Bracing up for Recession

Looks like this is gonna be recession year in the US. Recession means a drop in economic activity and associated with drop in investments, company profits and employment rates. How this going to affect various people?

First, interest rates will significantly drop as a reaction to recessionary pressures, and couple with high unemployment rates and inflation, this looks to be bad for saving money :-(. However, this seems to be right time to take a look on basic things. Based on my readings I find the following to be the reasonable advice for people like me.

1. Dont leave secure jobs, as job market will go south this year.
2. This is not the best time to go to school for doing MBA and such, as markets might tighten up in the next year. But, a lot of experienced folks who can untangle the mortgage mess and stuff will find great jobs.
3. Maintain 6 month emergency fund that should take care of ourself even if we dont have job for a long period. This fund must be maintained separately in money market or savings accounts.
4. Reconsider the portfolio. While stocks do better in the long term, it is time to reduce the risk by taking bit more of bonds and other secure avenues. I moved mostly to secured investments last October, and could wither some of the drop in my retirement plan.
5. Rethink investments. As big ticket investments like starting companies or building houses will be hit during this recession, it is time to reconsider those things for now.

If we are able to maintain jobs and have savings cushion, recession could also be a great time. A lot of great investment opportunites will be available at the later part of recession when everybody else will run out of cash. Houses and companies could be got for dirt-cheap prices and the recession will also help the economy overall by cutting down wasteful expenditures and over consumption while moderating the prices (of oil, houses etc that had runaway inflation during the current boom).

In terms of countries, the expectation seems to be that China and India will cool down affording them to rethink their policies and priorites. China will be hit by drop in exports, while India will be hit by drop in investments. So, its time for China to put renewed focus on domestic consumption (including by appreciating Yuan) and India to start second wave of reforms. When India badly needs money it can no longer afford to keep sectors like Banking, Aviation, Retail stores under tight leash and might be forced to open these to foreign investments. Dollar looks to get weakened more as there is a substantial interest rate gap between India and US, and IT companies will be hit both by strong rupee and a drop in US economic activity. Its time to rein in the India's runaway salary growth and diversify beyond IT.

India can gain a lot. First, if IT weakens a bit and salaries start cooling down, other Indian sectors like Auto and manufacturing can pick up as they can get quality engineers at affordable salaries. It makes no sense for the nation to train a mechanical engineer only to lose to Infosys to do some payroll processing. Also, this recession could get the hell out of Ford and GM who would be forced to do a lot of offshoring and India seems to be the best choice. Already Tata Motors and Hyundai and have begun huge expansionary cycles. And healthy Indian companies can get great bargains with a weak western economy. I wont be even surprized if a group of Indian companies together buy up Ford in the next decade. Also, its time to realize our strengths in Finance and Banking. Its illustrative to note that almost all of the Citi's current top management are Indians and we have similiar loads of talent hidden in our moribund banking sector. Its time to get to Basel-II banking standards and open them to International capital and competition. Maybe, someday we could see a ICICI or a privately owned SBI could take on Citi or Bank of America in head on competition in international turf.

Second, Indian economy can also gain by cooling down of real-estate markets at home. Just like Americans, Indians seem to harbor the thought that house prices can never go down. Americans have learnt the lesson and Indians have still not. Just like any investment, house prices can as much go up as down. A lot of houses are priced at 100 times the annual per-capita income of Indians and the development looks unsustainable as a lot of them were made with unreasonable expectations of salary growth. Now, house prices can go down significantly in a lot of over-priced markets and this will improve affordability for common man.

Third, the market crash will make people rethink consumption. While too much dropping of consumption is bad, too much of consumption is even more bad. Indians are consuming rather too much for their salary levels and savings are not as great as Asian levels. This can hurt a lot of people in the forthcoming real-estate and stock crash, and if managed correctly this could lead to a long term balance between savings and consumption.

The extraordinary lectures of Hans Rosling

Hans Rosling has given an amazing presentation that debunks some of the myths about Third World. It is presented so beautifully that even total strangers to economics and public policy can understand every part of it. It should be a bible for all powerpoint presenters and those want to present analysis on the data. Watch the presentation and enjoy.

See this followup presentation on poverty:

A third video about the beauty of statistics

A Brief history of Current Crisis

The last couple of weeks the world markets are choppy. Stocks are crashing, finance companies and hedge funds are on their knees, emerging currencies are heading lower and there is a virtual panic in the capital markets. Even commodities and real-estate were not spared. Even having a not too aggressive portfolio, I lost more than 1300 dollars in just 7 days. But, things are far from being over. The Monday opening could be a very crucial factor that could affect the world economy for a long time to come. If things stabilize, then its business as usual (we have successfully postponed the crisis), but if the waves get higher and panic goes in a vicious circle then whole world could go into a recession, dwarfing the Asian crisis of 1997. This article would briefly explore the history of current crisis.

The historians would always disagree when the core events for the current crisis started, but I would say 1989 as the year from which world economy started getting very different and is a crucial year for the current crisis. It was the year when USSR pulled out of Afghanistan accelerating the collapse of the Union of Silly and Stupid Republics two years later. It was the year when Berlin wall collapsed, crashing serially all the imaginary walls built by the socialistic societies of the 20th century and forming a formidable economy of Europe - Germany. It was the year when Chinese government massacred a large group of innocent students in the watershed event at Tienanmen Square of Beijing, leading to unprecedented international pressure that caused China to abandon communism and join world economy. It was the year, when a loose and directionless coalition of political parties took power in India, making it finally bankrupt in 1991 and forced to abandon socialism join World economy. Free elections were held and Brazil became a democracy leading it to overcome an economic crisis and become a big world player. And in Eastern Europe nations got decoupled from Soviet Russia and its Warsaw Pact, with nations like Hungary declaring independence. And in South Africa, apartheid was coming to an end leading to the end of years of economic isolation.

Too much for a single year? In economics and politics, things linger for a long time and when they start coming down they come down like a pack of cards. Whatever it be, it was a watershed year for international capitalism. In one stroke - the biggest countries of the world joined the world economy that earlier just had just Uncle Sam and kids (Japan, UK and Western Europe) that were far more homogeneous. They had similar per-capita incomes, similar political systems and far more open markets and financial systems. But, these new countries - Brazil, Russia, India, China, South Africa (BRICS) had vastly different economies and political systems. They are some of the biggest countries in the world, with vast histories and totally different per-capita income levels. Even today, India's per-capita income is one-thirtieth of those in Western Europe. The new entrants of world economy were greatly welcomed and in 2000's they all had sputtering growth - India became a service superpower and China built the greatest industrial establishment of history. Russia and Brazil became major commodity superpowers much later. There was an humongous gain in productivity in China and East Asia.

Fast forward to 1997. The vast increase in investment opportunities in these emerging markets were a great blessing for international capital markets who took them with too much of enthusiasm. While, China and India were pretty closed, rest of Asia welcomed these capital with four hands. Thailand and Malaysia were particularly too kind to these. But, things started getting bad. Investors and economists started to realize that productivity gains were not too much and most of the growth was just an illusion caused by speculation and capital flows. These emerging markets are not an elixir for all the woes for international investors, and as the realization started to sink in, a crisis was looming and before anybody could realize the summer of 1997 was a bloodbath in East Asia. Indonesia, Malaysia and Thailand were devastated and even after 10 years, their real economic level has not come to their pre-1997 levels. And the echo started falling all over Asia and due to few other factors (like Hedge fund manipulation) Russia became bankrupt in 1998. The sum total of all these factors led to a massive inflow of capital back into United States, leading to a collapse of all these currencies, as panic-ridden investors always look for safe havens in times of crisis.

Forward to 2000. Capital never stays calm. It is a fluid and it has to find a lot of new resting place. Where did they go? They went to a new found fad in California, called the dot-com boom. Any tom, dick and harry who knew to put like ... Bunch of trash ... started a company, went on an IPO and sucked millions of dollars. The process could not be slowed by statements of caution of wise men (Alan Greenspan said a prophetic 'Irrational Exuberance') and this farce continued till some one had to say "the emperor had no clothes". And everything came down with a thud in March 2000 and continuing all the way upto 2001.

Now, the US fed got into thinking. It had to pull out of recession caused by the crash and find alternative means of growth. In a series of breathtaking sessions, it brought the interest rates down to ridiculously low figures and by 2003, it was just around 1%. In the meantime, lending standards were relaxed and any jane and mary with just an existence to show, could borrow millions to buy dozen of housing properties. This had three big effects. One is that all that money found into places like Real estate and commodities that were long ignored. The oil prices went up by 5 times in a space of as many years and there was boom in all those metals - steel, copper, gold, etc and house prices doubled and trebled in many places. Second, the bad experience in US markets and the low interest rates pushed money out of US and they directly entered emerging markets. Parallely, India and China established themselves as great players in their game and opened their economies much further. This combo effect had billions of capital inflows in the form of FII and FDI. Brazil and Russia also were back on their feet with commodities soaring. These currencies suddenly started appreciating further and hurt their domestic industries a bit. Third, the cheap capital caused the Hedge funds and Private Equity to take control of world economy. Corporations like Chrysler and Hilton found their way into the kitties of companies that had nothing to do with automobiles or hotels.

The current crisis is thus a series of flip-flops where investors swing like monkeys from one investing to tree to another. Commodities were not so kool in 1990s and they were the hottest plays of 2000s. Emerging markets were too risky in late 90s and they were the toast of the day in mid 2000's. Housing markets were not so interesting in 90s and in 2004 they all believed "house prices will always go up and no one can lose in real estate". Dollar is a loser in early 90s, safe haven in late 90's, loser again in middle 2000's and now again a safe haven. Most of investing is now just momentum and bringing new fad of the day, than an appreciation for grey cells. The most important of all is that world still has not come to terms with globalisation.

Future of Rupee - Part I

Now that the inflation in India is tamed, the central bank in India (RBI) started back to its good old ways - buying humongous loads of dollars and increasing money supply bringing down call rates and also simultaneously increase Cash Reserve Ratio, affecting the profit margins of banks.

In the last couple of months, after I wrote the article series - "Is RBI handling inflation correctly", I had been in touch with a few financial columnists in India, working for Bloomberg, Hindu Business line and Business Standard and a few of them were very apprehensive of the rupee's effect on exports and cite their good old model - China on how to manage the inflows. However, good China had been in energizing the economy, I dont think that it is an good example for everthing. It has its price.

To put it short, if you have to manage heavy inflows - you have to screw one or more among the four crucial variables
a) Inflation
b) Export competitiveness
c) Financial health of banks
d) Interest rates and capital availability

So, if you have allow all those dollars to flow into India, unhindered, you will immediately cause rupee to appreciate (by simple demand-supply) and India's export competitiveness will be eroded as exports will be costs compared to imports. So, if the central bank buys up the dollars and prints rupee to prevent appreciation, it will cause inflation by making more money available in the system and weakening the currency. Now, to keep money supply constant and prevent inflation, the central bank has to increase interest rates and cash reserve rates (the amount banks have to keep idle and not use for loans from their deposits) affecting the availability of domestic capital and affective investment in crucial sectors. Now the Chinese model - sanitise all those dollars and not cause inflation by arm twisting the market by fixing constant prices and wages. And use banking sector to fun unproductive enterprises and load them with debt. This way the banks will take all those blow associated with maintaining the dollar low.

Each of these paths have a price. Inflation is the worst and no elaboration is needed here. If managed wrong and allowed to go on a vicious cycle, can cause the worst nightmares as seen in the hyper-inflation in Greece, Germany in the early 20th century and in Latin America in 1980's and 90's. Interest rates are among the next worst as it affects needy companies from raising adequate capital and affects crucial investment opportunities. Corporations would be unable to raise debt at favourble prices and affect economic expansion. And financial institutions are very crucial for a good market economy and making them a scape goat for increasing exports will debiliate the economy in the long run. Its like smashing the leg to give more blood to the hair. The last comes exports - whose importance varies from economy to economy.

For economies like Japan, Korea, Singapore and even Germany, the domestic population is so small and spend allergic that there is no way that they can ensure good jobs by relying on producing for local markets. They are forced to export and to export they have to have good currency support and so artificially affect exchange rate even at significant costs to economy. But, this doesn't hold good for China or India. They have 1 billion+ customers each and a good economic history that they dont theoratically need any external markets for their goods. If they can stand on their own legs by developing good local markets, the enterprises have so much of room to grow that they can forget about currency manipulation. And given their rate of expected growth and scale of operation, they cannot afford to depress currencies forever. Elephants cannot afford to jump trees and hide in burroughs and the managers of these trillion+ dollar economies better know this.

(Next part: The reasons why should the RBI allow freer flows and there is a solution, where we could avoid screwing up any of these 4 variables, to a great extent)

Is RBI handling inflation correctly? Part 3

In Part 1, we saw why RBI had to resort to hard measures like interest rate hikes and free exchange rate controls. 6% inflation is just a small indicator of the overall overheating that could be witnessed in the asset prices that show more than a triple digit appreciation, leading to a monetary policy change. In Part 2, we saw about the main tools for a Central bank - interest rates and exchange rates and how they could be used. No how all these changes impacts on us? The "us" involves exporters, importers, India economy, Indian consumers, Indian banks, Indian enterprises and Indian/overseas investors. In this part we will mainly see the impact on major export industries and in the next part we will see the impact on others.

In general, an interest rate hike dampens growth rate by squeezing liquidity (more money is absorbed by bank deposits, bonds and other fixed instruments) and make credit unaffordable (businesses have to pay more money on the loan). An exchange rate hike rate will discomfort exporters and help importers leading to a more bigger trade imbalance, and might again dampen economic growth. But, when we have to choose the lesser of two evils, the choices are not so clear. A point to be taken is between 1970s to 1990s when Rupee tumbled so much, did our exporters become very strong?

Exporters: In general exports go down as Rupee rises against the dollar. Why? For example, you make a car for Rs.2 million in India, at an exchange rate of Rs.50 to a dollar you can export and sell it to US or other countries at $5,000 (Rs.2.5 million) and still make a Rs.500,000 in profit. But, what if the exchange rate changes to Rs.40 to a dollar? Now, you cannot sell it at $5000 and might have to increase the price to $6250 to make the same margin but face a tougher competition against other country exporters who might sell for $6000 or something, or sell it under $6000 to gain the markets but lose the profit margin. In both the cases, the exporters are to lose, if you assume that the car will be made at the same Rs.2 million independent of the exchange rates.

But, this is where nominal and real exchange rates come into place. To put it simply, if the exchange rate changes there will be some impact on the price of production of the car. The movement from Rs.50/$ to Rs.40/$ will reduce inflation and can reduce the wage rises and domestic production costs. More importantly, you could import the components like engines, tires and steel bodies far more cheaply and the production of the car might fall much below Rs. 2million if other things are equal. The converse is also true, a runaway inflation and high import costs can offset whatever gains exporters get from a depreciating rupee as seen in the previous 20 years. Thus, if the central bank manages appropriately, the rupee appreciation can help a lot of sectors to get stronger, though in the short term they will be squeezed. In effect it is sector specific - the dependency of a particular sector on imports and domestic wages.

India's main exports include - Petroleum, Gems and Jewellery, IT services & Software, Textiles and emerging sectors like Auto, Pharma and Electronics.

Petroleum and Chemicals: India is oil poor, but still Petroleum is one of its top exports. Weird is it not? Iran imports good amount of its gasoline from India. Its primarily because of the Administered Pricing Mechanism for oil, where oil distribution companies have to sell things at a loss while private refiners are under no such compulsion. Result: private refining companies like Reliance and Cairn sell or plan to sell most of production abroad earning their actual value, while public sector companies like IOC and BPCL stand like losers. Politics apart, this indirectly helps India to have a very good refining capacity and become a good power in petro chemicals. But, this industry is not going to be much affected by exchange rate hikes as most of the export component is imported thus, profit dents will be marginal at best.

Gems and Jewllery: India is a market leader in Diamond cutting and polishing and one of the top makers of Gold jewellery that is mostly consumed at home. Since, gold and diamond are mostly imported like petroleum, this sector is not much affected. Even more, the industry being labor centric is also sensitive to wages (of skilled artisans) that could be affected by inflation. Thus, if inflation is dampened by exchange rates, thereby reducing wage rises the net effect on this will be very close to ZERO. And the domestic consumption is very high for these gold and diamond sectors to cushion any significant drop in overseas markets.


IT Services and Software: This is my favorite industry :) and if this industry is impacted who cares. There is much more cushion and slack in this industry than any other India's export industry and whatever perceived competition of China, Vietnam etc, they are not gonna be too soon to take advantage of this currency appreciation. This industry has its own problems like runaway wage appreciation and talent shortage, and compared to them exchange rate is still a minor thing. $1 still equals Rs.41+ and in India even now Rs.10000/month ($250) can earn a reasonable middle class living for a family of 4. So, most people demand more wages just because the companies could afford to give it. Surely, the current condition of an IIT professor or the Prime Minister receiving lesser wages than some startup junkie moving one file from this computer to another is not a perpetually sustainable one. And the sector is fat enough from a lot of tax holidays. Time for milking this holy cow.

Since, this exchange rate uniformly applies to all Indian IT companies they can uniformly cap wage hikes and with a very good margin they can still thrive in the competition. Thus, this sector does not deserve much merit in including for exchange policy settings and surely if Indian IT companies die out in competition, exchange rate will be the last thing in the post-mortem list.

Textiles and Leather: By far this is the export sector that is gonna be receiving the biggest blow. Not much of the components are imported, though some part of the sector is labor centric thereby benefiting if a lower inflation comes out of stronger rupee. But, for now the 500 pound gorilla (Chinese exports) is held back till next year due to export caps and China itself is facing currency appreciation, wage rises, reduction of tax benefits for exporters etc. So, the competition will also be slightly scaled back (relatively). But, being labor centric and producing $25billion+ this industry merits serious attention from the Indian government and sector specific sops and tax holidays apart from investments in new design could be promoted by the government.

Emerging Industries: These include Auto, Electronics and Pharma where India is not a major power yet but have a good future. We export a good amount of design and we still dont have much competition as we operate in a niche. For example, Indian pharma companies have established themselves as leaders in Generic drugs, in Electronics we operate on chip design etc and Auto we are into designing reliable components. In my opinion, we still have more margins to be worried about immediate exchange rate crisis. If the government sets up a proper environment and enables progressive policies, this sector can go far beyond the current level and the government must step up huge investment in these sectors that in the future could become cash cow for us. Personally, I would like the government to shift tax holidays and sops to these industries from the IT services and software, as the latter has matured enough.

Tourism and Services: Finally tourism. Again, the asset prices affects hotel rates so much that it is far more cheaper to stay at Manhattan than a rundown Bangalore, even in dollar terms. So, the asset prices have to be cooled to make India a good player in tourism and exchange rate appreciation will reduce the cost of buying planes and fuel for airlines, making India travel cheaper and competitive. And we have far more potential to be achieved in sectors like Medical tourism and cultural tourism, apart from NRI tourism, so this sector has only one way to go (up).

Is RBI handling inflation correctly? Part 2

In part 1, we saw the overheating phenomenon in India and why RBI is pushed into action. In short, consumer inflation is just part of the story, most important danger lies in the asset price appreciation that pushed RBI to take hard steps. So, what is inflation? In this part we will see how the central bank controls the two main entities - interest rates and exchange rates that affect inflation. This part will be more about inflation theory about the two main tools of a central bank.

Inflation is the classic condition of more money chasing few goods, and it means that the value for the currency you hold is having less value than what it used to be. There are four main components - domestic production, exchange rates, interest rates and consumption rate. Here interest rates (atleast short term) are more of an independent variable controlled by the central banks, domestic production depends on this and entrepreneurial skills + healthy conditions, exchange rate is semi independent in some countries controlled by government while it has to be really proportional to domestic production and consumption rate is dependent on people's psychology and all other variables. Together the effects end up at the consumer when he sees the high price and calls that inflation. Actually, it is just an end product of a whole deal of complex dependent and independent variables. Let us briefly look at each of them.

Interest Rate:

Interest rate is fairly direct. I giveup today's thing to you in anticipation that you will give me something better tomorrow. So, I pay you $10 today and expect you give me $11 back after a year. Here I have $10 available readily, and the other guy has expectation of making atleast $1 in the year's time. The $10 ready availability is called liquidity and the $1+ that he could make with this is called productivity. Now, if the system is perfectly elastic, and I now have $20 still I can loan it to him fully and get $2 back and so on, indefinitely. But, real systems are seldom elastic. At somepoint, the other guy cannot take all my money and still make enough money to give me the interest. At the that point the interest rate starts climbing down. Thus, in global bond markets (that is essentially a market for trading loans) as liquidity increases interest decreases. Conversely, if there is a credit crunch where I dont have $10 even and none of the people have it then the interest rates increase. But, there is a limit here, at some point the producer cannot give enough interest to you without raising prices so much or go out of business.

In the first case, when there is excess liquidy, the money fetches lesser interest rates in the long term, and this makes somepeople to not giveup today's comforts or they go for other sources of making money. Henc, they buy up junk instead of loaning the money and this causes inflation and asset boom. In the second case, the increase in interest rates causes the end products to be costlier and drives up the interest. Thus, inflation can be a resultant of both over liquidity and under liquidity - Damned if you do. Damned if you dont! This is where the central banks enter the system. They first establish some mechanism in which the markets are dependent on them and keep this as an handle. For example, they always give banks the short-term loans (they can print money at will and destroy it when they get back) and mandate the banks to keep some of their long term loans with them and this is the great way in which hold control. And even more, since they are the most trustable business system (they print currencies) they can setup some rate for taking medium term loans from other people (these are called treasury notes or bonds or T-bills) and many people keep atleast some portion of assets in these instruments as they are the safest.

So, now they have a full handle on the system. On one end they can get money from people at pretty low interest rate and on the other end they can loan short term money to banks at any rate they choose, as they print money. So, if the liquidity goes beyond a certain limit, they start issueing more higher rate treasury notes and increase short term interest rates so that people will put more money into governments and take less money from them. Thus, contrary to what we expect, liquidity forces T-bill interest rates to go up, while the rest of the interest in other long-term instruments that offer at more interest rates might fall if they dont find enough takers. This is what currently happening in the US. Long term bond rates have fallen and short-term T-bills have increased for a while now. At some point, the yield curve will be inverted, short-term loans fetching more interest rates than long-term loans.

Now, what if there are enough takers for the loans. Then, both T-bills and long-term rates go up, and this is essentially not an over liquidity situation but actually a liquidity cruch (more demand than supply of money). This is what happening in India. Whether RBI had increased rates or not, the banks would have increased the rates, as there were more demand for loans than more supply of deposits. This is actually a healthy condition IF the loans were absorbed by the producers implying we are having rising productivity. But, most of the loans were absorbed by stupid consumers who bought houses and depreciating assets out of them, thereby not causing any increase in productivity. With the natural increase in rates these people will be priced out, but in a dramatic change of fate we will have higher inflation as the interest rates will cause producers to mark their prices up or else lose margins. The first will cause inflation, second will cause market crash. In some sectors (steel, oil and cement) Indian government deliberately muscled in to cause the second.

In short, interest rate is a function of liquidity and productivity, and we are actually having a liquidity crunch in many sectors causing interest rates to spike which will also puke up the sectors that have been gorging money, like housing and auto loans. While, this could increase prices in the long term, it will reduce demand in the short and medium terms and cause asset depreciation thereby cooling the system.

Exchange rates:

Exchange rate control how much one good should be exchanged for to get another good, in a open market. For example, in a closed system if a farmer produces 10 kgs of rice and a gatherer produce 5 kgs of firewood, they both can exchange stuff on some fixed mechanism, say 1kg rice = 0.5 kg of firewood, so that both benefit from other's stuff. Now, if the farmer could produce 20kgs of rice, can he get 10 kgs of firewood from the market in this closed system? The answer is no. So, now the exchange rate would be adjusted such a way that 1kg rice = 0.25 kg of firewood. Thus, the price of firewood is said to be inflated, whereas it is actually the production of rice that is inflated 10 to 20kg and as a result its dependent exchange mechanism got changed. This is ECON 101.When you produce something more than the exchangeable limit, its value keeps going down and this is the natural process by which economies readjust and make things that are more valuable and productive. In the closed system case, the farmer could focus more energy on gathering some firewood too instead of overproducing rice.

This is all in open market (in 2 person system it ought to be), but are they true in complex real world markets? Not necessarily. The farmer can keep producing his 20 kgs of rice and then give it to the gatherer at the same exchange rate and each time he will get 5 kgs of firewood and 5kgs of firewood in I Owe You notice, which means he writes a paper in which he says he has to give the farmer 5kgs of firewood later (and in this closed case, it is impossible unless he finds a way to dramatically improve the yielf of firewood). This is the farce that is currently going on in the pegged exchage rate system done by Japan, China, Europe and others including India. Instead of allowing the exchange rate of Yen/Renmimbi/Rupee to Dollar (rice to firewood) to flow by natural process they just keep getting the stupid IOUs that the gatherer (USA) has no intention of paying back. But, it doesnt matter: by the time the crisis occurs the old men in the central banks would have died leaving us all in the jeopardy.

Now, what we like many other central banks have been doing is to keep getting IOUs from US (called dollars and T-bills) and right now we have more than $200b worth of them. This whole money has not dont much good to the country and it has just made the exporters like IT sector filthy rich. The appreciation of rupee could have reduced the cost of imports and increase rupee's value threby reducing inflation. But, instead of allowing rupee to appreciate when we got billions of dollars from investments and exports, what RBI did was to print trillions of rupees of money and got the dollars from the exporters and FIIs. Thus, our money supply went up by many trillions (2 to 3) in the last few months just because of this. In effect, indirectly we were subsidizing FIIs and exporters by putting domestic people to strain. And this has currently been stopped for a while, thereby appreciating the currency.

In essense, RBI is currently doing the right thing of allowing the rupee to float freely and the markets determine the exchange mechanism instead of just gorging on the dollars, that might not have any use if US falls.

So, how this twin effect of interest rate hike and exchange rate appreciation going to impact us? That's in part 3.

Is RBI handling inflation correctly?: Part 1

Nowhere in the recent economic history of India, has an issue that is so well debated and polarized as the inflation/ overheating debate going on India circles. Now, the question has changed slightly from "is India overheating" to whether Indian central bank (RBI) is correctly handling the overheating. Inflation has spiked from around 4% to over 6% now and RBI has recently gone through a round of interest rate hikes that pushed the interest rates from around 7% last year to over 13% now. Simultaneously, it has hiked the reserve rates (that will prevent banks from giving more loans) and allowed the rupee to appreciate against the dollar. As the stakes in Indian economy are growing bigger and bigger, different parties are taking sides on what are the implications of the policy. The market has voted with its foot by crashing the Sensex (it has recovered partly though as i write this) and analysts have smashed the policies. I myself have written a couple of articles arguing against the RBI's policy. Here, I'm giving the other side of the picture. So, what is happening and what will be the implications on various parties concerned - Indian poor, middle class, corporates, exporters, government, foreign investors?

Great Indian Growth:
First, what is happening? India is on a big boom cycle since 2003 and a lot of people have come to begun that the time has come for India to get to the center stage and rightly so. The growth rates have gone up over 9% from a dormant 6% rates 3 years ago, and the efforts of reforms during the previous regime is finally paying off. The fundamentals look good - a nation with atleast 250 million people with reasonable spending power, a vast network of well bred universities (atleast 25 of the institutions are now in the elite category, including the IITs, IIMs, AIIMS & IISc), a great history, center of major trading routes in Asia, and a vast network of expatriates providing free diplomacy and act as conduits for knowledge and economic exchange. India is simply in the best possible position for development, so far, and here is the link for India's scorching growth prediction.

Oh no... not so soon. However, too many things happened and the growth was simply too fast for the system to handle and the overheating signs have been showing its ugly teeth now. 6% core inflation shows nothing and honestly, I believe the RBI doesnt care as much about that. What is dangerous is a precarious position in asset markets. Indian infrastructure and housing development, along with even good corporate stocks, couldnt withstand a sudden barrage of this huge money flood. House prices in Indian major cities have gone up by over 300% in 3 years, stock index appreciated over 300% in the mean time, real-estate and commercial property have gone up by over 5 times in a few places, and all these dwarf the 6% core inflation rate that is mainly showing global inflation in commodity prices. And all these were fed with cheap credit, and loan growth is at a dangerously high 30%/year. The condition is really risky now.

Indications of overheating:
Housing: Rocketing house prices where people are willing to pay $200,000 for some second-grade apartments in not-so-good localities when the country's per-capita income is just around $1000/year is definitely a scary sign. To put things in perspective, in Seattle (the home of Boeing, Starbucks, Amazon and Microsoft) good apartments in nice localities can be got for $400,000 when the median household income is over $100,000, and people fear overheating here! So, the hard-earning middle class is priced out, while a lot of people have dangerously accumulated huge amount of loans to buy white elephants. In the last 1-2 years RBI has issued a lot warning regarding this situation, and asked banks to cool down housing loans, but banks have not turned their ear to it.

Real Estate: Its not just the houses that are too expensive. Commercial property is an unexpected peak where shady locations in Bombay and Delhi seek prices that would shame even Manhattan. This has affected expansion plans for many hotels (nation of India has less hotel rooms than the city of New York), many companies are holding their plans to open offices in Mumbai and Bangalore, and even retailers are affected by this skyrocketing prices. At some point the cost of doing business will cross a tipping point, and India will no longer be a favourite service/production outsourcing even with low wages, if we dont address this real-estate quandary.

Stocks: And the stock markets have been affected by this irrational exuberance. While the fundamentals are definitely good, the prices (in terms of P/E ratios) are really high for an emerging country, enough to price out many serious investors. And a lot of investment is in the hot-money section (foreign institutional investors and domestic buyers trading on margin) that could vaporize at a degree above room temperature. While, a good stock appreciation encourages the corporations to expand more, over-appreciation and over-hype could cloud us on crucial things like efficiency and cost-management, and over-paying on unworthy assets like what the Japanese did in 1980s. It is time for some correction to more moderate levels (probably around the 10-11K region in the Sensex).

Savings: For an Asian country, India's saving rate is not impressive. While, the Europeans and Americans have social security and good nets (comparatively) and the Asians have good domestic savings, Indians have neither. India is on a complete blow-out cycle, learning to spend from the Americans, before even they have learnt to earn from them. Personal credit growth is rocketing, and unlike their previous generation, people are not afraid to go on big loans for flat-screen TVs and unaffordable houses. Automobiles are overcrowding before the roads are even built and Indian researchers are worrying more about obesity and cholestrol than hunger and poverty! Indian domestic consumption as visible from rocketing non-oil imports have also caused the current account deficits to zoom (imports much greater than exports) inspite of a healthy growth in export industries like IT, Auto, Pharma and Chemicals. Indians are currently just over-consuming and a developing country cannot afford to have deficits for long.

Thus, the current overheating, if left unchecked, could rock the Indian boat and the Japan's painful experience from over-exuberance in 80's and America's experience in 90's should not be forgotten. Brimming prices of Housing, stocks, commercial properties and runaway loan growth has already given enough indications that the supply-side pressures from agricultural commodities, oil and metals are just an excuse for the inflationary pressure. RBI has got nothing to do with these latter things, and the solutions are pretty simple and are with the government: Liberalize sectors like power, mining and agriculture and you would see the same benefits. But, we are not arguing about these core principles for now, and RBI with its monetary stick is tackling the runaway overheating than core-inflation with interest rate hikes. Commodity inflation is just a pretext for RBI to pull the government to take action (governments are the biggest beneficiaries of inflation and low interest rates, as they are usually the biggest borrowers). If RBI is even half as intelligent as I would assume them to be, they would know that monetary policies cannot control commodity inflation (no one is going to stop eating food because you increase interest rate by 0.5%) and so it should not be a secret that the recent measures are more against over-heating fears than CPI per se, what many analysts assume it to be.

In the next part let us see, how the current measure are enacted and in the third part how it will individually affect the various players in the game (including us).

(This article has been included as an Op-Ed in Asian Development Bank's E-Newsline)

Three Billion New Capitalists

I was reading through Clyde Prestowitz's "Three Billion New Capitalists - the Great shift of wealth and power to the east" that came in 2005. Like many of the books of the same era including the "World is Flat" it describes opportunities and challenges that is unfolding for America given the revolutionary changes that is occurring in India, China, Brazil & the East Europe-Russia. All these countries were warped in some kind of socio-communism till the late 1980's and (almost) everything came down with a thud with the fall of Berlin Wall. East Europe followed Germany into capitalism and USSR collapsed in 1991, India became almost bankrupt in 1991 and turned into a market economy partially due to the fact that its main export destination went down pinching foreign earning, China was forced to become a capitalist with a host of events including the Tiananmen square massacre in 1989 and Brazil became democratic with a new constitution in 1988. By now the concept of BRIC (Brazil, Russia, India, China) has become a cliché for international economists.

The globalization process started since the 15th century when Turks captured Constantinople in 1453 closing an important trade route for the West with India. So, starting with Portugal, European countries were sending their great expeditions towards India and unimaginable wealth was found in Asia, Africa & Americas accidentally. This process was accelerated with the industrial revolution and Renaissance and by early 20th century the strains of protectionism-mercantilism that came as a reaction for globalization almost destroyed the world with two great World Wars, along with producing diseases of socialism, fascism, Nazism, communism, Maoism & Fabian (India).

This time the challenges are much more than the earlier rounds of capitalism-globalization that occurred till 1980s. The players were relatively small Japan, West Europe along with the big boss - America together accounting for a population of half billion+. But, the challenges that are posed with the rise of three billion new capitalists (from India, China, Russia, Brazil, East Europe) poses totally different challenges. Of fundamental worry is the Export imbalances caused by curency manipulation by Asian countries that causing dollar to be artificially strong and posing threat to everyone in the system.

The book covers a lot of these aspects and the author puts his vast experience in government commissions and private executive boards to explain how each of these challenges unfold and how US can cope up with them. Some of the interesting observations made by the author are:

1. Linkages between various sectors of economy: A lot of macroeconomists believe economies to be working linearly and free market principles can stabilize systems in almost no-time. For example, you lose an industry to abroad due to productivity difference and this will help you to have cheaper product and eventually you currency will depreciate and cost of labor will go down and you will eventually get equal or better industry. But, a lot of cases such things don’t happen. The author gives an example of how US companies like Ampex lost VCR business to Japan, thereby US lost all the additional things like disk storage & recording etc. and Japan built its CCD industry with VCR revolution and this led to Digital Cameras. Thus, by losing one industry US lost a dozen industries.

2. Economies are ecosystems: While dealing with biological & physical systems we are sometimes so amazed and shocked how important certain minor linkages are. Destruction of certain animals/plants or loss of certain soil & water streams can break an entire system just like how faulty screws could potential bring down great machinery. While biologists and ecologists are starting to appreciate such crucial links, economists are late in the game. The author gives an example of Silicon Valley. It is not just a place of producing h/w & s/w. It is a region watered by the great brains of Stanford & Berkeley, powered by thousands of venture capitalists, lawyers, Research labs and corporations and each are important to other. The corporations need universities for talent and Universities need corps for funding, and both require capital from the VCs & investment bankers. You break one linkage and you collapse the whole system. Thus, US should be careful of what it moves offshore and should make a few industries national priorities just like how biologists designate few animals to be endangered.

3. Currency manipulation & Monetary policy: The world system has gotten to a point, where one part of the world (read: America) is mad consuming while a lot of rest of the world is mad saving. Both cannot continue forever. Over saving is as bad as over consumption like what the great depressions showed. Like fat accumulation in the body, a lot of regions including Japan & China have accumulated a massive reserve of dollars (running in trillions) and they have no sound plans for consuming them. The system is thus very precarious and small moves can bring the entire system to a thud. So, major savers should diversify their savings and move a lot of it for domestic consumption. Major economies like China should move their focus from export-centric to serving their huge domestic markets. Interesting suggestions he gave include bringing Japan into dollar zone (effectively ending currency manipulation) and work with Europe & IMF to bring alterative international currencies to reduce the burden on dollar.

4. Energy security: US is spoilt with a couple of decades of cheap oil that brought new beasts like SUVs into the market. This has put it an unsustainable situation of consumer of more than a quarter of world oil. By a combination of activities including support of energy efficient vehicles, tougher standards for SUVs and support for alternate energy sources like oil from shale, tar and ethanol should be pursued to totally eliminate the dependence on Middle east oil as world oil reserves are going to be extremely pressured with the rise of the three billion people.

5. Focus on Education: Due to the policies that centered on baby boomer generation, US education is in a state of deep shit. There was a time when people could land in life long good employment with a mediocre high school graduation and such laxity has removed focus on a rigorous schooling curriculum. Teachers are underpaid and hence of poor quality, and due to legal action discipline is not properly enforced. Thus US lags the rest of the world in student quality and this must be redressed.

6. End US hegemony: Many of policies of US including the Iraq war are not adding any more friends to the US and now it has been totally isolated. So, it should focus on strengthening international institutions like UN & EU to share its burden and consult with the rest of the world in greater actions. As US is slowly losing its economic superiority comparable changes in defense policy must be made, and defense allocations pruned.

However, I disagree with the some of the observations of the author including his undue fear of wage equalization. Eventually, there will be a wage equalization where US and the rest of the world will come closer. This is because US gotten to where it was, because the great countries of the world were sleeping then. India & China contributed to 75% of world GDP till 17th century and then due to external intervention were totally broke & poor. In the meantime wars weakened Europe, and US got a golden chance to rebuild the world and in the process built a legendary economy. There were more kids and very little old men and so everybody got great safety nets and high school students landed in great jobs. US consumed half of world's major resources with one-twentieth of the population. So, what it reached in early 1980's & 90's were peaks that, in my opinion, can never be reached ever. As other nations start waking up there will be a need for equitable distribution of resources and balancing act will continue. Eventually, US will become like rest of the world consuming what it deserves and that is the best that could be hoped for a nation with scarce history & no ancient culture though they can partially equalized by great entrepreneurial spirit of the 19th & 20th centuries.

But, the challenges that involve the spreading of resources among the old and new owners will be anything but painless and great powers must ensure a smooth transition to ensure the continuity of the world.

Inflation! Why should India care?

There are two people - one a 70 year old man seen the best of his life and in a hospital bed and another is a 18 year old healthy boy playing an aggressive soccer game. Now, a rise/drop of blood pressure for the former by even a few percentage requires immediate attention and intervention by the doctors. But, what about the latter? Should same yardsticks be applied? Should the doctors barge in the middle of the game, and medically intervene if the heart rate marginally increased above 70?

This is the game that is currently going on in India. The pundits at Reserve Bank of India (RBI), worry day-in day-out anxiously watching the inflation jumping around 6%. They have reasons to worry. They follow a lot of practices of the US Federal Reserve, Bank of Japan & European ECB that have set their main mandates as controlling inflation, and growth is a footnote for them. But, at some point those worriers at RBI should ask themselves - are the comparisons valid? Inflation control makes sense for Europe, Japan & US that have had their best times, whose people lead a comfortable life currently, whose growth rates are barely a few notches above ZERO, and small changes in this stable economic equilibrium can wreck people's life-long savings and bring financial disasters. In many sense, they are like the 70 year old man - survivability and maintaining status quo is the key.

But, what about India that has just started to grow. Majority of its people are poor, not many have too much of life-long bank savings to worry about losing a percentage due to inflation, and a lot of development is just waiting to happen. Simply, status quo and economic equilibrium is not an option. If it a'int grows, it dies. As simple as that. In this condition, with growth rates clocking in excess of 9% and bank interest rates above 8%, why does a 6% inflation bother anybody? And a lot of this 6% is due to global factors including global rise in prices of wheat, corn & dairy, along with sky-rocketing oil prices, commodities including metals and increase in transportation costs.

Secondly, this higher inflation coming after two years of unusually low inflation rates. Before that period, even double digit inflation was not unusual. Thus, another part of the game is a lower base to start out with.

Third, apart from global forces, a lot of inflation is due supply side forces - less availability of developed urban areas, rusty food production and full capacity utilization in industries. A healthy inflation rate can and will encourage more entrepreneurs to add capacity and build more production. Farmers will be eager to increase food production and property developers can wipe out scarcity in good urban development. An artificial intervention, puts water in all these positive developments and precludes natural development that should have happened.

Fourth, increase in interest rates have put enormous strain on government finances and non-plan expenditures have skyrocketed leaving little for capital & infrastructure expenditures and this will cause further damage to this fragile nation badly in need of development.

So, its too early for RBI to nose in and spoil the exciting game. Simply, its interventions are unwarranted and unnecessary - the 18 year old boy can take a bit more increase in heart rate and can enjoy the game. RBI is dealing with a healthily growing country, not some ageing nation.

Last but not the least, RBI is a tiny factor in the world game with gazillions of liquid money. When US Fed, ECB & BoJ are finding it extremely hard to rein in this flood, its preposturous for RBI to think of putting brakes on it. If you are pressing too hard on a wet soap, you know the consequences. So, RBI should know its limitations, and carefully guide the game externally instead of its fiats to banks.

Rollback the interst rates close to international levels and work with the government on producing proper development and consider sector-wise tightening of capital through well-guided regulations.

Bank of Japan (BoJ) rises rates: What are the impacts?

While, writing this I find BoJ has increased the rates to 0.5% and this surprize jolt has hurt a lot of speculators.

The speculators and short term traders will get hurt by any upward moment of the currency (strangely the currecy moved downward yesterday, as the rate increase was below expectation of few organizations) and/or increse in rates.

However, long term is a different story. I dont believe Japan/Germany can ever attain the state they were once in the early 80's. The world economy then looked totally different with tiny nations like Japan, UK, Germany, Italy along with their big boss US controlled the world economy. Now, those days of tiny tots are gone, and big wigs - BRICs are entering the show and if terrorism could be controlled even Middle east will join the show.

What this means is that not only there is enormous potential for greater depths for world markets, but also that these nations are no longer in US control to take things like Plaza Accord or Bretton-Woods agreements.

These nations by their size and population have enormous appetite for capital and can easily suck in trillions of dollars in the next decade for their development to come in par with the west. Atleast India, with its huge infrastructural requirement could suck few hundred billions in the next couple of years.

So, Japanese currency's appreciation potential will get diminished as they face import pressures due to rising oil prices and export pressures, where even countries like India would join as competitors for electronics, Auto and Steel. And with current deflation there is very little room for upward movement of currecy and the ageing society doesnt want to spend as much as their younger counterparts.

So, my guess is that these new countries could suck the entire investment fountains dry and would coast on the wealth that Japan and Germany built up for decades.

It is great time for countries like India that has great entrepreneurship scope but limited access to capital (till very recently) and can use this great "Akshaya Pathra" for supercharging growth.

Should government subsidize Oil?

This question has been puzzling me and the answer to the question "Should Indian govt. control the petrol/diesel prices" produces an answer even baffling to me. I'm a free market supporter and in general against government intervention, but I feel Indian govt is not too wrong in controling the oil prices at the moment. At the same time, I also feel we in the US are enjoying a much cheaper petrol and the government here must raise the prices by increased taxes. I'll explain my contradictory position in this article.

Background:
In India, oil prices are not directly determined by the world prices, but controlled by the government in a process called APM (Administered Price Mechanism). What this means is that periodically, based on the international prices, government would set a prices for Petrol (Gasoline), Diesel (used by trucks), Kerosene (used by poor for cooking & lighting) and LPG (used for cooking by middle class) and all the oil market companies have to fix to that price. The price is set in a way that oil companies make profits on Gasoline, break even on Diesel and losses on Kerosene & LPG, and in return get compensated by government bonds.

In an effort to curtail inflation (and score political points ahead of forthcoming elections), the government has reduced the oil prices though the oil companies are still making losses out of subsidies on Kerosen & Diesel. A lot of columnists have blasted the government, and for once I'm not going to attack the government.

In India, currently after the reduction the price for petrol (gasoline) is around Rs.50/liter ($4.18/gallon) compared to US prices of around $2.3/gallon, while Diesel costs around Rs.32/liter ($2.55/gallon) almost the same price as in the US. And India has better refineries and slightly hence lesser cost of fuel production and distribution. Thus, its not correct to say that Indian government subsidizes oil. In effect, what Indian govt does is to tax the fuel heavily and then make profits at all levels mostly going to state & provincial governments.

So, gasoline in India is not cheaper than most countries and this makes sense as India should curtail the use of more cars till the necessary infrastructure comes up, and even then it is better not to go the American way of automobilzation. High gasoline price makes sense, but very high prices can affect sectors like tourism etc. and so I believe that current prices for petrol are neither too high nor too low. And the pricing of Diesel at lower rate makes sense, because Diesel is much more efficient (40% more power compared to Petrol) and it emits just 69% as much greenhouse gases as petrol for every kilometer of ride. Thus, by encouraging the Diesel usage government is pushing more people out of the more inefficient and nasty petrol towards a shade better Diesel. Moreover, Diesel is used by trucks transporting essential items and public transportation (Trains & Buses), apart from small captive power plants. Thus, Diesel subsidization encourages a more healthier practice of relying on public transportation rather than Automobilzation a trap that America got into. Now, US is considering more sops for Diesel based cars. And, since diesel is used in core sectors, a lower price will curtail inflation in a lot of sectors.

Now, coming to the sacred cow of Kerosene & LPG the main cooking and lighting source for the poor and middle class respectively. India has a ultra low price for Kerosene almost half the cost of production and this alone leads to a loss of over $2b/year and a similiar amount in LPG. I believe that LPG prices have to be gradually increased so that it breaks even, while some efforts must be made to modify Kerosene distribution. $2b is not a big deal for trillion dollar economy and the Indian government can effectively carry on protecting the poor for a longer time from the vissicitudes of global economy. The poor spend considerable portion of their earnings on energy, food & transportation and all these are directly affected by the fuel costs, and the resulting unrest can put the economy down by tens of billions of dollars, and hence Kerosene subsidies make sense. But, distribution mechanisms must be modified so that it reaches the appropriate persons and to protect the blackmarket sale and adulteration into petrol and other fuels. This paper has proposed good methods for this problem.

http://www.iimahd.ernet.in/publications/data/2006-07-06smorris.pdf

Global oil prices are erratic and you cannot have mechanisms that directly reflect the global prices in a developing economy. Oil prices swing from $10 to $80 in 5 years before coming to $50 in a few months, and this could totally collapse a fledgling economy like India, if the government doesn't interefere and smoothen things out. If you calculate all the taxes that various governing bodies in India make out of oil, it could easily compensate for the various subsidies - notably in Kerosene & LPG. And, even if you have to spend a couple of billion dollars more, its worth it to keep running an economy that adds $100billion to GDP every year. And to compensate the oil majors for the loss, the government has to provide sops, though in the long run I would prefer a more simple system, where the government reduces taxes on these oil products and also take away some of the sops from the companies. The non-m0netary sops including governmental intervention and support for acquiring global oil assets and exploration of alternative fuels and efficient systems should be pursued more.

In the end, I believe that India's currently policy of keeping a higher price for gasoline and a moderate price for diesel makes sense and should be continued. While the oil companies face losses due to this, they could easily be compensated with the government bonds, which inturn can be paid from the taxes the government earns on these fuels. And LPG prices in the long run should get in par with the global market, while Kerosene subsidies should continue but mechanisms must be reformed to ensure appropriate distribution.

Regarding the situation in US, I recommend higher prices and here is a slightly older post, but still relevant to the current issue.

Rate Hikes in India - Part 2: Effect on Corporations

The previous post had given an introduction to the sectors that could face trouble due to the rate hikes. We will go further on analyzing the ramifications.

First, the rate hike would pressurize a fledgling banking system in India. Indian banks are tiny compared to world standards, inspite of India having one of the deepest and oldest financial markets and some of the best talent in this arena. One of the main reason for this is the over meddling of Indian government in its affairs. Now, things are going for worse. The Prime Lending rate in India has climbed above 12% for many banks, while you could borrow at 5% in Libor (London) or around 1% in Yen nominated loans from Japan. And, given that Indian rupee has bullish prospects both in short & long term, the overseas loans would have an effective rate of less than 3% in rupee terms. To add to this, recently Standard & Poor has upgraded India's ratings and thus, Indian corporations could get better rates due to lesser perceived risk. Thus, any corporation that could borrow from overseas will skip Indian banks and get it at the concessional rates. So, when you read about Tata or Birla's mega acquisitions and dont read any Indian bank acting as the banker for the deal, dont be too surprized. By being burdened with enormous rates, Indian banks lose out the best customers and have to be put up with the lousy ones.

Second, RBI would slowly lose control of Indian market. By forcing more companies to look outward for loans, RBI has little leverage over the market and over the course of time market would act independent of RBI's whims & wishes and long term rates would be less under control. This is somewhat similiar to the situation with US Fed that has control over short term rates but has little control over the long term rates. While, it is debatable whether RBI should have greater control over the economy or not, but an economy totally running out of governmental controls might get reckless if the markets are not mature and deep.

Third, small & medium scale enterprizes would lose out of competition. Large concerns like Tata, Reliance, Birlas, Essar, etc. could borrow at international rates, while their smaller rivals back home cannot do that and have to put up with twice the cost in interest rates. In many businesses that run on lower margins, a small change in the rates could topple the competition totally towards other side and kill a lot of fledgling enterprises that is essentially not good for the country.

In Part 3, we would see what other steps India could take to counter the current inflation crisis

Rate Hikes Counterproductive

What?

The RBI (Reserve Bank of India) the central bank in India has yet again raised the Cash Reserve Ratio. What this means is that banks should lend less of their deposits and currently keep more than 6% of the deposits with the RBI instead of lending. This will lead to higher interest rates for loans, by the supply-demand economics.

Why?

Inflation in India is raising very high and currently over 6%, the highest in 2 years. It has mainly contributed by the increase in food prices, along with world oil prices, property boom in India along with expanding business cycles. Whenever inflation grows high, banks follow the textbook method of raising interest rates, so that people will borrow lesser to buy stuff and the the demand will reduce therefore and the price raise will be contained.

Why is it counterproductive?

First, the inflation is more due to the supply side economics rather than demand side economics.

1. Real Estate

While, it is true that people are betting high & high for good properties, the core problem here is the lack of availability of good properties. For example, my 2000 sq ft property in Madurai has hardly experience inflation, while properties in Chennai, B'lore & Mumbai have shot over the roof. This is because, people get very few choices to buys houses if they want a minimum level development. The solution will be to develop properties more and more so that anybody with a decent level of employment could get a decent housing. India is no short of land - currently having more than 30 trillion sq ft of which atleast 10% is fallow and underutilized. So, if we have 3 trillion sq ft, every Indian household could build a 12000 sq ft bungalow and dont even need high raises! That's ideal, but the point is with proper development every household could be assured of a good housing. Invest more in planned housing development and allow real estate developing corporations to expand more and even if the SEZs turn out to be just real estate development, still it will do good for the nation. And once, enough supply of good houses are made, the prices will fall in the super hot spots.

2. Agriculture

Why the food prices have gone up should not be a surprize for those who watch Indian agriculture. The sector is in a state of shit, and the last decade there has been no growth in the yield or productivity, while industrial production surged and technology zoomed. Our per-hectare productivity for most crops are among the lowest in the world, and we have the highest wastage in the world. Lands have to be consolidated, supply chains strengthened and flattened and technology/capital has to reach the field. Allow big private houses to repeate their magic with industry on the field, and with a good retail sector growth, Indian farmers have huge potential to grow. If we do right things, we could potential expand the end value of Indian agricultural produce by 3-4 times and wipe out shortage that is boosting the prices now.

3. Cement/Steel & basic commodities

These are not too different from agriculture. India has vast reserves of coal, iron ore and bauxite (aluminum ore) and they are hardly utilized due to red-tapism. This had forced the stellar players in this field like Tata Steel & Birla's Hindalco to look for overseas purchases. Allow greater reforms, liberalize laws and promote greater development. Given our enormous potential in this segment, most commodities excluding copper & oil, could head south with better technology.

The key in all these three things are - investments, reforms & consistent policies. Regarding the last two the government has the ball in its court and regarding investments the increase in interest rate will jeopardize all the growth. If the interest rates climb up so much, the infrastructure, power development and these three sectors will suffer and the projects might be derailed.

Instead of taking a myopic view, the RBI should curtail the temptation to increase rates and realize that textbook methods are not directly applicable to this complex nation. The need for the hour is greater investment and the RBI should direct them to the right sector and by increasing the rates the RBI is not only curtailing growth but also leading to future inflation by choking supply & infrastructure.

God shall bring lights to the darkness filling economists' brains.

Guru: A film & economics review

(Disclaimer: I'm not here to comment on how the songs were, how the this & that pinky minor details were... search some other blog for that. I'm not gonna talk about Mani Rathnam or AR Rahman or even Rajiv Menon. I felt most other reviews were pathetic in that they totally missed the whole point. I'm here for the story and story alone, what it means.)

Oh boy! what a week of movies... This whole week I had been spending watching some of the best movies (apart from doing my day job) included one of the best movies of all time - "Life is beautiful" (that got me to spend most of the tissues in my house) and the first day of this Hindi movie - "Guru". I loved it so much that I didnt even talk coming out of the theatre with my dozen frens and drove the car without switching on the music. I wanted the film to settle in me and blogging as soon as possible. This is my review based on my experiences with both investing & films and ya... ATLAS SHRUGGED. Kindly bear if dont talk about AR Rahman at all (the music director) as I'm someone who believe that most films dont need songs and in this film most of the songs were out of place (but you know I loved the Mallika Sherawat's song ;)).

The movie is about the story of one of the world's greatest entrepreneurs Dhirubhai Ambani, the founder of the conglomerate Reliance. To me he is much more than even Henry Ford & Andrew Carnegie (the former pillars of American economic ascendence) as he battled India's highly idiotic anti-business atmosphere and built a vast empire (from texitles to petroleum, telecom, and now retail malls & real estate) starting from nothing. He should be a hero for any Indian dreaming to do something big by the power of economics and today we are seeing the brilliant empire slowly on the footsteps of becoming a GE of the world. So, how did a guy with no political or business links to start out with, built such a magestic empire is a great legend. I once read about it again and again (12 years ago during the Indian boom) and its fascinating. And this movie brilliantly captures that (Hindi films are getting better and better in every genre) and top the director ices with the film depiction of Hank Rearden's extraordinary court scene in "Atlas Shrugged". (For those who didnt read the novel, I cant pity you for the lack of understanding of the climax). One moron writes >> he attempts to justify the man’s deeds in a weak climax which puts forward the dubious premise that as long as you bring happiness to your shareholders here
What the heck he knows about climaxes or business?

The story revolves around Gurubhai (does it sounds like Dhirubhai) & his brilliant political & business maneuvres (basically he got around India' archaic rules of milking out well-run companies and increased production enormously and fought a system by breaking all its bad rules and involved one of the biggest sharebases in the country, thereby benifitting most middle class in the country) and his pitched battles with Nanaji (Ramnath Goenka of Indian express).

Simple story: Guru fails in his exams and runs to Turkey to work in a petrochemical firm and learns in and out of business and commodities trading. He then beleives that he can do much better by starting business in India and returns back. Here, he then partners with his close friend and marries his sister (played by Aishwarya Rai) partly for the dowry with which he can open a company. He then goes to Mumbai and wants to trade in the rudimentary commodities exchange there. However, he finds redtapism there, with the President of the exchange a wealthy Mr.Contractor (Nusli Wadia of Bombay Dyeing) doesn't allow new members and extends full control over it, thereby blocking development. Guru accidentally Nanaji, a news baron, and Nanaji agrees to publish his story of how business is blocked by vested interests in the exchange. Contractor gets pissed off and using his political power closes the exchange itself in anger. But, Guru does an intelligent convincing and puts the IAS officer incharge to a great embarassment and forced to reopen.

Guru becomes a great trader, and later opens a big factory and in a path that revolutionized Indian industry, he went for an equity based approach with an IPO (that time called new issues) instead of taking the conventional debt based aproach. An ingenious decision that brough millions of commoners into shareholder governance thereby ensuring its success with politicians. He dreams of beating Burma Shell (Bombay Dyeing) with his company and does extrordinary maneuvres - creating bogus exports (Indian law then allowed teh companies to import only if they export something, so he created ghost entities abroad that bought his empty boxes) and then channeled the revenue to import a lot of capital goods (machinery). And he understaded the imports to avoid taxes and made use of teh capital gains laws to avoid most of the taxes.

An entreprising reporter in Swathanthra (Indian Express) exposes all the violations and a government commission gets into full swing. He is accused by everybody and the great company was on the verge of closing down with Ambani facing the prospect of jail (in 1980s). In the state of shock he gets a paralytic attack. In the climax court scene, he delivers a brilliant speech (exactly like Hank's speech in Atla Shrugged), where he questions the verasity of those archaic laws and doesnt hide the fact that he broke the laws. He demands whether making a prosperous business that led to India's growth and alleviation of poverty as a crime & whether making all those middleclass shareholders prosperous is a crime. A host of brilliant questions in the licence raj regime of pre-economic indepence India (got independence in 1991). The govt was dumbstruck and it had millions of common shreholders whose rights the common cannot affect. So, the government had to go back, and eventually India started its reforms (not in the movie).

The movie ends with how Dhirubhai dreamed of India to become a first world country and why chasing dreams is not bad. If it means breaking stupid laws so be it (Mahatmaji called it Civil Disobedience movement). I perfectly agree with Dhirubhai, I liked the powers of a man's dream and seeing the status of Reliance today as teh backbone of Indian economy, I cant just wonder what wud have happened to India if those stupid politicians got carried away and killed Reliance.

It was a great movie - a great lesson. Rand's lovers wud love the concept (though the songs showed typical Bollywood Masala strains) and Indian businessmen should learn a lesson or two from him.

India's Growth Model: China or America?

In the previous post, we discussed about whether India and China were ever equal. Now we will go further and discuss the right model for c