Sunday, April 10, 2011

The Inflation Conundrum... (Part-1)

In a country where people in the bottom quintle spend about 67% of their earning on food items, the current inflation is literally burning them out. The growth saga of India is known to one and all. I feel there are three puzzles contained in the inflation conundrum. Growth is coming at a price, lets see what price we are paying and for how long do we have to pay.

Faster and Inclusive growth”, that’s on agenda for the eleventh five year plan of Government of India. Inclusive growth contains in itself both social inclusion and financial inclusion. Where social inclusion is the end, financial inclusion is the means to achieve that end. Let’s first look out for how the financial inclusion is taking place. Keeping it very simple, by Financial Inclusion, Government of India is trying to bring more and more people into the ambit of banking. The equation will work both ways, people will get interest on savings, which otherwise was lying in their homes, and banks will get more funds. “Swabhiman”, a scheme where bank correspondents/bank sathis are created for a door to door service is being launched. This way financial inclusion looks a pretty good thing for any economy, which I will not deny. But this inclusion comes at a cost…

Banks in any country play a role of mobilizing the funds, in turn channelizing them in the market. Now what financial inclusion brings with itself is the money that was lying dormant in the common rural household. People start saving their money in financial institutions like banks, so as to gain some interest on their saving, which was not giving any returns earlier. The money, as soon as it reaches the banks, gets into the channel and thus becomes available for investment in the market, which imperatively means that the liquidity in the market increases. It needs no explanation that outcome is inflation.

In earlier days, when the society was not so convoluted, the economy was not liberalized, a few private players in the market, investments more in the control of public sector, RBI with its monetary policy was in a better position to increase or decrease the money supply, which further directly affected the demand. It was easy to control inflation then. Now the equation has become complex, with money and investment pouring from different sources, the monetary policy plays a crucial role in tackling inflation. This also gives the reason why RBI has started mid quarter reviews, as we can’t wait for three months in such dynamic society. The savings are increasing through financial inclusion, people are getting benefitted, but Inflation is bound to increase with financial inclusion, but that cannot be the reason to stop financial inclusion as other benefits are far reaching. This puzzle has to be solved…

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