The organised retail system enhances efficiency in the value chain. The farmer gets a better price and grows a better quality of the product; the value chain is truncated and, in the process, an organised infrastructure structure is created
The resistance encountered by the corporate foray into organised retail is not dissimilar to the impediments that have been put in the way of futures trading. One may recollect that when futures trading was banned in some critical commodities this year, the reason given was that futures trading contributed to inflation, by which consumers would be affected as they would have to pay more for food products.
The irony of the tirade against corporate retail is that it is displacing scores of retail traders, even though the consumer is paying a lower price for the same products. The consumer was the explanation for banning futures trade, while his interests have become secondary to the traders in the retail saga. This surely makes one stop to think.
There are six interesting patterns that emerge from these two issues. The first is that Indians as a rule are averse to change and would always like to have a status quo situation, howsoever inefficient or hard conditions may be. It is probably human tendency, or rather frailty, that makes us resistant to change, as we become quite comfortable with inaction. Competition fear
The second is that we are apprehensive of competition and, hence, prefer a protected set-up. Competition demands performance, which we are unwilling to work with. Further, competition erodes the oligopolistic power that is wielded by certain groups, which is not acceptable.
The third is that we abhor transparency and like systems to be opaque, as non-disclosure helps in increasing profit. This, in fact, is a corollary of the first two features of preference for the status quo and the hostility towards competition.
Fourth, whenever we talk of systems and their working, we tend to take sides and play favourites. We never ask whether the system works efficiently, but are always looking to see if some groups or participants are benefiting from the system.
Fifth, we are so used to the system of having intermediaries in our lives that we do not want to get rid of them, even though very often they do not add much value.
Last, for any progressive move, there are usually activists who come in the way and often use irrational excuses to thwart such activity. The icing is provided by the political undertones, which are always present.Benefits of organised retail
Let us examine what organised retail involves. The organised retail system enhances efficiency in the value chain. The farmer gets a better price and grows a better quality of the product; and, more importantly, is not forced to do so, and only gets into such contracts with the corporate because it benefits him.
The value chain is truncated as the intermediate layers are pruned and, in the process, an organised infrastructure structure is created.
This starts at the purchase level at farm gate and moves across the packing, transportation, warehousing (including cold storage, when required), processing and packaging stages before being delivered at the consumer’s end.
The consumer buys from these outlets because he gets the right quality at a lower price. Outlets such as Spinach, Big Bazaar, Reliance Retail and Subhiksha have been delivering quality produce at lower prices. Alongside, there are vast investments being made, which open up multiple employment opportunities of a different kind. The Government also gains substantially as all the taxes and duties are paid along the way and there are no leakages. Therefore, all the parties concerned stand to gain. However, there is one class that apparently gets affected adversely, which is the trader. Given that retail is generally unorganised, it is but natural that if there is a large retailer, it could replace several small ones. How does one tackle this issue?
To begin with it must be stated that the so called ‘mom and pop stores’, which is the name given to our friendly retail grocer, will always have their own role to play. Home delivery services, the convenience of being next door, availability of small quantities of goods (like sachets and in low denominations), credit facilities, personalised service etc are some of the benefits that retain customer loyalty to these outlets. But, to the extent that there would be some replacement of loyalty, there can be a social problem even though this is not one for Economics to resolve. But, there is a way out. The large retailers cannot be everywhere as the investment involved is considerable. The small retailers will become franchisees of the corporates and can enjoy a fixed income plus commissions. Trader-corporate link-up
Moreover, there is a growing trend of the these shops to get associated with the larger corporates such as Hindustan Unilever, Marico and Dabur, which have set up their own chains with such names as Super Value, Parivar and Mera respectively where the goods are sold to them at the same price as that to large retail chains on certain conditionality like focus on display or walking space for consumers.
Alternatively, the smaller vegetable and fruits vendors could become employees of the corporate retail chain, which is also taking place in a gradual manner. Further, the local shop owner, who is the last intermediary in the chain, can actually procure from these corporate retail stores and save on costs and sell them to the consumer.
Thus, while the mindset has to change and some adjustment made, it is certainly not going to be anywhere close to large-scale substitution taking place.Higher resistance
Opening up the retail sector was also going to be the clichéd ‘last mile’ in economic reforms. The problem is acute as the sector is unorganised; the organised sector’s adaptability to reforms has been better, though, to begin with, there were major hiccups.
Once we move to the unorganised sector, the level of resistance increases. Further, given that there is already talk of foreign investment in this sector and the carry-over xenophobia that flows in us, organised retail becomes a more vulnerable target.
But there are viable solutions, as described earlier, if we are willing to look beyond narrow interests, and we should consider them rather than impede the retail revolution waiting to happen.
Tuesday, May 27, 2008
Wednesday, May 21, 2008
Only a grain of truth: Outlook Business, 31st May 2008
Export curbs and duty cuts are stop-gap measures to check inflation. The only lasting solution is a big increase in agricultural output
Inflation today has two distinct features. First, it is a global phenomenon, as rising prices have severely affected almost every country across the globe. Considering that the phenomenon has even triggered food riots in some less-developed countries and many other countries have witnessed a higher rate of inflation, India has done creditably so far, with the rate of inflation being pegged at around 7.5% in the country. The second distinct feature of the current crisis is that it has been caused by distortions in fundamentals, which have severely widened the gap between demand and supply. Rarely any other reason except supply shortfall has caused price hikes. Economic theory calls this cost-push inflation.
India was prepared for an inflation rate of 5% for the year. But the applecart has been upset with the figure reaching over 7% in the past weeks. Usually, governments and policymakers grapple with the twin issues of growth and stability. Higher growth and price stability are desirable, but it may not always be possible for a country to enjoy this ideal situation. Policymakers have to work on trade-offs, and growth can be sacrificed here as it is not really visible across the country, as lower wage hikes and layoffs, which characterises these downturns are restricted to urban areas and all specific to industry. But higher inflation affects everyone and, when it is triggered by food, it is serious business.
Cash in reserve
The government has been taking a series of measures to control an increase in prices. On the demand side, the Reserve Bank of India has increased the cash reserve ratio (CRR) to lower the ability of banks to lend. The rationale is that when CRR is up, banks have fewer resources to lend, which, in turn, controls the growth of liquidity in the system and the demand. Interest rates have consequently moved up and are probably coming in the way of growth in demand, which comes from individuals and the industry.
However, this has not really had an impact, as the demand-pull forces had a limited role to play in pushing up prices this year. In fact, the recent hike in CRR is unlikely to be effective because growth in credit is also slack. That banks would be treading cautiously this year in the wake of derivatives losses that some of them suffered would have restricted the growth in credit. So, chasing the demand-pull trail is unlikely to yield positive results.
Reading the flow
On the supply side, the government has followed the twin policy of increasing the flow of goods by liberalising imports to enhance the flow of goods, as well as reducing import costs. This was done earlier in the case of wheat through imports; and reduction in tariffs for cement and pulses last fiscal; and for edible oils and rice more recently. Such measures have been supplemented by export restrictions on rice, edible oils and pulses to ensure that scarce food resources are not exported. Also there have been announcements on stocking essential commodities, since such situations tend to encourage hoarding. Banks have been advised to be cautious in such lending operations.
Reduction in import duties has worked well to reduce the prices of edible oils and thus countered the lower production of mustard (the rabi crop). But the fundamental problem of shortfall in production could not be eschewed.
Building buffers
Increasing imports and curbing exports will work at a country level, not in a global scenario. In a global economy, such measures only add to the supply shortage, as countries are keen to import more while shying away from exports. Countries such as China and Thailand have been imposing export controls, creating imperfections in trade flows. This approach sets up what is called an ‘economic game’, where every country protects their own food stocks and relies more on imports so that they can avoid a crisis.
This eventually affects everyone as global supplies get stifled, leading to higher
Increasing agricultural output is spoken about, but little is done. Unless this balance is corrected, India runs the risk of high inflation every time there is a food shortageinflation. One has been observing this in the crude oil sector, where countries such as the US are saving their own reserves and relying more on imports, leading to a rise in prices.
The other factor that has been working against inflation is the relatively lower base last year at this time. Prices had moved downwards, towards the end of last fiscal year, which pushed up growth rates this year. However, the impact of the base-year phenomenon should not be overstated here.
Getting inflation down can finally work only if we are able to increase agricultural productivity, so as to ensure that supplies keep increasing. This has been spoken of, but little has been done. Hence, we will be running the risk of inflation every time there is a food shortage. This year, production of rice, chana and mustard have been down in the rabi season, which has had its effect on prices as against a good kharif harvest in 2007.
We cannot insulate ourselves from global inflation because there is a progressively greater cohesion between global and domestic prices. These influences come into the system through imports, as has been witnessed in the case of edible oils. Therefore, policies like export restrictions or lowering of import duties can at best be a short-term solution.
Missing links
While the focus of all inflation talk is agriculture and food items, many of those who are into the debate have missed two important points. In the current financial year, prices of manufactured products have increased by over 7%, and this category contributed to about 53% of total inflation. Here, the increase has come from the metals segment on which such policy actions do not work. Further, the increase in administered prices of some fuel products has also fed inflation through higher input costs for farmers as well as for industry.
The government has made clear its priorities in terms of controlling inflation, and has taken several steps to lower the rate. However, such intervention in the markets is likely to have an adverse impact on the fiscal balance, as the thrust has been on trade measures that will affect tax collections. Add to this the higher procurement of wheat this year of over 17 million tonnes (the FCI expects this to touch 20 million tonnes), and the subsidy bill is also likely to increase over time.
Quite clearly, there is a trade-off being traversed by the government, which is understandable under the present conditions. However, one cannot dodge the issue of increasing the presently stagnant yield from agriculture in the country. There appears no other way out. Since this cannot happen immediately, we may have to live with agflation—an increase in the price of food that happens as a result of increased demand—at least for some time, while global factors will influence the price of metals and energy products, over which a country like India may have little control. Monetary policy must keep this in mind to ensure that growth does not suffer with restrictive policies. Therein lies the rub.
Inflation today has two distinct features. First, it is a global phenomenon, as rising prices have severely affected almost every country across the globe. Considering that the phenomenon has even triggered food riots in some less-developed countries and many other countries have witnessed a higher rate of inflation, India has done creditably so far, with the rate of inflation being pegged at around 7.5% in the country. The second distinct feature of the current crisis is that it has been caused by distortions in fundamentals, which have severely widened the gap between demand and supply. Rarely any other reason except supply shortfall has caused price hikes. Economic theory calls this cost-push inflation.
India was prepared for an inflation rate of 5% for the year. But the applecart has been upset with the figure reaching over 7% in the past weeks. Usually, governments and policymakers grapple with the twin issues of growth and stability. Higher growth and price stability are desirable, but it may not always be possible for a country to enjoy this ideal situation. Policymakers have to work on trade-offs, and growth can be sacrificed here as it is not really visible across the country, as lower wage hikes and layoffs, which characterises these downturns are restricted to urban areas and all specific to industry. But higher inflation affects everyone and, when it is triggered by food, it is serious business.
Cash in reserve
The government has been taking a series of measures to control an increase in prices. On the demand side, the Reserve Bank of India has increased the cash reserve ratio (CRR) to lower the ability of banks to lend. The rationale is that when CRR is up, banks have fewer resources to lend, which, in turn, controls the growth of liquidity in the system and the demand. Interest rates have consequently moved up and are probably coming in the way of growth in demand, which comes from individuals and the industry.
However, this has not really had an impact, as the demand-pull forces had a limited role to play in pushing up prices this year. In fact, the recent hike in CRR is unlikely to be effective because growth in credit is also slack. That banks would be treading cautiously this year in the wake of derivatives losses that some of them suffered would have restricted the growth in credit. So, chasing the demand-pull trail is unlikely to yield positive results.
Reading the flow
On the supply side, the government has followed the twin policy of increasing the flow of goods by liberalising imports to enhance the flow of goods, as well as reducing import costs. This was done earlier in the case of wheat through imports; and reduction in tariffs for cement and pulses last fiscal; and for edible oils and rice more recently. Such measures have been supplemented by export restrictions on rice, edible oils and pulses to ensure that scarce food resources are not exported. Also there have been announcements on stocking essential commodities, since such situations tend to encourage hoarding. Banks have been advised to be cautious in such lending operations.
Reduction in import duties has worked well to reduce the prices of edible oils and thus countered the lower production of mustard (the rabi crop). But the fundamental problem of shortfall in production could not be eschewed.
Building buffers
Increasing imports and curbing exports will work at a country level, not in a global scenario. In a global economy, such measures only add to the supply shortage, as countries are keen to import more while shying away from exports. Countries such as China and Thailand have been imposing export controls, creating imperfections in trade flows. This approach sets up what is called an ‘economic game’, where every country protects their own food stocks and relies more on imports so that they can avoid a crisis.
This eventually affects everyone as global supplies get stifled, leading to higher
Increasing agricultural output is spoken about, but little is done. Unless this balance is corrected, India runs the risk of high inflation every time there is a food shortageinflation. One has been observing this in the crude oil sector, where countries such as the US are saving their own reserves and relying more on imports, leading to a rise in prices.
The other factor that has been working against inflation is the relatively lower base last year at this time. Prices had moved downwards, towards the end of last fiscal year, which pushed up growth rates this year. However, the impact of the base-year phenomenon should not be overstated here.
Getting inflation down can finally work only if we are able to increase agricultural productivity, so as to ensure that supplies keep increasing. This has been spoken of, but little has been done. Hence, we will be running the risk of inflation every time there is a food shortage. This year, production of rice, chana and mustard have been down in the rabi season, which has had its effect on prices as against a good kharif harvest in 2007.
We cannot insulate ourselves from global inflation because there is a progressively greater cohesion between global and domestic prices. These influences come into the system through imports, as has been witnessed in the case of edible oils. Therefore, policies like export restrictions or lowering of import duties can at best be a short-term solution.
Missing links
While the focus of all inflation talk is agriculture and food items, many of those who are into the debate have missed two important points. In the current financial year, prices of manufactured products have increased by over 7%, and this category contributed to about 53% of total inflation. Here, the increase has come from the metals segment on which such policy actions do not work. Further, the increase in administered prices of some fuel products has also fed inflation through higher input costs for farmers as well as for industry.
The government has made clear its priorities in terms of controlling inflation, and has taken several steps to lower the rate. However, such intervention in the markets is likely to have an adverse impact on the fiscal balance, as the thrust has been on trade measures that will affect tax collections. Add to this the higher procurement of wheat this year of over 17 million tonnes (the FCI expects this to touch 20 million tonnes), and the subsidy bill is also likely to increase over time.
Quite clearly, there is a trade-off being traversed by the government, which is understandable under the present conditions. However, one cannot dodge the issue of increasing the presently stagnant yield from agriculture in the country. There appears no other way out. Since this cannot happen immediately, we may have to live with agflation—an increase in the price of food that happens as a result of increased demand—at least for some time, while global factors will influence the price of metals and energy products, over which a country like India may have little control. Monetary policy must keep this in mind to ensure that growth does not suffer with restrictive policies. Therein lies the rub.
Friday, May 2, 2008
Valuable Commodities: DNA, 2nd May 2008
Inflation now appears to be an annual phenomenon, with February through April being quite critical. This is when rabi crops are harvested and prices tend to move northwards everytime there is some bad news.
Futures trading have been in operation for the last four years, and in the last two years kicked up dust. Critics have drawn the conclusion that since futures trading is vibrant and prices are moving up, the former is responsible for higher inflation.
The assumptions here are incorrect because if futures trading were the sole guiding factor, then they should have been commended when inflation was low! Quite clearly, there is an issue here with the understanding of the purpose and functioning of the futures market.
The commodity futures market is one where one can buy and sell a derivative instrument called a ‘future’ at a predetermined price. Therefore, a chana June future contract refers to the price in June for chana as determined by the market.
Futures trade at a multiple of the physical underlying as all members of the value chain would have an interest in trading in the same quantity of the product. Each player enters the market anonymously with an expectation of the price, based on fundamentals. If I think that there is going to be a shortage, then I will bid a high price, and if all think so, then the final price will be higher. The future price is normally defined as the spot price plus cost of carry, which in rudimentary language is the interest cost.
To gauge if the market is working well or not, three questions need to posed. The first is whether the market is being driven by some players in a particular direction. Here, the exchanges have rules laid down to ensure that the positions taken by any member or client does not exceed the limit, which is fixed in relation to the overall availability of the product in the country.
Also the exchanges ensure that the overall open interest, which is the quantity that can be potentially delivered on the exchange, does not exceed 1 to 3 per cent of total availability, so one can be sure there is no manipulation. This also ensures that there are is no subversive hoarding being carried out on the futures platforms.
Secondly, the price monitoring division checks to see if the price movement is in consonance with fundamentals. Shortages, sudden import/export orders, inclement weather conditions are also tracked assiduously. Lastly, price convergence is tested wherein the cost of carry should typically fall as one approaches the settlement date where finally the spot price must equal the futures price.
Intuitively it may be seen that the futures price is a very useful barometer of expected demand-supply positions. By looking at the futures price, one can guess that there will be a shortfall, something which has been predicted in chana and mustard today.
These signals can be used for policy action. In 2006, the rising futures price of wheat indicated a crop shortfall. If the signal was taken by the government, it could have reckoned its imports in the month of December itself.
Today, inflation in food products has been caused by supply shortages. Prices of edible oils are rising because of high international prices which get imputed into domestic prices as we import 45 per cent of our requirements.
When prices are volatile, there is inducement to trade in the futures market, and traded volumes increase. The error here is in linking these traded volumes with price increases and drawing a causal relationship. Curiously, price increases have been even more pronounced in commodities that are not traded such as vanaspati, rice, coarse grains, pulses such as arhar and masoor.
Futures trading are not a new concept in India — the first cotton exchange in Mumbai started in 1875. Globally, commodity exchanges register higher volumes than securities markets.
Futures trading were popular until the ’60s when on account of shortages due to wars and near-drought situations in some states, the government banned it with the belief that it encouraged hoarding and contributed to inflation. Almost four decades later, the markets were revived, but it appears that they are not yet well understood.
The government banned four important commodities last year, but it did not really help as prices of rice, wheat and tur continued to rise because of supply bottlenecks or global factors.
The same conundrum has been poised again, but hopefully, the response will be better. One must not forget that futures trading reflect the image that is to be seen in future. There is no use in shattering the image as it will not change.
Futures trading have been in operation for the last four years, and in the last two years kicked up dust. Critics have drawn the conclusion that since futures trading is vibrant and prices are moving up, the former is responsible for higher inflation.
The assumptions here are incorrect because if futures trading were the sole guiding factor, then they should have been commended when inflation was low! Quite clearly, there is an issue here with the understanding of the purpose and functioning of the futures market.
The commodity futures market is one where one can buy and sell a derivative instrument called a ‘future’ at a predetermined price. Therefore, a chana June future contract refers to the price in June for chana as determined by the market.
Futures trade at a multiple of the physical underlying as all members of the value chain would have an interest in trading in the same quantity of the product. Each player enters the market anonymously with an expectation of the price, based on fundamentals. If I think that there is going to be a shortage, then I will bid a high price, and if all think so, then the final price will be higher. The future price is normally defined as the spot price plus cost of carry, which in rudimentary language is the interest cost.
To gauge if the market is working well or not, three questions need to posed. The first is whether the market is being driven by some players in a particular direction. Here, the exchanges have rules laid down to ensure that the positions taken by any member or client does not exceed the limit, which is fixed in relation to the overall availability of the product in the country.
Also the exchanges ensure that the overall open interest, which is the quantity that can be potentially delivered on the exchange, does not exceed 1 to 3 per cent of total availability, so one can be sure there is no manipulation. This also ensures that there are is no subversive hoarding being carried out on the futures platforms.
Secondly, the price monitoring division checks to see if the price movement is in consonance with fundamentals. Shortages, sudden import/export orders, inclement weather conditions are also tracked assiduously. Lastly, price convergence is tested wherein the cost of carry should typically fall as one approaches the settlement date where finally the spot price must equal the futures price.
Intuitively it may be seen that the futures price is a very useful barometer of expected demand-supply positions. By looking at the futures price, one can guess that there will be a shortfall, something which has been predicted in chana and mustard today.
These signals can be used for policy action. In 2006, the rising futures price of wheat indicated a crop shortfall. If the signal was taken by the government, it could have reckoned its imports in the month of December itself.
Today, inflation in food products has been caused by supply shortages. Prices of edible oils are rising because of high international prices which get imputed into domestic prices as we import 45 per cent of our requirements.
When prices are volatile, there is inducement to trade in the futures market, and traded volumes increase. The error here is in linking these traded volumes with price increases and drawing a causal relationship. Curiously, price increases have been even more pronounced in commodities that are not traded such as vanaspati, rice, coarse grains, pulses such as arhar and masoor.
Futures trading are not a new concept in India — the first cotton exchange in Mumbai started in 1875. Globally, commodity exchanges register higher volumes than securities markets.
Futures trading were popular until the ’60s when on account of shortages due to wars and near-drought situations in some states, the government banned it with the belief that it encouraged hoarding and contributed to inflation. Almost four decades later, the markets were revived, but it appears that they are not yet well understood.
The government banned four important commodities last year, but it did not really help as prices of rice, wheat and tur continued to rise because of supply bottlenecks or global factors.
The same conundrum has been poised again, but hopefully, the response will be better. One must not forget that futures trading reflect the image that is to be seen in future. There is no use in shattering the image as it will not change.
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