Sunday, October 14, 2012

Inflation and Role of RBI


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:

India launched Consumer Price Index (CPI) in January 2011.The CPI measures the prices of goods and services purchased by householders. Therefore, it is a better indicator for measuring general level of prices i.e. inflation. The data for CPI is collected from 310 cities and towns and 1,180 rural centers by National Sample Survey Organisation (NSSO) and from selected villages by the Department of Posts.

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 inflation rate in India was at 10.215 percent in April 2012. From 1969 until 2010, the average inflation rate was 7.99 percent. In September 1974 it was the highest at 34.68 percent, and was lowest -11.31 percent in May 1976.

 Classifying Inflation:

 Inflation in India can be classified into Price Inflation and Monetary Inflation. Price inflation is when the prices of goods and services rise. When inflation is high, firms and business houses face uncertainty about the future, and this changes their behaving pattern. Price changes provide useful information to producers in deciding whether they should produce more or less of a particular good or service. When inflation is volatile, it becomes less clear whether a price change reflects a change in the demand or supply of that individual good or service, or whether it is just part of a generalised movement in prices across the board.
Monetary Inflation is when supply of money increases in the economy.

                      
Objectives of Reserve Bank’s Monetary Policy:         

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.’

 “Market borrowing programme” mean the domestic rupee loans raised by the Government of India and the State Governments from the public and managed by the Reserve Bank of India through issue of marketable securities, governed by the Government Securities Act, 2006 and the Regulations framed there under, through an auction or any other method, as specified in the Notification issued in this regard.

 RBI introduced a new Marginal Standing Facility (MSF) from 9th May 2011 for availing funds from the Central bank on overnight basis against the excess holding of statutory liquidity ratio (SLR). The MSF is a second liquidity window offered by the RBI which can be undertaken in all SLR-eligible Government of India’s dated Securities/Treasury Bills and State Development Loans. MFS is on the lines of the existing Liquidity Adjustment Facility–Repo Scheme (LAF–Repo). Banks can avail a minimum amount of INR One crore and in multiples of INR One crore  up to two per cent of their respective Net Demand and Time Liabilities (NDTL) outstanding at the end of the second preceding fortnight.

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.

           Table-2   CRR/SLR

 
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
 
 
 
 

 It would be observed from table-3 that RBI raised borrowing rates fourteen times since March 2010, which was the fastest pace of interest rate rises among the major Asian economies.

 

        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

 The bank rate which was decreasing from 22.07.2000 and was stabilized to 6% on 30th April 2003 was further raised to 9.5% on 14th Feb.2012 and was again reduced to 9% from 17.04.2012 at 29th April 1998  level. The moot point is what happened within 2 months that the rate was further reduced?

                                                  Table-4   Bank Rate

                                     

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.

 This obviously means that CRR has no relevance in controlling money supply. On the contrary excess funds in the hands of banks do not go for productive purposes, but banks try to increase profit by deploying funds in their investment portfolio.

 The other question is that whether reduction in CRR really helps bank in pumping funds for productive purposes. Pumping of funds do not increase production of goods and services, but adds to inflation. Banks are even shy in investing funds in new units as they are not sure when the RBI would enhance rates. It is therefore better to be liquid by deploying funds in the investment portfolio.

 The demand for loans is a challenge for most banks as very few new projects are coming up. Yes, for existing units there may be a demand for working capital finances which may be mainly due to inflationary trend.

 Banks give cash credit limit to borrowers for their working capital requirements. Limit is worked out on the basis of both present needs and future growth which is reviewed every year. Prices of products increase with the rise in the cost of inputs.

                                      Table-5     Business of Banks                        

           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

                     State Bank of India and Associates

 
 
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

                         Nationalised Banks (including IDBI)

               
 
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

                                         Old Private Sector Banks                 

 
 
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

                      New Generation Private Sector Banks


 
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

 
When bank finances new units, funds are not disbursed at a go, they are disbursed gradually. Since a new unit has a gestation period, production starts only when the unit is commissioned and starts operation.

 Demand for housing loans, in tier-II and III markets are expected to grow by 20-22 per cent during this financial year. Higher growth in real estate causes inflation as unaccounted money is pumped into this sector.

 Growth of Core Sector:

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.”

 RBI act also states that “The Central Government may from time to time give such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public interest.”

“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.

 
Reserve Bank of India:

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:                                                     

 Inflation in India is mainly due to the policies of Government, Reserve Bank and circulation of black money in the economy. Government influences the economy, by monetary policy and fiscal policy. Monetary policy is the popular instrument for managing inflation in any economy. It can not affect the economy's capacity to supply, but can stimulate or dampen demand. It is managing the supply of money in the economy by adjusting short-term interest rates. The Reserve Bank tries to influence the output gap.

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.

 Unless the Government looks at its own revenue and expenditure gap and reduces it to a manageable level, inflation will continue. It would be observed from table-6 that RBI’s Net bank credit to government has substantially increased over the period.

                                    Table -6

 
2010-11
19,827.7 Billion
2009-10
16,691.9 Billion
2008-09
12,773.3 Billion

 
The major portion of the physical deficit has been financed by the banking system, particularly by the Reserve bank. A large fiscal deficit with large expansion of bank credit to government leads to substantial increase in money supply which is the main cause of inflation, provided there is substantial increase in production.
 
“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  

 Solution for controlling inflation:

 The RBI’s monetary control measures and finance ministry have to take economic measures for controlling rising inflation. Changing policy rates will not do much in curbing inflation unless care is taken of other bottlenecks in the economy. There has to be focus on building infrastructure, putting a lid on deficit, and in improving the supply side economics.

 1.    For reducing flow of funds in the economy, banks should be asked to increase deposit ratio at least minimum 25% over the previous year.

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.).

 Government has to give a high priority to keeping control of inflation, but it has miserably failed. Government has to control deficit financing and give free hand to RBI in dealing with the situation, even though the decisions of RBI may not be palatable to the Government. The unaccounted money has become one of the dominant objectives of macroeconomic policy. Government has to take stern action for controlling black money as actual circulation of black money results into higher inflation.

 References:

  1.    Central Banking Revisited in “The voice of Wisdom” Page 151/152 by Prof.S.L.N.Simha, Southern Economist Publication, 2004, Bangalore

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’

5.    http://dbie.rbi.org.in for Tables:-2,3,& 4

6.    http://www.global-rates.com/ economic-indicators/inflation /consumer-prices/cpi/india.aspx

7.    A Profile of Banks 2009-10 and 2010-11 Reserve Bank of India publication

8.    Reserve Bank of India Act, 1934
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