The Bank of India to Reverse its Monetary tightening and Resume Inflationary Expansion

Posted by PITHOCRATES - March 4th, 2012

Week in Review

After battling inflation in India for over a year the Bank of India is ready to reverse course.  To halt the decline in their export market growth rate.  With some inflationary Keynesian policy (see Factory growth eases, but keeps healthy pace in Feb by Sumanta Dey posted 3/1/2012 on Reuters).

…employment contracted for the first time in three months and export orders grew at their slowest pace since November…

Price pressures also rose, with the sub-index for output prices, or the cost of finished products, hitting an 11-month high, and the survey suggests inflation could tick up.

A fall in the headline inflation, as measured by the wholesale price index, to 6.55 percent in January, its lowest level in more than two years, had raised expectations the Reserve Bank of India could start easing policy.

After 13 rate rises to stamp out inflation in between March 2010 and October 2011, the central bank signalled in January it was shifting its focus to growth by cutting the cash reserve requirements for banks by 50 basis points.

Clearly with falling export orders the rise in prices isn’t due to demand.  This rise in prices is inflation driven.  Something they’re no stranger to in India.  And something very Keynesian.  Thirteen interest rate hikes in about 19 months?  That’s about one rate increase every month and a half.  That’s some serious monetary tightening.  And now that inflation is down to 6.55% they’re ready to ease policy.  With some inflationary policy.  By lowering bank reserve requirements.  To expand the money supply via fractional reserve banking.  Which will, no doubt, increase prices further.  As inflation tends to do.

By lowering interest rates they are encouraging Indian manufacturing to borrow and expand production.  To meet a falling demand.  And what happens when businesses expand production amidst a falling demand?  Well, in Japan and the United States that resulted in some nasty asset bubbles.  That brought on some long and unpleasant deflation.  Will this happen in India?  It could.  And may.  Unless some markets open up to absorb any increase in supply.  But with the European Union and the United States still limping along and a Chinese export market competing head to head with the Indians, that’s not likely going to happen.

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