As the RBIs monetary policy has come and gone there is a major argument on between economists about the amount of monetary tightening that RBI should do and how inflation can be controlled. Most of the textbook economists are proposing that RBI should be much more aggressive. However the key is to evaluate whether a more aggressive policy at a time when RBI has been one of the most aggressive Central Banker in the world is the way to control inflation at all.
As I have argued several times in the past, in an integrated world where commodities and money flows are linked to each other and most commodity price movements are global in nature it is very difficult for a country like India to control primary articles inflation by its own monetary policy. If India decides to control demand and slow down its economy due to the fact that the United States is pumping in huge amounts of money into the world monetary system and creating bubbles in commodities or China is refusing to slowdown its economy then it will hurt the country in the long run. Over the last two decades China has followed a single minded mandate of growing aggressively and has done so at any cost. They continuously boosted supplies of all products by augmenting supplies and have become the largest producers of a large number of products in the world despite being nowhere around 15 years back. If inflation was so much demand induced then shouldn’t it have reared its head more sharply in China? It did not do so as they focused on increasing production as well as improving productivity on a continuous basis. Interest rates in China have been kept low by the government on a continuous basis. The other major positive factor in China has been that it has kept its Fiscal position strong and run surpluses which resulted in there being no crowding out of private investments. Huge FDI flows also helped China in augmenting its supply base across products and economies of scale boosted productivity.
In India unfortunately most projects to boost supplies get entangled in the web of bureaucracy and most projects are delayed. In areas where government intervention has been minimal and the private sector has not been bogged down by bureaucracy we have seen the productivity gains flow to the consumers. The best example remains telecom where Indian calling rates have fallen from nearly highest in the world to the lowest in a period of just 10 years. Despite having the one of the largest reserves of coal in the world we are not able to produce enough as there are restrictions on private sector participation and the public sector behemoth in this segment remains extremely inefficient. The advantage of boosting supplies in controlling inflation in prices is most evident in the case of the Cement industry where despite very strong demand over the last two years and huge input price inflation the prices have remained stable or come down due to significant capacity additions.
Power is another segment where we are likely to see huge additions of capacities by the private sector over the next 3-4 years. This will keep electricity prices in India stable to subdued for a prolonged period of time. However this advantage will be lost if new projects do not come through for the future and remain entangled in land acquisition and environmental issues.
On the agricultural side also we have seen a revolution in Cotton production due to better productivity after the introduction of BT Cotton. However in lot of other agri products where production can be boosted significantly by better seed usage we have not seen any moves for the last several years. In a large number of agri products India has the largest area under cultivation, however the productivity remains way below global norms. Even if we assume that with increasing affluence the food consumption is going up, it cannot shoot up suddenly to cause the kind of food inflation we are seeing today. If population growth is 1.5% per annum then food consumption at most will increase by 2-3% and improving production to that extent should not be so difficult.
One example of pathetic yields in agriculture is on the oilseeds front where at 950 kg per acre Indian yields are half of the global average and one third of the leading producers. As a result India imported Rs 38000 Cr of edible oils last year. A 50% yield improvement can eliminate all these imports.
Even when production is strong poor supply chains and outdated Agriculture Produce Marketing norms lead to a huge amount of losses which is estimated to be more than 30-40% of the perishable products.
My point to all the monetarists is that the basis of their analysis is flawed when they give a huge weight age to Indian monetary policy when the global policy is extremely loose. Monetary policy works best when the largest economies of the world move in that direction. Prices of crude oil, steel, copper or any other industrial commodity is hardly dependant on whether Indian consumption is rising by 5% or 10% as we are still 2-3% in the consumption of most such commodities. Except for food grains, sugar etc. Indian consumption does not really impact global commodity prices. Indonesia today has kept an ultra loose monetary policy, however India is compared to that country despite the fact that monetary tightening in India has been the most. In the ultimate analysis it will not matter so much as eventually it is when China decides to actually control inflation the impact will be seen on commodity prices.
RBIs monetary policy is most effective for controlling asset bubbles and in the current monetary policy statement they have excluded the paragraph on the asset prices as they believe that there is no bubble formation in that segment.
This issue can be discussed ad nauseum as there are arguments on both sides; however the only way to go in my view is to go for large scale investments across various segments in order to boost supplies and improve productivity as that is the only way to control inflation. For how long India will control growth and be on the cyclical path of high and low growth & low and high inflation? A high growth low inflation model has been successfully demonstrated by our neighbor China over the last two decades. Its time for India to move in the same direction as that is also the only way to have a voice in the world. Every couple of percentages of lost growth in a year adds up to a bigger price on compounding over the longer time frame.
It seems I changed by view on a correction to the 5400 range too soon around a month back as I became positive on the world markets and did not really think that Indian can under perform so severely. Whereas Indian market correlation with the Hong Kong markets has been more than 80% historically over the last month we have seen a totally inverse correlation with India down 11% and most other markets up in this time frame with the Hang Seng up over 4%. Korean markets in this time period have gone to all time highs and other troubled markets like Spain, Portugal also have been very stable. Most key European & US markets have rallied sharply as investors have been focusing on inflation in the short run. Countries with upgrades in outlook have done better than the fancied countries of last year. Most global markets have rallied by 3-10% from the end of October and the Indian markets are down by nearly 15% in the same time period.
The key for investors today is to evaluate how things will be a year from now and not how things look today. The problem normally is that most investors extrapolate today into the future, however the best returns are made in adversity and as such I believe the next few days and weeks are the best ones for investing into India. I reiterate my view of a marginal downside risk vis a vis a 25-30% upside potential over the next 12 months.