It is too early to say we will change our stance!

It is too early to say we will change our stance.. well it's RBI Governor D. Subbarao who said this recently.  The context - inflation.  Deputy Governor Subir Gokarn says going soft on inflation could involve huge risk.   With food inflation scorching ahead at around 10%, the fight against inflation is only going to intensify.

Ha..Ha..

Sriman Cynic has started reading newspapers... rather scanning through them.  This headline caught his attention - "Overall inflation to moderate to 6% by Dec, says Chawla" (Business Line, July 6, 2010).

"Food inflation is going down. It will take some time before it comes to a range that is acceptable to the Government and good for the people," Mr Ashok Chawla, Finance Secretary, told reporters on the sidelines of a conference here on Monday. He, however, declined to put a timeframe as to when the acceptable range would be achieved. 

"Declined to put a timeframe" - these words keep ringing in the ears of Sriman Cynic.  After all how can the government put a timeframe - we can put a timeframe, once we are in control of the situation.  Deadlines have come and gone, only to be replaced by a fresh set of deadlines. The entire inflation debate has become a cruel joke. Times of India's headline (July 29, 2010) sums it up better -

Future, tense..?

Sri V Anantha Nageswaran in his article "Can Asians exhale?" (Mint, June 14, 2010) says that a news item in The Times of India on the relentless rise in apartment prices in Mumbai caught his attention. The asking price for a 620 sq. ft apartment was around Rs44 lakh.  While buyers are turning away, the developers do not appear to be deterred. 

 

The price rise is unreasonable.  In a place like Bombay (or Mumbai, to be politically correct), the rise is spectacular.  People who bought flats in the range of Rs.15-20 lakh 4 to 5 years back are getting offers of Rs.80 to 100 lakh.  In an earlier flat where we stayed (on rent), after the owner promised that we can stay for as long as we want, within 6 months, we had real estate agents swarming the place as there was change of heart of the owner.  The offers he was getting was very good though the housing complex (where our flat was located) was considered as part of the forest land and it was anybody's guess about the final decision in the matter.  After months of uncertainty, we finally shifted to another flat, wherein again after 6 months, we ended up with same uncertainty, as the flat came up for sale.  

Today people are getting offers, which have no basis or economic rationale.  After twenty years of working, I ventured into buying a flat and that too with trepidation.  We are taking a huge risk with a long term commitment.  The key assumption is that our jobs would be intact - our companies would grow - our salaries would go up etc.  We are living in an uncertain world and these assumptions, age has taught me, is pretty dangerous.  Today, too many youngsters are in the job market and they have never seen a downturn / recession.  That's why I feel too many young people are out to buy flats... even if its only for investment.  Maybe the growth in the economy in the last few years, has made corporates loosen their purse strings.  Too many young people make money too quickly and they don't know what to do with that money.  As they have seen that the prices of flats have gone up (in the recent past) they believe that it will go up in similar fashion in the coming years and end up buying flats at whatever be the price.  The situation is unsustainable.  Often I hear people say that it is better to buy flat now, as it will be too late tomorrow.  Here again, people make the assumption that the rosy job / salary / income situation would continue in the future for an indefinite period.  Only time will tell, if such an assumption is correct.

Anantha Nageswaran says -  

.. a combination of interest rate increases, currency appreciation, capital controls, anti-speculative measures targeted at specific sectors and moral suasion with the financial sector and with the public have to form part of the policy response in Asia.

... the overheating is also being fanned due to the pursuit of short-term economic growth as an end-goal in itself. Asia is still anxious to catch up fast and to compress the two or more centuries that Western nations took to achieve their current status into a generation. That is neither desirable nor feasible. There is needless insecurity and breathless activity, consequently. The social, environmental and geopolitical costs of such a pursuit are eluding their grasp.

The point is that no one wants to rock a boat when it apparently is sailing smoothly.  Who will bell the cat?  Politicians, media, banks ... everyone seems to have a vested interest in not rocking the boat.  Why fix something that isn't broke?  That seems to be the thinking.  I only wish it doesn't become a tsunami in future and wipe off all the hard work of the past.  The inflation that is raging on every single item of day-to-day use has to be seen to be believed.  But it doesn't pinch the politicians.  It doesn't pinch the government employees, as they have something like Dearness Allowance, to take care of price rise.  What about the employees from the private sector and the unorganised sector who work for fixed salaries (or CTCs)?  Who talks about them, now-a-days?

As China is growing at 10+% for decades, Indian politicians feel it will be below our dignity if the growth rate goes down a bit and so loose money policy will continue.  In the process, we lose our fight against inflation and impose a cruel tax on the poor.  I am increasingly worried about the future.  Sensex may go wherever it wants.  It doesn't matter to me.  For the common man, it is important to know whether he/she would be able to service large loans taken for housing purposes over 15 to 20 year periods?  I think, today no one is thinking about that.  Everyone feels that the prices of flats would only go up and in case of emergency situation, they can always sell the flat and get out.  In the event of a worse case situation emerging, can everyone get out at the same time?  Will not the prices crash in that case?  Who will service the EMI in such an event?  How will banks manage a tsunami of defaults?  Do they have a macro model where such events are taken cognizance of?  I am not sure. 

Anantha Nageswaran quotes George Akerlof and Robert Shiller for their excellent description of overheating (page 65 of their book Animal Spirits) -

The term overheated economy, as we shall use it, refers to a situation in which confidence has gone beyond normal bounds, in which an increasing fraction of people have lost their normal scepticism about the economic outlook and are ready to believe stories about a new economic boom. It is a time when careless spending by consumers is the norm and when bad real investments are made, with the initiators of those investments merely hoping that others will buy them out, not feeling independently confident that the underlying real investment is sound. It is a time when corruption and bad faith run high, since they rely on trusting behaviour on the part of the public and of apathetic government regulators. This corruption, however, is mostly recognized publicly only after the fact, when the euphoria has ended. It is often also a time when people feel social pressure to consumer at a high level because they see everyone else doing so, do not want to be seen as laggards, and do not worry about such high levels of consumption because they feel that others don’t either.

To me, this definition would definitely hold good in the Indian scenerio and that makes the future... tense.  

Sri Ashoak Upadhyay in his biting article "False optimism, empty promises" (Business Line, June 28, 2010) points out the policy makers have been endlessly dishing out a rosy perception of the future to those who want to hear it endlessly. For the rest, the miseries of inflation and poor infrastructure are here to stay. 

Sri Upadhyay says -

SAME OLD CLAPTRAP

But the policy player seems to have advanced a step. The only way to connect India with modern infrastructure is to fill the funds gap — itself an endless incantation — with capital from the advanced markets that have it.

So the critical problem affecting the the Indian economy is both capital and the institutional mechanism to ensure its smooth flow into the sector. That sounds familiar, too.

So do a raft of assurances on everything that is wrong with India. Consumer prices have been riding high since mid-2008 — in their endless round of increases — and policymakers have never tired of assuring the nation, on television, in print, that their reversal is just round the corner.

How, one asks; what is the Ministry of Agriculture going to do? Crack the whip on hoarders? Boost farm productivity? Everyone is betting on rain, it appears. Last year the drought spoilt the kharif crop; then it was said the rabi would do the trick.

In April when prices soared (and even the Wholesale Price Index, or headline inflation defied North Block) policy players, from the advisor to the Finance Ministry to the Prime Minster himself, rushed to assure us that by year's end, December 2009 that is, prices would drop.

The Reserve Bank of India, for its part, magisterially pronounced its own time-table for deliverance —next March.

Even as policy makers repeatedly assured that inflation would go down, it has defied control.  It has not stopped policy makers from making one promise after another, as if to show that they are in control of the situation.  This graphic from Mint (June 22, 2010) throws light on this issue.

Somewhere down the line, we seem to have lost control over inflation.  Policy makers are caught between showing "better growth rates" so that capital markets don't tank and lower prices expected by the masses.  Today, elections are not there.  Thus, policy makers may think, that the masses can wait and may feel that keeping the capital markets happy is of paramount importance. Policy makers keep making announcements about how inflation is getting controlled or when it will be fully under control.  The media is swallowing and vomitting the policy makers' versions.  The inflation tiger has run away carrying the common man (and woman) in its mouth and the policy makers don't know how to get out of their growth tiger without getting hurt.  There is no satisfaction in knowing that other countries too are facing the same situation.  If I am hungry, I should have food to eat.  Knowing that ten others are also without food, is no satisfaction for me.  It is not going to satisfy my hunger.

Aparajita Sinha & Chandni Gupta point out in Mint (June 22, 2010) that there are indications that inflation is recently spilling over into the manufactured products sector. The big question then: Is the worst behind or ahead of us?  If the capabilities and intentions of the policy makers are any indication, our worst is yet to come.  Too many people are going to get hurt when the growth machine comes to an abrupt halt.  To me, future is uncertain and it definitely looks tense.

Uncomfortable Answers to Questions on the Economy

We have heard that Fannie and Freddie, may cripple the US financial system. We have heard about the increasing job losses and plummeting home prices in USA. Economists keep debating whether it is recession already in the world's largest economy. Something has clearly gone wrong with the economy. But how bad are things, really? And how bad might they get before better days return? Are you are interested in knowing the answers to the following questions:

• Is this a recession?
• How bad is housing?
• When will banks revive?
• Is my job safe?
• Are consumers done?
• Who’s to blame?

If yes, please read this informative article in NY Times.

Whip Inflation Now

Highlights from John Mauldin's "Thoughts from the Frontline".

President Nixon instated price controls on the 15th of August, 1971. Inflation was a little over 4% at the time. Price controls manifestly did not work (resulting in shortages of all sorts and a deep recession) and were rescinded a few years later. President Ford went to Congress with programs to fight inflation that was running closer to 10% in October of 1974, with a speech entitled "Whip Inflation Now" (WIN). He famously urged Americans to wear "WIN" buttons. That policy too was less than effective, and the buttons, in a history replete with silly gestures by governments, should stand on anyone's top ten list of such silly gestures. Cynics more thoughtfully wore the buttons upside down and said the inverted letters (which looked like NIM) stood for "No Immediate Miracles." They were right. There was no miracle, just eventual pain and lots of it. Ultimately, Paul Volker defeated inflation, but at the cost of two serious recessions and a lot of economic misery, with unemployment levels over 10% for nine months in 1983.

Some call for the Fed to raise rates so that we do not have to experience another lost decade like the '70s and then ultimately see some future Volker forced to raise rates and drive unemployment back to 10%. Others suggest that "core" inflation is what should be paid heed to, and urge caution. "What will Ben do?" As Donald Coxe has noted, North America has had an 18-year run of remarkably good weather in our growing season. You have to go back 800 years to get a string of years that were that good. Yet today food reserves of all types are at decades-long lows. There is very little room for any type of problem.

Bottom line, Bernanke is in a very difficult position. Inflation by any standards is too high. But the cause of the inflation is not something in the Fed's control. To bring inflation back to 2%, he would have to savage the economy, perhaps at least as much as Volker did. Do you want to see unemployment go to 8-10%? Volker was dealing with wage inflation. Everything had cost of living adjustments (COLAs) back in the late '70s and early '80s. Spiraling wages were one of the primary causes of inflation, if not the most important. A higher Fed funds rate could do something about rising wages by increasing the unemployment rate. Tough love, but effective. Volker had to kill inflation expectations. Today, that is not (so far) Bernanke's problem.

Raising rates in any serious manner would whip inflation but would kill the economy at this point. Rates will need to go back up at some point, but not until the economy shows signs of a rebound. Countries throughout Asia would love to have a 4.2% inflation rate. Indonesia is at 10.4%, almost twice what they were a year ago. Vietnam would love to have such mild inflation, as its own level is up over 25%. Inflation in China is 8%. Inflation is up throughout the continent. And oil and food are the culprits. Korea is particularly strained. Korea has seen its import prices rise by almost 45% in the last 12 months.

What good would a rate hike do? How much more oil or corn would be produced? Why increase our pain when there could be no positive result? The central banks of the world got by for years with easy monetary policies (think Greenspan) because of rising productivity, cheap energy, increased international trade, a disinflationary environment because of cheap Asian labor and imports, etc. Now that economic regime has come to an end. Stability had bred instability in a very uncomfortable Minsky Moment. There are no good solutions. There will only be a choice of how much and what type of pain. The US, Europe, and Japan are entering Muddle Through World. The rest of the world is faced with increased volatility. This is a tough environment in which to be a central banker.

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The Indian context
"Inaction may be India's solution" - Financial Times. Though humorous it speaks volumes about the difficulties in fighting price rise in a country which is very sensitive to price rise and which is going for an election next year. The ADB cautions that rising inflation could also hit investment and corporate earnings, and destabilise governments in Asia.

Annual inflation in India rose to 8.75% for the week ended May 31, 2008 which is a 7-year high. There is a consensus view that the near-term battle against inflation in India has been lost and inflation is likely to settle down around 9-10% in the near-term. So, the struggle has now shifted to how to bring it under control in the medium-term. And this is after taking up short-term administrative measures to try to stop price rises, including cutting import duties on edible oils, fuels and other food items, introducing export curbs on essential items and suspending futures trading in staple foods such as rice and wheat.

Interestingly, inspite of these measures, there is a view that the Government will not be able to stop it from accelerating beyond 10%. The only consolation (if at all we can call it that way) is that price gains in neighboring Pakistan accelerated to 19.3% in May, the highest in 30 years. Inflation in Vietnam was 25.2% in the same month, the fastest since 1992, and in Indonesia consumer prices jumped 10.4% from a year ago. But this is no consolation. In a democratic country, where elections are due next year, the poor are more likely to vote, with anger, at the extra-ordinary increase in prices of essential day-to-day consumption items.

Major steel producers decided to reduce prices by Rs 4,000 a tonne after meeting the Prime Minister Manmohan Singh on May 7, 2008. Some cement companies have also announced Rs 3 to Rs 7.5 reduction on a bag of 50 kg. However, it is believed that the government persuasion which lead the commodity manufacturers to reduce prices may not have long lasting effect, as their input costs also are increasing.

While inflation rate at 8.75% has brought out headlines in newspapers crying for immediate action, some economists assert that India's method of calculating inflation is wrong as there are serious flaws in the methodologies used by the government. How does India calculate inflation? And how is it calculated in developed countries? India uses the Wholesale Price Index (WPI) to calculate and then decide the inflation rate in the economy. Most developed countries use the Consumer Price Index (CPI) to calculate inflation. As a common man, I am a witness to the phenomenal increase in all items of daily use, which unfortunately doesn't reflect in the 8.75% inflation rate. To me, the inflation rate clearly appears to be understated. Thus, the actual inflation rate is expected to be much higher than what the official figures indicate.

As an outside observer, I believe that the Reserve Bank of India (RBI), is currently caught between two divergent objectives viz., currency rate management and inflation targeting. The appreciation in the Indian rupee which was happening, suddenly reversed trend and the rupee has gone back from around Rs.39 (for 1 USD) to around Rs.43 (for 1 USD) in a relatively short span of time. May be the outcry from export sensitive sectors employing large number of labour in concentrated locations / industry segments forced the Government to nudge RBI to allow the Indian rupee to depreciate vis-a-vis the USD. But it has also bloated the petroleum bill.

Today, we are at a situation where a very large segment of the population is suffering from the impact of inflation (which is the cruelest form of tax on the poor). May be allowing the currency to increase could be one of tools to use against inflation. How does it matter to the Aam aadmi that sensex is rising or falling? As of now, the situation is clearly unsatisfactory. Whip Inflation Now, is the message for politicians.

Financial speculators and ban on futures trading

"In Washington, financial speculators are being blamed for high gas prices, soaring grocery bills and volatile commodity markets, and lawmakers are lashing out at market regulators for not cracking down on them more vigorously," says this article in New York Times. Even billionaire George Soros, has said that speculation has spurred the rise in crude prices. The phenomenal increase in the commodity prices have turned the attention of the authorities on the speculators who are otherwise viewed as performing an important function by bringing liquidity to the market.

The Indian Context
The runaway price rise in India has prompted the authorities to extend ban on futures trading in respect of some commodities to cool prices. But Chairman of the Forward Markets Commission, B.C. Khatua, says the ban on futures trading in some agri commodities is resulting in illegal or ‘dabba’ trading. Interestingly, earlier some traders' groups themselves sought delivery-based forward trading (instead of futures trading), a system that will considerably prevent large scale flow of speculative funds chasing commodities in genuine short supply.

Mint says that instead of taming inflation, futures ban has seen prices rising and may result in illegal trade and hoarding. An article in Mint argues that the current trend of rising prices has put a question mark on the role of futures markets in fuelling inflationary tendencies in the economy. As less than 2% of farmers were aware of the futures market, leave alone participating in it, the general belief is that it is the speculators who are participating and influencing inflationary trends. Unfortunately, the signals which policy makers would otherwise get by the functioning of a well established futures market, would now not be available for the policy makers. As far as India is concerned, my feeling is that conclusive evidence that only speculators are the reason for the price rise is yet to come, though too many people including politicians, bureaucrats and strangely even traders groups themselves have blamed it all on speculators.