 You're watching News Made Easy, I'm Anandya Chakravarty, India's central bank, the RBI has increased its signal interest rates, which kind of sets the flow for interest rates in the entire economy in the banking system. Now, depending on what you do and where you are, it will be good or bad news for you. If you're one of those people who's got almost all its savings, her savings in a bank deposit, then this is good news for you. On the other hand, if you have taken a home loan on a floating interest rate, then the number of EMI's that you'll pay will increase because interest rates will go up. If you were planning to buy a car, upgrade a car and you wanted to buy it on EMI and you thought, okay, this EMI is within my reach and I'll buy it, I'll be able to pay it off. And now suddenly you get a call from the bank and they say, no, the EMI is actually going to go up or you have to extend the time period. You decide which one you want to do and you say, okay, I'm going to postpone that decision. I'm going to buy it later. And if you are a small or medium-sized business or a large business, your cost of financing is going to go up, which means that your working capital requirements, the money that you need for everyday use, production, for paying wages, buying raw materials, administrative costs, that cost is going to go up because businesses run on borrowing money and then paying it back. There's a constant back and forth that takes place in the system. And of course, if you wanted to buy a new machine, if you wanted to set up a new factory, if you wanted to upgrade your office, you would have gone and borrowed money, all of that is going to become more expensive. Now, why has the RBI done that? It's pretty simple. The reason that everyone's talking about is inflation. We have runaway inflation in India and generally it is believed in textbook economics that if inflation goes up, then the best way to bring it down is to increase interest rates. Now, how can you do that? That's a bit odd. You think that what has interest rates got to do with inflation? Again, the explanation is pretty simple. Let's say, as I said, that the car buyer, the business owner who was going to expand, they're all going to postpone the decisions or not expand in the way they were going to. So, the amount that they were going to spend in the market is going to reduce. The business owner is not going to buy a machine or increase raw material expenditure. The car buyer is postponing the decision to buy. So, the total demand in the market reduces and if the demand reduces, what happens that prices, the supply remaining the same, prices will drop. That's the first. The second reason that it is believed that when an economy is working at full employment or very high employment level, what happens is that let's say that a business, a particular company wants to produce more. To produce more, it can buy more raw materials. But what happens about labor? Everyone is employed. So, what does it have to do? It has to poach from somewhere else, right? And it'll have to pay more wages. And those who want to hold on to their workers from going to another company, they'll have to raise the wages as well. When wages rise, not do just the costs of those companies increase, but also another thing happens. There's more money in the hands of workers, so they spend more, production levels are more or less the same, so prices go up. In the long run, of course, supply will end up matching demand in the mainstream theory, but in the short term prices go up. So what do you do? You curtail that by reducing investments. So if someone wanted to borrow money and invest and increase the demand for labor, you stop that. If companies which were borrowing heavily and expanding have to shut down because you have increased interest rates, well, that's it. So there's a trade-off in mainstream economics which is believed that there is a point at which there is an optimization of employment where inflation is tolerable, right? People want that inflation. Beyond that, when inflation goes up, you have to reduce employment. There's no other thing that you can do. Now, they're very simple ideas and because they're so simple, they're wrong. This is very clear. They're wrong. All the evidence that has come from across the world over the last so many years since the 80s has proved that this is wrong. This correlation between interest rates, inflation and employment simply does not exist. It is very simple. It is wrong. It is now accepted by big bankers, by central bankers all over the world that this monetarist theory which had become a dogma across the world and continues to be a dogma in India, by the way, the rest of the world is giving it up is wrong and it doesn't work in that way. In any case, we'd say that aside. Just think of India as inflation. In India, inflation is being caused mainly by two or three things. Number one, the cost of fuel, petrol and diesel. We can't control that. We buy most of our petrol and diesel from outside. The global market, 85% of our crude, not petrol and diesel, comes from there, gets refined and then there's a protection given to refineries. No amount of interest rate hikes is going to change that. There is taxes being taken by governments, centre and states. That's not going to change. So increasing interest rates is not going to make people consume less and bring prices down of petrol and diesel because in a sense they are controlled and administered prices. They depend on the international trade parity prices. There's nothing the central bank can do about it. Number two, food prices. Does anyone borrow to buy food? Yes they do, but they don't borrow it from banks. They borrow if poor people borrow to buy food or get food, then they have to pay interest rates which have nothing to do with the formal banking system. Yes, there is a way in which one could argue that interest rates do affect food prices but big traders, big farmers, they borrow and then buy up all the grain in the market or the pulses in the market and store it and wait for prices to rise or export it. So when you make it tougher for them to borrow money and their cost of finance reduces, they will have to sell off some of the grain that they've stored and hold it and that will bring down prices. But right now, that cannot be done by cutting interest rates. That's something that the government can do without increasing interest rates. The government can crack down on this. The government can do things directly without the RBI having to intervene there. So all these things, whether it is food prices, whether it is the cost of petrol and diesel and whether it is inputs which are dependent on the global commodity prices none of these can be controlled by increasing or reducing interest rates. The only thing that the RBI could possibly achieve by increasing interest rate is to reduce the exodus of foreign capital. It doesn't want to make the rupee more and more weak. It is, as you know, the weakest it has ever been against the dollar and the dollar is likely to be strengthening over the next few months because the interest rates in the US are going to go up and you'll ask why should that matter? The dollar is the global store of currency and if the US interest rates go up and you can earn, let's say, 2.5-3% return on dollar it is probably better than a 6% return on rupee because it is much more volatile, the rupee can weaken and also, well, the markets can fluctuate and you can lose some money. So to make that differential in interest rate the same the RBI actually increased its rates just ahead of what it thought the US Fed would do. So the only reason could be to keep the rupee stable against the dollar and there's something to say about that simply because we are net importers we import a lot and our exports might be boosted a little bit here and there if our rupee weakens but it's not actually that price elastic there suddenly we'll take over the global market if the rupee weakens that's not going to happen, right? So since we import more than we export a weak rupee is bad for us and therefore the RBI might be within its right to do that but we really don't know why it's been done there's not been much clarity, not much commentary from the RBI and neither from the government which claims to be maintaining a distance from the RBI of course but we'll have to wait and see what the RBI comes out to say and why it has done it and whether there'll be more over the next few months that's the show today keep watching, news click, subscribe to our channel like us and share our video as well