RBI is inflating the Indian economy
Saturday, 16 August 2008
Syed Zahid Ahmed from Mumbai
THE recession in the US and the prevailing uncertainty in petroleum-producing nations provides an opportunity for India to pull capital resources from the US and Gulf countries. But the practical approach of the Reserve Bank of India (RBI) has converted the opportunities into challenges as the liquidity and inflation is certainly not under control of the RBI. The central bank is attempting to freeze the liquidity by increasing the interest rate and cost of credits. The Federation of the Indian Chamber & Commerce (FICCI) and the corporate sector have already criticised the RBI's recent announcement to increase the rate of interest.
With trend of increased capital inflow to India, the aggregate deposits by the scheduled commercial banks (SCBs) have increased from 80.7% in 2005-06 (Rs. 21,09.049 billion) to 102% (Rs. 31,96.939 billion) of gross domestic product (GDP) at factor cost by 2007-08. With increased deposits, the bank credits has also increased from Rs. 15,07.077 billion in 2005-06 to Rs. 23,61.914 billion by 2007-08, reflecting 75.6% of GDP at factor cost in 2007-08 as credit against 57.7% in 2005-06. This indeed is a situation where our economists and financial sector regulators need to review the policy and practices adopted by the RBI as we hardly evaluate the multi-level impact of interest in our economic process.
The theory of J. M. Keynes has failed to guide us optimising the growth opportunities with abundance of foreign direct investment (FDI). The practical approach of the RBI to curb the rate of inflation by increasing the rate of Repo Rate and cash reserve ratio (CRR) for last 24 months (since July 2006) is not controlling inflation. It is instead leading towards stagflation as the prices continue to increase, but the expenditure, investment and net GDP growth rate is falling.
By increasing the Repo rate and CRR, liquidity might be freezed for shorter period, but it will increase cost of credit and output. That inflate the GDP value. Since July 2006, the RBI is increasing the Repo Rate and CRR, but inflation is also increasing. Interestingly, the interest income to SCBs was Rs. 1,85.385 billion in 2005-06 which increased to Rs. 2,37.271 billion by 2006-07. It means by 2006-07 total interest income to SCBs was 7.1% of GDP at factor cost. It simply means that the interest income to SCBs has inflated the value of GDP at factor cost by 7.1%.
With increase in rate of interest, the aggregate deposits might increase and SCBs may need to pays more interest over increased deposits. Total Interest expended by SCBs over deposits was Rs. 89.742 billion in 2005-06 which increased to Rs. 1,20.261 billion by 2006-07 showing a net annual increase of 34%. This growth is inflationary as it increases the buying capacity of the depositors. By 2006-07, the interest expended over deposits was around 4.20% of GDP at factor cost.
If we add the interest income of SCBs to interest expended over deposits, it stands for around 12.5% of GDP at factor cost and 8.6% of GDP at market prices in 2006-07. Considering the impact of interest on inflation, we may need to add interest income of SCBs through investments / commercial credits with interest expended by SCBs over deposits. This amounts to approximately 9.0% of GDP at factor cost and 5.0% of GDP at market prices in the year 2006-07 while annual rate of inflation was 6.7%.
It reflects that basically inflation is a result of interest charged on credits expanded by SCBs and interest expended over deposits. The interest charged by SCBs increases the cost of GDP and the price levels, while the interest paid by SCBs over deposits increases the purchasing power of the depositors. Both ways the interest is increasing the price level and causing inflation. Since the RBI regulates the banking business in India, by increasing rate of interest it is increasing the inflation and decreasing the real-term growth rates.
Further to note that the RBI is increasing the rate of interest for over one year to control the inflation which ultimately increasing the cost of GDP showing higher GDP value and increasing inflation instead of controlling it. Our total final consumption expenditure as percentage of GDP at market prices is already declining from 67.8 in 2005-06 to 65.5 by 2007-08. This decline, along with inflation, cannot be controlled by increase in interest rate. This economic tendency may leads to stagflation which is more dangerous for economic stability and growth. The RBI should review its policies and practices to monitor liquidity, credit and inflation, if India have to combat inflation and attain the desirable growth rate.
Often it is argued that inflation devaluates the money and interest over deposits compensates its money value, but this argument is missing to note the cruel problem of inflation which arises due to interest and could worsen, with more interest over deposits. Islamic economic ethics suggests mechanisms for stable and anti inflationary monetary system which should be adopted by RBI to make our monetary system more stable and anti inflationary. We hope the RBI will consider these ethics as measure to combat inflation and stagflation. The Islamic Banking principles and practices will not only increase the equity deposits and finances but also promote capitalisation and investments. It will help increase employment and business opportunities which are must for inclusive and faster growth of India at a time when the world is eying upon the Indian economy for making more investments. Otherwise consistent approach of the RBI to control inflation through interest rate may let the UPA government face cruel failures in capitalising the investment and growth opportunities with the worst-off inflation and stagflation.
....................................................
The writer may be reached at
e-mail: aicmeu@yahoo.com
THE recession in the US and the prevailing uncertainty in petroleum-producing nations provides an opportunity for India to pull capital resources from the US and Gulf countries. But the practical approach of the Reserve Bank of India (RBI) has converted the opportunities into challenges as the liquidity and inflation is certainly not under control of the RBI. The central bank is attempting to freeze the liquidity by increasing the interest rate and cost of credits. The Federation of the Indian Chamber & Commerce (FICCI) and the corporate sector have already criticised the RBI's recent announcement to increase the rate of interest.
With trend of increased capital inflow to India, the aggregate deposits by the scheduled commercial banks (SCBs) have increased from 80.7% in 2005-06 (Rs. 21,09.049 billion) to 102% (Rs. 31,96.939 billion) of gross domestic product (GDP) at factor cost by 2007-08. With increased deposits, the bank credits has also increased from Rs. 15,07.077 billion in 2005-06 to Rs. 23,61.914 billion by 2007-08, reflecting 75.6% of GDP at factor cost in 2007-08 as credit against 57.7% in 2005-06. This indeed is a situation where our economists and financial sector regulators need to review the policy and practices adopted by the RBI as we hardly evaluate the multi-level impact of interest in our economic process.
The theory of J. M. Keynes has failed to guide us optimising the growth opportunities with abundance of foreign direct investment (FDI). The practical approach of the RBI to curb the rate of inflation by increasing the rate of Repo Rate and cash reserve ratio (CRR) for last 24 months (since July 2006) is not controlling inflation. It is instead leading towards stagflation as the prices continue to increase, but the expenditure, investment and net GDP growth rate is falling.
By increasing the Repo rate and CRR, liquidity might be freezed for shorter period, but it will increase cost of credit and output. That inflate the GDP value. Since July 2006, the RBI is increasing the Repo Rate and CRR, but inflation is also increasing. Interestingly, the interest income to SCBs was Rs. 1,85.385 billion in 2005-06 which increased to Rs. 2,37.271 billion by 2006-07. It means by 2006-07 total interest income to SCBs was 7.1% of GDP at factor cost. It simply means that the interest income to SCBs has inflated the value of GDP at factor cost by 7.1%.
With increase in rate of interest, the aggregate deposits might increase and SCBs may need to pays more interest over increased deposits. Total Interest expended by SCBs over deposits was Rs. 89.742 billion in 2005-06 which increased to Rs. 1,20.261 billion by 2006-07 showing a net annual increase of 34%. This growth is inflationary as it increases the buying capacity of the depositors. By 2006-07, the interest expended over deposits was around 4.20% of GDP at factor cost.
If we add the interest income of SCBs to interest expended over deposits, it stands for around 12.5% of GDP at factor cost and 8.6% of GDP at market prices in 2006-07. Considering the impact of interest on inflation, we may need to add interest income of SCBs through investments / commercial credits with interest expended by SCBs over deposits. This amounts to approximately 9.0% of GDP at factor cost and 5.0% of GDP at market prices in the year 2006-07 while annual rate of inflation was 6.7%.
It reflects that basically inflation is a result of interest charged on credits expanded by SCBs and interest expended over deposits. The interest charged by SCBs increases the cost of GDP and the price levels, while the interest paid by SCBs over deposits increases the purchasing power of the depositors. Both ways the interest is increasing the price level and causing inflation. Since the RBI regulates the banking business in India, by increasing rate of interest it is increasing the inflation and decreasing the real-term growth rates.
Further to note that the RBI is increasing the rate of interest for over one year to control the inflation which ultimately increasing the cost of GDP showing higher GDP value and increasing inflation instead of controlling it. Our total final consumption expenditure as percentage of GDP at market prices is already declining from 67.8 in 2005-06 to 65.5 by 2007-08. This decline, along with inflation, cannot be controlled by increase in interest rate. This economic tendency may leads to stagflation which is more dangerous for economic stability and growth. The RBI should review its policies and practices to monitor liquidity, credit and inflation, if India have to combat inflation and attain the desirable growth rate.
Often it is argued that inflation devaluates the money and interest over deposits compensates its money value, but this argument is missing to note the cruel problem of inflation which arises due to interest and could worsen, with more interest over deposits. Islamic economic ethics suggests mechanisms for stable and anti inflationary monetary system which should be adopted by RBI to make our monetary system more stable and anti inflationary. We hope the RBI will consider these ethics as measure to combat inflation and stagflation. The Islamic Banking principles and practices will not only increase the equity deposits and finances but also promote capitalisation and investments. It will help increase employment and business opportunities which are must for inclusive and faster growth of India at a time when the world is eying upon the Indian economy for making more investments. Otherwise consistent approach of the RBI to control inflation through interest rate may let the UPA government face cruel failures in capitalising the investment and growth opportunities with the worst-off inflation and stagflation.
....................................................
The writer may be reached at
e-mail: aicmeu@yahoo.com