Increasing prices of each commodity has made life of common man more difficult. Last four-five years have witnessed steep price hike of everything. Inflation at the rate around 5% is sign of healthy economical growth. But constant double digit inflation rate for almost four years is definitely not growth. It is something else.
Well, I am not an economist. But I try to understand the situation as a common man. Country is headed by a prominent economist. The person is capable to forecast the inflation rise. But for some reason he allowed the kite to fly high. Why?
On international podium the size of economy matters. Size of economy measures primarily by the GDP (Gross Domestic Product) of the country. The GDP is total production of agricultural, industrial and service-sector of the country. Our GDP is growing at an average of 5 to 8 percent for many years. At this rate of GDP growth, the size of our economy can not reach a level desired by the government(!). Our agriculture growth is around 4% and that of industrial output is 7-9% for past many years. Service sector is doing well but it alone can not provide the required GDP growth.
Basic difference in the economies of western developed countries and ours is pattern of spending. Because of social security and easy availability of job they (the common man of western countries) do not bother about savings and spend whatever they earn. The money is rotating fast in the economy as spending is very quick. On the other hand in our economy the major part of spending (of course of common-man) is on food-grains. Then comes creating long duration assets like house. Replacement of a vehicle never even thought before ten years. All these results in slow rotation of the money in the economy.
A classic example of US economy :
One man went to a country hotel. He gave $100 deposits to the hotel-owner and said he will hire the room if he found it ok. The owner called a bellboy and sent the customer with him to see the room. He gave the $100 immediately to the nearby shop-keeper who was supplying him grocery. The shop-keeper paid his weekly rent of $100 to the shop-owner. The shop-owner immediately paid his due to local pro. The prostitute paid $100 to the hotel-owner for the room she had rented for entertaining the shop-owner. Meanwhile the customer came back and said he did not like the room. The hotel-owner refunded him $100. Without any real production, the GPD of US went up by $300.
Anyway this was on lighter side but it is a fact the faster the money moves, the quicker the economy grows. But because of many reasons, it is not possible to induce common man here to spend his all income quickly. What is the way to increase the size of GDP then?
If you can not produce more, you can sell the same thing with higher sale price and result will be increase in your sales. But again the increase in price will result in lower demand. Therefore, increase in prices of the articles without which a common-man can do with will not gave any positive result. You increase the price of TV, CAR or other FMCG(fast moving consumer goods) and result will be in decreasing demand. But if prices of items which are must of living will increase, the common man will have no alternate but to purchase it. Food-grains, pulses, protein, vegetables, cloths etc. are in this category. Stage was set before some four-five years to let the prices of this items balloon. Policies were framed accordingly. Steps were taken to ensure that prices shoot up. The common-man had no alternate but to purchase these commodities. But how this can be sustained. Such an inflation rate can be resulted in political instability or civil-war. Policy makers are not fools. With increasing the price rise, they started infusing more money in the economy to increase the income of the poor common man. Public sector employees’ salaries were increased by way of wage revisions and more importantly by increasing dearness allowances. With mounting pressure on their pockets private sector employees have also demanded and got salary rise. Casual laborers have increased their daily rates. If you just look around, you will see that nothing is available, except some FMCG, below 150% rate of it was available in 2006-07.
The money supply(M3) in economy has more than doubled in last five years. M3 is total of (1) currency with public (2) Other deposits with RBI and (3) deposits with banks. Of these, the deposits with banks consists almost 85%.
Now if the prices are increased, how bank deposits increased. Very simple. As we have observed that there is increase in income also along with the price rise. On an average, the income rise is about 60% or more comparing it with the income of 2006-07. Now, if you are saving average 20% of your total income (national average is around 18%), you are now saving more amount in absolute term. For example, your savings was Rs 20 (i.e. 20% of your income or Rs 100) in 2006-07. Now with increase in prices and income you are savings 18% of your income of Rs160, it will be Rs 29. Thus you are infusing more Rs 9 in the banking system. A bank can increase its loans twice the increase of the deposits. Well we will not go in the details how banks uses the deposits and what can be impact of increase of deposits on the economy. However, the increase in your savings is of not beneficial to you as the prices of everything has also doubled. So your actual purchasing power is actually decreased even with more absolute savings.
Let us focus on price hike again. Now, as a common man you have adjusted with this inflation in four-five years. A little by the increase in your income and somewhat by adjusting your needs according to your resources.
The question is who are really benefited and how with this high rate of inflation?
The size of economy has grown with total value of GDP is increased with this price hike and the world has to take a note of our economical growth. Though, the absolute production is not increased significantly in this period, our economy has grown in monetary terms and our economy-pundits barks(!) that we will take over Chinese economy in next 20 years. (This can happen actually if China has also taken the same route for economical growth. I don’t know.)
But the real gainers are business houses and MNCs. (Mostly they are funding the election/other costs of the politicians. Mostly I am right.)
For example, a business unit has sales of Rs 100. Its total costs were 90% of sales and it profits were 10% of sales i.e. Rs 10. The owner’s own expanses(i.e. personal and household) was say 20% of profits i.e. Rs 4 and therefore the owner’s net surplus was Rs 6 at the end of the day. Now, with sale prices say doubled, the unit is selling same number of units at Rs 200. With increase in cost or raw-materials, labours etc, the cost of production of the same number of units is also doubled. So now costs are Rs 180 and profits are Rs 20. Owner’s personal expenses are also increased to Rs 8 leaving Rs 12 as surplus. This is real gain. Earlier the owner had surplus of Rs 6 and now it is Rs 12. But one will argue that with purchase power is reduced at 50% this surplus is not real gain, because whenever the owner want to buy something(goods or services), he has to spend double of what he was spending in 2006-07. So actually he has not gained anything by increase in his surplus.
Correct. But think about those who are spending their surplus for buying foreign goods, importing machineries, spending on vacations abroad and more importantly who are sending their surplus out of country legally by way of taking back the profits (MNCs) or illegally by Hawala. The $ was available @ Rs 46 to Rs 50 in 2006-07 and is available at the same rate now. This means the person having more surplus in form of rupee can buy more foreign goods/services since other currencies are stable. The foreign-purchase-power is almost doubled for those who are buying foreign services/goods. My friend, with liberalization/globalization most business houses are spending a large percent of their surplus is buying foreign goods/services. MNCs who have invested in the country before 5 to 10 years are now getting more $ for their rupee surplus. Politicians/bureaucrats who have ‘surplus’ to feed the Swiss Bank/other foreign accounts are getting more $ (or other foreign currency) as their surplus has almost doubled with the inflation. They are real beneficiaries of this inflation. And the number of such entities/persons is much higher then we can imagine.
This is my understanding of state-sponsored inflation. If any other credible theory is there to justify the steep inflation of last four-five years, I welcome it.