"THE PPP Catch-up factor"
Two major milestones in Indian Economy, first one being the liberalization of economy in 1990s and other one being the onset of growth explosion in 2005. For three consecutive years India posted a huge GDP growth rate, bolstering its economy. Brakes were applied by the global meltdown, but India is again poised for high growth rate. The growth is coming but again at some cost, lets see what cost are we paying for this high growth rate.
As a country grows the per capita income increases, which in turn increases the purchasing power of the people living in that nation. PPP(Purchasing Power Parity) is low for any developing country like India. Currently India's PPP correction factor is 2.9. Which indicates that a basket of goods costing 100$ in India, will cost around 290$ in US. The equation is simple, as US is a developed economy so prices of goods are higher as compared to India. As India grows, this PPP correction factor will come down (Indian economy will start matching the US economy). Supposedly after 30 years, it becomes around 1.6. Now, the same basket of goods costing 290$ in US will cost 181$ in India!!. If I take exchange rate to be 50, then the basket costing 5000 INR today, will cost 9050 INR 30 years later.
So, making no policy changes, doing nothing, the inflation will grow by around 2%, just because of the growth of the nation. The point of contention here can be that the exchange rate would not remain the same after 30 years, If India grows then Rupee will appreciate. If Rupee appreciates and the exchange rate becomes 1USD=27 INR then this PPP correction factor will balance the exchange rate. But, the empirical studies of various fast growing economies like Brazil have shown that the exchange rate does not change by this much amount. Rupee will definitely appreciate, but not this much. So, if we take a major contribution by PPP correction factor and a small by Exchange Rate change, then also there will be inflation.
This is the second puzzle government needs to solve, the growth brings with itself inflation, so comparing today's situation with a comfortable 3% inflation during 2001-2004 makes a little sense. Inflation has to be controlled, the policy review is reflecting the concerns and efforts of RBI in this direction, but growth is coming at a price and we all are paying it right now...
Note: Major Inputs from Indian Economic Survey