Friday, September 12, 2014

Why India is not able to tame Inflation

Inflation has been the most important phenomena for Indian economy for last 3 years. It has run like a wild fire and remains uncontrollable. In spite of tightening cycles of RBI, the inflation does not seems to be under control.
Before we venture into why India is not able to tame, we need to understand the nature of inflation especially from the perspective of demand side and supply side inflation. Both essentially drive the supply demand curve but impact the curve in a different way. A demand side inflation is basically because of high demand of commodity whose supply is still at the same level. However the supply
side inflation is because of the issue of supply side constrains itself at the first place.
We saw demand side inflation till 2008-09, till around Lehman collapse. The housing sector was a
clear example of demand side inflation at that point of time. Also with an expectation that the housing prices will keep on increasing gave legs to inflation further. Also with the new found prosperity in India, Indians took a bold step in the direction of consumption economics. Similar thing happened in China and two fifth of the population of world is a sure to impact.
To contain the inflation, RBI got into the mode of interest rate hikes. A perfect recipe for containing demand side inflation, perfectly fits into the economics model. However this resulted in lower investments in different areas. This at some point was containing demand side inflation but building up supply side inflation. With no new investment in infrastructure, which in turn constrained the logistics in not working efficiently, the supply side inflation took over. The question is now if the same recipe of hiking interest cycle, would it help containing inflation? I think across the board interest hikes is not a solution for containing supply side inflation. For containing supply side inflation, we need to raise the supply levels. This can only be done if more investment is infused in certain sectors. Again we do not want to do the across the board interest rate relaxation as it can pent up the demand side inflation, especially if the easy money goes in the consumption economics by way of personal loans etc. But we do need to provide easy capital to companies building roads, generating power. We need to invest on companies which are working on alternative energies, as the oil bill is going to be a single big reason for the inflation in the years to come. Also we need to put more capital in whatever can save energy for us. We need to invest on irrigation companies, logistics and transportation. We need to kick start the things so that we can contain the supply side inflation. 

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