Economic & Financial Rendezvous

This thread is for people enthusiastic about the developments happening in the world related to economic and financial issues and are eager to contribute in healthy discussions about them. People can their share personal views, articles, editorials and any other intellectual piece of information. Aspirants of different exams are welcome to join this discussion to enhance their knowledge that can be helpful in the selection processes.

as we have been noticing for few months about d lot of inflow of fdi. in d industrial and manufacturing sector and much more to come ......what have been d technical advancmnts related to agri. sectr?........what can be some ideas for raising their financial living standards? most of d population is leaving d sectr itself...for better income...

nice initiative .........

Thank you so much guys for following this thread. 

And again I request to all those followers who have joined their jobs or are about to join to remain active on this thread because there are umpteen number of issues on which only you people can give information and not the exam aspirants.

I am posting an article that I posted in one of the thread but I think it must have got unnoticed because of some random and unproductive things happening. Please share your views.


                                   CHINESE SLOWDOWN

Recently, devaluation of Yuan by the Central Bank of China - People's Bank of China (PBOC) - created havoc in the global economy. This incident not only affected the emerging economies like India but also developed economies like USA, UK, Japan, etc. Many feared that the recent devaluation process was because of the slowdown in the Chinese economy which was corroborated by the release of the Chinese export data showing around 8% decline year-on-year. Also, the fall in prices of crude oil is also attributed to the fall in demand due to slowdown in the global economy particularly in China.

On the other hand, Chinese Government and PBOC clarified that the devaluation was result of their efforts to link the value of Yuan to the market forces. This move will make the case strong for China to include Yuan in the SDR basket (explained below in detail) which is set to be reviewed in 2015 by the IMF.

In spite of the clarifications given by the Chinese authorities, it is quite evident that the Chinese economy is in the phase of a slowdown and is not set to perform up to the same level it has been doing for the past 3 decades.

It is said that China does not have any international friends; still slowdown in the Chinese economy is a matter of concern for the global fraternity including India.

To understand the situation it is important to know some terms and background of some recent developments that is responsible for the current situation.

China Real Estate Bubble

The deflation of the real estate bubble is one of the major causes of the economic slowdown. Many factors worked in tandem to inflate this bubble.

For the past 3 decades Chinese economy grew at an average of about 10% annually. Also, during this period the urban salaries grew 15% per year on an average. Notably, in 1990 only 17% of the households owned their homes, in 2005 this figure went up to 85%. In addition to this, Chinese people started to save more. Although majority of the people now owned their house, their aspirations increased to upgrade to a better one. The saving rate increased to 25% of gross income in 2012 from 17% in 1995.

Moreover, Chinese policy became more accommodative in 2000s. The loan rate was around 6% per annum, which is extremely low in an economy that is witnessing average 10% growth rate for three decades.

During this period of bubble local government relied on sale of land for their revenues (Nearly 50% of the revenues) and hence incentivized sale and purchase of land.

Limited access to foreign investment, Chinese people started to see real estate as a lucrative investment destination.

As a result of these significant investments in the real-estate sector, China consumed around 60% of the cement produced around the world and 43% of construction equipment, such as bulldozers and other heavy machinery. The construction sector consumed 40% of the steel produced in the country, representing 12% of GDP, and employed 14% of the active population in China.

Result of inflating the real estate bubble over an extended period of time was large number of vacant or under-performing commercial and residential properties, an estimated 64 million vacant apartments. The high price-to-income ratios for real estate, such as in Beijing where the ratio was 27 to 1 years, five times the international average and high price-to-rent ratios for real estate, such as in Beijing where the ratio was 500:1 months compared to the global ratio of 300:1 months.

There was a weak secondary market for Chinese homes, with the ratio of secondary to primary residential property transactions at 0.26 for the first half of 2009. Comparably, Hong Kong had a ratio of 7.25, and the U.S. had a ratio of 13.45.

Contributing to the bubble were Chinese companies in the chemical, steel, textile and shoe industries opening real estate divisions, expecting higher returns than in their core businesses.  Residential housing investment as a share of China's GDP tripled from 2% in 2000 to 6% in 2011, similar to the peak of the U.S. housing bubble.

Between 2010 and 2011, Chinese Government started to enact policies intended to curb the bubble from worsening. The Chinese Government announced in 2010 it would monitor capital flows to stop overseas speculative funds from jeopardizing China's property market and also begin requiring families purchasing a second home to make at least a 40% down-payment.

Beijing banned the sale of homes to those who have not lived in Beijing for five years. Beijing also limited the number of homes a native Beijing family could own to two, and allowed only one home for non-native Beijing families. By July 2011, the Chinese Government raised interest rates for the third time that year. A new nationwide real estate sales tax was introduced in China in late 2009 as a measure to curb speculative investing.

The deflation of the bubble began in the summer of 2013, when home prices began to slow or fall in Chinese cities.

This end of the property bubble is seen as one of the primary causes for China's declining economic growth in 2014.

Slowdown in the Allied Industries

The deflation of the property bubble lead to the slowdown in the allied sectors, like steel, cement, glass, furniture, construction equipment etc, supporting the real estate sector. These allied sectors also provided employment to a significant portion of population. So any adverse effect on the real estate sector affected the livelihood of people employed in the allied activities.

After the real estate prices started to fall, the real estate sector started to lose their profit margin affecting their ability to repay their loans.

Moreover, countries supplying raw material to China were also affected due to weakening demand. These countries were compelled to search for other markets in the world which was already reeling under the pressure of economic crisis.

Slowdown in Global Economy

Since 2007-08 Great Recession global economy was severely affected. Major blowback came to Europe which was not able to revive itself in spite of all the efforts of Government authorities and the European Central Bank. Greece, which received two bailout packages in 2010 and 2012 could not revive its economy and was on the verge of an exit from the European Union. United Kingdom, one of the major economies in the world was suffering from the deflationary trend.

This slowdown in the world and specifically in Europe affected the demand for the Chinese exports very badly. Any adverse effect on the Chinese export world would mean hurting the whole Chinese economy, which emerged as a "poster boy" for export oriented economic growth.

Inclusion of Yuan in SDR Basket

SDR stands for Special Drawing Rights and is used by IMF for accounting purposes. Its value is linked to 4 currencies - US Dollar, Pound Sterling, Euro and Japanese Yen. The inclusion of a country's currency depends on the share of its trade in the global market and exercising globally excepted practices by the country. IMF provides a specific amount of SDR to its member nations according to their IMF quota. Member countries can use their share of SDR in building their reserves and exchange SDR with other countries to maintain their Balance of Payment.

Inclusion of country' currency in the SDR basket provides the economic clout to that country. Also, that country will have more say in the global economy after the inclusion of its currency in the SDR basket.

Although China has emerged as one of the major players in the global economy in terms of trade, Yuan was not included in the SDR basket by IMF. Reason stated by the IMF was that China follows fixed exchange rate for Yuan and not the globally accepted practice of floating exchange rate. On daily basis, PBOC used to set an exchange rate and give traders a band of 2% above and below that value for operating. The composition of the basket of currencies used by the PBOC to decide the exchange rate for Yuan is unknown, but it is believed that the basket gives maximum weightage to US dollar. One of the plausible explanations is the appreciation of Yuan in tandem with the appreciation of US dollar. And this trend has been noticed widely since the coming back of US economy from the period of Great Recession (2007-08).

China wants Yuan to be included in the SDR basket as soon as possible to provide fillip to its effort of increasing its economic clout in the world and challenging the US Dollar in the future.

Yuan Devaluation

There were both international and domestic pressures on Chinese authorities to devalue its currency.

On the international front all the major economies, particularly USA, accused China of deliberately keeping the value of its currency at low level to make its export competitive in the international market. On the domestic front, traders accused Chinese authorities of keeping the value of Yuan high and thus making their exports less competitive.

China ultimately started Yuan devaluation. Although not stated explicitly by PBOC that Yuan devaluation was done to revive the falling exports and hence revive the Chinese economy, reason was pretty clear from the fact that devaluation was done after the release of weak Chinese export data.

Effect on Stock Markets

Yuan devaluation was not received well by the investors all over the world and resulted in capital flight from stock markets of developing as well developed countries which were dependent on Chinese economy directly or indirectly. Although the effect on Indian stock market was a bit delayed and subdued, capital flight eventually took place on the announcement of China allowing its 500 billion dollar pension funds - largest in the world - to invest in Chinese stock market. This announcement gave signal to the world that there is liquidity crunch in the Chinese stock market that is indicative of weak Chinese economy.

Effect on other Economies

In today's intertwined world, no country can remain isolated from the deteriorating economy of other country. Countries which supplied raw material to China were the most effected by the turmoil created by the weak Chinese economy.

Almost 30% of the Australian export was consumed by China. So, slowdown in Chinese economy resulted in the decline in demand for the raw material. Hence, Australia was compelled to look for other markets having the capacity to absorb its exports.

Recently, China started to venture in the African continent to gain excess to the natural resources and minerals available that can fuel the growth in the Chinese economy. Slowdown resulted in the fall in demand for these natural resources. Due to the fall in demand commodity prices for goods such as copper ore, iron ore, etc started to get effected.

Similar effects were experienced in other countries whose exports were absorbed by China.

Fear of Deflationary Trend

Yuan devaluation made Chinese exports less costly as compared to goods of other countries. This would result in declining of prices in the countries importing Chinese exports. This was a bad news for major economies such as UK which was under the pressure of deflationary trend for the past few years and could even slip back to this trend following the Yuan devaluation. There were also speculations that the declining prices can also affect US which absorbs substantial part of Chinese exports and where inflation level is at a low level of around 2%.

Effect on India

India's Current Account Deficit (CAD) with respect to China is under stress and is increasing for the past few years. Recent visit of Prime Minister Narendra Modi to China also stressed on the moves to reduce CAD. But fall in the prices of exports will increase India's CAD with China. This is not good news for Indian Government that has vowed to revive Indian economy and has set a target of double digit growth in the near future.

Also, with decline in the prices of Chinese exports there is a fear that Chinese goods will be dumped in the Indian market. This situation can adversely affect domestic market by making Indian goods less competitive for the consumers.

@Anubhav22 thank you Anubhav sir 😃

China's market crash

## The mains behind the china's market crash is

1) Many chinese citizens borrowed money to invest in the stock markets ans shares which sunk owing to which inflation of prices took place to a unsustainable level

2) When prices of the so-called shares went down , these people tries to sell their shares and want their money back to recover their loss

3) The huge amount of money has been put in chinese stock market from the past few years due to uprising economy.

4) 80% of the shareholder market was made up of chinese citizens rather than communist party

5) Around 90 million were retail investors

6) And this uprising in the market coincides with the upward surge in shanghai composite market which upthrusted 150% from january to june...

7) After the downfall of the prices of few cos. like HANERGY marked the era of crash of chinese market


Best video I have come across to understand the European Debt Crisis. All those who want to have a clear basic understanding of the problem do watch this video. And after watching this video all other resources will be easy to comprehend.

It will also help to understand what is actually ailing Greece economy.

What is the criteria to select banks as DSIBS .??

Banks with assets that exceed 2% of GDP will be considered as Dsibs . is this true .??

A detailed and illustrated explanation of GST by a CA himself. Table of comparison will ease the technical portions more

The following article sheds some light on the reason why benefits of recently falling crude oil prices is passed on to the consumer only partially.


There is a general misconception that Governments do not pass on the benefit of falling oil prices fully to the citizens of its country for political reasons and to fill its coffers. This allegation is made by the people and also opposition political parties to score some brownie points over the issue. However, the reason for keeping portion of the benefits of falling prices is economic and not political.

To understand the reason for this partial transfer of benefit it is important to know about a concept called terms-of-trade.

Terms-of-Trade (TOT)

Terms-of-trade is the ratio of export price to import price. When due to some development the price of import or export changes the value of TOT changes. This change is known as terms-of-trade shock. If the relative value of export increases with respect to import terms of trade shock is said to be moved in positive direction and if the relative value of export decreases with respect to import terms of trade is said to be moved in negative direction.

The nature of terms of trade shock can be temporary or permanent. In case the positive effect is permanent, country promotes consumption in the economy that can lead to increase in the aggregate demand by passing on the benefits to the consumer. This increase in demand will fuel the economic growth in the country. In case, the positive effect is temporary country promotes savings by not passing the benefits to the consumer to ready itself for any negative shocks in the future.

Effect on TOT of India

In case of crude oil, fall in prices will lead to the positive terms of trade shock for India. But the question arises whether the effect is temporary or permanent? This can be answered by examining the reasons for the fall in prices.

In particular there are two reasons for the fall in prices - geo-political reasons and slowdown in the global economy. But in both the cases there is one mechanism that plays important role in determining the prices and that is demand-supply mechanics. So let's first learn about the reason for falling oil prices and then come back to our main topic of this article.

Demand-Supply Mechanics

Whenever the gap between the demand and supply decreases, price of the entity increases. And vice versa is also true.

So when the gap between the demand and supply increases, for any reason, price of crude oil decreases.

Reason for Falling Oil Price

Reason for falling oil prices can be attributed to the geo-political scenario. USA and Saudi Arabia wants to pin down Russia, Iran and Venezuela. Also, slowdown in the world economy, especially Chinese economy, has contributed to the fall in demand for the oil. If supply of oil is not decreased accordingly but is increased or maintained at the same level, price of oil will fall. This is what USA and Saudi Arabia is taking advantage of. They are not decreasing the supply of oil so that oil prices do not fall and remain stable. This will affect their International foes like Iran, Russia and Venezuela that are dependent on oil exports for their revenues.

Nature of TOT Shock

So, it is clear that the prices of oil can rise in the future if geo-political scenario improves. Whatever the benefit that India gets from falling prices can be reversed to some extent if not to the same level. Taking this uncertainty into account India went for appropriate hedging.

India passed 34% of the fall in price to the consumer and kept rest (66%) with itself. The 34% part will promote consumption in the economy as fall in petrol and diesel prices will lead to decline in the price of goods and also decrease the input cost. The effect of which is already evident from negative WPI inflation. This decrease in the cost will boost demand in the economy which in turn will promote economic activity and growth. The 64% part that Government kept with itself will promote savings. The savings part was given preference over consumption because of the uncertainty of crude oil price in the future. Also there is great amount of probability that price will increase in the future, the fact that Raghuram Rajan also confided in an interview.

It is for these very reasons that price benefit is not passed fully to the consumer. In spite of immense political benefit of passing on the whole price to the consumer, Government decides to take an appropriate hedging stance keeping in mind the macro-economic situation and economic stability of the country.

Rule of Thumb

In the end I would like to mention rule of thumb that Indian policy makers follow - US $10 reduction in price of oil improves current account by US $ 9.4 billion.

This is the trailer of the movie based on 2008 financial crisis made by BBC. A must watch for those who want to know what happened behind the doors in the office of Secretary of Finance Henry Paulson and The Federal Reserve.

The screenplay, direction and acting will not bore you.

Highlights of this movie are The Fall of Lehman Brothers and AIG Bailout.

There was accusation on Henry Paulson that why he didn't bailed out Lehman Brothers but bailed out AIG. Also, the congressional leaders were all over him for helping Wall Street at the expense of Main Street. This movie will give you some insights behind the decision taken by Henry Paulson and his team and The Federal reserve.

The movie is available on torrent . Do watch !!!!!

Peace Out.....


Here in this post, we shall broadly discuss the basic concepts of Currency, Inflation, Deflation & Exchange Rate. I do not want to merely present the definition of these topics for you to read, and that is why, I shall be explaining the above concepts by answering the following 3 questions.

Q1. Why can't Indian Govt. pay World Bank loan by just printing money?

Q2. Why can't RBI control the Rupee value against US Dollar by simply printing lesser money?

Q3. On what basis does RBI decide how much money to print?At the end of this discussion, though you'll not come across an exact explicit definition of subject topics, but you shall definitely have a thorough understanding of each one of them. Above questions have been answered in the chronological manner since answering one will invariably incite your curiousness and make you ask the follow up question. To understand the answer to our first question, let us make ourselves our own Economy.Let us say you are a farmer and you have mango plantation. You do hard labor and work day and night and grow 100 kg mangoes every year. One cannot live his life eating only mangoes, And since mango is a good seasonal fruit, good for health, and not to mention utterly delicious, there would be others who'd happily trade their farm products, say wheat, for some of your mangoes. Realizing this, you decide to exchange your mangoes for other products. You tell about it to your friend who has wheat farms. Incidentally, he happens to be a mango lover and together you develop a rate of exchange, with mutual understanding of course in this example, say, 5 kg mangoes for 10 kg of wheat. You give him 10 kg mangoes and get 20 kg wheat for your family, which you assume should suffice for 6 months. You do the same thing with your other friends as well in exchange for pulses, rice, vegetables etc.Now, past 6 months comes winter, and your supplies have started to diminish. Moreover, you do not have any mangoes to offer in exchange for wheat and other commodities. But without the commodities you won't survive for next six months. Now what should, or rather, what could you trade in exchange for wheat?You find a solution. You go to your best friend who trusts you a lot, and you promise to give him 5 kg of mangoes next summer for 10 kg of wheat right now. He thinks about it for a while. There are of course things to be concerned here. What if you refuse to give him mangoes later? What if the mangoes you give him aren't good quality? What if next year is a drought and there are no mangoes?

Let us say for the sake of simplicity here that your friend here thinks about it but on goodwill and years of friendship, he trusts you and agrees. Similarly, you go to your other friends, gain their confidence and promise them some mangoes next summer for providing you with supplies right now. Now, what you have done here is that you have developed a trading system wherein you trade items and commodities for other items and commodities. And the trading currency is none other than the "items and commodities".

But now, since you are trading with so many different people at different time, it is getting difficult for you to keep track of how much mangoes you owe to whom. So what you do is that you start handing over promissory notes to the people you trade with, with your sign on it and the amount of mangoes you owe them. So next summer, whenever you have mangoes harvested, people come to you, show you the promissory note with your sign on it, and take the mangoes.

But there is a problem with this system: you are promising X kg of mangoes which you have not harvested yet, i.e., which do not exist. Similarly you would have supplied mangoes to someone for a certain commodity he'll have in future but doesn't have it now. And then there is always a risk factor, i.e., next year maybe a dry one and you may not have enough mangoes to trade.

Realizing this, you are worried now. You need a damage control. You consult this with your trusted friend and ask him how to avoid possible damage. Now this friend of yours is quite a trader himself and has travelled many cities and traded with many people. He tells you not to worry about it and that he'll let you on a little secret. He explains it to you how people will need mango no matter what: after all it is a seasonal fruit and very delicious. Now if there is less growth of mangoes next year, then he can ask to negotiate exchange rates in his favour, i.e., more commodities for same amount of mangoes. Simply put, due to scarcity, his mangoes will become costly.

You get it a little bit, but you are still confused. You wonder how will you negotiate rates when you do not know how much mangoes you are going to harvest next year; how can you negotiate when there is uncertainty? Your friend smiles, and tells you that you can. He suggests you to issue only a certain value of promissory notes, let's say  1000, and then do the trading with these notes after declaring their new meaning to the traders. These 1000 notes will represent 100% of your harvest, no matter how much you harvest. So if there is a guy with your promissory notes valuing to 100, he''ll have 10% of your harvest next summer, no matter how much you harvest. He can also decide to not exchange it for mangoes next year when there is a drought, and wait for next to next year hoping for more amount of mangoes then. Let's call your promissory notes as Mango Currency (MC).

All goes good and the mangoes, being good quality and sweeter than its competitors, are valued more. People want to buy mangoes from you even if they have to pay more. This means the value of MC gets more, only a few people can afford it. The very lower class, who wants to eat mangoes but cannot get hold of MC due to its high value is suffering. This also causes you loss in business since people are now holding MC instead of trading it for mangoes since the value is increasing. Since mangoes are not being traded, they are rotting in the collecting compound with very less people to buy them, causing you huge loss. You now need to keep the value of MC in check so that people do not hold up to it.

You go to your friend again and consult him on how to keep value of MC in check. He tells you to simply issue more promissory notes. Since the total sum of promissory notes is equal to 100 % of your harvest, if you issue 1000 more promissory notes in addition to the initial 1000 that you've had, the value of MC would be halved. 100 MC that was 10% of the harvest would now only be 5% of your harvest. (This is also how RBI keeps the value of Rupee under check, else Economic activity of country would go down)

Now you have developed a good trade system and also know how to keep the value of MC under check by regulating the supply of promissory notes. Now you decide to expand your business. You go to your best friend who deals in wheat and has currency WC (Wheat Currency). He is already doing very good in business and has surplus money. You tell him about your plans to expand our business and your requirement of more money for expansion purpose. He listens to you and agrees to lend you some money at certain interest rate: he already has enough money and extra money sitting at home isn't earning him anything, so lending it to you for certain interest seems a good deal.

You borrow 500 WC from him. Now WC is quite strong in market. So much that 500 WC costs around 1000 MC (how much % of wheat harvest it represents doesn't matter).

Now, you use up all the WC for expansion but suffer heavy losses. All the WC went down into the drain. You bought some stuff from it and have it still, but it is not bringing you any revenue and nobody is ready to buy it back. You are now left with only a few MC (remember, your currency is also floating in the market; you have maybe 1200 MC at hand). To pay back 500 WC, you need 1000 MC. But if you give 1000 MC right now, your remaining business will not be able to sustain itself with only 200 MC at disposal and you'll eventually end up bankrupt.

You now think about possible way out. You plan to issue 2000 MC more, exchange 1000 MC for WC and return the loan. But if you issue more MC, the value of MC will be halved. Moreover, you cannot think of cheating because the value of various currencies is now checked by Association of Auditors and you need to report any more printing of currency to them before it can be floated in the market, and all the currencies are numbered to keep the authenticity in check.

Basically, you are now left with only one option: to try to get your act together and grow your business back to what it was, and then further more to get enough MC with sufficient value, to be able to return the loan amount.

Now in the above scenario, let's replace you with our country India, and replace mangoes you harvest with the economic activity that takes place in country; and replace your promissory notes, valuing to 100% of your harvest, to 100% of the economic activity in the country.

Now, back to the questionWhat happens when RBI prints more money to pay off bank loans? You should be able to guess it. More the money printed, lesser the value of currency. Money flowing in the country is nothing but standardized promissory notes issued by RBI. They are equivalent to the total economic activity of the country. If the economic activity does not increase in proportion to the money printed by RBI, the value of Indian Rupee will go down.

And obviously, value of MC will go down with respect to promissory notes issued by other people for other commodities. So when value of Rupee goes down, it does w.r.t other currencies, USD being one of them.

It's not difficult to guess that loans provided by World Bank are in USD. If money is printed to pay off the loan, value of Rupee goes down, which means you need more Indian Rupee to buy USD. As you can see, you cannot repay the loan unless you actually have the money, over and above what you'll need to run the country.

Now, a moment of truth: this is not how an Economy works. That is to say that money is not issued in the manner explained above. The take away from the story is that money gets its value from the amount of goods being produced in the country, like mangoes in this case. For an actual economy like India, these goods will range from matchsticks to Airplanes. Not only products, but services are included as well; intellectual work also has its value. All these is collectively termed as Economic activity of the country, i.e., activities which produce some output, physical, intellectual, or work (labor). In essence, the money in any economy gets its value from the amount of economic activity in the country.

You may ask, if this is not how money is issued then how else? You'll get the answer further in the post. But, for now, let's consider other takeaways from the story above: increase in printing of money decreases its value & vice versa.
From above story, what you understand is that the farmer cannot print excess money because of the 'Association of Auditors'. You may ask here is, what is this Association of Auditors in our national Economy?

There is none. Let's forget that there is an association of auditors in above case and he prints money without actually telling anyone and issues it. What would happen if everyone with the money came at the same time asking for their share of mangoes? Since the currency value has not changed, the actual % of harvest that the money will represent will be more than 100%. Hence, it is more sort of a damage control.

But again, that is also not how the Economy works. Value of any currency follows demand-supply principles. If more money is available to citizens, they'll be willing to spend more. Prices of products & commodities will increase, effectively reducing the value of currency. Similarly, shortage of money supply in any economy will lead to increase in its value and reduction in prices of commodities.These effects are called Inflation & Deflation respectively.*************************************************************************Moving on to the second question: "Why doesn't RBI simply print lesser money in order to keep the value of Rupee against Dollar under check?"I've already explained above the effects which printing excess amount of currency in any country causes (the basic demand-supply concept of goods & services: more demand of goods than supply, or more supply of money than demand results inmore value of goods or less value of money, and vice-versa). To cite an example, refer the case of hyperinflation in Zimbabwe, wherein the Govt. printed money like paper, and that's what the currency's value came to be like. I suggest the readers to read the wiki article on Hyperinflation.Now, let us apply the same concept here. Let us assume the RBI decides to stop printing the currency for a while. Quite opposite to inflation, where value of money decreases, value of money starts to increase here, i.e., you can buy more goods and services for same amount of money than you could before. Another way of saying it would be: the prices of goods & services are falling.Now let us stop here for a while and think over the situation with the help of an example. Let us take gold. Somebody tells you the value of gold is falling down, i.e., you can buy more gold for same amount of money. Further, he tells you that value of gold will go down even further. (Lets just say that your source is impeccable and if he says so, it's going to happen). What would you do?You, as an investor, would not buy gold right now. Instead, you would wait till the prices are little more down so you could get a better deal. It is human nature, you cannot help it; neither can rest of the population in the country. So everyone waits, nobody buys, hoping for the prices to fall further.Now, let us replace gold with other goods and services. The basic concept remains same. People do not buy goods or services in hope for a better deal later. They wait. Result: the aggregate demand goes down.There is a fall in how much the whole economy is willing to buy and the ongoing price for goods. Because the price of goods is falling, consumers have an incentive to delay purchases and consumption until prices fall further. The fall in demand causes a fall in prices as there is excess in supply. This becomes a deflationary spiral when prices fall below the costs of financing production. Businesses, unable to make enough profit no matter how low they set prices, are then liquidated. As can be seen, the overall economic activity of the country is reduced.This whole process of reduction in value of goods and increase in value of money is called Deflation. There could be many reasons for deflation; read DeflationNow, Deflation is generally regarded negatively, since it causes a transfer of wealth from borrowers and holders of non-liquid assets, to the benefit of savers and of holders of liquid assets and currency. Simply put, the land you owned now has less value than it had, and the money in my hand now has more value than it did.While an increase in the purchasing power of one's money benefits some, it amplifies the sting of debt for others: after a period of deflation, the payments to service a debt represent a larger amount of purchasing power than they did when the debt was first incurred. Consequently, deflation can be thought of as an effective increase in a loan's interest rate.Deflation, like Inflation, is not good for an economy. This is the reason why printing of the currency has to be regulated: you cannot print too much and you cannot print too less either.

Few questions that some of you may have:Q: How is printing lesser INR related to USD?A: Isn't it? Think about it. A certain service X here costs Rs. 10. Govt. decides to double the supply of money. Consequently, the prices rise and same service now costs 2x, i.e., Rs. 20, since value of money is halved.Now let us assume the exchange rate for INR to USD be 50, i.e., 1 USD costs Rs. 50. Think from the point of view of a nation: would you pay twice the amount for same service just because the other nation decided to double money supply and screw their own economy? No, you won't.Initially, US could get 5X for 1 USD. Why should it change? But back here in India same service now costs Rs. 20. Hence, to get 5X for same 1 USD, exchange rate has to be at the rate of Rs. 100.Similarly for printing less: it would then be Rs. 25 for 1 USD.Q: So you agree that rupee value against USD can be increased by printing less?A: Well, that will be one initial effect, yes; provided that the overall economic activity of the country remains same. But as you can see from the answer above, there would be a reduction in economic activity. Hence, the value of rupee would start to fall again, and this time beyond its original value against dollar.Q: Shouldn't there be a sweet spot in between where the inflation rate reduces but still remains positive? Why not just hit that spot? Why not ensure a small positive rate of inflation (say 5%) - which seems to be ideal for everyone.A: Well, you are correct in your thoughts; although, an ideal rate of inflation is around 1-2 % and not as high as 5%. But then again it varies from country to country. For example, Indian Govt. recently informed that the sweet spot of inflation they are targeting is around 4%.A low but positive rate of inflation is always desirable for number of reasons, but mostly because other scenarios are not desirable. Following the method of exclusions, following is not desirable:1. Very High Inflation: For reasons explained above: it is costly.2. Negative Inflation or Deflation: Again, for reasons explained above. It should be known that deflation is much more costlier than a similar rate of inflation.3. No Inflation or very low inflation: At very low rate of inflation, interest rates are close to zero, thus limiting a central bank's ability to respond to economic weakness.A constant inflation at 1-2% checks the point 3 above, and is, hence, most desirable of all the scenarios.Although in current scenario, RBI should not and would not resort to such method since strengthening of Rupee right now will promote imports even further, and reduce exports. This is not desirable as it would further reduce value of Rupee.Q: So are you saying that any attempt to increase the value of rupee would increase imports creating an additional lack of demand of rupee (thus devaluing it again) to such an extent that the net effect would be a decrease in its value?A: Without going into technical details, broad concept is that strengthening of currency favors imports and discourages exports, and vice-versa.Already the Indian economy is not in a very good state, our imports being huge and exports less. This is not good for any economy. If anything, RBI would try to keep the rupee at the same value, if not let it fall further, to support the exports and discourage the imports. If RBI tries to strengthen rupee, imports get favored and value of rupee starts to go down. As can be assumed, it would be oscillation rupee value. Why would RBI try something like that??Final outcome in terms of rupee value cannot be measured since it would depend a lot more factors.**************************************************************************

Now, for our 3rd and final question: "On what basis does RBI decide how much money to print?"First of all, let's start with the assumption that Govt. knows how much money to print. Let this quantity be X. Now, what happens if Govt. prints more than X, or less than X? You already know: decrease or increase in value of currency.If you print more than X, Inflation occurs and prices start to rise; if you print less, Deflation occurs and prices start to fall. The negative effects of both have been brought out in my answer above. What we need is to print neither more, nor less, but just the right amount so that excessive inflation or deflation does not happen.Now, how is this amount is determined by the RBI? The answer is the Economic Growth of country, or simply GDP. Actually, GDP is also not the exact measure of growth, which is explained in the subsequent paragraphs.GDP is basically a number which is sum of all the products & services produced in the country during a financial year in Rupee terms. Simply put, numerical measure of goods & services produced in a year. Quite obviously, more goods and services produced in a country, more would be the GDP, right? Not necessarily.Let's say 5 products are produced in a country, each costing 20 bucks. So GDP = 5x20 = 100. Let's assume this is also the amount of money RBI has circulated in the country. Now, assume RBI doesn't print any more money the next financial year, and the number of products being produced rises to 10. Now GDP = 10x20 = 200? Wrong!Since money circulation hasn't increased, Deflation occurs and prices go down. This would be in inverse proportion to increase in production and hence price would be now 10 bucks only. Hence GDP = 10x10 = 100 only. Note that there is no increase in GDP despite the fact that production of a country is DOUBLED!!!Now, you already know what happens when Deflation occurs and we do not want it to happen. And you also know how to tackle it: print more money. And somewhere in your mind, you already know how much to print so that Deflation is tackled without causing any Inflation: you measure the growth in your Economy/Production, and increase the money supply accordingly. So, RBI prints 100 Rupees more; price rise back to 20 bucks a product, and GDP = 10x20 = 200. (This is also the example of why GDP is not the exact measure of growth in any country: it could deceive you. But, if we keep the prices of all goods and services constant, that the only way GDP can rise is by ACTUAL increase in production/services, and hence the economy)This is what RBI does as well. Only difference is that the RBI estimates this demand on the basis of the growth rate of the economy, the replacement demand and reserve requirements by using statistical models, due to the complexity of any economy.In addition to this estimated demand due to growth in economy, the amount of money that needs to be printed also includes replacement of damaged notes, reserve requirements, circulation purposes, etc.

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