Smoke and numbers: DNA 23rd March 2009

Wholesale Price Index (WPI) inflation has come down to less than half a per cent, and next week it could be even lower or negative. Hurrah! Inflation has been conquered finally and the talk doing the rounds is that there is deflation today as prices are falling. This should bring a smile to your lips, but instead there is a grimace when you go to the market place as your grocery bags get lighter.What is the true picture?The word deflation now dominates our vision and pre-empts our ears especially so as people are talking of a recession. There is evidently a conceptual issue here. Deflation is a concept when all or most prices are crashing and not when some prices are falling, which is the case today. What are we trying to say here? Basically, the inflation rate that is flashed at noon time on all working Thursdays is the WPI which compares the index number with that exactly 52 weeks back, which is a point to point comparison. The WPI consists of a large number of products which have been assigned weights based on their importance. Intuitively you can see that if one set of products with a good enough weights registers a fall, then the index will reflect the same. The question you need to ask is whether these products with declining prices are really pertinent to you.The products that are falling or are rising moderately are transport equipment, metals, rubber, chemicals, minerals and fibres which you and I do not encounter in our lives. Fuel is the only product which affects our lives which is declining. The ones which affect us such as food and textile items are rising. Therefore, we face this contradiction in the market place.WPI is actually reflective of producer prices and does not talk of consumer prices, for which there are different indices called the Consumer Price Indices (CPI). The CPI comes in different variants as it captures the consumption baskets of different kinds of workers. If you are an industrial worker, the CPI inflation would be 10.4 per cent (up to January) while it would be 11.6 per cent if you are a farm worker. The former is used in all organised settings where dearness allowance is marked against prices. These indices give a weight of over 50 per cent to food items and also include transport and rent which does not enter the WPI basket.However, it has become a tradition today for us to fall back on the WPI because it is weekly as against CPI which is monthly. This number is used for all policy formulation, which is why it is tracked quite assiduously. The Budget talks about it and so does the RBI. Governments talk about this number because it is almost always lower than the CPI, and hence is a more convenient number. In the west, inflation is always related to the CPI and never producer prices.So, what are the takeaways from this understanding of inflation or deflation? The first is that we are not in a state of deflation, andthe use of this term is iced more with hype and propaganda. If you are a producer, you are confronting lower prices which are good as it helps to enhance sales, profits which will please the shareholders. If you are a consumer; you should not really feel elated by these rosy numbers as the harsh reality in the market place is different.As a policy framer, like the RBI lower WPI inflation means that it is time to lower interest rates, which they are relentlessly trying to do. The concept of real interest rate comes in here which is defined as interest rate minus inflation. If inflation is close to zero, then the nominal or absolute rate must come down to maintain constant real rates. Hence, if inflation is 8 per cent and the lending rate say 12 per cent, the real lending rate would be 4 per cent. Now, with inflation being at zero, the lending rate must come down towards 4 per cent!Therefore, borrowers are to be encouraged with lower lending rates and industry is savouring this thought. Notice how banksare luring customers with attractive home schemes where coincidentally for other reasons, property prices are on the decline.But, the same also means that the saver, especially those dependentonfixed income as well asretired folks will fume because lower deposit rates on grounds of low real interest rates is 'rubbish' to them as they are still paying higher prices in the market for their daily purchases with their incomebeing eroded. Politicians, it is said, always have the last word, and this negative number comes at a time when the economy is putting up a mediocre performance. The common man does not understand GDP or financial crisis, but knows prices. Negative inflation or deflation -- call it what you may, is a potential winner on the pulpit, which will ultimately matter.

Election Economics: DNA 12th March 2009

Recession and inflation are seen as vulgar words at the time of elections. That is because the man on the street may not understand globalisation or meltdowns, but grasps loss of jobs and higher prices quite quickly. Therefore, the government has tried its best to prop up the economy in every which way, alternating between monetary policy measures such as lowering of interest rates and fiscal impulses in the form of tax cuts and higher expenditure outlays.While all alternatives have been explored, a major big-bang stimulus is on the anvil, albeit quite inadvertently. It is not a result of any conscious Keynesian policy of pump priming but from the big grand process of elections. This is over and above the various populist schemes which have been announced by government in the past keeping the elections in mind. In fact, this is significant because once the elections are announced the government cannot introduce new schemes which can be seen as measures to invite a more favourable voting pattern. But, the process by itself has the ability to provide an additional dose of the booster that has been spoken of by the government.The 15th Lok Sabha election has tremendous potential to provide the impetus to the economy because it involves the cycling of a large amount of funds. It provides employment to a lot many people and in the normal course allows for strong backward linkages for a number of industries especially at the small scale level, which is beneficial to a larger section of blue collared labour. More importantly, all the outlays are instantaneous and do not involve any time lags.
Let us look at the outlays involved. Based on what the EC has mentioned as well as the numbers of the earlier elections, there would be at least 5500 candidates in the fray who can officially spend up to Rs25 lakh each, amounting to Rs1350 crore. The number would only move upwards as more candidates enter the fray. There would be 8 lakh voting booths across the country. These booths would be in schools/panchayat offices, town halls with the paraphernalia of shamianas being erected. They have to be rented out for this time period which at an average cost of Rs10,000 per booth would add another Rs800 crore. This cost would be higher actually as the space has to be blocked for more than the day of the elections.There would be over 13 lakh EVM (electronic voting machines) used, which though already purchased would have to be serviced with batteries being changed and transported across the country, which at an average cost of Rs5000 would mean an expense of Rs650 cr. The EC also recorded that there would be around 40 lakh officials as well as 21 lakh security personnel who would be deployed. Each of these personnel has to be ferried, housed and looked after for more than 3 days around the elections which are spread around over 30 days. A conservative expense of Rs5,000 per head, would add another Rs3000 cr. It's a conservative estimate.Add to this the money spent by individual parties (there were 220 such outfits in the last Election), which could cross Rs1500 crore. The Congress and BJP are expected to spend at least Rs 1000 crore between themselves. Further, there would be vast sums of money paid to get votes, which is pertinent especially in UP and Bihar, and now more prominently in the southern states of AP, TN and Karnataka. This amount has been estimated to be Rs 2500 crore.Now, if we add up these numbers, the total direct cost would come close to Rs10,000 crore, which is probably more than what was spent on the recent US presidential elections. One may take umbrage to this amount being spent, but there is need to reflect over the implications. This number is equivalent to the infrastructure announcements made by the government or the tax cuts given to various industries or the loan waivers announced earlier. It covers the entire country, and more importantly provides additional purchasing power to several classes.Most of this expenditure is on consumption and is instantaneous. Further, this money provides succour to industries such as transport operators (trucks, tempos, autorickshaws, taxis), paper, ink, tent houses, artists, roadside food stalls, diesel/petrol dealers, advertising agencies etc. It provides employment opportunities, especially to the lumpens who are employed by the parties to muscle votes.Given that the money is spent on consumption items, all these related industries will see a higher and more rapid multiplier effect which will help stimulate the economy. It is pan-India and not project or region specific. So, the benefits percolate throughout the country. Hence, even pessimistic economists should see a high GDP growth rate in the first quarter of 2009-10. There is hence, a very thick silver lining here to the so called wasteful expenditure, much like the Keynesian 'digging up holes to fill them up' policy.

Sub Seven: Financial Express: 16th March 2009

It is often said that despite the financial crisis and the global recession in the rest of the world, India will remain one of the fastest growing economies, touching the 7% mark (7.1% is the government’s estimate) and trailing only China. The CSO had two releases on growth in the month of February 2009. The first one had a forecast for 2008-09 while the second one had an update on the progress made in the third quarter of the year, as well as that for the first three quarters. We also have numbers coming in from the CSO on industrial performance for this period, while the Ministry of Agriculture has not presented a very pleasant picture in its second advanced estimates for agricultural production.
Based on the agricultural estimates put forth, around 80% of the rabi crop comprising cereals, which will be harvested in the fourth quarter would actually decline by 1%, while the balance in the form of pulses and oilseeds would increase by 2.4% and 6.6% respectively. Quite clearly, growth of 8.2% may not be attainable under these conditions unless prospects for cereals, especially wheat changes dramatically. Industry has already shown low growth rates of -1.11%, 1.76% and -2.51% in October, November and December respectively. With growth averaging 3.4% so far, it would be a bit difficult to suddenly surge to 6.2% to justify 4.1% growth for the full year. The same holds for electricity which has had three declining growth rates. Therefore, in the real sector it would be difficult to achieve the desired growth rates. This picture has held based on the impressionistic views presented by various sectors of industry in the first 2 months of this calendar year.
The other sector which has to accelerate is trade, hotels etc. which has been one of the more buoyant sectors registering growth of 9.4% this year . However, around half of this sector is explained by transport and communications, where growth is inexorably linked with that in the real sector. Also with foreign and domestic trade slowing down in the last 4-5 months on account of the recession and the fall in tourism following the terrorist attacks in Mumbai, growth could at best be sustained at the existing levels. The finance, insurance, etc. sector is already in the slowdown mode, with the banking and insurance sector, which accounts for 40% of this sector’s output, facing stagnant business lines. The two sectors that have excess growth capacity are construction and community and social services, which together account for 20% of GDP. These sectors have accelerated growth and will have to make up for the loss of growth in the other sectors. The construction sector is up mainly due to the efforts of the government in the form of infrastructure projects as the housing industry is still to pick up under the generally adverse economic conditions. The category of community and social services also includes general administration which at times may convey the impression of growth due to the higher level of expenditure of the government. Around 40% of this component is accounted for by public administration and defence. There is scope for an increase in this component, which can affect around 5.2% of GDP.
Therefore, with virtual zero growth in agriculture expected this year and possible negative growth in industry or at best marginal growth in the next three months, there has to be overwhelming growth in the construction and government sectors to boost growth. Growth of 7.7% in GDP in the last quarter of the year is hence not attainable and a number in the range of 5% looks more reasonable. With growth of 5% in the last quarter, overall growth would be around 6.4%. In a better case scenario of 6% growth in the last quarter, annual growth would get enhanced to 6.6%. The 7.1% number certainly does not look plausible in the context of the horizon that exists today.

Don't blame banks for not lending: Busines Standard: 7th March 2009

Banks have been doing a good job on the lending side in a prudential manner and India Inc should not really be complaining too much .
A question that is being raised quite often now is that banks are not lending much to industry, which is one of the reasons for low growth. Bank lending has two aspects, the first relates to the willingness to lend, and the other, to the cost of credit. That is the picture presented by industry. On the other hand, banks aver that they have been lending sufficient quantities of funds to the corporate sector, though the cost may be high. The cost factor is another issue and is not the point for discussion here. The purpose is to explore the story of the quantum of credit being provided by banks and whether or not industry has a valid grievance.
Any such analysis must also take into account the fact that banks are commercial organisations and have a right to make profits just as much as industry. Further, they also need to follow prudential norms relating to capital adequacy and quality of assets. Therefore, they should be lending to sectors where there is strong growth taking place and there is less probability of assets turning unsatisfactory.
The first point that can be made is that growth in bank credit has slowed down from 14.5 per cent in the first 10 months of FY08 to 11.6 per cent in FY09. In absolute terms, the increment is around Rs 2.74 lakh crore as against Rs 2.79 lakh crore last year, which is still better than the decline in incremental deposits during this time period. Unfortunately, the data on sectoral distribution of credit comes in with a lag and hence makes a meaningful discussion slightly difficult. However, RBI has provided data prior to the last policy for the sectoral allocation for the nine-month period till December. These figures indicate that the corporate sector should not be complaining as growth on a year-on-year basis was 30.2 per cent as against 24.9 per cent last year. In absolute terms, incremental credit to industry was higher by Rs 2.36 lakh crore as against Rs 1.56 lakh crore last year. If the petroleum sector is excluded, which is a common issue that is raised, incremental credit would still be Rs 1.94 lakh crore as against Rs 1.51 lakh crore. In fact, the sectors which bore the brunt of lower growth in credit were the priority sector and mortgages, where there was a decline in growth rate. Yes, the small-scale sector was also affected, though the medium and large enterprises had witnessed a swift growth in credit.
One must remember that this period was associated with the financial crisis in the US, and there were also considerable layoffs in the corporate world. And more importantly, demand was down, which meant that industrial growth was sluggish at 3.2 per cent for this time period. In this context, the share of sectors in total credit to the industrial sector can be juxtaposed with growth scenarios to discern a pattern.
From the table, it appears that there is a direct linkage between sector performance and the credit that is being disbursed. The industries that are growing, or rather doing better than the industry average, have registered high growth in credit and maintained their share in total credit. The engineering, automobile and metals segments, which have grown better than the industry average, have maintained their shares in credit. Banks this way have been cognisant of the quality of assets and have channeled funds to the growing sectors. Chemicals and metal products, which have witnessed a slowdown, have still witnessed a higher incremental share in credit. The sectors that have registered lower growth, such as food processing and textiles, have witnessed a fall in incremental share this year.
The petroleum sector has, however, taken the largest share of incremental credit, which is understandable given that the oil companies had to borrow more because of the high price regime till September-October. Infrastructure credit has also increased rapidly and its share has increased in total credit, which is a good sign as this means that this particular segment has little reason to complain. Therefore, it is possible to conclude that industry as a whole has got credit commensurate to the growth tendency shown.
What about the other sectors? Overall bank credit to the personal segment has declined with the share in incremental credit during this time period being 14.7 per cent as against an average of 23 per cent in total credit outstanding. Housing loans had a share of just 4.5 per cent. Here the reasons could be on both sides. Banks have raised interest rates given the possible threat of higher NPAs in the midst of an economic downturn. The demand for such loans has also dropped, given the layoffs and pay cuts seen in the private sector. Further, with the stock market down, there is a direct slowdown in the purchase of houses as such gains are normally used for such purchases. Surprisingly, the share of credit cards had gone up from an average of 1.2 per cent to 2.5 per cent on the incremental credit this year. Banks have also lent a larger share to the real estate sector with the increment being 5.1 per cent over an average of 3.1 per cent.
All this shows that banks have been doing a good job on the lending side in a prudential manner. India Inc should not really be complaining too much, though it may have an issue on interest rates being high. But then, pricing is a commercial decision which has to be taken by banks, just as industry fixes its own prices based on its own commercial judgement. Therefore, any such argument is more academic in nature.

Why inflation is still not dead: Financial Express:2nd March 2009

A lot has been made of inflation coming down to an all time low, and all economists and statisticians are quick to add that we may see a negative rate of inflation by March-end. This is naturally so as the WPI for all products is actually falling by 0.5 every week on an average basis, while the base for comparison i.e. last year’s index is increasing by 1.0 every week. And hurrah, there is fear of disinflation now, and its implications are being discussed in various forums. Does this mean that inflation is dead?
Inflation is always a tricky subject because the point to point rate of 3.9% as of February 7 corresponds to an average inflation number of just over 9%. This means that even if we accept the lacunae in the interpretation of the WPI as against the CPI, while prices (or rather the WPI) today appear to be lower than those of last year, we were actually poorer by 9% over the year. This is so because prices had increased during the year before declining, which means that there was substantial erosion in purchasing power during this time period.
However, a negative overall inflation rate does not mean that you and I are witnessing falling prices across the board. It is essential to take a closer look at the structure of inflation by dissecting the WPI as it stands now. Double digit inflation is still seen in around 10% of the WPI constituents. Another 42% of the constituents had an inflation rate of 6.5% where individually each sector had an inflation rate ranging between 4-10%. The 4% cut-off mark is taken to be the ideal rate as defined by the RBI in its credit policy last April. The last category of negative inflation covered product groups that constituted 9% of the WPI.
There are some really interesting points that come from this dissection of the WPI. The first is that while the number that strikes us every Thursday is for all products, it certainly is not indicative of the movement of all prices. Therefore, when people talk of disinflation, it is misleading. Disinflation is where all products are witnessing declining prices. At the moment, there is a fall in only around 10% of the WPI product groups. The second is that for around half of the WPI products, inflation is well above the so called target rate of 4%. The third is that where inflation is negative or low for some groups, these prices have been mainly driven by global factors. Oil prices have fallen sharply by over 70% and the global slowdown has led to the fall in metal prices by over 50% in most cases. Hence, lower inflation here is actually exogenous to the system. The last is that the basic home products, i.e. products that we consume have still seen substantially higher prices this year which should be a concern. Food products, in particular, are up in both the primary and manufactured stages which still make costs of living difficult. As a corollary, the products showing low price increases are basically the industrial goods which do not enter our consumption basket. In fact, they derive their lower value from the fact that they are the final products of the raw metals that are used for their manufacture.
What does all this amount to? Most importantly we must not get carried away by the lower single numbers that we will be seeing over the next 6-7 Thursdays. Let us also ot get into the habit of asking whether we are heading for disinflation. It would be adding hype to an incorrect thought process. Also while the Thursday number does guide market sentiments which in turn mounts pressure on Mint Street to lower interest rates—with the ‘real interest rate’ theory being floated—it does not make our pockets any lighter. This is the real truth.