The RBI (Reserve Bank of India) the central bank in India has yet again raised the Cash Reserve Ratio. What this means is that banks should lend less of their deposits and currently keep more than 6% of the deposits with the RBI instead of lending. This will lead to higher interest rates for loans, by the supply-demand economics.
Inflation in India is raising very high and currently over 6%, the highest in 2 years. It has mainly contributed by the increase in food prices, along with world oil prices, property boom in India along with expanding business cycles. Whenever inflation grows high, banks follow the textbook method of raising interest rates, so that people will borrow lesser to buy stuff and the the demand will reduce therefore and the price raise will be contained.
Why is it counterproductive?
First, the inflation is more due to the supply side economics rather than demand side economics.
1. Real Estate
While, it is true that people are betting high & high for good properties, the core problem here is the lack of availability of good properties. For example, my 2000 sq ft property in Madurai has hardly experience inflation, while properties in Chennai, B'lore & Mumbai have shot over the roof. This is because, people get very few choices to buys houses if they want a minimum level development. The solution will be to develop properties more and more so that anybody with a decent level of employment could get a decent housing. India is no short of land - currently having more than 30 trillion sq ft of which atleast 10% is fallow and underutilized. So, if we have 3 trillion sq ft, every Indian household could build a 12000 sq ft bungalow and dont even need high raises! That's ideal, but the point is with proper development every household could be assured of a good housing. Invest more in planned housing development and allow real estate developing corporations to expand more and even if the SEZs turn out to be just real estate development, still it will do good for the nation. And once, enough supply of good houses are made, the prices will fall in the super hot spots.
Why the food prices have gone up should not be a surprize for those who watch Indian agriculture. The sector is in a state of shit, and the last decade there has been no growth in the yield or productivity, while industrial production surged and technology zoomed. Our per-hectare productivity for most crops are among the lowest in the world, and we have the highest wastage in the world. Lands have to be consolidated, supply chains strengthened and flattened and technology/capital has to reach the field. Allow big private houses to repeate their magic with industry on the field, and with a good retail sector growth, Indian farmers have huge potential to grow. If we do right things, we could potential expand the end value of Indian agricultural produce by 3-4 times and wipe out shortage that is boosting the prices now.
3. Cement/Steel & basic commodities
These are not too different from agriculture. India has vast reserves of coal, iron ore and bauxite (aluminum ore) and they are hardly utilized due to red-tapism. This had forced the stellar players in this field like Tata Steel & Birla's Hindalco to look for overseas purchases. Allow greater reforms, liberalize laws and promote greater development. Given our enormous potential in this segment, most commodities excluding copper & oil, could head south with better technology.
The key in all these three things are - investments, reforms & consistent policies. Regarding the last two the government has the ball in its court and regarding investments the increase in interest rate will jeopardize all the growth. If the interest rates climb up so much, the infrastructure, power development and these three sectors will suffer and the projects might be derailed.
Instead of taking a myopic view, the RBI should curtail the temptation to increase rates and realize that textbook methods are not directly applicable to this complex nation. The need for the hour is greater investment and the RBI should direct them to the right sector and by increasing the rates the RBI is not only curtailing growth but also leading to future inflation by choking supply & infrastructure.
God shall bring lights to the darkness filling economists' brains.