There are several factors which give rise to inflation. Some of them are mentioned below:
1) Increase in Government Expenditure
Government has been increasing the spending every year. Almost half of the expenditure by Government is on activities such as defense, police, law and order etc. This expenditure is recurring and does not add to any developmental activities.
2) Deficit Budgeting and Financing
In order to meet the deficit, Government either borrows money from banks by floating bonds and also by printing currency notes. This adds to the devaluation of our currency thus resulting in inflation.
We are dependent on monsoon for our agriculture. Crop failures due to deficient rains are common. Scarcity of food grains cause the prices to rise. Also hoarding of commodities by some unscrupulous traders create artificial shortage resulting in higher prices.
4) Industrial Production
Industrial products are in huge demand but the industrial growth is insufficient to meet this demand. This causes higher pricing of the industrial goods.
5) Government Administered Prices
Many commodity prices are administered by the Government eg. Petrol. Diesel, gas etc and though the actual cost is low, we end up paying huge indirect taxes on these items. eg Any increase in price of diesel results in transportation costs going up which ultimately leads to higher prices of commodities and goods.
6) Very few People pay Income Tax
Unfortunately,approx 3% of the population pay income tax. Many agriculturists earning very good income are exempted from paying income tax. Also rampant tax evasion leads to generation of cash which has become a parallel economy. Government has therefore, to rely on indirect taxes such as excise, vat, service tax, octroi, customs duty etc which when added to goods leads to higher price.
7) High Interest Rates
Cost of borrowing is also high. Industrialists and Entrepreneurs have to borrow at a higher rate of interest for their business/industries which ultimately leads to higher cost of products.
Actual inflation is in the region of +/- 10%. We should plan accordingly and not based on the figures the Government wants us to believe. It is therefore, advisable to invest in equity funds which can give you inflation adjusted returns.