Economic laws do not always hold

The rudimentary law of supply and demand mentioned in textbooks suddenly became ambiguous in the Indian context. Therefore, the reasoning that higher demand leads to higher price or higher supply leads to lower price is outdated. Also, a lower price does not necessarily lead to a higher demand, which it normally should. Let’s see how these violations of economic laws have taken place this year.

Look at the G-Sec rate first. The 10-year paper has now crossed the 6.50 percent mark and the story for the current fiscal year is that it has climbed higher, never slacking off, despite the RBI’s efforts to keep it down. cash in excess all the time. The excess is in the range of ₹ 6-8 lakh crore on a daily basis. This was done by inducing funds through the G-Sec acquisition program (which has now been discontinued), in addition to the surpluses generated within the system. Bond yields should ideally have gone down. Indeed, some auctions are either devolved to PD (primary dealers), or withdrawn by the RBI when the market has not accepted a lower rate. Therefore, the law of supply did not work.

The reason is that the market expected a higher return in two respects. The first is that inflation has increased and is expected to continue to be in the 5 to 6 percent range this year through March. Therefore, the market began to watch real interest rates. The other is the size of the government’s borrowing program or rather the expectation that it exceeds the budgeted ₹ 12 lakh crore.

While the government has announced new spending, the indication given is that there will be no excess borrowing, which is difficult to accept even though tax revenues have been sustained. Divestment is always on the move and it seems difficult to think that around 1.6 million lakh crore can be raised over the next three months. Therefore, the market demands higher yields from auctions.

Loan rate

Second, because the RBI has kept the repo rate at 4 percent despite the rising inflation syndrome on the grounds that growth is the driving factor, banks have lowered their lending rates in general. On a point-to-point basis, the weighted average lending rate on new loans for all banks fell from 8.07 percent in April to 7.98 percent in November, although there were variations in both ways during the year. But the weighted average rate on outstanding loans declined steadily from 9.10 percent to 8.91 percent during this period.

Therefore, the loans were cheaper. Still, the increase in credit was only 3.3% from March (1.7% last year) and 7.3% year-on-year. Obviously, the demand for credit is less and therefore the price is not a deciding factor. In fact, today there is a pretty absurd situation where some banks give home loans at 6.40 percent, which is even lower than the rate at which the government borrows.

In November, growth in credit to the manufacturing sector was negative, led by large industry, while that in services was only 0.8%. Agriculture and retail credit had allowed this minimal growth. Here, the industry’s excess capacity has hampered the demand for credit.

Third, while we had the advantage of having a good kharif harvest this time around, food inflation remains the Achilles heel. The prices of edible oils and horticultural products have risen quite threateningly, upsetting the RBI’s calculations. In addition, even core inflation rose against a backdrop of stagnant demand. This too calls for an explanation.

While the overall Kharif harvest has been good, India imports 60 percent of its edible oil requirement, which means inflation is imported when world prices rise. The monsoon retreat came later than usual – this has become a worrying trend in recent years – which in turn has pushed up the prices of vegetables in particular. As a result, the steady growth in agriculture has resulted in spikes in inflation due to a few product categories.

In the case of so-called basic products, which are non-food and non-energy, the picture is different. Higher raw material costs due to rising global raw material prices have pushed up retail price inflation for consumer, personal care and pharmaceutical products. In addition, services such as health care, education and entertainment have become more expensive.

Companies have adjusted their prices to maintain their creditworthiness at a time when restrictions have been placed on their operational capacity for entertainment or tourism. In the case of health, these are hospitals that are taking advantage of a situation of strong demand growth which has led to a rise in prices even though costs may not have evolved to the same extent. Therefore, the inflation of the prices of commodities and services is due more to supply-side factors than to demand-side factors.

Finally, the currency was also quite fancy. Normally, textbooks say that the exchange rate is the result of the demand and supply of dollars. Over the past year, the country’s foreign exchange reserves have grown by around $ 58 billion. This should normally have led to an appreciation of the rupee. But the dollar rose from 72.5-73 yen in April to 74-75 yen in December. This can be explained by the global factor where a stronger dollar against the euro caused all currencies to fall, including the rupee.

Deposit rate

On the other hand, if we look at the balance sheets of banks, the table on deposits is interesting. The weighted average deposit rate on outstanding deposits increased from 5.26 percent to 5.04 percent. This is a situation where banks are lowering the deposit rate to ensure that deposits do not increase as they have a negative carry of 165 basis points when invested in the take window. in reverse board.

Deposit growth slowed to 5 percent from 6.7 percent last year (as of December 17). Banks here may be better off because the flow of deposits has slowed down. Households have turned to alternative solutions such as mutual funds, coins and cryptocurrency. This can be of concern to the system in the future as higher risks are taken by individuals.

As a result, markets seem to no longer be guided by the forces of supply and demand; external factors have guided the prices. This will also be the way forward. Therefore, we cannot assume that the forces of supply and demand will drive prices. Welcome to the new market economy.

The author is Chief Economist, Bank of Baroda. Views are personal


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