World Inflation and the Developing Countries

By Surjit S. Bhalla; Gabriel Siri et al. | Go to book overview

Conclusion

Both domestic and external causes accounted for the leap in Indian inflation from its range of 3-5 percent yearly in the 1960s to 17 percent in 1973 and 27 percent in 1974. Agricultural supply appears to have been one important factor. Food grain production declined in 1973 when there were no more P.L. 480 imports to bridge the supply gap and when world prices of imported food were at all-time highs. The result was severe upward pressure on food prices.

For import prices more generally, with external trade only 5 percent of Indian GNP, external price movements might be expected to have a limited impact. In the specific instance of petroleum, although Indian inflation had already reached an annual rate of 22 percent before the November 1973 OPEC oil price rise, the rise did worsen inflation and the import bill (with oil rising from 10 percent to 26 percent of import value).

For its part, money supply grew excessively in the period 1970-73, reaching a peak annual growth rate of 17 percent in 1972-73. External reserves did not account for this expansion, as they did in many developing countries. Fiscal policy was also expansive in the period 1970-73, as the result of the Bangladesh War in 1971-72 and poor food crops in 1973-74 (requiring purchases of food abroad and increased government wages). By mid-1974, however, fiscal as well as monetary policy turned to restraint.

The statistical monetarist model of Indian inflation augmented by variables for import and food price inflation finds that these two variables, in addition to monetary variables, are significant in explaining inflation. The estimated coefficient of import prices in explaining domestic inflation is approximately 0.2, far in excess of the share of imports in the economy. This result indicates a major role for imported inflation. Even though India's economy is relatively closed, with traded goods constituting only 5 percent of the GNP, rising prices in the foreign sector accounted for approximately one-third of the country's inflation in 1973 and 1974. The other part of India's exceptional inflation in those years was attributable to domestic monetary and fiscal influences rather than imported inflation. After mid-1974, monetary and fiscal restraint, combined with a sharp drop in the inflationary pressure from import and food prices, enabled India to regain its earlier price stability.

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