Lot of posters here are just whining due to their increased EMIs on their unaffordable homes and cars, but it appears a lot of them dont appreciate the working of economics as much.
First, every government would personally want a lower rate with higher inflation as much as politically possible. This is because it is the biggest borrower, and low rates and high inflation both punishes the good savers & investors, in favor of bad borrowers. Thats why FM had put down a long necessary interest rate hike, that should have come out much earlier. This is a bit too late. A high rate will discourage government to borrow less (already among the worst in government's with highest loans) and be better in fiscal management.
Second, Indian housing market is white hot and some shitty apartments in Indian cities are more expensive than good homes in American cities even in dollar terms and when you consider the fact that Indian per-capita income is like 40 times lower than America's, this is outrageous. People are borrowing like crazy and appreciated houses like 3 times in the last 3 years along with borrowing money to zoom the Sensex to 14K from around 5K a while ago. Inflation of 6% or not, RBI should interfere to curb this irrational exuberance in real-estate and stock markets. This could be done by hurting the personal loan rates and eventually in 1-2 years, the asset and stock prices will settle to a more reasonable rate aiding in long term progress.
Third, for a developing country our saving rates are still lower compared to China, Japan and rest of Asia. We need to encourage our people to save more rather than blow away their new found riches for temporary passions. India is still poorer by international standards, and given the fact that we dont have strong safety nets, a lot of people dont realize how less they are saving for a livable retirement or other unforseen crisis.
Fourth, while the corporate sector will be hurt a bit, there wont be too much of a pain. There will be a bit of consolidation where the small guys lose out to large guys, and a lot of overseas money will enter with benign interest rates.
So, this temporary hike in rates is a long overdue and I'm sure it will be brought back to a lower level after a couple of years of solid growth, and this will do overall good to the country by countering a runaway credit growth fuelling an irrational exuberance.
RE:Basic misunderstanding of inflation
by Rohit on Apr 11, 2007 06:06 AM Permalink
Balaji Bhai:
Thank you for setting the record straight. The economic illiteracy I see on this board is indicative of why it is so hard to implement sound economic policies in India: people do not understand Economics and therefore end up voting for bad Economic Policy-makers.
I would like to add to your analysis. The RBI is also drawing a line in the sand about how much inflation it is willing to tolerate at all times and at all cost. This will depress inflationary expectations and make it less likely that inflationary expectations will build up and translate into actual higher inflation in the future. Tis called 'Rational Expectations' following the work of Muth Sargent Lucas et al
