Ten moments that defined the economy : Mint 30th December 2021

 With 2021 coming to an end, independent economist Madan Sabnavis takes a look back at the major economic events that drove emotion

Playing will it, won’t it with the US Fed

The US Federal Reserve’s stance on quantitative easing and interest rates has become the beacon for all central banks and markets which are trying to guess when the Fed will pull the plug. Indications are that happy liquidity days are over, and there will be tightening from 2022. There is still anxiety before the Federal Open Market Committee meet, and, indices slide and bonds remain nervous till the statement goes public. The ‘when’ of it kept everyone on their toes....

The RBI and its firm 9.5% stance

The Reserve Bank of India is firm in its conviction that it will not budge until growth is here to stay. The government is gung-ho about double-digit growth and believes the economy is in take-off state, but the RBI maintains its 9.5% stance. How long will inflation not matter? Inflation was 6.2% last year and has averaged 5.2% so far. This looks embedded. The question: When will the RBI decide to raise rates, as real interest rates are negative, and inflation is hurting.

Growth and its many shapes

GDP growth was 4% in FY20, -7.3% in FY21. Therefore, anything will statistically look large in 2022. Economists debated if it was U-shaped (gradually rising) or V (sharp recovery). Even 9.5% growth would mean not more than 1.5% over FY20. The clairvoyant went to K-shaped (some sectors spike, others decline). It is a matter of time to get to F-shaped, where sectors stabilize at lower and higher levels, or W, which alternates over quarters. In the end, we could just go in circles, or O.

Petrol, diesel prices shoot past ₹100

The price of petrol continues to be a stormy issue and became a political tool for the opposition. The public’s screams do not seem to matter as the price has shot past ₹110 a litre and settled there. The Centre lowered excise duty by ₹10 a litre and asked states to do the same. Some did; others did not. Even as the global price of crude fell from $85 to $75 a barrel, we continue to pay ₹110 a litre for petrol and over ₹100 per litre for diesel. This economics is still baffling, to say the least.

Waking up to cryptocurrency

Cryptocurrency flourished, followed by a call for a ban and regulation. As exchanges sprang up, no one paid heed. It has now dawned on everyone that it could be a black hole. Are hawala transactions taking place? Is money being used for illegal activity? Are people paying taxes? We don’t have answers though websites of exchanges are transparent. Investments could total ₹6 trillion, almost 50% of small savings. There is an awakening though no one knows what to do.

Exciting but rocky ride at the bourses

The stock market revelled in the U-shaped, K-shaped or V-shaped recovery. As the market gurus showed us the moon, IPOs flowed like an endless stream. This reverberated in the secondary market too with the Sensex climbing to dizzy heights. 50,000 seemed to be the base as 60,000 was crossed and 75,000 was spoken of. But what goes up must come down. The fear is palpable, the indices have become volatile. Almost 50% of the IPOs are going below the issue price.

The magic math of the Budget

GST (goods and service tax) flows picked up; the target of ₹1.1 trillion per month seems conservative as ₹1.4 trillion looks more likely. All collections are up and the government is confident of the big LIC sale that is to garner ₹1 trillion. The government has got a supplementary demand for ₹3 trillion expenditure outside the budget. Yet pundits say fiscal deficit will be maintained at 6.8%. This will be nothing short of a miracle and a model for other countries to borrow!

Air India: The deal that left all happyi

This was the toughest company to disinvest. A loss-making venture and a debt of over ₹60,000 crore was a deterrent for any potential buyer. But Air India has some of the best aircraft and routes. The Tatas prevailed, and paid just ₹18,000 crore, including cash of ₹2,700 crore only. The Tatas said it was a homecoming; the government was happy to get the company off its hands. The ₹42,000-crore debt was transferred to a special purpose vehicle. Everyone wins.

The liquidity deluge, a problem of plenty

The government doing everything it took, and everything it could, to support the economy meant an infusion of almost ₹6 trillion to ₹8 trillion of liquidity in the system. The problem with this plenty, now, is how to drain it out. It will have to be by the drop as any statement made by the Reserve Bank of India can get magnified in the market, which is already on the edge and asking questions about when and how the RBI will roll it all back.

The great repeal: The farm laws

The farmers finally withdrew their stir after a year. We are back to only the mandi system and the continuation of the tyranny of status quo for small farmers. That one group of farmers could hold the government back from introducing what would have been great reform shows the power of a lobby group. Some may say Gandhian protest still works in independent India. But these farmers had the wherewithal to remain on the ground for a year. Who was tilling the land then?

Farm reform: the Achilles’ heel of any Indian government: Indian Express 29th December 2021

 The Achilles’ heel of any government in India is implementing reforms in agriculture. The importance of agriculture is known and while we were able to address issues relating to productivity in the 1960s thanks to the Green Revolution, bringing about changes that involve altering the structures is more challenging. This year, three issues that are hard to resolve gathered attention — two of them pertain to debates that have been brewing, while the third is more medium-term in nature.

The withdrawal of the farm laws was certainly a major victory for the protesting farmers, but it does push back reforms that could have helped in commercialising this sector. The reforms per se did not introduce anything that was not happening in pockets of the country already. For instance, selling outside the mandi is already possible where the Model APMC laws have been passed (over a dozen states have passed these laws, though the mandi continues to be the pivot). Also, the operation of eNAM (e-National Agricultural Market) is well afoot, though the volumes are limited to specific commodities and geographies. Yet, a national law that overtly allows farmers to sell their produce outside the mandi has been opposed. This means that farmers will continue to struggle within the ambit of the mandi system where oligopolistic structures prevail and impede fair play. The intermediaries quite clearly are the winners as they will continue to rule the markets.

Also read |Tackling agricultural reforms after farm laws repeal

Similarly, contract farming is something the government batted for. Contract farming does exist today and most of the supermarket groups have backend relations with farmers which ensures that standardised products are available. This holds especially where food products like ketchups, jams, and wafers conform to uniform standards. The same can be seen with fast-food chains, which have tie-ups with farms to get standardised quality of vegetables. Hence, the concept is not new and while it has worked at the micro-level, scaling up is not possible given the limited avenues for sale. There was actually little reason to oppose this idea, but it has led to exaggerated claims of India Inc buying up the entire agricultural sector and then pauperising the same. While there is no logic, the relentless protest finally worked, and the law has been withdrawn.

The other major reversal is the gradual ban on trading in futures of all major farm products. What started off with chana and mustard now covers the entire soya complex besides crude palm oil, moong, paddy and wheat. The message is very clear — futures trading is not going to be given a free hand. Interestingly, the major agri exchange, NCDEX, has been successfully reaching out to farmer producer organisations and getting them on board. This link will now be severed. The decision taken is clearly not backed by economic rationale as the latest CPI and WPI inflation data for pulses shows that there has been low inflation. Chana had inflation of 2.7 per cent while moong which is hardly traded had witnessed a fall of 0.2 per cent. Paddy is not traded while wheat witnesses limited trades. The same holds for crude palm oil. Oils have been a problem with high CPI inflation of nearly 30 per cent, but here the cause is global with edible oil prices increasing sharply by 40 per cent according to the World Bank. Since India imports around 60 per cent of its requirements, the same gets translated here. The present ban which is to last for a year virtually puts the nail in the coffin of futures trading in agri commodities which also means that it will be back to the past for farmers.

The last issue relates to MSP and its linking with the project on direct benefit transfer that the government has been working on. As part of the discourse on the farm laws, it was argued that an attempt was being made to gradually remove the MSP system, which would leave the farmers at the mercy of the private companies. MSP, though announced for all crops, is effective for rice and wheat only where there is a procurement system which then gets tied up with the PDS. The government has been trying to use direct benefit transfers to replace the PDS to ensure that there are no leakages. The problem for the government is that the entire system is convoluted. MSP is tied to procurement, which in turn is tied to the PDS and buffer stocking. MSP is open-ended and FCI ends up procuring large quantities of rice and wheat as the price offered is very attractive. Farmers prefer growing them as it gets them better income, but these two are water-guzzlers and their cultivation lowers the water table. There is no cogent policy for the disposal of surpluses and hence, large stocks are lying with the FCI. To get some idea one can look at some numbers.

The buffer stock norms are fixed for every quarter. The highest that must be held is 41 million tonnes as of July 1, while the lowest is 21 million tonnes as of April 1. As of December 7, 2021, 59 million tonnes were held — almost 38 million tonnes higher than the January 1 norm. The government must at some stage address the issue of procurement and distribution, else this cost will continue to be borne by the budget. Cash transfers, which have been largely successful for LPG, have been a non-starter here because of the system that has to be maintained even if it is inefficient. Ideally, if farmers are brought on the futures platform for selling their grains, the government could pay the option premium to ensure they get a good price. The distribution part can be served by cash transfers where households buy their foodgrains locally. FCI would only have to keep the buffer stocks.

If one looks at the buffer stocks, one realises that these stocks have never been dipped into in the last two decades or so as India produces large quantities of rice and wheat which end up as surpluses in warehouses. Logic demands that buffer stocks be abandoned as the carrying cost is high and there is not any real gain in a world where countries can freely trade in agricultural commodities.

One cannot be sure as to when these reforms will finally be accepted as there do appear to be many vested interest groups at work who will ensure that it will be hard to move forward.

Beating the markets | Book Review: Trillions: How a band of Wall Street Renegades.... Wigglesworth: Financial Express 26th December 2021

 There are several books on economists and their lives, starting with Adam Smith and all the way down to Paul Samuelson. But there are not too many tomes on a series of stock market gurus, especially those focusing on specific kinds of investing. Robin Wigglesworth of Financial Times brings out a rather interesting book called Trillions, which talks of passive investing through the use of index funds. But while explaining the worth of such funds, he takes us through the history of various fund managers and academicians who have made their contributions in this field. Interestingly, the value of funds in such passive investing is around $26 trillion, which is the size of the GDP of USA.

Warren Buffet is known to have wagered on passive investing through index funds and won substantial money on such bets. He had said that over 10 years such an approach would thrash an elite crew of hedge funds picked by Protégé Partners, a Wall Street investment firm. Simply put, if one invests in say the S&P 500 index or the Sensex in India, one can reap superior benefits in terms of rewards over a time horizon of 5-10 years. This also means that all the fund managers who have their techniques in investing in various stocks during this period cannot actually do better than the index. He showed how the free, “dumb” index fund prevailed, returning 126% over the decade, while hedge funds made a more modest 36%.

The interesting facet of such index funds is that they mimic a market benchmark which can be the FTSE 100, the S&P 500 or developing country bonds with low cost. They can also be unmanaged mutual funds or exchange-traded funds (ETFs) that can be bought and sold throughout the day, just like any stock. As the approach to trading is fixed by definition, one only needs technology to execute and no human intervention is required.

This surely is interesting because when one looks at research on the performance of any fund, mutual or hedge, a comparison is always made with the benchmark indices and the conclusion drawn is that passive investing is a more efficient way. The way it works is simple. As the index has certain stocks, the fund manager has no choice but to invest in proportion any new subscriptions to these funds, which automatically keeps the buying pressure up under normal times, leading to prices rising. Hedge fund managers would be indulging in all kinds of strategies to beat the market, which they may succeed in the short run, but not in the medium term. This holds for equities as well as bonds and hence even passive investing in bond funds give better returns. Paul Samuelson, the famous economist, had also believed in this approach.

All this flows from the fact that one cannot predict share movements and they follow a random walk, meaning thereby that the movements tomorrow could be just as good or bad as yesterday and there can be no pattern as such. This means that all kinds of modelling may not work in practical life. The author puts all the pieces together by starting with Markowitz’s portfolio theory followed by Sharpe’s risk-reward matrix to Gene Fama’s efficient markets hypothesis to Bogle’s index funds. The concept of beta (Greek letter to denote performance against benchmark) is explored and the creation of various indices as well as funds that invested in them

Wigglesworth takes us in considerable detail through the history of index funds and how they were formed and the protagonists along the way. These fund managers came together five decades back and contributed to this unique thought process. The first fund came in July 1971 and Wells Fargo became a sort of pioneer with a fund that mimicked the S&P 500. In fact, the first investible index came when Jack Bogle started Vanguard and created the first S&P 500 fund in 1973. Ironically what is the biggest fund today had an indifferent response when launched as it only raised $11 million, which wasn’t even enough to buy all the stocks in the S&P 500.

The ideas presented here are deep and if what has been written is true, then the hype over fund managers and their well thought strategies may not really be superior to the market. Hence, this can lead to the conclusion that one may not be able to beat the market as such. In this tryst the author also takes us through the efficient markets hypothesis as well as the capital asset pricing model (CAPM). It makes interesting reading for sure, though it does reduce the halo we normally attach to the brains that deal with our funds. One may just as well invest in a Sensex or NSE500 fund and sit back and reap the rewards without bothering about the internal stocks.

Along the way there are some insights thrown in by the author on the composition of indices that will be relevant for us in India, especially as there is some degree of excitement on Indian bonds being included in global indices. Essentially getting included in the index will automatically mean that investment made in the indices will percolate to the Indian bonds or any share if it is a stock index. This creates an ever-flowing demand for the security (debt or equity) and hence there is this craze to be included in these global indices.

If one is a stock market buff, then Trillions is the way to go, and the reading will be satisfying.

Madan Sabnavis is an independent economist

Trillions: How a band of Wall Street Renegades Invented the Index Fund and Changed Finance For Ever
Robin Wigglesworth
Penguin Random House
Pp 336, Rs 899

Futures contracts ban in 7 agri-products: Blighting the future, again: Financial Express 24th December 2021

 The banning of futures contracts in seven products is a major setback to commodity derivative trading in India. This comes at a time when the industry was witnessing various innovative products, including options on goods (akin to the MSP), as well as new players in the market.

High food inflation is the reason proffered; however, data doesn’t supported this. The edible oil complex and pulses have come under the ban; the price movements are interesting. The derivative trade in chana was banned in August, while the ban on mustard came in October.

Two primary questions arise here: Whether prices have increased disproportionately in the market and whether the ban on futures trading in chana and mustard helped to bring down prices.

A third question, pertaining to a broader concern, is how long can we insulate ourselves from global influences when it comes to commodities.

The accompanying graphic shows that after the ban on chana, the prices of chana dal products in retail markets did not go down; they were in fact slightly higher in the following months. In the case of mustard, the retail price of oil and seed remained elevated post the ban. The reason is not hard to guess. The global prices of edible oils have been rising sharply since last year. The demand-supply mismatch has been essentially due to the opening of economies, leading to higher demand from hospitality, airports, offices, etc. Further, higher freight costs and supply bottlenecks including logistics have pushed up prices. India imports 55-60% of its edible oil requirement and hence is a ‘price-taker’. As international prices increase, domestic prices must also rise in consonance.

The prices of edible oils have increased sharply in the last year. The domestic prices of soy oil , crude palm oil, and mustard oil have increased by 42.5%, 31.7%, and 41.7%, respectively. When the inflation in commodities is global, and India is a price-taker—as the largest importer of the product—imported inflation can’t be escaped. Futures trading, being a reflection of these market conditions, would provide an early warning signal to all the supply chain participants and help in hedging. Now, this tool will not be available and higher risk has to be carried on the books.

The ban on other commodities—moong, paddy, wheat—is quite surprising as the price changes over the last 6 months or so have been modest and, more importantly, the products are not ‘liquid’ in the futures market. The accompanying graphic gives the trends in movement of prices at the retail level (as per the department of consumer affairs). Wheat atta has been used instead of wheat as this is what is provided by the department—as is the case with rice as price of paddy is not provided. As can be seen, the prices have largely been constant in these six months.

With state elections around the corner, there is definitely pressure from some groups to ban commodity trading as food inflation is high (when it comes to edible oils). However, for pulses, a one-year growth in prices shows a decline for both chana dal (-0.1%) and moong dal (-4.1%). There is no justification for the ban when prices have been steady or declining!

Bans on trading in agricultural products in the derivative market are not new, and, hence, agri-products are risky from a commercial perspective for any exchange. Given the socio-political environment, such action is always on the anvil. But, banning futures trading drives back the market significantly. First, the farmers are prevented from getting better prices. The exchanges along with SEBI have managed to involve farmers at the micro level which gets vitiated now. Second, corporates hedging their price risk will now suddenly be at a loss, especially for oils, given it is an international phenomenon and hedging was the only way out. Last, all future reforms will be in jeopardy on account of such actions. The government should reconsider these bans and end these soon, perhaps after doing an internal analysis on the lines suggested here.

Are jobs really being created? Business Line 21st December 2021

 

While data from CMIE and EPFO present a contrasting picture, jobs in the unorganised sector continue to be difficult to assess

Employment data in India have always been controversial as the concept per se is quite nebulous. While corporate data on employment is foolproof as the headcount is known and revealed in annual reports, the same cannot be said about the non-corporate sector. Often, data on employment exchanges are used to denote demand for work, but such data cannot be banked on as they include people who are actively employed and looking for a change in terms of quality or pay.

Surveys are done by organisations like CMIE to track employment. NSSO does the same periodically and has different criteria like usual, daily or weekly status. They have their use, but it depends on how questions are asked and how they are answered.

Provident fund data is another source of information for people employed and here there is a view that as more people are enrolled in the Employee Provident Fund Scheme, it is proof that jobs are being created. Hence, this is indicative of employment created rather than unemployment. The argument here is that even if people change jobs, the account remains and the contribution only changes from the organisation, and hence any increase in the number of PF accounts must be new people coming in. The counter argument is that with the new rules on enrolment and the benefits given during the pandemic, several smaller units opted for PF for employees and hence they were technically not new jobs being created but existing jobs getting registered indirectly.

There are two views as usual. One says that jobs are being created and the growth in sales of TVs, scooters, washing machines, etc., show that people are buying goods with income that can come from jobs being created. The spectacular increase in mobile phone sales is indicative of the fact that more people are buying them and hence are employed. This sounds fair.

The second, and contrary, view is that there has been stagnation in consumption as seen by low or negative growth rates in production of consumer durable goods even when GDP was growing. This means jobs were not created and hence while the higher income groups will replace goods, it will not happen every year. The consumption stream can be filled only if new jobs are created.

There is truth in both the arguments. If jobs were created, there should have been a never-ending stream of consumption.

 

Comparing data

CMIE data, for instance, show that since 2017-18, the unemployment rate has been going up (see Chart). While there would be variations during the month, the annual numbers are indicative of the trend. As this is based on a sample survey, one may argue that it cannot capture the entire universe. But this holds for almost any result based on samples, and hence also holds for NSSO where even a number of one million can be contested.

Putting CMIE data alongside with EPFO data shows an interesting picture. PF data shows that in FY18, 8.5 million accounts were added, followed by 13.9 million and 11 million in the subsequent two years. In FY21, 8.5 million were added. Hence, while the EPFO data suggest a lot of jobs were added, CMIE numbers show that the unemployment rate went up. EPFO also gives net addition, which is presented with the CMIE data (see Table). There is incongruity here as CMIE shows the total employment numbers came down in three of the four years, while EPFO talks of net additions in payroll accounts.

Therefore, it is tough to draw firm conclusions as different sets of data show varied tendencies. The unequivocal call is when one looks at the corporate sector and tracks how headcount has fared as there can be no ambiguity here.

A study by CARE Ratings on employment based on annual reports of 2,618 companies shows that there was an increase in the stock of employees in FY20 by 2.2 per cent which fell by 1.3 per cent in FY21. This is significant because the drop in employment was seen in 27 of the 34 industries that were considered in the sample. Of the seven industries which had a positive growth rate in employment, three were in services (IT, logistics and banking) and the others in manufacturing (power, consumer durables, healthcare and chemicals).

There was also a strong linkage with growth in sales though the explanatory power was limited to around 36 per cent. Intuitively it can be seen that for employment to grow there must be buoyancy in growth in sales.

Interestingly, the Central Government has been hiring more people, and per the Budget document there has been an increase, from 3.27 million in 2019 to 3.30 million in 2020 and further to 3.41 million in 2021 (as of March 1). The largest employer was the Railways, which had an unchanged headcount of around 1.27 million. The police, tax departments and defence are the other ministries with high headcounts.

Mixed picture

There is, hence, a mixed picture on job creation. The organised corporate sector has witnessed a decline in employment in FY21, and the future course will depend on how the economy shapes up and companies perform. The Central Government has been on an employment drive for sure. As for the unorganised sector, there are no clear indications. The impressionistic view following the pandemic is that there was a large-scale migration away from the cities and towns to the rural hinterland. Further, several units had closed down which would mean that there would have been lesser demand for labour.

While the EPFO data may reveal that there has been some return of jobs, the true picture will be hard to ascertain as most of these units would be employing 4-10 workers at the micro level which can go up to 50 for smaller manufacturing units.

What can be said with some certainty is that for employment to be generated, ultimately there is need for growth to take place as the demand for labour is contingent on how output behaves. But one can say that if jobs are being created, consumption should be increasing more than proportionately. If this is not happening, then the pace of job creation can be questioned.

The art of storytelling | Book Review: What’s Your Story? By Adri Bruckner, Anjana Menon, Marybeth Sandell: Book review in FE 19th December 2021

 What’s your story by Bruckner, Menon and Sandell is a useful book meant to be read by the top management in all companies, because in today’s age where investors are always looking for news on companies of interest, what one projects is very important. Here, the authors handhold us and take us through the main elements of the plot.

First, we need to be clear about what the company is all about and hence it is necessary to convey the right message. This normally comes into the mission or vision statement of the company or simply the tagline. Now when you hear ‘connections between people around the world’, which company would you think of? This is Hershey’s and sounds so out of place as these words could go with any company that is global. It tells us nothing of chocolate and other confectionery items. Similarly, if a company tells you that it helps you save money to live better, getting to know it is Walmart will be a comedown as you really don’t know if it delivers on the second promise of living better. This is where companies need to be careful because their customers and employees should understand what the company stands for.

It is with these kinds of examples the authors take us through the follies that must be avoided and one thing that will strike any reader is when companies play around with jargon. The chapter interestingly is also called Death by Jargon. We need to keep things simple and not get into details that involve the reader understanding what the words mean. Hence, if a company takes over another one, it should just say that this is good as profits will get better. Using words like synergies and ecosystem, which are favourites these days, just mean nothing to most readers and could make one skip the article.

A good tip given is to keep all communication brief and to the point and here they believe in the BBC approach, where things are direct and free of redundant words. In fact, keeping things simple is the biggest challenge for most writers who tend to get bombastic to impress readers, which at the corporate level could be counterproductive.

Similarly, presentations made should carry pictures and graphics and, according to the authors, bullet points must be avoided. Now this will come as a blow to most presentations which follow this format! Further, if numbers are to be presented it should be easy for the reader to grasp and discretion should be used when using decimals or units so as not to confuse.  The basic pitch is that if one wants to reach out to the audience, things should be easy to understand without the reader having to work out the numbers.

The other area that the authors talk of is the medium of communication. Today, there is a variety of options as we have moved from newspaper and television to social media. Here, the company needs to evaluate where the story should be heard. It can be universal for some products, in which case a balance needs to be drawn across all the three, while at times one can be selective, especially when appealing to the millennials. Similarly, a B2B business which does not involve a retail customer could be better off using social media options depending on the product involved.

YouTube today is great for certain types of communication, especially dealing with knowledge, as everyone wants to hear what CEOs are saying. Podcasts are in vogue and work very well as people may not have time to read something that is long and a minute or two of a verbal commentary makes things easier.

Even when dealing with newspapers one should know the recipient of the communication. The editor of the newspaper does not look at news releases and a journalist who covers banking cannot be sent a release on automotive. If this is done, then they may just start ignoring all the company releases.

There is also another reading for CEOs which goes under a separate section. Do we want to know the company or the person? Warren Buffet is more well known than his company Berkshire Hathaway. The same holds for Richard Branson. Here the company should take a call, especially if it is a professionally run and not owner-driven where the motivation will be different. If the CEO becomes more popular, the company will suffer once the person leaves.

The authors give tips on how to present the CEO and sponsor events or create their own shows. They differentiate between advertising, advertorials, opinion columns and unbiased views. Companies must be aware of these differences and accordingly plan their stories for communication.

This book is very useful for all companies that are keen on strengthening their communication with their stakeholders. The book may sound pedantic at times, but then when companies get carried away with their emotions, there is need to check some basic principles and, What’s Your Story helps to a large extent to provide the clues.

Madan Sabnavis is an independent economist

What’s Your Story?
Adri Bruckner, Anjana Menon, Marybeth Sandell
Penguin Random House
Pp 284, Rs 599

Surplus liquidity in the system: How it came and how it may go: MInt 16th December 2021

 

Surplus liquidity in the system: How it came and how it may go

Large doses of liquidity have been provided by the Reserve Bank of India (RBI) starting in 2020 even before covid, when it used its LTRO (long term repo operations) and OMO (open market operations) as tools A complex set of economic conditions would be needed for India to attain normalcy on this count

When the US Fed started its quantitative easing (QE) plan, it was to make liquidity available at a time when every institution was suspicious of the solvency of the other, as it was unclear how toxic their assets were. To help, the Fed bought other bonds apart from US treasuries.

India’s QE has been different. Large doses of liquidity have been provided by the Reserve Bank of India (RBI) starting in 2020 even before covid, when it used its LTRO (long term repo operations) and OMO (open market operations) as tools. This was later topped with TLTRO (targeted long-term repo operations) and its GSAP (government securities acquisition programme). In its pandemic response, RBI had stated that it would do everything needed to ensure adequate liquidity in the banking system. Banks could lend this money at low interest rates, which was the crux. RBI’s repo rate was lowered, as was the CRR (cash reserve ratio). The Centre backed this programme by providing a credit guarantee for loans given to micro, small and medium enterprises (MSMEs), a scheme that was subsequently expanded to include multiple sectors.

Let’s look at the consequences. Liquidity evidently increased: Almost ₹6-8 trillion of surplus liquidity resides in RBI’s reverse repo window (both overnight and short-term variable rate reverse repo or V3R). This surplus has just been increasing as RBI kept buying paper from banks to provide liquidity. But deployment avenues were limited for a variety of reasons.

First, demand was anaemic, with low capacity utilization rates in most sectors (60-69%) holding back investment. Second, private investment in infrastructure hasn’t yet taken off. Third, while MSMEs borrowed on the back of the guarantee, the funds were used to repay loans and maintain business rather than for growth. Fourth, banks too were cherry picking customers as they had just about come to get bad loans off their books. Besides, the backstop’s precondition on loan performance as of 1 March 2020 meant that stressed units did not qualify.

The puzzle was the success of RBI’s bond acquisition spree through GSAP, as it went about buying securities from banks. Together with OMO, a total of ₹2.4 trillion has been released by RBI so far this year with the goal of anchoring yield expectations. The logic of this was hard to understand because there was little point in banks giving up securities which paid an annual interest rate of, say 5-7%, depending on their residual tenor, to get cash that was put in the reverse repo or V3R window for returns of just 3.35-3.75%. These operations led to a negative carry for banks. It would have made sense if they procured liquidity to extend loans at 9% or more per annum. One justification was that the securities were illiquid and banks got a chance to offload these even though their returns were ultimately negative.

How RBI exits a surplus scenario of ₹8 trillion is now a challenge. Curbs on its reverse repo window would spook the system. Raising the reverse repo rate will be taken as a policy signal of tightening, which would not be in consonance with its current commentary. GSAP buys have stopped, which is fine, but it does not address the issue of surplus liquidity.

Banks, on their part, are trying their best to stop deposits from coming in by keeping interest rates low. This being so, it’s no surprise that funds are moving to equities and crypto assets. While this can ensure surpluses don’t increase, it does not reduce them either.

Ironically, financial markets have not quite reacted positively to surpluses, as government bond yields remain high in relative terms, with the 10-year yield in the region of 6.35%, up from under 6% till 21 January. In fact, there has been a battle between RBI and bond players, with the latter demanding higher yields (lower prices). There was a phase of RBI auctions not going through or devolving on primary dealers. Almost ₹1.5 trillion of auctions went unsubscribed by the market this year. Therefore, surplus liquidity has not really reduced interest rates sharply, though it could counter-intuitively be argued that rates would’ve gone up further, with the 10-year paper crossing 7%, had RBI not acted as it did.

The market has been wary of high government borrowing and inflation. The Centre’s borrowing programme is to be retained at around ₹12 trillion for the year, while inflation is expected to be around 5.5%. The recent supplementary demand put before Parliament involving ₹3 trillion of cash payouts does mean higher borrowing at some point of time. Besides, if GST revenues don’t remain buoyant, the government’s need for additional borrowing to plug shortfalls in GST-compensation-cess collections would increase.

It does look as if draining excess liquidity will require a combination of some developments. First, bank credit demand must pick up, with the economy’s investment cycle turning around. Second, the Centre should be borrowing more so that banks automatically channel their surpluses back. Third, RBI should be going in for some OMO sales to reverse its GSAP effort, so that these securities return to banks. Until these happen, either thanks to a central bank push or through the natural course of events, big surpluses will stay.

More importantly, the relationship between surplus liquidity and interest rates will remain severed.

on ETNOW 13th December 2021 on CPI inflation

 Link to India Development debate

https://www.timesnownews.com/videos/et-now/shows/cpi-at-4-91-is-mehengai-set-to-be-a-lasting-worry-india-development-debate/115875

India’s unequal growth journey: Businessline 15th December 2021

 

For sustained growth and development, the spending power of the poor has to increase continuously

India has been known as a land of contradictions with superstition coexisting with technology and financial centres and superhighways masking the poor infrastructure facilities in the hinterland.

While the socialistic tilt did make policy makers to look at development from below with direct action till the eighties, the paradigm changed in the 1990s when reforms were implemented. Making the economy more market oriented with facilitative policies meant that there was scope for growth led by big business to thrive and the result is visible today. India is clearly the market for all goods and services across the world and we are an economic force to reckon with. But has this growth been even?

Here the World Inequality Report vindicates the view that while reforms and markets have improved the quality of life and made the country better off, there has been severe concentration in the distribution of these rewards. The Report maps the shares of the top 1 per cent, 10 per cent and bottom 50 per cent of population in total income and wealth over the last five decades or so. The accompanying table presents data for the World and India at five different points of time — 1980, 1990, 2000, 2010 and 2021.

The trends are interesting when the inequality status is compared for the world and India. 

First, in case of the world, there was a tendency for the shares of the top 1 per cent and 10 per cent to increase between 1980 and 2000 after which they have come down in the subsequent two decades. In case of India the increase from 1980 to 1990 was gradual but then accelerated in the post reforms era with the last two decades showing that the top echelons had more income than even the world average. Second, the share of the bottom 50 per cent has shown a varying trend. In case of India, it has fallen continuously over the 40 years, while the global average, though lower than India has witnessed an increase during this period.

This leads to some interesting conclusions. The world numbers include several of the poorest countries which bring down the average. India did significantly better with the bottom 50 per cent owning 21.2 per cent of income in 1980. While the starting point was better, the share has come down indicating that the gains from liberalisation have not quite percolated evenly. While living standards have improved with development and access to basic needs, goods, services, infrastructure has proliferated, the rewards for this section has been disproportional.

Reforms’ uneven outcomes

Second, liberalisation with focus on private sector has meant that the income pattern has been distorted. Hence while we do hear of top companies’ starting salaries of fresh management graduates at above ₹1 crore with the average being in the region of ₹10-20 lakhs per annum, the rural folk still only earn a wage of ₹200 a day (as per MGNREGA), which if available, for 365 days will give a return of ₹73,000/annum. Hence while the NREGA wage has increased to ₹200 since it was introduced which kept pace with inflation, capitalist India has offered much better salaries to employees.

This is the classic manifestation of what Karl Marx had spoken where capitalists will pay workers just enough to keep them going and not revolt while keeping a larger part of the surplus with themselves. Hence, the lower 50 per cent would not be badly off as they would be above subsistence with even access to pizzas and toiletries but could never dream to come close to the upper echelons.

The same picture gets replicated when wealth is considered. The shares of top 1 and 10 per cent as well as bottom 50 per cent in total wealth is presented in Table 2.

 

The table shows that the inequality is starker when wealth is considered. The growth of large industry, stock markets and stock options awarded to specific employees, land and housing, are all manifestations of this inequality. While it is a matter of pride that any country can speak of billionaires on the world stage, it is also a reflection of the extent of inequality.

The combined data really shows that around 130-140 million people in India, which would be around 33-35 million families are much better off than the rest of the country and control nearly two-thirds of the wealth and 60 per cent of income.

This as Thomas Piketty had stated was a feature of capitalism. The exacerbation of this inequality can be seen by the content of public policy which is oriented towards growth and ends up supporting industry.

The assistance for the poorer sections has always been in the form of subsidies and cash transfers. While it works in the short run, it does not change the working life of the beneficiaries and take them to a higher level of income. Unfortunately, the repeal of the farm laws is a major speed breaker in commercialising agriculture.

The long-term impact

Should this be a problem? The answer is yes even if there are natural buffers which ensures that there are no social upheavals in future. This is so because all economies finally have to be driven by consumption and there are limits to consumption of the upper income groups. For the economy to gallop along one needs the poorer to become less poor faster so that they are able to satiate their demand and hence add to consumption and investment.

The skewed distribution of income will come in the way of this progress as consumption tends to stagnate or grow at very sluggish rates. This is a challenge India had even before the pandemic where consumption had not kept pace and led to surplus capacity in most consumption goods-oriented industries.

Therefore, it is necessary to reduce the level of inequality in the country. And it is not just in terms of redistribution but having models which generate employment and hence spending power at the lower levels. Admittedly this is a slow process, but the effort has to be relentless.