How Trump can affect the world economic order : Business Line 15th November 2024

 

The President-elect’s ‘America First’ policy and tariff hike threats against China could affect global trade and inflation

There has been considerable speculation on what the Trump administration, which will take over in January, would mean to the rest of the world, including India. During the election campaign, several messages were conveyed. But how seriously does one take such rhetoric? While his articulation tends to be aggressive, it is consistent and not different from what it was in his first stint. Nevertheless, some conjectures can be made on what lies in store.

The ‘Make America Great Again’ or ‘America First’ campaign is likely to be at the forefront of all policies. First, the issue of immigration has been high on the agenda of the Republican Party which has overtly stated that jobs need to be created more for the local population.

While the target appears to be the southern border, strict laws for the world are a likely corollary. This can make it challenging for US companies to hire relatively cheaper workers from outside. And, this could have an impact on India’s IT sector, for which US is a major destination. There can be some concerns here for India’s services exports, which have grown at remarkable rate in the last few years. The fine-print of the policy which sifts skilled and unskilled workers would be important. Stringent policies on hiring of immigrant labour can lead to a labour crunch internally, leading to higher wage-pull inflation.

Second, there has been a frontal attack on China for using unfair means to dump goods in the US. This would mean high tariffs on goods from China. The extent of increase would vary across goods to ensure that it would make sense for domestic buyers to choose locally produced goods. What is being spoken of is 10-20 per cent additional tariff on all imports, 60-100 per cent for those from China, and even higher for auto imports from Mexico. Given that the US is the largest export destination for non-oil products from India, we must pay attention to any action taken on imports in general. While the US reducing dependence on China for goods can be an opportunity for India, Trump’s rhetoric with respect to other countries would also be critical.

Third, the threat of higher tariffs on China has already spurred the country to roll out stimulus measures, which can have implications for global trade. China would look to other markets, and hence India has to be prepared with counter-measures to ensure that cheap goods are not dumped.

The overall growth pattern of China will be important because global commodity prices will be driven by this. As China seeks to grow faster, commodity prices would ratchet upwards. China’s stimulus measures are already leading to a reversal in the trend of low commodity prices.

Fourth, higher tariffs in the US would mean higher inflation. Higher inflation would also come in the way of how the US Fed sees the economic trade-off between growth and inflation. Trying to support growth through tariffs would end up pushing up inflation which, in turn, will come in the way of lowering interest rates. This is a conundrum the Fed faces, especially as the dot plot already indicates that there would be another 100 basis point cut in rates in 2025, which will be the first year of the new President.

Fifth, Trump has always been for lower corporate taxes and is considered to be pro-industry, and this is why there has been overwhelming support for him from the corporate sector. But lower taxes and maintenance of healthcare will mean larger deficits and borrowing costs. And this is already being reflected in terms of bond yields moving up. There will be additional pressure on the Fed when it comes to tackling inflation.

Imported inflation

The RBI has often reiterated that the decision on repo rate is based on domestic inflation considerations. But actions taken in the US have the potential to affect global inflation too, which will feed into the system through imported inflation and hence cannot be ignored, especially when core inflation is already inching upwards.

Sixth, the status of the dollar will be uncertain. Higher inflation will mean higher interest rates for longer periods, which will keep the dollar stronger. And this is already visible since the election results were out.

However, there are also arguments for a weaker dollar, to ensure there is an export advantage for the US. Either of these two situations would mean work for central banks across the world. A stronger dollar will mean that central banks have to defend their currencies. A weaker dollar would mean ensuring that countries do not lose their competitive advantage.

From the point of view of markets, Trump regime could mean more volatility. As far as FPI flows are concerned, they would tend to be less predictable. A stimulus earlier by China saw major withdrawals from emerging markets. Actions as well as intentions announced by the US would tend to drive sentiment, which in turn has the potential to have an influence on global currencies.

The world would have to be prepared for a new normal with Donald Trump taking over. His stance at the time of campaign was no different from the action taken when he was President earlier. Therefore, consistency can be expected, though the extent could get tempered given the new world economic order. But for sure, all governments and central banks have to remain vigilant when the world’s largest economy targets the second largest.

How To Gauge Consumer Spending This Time? Free Press Journal 9th November 2024

 

While there is still need to exercise caution in forming judgements on overall consumption including urban spending, the commentary on Q3 sales will throw light on the final picture

With some of the leading FMCG companies raising a red flag on demand conditions in the second half of the year, there is some concern on the growth path of the economy for FY25. This is understandable as any projection of high growth was premised on a sharp recovery in consumption. As the IMD has indicated that monsoon is above normal and well spread, it was logically assumed that the cog in the wheel, i.e. rural consumption would turn positive. This is the basis for being more sanguine about Q3 of the year as the period coincides with the post-harvest cum festival season.

The issue which has been flagged is urban consumption which does not appear to be in the take-off mould. In the last couple of years the picture was fogged to an extent by the pent-up demand phenomenon where there was an upsurge in spending. While the lower end products did not quite see the same traction it did not matter as the sales of higher priced goods were up. This was the phenomenon of premium products selling well in the market. The higher income groups have been impervious to any external effects; and post covid have been on an upward spending spree. This has manifested in buying more high-end goods. In fact, the number of BMWs, Audis and Mercedes cars on the roads has increased and reflect the wealth of this class. But lower down the pecking order, things have been different.

Quite clearly when segmenting society in terms of targeting goods and services, it is no longer a dualistic approach of rural and urban. There is also an income group which comes into the picture where there are three distinct classes. The affluent would be at the top while the middle order encompassing a large mass, which includes those employed in relatively low-income jobs get covered. At the bottom are the poor who are just on subsistence and would be surviving mainly due to the largesse of the central and state governments. Even with the rural folks, it is not just agriculture which matters as the allied activity comprises almost half of the workers as well as output and hence a classification here is relevant. And then there is the non-farm class which is primarily the MSMEs in petty manufacturing and service activity. Therefore, a more nuanced look is needed to understand why things are the way they have shaped up.

There are several factors at work which drive consumption. The first is the case of repressed consumption in the past in the last couple of years which can lead to higher spending especially at the lower- and middle-income levels. The current picture is that there has been less compromise made on expenditure on services like better living which includes travel, tourism and dining. But the same on goods has been limited. Second is inflation which has cumulatively taken a toll on real income. While incomes have been rising the real value is denuded due to inflation. This leads to less spending on discretionary goods. As food inflation has been high with the products being necessities, there has been a cutback on other goods.

Third, while employment numbers do indicate that more people are getting jobs, there has been concentration in those involving lower skills. Here typically incomes are low and can be seen in sectors such as construction sites or logistics where delivery has seen an upsurge in job creation. The spending power is limited after accounting for rentals in cities and the phenomenon of sending money back to families in the hinterland. Fourth, there has also been a case of jobs being lost in the organised sector and this is manifested in the layoffs announced publicly by several companies. This is due to downturn in business as well as shift to greater use of technology. Either way this means the threat of loss of jobs is always there. Aligned to this phenomenon is the salary increases which have been modest since covid where companies have not been giving hikes of double-digit numbers as their performance has tended to be under the weather for a longer period of time. The top echelons reap the benefits of stock options and have made substantial gains due to the stock market boom.

Last the access to finance has become a little tougher ever since the RBI came up with stricter norms for unsecured loans which has pushed up the cost. Therefore, leverage based consumption has ebbed which is again a factor working at the margin.

Now there is less clarity on how these factors will work out in the next couple of months. While data for October is not yet available there is a view that the spending from the urban side could be low key this year. One reason for the picture to be blurred is that September was a month that did not see much traction in sales for automobiles as well as consumer goods due to the custom of not purchasing such products during this phase which is considered inauspicious by some sections of society. This year all the festivals have come earlier which has come in the way of sales. Hence there is some hope that there would be a revival in sales which again could be more from inventories built-up rather than fresh production.

Hence the picture is quite blurred today though the major comfort which comes from a critical proxy variable i.e. GST collections is reassuring. The fact that collections in the first 7 months of the year are higher than that of last year is reason to believe that conditions are stable. The fact that a large part of consumption has shifted to the online mode means that what is observed at the brick-and-mortar outlet and shopping malls do not give a reliable wholesome indication of the picture. The higher discounts offered by the major portals has already weaned consumption away from the physical outlets.

Therefore, while there is still need to exercise caution in forming judgements on overall consumption including urban spending, the commentary on Q3 sales will throw light on the final picture. All underlying conditions of good monsoon, better kharif crop and declining inflation (which is rate of change of prices and not absolute change in prices) seem to be in place. However, higher absolute prices for food products and low pace of growth in employment in the organised sector are still areas where the picture is not too clear.

Playing Gate-keeper: There are two sides to every billionaire’s story, and viewing only one can be misleading: Financial Express November 3, 2024

 Before reading this book, a question we need to ask is whether or not the judgment of a corporate leader should stop at professional achievements. Does personal life matter or the associations that a person may have? If the person has achieved distinction by probably lobbying to get certain laws passed, is there anything amiss here? And last, if the person at some stage of career decides to give a large part of wealth for general welfare, even though there could be some business round-tripping, should it taint the image?

To digest the book written by Anupreeta Das, titled Billionaire, Nerd, Saviour, King, one needs to answer these questions. While there are several tech entrepreneurs who would qualify under this heading, this book is all about Bill Gates. The author has a sub-title which goes as ‘the hidden truth about Bill Gates and his power to shape our world’. This indicates that the author is going to be very critical of Bill Gates, and this is actually the train of thought that pervades the 320-odd pages. In the book, Gates comes across as a person who is a slave-driver employer and very demanding, even getting abusive if things do not go his way. Hence employees have to give their best, keeping aside things like a work-life balance. The book says Gates’ philanthropic work in terms of money given has been questioned based on motivations and the fact that the foundation funds may be finite can raise some questions on intent.

The first page of the introduction in the book talks of his association with Jeffrey Epstein, who was a convicted sex offender and a pariah who died in jail. The reader would evidently start reading the book with a bias that could turn to prejudice along the way when viewing Bill Gates. His achievements at Microsoft could get dimmed in this process.

Gates was a drop-out from Harvard in 1975 who co-founded Microsoft as a teenager. His early life is described as one of relentless coding through the night after promising a company ‘software that he hadn’t yet written’. The company went public 11 years later, and a year after that Gates became a billionaire at the age of 31.

His image got sullied due to legal issues that came up, as Microsoft allegedly misused monopoly power to the extent that anti-trust suits were filed. Microsoft’s refusal to allow Netscape access to Windows 95 sparked a long-running antitrust battle with the government, where it was accused of monopolising the web browser market. By 2001 Microsoft had been sued more than 200 times in the US because of monopolistic conduct highlighted by the justice department. Gates genuinely felt this was absurd as Microsoft generated myriads of jobs as well as added wealth to America, in a way reflecting his arrogance. In the hearings and question sessions, he openly stated that the government was only stifling innovation, which would hurt the country.

A major area that Das has written about is the philanthropic work of Gates through the foundation set up in 2008 at a time when he stepped out of Microsoft. The core of the critique here is that the money involved has given the foundation disproportionate power over how public issues and policy are framed. The focus on using technology fixes and absence of democratic accountability affected final outcomes. The book implies based on the sequence of events that getting into philanthropy was a way to change the image of a ruthless capitalist to a saviour of the underprivileged.

An interpretation of his actions has been that the charity has been used as a political tool, taking advantage of tax breaks, besides creating an image for the self. The author writes that in India, Gates has not been apolitical but aligned with the Modi government and some of his programmes did not quite work. Das has a gone a long way to show probably only the darker side of Gates to reveal how billionaires wield their power, manipulate their images, and use philanthropy as a tool to become heroes. In the course of these actions they help repair their damaged reputations while directing policy to derive their preferred outcomes.

The author has written this book after interviewing several people who have worked with Gates. These include both current employees of Microsoft as well as the former staff, besides those from the Gates Foundation. The author also spends several pages on his relationship with his wife as well as Warren Buffett, who was a contributor to the foundation.

Given the title of the book and the implicit bias that will strike the reader continuously in the first few pages, there is little praise for Gates’ achievements as the creator of Microsoft or the good that has come from the work of the foundation. Hence it is a very one-sided view that can only add to prejudice and not a fair evaluation of the persona. A more balanced approach would have been appropriate given that a lot of good has come from Gates. Therefore, the reader should keep this in mind when forming judgments because it does tend to present only the darker side. Some of the titles of the chapters bring out the unconcealed prejudice— ‘why we hate billionaires’ and ‘cancel bill’ or ‘rockstar to robber baron’. However, if one really dislikes billionaires anywhere in the world, then this is a book to pick up and read for reaffirmation!

Implications of RBI's securities buyback: Business Line 28th October 2024

 

The Mumbai Metro Is An Exemplar Of Improper Planning: Free Press Journal: 26th October 2024

 Today the drive to the financial capital via the western express highway best explains everything about the growth model. Motorists tend to use the service road to enter this financial hub. It is lined with little houses with asbestos roofs and unauthorised constructions at the first-floor level. They have withstood the tough monsoons and absence of care over decades. The authorities had erected curtains along the almost 2 kilometre stretch when the G20 was on to ensure that foreign dignitaries did not get to see what lay behind these covers.

The drive through the inner roads reveals that it is the lower middle class which resides and these settlements have only common toilets. The drive along the bumpy lane leads to a high class IB-school which has chauffeurs waiting outside in their BMWs, Audis and Mercedes cars. One would pass the little used metro station which has strays taking shelter before reaching a high-end housing complex named after a European city. Further down before one reaches a five-star hospital, there is open defecation as the hamlet does not have running water and there are myriads of slums. The entry to the financial capital takes a turn for the grandiose as almost every financial institution is located here. Chaotic traffic and several Michelin star restaurants dot the way as one can get lost in this unreal world. How do we plan our cities, as this could be the story anywhere in the country?

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Mumbai Aqua Line Metro Misery: Glitches, Gimmicks, Gaps

Every year all governments — centre, state and municipals spend a lot of money in building infrastructure. The word to use is spend and not invest, which is typical of how capex is structured in the country. There are ambitious targets which are met. The best engineers are given contracts to execute projects. But — as can be seen in Mumbai — there are horrendous time overruns which also leads to cost overruns and vitiates the effort in terms of time and money expended.

The Mumbai metro project was to be completed by October 26 in a period of 15 years. There are to be around 16 lines spanning over 500 kms. The opening of the only underground metro has been celebrated as being quite singular. This is the famous Colaba-Bandra-Seepz line which is to run for 33.5 km long underground metro line. The first 12.44 km has been opened. It has been developed at a cost of over Rs 32,000 crore. The present stretch is open from SEEPZ to Bandra Kurla Complex which is the financial hub of the country. A journey taken during peak time will reveal that there are not too many users of this line. The problem is with the design of the metro line.

Metro lines everywhere in the world operate on the concept of inter-connectivity wherein there are easy transfers to other lines. This enables commuters to cross over across different zones which in Mumbai would mean the western, central and New Mumbai links. While there are only a few lines operational, introspection would call for ensuring there is this connectivity. In fact, there is a pressing need to have a connection to the existing railway lines operated as the Western, Central and Harbour lines by the Indian Railways so that these lines are effective. Further, there is need to ensure that once a person emerges from the metro station, there is road transport available. The aqua line fails on all these scores. The metro lines are under the jurisdiction of MMRDA and MMRCL which are in charge of developing different lines. While it is not clear if they have been talking to each other while designing the network, there is definitely absence of coordination with the suburban railway authorities which come under Indian Railways.

The present station which leads to the financial centre is way off and requires a 15-30 minutes’ walk to the offices which are sprawled across this region. There is no option of using public transport to reach the office nor a taxi-auto service given that the roads do not allow turns given the congestion. The larger question is whether this line will serve any purpose to ease travel. In fact, ideally the aqua line should be connected to what is called the red line or Line 7 which is operational and goes down the western express highway.

In retrospect this sounds a rudimentary idea which should have occurred to those who planned this line as this is the basic concept of metro railway network. While it is true that there will always be commuters who travel once all the lines are operational in the next five years, given the size of the population, it does not reflect well on planning.

Interestingly the mono-rail service which runs between Chembur and Mahalaxmi started in 2014 but had to close down for several reasons including the usage. It has recommenced operations but capacity utilisation is still low at around 20-25%. It is not surprising that the frequency of these trains has been reduced to lower operating costs. But it defeats the purpose of having such a system in place. The losses are supposed to be over Rs 500 crore. There should have been lessons to be learnt when the metro system was drafted.

There is reason to believe that while the authorities are good in starting various projects, there is not much effort which goes into these final details. Mumbai is a city known for not having footpaths, and it does look like the authorities do not have this high on the agenda as scant attention is paid. The state of roads during the monsoon season is well known to the point that the public face potholes with stoicism which comes from accepting the fact that the megapolis will never change.

As the country embarks on the journey to become a developed economy, there is need to stress on quality of growth. Reaching the threshold of $ 14,000 per capita income will happen as the size of the cake expands. But the qualitative aspect would require a different mindset. More importantly, we need to focus on quality along with quantity to bring about real development.

‘Put’ option to aid bond market: Financial Express 24th October 2024

 An issue which has always been debated is getting more retail investors to invest in the corporate debt market. Retail interest is high in the equity segment either directly or indirectly through mutual funds. When it comes to corporate bonds, however, the interest is more through the mutual fund route. Few individuals invest directly in corporate debt. One of the factors that has kept back retail investors is the difficulty in selling the security before maturity. In case of equity or mutual funds, there is a window open at any time for a sale transaction. For a listed debt security it is theoretically possible to be sold, but there may not be buyers as few securities are liquid. The absence of liquidity is the biggest challenge where the secondary market is not active for most securities. Unlike equity which is unique to a firm, a company would have multiple bonds listed at any point of time depending on the number of public issuances. Further, most buyers are institutions who would hold the securities to maturity to match their liability tenures.

It is against this background that the Securities and Exchange Board of India’s (SEBI) recent move to allow companies to announce a voluntary “put” option should be seen. In simple terms, an issuer of debt has the choice to give the investor a choice to redeem the security before maturity at specific points of time post-issuance subject to a minimum holding of one year. There are requisite approvals to be secured from the board for this purpose. The valuation norms for this “put” option have been specified as also the minimum amount of the issue size under this umbrella. The regulation is comprehensive.

On the face of it, having a “put” option on such issuances is a very good idea. It is not mandatory as of now, but it may be considered depending on how things work out. The new regulation fills the lacuna in the system, which has kept retail investors away, and hence is progressive. This becomes analogous to a fixed deposit with a bank that can be withdrawn 

any time after it is opened subject to the minimum period and a penalty clause. The penalty clause here for a debt security would be similar as the value would not be the issue price but something different based on market conditions. Intuitively in a scenario of rising interest rates, the value could be lower. Therefore, from an investor point of view, this should read well as it mimics to a large extent the preferred bank deposit.

What could be the incentive for a company to have a “put” option? The first is that it would have access to a wider investor base. SEBI has made the concept optional to the issuer and also given the prerogative to choose the category of investors who qualify. It could be specified for only retail or all investors. Second, the “put” issuances would go with a different International Securities Identification Number (ISIN) and not clubbed with the existing mandatory limit placed by the regulator on the number of ISINs that can be issued in a year. It would thus enable the company to eschew the necessity of re-issuing a security if it has hit the limit of maximum permissible ISINs.

Third, the issuer may like to take advantage of the changing interest rate regime, and buy back their earlier security and issue a new one. This helps in treasury management. Fourth, depending on the market conditions, the issuer may price it better as it gives the option of early redemption to the investor. The coupon rate offered could be slightly lower with this option being provided. Fifth, for a lower rated company, such issuances with a “put” option would work better as investors can redeem before maturity depending on the prevalent conditions.

For all categories of investors the “put” option would work as it is not necessary to redeem but is an alternative. Individuals, in fact, already invest in some non-redeemable securities like the government floating bond. A better return for the investor on the corporate bond with the “put” option would be a better alternative, especially if the rating is high.

Therefore, SEBI’s move is very good and a big step in the direction of adding depth to the corporate bond market. It also opens the doors for retail investors to enter this segment. However, some awareness programmes should be carried out so that investors know how the bond market works. Unlike a bank deposit which has a fixed principal and interest, a bond which is redeemed in advance will have a variable value depending on the market conditions. Hence while the coupon rate is fixed, the capital redeemed before maturity will not be so. This is an issue also with investing directly in government securities, which is possible through the trading window offered by the Reserve Bank of India. The nuances need to be understood before investing.

A pertinent conundrum for the issuer is that once there is a “put” option, provisions have to be made periodically for possible redemption. This will mean having an active treasury which ensures funds are available. While this holds even for instruments that are redeemed on the due date, the exercise becomes periodic for such bonds. This could mean borrowing in the market or taking a loan from financial institutions to repay such debt in case normal business operations do not generate the requisite funds.

Developing the corporate bond market to include more retail players is a necessity. To do this, one has to mimic what happens in the conventional banking sector where deposits are offered with certain flexibility. The “put” option largely addresses a major concern for any household. Intuitively it can be seen that this idea will resonate well where the company is rated AAA or AA. The risk factor for a lower rated paper will always be overwhelming because a possible default will be a consideration. A way out would be to consider providing “bond insurance” much like deposit insurance where issuers would have to pay the insurer to provide cover of up to Rs 5 lakh as is the case with bank deposits. This could be an issue which can be further deliberated.

Equities reign atop the league table of investment returns: Mint 23rd October 2024

 https://www.livemint.com/opinion/online-views/currency-gold-silver-investment-portfolio-equities-fixed-income-instruments-inflation-crude-oil-chana-tur-dal-11729562693859.html

The Economics Nobel for 2024 underlines the connection between wealth of nations and democracy: Indian Express 14th October 2024

We are all aware of the fact that there is a rather large gap between rich and poor countries. The income gap between these two sets is persistent, and while the poorest countries have become richer, they are not catching up with the richest. Some part of this inequality is historical, but there is strong reason to believe that institutional differences in countries can explain this difference. The developed world has a common thread in the form of political and economic structures, and probably mindsets too. This is the theory espoused by three economists, Daron Acemoglu, Simon Johnson and James Robinson, who have been accorded this year’s Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.

What exactly do they mean by institutions? It is a gamut of political and economic edifices which drive the growth agenda of a country. Simply put, the regime can be inclusive, which is best exemplified by the West which is also largely democratic. This would mean a strong legal system where rules are defined, with an adjudication system in place. There are transparent laws relating to doing business, covering taxes, trade and commerce etc. This provides the contours for doing business.

Alternatively, it can be exploitative as can be seen in autocratic regimes, such as in some parts of Africa. Quite clearly, societies with poor rule of law and institutions that exploit the population do not generate growth or change for the better. When multilateral institutions keep harping on economic reforms, this is what they are talking about.

The 2024 Nobel Laureates do trace their theory to colonialism where they link the quality of institutions to the number of settlers in colonies post-independence. In some places, the aim of the colonists was to exploit the indigenous population and extract resources for their own benefit. In others, the colonists formed inclusive political and economic systems for the long-term benefit of European migrants. This varied across Europe and Asia and Africa. Where colonists remained and settled due to lower mortality, there was evidence of creation of institutions which worked well. They do not justify colonialism, which was exploitative, but do find this positive correlation in places where the colonists became settlers and contributed to this development.

The two main takeaways from their body of work is the importance of a democratic set up and the creation of the right institutions that foster investment. Democracies definitely work better, as there are free elections and while different parties may have varied motivations, one needs to perform in order to get back to power. Hence institutions would necessarily have to be built. Protection of private property is such an institution which comes automatically if there is a strong judicial system. Similarly, various policies that support the growth process would be part of the system.

A question which would come to mind is how China has managed to create one of the largest economies with the latest state-of-the-art infrastructure and production processes. The political system is autocratic for all practical purposes, but has delivered well. Here, the counter argument can be that while the economy is large and competes well with other developed nations, there is immense inequality within the country. Therefore, such guided growth, where the government owns and controls a large part of the means of production, does not bring about an optimal solution in terms of equality.

Singapore can be another contrarian example which is not democratic but has strong institutions. It can be considered an outlier for sure. There are also some of India’s neighbouring countries which are ostensibly democratic but tend to get oligarchic, which has impeded development.

Let us look internally now. The government has focused a lot on the ease of doing business which has been achieved by creating the appropriate institutional structure through a series of reforms in every sector. Providing access to infrastructure, land laws, dispute resolution, strong financial systems etc. are all part of the institutional set up that is required to keep growth ticking. This has been vindicated in our context in the last 10 years or so where India has become the fastest-growing economy though, admittedly, there is a long way to go in becoming a developed economy.

Therefore, while the Laureates do not provide specific solutions, a takeaway can be that unless there are democratic regimes which foster the building of strong institutions, growth across countries will remain lopsided.

How Should Households View The Credit Policy? Free Press Journal: 14th October 2024

 As a layman what is one to make of the credit policy? Credit policies are all about deciding on the repo rate which is the benchmark used as part of the toolkit for ensuring macro-economic stability by the central bank. The repo rate, which is nothing but the rate at which the RBI lends to banks on an overnight basis, is the anchor rate. It is just like the Fed rate which is similar in scope. What these anchor rates do is to guide the direction of movement in all other interest rates in the financial system.

As far as banks are concerned the repo rate becomes the anchor to decide on all other interest rates concerning their deposits and lending rates. The lending rates of banks are driven by two sets of factors. The first is what are called external benchmark lending rates where the interest rate is fixed to a benchmark which is normally the repo rate. It could also be the yield on a security or Treasury bill. Therefore any change in the repo rate would automatically tend to move the lending rate for all banks for loans that are tied to this formula. By statute all retail loans and those to MSMEs are linked to this benchmark.

The second is what is called the MCLR which is the marginal cost lending rate that is a formula-based rate. Here the lending rate is based on the marginal cost of funds which is primarily the deposit cost with other variables being included. This is the minimum rate at which anyone can borrow from a bank and normally there is a spread over the MCLR. Therefore it could be in the range of 50-300 bps and can stretch higher given the risk profile of the customer.

Intuitively it can be seen that what matters here is the deposit rate which is again linked somewhere to the repo rate. The credit policy was eagerly awaited this time because conditions looked seemingly appropriate for expecting some action on the repo rate given that the last two inflation numbers for July and August are less than 4%. The RBI has decided not to change the repo rate which will remain at 6.5%. Therefore, there is no policy push to alter the lending rates as of now.

However, after a long hiatus the stance has been changed to neutral. The stance is something which has been debated for quite some time now. It has been kept as ‘withdrawal of accommodation’ ever since the Ukraine war started. It has been interpreted as a position taken when the RBI is waiting for all past actions on repo rate — the increase by 250 bps invoked since 2022, to be transmitted to the deposit and lending rates.

A ‘neutral’ stance can be taken to be interpreted as the central bank being comfortable with the present state of the system where transmission of interest rates is more or less complete and there is reason to look at rolling back rates when the time is opportune. Here, the policy actually blows hot and cold. There is a lot of caution being expressed over the future course of inflation. The high base effects kept inflation low in July and August and the expectation is that inflation will cross 5% in September. Further the forecast for inflation for Q3 of the year is 4.8% which is much higher than what was witnessed in the first two quarters. This gives a sense of caution that a rate cut cannot be in the offing any time soon.

The RBI has highlighted three factors which can be influencing inflation in times to come. The first is the impact of climate which has manifested in extreme heat and rains in different parts of the country. The potential to affect agricultural output is high, and this is already seen for tomatoes and onions. The second is the geo-political situation which is becoming unstable ever since the Israel issue has resurfaced with Iran getting involved. The potential impact on crude prices as well as logistics costs is sharp and cannot be conjectured at present. Last, there has been a tendency for global commodity prices to rise which will feed into the costs of manufactured goods and increase core inflation.

What does all this mean? It appears that the RBI believes that the worst of high inflation is over. But there is some uncertainty on the durability of the present low inflation and therefore there will be a wait and watch approach. The fact that the stance has been changed to neutral is indicative that a rate cut would be on the horizon, as a stance change prepares the system for a rate change which can be only in the downward direction.

Therefore, one can assume that the era of ‘peak interest rates’ may have ended. Therefore from the point of view of borrowers the picture is clear. The lending rates will only come down though the timing is hard to guess. But from the point of view of deposit holders, it may not be very clear. While deposit rates in general are unlikely to increase across all banks and tenures, the downward movement would also not be generalised. This is so as liquidity conditions vary across banks. While system wide liquidity is comfortable, individual banks are using other means of raising funds including raising deposit rates across specific tenures. Hence it is still possible for certain banks to offer higher rates on some deposits.

In a way it can be said that we may be starting on the cycle of lower rates in future. Going by the inflation forecasts of the RBI and the current geo-political situation, a rate cut is possible earliest in February 2025. While this would be good news for borrowers, it should also be mentioned that in this particular cycle of lower rates, the repo rate cuts could sum to 50 bps as 6% repo rate has been the average over the years. Anything lower could at best be temporary, as inflation would always be a variable that would be hard to keep low for all time.

RBI policy: Prelude to future rate cuts? Inflation numbers hold the key: Business Standard 9th October 2024

 The major takeaway from the credit policy is the change in stance, as it was unexpected. The fact that this was unanimous points to a common view taken by all the six members. This is important because it is largely assumed that a change in stance to ‘neutral’ is a prelude to a rate cut possibility in the future policies. This follows from the view that changing both the repo rate and the stance at the same time is not appropriate, as the power of the stance gets diluted when they are done in unison.  

The change in stance is based on the premise that the growth-inflation matrix is well balanced and conditions are favourable for attaining the goal of durable low inflation in the near future. This raises the issue of whether a repo rate cut is possible in December, as the stance has been changed in this policy.

Going by the forecasts made by the Reserve Bank of India (RBI) on inflation for the balance quarters, there will be an uptick to 4.8 per cent in the third quarter (Q3), which will be the October-December period. It is subsequently supposed to come down in Q4 to 4.2 per cent, which is a signal for assuming durable low inflation. Therefore, a cut in repo rate in the December policy looks unlikely and will have to be pushed forward to February 2025, unless the inflation numbers surprise significantly on the downside in the next couple of months. 

Inflation risks

The policy remains open-ended on the future possibility of rate cut, which sounds reasonable given that the future course of inflation is hard to gauge. The policy highlights three possible risks for inflation. The first is weather changes that can affect food inflation. The monsoon has not yet withdrawn fully, and any possibility of heavy rains can affect harvests. 

Second, the geo political situation is tenuous with the threat of oil prices going up again. While this has not happened when the Israel conflict started, the entry of Iran can change this direction. Third, other commodity prices such as those of metals have been going up, which can add to core inflation. Here the China factor will have a role to play. 

The policy has presented a balanced view of risks and signaled that while it does feel that conditions would be improving on the inflation front, one cannot be too sure. Therefore, the change in stance to neutral echoes that sentiment. There has been no change in the GDP growth forecast, which means that there is no concern on this variable. This has been supported by strong growth in both consumption and investment, which is expected to continue. 

It is hence indicative of the fact that the present interest rate regime does not militate against growth.  With inflation moving down and a good kharif harvest, chances of rural and urban consumption improving looks likely.  

The market reaction would need to be seen. While bank deposit and lending rates would be driven more by liquidity conditions of individual banks, bond yields should move down further. So far they have been influenced more by decisions taken by other central banks as well as liquidity situations. A further downward movement can be expected that will help the government in particular as borrowing costs come down. 

The change in stance is the first alteration made by the MPC ever since the Ukraine war when rates and stance were changed. This does indicate a return to equilibrium state for the economy in the coming months.

Food inflation has strong linkages with other parts of the price index; keeping interest rates high amid high food inflation helps prevent excess demand pressures: Financial Express 8th October 2024

 The economist Milton Friedman had said that inflation is always and everywhere a monetary phenomenon. That is how monetary policy came to the forefront with inflation targeting being the result. An issue which has come up particularly in India is that if inflation is being driven by food products over which monetary policy has no control, are we barking up the wrong tree? As a corollary, some arguments suggest that the share of food in the index should come down or that the central bank should be targeting core inflation which excludes food and fuel. These issues are prima facie pertinent but deserve further probing.

The answer is not straightforward even when one talks of food inflation. While overtly it does seem that supply shocks lead to higher prices there is a demand factor also at play. For example, demand for coarse cereals has been rising over time with the society being driven by health motivations. This has increased the prices of the products. The same holds for cereals where value added products are driven by demand conditions and often not related to supply-side factors. Besides with an open-ended procurement programme run by the Food Corporation of India a lot of grain gets diverted, leaving less for the market in the face of rising demand. At times, such diversion leads to excess demand in markets, which pushes up prices.

Higher incomes make people move to higher-value products, which play in the background. This is but natural. The proliferation of catering, hospitality, and travel businesses has added to the demand of edible oils. A similar example is pulses (especially chana) whose prices rise during festivals due to exceptional demand.

Further, leverage is used for the purchase of goods at supermarkets by even lower income groups. Personal loans have grown at a smart rate across all segments where interest charged has a bearing on purchases. Thus, there is merit in the link between interest rates and demand for food. The problem comes to the fore when there are supply shortages and sharper price increases. Interestingly, even the “core inflation” products do not always witness price rise due to demand factors alone. The increase in, say, telecom prices has nothing to do with demand which remains inelastic once it is a habit. Similarly, when hospitals or educational institutions increase fees, it is not due to demand but the “cost factor”. The cost will include staff salary as well as cost of other inputs going into the service. The same holds true for consumer products, where higher input costs are not driven by demand but global and domestic factors that feed into the final price.

Hence it can be argued that price changes for non-food products are also driven by supply. Further, housing price included in the index is linked to the house rent allowance of government officials, which too is a periodic change and not a demand-side factor though high demand increases housing rent in the real world. It can be countered that with the boom in housing the supply of tenements for rent would always be increasing and often the movements in rent are sluggish.

Therefore, it is hard to distinguish between price increases due to pure demand or supply factors. Both are at play and separating the two forces on the assumption that product (or service) prices are driven exclusively by one can lead to erroneous conclusions. Today, retail credit is the leading segment which involves households. Higher interest rates do keep a check on spending based on leverage as budgets are realigned. Hence even if, for the sake of argument, it is assumed that the food price shock is purely due to supply factors, interest rates have a bearing on household borrowing and hence spending, making policy very relevant.

The problem with food inflation is that when it is high, it feeds into inflationary expectations which then spreads to core inflation and over time becomes generalised. This happens in two ways. One, when there is an upward adjustment of incomes, including wages, which in turn trigger demand pull forces for other non-food products. The Mahatma Gandhi National Rural Employment Guarantee Act wage, which is a benchmark for wage setting in other sectors, gets adjusted with inflation every year and hence automatically increases incomes in other professions. Second, there is a tendency for producers of manufactured goods to also raise prices once food price inflation is anchored at a high level. This happens with a lag of two-three quarters. In fact, often producers absorb higher input costs to begin with before transmitting the same to the final consumer. For example, higher wages paid by movie theatres get reflected in higher ticket prices.

Therefore, it may not be prudent to ignore food inflation from the point of view of monetary policy as there are strong linkages with other parts of the price index. Further, by keeping interest rates higher when food inflation is high, it helps in preventing the build-up of excess demand pressures. This is why it is often argued that monetary policy has to be reactive and keep looking continuously at the rear-view mirror. The precise impact of food shocks on inflation is hard to guess. The price shocks either last for a couple of weeks, or get entrenched in the system and become durable.

This is why it is observed that central banks target headline inflation and do not ignore food inflation. In India especially, consumption trends of food products have changed greatly with demand-side factors coming into play. Ignoring this aspect of inflation will mean missing one significant piece of the puzzle.

Indian agencies should get into sovereign ratings: Buisness Line 8th October 2024

 

Book review: Monumental measures: Financial Express 29th September 2024

 It has become fashionable for experts to draw up models and templates for creating a successful organisation. While there is a plethora of books on the subject, there are two ways of addressing the issue. The first is to look at successful organisations and draw lessons from what was done. This goes in terms of lessons that can be learnt from such an experience. The other is to construct a model that outlines what all has to be done to be successful. Sandeep Chennakeshu, in his book titled Your Company is Your Castle, follows the second route. The title is eloquent as he draws analogies from the architectural parallel. This is a novel way of presentation of ideas.

The author has eight structural elements that are part of this framework or rather castle-building exercise. The analogy of a castle holds for a company because like any monument it has to be defended for all times. Therefore, there has to be care taken when defining the goals as well as processes. The latter are more important because organisations run not because of goals but the routes that are taken to continue generating value on a sustainable basis. A long-term view needs to be taken which also means that one has to anticipate change and react in an appropriate manner.

More importantly, one has to be constantly in touch with the real world and not get carried away when times are good. For this, the basic principles of castle building are important.

One of the elements pertain to culture of the organisation. This is critical because at the end of the day companies are run by people and they need to be aligned with the goals and strategies being adopted. Similarly, certain functions like customer service, for example, are part of culture where the standards have to be set and adhered to and monitored for any deviations. While sales is an immediate target, to maintain the momentum the culture of dealing with customers is critical.

This is where leadership is important because in all organisations this quality can make a difference. This person not only drives strategy after it is approved by the board, but also gets the right people to execute the plan. This is probably the distinguishing factor across companies in an industry. The top person may have the ideas that are right but executing could fail if the right people are not there. Leadership can fail if it is not able to execute the plan, which is why people are important. This is where organisations which reward meritocracy tend to be better than those which don’t.

Another part of the castle that he calls the ‘walls’ is strategy. Here the decisions taken have a bearing on another structure, which is the ‘foundation’ that he refers to for ‘growing cash’. Looking at the foundation, which is probably most important when there are multitude shareholders, is profit generation. To ensure that profits are generated it is essential that revenue has to grow and as profit is the difference between revenue and expenses, the latter needs to be optimised. These may sound rudimentary but once companies slip up here, there is only a downward descent. This is why the walls have to be strong.

This means having the right strategy in place that will have bearing on the investments made as cash is scarce. The need to study the market and competition is also important because all strategies are formulated keeping in mind the outside environment. Therefore, one has to understand changing market trends. In this context, it is necessary to keep differentiating products or services as the case may be. At times companies may just attain a high slack quotient when they feel they are comfortably placed and immune to such changes. Accepting changing market trends is also important or else one can be left with out-of-date products.

Here he uses some imagery again, calling the arsenal of products the ‘East Tower’. There is a to-follow-list which the author draws up. This has to be an integral part of strategy that will drive the quest to make profits. In a similar fashion, he draws up other templates that have to be adhered to when creating this castle. He calls the ‘castle roof’ the domain of the stakeholders. This is the ultimate entity to which all managements are answerable. Hence the model has to be robust and immune to shocks.

The author has evidently gotten all the pieces together for a successful organisation to not just survive but also grow over a long period of time. Stakeholders look for four tenets to be followed all the time. The first is sound financial health to be maintained for all time. The second is revealed execution capabilities that ensure that the first is achieved and not just based on promises. The third is being innovative as this gives comfort that the company is evolving with times. Last is constant engagement with the stakeholders. This is why the investor calls made by companies every quarter are important because there is a two-way conversation.

He ends on more a personal philosophical note where he talks of seven beliefs that individuals need to have in this journey. This can be more in the realm of self-help books. He talks of being curious, dreaming with conviction and leaving the comfort zone. These are always challenges for individuals who cannot really start off their careers keeping such tenets in mind. The same holds for dealing with adversity where reaction is more spontaneous than mature as one rarely has the level of maturity to deal with such setbacks even at the age of 60, when one is a CEO.

The book is full of advice and also philosophical at times. But several examples make it readable. The question is that when all the parts of the castle make business sense, why do companies not follow them? Clearly, most CEOs go by instinct rather than the book.

This Credit Policy Will Be Different, For A Variety Of Reasons: Free Press Journal 28th September 2024

 https://www.freepressjournal.in/analysis/this-credit-policy-will-be-different-for-a-variety-of-reasons

The credit policy to be announced on October 9 is going to be special and different for a variety of reasons. Normally what one looks from the policy is whether the repo rate is going to be changed or not. This is so because as a saver one is interested to know if the deposits opened will receive a higher or lower interest rate. This may not always hold because banks have their own reason for changing deposit rates depending on their requirements. But any cut in the repo rate will not be good news. From the point of view of a borrower, a lower repo rate will be beneficial as all retail loans are linked to what is called an external benchmark, which is the repo rate here. Hence if a housing loan is reckoned at say the repo rate plus 200 bps which is presently 8.5%, a reduction of 25 bps in the policy rate will bring the cost down to 8.25%. Therefore there would be an asymmetric impact on the customers depending on whether it is a deposit holder or borrower.

The present situation is quite different given the developments that have taken place. To begin with there would be new members appointed to the Committee. The Monetary Policy Committee comprises three members from RBI and three external experts. The Committee in the last term had a slight tilt towards a rate cut with 2 of the 3 external members voting for it in August. In the June meeting 1 of the 3 votes for a cut. With the new composition of the Committee, it would be interesting to see how the members view the situation.

Second the variable which is targeted is inflation which has been quite benign in the last 2 months at 3.6% and 3.7% in July and August respectively. The RBI is targeting an inflation rate of 4% with a two percent band on either side. Therefore, prima facie the number looks to be below the target. However, a point which has been made by the RBI in various forums is that the central bank cannot be looking just at the current inflation rate only but has to form judgments or conjectures on future inflation. This is necessary because the repo rate has been at 6.5% for a long time and any change will mean a pivot that should not ideally be reversed in the next couple of months. This can happen only if one is firm on the future inflation view.

The RBI’s current forecasts of inflation are relevant here. For Q2, the forecast is 4.4% which is to rise to 4.7% in Q3 before coming down to 4.3% and will average 4.5% for the year. The Q2 forecasts could come in lower than 4.4% given the inflation rates in the months of July and August. It has been pointed out that the low numbers so far this quarter are due to the high base effect which means that since inflation was high last year, on this base, the growth would optically seem lower.

But there is hope that prices would cool down once the kharif harvest enters the market. The rains have been good and bountiful and the crop is likely to be normal. The concern would be more on non-crops in the area of horticulture where prices are very high for onions, potatoes and tomatoes. This can skew the picture. Also as seen in the past, a late withdrawal of monsoon or excess rains in any pocket at this stage can impact output. As this picture will get clearer only by November, it would be pragmatic to wait and watch before taking a call on inflation trajectory.

Besides, some elements of non-food inflation also called core inflation are showing some signs of spiking up like telecommunication charges as well as consumer personal products as higher input prices are being transmitted by manufacturers. A clearer picture will emerge after a couple of months.

At a different level, there have been some interesting developments in other geographies. The US Federal reserve has lowered their target rate by 50 bps to 4.5-4.75%. This was a big cut and while some sections in the market did expect it, indications are that there would be more cuts in the offing. The ‘dot plot’ indicates that there could be another 50 bps cut this year followed by 100 bps next year and another 50 bps in 2026. What is important is that there has been a pivot in policy to lower rates and depending on the evolving conditions would glide downwards over time. The ECB and Bank of England have also lowered their rates earlier. The fact that rates are moving down globally also raises expectations that the RBI should be following suit soon. The question is how soon will this be done?

It has been maintained that the Fed action is not a primary motivating factor for RBI action as domestic conditions matter more. While Fed action is considered in the discourse as it has an impact on currency movements and forex flows, it is not the overarching argument as the direct impact on inflation is not significant. Right now, growth appears to be on the right path and it does look like that 7% plus is something that will be achieved. Inflation is the unknown though all indications are that it will remain lower. Crude oil prices have come down to the sub-$ 80 mark, which actually opens the door for possible lowering of duties on fuel products which can further bring inflation down.

Under these conditions there are strong reasons for lowering the repo rate. But waiting till November would bring more certainty in the policy stance as the inflation picture gets firmer. Hence with equally convincing arguments on both sides it would be of interest to see which way the MPC decides on October 9.