Inflation, Rates & Supplies

Inflation & Rates

A lot of buzz around the world these days on Inflation, higher commodity & fuel prices, increasing debt on economies, banning imports of luxury items, prediction of a probable recession in 2022 etc.

As a measure, countries Central banks are coming in to save their respective economies by increasing rate.

Obviously, a lot of these measures are not understandable easily for any person. I thought of giving it a try on linking some basic concepts of Inflation, Repo Rate & CRR with the current scenario.

Specific to India, Let's look at Repo Rate first (also known as interest rate)

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Now Repo rate is the interest that the RBI charges to banks for lending money. Yes, banks borrow money from RBI too, and they pay interest on it, known as the Repo Rate.

Increasing this Repo rate means that banks will have to pay higher interest on the money that they borrow from RBI. And since the cost of borrowing is higher, this naturally means that they will also increase the interest that they charge to their customers for loans. So loans will get expensive.

Let's get to why this was done, in 30 seconds.

But before that let's look at the second part.

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Now CRR stands for Cash Reserve Ratio. It is basically a percentage of total deposits that banks need to compulsorily keep with RBI.

So for example, if a bank has a total of 1000 crore worth of deposits, it will have to keep 45 crores with RBI.

Increasing this means banks have to keep more money with RBI, which means they have less money to lend or invest. So what banks do is, try to encourage people to make more deposits so that the bank gets more money available to lend. Customers therefore keep more money in the bank. Also, loans tend to get more expensive because the bank has lesser money.

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Let's see. Inflation in India is close to 7%, which is very high. [Inflation is nothing but a rise in prices of goods and services. 1kg of wheat that cost Rs. 30 till 5 years ago, now costs Rs. 40. That's inflation]

Increasing Repo rate and CRR means that loans will get more expensive. That means that lesser people will borrow, which means lesser people will spend money on automobiles, homes and other goods and services. This means there is lesser money rolling in the economy, i.e there is lower ??????????????????.

Due to this low liquidity, sellers will reduce prices of goods and services, since there are lesser people wanting to buy them.

Thereby controlling inflation.

And that's exactly why, RBI increased the Repo rate and CRR yesterday. It will be interesting to see the combined effect of increasing both in the coming few days!

If this post explained the concept well, please let me know in comments. I'm planning to write more on economics going forward, so your feedback will help!

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