In a lighter manner, it is said that published data is as whimsical as forecasts made by a plethora of experts and organisations, including several government arms. The recent revisions of GDP and exports data cast a shadow on the robustness of our data. The downward revision of GDP growth by 0.1% points implies around R5,000 crore in real terms. In fact, even the balance of payments data, which is normally not susceptible to change as it is based on actual dollar inflows, has shown inconsistencies, leading to wider debate on what should be done about it.
Forecasts today are taken with a full glass of salt, given that there are variances in what even various officials project or forecast or target or hope. The foreign organisations tend to understate their numbers while Indian banks strike a cautious balance. One is not quite sure how seriously these are taken. But what is a concern is the actual data put out by the concerned agencies, which changes frequently and is used by all.
Official data is sacrosanct and used by analysts to take their own views, which are sent out to their clients. The media makes hay with various views of experts and analysts, which then spooks the markets—stocks, money and forex. Then, ironically, various other government bodies, such as the ministries and RBI, have to formulate their policies based on these numbers and could end up taking an incorrect call in retrospect when data is revised.
One can look at some really drastic changes that have taken place in data sets that affect policy. For FY10, we had started of with advance estimates of 7.2% growth in GDP, which is mediocre compared with 8.4%, which is the final rate. Similarly, in case of capital goods this year, in April 2011 we had the provisional estimate of 14.5% growth, which caused optimism to overflow. But with a series of changes, it is now 6.6%. In the same period, the overall IIP has been revised downwards from 6.3% to 5.3%. Clearly, any policymaker will be flummoxed with such revisions, especially so as decisions are taken with the first number in mind. The problem is with collection of data.
Let us look at the frequency of data releases. WPI on primary and fuel products used to be a weekly affair with a lag of a fortnight, while manufactured products were monthly. Industrial growth numbers and CPI inflation come on a monthly basis, while GDP, balance of payments are quarterly handouts. Banking data comes fortnightly (credit, deposits and money supply), while others come weekly, such as forex reserves. Agriculture data comes out as advance estimates with up to four rounds, with the last one coming 4-5 months after the year. Banking data is usually more robust based on returns filed by banks periodically. The others are provisional data and tend to change drastically at times.
A higher inflation number causes bond yields to rise and stocks to fall. Forex rates move when there is news of a high current account deficit, though this data too comes with a lag. There is a cost involved in terms of market
capitalisation, GSec trades or forex transactions. Also, such numbers create expectations of RBI policy moves, which in itself cause volatility in the call market.
Why does this happen? The first is that we are forcing data to come out with higher frequency without updating our systems. We have changed the base year with the hope that numbers become more reliable. But when the underlying systems remain the same, the revisions will remain.
Second, a large section of our economy is unorganised, like agriculture, small industry and services such as transport, retail trade, real estate, storage and hospitality. The problem then is that accounting systems are not maintained and data is based on imputations, causing the GDP numbers to change.
Third, the APMCs are still traditional in operations and the hopes of linking them electronically are still several decades away. Farm prices are reported in a haphazard manner and often there is a major variance between prices recorded in the mandis and the prices disseminated by commodity exchanges such as NCDEX, which are based on a more scientific MIBOR like polling system.
What are the solutions? The first is that we should abandon the system of having high frequency data until such time we are sure that the numbers are robust. Second, we have to ensure that data reporting takes place at the right time and manner. Electronic linking of mandis is absolutely essential so that all transactions are automatically captured. Third, companies should be compelled to report their factory gate production dispatches just the way the tax department ensures tax payments. In fact, given the spread of telecom in the country, every production unit should perforce be made to submit such returns to the concerned department and it can be linked to the provision of public utilities, especially for the small sector. Admittedly, this is a huge task as even the tax department has not been able to get them in the net.
Given these issues, it is quite appropriate that we have decided to settle for only monthly WPI numbers. Maybe even for others we should wait before releasing data. And, if we must, we should also alongside have the error probability, as this will help in using such numbers for taking business decisions.
Monday, February 20, 2012
No surprise on GDP, but : Financial Express: 8th Febuary 2012
At 6.9%, the advance estimate of GDP for FY12 is not really a surprise, since we have sequentially lowered the
number from 9% in February 2011 at the time of the Budget to 7% in the last RBI outlook. The fact that it is lower than 7% is psychologically compelling as it brings the growth story down by another step. The stance that we are not that much affected by global economic developments, implying thereby that there is some kind of a decoupling working in the background, no longer holds.
The internals of this growth are quite hard hitting. Farm growth is going to be 2.5% despite the high foodgrain output projected by the ministry of agriculture. The number per se is good considering that it comes over a high base of last year, which was 7%. But the question really then is as to how much more can we improve on this number next year as farm trends have tended to be erratic at times.
Second, manufacturing growth of 3.9% is definitely on the lower side but this has been scaled downwards as the year has progressed due to responses to policy. Will there be a turnaround next year? The basic pre-requisites are the following: First there has to be a pick up in demand. Second, interest rates have to be congenial to enable investment. Third, fiscal policy has to be active and not overly cautious. It may sound clichéd here but government spending on infrastructure is necessary and the use of PPP model has to be hastened. Lastly, there are gestation lags before investment materialises into output. All this means that industrial growth in FY13 will be under pressure and the recovery will be gradual. The low base number will definitely help prop up this number.
Third, the services sector performance, which traditionally has been supportive with growth of 8-9%, has done a good job. It is a bit puzzling although that the trade, transport, communication and finance sectors have registered high growth rates at a time when the real sector is performing at low levels. The CSO has linked this growth with higher civil aviation traffic and telephone lines, which can only partly explain these numbers. Further, banking is to lead with high growth though the growth targets this year have been subdued with focus being on investing in government paper, as commercial demand is low due to growth conditions and high interest rates.
Fourth, the government’s contribution to GDP growth has been muted at 5.9%. This is worrisome because we have a situation today where the fiscal deficit has gone beyond the target and will probably be exceeded by over
100 bps. But, at the same time, we have not seen any definite stimulus for the economy through higher spending, which means that the focus has been more on transfer payments in the form of subsidies rather than project expenditure, which may have been compromised. In fact, curiously, project expenditure is probably the only component of the overall budget over which the government has control, which invariably faces the hammer when the chips are down.
Fifth, the worrisome factor is the declining investment rate that has come down from 30.8% in FY10 to 30.4% to 29.3 in FY12.
This is reflective of low growth in infrastructure and capital goods, both of which are needed to propel the economy.
Are there any messages for the coming year? With the elections going by, the government can get down to some serious thinking on the fiscal and monetary fronts. Inflation will continue to be an issue and the comfort we have today is not quite reassuring, given the latent inflation in the system. However, with easing of the rupee and global commodity prices remaining stable, it may be expected that the inflation rate will remain within range, so that RBI can work on the assumption of stability. The issue of course is when will RBI intervene to lower rates? It needs to be confident that there will not be a reversal in inflation and will pause till the first quarter of Q1-FY13 before taking such action.
The government, on the other hand, will have to take a lead role in two areas. The first is that all the pending legislations that have acted as barriers need to be resolved. The low hanging fruits such as land reforms, stance on environment, insurance and pension reforms are easier to take on, while broader issues like FDI in retail can wait. Where there is little controversy, one should logically go ahead and bring about change. The second is the Budget. While there are limitations in terms of the extent to which the government can increase its expenditure, given the obeisance to be paid to the FRBM rules, tax incentives on investment would be compelling. The Budget has to be made growth-oriented by providing the right incentives without hurting revenue. The tenets of the Laffer curve should be considered wherein incentives lead to higher output, which, in turn, will generate the revenue in the next few years.
Everything put together, indications are that FY13 will remain sober with few reasons to get excited as we inch towards the 7.5% mark, provided we keep our house in order. The Planning Commission will have to seriously take another look at its own projections and resources when looking ahead till 2017.
number from 9% in February 2011 at the time of the Budget to 7% in the last RBI outlook. The fact that it is lower than 7% is psychologically compelling as it brings the growth story down by another step. The stance that we are not that much affected by global economic developments, implying thereby that there is some kind of a decoupling working in the background, no longer holds.
The internals of this growth are quite hard hitting. Farm growth is going to be 2.5% despite the high foodgrain output projected by the ministry of agriculture. The number per se is good considering that it comes over a high base of last year, which was 7%. But the question really then is as to how much more can we improve on this number next year as farm trends have tended to be erratic at times.
Second, manufacturing growth of 3.9% is definitely on the lower side but this has been scaled downwards as the year has progressed due to responses to policy. Will there be a turnaround next year? The basic pre-requisites are the following: First there has to be a pick up in demand. Second, interest rates have to be congenial to enable investment. Third, fiscal policy has to be active and not overly cautious. It may sound clichéd here but government spending on infrastructure is necessary and the use of PPP model has to be hastened. Lastly, there are gestation lags before investment materialises into output. All this means that industrial growth in FY13 will be under pressure and the recovery will be gradual. The low base number will definitely help prop up this number.
Third, the services sector performance, which traditionally has been supportive with growth of 8-9%, has done a good job. It is a bit puzzling although that the trade, transport, communication and finance sectors have registered high growth rates at a time when the real sector is performing at low levels. The CSO has linked this growth with higher civil aviation traffic and telephone lines, which can only partly explain these numbers. Further, banking is to lead with high growth though the growth targets this year have been subdued with focus being on investing in government paper, as commercial demand is low due to growth conditions and high interest rates.
Fourth, the government’s contribution to GDP growth has been muted at 5.9%. This is worrisome because we have a situation today where the fiscal deficit has gone beyond the target and will probably be exceeded by over
100 bps. But, at the same time, we have not seen any definite stimulus for the economy through higher spending, which means that the focus has been more on transfer payments in the form of subsidies rather than project expenditure, which may have been compromised. In fact, curiously, project expenditure is probably the only component of the overall budget over which the government has control, which invariably faces the hammer when the chips are down.
Fifth, the worrisome factor is the declining investment rate that has come down from 30.8% in FY10 to 30.4% to 29.3 in FY12.
This is reflective of low growth in infrastructure and capital goods, both of which are needed to propel the economy.
Are there any messages for the coming year? With the elections going by, the government can get down to some serious thinking on the fiscal and monetary fronts. Inflation will continue to be an issue and the comfort we have today is not quite reassuring, given the latent inflation in the system. However, with easing of the rupee and global commodity prices remaining stable, it may be expected that the inflation rate will remain within range, so that RBI can work on the assumption of stability. The issue of course is when will RBI intervene to lower rates? It needs to be confident that there will not be a reversal in inflation and will pause till the first quarter of Q1-FY13 before taking such action.
The government, on the other hand, will have to take a lead role in two areas. The first is that all the pending legislations that have acted as barriers need to be resolved. The low hanging fruits such as land reforms, stance on environment, insurance and pension reforms are easier to take on, while broader issues like FDI in retail can wait. Where there is little controversy, one should logically go ahead and bring about change. The second is the Budget. While there are limitations in terms of the extent to which the government can increase its expenditure, given the obeisance to be paid to the FRBM rules, tax incentives on investment would be compelling. The Budget has to be made growth-oriented by providing the right incentives without hurting revenue. The tenets of the Laffer curve should be considered wherein incentives lead to higher output, which, in turn, will generate the revenue in the next few years.
Everything put together, indications are that FY13 will remain sober with few reasons to get excited as we inch towards the 7.5% mark, provided we keep our house in order. The Planning Commission will have to seriously take another look at its own projections and resources when looking ahead till 2017.
Sunday, February 5, 2012
2012 - The year for commodities? Business Standard: 4th February 2012
Given the rather less than sanguine economic conditions, an investor who would like to make an informed guess at various options can look at what happened in 2011 before taking a decision. Conventionally, investment options lie between deposits or government securities (G-Secs) at one end and the more volatile stock market at the other. Also there is a risk-reward trade-off that reflects the investor’s appetite. What are the options today?
Investment decisions can never be guided by the theory of static or adaptive expectations since one can never be sure that what happened yesterday will also happen tomorrow. What is required is the use of rational expectations, that is, using all the information available for taking informed decisions. This is what got Thomas Sarjent the Nobel Prize and can be applied today on the premise that markets are efficient, where the market price reflects ex post all the information that is available.
The table provides comparable returns for 2011. Annualised price volatility is calculated by the standard deviation of daily returns, while total returns have been reckoned in two ways: an investor buying the product on the first day of January 2011 and selling on the last day of 2011 or a trader buying and selling everyday where the annual return is the sum of daily returns.
The table shows that almost all assets had high volatility with the exception of soy oil and the exchange rate. Further, the investor and trader would have been almost on a par in terms of returns. Also, commodities that are a good risk diversifier were the flavour — chana gave the best returns followed by dollar, silver, soy oil and crude oil. The risk adjusted return would also be very competitive (nominal return divided by standard deviation). Finally, crude and bullion had high volatility though returns were lower than that on chana. Clearly, investors need to look at a diversified portfolio in these volatile times as commodities are intrinsically more efficient because their prices are driven by fundamentals of demand and supply.
Looking at commodities, bullion – which includes gold and silver – are safe harbour investments. Their prices move inversely with that of the dollar and as long as the dollar is fragile will continue to be preferred. The dollar will strengthen due to the euro’s weakness, while the US’ high deficits will keep pulling it down. Gold has historically yielded returns between 10 per cent and 15 per cent a year and that will hold in the coming year.
Farm products are straight options but difficult to understand. In a well-developed market – as it exists on, say, the National Commodity & Derivatives Exchange Limited for chana and soy oil – fundamentals drive prices. Lower production of chana this year has driven up prices, while global pressures on edible oils as well as lower production of soya bean in India has driven prices. However, one has to research these products well, which makes it difficult to understand. The same may not hold in 2012 because prices will be guided by the fundamentals that emerge during the cropping seasons.
Crude oil returns are driven by global demand and geo-political factors. With the passage of winter and generally stable global conditions, at best, demand will not really exert pressure. Further, stable political equations will work to maintain equilibrium that will also be supported by a stronger dollar. Therefore, crude oil would be less attractive than, say, farm products or bullion.
Coming to dollar futures that can be accessed by all, the movements have been an enigma, as the rupee is driven by the dollar-euro relation and our balance of payments. The fundamentals will remain under pressure as the trade deficit widens when imports increase to support growth, while exports struggle in the face of slower global growth as forecast by the International Monetary Fund and the World Bank. This will also slow down capital flows like foreign institutional investors, thus, making the dollar an exciting option. In the pecking order, however, it will still be lower than commodities since the Reserve Bank of India (RBI) factor will be at play to ensure that volatility is limited.
G-Secs will continue to move within a narrow band, thus, giving minimal returns. However, stock markets will be the one to watch out for. RBI’s lowering of rates will make stocks attractive. A progressive Budget – with growth stimulus – will be a booster shot. A possible Greek crisis will spook the markets, while certain trends in the election wave in the US could do the same. Therefore, volatility is bound to remain in this market. However, anecdotal evidence shows that when capital markets boomed and delivered, the economy was also doing very well. It is a necessary though not sufficient condition. With our expectations of a modest recovery this year, the markets can provide better returns than government paper, but will be several steps below commodities.
Therefore, it may just be the right time to get back to the textbook and study the fundamentals of commodities, including farm products that could spice up the investment basket.
Investment decisions can never be guided by the theory of static or adaptive expectations since one can never be sure that what happened yesterday will also happen tomorrow. What is required is the use of rational expectations, that is, using all the information available for taking informed decisions. This is what got Thomas Sarjent the Nobel Prize and can be applied today on the premise that markets are efficient, where the market price reflects ex post all the information that is available.
The table provides comparable returns for 2011. Annualised price volatility is calculated by the standard deviation of daily returns, while total returns have been reckoned in two ways: an investor buying the product on the first day of January 2011 and selling on the last day of 2011 or a trader buying and selling everyday where the annual return is the sum of daily returns.
The table shows that almost all assets had high volatility with the exception of soy oil and the exchange rate. Further, the investor and trader would have been almost on a par in terms of returns. Also, commodities that are a good risk diversifier were the flavour — chana gave the best returns followed by dollar, silver, soy oil and crude oil. The risk adjusted return would also be very competitive (nominal return divided by standard deviation). Finally, crude and bullion had high volatility though returns were lower than that on chana. Clearly, investors need to look at a diversified portfolio in these volatile times as commodities are intrinsically more efficient because their prices are driven by fundamentals of demand and supply.
Looking at commodities, bullion – which includes gold and silver – are safe harbour investments. Their prices move inversely with that of the dollar and as long as the dollar is fragile will continue to be preferred. The dollar will strengthen due to the euro’s weakness, while the US’ high deficits will keep pulling it down. Gold has historically yielded returns between 10 per cent and 15 per cent a year and that will hold in the coming year.
Farm products are straight options but difficult to understand. In a well-developed market – as it exists on, say, the National Commodity & Derivatives Exchange Limited for chana and soy oil – fundamentals drive prices. Lower production of chana this year has driven up prices, while global pressures on edible oils as well as lower production of soya bean in India has driven prices. However, one has to research these products well, which makes it difficult to understand. The same may not hold in 2012 because prices will be guided by the fundamentals that emerge during the cropping seasons.
Crude oil returns are driven by global demand and geo-political factors. With the passage of winter and generally stable global conditions, at best, demand will not really exert pressure. Further, stable political equations will work to maintain equilibrium that will also be supported by a stronger dollar. Therefore, crude oil would be less attractive than, say, farm products or bullion.
Coming to dollar futures that can be accessed by all, the movements have been an enigma, as the rupee is driven by the dollar-euro relation and our balance of payments. The fundamentals will remain under pressure as the trade deficit widens when imports increase to support growth, while exports struggle in the face of slower global growth as forecast by the International Monetary Fund and the World Bank. This will also slow down capital flows like foreign institutional investors, thus, making the dollar an exciting option. In the pecking order, however, it will still be lower than commodities since the Reserve Bank of India (RBI) factor will be at play to ensure that volatility is limited.
G-Secs will continue to move within a narrow band, thus, giving minimal returns. However, stock markets will be the one to watch out for. RBI’s lowering of rates will make stocks attractive. A progressive Budget – with growth stimulus – will be a booster shot. A possible Greek crisis will spook the markets, while certain trends in the election wave in the US could do the same. Therefore, volatility is bound to remain in this market. However, anecdotal evidence shows that when capital markets boomed and delivered, the economy was also doing very well. It is a necessary though not sufficient condition. With our expectations of a modest recovery this year, the markets can provide better returns than government paper, but will be several steps below commodities.
Therefore, it may just be the right time to get back to the textbook and study the fundamentals of commodities, including farm products that could spice up the investment basket.
To tackle inflation effectively, several government departments have to coordinate policy action: Economic Times 19th January 2012
First we were in denial about inflation: the supply-shock explanation fell flat with very good production numbers in FY2011, likely to be replicated this year. The excuse that the poor were less poor and eating more was used to show that inflation was due to prosperity, with the MGNREGA being the motivator.
While this factor could be at play at the margin, it has not been decisive and is no longer harped on. The RBI is firing away at inflation with a relentless policy of rate hikes, which has not worked quite the way it was expected to. But we need to know how this inflation has come to tackle it appropriately.
The answer seems to be a shrug. One way to tackle this issue is to actually analyse threadbare the mechanics of inflation. This is so because inflation combat has to be a joint action from various ends and cannot be the sole responsibility of one agency, which today is the RBI. The accompanying table provides the contribution of various products to inflation along with the ministry or agency responsible.
To calculate the contribution of various sectors to inflation, the weighted change in the overall WPI and individual products has been calculated. Various products have then been grouped under different ministries that oversee their operations. The major cause of price increase has been noted so that the respective body can address price issue.
There are multiple factors that have contributed to inflation. The highest share has come from the so-called core sector: non-food, non-fuel manufactured products over which the RBI has control. Globally, prices of metals have started declining, but we have not seen that in India. So, around 40% of inflation may be attributed to possible demand-pull pressures. While global prices have come down, the rupee has depreciated, nullifying those gains.
We can see that there are various arms of the government that should take some responsibility for inflation. First, the agriculture ministry has to review its policy of minimum support prices (MSP). The MSPs have been increased relentlessly by the Commission on Agricultural Costs and Prices (CACP) to reward farmers.
While production has increased for cereals and to a certain extent in pulses, it has had the tendency to increase benchmark prices in the market resulting in higher inflation. Second, the ministries of petroleum and finance have tried to align the prices of petroleum products to the market, which actually makes us work on a delicate three-dimensional trade-off: higher prices, fiscal deficit and health of oil marketing companies. Around 11% of inflation has resulted from this factor.
Third, the ministry of consumer affairs has to address the issue of warehousing and the Warehouse Development and Regulatory Authority should put in a structure to improve storage to cut down on wastage in fruit and vegetables. Around 40% of our horticulture output goes waste due to absence of cold storages.
In this segment, we have witnessed high growth and where supply outstrips demand provided we can harness it through lower wastage. These organs need to make the system more efficient. While the contribution to inflation was negative in December, it was as high as 8.18% in October, prior to the decline in prices.
Fourth, the area of milk, dairy products, eggs, meat and so on comes under the department of animal husbandry. Higher cost of animal feed and fodder has hiked the cost of production of these products. The significant aspect of these prices is that they are never mean-reverting, which happens for horticulture and cereal products.
Fifth, the higher prices of textile products have to be looked at jointly by the finance ministry which hiked taxes on readymade garments and the ministry of agriculture, which oversees the MSP. But they might have limited control because of global factors.
Sixth, there is the global factor in the form of oil prices that directly impacts the prices of domestic crude as well as non-regulated oil products. Global prices translate into domestic ones through the exchange rate mechanism. The RBI could have a role to play in stabilising exchange rates to smoothen price volatility.
The inflation matrix is, hence, quite complex and there is evidently no singular solution. And the conundrum really is that as every constituent is impacted by inflation - as the producer of a product consumes other products whose prices are increasing, there is an inherent motivation to increase one's own price to maintain the standard of living.
This inflationary spiral, or rather the vicious circle, needs to be broken, and it appears that it can happen only in the medium run.
Roughly 70% of inflation can be addressed by various departments while the balance, which includes global influences, would still be beyond anyone's purview. What is most important is that all these departments should start talking to one another.
While this factor could be at play at the margin, it has not been decisive and is no longer harped on. The RBI is firing away at inflation with a relentless policy of rate hikes, which has not worked quite the way it was expected to. But we need to know how this inflation has come to tackle it appropriately.
The answer seems to be a shrug. One way to tackle this issue is to actually analyse threadbare the mechanics of inflation. This is so because inflation combat has to be a joint action from various ends and cannot be the sole responsibility of one agency, which today is the RBI. The accompanying table provides the contribution of various products to inflation along with the ministry or agency responsible.
To calculate the contribution of various sectors to inflation, the weighted change in the overall WPI and individual products has been calculated. Various products have then been grouped under different ministries that oversee their operations. The major cause of price increase has been noted so that the respective body can address price issue.
There are multiple factors that have contributed to inflation. The highest share has come from the so-called core sector: non-food, non-fuel manufactured products over which the RBI has control. Globally, prices of metals have started declining, but we have not seen that in India. So, around 40% of inflation may be attributed to possible demand-pull pressures. While global prices have come down, the rupee has depreciated, nullifying those gains.
We can see that there are various arms of the government that should take some responsibility for inflation. First, the agriculture ministry has to review its policy of minimum support prices (MSP). The MSPs have been increased relentlessly by the Commission on Agricultural Costs and Prices (CACP) to reward farmers.
While production has increased for cereals and to a certain extent in pulses, it has had the tendency to increase benchmark prices in the market resulting in higher inflation. Second, the ministries of petroleum and finance have tried to align the prices of petroleum products to the market, which actually makes us work on a delicate three-dimensional trade-off: higher prices, fiscal deficit and health of oil marketing companies. Around 11% of inflation has resulted from this factor.
Third, the ministry of consumer affairs has to address the issue of warehousing and the Warehouse Development and Regulatory Authority should put in a structure to improve storage to cut down on wastage in fruit and vegetables. Around 40% of our horticulture output goes waste due to absence of cold storages.
In this segment, we have witnessed high growth and where supply outstrips demand provided we can harness it through lower wastage. These organs need to make the system more efficient. While the contribution to inflation was negative in December, it was as high as 8.18% in October, prior to the decline in prices.
Fourth, the area of milk, dairy products, eggs, meat and so on comes under the department of animal husbandry. Higher cost of animal feed and fodder has hiked the cost of production of these products. The significant aspect of these prices is that they are never mean-reverting, which happens for horticulture and cereal products.
Fifth, the higher prices of textile products have to be looked at jointly by the finance ministry which hiked taxes on readymade garments and the ministry of agriculture, which oversees the MSP. But they might have limited control because of global factors.
Sixth, there is the global factor in the form of oil prices that directly impacts the prices of domestic crude as well as non-regulated oil products. Global prices translate into domestic ones through the exchange rate mechanism. The RBI could have a role to play in stabilising exchange rates to smoothen price volatility.
The inflation matrix is, hence, quite complex and there is evidently no singular solution. And the conundrum really is that as every constituent is impacted by inflation - as the producer of a product consumes other products whose prices are increasing, there is an inherent motivation to increase one's own price to maintain the standard of living.
This inflationary spiral, or rather the vicious circle, needs to be broken, and it appears that it can happen only in the medium run.
Roughly 70% of inflation can be addressed by various departments while the balance, which includes global influences, would still be beyond anyone's purview. What is most important is that all these departments should start talking to one another.
Forget the fiscal deficit: Financial Express 19th January 2012
When there is limited hope and an air of despondency clouds the future prospects of any economy, it is only appropriate that we go back to the textbook for an answer. There will be solutions somewhere, as it is not for nothing that the big names like Keynes, Friedman, Sargent and Hayek are debated even outside the university today.
There are two ways of looking at the economy. There is a more positive view, which says that growth will pick up in FY13 on the back of industry, with agriculture providing normal comfort. Inflation will be under control while the government has to take a call on the deficit and RBI on interest rates. The external account will remain volatile but largely manageable, being beyond the control of internal policies. This is impressionistic art.
The other view is more ominous. Growth will falter and slip. The absence of reforms and high interest rates has brought investment to a standstill and it will not recover for some time. GDP growth of 6% looks more likely and the government does not have the stomach to take on reforms in subsidies, deficits, land, environment, FDI and so on. A weak economy with feeble opportunity typifies the bleak canvas and is a product of the expressionistic brush.
Sitting back today, both the options seem possible and, given that no one expected what happened in FY12, even soothsayers would desist from sticking their necks out. But what really can be done is to have the right approach in place. The starting point is to revive spending so that growth picks up as the backward linkages are fostered and strengthened. In FY12, we consciously chose the tradeoff with inflation and, while it is debatable whether or not we have succeeded, we are sure that nothing more can be done from Mint Street. The fact that we still have capacity means that there is actually no ideological conflict here.
When conditions are depressed and no one is spending because there is no money, Keynes would say that the government should step in and provide the stimulus. Contemporary fiscal history shows that the stimulus worked after the Lehman crisis and critics will smile when they look back over the bold decision taken by the government to roll back the same a bit too soon. In 2011, the US, UK and Japan have run fiscal deficits of 8.7%, 8.8% and 8.3%, respectively. Today, the government is the only entity that can borrow at sub-8.5% and also has free access to funds. This being the case, project expenditure should be undertaken in the infra space, which, along with certain PPP arrangements, can kickstart the economy. Keynes cannot fail and, given that food inflation is down and probably overall inflation too will remain benign, this can be compelling. If this is acceptable, we must not bother about the fiscal deficit number, which can actually go past 6%.
Monetary policy is inflationary according to Friedman, provided we have reached full employment of resources. If this is not so, as is the case today, interest rate easing, which is Keynesian in spirit, will also take a tinge of monetarism along to boost consumption. Lower rates will spur consumption based on leverage as households should be encouraged to spend on housing and auto—the two sectors that drive the economy
in a decisive manner. Friedman would not mind this easing under these circumstances.
Hayek, a believer in free markets and private enterprise, will ask for the unshackling of the economy, which will mean less interference when it comes to policy. This environment should be provided through aggressive reforms, like FDI, land reforms, GST, DTC, etc, which will provide the ground to play on. Combined with Keynesian pump-priming (here even MGNREGA will help to provide demand) and lower interest rates, growth will receive the much-needed boost. Freeing oil product prices would, however, still be a touchy issue, which can be deferred as we are still not out of the direct inflation spiral. Hopefully, with political compulsions not being in the way in FY13, this should be easy to attain.
What about the rational expectations proponents like Sargent and Wallace? How important should the surprise element be here? These economists felt that policies work only in case the market is behind you. As long as the market knows, policies do not work. This means that especially when it comes to monetary policy, we should have more surprises—which can mean larger doses of rate cuts or liquidity inflows through CRR cuts. Or from the government side, some really large schemes that attract capital as well as generate employment would help. Maybe a reorganisation of the MGNREGA to make it more productive in rural infrastructure will help.
What can be the cost of such an aggressive stimulus? Inflation should not really result from such spending as it will be adding to our productive capacity. Non-food inflation could increase, but the lower food inflation numbers as well as a declining trend in global prices would counter this to a large extent. Deficits will be high and will raise eyebrows, but it may be worth it as we need a kickstart for the private sector, which cannot come about exogenously. Besides, if investment increases and some reforms are initiated, it may just about be a win-win situation for us. As the alternative is possible stagnation, this alternative sounds good.
There are two ways of looking at the economy. There is a more positive view, which says that growth will pick up in FY13 on the back of industry, with agriculture providing normal comfort. Inflation will be under control while the government has to take a call on the deficit and RBI on interest rates. The external account will remain volatile but largely manageable, being beyond the control of internal policies. This is impressionistic art.
The other view is more ominous. Growth will falter and slip. The absence of reforms and high interest rates has brought investment to a standstill and it will not recover for some time. GDP growth of 6% looks more likely and the government does not have the stomach to take on reforms in subsidies, deficits, land, environment, FDI and so on. A weak economy with feeble opportunity typifies the bleak canvas and is a product of the expressionistic brush.
Sitting back today, both the options seem possible and, given that no one expected what happened in FY12, even soothsayers would desist from sticking their necks out. But what really can be done is to have the right approach in place. The starting point is to revive spending so that growth picks up as the backward linkages are fostered and strengthened. In FY12, we consciously chose the tradeoff with inflation and, while it is debatable whether or not we have succeeded, we are sure that nothing more can be done from Mint Street. The fact that we still have capacity means that there is actually no ideological conflict here.
When conditions are depressed and no one is spending because there is no money, Keynes would say that the government should step in and provide the stimulus. Contemporary fiscal history shows that the stimulus worked after the Lehman crisis and critics will smile when they look back over the bold decision taken by the government to roll back the same a bit too soon. In 2011, the US, UK and Japan have run fiscal deficits of 8.7%, 8.8% and 8.3%, respectively. Today, the government is the only entity that can borrow at sub-8.5% and also has free access to funds. This being the case, project expenditure should be undertaken in the infra space, which, along with certain PPP arrangements, can kickstart the economy. Keynes cannot fail and, given that food inflation is down and probably overall inflation too will remain benign, this can be compelling. If this is acceptable, we must not bother about the fiscal deficit number, which can actually go past 6%.
Monetary policy is inflationary according to Friedman, provided we have reached full employment of resources. If this is not so, as is the case today, interest rate easing, which is Keynesian in spirit, will also take a tinge of monetarism along to boost consumption. Lower rates will spur consumption based on leverage as households should be encouraged to spend on housing and auto—the two sectors that drive the economy
in a decisive manner. Friedman would not mind this easing under these circumstances.
Hayek, a believer in free markets and private enterprise, will ask for the unshackling of the economy, which will mean less interference when it comes to policy. This environment should be provided through aggressive reforms, like FDI, land reforms, GST, DTC, etc, which will provide the ground to play on. Combined with Keynesian pump-priming (here even MGNREGA will help to provide demand) and lower interest rates, growth will receive the much-needed boost. Freeing oil product prices would, however, still be a touchy issue, which can be deferred as we are still not out of the direct inflation spiral. Hopefully, with political compulsions not being in the way in FY13, this should be easy to attain.
What about the rational expectations proponents like Sargent and Wallace? How important should the surprise element be here? These economists felt that policies work only in case the market is behind you. As long as the market knows, policies do not work. This means that especially when it comes to monetary policy, we should have more surprises—which can mean larger doses of rate cuts or liquidity inflows through CRR cuts. Or from the government side, some really large schemes that attract capital as well as generate employment would help. Maybe a reorganisation of the MGNREGA to make it more productive in rural infrastructure will help.
What can be the cost of such an aggressive stimulus? Inflation should not really result from such spending as it will be adding to our productive capacity. Non-food inflation could increase, but the lower food inflation numbers as well as a declining trend in global prices would counter this to a large extent. Deficits will be high and will raise eyebrows, but it may be worth it as we need a kickstart for the private sector, which cannot come about exogenously. Besides, if investment increases and some reforms are initiated, it may just about be a win-win situation for us. As the alternative is possible stagnation, this alternative sounds good.
India needs a currency stability fund: January 9, 2012 MInt
The fund will help improve confidence among investors by making more efficient use of the country’s reserves
Currency fluctuations always cause panic as sharp unidirectional movements shake the market. Anecdotal evidence shows a standard five-stage pattern in our reaction. First, the stance is that nothing amiss is happening. Second, we maintain that the rupee is market-driven and that there should be no interference. Third, we use the real exchange rate argument to show that while nominal rates are up/down, in real terms the rupee is actually undervalued/overvalued. Fourth, we say that we are helpless and cannot do anything since halting appreciation in currency has liquidity implications, while depreciation cannot be supported with our limited reserves. Fifth, we talk up or down the rupee with suitable measures to stem volatility, which could also mean direct or indirect intervention, which actually works.
Since unchecked significant movement in the currency is never desirable for any country, can we think of ways of intervention when the rupee falls so that the fundamentals can be corrected? To borrow an analogy from the farm sector, we have the concept of use of buffer stocks when commodity prices move up. Or closer to this market, forex inflows leading to currency appreciation is tackled by sterilization through the market stabilization scheme bonds that address the issue of monetization. There certainly must be a way of creating a buffer of dollars that can be selectively used for stabilization purposes when the rupee falls.
Intuitively, rupee depreciation hurts more for any country that has a current account deficit as there are more outflows than inflows indicating a net loss for the country. Add to these capital commitments such as debt service, and one can justify a halt to the free fall of the rupee through intervention. An issue raised is whether we have the wherewithal to provide such support. Does a number of, say, around $275 billion as foreign currency assets sound good enough for India, or is it inadequate? While there are certain contingencies that must be provided for by a central bank, keeping reserves beyond this level merits debate, especially as they are invested in Fed bonds, where returns last year were just about 1.8%. We can do better by using it to alleviate the pain of forex users in the country.
The table provides certain trends in components of forex requirements as a safety buffer.
The main buffers that have to be built by any central bank are included under “theoretical requirement”: four months of imports, which is the globally accepted prudential norm, or actual trade deficit, whichever is higher; short-term debt, which is hot money that may move out on short notice; debt service for the year (which is known in advance) and the highest outflow of foreign institutional investor (FII) funds in our history. In the case of debt service and FII outflows, $20 billion and $10 billion have been assumed, which is slightly on the higher side, as FIIs have only once had such outflows, and the debt repayment calendar released by the Union ministry of finance also includes short-term debt, which has been taken separately in its entirety. However, there is still nothing sacrosanct about this approach and the numbers can be tweaked based on the Reserve Bank of India’s (RBI’s) perspective.
The surplus that exists can actually be put into an exchange rate stabilization fund (ERSF), which will build up in times when there are more inflows and can be used to ensure that depreciation of the currency is more guided. RBI may choose a fraction of this surplus to be used for this purpose. The central bank, in turn, can hedge this fund on global exchanges to ensure that the risk is covered to a large extent. Quite interestingly, this ratio of surplus has been coming down over the years.
The idea of such a fund is not really bizarre, because we do see interventions in almost every market. The capital market has the insurance companies come in when things get volatile, and the government securities market is monitored through selective intervention by RBI directly or through proxy by public sector banks. Therefore, to do the same in the forex market makes sense. A declining currency is obviously not good for those who require dollars, and it also erodes global confidence in the economy, which can affect investment decisions. Foreign investors would buffer in this risk when putting in money as any withdrawal would become expensive. The same holds for companies borrowing from the euro markets.
How would this work? Ideally RBI should work within a band and intervene directly to stabilize the rupee. The central bank’s judgment can be used when looking at, say, the real effective rate that also adjusts the exchange rate with relative inflation.
By creating an ERSF, we can minimize the net loss for users of foreign currency, improve confidence of investors by making more efficient use of our reserves. It is an idea worth persevering with.
Currency fluctuations always cause panic as sharp unidirectional movements shake the market. Anecdotal evidence shows a standard five-stage pattern in our reaction. First, the stance is that nothing amiss is happening. Second, we maintain that the rupee is market-driven and that there should be no interference. Third, we use the real exchange rate argument to show that while nominal rates are up/down, in real terms the rupee is actually undervalued/overvalued. Fourth, we say that we are helpless and cannot do anything since halting appreciation in currency has liquidity implications, while depreciation cannot be supported with our limited reserves. Fifth, we talk up or down the rupee with suitable measures to stem volatility, which could also mean direct or indirect intervention, which actually works.
Since unchecked significant movement in the currency is never desirable for any country, can we think of ways of intervention when the rupee falls so that the fundamentals can be corrected? To borrow an analogy from the farm sector, we have the concept of use of buffer stocks when commodity prices move up. Or closer to this market, forex inflows leading to currency appreciation is tackled by sterilization through the market stabilization scheme bonds that address the issue of monetization. There certainly must be a way of creating a buffer of dollars that can be selectively used for stabilization purposes when the rupee falls.
Intuitively, rupee depreciation hurts more for any country that has a current account deficit as there are more outflows than inflows indicating a net loss for the country. Add to these capital commitments such as debt service, and one can justify a halt to the free fall of the rupee through intervention. An issue raised is whether we have the wherewithal to provide such support. Does a number of, say, around $275 billion as foreign currency assets sound good enough for India, or is it inadequate? While there are certain contingencies that must be provided for by a central bank, keeping reserves beyond this level merits debate, especially as they are invested in Fed bonds, where returns last year were just about 1.8%. We can do better by using it to alleviate the pain of forex users in the country.
The table provides certain trends in components of forex requirements as a safety buffer.
The main buffers that have to be built by any central bank are included under “theoretical requirement”: four months of imports, which is the globally accepted prudential norm, or actual trade deficit, whichever is higher; short-term debt, which is hot money that may move out on short notice; debt service for the year (which is known in advance) and the highest outflow of foreign institutional investor (FII) funds in our history. In the case of debt service and FII outflows, $20 billion and $10 billion have been assumed, which is slightly on the higher side, as FIIs have only once had such outflows, and the debt repayment calendar released by the Union ministry of finance also includes short-term debt, which has been taken separately in its entirety. However, there is still nothing sacrosanct about this approach and the numbers can be tweaked based on the Reserve Bank of India’s (RBI’s) perspective.
The surplus that exists can actually be put into an exchange rate stabilization fund (ERSF), which will build up in times when there are more inflows and can be used to ensure that depreciation of the currency is more guided. RBI may choose a fraction of this surplus to be used for this purpose. The central bank, in turn, can hedge this fund on global exchanges to ensure that the risk is covered to a large extent. Quite interestingly, this ratio of surplus has been coming down over the years.
The idea of such a fund is not really bizarre, because we do see interventions in almost every market. The capital market has the insurance companies come in when things get volatile, and the government securities market is monitored through selective intervention by RBI directly or through proxy by public sector banks. Therefore, to do the same in the forex market makes sense. A declining currency is obviously not good for those who require dollars, and it also erodes global confidence in the economy, which can affect investment decisions. Foreign investors would buffer in this risk when putting in money as any withdrawal would become expensive. The same holds for companies borrowing from the euro markets.
How would this work? Ideally RBI should work within a band and intervene directly to stabilize the rupee. The central bank’s judgment can be used when looking at, say, the real effective rate that also adjusts the exchange rate with relative inflation.
By creating an ERSF, we can minimize the net loss for users of foreign currency, improve confidence of investors by making more efficient use of our reserves. It is an idea worth persevering with.
Monday, January 9, 2012
People And The Economy: Business World : Book Review: 2nd January 2012
Public Economics:Theory and Policy, Essays in Honor of Amaresh Bagchi
Edited by M. Govinda Rao and Mihir Rakshit
This one-stop book on public economics is a tribute to economist Amaresh Bagchi. Edited by M. Govinda Rao and Mihir Rakshit, Public Economics is a compilation of 10 eclectic articles covering the entire gamut of relevant and important issues. Expectedly, there is a chapter on Bagchi and his contribution to India’s fiscal policy. The article evaluates the extent to which fiscal deficit targets make sense in our economy, considering our socio-economic goals, which make static targets quite irrelevant. Complimenting this view is an article on how we should be broad basing our tax system and lowering rates.
The book presents Bagchi’s pioneering work on consumption tax and highlights issues in bringing about harmonisation in our federal set-up. This is followed by Rao’s own take on federalism. An interesting survey that says gains of peace, trade and environment have led to interest in these global public goods. Curiously, it says that the WTO and the UN Framework Convention on Climate Change do not quite focus on developmental concerns. An article on environment taxes highlights how industries can cope with this through a ‘cap and trade’ scheme.
The last few articles are more conceptual. The final piece comprising budgetary principles, non-tax revenues and global fiscal concerns, belongs more in a class room and can put off the reader. On the whole, the book is a commendable compilation that will appeal to students and probably, bureaucrats and is worth reading.
(This story was published in Businessworld Issue Dated 02-01-2012)
Edited by M. Govinda Rao and Mihir Rakshit
This one-stop book on public economics is a tribute to economist Amaresh Bagchi. Edited by M. Govinda Rao and Mihir Rakshit, Public Economics is a compilation of 10 eclectic articles covering the entire gamut of relevant and important issues. Expectedly, there is a chapter on Bagchi and his contribution to India’s fiscal policy. The article evaluates the extent to which fiscal deficit targets make sense in our economy, considering our socio-economic goals, which make static targets quite irrelevant. Complimenting this view is an article on how we should be broad basing our tax system and lowering rates.
The book presents Bagchi’s pioneering work on consumption tax and highlights issues in bringing about harmonisation in our federal set-up. This is followed by Rao’s own take on federalism. An interesting survey that says gains of peace, trade and environment have led to interest in these global public goods. Curiously, it says that the WTO and the UN Framework Convention on Climate Change do not quite focus on developmental concerns. An article on environment taxes highlights how industries can cope with this through a ‘cap and trade’ scheme.
The last few articles are more conceptual. The final piece comprising budgetary principles, non-tax revenues and global fiscal concerns, belongs more in a class room and can put off the reader. On the whole, the book is a commendable compilation that will appeal to students and probably, bureaucrats and is worth reading.
(This story was published in Businessworld Issue Dated 02-01-2012)
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