Economics had never been my strong subject. But of late, I’ve begun understanding the various concepts that form up the modern economics as we know it today.
Just a minor tweaking of rules here and there can end up having a domino effect on the entire system.
Let us discuss one such tweak which has happened recently and I’m sure by the end of this post, you’ll be amazed by the brilliance of this subject just like I have been.
The year 2020 has been a very gloomy year for the global economy. With businesses unanimously reporting degrowth across all sectors and Q1 GDP declining by 23.9%, the overall sentiment should supposedly be negative. But ground reality is completely different. India has reached record high forex reserves. Inflation, which ideally should have skyrocketed due to almost zero supply for nearly two months, has surprisingly remained at 7% levels (retail), which is higher than the mean of the previous 12 month data, but considering the pandemic situation, is still in a very good range. INR is appreciating steadily and exchange rate today is at Rs. 73.40 to 1$ (it had touched Rs. 72. 76).
How has India managed all this ?
The first and foremost reason is that agriculture sector is luckily still growing and showing no signs of stress, complemented by an above average monsoon (upwards by almost 20%).
Now, with a growing agriculture sector, the only worry at the moment is about rising inflation and the best option to check inflation is increasing the repo rate. The supply of rupees will diminish as no one will want to take loans at high rates. This will automatically take liquidity out of the hands of the people and restore balance. But how can RBI raise repo rates, since that would mean blowing a death knell for the majority of MSMEs and a lot of large industries as well, who wouldn’t be able to manage their rolling in such times without cheap external support.
Yet, tackling inflation is also necessary as agricultural employment has it’s limitations and Indian workforce is huge. So a very smart decision was taken which had two pronged effect – one on inflation and the other on currency appreciation.
RBI, via a notification, declared that it will start selling the dollar reserves, which are already at their all time high.
The effect was amazing.
Firstly, as the supply of dollars increased in the market, it’s value started decreasing (conversely, Rupee started appreciating). And secondly, liquidity dried up – who could resist those cheap dollars, right ?
And thus, using simple Economics and some luck, RBI managed to hit two birds with one stone. This is really something to marvel at.
Bidding adieu until next time!