Saturday, February 19, 2011

India inflation explained

In this crisis ridden world, economies around the world are experiencing high bouts of inflation (see here), and India is no exception in that. Indian economy is facing the effects of severe inflation in the form of rising food and energy prices (see here, here, and here). Indian government is either clueless about the cause of this inflation or is pretending to be clueless to fox the people from seeing the true cause of this rise in prices. Moreover it is trying to shift everyone's attention from the true cause of inflation by creating scapegoats like consumers (high demand), hoarders, speculators, food drought etc. This is an age old trick which all governments use to fool its populace when it embarks on the inflationary path in full speed.

In this blog I will expose Indian government's lies and will explain the true cause of inflation.

Why inflation?
Inflation is increase in the supply of money due to government's money printing process through its central bank (RBI in case of India). It's primary effect is rise in prices across the economy, although initially in an uneven manner, and then generalized once full inflationary effect sets in. The reason there is double digit inflation in India (and around the world) is this same government money printing world wide through central banks, especially printing by US federal reserve i.e., the so-called 'quantitative easing' program (QE1, QE2 and soon to be announced QE3, QE4 and so on).

Since the beginning of recent financial crisis in 2008, Indian government is printing gargantuan amount of money. Here are the evidences:
  1. Stumulus package 1, Package 2 and this, Package 3
  2. More money printing from RBI in 2010 (Here, here, and here)
  3. Since November 2010 Indian banks are borrowing on an average 1 trillion rupees daily from RBI!!! (read this)
  4. Indian government is bailing out bankrupt PSUs e.g., recent Air India bailout of 12 billion rupees.
Not only this, USA is also exporting inflation around the globe through its QE programs. How? Here's how:

The US dollar is an international reserve currency. That means every country citizens need it for trade transactions with other country citizens (although many countries have started to dump the dollar because of its falling purchasing power as a reserve currency e.g., recently China and Russia decided to carry out the mutual trade in their respective currencies. And now India and China has also decided to dump the dollar). Thus the demand for dollar is universal due to its international reserve currency status.

After the financial crash of 2007, US economy is in recession. To take the economy out of recession US central bank Federal Reserve and the Federal government is following Monetarists and Keynesian policies. In nutshell these policies are nothing but 'printing massive amount of money' and thus increasing the money supply. These people (falsely) believe that spending huge amount of paper currency will spur the aggregate demand and that will lift the economy out of recession. Following this reasoning US Fed is conducting its QE programs, and Potomac is accumulating massive amount of debt.

These deliberate policies of debasing the dollar is resulting into two things:
  1. Commodity (crude oil, food items like wheat, rice etc., base metals like copper, aluminum etc.) prices are rising because they are traded in dollars in international market (see here, here, and here). These are all important items in India's import bill. Because of these costly imports Indian domestic prices are going higher e.g., petrol/gas prices.
  2. International Investors are pouring the newly created supply of dollars into emerging market economies to protect their returns which is loosing value because of weak dollar and ultra low interest rates in the developed world markets. This hot money is pouring in the Indian capital market (BSE, NSE etc.) lifting the rupee:dollar exchange rate resulting into rupee appreciation against the dollar. Strong rupee is creating troubles for the exporters. They are finding it difficult to sell their now dearer products in the international market. Because of this, they are lobbying the government for protection. Today's mercantalist governments believe that export is good for the economy and import is bad so they all try to boost their export sectors by artificially keeping their currency cheap in the international market (beggar thy neighbor policy). To stop rupee from appreciating, RBI is intervening into Forex market to buy dollars to make rupee cheap again (for example see here and here). For that they are printing more rupees. This increases the rupee money supply, which is INFLATION.
Once inflation is created by the Indian government, RBI, and USA its evil effects slowly spreads into economy in the form of higher prices. As the printed rupee gets into people's hand (in form of wages, loans etc.) they go and spend that money in the market for consumption raising demand for goods and services compared to its available supply at that given point of time, which bids the prices of those goods and services higher.

Supply shock in the form of political manoeuvrings by the politicians and resource misallocation by the government central planning (subsidies, import/export ban etc.) exacerbates this situation. On one side rupee is loosing its purchasing power because of Indian government's money printing programs and on other side already scarce supply becomes more scarce due to various supply shocks. This results into astronomically higher prices of various products.

Conclusion
Inflation in India and all around the world is a result of government & central bank's crazy Keynesian Monetarists policies of printing money to get economies out of recession. They don't understand that by printing money they are only going to create more havoc in people's life by creating inflation or possible hyperinflation. Printing money is not wealth creation. It actually destroys wealth. It results in capital consumption which reduces the possibilities of higher economic growth in future. Governments around the world are blowing another big economic bubble which surely will bust in future taking all economies with it in the great depression.