Land speculation is giving inflation and CAD a boost

Land that is not used for productive purposes but is treated as a speculative asset class has a direct impact on the economy. The impact of land speculation is clearly negative as it pushes up inflation and leads to a rising current account deficit.

India has been suffering from high inflation that has been running well above the Reserve Bank’s comfort zone of 5 percent and below for over three years running. India’s current account deficit (CAD) has seen record highs of 5.4 percent of GDP in the second quarter of fiscal 2012-13.[caption id=“attachment_617158” align=“alignleft” width=“380”] Land valuation. Reuters[/caption]

How does land speculation lead to rising inflation and a rising CAD? Let us take an example of agricultural land that was growing crops. The produce of the land added to the food supply in the economy leading to a reasonable demand-supply balance.

The speculator now comes into the picture and pays off the farmer owning the land. The farmer receives a sum of cash for selling the land. The speculator does nothing with the land except to hold it and sell it at higher prices to the next speculator.

The farmer has cash to spend but the economy has less food supply, as the agricultural land is now not producing any crops. The farmer, when he is spending the money, is creating demand for products, including food. However the supply to meet the farmer’s demand has not gone up, as land is not producing anything whether it is food crops or manufactured goods. The demand from the farmer who sold the land is now creating inflation in the economy.

The high prices of goods in the country now attract foreign exporters who look to sell goods at higher prices. The influx of foreign goods in the economy leads to rising imports, which is not matched through commensurate exports, leading to a high trade balance. The high trade balance leads to a rising CAD if other receipts do not match the trade deficit.

The agricultural land example is one example of how land speculation leads to higher demand for goods without commensurate supply leading to inflation and CAD. The same example applies to land that was used for manufacturing, with manufacturing being stopped for constructing townships and houses that do not see end-users living in them.

Land that has not been used for any production but is used for speculation also has an inflationary impact on the economy. In this case the landowner receives money for doing nothing and he now creates demand in the economy as he has cash to spend from selling the land to the speculator.

The speculator who makes money from buying and selling land creates more and more imbalances in the economy. One profitable deal makes the speculator go to other landowners and make them sell their land. If the land was being used productively before the speculator stepped in, it stops being productive, leading to a lower supply of goods in the economy. On the other hand, the productive landowner is now creating short term demand in the economy as he spends the money he has received from selling the land.

The cycle of the land owner-speculator-land owner-speculator continues until a bubble is formed in land prices, inflation has skyrocketed and CAD becomes unmanageable. A classic case for bubbles bursting.

Arjun Parthasarathy is the Editor of www.investorsareidiots.com , a web site for investors.