I just thought that I would write a piece on what I think are the worst logics being presented so as to justify some actions. The primary one going around these days is that
If low rates could lead to economic recovery then the Western world would be booming – This logic is being used by armchair economists and also RBI to some extent for not cutting rates at a time when lower rates are required for economic revival as well as to prevent the increasing stress of bad loans on bank balance sheets along with the huge stress that capex oriented company balance sheets are under today. Since the RBI interest rate hike cycle started SBIs base rate went up by 250 basis points or 33%. Can one say that such a drastic increase in rates have no impact on economic growth. Did the RBI not increase rates to constrain growth so that inflation could come down due to lower demand pressures?
The Western world did have boom and bust cycles earlier and interest rates played a huge part in them. The reason why these economies are now not responding to low rates is in no way comparable to the Indian situation where we are a developing economy with a high saving rate. We do not have a banking system that has gone bust due to excessive speculative activities (with due credit to the RBI) and have got enough capital buffer to sustain growth. We do not have a situation in
India where banks are required to shrink their balance sheets as they are so bloated that the capital levels cannot sustain the kind of liabilities that sit on the balance sheet. Indian banks have not indulged in instruments like CDS and taken excessive balance sheet leverage which the central bank cannot monitor. Neither are Indians excessive borrowers with a high saving rate and nor is our real estate and housing sector bust. Any lastly among various things we do not have a sovereign default issue that a large part of the Western world is facing.
The monetary policy of RBI is traditional (which is not necessarily bad); however it does not take into account the various non traditional instruments of generating liquidity that the US FED or the ECB have used like the QE1, 2 and 3 & also LTROs and OMTs. The entire inflation that we see in
today ex of the food inflation can be explained via the global commodity boom due to money printing as well as INR depreciation.
Every time the RBI has taken small baby steps of infusing liquidity the rupee has sold off thus reflecting the view that the market as a whole believes that that the steps that RBI is taking are not growth supportive. Today the INR needs growth support as
Indiais one of the best placed country today in the global context to absorb huge amount of cheap capital that is floating around. There is a real need to setting up new factories, power plants, roads, urban infrastructure in India. Can anyone support the logic that an investment that is viable at an 8% interest rate will have the same viability at a 12% interest rate? It is not true and as such those who say that monetary policy has a small role to play in economic revival do not know their economics very well.
There is need of lateral thinking among arm chair economists and also those who advise the RBI. However the good part is that the incremental destructive impact of new money printing by the US FED has been extremely muted and most commodities including old have sold off subsequent to the announcement of QE3. This sets the pace for much lower price pressures and lower inflation in 2013. NO Credit to the RBI please
The big revolution – In the midst of slowing economy, poor governance and high interest rates a big revolution is also on. This revolution involves the entire direct cash transfer scheme as well as the digitization of the PDS network in the country. The country wide optical fiber network that is going to connect all district headquarters is also a huge move that is on in the country. As is being widely discussed these days, whether it is as a result of the conviction in the government that this is something that should be done for the good of the economy or whether they are doing this in order to build a story for the next elections is irrelevant in my view. The fact of the matter is that all this is going to have a significant impact on poverty alleviation, rightful distribution of subsidies as well as reducing the government’s subsidy burden drastically.
The recent move of capping the LPG allocation to every household to 6 per cylinder is being estimated to reduce the subsidy burden of the government by around 50%, however in my view in reality the actual reduction will be more in the 75-80% range. The reason for the same is the large scale diversion of domestic cylinders to commercial and industrial usage coming to an end. Given the huge differential in prices between the subsidized product and the market price driven product (100%) diversion was imminent. The next big saving will come as cash transfers start in Kerosene on an all
Indiabasis. The major usage of kerosene is clearly in diesel adulteration as the price differential is over 300%. Kerosene usage as a result will fall drastically and cut the subsidy even more than or equal to LPG subsidy reduction. Cash transfers are clearly going to have a positive political impact on the government of the day, the key is to see why takes the credit the Centre or the states. The spending on NREGA have stagnated or reduced over the last two years despite higher minimum wages as the leakage in most of the Bharat Nirman schemes was excessively huge. The reduction in Fiscal Deficit which will come from the leakage of subsidies will me much more than what the government can achieve due to any other form of expenditure reduction.
The next big steps should be in the form of doing away with middlemen in agri product sourcing via the APMC’s which lead to significant food inflation. Some states have moved on this but not a majority of them. This will reduce another big source of corruption in the system and create huge goodwill among farmers. Whether FDI in retail can actually lead to a build up of cold chain and refrigeration networks in order to reduce food product wastage from farm to consumer or not is something that we need to see.
The biggest oligopolies – Two of the biggest monopolies that I can see in the Indian system are the coterie of Oil Marketing Companies. The second are the cigarette manufacturers of the country. Irrespective of tax increases in cigarettes the company is able to pass on price increases as well as maintain or increase margins. This shows extreme pricing power which is not possible in a normal market economy where cost increases impact demand as well as profitability. The other segment of the market is the OMC’s who price products in a totally non transparent manner. The biggest flaw in the pricing is in the fact that products are priced on an import parity basis rather than export parity. In any product segment in which a country is in surplus the pricing will be on export parity as the domestic market cannot absorb all the production and the excess needs to be exported.
India is dependant on crude imports in a big way but is surplus in refining and as such pricing needs to be on export parity. Such pricing will reduce the subsidy calculations of the government by at least 10-15%. Moreover price controls and subsidies reduce the incentive for these companies to procure crude in an efficient manner which also would be bloating the subsidy burden to some extent.
Markets are consolidating in the midst of a decent results season, a bottoming economy and improving government decision making & policy environment. The more markets consolidate right now the better will be the scenario for 2013 as we should see a significant interest rate cuts by the RBI over the course of 2013 as stabilizing food prices as well as lower global commodities take inflation down (no credit to the monetary policy). Better decision making by the government and focus on infrastructure investments should also boost economic growth. Global headwinds also seem to be stabilizing and moderating. I had expected a 20-25% stock market return in the year 2012 at the beginning of the year in contrast to most others who were predicting gloom and doom. As things stand now things are shaping up better for the year 2013. However I will write more on the 2013 outlook nearer to the end of the year 2012.