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Asset inflation: before and after demonetisation

Asset inflation: before and after demonetisation

By Shweta Shaju

Asset price inflation is an economic phenomenon indicating a rise in the price of assets, in contrast to ordinary goods and services. The assets generally include financial instruments such as bonds, shares, and real estate. In the Indian case, gold is also considered an asset.

Asset price inflation must not be confused with inflation as they are two distinct terms, implying two different things. While the former focuses on the rise in assets, the latter is generally perceived as a rise in prices of ‘ordinary’ goods and services, as measured by the Consumer Price Index (CPI). Some examples of extreme asset price inflation leading to asset price crashes are the Dutch Tulip (17th century) and the Japanese Metropolitan Real Estate and Stocks (early 1900s).

Prices in the housing market

In 2006, Himanshu Joshi—an official of the Reserve Bank of India—published a paper that raised concerns about the rapid growth of the housing market and its sustainability. The paper claimed that the prices of houses in India were correlated more with the interest rates and credit growth, and vaguely with the growth of real income. From the Q4 of 2009-10 to Q1 of 2012-13, the housing inflation has been consistently higher than the general price inflation. Housing Price Index (HPI) was as high as 26.0% in the third quarter of 2012-13, whereas the consumer price index (CPI) was 10.1 in the same quarter.

Reasons for inflation in the housing market

This colossal asset inflation is believed to be caused either due to the lack of investment opportunities or due to the loss of faith in alternate forms of investing. The lack of investment opportunities as the economy fluctuated and the existing inflation eroding financial returns, has caused the demand for assets in the housing market to exceed its supposed supply. This is leading to an upsurge in the prices. Additionally, the credibility of alternate investment opportunities was lost, owing to negative real returns on bank deposits and poor and volatile return on equity. This has made people instead opt for lucrative investments in the housing market.

The post-demonetisation scenario

After demonetization, the restricted money supply and the cutback on High Denomination Currency Notes (HDN) have systemically applied brakes on the asset price inflation. Real estate prices have fallen, and they are likely to fall further, as investing undeclared income has become more difficult. The Chief Economic Adviser, Arvind Subramanian, claims that bringing down real estate prices were one of the aims of demonetization, in which it was apparently successful.

A bubble ready to burst?

Sachin Sandhi (the Global Managing Director of Emerging Business), RICS, and many economists believe that cash transactions in the real estate sector will reduce, moving to a more digitised form of transaction. This is supposed to make the housing market more transparent and help allure foreign investment. The costs of demonetization had to be borne by everyone, some more than others. However, it is believed that in the longer run, it will burst the supposed asset-price bubbles, and will cause the asset prices to hover close to their intrinsic values. The veracity of the claims can only be substantiated with time, and until then, we must wait.

Featured Image Source: Pixabay

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