There must be something wrong with the macro economic conventions. The conventional wisdom is that when the interest rates go up, money will be sucked out of the system, leading to a release of inflationary pressures.
The RBI has increased the rates in six phases during the past year to the tune of nearly 200 base points (that is 2%). By all logic, inflation should have come down to less than 8% by now, especially in view of the more than fair monsoon.
This has not happened. This could mean two things. Since we can rule out major supply side constraints, and unnatural demand spike, as there are no visible signs of both, the only logical conclusion is money flow in the market is higher.
More money is being pumped in from sources, that is greater than the money that is sucked out of the system by the interest rate hikes. There are many suspects.
Pakistan has been very active in printing Indian currency and introducing them into our system. But the amount is too negligible.
With interest rates at an all time high, Foreign Institutional Investors have ensured that there is considerable dollar inflow to the Indian Stock Market (undesirable though), that has seen the stock market touch a record high. This means, the producers are not wanting in capital, which would have been the case when interest rates go up, leading to reduction in production, and wages paid leading to less money in ciculation. But if this were the case, then industrial production should have seen an unprecedented growth, which it hasnt.
The story about National Rural Employment Guarantee Scheme, increasing the purchasing power of the rural population, leading to inflation is pure humbug. If at all, it has to do more with the money siphoned off by the middle men finding its way back.
But my finger of suspicion points to the money stashed in Swiss Banks finding their way back. Swiss Banks are not safe as before and the black money hoarders, ranging from politicians to businessmen to middle men are jittery. With a pliant government that turns a blind eye to corruption, I guess huge sums of money is being drawn out of Swiss Banks and pumped into our system. There is no other plausible reason.
