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Main causes of inflation in India

Inflation can take place as a result of a rise in aggregate demand or a failure of aggregate supply or both. Let us understand these factors one by one.

Increase in public expenditure

Public expenditure has risen from 18.6% of GDP in 1961 to around 28% in 2012-13. Around, 40% of the government expenditure in India is on non-developmental activities like defense, law and order, etc. See chart 1 and 2:
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Deficit financing

Deficit financing means financing of budget deficits either by borrowing from the banks or by printing of more currency. The Government of India has frequently resorted to deficit financing in order to meet its developmental expenditure. The budgetary deficit was 20,000 crores in the eighth plan, but the actual deficit was around 33,000 crores. In the ninth, tenth and eleventh plans, the Government decided not to raise money through deficit financing.

Erratic agricultural growth

Agriculture is mainly dependent on monsoons and thus, crop failures have been a regular feature of agriculture. During times of scarcity of food grains, not only do the prices of food articles increase, but also the general price levels.

Agricultural price policy of the Government

The Government has been pursuing a policy of price support to the agriculturists. This ensures a minimum price to the farmers. Though beneficial to the farmers, it has been a major contributory factor to the inflationary price rise in the country.

Inadequate rise in industrial production

There is a huge demand for industrial good due to increase in money supply in the economy but the rise in industrial growth has been inadequate there by raising the prices of industrial products. This has led to cost-push inflation.

Upward revision of administered prices

There are a number of commodities and services in public sector (like bus service, railways, etc.) for which the price levels are administered by the Government. The Government keeps raising these prices from time to time in order to cover the losses in the public sector. This also results in cost-push inflation.

Other factors

  • Failure of the Government to bring the increasing income of the people within the ambit of taxation
  • Large scale tax evasion and avoidance
  • Increasing reliance on indirect taxes
  • Black marketing and hoarding of essential commodities
  • Unused capacity in industries
  • High capital output ratio
  • Shortage of essential raw materials, etc.
Demand factors
Supply factors
Increase in public expenditure
Erratic agricultural growth
Deficit financing
Agricultural pricing policy
Rapid growth of population
Inadequate rise in industrial production
Upward revision of administered prices

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