Taking a cue from the recent economic crisis in our benign neighborhood Sri Lanka, ever wondered, why a kilogram of sugar used to cost us just INR 17 during the initial years of the 21st century while the same costs up to INR 45 today?
Well I am pretty sure most us must have given a thought to it. And it is just not limited to the above example. There are plenty of similar examples around us. Our grandparents used to earn just INR 400-500/ month and even then, they were able to bear the expenses of housing, food, clothing, education, and other miscellaneous expenses for themselves and their families. It was just the male member of the family who used to work while the females would take care of the household chores and upbringing of their children. Houses/ mansions which used to cost in few thousands now costs us in crores.
So, what is driving up the prices? What is fueling the need for both husband and wife to work for their living. Is just the awareness related to gender equality or is it something related to the paradigm shift in our standard of living or is it driven by some kind of demand and supply interaction or there is something more to it? Although these reasons are definitely responsible to some extent for driving up the prices but there is something more and very important which is affecting the way and the amount of money, we spend to procure our desired goods and services. Yes, it is the VALUE OF MONEY and the same is being discussed in the following sections.
By referring to the value of money it can be understood that how much of a product or service can be procured in an open market in exchange for a particular amount of money. We can see that the value of money has decreased because in present times we need to spend more to purchase the same quantity of sugar as compared to those 20 years back. We are also witnessing unprecedented hike in Petrol and Diesel prices in the recent times in India. Why is it we are being compelled to spend more to purchase the same quantity of a given commodity. The answer lies before us, value assigned to a given denomination of a currency is becoming less effective day by day owing to which we are putting in more currency on the table to satisfy our demands.
In our previous article we discussed about the Bretton Woods System and the inherent science of printing money. It was discussed that the amount of money printed of any country was valued against its total gold reserves. However, the same system was given up completely by 1973. So, in the light of the same, let us discuss what is causing our monetary value to depreciate-
- With nothing tangible against which our money is valued, governments around the world could print and circulate as much money as they want which ultimately devalues the money. This is because the purchasing power of the currency tends to decrease with the increase in its supply as the demand of the currency decrease because of its excess circulation. It is also argued that money printing is directly or indirectly related to the GDP of a nation. Unfortunately, there appears to be no clearly defined parameters for the same because of the complex nature of modern economies around the world owing to the globalization.
- In India, currency is printed under the guidelines of the Reserve Bank of India (RBI) since 1935. RBI does not print money by keeping/ reserving an equivalent worth of gold. Instead, the money is printed and circulated in a given time period by assessing the worth of the nation’s Gross Domestic Product (GDP).
GDP is the sum total of the new product and services during a given time period of any country.
Thus this means, sum of value of all goods and services produced must be equal to sum of all the corresponding amount of total currency present in circulation.
Also, printing more money with the availability of new product/ service being relatively lower or constant would mean that there is more money in circulation to purchase a given commodity and the same will eventually lead to inflation.
- Under the influence of several external forces such as- epidemics, pandemics, natural disasters, etc. and competitive forces such as- electoral victory, securing better growth rate, fast eradication of poverty, etc. government is propelled to launch several schemes offering subsidies and other welfare schemes the fund of which is to be provided by the government.
So, how do you think the government will finance such multi-million schemes? Is it just through the tax payer’s money or by raising some loan from leading financial institutions such as RBI, World Bank, or Asian Development Bank?
Well, the government can arrange its finance either way and usually it arranges funds from both the routes.
This implies, as both the central and the state governments have started to spend on public welfare schemes such as- Pradhan Mantri Awaas Yojna, relief packages, free/ subsidized ration distribution, power supply, MNREGA, free LPG cylinders, solar subsidies, etc. more tax will be levied on the public of India. Eventually, we will be paying more to purchase a given commodity.
- Now comes the most interesting and the most important means to assess the value of our Indian Rupee which is on the basis of the US Dollar which because of the America’s Superiority post the World War II gained global acceptance and became the international means of transaction.
At the time of independence in 1947, 1 INR was equal to 1 US$. However, the value of the Indian Rupee was devalued in the year 1951 with the launch of the 1st Five Year Plan to attract more foreign investment and increase its export. A fix exchange rating system came into existence.
In 1962 and 1965 the Indian government again devalued its rupee to compensate for its war expenses and boost its agricultural practices. By the year 1991 the Indian economy was struggling to survive, inflation, low industrial production, dried up foreign reserves forced further devaluation of the Indian Rupee. Finally, in the year 1993, flexible exchange rate system was introduced where the value of the Indian Rupee against the US$ was to be regulated by the market itself. However, RBI was still empowered to control the same.
- Thus, it is obvious that more the foreign reserve of a nation, more is the strength of its currency. However, in the current times as India imports almost most of its crude oil from other nations, it has to pay them in US$. This is because of the higher demand for the US$ in the international market as investment in the US market yields higher returns. Increasing current account deficit is also responsible for the falling value of the Indian Rupees against the US$.
On the contrary if the RBI decides to pay more interests on the deposits, the foreign investment in India will increase and people rather than investing their Dollars in the US, will start investing in India and the value of Indian Rupee will rise with the fall in demand of the US$ in the international markets.
- Governments across the world have been raising money by issuing bonds as these are more reliable and less risky. Bonds in different countries are referred to as mentioned below-
India- G-Secs/ Government Securities
- The RBI under the G-SAP (Government- Securities Acquisition Program) in the preceding year was supposed to purchase INR 1 lac crore worth of government bond in order to increase money supply in the market.
However, with a decline in the GDP and share market investors will prefer to invest in the G-Secs which are relatively safe.
Under the scenario of the inflation, RBI may sell back the government bond to pull back some money from the market. The central government intends to borrow INR 12 lac crore from the market to tackle the economic menace caused by the pandemic. This will again lead to inflation as the government will be utilizing these funds to finance its various schemes.
- The return on the bond is fixed by the government irrespective of the sale price of the bond. Thus, with the increase in the demand for the government bonds, the primary bond holders sell their bonds to the secondary buyers at higher rates but the bond yield remains the same. This is why we can infer that as the bond prices increase the bond yield tend to decrease. This is true for all the markets across the world.
In the USA the return on bonds being higher, more money will leave India in the form of US $ and subsequently greater will be the devaluation of the Indian Rupee.
It is evident from the above discussion that some of the so called good economic and financial practices are driven by a complex set of internal, external, political, and environmental factors which control the strength of the nation’s currency. India is gradually strengthening its fight against inflation and unemployment. However, again because of many different factors and their complex relationship with each other, safeguarding the value of the Indian Rupee is still a challenge.