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Friday, January 21, 2011

Indian Inflation thanks to China & US

The article which I found on Bloomberg is an interesting read on the way countries are trying to protect their vested interest. This is not a bad thing, for long Kings, statesmen and even animals have been known to mark their territory and trying to protect them. 

The point is an increasingly global scenario were most of the economies are interdependent on each other and where there is free flow of capital things could get a bit tricky. 

It’s become commonplace to accuse the U.S. of exporting inflation to the rest of the world. After all, the dollar is the world’s reserve currency. International trade is conducted in dollars. Print too many of them, and inflation is sure to follow. 

Not so fast. The U.S. needs a partner in crime, a willing counterparty to import what the U.S. is selling. It has a perfect ally in the People’s Bank of China, which prints yuan to absorb the dollars that flow into the country in exchange for its exports. 

How is it, then, the Fed can export inflation to all these other countries? 

The Fed can print dollars, and those dollars may very well find their way into global commodities prices, emerging debt and equity markets or country-specific goods. That’s not inflation. No matter how many dollars the Fed prints, it cannot affect another country’s inflation unless that country is complicit in increasing its own money supply to prevent its currency from appreciating. 

China is making a choice to import inflation. (Actually, in pegging the yuan to the dollar, the PBOC is choosing to cede control over its domestic monetary policy to the Federal Reserve. Inflation is the result.) 

Whether a zero percent interest-rate policy is suitable for the U.S. is an open question. It’s not appropriate for a country like China, which grew 10.3 percent in 2010 and is faced with accelerating inflation, a property bubble and soaring money and credit growth. 

The PBOC has been raising reserve requirements and short- term interest rates, selling bills and setting caps on loan growth in an attempt to reduce liquidity and fight inflation. It has allowed the yuan to appreciate only gradually -- about 3 percent in the last six months -- even as China receives an average of $20 billion each month as a result of its trade surplus with the U.S. 

Of course, the choice not to import inflation isn’t quite as simple as trade-surplus countries allowing their currencies to appreciate. Exchange rates have lots of effects on the rest of the economy that a country may or may not be able to tolerate, China’s economy has grown 100-fold, in nominal terms, since Communist Party leader Deng Xiaoping introduced free-market policies in 1978. It has done that by adopting a mercantilist policy of selling more abroad than it buys, holding its exchange rate down to maintain that advantage. China keeps consumers poor so it can grow through mercantilism. Prices and wages eventually move up, making Chinese goods less competitive. In the long run, inflation will destroy any competitive edge China derived from its undervalued currency. 

Now the above was the brief view of a scenario between US$ and the Yuan, my point is what about India were do we stand. Inflation in our country is also soaring petrol prices are already up 20% in the last one year. Food price are up more than 100% in a year. We are also equally affected by the dollar overflow creating bubbles in our market. 

For me India has never taken any strong stance till now on any economic as well as political policy. We have always been a moderate government with little bit of this and that. Our economy is also like that not authoritarian nor capitalist, nor purely socialist. Hence we suffer. Of course there is an advantage and disadvantage. People say our central bank thought about all this and hence did not take any active decision on importing sophisticated financial products into our banking system. For me it is purely luck the time that goes behind every decision slowed us down and turned out to be lucky. 

It is not that we had not taken any decision against using structured debt products. Banks like ICICI had already had a few of these products under their belt. Our slow approach saved us. 

Same way, we have partially pegged ourselves to the dollar hence still under the influence of the US Federal reserve. But the point is we are not gaining from importing this inflation from US. 

We are not a country with net exports nor do we have any attractive competitive country advantage due to our lesser currency value. In spite of this we imported inflation. Leading to rise in product prices, wages and thereby loosing further due to our high cost exports when compared to China. The constant flow of capital has also led to creation of asset bubbles in the stock market and real estate. 

We are still an economy that needs cheap capital if RBI continues to raise rates to curb inflation. We are going to lose heavily in the long run. China and the US have clear cut policies; the former is hell bent on being the world’s largest economy and the later is trying to revive its dead white elephant of an economy. 

I am just wondering when India will have the fortitude to stand up for its economic policies and stop trying to adjust itself with shifting economic policies of the west. 

When will RBI create policies that could lead our country to economic independence and protect our interest instead of siding with the vested interest of the west?

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