Published in Southern Economist ,Volume 51,Number 11,1st
October,2012
The word
inflation has been derived from inflate. Inflate means “blow up, dilate,
enlarge, swell or expand”. In the economic context the word inflation means abnormal
circulation of money or we can say that it is enlarging money supply like
expanding a balloon. Persistent rise in money supply increases price level of
commodities and services and decreases purchasing power of the currency. When the overall
demand for goods and services exceeds economy's capacity to supply goods and
services, inflation increases. Similarly, when productive capacity is greater
than demand, the rate of inflation decreases.
When circulation of money exceeds production of goods
and services, prices of commodities are bound to increase that leads to
inflation. Inflation in India
is rising at a galloping rate. High level of inflation has negative impact on the
economy that results into economic stagnation and hurts masses.
Though, it is said that inflation is better for the economy, but galloping
inflation is dangerous.
The problem of inflation which was mainly due
to domestic money supply and price rise and was confined to national boundaries
has become a global phenomenon. Like other imports, inflation is also imported
from cross borders.
Inflation in India :
CPI measures retail prices in five major groups viz.
food, clothing, housing, fuel and power. Food comprises the highest weighting
of 45.50 percent in the CPI. It provides a realistic view on how consumers are
affected by inflation at the retail level. Indian masses are more concerned
with the price rise in the commodities of daily use viz. milk, vegetables,
pulses, oil, spices, fruits etc. i.e. those commodities which satisfy their
basic needs. The general masses are not much concerned with the rise in the
white label goods or the goods of luxury, as luxury goods satisfy the hedonic
needs of rich and elite people.
Table-1
History
of CPI India in percentages
|
|
Period
|
Inflation
|
April 2012
|
10.215
|
April 2011
|
9.412
|
April 2010
|
13.333
|
April 2009
|
8.696
|
April 2008
|
7.812
|
April 2007
|
6.667
|
April 2006
|
4.653
|
April 2005
|
4.960
|
April 2004
|
2.231
|
April 2003
|
5.117
|
Inflation is measured
against a standard level of consumer purchasing power. A base year is selected
and its index is assumed as 100. On the basis of the base year, price index is
calculated for the current year. If the index of the current year is above 100,
it indicates the state inflation. With the
increase in the price index, value of money reduces and vice–versa. Iinflation and purchasing power of money are inversely
correlated.
The Reserve Bank of India , the apex bank of the country
plays important role in the financial markets through its monetary policy.The objectives of RBI’s monetary policy is to maintain price stability,
ensure adequate flow of credit through bank rate, repo rate, reverse repo rate
and the cash reserve ratio. SLR securities fulfil financial requirements of
government.
RBI vide
circular number RBI/2010-11/516 Ref. DBOD No. Ret. BC . 92
/12.02.001/2010-11 of May 09, 2011 on Maintenance of Statutory
Liquidity Ratio (SLR) has interalia advised about the securities which include ‘Treasury Bills of the Government
of India, Dated securities of the Government of India issued from time to time
under the market borrowing programme and the Market Stabilization Scheme, State
Development Loans (SDLs) of the State Governments issued from time to time
under the market borrowing programme, and any other instrument as may be
notified by the Reserve Bank of India.’
According
to RBI, the government has so far raised INR 85,000 crore via sale of T-bills
in Financial Year 2013, thus the total amount of dues on this has become INR
3.8 lakh crore.
Legislative amendments to the RBI Act, 1934, have enabled it to use CRR for monetary management, without a statutory floor or ceiling. The amendments to the Banking Regulation Act, 1949 has also permitted RBI to lower the SLR to levels below the pre-amendment statutory minimum of 25 per cent of net demand and time liabilities (NDTL) of banks. It gives flexibility to RBI in liquidity management. Banks can borrow funds from RBI at a repo rate for meeting liquidity deficit.
Sec.12AB of RBI Act deals with repo or reverse
repo. It mentions that lending or borrowing of funds by way of repo or reverse
repo shall not be subject to any limitation contained in this section.
“(a) "repo" means an instrument for borrowing funds by
selling securities of the Central Government or a State Government or of such
securities of a local authority as may be specified in this behalf by the
Central Government or foreign securities, with an agreement to repurchase the
said securities on a mutually agreed future date at an agreed price which
includes interest for the funds borrowed;
(b) "reverse repo" means an instrument for lending funds by
purchasing securities of the Central Government or a State Government or of
such securities of a local authority as may be specified in this behalf by the
Central Government or foreign securities, with an agreement to resell the said
securities on a mutually agreed future date at an agreed price which includes
interest for the funds lent. “
Repo is a collateralized lending. It is an
instrument of money market.
Banks borrow money from RBI for meeting their short term needs by selling
securities, with an agreement to repurchase the same at a predetermined rate and date. Reduction in the repo rate
indicates a downward shift in the monetary position. Reserve Bank charges interest on the funds borrowed by banks, which is
usually less than the interest rate on bonds. In a reverse repo, Reserve Bank
borrows money from banks by lending securities. The interest paid by Reserve
Bank in this case is called reverse repo rate. Whereas Repo provides short
term liquidity in the market, Reverse Repo is
sucking liquidity from market.
Monetary policy has an impact on the economy and on the exchange rate.
Movements in Exchange rate have an indirect impact on inflation. Changes in the
exchange rate affect the prices of imported goods. An increase in the price of
imported goods and services increase inflation. If rupee depreciates then
products, become relatively cheaper and demand for exports increase. The
increase in demand for goods and services exceeding potential output causes
inflationary pressure. Both these influences work in the opposite direction
when the value of rupee increases, or appreciates. If the interest rates are
relatively higher in India
than in other countries, overseas investors invest as they receive higher
return for their money. Even future developmental policies of the government
have an impact on the exchange rate. The money invested by overseas investors
is hot money and creates ripples when they suddenly start withdrawing funds. Investment
by overseas investors is also influenced by country’s ratings.
Cash Reserve Ratio:
According to the RBI, the CRR is a policy instrument with
liquidity dimension. Its reduction brings down the cost of money for banks and
has a bearing on their ability to lend at lower rates.It would be
observed from table 2,3 and 4 that from 2001 on words RBI has been relying much
on CRR, Repo and reverse repo rate for controlling money supply in the economy.
“Cash reserve ratio changes have an instantaneous
effect on the reserve money available to banks.
When the ratio is raised there is decline in the reserve money available.
Unless banks are already holding high cash reserve, they are compelled to cut
down their lending. In case of a decrease in CRR, the reserve money available
goes up, making it possible to enlarge their lending and investment operations,
though it takes time to take advantage of the opportunity provided by the
decrease in the CRR.”1
It would be observed that
frequent changes in the interest rates that too in rapid succession to control
high inflation do not yield result but indicates helplessness on the part of
RBI. Frequent changes create adverse impact on the economy. Banks have to
adjust their asset liability management. Bank’s income decreases when the CRR
instrument is used. A change in the rate has multiplier impact on the
system. To tame the rising inflation the Reserve Bank of India raised CRR rate 22 times
(table-2) from 2007 till 10th March 2012.
Impact of CRR (in Percentage)
|
|||||
CRR
|
SLR
|
CRR
|
SLR
|
||
10.03.2012
|
4.75
|
06.01.2007
|
5.50
|
||
28.01.2012
|
5.50
|
23.12.2006
|
5.25
|
||
18.12.2010
|
24.00
|
02.10.2004
|
5.00
|
||
24.04.2010
|
6.00
|
18.09.2004
|
4.75
|
||
27.02.2010
|
5.75
|
25.08.2003
|
4.50
|
||
13.02.2010
|
5.50
|
16.11.2002
|
4.75
|
||
07.11.2009
|
25.00
|
01.06.2002
|
5.00
|
||
17.01.2009
|
5.00
|
29.12.2001
|
5.50
|
||
08.11.2008
|
5.50
|
24.00
|
03.11.2001
|
5.75
|
|
25.10.2008
|
6.00
|
19.05.2001
|
7.50
|
||
11.10.2008
|
6.50
|
10.03.2001
|
8.00
|
||
30.08.2008
|
9.00
|
24.02.2001
|
8.25
|
||
19.07.2008
|
8.75
|
12.08.2000
|
8.50
|
||
05.07.2008
|
8.50
|
29.07.2000
|
8.25
|
||
24.05.2008
|
8.25
|
22.04.2000
|
8.00
|
||
10.05.2008
|
8.00
|
08.04.2000
|
8.50
|
||
26.04.2008
|
7.75
|
20.11.1999
|
9.00
|
||
10.11.2007
|
7.50
|
06.11.1999
|
9.50
|
||
04.08.2007
|
7.00
|
08.05.1999
|
10.00
|
||
28.04.2007
|
6.50
|
13.03.1999
|
10.50
|
||
14.04.2007
|
6.25
|
29.08.1998
|
11.00
|
||
03.03.2007
|
6.00
|
11.04.1998
|
10.00
|
||
17.02.2007
|
5.75
|
Table-3 Repo/Reverse Repo
RBI latest interest rate changes in percentage
|
||||||
Repo
|
Reverse Repo
|
Repo
|
Reverse Repo
|
|||
17.04.2012
|
8.00
|
7.00
|
31.03.2007
|
7.75
|
||
25.10.2011
|
8.50
|
7.50
|
31.01.2007
|
7.50
|
||
16.09.2011
|
8.25
|
7.25
|
31.10.2006
|
7.25
|
||
26.07.2011
|
8.00
|
7.00
|
25.07.2006
|
7.00
|
6.00
|
|
16.06.2011
|
7.50
|
6.50
|
08.06.2006
|
6.75
|
5.75
|
|
03.05.2011
|
7.25
|
6.25
|
24.01.2006
|
6.50
|
5.50
|
|
17.03.2011
|
6.75
|
5.75
|
26.10.2005
|
6.25
|
5.25
|
|
25.01.2011
|
6.50
|
5.50
|
29.04.2005
|
5.00
|
||
02.11.2010
|
6.25
|
5.25
|
27.10.2004
|
4.75
|
||
16.09.2010
|
6.00
|
5.00
|
31.03.2004
|
6.00
|
||
27.07.2010
|
5.75
|
4.50
|
25.08.2003
|
4.50
|
||
02.07.2010
|
5.50
|
4.00
|
19.03.2003
|
7.00
|
||
20.04.2010
|
5.25
|
3.75
|
07.03.2003
|
7.10
|
||
19.03.2010
|
5.00
|
3.50
|
03.03.2003
|
5.00
|
||
21.04.2009
|
4.75
|
3.25
|
12.11.2002
|
7.50
|
||
05.03.2009
|
5.00
|
3.50
|
30.10.2002
|
5.70
|
||
05.01.2009
|
5.50
|
4.00
|
27.06.2002
|
5.75
|
||
08.12.2008
|
6.50
|
5.00
|
28.03.2002
|
8.00
|
||
03.11.2008
|
7.50
|
05.03.2002
|
6.00
|
|||
20.10.2008
|
8.00
|
07.06.2001
|
8.50
|
|||
30.07.2008
|
9.00
|
28.05.2001
|
6.50
|
|||
25.06.2008
|
8.50
|
30.04.2001
|
8.75
|
|||
12.06.2008
|
8.00
|
27.04.2001
|
9.00
|
6.75
|
||
Bank Rate in Percentage
|
||||
17.04.2012
|
9.00
|
17.02.2001
|
7.50
|
|
14.02.2012
|
9.50
|
22.07.2000
|
8.00
|
|
30.04.2003
|
6.00
|
02.04.2000
|
7.00
|
|
30.10.2002
|
6.25
|
02.03.1999
|
8.00
|
|
23.10.2001
|
6.50
|
29.04.1998
|
9.00
|
|
02.03.2001
|
7.00
|
|||
It would be observed from table2, 3 and 4 that on the 17th
April 2012 RBI reduced bank rate, repo and reverse repo rate.
Take another example of Repo/Reverse repo rate which was 4.75 and 3.25 on
21.04.2009 respectively and was continuously increasing, in some cases the
rates were reduced twice a month and on 17.04.2012 it was reduced to 8% and 7%
respectively. Similarly CRR which was 5.50% on 28th Jan.2012 was
reduced to 4.75 on 10.03.2012 i.e. exactly after 51 days. All these statistics
indicate that there was no logic or rational in changing rates. It appears that
RBI was desperate and in desperation it went on reducing rate. Either it
is as per the whims of RBI or from the directives of government. It is RBI
which has to decide which instrument should be given greater weightage.
Real
Impact of CRR:
If we compare
table 2 and 5, it would be noticed that CRR which was 8.50 % on 8th
April 2000 till 16th February 2007 did not have much impact on
bank’s investment portfolio. Reduction in the level of CRR to 6.25% on 14th
April 2007 boosted the investment portfolio of banks. CD ratio and CRR have
direct relationship with the investment portfolio of banks. Reduction in the CD
ratio which was 74.605% on 2006-07 of All Scheduled Commercial Banks boosted
the investment portfolio of banks.
With a view to
increasing profit, banks reduced their advances portfolio and diverted funds
towards their investment portfolio. With the reduction in CRR in 2008-09, the
investment portfolio of banks jumped and declined with the rise in 2009-10.
All scheduled Commercial Banks
2005-06
|
2006-07
|
2007-08
|
2008-09
|
2009-10
|
2010-11
|
|
Deposits *
|
2164682
|
2696937
|
3320062
|
4063201
|
4746920
|
5616432
|
Deposits @
|
24.59
|
23.10
|
22.38
|
16.82
|
18.32
|
|
Advances*
|
1516811
|
1981236
|
2476936
|
2999924
|
3496720
|
4298704
|
Advances@
|
30.62
|
25.01
|
17.43
|
16.56
|
22.04
|
|
Investments*
|
866508
|
950982
|
1177330
|
1449551
|
1729006
|
1916053
|
Investments@
|
9.75
|
23.80
|
23.12
|
19.28
|
10.82
|
|
CD Ratio
|
70.070
|
73.463
|
74.605
|
73.833
|
73.663
|
76.538
|
Investments#
|
40.029
|
35.262
|
35.461
|
35.675
|
36.423
|
34.115
|
2005-06
|
2006-07
|
2007-08
|
2008-09
|
2009-10
|
2010-11
|
|
Deposits*
|
542409
|
633476
|
773875
|
1007041
|
1108086
|
1245862
|
Deposits@
|
18.63
|
20.26
|
30.12
|
10.03
|
12.43
|
|
Advances*
|
371679
|
482270
|
593722
|
739450
|
857937
|
994154
|
Advances@
|
29.75
|
23.10
|
24.54
|
16.02
|
15.87
|
|
Investments*
|
224761
|
211875
|
263823
|
357624
|
387473
|
385697
|
Investments@
|
-5.73
|
24.51
|
35.55
|
8.34
|
-0.45
|
|
CD Ratio
|
68.523
|
76.131
|
76.721
|
73.428
|
77.425
|
79.796
|
Investments#
|
40.974
|
33.446
|
34.09
|
35.512
|
34.968
|
30.958
|
2005-06
|
2006-07
|
2007-08
|
2008-09
|
2009-10
|
2010-11
|
|
Deposits*
|
1080072
|
1360724
|
1679993
|
2105706
|
2583934
|
3127122
|
Deposits@
|
25.98
|
23.46
|
25.34
|
22.71
|
21.02
|
|
Advances*
|
734608
|
957877
|
1203678
|
1519762
|
1843082
|
2311478
|
Advances@
|
31.75
|
25.66
|
26.26
|
21.27
|
25.43
|
|
Investments*
|
408796
|
452981
|
536018
|
655042
|
828125
|
942837
|
Investments@
|
10.83
|
18.33
|
22.20
|
26.42
|
13.85
|
|
CD Ratio
|
68.014
|
76.395
|
71.648
|
72.181
|
71.328
|
73.917
|
Investments#
|
37.849
|
33.289
|
31.906
|
31.108
|
32.049
|
30.150
|
2005-06
|
2006-07
|
2007-08
|
2008-09
|
2009-10
|
2010-11
|
|
Deposits*
|
130456
|
138249
|
165589
|
199274
|
229897
|
264157
|
Deposits@
|
5.97
|
19.77
|
20.34
|
15.36
|
14.90
|
|
Advances*
|
82957
|
92887
|
111670
|
128504
|
154085
|
184647
|
Advances@
|
11.97
|
20.22
|
15.44
|
19.80
|
19.83
|
|
Investments*
|
45254
|
43647
|
54080
|
72393
|
83499
|
92617
|
Investments@
|
-3.55
|
23.90
|
33.86
|
15.34
|
10.92
|
|
CD Ratio
|
63.590
|
67.188
|
67.146
|
64.486
|
67.034
|
69.900
|
Investments #
|
34.689
|
31.571
|
32.659
|
32.328
|
36.320
|
35.061
|
2005-06
|
2006-07
|
2007-08
|
2008-09
|
2009-10
|
2010-11
|
|
Deposits*
|
298000
|
413738
|
509444
|
537104
|
592904
|
738602
|
Deposits@
|
38.84
|
23.13
|
5.43
|
10.38
|
24.57
|
|
Advances*
|
230005
|
321865
|
406733
|
446824
|
478356
|
612886
|
Advances@
|
39.94
|
26.36
|
19.85
|
7.06
|
28.12
|
|
Investments*
|
135314
|
171008
|
224498
|
234139
|
270618
|
329403
|
Investments@
|
2.67
|
31.28
|
4.29
|
15.58
|
21.72
|
|
CD
Ratio
|
77.182
|
77.794
|
79.836
|
83.191
|
80.680
|
82.979
|
Investments#
|
45.407
|
41.332
|
44.067
|
43.592
|
45.642
|
44.598
|
* Figures Rupees in Crore
@ Progress in percentage on year on year basis
# Deposit Investment Ratio
|
The rate of growth of eight core sectors improved
from 2.8% in 2008-09 to 6.6% in 2009-10. It moderated to 5.8% in 2010-11. In
2011-12(Apr to Feb), eight core sectors recorded a growth of 4.4% compared to a
growth of 5.8% in the corresponding period of 2010-11. Lower growth rate during
2011-12 was mainly due to a lower growth in crude petroleum, natural gas and
steel sectors.’
The Eight core industries have a combined weight
of 37.90 per cent in the Index of Industrial Production. The combined Index was
158.4 in March 2012 with a growth rate of 2.0% compared to their 6.5% Growth in
March 2011. During April to March 2011-12, the cumulative growth rate of the
Core industries was 4.3 % as against their growth at 6.6% during the
corresponding period in 2010-11. The factory output measured in term of Index of
Industrial Production (IIP), declined by 3.5 per cent in March, 2012, against
an impressive growth of 9.4 per cent a year ago. It
was mainly due to weaker domestic demand and tumbling exports. Falling industrial output and deteriorating
currency and inflation are the challenges before Reserve Bank of India .
What RBI should do?
The preamble to the Reserve Bank for India states that “to regulate the issue of Bank
notes and the keeping of reserves with a view to securing monetary stability in
India and generally to operate the currency any credit system of the country to
its advantage.”
“Generally, the
Governor is a person who hails from Government service, usually in the Ministry
of Finance in the capacity of secretary or some such very senior position. So
it is difficult for him to adjust himself from the position of being a
subordinate of the Finance Minister…. He does not have the mental make up to
argue his case powerfully and fearlessly. He is cowed down easily by the
Finance Minister.”2
This means that RBI governor is a puppet in the hands of bureaucrats
of Ministry of Finance; hence he can not take independent decision and even if
he takes independent decision, for better of the economy, but does not suit the
government he can be removed from office in terms of Sec. 11 of RBI Act.
Thus “The Governor talks from an inferior position, a
subordinate of the finance minister. His job is dependent……. on the pleasure of
the Finance Minister” 3
Time magazine called Prime
Minister Manmohan Singh as an ‘underachiever’. I have a feeling that
“as a Governor of RBI he always talked from an inferior position, a subordinate
of finance minister.” Probably this was the reason that he could not perform
and was termed as “underachiever”.
If RBI really wants to control inflation and regulate
monetary stability, it has to be out of the clutches of Ministry of
Finance and has to be independent, autonomous
with no
strings attached. RBI being the Central Bank of the country has to decide what
government has to do. It is RBI who has to decide the quantum of physical
deficit and government has to abide by it and gradually reduce it over a period
of time. If government really wants to control inflation and wants the economy to
prosper, it should not interfere in the affairs of RBI and banking industry.
Unless RBI has free hand the problem of inflation is not going to be resolved.
In USA
the Board of Governors of the Federal Reserve System is appointed by the
President. The Banking Act of 1935 clearly stipulates this. The appointment is
confirmed by senate. Once appointed, Governors may not be removed from office
for their policy decision. The chairman and vice-chairman are chosen by the
President from among the sitting Governors for four-year terms; these
appointments are also subject to Senate confirmation. Similarly eminent
economist should hold the key position in RBI and not the burucrates. President
should appoint Governor and deputy governors for a minimum term of seven years
and should have the same status as judges have. Governor and deputy governors
can not be removed by finance ministry.
RBI
acts as banker, both to the central government and state governments. It
manages all the banking transactions of the government involving receipt and
payment of money and provides short-term credit to the central government. Such
credit helps the government to meet any shortfalls in its receipts over its
disbursements.RBI also provides short term credit to state governments as
advances and manages all new issues of government loans, servicing the
government debt outstanding, and nurturing the market for government.
Reasons
for Inflation:
The
fiscal policy is concerned with the raising of government revenue and incurring
of government expenditure. Fiscal policy decides the size and pattern of flow
of expenditure from the government to the economy and from the economy back to
the government. In other words, fiscal policy refers to the policy of the
government with regard to taxation, public expenditure and public borrowings. One of the main objectives of fiscal policy is to
control inflation and stabilize price. The major reason for inflation is getting more
money in the market and the government contributes heavily to this problem.
2010-11
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2009-10
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2008-09
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“The Reserve Bank was not set up primarily for
being lender to the government sector, whether as the last resort or the first
resort. About forty years ago, when things were not so bad as now, that
well-known and outspoken economist, Dr. S.K. Muranjan, had asked the question
whether the RBI should not be closed down.” 4
2.
RBI must ask
banks every time what they did when CRR was reduced. This would give RBI how
banks are using cut in CRR.
3.
Make it clear
to the Ministry of Finance to gradually reduce physical deficit.
4.
It is RBI who
has to decide supply of money in the economy and not the government.
5.
Banks to popularise
debit cards, and curtail issuance of credit cards as its use results into
inflationary trends in the economy.
6.
All payments
above Rs.50,000 to be made by cheques/bank drafts or through bank account by
using RTGS/NEFT.
7.
There has to
be strict vigilance on property and real estate finance.
8.
The High
Denomination Bank Notes (Demonetization) Act, 1978 states “Whereas the
availability of high denomination bank notes facilitates the illicit
transfer of money for financing transactions which are harmful to the national
economy or which are for illegal purposes and it is therefore necessary in the
public interest to demonetise high denomination bank notes….;”
Therefore
time has come for demonetising high denomination notes of Rs.500/1000
immediately, as this would curb black money, reduce money supply and control
inflation.
In the past Rs.
1000 and Rs.10000 banknotes, which were then in circulation in January 1946
were demonetized to curb unaccounted money. The higher denomination banknotes
reintroduced in the year 1954, for Rs.1000, Rs.5000 and Rs.10000 were again
demonetized in January 1978.
Conclusion:
While
forming monetary and fiscal policies it becomes difficult for the government to
take into account the circulation of black money in the economy. Black-money
results in parallel economy. It is estimated that the amount of black-money has
reached over INR 72 lakh crores (appx.).
2. Page 133/134 of
Central Banking Revisited in “The voice of Wisdom by
Prof.S.L.N.Simha, Southern Economist Publication, 2004, Bangalore
3.
ibid page 133
4. ibid page 170
‘Ramifications of Fiscal Indiscipline’
7.
A Profile of Banks 2009-10 and 2010-11 Reserve Bank of India
publication
8.
Reserve Bank of India Act, 1934