There is talk once again of allowing FDI into retail. This thought has been driven not so much by change in ideology of being less xenophobic but by the high food inflation numbers. The fear is quite palpable that inflation may not come down that easily and that FDI can provide some comfort. Let us see how this can work.
FDI in retail as typified by Wal-Mart or Carrefour are examples of how quality products are delivered to the customer at low prices. These companies provide end-to-end solutions to deliver superior results with the creation of logistical support being an integral part of their business models. They procure foodstuff cheap and have it delivered via their retail outlets through modern storage, processing and transportation, thus eschewing wastages. All this is done maintaining standardisation in quality, which adds value for the customer.
This looks like the cure that we are looking for, as the government has admitted that the extent of losses in horticulture could be around 40% due to absence of cold storage chains. The Budget provides incentives here and there, but definitely cannot create such superstructures. This is where FDI matters. Today, FDI is permitted in cold chains, but no one is interested as retail, which is the creamy layer, is out of its purview. Once allowed, their business models would bridge the gap. A study carried out by NABARD some years ago showed that the farmer gets just around 30% of the final price paid by the consumer in certain horticulture products. The World Bank puts this at around 15%. FDI will help to truncate this value chain and ensure that both sides get a better deal as it rakes in its profit. This way it is a win-win situation.
If the solution is quite simple then what is holding us back? Essentially the retail segment in India is in the unorganised sector with just about 3-4% qualifying as organised. A large number of small mom-and-pop stores exist that serve as points of sale with many being brought into the fold of some of the Indian corporates. A sudden influx of FDI would threaten these small outlets as well as the corporates that have built this retail franchise in the smaller towns.
Today consumers are driven by prices and quality. If both are offered, which will be the case with FDI, then the natural choice would be to switch loyalties. This is already evident in the metro cities where organised retail has made significant inroads, with the positioning in a mall working well for the owners as well as for the consumers from all income streams. Given that around 33 million are employed in this segment, will there be any adverse consequences? The kiranas will still have their place, given the smaller quantities that they deal with, provision of home delivery, credit etc.
Further, the solution would be to integrate these outlets in the model where they become franchisees of the superstore for a commission just as being done by chocolate, soft drinks and cosmetic firms. In fact, the fresh employment opportunities that will be generated would be significant with superior skill sets being imparted. The icing will be provided to the government in the form of better tax collection as organised retail has a tax audit trail.
The class to be affected severely would be the intermediaries who would lose their grip on the market. The barrier here will be erected in the form of political interference as there will be parties that are sympathetic to this class who will oppose this move as it will virtually keep them out of business once the model develops.
There is a concern of the FDI entrants squeezing the farmers, which has been the case in the West. This is something that the government has to address with its price support policies that are otherwise relevant for only rice and wheat in out context. This will minimise this threat of farmers being squeezed.
There are, however, two reforms that have to be implemented as precursors to getting in FDI into food retail. The first is that the APMC laws have to be amended to allow for free movement of farm products across states. In the absence of the 2003 Model Acts being passed, it will not make sense for any investor to enter this area. Currently, there are restrictions on the movement of goods across states and, as a result, products grown in a state can be sold only in the same region, which, in turn, imparts rigidity to prices given that the mandis are oligopolistic in nature. The other is to formally permit and encourage the concept of contract farming as this will benefit the farmers directly once the FDI investors are in. In fact, these two reforms will provide the current domestic organised retail this advantage that can minimise the distance between the foreign counterparts when they are permitted.
But, will this help to reduce food inflation? The answer is still a shoulder shrug because there are certain factors at play that have severed the relation between higher production and lower prices. The first is the price policy of the government. MSPs tend to increase the benchmark prices in the market even when there is no direct procurement. The second is that as farm productivity has been stagnant or increasing only marginally, farmers will increase their prices to maintain their consumption levels at higher inflation levels.
FDI, as a rule, is good for the country and in the case of retail (food) will definitely bring in value by filling lacunae that we have not been able to address in the last 60 years. By truncating the value chain and cutting down wastages, it can, along with ‘domestic organised retail’, change the landscape of retailing of food products. The farmers will gain, consumers will be better off, kiranas will survive or get integrated in the model while the nation benefits from the investments. The intermediaries will probably have a hard time, but then they were anyway not really adding value. Therefore, this should be welcomed and introduced with some urgency when sentiment is also at a high. But, this may not yet be a panacea for our price woes.
Wednesday, June 22, 2011
Cracks in the citadel: Financial Express: May 17, 2011
The mood in the economy after the presentation of the monetary policy is quite a contrast to that when the Union Budget was announced. There is a hint of despondency as we discuss economic numbers today compared with March and the mood has shifted from optimism to caution. How serious is this loss of confidence?
GDP growth expectations for the year have been rolled back from 9% to 7.5-8%. This means that the three sectors will not be able to measure up to expectations. Agricultural production peaked in FY11 and retaining the momentum of 5%-plus in the coming year will be a challenge, considering that we have, so far, not had two successive high growth rates in this sector in the last decade. Therefore, moderate growth can be expected, provided the monsoon is normal and well-distributed across geographies and crops, besides its normal ‘arrival and departure’.
Industrial growth for the year has been lower in FY11, at 7.8% (10.5% in FY10), which can be partly explained by the high base year effect. Can this number be bettered in FY12? High interest rates have been fairly neutral for most of FY11 but may impact growth in the coming year. RBI is willing to sacrifice growth for inflation control, which may be interpreted as the possibility of there being further increases in interest rates that, in turn, will impact investment decisions. Interest rates have a bearing not just on investment and cost of working capital but also on retail loans in the housing and consumer goods segments. This would have a bearing on the production of capital goods, metals, construction, etc. Therefore, a number of 8% or so in the coming year would be an optimistic call, aided partly by the relatively low base year effect.
Next, government balances looked well under control in February. Lower growth in industry will have a bearing on production as well as imports, thus posing a potential loss of revenue in indirect tax collections that will pressurise the deficit. The government has to take a call on taxes/duties on oil products, given the volatile nature of crude prices globally. Therefore, the number of 4.6% for the fiscal deficit will have an upward bias if any of the assumptions made at the time of its drafting change. Also, in this environment, a decision that has to be taken is on government expenditure, as it is the only entity that can provide demand stimulus as higher interest rates do not impact them significantly. But, it has withdrawn this stimulus quite drastically in FY12 with overall expenditure to grow by just 3.4%. With lower spending, the component of services sector, i.e., community and social services, will show a modest increase.
Inflation is a phenomenon that no one has been able to grasp. It appears that we have entered a high cost economy, which is hard to reverse and at best can be stabilised at these levels. MSPs have risen, as has the cost of cultivation. Protection of farm incomes has meant that prices have to increase to preserve real consumption levels. Prices have become sticky in the downward direction. Global prices have provided cues to domestic prices and this linkage is becoming stronger. They, in turn, have been driven of late by speculative forces and may be expected to remain volatile. While a high base should bring down prices, the same did not happen last year, notwithstanding the high base.
The stock market has been largely stable in the 18,000 to 20,000 region, reflecting caution. FII funds have not exactly given the thumbs down signal but have been vacillating in the last few months. June to November 2010 was a boom phase after which flows ebbed for 3 months before turning positive again. FDI has also slowed down for several reasons. Besides, the global economy would be recovering and interest rates could move up, thus re-diverting funds to the developed economies. All this means that there could be pressure on the balance of payments.
The exports story has been impressive in FY11 even if looked at in absolute terms and not just growth rates. Surpassing the mark of $200 billion was an achievement but maintaining this tempo will receive a shoulder shrug, as growing exports by even 20% over a base of $245 billion is a challenge. Imports growth will be linked to industrial production and would tend to slow down if industrial growth is lukewarm. However, higher commodity prices, in particular oil, can spoil the party. While we have been talking of a manageable current account deficit at 2.5% of GDP for FY11, the FY12 outcome could be different.
While it may not be proper to predict doomsday, there is definitely a circle of apprehension over all the economic numbers that defied global gravity in FY10 and only stumbled a bit in FY11. FY12 may still be better than what is happening in the rest of the world, but certainly the inflation impact has distorted images that were constructed at the beginning of the year. The 10% terminal year growth target is obviously ruled out and the five-year average will now be lower than 9%, as was envisaged by the Planning Commission.
GDP growth expectations for the year have been rolled back from 9% to 7.5-8%. This means that the three sectors will not be able to measure up to expectations. Agricultural production peaked in FY11 and retaining the momentum of 5%-plus in the coming year will be a challenge, considering that we have, so far, not had two successive high growth rates in this sector in the last decade. Therefore, moderate growth can be expected, provided the monsoon is normal and well-distributed across geographies and crops, besides its normal ‘arrival and departure’.
Industrial growth for the year has been lower in FY11, at 7.8% (10.5% in FY10), which can be partly explained by the high base year effect. Can this number be bettered in FY12? High interest rates have been fairly neutral for most of FY11 but may impact growth in the coming year. RBI is willing to sacrifice growth for inflation control, which may be interpreted as the possibility of there being further increases in interest rates that, in turn, will impact investment decisions. Interest rates have a bearing not just on investment and cost of working capital but also on retail loans in the housing and consumer goods segments. This would have a bearing on the production of capital goods, metals, construction, etc. Therefore, a number of 8% or so in the coming year would be an optimistic call, aided partly by the relatively low base year effect.
Next, government balances looked well under control in February. Lower growth in industry will have a bearing on production as well as imports, thus posing a potential loss of revenue in indirect tax collections that will pressurise the deficit. The government has to take a call on taxes/duties on oil products, given the volatile nature of crude prices globally. Therefore, the number of 4.6% for the fiscal deficit will have an upward bias if any of the assumptions made at the time of its drafting change. Also, in this environment, a decision that has to be taken is on government expenditure, as it is the only entity that can provide demand stimulus as higher interest rates do not impact them significantly. But, it has withdrawn this stimulus quite drastically in FY12 with overall expenditure to grow by just 3.4%. With lower spending, the component of services sector, i.e., community and social services, will show a modest increase.
Inflation is a phenomenon that no one has been able to grasp. It appears that we have entered a high cost economy, which is hard to reverse and at best can be stabilised at these levels. MSPs have risen, as has the cost of cultivation. Protection of farm incomes has meant that prices have to increase to preserve real consumption levels. Prices have become sticky in the downward direction. Global prices have provided cues to domestic prices and this linkage is becoming stronger. They, in turn, have been driven of late by speculative forces and may be expected to remain volatile. While a high base should bring down prices, the same did not happen last year, notwithstanding the high base.
The stock market has been largely stable in the 18,000 to 20,000 region, reflecting caution. FII funds have not exactly given the thumbs down signal but have been vacillating in the last few months. June to November 2010 was a boom phase after which flows ebbed for 3 months before turning positive again. FDI has also slowed down for several reasons. Besides, the global economy would be recovering and interest rates could move up, thus re-diverting funds to the developed economies. All this means that there could be pressure on the balance of payments.
The exports story has been impressive in FY11 even if looked at in absolute terms and not just growth rates. Surpassing the mark of $200 billion was an achievement but maintaining this tempo will receive a shoulder shrug, as growing exports by even 20% over a base of $245 billion is a challenge. Imports growth will be linked to industrial production and would tend to slow down if industrial growth is lukewarm. However, higher commodity prices, in particular oil, can spoil the party. While we have been talking of a manageable current account deficit at 2.5% of GDP for FY11, the FY12 outcome could be different.
While it may not be proper to predict doomsday, there is definitely a circle of apprehension over all the economic numbers that defied global gravity in FY10 and only stumbled a bit in FY11. FY12 may still be better than what is happening in the rest of the world, but certainly the inflation impact has distorted images that were constructed at the beginning of the year. The 10% terminal year growth target is obviously ruled out and the five-year average will now be lower than 9%, as was envisaged by the Planning Commission.
How to manage farm inventories: Economic Times 12th May 2011
The recent debate on the merits of exporting surplus wheat is important as it brings to the forefront the fact that we do not have a comprehensive food policy . Normally, concerns on food production relate to ashortage in case there is crop failure. Even here, the reaction is always a case of too little, too late aswe are reluctant to accept the problem and the acknowledgement comes only when the crisis is at the doorstep. It is also ironic that we donot know how to deal with a surplus. When there is a surplus, we hold on to it and do not want to part with it as there is fear that the next harvest may not be good enough. What is required is a comprehensive policy that deals with both surpluses and shortages.
Let us look at the surplus story first. The country had surplus sugar production in 2007-08 and 2008-09 and exported 4.7 million tonnes and 3.3 million tonnes respectively. Subsequently, there was a shortfall in production, which was a global phenomenon that had led to considerable criticism of the country not building a buffer that could have been harnessed. The solution was to ban sugar export, and import 2.4 million tonnes. Now, with wheat stocks overflowing in the granaries and the procurement season being on, there is talk on the possibility of exporting the surplus. Is this a good idea?
Today, about 60% of the produced wheat enters the market as marketed surplus. Hence, of the 84 million tonnes, about 50 million tonnes enter the market. About half of this is absorbed through the procurement process by the government, thus leaving just 25 million tonnes for private traders.
Intuitively, we can see that an artificial scarcity is being created by the government even in times of surplus production as the government is procuring and storing more than the buffer norms warrant.
Clearly, the answer here is that the government should offload the excess stock to private marketers and channel the rest through exports as the cost of holding on to the grain is high and not commercially viable. The under-recovery is close to Rs 9 per kilo of wheat dealt with by the government in terms of difference between economic cost and PDS price. Surplus stocks being held magnify this holding cost of wheat.
Now, since the government has a commitment to the farmers to buy wheat as part of an open-ended procurement programme, there is need to review this system. Even at the level of status quo in the extreme case where the systems are not changed, the surplus wheat above the buffer norms should be offloaded in the market (there will be double costing in the present scenario). Alternatively, with the UID scheme, the government can pay the farmers the difference in price but not physically take on more than what is required. This way, the surplus can be harnessed.
What about export? Export is the best option once the domestic market is satiated as it helps us to take advantage of the global market to get better returns, which would have been the case this year as there has been a case of declining global stocks due to lower production in Russia and China. Producers would have been able to get better value for their produce while we would simultaneously lower our holding cost of such surpluses given the limited warehousing space.
On the shortage side, the medium-term strategy has to be to improve productivity and migration of farmers to grow crops where we have a deficit, such as pulses and oilseeds, and those that consume less water. But that is more on the production side that necessarily involves providing incentives such as water supply, seeds, fertilisers, etc.
However, from a policy perspective, we need to decide in advance the strategy for products that are imported such as pulses and edible oils. Around 20% of our pulses and 55% of edible oil requirement are met through imports today. Output of pulses will peak at 17.3 million tonnes and oilseeds at 30.25 million tonnes in 2010-11.
But the Indian case is peculiar because, in years where production is good, like 2010-11 for pulses, we end up importing less. The clue is to create a buffer for pulses and edible oils in years when production is better and global conditions are normal. This way, we can ensure that when production fails, which can be anytime due to variable weather conditions, we can fall back on these buffer stocks. This will help ease supplies as well as moderate prices. This policy will also help in using the released warehousing space in wheat for other crops such as pulse, oilseeds and sugar.
The message here is that we should learn to manage our production levels more cogently. Variations in output are going to be part of a system that still has around 70% of farm output dependent on monsoon and where logistics support is suboptimal. We have to judiciously stock surpluses and leverage the export market to incentivise our farmers. Hence, this entire process of managing surpluses and shortfalls has to be dynamic, and just as companies manage their inventory, so too should the government. The issue is that the government being a non-profit organisation does not know how to handle these stocks and, hence, is over-obsessed with security and being politically right. The obsession for security leads to excess stocking. And acknowledging food shortage is a political issue and, hence, self-defeating. Ideally, the government should cease its intervention once the buffer stock level is met through the FCI and re-route the surplus stock into the private market beyond these levels.
The choice of providing increasing MSPs is with the government, and cash may be paid to the farmer directly. But trade in farm products should be left to the market because when there is profit motivation through private marketing and exports, the solutions that emerge are superior, which is what it should be at the end of the day.
Let us look at the surplus story first. The country had surplus sugar production in 2007-08 and 2008-09 and exported 4.7 million tonnes and 3.3 million tonnes respectively. Subsequently, there was a shortfall in production, which was a global phenomenon that had led to considerable criticism of the country not building a buffer that could have been harnessed. The solution was to ban sugar export, and import 2.4 million tonnes. Now, with wheat stocks overflowing in the granaries and the procurement season being on, there is talk on the possibility of exporting the surplus. Is this a good idea?
Today, about 60% of the produced wheat enters the market as marketed surplus. Hence, of the 84 million tonnes, about 50 million tonnes enter the market. About half of this is absorbed through the procurement process by the government, thus leaving just 25 million tonnes for private traders.
Intuitively, we can see that an artificial scarcity is being created by the government even in times of surplus production as the government is procuring and storing more than the buffer norms warrant.
Clearly, the answer here is that the government should offload the excess stock to private marketers and channel the rest through exports as the cost of holding on to the grain is high and not commercially viable. The under-recovery is close to Rs 9 per kilo of wheat dealt with by the government in terms of difference between economic cost and PDS price. Surplus stocks being held magnify this holding cost of wheat.
Now, since the government has a commitment to the farmers to buy wheat as part of an open-ended procurement programme, there is need to review this system. Even at the level of status quo in the extreme case where the systems are not changed, the surplus wheat above the buffer norms should be offloaded in the market (there will be double costing in the present scenario). Alternatively, with the UID scheme, the government can pay the farmers the difference in price but not physically take on more than what is required. This way, the surplus can be harnessed.
What about export? Export is the best option once the domestic market is satiated as it helps us to take advantage of the global market to get better returns, which would have been the case this year as there has been a case of declining global stocks due to lower production in Russia and China. Producers would have been able to get better value for their produce while we would simultaneously lower our holding cost of such surpluses given the limited warehousing space.
On the shortage side, the medium-term strategy has to be to improve productivity and migration of farmers to grow crops where we have a deficit, such as pulses and oilseeds, and those that consume less water. But that is more on the production side that necessarily involves providing incentives such as water supply, seeds, fertilisers, etc.
However, from a policy perspective, we need to decide in advance the strategy for products that are imported such as pulses and edible oils. Around 20% of our pulses and 55% of edible oil requirement are met through imports today. Output of pulses will peak at 17.3 million tonnes and oilseeds at 30.25 million tonnes in 2010-11.
But the Indian case is peculiar because, in years where production is good, like 2010-11 for pulses, we end up importing less. The clue is to create a buffer for pulses and edible oils in years when production is better and global conditions are normal. This way, we can ensure that when production fails, which can be anytime due to variable weather conditions, we can fall back on these buffer stocks. This will help ease supplies as well as moderate prices. This policy will also help in using the released warehousing space in wheat for other crops such as pulse, oilseeds and sugar.
The message here is that we should learn to manage our production levels more cogently. Variations in output are going to be part of a system that still has around 70% of farm output dependent on monsoon and where logistics support is suboptimal. We have to judiciously stock surpluses and leverage the export market to incentivise our farmers. Hence, this entire process of managing surpluses and shortfalls has to be dynamic, and just as companies manage their inventory, so too should the government. The issue is that the government being a non-profit organisation does not know how to handle these stocks and, hence, is over-obsessed with security and being politically right. The obsession for security leads to excess stocking. And acknowledging food shortage is a political issue and, hence, self-defeating. Ideally, the government should cease its intervention once the buffer stock level is met through the FCI and re-route the surplus stock into the private market beyond these levels.
The choice of providing increasing MSPs is with the government, and cash may be paid to the farmer directly. But trade in farm products should be left to the market because when there is profit motivation through private marketing and exports, the solutions that emerge are superior, which is what it should be at the end of the day.
Will rate hikes work? Business Standard 14th May 2011
The major takeaway from the credit policy is that we are taking a chance on growth to bring down inflation. Friedman has triumphed over Keynes and markets know what to expect. Besides increasing rates, the policy has done much to improve the transmission mechanism to ensure that higher singular policy rates (now the repo rate), combined with measures on provisioning and higher savings account rate, translate into higher commercial lending rates which will slow growth in credit, money supply and inflation.
There are two underlying assumptions here: inflation is caused by monetary measures and can, therefore, be controlled by rate increases which will, in turn, be reflected in the base rate. Table 1 dissects the composition of inflation last year in terms of the contribution of various components to inflation in FY11 (March over March) and highlights the causes and states whether policy can bring down prices. One, it shows that monetary policy could, at best, control around 23 per cent of inflation that was caused last year. This will cover a weight of just a little above 40 per cent of the wholesale price index. Two, of the products mentioned the ones that witnessed a high increase in prices were rubber and plastic products, metals and chemicals for which the global influence was dominant. Three, a corollary is that monetary policy can seek to lower demand for these segments but cannot ensure that prices come down since global factors drive prices of metals and chemical products including plastic products. Four, the government will have to simultaneously take a stance on administered prices of oil products and minimum support price because, while non-market prices are inefficient, we cannot have the Reserve Bank of India (RBI) raising rates and inflation rising in the other 60 per cent owing to government policy. This will weaken the efficacy of monetary policy which can control only demand-pull factors.
How strong is the monetary policy transmission today? To RBI’s credit, the concept of a base rate has brought much greater transparency and made monetary policy stronger because it is based on a formula and the transmission of costs becomes a necessity rather than an option for banks. Table 2 shows the road travelled in the last year on how banks reacted to rate increases in deposit and lending rates. The base rate concept came in July and superseded the prime lending rate which remained fixed.
Table 2 reveals that rate hike transmissions have been more effective in the second half of the year than the first. This was more a result of the shortage of funds for banks during the busy season. Therefore, the transmission system will work when banks require more funds and pay higher deposit rates. Alternatively, these rates should also affect their overall cost of operations through, say, the repo borrowings. What does this mean? The RBI may also have to look at certain quantitative measures to control the amount of resources available for lending. They may include either increasing the cash reserve ratio or placing a limit on the repo window to ensure the overall cost of borrowing goes up.
Assuming that rate hikes lower growth, will that temper inflation? A regression analysis for the last five years shows that around 34 per cent of inflation can be explained by growth in credit. However, the standard Granger causality test shows there is no causal link between growth, credit and inflation.
The three arguments examined here indicate that the impact of policy changes on inflation is equivocal and the present move is not quite the conjurer’s wand, 50 basis points notwithstanding.
There are two underlying assumptions here: inflation is caused by monetary measures and can, therefore, be controlled by rate increases which will, in turn, be reflected in the base rate. Table 1 dissects the composition of inflation last year in terms of the contribution of various components to inflation in FY11 (March over March) and highlights the causes and states whether policy can bring down prices. One, it shows that monetary policy could, at best, control around 23 per cent of inflation that was caused last year. This will cover a weight of just a little above 40 per cent of the wholesale price index. Two, of the products mentioned the ones that witnessed a high increase in prices were rubber and plastic products, metals and chemicals for which the global influence was dominant. Three, a corollary is that monetary policy can seek to lower demand for these segments but cannot ensure that prices come down since global factors drive prices of metals and chemical products including plastic products. Four, the government will have to simultaneously take a stance on administered prices of oil products and minimum support price because, while non-market prices are inefficient, we cannot have the Reserve Bank of India (RBI) raising rates and inflation rising in the other 60 per cent owing to government policy. This will weaken the efficacy of monetary policy which can control only demand-pull factors.
How strong is the monetary policy transmission today? To RBI’s credit, the concept of a base rate has brought much greater transparency and made monetary policy stronger because it is based on a formula and the transmission of costs becomes a necessity rather than an option for banks. Table 2 shows the road travelled in the last year on how banks reacted to rate increases in deposit and lending rates. The base rate concept came in July and superseded the prime lending rate which remained fixed.
Table 2 reveals that rate hike transmissions have been more effective in the second half of the year than the first. This was more a result of the shortage of funds for banks during the busy season. Therefore, the transmission system will work when banks require more funds and pay higher deposit rates. Alternatively, these rates should also affect their overall cost of operations through, say, the repo borrowings. What does this mean? The RBI may also have to look at certain quantitative measures to control the amount of resources available for lending. They may include either increasing the cash reserve ratio or placing a limit on the repo window to ensure the overall cost of borrowing goes up.
Assuming that rate hikes lower growth, will that temper inflation? A regression analysis for the last five years shows that around 34 per cent of inflation can be explained by growth in credit. However, the standard Granger causality test shows there is no causal link between growth, credit and inflation.
The three arguments examined here indicate that the impact of policy changes on inflation is equivocal and the present move is not quite the conjurer’s wand, 50 basis points notwithstanding.
Sunday, May 1, 2011
Please Take Them To The Morgue : Book Review of Zombie Economics Business World 23rd April 2011
Zombie Economics:How Dead Ideas Still Walk Among Us
By John Quiggin
Princeton University Press
Economist John Maynard Keynes said ideas of economists, when they are right or wrong, are more powerful than is commonly understood, “indeed the world is ruled by little else”. Quite prophetic. And John Quiggin will have you believe the same in Zombie Economics. He shows how these incorrect ideas or the proverbial ‘zombies’ keep getting resurrected to outlive their originators. Which are these ideas? The great moderation, efficient-market hypothesis, concept of dynamic stochastic general equilibrium (DSGE), trickle-down theory and privatisation are the esoteric ideas that had dominated our cerebrum for years and need to be discarded given the havoc they caused. They come under different garbs — Thatcherism, Reaganism or simply market liberalism. But they have been unequivocally inappropriate solutions.
In the light of the recent financial crisis, Quiggin indulges in some exfoliation of their logic with impunity, which is largely entertaining, though one-sided. The reader may not agree with him as, at times, his examples are selective.
The great moderation, made popular by Ben Bernanke, currently chairman of the US Federal Reserve, was an eyewash, which created a delusion that the business cycle was dead and growth was there to stay. Policies were formulated to support this feeling. It led to Ponzis being created by making capital cheap. When momentum was created, they came in as those deadly, exotic derivative products.
Quiggin is even harsher when it comes to the efficient markets hypothesis, where prices embed all possible information in a perfect manner. As this can never be so, markets have to be inefficient. But then all other fancy models such as the Black-Scholes pricing of options or capital asset pricing model are based on premises that turned catastrophic. With a wry twist of humour, he talks a lot on the concept of the ‘Greenspan put’, named after Alan Greenspan, which is an interesting ‘option’ where markets are bailed out in case of financial failure.
The third zombie idea is the DSGE model. Quiggin takes us through vintage theory from Say’s law to new classical economics, which is déjà vu stuff. His contention, however, is we cannot elevate micro-economic theories to the macro level. The DSGE models did not quite provide solutions and every crisis invariably had us turn back to Keynes for a solution as they understated the crisis until it hit us hard.
The trickle-down theory, another bastion of economic liberalism, is a mirage, and we should not be carried away by the goodies that are accessible to the poor. Theory says if we concentrate on efficiency, equity would automatically follow in the long run. But taxes fall on wage earners as the rich do not consume all their income and consumption taxes are high. While the rich benefit from zero or low capital taxes, the poor lag in healthcare, education and social cohesion as governments spend less. Not unsurprisingly, income inequality has increased in the past four decades with the income of the top echelons multiplying several times, while those below have witnessed only marginal increases.
Privatisation is the last zombie, which was part of Thatcherism in the 1980s. The idea was to collect funds by selling government companies on grounds of efficiency. Government’s role was relegated to being a provider of public services and the fall of the Soviet bloc and the beginning of the Washington Consensus only supported this zombie idea. This served everybody; public servants got better-paid jobs, while private entrepreneurs are able to buy cheap and then sell dear. Quiggin calls it a policy in search of a rationale. The ultimate irony was when the financial crisis led to the re-nationalisation of capitalist enterprises such as Citigroup, Bank of America and General Motors.
How then do we put these pieces together? The book works on the premise that risk managed by financial markets under economic liberalism outperforms the government, leading to optimal solutions that create the illusion of great moderation. This had the DSGE models inbuilt, which was supported at the micro level by the efficient-markets hypothesis. Privatisation was at the heart of this ideology where the entire model was reinforced by the trickle-down theory. Alas, the financial crisis dealt a big blow to this structure, and it is time for us to review it, and probably go back to the government and Keynes.
By John Quiggin
Princeton University Press
Economist John Maynard Keynes said ideas of economists, when they are right or wrong, are more powerful than is commonly understood, “indeed the world is ruled by little else”. Quite prophetic. And John Quiggin will have you believe the same in Zombie Economics. He shows how these incorrect ideas or the proverbial ‘zombies’ keep getting resurrected to outlive their originators. Which are these ideas? The great moderation, efficient-market hypothesis, concept of dynamic stochastic general equilibrium (DSGE), trickle-down theory and privatisation are the esoteric ideas that had dominated our cerebrum for years and need to be discarded given the havoc they caused. They come under different garbs — Thatcherism, Reaganism or simply market liberalism. But they have been unequivocally inappropriate solutions.
In the light of the recent financial crisis, Quiggin indulges in some exfoliation of their logic with impunity, which is largely entertaining, though one-sided. The reader may not agree with him as, at times, his examples are selective.
The great moderation, made popular by Ben Bernanke, currently chairman of the US Federal Reserve, was an eyewash, which created a delusion that the business cycle was dead and growth was there to stay. Policies were formulated to support this feeling. It led to Ponzis being created by making capital cheap. When momentum was created, they came in as those deadly, exotic derivative products.
Quiggin is even harsher when it comes to the efficient markets hypothesis, where prices embed all possible information in a perfect manner. As this can never be so, markets have to be inefficient. But then all other fancy models such as the Black-Scholes pricing of options or capital asset pricing model are based on premises that turned catastrophic. With a wry twist of humour, he talks a lot on the concept of the ‘Greenspan put’, named after Alan Greenspan, which is an interesting ‘option’ where markets are bailed out in case of financial failure.
The third zombie idea is the DSGE model. Quiggin takes us through vintage theory from Say’s law to new classical economics, which is déjà vu stuff. His contention, however, is we cannot elevate micro-economic theories to the macro level. The DSGE models did not quite provide solutions and every crisis invariably had us turn back to Keynes for a solution as they understated the crisis until it hit us hard.
The trickle-down theory, another bastion of economic liberalism, is a mirage, and we should not be carried away by the goodies that are accessible to the poor. Theory says if we concentrate on efficiency, equity would automatically follow in the long run. But taxes fall on wage earners as the rich do not consume all their income and consumption taxes are high. While the rich benefit from zero or low capital taxes, the poor lag in healthcare, education and social cohesion as governments spend less. Not unsurprisingly, income inequality has increased in the past four decades with the income of the top echelons multiplying several times, while those below have witnessed only marginal increases.
Privatisation is the last zombie, which was part of Thatcherism in the 1980s. The idea was to collect funds by selling government companies on grounds of efficiency. Government’s role was relegated to being a provider of public services and the fall of the Soviet bloc and the beginning of the Washington Consensus only supported this zombie idea. This served everybody; public servants got better-paid jobs, while private entrepreneurs are able to buy cheap and then sell dear. Quiggin calls it a policy in search of a rationale. The ultimate irony was when the financial crisis led to the re-nationalisation of capitalist enterprises such as Citigroup, Bank of America and General Motors.
How then do we put these pieces together? The book works on the premise that risk managed by financial markets under economic liberalism outperforms the government, leading to optimal solutions that create the illusion of great moderation. This had the DSGE models inbuilt, which was supported at the micro level by the efficient-markets hypothesis. Privatisation was at the heart of this ideology where the entire model was reinforced by the trickle-down theory. Alas, the financial crisis dealt a big blow to this structure, and it is time for us to review it, and probably go back to the government and Keynes.
Not for the 9th time: Financial Express: 29th April 2011
Ever since we embarked on the path of fine tuning monetary policy last year, meaning eight such announcements, a lot has been said every time about what RBI should or should not do. Fiscal year 2011 was quite unique in the sense that it has thrown up a lot of surprises. Inflation has been an enigma that we just could not understand and several theories that popped up did not stand the test of time. We spoke of food
inflation but agricultural production has reached a peak this year. We are now talking of core inflation rising, i.e., non-food and -fuel inflation. But aren’t commodity prices, such as those of metals, moving up increasing the prices of manufactured goods? And if core inflation is the issue, then we should be seeing excess demand forces somewhere. But, is this visible?
This is critical because the policy to be announced on May 3, 2011, is for the year, and RBI will be giving direction on both GDP and inflation targets. While these are not sacrosanct numbers, they would indicate to a large extent the course of likely action by RBI during the year, which is more important. An inflation target of, say, 5%, which has been the convention so far, will mean that RBI will keep increasing interest rates until such time that the number comes down to this level. On the other hand, if it is in the region of 6-7%, then maybe we can expect a pause as the present inflation number will come down gradually.
The other issue is, of course, GDP growth. Normally, the targeted range has been between 8-9% and given that the Planning Commission is looking at higher numbers from FY13
onwards, RBI will have to strike a balance between such optimism and the pessimistic numbers rolled out by private agencies, which are looking at the range of 7-8%.
Therefore, the announcements made in this credit policy will be crucial as it will once again be all about interest rates. RBI has increased rates eight times since last March but the impact on inflation has been limited (Chart 1). The prices of primary products have shown an uneven trend, while those of manufactured goods have increased in the last few months. Higher interest rates have certainly maintained the level of ‘real interest rates’ and protected deposit holders and other returns on debt instruments quite well. The question is whether we have reached an inflection point after which further rate hikes will impede growth. This is pertinent because if increasing interest rates has not helped to temper inflation, are we chasing the incorrect shadow?
There are already signs that investment decisions may be getting deferred today in the current environment. This holds especially for capital intensive and infrastructure projects where funds will be locked in at higher rates of, say, 13-15% for an extended period of time. The internal rate of return so
calculated may not justify these high borrowing rates. The SME segment, which may be confronting even higher rates, may not find it feasible to expand further at this stage. Chart 2 shows that in the last three years, there are signs of the rate of fixed capital formation coming down, which is certainly not good news for growth prospects.
So what should RBI be looking at? As the controller of monetary policy, RBI has to choose between the Keynesian and Monetarist hats. Chart 3 juxtaposes growth in GDP with bank credit and money supply. Growth in money supply has been lower this year while growth in credit has been commensurate with higher GDP growth, which is still lower than that in FY07 and FY08. Clearly, growth in credit (which will be lower if an adjustment is made for the R1 lakh crore outflows on account of 3G auctions that have been locked with the government during FY11) has not shown signs of going overboard. If we are looking to control inflation, then the question is whether there are demand pull inflationary forces in the economy that can support the argument.
Looking at the GDP numbers of the CSO, we see that there are three elements there. Consumption growth has been steady, with the higher value of consumption being more on account of protecting existing consumption. Chart 4 shows that consumption as a proportion of GDP has actually been coming down over the years. Therefore, it cannot be argued that households are borrowing money to meet their growing consumption requirements. The second element, capital formation, as mentioned earlier, has shown signs of slippage and will be on the radar of RBI.
The third important element is growth in government expenditure which is captured by the community,
social and personal services in the GDP numbers. The quarterly growth numbers provided by the CSO, again, show a continued slowdown in this number. This was a conscious act of the government to roll back on the fiscal stimulus (Chart 5).
Therefore, there are two fairly unequivocal observations that stand out. The first is that interest rate hikes have not really had an impact on inflation, with the prices of primary products showing double digit growth. The second is that there is reason to believe that growth can slow down in case there is further monetary policy action. Therefore, a modified Keynesian approach of deferring a rate hike and, hence, taking a pause can be argued for under these circumstances.
inflation but agricultural production has reached a peak this year. We are now talking of core inflation rising, i.e., non-food and -fuel inflation. But aren’t commodity prices, such as those of metals, moving up increasing the prices of manufactured goods? And if core inflation is the issue, then we should be seeing excess demand forces somewhere. But, is this visible?
This is critical because the policy to be announced on May 3, 2011, is for the year, and RBI will be giving direction on both GDP and inflation targets. While these are not sacrosanct numbers, they would indicate to a large extent the course of likely action by RBI during the year, which is more important. An inflation target of, say, 5%, which has been the convention so far, will mean that RBI will keep increasing interest rates until such time that the number comes down to this level. On the other hand, if it is in the region of 6-7%, then maybe we can expect a pause as the present inflation number will come down gradually.
The other issue is, of course, GDP growth. Normally, the targeted range has been between 8-9% and given that the Planning Commission is looking at higher numbers from FY13
onwards, RBI will have to strike a balance between such optimism and the pessimistic numbers rolled out by private agencies, which are looking at the range of 7-8%.
Therefore, the announcements made in this credit policy will be crucial as it will once again be all about interest rates. RBI has increased rates eight times since last March but the impact on inflation has been limited (Chart 1). The prices of primary products have shown an uneven trend, while those of manufactured goods have increased in the last few months. Higher interest rates have certainly maintained the level of ‘real interest rates’ and protected deposit holders and other returns on debt instruments quite well. The question is whether we have reached an inflection point after which further rate hikes will impede growth. This is pertinent because if increasing interest rates has not helped to temper inflation, are we chasing the incorrect shadow?
There are already signs that investment decisions may be getting deferred today in the current environment. This holds especially for capital intensive and infrastructure projects where funds will be locked in at higher rates of, say, 13-15% for an extended period of time. The internal rate of return so
calculated may not justify these high borrowing rates. The SME segment, which may be confronting even higher rates, may not find it feasible to expand further at this stage. Chart 2 shows that in the last three years, there are signs of the rate of fixed capital formation coming down, which is certainly not good news for growth prospects.
So what should RBI be looking at? As the controller of monetary policy, RBI has to choose between the Keynesian and Monetarist hats. Chart 3 juxtaposes growth in GDP with bank credit and money supply. Growth in money supply has been lower this year while growth in credit has been commensurate with higher GDP growth, which is still lower than that in FY07 and FY08. Clearly, growth in credit (which will be lower if an adjustment is made for the R1 lakh crore outflows on account of 3G auctions that have been locked with the government during FY11) has not shown signs of going overboard. If we are looking to control inflation, then the question is whether there are demand pull inflationary forces in the economy that can support the argument.
Looking at the GDP numbers of the CSO, we see that there are three elements there. Consumption growth has been steady, with the higher value of consumption being more on account of protecting existing consumption. Chart 4 shows that consumption as a proportion of GDP has actually been coming down over the years. Therefore, it cannot be argued that households are borrowing money to meet their growing consumption requirements. The second element, capital formation, as mentioned earlier, has shown signs of slippage and will be on the radar of RBI.
The third important element is growth in government expenditure which is captured by the community,
social and personal services in the GDP numbers. The quarterly growth numbers provided by the CSO, again, show a continued slowdown in this number. This was a conscious act of the government to roll back on the fiscal stimulus (Chart 5).
Therefore, there are two fairly unequivocal observations that stand out. The first is that interest rate hikes have not really had an impact on inflation, with the prices of primary products showing double digit growth. The second is that there is reason to believe that growth can slow down in case there is further monetary policy action. Therefore, a modified Keynesian approach of deferring a rate hike and, hence, taking a pause can be argued for under these circumstances.
Don’t ban our futures: Financial Express 22nd April 2011
The growth of the commodity futures markets has been quite amazing in the last few years. Forward Markets Commission (FMC) data shows that volumes have been around Rs 120 lakh crore in FY11, which is almost 1.5 times India’s GDP at current market prices. Does this mean that commodity futures trading has finally arrived?
Let’s go back to the basics. When futures trading were revived in 2003, the idea was to bring in a price discovery mechanism that would finally help the farmers get higher prices for their produce. But for these prices to be determined, we needed to have active trading to generate the requisite liquidity. Therefore, we required the arbitrager, investor and speculator to take contrary positions.
The market has been mired in controversy as every bout of inflation has been associated with futures trading. The conundrum is that futures prices are supposed to tell us what lies ahead, in case the market is efficient. However, when futures prices of, say, tur or urad or wheat indicated a crop failure, these price signals were taken to be proof of futures’ role in fuelling inflation, leading to a ban. The banning of futures products and their subsequent reintroduction has not really helped as traders are wary of future bans. It is not surprising that contracts in wheat and sugar, which were extremely robust before the ban, are quite muted after their reintroduction.
The question now is, how can we evaluate the market as it stands today? The first is that the share of farm products in total volume traded has come down to a low of 12.2% in FY11. These are the only products where price discovery takes place within the country and hence add value to the pricing system. The canvas is limited with noteworthy volumes in soybean, soy oil, mustard and chana, and some of the spices during the season besides guar, which is traded more as a proxy for weather.
The second issue is whether the farmers are gaining from such trading. The answer is yes and no. No, because they do not trade. Yes, because the price information is available to a large cross-section of the community, thanks to the development role taken on by the FMC and the exchanges in price dissemination. The Indore oilseeds mandi or the Delhi chana markets commence daily trade based on the National Commodity & Derivatives Exchange (NCDEX) futures prices. Therefore, futures prices do get used in the spot market.
The third is whether there has been any use of futures trading in metals and energy, which constitute around 88% of volumes, especially when there is virtually no price discovery taking place in India and where deliveries are non-existent. Crude prices are determined on the New York Mercantile Exchange (NYMEX) or Intercontinental Exchange (ICE), bullion on the Commodities Exchange (COMEX) and copper on the London Metal Exchange (LME). The answer is that these commodities have now become alternative investment classes and offer opportunities to investors. While there is no direct value for the economy, investors can diversify their portfolio as these commodities do not have a relationship with stocks or interest rates. Regulation must change so that the retail investor can harness these benefits through commodity funds where the mutual fund can invest in these products. Currently, regulatory overlap does not permit such an option.
The fourth is whether the market needs multiple exchanges when most of the terms of operation are fixed by FMC. Today, FMC data shows that there are 21 operating exchanges. However, the Multi Commodity Exchange of India (MCX) has a market share of over 80% and NCDEX a little over 10%. The National Multi Commodity Exchange of India (NMCE) is the third while the Indian Commodity Exchange (ICEX), the Ahmedabad Commodity Exchange (ACE) and the National Board of Trade (NBOT) are players around the fringe. The broader issue is what is being done to revive the age-old exchanges. While two of the new exchanges are operating and one more is on the anvil, will these exchanges really survive? This is important because anecdotal experience shows that liquidity gravitates towards an exchange and then gets stuck to it. Moving liquidity away is a challenge and exchanges are natural monopolies. This being the case with a firm demarcation between the original electronic exchanges (besides NBOT, which has its own loyal members), there is a need to reconsider making the system well knit. In the stock market, only two exchanges dominate, and a similar picture appears to have emerged here. The FMC needs to work towards consolidation or enabling measures like market-making to ensure that they survive.
So what does this all mean? It is hard to think of futures trading changing the architecture of farming in the context of what has transpired in the last few years. Trading in farm futures will continue to remain on the periphery as it can no longer be pursued as a goal by exchanges that have to return a profit to their shareholders. It will evolve to be analogous to the equity market as a platform for investors who look at non-farm products. Here, it will be a challenge to the FMC to get in end-user and retail participants so that a wider audience can draw benefits from this investment alternative. Along the way, the market, too, will attain more respectability.
Let’s go back to the basics. When futures trading were revived in 2003, the idea was to bring in a price discovery mechanism that would finally help the farmers get higher prices for their produce. But for these prices to be determined, we needed to have active trading to generate the requisite liquidity. Therefore, we required the arbitrager, investor and speculator to take contrary positions.
The market has been mired in controversy as every bout of inflation has been associated with futures trading. The conundrum is that futures prices are supposed to tell us what lies ahead, in case the market is efficient. However, when futures prices of, say, tur or urad or wheat indicated a crop failure, these price signals were taken to be proof of futures’ role in fuelling inflation, leading to a ban. The banning of futures products and their subsequent reintroduction has not really helped as traders are wary of future bans. It is not surprising that contracts in wheat and sugar, which were extremely robust before the ban, are quite muted after their reintroduction.
The question now is, how can we evaluate the market as it stands today? The first is that the share of farm products in total volume traded has come down to a low of 12.2% in FY11. These are the only products where price discovery takes place within the country and hence add value to the pricing system. The canvas is limited with noteworthy volumes in soybean, soy oil, mustard and chana, and some of the spices during the season besides guar, which is traded more as a proxy for weather.
The second issue is whether the farmers are gaining from such trading. The answer is yes and no. No, because they do not trade. Yes, because the price information is available to a large cross-section of the community, thanks to the development role taken on by the FMC and the exchanges in price dissemination. The Indore oilseeds mandi or the Delhi chana markets commence daily trade based on the National Commodity & Derivatives Exchange (NCDEX) futures prices. Therefore, futures prices do get used in the spot market.
The third is whether there has been any use of futures trading in metals and energy, which constitute around 88% of volumes, especially when there is virtually no price discovery taking place in India and where deliveries are non-existent. Crude prices are determined on the New York Mercantile Exchange (NYMEX) or Intercontinental Exchange (ICE), bullion on the Commodities Exchange (COMEX) and copper on the London Metal Exchange (LME). The answer is that these commodities have now become alternative investment classes and offer opportunities to investors. While there is no direct value for the economy, investors can diversify their portfolio as these commodities do not have a relationship with stocks or interest rates. Regulation must change so that the retail investor can harness these benefits through commodity funds where the mutual fund can invest in these products. Currently, regulatory overlap does not permit such an option.
The fourth is whether the market needs multiple exchanges when most of the terms of operation are fixed by FMC. Today, FMC data shows that there are 21 operating exchanges. However, the Multi Commodity Exchange of India (MCX) has a market share of over 80% and NCDEX a little over 10%. The National Multi Commodity Exchange of India (NMCE) is the third while the Indian Commodity Exchange (ICEX), the Ahmedabad Commodity Exchange (ACE) and the National Board of Trade (NBOT) are players around the fringe. The broader issue is what is being done to revive the age-old exchanges. While two of the new exchanges are operating and one more is on the anvil, will these exchanges really survive? This is important because anecdotal experience shows that liquidity gravitates towards an exchange and then gets stuck to it. Moving liquidity away is a challenge and exchanges are natural monopolies. This being the case with a firm demarcation between the original electronic exchanges (besides NBOT, which has its own loyal members), there is a need to reconsider making the system well knit. In the stock market, only two exchanges dominate, and a similar picture appears to have emerged here. The FMC needs to work towards consolidation or enabling measures like market-making to ensure that they survive.
So what does this all mean? It is hard to think of futures trading changing the architecture of farming in the context of what has transpired in the last few years. Trading in farm futures will continue to remain on the periphery as it can no longer be pursued as a goal by exchanges that have to return a profit to their shareholders. It will evolve to be analogous to the equity market as a platform for investors who look at non-farm products. Here, it will be a challenge to the FMC to get in end-user and retail participants so that a wider audience can draw benefits from this investment alternative. Along the way, the market, too, will attain more respectability.
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