{News Analysis} Rupee value is dropping steeply - What RBI has done?

    In recent times, we have been hearing news about plunging rupee value against US dollar. As a layman, let's take a closer on 'what is happening?' in this article. Before that lets set some basic rules.

    In a market, items or commodities are sold and/or bought. So, the value of a commodity depends on three criteria,

1. Buyers
2. Sellers
3. Availability

With respect to the buyers, If there are more buyers for a commodity, then its value would be raising more likely. Otherwise its value may fall. [Demand]

With respect to the Sellers, if there are more sellers who want to get rid of a commodity they have by selling it off, then its value would be falling more likely. Otherwise its value may raise or sustain. [Supply]

The sellers and buyers can sell or buy a commodity if only it is available. So, with respect to availability, if an item is available scarcely then its value would tend to raise. If it is available abundantly its value may fall. [Supply Management]

With the above rules in mind, lets analyse the current situation. In our market, the commodity is money or currency (Rupee, Dollar ...etc). With respect to the demand and supply of a particular currency, its value may vary (There are hell lot of factors involved in determining a currency's demand and supply. Like, demand for a country's goods and services...etc. Now, we can simply assume that globally there are more demand for American goods and services, so the demand for dollar is more and thus its value is high). When the global economic variations affects a country's currency, the central bank of that country has a major role in managing that situation. In our country, it is the RBI.

What are the options that the RBI has in its hand to tackle the falling rupee value against dollar?
1. Making the US dollar easily available in Indian market by supplying/injecting more dollars into the market.

Result : Dollar is available easily in market, so its value would fall. If not, at-least the value of dollar will not raise in market for some time. But there is a drawback here. From where RBI would get dollar currencies? of course, from the external reserves. The dollar availability in reserve depends on our export earnings. Currently, our country is already facing current account deficit. So, decreasing the for-ex reserves to save the value of rupee will backfire badly. Moreover this option is temporary i.e., it can save rupee value for some time only.

2. Decreasing the availability of the rupee in market. So its value would raise. If not, at-least the value of rupee will not fall down further or it will ease.

How it is done?

• Make the interest rate higher (MSF-short term, Bank rate-long term). So borrowing rupee will become costly, thus less availability of rupee.
• Decrease the availability of rupee for lending to banks (i.e., limiting the LAF to 1%).
• Buy rupee from market by selling Govt securities (Open Market Operations).

Result : Less availability of rupee leads to less money to lend to the businessmen. This will lead to less GDP growth.

What is "Cheap Money Trap"? and What are all its ramifications?

Cheap Money Trap:

In an economy, to boost the growth the policy makers lower the interest rate of the central bank. So that the entrepreneurs would get money for lower rate and they produce goods and sell it. Thus the economy will grow. But in real world this have not been worked that perfectly.

During 'Great Depression' (1930), UK govt tried this cheap money regime. They targeted the entrepreneurs, but the people took advantage of cheap money and borrowed more loans for housing. So, less economic transactions lead to less growth. Thus, the cheap money regime was a largely unsuccessful one.

This cheap money policy becomes a trap, when the fear of depression/recession tend to keep the rates low always. This is like economy becomes addicted to 'cheap money'. If we try to stop the drug (raise interest rate), the sick guy (economy) may collapse and the safe way to do is unknown. Thus the "cheap money trap".

Ramifications:

As for as the rich countries are concerned, their problem would be like "If we raise the interest rate, will the economy collapse?". But, sooner or later, when the situation is most favorable they will surely raise the interest rate.

With reference to India, we are now(2013) largely depending on the foreign investments. Whenever we receive USD in any form (FII or FDI), we become happy that our reserve raises. But actually we are accumulating debt. During cheap money regime the foreign investor gets easy money and he would want to get more returns out of it. So he invests in India. But when the cheap money supply stops, the foreign investment flow also stops. In fact it would get reverse and investment flows out of the country (i.e., India). This effect would destabilize our economy and lead to another BoP crisis. The possible way out from these difficulty (for India) is to strengthen the domestic Industries. Because, only a competent domestic industry will ensure the export earnings.

The year of Great Divide - Population of India

    In general, impact of economic growth in an economy on the population will show following behavior,

1. High rate of birth and High rate of deaths - Low population growth (under-developed)
2. High rate of birth and Low rate of deaths - High population growth (developing)
3. Low rate of birth and Low rate of deaths - Low population growth (developed)

    In a country like India, where the children are considered as assets, rate of birth tend to be high. But at the same time, due to low economic growth health services will be lower. So that there will be high death rates also.

    In due course of time, after achieving certain level of economic growth, the health services would be accessible to people. So, that the country will show high rate of births and low rate of deaths.

    After achieving good level of economic growth and better literacy rate, people tend to have less children. So, there will be low rate of births and low rate of deaths.

    The year 1921 is a "year of the great divide" in the demographic history of India when mortality started to decline leading to acceleration in the rate of population growth . During the next three decades (1921-51) the rate of population growth continued at a level of over one per cent per annum. The slight dip in the growth rate in 1941-51 partly reflects the Bengal famine of 1942-43 and dislocation,-, due to the partition of India in 1947. After independence the rate of population growth accelerated considerably because of extension of public health services. The growth rate was at its peak in the period 1961-81 with the popu lation growing at a rate of 2.2 per cent per annum. The decade 1971-81 is a turning point in that fertility started declining and continued to decline every year thereafter. during the decade 1981-91 the rate of population growth declined from 2.2 per cent per annum to 2.1 per cent. Though the decline is a welcome sign the pace of decline is not enough to ease the relent less pressure on social services. The population has crossed the one billion mark in 2001. There are sharp regional variations. Another feature of the growth of population in India is the absolute size of its increase in the decade of 1981-91 India added 163 million people: an incremental population almost equal to the population of Indonesia, the fifth most populous country of the world. India adds every year a population almost equal to that of Australia. Given a population increase of this magnitude it would be difficult to provide even rudimentary social services despite best efforts

    

    The observation from the above graph shows that the population in India started steadily increasing from 1921. And continued to increase, that is the sign of India entering into the second stage of population growth. It is long way for India for stepping into the third phase of population growth, i.e., low growth. Despite India's economic growth, population is keep on increasing. 

Census 2011

    As per the 2011 census, there are 181 million people (~Brazil's total population) added to Indian population. There is another noteworthy point, i.e., after 1911-1921, 2001-11 is the first decade that has added lesser population than previous decades. If this behavior continues, then India will enter into the third phase within few more decades.

Highlights from census 2011

Tax System - Simplified

Tax
What is tax? Well, there are hell lot of view about this. Let take it as a tool for redistribution of income. We can also say that tax are imposed for fulfilling expenditure obligations of the government. Lets see some terms about tax. Incidence of tax - the event of tax being imposed. Impact of tax - when tax makes its presence felt, that is impact of tax. Direct tax - (Incidence + Impact @ same point) i.e., the tax is being imposed on you and you feel it. Indirect tax - (Incidence + Impact @ different point)i.e., the tax is being imposed on you but you make others pay for it.

Okay, lets see how taxes are imposed on people.
1. Progressive Taxation
You gain more, you pay more taxes. This may seem like, you are getting rewards for being poor. And the riches get the punishment og more tax so they try to evade taxes.
2. Regressive Taxation
Its the opposite, If you earn more you pay less taxes. This is imposed on small industries excise duty. If they produce more they can pay less taxes. Hence SMEs encouraged.
3. Proportional Taxation
Whatever your earning may be, you have to pay a fixed tax.

Hmm, How good a tax system can be?
To answer this question economists give some principles. So if a country's tax system follows those principles, then it is deemed to be good tax system. So, what are they?
1. Fairness
Persons in similar situation should pay similar taxes (Horizontal equity). And the 'better off' people pay more taxes (Vertical equity).
2.Efficiency
Cost of payment of tax should be less (Online, one click instead of long queue in IT office). And the tax system should not decide how much you save or invest or spend etc (Less interference on the allocation of resources). Moreover, by imposing tax on pollution, smoking nation will get double divident (money+social purpose).
3. Administrative Simplicity
The activities like computation, filing, collection, etc of taxes should be as simple as possible.
4. Flexibility
The tax system should be in such a way that it can be modified easily in future.
5. Transparency
The government should say aloud that "I got this much money from taxes and I gave you these services".

Wow! Now the government have tax money collected. So what it should do with that?
Well, It has to obviously spend on development. Here also three types are present - Progressive, Regressive, Proportional. Here, progressive spending is good. Because, its always good spend only as much as you earn.

References: 
Indian Economy - Ramesh Singh