What’s Up With the Economy?

Oil prices – high. Food prices – high. Overall inflation – high. Losses – high. Sensex – down. With all these problems, stress in the economy has transcended the normal degree. The budget management of families has been shattered. People have started to liquidate their savings and a normal middle-class family is not left with enough to save. Everyone is wrapped in their own problems and the greatest concern is to put even a single rupee to the best use.

Oil prices have been spiraling around $145/ barrel either due to speculation or the international supply-demand factors. Currently, the Algerian Energy Minister and President of OPEC, Chakib Khelil, said on Thursday that prices could reach $170 dollars a barrel in the coming months, and stressed that speculation – and not a supply problem – was driving oil to new highs. With such a condition, the demand for cheaper fuel (CNG & LPG) has increased by three-folds.

Iinflation is out of control at 11.63 per cent for the week ended June 21, the highest since the annual numbers in the current series began in 1995. It was 11.42 per cent in the week earlier.

The RBI has responded to the rising inflation by increasing the repo rate and the Cash Reserve Ratio (CRR) by 50 basis points.

The RBI’s decision came within days of the Finance Ministry saying that monetary steps are the first line of defense in the fight against inflation which touched 13-year high of 11.05 per cent for the week ended June 7.

The hike in CRR has increased to 8.75 per cent from 8.25 per cent. Now, since the CRR has increased, this impacts the banks in terms of lending the loans to the borrowers. As the percentage of the deposits with the RBI has increased, the money available with the commercial banks has lessened. With lesser money in hand, the lending capacity gets affected. And, decline in the lending capacity means a decrease in the aggregate demand for the consumers, which in the long term, affects in favor of anti-inflation.

Now the repo-rate (the short term lending rates to the commercial banks by the RBI) has also increased under the revision of the monetary policy. The RBI had earlier increased the repo rate by 0.25 per cent to 8 per cent on June 11. And, with the revision of the monetary policy it has further increased to 8.5 per cent, a 50 basis point increase. This means that, if in any case, the commercial banks across the country needs short term loans to meet the demand for loans; the RBI would lend the funds at the above mentioned rate. The repo-rate is less than the current market rate prevailing in the country. In addition, the lower rates are accompanied with a set of persuasion and pressure by the RBI (also known as moral suasion) so that the commercial banks don’t borrow much from the RBI and instead go to the open market where high interest rate prevails. Now, the UPA government has increased the repo-rate and this means that the cost of borrowing funds has increased for the commercial banks. With increase in the rate at which the commercial banks buys, these banks pass on the burden onto the consumers. When consumers have to pay a higher rate of interest on every loan they take, the aggregate demand slides down. No company would like to purchase a land when the cost of buying it has increased recently. Therefore, a decrease in the aggregate demand pushes down the prices. The entire process takes months to come into action, provided that the correct measures have been taken to control inflation.

Sanjay Kataria


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