Now that the inflation is cooling down as they say, every businessman and economist worth his millions is making a hue and cry about RBI not lowering interest rates. Even Arun Jaitley, our FM, is queering a pitch for interest rate reduction. I will argue against such a reduction.
Inflation as measured by statisticians is falling. But other than prices of petrol and diesel and onions (supply glut and storage issues) which prices are falling? Which price rises are moderating? House prices are still high, transport costs (truck rentals) are still high despite higher production of trucks, manufactured goods haven’t seen price moderation, services like telecom and internet are becoming costlier. Costs of travel by buses and rikshas remain high. In fact a proposal for bus price rise by 20% in Pune was recently shot down. Costs of eating out remain high.
If the demands (cars, houses, etc) are not picking up it is not because of interest costs, it is because people don’t save enough to service repayment of principal amounts. Real wages are falling and job creation is not picking up. Enough has already been written about structural reasons for lack of consumption and investment demand (labor laws, interstate trade issues, agriculture sector controls, land availability, costs of enforcing contracts, slow bankruptcy procedures etc.).
And all this talk is about the ‘white economy’. When the black economy is about 50% (estimates vary) in size how can we ignore it? Do economists take into account the effects of black economy?
Black economy increases percent costs of white money by reducing the denominator (total money) and by increasing numerator (cost of money). Black money increases the taxation burden on white economy since avoiding taxes is its main purpose.
There is more. black money makes decision making inefficient. Greasing some palms for a speedy clearance may help black money funded cases but they scuttle countless other white money cases (which don’t pay as much). Black money also creates incentives for making rules complicated thereby bringing down processing speed and increasing costs of money (money stays blocked longer).
I am leaving out other pernicious effects (drugs, funding of criminal activities, funding of terror) of black money.
The main reason for higher cost of money is that we don’t use money efficiently despite our penchant for scrounging. Our supply chains and all economic making processes are slow (some have improved in last two decades) and full of friction and meandering ways. This is main cause of inflation (you want to charge more and more to cover for uncertainties and slowness in system)
Inflation (hence interest rate) has two components: (1) monetary (loss of currency’s purchasing power due to printing of money through deficit financing) and (2) costs imposed due to inefficiencies in the system.
Do the economists take into account the second factor?
I would like to argue that black money contributes a lot to the costs of system inefficiencies hence to the inflation and interest rates for the above reasons. Therefore I would like to describe Indian inflation as “Blackflation”
Blackflation can’t be tamed by high interest rate but it is illogical to drop interest rate when costs of money are high. It will discourage savings, precisely opposite of what we need.
Economists and companies argue FDI as way out , so that you don’t have to fix black money (no body says that but that’s what it means). Promoting FDI without fixing blackflation is equally illogical and will make the problem worse.
Tackling blackflation through simplifying and cutting taxes, faster supply chains, faster processes, faster court verdicts and unearthing black money is a long road and is a must. Quick fixes like interest cuts will not work.