Inflation in India: Causes and Effects

Introduction to Inflation

Inflation refers to the consistent rise in the prices of goods and services over time, reducing the
purchasing power of money. For example, if a liter of milk costs ₹50 today but increases to ₹55
next year, inflation has made it more expensive.

Inflation affects individuals, businesses, and governments alike. It determines consumer

purchasing power, influences business pricing strategies, and impacts government policies. In
India, inflation is primarily measured using the Consumer Price Index (CPI), which tracks the
price fluctuations of essential commodities such as food, fuel, clothing, and housing.

A balanced level of inflation is necessary for economic stability:

• Moderate inflation (2%-4%) is beneficial as it encourages spending and
investment.
• High inflation (above 6%) makes essential goods expensive, reducing
purchasing power.
• Very low inflation or deflation (falling prices) can slow economic growth,
negatively impacting businesses.

To manage inflation, the Reserve Bank of India (RBI) employs various monetary
policies to keep it within a stable range.

Current Inflation Scenario in India

As per the RBI, India’s retail inflation rate stood at 4.31% in January 2025, aligning closely with
the 4% target (Trading Economics). However, in 2022-23, inflation exceeded 7%, causing
substantial increases in food and fuel prices.

Some notable instances of inflation’s impact in India include:

• 2022: Cooking oil prices surged by over 20% due to supply chain
disruptions.
• 2023: Tomato prices skyrocketed from ₹30 per kg to ₹100 per kg due to
crop damage.
• Fuel costs have increased due to global oil price fluctuations, affecting
transportation and daily commuting expenses.

Key Causes of Inflation in India

Inflation arises due to multiple factors, either increasing demand or reducing supply. The primary
causes of inflation in India include:

1. Rising Food Prices

Food prices in India fluctuate due to climatic conditions, supply chain inefficiencies, and global
market trends. Since food is a daily necessity, any price increase significantly impacts inflation.

Reasons for food price inflation:

• Dependence on monsoons for agriculture—droughts or floods can damage
crops.
• Inadequate storage and distribution facilities leading to shortages.
• Example: In 2022, excessive rainfall destroyed tomato crops, leading to a
200% price increase.

2. Fuel and Energy Price Increases

Fuel is essential for transportation, industries, and electricity generation. When fuel prices rise,
the cost of production and transportation also increases, leading to inflation.

Causes of fuel price inflation:

• India imports over 80% of its crude oil, making it vulnerable to global price
changes.
• A rise in fuel costs increases transportation and manufacturing expenses.
• Example: A 20% rise in global oil prices in 2023 led to higher petrol and
diesel rates in India, making daily expenses costlier.

3. Excess Money Supply (Demand-Pull Inflation)

When there is an excess supply of money in the economy without a corresponding increase in
goods and services, inflation rises.

Causes:
• If the government prints more money without boosting production, inflation
occurs.
• Example: Post-COVID-19, the Indian government introduced stimulus
packages, increasing consumer demand and leading to inflation.

4. Fiscal Deficit and Government Spending

Government expenditures on infrastructure, welfare programs, and subsidies inject more money
into the economy, fueling inflation.

Example:
• In 2023, India spent ₹1.3 lakh crore on welfare schemes, increasing money
circulation and inflation.

5. Global Supply Chain Disruptions

India imports essential goods like fuel, fertilizers, and electronic components. Any disruption in
global trade increases the cost of these imports, contributing to inflation.

Example:
• The Russia-Ukraine war disrupted the supply of edible oils and fertilizers,
raising prices in India.

Impact of Inflation on the Indian Economy

Inflation influences various aspects of the economy, from individual purchasing power to
business operations and government policies.

1. Declining Purchasing Power

As prices rise, salaries may not increase at the same rate, reducing people’s ability to afford
basic necessities.

Example:
• In 2023, vegetable prices surged by 30%, making everyday groceries more
expensive.

2. Higher Interest Rates

To curb inflation, the RBI raises interest rates, making loans costlier for businesses and
individuals.

Example:
• In 2022, the RBI increased the repo rate from 4% to 6.5%, making home
loans more expensive.

3. Effect on Savings and Investments

When inflation outpaces interest rates on savings, money loses value over time.
Example:
• In 2013, inflation stood at 10%, but bank interest rates were only 7%, leading
investors to shift towards gold and real estate.

4. Rising Business Costs

Higher inflation increases raw material costs, wages, and transportation expenses for
businesses.

Example:
• A 25% rise in steel prices in 2023 made construction projects more
expensive, impacting small businesses.

5. Slower Economic Growth

High inflation discourages investment and reduces consumer spending, leading to slower GDP
growth.

Example:
• In 2013, India’s inflation rate hit 11%, causing businesses to delay
investments, which slowed economic growth.

Government Measures to Control Inflation

The RBI and the Indian government employ various strategies to manage inflation, using both
monetary and fiscal policies.

1. Monetary Policy (RBI’s Role)

The RBI regulates money supply, interest rates, and liquidity to stabilize inflation.

Key tools:
• Repo Rate Adjustments: Raising repo rates makes loans expensive, reducing
borrowing and inflation.
• Cash Reserve Ratio (CRR) & Statutory Liquidity Ratio (SLR): Increasing
these reserves reduces money circulation, controlling inflation.
• Open Market Operations (OMO): The RBI buys or sells government bonds to
regulate liquidity.

Example:
 • In 2022, the RBI increased the repo rate from 4% to 6.5% to combat rising
inflation.

2. Fiscal Policy (Government’s Role)

The government uses taxation, subsidies, and spending policies to control inflation.

Key strategies:
• Reducing Taxes on Essentials: Lowering taxes on food and fuel can make
them more affordable.
• Providing Subsidies: The government subsidizes essential goods like food,
fuel, and fertilizers to reduce inflation.
• Price Regulation: Setting maximum retail prices for critical goods prevents
excessive price hikes.

Example:
• In 2023, the government reduced excise duty on petrol and diesel to control
fuel inflation.

3. Supply-Side Reforms

Long-term solutions focus on increasing production efficiency and reducing import dependency.

Key measures:
• Boosting Domestic Manufacturing: The “Make in India” initiative promotes
local production, reducing reliance on imports.
• Infrastructure Development: Investments in logistics and transportation
lower production costs.
• Reducing Import Dependency: Encouraging local semiconductor and
electronic production reduces exposure to global price fluctuations.

Conclusion

Inflation is a critical economic factor that influences purchasing power, business operations, and
economic stability. While moderate inflation (2%-4%) supports economic growth, high inflation
(above 6%) leads to increased costs and reduced affordability.

Why Inflation Control is Crucial:

• Unchecked inflation can lead to a recession, job losses, and financial
instability.
• The RBI and the government use monetary and fiscal policies to maintain
 stable inflation.
• Long-term measures like boosting domestic production and infrastructure
help sustain economic stability.

Current Trends:
• Inflation in India has moderated to 4.3% in 2025, but global and domestic
factors like oil prices, food supply, and economic policies require continuous
monitoring.

Final Thoughts:
Managing inflation effectively ensures sustainable economic growth, protects consumer
purchasing power, and maintains financial stability.