With today’s inflation figures coming out and a 7.14% inflation, RBI’s response has been to hike the Cash Reserve Ratio by 0.5% to 8% now. The CRR hike is a signal that the RBI wants to rein in inflation through interest rate hikes.
CRR is the percentage of their money that banks are supposed to deposit with RBI otherwise RBI will get really angry. How does the CRR affect inflation? I mean why would the hafta that banks need to give RBI to stay in business affect the price you pay for vegetables? The answer, my friend, is “magic”.
I wish it were, so that I don’t have to type all of this, most of which is theoretical and amazingly paradoxical considering the state of today’s world, but I’ll go ahead anyhow.
CRR means banks give money to RBI so they have less to lend. And in general they have less money to invest or trade or whatever shady things they do. If they have less to lend, they will raise interest rates to maintain their return on capital. They will trade lesser, because there is less to go around. Or so we all like to think, because this is NOT what is happening right now, but please listen to this theory.
Having less money hanging around means the value of money goes up. Inflation usually means the value of money has gone down. So net-net, the value of money gets stabilised and inflation gets controlled. Clap-Clap.
That must means your vegetable vendor who has a huge loan from your bank, which has just increased interest rates, will now REDUCE his prices because the value of money has gone up. Er. Wait. There is something wrong with that sentence. Uhm. Ok, we don’t really know how veggie prices come down. Maybe RBI sends someone with a gun to all vegetable vendors and they reduce rates. Or maybe it’s magic.
Whatever happens, interest rate hikes are supposed to be the preferred way to contain inflation. If it works, it is with a serious lag – 6 months to a year. Inflation however is a political problem once it gets out of hand, and right now these 7% figures are just bunk – the real inflation in food and goods prices is much much higher. I’ve seen the price of rice and wheat go up more than 10% in the last two weeks itself, and it’s even higher in the cheapest varieties.
Interest rates weren’t exactly low earlier, so why did prices go up? I think this inflation is imported. Prices abroad have gone up – because for one the US has absurdly low interest rates due to their internal problems – so we have people who prefer to export, or that imports are expensive now. Low interest rates do cause inflation, so inflation in western countries is hopping over here.
Maybe we would do better off by strengthening the rupee. That way imports aren’t much more expensive in rupee terms and exports are less attractive. And it deters anyone thinking they can borrow cheap from the US and get risk free high rates in India – if the dollar depreciates that advantage is wiped out.
But rupee appreciation kills exporters. Still, inflation today is a bigger problem than export jobs, so I’m sure that the numbers will play on the mind of the politicians soon.
If the rupee goes up – it went up by what, 20 paise to the dollar today – we will see all IT stocks impacted seriously. And it’s not just the dollar, it’s the Euro as well, so no hiding there this time. Plus, textile stocks which just went up, will be impacted seriously as well.
Watch the rupee closely. If it hits 39 and goes below, it’s going way below. Inflation has to be controlled. No choice on that matter.