by archit on January 31, 2011

Our dear friend is making our life more dearer, Inflation. Hope your dearness allowance too has increased over the years. Nobody needs an explanation to what is Inflation. Simply to say, money in hand is not enough to buy the regular necessities or fulfill our wants.

A little go through into my old graduation books has helped me to put more light on the subject. What our country is going through is a Demand Pull Inflation. The demand is more than the supply. Truly so, you see the vegetables, like onions, which we were exporting till a month ago, is now being imported. And so prices will go up.

Coming to the Reserve Bank of India, it plays a significant role to curb the inflation. It has the tools like Cash Reserve Ratio (CRR), Bank Rate, Repo and Reverse Repo rate. CRR is the  funds kept by the banks with the RBI. Its a part of liability which is at the disposal of RBI.

Bank rate is the discount rate on the commercial papers or bills which are sold by commercial banks when they are in dire need of funds.

Repo rate or Repurchase agreement is a short term fund made available to commercial banks. Reverse repo is simply the reverse of it, its the rate that is payable on the funds bought by RBI from the commercial banks.

CRR and Repo rate are more frequently used by the RBI to control inflation. Bank rate is untouched and has been stagnant for a long time.

The obvious perplexity would be that if this is all between the banks then how can it be a help?

This is a very interesting link and if you try to understand it, it will be helpful not only when you go for a simple loan but also when you might go for funds for your business at any bank.

RBI raises the CRR, say from 5% to 6%, the amount to RBI payable has increased by 1%. Now, in the context of the banks, funds kept with the RBI would be huge, may be in hundreds of crores. So now that the CRR has increased, the banks would have to arrange the additional payment. For this, they will hike the lending rate i.e. the interest you pay on your loan. You would either go for the loan or manage most part of the need by yourself.  Therfore, now you have to shell out more from your pocket, by either paying more interest or paying the huge amount for the purpose you needed.

This in turn would tighten your purchasing power. You wouldnt go for the things which you could have purchased earlier. Not just you but people around you would have less money in hand. Boom! the demand goes down in the social scenario. So now nobody would pay more for anything which is not much of a use. For eg. Onions, prices are very high. People would look for alternatives, hence demand for onions would fall. Import of onions would come to a halt. And then, nobody would  buy expensive onions, consequently prices will start falling. Inflation under control!

Its easier said then done. But to be more practical, now-a-days changes in the above rates is not helping much. Indian economy has got more factors controlling inflation. Its all up to the people in the capital to sort out the problems.

Lets hope that they soon will come out with a bulls eye and give us some respite.

Read more about Gold ETF. Gold acts as a hedge against inflation.