One Response

1. Syed Zahid Ahamd

   July 30th, 2008 at 9:16 pm

   1

   RBI is increasing inflation instead of controlling it!
   The action taken by RBI to control inflation is not admirable. The tool of interest is spoiling our nation. Every time attempt to control inflation through altering interest rate is easy for RBI, but disastrous for the economy. RBI should revisit the decisions taken up to control inflation. Interest can affect liquidity and control inflation for time being by curbing the demands but cannot control ultimate inflation as the higher deposits at banks will yield higher interest expended over those deposits which in turn enhance the purchasing power of the depositors with no increase in real GDP. Thus this practice by RBI to control inflation itself leads to inflation.
   The annual interest income by banks is over 5% of GDP at Market Prices. It means the prices of commodities and services produced with help of bank credits would be increased by at least 5%. Interest income by banks thus increases the price levels by minimum 5%. Moreover the interest expended by banks over deposits is over 3% of GDP at Market Prices. It means the deposits buying capacity would be increased due to interest while GDP remaining unaffected; the price level would further increase by at least 3%. So due to interest earned by banks and expended over deposits, the price level increases by over 8% per annum. In this situation if interest rate is further increased, the inflation will not be controlled, rather stagflation will increase. Already we can see that our total final consumption expenditure as % of GDP at market prices is declining from 67.8% in 2005-06 to 65.5% by 2007-08. This decline along with inflation cannot be controlled by increase in interest rate. On the contrary, we need stimulator for productivity and sales in the real market, which requires reduction in interest rate.
   The practice of RBI to control inflation by interest rate is disastrous for Indian economy and should be questioned. The role of interest to control liquidity is not questionable but its impact over income level of depositors, borrowers and the price level should be re-considered and it is important that RBI should review these impacts. It should be noted that if banks expend worth 3% of GDP at market prices as interest to deposits, the liquidity automatically increases without real change in GDP, thus causing inflation.
   We should consider and find long term solution for instability in financial and real markets. If RBI or financial sector regulators wish, Islamic ethics on Banking and Finance may guide us promote ant inflationary, stable and equitable system for economic growth. Islamic Banking is the most needed mechanism at this time which could solve the problems. The fear that Islamic banking would not benefit the corporate or nationalized bankers is just based on prejudice only. The corporate and national bankers along with stock market would be in better position after introduction of Islamic Banking. Islamic Banking would also increase D mat account and capitalization at stock market. Hopefully AMU with attempt to promote education about Islamic Banking and Finance may improve our understanding about the alternative banking and financial mechanism. Islam advocates for anti inflationary and stable economic system with socio-economic justice as an objective of governance.
   Syed Zahid Ahmad