Insufficient Investment Fuels Inflation in India 21. October 2011 Rahul indian economy (0) The whole world is suffering from collapsing aggregate demand. Monetary authorities everywhere are struggling with liquidity traps as they experiment with alternative ways of injecting money into the system after taking short term interest rates to zero. China stimulates its economy fiscally by planned and targeted capital investment (fraught with gross capital misallocation albeit). India is suffering from a completely different problem. India has structural and too much aggregate demand. Its demographics are driving demand that is relatively price inelastic. In India, inflation is not being driven by the classic monetary reason of too much money chasing too few goods but is being driven by too many people chasing too few goods. What India needs to do is create capacity. It needs to create capacity at a pace not seen before in history. It is appalling to see the country suffer from shortages of coal, power, food, fuel, airports, railways, roads, ports etc. etc. Investment is a function of demand, capital and animal spirits. While India has the first attribute, the Reserve Bank of India (RBI) and global financial market uncertainities are choking the second attribute and the media and government are choking the thrid attribute. I will dare to suggest that by excessively tightening money, the RBI is actually exacerbating India's inflation situation. By starving all asset markets of liquidity, the RBI has created global negative sentiment toward allocating assets to India. Animal spirits will return. They always do. That is the way of humanity. When they do return, India will embark on a capital investment cycle that the country has never seen before. The government has always been a spectator and it will be no different this time.