The discussion paper on foreign banks in India is timely and appropriate as we need to look at the banking sector with the larger picture in mind and not get bogged down with ideological, operational and supervisory issues. This comes just on the back of the discussion on getting corporate houses into banking, where arguments have flowed from one end to the other on whether we should have more private banks. Alongside, there has also been the issue of MFIs, which has raised a controversy of a different sort. Curiously, for every step forward, there are arguments to push us two steps back. As RBI has brought out papers on all these subjects at about the same time, it is pragmatic to put the parts together.
The right way to address the issue is to look at banking as a strategic goal. Let us ask ourselves a question: do we need more ‘banking’ in the country? The answer is yes, from the point of view of getting a larger population involved through deposits and supporting the high growth that we are targeting by channelling funds for productive use and making it inclusive. India still follows a bank-oriented financing model, where the debt market is absent and hence relies heavily on the banking system to provide funds for growth—both short and long term. Now when we speak of growth of, say, 9-10% per annum, we require this sector’s support to come at over 20% per annum on a sustained basis for the next five years. Using March 2010 as the base, when credit was Rs 35 lakh crore, this kind of growth would mean raising the base to around Rs 85-90 lakh crore. The number is daunting, but then we need the capital for this purpose, which, using a ratio of 10% capital adequacy means getting in Rs 4-4.5 lakh crore. Where will this money come from?
Looking internally, we have all kind of issues with banking capital. The sector is dominated by public sector banks, with a share of 74% in total assets, where there is debate over disinvestment or offloading of shares to the market. While there are arguments about retaining the public nature of such banks, the fact is that garnering more capital will be a challenge. Private sector banks are aggressive in the market and can provide a solution, but the present set of banks has its own limitations. This has called for the inclusion of new banks with corporate support. Corporate houses have deep pockets and can provide the funds that are needed by the economy to move ahead. It is here that the foreign banks fit in as they too have deep pockets and the subsidiary route offers a way out as against the present branch approach with its limitations.
RBI has set the entry norms in terms of capital and suggested some very stringent conditions for screening the banks that could operate as subsidiaries and hence as specific entities. This by itself will actually end up offering opportunity to the bigger banks in the country, which hitherto have not been able to expand due to various reasons that surround the conditions placed for opening branches. Therefore, we would not really see the smaller players asking for more and it would be those with a history of operations in the country that would probably find this route attractive. The subsidiary route thus takes care of the issue of systemic risk that can emanate from banks expanding through the branch route. Foreign banks, though, are not keen on coming as subsidiaries as this exposes the parent’s balance sheet.
Will this be a panacea for our problem on capital? The answer is no. Foreign banks cannot, on their own, address this issues, but can contribute smartly to the requirement. Besides, they will evaluate the terms on dividend repatriation, listing and conversion of branches etc before taking a decision. The subsidiary route proposed makes a lot of sense from the point of view of the regulator as well as the banks and should be complemented by a more open approach to new private banks.
The important thing is that we need more banks to address the issues of capital, growth in business and inclusion. Public sector expansion—either through organic means or inorganic methods such as disinvestment or consolidation, new private banks and foreign bank subsidiaries—could work together to deliver superior results. We only need to ensure that the regulatory processes and supervisory mechanism is in place at all times. A start certainly must be made in all these areas. Given the more stringent terms imposed by Basel III, this is probably the right time.
Friday, January 28, 2011
Living with Inflation: Editorial in Financial Express 26th January 2011
The market was expecting a 25 bps increase in the repo and reverse repo rates. So when invoked, it was more or less self-fulfilling, which also means that it is unlikely to have much of an impact. RBI has also upped its inflation number for March to 7%. Put these two together and we can draw two conclusions. The first is that we will be living with high inflation for the remaining two months, which is probably an honest idea conveyed and second, even RBI is helpless. Less than two weeks ago, the government threw up its hands on inflation saying nothing could be done in the short run and that it was up to RBI to take suitable measures. RBI, in turn, meekly increased rates by 25 bps and left it to nature to take care of the rest. Maybe it was the best that could be done, but the tone of helplessness is significant and probably disappointing as the economic review released a day before made inflation tackling a more serious issue.
Also, RBI has left banks to improve liquidity by dealing better with imbalances in funds, which is surprising. It has cautioned more on banks reconciling their high credit growth with limited deposits backing them. Is there an ALM mismatch? The SLR and OMOs did not quite deliver the result and ideally RBI could have announced direct measures to alleviate liquidity. The implication is that we can expect tight liquidity conditions to prevail in the coming months unless banks are able to play the conjurer’s role and get in deposits by increasing deposit rates further—increased government spending in the year’s last quarter, though, could help. This brings to the fore the issue of lending rates. RBI has maintained that growth is on target, which means that there has not so far been an impact due to higher interest rates. We are betting that the same sentiment will hold for the next quarter, too, which could be the surprise element. Higher interest rates up to a point will not militate against investment and growth, but once we reach an undefined limit, profits are affected and there could be some adverse repercussions. Protagonists of the growth-neutral theory say that as long as demand is there, no one will cut back on production, as it is their business to produce. But, industry has another story to tell, as beyond a point profits come under pressure—especially for infrastructure projects. What exactly is this inflexion point is the moot question.
Also, RBI has left banks to improve liquidity by dealing better with imbalances in funds, which is surprising. It has cautioned more on banks reconciling their high credit growth with limited deposits backing them. Is there an ALM mismatch? The SLR and OMOs did not quite deliver the result and ideally RBI could have announced direct measures to alleviate liquidity. The implication is that we can expect tight liquidity conditions to prevail in the coming months unless banks are able to play the conjurer’s role and get in deposits by increasing deposit rates further—increased government spending in the year’s last quarter, though, could help. This brings to the fore the issue of lending rates. RBI has maintained that growth is on target, which means that there has not so far been an impact due to higher interest rates. We are betting that the same sentiment will hold for the next quarter, too, which could be the surprise element. Higher interest rates up to a point will not militate against investment and growth, but once we reach an undefined limit, profits are affected and there could be some adverse repercussions. Protagonists of the growth-neutral theory say that as long as demand is there, no one will cut back on production, as it is their business to produce. But, industry has another story to tell, as beyond a point profits come under pressure—especially for infrastructure projects. What exactly is this inflexion point is the moot question.
Less wastage, lower MSP dependence & better yields the way forward: Economic Times 26th January 2011
Let's look at six frames in agriculture. We had the wheat crisis in 2006 and 2007 and, by the time we recognised the problem and imported wheat, we ended up paying about Rs 920 a quintal against a minimum support price (MSP) of Rs 750 in 2006-07 and Rs 1,490-1,500 a quintal in 2007-08 against an MSP of Rs 1,000. Today, we have stocks of around 47 million tonnes of wheat and rice as of January 1, when the buffer norm is 25 million tonnes for January (peak of 32 million in July).
Second, in 2009-10, there was a shortfall in production of sugar and we imported 2.4 million tonnes, while in 2008-09, we exported 5.5 million tonnes of surplus sugar. Third, the country is the second-largest producer of fruit and vegetables (210 million tonnes); yet prices rise when production fails. This happens because we have wastage that could be 30-50% of production.
Fourth, we are the largest producer and consumer of pulses, and a crop failure in 2009 meant we had to import large quantities at high prices. We import 15-20% of our requirement (3.5 million tonnes out of 18 million tonnes in 2009-10).
Fifth, we import 55-60% of edible oil requirement that gets camouflaged on account of global supplies being stable.
Sixth, when prices of grains and oilcakes rise, this feeds into the cost of production (breeding) of dairy cattle and poultry that, in turn, pushes up final prices, which is irreversible. This is the agricultural conundrum confronting us today.
Given this background, what are the issues for creating food security? Food inflation in the last five years has been a result of higher prices in one or more of these six categories and is exhaustive in terms of composition in WPI. An approach to food security must necessarily tackle all of them.
Horticulture shortfalls cannot really be met through higher production, because the issue relates to paucity of storage facilities. We have to cut down on these wastages through extensive investment in warehousing, including cold storages.
Organised retail or FDI in retail is a solution but given our xenophobia for foreign investment or transparent systems, it will be a gradual process as organised retail constitutes less than 5% of total business. Contract or corporate farming works in bits and pieces but is currently not all pervasive.
The second priority is enhancing cultivation and improving yields for pulses and oilseeds. There are three options here. The private sector can play a bigger role, especially when it comes to corporate farming. However, given our own antipathy to markets, like the reaction to futures trading, there is a lot of suspicion attached to private farming. We have had futures trading being banned or stock limits being invoked every time there is a crisis.
The second option is for the government to get into agriculture in a big way to keep production and prices directly under its control. The third alternative is to actually go in for contract farming in other countries, especially in Africa and Latin America, which is today quite prevalent in mining.
The third priority is dealing with surpluses. Today, it is a mess. High MSPs and indiscreet procurement have created shortages, the government being the biggest foodgrain hoarder. Procurement is over 25% of production while another 15-30% is used for self-consumption or seeds. This has to change and MSP should be made the last resort for the farmer - not the first.
With the UID scheme being implemented, we can map the really poor farmers to the procurement process to ensure that access is restricted. Also, stocks beyond a limit should be offloaded in the market to cool prices and ensure artificial shortages are not created.
Fourth, buffer stocking in sugar and pulses to the extent possible is necessary given that sugar production follows a cycle of 4-5 years that is also replicated globally. Such buffers should be used to alleviate shortages. Such stocks may be held by the sugar companies on behalf of the government and rolled over to eschew damages.
Fifth, most food problems would be addressed if import action is taken with alacrity. Here, futures trading plays an important role in signalling shortages well in advance. While better regulation of the market is a corollary, this aspect of farming will help in providing warning signals. This way, we can avoid the situation where the news of India's entry into a farm import deal automatically pushes up global prices given the quantity involved.
The crux is that the government has to play an active role given that we are not prepared to provide width to the private sector and are apprehensive of letting in FDI. Given the existing fiscal strains, there should be a movement away from activities where institutions work well through privatisation and focus on this new kind of infrastructure: agriculture.
Also, money spent on programmes like NREGS should be elevated to create farm assets where labour is gainfully employed. The panchayats can be involved in such state farming activity. The state governments can act as a kind of market maker to stabilise prices just like the SBI does in money markets and insurance companies in the capital market. Clearly, we should change the narrative to eschew future crises.
Second, in 2009-10, there was a shortfall in production of sugar and we imported 2.4 million tonnes, while in 2008-09, we exported 5.5 million tonnes of surplus sugar. Third, the country is the second-largest producer of fruit and vegetables (210 million tonnes); yet prices rise when production fails. This happens because we have wastage that could be 30-50% of production.
Fourth, we are the largest producer and consumer of pulses, and a crop failure in 2009 meant we had to import large quantities at high prices. We import 15-20% of our requirement (3.5 million tonnes out of 18 million tonnes in 2009-10).
Fifth, we import 55-60% of edible oil requirement that gets camouflaged on account of global supplies being stable.
Sixth, when prices of grains and oilcakes rise, this feeds into the cost of production (breeding) of dairy cattle and poultry that, in turn, pushes up final prices, which is irreversible. This is the agricultural conundrum confronting us today.
Given this background, what are the issues for creating food security? Food inflation in the last five years has been a result of higher prices in one or more of these six categories and is exhaustive in terms of composition in WPI. An approach to food security must necessarily tackle all of them.
Horticulture shortfalls cannot really be met through higher production, because the issue relates to paucity of storage facilities. We have to cut down on these wastages through extensive investment in warehousing, including cold storages.
Organised retail or FDI in retail is a solution but given our xenophobia for foreign investment or transparent systems, it will be a gradual process as organised retail constitutes less than 5% of total business. Contract or corporate farming works in bits and pieces but is currently not all pervasive.
The second priority is enhancing cultivation and improving yields for pulses and oilseeds. There are three options here. The private sector can play a bigger role, especially when it comes to corporate farming. However, given our own antipathy to markets, like the reaction to futures trading, there is a lot of suspicion attached to private farming. We have had futures trading being banned or stock limits being invoked every time there is a crisis.
The second option is for the government to get into agriculture in a big way to keep production and prices directly under its control. The third alternative is to actually go in for contract farming in other countries, especially in Africa and Latin America, which is today quite prevalent in mining.
The third priority is dealing with surpluses. Today, it is a mess. High MSPs and indiscreet procurement have created shortages, the government being the biggest foodgrain hoarder. Procurement is over 25% of production while another 15-30% is used for self-consumption or seeds. This has to change and MSP should be made the last resort for the farmer - not the first.
With the UID scheme being implemented, we can map the really poor farmers to the procurement process to ensure that access is restricted. Also, stocks beyond a limit should be offloaded in the market to cool prices and ensure artificial shortages are not created.
Fourth, buffer stocking in sugar and pulses to the extent possible is necessary given that sugar production follows a cycle of 4-5 years that is also replicated globally. Such buffers should be used to alleviate shortages. Such stocks may be held by the sugar companies on behalf of the government and rolled over to eschew damages.
Fifth, most food problems would be addressed if import action is taken with alacrity. Here, futures trading plays an important role in signalling shortages well in advance. While better regulation of the market is a corollary, this aspect of farming will help in providing warning signals. This way, we can avoid the situation where the news of India's entry into a farm import deal automatically pushes up global prices given the quantity involved.
The crux is that the government has to play an active role given that we are not prepared to provide width to the private sector and are apprehensive of letting in FDI. Given the existing fiscal strains, there should be a movement away from activities where institutions work well through privatisation and focus on this new kind of infrastructure: agriculture.
Also, money spent on programmes like NREGS should be elevated to create farm assets where labour is gainfully employed. The panchayats can be involved in such state farming activity. The state governments can act as a kind of market maker to stabilise prices just like the SBI does in money markets and insurance companies in the capital market. Clearly, we should change the narrative to eschew future crises.
A Credit policy like never before: January 22 1011 Financial Express
Even though we have a credit policy review every second month, the one to be announced on January 25 will be special for several reasons. There are basically going to be four takeaways—two operational issues for banks and two for the general public, too.
Currently, the situation is full of contradictions. There is a liquidity problem with credit growing faster than deposits. Inflation is high on account of supply shocks that were not anticipated. Industry is doing well on a cumulative basis, though monthly performance is disturbing, with high growth rates alternating with low ones. Exports are booming but the current account deficit is a worry. Tax collections, especially indirect taxes on goods, have been robust, which means lots of things are happening. FII inflows, which were gushing in a couple of months back, have now stagnated, and the rupee is depreciating as against appreciating earlier. Capital issues are up, as are debt issuances, but the stock market remains whimsical with inflation and possible RBI action dominating sentiment. The question is how RBI would react to this situation.
The government has given up on inflation and passed the baton to RBI, which means that RBI is expected to increase interest rates, which it will. Higher interest rates cannot produce goods but it can reduce other demand for goods and investment. By increasing interest rates, RBI can lower the demand for credit that can be deferred, which affects households through, say, mortgages and auto finance. Simultaneously, deposits would increase, thus lowering the liquidity deficit. How much should RBI increase interest rates? Ideally, 50 bps will work, but given that RBI has followed a gradualist approach, 25 bps looks more likely on both the repo and reverse repo.
What about liquidity? In the last policy, the liquidity position was acute, with over Rs 1.3 lakh crore going into repos every day. RBI chose to lower the SLR and announced OMO purchases for Rs 48,000 crore. But this has not really helped as banks are still resorting to borrowings of Rs 1 lakh crore a day from RBI through the repo auctions. The answer is hence in lowering the CRR. But, lowering CRR is contrary to increasing interest rates in the strict sense as more liquidity actually lowers rates. But in the current situation, where liquidity is very tight, this may not happen. Also, if RBI believes that for two problems we need two instruments, then these two moves can be synchronised and may not be contradictory. Therefore, a CRR cut may not be out of sync here as it will release around Rs 25,000 crore into the system. There is otherwise little that RBI can do to augment liquidity. Further OMO purchases could be persevered with but then one is not sure of the result. Probably a combination of higher rates which slows down credit and CRR cut would work in unison to ease liquidity.
The other two areas of interest is RBI’s take on growth and inflation. So far, we have all been sanguine on growth as the first half GDP number has been 8.9%, with an upside being believed for the remaining half. However, industrial performance has been volatile this year so far and hence RBI’s revised target would be of interest. Higher interest rates, it is argued, have a negative impact on industry as investment is postponed. But the counterview is that higher rates make industry manage their inventory in a more efficient manner and also use capital more judiciously. As long as demand is there, investment will carry on. Today, households are spending more on account of inflation and not really cutting down on such activity while savings are being affected as seen in the tardy growth in deposits. Hence, while there are arguments on both sides, the final call guidance from the central bank would be instructive.
Inflation is another parameter for which one would be looking for guidance. It is generally believed that inflation will end up over 7% this year by March and probably be in the 8.5-9% on an average for the year. RBI will evidently have its own impact analysis in place to gauge the effect of another round of interest rates on the inflation number. Hence, RBI’s call on inflation will not just give us the official picture but also indicate further policy action, especially if it varies significantly from the existing trends.
Hence, this policy statement of RBI will be very critical and the market will surely read the words carefully to take hints about future scenarios.
Currently, the situation is full of contradictions. There is a liquidity problem with credit growing faster than deposits. Inflation is high on account of supply shocks that were not anticipated. Industry is doing well on a cumulative basis, though monthly performance is disturbing, with high growth rates alternating with low ones. Exports are booming but the current account deficit is a worry. Tax collections, especially indirect taxes on goods, have been robust, which means lots of things are happening. FII inflows, which were gushing in a couple of months back, have now stagnated, and the rupee is depreciating as against appreciating earlier. Capital issues are up, as are debt issuances, but the stock market remains whimsical with inflation and possible RBI action dominating sentiment. The question is how RBI would react to this situation.
The government has given up on inflation and passed the baton to RBI, which means that RBI is expected to increase interest rates, which it will. Higher interest rates cannot produce goods but it can reduce other demand for goods and investment. By increasing interest rates, RBI can lower the demand for credit that can be deferred, which affects households through, say, mortgages and auto finance. Simultaneously, deposits would increase, thus lowering the liquidity deficit. How much should RBI increase interest rates? Ideally, 50 bps will work, but given that RBI has followed a gradualist approach, 25 bps looks more likely on both the repo and reverse repo.
What about liquidity? In the last policy, the liquidity position was acute, with over Rs 1.3 lakh crore going into repos every day. RBI chose to lower the SLR and announced OMO purchases for Rs 48,000 crore. But this has not really helped as banks are still resorting to borrowings of Rs 1 lakh crore a day from RBI through the repo auctions. The answer is hence in lowering the CRR. But, lowering CRR is contrary to increasing interest rates in the strict sense as more liquidity actually lowers rates. But in the current situation, where liquidity is very tight, this may not happen. Also, if RBI believes that for two problems we need two instruments, then these two moves can be synchronised and may not be contradictory. Therefore, a CRR cut may not be out of sync here as it will release around Rs 25,000 crore into the system. There is otherwise little that RBI can do to augment liquidity. Further OMO purchases could be persevered with but then one is not sure of the result. Probably a combination of higher rates which slows down credit and CRR cut would work in unison to ease liquidity.
The other two areas of interest is RBI’s take on growth and inflation. So far, we have all been sanguine on growth as the first half GDP number has been 8.9%, with an upside being believed for the remaining half. However, industrial performance has been volatile this year so far and hence RBI’s revised target would be of interest. Higher interest rates, it is argued, have a negative impact on industry as investment is postponed. But the counterview is that higher rates make industry manage their inventory in a more efficient manner and also use capital more judiciously. As long as demand is there, investment will carry on. Today, households are spending more on account of inflation and not really cutting down on such activity while savings are being affected as seen in the tardy growth in deposits. Hence, while there are arguments on both sides, the final call guidance from the central bank would be instructive.
Inflation is another parameter for which one would be looking for guidance. It is generally believed that inflation will end up over 7% this year by March and probably be in the 8.5-9% on an average for the year. RBI will evidently have its own impact analysis in place to gauge the effect of another round of interest rates on the inflation number. Hence, RBI’s call on inflation will not just give us the official picture but also indicate further policy action, especially if it varies significantly from the existing trends.
Hence, this policy statement of RBI will be very critical and the market will surely read the words carefully to take hints about future scenarios.
Wednesday, January 12, 2011
The Inflation Delusion: 12th January 2011: Financial Express
The course of inflation and the official response this year has been quite interesting, as it has been iced with optimism. After being in denial mode for almost 4 months, with the standard response being that inflation will come down to 5% by March, we do realise today that this will not be so. The feeling was that over a high base of last year, the number had to come down, which has not happened and food inflation is ominously in the double-digit range. Now, one is looking at 6-7%.
Some of the myths that have been busted about inflation can be put into perspective. The first reassurance was that we had large stocks of foodgrains with the FCI. Debates ranged on how to get these grains to the poor and the damaged grains in the warehouses added to the decibel levels of discussions. But, FCI holds on to only rice and wheat and, hence, can theoretically influence only their prices. The lesson learnt is that we should not get carried away by this fact as rice and wheat account for around 3.5% of the weight in WPI and there are other components that can jack up the inflation rate.
The second comfort provided was that the kharif production would be higher and, hence, prices would come down from October onwards. While the first advance estimates are sanguine, the point missed is that we have only been brought back to the pre-drought levels. Further, while these products have not displayed a significant increase in prices, other components continued to increase, thus making the inflation number nasty. The clue here is that we clearly need to look beyond the usual staples of cereals, pulses and oilseeds when viewing food inflation.
The third factor in the sidelines was the high MSPs announced, which have ranged from 5% to 30% for various crops and which has increased market benchmarks. While most MSPs are not actually used by farmers, as market prices are higher, there has been an inherent upward thrust to the prices. We really need to revisit this policy of MSPs, as it has been taken to be a panacea for our farm problems. By announcing higher prices, it is hoped that production will increase, which has not always happened. In fact, such high MSPs have tended to divert land from other crops to rice and wheat, where the returns are better and assured. Therefore, MSPs have distorted the cropping pattern as well as imparted an upward thrust to prices. This is a difficult decision to take because higher MSPs give farmers the benefit (to the extent that it does not go to the adathiya), but also add to the woes of the consumer and RBI.
Now, higher prices of food products have tended to become a structural problem and get built into the costing for farmers. With unchanged productivity and land under cultivation, the only way a farmer can protect his income is by increasing prices, which increases cost for users—especially of dairy and poultry. The cost of animal feed has increased due to the drought last year, which has pushed up the final prices. Today, this category, along with the fall in production of vegetables and fruits, has increased prices. Hence, we have a situation of robust kharif production and higher inflation in other products.
The fourth diversion has been the RBI increasing interest rates. But, can higher rates augment production? Certainly not, and while interest rate hikes are necessary to protect savings and address inflationary expectations, they cannot make up for shortages in supplies.
Quite curiously, the government has decided not to increase diesel prices this time as inflation is high. This is an interesting statement because earlier in 2010 when diesel prices were increased, we were reassured that such an increase would have no impact on inflation. What is one to make of it?
Are there any solutions? The answer is actually a confident ‘no’ in the short run, because the solution is to augment supplies, which can only happen in the medium term. Clearly, this issue has to be addressed, speaking literally, at the ground level, and the government has to take the lead here. Farming is no longer attractive and the private sector’s indulgence is restricted to its own activity in the retail segment.
A way out would be to use the funds that are allocated under the MGNREGA programme to actually work on making land fertile and grow crops, which will make the scheme more useful and go beyond a pure dole system, which is what it is today. Modalities can be worked out on using probably a cooperative approach here so that the farmers can also draw benefits from the profits made through such cultivation.
Some of the myths that have been busted about inflation can be put into perspective. The first reassurance was that we had large stocks of foodgrains with the FCI. Debates ranged on how to get these grains to the poor and the damaged grains in the warehouses added to the decibel levels of discussions. But, FCI holds on to only rice and wheat and, hence, can theoretically influence only their prices. The lesson learnt is that we should not get carried away by this fact as rice and wheat account for around 3.5% of the weight in WPI and there are other components that can jack up the inflation rate.
The second comfort provided was that the kharif production would be higher and, hence, prices would come down from October onwards. While the first advance estimates are sanguine, the point missed is that we have only been brought back to the pre-drought levels. Further, while these products have not displayed a significant increase in prices, other components continued to increase, thus making the inflation number nasty. The clue here is that we clearly need to look beyond the usual staples of cereals, pulses and oilseeds when viewing food inflation.
The third factor in the sidelines was the high MSPs announced, which have ranged from 5% to 30% for various crops and which has increased market benchmarks. While most MSPs are not actually used by farmers, as market prices are higher, there has been an inherent upward thrust to the prices. We really need to revisit this policy of MSPs, as it has been taken to be a panacea for our farm problems. By announcing higher prices, it is hoped that production will increase, which has not always happened. In fact, such high MSPs have tended to divert land from other crops to rice and wheat, where the returns are better and assured. Therefore, MSPs have distorted the cropping pattern as well as imparted an upward thrust to prices. This is a difficult decision to take because higher MSPs give farmers the benefit (to the extent that it does not go to the adathiya), but also add to the woes of the consumer and RBI.
Now, higher prices of food products have tended to become a structural problem and get built into the costing for farmers. With unchanged productivity and land under cultivation, the only way a farmer can protect his income is by increasing prices, which increases cost for users—especially of dairy and poultry. The cost of animal feed has increased due to the drought last year, which has pushed up the final prices. Today, this category, along with the fall in production of vegetables and fruits, has increased prices. Hence, we have a situation of robust kharif production and higher inflation in other products.
The fourth diversion has been the RBI increasing interest rates. But, can higher rates augment production? Certainly not, and while interest rate hikes are necessary to protect savings and address inflationary expectations, they cannot make up for shortages in supplies.
Quite curiously, the government has decided not to increase diesel prices this time as inflation is high. This is an interesting statement because earlier in 2010 when diesel prices were increased, we were reassured that such an increase would have no impact on inflation. What is one to make of it?
Are there any solutions? The answer is actually a confident ‘no’ in the short run, because the solution is to augment supplies, which can only happen in the medium term. Clearly, this issue has to be addressed, speaking literally, at the ground level, and the government has to take the lead here. Farming is no longer attractive and the private sector’s indulgence is restricted to its own activity in the retail segment.
A way out would be to use the funds that are allocated under the MGNREGA programme to actually work on making land fertile and grow crops, which will make the scheme more useful and go beyond a pure dole system, which is what it is today. Modalities can be worked out on using probably a cooperative approach here so that the farmers can also draw benefits from the profits made through such cultivation.
The numbers that matter: Mint 6th January 2011
Inflation, growth and production figures are influential in policymaking. Yet they contain structural inconsistencies
Agricultural growth will be robust, Wholesale Price Index (WPI) inflation is edging down, industrial growth will decelerate in the months to come, and exports are growing rapidly and may cross the $200 billion mark. These are facts cloaked with some idiosyncratic statistical proclivities.
The term that pre-empts our ears is “base-year effect”, which is a valid explanation of most of what has been stated above. This has at times made growth numbers meaningless, conveying trends that may be divorced from reality. When vegetables are relentlessly selling at Rs 40/kg from Rs 20/kg a few months back, it is hard to accept a low inflation number. More significantly, it obfuscates the actual factors at work.
Financial year 2011 (FY11) has been a contrast to FY10. There was a drought in FY10, while industry topped with double-digit growth on a low base of 2.7%. Inflation was in the double-digit zone by the end of March. Further, exports had declined in FY10 as global demand had slumped. Now, with a gentle reversal of most of these indicators, the picture looks rosier, though disguised.
Take, for example, agricultural production. We are satisfied with the good monsoon and the kharif harvest, and the first advance estimates of farm output show foodgrain and oilseed production at 115 million tonnes (mt) and 17.3 mt, respectively. While these numbers show significant growth over FY10, they are still lower than the 118 mt and 17.8 mt, respectively, in FY09. This means the current growth has at best brought us back to the pre-drought level. The same holds for exports, which grew by more than 25% till November; but at $140 billion, was higher by just 3% over FY09.
At a different level, WPI inflation appears to be coming down, and the Reserve Bank of India’s target of 6% looks achievable by March. However, this is more because of the high base-year effect of FY10, when WPI climbed sharply during the November-March period. But month-on-month index numbers are still increasing even in the harvest period, while the inflation rate is coming down. The Consumer Price Index (CPI) inflation number, on the other hand, has shown an increase of 9.7% in October over 13.5% in 2009. How does one evaluate inflation then?
Second, the situation has been further obfuscated by adopting 2004-05 as the base year for WPI and gross domestic product (GDP). The WPI number has come down by 1 percentage point right away on doing this. The CPI, on the other hand, goes with a base of 2001 and a different set of goods, further queering the pitch for comparison. There is talk of the Index of Industrial Production (IIP) base also being aligned to the others. This makes sense, but perspectives could change and the current high numbers could become lower with the new base year.
Third, there is a logistics issue relating to revisions in numbers. The WPI is susceptible to changes, as is the IIP. In the last six months of 2010, the variation between the announced and revised IIP growth rates was 0.6-1.3%. Given that the numbers at times were of a low order, this could make a difference in interpretation. Even recent WPI numbers are susceptible to change, with an upward revision for September.
There are basically two policy implications here. The first is that data collection has to be made more robust. This is a challenge, given that 40-45% of the economy is unorganized. Farm prices are not homogeneous, while industry associations may not be reporting in time, making data collation difficult. Ideally, we need to elongate the data period, and can consider monthly numbers for even primary and fuel products.
Second, the focus of monetary policy has to change from “inflation rate” to “price level”, as the base-year effect cannot be eschewed. We have rarely had five successive years of high or steady industrial growth or inflation. This has led to a debate globally over whether the monetary authority should target inflation or the price levels. For example, if inflation is a target for RBI, should it be satisfied that the inflation rate is, say, 6% after 10.3% in March? The normal tendency during droughts is for prices to increase by 20-40%, and then drop by 20-30% to settle at a higher level than the pre-drought level. In such a case, has inflation really come down? As a corollary, should the monetary strings be loosened, assuming there is no latent inflation?
One way out is to actually compare the present with a moving average of the past two or three years. This will bring proper focus to policy, or else the targeted variables could be at variance from the ground situation. Also, the base-year changes must be synchronized and data released at the same time for easier comprehension. Above all, given the logistical challenge in an economy where a significant part is not organized, we should concentrate more on quality of data rather than frequency.
Agricultural growth will be robust, Wholesale Price Index (WPI) inflation is edging down, industrial growth will decelerate in the months to come, and exports are growing rapidly and may cross the $200 billion mark. These are facts cloaked with some idiosyncratic statistical proclivities.
The term that pre-empts our ears is “base-year effect”, which is a valid explanation of most of what has been stated above. This has at times made growth numbers meaningless, conveying trends that may be divorced from reality. When vegetables are relentlessly selling at Rs 40/kg from Rs 20/kg a few months back, it is hard to accept a low inflation number. More significantly, it obfuscates the actual factors at work.
Financial year 2011 (FY11) has been a contrast to FY10. There was a drought in FY10, while industry topped with double-digit growth on a low base of 2.7%. Inflation was in the double-digit zone by the end of March. Further, exports had declined in FY10 as global demand had slumped. Now, with a gentle reversal of most of these indicators, the picture looks rosier, though disguised.
Take, for example, agricultural production. We are satisfied with the good monsoon and the kharif harvest, and the first advance estimates of farm output show foodgrain and oilseed production at 115 million tonnes (mt) and 17.3 mt, respectively. While these numbers show significant growth over FY10, they are still lower than the 118 mt and 17.8 mt, respectively, in FY09. This means the current growth has at best brought us back to the pre-drought level. The same holds for exports, which grew by more than 25% till November; but at $140 billion, was higher by just 3% over FY09.
At a different level, WPI inflation appears to be coming down, and the Reserve Bank of India’s target of 6% looks achievable by March. However, this is more because of the high base-year effect of FY10, when WPI climbed sharply during the November-March period. But month-on-month index numbers are still increasing even in the harvest period, while the inflation rate is coming down. The Consumer Price Index (CPI) inflation number, on the other hand, has shown an increase of 9.7% in October over 13.5% in 2009. How does one evaluate inflation then?
Second, the situation has been further obfuscated by adopting 2004-05 as the base year for WPI and gross domestic product (GDP). The WPI number has come down by 1 percentage point right away on doing this. The CPI, on the other hand, goes with a base of 2001 and a different set of goods, further queering the pitch for comparison. There is talk of the Index of Industrial Production (IIP) base also being aligned to the others. This makes sense, but perspectives could change and the current high numbers could become lower with the new base year.
Third, there is a logistics issue relating to revisions in numbers. The WPI is susceptible to changes, as is the IIP. In the last six months of 2010, the variation between the announced and revised IIP growth rates was 0.6-1.3%. Given that the numbers at times were of a low order, this could make a difference in interpretation. Even recent WPI numbers are susceptible to change, with an upward revision for September.
There are basically two policy implications here. The first is that data collection has to be made more robust. This is a challenge, given that 40-45% of the economy is unorganized. Farm prices are not homogeneous, while industry associations may not be reporting in time, making data collation difficult. Ideally, we need to elongate the data period, and can consider monthly numbers for even primary and fuel products.
Second, the focus of monetary policy has to change from “inflation rate” to “price level”, as the base-year effect cannot be eschewed. We have rarely had five successive years of high or steady industrial growth or inflation. This has led to a debate globally over whether the monetary authority should target inflation or the price levels. For example, if inflation is a target for RBI, should it be satisfied that the inflation rate is, say, 6% after 10.3% in March? The normal tendency during droughts is for prices to increase by 20-40%, and then drop by 20-30% to settle at a higher level than the pre-drought level. In such a case, has inflation really come down? As a corollary, should the monetary strings be loosened, assuming there is no latent inflation?
One way out is to actually compare the present with a moving average of the past two or three years. This will bring proper focus to policy, or else the targeted variables could be at variance from the ground situation. Also, the base-year changes must be synchronized and data released at the same time for easier comprehension. Above all, given the logistical challenge in an economy where a significant part is not organized, we should concentrate more on quality of data rather than frequency.
Tuesday, January 4, 2011
Of price rise, price wars and paradoxes: Financial Express: 31st december 2010
Lady Antebellum, Lady Gaga, Justin Beiber, Jay-Z, Eminem, Rihanna, etc, feature in the top 10 on the billboards. But what about our world of economics and finance, which has had some of the most amazing situations that need to be reminisced?
At number 10 was the crisis that came in just as we were ready to roll-back the stimulus. Lehman was in the past and several experts had already won their battles with their supercilious ‘I told you so’ phrase— Roubini, Rogoff, Reinhart, etc; and several others like Sorkin wrote books that made sound capital. But, then the Greece crisis came unexpectedly, which had us on our back foot, so to say, and while the wise ones warned of Ireland, Spain and Portugal, the Irish crisis was just a whimper and passed by like the idle wind.
At number 9 was the great revaluation of the yuan. No one quite believed it when it was announced just before the G20 meet. The idea was to placate other heads of state so that this subject would not be broached during the meet. And quite surely, the renminbi has remained unflappable—from 6.83 in January 2009 to 6.64 in December 2010, even though reserves have increased by $600 billion. Wonder why Indians got hassled by the rupee appreciation.
At 8 was the ecstasy over dollar inflows that dominated conference space. The concept of the Tobin tax came up and economists debated whether there should be physical controls as in Brazil and Thailand. One almost got a feeling that here was a country with excess dollars that could say its plate was full. Fortunately, RBI’s response was more mature and we are no longer talking of superfluous surpluses. The conference sponsors had won anyway!
At 7 was one of the most robust sub-economies in our country—the scam economy. The numbers involving the 2G auction, Adarsh, Commonwealth games, etc, just kept getting bigger and, at a conservative level, could be sized at least 5% of India’s GDP. Was this a Keynesian way of tackling the recession of FY09 and FY10 in FY11?
The confrontation with the regulator was at number 6. This time we had MCX-SX taking Sebi to court over what it felt was an injustice. This comes one year after the commodity space witnessed NCDEX take the FMC to court for coming in its way of interfering with its transaction charges, which would have affected the business of MCX! The Jalan Committee Report on ownership patterns of stock exchanges created a furor as it commented on the listing options for such entities as well. Surely, we will hear more of this in 2011.
At 5 was the stock market. The Sensex yo-yoed but no one got carried away with the 20,000 number. The past has taught us to be sanguine but not ecstatic and for a change the players did not overstate the case of India shining. The experts were cautious of suggesting an upside but never ruled out the downside of the slippage to 17-18,000. The market is surely mature today.
The paradox presented by interest rates was at 4. RBI kept increasing rates to combat inflation. Everyone applauded these moves as inflation came down, though prices remained high. Growth has been very buoyant with investment continuing to take place, thus questioning the thought that high interest rates dampen investment.
In third position is the fall from grace of MFIs. Once acclaimed to be a panacea for inclusiveness, the SKS IPO became a manifestation of its success. Then suddenly someone pointed out that the rates charged and techniques used were not good enough. Down came the shibboleth and now MFIs seem to have become apologetic about their own existence. In India, we always want free lunches, notwithstanding the so-called liberalisation that we talk of. At times politics scores over economics.
Close on the heels of MFIs came the airlines prices. Private airlines are making losses but an increase in fares by them has been interpreted as being anti-competitive. So we have another clampdown on free enterprise where prices have been lowered. This certainly takes the second position in our economic scenes for the year. Should the five star hotels now also watch out for some controls on their pricing?
The top most position is of course inflation. The high base year effect and change in base year, was meant to make the numbers look better. But the better numbers looked bitter, even while the bitter taste of sugar in 2009 was replaced with tears in our eyes as onions hit the Rs 80 mark in the retail market. Hence despite all the 8.8% growth numbers that we are being told about, the high price level does, as Bono of U2 would say—leave a bad taste in the mouth.
At number 10 was the crisis that came in just as we were ready to roll-back the stimulus. Lehman was in the past and several experts had already won their battles with their supercilious ‘I told you so’ phrase— Roubini, Rogoff, Reinhart, etc; and several others like Sorkin wrote books that made sound capital. But, then the Greece crisis came unexpectedly, which had us on our back foot, so to say, and while the wise ones warned of Ireland, Spain and Portugal, the Irish crisis was just a whimper and passed by like the idle wind.
At number 9 was the great revaluation of the yuan. No one quite believed it when it was announced just before the G20 meet. The idea was to placate other heads of state so that this subject would not be broached during the meet. And quite surely, the renminbi has remained unflappable—from 6.83 in January 2009 to 6.64 in December 2010, even though reserves have increased by $600 billion. Wonder why Indians got hassled by the rupee appreciation.
At 8 was the ecstasy over dollar inflows that dominated conference space. The concept of the Tobin tax came up and economists debated whether there should be physical controls as in Brazil and Thailand. One almost got a feeling that here was a country with excess dollars that could say its plate was full. Fortunately, RBI’s response was more mature and we are no longer talking of superfluous surpluses. The conference sponsors had won anyway!
At 7 was one of the most robust sub-economies in our country—the scam economy. The numbers involving the 2G auction, Adarsh, Commonwealth games, etc, just kept getting bigger and, at a conservative level, could be sized at least 5% of India’s GDP. Was this a Keynesian way of tackling the recession of FY09 and FY10 in FY11?
The confrontation with the regulator was at number 6. This time we had MCX-SX taking Sebi to court over what it felt was an injustice. This comes one year after the commodity space witnessed NCDEX take the FMC to court for coming in its way of interfering with its transaction charges, which would have affected the business of MCX! The Jalan Committee Report on ownership patterns of stock exchanges created a furor as it commented on the listing options for such entities as well. Surely, we will hear more of this in 2011.
At 5 was the stock market. The Sensex yo-yoed but no one got carried away with the 20,000 number. The past has taught us to be sanguine but not ecstatic and for a change the players did not overstate the case of India shining. The experts were cautious of suggesting an upside but never ruled out the downside of the slippage to 17-18,000. The market is surely mature today.
The paradox presented by interest rates was at 4. RBI kept increasing rates to combat inflation. Everyone applauded these moves as inflation came down, though prices remained high. Growth has been very buoyant with investment continuing to take place, thus questioning the thought that high interest rates dampen investment.
In third position is the fall from grace of MFIs. Once acclaimed to be a panacea for inclusiveness, the SKS IPO became a manifestation of its success. Then suddenly someone pointed out that the rates charged and techniques used were not good enough. Down came the shibboleth and now MFIs seem to have become apologetic about their own existence. In India, we always want free lunches, notwithstanding the so-called liberalisation that we talk of. At times politics scores over economics.
Close on the heels of MFIs came the airlines prices. Private airlines are making losses but an increase in fares by them has been interpreted as being anti-competitive. So we have another clampdown on free enterprise where prices have been lowered. This certainly takes the second position in our economic scenes for the year. Should the five star hotels now also watch out for some controls on their pricing?
The top most position is of course inflation. The high base year effect and change in base year, was meant to make the numbers look better. But the better numbers looked bitter, even while the bitter taste of sugar in 2009 was replaced with tears in our eyes as onions hit the Rs 80 mark in the retail market. Hence despite all the 8.8% growth numbers that we are being told about, the high price level does, as Bono of U2 would say—leave a bad taste in the mouth.
The Many Avatars Of Capitalism: Buisness World Book review of Capitalism 4.0
'Capitalism 4.0' documents the evolution of economic thought and capitalism in its various forms by combining macroeconomic theory with financial crises
Capitalism 4.0: The Birth Of A New Economy
By Anatole Kaletsky
Bloomsbury (Penguin)
The surest way to be taken seriously as an economist is to predict disaster, quips Anatole Kaletsky in Capitalism 4.0. But the economist-journalist does a lot more than doom-saying in this outstanding work. “All great financial crises begin with the belief that the world has changed forever. They end with the realisation that change was not what it seemed,” he begins the book with this prelude, and takes the reader through various stages of capitalism.
This work is full of optimism and spoils the fun of the still-surviving Marxists who saw the end of capitalism after Lehman. The odyssey goes through the evolution of economic thought and capitalism. There are chapters where he brings macroeconomic theory and explains how they shaped policy. The narration is brilliant, especially where it blends theory with crises.
The Austrian model would argue that when interest rates get low, investment surges and moves into low-quality assets such as sub-prime lending. John Maynard Keynes would say investment increases due to animal instincts, and when it falls, the correction is slow; so governments are needed like the bail outs. US economist Hyman Minsky’s theory would point to investor psychology leading to overconfidence and innovation to promote excess risk, leverage and debt. George Soros explained the crisis as the gap between our cognitive function, which understands reality and the manipulative function that tries to change it — a clash of reflexivity.
Kaletsky says the latest financial crisis came about not because of the greed of bankers or speculators, or the stupidity of regulators, but bad judgement of former US Treasury Secretary Henry Paulson. He jolts the reader when he says that talent is applicable to rock stars and Hollywood actors and not bankers.
Easy to read even for the novice, the book explains how each era of capitalism had its own economists and politicians. Adam Smith, David Ricardo, William Jevons and Léon Walras dominated Capitalism 1.0. Keynes ruled capitalism 2.0, supported by US Presidents Richard Nixon and Jimmy Carter. Capitalism 3.0 was (Milton) Friedman-dominated, with Margaret Thatcher and Ronald Reagan backing the wave; it was persevered by George W. Bush, Paulson and Alan Greenspan. This was also the phase of the Washington Consensus, which used a lot of mathematics and was governed by two theories: the rational expectations hypothesis (REH) and the efficient market hypothesis (EMH).
Rational expectations assumed governments do not work and that the Ricardian equivalence resulted when states spent more; consumers spent less. The EMH was full of math and led to high levels of leverage and depended equally on complex risk management models, which ultimately failed. The ultimate blow was that the models projected there was only 1-in-3-trillion-years a chance of such a crisis, when it had happened thrice in 20 years — 1987 (stock market), 1994 (bonds and currencies) and 1998 (LTCM).
Capitalism 4.0 works on the premise that economies are not static and that the relation between the state and the private sector is symbiotic. There are four key dangers for capitalism 4.0: rising government debt; financial paralysis as countries balance private requirements with state expenditure; trade imbalances as the US and the Euro region sort out contradictions through state intervention, while China and Japan rely on market forces; and stagflation caused by Opec, trade unions and protectionism. Kaletsky sees some interesting reconciliation taking place after the usual clash of ideologies in this brand of capitalism. Some of them are competition between the US and China, convergence between the US and Europe, rivalry between western and Asian values, working of businesses and government together, environment and growth, currencies and financial relations, prosperity without growth, natural resources and limits to growth, etc.
But, he admits, nothing about capitalism 4.0 would be rational or perfectly efficient or balanced, and the future will be unpredictable.
Finance ministers have to be dour and stodgy, while central bankers repeat the sadomasochistic catchphrase — I am paid to worry. This is a must read book for anyone who likes to smile when being serious.
Capitalism 4.0: The Birth Of A New Economy
By Anatole Kaletsky
Bloomsbury (Penguin)
The surest way to be taken seriously as an economist is to predict disaster, quips Anatole Kaletsky in Capitalism 4.0. But the economist-journalist does a lot more than doom-saying in this outstanding work. “All great financial crises begin with the belief that the world has changed forever. They end with the realisation that change was not what it seemed,” he begins the book with this prelude, and takes the reader through various stages of capitalism.
This work is full of optimism and spoils the fun of the still-surviving Marxists who saw the end of capitalism after Lehman. The odyssey goes through the evolution of economic thought and capitalism. There are chapters where he brings macroeconomic theory and explains how they shaped policy. The narration is brilliant, especially where it blends theory with crises.
The Austrian model would argue that when interest rates get low, investment surges and moves into low-quality assets such as sub-prime lending. John Maynard Keynes would say investment increases due to animal instincts, and when it falls, the correction is slow; so governments are needed like the bail outs. US economist Hyman Minsky’s theory would point to investor psychology leading to overconfidence and innovation to promote excess risk, leverage and debt. George Soros explained the crisis as the gap between our cognitive function, which understands reality and the manipulative function that tries to change it — a clash of reflexivity.
Kaletsky says the latest financial crisis came about not because of the greed of bankers or speculators, or the stupidity of regulators, but bad judgement of former US Treasury Secretary Henry Paulson. He jolts the reader when he says that talent is applicable to rock stars and Hollywood actors and not bankers.
Easy to read even for the novice, the book explains how each era of capitalism had its own economists and politicians. Adam Smith, David Ricardo, William Jevons and Léon Walras dominated Capitalism 1.0. Keynes ruled capitalism 2.0, supported by US Presidents Richard Nixon and Jimmy Carter. Capitalism 3.0 was (Milton) Friedman-dominated, with Margaret Thatcher and Ronald Reagan backing the wave; it was persevered by George W. Bush, Paulson and Alan Greenspan. This was also the phase of the Washington Consensus, which used a lot of mathematics and was governed by two theories: the rational expectations hypothesis (REH) and the efficient market hypothesis (EMH).
Rational expectations assumed governments do not work and that the Ricardian equivalence resulted when states spent more; consumers spent less. The EMH was full of math and led to high levels of leverage and depended equally on complex risk management models, which ultimately failed. The ultimate blow was that the models projected there was only 1-in-3-trillion-years a chance of such a crisis, when it had happened thrice in 20 years — 1987 (stock market), 1994 (bonds and currencies) and 1998 (LTCM).
Capitalism 4.0 works on the premise that economies are not static and that the relation between the state and the private sector is symbiotic. There are four key dangers for capitalism 4.0: rising government debt; financial paralysis as countries balance private requirements with state expenditure; trade imbalances as the US and the Euro region sort out contradictions through state intervention, while China and Japan rely on market forces; and stagflation caused by Opec, trade unions and protectionism. Kaletsky sees some interesting reconciliation taking place after the usual clash of ideologies in this brand of capitalism. Some of them are competition between the US and China, convergence between the US and Europe, rivalry between western and Asian values, working of businesses and government together, environment and growth, currencies and financial relations, prosperity without growth, natural resources and limits to growth, etc.
But, he admits, nothing about capitalism 4.0 would be rational or perfectly efficient or balanced, and the future will be unpredictable.
Finance ministers have to be dour and stodgy, while central bankers repeat the sadomasochistic catchphrase — I am paid to worry. This is a must read book for anyone who likes to smile when being serious.
Roti, Kapada aur Car: Autocar Professional December 2010
In the last five year, India’s per capita income has doubled from Rs 29,676 in FY05 to Rs 58,683 in FY10. In this same period, private final consumption increased by around 80 percent. At the same time, the production of cars has doubled from 10.47 lakh to 21.20 lakh.
Evidently, higher incomes are getting translated into demand for cars, which is probably one of the first striking signs of an economy on its feet. Those walking are on to a bicycle today while bicycle owners have graduated to two-wheelers, who in turn are owners of cars, with the Nano being the latest from the industry stable.
This resurgent demand for cars is a contrast to what we had in the 1980s when the Maruti 800 came on road, where only the cream of society had access to this luxury. Things have changed today, and higher incomes across all segments of society have contributed to this phenomenon where owning a car at times looks more like a necessity than a vanity. Nonetheless, the main economic factors driving this boom are the forces of demand and supply. Let us see the demand side first which has gone up for four reasons. The first is that man as a rule wants to ascend the ladder of living standards. Therefore, we are always in the mood to move up the consumption chain right from regular FMCG items to durable goods.
Owning a two-wheeler or car is probably the closest to what most people aspire for to begin with even while possessing a house is the ultimate goal. However, given that the housing prices have escalated for the middle class, it is still beyond the bank balances of most people and hence a vehicle is the first sign of conspicuous consumption that we are witnessing, keep mobile handsets aside.
The second is that the passenger cars industry has benefited immensely from the ‘Veblen’ effect, where we are always trying to keep up with the Joneses. This makes one migrate from a small to mid-size sedan to the more luxurious cars. The demonstration effect is manifested typically in middle class societies where people aspire to be what we may actually not be through the goods we consume. As this happens, those at the higher income levels maintain the distance by moving over to the luxury segment, thus keeping the class differentiation alive. This, in turn, has created a market for the cars, which have kept the manufacturers thinking and innovating. We, therefore, have multiple models coming from the factories of all manufacturers.
The third factor is that many jobs come with a company loan scheme which means that there is direct access to finance to buy the first real asset for an individual. An important factor here is higher incomes, where even entry level employees of banks earning something like Rs 25,000-30,000 a month can think of buying a car. At the higher level, jobs come with bigger cars which keeps demand ticking. This is a more recent phenomenon in urban areas which adds to the demand which traditionally came from the so called gifts given at the time of marriages.
Fourth, easy finance. Banks have been aggressive in lending for the purchase of automobiles where the repayment schedule is typically five years. This has helped individuals to actually take a loans of say Rs 4-5 lakh which can be repaid over five years depending on the person’s repayment ability. Today the interest rate structure is quite endearing with a single digit rate in the first year thane moves up with time linked to the base rates of banks. Easy bank finance has kept the demand for cars up over the years. The fact that interest rates were lowered by the RBI until the financial crisis set in, did make such loans cheap and which helped the industry.
On the supply side, carmakers have leveraged this boom and customised their vehicles to suit the requirements. While we have many international brands in India, they have kept introducing new models to suit every echelon and also made modifications in design and features to sell new products. This also causes people to shift their preferences and change their model with greater frequency than they would have, say, a decade back. Car prices have tended to be stable, if not come down under the force of competition at least for the mid-level cars.
For the luxury cars, the cost anyway does not matter and given the snob value, they can actually overcharge, as often the buyer is indulging in a brand. The same cannot be said about houses, as the cost of housing has risen sharply across all urban centers by between 20-100 percent over this period. Given that India’s growth story is real and here to stay, we can expect incomes to increase as new sets of people entering the spending stream. More importantly, the automobile industry on its own has the power to propel the economy as faster growth in this sector translates into higher demand for machines, metals including steel, plastic products and chemicals which will be critical going ahead. This in itself will maintain the boom in the industry calling for more players and models (products) as it becomes a virtuous cycle.
Evidently, higher incomes are getting translated into demand for cars, which is probably one of the first striking signs of an economy on its feet. Those walking are on to a bicycle today while bicycle owners have graduated to two-wheelers, who in turn are owners of cars, with the Nano being the latest from the industry stable.
This resurgent demand for cars is a contrast to what we had in the 1980s when the Maruti 800 came on road, where only the cream of society had access to this luxury. Things have changed today, and higher incomes across all segments of society have contributed to this phenomenon where owning a car at times looks more like a necessity than a vanity. Nonetheless, the main economic factors driving this boom are the forces of demand and supply. Let us see the demand side first which has gone up for four reasons. The first is that man as a rule wants to ascend the ladder of living standards. Therefore, we are always in the mood to move up the consumption chain right from regular FMCG items to durable goods.
Owning a two-wheeler or car is probably the closest to what most people aspire for to begin with even while possessing a house is the ultimate goal. However, given that the housing prices have escalated for the middle class, it is still beyond the bank balances of most people and hence a vehicle is the first sign of conspicuous consumption that we are witnessing, keep mobile handsets aside.
The second is that the passenger cars industry has benefited immensely from the ‘Veblen’ effect, where we are always trying to keep up with the Joneses. This makes one migrate from a small to mid-size sedan to the more luxurious cars. The demonstration effect is manifested typically in middle class societies where people aspire to be what we may actually not be through the goods we consume. As this happens, those at the higher income levels maintain the distance by moving over to the luxury segment, thus keeping the class differentiation alive. This, in turn, has created a market for the cars, which have kept the manufacturers thinking and innovating. We, therefore, have multiple models coming from the factories of all manufacturers.
The third factor is that many jobs come with a company loan scheme which means that there is direct access to finance to buy the first real asset for an individual. An important factor here is higher incomes, where even entry level employees of banks earning something like Rs 25,000-30,000 a month can think of buying a car. At the higher level, jobs come with bigger cars which keeps demand ticking. This is a more recent phenomenon in urban areas which adds to the demand which traditionally came from the so called gifts given at the time of marriages.
Fourth, easy finance. Banks have been aggressive in lending for the purchase of automobiles where the repayment schedule is typically five years. This has helped individuals to actually take a loans of say Rs 4-5 lakh which can be repaid over five years depending on the person’s repayment ability. Today the interest rate structure is quite endearing with a single digit rate in the first year thane moves up with time linked to the base rates of banks. Easy bank finance has kept the demand for cars up over the years. The fact that interest rates were lowered by the RBI until the financial crisis set in, did make such loans cheap and which helped the industry.
On the supply side, carmakers have leveraged this boom and customised their vehicles to suit the requirements. While we have many international brands in India, they have kept introducing new models to suit every echelon and also made modifications in design and features to sell new products. This also causes people to shift their preferences and change their model with greater frequency than they would have, say, a decade back. Car prices have tended to be stable, if not come down under the force of competition at least for the mid-level cars.
For the luxury cars, the cost anyway does not matter and given the snob value, they can actually overcharge, as often the buyer is indulging in a brand. The same cannot be said about houses, as the cost of housing has risen sharply across all urban centers by between 20-100 percent over this period. Given that India’s growth story is real and here to stay, we can expect incomes to increase as new sets of people entering the spending stream. More importantly, the automobile industry on its own has the power to propel the economy as faster growth in this sector translates into higher demand for machines, metals including steel, plastic products and chemicals which will be critical going ahead. This in itself will maintain the boom in the industry calling for more players and models (products) as it becomes a virtuous cycle.
Rates rise due to fiscal deficits? Economic Times 23rd Dcember 2010
A working paper brought out by the IMF titled, “Fiscal Deficits, Public debt and Sovereign bond yields” authored by Emanuele Baldacci and Manmohan S Kumar , examines the relationship between fiscal deficits and interest rates in 31 countries and concludes that higher deficits and government debt increase sovereign yields, thus imparting an upward thrust to interest rates. Does this theory hold in India ??
Ever since Fiscal Responsibility and Budget Management (FRBM) rules were enforced, the fiscal deficit has become a priority. However, since fiscal year 2005, fiscal deficits have been rising quite prodigiously. It has accelerated in the last three years, necessitating larger borrowings by the government. The financial crisis further necessitated a stimulus package, which exacerbated these imbalances. It is projected to cross Rs lakh core this year.
But, curiously, the impact on interest rates has been quite different from what was expected. The average cost of raising fresh funds for the government increased up to fiscal year 2008 when issuance of paper was `1.88 lakh crore, but then came down in the next two years even as borrowings more than doubled. The accompanying table shows that the cost of fresh borrowing has actually gone below the level of fiscal year 2006 when borrowing was less than 40% of that in fiscal year 2010. Clearly, the government has been able to borrow at a lower cost. The same trends are reflected in the secondary market, too. But, what about the private sector?
The average lending rates of banks (as denoted ex post by the return on loans outstanding) have been increasing over time, but accelerated after fiscal 2009 even when the cost of borrowing fell for the government. Simultaneously, the corporate spreads have shown an increase since fiscal 2007. In fiscal 2010, the spread between government and commercial borrowing widened to 527 basis points. The cost of deposits has also increased albeit more gradually.
Therefore, two conclusions can be drawn here. The first is that the government is able to borrow money from the market at a cheaper rate than borrowers from banks. This has also contributed to increasing the spread for corporates. The second is that deposit holders on an average get a return that is lower than what the government pays on its borrowing. This means that if the same money was put in GSecs, which have limited liquidity, the returns would be better. Banks, in fact, do make up for lower yields on GSecs by charging higher rates to borrowers.
Can the government be held responsible for this structure of interest rates? The answer is yes and no. The ratio of incremental credit to fresh GSecs issues has declined over time, which is a concern as it shows that there could have been a crowding out of the private sector. But, this comes with a caveat insofar as that higher allocation of bank funds to the government is voluntary as their investment deposit ratio is over 30%, which is higher than what is mandated. This implies that if credit has not increased commensurately, there are other reasons such as economic slowdown of the recent times or greater prudence exercised by banks in accordance with the RBI/Basel recommendations.
Also, that the credit-deposit ratio has remained high (above 70% in last five years) means that the RBI has actually paved the way for the borrowing programme without creating a funds crunch. It has used open market operations (OMOs), a process by which it buys securities for banks, to provide liquidity in times of stress.
The increase in interest rates can be partly attributed to policy changes. Banks too have been altering their rates to balance their net funds to reflect the cost. At another level, most banks have announced base rates in the range of 7-8%, allowing the government to borrow at this rate, while ensuring a minimum return on capital for themselves. But, the gap between cost of deposits and the government rate has narrowed, thus making banks recoup this difference (from 300 basis points in fiscal 2007 to 63 basis points in fiscal 2010) on commercial lending.
Therefore, there are three takeaways from this discussion. First, higher borrowings do not increase sovereign yields, which, on the contrary, show downward proclivities. Second, the RBI has ensured that there is no physical crowding out of the commercial sector from credit on account of this phenomenon through astute liquidity management through OMOs and phasing of auctions.
Lastly, commercial lending rates have certainly increased sharply due to higher cost of deposits, regulatory compliance (capital adequacy and provisioning), and maybe higher rent seeking — but less due to government borrowing .
Ever since Fiscal Responsibility and Budget Management (FRBM) rules were enforced, the fiscal deficit has become a priority. However, since fiscal year 2005, fiscal deficits have been rising quite prodigiously. It has accelerated in the last three years, necessitating larger borrowings by the government. The financial crisis further necessitated a stimulus package, which exacerbated these imbalances. It is projected to cross Rs lakh core this year.
But, curiously, the impact on interest rates has been quite different from what was expected. The average cost of raising fresh funds for the government increased up to fiscal year 2008 when issuance of paper was `1.88 lakh crore, but then came down in the next two years even as borrowings more than doubled. The accompanying table shows that the cost of fresh borrowing has actually gone below the level of fiscal year 2006 when borrowing was less than 40% of that in fiscal year 2010. Clearly, the government has been able to borrow at a lower cost. The same trends are reflected in the secondary market, too. But, what about the private sector?
The average lending rates of banks (as denoted ex post by the return on loans outstanding) have been increasing over time, but accelerated after fiscal 2009 even when the cost of borrowing fell for the government. Simultaneously, the corporate spreads have shown an increase since fiscal 2007. In fiscal 2010, the spread between government and commercial borrowing widened to 527 basis points. The cost of deposits has also increased albeit more gradually.
Therefore, two conclusions can be drawn here. The first is that the government is able to borrow money from the market at a cheaper rate than borrowers from banks. This has also contributed to increasing the spread for corporates. The second is that deposit holders on an average get a return that is lower than what the government pays on its borrowing. This means that if the same money was put in GSecs, which have limited liquidity, the returns would be better. Banks, in fact, do make up for lower yields on GSecs by charging higher rates to borrowers.
Can the government be held responsible for this structure of interest rates? The answer is yes and no. The ratio of incremental credit to fresh GSecs issues has declined over time, which is a concern as it shows that there could have been a crowding out of the private sector. But, this comes with a caveat insofar as that higher allocation of bank funds to the government is voluntary as their investment deposit ratio is over 30%, which is higher than what is mandated. This implies that if credit has not increased commensurately, there are other reasons such as economic slowdown of the recent times or greater prudence exercised by banks in accordance with the RBI/Basel recommendations.
Also, that the credit-deposit ratio has remained high (above 70% in last five years) means that the RBI has actually paved the way for the borrowing programme without creating a funds crunch. It has used open market operations (OMOs), a process by which it buys securities for banks, to provide liquidity in times of stress.
The increase in interest rates can be partly attributed to policy changes. Banks too have been altering their rates to balance their net funds to reflect the cost. At another level, most banks have announced base rates in the range of 7-8%, allowing the government to borrow at this rate, while ensuring a minimum return on capital for themselves. But, the gap between cost of deposits and the government rate has narrowed, thus making banks recoup this difference (from 300 basis points in fiscal 2007 to 63 basis points in fiscal 2010) on commercial lending.
Therefore, there are three takeaways from this discussion. First, higher borrowings do not increase sovereign yields, which, on the contrary, show downward proclivities. Second, the RBI has ensured that there is no physical crowding out of the commercial sector from credit on account of this phenomenon through astute liquidity management through OMOs and phasing of auctions.
Lastly, commercial lending rates have certainly increased sharply due to higher cost of deposits, regulatory compliance (capital adequacy and provisioning), and maybe higher rent seeking — but less due to government borrowing .
A breather from RBI: Financial Express: 18th December 2010
Market expectations are normally self-fulfilling. So was it with the monetary policy announced, when the market expected that nothing will happen, and quite surely, nothing did. At least for the repo/reverse repo and CRR there were no surprises. This neutral stance of RBI does raise some interesting issues.
If one goes back to the last three policies, including this one, economic conditions have been quite unchanged. From September, WPI has come down while the economy has been doing well in terms of IIP and GDP growth. This was the case of supply bottlenecks being released as well as strong economic growth tendencies being displayed at the same time. Yet, RBI persisted with rate hikes in two policies, and an unchanged stance in the recent one. In fact, the policy came just after the weekly WPI came as a shocker with food inflation rate rising for the fourth week in a row when the base year effect was already high as well as harvest coming in. In a way, a rate hike at this time would be more compelling as food inflation has been increasing and month on month index numbers are on the rise.
If one were to interpret the RBI stance, it can be concluded that it was giving a break to the system from the series of interest rate hikes, before probably reviewing the situation in January. Inflation is on the rise on the demand side and today there is some scepticism of inflation coming down as price levels remain elevated in the market place. This has kept inflationary expectations high even though the number appears to be lower, which is more on account of the base effect.
How RBI addressed the liquidity issue is also interesting. We have a situation where bank credit is growing faster than deposits. Incremental deposits available for financing credit are low, which contributes to the liquidity problem. Deposits are not growing for a variety of reasons. To begin with, real deposit rates continue to be in the negative zone (going by the CPI). The stock market offers better enticement for those with risk appetite. Further, high inflation has led to more hoarding of currency— the increase in holding of currency has been Rs 103,864 crore compared with Rs 58,166 crore last year during the same period. This normally happens when the cost of living increases.
Also, incremental deposits have been whimsical given that the several IPOs, especially of PSUs, have led to the blockage of funds with oversubscription of these issues. To top it all, the government is not spending the money it collected form the 3G auctions, which would have come back into the system partly in the form of deposits. Hence, there has been hoarding of money at this end too.
Would such a liquidity situation be called transient or more permanent? We have had RBI lending around Rs 1 lakh crore through the repo window on a consistent basis since October. RBI had waived the penalty on non-maintenance of the SLR as well as undertaken buy back of securities from banks, but with mixed success. Under these circumstances, it does appear that the liquidity issue is more on the structural side since the situation on the deposits side is going to continue to prevail in a similar manner for the rest of the year with another Rs 20,000 crore of disinvestment in the offing. Therefore, CRR cut would have been in order, to release between Rs 25-50,000 crore through a cut of 50-100 bps. Given that the investment deposit ratio for the system is already 30.6%, a 1% cut in SLR will affect only those banks which are on the fringe of 25% SLR today.
But, RBI’s dependence on the OMO route suggests that it expects the situation to improve. The day of the credit policy saw the two LAFs provide around Rs 145,000 crore to banks, which does show the severity of the issue, though admittedly, this pressure will ease once the advance tax payments flow back to the system. To conclude, it may be said that RBI has evidently paused to assess the situation later in January before reviewing its options after taking an informed call on the permanency or transience of liquidity and inflation.
If one goes back to the last three policies, including this one, economic conditions have been quite unchanged. From September, WPI has come down while the economy has been doing well in terms of IIP and GDP growth. This was the case of supply bottlenecks being released as well as strong economic growth tendencies being displayed at the same time. Yet, RBI persisted with rate hikes in two policies, and an unchanged stance in the recent one. In fact, the policy came just after the weekly WPI came as a shocker with food inflation rate rising for the fourth week in a row when the base year effect was already high as well as harvest coming in. In a way, a rate hike at this time would be more compelling as food inflation has been increasing and month on month index numbers are on the rise.
If one were to interpret the RBI stance, it can be concluded that it was giving a break to the system from the series of interest rate hikes, before probably reviewing the situation in January. Inflation is on the rise on the demand side and today there is some scepticism of inflation coming down as price levels remain elevated in the market place. This has kept inflationary expectations high even though the number appears to be lower, which is more on account of the base effect.
How RBI addressed the liquidity issue is also interesting. We have a situation where bank credit is growing faster than deposits. Incremental deposits available for financing credit are low, which contributes to the liquidity problem. Deposits are not growing for a variety of reasons. To begin with, real deposit rates continue to be in the negative zone (going by the CPI). The stock market offers better enticement for those with risk appetite. Further, high inflation has led to more hoarding of currency— the increase in holding of currency has been Rs 103,864 crore compared with Rs 58,166 crore last year during the same period. This normally happens when the cost of living increases.
Also, incremental deposits have been whimsical given that the several IPOs, especially of PSUs, have led to the blockage of funds with oversubscription of these issues. To top it all, the government is not spending the money it collected form the 3G auctions, which would have come back into the system partly in the form of deposits. Hence, there has been hoarding of money at this end too.
Would such a liquidity situation be called transient or more permanent? We have had RBI lending around Rs 1 lakh crore through the repo window on a consistent basis since October. RBI had waived the penalty on non-maintenance of the SLR as well as undertaken buy back of securities from banks, but with mixed success. Under these circumstances, it does appear that the liquidity issue is more on the structural side since the situation on the deposits side is going to continue to prevail in a similar manner for the rest of the year with another Rs 20,000 crore of disinvestment in the offing. Therefore, CRR cut would have been in order, to release between Rs 25-50,000 crore through a cut of 50-100 bps. Given that the investment deposit ratio for the system is already 30.6%, a 1% cut in SLR will affect only those banks which are on the fringe of 25% SLR today.
But, RBI’s dependence on the OMO route suggests that it expects the situation to improve. The day of the credit policy saw the two LAFs provide around Rs 145,000 crore to banks, which does show the severity of the issue, though admittedly, this pressure will ease once the advance tax payments flow back to the system. To conclude, it may be said that RBI has evidently paused to assess the situation later in January before reviewing its options after taking an informed call on the permanency or transience of liquidity and inflation.
Marriage mart is just like a job market: 30th October 2010: DNA
Economic theories are known for three stylised facets: they start with unrealistic assumptions, yet come up with rudimentary conclusions, which ironically have profound implications. The reader will feel the same when going through the basic work of the Nobel Prize winning economists this year: Peter Diamond, Dale Mortensen and Christopher Pissarides. The trio have been developing theories in what can be called ‘search
economics’. What is this all about?
Today, the labour market is quite typical of a ‘search market’ where there are disconnections between those who are looking for jobs and those offering them. This leads to anomalous situations where there is unemployment in the midst of several job vacancies. Why should this be so?
To begin with, there is an information asymmetry where those seeking jobs are not aware of the opportunities. Secondly, labour is not homogeneous and the skillsets and experience lead to complex mapping of available jobs where qualifications matter.
Third, even when skillsets match labour, they are not always mobile across geographies. Fourth, assuming all these factors are taken care of, the search would continue when recruiters have preconceived preferences — convent educated or top B-Schools.
Lastly, there is the issue of remuneration where both sides have their own expectations.
Further, in developed countries, where unemployment benefits
exist, there would be the tendency for the duration of unemployment to get dilated and people may not recognise their status of being unemployed. This gets reversed only when the benefits are exhausted.
How is this asymmetry bridged? Today we have advertisements,
recruitment firms and employment agencies that address the requirements of the organised sector. At the entry and middle levels, advertisements work. In fact, they are mandatory when it comes to government recruitment. At the higher level, it is the recruitment firms which fill the gap. However, there could still be information lacunae as there is no way that all job consultants put together can find all the recruiters as well as those seeking better jobs.
The ‘search theory’ has some relevance to ‘the mating game’. Mortensen felt that it takes time to meet a partner and to learn the uncertain value of any partnership. There will always be a mismatch of those looking for a partner but not finding one — which explains the large number of unmarried men and women. If one excludes marriages where the partners fall in love and marry, then the search game goes on in an analogous manner. People never know that the right partner exists somewhere.
Advertisements and dating portals do the matching but one could still end up with a sub-optimal match.
Besides, dating seldom reveals the true person as the partners are on their best behaviours. Hence, search models do not rule out the possibility of good matches that could end in separation later.
In 2001, Akerlof, Spence and Stiglitz won the Nobel for their work in a similar field of imperfect markets with information asymmetry. Akerlof had the classic case of a market for lemons, or second hand cars. Sellers always know how good their product is while buyers aren’t sure. So they always go by the lowest price and hence even good cars have to go at a lower price, thus justifying the premise that all lemons are lemons.
Signalling was the solution here, wherein one advertises the special attributes, or the vehicle is marketed by a respectable agency. The study of imperfect markets surely is a way to the top!
This holds in the labour market too where employees may actually opt for the wrong job, based on high pay and take on a job where the content may not be too exciting. This would hold for houses where buyers may not get the best deal and will never know the sand content in walls. But, more interesting is the search solution for matrimony, where both sides could assume the role of dealer of the proverbial lemon until their honeymoon ends!
economics’. What is this all about?
Today, the labour market is quite typical of a ‘search market’ where there are disconnections between those who are looking for jobs and those offering them. This leads to anomalous situations where there is unemployment in the midst of several job vacancies. Why should this be so?
To begin with, there is an information asymmetry where those seeking jobs are not aware of the opportunities. Secondly, labour is not homogeneous and the skillsets and experience lead to complex mapping of available jobs where qualifications matter.
Third, even when skillsets match labour, they are not always mobile across geographies. Fourth, assuming all these factors are taken care of, the search would continue when recruiters have preconceived preferences — convent educated or top B-Schools.
Lastly, there is the issue of remuneration where both sides have their own expectations.
Further, in developed countries, where unemployment benefits
exist, there would be the tendency for the duration of unemployment to get dilated and people may not recognise their status of being unemployed. This gets reversed only when the benefits are exhausted.
How is this asymmetry bridged? Today we have advertisements,
recruitment firms and employment agencies that address the requirements of the organised sector. At the entry and middle levels, advertisements work. In fact, they are mandatory when it comes to government recruitment. At the higher level, it is the recruitment firms which fill the gap. However, there could still be information lacunae as there is no way that all job consultants put together can find all the recruiters as well as those seeking better jobs.
The ‘search theory’ has some relevance to ‘the mating game’. Mortensen felt that it takes time to meet a partner and to learn the uncertain value of any partnership. There will always be a mismatch of those looking for a partner but not finding one — which explains the large number of unmarried men and women. If one excludes marriages where the partners fall in love and marry, then the search game goes on in an analogous manner. People never know that the right partner exists somewhere.
Advertisements and dating portals do the matching but one could still end up with a sub-optimal match.
Besides, dating seldom reveals the true person as the partners are on their best behaviours. Hence, search models do not rule out the possibility of good matches that could end in separation later.
In 2001, Akerlof, Spence and Stiglitz won the Nobel for their work in a similar field of imperfect markets with information asymmetry. Akerlof had the classic case of a market for lemons, or second hand cars. Sellers always know how good their product is while buyers aren’t sure. So they always go by the lowest price and hence even good cars have to go at a lower price, thus justifying the premise that all lemons are lemons.
Signalling was the solution here, wherein one advertises the special attributes, or the vehicle is marketed by a respectable agency. The study of imperfect markets surely is a way to the top!
This holds in the labour market too where employees may actually opt for the wrong job, based on high pay and take on a job where the content may not be too exciting. This would hold for houses where buyers may not get the best deal and will never know the sand content in walls. But, more interesting is the search solution for matrimony, where both sides could assume the role of dealer of the proverbial lemon until their honeymoon ends!
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