India is a nation of traders and the success of the United Stock Exchange (USE) in its first week of operations bears testimony to this observation. Coincidentally, the spot markets in equities, foreign exchange and government securities (G-secs) register an average daily turnover of around Rs 20,000 crore.
The derivative markets several multiples of this amount and the only exception is the interest rate (IRFs) market, which has witnessed little interest despite its many versions — the last being in 2008.
The response to F&O trading has been quite remarkable in the past few years, especially in new areas such as commodities and currencies. Currencies currently trade about 3.8 times the physical underlying (comprising foreign trade and external loans) and would go up to 5.5 times if volumes increase by a comparable level with USE coming in.
Gold trades at a multiple of 25, crude oil at four, farm products at unity while stocks three times the cap of the National Stock Exchange (NSE). The nagging thought here is as to why have IRFs not quite caught on.
The market for G-secs is large with the outstanding portfolio being Rs 14 lakh crore. If 25% is excluded, which is classified as ‘held to maturity’ securities, the physical underlying would be Rs 10.5 lakh crore. Institutions trade Rs 20,000 crore of such securities every day and, as interest rates have been volatile in the past, carry a big risk of mark to market (MTM) when they have to value their portfolios. Do IRFs actually satisfy the prerequisites for futures trading?
First, the basic driver of trade is volatility in any market, and NSE Primary Returns Index has witnessed volatility of 7% between April and September. This is comparable to that in other markets, and lies between agri products (5%) and forex (9.5%). Therefore, risk-cover is necessary given the large underlying — 1% change in rates can hit the portfolio by Rs 10,500 crore or 1 bps by Rs 100 crore.
Second, given that is a single product contract which can be settled with other pre-specified ones, for this to be a success, there should be strong correlation with other securities. Here, RBI data shows that there is strong correlation between change in yields on 10-year paper and those on 5, 11, 12 and 20 years and moderately high (around 60%) for eight and nine years. Hence, this too cannot be a reason to reject the product as the contract can be benchmarked with the other papers, though admittedly, the others are not as widely traded as the five- and 10- year securities.
Third, the cost of trading could be another militating factor. But, this segment, like the currency market, is free of this charge unlike the commodity or stock markets, where the charges vary between 0.002 and 0.003%. Therefore, this too could not be an explanation. Fourth, one can surmise that the absence of a yield curve, which is vibrant along all points, is the reason holding back the market, as liquidity in the spot market should enthuse the IRF market.
But still one should expect high volumes of trade for the most widely traded and held 10-year security.
Fifth, the market may not interested in such hedging, especially in an environment when interest rates are expected to move up as there would be less incentive to get into such contracts. Sixth, and probably the more plausible reason could be that players are making use of the volatility in the market through purchase and sale to book their gains and find no need to go in for a hedge.
This could explain why the 75% of G-secs, which are ‘available for sale’ or ‘held for trading’ is actually traded. Lastly, non-G-sec participants do not see this as a hedge as lending rates, for example, do not move in tandem with these rates and hence one could get left out of this market.
Globally, 60% of the derivative market is dominated by equities, followed by interest futures with 15% and currencies with 11%. In India, things are different with equities taking a share of 45%, followed by currencies with 38% (assuming that the Rs 60,000 crore daily volumes are maintained) and gold with just less than 10%. The IRF segment is the missing link that has to be connected. The unanswered question is, how?
Wednesday, September 29, 2010
More Price indices needed: Financial Express 21st September 2010
There has been quite a bit of hype on the new WPI, which has gone about correcting the data set that will be used to gauge inflation in future (thankfully the weight of sugar and its derivatives comes down from 5.23% to 2.71%). Lots of items have come in, the number of quotations has increased and irrelevant products have been taken out from the calculation. The entire task of collecting prices in India is a challenge given that a large part of our market is unorganised and data is not easily available. Even AGMARKNET has only partial reporting of prices. Let’s see whether or not things have changed significantly.
The new index shows a lower inflation number for August and has generally provided similar numbers in the past against the old series. However, primary products have an upward bias despite the lower weight, while prices of manufactured goods have been lower with a higher weight. Fuel products have more or less been within range with no particular bias. This has actually brought the number down during the last year. Therefore, on the face of it, the new inflation index is progressive as it is theoretically on a stronger footing and depicts similar pictures.
One is however, not quite sure if major lacunae that existed earlier have been plugged relating to the receipt of information. Having more quotations is good as it makes the system robust and this number has gone up from 4.4 to 8.1 per product included in the index with the multiple almost doubling to 15.2 for manufactured products. The issue really is with getting data on a continuous basis with few revisions. The present set of data reporting has been fuzzy and more quotations run the risk of higher levels of under-reporting. Assuming that this has been addressed by the Committee, logically we could have all the three sub-indices on a weekly basis that would make the system more transparent.
A broader issue here is how representative the WPI is of inflation. We have tended to take this number to be sacrosanct and used it for policy formulation on the grounds of this concept affecting our purchasing power. If one looks at the new WPI, just about 52% of the composition actually enters our lives. The rest are more for the producers and actually do not affect us. It is for this reason that we have been looking at food inflation rather than the overall number. In fact, going by NSS data on consumption patterns in 2005-06, which is just one year ahead of the current base year chosen for WPI, around 53% of rural consumption and 40% of urban consumption is on food products. The share of these products in the new WPI is just 24.3%. Quite clearly, we need to distinguish between different inflation indices when looking at specific aspects of policy targeting.
Ideally, the WPI is a policy instrument when looking at growth per se and aspects related to it; while the CPI needs to be looked at closely when talking of standard of living. We still have an anomalous situation today where the monthly WPI inflation rates were 9.8% and 8.5% in July and August, respectively, while the CPI for industrial workers has increased by 11.25% in July. This is the true impact on the consumer as there is a long value chain in the production processes between the first point of sale (wholesale) and the final point of sale (consumer), which can be as high as 5-7 at times that add to the cost as value addition and corresponding margins are built in. Quite evidently, we should be focusing on the CPI and partly on the WPI to the extent that it includes products in the household consumption basket when assessing inflation.
The government is also considering bringing in a price index on services, which is good though, given that most services are in the unorganised sector, there would be issues in getting accurate information. To some extent some of the common services that we use such as transport, communication, education, recreation, medical care etc are included in the CPI. Probably, we could work towards making the CPI a little more contemporary as it has a lag of one month presently vis-à-vis the WPI.
Inflation certainly has come to the forefront of Indian economics in the last year leading to discussion and deliberation, which have been productive. The recent controversy on the GDP numbers based on market and constant prices has also directed attention to the GDP deflator, which would be the ideal inflation indicator that covers all segments albeit at the producer level rather than the consumer level. As the discussion levels are still fresh, this may be the right time to really pursue with the creation of new price indices.
The new index shows a lower inflation number for August and has generally provided similar numbers in the past against the old series. However, primary products have an upward bias despite the lower weight, while prices of manufactured goods have been lower with a higher weight. Fuel products have more or less been within range with no particular bias. This has actually brought the number down during the last year. Therefore, on the face of it, the new inflation index is progressive as it is theoretically on a stronger footing and depicts similar pictures.
One is however, not quite sure if major lacunae that existed earlier have been plugged relating to the receipt of information. Having more quotations is good as it makes the system robust and this number has gone up from 4.4 to 8.1 per product included in the index with the multiple almost doubling to 15.2 for manufactured products. The issue really is with getting data on a continuous basis with few revisions. The present set of data reporting has been fuzzy and more quotations run the risk of higher levels of under-reporting. Assuming that this has been addressed by the Committee, logically we could have all the three sub-indices on a weekly basis that would make the system more transparent.
A broader issue here is how representative the WPI is of inflation. We have tended to take this number to be sacrosanct and used it for policy formulation on the grounds of this concept affecting our purchasing power. If one looks at the new WPI, just about 52% of the composition actually enters our lives. The rest are more for the producers and actually do not affect us. It is for this reason that we have been looking at food inflation rather than the overall number. In fact, going by NSS data on consumption patterns in 2005-06, which is just one year ahead of the current base year chosen for WPI, around 53% of rural consumption and 40% of urban consumption is on food products. The share of these products in the new WPI is just 24.3%. Quite clearly, we need to distinguish between different inflation indices when looking at specific aspects of policy targeting.
Ideally, the WPI is a policy instrument when looking at growth per se and aspects related to it; while the CPI needs to be looked at closely when talking of standard of living. We still have an anomalous situation today where the monthly WPI inflation rates were 9.8% and 8.5% in July and August, respectively, while the CPI for industrial workers has increased by 11.25% in July. This is the true impact on the consumer as there is a long value chain in the production processes between the first point of sale (wholesale) and the final point of sale (consumer), which can be as high as 5-7 at times that add to the cost as value addition and corresponding margins are built in. Quite evidently, we should be focusing on the CPI and partly on the WPI to the extent that it includes products in the household consumption basket when assessing inflation.
The government is also considering bringing in a price index on services, which is good though, given that most services are in the unorganised sector, there would be issues in getting accurate information. To some extent some of the common services that we use such as transport, communication, education, recreation, medical care etc are included in the CPI. Probably, we could work towards making the CPI a little more contemporary as it has a lag of one month presently vis-à-vis the WPI.
Inflation certainly has come to the forefront of Indian economics in the last year leading to discussion and deliberation, which have been productive. The recent controversy on the GDP numbers based on market and constant prices has also directed attention to the GDP deflator, which would be the ideal inflation indicator that covers all segments albeit at the producer level rather than the consumer level. As the discussion levels are still fresh, this may be the right time to really pursue with the creation of new price indices.
Which way will RBI go? Financial Express 11th September 2010
Having more formal monetary reviews and possible announcements is just what is required to keep the hype alive on monetary policy. The market is always trying to guess what RBI is going to do between policies, and RBI has decided to have more policies between the four policies to remove uncertainty. However, this has still not stopped the media from ‘asking’ between these new policies whether RBI is up to something. One can guess that the media and markets will always be trying to out-guess what RBI will do. More policies may not really reduce the level of speculation.
The question being raised again is whether or not RBI will increase rates, now that inflation and growth show different tendencies. Inflation appears to be coming down, although admittedly, it is a mirage. The growth perspective is fogged by the June IIP numbers. So there may be a case to legitimately ask for a guess on the rates issue.
Now, when RBI comes up with the next policy later this month, there are certain issues that should be addressed so that it becomes more than a stance on rates. Monetary statements are normally cloaked with conservative statements of a number for GDP and some words on the downside risks, which is inflation today. But, it would be useful if RBI can actually throw some light on certain pressing issues.
The first is, why are deposits not increasing at a steady rate? There are explanations being given in terms of households moving to capital markets or corporates withdrawing their deposits or banks not raising wholesale deposits as there is not much demand. We really need to know the ‘why’ of it since interest rates have been increased several times this calendar year and if savings are sensitive to interest rates, they should be going up.
The second pertains to credit. There are conflicting views on growth in credit. We all know that the 3G auctions necessitated a large demand for credit. But this credit is analogous to unproductive expenditure as the money is being transferred to the government through borrowings that will go into consumption. Hence, it is not reflective of what kind of investment is taking place in the economy. Then there is the question of whether there is less demand for credit or whether the cost is keeping firms away. Any which way, RBI can ask banks to provide an explanation that can be put forth this time so that we get the true picture.
The third pertains to the question of industrial growth. The June numbers show that there was a slowdown and that the base year effect would percolate for some time. The July numbers for infrastructure industries are abysmal. So what is the true picture like on industry? RBI usually presents the CSO picture on industry and does not really give its own view. By providing an independent perspective there would be some value addition on the subject of state of industry and growth.
Can RBI have anything new to add? The answer is yes, if it wants to, as there is one issue of monetary management that has to be resolved. RBI, for example, has raised interest rates in a bid to make funds expensive. In a deregulated set-up, the banks do not have to follow RBI and can take an independent decision. Now, in the last two policies when RBI increased rates, some of the top bankers had officially responded by saying that they would not be increasing rates. This raises a dilemma for RBI. If banks are openly going to say that they will not follow suit, then the idea of announcing rate hikes gets diluted. While it is good from the point of view of the working of banks, it is not so from the point of view of policy. How does one get over this one?
Today, RBI controls the repo and reverse repo rates and works on the premise that these rates get translated into other bank rates. With there being no limits to these auctions, banks actually can invest at 4.5% and get funds at 5.75%. If RBI instead brings in a quantitative limit on the same, then it would actually jack up the rates in the money market and banks would be compelled to follow suit. While quantitative restrictions are actually not an efficient system, in the given case, RBI should think of bringing this back as it was earlier. This is one way of ensuring that the rates do rise when we are in the repo mode of operation in the market.
Getting in some of these possibilities will most certainly add a breath of fresh air to the policy.
The question being raised again is whether or not RBI will increase rates, now that inflation and growth show different tendencies. Inflation appears to be coming down, although admittedly, it is a mirage. The growth perspective is fogged by the June IIP numbers. So there may be a case to legitimately ask for a guess on the rates issue.
Now, when RBI comes up with the next policy later this month, there are certain issues that should be addressed so that it becomes more than a stance on rates. Monetary statements are normally cloaked with conservative statements of a number for GDP and some words on the downside risks, which is inflation today. But, it would be useful if RBI can actually throw some light on certain pressing issues.
The first is, why are deposits not increasing at a steady rate? There are explanations being given in terms of households moving to capital markets or corporates withdrawing their deposits or banks not raising wholesale deposits as there is not much demand. We really need to know the ‘why’ of it since interest rates have been increased several times this calendar year and if savings are sensitive to interest rates, they should be going up.
The second pertains to credit. There are conflicting views on growth in credit. We all know that the 3G auctions necessitated a large demand for credit. But this credit is analogous to unproductive expenditure as the money is being transferred to the government through borrowings that will go into consumption. Hence, it is not reflective of what kind of investment is taking place in the economy. Then there is the question of whether there is less demand for credit or whether the cost is keeping firms away. Any which way, RBI can ask banks to provide an explanation that can be put forth this time so that we get the true picture.
The third pertains to the question of industrial growth. The June numbers show that there was a slowdown and that the base year effect would percolate for some time. The July numbers for infrastructure industries are abysmal. So what is the true picture like on industry? RBI usually presents the CSO picture on industry and does not really give its own view. By providing an independent perspective there would be some value addition on the subject of state of industry and growth.
Can RBI have anything new to add? The answer is yes, if it wants to, as there is one issue of monetary management that has to be resolved. RBI, for example, has raised interest rates in a bid to make funds expensive. In a deregulated set-up, the banks do not have to follow RBI and can take an independent decision. Now, in the last two policies when RBI increased rates, some of the top bankers had officially responded by saying that they would not be increasing rates. This raises a dilemma for RBI. If banks are openly going to say that they will not follow suit, then the idea of announcing rate hikes gets diluted. While it is good from the point of view of the working of banks, it is not so from the point of view of policy. How does one get over this one?
Today, RBI controls the repo and reverse repo rates and works on the premise that these rates get translated into other bank rates. With there being no limits to these auctions, banks actually can invest at 4.5% and get funds at 5.75%. If RBI instead brings in a quantitative limit on the same, then it would actually jack up the rates in the money market and banks would be compelled to follow suit. While quantitative restrictions are actually not an efficient system, in the given case, RBI should think of bringing this back as it was earlier. This is one way of ensuring that the rates do rise when we are in the repo mode of operation in the market.
Getting in some of these possibilities will most certainly add a breath of fresh air to the policy.
DTC and 2C2E2I: Financial Express Aug 31 2010
We can never have a tax code that satisfies all of us. Individuals want to pay fewer taxes and ask for lower rates and more exemptions. Corporates are lavish with executive pay (yes, this is relevant today) and talk of corporate social responsibility, but are unwilling to pay more taxes. They will always selectively give examples of countries where tax rates are lower, though assuredly there are others that charge higher rates, depending on whether we benchmark with BRICs, Southeast Asia or developed countries. Yet all of us want the government to spend money the way we want (they should not increase their own salaries), balance the budget (how can that be done) and be efficient. How does one strike a balance?
We had DTC1 and DTC2, which evoked strong responses. DTC3 appears to be a diluted version and should please all. Individuals are better off, though not as well off as with DTC1. But they get their EEE on savings and don’t pay more taxes and retain all housing benefits. Corporates will pay less than now, but more than what the earlier DTC versions had promised. They are sulking that MAT has gone up from 18% to 20%, but is this significant?
A dispassionate way of judging a tax approach is to go back to the textbook and examine what Adam Smith had to say. Smith used the 2C2E formula to define a good tax code. Taxes should be ‘convenient’ and easy to pay so that paying does not inconvenience the payer. Has our code thought about such a thing? Prima facie, having a TDS on every transaction with those being exempt filling the requisite form would make life easy for all tax payers, because by the end of the year you cannot have a record of the Rs 100 that came to you as interest income. Our tax reforms address numbers and seldom processes.
The second C pertains to ‘certainty’. One should be able to understand the tax laws easily. The present rounds of DTC create a lot of uncertainty and we need to have a fixed approach that does not change. Hopefully, this DTC will bring an end to the uncertainty. This holds for all investment decisions—individuals would like to be certain that if they go for an EEE scheme today, it would not become taxable later. A corporate would like to have a clear vision of, say, five years to take informed decisions.
The first E stands for ‘equity’. Is the tax code equitable? The answer is yes. The rates are progressive, though the critic will argue that compared to DTC1 the rich are better off than the less rich. By continuing with the EEE schemes and housing benefits, the code does support the middle class too and should be commended. In a country that has no social security system, such benefits are required so that people can fend for themselves in old age.
The second E is ‘efficiency’. The cost of administering the tax collection process should not be disproportionate to the amount collected. If tax collection is simplified, then the cost can be reduced, too. Today, the paperwork that has to be maintained by each individual/company is considerable and easing the system will save a lot of time for tax payers. The government has made life easy with tax returns processes being given online facilities, which should be widened to lower costs for the tax payer.
DTC is in general conformity with the basic 2C2E tenets and only needs to be tweaked in certain places. To these four traditional goals we need to add two more tenets that are germane to all economies: 2Is. DTC should specify the sectors that are to be defined as priority so that ‘incentives’ may be provided—exports, infrastructure and housing could be such sectors for the next 10 years. Accordingly, tax rules could evolve in various forms to provide the necessary incentives along the way so that entrepreneurs or investors looking to the future can benefit through tax breaks and simultaneously contribute to the national cause.
The second ‘I’, which is critical, is ‘inflation’ adjustment. This holds for individuals where all taxable income should be adjusted for annual inflation to arrive at the initial taxable income.
This way, the government can provide an inflation buffer and need not keep tinkering with the tax rates as conditions change in the country.
Drawing a tax code that satisfies payers, critics and economists is a challenge, and the code in its current form is well-balanced. While theoretically one can fi
We had DTC1 and DTC2, which evoked strong responses. DTC3 appears to be a diluted version and should please all. Individuals are better off, though not as well off as with DTC1. But they get their EEE on savings and don’t pay more taxes and retain all housing benefits. Corporates will pay less than now, but more than what the earlier DTC versions had promised. They are sulking that MAT has gone up from 18% to 20%, but is this significant?
A dispassionate way of judging a tax approach is to go back to the textbook and examine what Adam Smith had to say. Smith used the 2C2E formula to define a good tax code. Taxes should be ‘convenient’ and easy to pay so that paying does not inconvenience the payer. Has our code thought about such a thing? Prima facie, having a TDS on every transaction with those being exempt filling the requisite form would make life easy for all tax payers, because by the end of the year you cannot have a record of the Rs 100 that came to you as interest income. Our tax reforms address numbers and seldom processes.
The second C pertains to ‘certainty’. One should be able to understand the tax laws easily. The present rounds of DTC create a lot of uncertainty and we need to have a fixed approach that does not change. Hopefully, this DTC will bring an end to the uncertainty. This holds for all investment decisions—individuals would like to be certain that if they go for an EEE scheme today, it would not become taxable later. A corporate would like to have a clear vision of, say, five years to take informed decisions.
The first E stands for ‘equity’. Is the tax code equitable? The answer is yes. The rates are progressive, though the critic will argue that compared to DTC1 the rich are better off than the less rich. By continuing with the EEE schemes and housing benefits, the code does support the middle class too and should be commended. In a country that has no social security system, such benefits are required so that people can fend for themselves in old age.
The second E is ‘efficiency’. The cost of administering the tax collection process should not be disproportionate to the amount collected. If tax collection is simplified, then the cost can be reduced, too. Today, the paperwork that has to be maintained by each individual/company is considerable and easing the system will save a lot of time for tax payers. The government has made life easy with tax returns processes being given online facilities, which should be widened to lower costs for the tax payer.
DTC is in general conformity with the basic 2C2E tenets and only needs to be tweaked in certain places. To these four traditional goals we need to add two more tenets that are germane to all economies: 2Is. DTC should specify the sectors that are to be defined as priority so that ‘incentives’ may be provided—exports, infrastructure and housing could be such sectors for the next 10 years. Accordingly, tax rules could evolve in various forms to provide the necessary incentives along the way so that entrepreneurs or investors looking to the future can benefit through tax breaks and simultaneously contribute to the national cause.
The second ‘I’, which is critical, is ‘inflation’ adjustment. This holds for individuals where all taxable income should be adjusted for annual inflation to arrive at the initial taxable income.
This way, the government can provide an inflation buffer and need not keep tinkering with the tax rates as conditions change in the country.
Drawing a tax code that satisfies payers, critics and economists is a challenge, and the code in its current form is well-balanced. While theoretically one can fi
The inflation delusion and why prices won’t come down soon:DNA 30th August 2010
Inflation has become an eyesore today because, frankly, we do not know what to do about it. We all know there is a problem which has to be solved; but there seem to be no fixes here.
As a policy maker, one is staring hard at the WPI indices hoping that the high numbers of yesteryear will help lower the numbers this year. As we try nervously to assure one another that all will be right soon, there are several myths that need to be addressed.
The first is that inflation will come down. If you are an economist; you attribute a number to it and arrive at 6% by December or March. Is there a rationale for the same? Honestly, there is none except that we all know that the prices kept zooming last year from September
If we paid Rs95 for tur dal last November, it will come down to Rs70, which means that prices have crashed. Never mind that they were Rs49 a kg in January, 2009, when prices moved up despite us being told that production was higher.
The second is that the government has lots of food stocks. Presently there is considerable quibbling about how stocks are rotting in the open and are even unfit for cattle. Others are arguing that offloading the same will cost money which will inflate the fiscal deficit. One forgets that the government only stocks rice and wheat where prices have increased by Rs2-3 kg in the last 18 months.
The government does not stock sugar, pulses, milk, poultry, coarse cereals, edible oils, etc. These are the prices that have increased substantially by between 30-100% since January, 2009. Hence talking of food stocks is only a weak diversion and is not quite reassuring.
The third is that in the present situation things will improve soon. But, the reality is that nothing can happen on the price front until harvest time. Crops are harvested in October and April onwards for the kharif and rabi seasons. Once the crop is in short supply, we have to live with the same till the next season. It cannot be replenished unless we have buffer stocks or import the same.
If there are no stocks (pulses, sugar) or if they can be imported only at a higher price, then imported inflation will ensue. Similarly, once the price of fodder increases, milk prices will move to a new high. The WPI is an index consisting of several products. While the WPI may come down, food prices cannot. The assurance that inflation will touch 6% is meaningless when we pay more for our vegetables at the market place.
The fourth myth is that prices will come down at the time of harvest. Anecdotal evidence shows that prices are not mean-reverting once they increase. A new high is always established, which becomes an average threshold for the future. Hence we should not expect tur dal to come back to Rs40 per kg times, and should be content to buy the same at a higher price.
The fifth myth spoken of is that the RBI can bring down prices. While the RBI has to increase rates to combat inflation, monetary policy cannot enhance supplies. It can control the supply of money which lowers demand for goods and hence prices. But that takes two-four months to work. If there are shortages, then we have to live with them and pay higher prices for these products. Higher interest rates only help us earn more on our deposits which gives an illusion that inflation is being controlled.
The sixth view is sympathetic to a government which is trying hard but is a helpless spectator. The government has contributed to inflation by increasing the minimum support prices of commodities (MSP) over a period of time. The MSP is the price offered by the government to farmers which is announced at the time of sowing. While it is effective in terms of procurement of wheat and rice, it increases the base price of crops for consumers.
These prices have almost doubled across all cereals and pulses in the last five years and hence the government cannot exculpate itself from this current trend of high prices. The choice is between consumers paying more and farmers receiving higher incomes.
The last facet of inflation justifies the hike in petro-product prices on grounds that the deficit needs to be reduced and it is only those who drive Mercedes cars who would be affected. While fiscal austerity cannot be challenged, increasing petroleum product prices at a time of high inflation is a recipe for even higher inflation as it feeds into our travel costs and transport costs of all goods.
Hence, practically speaking, we have to live with higher levels of prices and should interpret the WPI numbers with the proverbial portions of salt!
As a policy maker, one is staring hard at the WPI indices hoping that the high numbers of yesteryear will help lower the numbers this year. As we try nervously to assure one another that all will be right soon, there are several myths that need to be addressed.
The first is that inflation will come down. If you are an economist; you attribute a number to it and arrive at 6% by December or March. Is there a rationale for the same? Honestly, there is none except that we all know that the prices kept zooming last year from September
If we paid Rs95 for tur dal last November, it will come down to Rs70, which means that prices have crashed. Never mind that they were Rs49 a kg in January, 2009, when prices moved up despite us being told that production was higher.
The second is that the government has lots of food stocks. Presently there is considerable quibbling about how stocks are rotting in the open and are even unfit for cattle. Others are arguing that offloading the same will cost money which will inflate the fiscal deficit. One forgets that the government only stocks rice and wheat where prices have increased by Rs2-3 kg in the last 18 months.
The government does not stock sugar, pulses, milk, poultry, coarse cereals, edible oils, etc. These are the prices that have increased substantially by between 30-100% since January, 2009. Hence talking of food stocks is only a weak diversion and is not quite reassuring.
The third is that in the present situation things will improve soon. But, the reality is that nothing can happen on the price front until harvest time. Crops are harvested in October and April onwards for the kharif and rabi seasons. Once the crop is in short supply, we have to live with the same till the next season. It cannot be replenished unless we have buffer stocks or import the same.
If there are no stocks (pulses, sugar) or if they can be imported only at a higher price, then imported inflation will ensue. Similarly, once the price of fodder increases, milk prices will move to a new high. The WPI is an index consisting of several products. While the WPI may come down, food prices cannot. The assurance that inflation will touch 6% is meaningless when we pay more for our vegetables at the market place.
The fourth myth is that prices will come down at the time of harvest. Anecdotal evidence shows that prices are not mean-reverting once they increase. A new high is always established, which becomes an average threshold for the future. Hence we should not expect tur dal to come back to Rs40 per kg times, and should be content to buy the same at a higher price.
The fifth myth spoken of is that the RBI can bring down prices. While the RBI has to increase rates to combat inflation, monetary policy cannot enhance supplies. It can control the supply of money which lowers demand for goods and hence prices. But that takes two-four months to work. If there are shortages, then we have to live with them and pay higher prices for these products. Higher interest rates only help us earn more on our deposits which gives an illusion that inflation is being controlled.
The sixth view is sympathetic to a government which is trying hard but is a helpless spectator. The government has contributed to inflation by increasing the minimum support prices of commodities (MSP) over a period of time. The MSP is the price offered by the government to farmers which is announced at the time of sowing. While it is effective in terms of procurement of wheat and rice, it increases the base price of crops for consumers.
These prices have almost doubled across all cereals and pulses in the last five years and hence the government cannot exculpate itself from this current trend of high prices. The choice is between consumers paying more and farmers receiving higher incomes.
The last facet of inflation justifies the hike in petro-product prices on grounds that the deficit needs to be reduced and it is only those who drive Mercedes cars who would be affected. While fiscal austerity cannot be challenged, increasing petroleum product prices at a time of high inflation is a recipe for even higher inflation as it feeds into our travel costs and transport costs of all goods.
Hence, practically speaking, we have to live with higher levels of prices and should interpret the WPI numbers with the proverbial portions of salt!
Who SEZ exports can’t do better? Financial Express August 24 2010
The last two years have been fairly turbulent for Indian exports. After six successive growth rates of over 20% per annum up to FY08, there was a slowing down to 12.3% in FY09, followed by a decline of 2.6% in FY10. The $200-bn mark has been elusive for some time now. The target for this year has been placed at $216 bn, which implies growth of 21%. Going by the first four months’ performance, prima facie looks probable. The Exim Policy is in place up to 2014 and the announcements made in this regard in the Annual Policy should be viewed against this background.
There are basically three issues concerning exports from a macroeconomic standpoint. The first is its composition. Today, around 50% of our exports are traditional goods through textiles, petro & agro products, gems, ores, etc, while another 22% is in the fast growth category of engineering goods. These are the ones that have growth potential and can put exports on a higher trajectory. Chemicals are important, accounting for 10% of exports, but are a commodity that grows in a negative way as the developed countries would prefer to import them rather than produce for environmental reasons. When there was a slowdown in exports, it was the engineering sector (automobiles, machinery and metal products) that got hit the most. Exports of gems & jewellery and petro & agro products registered marginal increases as demand is typically inelastic in these sectors.
The second is the direction of exports. The US and EU account for 30% of our exports, which means that growth in this segment would be contingent on what is happening there. Africa and the Middle East account for 29% while Asia 31%. But the core of our growth will be guided by what happens in the US and EU.
The third is the exchange rate. A point often argued is that rupee depreciation is required for exports to increase. While this is theoretically true, it has been observed that between September 2008 and September 2009, exports declined on a month-on-month basis, but the rupee was weakening. This indicates that currency weakening is not a sufficient condition for the growth of exports. Demand is a critical factor that drives growth in this sector, which has to be supported internally by appropriate incentives.
If demand is the deciding factor, what are the prospects for growth in the world economy? Currently, there are mixed signals coming in. According to the IMF, global trade is to recover meekly to grow by 2% this year over negative 11.3% last year. The US economy has slowed down from an apparent recovery in Q1, while the Eurozone has grown rapidly, with Germany spearheading the process. This is a refreshing development considering that the Greek crisis had threatened to throw the region back into a recession. The UK, too, has bounced back. Japan is clawing to stay afloat while China is displaying a feeble growth path. In this situation, imports would show a varying trend. A view is that whatever growth has been witnessed is largely due to the stimulus packages invoked by various governments and supported by the central banks. As a corollary, there are doubts of its sustainability in case of a withdrawal of stimulus.
The logical approach would be to focus on incentivising the traditional goods where India has a comparative advantage and focusing on the engineering goods segment where there are growth numbers to be had. In this context, what has the Policy done?
The commerce minister has indicated that the trade policy has to work within the limits of resource constraints and that high inflation will place restrictions on export of agro products. The Policy has worked within these contours and extended the DEPB, focus market scheme, SHI and EPCG schemes for 6-12 months. It has also extended the 2% interest rate subvention schemes for thrust areas such as leather, textiles, jute, small engineering, etc.
While these measures are beneficial for propping exports, an aggressive policy on the SEZ front would have been effective to turn things around. The exchange rate cannot be relied upon to provide the competitive edge, with a range of Rs 46 to a dollar expected for the year. The current measures are basically extensions of existing provisions, which will help lower transaction costs for exporters. The thrust has been more on labour-intensive industries, which, though useful, may not be able to bring about the desired acceleration. So, while the government has done well in retaining the status quo, exporters could be justified in wishing for more.
There are basically three issues concerning exports from a macroeconomic standpoint. The first is its composition. Today, around 50% of our exports are traditional goods through textiles, petro & agro products, gems, ores, etc, while another 22% is in the fast growth category of engineering goods. These are the ones that have growth potential and can put exports on a higher trajectory. Chemicals are important, accounting for 10% of exports, but are a commodity that grows in a negative way as the developed countries would prefer to import them rather than produce for environmental reasons. When there was a slowdown in exports, it was the engineering sector (automobiles, machinery and metal products) that got hit the most. Exports of gems & jewellery and petro & agro products registered marginal increases as demand is typically inelastic in these sectors.
The second is the direction of exports. The US and EU account for 30% of our exports, which means that growth in this segment would be contingent on what is happening there. Africa and the Middle East account for 29% while Asia 31%. But the core of our growth will be guided by what happens in the US and EU.
The third is the exchange rate. A point often argued is that rupee depreciation is required for exports to increase. While this is theoretically true, it has been observed that between September 2008 and September 2009, exports declined on a month-on-month basis, but the rupee was weakening. This indicates that currency weakening is not a sufficient condition for the growth of exports. Demand is a critical factor that drives growth in this sector, which has to be supported internally by appropriate incentives.
If demand is the deciding factor, what are the prospects for growth in the world economy? Currently, there are mixed signals coming in. According to the IMF, global trade is to recover meekly to grow by 2% this year over negative 11.3% last year. The US economy has slowed down from an apparent recovery in Q1, while the Eurozone has grown rapidly, with Germany spearheading the process. This is a refreshing development considering that the Greek crisis had threatened to throw the region back into a recession. The UK, too, has bounced back. Japan is clawing to stay afloat while China is displaying a feeble growth path. In this situation, imports would show a varying trend. A view is that whatever growth has been witnessed is largely due to the stimulus packages invoked by various governments and supported by the central banks. As a corollary, there are doubts of its sustainability in case of a withdrawal of stimulus.
The logical approach would be to focus on incentivising the traditional goods where India has a comparative advantage and focusing on the engineering goods segment where there are growth numbers to be had. In this context, what has the Policy done?
The commerce minister has indicated that the trade policy has to work within the limits of resource constraints and that high inflation will place restrictions on export of agro products. The Policy has worked within these contours and extended the DEPB, focus market scheme, SHI and EPCG schemes for 6-12 months. It has also extended the 2% interest rate subvention schemes for thrust areas such as leather, textiles, jute, small engineering, etc.
While these measures are beneficial for propping exports, an aggressive policy on the SEZ front would have been effective to turn things around. The exchange rate cannot be relied upon to provide the competitive edge, with a range of Rs 46 to a dollar expected for the year. The current measures are basically extensions of existing provisions, which will help lower transaction costs for exporters. The thrust has been more on labour-intensive industries, which, though useful, may not be able to bring about the desired acceleration. So, while the government has done well in retaining the status quo, exporters could be justified in wishing for more.
Why futures are yet to deliver: Financial Express 18th August 2010
Commodity futures were revived in 2003 with much fanfare, ostensibly to lead to efficient price discovery. Six years later there is need for some serious introspection as the enactment of the play has varied from the script.
First, the good parts of the story. There has been manifold increase in business volumes; in FY10, volumes at Rs 78 lakh crore were 1.25 times India's GDP at current market prices. MCX is now one of the leading commodity exchanges in bullion. Second, the awareness of commodity futures has spread with wide scale participation. Electronic trading has helped, with exchanges like NCDEX having over 20,000 terminals and a similar number at other national level exchanges. Third, the improvement in logistics on account of futures trading has been remarkable. NCDEX has created warehousing space of over 1.3 million tonnes and enables deliveries of assayed and certified farm products to the extent of 50,000 tonnes a month. As a corollary, the concept of grades and standards has been established and traders are more quality conscious.
Fourth, there has been some migration from the grey market to the organised trading platform. Fifth, futures prices have provided fairly accurate signals about crop prospects—wheat in 2006 and 2007, sugar in 2009, soybean and chana in almost all the years. This should be leveraged by the government to formulate policy. Sixth, significant number of corporate hedgers trade in farm products on NCDEX thus making the system credible. Seventh, price information has percolated to farmers in certain pockets for specific commodities. Last, trading has been orderly and disciplined for which the credit goes to the exchanges and the regulator, FMC.
While this has been the better part of the story, the road has been uneven. To begin with, there is limited price discovery in farm products. Metals and energy products constitute a large part of the volumes traded, where price discovery is global. While there is nothing amiss, the fact that less than 15% of the trade is leading to domestic price discovery questions the success of reintroducing futures trading. The regulator has been banning trading in certain farm products, ostensibly on grounds of their relationship to inflation, which has pushed the market back. The credibility of the regulator has been questioned as, even though it vouched for futures trading and assured that no bans would be enacted, the FMC has been forced to do so and is hence viewed as a weak regulator. To be fair, the FMC has tried hard to preserve these contracts but, after a point, extraneous compulsions have overridden their authority.
The FMC has not been able to revive the regional exchanges, which are marginal players and can close down any day. So, while the focus is on allowing more national level exchanges, little has been done for integrating these niche players. Also, the market has become stagnant in terms of number of players. Banks, FIIs and mutual funds are out as there is a regulatory issue involved. In 2004 there was debate on whether the FMC should be merged with the markets regulator, but that was resolved in favour of the present structure. Some feel that this has kept the market behind.
A lot has been done to educate farmers, but once again the approach has been incorrect. While a novel form of PPP awareness programmes are undertaken by the FMC along with a cost-sharing agreement with the exchanges, the programmes have not delivered. In fact, they cannot, because there has been no move to facilitate actual farmer participation through aggregation. Thus, holding programmes without facilitating trading makes the whole effort quite futile and resembles an unfortunate trait in some government programmes, where the focus is only target attainment. Also, the FCRA Amendment Bill has become farcical as it has never come up for discussion so far. So, any policy level change looks unlikely. Lastly, a regulatory (and now legal) spat with a participant on the issue of trading fees has virtually made the market a monopoly with the other national level exchanges just about surviving.
Futures trading in commodities will always remain an enigma. When prices go up, futures trading is blamed, while it is not applauded when prices decline. Further, the market is governed by two conflicting ministries—the ministry of agriculture that wants the farmer to get higher prices and the ministry of consumer affairs that is upset when consumers pay higher prices. Finally, the unresolved issue will be whether futures trading affect spot prices—a catch-22 situation. If it does, it will be blamed for fuelling inflation—fundamentals notwithstanding. If it does not, then what price discovery are we talking of. Therein lies the rub.
First, the good parts of the story. There has been manifold increase in business volumes; in FY10, volumes at Rs 78 lakh crore were 1.25 times India's GDP at current market prices. MCX is now one of the leading commodity exchanges in bullion. Second, the awareness of commodity futures has spread with wide scale participation. Electronic trading has helped, with exchanges like NCDEX having over 20,000 terminals and a similar number at other national level exchanges. Third, the improvement in logistics on account of futures trading has been remarkable. NCDEX has created warehousing space of over 1.3 million tonnes and enables deliveries of assayed and certified farm products to the extent of 50,000 tonnes a month. As a corollary, the concept of grades and standards has been established and traders are more quality conscious.
Fourth, there has been some migration from the grey market to the organised trading platform. Fifth, futures prices have provided fairly accurate signals about crop prospects—wheat in 2006 and 2007, sugar in 2009, soybean and chana in almost all the years. This should be leveraged by the government to formulate policy. Sixth, significant number of corporate hedgers trade in farm products on NCDEX thus making the system credible. Seventh, price information has percolated to farmers in certain pockets for specific commodities. Last, trading has been orderly and disciplined for which the credit goes to the exchanges and the regulator, FMC.
While this has been the better part of the story, the road has been uneven. To begin with, there is limited price discovery in farm products. Metals and energy products constitute a large part of the volumes traded, where price discovery is global. While there is nothing amiss, the fact that less than 15% of the trade is leading to domestic price discovery questions the success of reintroducing futures trading. The regulator has been banning trading in certain farm products, ostensibly on grounds of their relationship to inflation, which has pushed the market back. The credibility of the regulator has been questioned as, even though it vouched for futures trading and assured that no bans would be enacted, the FMC has been forced to do so and is hence viewed as a weak regulator. To be fair, the FMC has tried hard to preserve these contracts but, after a point, extraneous compulsions have overridden their authority.
The FMC has not been able to revive the regional exchanges, which are marginal players and can close down any day. So, while the focus is on allowing more national level exchanges, little has been done for integrating these niche players. Also, the market has become stagnant in terms of number of players. Banks, FIIs and mutual funds are out as there is a regulatory issue involved. In 2004 there was debate on whether the FMC should be merged with the markets regulator, but that was resolved in favour of the present structure. Some feel that this has kept the market behind.
A lot has been done to educate farmers, but once again the approach has been incorrect. While a novel form of PPP awareness programmes are undertaken by the FMC along with a cost-sharing agreement with the exchanges, the programmes have not delivered. In fact, they cannot, because there has been no move to facilitate actual farmer participation through aggregation. Thus, holding programmes without facilitating trading makes the whole effort quite futile and resembles an unfortunate trait in some government programmes, where the focus is only target attainment. Also, the FCRA Amendment Bill has become farcical as it has never come up for discussion so far. So, any policy level change looks unlikely. Lastly, a regulatory (and now legal) spat with a participant on the issue of trading fees has virtually made the market a monopoly with the other national level exchanges just about surviving.
Futures trading in commodities will always remain an enigma. When prices go up, futures trading is blamed, while it is not applauded when prices decline. Further, the market is governed by two conflicting ministries—the ministry of agriculture that wants the farmer to get higher prices and the ministry of consumer affairs that is upset when consumers pay higher prices. Finally, the unresolved issue will be whether futures trading affect spot prices—a catch-22 situation. If it does, it will be blamed for fuelling inflation—fundamentals notwithstanding. If it does not, then what price discovery are we talking of. Therein lies the rub.
Subscribe to:
Posts (Atom)
