What is the effect of increase of interest rates in developing economy on cost push inflation?

   

               THE FREEMEN

Dear Brethren,

In response to my appeal Dated August 5, 2010, the Executive Director vide his reply Dated September 27^th, 2010 stated that there is no way to know the effect of increase in interest rates on inflation, increase in unemployment, poverty, closure of industries, foreclosure of mortgages and general effect. http://kapildevaggarwal.blogspot.com/2010_11_01_archive.html

This is palpably incorrect. The effect of increase in interest rates on inflation, increase in unemployment, poverty, closure of industries, foreclosure of mortgages and general effect is easily known. Following is the response which I sent to him;

To,                                       Dt January 20^th 2011

                                                                                                        

Sh C Krishnan, Executive Director,

Reserve bank of India, Shahid Bhagat Singh Marg,

Fort, Mumbai – 400001.

Sub; Your letter / order Dt 27.9.2010

Ref; My letter /appeal Dt August 5 2010

Dear Sir,

A.     Demand pull inflation can be controlled by increase in lending rates but cost push inflation can only be controlled by reducing lending rates.

1.         Vide my letter /  appeal Dt 5.8.2010 I has asked the following query under RTI;-

“After RBI decides to increase rates;-

1)         How many company / business declare bankruptcies?

2)         How many accounts are declared NPAs

3)         How many people loose employment?

4)         How many mortgages are foreclosed?”

2.         Vide your order Dt 27.9.2010 you were pleased to pass the following order;-

“4.        …. It’s needed to be mentioned here that the queries made by the appellant are not capable of eliciting any definite information from the Reserve bank or for that matter, any public authority….”

3.         Should the matter simply end there or is it our duty of to measure the effect of monetary policy on public at large. Is the information too difficult to collect?

a)         Banks collect monthly NPA figures and send them to RBI. The format can include bankruptcies. NPA figures are directly proportionate to repo rates.

b)         Banks have KYC Norms whereby they should also get monthly employment figures of their loanees or can get them along with monthly stock statements.

c)         Banks already submit monthly statements where they have foreclosed mortgages under securitization Act.

d)         Government is already giving monthly IIP (Index of Industrial production) which sees a dip whenever there is increase in repo rates.IIP figures are inversely proportionate to repo rates.

When I asked my query under RTI, I already knew the answer. Object was that RBI should start tabulating / collecting data which is the most important input required for laying down monetary policy. You may argue that closure of factories of business may be for lot other reasons than merely high cost of debt. However a careful analysis of the above data will give a reasonable accurate data about the businesses which are closed / increase in NPAs / increase in unemployment solely because of increase in repo rates.

4.         In my August 5 2010 letter, I had mentioned in ‘PS’ Para 5 that current monetary policy of RBI will lead to hyper inflation in economy. After 5 months results are before you. The simplified version of my contention in Para 5 is as below;-

Causes of Inflation;

Inflation is dependent on constraint in supply.

Lesser the supply- higher the inflation.

Supply is further dependent on cost of supply.

Higher the cost of debt - higher the cost of supply

higher the cost of supply - leads to reduction in supply/

Successive increase in cost of debt since march 2010 has led to present situation.

Suggestions;-

Reduce the cost of debt (lending rates) ie Repo Rate by at least 1.5% immediately.

RBI should buy back bonds in open market operation to increase liquidity which has seen a dip.

I hope you will take my suggestions in the right perspective.

Yours truly in service of nation

            Sd/-

CA K D Aggarwal

Copy to ; Sh Manmohan Singh, Prime Minister of India, 7 Race Course Road, New Delhi for information and necessary action.