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Economy

CRR Hike And Rupee Woes

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.

  • paddy says:

    >Your observations on Rupee apprecitation is very good. I have also invested in Mudra Lifestyle. Do you feel that there will be adverse impact on this stock due to Re. Appreciation?
    thanks
    Venu

  • Anonymous says:

    >”…- 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.”

    The inflation you are talking about above is inflation on consumper price index. What govt. measures is inflation on wholesale prices.

  • Deepak Shenoy says:

    >paddy: Mudra’s exports aren’t a massive part of its turnover so they should be fine in general.

    Anon: True, but there is a CPI (consumer price index as well). But that is released only once a month and was 8%+ last month, afaik.

  • Anonymous says:

    >Inflation on consumer prices is easily 15-20%. My experience in India (anything goes up – never comes down ..period. They have a knack of charging the consumer, somehow,,,and rarely, very rarely any of the handouts from Govt are passed back to the idiotic consumer)…
    The so called 7%+ calculation is simple hoodwinking and hogwash; even if it is in wholesale prices – my guess – it should be 10-12% in whole sale prices.
    IMHO – Rupee appreciation will be sharp and will wipe out all exports and that includes textiles (whatever little left)..

    Indian IT will be in X roads..and India will have a sub prime crisis of its own since many of these IT wizards have taken home loans of the order of 20-30-50L for a salary of 20-50-100K and believe me, not a soul will pay that outside the a/c halls of IT. So, what will happen – simple default and banks will employ goonds to sell the flats in B’lore/Noida/Hyd/Chennai. There will be a glut and when all this is over, there will be a sea of red

  • Vikram says:

    >Hmmm. I remember a quip about inflation from my college days.”Too much Money chasing too few Goods”. So (theoretically), because of this demand-supply mismatch, prices rise. By increasing CRR, money supply in the economy is reduced and causes the prices to stabilize. I believe thats the funda.
    However, because the inflation we are seeing now is due to actual supply side deficiencies, monetary policies may/may not result in decrease of prices.
    Also instead of considering vegetable vendors whose loans dont really amount to that much, consider builders and contractors who take huge loans. If banks restrict lending to these folks, they dont have the money to spend on cement and steel causing the prices to come down, and thereby bringing down the WPI.
    I guess this is what RBI intends to do.

  • Shankar Nath says:

    >Hi Deepak,

    I think the underlying theme of your post, points to the differences in the theory and reality of govt policies .. in this case, inflation. Some notes –

    In theory – increasing interest rates, reduces the amount of funds available for banks to lend. Reduced loans means demand for some products like washing machines, cars etc. go down. Lowered demand, reduces product prices and hence inflation is arrested.

    In practice –
    1. Its very difficult to predict movements and there is always a lag between observation and action. (aka global credit crisis or even me, paying my credit card bill).
    2. Inflation cant exactly be a political problem and shelved into a populist measure, can we? If I have this right, no one loves inflation. A 4% increase is good for the economy but not a 10% steeper.
    3. Inflation is also a function of demand-supply, as it is with interest rates. Higher demand and lower supply .. raises the price of commodities and everything else.
    4. Inflation being an import does hold true.

    Warm Regards
    Shankar

  • Deepak Shenoy says:

    >Shankar: Good points, but in reality no interest rate changes have happened! and teh FM has gone on record multiple times asking banks to maintain and not increase interest rates. That is so weird, I don’t know how to address the inconsistency.

    I’m also having problems understanding the theory of a one-time increase in rates. In reality, to address inflation you need a policy to dramatically raise rates, to whatever it takes to arrest inflation. Otherwise you get status-quos at various points, and inflation does not recede.

    So if this action has anything readable in it, it is that rates will soon be increased further and then some more until inflation comes down – and meanwhile inflation will continue to rise. The only way to bring inflation down is to stem credit growth, and that means curbing consumer spending, corporate expansion and in general, sacrificing growth.

    If they want to maintain growth and contain inflation, the only way then may be to inflate the rupee. The RBI’s further actions will show the path they intend to take…

  • techntrek says:

    >Most intelligent economists have repeated the need for the rupee to be allowed to appreciate reasonably.. but who is listening ?
    Rbi is holding it strong and playing the futures mkts these days but for how long ???

    plus if u trust sa aiyar the fisc deficit is heading to 1991 levels
    http://timesofindia.indiatimes.com/Opinion/Columnists/Swaminathan_A_Aiyar/Fiscal_deficit_back_to_record_level/articleshow/2964504.cms

    singapore has started to revalue/repeg the sing $ to reasonable levels

    I see psu banks suffering the most ,one more oil psu like story in the making – that after all the fms diktats

    Where do u predict infy say if rupee appreciates to 38?

  • Ramesh says:

    >Deeak when do you think this problem will happen in India.
    All the IT companies are talking of good growth for next 5 to 10 years so this roblem might not haen at all. your comments please

    “Indian IT will be in X roads..and India will have a sub prime crisis of its own since many of these IT wizards have taken home loans of the order of 20-30-50L for a salary of 20-50-100K and believe me, not a soul will pay that outside the a/c halls of IT. So, what will happen – simple default and banks will employ goonds to sell the flats in B’lore/Noida/Hyd/Chennai. There will be a glut and when all this is over, there will be a sea of red

  • Anonymous says:

    >There is a constant change in the…
    "RATE OF INTEREST" on the savings and deposits of the public in the banks and the financial institutions.
    This is shown as "FROM INTEREST" in the "BANK PASS BOOK & STATEMENTS".

    To enable transparency…
    the "RATE OF INTEREST" and the "AMOUNT ON WHICH IT IS EARNED" should also be reflected (SHOWN) in print in the "BANK PASS BOOK & STATEMENTS"
    This will enable easy filling of tax returns also.