CRR cut may not increase inflation always!!!

Today, in ET I read that reduction in CRR [Cash Reserve Ratio is the percentage of the amount each bank has to keep with the Reserve Bank of India (RBI)] of 50 basis points from 9% to 8.5% may increase the inflation worries. Because of this CRR reduction there will be Rs. 20000 crore amounts will be available in the economy from 11th October.

But I don’t think so! I would have agreed this argument if condition would have been normal (In the sense according RBI inflation would have been below 5% and no financial crunch and obviously no fear of recession). But in this kind of financial crisis and fear of world wide recession, this CRR reduction may not exactly lead to increase in the inflation.

Because what I believe is Indian inflation is due to both the reasons:

 Demand pull
 Cost push

First one, demand pull, as the name suggests too many people/too much money chasing too few goods. Here rate of growth of demand is more than the rate of growth of supply. So there is mismatch in the demand & supply. This leads to inflation for example, crude oil and other commodity prices.

Second one, cost push, as the name suggests increase in the cost of the goods because of increase in the living of standard of the people. From last 4-5 years Indian GDP is growing at the rate of 8-9%. This means growth in the income. And at the same time increase in the prices of raw material due to shortage.

And our Indian inflation is not only because of domestic developments but also because of the international affairs like demands in US & China, crude oil price movements and so on.

Now coming to present condition, why CRR reduction may not lead to inflationary worries are:

1. RBI reduced the CRR but not Repo rate!!! (Repo rate is the rate at which RBI lends to banks)

This means, there may not be reduction in the interest rate as a whole measure. But there will be liquidity in the whole economy. Whoever is capable of paying higher interest rates can take the money and use it for at least to fulfill the working capital requirements.

2. Financial crunch!!!

Due to real estate boom in the US sub prime lending started as much unanticipated manner. In addition to that Securitization came into light much brighter than its earlier existence. When real estate bubble burst everything started busted with the bubble. This is leading many legendary financial firms’ collapse leading to financial crunch or crisis. Experts started comparing this crisis is with the great depression of 1929. Once liquidity in the economy dries there will be sudden drop in the demand side.

3. Possible fear of recession

Recession means two consecutive quarters of negative economic growth as measured by a country's gross domestic product (GDP). So as I stated GDP depends upon the total production which intern depends upon the gross demand. So once apprehension on investment starts then there will be a break in the vicious circle (increase in the wages/salary increase in the living of standard  increase in the demand  increase in the inflation).

4. Base Effect

As I said in my earlier posts, base effect plays very important role in calculating the WPI index. Inflation started increasing by the year end of 2007. That factor will be helpful in the automatic easing of inflation numbers by this year end or beginning of New Year 2009.

So looking at above points you guys can also think and revert to me back about what you feel!!!