Getting the diesel pricing right this time : Financial Express 18th January 2013

While hike in diesel prices will help lower losses of OMCs and fiscal deficit, the timing is important for inflation and rate cuts

The move to partially deregulate diesel prices has had an important announcement effect with the market spooking upwards. There can be nothing fundamentally incorrect about this move to make the price market-oriented, and the two questions that need to be asked are whether companies will increase prices and to what extent? With the fiscal deficit under strain and the next Union Budget to be critical in terms of providing future direction to the economy, this move is quite appropriate, as something seriously needs to be done to control the petroleum subsidy bill and hence the viability of the OMCs. The issues here are three-fold: pricing per se, fiscal deficit and inflation.
The current under-recovery on diesel is quite high at R9.6/litre. This needs to be brought down. The overall under-recovery on this bill has been around R53,000 crore for the first half of the year, which is around 60% of the total under-recovery on the fuel account. The justification of providing a subsidy is based on the use of this fuel by farmers. With the direct cash transfer concept catching on, it would be easier to charge market rates for diesel, and subsidise farmers directly through cash transfer. As the other users can afford to pay the market price, vehicle owners as well as power generators can be made to get market-oriented, though the issue of inflation would still have to be addressed.
The related question is how will prices move up? Will it be a big increase of, say, R5/litre, as was done last time, or a gradual one? Ideally, a gradual increase makes sense as it is easier to absorb and does not come as a shock. Therefore, incremental prices of, say, R0.5-1 would be easier to take in on a more frequent basis until such time that the gap is closed.
The fiscal deficit is the second element which is being addressed here. For this year, the petroleum subsidy has been targeted at around R45,000 crore. Last year, out of the total under-recovery of close to R1.38 lakh crore, around 60% was taken on by the government through the subsidy while the rest was borne by the upstream companies. Assuming that the current level of R85,000 crore of under-recovery for the first half of the year doubles to R1.7 lakh crore, the subsidy level would be close to R1 lakh crore, or more than double of what has been projected. This is a scary number and the FM would be pleased to cut this down considering that there have been pressures on the LPG and kerosene ends. By raising the diesel prices, one part of the subsidy bill could be addressed.
Quite clearly, this approach would be more critical from next year onwards, as there is little that can be done for the next two months or so when the financial year ends.
Third, inflationary impact of a diesel price hike is critical. With the under-recovery of R9.6/litre, the overall future correction would be around 20% over a period of time depending on the phasing of this increase. Diesel has a weight of 4.8% in the WPI and, using the thumb rule of indirect weight being another 50% of the original, the total weight is close to 7%. Intuitively raising the price by 20% means an inflationary impact of around 1.4-1.5% on a point-to-point basis. This is where the phasing of the price increases comes in. If done gradually, it would not get reflected immediately and can get absorbed in the system, given price fluctuations of commodities. The impact on retail inflation would be higher as it comes in both directly and indirectly as price of transportation increases. Railway fares have already been hiked and higher diesel prices will add to the retail prices of derived and user products (public transport). But, this is inevitable and we really have a tradeoff between getting the fiscal balances and viability of OMCs right against higher inflation. By spreading these increases in price, the pain can be alleviated to an extent.
This brings the discussion on the timing of these price increases. While the quantum may be in bits and pieces, the timing is important. Today WPI inflation is 7.2% and CPI inflation 10.6%. Increasing the prices currently could just add to inflationary expectations that RBI would be looking at closely, as there is debate on whether the central bank will lower interest rates later this month given that inflation is getting tempered. Such rate actions could get pushed forward.
The other thought on this move relates to who will take this decision? The OMCs are government-owned and, therefore, even if they wish to increase the price by, say, R5/litre, the ministry of petroleum and the ministry of finance will actually have the final say. Thus, there is reason to believe that the deregulation moves by the OMCs would not be in a hurry and will be done on due consultation with the relevant authorities.
Given that the government is keen on controlling this subsidy bill and that it is willing to increase prices of petroleum products, a thought that comes to mind is that the government should ideally follow a strict budget when it comes to petroleum subsidy. As the subsidy for the three products is known in advance and budgeted, it should ideally be apportioned across 12 months so that the allocations are fixed. The subsidy can be provided until this amount is exhausted, after which prices should be revised so that a price-rationing system is created. This way, the subsidy level, which is required in a society where lots of people do require such assistance, is provided but not breached. While this may not be easy to implement, a beginning is worth trying, as one cannot really lose in this scheme.

Don't expect any good IIP numbers: Business Standard 11th January 2013

The industrial growth numbers for the year have progressively become an academic exercise and while at times there appear to be signs of green shoots sprouting, it is morose for most of the other months. The fact is that there is not much happening in this space and growth rates of 8.2% in October or -0.1% on November are more statistical images rather than a reflection of real industrial activity.
The busy or festival season was one hope for us as this was the time when it was expected that people would spend money which would translate to higher industrial growth. The higher number in October was more on account of Diwali stretching into November which led to higher production in certain segments. One did not expect a replication of the same in case such spending was sustained. The present numbers for November don't really surprise. Automobiles, white goods, electronics are still largely lackluster and there is little investment taking place. Earlier it was only the electrical machinery segment that was down, but now it seems to have covered even the non electrical segment. Clearly, both consumption and investment have taken a back seat this year.

While there is a tendency to point towards interest rates, it explains at best only a part of the story. People are not spending partly due to high retail inflation which is causing more income to be diverted to food items. Investment is not taking place as we still have surplus capacity and no one is going in for expansion as interest rates are high. Infra projects are stuck due to policy issues. The government is not spending due to fiscal concerns. Exports are not rising because the world economy is in a downward phase.

The basic industries including some of our infra industries have done relatively better as cement and steel have seen some positive growth signs. But it is not clear if this momentum can be maintained in the remaining months. By itself this sector cannot propel growth as consumer and capital goods have to be the starting points.

Also the mining-electricity sector nexus is getting a bit pronounced. We have gotten away with reasonable power sector growth at a time when coal production declined in FY12. But this year we have seen that the electricity sector has shown signs of faltering. We clearly need to get our acts for mining (sort out the environment issues), as well as complete the power projects and make our SEBs financially viable or the entire edifice will be in jeopardy in future.

Given the disparate impact of statistical base effects being positive or negative we may just get away with growth of 2-3% this year which will be a consolation of something happening in the absence of any affirmative factor. It is a warning that it could be a status quo next year in case we do not get the house in order. While it is true that things have bottomed out, we cannot take a recovery for granted and it could become a more pronounced U shape future recovery curve with the trough getting elongated. Several things need to happen. Inflation should come down so that rates are lowered. Government should focus more on development expenditure. People should start spending and with administrative hindrances out of the way, investment should recommence.

As one may not expect anything significant to happen in the next few months with probably only a token rate cut at the end of this month, the best that can happen is that industrial growth will not slip into the negative zone, as it has done in November.

How to stop the gold rush Financial Express January 10, 2013

The issue of control of gold imports has once again come to the forefront, especially after the recent current account deficit numbers showed some disturbing trends. India accounts for around a quarter of global gold consumption. RBI has brought out another lengthy discussion paper on how one can control gold imports. A number of measures have been recommended and the report actually covers all options.

Gold has a very important place in Indian society and is consumed by even the poorer classes. It is held for the purpose of security as well as vanity. This point should be considered whenever we look at options for lowering demand for gold. These factors explain as to why India’s demand for gold kept increasing last year, even when the rupee had fallen by over 20%, which had pushed up the domestic price. Quite evidently, while we do look at ex-post factors that could have affected demand for gold like the underlying being a very good investment option, this could not be the driving force for such demand. Yes, there certainly is a class of people who buy gold for investment purpose, but they do not actually sell it when the price goes up--much like property, where individuals own multiple dwellings for creating assets that are rarely sold. If there is agreement on these factors, then some of the recommendations made by RBI can be examined.
RBI talks of gold deposits, accumulation and pension schemes. Will people really come forward and deposit their gold and take it back after say 5 or 10 years? If it is held for security or vanity, then this will not happen. Also, most gold held by households could be in the form of jewellery and not coins especially in rural areas, which makes such a scheme a non-starter as the individual would expect the same to be returned at the end of the tenure. If the idea is to churn this gold for meeting further demand, then the scheme may not work.
Earning interest on such deposits can be a valid temptation. But then the problem rolls over to the banks. They can recycle the gold, if it is not jewellery. But then what about the price and exchange risk which will come into play at the time of maturity? Also, in the terminal year, there could be a bunching of gold that will create problems for banks and the economy, as the country may have to import large quantities for paying back the deposit holders.
Banks have to necessarily hedge on futures exchanges to cover themselves, which involves a cost. If banks cannot participate in futures trading today, how will they cover themselves? Therefore, any move to collect gold and recycle it will only mean deferring the problem for a future date even if the process works out. In fact, any sharp increase in the price of gold in international markets will cause a run on banks for return on gold deposits, which will not be very pleasant for them. Right now, the price is in the range of $1,700/ounce and the expectations are that it would move over towards the $2,000 mark depending on how long the dollar takes to stabilise given the current account deficit of the US. With an annual return of between 10-15% on gold, this may not be far off.
A way out is to dissuade the import of gold through higher tariffs or quantitative restrictions. The former is being contemplated; it worked in early 2012. Last year, the landed cost rose on account of both rupee depreciation as well as tariffs. Today, with the rupee largely stable between R53-55 per dollar, the exchange effect would be lower and a higher duty will be required to bring about any impact on demand. Quotas are outdated but could be more effective if we go back to the old license raj days. But any such restrictions bring in a black market which will also mean tightening up the forex regulations which have been opened up on the current account.
Another option is to encourage investors, who are buying physical gold, to go in for commodity futures because this way they can reap the benefits of gold price changes without going in for physical holdings. Exchanges like MCX and NCDEX offer such contracts, which can be provided with certain benefits such as trading charges to ensure that they become more attractive for investors. Contracts in longer tenures should be made liquid, as presently the main interest is in contracts up to three months. But what about ETFs? They do physically hold on to gold that can be demanded by investors. Globally, too, ETFs have contributed to the demand for gold in recent years. Should we stop such funds from coming up? This is a difficult question to answer in the present circumstances.
Gold loans are popular today among NBFCs. An idea that comes up is whether such loans should be done away with. If done, then holders will see less use of gold. Today, one invests in gold and takes a loan for liquidity knowing well that it can be gotten back with the investment value intact. In fact, with appreciation a near certainty in the medium run, the return of 15% per annum could well compensate for the cost of the loan being taken from the financial institution. Therefore, by not allowing finance against gold, the value could be dented. This is contrary to what RBI is espousing on encouraging such loans with prudential regulation to enable rural folk to get loans.
There are clearly few easy solutions here and higher tariffs appear the best way out, if it works. All other ideas appear to be fairly lengthy to work out and may not elicit the required response. Given its ‘tradition’ value in Indian society, people will not willingly give up buying gold even when the price rises, which was evident last year. This is the real entrance to the maze.

Underrating a triple-A story Business Standard 4th January 2013

The story of India's pioneer rating agency Crisil underplays the issues it faced in its development
Biographical books on companies are invariably written to either eulogise the institution or chronicle events to create a compilation. Doing What is Right: The CRISIL Story does more of the first and less of the second.

The authors, Hemanth Gorur and Sumit Chowdhury, have tried to make an otherwise steady story exciting, but have fallen short with some omissions that could have strengthened the narrative. Even with endorsements from the likes of Chanda Kochhar, Ishaat Hussain, Rakesh Jhunjhunwala and Madhusudan Kela, the authors have not exactly been able to make the story engaging for a reader who is not familiar with the financial world. Names of employees who have been part of this adventure may not mean much to the layman. Besides, the authors tend to iconise two leaders, Pradeep Shah and Ravimohan. This puts the rest in the shadow, which cannot be the case for a well-established successful organisation that has some of the best minds in the industry.

The concept of Crisil goes back to the eighties, when the idea originated in the mind of N Vaghul of ICICI Limited. Mr Shah took it forward and, despite the uncertain nature of the concept of rating, created a market for it with admirable success. When it started, the industry was monopolistic for about four years. The authors, however, do not look at the early mover advantage that Crisil had in a sticky business where clients typically tend to remain with one agency. Moreover, though the role played by regulation in furthering the rating business was critical, it has been missed out here — both the Securities and Exchange Board of India and the Reserve Bank of India have played their part by making rating mandatory at different points of time. But Crisil has always been willing to experiment and innovate, despite its share of setbacks — it did not quite get it right in terms of its acquisition of EconoMatters, its transfer-pricing venture and healthcare ratings.

It is interesting to read about Crisil’s culture of free-flowing ideas in the rating committee meetings, which is imperative in any rating agency if independence of thought is to be maintained. Juniors and seniors mingle on a similar platform when it comes to ratings discussions, which has been a hallmark of the organisation. However, the story would have been enhanced if the authors had debated why Crisil opted for a rating committee that had only internal experts, unlike an external committee that it had earlier. While there is merit in having an internal committee, the idea of conflict of opinion does come up for debate often.

Rating agencies actually have no stake in their ratings; what works is the “credibility factor”, which is a necessity in this business since the worth of a rating is the acceptance by the investor, which is the lender. The ratings have to perforce be good. Since their role is “making markets function better”, the product – that is, ratings – has to be unbiased if market acceptance is to be obtained. Therefore, Crisil has always stood for selling credibility.

Curiously, as the authors point out, Crisil has now grown to be more of a research and analytics firm that does ratings rather than a rating agency that does analytics; more than half the business comes from the former. The Irevna-Pipal acquisitions have been largely successful, as was INFAC earlier, which has helped bring about the transformation in the company’s profile. The company has definitely been more aggressive in the market in terms of branding, and its own mutual funds awards are popular. The Crisil brand has been leveraged with governments to expand business. But here, the authors have downplayed the role of the Standard & Poor’s brand, which has certainly added “mascara” to the company’s public face.

The authors do discuss the innovativeness of Crisil, which was manifested in the inroads made into the small and medium enterprises business. This, along with diversification and their IPO, is the high point of the company’s business growth.

The authors could have included some discussion on how Crisil worked with growing competition, which is expected in all business lines, where more players mean declining market share — which, in turn, leads to changing strategies such as new products or diversification. Crisil’s diversification, as projected here, appears to be more a case of foresight and opportunity than a reaction to the loss of market share.

By swinging across time points, the authors have not succeeded in coherently chronicling developments. Also, their attempts to bring in conversations look out of place because they are infrequent and, evidently, cannot be from memory. By focusing on conversations involving the icons, the context looks a bit contrived. A plain prose description would have made the narrative flow better. In fact, the last chapter comes as quite an anticlimax. Here the authors recount the release of a research report on the power sector. Though the report contains an excellent prognosis, it should not have merited a separate chapter that dramatises a setting that, however true, does not gel with the flow of the story.

The Crisil story is certainly impressive, given that it was the pioneer of the business in India. However, the narrative could have done more justice if it included more discussion.
DOING WHAT IS RIGHT: THE CRISIL STORY
Hemanth Gorur and Sumit Chowdhury
Westland Limited; 135 pages
 

The countdown begins … Financial Express: 24th December 2012

The economic scene, as usual, had interesting tales to narrate this year, which put policymakers in the centre of several storms as economists continued to offer advice that, when combined, covered all possibilities. Here is how the billboard would read.

At 10 is the euro crisis, which is now into its third year. The beauty of the crisis is that while questions are raised every year on the disintegration of the euro and the eurozone, it has not quite happened. The ECB has plans to revive the economies and actually thinks that they will follow austerity as it buys back securities. Germany opposed saving Greece and Spain, but finally relented. After all, if any country falls, it will bring down the others. They are all in it together.
At 9 is the US economy. Last year, it was a possible default that made rating agencies trigger-happy. It was actually seriously debated that the US would default on its debt. This year, it is the fiscal cliff that became an issue during the elections when Obama batted for tax increases and Romney for expenditure cuts. But, with Obama coming back, it is the devil or the deep sea. It has to be resolved with either or of the two options. 2013 will witness which way the die is cast.
At 8 are the Fed and the ECB, which sort of competed to induce liquidity into their systems. QE4 looked like a cynical joke at the beginning of the year, but is now a reality. We have had QE (various versions) operation twist, LTRO, government-bond-purchase programme and so on. The Fed will keep buying all bonds now to ensure that banks have money to lend. The ECB also will buy back bonds provided the countries promise to be good. So it is liquidity everywhere. The question is whether it will help?
At 7 the emerging countries come into focus, talking of BRICS getting together to create a bank. Can this happen? Each country is of a different variety with differing forms of governance iced with a large degree of mistrust. Will this ever work given that these countries are spread so far apart—any economic union of sort should qualify for the proximity factor which is missing here?
At 6 it is our own GDP growth forecast. Starting with some degree of pomposity at the beginning, and a strong sense of denial during the year, we have now come down to earth with official estimates ranging between 5.5-6%. More importantly, this is based more on hope and optimism and partly on statistical effects with little happening at the ground level. But one likely possibility is that while we may crawl, we will not slide down further. This is probably good news.
At 5 is inflation, which has always been a hard nut to crack. Everyone talks of inflation and the need to control it. But no one except RBI is serious on prices. MSPs are being raised and justified. Fuel prices have been increased and will probably be done again, which is inflationary. Crops have failed, which has added to price increases. To top it all, the CPI numbers, which is closer to our homes, is still near 10%. But nobody has done anything to actually bring them down. It is a case of what the bard would say—‘time is a great healer’.
At 4 are the rating agencies that continued to threaten to downgrade India to junk status. We were appalled and rubbished such threats; but finally tweaked our policies to their liking. A Freudian slip was made when these policy statements made references to them meaning thereby they were influenced by their warnings. The rating agency views still did not quite gel with what foreign investors felt about India as FII funds continue to pour into the country. And these are the people who are putting their money where their noses are. The Sensex showed resilience and ranged around the 18,000 mark—give or take 1,000 points. If this was the market sentiment, then things could not really be that bad.
At 3 comes the interest rates that were kept at elevated levels by RBI. The banks wanted RBI to ease rates, which they did—repo by 50 bps and CRR by 50 bps this year. Yet banks were not satisfied. The benchmark 10-year G-Sec yields have come down to 8.15%, but base rates of bank remain high at 10.25%. Quite clearly, banks are not lending for other reasons, which is partly due to NPAs and partly due to cherry picking. At their end, their NPAs have been increasing substantially (around 2.8% by September) and their restructured assets have also risen to almost R1.87 lakh crore in September 2012.
At 2 is the rupee, which continued to be volatile in the range of R51-56 to a dollar during the year. The current account deficit continued to increase with declining exports and the capital flows fluctuated periodically giving different signals. RBI was at peace because it was not like 2011 when it had to intervene regularly to steady the rupee. The euro-dollar influence is still there, and as long as the euro crisis surfaces periodically, the rupee is in for a bumpy ride.
The top position actually goes to critics and economists. They just revelled in bashing the government for inaction, and coined the term ‘policy paralysis’. The scams came and went and this provided further ink to the pen. Suddenly the government awoke and announced a plethora of reform measures, some of which like hiking diesel prices and LPG subsidy created a stir. The FDI-in-retail debate became even more important than the US elections as the coalition developed fissures that were bonded by other parties whose views are known to be even more volatile than the rupee. But, what did the disparaging economists say—these are not really reforms and not enough. Some people are hard to satisfy.
The New Year will probably have its own such moments. Happy New Year.

Poor economics in real time: Book Review: Business Standard 19th December 2012

Respected economic journalist D K Rangnekar's book provides a useful analysis of Nehruvian socialism at its height

The Politics of Poverty is a fairly unique book to be published recently, given that its author, D K Rangnekar, an economist and journalist who had held multiple posts in various publications, including Business Standard, died in 1984. This book is a collection of his articles. Comments have been provided by both T N Ninan and Sanjaya Baru on the author as well as the selection of articles. The question, really, is: what would be the level of interest in a book that talks critically about economic paradigms pursued from the mid-fifties to 1984, the famous Orwellian year?

There are two compelling reasons to read these thoughts carefully. The first is that Dr Rangnekar was a pro-socialist thinker who believed in Nehruvian Fabian economics, which looked at life more from the point of view of government activity than that of the capitalist. This automatically makes it refreshing to read; readers can compare how things look different today, when we have moved fully to a market-oriented economy and many of these concepts are held to be anachronistic. The second reason is that this is a delight for the researcher who gets in one place all the thought processes and critiques on issues that were held sacrosanct for around three decades. The fact that they are pieces written in those times makes them frank and honest, and therefore not coloured by any retrospective bias.

The book is divided into four parts and the articles are grouped under these headings, not necessarily in chronological order. Part one is called “Social crisis of development”. Here the author is critical of the growth paradigm that was being pursued at the time: it was pro-capitalist and anti-poor. Even as the government paid lip service to poverty alleviation, poverty remained high. Consumption was elitist and the system favoured landlords, moneylenders, capitalists, traders and so on. As late as 1982, Dr Rangnekar’s belief was that the system was developing cracks, which found expression in riots in Maharashtra where farmers revolted. Price policies were distorted. And while the tilt was towards agriculture till around 1972, it had moved to industry by 1981. Also, when the terms of trade favoured agriculture, it was the kulaks who benefited from it.

Part two, titled “dependencies’ independence”, talks about our international relations. Contrary to the picture today, when one is either with the US or not, the choice then was between the USSR and the US. This, according to Dr Rangnekar, was good for us because we were able to actually cement co-operation, pursue independent policies and also work towards non-alignment, which would be unthinkable today. The north-south divide was open, and taking aid from the US was inevitable. Therefore, he did not see anything wrong in taking this aid, as long as there was transparency. But when it comes to trade, he favoured import substitution, which does not seem an interesting or efficient option today.

Part three, called “Rope tricks”, discusses planning for the development process. The author was critical of the fact that budget sizes increased sharply over the years but this expansion was not being reflected in spending on the poor. This is interesting because even today most economists are critical of programmes like the Mahatma Gandhi National Rural Employment Guarantee scheme and focus on lowering such expenses rather than correcting the system. Dr Rangnekar would certainly not have shared these views. He had also pointed out how the Centre performed better than the states, unlike today when it’s the states that are more bound by fiscal responsibility rules than the Centre. Other issues that have been written about – black money, tax rates, tax base, etc – are still challenges on which we as a country have probably made limited progress.

In the last section, the author shares his views on industrialisation. Contrary to what many economists say about this process beginning in 1991, the author has argued that a lot of good happened in these three decades, starting with the industrial policy resolution of 1956. The socialist bent was justifiable since the private sector model did not work between 1948 and 1955. The heavy industry focus built a base for us, which showed foresight by policy makers. He felt that there was a point in controlling large businesses and that licensing was justifiable. He was against the infamous loan from the International Monetary Fund in 1981. Even Joseph Stiglitz has been critical of this in the aftermath of all the financial crises. In fact, he felt all these policies favoured unbridled markets, conspicuous consumption, imports, misdirected flow of funds to speculative activities in stock and commodity exchanges.

On the whole, the book is likely to appeal more to those who have lived through both the pre- and post-reform eras, when we swung from a mixed to an open economic system. The present generation may find many of his views out of place. But when he talks of public policy, poverty and inequality, it rings a bell even today. In that sense, this book is timely and helps evoke introspection.
THE POLITICS OF POVERTYPlanning India’s Development
D K Rangnekar
Sage Publications; 256 pages