Macros Simplified in form of Santa & Banta Conversation

Let me today, try to share with you, a Simpliifed Conversation, between 1 of our Favourite Character’s, whose jokes we are always surrounded by, in a way or Other.

Santa & Banta, once met & started a serious & sensible Conversation, to exchange thier Understanding on Macros & how they impact the Global Economies.

Santa: I have heard recently, that Mr. Rajan has reduced Repo Rate, by 50 basis points and everyone is saying that this is good for the market. Loan EMI may also come down. What this Rate cut means actually? I want to understand this.

Note: For awareness of those, who have not heard, about who Mr Rajan is, he is our Reserve Bank of India (RBI) Governor, who is the mind behind, framing/refining our Monetary Policy.

Banta: To understand this you first need to know, how does a Bank functions?

Santa: Why?

Banta: Because all these are inter-related. Tell me – What does a Bank do?

Santa: Bank takes Money from Depositors and gives Loan to earn Interest. That way, they keep everyone happy, and make a profit also.

Banta: Correct, but there is more to it.

Let me explain this in a very Simplistic way. Bank needs Money. Bank can get Money from depositors like you and me and also from RBI. But bank also needs to pay certain Interest to us and also to RBI.

Santa: Ok.

Banta: Let us try to understand first – What happens when we deposit, say, Rs. 100 with a Bank?

Santa: I know that. Bank gives that Rs. 100, to someone, who needs a Loan.

Banta: No, it is not that simple. Remember, though, Bank can earn Interest by giving away Loans, but it is also very risky. There are many cases of Loan Defaults. This way, Banks can put all our Money, into High Risk areas. It has to be protected.

Santa: How?

Banta: Ok, RBI has made it mandatory, that upon receiving, say, Rs. 100 – Banks first, have to deposit Rs. 4 with RBI. RBI keeps this Rs. 4 in its Current A/c and hence Banks do not receive any Interest on this Money. This is known as Cash Reserve Ratio or CRR, which is currently at 4%.

Santa: Hmmm, then?

Banta: RBI has also made it mandatory, that upon receiving, say, Rs. 100 – Banks need to compulsorily buy Central and State Govt. Securities of Rs. 21.50. Of course, Banks will earn some Interest Income here. This is known as Statutory Liquidity Ratio (SLR), which is currently at 21.50%.

Santa: Ok, so you mean to say that upon receiving Rs. 100, Banks can Lend only Rs. 74.50 at its own will.

Banta: Correct. 100 – (4 + 21.50) = 100 – 25.50 = 74.50

Santa: But you were saying that Banks can also borrow from RBI. What Interest Banks need to pay to RBI?

Banta: Before 30th September, Banks were paying 7.25% Interest to RBI, when they borrow Money from RBI. Now this Rate has been reduced by 50 Basis points. So Banks, now need to pay Interest to RBI, if they borrow from RBI, at the rate of 6.75%. This is known as Repo Rate.

Note:For awareness of those, who do not know, what a Basis Point is: In financial terms, ‘One’  Basis Point  is a unit equivalent to  0.01% i.e. 1/100th of a percent.     Thus 10 bps means 0.10% and   100 bps means 1%.    BPs is mostly used to indicate the changes in Interest Rates and also Bond Yields.

Santa: Can Fixed Deposit (FD) rates, be affected by reduction of Repo Rate?

Banta: Of course. If banks get Money from RBI @ 6.75%, Why will Banks pay, higher Interest to you and me? One year FD rate is already revised by many banks and it is equal to or very close to 6.75%.

Santa: But as now Banks are getting Money, at a Cheaper Rate, then they should reduce the Loan Interest Rate as well (i.e. pass on the benefits, they are receiving).

Banta: Correct. They should. And on that hope only, Market (Stock Market) is cheering. If Companies, get Loan at a cheaper rate, they will likely to expand their Businesses. That will create more jobs, more Income (Disposable or Discretionary for Individuals & households) and in turn,boost the Economy.

Santa: How is Inflation linked to this?

Banta: See, when Loans becomes cheaper, people tend to borrow more. That means, people will have more Money to spend. This will increase the Demand for Goods, and if Supply does not increase to match this Demand, then prices will increase.

Santa: So there is a chance, that Inflation may rise also?

Banta: Well, yes. But Inflation depends on many other factors as well, like Production (Industrial and Agricultural), Manufacturing, Export – Import, Foreign Currency Movement etc. So Inflation may increase or may not.

Santa: One last Question. Like we deposit our Money with Banks, Can Banks also deposit their Money with someone?

Banta: Yes, they can deposit with RBI and earn Interest too. This Interest is typically 1%, less than the Repo Rate. This rate is known as Reverse Repo Rate.

Key Ingredients of Monetay Policy

Santa: Great! So now I understand CRR, SLR, Repo Rate, Reverse Repo Rate and their impact on Deposit Rate, Loan Interest Rate and on Inflation. Thanks.

Banta: Welcome!

Hope this help as well & each one of us, would now find it so easier, to Understand these basic Concepts of Macroeconomics & its Impact on Economy as a whole (Global Economy).

Q1 2011 GDP Growth at 7.7%, weakest in 6 Quarters

India’s Economy grew at its weakest pace in Six quarters but outperformed even gloomier predictions, reinforcing expectations the Reserve Bank of India (RBI) will keep raising Interest rates to put a lid on Inflation.

Gross domestic product (GDP) growth in Asia’s third-largest economy slipped to 7.7 percent in the three months through June, slightly exceeding the median forecast in a Reuters poll for an annual rise of 7.6 percent.

“The latest growth number reinforces the view that although growth is slowing down, it is not collapsing as feared by some,” said Ashutosh Datar, economist at IIFL in Mumbai, who said another 25 basis point increase at the Central Bank’s next policy review on Sept. 16 was likely.

India’s economy grew 7.8 percent in the previous quarter.

The RBI’s 11 Interest rate increases since March 2010, including a sharper-than-expected 50 basis point increase last month, have failed to bring Inflation under control, but have undermined sentiment and demand in an economy that grew at 8.5 percent in the fiscal year that ended in March.

Wholesale prices grew 9.22 percent in July, the latest Inflation data shows, a tad below June’s 9.44 percent, but well above the central bank’s 4-4.5 percent comfort zone.

India’s slowing growth is the latest sign of cooling in the big emerging BRIC economies. Brazil’s economic activity fell in June from a month earlier, the first such drop since late 2008, while China posted slower growth in its June quarter.

India’s benchmark 10-year federal bond yield rose 2 basis points to 8.35 percent after the data failed to weaken the case for a rate increase at the next policy review in September.

The 1-year overnight indexed swap (OIS) rate rose 5 basis points to 7.85 percent while the 5-year rose 3 basis points to 7.03 percent. Dealers said the move reflected expectations of a maximum 50 basis points more rate increases in 2011, after which the RBI may press the pause button.

CONSTRUCTION WORRIES

Construction was a dark spot in the data, rising just 1.2 percent annually, down from 7.7 percent a year earlier, as higher Interest rates dampened the housing market and big-ticket projects were plagued by delays in approvals.

In Mumbai, India’s biggest and most expensive city for real estate, residential sales slumped to a 30-month low in the quarter to end-June, leaving the city with more than 100 million square feet of unsold real estate, according to data by Liases Foras Real Estate Rating and Research.

“The slowdown in construction is less pleasing at face value, but overall this robust report should leave RBI on track for one more 25 basis point hike this year,” said Sean Callow, senior currency strategist at Westpac Institutional Bank in Sydney.

India’s Manufacturing sector grew 7.2 percent in April-June from a year earlier, data released on Tuesday showed, an improvement from the previous quarter but below the 10.6 percent growth clocked a year earlier.

Farm output rose an annual 3.9 percent for the same period, down from its previous quarter growth but above 2.4 percent expansion a year earlier.

A steady rise in Interest rates combined with stubbornly high Inflation are curbing demand in India and squeezing Credit-Sensitive Industries, prompting many economists to slash their growth forecasts for the current fiscal year.

With the government preoccupied by Corruption Scandals that have stalled approval of legislation and projects that could help ease bottlenecks in the economy, the RBI has struggled in its battle with Inflation.

The RBI has made clear that containing prices is its priority, even as debt woes in the United States and Europe darken the global outlook.

“The only wild card here is heightened turmoil in the global financial markets and worries over global growth outlook which could pose downside risks to domestic growth driver,” said Radhika Rao, economist at Forecast Pte in Singapore, who expects a 25 basis point rate rise next month.

Courtesy : Reuters

GDP Projection by RBI after Credit Monetary Policy Review in Q2 FY 2011-12

Amid increasing Inflationary pressure and Worsening Global Sentiment Reserve Bank of India (RBI), the Central Bank of Country, continued its hawkish stance and hiked key policy rates by 50 basis points (bps) on Tuesday. However, it retained the Gross Domestic Product (GDP) growth projection at 8% with negative outlook.

GDP represents the Market Value of all the goods & Services produced in a country, over the period of a year. Industrial Production is a measure (it’s really an Index) of the activity/output in the Industrial or productive segment of the Economy. Movements in many areas of the economy are closely related to changes in GDP, so it is a good analytical tool. This number eliminates the effects of Inflation & thus measures the actual volume of production.

Real Growth in GDP has got a Positive Impact – it’s good for the market as well as Indian Economy.

RBI increased the policy Repo Rate under the Liquidity Adjustment Facility (LAF) by 50 bps to 8% from 7.5% earlier.

Accordingly the Reverse Repo Rate under the LAF, determined with a spread of 100 bps below the repo rate, automatically adjusts to 7.0%.

Retaining the growth projection at 8% RBI said, “The May 3 projection of 8% GDP growth rate was based on the assumption of a Normal Monsoon and Crude Oil Prices averaging US$ 110 per barrel. Subsequent data suggest that this projection remains valid. Therefore, the baseline projection of real GDP growth for the current year has been retained at 8.0%.”

While announcing the Credit Policy RBI said that the 2 broad considerations that went into decision behind the continued anti-Inflationary stance are strong demand pressure and there is no evidence, as yet, of a sharp or broad-based slowdown in growth.

RBI further said that the actual Inflation so far has been even higher than expected. In particular, non-food manufactured product Inflation has been significantly higher than the average rate of 4% over the last six years.

Inflation is detrimental to Stock Prices. Higher Inflation leads to higher Interest Rates & lower Price/Earnings (P/E) Multiples & generally makes business houses & Corporate India less happy, as their Profits & Net Operating Margins are reduced.

Another factor that RBI pointed while announcing the Credit Policy was the volatility in Crude Oil prices in International Market. The recent increase in domestic administered fuel prices and the minimum support price for certain food items will also keep Inflation under pressure, said RBI.

RBI pointed out that although several indicators such as Exports and Imports, Indirect Tax Collections, Corporate Sales and Earnings and Demand for Bank Credit suggest that demand is moderating, but there is no evidence of any sharp or broad-based slowdown in growth.

RBI expects that the 11th Consecutive Policy Rate hike will reinforce its effort to reign Inflation and the credibility of the commitment of Monetary Policy to control Inflation will be reinforced.

Meanwhile, the benchmark Sensex of Bombay Stock Exchange (BSE) reacted negatively to the 50 bps hike and was trading 1.50% down or 283 points at 12:20 Noon. All 14 stocks of Bankex (Banking Index) were trading in Red and the Index was 2.41% or 313 points down at the same  time.

Signaling about the Future Stance RBI said, “The Monetary Policy stance will depend on the evolving Inflation trajectory, which in turn, will be determined by trends in Domestic Growth and Global Commodity Prices. A change in stance will be motivated by signs of a sustainable downturn in Inflation.”

Speaking on the risk factors and major concerns for the RBI as well as Government it said, “The Sovereign debt problems that have beset the euro area over the past year now threaten larger Economies in the region.”

The Central Bank said, “Crude oil prices are generally still high compared with last year.”

Speaking about the Inflation outlook going forward RBI outlined factors like the Overall performance of the South-west monsoon, Crude Oil Prices whose outlook for the near future is uncertain, policy decisions with regard to increase in prices of petroleum products and other  administered items will have a significant influence on inflation.

RBI revised the baseline projection for WPI inflation for March 2012 upward to 7.0% from 6% projected earlier on May 3. The apex bank cautioned that Inflation is expected to remain elevated for a few more months, before moderating towards the later part of the year.

RBI said that after 11 Consecutive Policy Rate hikes scheduled Commercial Banks have been raising their Deposit and Lending Rates and since March 2010 banks have raised their Modal Term Deposit rate by 225 basis points.

Liquidity conditions have generally remained in deficit mode so far this fiscal and the average daily net injection of liquidity through the LAF window during this year was around Rs.48,000 crore.

RBI revised the Credit Growth Projection to 15.5% from 16.0% announced on May 3. Non-food bank credit growth projection has also been revised downwards from 19.0% to 18.0%.

July 26, Monetary Policy Review by RBI

Amid increasing inflationary pressure and worsening global sentiment Reserve Bank of India (RBI), the central bank of country, continued its hawkish stance and hiked key policy rates by 50 basis points (bps) on Tuesday.

The RBI, while announcing credit policy on Tuesday, announced that the short term lending rate (Repo) will be 8% and short term borrowing rate (Reverse Repo) will be 7%. The changed rates will come into effect immediately.

 

Headline inflation in India was at 9.44% in June as compared to 9.06% in May, higher than the RBI’s comfort level of 5%-6%.

 

Earlier last month, the RBI had hiked key policy rates by 50 bps while announcing the yearly monetary policy. The apex bank hiked key policy rates for 11 times since March 2010.

 

Going against the market expectation of 25 bps hike RBI hiked key policy by 50 basis points saying that the short term inflation projection to remain above average with a hope of going down by the year end.

 

RBI said that factors like Monsoon performance, crude oil price uncertainty and euro zone crisis could affect the growth of country in medium term. It further pointed that current account deficit is a point of concern for the central bank. 

June 17, Monetary Policy Review Aftermaths

Press Release from RBI states that:

Monetary Measures

On the basis of the current macroeconomic assessment, it has been decided to:

• Increase the repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.25 per cent to 7.5 per cent with immediate effect.

Consequent to the above increase in the repo rate, the reverse repo rate under the LAF will stand automatically adjusted to 6.5 per cent and the marginal standing facility (MSF) rate to 8.5 per cent with immediate effect.

Introduction

Since the Reserve Bank’ Annual Policy Statement of May 3, the global environment has changed for the worse, while domestic conditions are broadly consistent with the Statement’s projections. Growth expectations in advanced economies are visibly moderating, even as inflationary pressures, primarily from commodity prices, have increased. The capacity for conventional policy responses appears limited, with many countries having already committed to fiscal consolidation amidst growing sovereign debt risks. From our monetary policy perspective, global commodity prices still remain the key external risk though some signs of moderation are becoming visible.

Domestically, inflation persists at uncomfortable levels. Moreover, the headline numbers understate the pressures because fuel prices have yet to reflect global crude oil prices. On the growth front, even as signs of moderation are visible in some sectors, broad indicators of activity – 2010-11 fourth quarter profit growth and margins and credit growth do not suggest a sharp or broad-based deceleration.

Going forward, notwithstanding both signs of moderation in commodity prices and some deceleration in growth, domestic inflation risks remain high.  Against this backdrop, the monetary policy stance remains firmly anti-inflationary, recognising that, in the current circumstances, some short-run deceleration in growth may be unavoidable in bringing inflation under control.

Domestic Economy

Growth

GDP growth decelerated to 7.8 per cent in Q4 of 2010-11 from 8.3 per cent in the previous quarter and 9.4 per cent in the corresponding quarter a year ago. For the year as a whole, GDP growth in 2010-11 was 8.5 per cent. While private consumption was robust, investment activity moderated in Q4 of 2010-11. The Central Statistical Organisation (CSO) released the new series of industrial production with 2004-05 as the base. The new series represents a better coverage of the industrial structure in the country.  The trend in industrial production as revealed by the new series is significantly different from that indicated by the old series (base: 1993-94). While the old series suggested a sharp deceleration from 10.4 per cent in the first half of 2010-11 to 5.5 per cent in the second half, the new series suggested  broadly the same growth of a little over 8 per cent in both halves of the year. While the y-o-y IIP growth moderated to 6.3 per cent  in April 2011, growth in capital goods production at 14.5 per cent was buoyant. During April-May 2011, both exports and imports increased sharply and the trade deficit widened. The progress of south west monsoon 2011 has so far been satisfactory, which augurs well for agricultural production.

Overall, even as there is deceleration in some important sectors, notably interest-sensitive ones such as automobiles, there is no evidence of any sharp or broad-based slowdown. Corporate earnings growth and profit margins in the fourth quarter of 2010-11 were broadly in line with the performance over the past three quarters, suggesting that demand remained steady, and in the face of sharp increases in input costs, pricing power remained intact. Credit grew steadily (see below), while the composite Purchasing Managers’ Index (PMI) for May 2011 suggests reasonably good conditions.

Inflation

The headline WPI inflation rate was 9.7 per cent in March 2011. In April 2011, it was 8.7 per cent and rose to   9.1 per cent in May 2011. The numbers for April and May 2011 are as yet provisional and, given the recent pattern, these numbers are likely to be revised upwards. Thus, the headline WPI inflation rate remains elevated, consistent with the projections made in the Annual Policy Statement of  May 3. The main drivers of WPI inflation in April-May 2011 were non-food primary articles, fuel group and non-food manufactured products. The consumer price inflation for industrial workers (CPI – IW) rose from 8.8 per cent in March 2011 to 9.4 per cent in April 2011.

Non-food manufactured products inflation was 8.5 per cent in March 2011. Provisional data indicate that it increased from 6.3 per cent in April to 7.3 per cent in May 2011, numbers much above  its medium-term trend of 4.0 per cent. This pattern in non-food manufactured products  inflation is a matter of particular concern. Besides reflecting high commodity prices, it also suggests more generalised inflationary pressures; rising wages and costs of service inputs are apparently being passed on by producers along the entire supply chain.

Credit Conditions

Year-on-year non-food credit growth moderated from 21.3 per cent in March 2011 to 20.6 per cent in early June 2011, but remained above the indicative projection of 19 per cent.  The y-o-y deposit growth increased to 18.2 per cent in early June 2011 from 17.0 per cent in March 2011. Consequently, the incremental non-food credit-deposit ratio moderated to 80.5 per cent (y-o-y) in early June 2011 from 95.3 per cent in March 2011. The y-o-y increase in money supply (M₃) was at 17.3 per cent in early June 2011 as compared with 16.0 per cent in March 2011.

Monetary transmission has been quite strong with 45 scheduled commercial banks raising their Base Rates by 25-100 basis points after the May 3 Policy Statement. Cumulatively, 47 banks raised their Base Rates by 150-300 basis points during July 2010-May 2011. The higher cost of credit is restraining credit growth, but it still remains fairly high, suggesting that economic activity is holding course.

Liquidity Conditions

During the current fiscal year so far, liquidity conditions have remained consistent with the anti-inflationary stance of monetary policy. The Government’s cash balances moved from a surplus of ` 89,000 crore on an average during Q4 of 2010-11 to a deficit of ` 29,000 crore during Q1 of 2011-12 (up to June 15, 2011). Consequently, net injection of liquidity through LAF repos declined from an average of ` 84,000 crore during Q4 of 2010-11 to ` 41,000 crore in 2011-12 (up to June 15, 2011). The net liquidity injection by the Reserve Bank was higher at ` 60,000 crore as on June 15, 2011.  As articulated in the May 3 Policy Statement, the Reserve Bank will continue to maintain liquidity conditions such that neither surplus liquidity dilutes the monetary policy stance nor large deficit chokes off fund flows to productive sectors of the economy.

Summing Up

To sum up, the domestic growth outlook as indicated in the Annual Monetary Statement of May 3 remains unchanged. However, given the high degree of integration with the global economy, recent global macroeconomic developments pose some risks to domestic growth. Domestic inflation remains high and much above the comfort zone of the Reserve Bank.  Particularly, non-food manufactured products inflation rose in May 2011 after showing some moderation in April 2011. Domestic fuel prices do not yet reflect the current trends of global prices. Although global commodity prices moderated in recent weeks, it is too early to downgrade this as a risk factor. Monetary transmission has strengthened. The impact of the Reserve Bank’s recent monetary policy actions is still unfolding. The challenge of containing inflation and anchoring inflation expectations persists. Thus, while the Reserve Bank  needs to continue with its anti-inflationary stance, the extent of policy action needs to balance the adverse movements in inflation with recent global developments and their likely impact on the domestic growth trajectory.

Expected Outcomes

The policy action in this Review is expected to:

• contain inflation and anchor inflationary expectations by reining in demand side pressures; and
• mitigate the risk to growth from potentially adverse global developments.

Guidance

Based on the current and evolving growth and inflation scenario, the Reserve Bank will need to persist with its anti-inflationary stance of monetary policy.

Types of Inflation & its Basics

There are two theories in the economics that are generally accepted as the causes of inflation.

• Demand pull inflation – Happens when too much Money chases too few Goods.

This situation mostly exists in a Growing economy (Like India), where there are huge expansions from the Government and Private Sector, leading to increase in employment, which in turn will increase the purchasing power of the consumer.

This leads to an environment, where people have got too much money to buy goods and/or services, but the supply of goods and services are not growing at the same rate, resulting in a supply and demand mismatch. To adjust this, producers will increase the price of goods.

• Cost push inflation – Happens when the aggregate cost of resources goes up, for the companies due to decrease in supply or increase in taxes. This situation primarily exists in Developed Economies such as US or UK.

Companies pass this increase on to consumers in the form of increased prices. For example, Crude oil prices have gone up sharply in past few months on account of decrease in supply. The economy sectors where oil is the part of their cost element, will pass on this increase to customers by increasing prices of their goods and services.

It is not necessary that only one type of inflation exists in an economy at a time. They can co-exist.

For instance, in India right now we have both types of Inflation, Oil and Metal prices have gone up to record highs, giving rise to Cost Push Inflation. At the same time, purchasing power has also increased due to increases in employment, wages, and easy availability of money, creating Demand Pull Inflation. This combined effect has taking inflation to the 13-year high that we are experiencing right now.

Inflation is not always an Evil.

Within limits, Inflation is required for an Economy to grow. It’s very well said that inflation is the sign of a growing economy. Imagine an environment where there is no price increase; in fact prices are falling (this situation is opposite of inflation known as deflation). There will be no increase in wages. Nobody would like to have that environment.

But when inflation is too high it adversely affect the consumer and the economic conditions of the nation as well:

• In a fixed interest rate environment the Creditor will lose money, if he has not properly estimated the inflation and accordingly fixes the interest rate. High inflation can sometime result in negative real interest rates. This can be currently seen in India as the inflation is touching 11.4% and the interest rate on fixed deposit is 9% it is actually giving negative return of 2.4%
• It decreases the savings of the individuals. As the prices increase, the consumer has to shell out more money from his pocket to buy the same products but his income has not increased. Therefore he has to eat up his savings.
• As savings get reduced, automatically investments will reduce, affecting the economy negatively.
• If the inflation in one country is greater than another, the products and services of the former will become less competitive due to the increase in its prices.

To control inflation Central Banks, take Monetary actions and government takes fiscal measures. But individuals should also take some steps to get over it. They should invest their money in the investment avenues which gives better return, should try to minimize unwanted expenses, reduce the consumption of the commodity that has become very expensive, and find out some substitute that will help them in managing their own inflation.

Additions, Suggestions for Improvement & your feedback is always welcome.

Hope this article helps you in some way.

Relation between Inflation and Bank Interest Rates: How does Inflation affect rates?

 “Inflation is the overall or specific increase in the cost of goods or services.”

Inflation is an increase in the price of a basket of goods and services that is representative of the economy as a whole.

Inflation is basically a rate of increase in the price of goods and services which in economics defined as “The overall general upward price movement of goods and services in an economy, usually as measured by the Consumer Price Index (CPI).”

In India, however, it is measured using the wholesale price index (WPI).

The CPI is based on a basket of goods and services with different weights, reflecting the expenditure of a typical consumer. The weighted average of price rises of these goods and services gives the inflation figure.

Inflation simply reduces the worth of our money. For example: the same 1 kg of apples you used to buy at Rs. 100 will cost you Rs. 110 next year, if the inflation remains at 10%.

Inflation is when our Mom or Dad complains about the prices they have to pay nowadays compared to what they paid when they were younger. “I remember when a roll of Poppins only cost 20 paise.” “I used to buy Tur dal at Rs.14/Kg.” “When did milk get so expensive?” My Great Grandfather used to get a salary of Rs. 5 per month!!

Most people look at their present living standards and estimate how much they will need to accumulate to survive. They don’t even take a second look at inflation. India’s Inflationrate is currently above 9%. There are no Fixed Deposits which give such high returns. This means that for ever year that your money is in the bank you are actually losing money!!  Inflation is Eroding the value of our money lying idle in Savings Accounts in Banks, as it is fetching us only 4% ROI.

The best way to beat inflation when planning for the future is to include it in your calculations. The biggest problem we see with a lot of long-range financial planning, especially retirement planning, is that people forget to factor in the effect of inflation on their investments and savings.

Another quick way to account for the effect of inflation is to subtract the inflation rate from any rate of interest you will be receiving on an investment. So if you are going to assume a 10% inflation rate and the assumed rate of return is 11%, do the projection with only a 1% rate of return. This will give you a more accurate picture of the value (not the amount) of the investment at its maturity!!!.

If inflation is high, interest rates are increased. If repo, ie rates at which banks borrow from RBI, is increased, such borrowing will become costly and banks would thus either borrow less or pass on this increased cost to their borrowers. Again if reverse repo is increased, banks would divert more funds towards RBI and excess liquidity will be absorbed by RBI rather than going at cheaper cost in the economy. In either of the cases, actual lending will be less and demand for goods and services will be less

In the case of CRR, if the rate is increased, it affects in two ways. First, immediate liquidity in the system is absorbed to the extent CRR is increased as more money needs to be placed with the regulator. Second, in the incremental lending, potential capacity of banks to lend is curtailed. This again leads to less lending by banks.

How is inflation calculated in India?

India uses the Wholesale Price Index (WPI) to calculate inflation. Most developed countries use the Consumer Price Index (CPI) to calculate inflation.

      What is Wholesale Price Index (WPI)?

Wholesale Price Index (WPI) is the index that is used to measure the change in the average price level of goods traded in the wholesale market. In India, a total of 435 commodities data on price level is tracked through WPI which is an indicator of movement in prices of commodities in all trade and transactions. WPI is published on a weekly basis in India.

    What is Consumer Price Index (CPI)?

CPI is a statistical time-series measure of a weighted average of prices of a specified set of goods and services purchased by consumers. It is a price index that tracks the prices of a specified basket of consumer goods and services, providing a measure of inflation. In India, CPI is published on a monthly basis.

Cash Reserve Ratio (CRR) & it’s Impact on us

While watching the CNBC, swapping through the TV Channels, I heard a term CRR.  I went on further swapping other channels, without giving a food for thought— What CRR is all about?

Next Morning, the first thing, I saw on the front page of the Newspaper, to add on to my Curiosity, was : CRR hiked by 50bps (basis points).

This drove the headlight of my brain, that this is the term, which we come across every now & then, by 1 way or other, & it impacts us directly or in an Indirect fashion, but we never tend to dig it a further to understand it.

Also, Banks play a significant role in one’s life and the contribution of banks to the nation and the economy is immense. There are hundreds of things about banks which a common man does not know. One such concept is CRR. We all read in the news papers that

RBI has increased the CRR limits and the interest rate will go up. But what is the correlation between CRR and the interest rates? What is CRR? Why do they increase or decrease it? Like this, there are many questions. Here is a small article to answer all your queries relating to CRR.

Cash Resreve Ratio

CRR: This abbreviation is made up of 3 alpahabets, each of which has got a significant meaning: