Rate hikes to keep bean counters soaking

The worst isn't over. It may be wiser for India Inc to prepare for more interest rate hikes in the coming days. The chairman of prime minister's economic advisory council, C Rangarajan, has warned India Inc of the possibility of further interest rates hike and to factor in higher interest costs in their future planning to mitigate adverse impact of interest rate hikes.

Justifying the monetary measures initiated by the Reserve Bank of India, Mr Rangarajan underscored the need to contain inflation that can be achieved through various monetary measures the central bank has recently taken. High inflation is inconsistent with high growth in the long run. Policy makers need to do a balancing act of keeping inflation low and maintaining the growth momentum, he said.

Prudent policy measures in 1995-96 helped avert the impact of the Asian crisis in 1997. Similarly, the monetary authorities are right in taking the measures at a time when money supply growth is high in order to prevent future troubles. Corporates must also factor in the possibility of rising interest rates.

Inflation cannot be brought down if money supply growth is high and, therefore, there is a need to keep inflation low by restraining money supply growth and credit growth, he said. Sustained high inflation could be counterproductive and also have adverse impact on savings. Mr Rangarajan was addressing a round table discussion, An economic architecture for 10% GDP growth, organised by the Bombay Chamber of Commerce & Industry in Mumbai on Monday.

Although inflation was much higher in the 1980s and 1990s, it was against the backdrop of high global inflation. However, inflation has come down globally, and, therefore, there is a need to moderate inflation now, he said. As a result, the acceptable levels of inflation for the economy are also much lower now.

One of the signs of overheating in the economy is when inflation and current account deficit are running high. In India, inflation is running higher than the accepted level of 5.5%. Regarding current account deficit, it is not likely to exceed 1% of GDP. However, trade deficit is high at 6-7% of GDP as the surpluses of the services sector have helped to offset the trade deficit to an extent.
Thus, it cannot be denied that there are signs of overheating, he said. However, he said, overheating at present is cyclical in character and we should take care to prevent cyclical overheating from becoming structural overheating. It is in this context that a greater emphasis on availability of power assumes importance.

He outlined six challenges for the economy to maintain the high-growth momentum. These include stepping up agricultural growth, infrastructure development, fiscal consolidation, building social infrastructure, managing globalisation and good governance. Source:ET

Some intersting reasons for rise in Inflation

Here are some intersting views of readers on internet on rise in inflation (current scenario in India):

• There are 101 reasons why inflation may happen.But which reason is biggest contributors as of today? Well, it is because RBI-Gov is printing busload of curreny notes (Rs 72000cr in past 52 weeks, some 17% of volume back then) and as a result M3 exploded by Rs 450,000cr in 52 weeks (some 18% of base back then).Now do you expect prices to decrease?---The crude price increased for SAME reason. The M3 supply of US was rising at 5% to 7% a year. And crude supply increased at the reate of 2% to 3% a year. Despite wars, the total supply of crude did NOT drop. So war is NOT a reson why crude price went $30 in 90s to now $50 to $60.--There are 10s of other reasons. But above is most important as of today.
• Inflation is ONLY and EXCLUSIVELY due to the increase in the monetary mass, including paper and coin currency, government debts, fractional reserve banking credits as guaranteed by government etc.It is IMPOSSIBLE to have inflation through demand when the monetary mass remains fixed. Inflation = General increase in prices. Demand pressure = Increase in prices in the sector with higher demand, DECREASE of prices in the sectors with lesser demand, which is exactly what you want to get from a monetary system!!!This is called FEEDBACK: higher prices attract producers to the sector where demand is high and capacities are too low, while removing them from those areas that have low demand.If you can produce a mathematical model by which the total monetary mass stays the same but all prices rise and total turnover remains the same or increases, but it would be magic, not mathematics. "external supply shocks such an increase in the oil prices may lead to an overall increase in prices without there being an increase in the money supply"Sorry, MATHEMATICAL IMPOSSIBILITY!!! Something has to give, so some products DROP in price or completely disappear from the market, hence the added unemployment.So the statement that "all prices rise" is simply false.Price will rise for those goods that have a rigid demand, while goods with a flexible demand MUST lower their price or will lose in sales volume.This is exactly what happens with VAT: supposedly, producers can simply pass on the tax to consumers, but this is not at all what happens. Since ALL prices can not go up simultaneously and at the same consumption level, unless government increases the money supply by the VAT rate, almost all businesses will lose some income - some more, some less. Some because they don't "pass on" the tax, some because their volume will drop.Very few business will be able to maintain their sales and income intact, because the demand for their goods or services is rigid, but only at the expense of some other businesses.
• Interest rate = Inflation+ Risk premium + Cost incurred + Profit. So if inflation increases then interest rate increase while its opposite i.e inflation increase due to interest rate increase is not right statement. One example of this is Japan where interest rate is almost zero because there is no inflation.
• To understand how interest rates impact inflation - inflation first needs to be split into two types: demand drive and supply driven. Typically demand driven inflation starts from a low interest rate regime, which in turn creates a demand for credit. This channel translates into more money in the hands of people and a demand driven push takes place driving to higher inflation. In this case the central bank hikes policy rates, which then drives banks to raise rates. As the price of credit i.e. interst rates rises, the demand for credit declines. The impact of interest rates on inflation in this case is a function of (a) intial level of rates and (b) rate of capacity creation in the economy. If the initial level of rates is close to rock bottom as was the case for the US economy before the Fed started raising rates during the last round, then it maybe a while before they begin to bite. It may take about two years or so before any real impact takes place (though again this is dependent on the kind of monetary policy that is being followed).In the second kind of inflation i.e. supply driven, as in the case of an oil shock etc, interst rates make less of a material difference to inflation levels to start with.