Fiscal Policy in India: Budget, Deficits, FRBM Act, Types & UPSC PYQs

Inflation in India has been a significant economic indicator that policymakers and analysts closely monitor. Inflation refers to the rate at which the general level of prices for goods and services increases, resulting in a decrease in purchasing power over time. 

This topic of ‘Inflation in India’ is important from the perspective of the UPSC Civil Services Examination, particularly under General Studies Paper III (Indian Economy), Monetary Policy, Public Finance, Price Stability, and Economic Development.

Inflation:

• Inflation is a condition characterized by a persistent increase in the general price level for goods and services in an economy, often creating expectations of further increases. 

• In simple words, it means your money buys less than it used to because things get more expensive, OR it is a reduction in the purchasing power of a unit of currency, as each unit can now buy fewer goods and services. 

Measurement of Inflation in India:

Inflation in India is measured using two key indices:

1. Consumer Price Index (CPI)

2. Wholesale Price Index (WPI)

Consumer Price Index (CPI):

• Calculated by: National Statistical Office (NSO), Ministry of Statistics and Programme Implementation (MoSPI)

• Frequency: Monthly

• Types of CPI:

• CPI Rural (54.18%) → Higher food & beverage weightage due to greater dependence on food expenses in rural areas.

• CPI Urban (36.29%) → Lower food & beverage weightage as urban populations spend more on non-food items.

• CPI Combined (45.86%) → Averages rural and urban CPI weights

• It tracks price changes of 200+ goods and services to measure inflation from a consumer perspective.

• Base Year: 2012

• It reflects retail market prices, directly affecting consumers.

Wholesale Price Index (WPI):

• Calculated by: Office of Economic Advisor, Ministry of Commerce & Industry

• Frequency: Monthly

• Coverage: Tracks price changes of 697 goods (no services included).

• Base Year: 2011-12

• Importance: Reflects wholesale market prices, which impact supply chains and businesses.

• WPI Goods (Weightage Distribution):

• Total Goods: 697

• Primary Articles: 117 items → 22.62%

• Fuel & Power: 16 items → 13.15%

• Manufactured Goods: 564 items → 64.23%

Producer Price Index (PPI) in India:

• The Government of India has decided not to adopt PPI separately, as necessary changes have been made to the Wholesale Price Index (WPI) to align it more closely with PPI.

• WPI reflects price changes at the producer level, making it conceptually similar to PPI.

Inflation Trends in India 

• Inflation in India is measured primarily through the Consumer Price Index (CPI), which reflects retail price movements and is used by the RBI for policy targeting.

• Over time, inflation has moved from high and volatile levels (pre-2014) to a relatively moderate and stable range, broadly aligned with the RBI’s target of 4% ± 2%.

• The key drivers of inflation remain food and beverages, fuel and light, and core inflation components, making it sensitive to monsoon variability, global crude prices, and supply disruptions.

• Recent trends show frequent food price volatility, while core inflation remains comparatively stable, indicating that inflation pressures are largely supply-side rather than demand-driven.

• The RBI manages inflation through a flexible inflation targeting framework using monetary tools such as the repo rate, liquidity management, and reserve requirements.

• Overall, India’s inflation trend reflects a shift from structural inflation pressures in earlier years to more supply-shock and global factor-driven fluctuations in recent years.

Causes of Inflation:

There are two factors behind inflation

• Demand Side Factors: Inflation arises when aggregate demand outpaces supply due to rising consumption, investment, government spending, and exports. There are:

• It could further be described as a situation where too much money chases just a few goods. 

• Examples: An increase in population, an increase in money supply, an increase in salary/wages, an increase in Government expenditure, an increase in black money, an increase in foreign exchange reserve, etc.

• Cost-Push Inflation: 

• Supply Side Factors: Inflation occurs when production costs rise or supply disruptions reduce goods availability, raising overall prices. There are two types such as:

• Cost-push factors: There are:

1. Factor Cost: Rising wages, interest rates, and rents increase production costs, pushing prices higher. 

2. Non-Factor Cost: Costs like raw materials, logistics, and energy affect supply costs, contributing to inflation.

• Supply Shocks: Unexpected disruptions (natural disasters, wars, pandemics) reduce supply, causing prices to spike rapidly.

•  

• Demand Side Factors: Inflation arises when aggregate demand outpaces supply due to rising consumption, investment, government spending, and exports. There are:

• Determinants of the Aggregate Demand Curve:

• Consumer Spending (C): Changes in income, population, preferences, and future expectations influence consumer spending significantly.

• Investment Spending (I): Determined by interest rates, taxes, credit availability, and investor confidence in economic stability.

• Government Spending (G): Fiscal policies like taxation and public expenditure directly shift aggregate demand in the economy.

1. Net Exports (X - M): Affected by exchange rates, foreign income levels, and international trade policies or agreements.

• Supply Side Factors: Inflation occurs when production costs rise or supply disruptions reduce goods availability, raising overall prices. There are two types such as:

• Cost-push factors: There are:

1. Factor Cost: Rising wages, interest rates, and rents increase production costs, pushing prices higher. 

2. Non-Factor Cost: Costs like raw materials, logistics, and energy affect supply costs, contributing to inflation.

• Supply Shocks: Unexpected disruptions (natural disasters, wars, pandemics) reduce supply, causing prices to spike rapidly.

Measures to Control Inflation

The following measures can be adopted to control inflation:

• Monetary Policy: An increase in the Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), Bank Rate, Repo Rate, etc., can decrease inflation in the economy. For example, raise policy interest rates to reduce the money supply and curb demand. Higher interest rates discourage borrowing and spending, thus reducing inflationary pressures.

• Fiscal Policy: Reducing expenditure, especially revenue expenditure. However, this is difficult. Thus, the Government generally decreases indirect taxes during times of inflation. 

• Administrative Measures:  These are the most important and most effective measures in the case of a developing country like India. This includes:

• Strengthening the public distribution shop and broadening its scope.

• Importing some essential commodities like wheat, sugar, etc., to tide over the domestic shortage. 

• Stop the export of goods that are increasing inflation. Enforcing measures like a ban on the export of essential commodities.

• Enforce the Essential Services Maintenance Act (ESMA) to prevent strikes in essential transportation systems like railways, trucks, etc.

• Issuing strict warnings to hoarders, speculators, and those who indulge in black marketing.

• Use a Public Distribution System (PDS) to sell goods that increase inflation.

• Imposing a ban on future trading of essential commodities.

UPSC Previous Year Questions and Practice Questions

UPSC Mains Question

https://pwonlyias.com/pyq/what-are-the-causes-of-persistent-high-food-inflation-in-india-comment-on-the-effectiveness-of-the-monetary-policy-of-the-rbi-to-control-this-type-of-inflation/

https://pwonlyias.com/mains-answer-writing/indias-inflation-problem-is-deeply-rooted-in-food-prices-and-the-suggestion-to-exclude-food-from-inflation-targeting-could-have-significant-implications-critically-examine-the-proposal-to-target-2/

Inflation in India PYQs

Q1. With reference to the Indian economy, demand-pull inflation can be caused/increased by which of the following? (2021)

1. Expansionary policies 

2. Fiscal stimulus 

3. Inflation-indexing wages 

4. Higher purchasing power 

5. Rising interest rates 

Select the correct answer using the code given below. 

1. 1, 2, and 4 only 

2. 3, 4, and 5 only 

3. 1, 2, 3, and 5 only 

4. 1, 2, 3, 4, and 5 

Answer: A

Expansionary Policies: Money in the market rises when the government spends more freely. It leads to an increase in demand for the goods and fuels demand-pull inflation. 

Fiscal Stimulus: It also increases the money in the market, which leads to an increase in demand for goods and fuels demand-pull inflation. 

Inflation-Indexing Wages: It means wages are linked to inflation, which means wages move as inflation changes in the economy. Such indexing is provided to reduce the effect of inflation on wages. It can not lead to demand-pull inflation in the economy.

Higher Purchasing Power: Consumers feel more confident and spend more when they have a better income. As a result, demand increases, driving up inflation.

Rising Interest Rates: It will reduce the money supply in the market. Borrowing money will become costlier, creating a credit crunch in the economy. So, it cannot cause demand to pull inflation in the economy.  

Q2. With reference to inflation in India, which of the following statements is correct? (2015)  

1. Controlling the inflation in India is the responsibility of the Government of India only 

2. The Reserve Bank of India has no role in controlling the inflation 

3. Decreased money circulation helps in controlling the inflation  

4. Increased money circulation helps in controlling the inflation 

Answer: C

Reserve Bank of India is the authority to control inflation through monetary policies which it does by increasing bank rates, repo rates, cash reserve ratio, buying dollars, regulating money supply and availability of credit. Decreased money circulation helps in controlling the inflation.