AJRBF

Volume2,Issue3(March,2012)ISSN:22497323

A Peer Reviewed International Journal of Asian Research Consortium

AJRBF:
ASIAN JOURNAL OF RESEARCH IN BANKING AND FINANCE DOES THE REPO RATE REALLY CONTROL INFLATION?
N SURESH* *Lecturer, Department of Commerce M V S Government Degree College Mahaboob Nagar. ABSTRACT It has become the common practice of Reserve Bank of India to rotate the repo rate in very frequent intervals to stabilize the supply of money and to curtail the pressures of inflation. The prudence of RBI certainly works when the inflation is caused due to the mounting pressures of demand side economies. But the bank rates can hardly yield any benefits if the inflation is cost pulled and stands to be the residual of supply side problems. It could be the reason why the consumer price index of the country has been sending alarming signals of proliferating inflation and making the repo rate a destitute of positive effects. So, this paper makes a preliminary attempt to discuss whether, the repo rate succeeds in managing inflation. Or, is there any need to find the formidable path of mitigating undesired rate of inflation. ______________________________________________________________________________ INTRODUCTION Inflation is one of the prime economic parameter reflecting the increase in the aggregate prices of goods and services in a particular time period and generally quantified as a percentage change in the consumer price index of the country. it not only replicate the purchasing power of money but also impacts the other important variables like exchange rate of the currency and interest rates of the banks and ultimately turns the financial system of the country to be more turbulent. It is the reason why, central bank of any country is expected to foster the most adroit monetary policy and to strike the fine balance between demand and supply of money to harness the price levels of goods and services. Reserve Bank of India is by no means an exemption from this plausible assumption. Hence, the following objectives are proposed to be examined in this paper to analyze the repurchase rates and inflation management in India.

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Volume2,Issue3(March,2012)ISSN:22497323

OBJECTIVES OF THE PAPER 1) To find the non monetary causes of inflation 2) To examine the effect of repo rates on inflation METHODOLOGY The first objective is designed to find the non monetary determinants of inflation so as to form a preliminary opinion with respect to the influence of monetary variables like repo rate on inflation. This objective shall be accomplished through reviewing the literature available in secondary data sources. The second objective forms the core of this paper, which shall be examined by means of a hypothesis. Null hypothesis H0 : there is no significant difference between the repo rates and inflation in India. Alternative hypothesis H1 : there is significant difference between the repo rate and inflation in India. The null hypothesis shall be tested with the help of t distribution which establishes the perfect statistical tradeoff between the observations of small sample. NON MONETARY CAUSES OF INFLATION IN INDIA JournalofAsianResearchConsortium80 http://www.aijsh.org It should not be confined to the mere hypothesis that inflation is caused only due to the imbalances of demand and supply side economies of money. Rather, inflation may take place in the following circumstances either. Increase in the cost of production may lead to cost pulled inflation. Tim Callen (2001)1 found from his empirical study that cost of overheads like fuel and energy prices have been showing spiraling impact on the ultimate prices and driving inflation to paramount. He further added that energy cost itself is leading 14 % changes in the price levels. Deregulation of the essential commodities may lead to artificial scarcity and causes inflation in the long run. Battacharya (2009)2 argued that deregulation of essential natural resources certainly leads to the formation of inflation. He took petroleum price deregulation as the underlying resource and proved that price regulation is better than price management. Chand (2010)3has also expressed similar opinions while finding the causes of food sector inflation. He stated that the poor management of food grains in terms of ensuring the optimum supply is one of the major causes of inflation in India. Forward trading is being emerged as the prime determinant of inflation which is nevertheless subjected to prudent regulation in India. Sahi( 2006)4has considered the

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Volume2,Issue3(March,2012)ISSN:22497323

forward contract prices of National Commodity and Derivative Exchange to illustrate the impact of forward trading on inflation. He applied Johansens co integration model with the short term data and drew the conclusion that there is significant impact of future prices of commodities on the core sector inflation. Nath (2008)5has also expressed similar interpretations. He applied simple linier regression and Granger causality test in this pursuit, and stated that, there is indispensable effect of forward trading on the prices of spot market. Hence it is obvious that inflation is also caused due to forward trading and not merely by the excess supply of money which has to be curtailed with repo rate adjustment. It is perhaps the reason why Indian government has imposed restrictions on forward trading in edible commodities in the recent past. Import restriction measures of the local government often lead to supply scarcity and form an avenue for inflation to run. Ball (2006) 6is of the firm belief that import restriction and export promotion measures of the local government often creates the scarcity of supply in the local markets and accelerates the rate of inflation in the short run. Nevertheless these measures are unavoidable to safeguard the long run interests. Failure of the public distribution system (PDS) in any country enhances the gap between demand and supply of commodities and increases their prices to give a fillip to headline inflation. Swaminathan (1996)7has stated that price fluctuations are common in the transitional economies like India. But such fluctuations must be managed by strengthening the public distribution system which also avoids unwanted intermediaries in the market and controls the inflationary pressure.

TRENDS OF INFLATION AND REPO RATES IN THE PAST TEN YEARS JournalofAsianResearchConsortium81 http://www.aijsh.org The following secondary data reflects the changes in inflation from the year 2002 and the corresponding changes made by RBI in terms of repo rate. year 2002 2003 2004 2005 2006 2007 2008 Repo rate( %) 7 7.05 6 6.25 6.875 7.75 7.75 Inflation(%) 3.888 4.158 3.194 4.062 6.332 6.452 8.333

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Volume2,Issue3(March,2012)ISSN:22497323

2009 2010 2011 Source: RBI bulletin September 2011

8 8.25 8.3

11.888 11.25 8.427

RBI adjusts repo rate in the frequent intervals of a single financial year. Therefore the repo rates projected in the table are the average values of intra annual repo rates. However, the inflation directly replicates the annual percentage change of the CPI.
14 12 10 8 Reporate(%) 6 4 2 0 1 2 3 4 5 6 7 8 9 10 Inflation(%)

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It can be seen from the above graph that, inflation kept on mounting, except in the two intervals in spite of the spontaneous increase in the repo rate. In other words, the negative relation can be seen between the repo rate and inflation only in the years 2010 and 2011.this minor deviation could have been caused due to some other exogenous parameters which can be better addressed by extending the graphical analysis to statistical analysis by means of t distribution which considers the correlation between repo rate and inflation in the selected time period to decide whether to accept the null hypothesis or not. The t distribution can be established with the help of following formula. T= r{
n 2 / 1 r 2 }

Where n= number of observations and r is the correlation value

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Volume2,Issue3(March,2012)ISSN:22497323

r = ( x x )( y y )

(x x ) ( y y )
2

Where, x and y represent repo and inflation rates respectively. TESTING OF HYPOTHESIS The residuals are calculated with the help of Excel spread sheet. Accordingly, R= 0.848222 T= 0.848 10 2 1 0.848 2 = 4.42 INTERPRETATION The calculated value of t is 4.42 with the two tail test where as the acceptable degrees of deviation from the table value at 5 % degrees of freedom is 2. 31. I.e. tcal>ttab which compels us to accept the null hypothesis hence it is possible to state that the increase in repo rate could not show any significant difference in inflation. CONCLUSIONS

) (

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The statistical inference of this paper empowers us to draw the bold conclusion that, the repo rate volatility may not curtail the mounting problem of inflation. Increase in repo rate may lead to increase in the cost of capital which in turn shows adverse impact on inflation. The Burdon of controlling inflation should not be shifted to the central bank of the country unless; such inflation is proved to be the consequent of excess money supply. Continuous increase in repo rate may hit the performance levels of banks which can become more detrimental to the credit rating of banks, instead of controlling the price levels. Managing the supply side economies of real sector is the best way of managing inflation in long run.

KEYWORDS Repo rate: it is the rete of interest at which banks borrow money from RBI CPI: it is the Consumer Price Index used to replicate the percentage change in inflation.

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Volume2,Issue3(March,2012)ISSN:22497323

Non monetary determinants: the determinants of money other then that of money supply. REFERENCES 1 Tim Callen, India at cross roads,IMF journal, 2001 2 S C Battacharya, united nations sustainable development journal volume 4 2009 3 Ramesh Chand, understanding the nature and causes of food inflation in India, EPW, vol 27, 2010 4 G S Sahi, commodity futures market efficiency in India and effect on inflation, 2006 ssn.com 5 G Nath, derivative market and its impact on spot market, 2008, papers.ssm.com 6 L M Ball, has globalization changed inflation? NBER paper no 12687, 2006 7 Swaminathan M, Structural adjustment food security and syste of public distribution, EPW, 1996

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