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)

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.

India's Scorching Economic Growth

In the recent days, I'm pretty much disappointed with what economists forecast for India. I'm not rather disappointed at Indian growth, rather, I'm disappointed at the skills of the economists :P. I dont know whether they understand the whole picture and take all the information into account of what is happening to India. The other day, I found an economist's article totally questioning the India's growth statistics just on the premise that the growth of services is unusual for a growing economy, and he just had the east asian economies in mind, when saying that. I also read a gazillion articles of why people should invest in China, and why India is overheating, India will be affected by slow downs, India is just call-center centric, blah blah blah. Let me get around to my own understanding of what is happening.

First, the obvious. India's IT & BPO are having extrordinary growth. At this rate, the IT exports alone would cross $60billion in 2010 and the overall revenues might get closer to $100b. A lot of people are worrying about the rise of China and other players, lack of quality engineers in India and rising pays and these area all honest fears. But, these fears are not all big enough to rock Indian boat, and Indian entrepreneurs are smart to see through innovative solutions. They plan to buy out a number of foreign operators in the the competing countries, giving them both expanding market & foreclosing competition, and their greater clout could lead to more techonology exchange and capital for investing. By aggressively entering cheap Tier-II & III cities, having dedicated massive training programs to train cheaper non-engineering workforce, they can effectively blunt many of the cost-based fears, and by better market diversification and innovation they have also broadened their approach.

For most Indian economic focusers, their prediction ends here and they are myopic enough not to look ahead. The following ones are going to be the trailblazers that are going to outsmart the Indian IT growth and overshadow them in the next decade.

1. Telecom - By far this is going to be the strongest sector for India in the next decade. In the last three years, our teledensity tripled and now we add 7 million mobile phones a month. At this rate we would move from our current presence of 180 million phones to over 250 million by 2007 and over 500 million by the end of this decade. This would place us head-head with China, and overtake US. Already, VSNL & Reliance's FLAG Telecom's hold the world's largest backbone telecom networks, (undersea cables & fiber optics handling most of Pacific & Atlantic lines) and this greater domestic clout will lead to greater buy outs in the saturated markets & bring more technology to India.

See: http://economictimes.indiatimes.com/News/News_By_Industry/Telecom/Flag_to_invest_15b_to_expand_cable_capacity/articleshow/969357.cms

Increasing Telecom clout would also lead to two major developments. First, is the growth of India as a major electronics player. To produce 500 million phones and for peculiar needs, major telecom companies are already increasing their massive presence in India in production, and such stellar demand for these devices would place us closer to China & Taiwan on electronics industry, using the same strengths in IT growth - good design knowledge, better English understanding & now backed by world's one of the largest markets. Second, the greater teledensity would enable better information exchange and ease of trade and commerce, and would lead to a stellar growth in a lot of sectors, particularly in rural areas that are the focus of cellular expansion from now.

2. Metals & Infrastructure - While analysts always crib about the India's faltering infrastructure, not much of a note is taken when a single state (one of the poorest) secured over 40 deals for investments in this core sectors worth a whopping $100b in a year. Given cheap labor, low cost of procurement and abundance of resources, 100 billion might be worth half a trillion in this state of Orissa. And, with that Reliance is planning to build a 12GW plant (world's largest single power plant), POSCO, Mittal & Tata for massive steel capacity expansion, stunning Aluminium expansion by Vedanta industries et al. and port and road/rail link expansion by a combination of players. Since, this is a poor state such developments can lead to stunning growth and these players are already building a city foused on health care & IT.

See: http://www.domain-b.com/industry/general/20061221_aluminium.html

Similiar to Delhi Metro, a lot of other expansion is expected to happen in city metro systems for almost all major cities including Pune & Bangalore, and this would pump billions of dollars in a decade & growth activities. Indian Railways has also emerged a strong company in the last couple of years and eyes on a massive expansion, including modernization of Railway stations with Private participation, Container privitizations, electrification etc. A number of road ways projects are moving at a breakneck pace, and in aviation India became the largest customer for planes in the last couple of years, and dozens of new airlines have started or staring by 2010 and airports like Delhi's & Mumbai's are going to get agreat facelift. All these might get in over $300 billion in the next couple of years, and if government plays right it would push India's manufacturing, construction sectors to new heights.

3. Banking & Finance- Though often ridiculed, the government owned banks have moved a great deal in the last decade. From being indifferent and lethargic, their employees have increased their zeal in expanding further. Indian banks are among the healthiest in Asia with the lowest Non Performing Assets, and greater branch coverage. With the sector opening up due for 2009, a huge growth is waiting to happen when new foreign banks will emerge and modernize the practices and the Indian banks would have a great footprint abroad. Public banks like Canara Bank, State Bank & Bank of India are aggressive on a massive expansion both in India and abroad along with private guys like ICICI & YES bank. With greater diversification into equity trading, investment banking, Indian banking sector is expected to grow leaps and bounds with their current strength and with that India's core sector will be pushed up, as they are the largest lenders & employers. Also, innovations like Microcredit are earnestly explored causing a potentially great rural expansion. India's stength with a huge number of finace & commerce students will not just lead Finance BPO expansion, but also massive stock & financial sector in India.

4. Organized Retail - This is one sector that would be a killer application in the future, as they start from almost nil, and would soon have over $50 billion investment in the next couple of years. Reliance has setup a highly ambition project of over few thousand outlets & Malls, Bharti with its Walmart tieup is looking to do big, and other smaller players will try to outbeat them by going early. The prospective opening up of FDI along with a greater middle class will let this sector grow by 100% in the next few years, as all these ambitious projects get along, and dozens of international bigwigs enter it. This would greatly increase the Indian revenue generation (current retail industry hardly contributes to revenue due to massive tax evasion), bring greater employment, reduce the prices & consumer inflation (ha! We have Walmart). But, to me the greatest development will be for Indian agriculture. Indian farmers hardly get a 5% of what they produce, while even with Wal-Mart squeezing American farmers get many times more than that. This is due to lowering wastage (this could be as much as 90% in India vegetables & fruits), increase farming productity with greater technology interchange & cutting down the middleman. Thus, we might finally have our Green Revoltion - II, finally.

5. Hoteling & Real Estate - Enough has been said about the fact that India has just as many hotel rooms as the New York City. While this is a disgrace, see it as a potential. As 99% of the market seems to be unutilized, with proper planning the hoteling industry can easily grow at 100% without reaching saturation for a long time. Atleast 75 International brands are eyeing India, and with proper real estate growth and better technology/infrastructure and greater tourism/business growth, this sector will add 100's of thousands of new hotel rooms in the budget and the luxury sector. Organized Real Estate will piggyback the growth of these & the retail industry. While the prime lands are at huge prices, still we have millions of hectares of lands at low prices of less than $2/sq ft, around the cities and these have huge potential for growth. For eg. a lot of hoteling industry is eyeing for the smaller city of Noida that has land at a fraction of price compared to the prime lands of Delhi. Indian Railways is also planning to share thousands of hectares of its land around the big railway stations for building hotels. A great hoteling expansion would in turn stengthen the tourism industry.

Read More here: http://www.hospitalitynet.org/news/154000355/4029788.search?query=india+china+growth

6. Healthcare & Pharma- By now you should have heard that medical costs in India are among the lowest in the world. Thus, we have a huge potential for expanding this booming industry as more and more people can now afford medical facilities leadind to a huge domestic expanision, and a lot of countries are thinking about formally sending their patients to India for treatment. And, Indian pharma companies are leading a great expanision, and busy buying assets abroad and expanding R&D facilities. Thus, with greater middle class clout and prosperity, these two industries will have a massive growth as more people can get medical care, and more drug development will be done in India.

7. Auto - There was a time when blindly took outdated european car designs and manufactured small amounts of car for domestic use. The times are changing. In Chennai alone four major manufacturers are setting up huge factories, Tata Motors is world's one of the largest medium & heavy commercial vehicle producer & also eyeing for a $2000 car. In auto components, India is slowly becoming the world's largest manufacturer. With great domestic market growth & a potential for cost cutting using cheap labor & facilities, a lot of foreign majors like BMW, Nissan, Fiat are entering India, big time.

8. Agriculture - Indian agricultural productivity lags behind world standards by a factor of few times though it has some of the best climatic and land advantage than all the other major nations. If the production is too low, then the wastage (which goes as high as 90% for some products) kills whatever remaining and due to inefficient practices we are not growing more lucrative crops. As technology, infrastructure & organized retail growth, are looming, this sector could close in on the international productivity standards, and this means we can have over 300% growth in the end value of what we produce, given our potential. This might take over a decade, but still if we have a potential for 300%+ growth in India's core sector in the long term, its effect on industrial consumption and Indian growth rate will grow exponentially.

As the article gets long & winding, I had to cut a lot of material and you could search online for each of the individual developments. The outcome it seems that, inspite of global slowdown India could maintain and increase growth, as the Indian core sector is starting from a very low base, and most of these developments can continue in spite of a weak world consumption, as they are based on domestic consumption that is again growing from world's lowest per-capita. Though, India could possibly slow in the medium term, in the long term, it could easily maintain a 10%+ growth, as all these segments above can maintain a double to triple digit growth in the near future.

A world recession can also indirectly benefit India, when its hungry entrepreneurs can get value buy outs at cheaper prices (like how VSNL & Reliance boughtout world's major telecom backbones like Tyco & FLAG). It would also hit upon the margins of international producers who might eye India for greater cost cutting, and Indian government would be more amenable to opening up to overcome the world recession. It would also make companies to look for the bigger & fast moving Indian market than the saturated world markets (like how Vodafone & Oracle are doing) and bring more investments. We benefitted from the American recession of 2001-02 (it increased outsourcing and cheapened telecom assets) and I guess we could now repeat the performance.

The writing on the wall is clear: India can grow inspite of what happens in the rest of the world - receding or prospering.