Impact of Inflation on the Performance of the Indian Economy-An Analysis

IntroductionIndian economy, the third largest economy in the world, in terms of purchasing power, is going to touch new heights in coming years. As predicted by Goldman Sachs, the Global Investment Bank, by 2035 India would be the third largest economy of the world just after US and China. It will grow to 60% of size of the US economy. This booming economy of today has to pass through many phases before it can achieve the current milestone of 9% GDP.Trade liberalization, financial liberalization, tax reforms and opening up to foreign investments were some of the important steps, which helped Indian economy to gain momentum. The Economic Liberalization introduced by Manmohan Singh in 1991, then Finance Minister in the government of P V Narsimha Rao, proved to be the stepping-stone for Indian economic reform movements. To maintain its current status and to achieve the target GDP of 10% for financial year 2006-07. Accelerate GDP growth from 8% to 10% and then maintain at 10% in the 12th Plan in order to double per capita income by 2016-17. Indian economy has to overcome many challenges of which Inflation is one significant one.InflationInflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every rupee you own buys a smaller percentage of a good or service.The value of a rupee does not stay constant when there is inflation. The value of a rupee is observed in terms of purchasing power, which is the real, tangible goods that money can buy. When inflation goes up, there is a decline in the purchasing power of money. For example, if the inflation rate is 2% annually, then theoretically a 1 pack of gum will cost rupee 1.02 in a year. After inflation, your rupee can't buy the same goods it could beforehand.Inflation is Caused due to Several Economic Factors* When the government of a country print money in excess, prices increase to keep up with the increase in currency, leading to inflation.* Increase in production and labour costs, have a direct impact on the price of the final product, resulting in inflation.* When countries borrow money, they have to cope with the interest burden. This interest burden results in inflation.* High taxes on consumer products, can also lead to inflation.* Demands pull inflation, wherein the economy demands more goods and services than what is produced.* Cost push inflation or supply shock inflation, wherein non availability of a commodity would lead to increase in price.Monetary InflationDemand-Pull Inflation - This theory can be summarized as much money chasing too few goods. In other words, if demand is growing faster than supply, prices will increase. This usually occurs in growing economies.Cost-Push Inflation - When companies' costs go up, they need to increase prices to maintain their profit margins. Increased costs can include things such as wages, taxes, or increased costs of imports.Costs of Inflation -Almost everyone thinks inflation is evil, but it isn't necessarily so. Inflation affects different people in different ways. It also depends on whether inflation is anticipated or unanticipated. If the inflation rate corresponds to what the majority of people are expecting (anticipated inflation), then we can compensate and the cost isn't high. For example, banks can vary their interest rates and workers can negotiate contracts that include automatic wage hikes as the price level goes up.Economic Cycle of InflationWhat Is GDP and how it is CalculatedGross domestic product (GDP) refers to the market value of all final goods and services produced within a country in a given period. GDP per capita is often considered an indicator of a country's standard of living. The monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. …