The decision to ban the export of cotton is significant as it has implications, not just for the industry, but also for the ideology that guides policy. In the past, too, the policy response to higher prices has been to restrict the export of the product. This was witnessed in the case of pulses and wheat in 2007, maize in 2008 and sugar in 2009—and now in cotton. The dynamics of such price movements and policy reaction needs to be put in perspective.
Cotton is a unique crop that was influenced by the introduction of the Bt variety, which has had an impact on its cultivation. Prices are sensitive to supply conditions. While there is a minimum support price that is offered to farmers, it is under discussion as the subsidy bill has been increasing. Production has tended to be cyclical and output that had started accelerating from 2003-04 to peak at around 26 million bales in 2007-08, slipped in 2008-09 to 22 million bales and remained stagnant in 2009-10. Demand, on the other hand, has been increasing from both domestic and global segments. This has been the primary reason for the increase in prices.
India is the second largest exporter of cotton in the world and a ban on these transactions means that some of the purchasers like Bangladesh, Pakistan, China, etc, will be affected and will have to look out for other avenues to sustain their textile industries. Quantitatively speaking, around 2.5 million bales of cotton will be required from other countries to fill in this gap.
The immediate impact is that the 25% increase witnessed in prices has been arrested, affecting the incomes of the farmers. From a price of around Rs 2,900-3,000 per quintal that had been fixed, they are now getting a lower return of around Rs 2,500 on account of this move, as the shortage has translated into excess supply. This fall in income has affected the incomes of farmers, especially those who cultivate a single crop in a year. Farmers had earlier tended to bring in more area under cotton cultivation by using Bt seeds. However, with lower prices this season, there could be a tendency for them to move to other crops such as soybean, which
is the closest substitute, in terms of soil conditions. This could affect the future area under cultivation, which will re-create the problem of supply in the next season.
The ban has already seen the global prices rising as major importers have started looking at sourcing cotton from other countries, particularly the US, which is the largest exporter of cotton. This has put pressure on the prices, which was reflected in the ICE cotton futures that have shown an upward movement. Higher international prices do tend to get buffered into domestic prices with price correlation being around 60-80% for most products. So, in the medium run, prices may remain at a higher level.
The broader issue to be debated is whether or not an export ban is a solution to the problem of higher prices. The argument here is that as long as prices are being guided by fundamentals, enhancing supplies is the only way to reduce prices. There are some issues regarding when a ban should be imposed. The first is that farmers would tend to substitute cotton with other crops, which will tilt the crop-balance in favour of others. Second, while prices will come down in the immediate run, the change in cropping pattern will affect prices in the following season. Third, export bans in particular will turn the competitive advantage in the product to other suppliers, which can make it difficult to recoup the loss in market share. Fourth, the very industry that the government is trying to protect through such a ban will find it more difficult to plan in the future with both the supply and demand sides being potentially affected. Last, such bans would affect the external credibility of the industry as legal disputes arise from reneging on contracts. This will impact the country’s ability to export in the future.
Interventions are hence not normally advisable, either in the form of bans (in terms of exports or futures trading) or price intervention through diktat. The issue is not just one of supporting the farmers or the user industry. With growing integration of commodity markets and prices, it will be difficult to control these linkages. An export ban will only push the country out of the market, which will be leveraged by competitors. And as we have seen in the case of sugar, bans did not help with the global price linkage returning to push up the prices further. There is need for more extensive debate on the issue of export ban, which goes beyond the current issue of cotton.
Thursday, May 13, 2010
Saturday, May 1, 2010
Should banks be allowed to tease? Financial Express: 1st May 2010
For those of us who enjoyed listening to Cliff Richard croon “I’ll give it to you straight right now, please don’t tease” in the 1970’s may be tempted to say the same about the rates being charged by banks today on housing loans. The most recent monetary policy announcement of RBI is over a week old and while one would have expected banks to raise interest rates, they have actually not done so. They had already buffered in a 25 bps increase in rates and hence these policy enhancements do not matter. The concern of RBI today is on the teaser rates being offered by some banks, which means that instead of increasing rates some have actually lowered them on mortgages, albeit for the first year. Is this a serious issue, especially at a time when it appears that rates would be increasing, and not decreasing, in the next few years?
The concept of teaser rates became fashionable post financial crisis. In rudimentary language, when interest rates came down to historically low levels of 1% in 2003, driven primarily by Alan Greenspan, banks and other mortgage institutions disbursed housing loans at very low rates with little due diligence. People borrowed heavily and bought houses and contributed to the boom in the economy. Simultaneously, housing prices went up, but with prosperity everywhere it did not matter. Loans were given at low interest rates for the first year and then linked to the market rate at a subsequent date—the classic floating rate scheme.
But problems surfaced once rates hardened as the Fed rate climbed to 5.25% by June 2006. As demand fell, home prices came down and those who had taken loans at the teaser rates had to pay as much as 500 bps more on their loans as rates had virtually doubled leading to large-scale defaults. When they tried to sell their houses, the crisis was exacerbated. The original lenders had moved away from these assets through the securitisation business and the rest, as the cynics would say, is history.
Today housing prices have started moving upwards quite sharply. Teaser loans come at 8.25% in the first year, 9% in second and then at the market rate subsequently. Clearly we have an issue on hand. People may jump into the fray to buy houses before prices rise further. Rationality dictates that with low interest rates today and an increase of 100 bps in the second year and probably something higher subsequently, one should enter the fray today that will, in turn, drive up housing prices in urban areas.
RBI’s concern is two-fold. First, banks may just be compromising quality in remaining ahead of competition and while India was quite insulated from the subprime crisis, that scenario remains a grim reminder of caution that should be exercised today. Second, there is a lingering question of ‘what if there is failure’. The country is in a unique spot with inflation being quite resilient and growth on a high trajectory. In this high growth-inflation scenario, rates tend to harden, which needs to be understood by anyone who is attracted to a home loan.
Hence, it is not a coincidence that RBI has also come out with a report on securitisation where the ground rules are laid. There is a minimum holding period of one year by the originator as well as a clause that makes it mandatory to retain 10% of the loan on its own books. This is to eschew the possibility of such teaser loans being bundled and resold to other investors. While securitisation of home loans is not really popular and has been confined mostly to deviant assets of banks, this move is certainly welcome as it does make RBI appear more proactive with the process of prudential regulation. Alongside, RBI is also going to get in the base rate concept, which is good, so that there are certain limits placed on banks in fixing their lending rates without compromising on prudence.
There is a curious game that is unfolding in the banking arena. Banks are back to getting more competitive, with home loans coming to the forefront once again. Personal loans account for around 20% of non-food credit (as on Feb 2010), of which home loans constitute 50%. Corporate loans follow a set pattern with limited manoeuvrability for banks. However, for the retail segment, there would be a tendency for banks to push forth their chances by offering competitive rates.
This is where RBI has come in with cogent moves at regulation, thus ensuring that the growth in credit is in accordance with the global best norms that have come into play in the aftermath of the crisis. But, yes, these are signals of competitive action picking up in this sector after a lull of two years.
The concept of teaser rates became fashionable post financial crisis. In rudimentary language, when interest rates came down to historically low levels of 1% in 2003, driven primarily by Alan Greenspan, banks and other mortgage institutions disbursed housing loans at very low rates with little due diligence. People borrowed heavily and bought houses and contributed to the boom in the economy. Simultaneously, housing prices went up, but with prosperity everywhere it did not matter. Loans were given at low interest rates for the first year and then linked to the market rate at a subsequent date—the classic floating rate scheme.
But problems surfaced once rates hardened as the Fed rate climbed to 5.25% by June 2006. As demand fell, home prices came down and those who had taken loans at the teaser rates had to pay as much as 500 bps more on their loans as rates had virtually doubled leading to large-scale defaults. When they tried to sell their houses, the crisis was exacerbated. The original lenders had moved away from these assets through the securitisation business and the rest, as the cynics would say, is history.
Today housing prices have started moving upwards quite sharply. Teaser loans come at 8.25% in the first year, 9% in second and then at the market rate subsequently. Clearly we have an issue on hand. People may jump into the fray to buy houses before prices rise further. Rationality dictates that with low interest rates today and an increase of 100 bps in the second year and probably something higher subsequently, one should enter the fray today that will, in turn, drive up housing prices in urban areas.
RBI’s concern is two-fold. First, banks may just be compromising quality in remaining ahead of competition and while India was quite insulated from the subprime crisis, that scenario remains a grim reminder of caution that should be exercised today. Second, there is a lingering question of ‘what if there is failure’. The country is in a unique spot with inflation being quite resilient and growth on a high trajectory. In this high growth-inflation scenario, rates tend to harden, which needs to be understood by anyone who is attracted to a home loan.
Hence, it is not a coincidence that RBI has also come out with a report on securitisation where the ground rules are laid. There is a minimum holding period of one year by the originator as well as a clause that makes it mandatory to retain 10% of the loan on its own books. This is to eschew the possibility of such teaser loans being bundled and resold to other investors. While securitisation of home loans is not really popular and has been confined mostly to deviant assets of banks, this move is certainly welcome as it does make RBI appear more proactive with the process of prudential regulation. Alongside, RBI is also going to get in the base rate concept, which is good, so that there are certain limits placed on banks in fixing their lending rates without compromising on prudence.
There is a curious game that is unfolding in the banking arena. Banks are back to getting more competitive, with home loans coming to the forefront once again. Personal loans account for around 20% of non-food credit (as on Feb 2010), of which home loans constitute 50%. Corporate loans follow a set pattern with limited manoeuvrability for banks. However, for the retail segment, there would be a tendency for banks to push forth their chances by offering competitive rates.
This is where RBI has come in with cogent moves at regulation, thus ensuring that the growth in credit is in accordance with the global best norms that have come into play in the aftermath of the crisis. But, yes, these are signals of competitive action picking up in this sector after a lull of two years.
Ring out the old assumptions: Mint 30th April 2010
The last fiscal year threw up five economic contradictions, challenging the shibboleths of policymakers
All economic policies are based on certain stylized expected outcomes that are dictated by economic theory. Accordingly, various indicators are tracked and policies are fine-tuned. But what in case there are contrary signals sent by these indicators? In 2009-10, there is evidence of contradiction where final outcomes have deviated from the expected. This makes it difficult for policymakers to conjecture future outcomes based on present observations, which would otherwise easily be taken as prior justifications for policy moves. Let us consider the five such situations India threw up last year.
The first relates to gross domestic product (GDP) growth. India was anyway not sure of the outcome of the financial crisis in early 2009; the monsoon failure just strengthened the belief that the economy would be in for a roller-coaster ride. However, the Central Statistical Organization estimates 2009-10 growth at 7.2%, others not ruling out 8%-plus. While this is good news, the conclusion is that the economy has got decoupled from agricultural performance—a sector that could be in the negative zone notwithstanding a healthy rabi hConventional theory says that agriculture affects the economy in two ways. One is on the demand side, where farm incomes are directed to non-farm goods and services. This has not dampened the growth in industry—especially for consumer durable goods—lending credence to the thought that a sector which has an 18% share of the GDP may not be the be-all-end-all for the country’s economic growth. The other is that this sector provides inputs for production of food products, which come into the Industrial Index of Production (IIP). If one looks at the IIP data, industry has moved ahead quite exceptionally: This means that growth through the capital goods and intermediate goods sector can propel the economy even if agriculture fails. The fiscal stimulus has, no doubt, played its part in reversing a potential adversity.
The second situation relates to the slower growth of bank credit, at 16.7% in 2009-10 against 17.5% in 2008-09. This is the quickest indicator of industrial growth, but sends contrary signals when juxtaposed with the actual IIP data. Clearly, industrial growth cannot be linked only with credit as the other avenue of funds—capital markets—has been ebullient, around Rs2.59 trillion being mobilized in 2009-10 against Rs1.54 trillion the previous year. Disintermediation has played its role—the bank is no more required as a middleman. This proves that bank credit is a sufficient, though not necessary, condition for growth. Alternatives do exist.
The third atypical trend seen in the credit market is the absence of a liquidity squeeze despite heavy government borrowing. Borrowings exceed Rs 4.5 trillion in both 2009-10 and 2010-11. Yet, it has been the case in the past that the Reserve Bank of India (RBI) has managed these borrowings without the environment getting obtrusive for private players. The “crowding out” theory—that government asking for funds deprives the private sector of the same funds—does not always hold. More importantly, cogent liquidity management by RBI through open market operations and unwinding Market Stabilization Scheme, or MSS, bonds has made the environment less stifling by infusing more cash. RBI’s monetary policy for 2010-11, released last week, can draw solace from this.
Fourth, the rupee should have been under pressure due to the gradual reversal in trend of trade— both exports and imports have increased. The trade deficit is at $97 billion for the first 11 months, which would ordinarily dictate that, because more non-rupee goods are in demand than rupee goods, the rupee should be weak. Yet the rupee is stronger, having appreciated by around 11% this year.
In the past, the trade deficit was critical; only remittances and software inflows provided some cushion. But, this has been passé for the last few years, as foreign capital has galloped into India through the capital account route. Foreign direct investment inflows and new foreign institutional investor flows were each around $24 billion between April and February. This demand for rupee assets has made the rupee stronger. The message is that a current account deficit may not matter that much today.
Fifth, there is an apparent paradox of food inflation amid overcrowded government warehouses. How is this possible? In actuality, the country is rich in only rice and wheat—these were around 46 million tonnes in March; there is shortage of other products such as pulses, oilseeds, vegetables and fruits, which has directly increased these food prices. And when the government reiterates the existence of high food stocks, it is more of propaganda; in fact, the government has affected rice and wheat prices too. Higher procurement at increased support prices and excess buffering by the government has meant less for the market and, thus, higher prices for us consumers.
All these pictures actually explain how the economic dynamics have deviated from conventional wisdom. This raises some interesting conundrums for policy formulation. Does growth in farm output, bank credit, government borrowings or trade deficit really matter in the broader picture? Or are farmer-supportive policies neutral in their impact? A fresh look beyond the textbook may be required. Policymakers can no longer assume that established shibboleths always hold.
All economic policies are based on certain stylized expected outcomes that are dictated by economic theory. Accordingly, various indicators are tracked and policies are fine-tuned. But what in case there are contrary signals sent by these indicators? In 2009-10, there is evidence of contradiction where final outcomes have deviated from the expected. This makes it difficult for policymakers to conjecture future outcomes based on present observations, which would otherwise easily be taken as prior justifications for policy moves. Let us consider the five such situations India threw up last year.
The first relates to gross domestic product (GDP) growth. India was anyway not sure of the outcome of the financial crisis in early 2009; the monsoon failure just strengthened the belief that the economy would be in for a roller-coaster ride. However, the Central Statistical Organization estimates 2009-10 growth at 7.2%, others not ruling out 8%-plus. While this is good news, the conclusion is that the economy has got decoupled from agricultural performance—a sector that could be in the negative zone notwithstanding a healthy rabi hConventional theory says that agriculture affects the economy in two ways. One is on the demand side, where farm incomes are directed to non-farm goods and services. This has not dampened the growth in industry—especially for consumer durable goods—lending credence to the thought that a sector which has an 18% share of the GDP may not be the be-all-end-all for the country’s economic growth. The other is that this sector provides inputs for production of food products, which come into the Industrial Index of Production (IIP). If one looks at the IIP data, industry has moved ahead quite exceptionally: This means that growth through the capital goods and intermediate goods sector can propel the economy even if agriculture fails. The fiscal stimulus has, no doubt, played its part in reversing a potential adversity.
The second situation relates to the slower growth of bank credit, at 16.7% in 2009-10 against 17.5% in 2008-09. This is the quickest indicator of industrial growth, but sends contrary signals when juxtaposed with the actual IIP data. Clearly, industrial growth cannot be linked only with credit as the other avenue of funds—capital markets—has been ebullient, around Rs2.59 trillion being mobilized in 2009-10 against Rs1.54 trillion the previous year. Disintermediation has played its role—the bank is no more required as a middleman. This proves that bank credit is a sufficient, though not necessary, condition for growth. Alternatives do exist.
The third atypical trend seen in the credit market is the absence of a liquidity squeeze despite heavy government borrowing. Borrowings exceed Rs 4.5 trillion in both 2009-10 and 2010-11. Yet, it has been the case in the past that the Reserve Bank of India (RBI) has managed these borrowings without the environment getting obtrusive for private players. The “crowding out” theory—that government asking for funds deprives the private sector of the same funds—does not always hold. More importantly, cogent liquidity management by RBI through open market operations and unwinding Market Stabilization Scheme, or MSS, bonds has made the environment less stifling by infusing more cash. RBI’s monetary policy for 2010-11, released last week, can draw solace from this.
Fourth, the rupee should have been under pressure due to the gradual reversal in trend of trade— both exports and imports have increased. The trade deficit is at $97 billion for the first 11 months, which would ordinarily dictate that, because more non-rupee goods are in demand than rupee goods, the rupee should be weak. Yet the rupee is stronger, having appreciated by around 11% this year.
In the past, the trade deficit was critical; only remittances and software inflows provided some cushion. But, this has been passé for the last few years, as foreign capital has galloped into India through the capital account route. Foreign direct investment inflows and new foreign institutional investor flows were each around $24 billion between April and February. This demand for rupee assets has made the rupee stronger. The message is that a current account deficit may not matter that much today.
Fifth, there is an apparent paradox of food inflation amid overcrowded government warehouses. How is this possible? In actuality, the country is rich in only rice and wheat—these were around 46 million tonnes in March; there is shortage of other products such as pulses, oilseeds, vegetables and fruits, which has directly increased these food prices. And when the government reiterates the existence of high food stocks, it is more of propaganda; in fact, the government has affected rice and wheat prices too. Higher procurement at increased support prices and excess buffering by the government has meant less for the market and, thus, higher prices for us consumers.
All these pictures actually explain how the economic dynamics have deviated from conventional wisdom. This raises some interesting conundrums for policy formulation. Does growth in farm output, bank credit, government borrowings or trade deficit really matter in the broader picture? Or are farmer-supportive policies neutral in their impact? A fresh look beyond the textbook may be required. Policymakers can no longer assume that established shibboleths always hold.
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