black money generation by the Global
Financial Integrity Report.

A former director of the Central Bureau of Investigations has said that the total
black money in India is around USD 500 billion.
Money Laundering
Money laundering is the process by which black money is converted
into white money.
People who possess black money cannot spend it publicly. They
should either hide it or spend it on the underground economy.
Through money laundering, they convert it into white money. It is a
method by which criminals mask their accumulated wealth.

Another commonly heard related term is round-tripping. Here, people send

money to a tax haven like Mauritius or Cayman Islands (to avoid paying tax)
and then invest that money into India, thus becoming a foreign investment.
Effects of Black Money in India

It affects the financial system of the country. The central bank is not able to
control money supply in the economy causing higher inflation. This will lead to a
fall in the value of the currency.

Black money affects the credibility of a country negatively.

Black money is most often used for illegal activities such as drugs and narcotics
dealing, terrorism, etc. which is detrimental to the heath of the country.

The government suffers a big loss in the form of taxes because of black money.

Black money creates a parallel economy in the country, which is completely

underground. For example, in Mexico, there is a thriving parallel economy because
of the illegal trafficking of drugs. This leads to governance problems.

Black money can also cause real estate prices to go up, which may lead to an
asset bubble.
Measures were taken by the Government to Curb Black Money
Tax reforms have been initiated with a view to resisting black money. The tax base has been increased
and rates have been slashed. Reforms are being made to incorporate tax deduction at the source
itself.

Through the Black Money Bill, the government has allowed the reporting of black money generated
through tax evasion in a given time frame.

Demonetisation of Rs.500 and Rs.1000 was carried out in 2016 with the primary view of making
black money useless. To know more about demonetisation, click on the linked article.

The government is encouraging cashless/digital transactions with a view to making things more
transparent.

Electoral reforms are also intended to curb black money as much of the black money generated in India
is used in elections.
Legislative Framework to deal with Black Money
Prevention of Corruption Act, 1988
Benami Transactions Prohibition Act, 1988
Prevention of Money Laundering Act, 2002
The Undisclosed Foreign Income and Assets (Imposition of Tax)
Bill, 2015
Lokpal and Lokayukta Act