Saturday, January 22, 2011

Inflation Nation

Anyone who goes to his local grocery store in the corner of the street realizes that the cost of basic food and vegetables have gone up many folds in recent months. The story is similar in almost all commodities across the various segment of people. Unfortunately it affects the poor people more than the rich people. This is because the percentage of money allocated for food is higher in the lower income group than others. Any price rise will affect the BPL (Below Poverty Line) and lower middle class segment of the population directly. Since the majority of Indians fall in this category its not a pleasant environment. Vegetables are part of regular Indian meal and they are consumed in abundance compared to other western nations. Onions and tomatoes are basic ingredients in any Indian food preparation. When the price of these items go from Rs. 20 a kilogram to Rs. 80, the ordinary people have the reason to be upset. It affects their monthly budget. Prices rises are significantly gone up for dhaal, oil, sugar and you name it. Even construction material cost have gone up making land, housing cost go through the roof over years now. Bottom line, the price rise is across board through out the country. We have the economist Prime Minister in Dr. Manmohan Singh, and its wondering what does he think conceptually on this. The recent press conferences from him merely reflects his political face rather than his economic thoughts.

The government as usual has come out against the rising pricing prices with more words, than actions, and has blamed it on the term "inflation". Inflation according to the government is the reason for price rises. Contrary to what the government says, inflation is NOT price rises. Price rise is the 'consequence' of Inflation. The Inflation itself is a concept of lose monetary policy (that is originally proposed by the government). The government completely hides this big elephant below the mat and propagates its version of story across the country. And in many ways succeeded. Inflation can be summed up as : too much money chasing too little commodities. People posses the money and are willing to pay more for the commodity that is in scarcity. lets take the example of onion price in reason days. The government is conveying a notion that the price of onions have shot up, because the of "more rain" in Maharashtra and Gujarat, the bigger producers of onions. This may be part of the reason, but not the entire problem. Politician always are comfortable to blame it on the seasonality factors. It suits them to hide the truth, and the listener for some reason buys that argument. If that was entirely true, it should always be true that people in a remote north Indian state of , Assam or Nagaland consumed a significant percentage of onions grown in Maharashtra or Gujarat. This is not the case. Bulk of the perishable items can only be locally grown and consumed in countries like India, where we lack huge storage facilities.
It would make sense to believe, the supply for the local community has come down because of loss in production or artificial demand creation facilitated by middle men and hoarders.
When the government managed to blame it on the rains for onions, what is the explanation it can give to the rise of price of cement, for example. It is just a chemical that is artificially produced. Its prices have gone up still. So the reasons for price rises are not what the ministers say in press interviews, the problem is bigger than what it is.

There are two kinds of inflation. Anticipated steady inflation and unanticipated inflation. The later is more lethal than the former. When people expect inflation to occur steadily over time, people are prepared for it. They make financial decisions based on that. The concept of leasing home dwelling is a good example. A family walks into a home, it pays the landlord a substantial amount, say 10-20% of the value of the house. They reside in the house for a predetermined period of time, say 5 years. After the lease expires the landlord gives back the same exact money. The assumption in this trade was the revenue generated on the initial principal equates to the rent on the property in the period. This is a classic case, where there are marginal inflation and no boom boom inflation. Both the owner and tenant benefit in the transaction. However these days, these deals are no longer common. It is because of unanticipated inflation prevalent in the recent decade. This crushes out the savers. Anybody who has money in the bank lose the value of money they hold. They do not anticipate the loss they make on risk free saving. It is just a wipe out and eaten out by inflation. Fixed income group of people lose their livelihood in the process, for example retires. The interest rates prevalent in the market and the ones published by RBI (Reserver Bank of India) do not do ample justice to these people.

For today's Indian problem of Inflation, the RBI does have a major role. It is merely a tool in the hands of the government. Usually the RBI publish and maintain interest rates on the market. As of now, the interest rate in India is around 6%. What it means is a person who has money in the bank, say Rs. 100/- gets a annual interest of 6%. So he ends up with Rs.106/- end of the year. It is the interest acquired on the principal. No risks, no hassle savings. The problem with that is - the real inflation is more than that. It is in double digits, with food inflation at 16%. So what it basically means is, the commodities he bought of Rs.100/- a year before is now worth Rs. 116/-. So basically the money has lost value in spite of the interest. The saver actually lost money by having it idle. Ideally interest rates must be higher than the inflation to encourage savings. Mathematically a 7% annual rise, doubles the value in 10 years. Savings are very important for the growth of the society. Savings create capital and create wealth and in turn create jobs. India really needs a high interest, low inflation society for a long term growth. In Brazil today, the interest rate is more than 11%. The Brazialian real has appreciated 35% against the US dollar in the last year alone. India should learn from Brazil.

The important thing that really really worries me is the RBI 'policy on inflation' where they "expect" inflation at 4-6% and consider that acceptable. Meaning they want a price rise of 5% a year on every Indian Citizen. How many of them make a pay rise of 5% a year at their work. Why can't we have it at less than 1 or 2 percent, like in most developed countries and in likes of China, Brazil. Economic principles are same across any nation of any size and richness.

When i mentioned the lose monetary policy followed by the government, it means low interest rates, and more importantly a lot and lot of printing artificial money, or fiat currency - rupees. The RBI prints money and it prints a tonne of it. This is the fundamental problem contributing to Inflation in India. It is just been 5 years, we have moved from abundant Rs.500 rupee bill to Rs. 1000 rupee bills. Until 5 years before the Rs. 1000 bill wasn't common. Now its everywhere. This is bad, and its going to cost the country dear. It is just a matter of time, they come up with Rs. 2000 or even Rs. 5000 rupee bills. This is the real problem. So now we know, why too much money chases too few goods. Countries create money out of thin air, and prosperity cannot be achieved through this. It generates a artificial period of growth, and eventually inflation will catch up, and will lead to ruins. The value of currency must go high and not low. These economist you see on TV say, the money losing value is a good thing because it encourages export to other countries. It is a void argument. It makes the exporters become poorer. The society becomes rich only on production and savings., and not by export based on cheap currency parity. If the government of India increase the interest rates significantly and STOP money printing, encourage production, the inflation will ease. The Prime minister Dr.Manmohan Singh, one of eminent economist the country has seen, realizes this? Isn't this basic economics. The counter argument, the RBI may make is to show the forex reservers accumulated by India that accounts to over $300 billions. Technically India can print as much money as the foreign reserve it holds. Unfortunately the foreign reserve itself is a fiat currency. Someone should ask Mr. Subba Rao, the RBI governor, how much Forex reserves does the Chinese have (they have 3 trillion), and why is the chinese yuan lot stronger than the Indian rupee vis-a-vis the US Dollar. (~6 yuan = 1USD).

For centuries, food production has been India's life blood. I am in all favor of food and farm subsidies in India. Agriculture is the primary occupation in the country and is monsoon dependent. The government must subsidize it and PDS (public distribution system) has to be made more efficient. This will reduce the inflation pressure on the BPL and middle class population. At the same time, i am against any other form of subsidizes like color tv sets, marriage funds, free housing, and other junk schemes these politicians come up at the time of elections. These are complete waste of money and affect the regular market structure. For example the cost of constructions materials have gone up after the Tamil Nadu government's "thoguppu veedugal" scheme, where the government gives free money to people to build homes. the government has no role to play in these things. It causes more problems than it solves. The other one is by the same government to pay insurance premiums to big health insurance companies for poor people to access doctors and hospitals when they get sick. This is a completely bogus scheme that is just a attention catcher than really benefit to people. If the government wants to give good health care to poor, it must refine the heath ministry and provide efficient and modern health care through the government hospitals that are already in place and are functioning inefficiently. That would give longer life for the poor.

The RBI and government have made India, an inflation nation. The government has to come up with policy that will encourage production and savings. Self-sufficiency in food can only be attained by that. Rationing everything is not going to solve the issue. It provides temporary relief but does not solve the problem. We need to move to an environment where prices remain stable, food production increases year after year. Printing money and pretending India is growing at a good rate, with such a huge inflation is very harmful. No growth is better than bad growth.

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