Monday, February 12, 2007

Key Talking Points 6

With Bangalore standing still, the posts on the blog grounded to a halt on Monday. So the analysis for the last two topics are pending and are coming in a while. I had allowed more time hoping for a larger participation.

I am also enthused by the fact that many people wrote to me that they discovered the site a few days back and found it very useful. That is feel-good factor for me as I have tried to give my best.

So as we head for the last rounds of GD, here comes a Key Talking Points relevant to the recent issue. Though we had covered inflation before, knowing your love for govt-shud-do-this and govt-shud-do-this, I thot you guys will have a lot to say on this :)

Recently the inflation has gone up and everyone seems to be concerned.
1. Since inflation is calculated on the basis of 'basket of essential goods' that contain mostly agricultural products, is curbing inflation negative from a farmer's perspective?
2. Does increase in the interest rates have a downward impact on inflation?
3. If the Govt removes 'tax benifit' on tax savings bonds, will it have an upward impact on inflation?
4. If the Govt removes 'tax benifit' on house loans, will it have an upward impact on inflation?
5. Since there is so much negative feeling about inflation, is having a negative inflation a good sign for an economy?

All the questions are very simple. All you need to do is THINK. So oil your brains and let your thinking flow.

Click here for the answers

Click Here for previous Talking Point

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8 Comments:

Blogger Gyan-ee said...

Do understand the basics of inflation and Govt actions and give a thought before answering. As always there are no negative marks for wrong answers :)

2:43 AM, February 13, 2007  
Blogger Himanshu Gupta said...

1) As from a perspective of seller only, curbing inflation is detrimental to farmer as the prices of his goods won't rise But from a viewpoint of farmer as a consumer (he spends the earned amount on his personal expenses), It will decrease his purchasing power too at the same time. So, Ultimately whatever the farmer will gain due to rising inflation can be lost at the same time.

2) Yes, Because it raises the cost of borrowing and removes the liquidity out of the Financial system ultimately leading to a downward impact on inflation. Obviously, the assumption here is that Supply side remains the same as before Because if the supply too decreases then again the prices of goods will continue to rise as is expected to happen in India.

3) Yes, it will. When interest rates on deposits are high, people will park their funds in Bank deposits and liquidity will be squeezed. Similarly, if tax benefit is removed from tax bonds. People will not invest in such bonds which will ultimately result in increased liquidity. So, this will give rise to increased inflation.

4) If tax benefit is removed on House loans, it will ultimately increase the cost of borrowing to retail consumers. So, asset prices will not rise as fast as they are rising now. But Real estate isn't a part of WPI or CPI indexes for inflation, So it won't have an impact on inflation.

5) In General, it is assumed that a negative inflation results when The Economy is on the decline. People's wages too are decreasing and people don't have money to purchase the goods which is resulting in decreased cost of goods resulting in negative inflation. So, a negative inflation is considered a bad sign for the health of the Economy.

- Himanshu

1:10 AM, February 14, 2007  
Blogger Aparna said...

1)The price of agricultural goods used for calculation, are the end market prices.How much of this reaches the farmer is not known.

A decrease in inflation would help the farmer get his input goods, fertilizers, seeds etc. at a lower cost as well.

So he stands to gain from it.

2)Yes, over a period of a few months, the decrease in the expenditure on loans, real estate, machinery etc, will help curb the demand. The excess money supply in the market will be controlled.

3)There are 2 possibilities.
a)The person removes the bond before the end date, due to lack of tax savings. In which case, he will be likely to put at least a part of it in another tax saving instrument.

So the money supply remains more or less the same.

b)The person lets the bond remain till maturity date, but is unable to reap tax benefits. In this case, the government gets more money as tax, which shall decrease the inflation.

So in both cases, inflation is unlikely to increase.

4)No. If the tax benefit is removed from housing loans, many people now planning to invest in real estate would hesitate due to the high cost without any rebate.

People who have already invested in it, would be paying more money as tax, & the money supply will decrease.

This would decrease the demand, & decrease inflation.Housing forms a part of CPI, & the rise in this would be curbed.

5)No. Negative inflation is a sign of stagnation of the economy, as there is not enough money to spend, so the prices of goods are decreasing.

A small amount of inflation is considered good, as it indicates normal demand & supply of money.

Aparna

1:53 AM, February 14, 2007  
Blogger praful said...

i don know much abt inflation and finance, i may be raising more questions than answers by this post!!

1. As aparna said, end prices are used to calculate the wholesale price inflation rate. The amount of farmer's revenue in this isnt sure.
And likewise farmer is gonna get his raw materials at reduced prices too.With the government reducing oil prices today, it will result in reduced transportation costs.
So, i think these moves will reduce the food prices but not affect the farmers much.

I want to ask one thing here. With the banks hiking their lending rates after the CRR hike, i understand its gonna make loans costly. Are farm loans insulated from this or are farm loan interest rates gonna rise too??

2.Increased interest rates like himanshu said will increase the cost of borrowing funds and remove liquidity from the system. But this isnt this limited to Indian funds only?? what abt the FDI inflows?? global inflation is on a downtrend. Wont the FDI inflows contribute to inflation??

3.Ya i think it will result in increased liquidity and hence increased inflation.

4.It will cool the real estate markets a little . But for people already with loans it will mean
increased expenditute. So, yeah it will result in reduced inflation.

5.Negative feeling about inflation is due to the rise in essential commodities due to it and the sudden importance to it is due to the 3 key states going to elections in the near future. Negative inflation means the economy is either stagnant or on a downslide, so it aint good.

5:48 AM, February 15, 2007  
Blogger Gyan-ee said...

Himanshu,

Right on all points except one.

Note that just because an item is not part of the CPI does not mean that its price change will not have an impact on inflation. E.g., price of diesel has a direct impact. So you cannot say that real estate prices dont have an impact :).

Click here for complere answers

11:12 PM, February 15, 2007  
Blogger Gyan-ee said...

Aparna,

Good view on the first one.

In the second one, the assumption in the question was all tax saving instruments are removed.
Govt getting more money may not mean it decreases inflation. Because if govt in turn spends the money (on roads etc) and the money will still be in supply.
It can reduce it by using the money for fuel subsidies etc to curb inflation. In short, govt will have better control.

Again, money supply does not necessarily decrease with increased tax.
Look at it this way and it will be clearer. When the tax benifit on the house loan is removed, it increases the effective interest rate on that loan. And hence the answer will be same as for Q2.

11:23 PM, February 15, 2007  
Blogger Gyan-ee said...

Praful,

Farm loans will also get affected unless it is controlled by the Govt.

Excellent point of FDI increase due to increased interest rates. Yes, there will be an upward impact on inflation. But it will be very limited and may not be able to reverse the trend.

On the whole pretty good, especially with your claim of low knowledge in finance :)

11:40 PM, February 15, 2007  
Blogger Atul said...

1) From a farmer's perspective, the inflation in any form is not good.Maybe a increase in prices of essential commodities can help them fetch a larger amount for their produce, but that will still leave him in a world which is more costlier to live. As we have seen in last year, even though inflation was around 5 %, the prices of essential commodities ahs increased by 20 % so inflation may decrease the purchasing power of farmers.

2) Increase in interest rates can be a means to curb inflation. A benefit in the form of good interest rate may decrease the spendings which may bring down the demand resulting in less inflation. But the need to look at the burdon on financial institutions due to high interest mayment must also be looked into.

3) If the Govt removes 'tax benifit' on tax savings bonds, people will possibly invest the money somewhere else and pay more tax. so there is no visible impact on inflation.The increased collection can be used by the govt. in order to provide the subsidies and control prices of essential commodities and can be used to check inflation.

4)If the Govt removes 'tax benifit' on house loans,it may have an negative impact on the real estate sectoe which is presently growing at a rate of 70-80 %. Banks lending rates will stop soaring and as a result, people will have more money to spend resulting in higher inflation.

5) A high inflation rate is useful for the export industry as if the trade deficit is negative, its good to have a devaluated currency.
But for a country like india, which imports a large amount of oil to satisfy its energy needs, a higher inflation rate imposes more burdon on people and increases inflation. But it also cut downs the profits of export and services industry ike IT.

P.S. - sorry if i have understood any term incorrectly but that was all i can deduce from the meagre knowledge of finance that i have.

12:05 AM, February 16, 2007  

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