The few who can play the property, equity and derivatives game earn huge incomes, driving up prices for all.

In the discourse on the nature of inflation in India, one aspect has been largely neglected: the ‘wealth effect’, or the impact of rising asset markets on inflation.

Rising asset prices are generally considered to be a result of inflation — when people pursue higher returns than the inflation rate — rather than a cause of it. However, it is time the latter, too, were given some consideration in the Indian context.


The returns from rising property, gold, equity and commodity markets contribute significantly to overall demand. The fact that asset values can rise independently of productive forces widens the demand-supply gap.

The resulting inflation, in turn, feeds a hunger for high return assets, giving rise to an inflationary spiral. This seems to be well entrenched, at least in the case of property, and more recently gold, in India. What initially begins as a pursuit of an inflation-plus rate of return then becomes a sort of speculative game. A small elite plays this game, leaving the rest behind.

In the case of commodities, the impact of rising prices is felt directly by the real economy. Therefore, the role played by ‘financial innovators’ is more disturbing. For instance, international coffee traders are apt to argue that in six months, the fundamentals catch up with prices driven up by speculators, leading to a ‘correction’. But during this period, a clutch of executives at trading terminals would have made their packet, driving up prices of everything around us, while real economy participants pick up the tab. If roasters and their employees are hit by high prices, producers and farm workers are hit, by both loss of incomes and inflation, when the smart ones press the ‘exit’ button.

Imagine the real economy and wealth-effect impact in the case of a more essential product traded on the commodity exchanges.

The RBI does not explicitly discuss these dynamics in its reports, even as it expresses concern from time to time on the property market and rightly imposes lending curbs.

Asset-driven inflation is best addressed by such specific measures. Interest rate interventions may not be helpful. Lower interest rates may fuel asset speculation, as witnessed in the Alan Greenspan years. And, higher interest rates may hurt some productive sectors, without affecting those already raking in higher returns than the inflation rate. (A heads-I-win-tails-you-lose situation!)

This may explain the failure of high interest rates to contain inflation in India. They may well have left asset-based inflation quite untouched on the one hand, while actually stoking inflation to the extent that it impairs bonafide productive activity.

There can be no denying that the growth of India’s finance, real-estate and insurance sectors has outpaced that of the economy (see table 1).

Commodity trading volumes have picked up sharply since 2008, although its slump in 2012 suggests a stronger correlation with the economy (see table 2).

While there is no reliable data on the property sector, the anecdotal evidence suggests that prices are rising in most metros, even though the rate of increase is less than in the 2004-09 period. The rise in gold prices is too well known to need recounting.

A market driven by black money such as property is unlikely to slow down (since black money will be reinvested), unless job losses throw the EMI-paying sector out of gear. Equities, say some market watchers, are making a comeback.

Hence, a buoyant asset market seems here to stay, no matter what the state of the real economy. There is clearly a lot at stake in keeping the markets going, of pumping up one asset class to offset the prospect of decline in another — and one reason for this drive is that a segment of the population is used to living off financial gain as opposed to real output.

This segment would not mind high inflation, if that indeed fuels asset markets.


The most disturbing feature of inflation that is fuelled by asset prices is that it widens inequalities. After all, it is only a sliver of the population, less than 5 per cent of Indian households, which can play the equity, property and commodity markets. To be able to do so, one needs not just capital but also information on the way these markets work.

This section could well be driving up food prices. There are two ways in which this might be happening. First, their property hunger is leading to a visible diversion of farmland, not just in the periphery of cities but even miles away from it. For example, Bangaloreans are being coaxed by builders to ‘invest’ (as opposed to live) in property in Hindupur, at least 150 km away.

Second, this class eats excessively, never mind if official data tells us that some 10 per cent of their total expenditure is on ‘food and beverages’. They eat out, in ‘fine dining’ ambience or on the move, which is not captured by official statistics. The booming restaurants sector may be a reflection of this trend.

Economic historian Avner Offer points out that eating out amidst pleasant company and music leads to higher food intake.

As for those who argue that inflation is being driven by the “rising incomes” of rural labour and MGNREGS beneficiaries, we should then have seen a moderation in food prices in the event of a subdued kharif season in 2012. Or, an improvement in their health status, which the National Family Health Surveys do not indicate.


Asset-price inflation is leading to a divergence even between the rich and the middle-class. To take only one example, in April-December 2012, the sales of utility vehicles increased by nearly 60 per cent, while two-wheeler sales increased 4 per cent.

According to the Asian Development Outlook 2012, an ADB report, inequalities in India have widened “from the early 1990s to around 2010”. Despite this, the benefits of high growth after 2004 would have benefited all, with schemes such as MGNREGS helping the vulnerable.

But an asset bubble amidst a growth slump leaves us with high prices and falling incomes — a situation of widening inequality and no trickle-down, or a recipe for social unrest.

Real economy producers will recoup their losses in the world of finance, making their canny ‘entries’ and ‘exits’, but what about the rest?

(This article was published on February 3, 2013)
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