Monetary activism

To douse the inflationary fire,the recommendation by the high level RBI committee must be worked upon with urgency and earnestness. 

India’s central bank, the Reserve Bank of India (RBI) is up with yet another concerted effort to combat the notoriously high inflation. A committee headed by RBI Deputy Governor Urjit Patel has recommended pegging monetary management with the Consumer Price Index (CPI) instead of the current practice of the Wholesale Price Index (WPI). Observers believe that the move is commendable since it is the CPI which directly affects the consumers, unlike the WPI. The recommendation, if accepted, will line the RBI in tune with the global central banks which target CPI as a nominal anchor.

However, there are reservations against this proposed step. Food and fuel inflation constitutes more than 50 per cent of the CPI. It is being pointed out that food and fuel price volatility will be difficult to accommodate in the policy decisions once CPI becomes the reference point of monetary policy. This seems a valid point. Nevertheless, instead of taking this into account what causes frequent variations in food and fuel prices in the first place is what one should look at.

Let’s first discuss the food prices. Though weather conditions have a role to play, government policies and supply side bottlenecks are the principle protagonists in the big picture. Without specifying how it would generate enough foodgrain to run, for instance, the Right to Food Security programme, the government chose to go ahead and implement it. Disregarding how it would meet the revved up demand due to increase in rural wages by MNEREGS on the ground, it is still choosing to run it. Also, no justification has been given as to why the Food Corporation of India (FCI) continues to hoard massive quantities of foodgrain, much of it is often left to rot and consumed by rats. Nor is there a grip on opportunist intermediaries either who hoard and block the food chain supply to inflate prices for purely vested interests driven by profit and greed. No legal action seems to follow in these cases of organised horading. Fluctuation in onion prices late last year is the best example of such deliberately manipulated price inflation. 

Coming to fuel prices, no government anywhere in the world can foresee fluctuation in international crude oil prices. The internal mechanism of setting up prices factors in such fluctuations. Unfortunately, India’s internal mechanism itself is faulty. There is no clarity on fuel prices which have been highly subsidized by government. Whether the benefits of subsidy reaches the needy or is enjoyed by the consumerist rich is a chronic debate. The case of subsidising diesel for swanky SUVs etc, is a glaring example.

That said, the food and fuel prices fluctuate due to the non visionary approach of the government. The failing of government should not be imputed as a hurdle on the progressive path of treating CPI inflation as the nominal anchor.

CPI inflation stood at 9.9 per cent in December. If it becomes the nominal anchor, it is feared that interest rates will have to be hiked dramatically to bring it under control. This is not something the government would like to hear at in the current phase since all it wants is to spur growth while an apparent economic slow-down stalks it relentlessly. It is true that the war against inflation is fought on the cost of growth. But, before citing this inflation-growth debate as a criticism, it is important to read the Urjit Patel committee report in-depth. The committee recommends targeting CPI at 4 per cent within the two years with the wiggle room of 2 per cent in either direction. It does not make a case to raise the repo rate in the next monetary policy review.  What the RBI panel is really looking at is to bring CPI inflation down to 8 per cent over the “next 12 months” and to 6 per cent the following year. Going by the Patel committee’s formula, a repo rate hike is therefore not in order at least until early 2015.

India’s Economic Affairs Secretary Arvind Mayaram has called the focus on CPI a “premature step” but there is a strong case for India’s monetary policy to be steered by CPI inflation. It is this inflationary trend which really impacts domestic households and influences their investment decisions. There has been much dispute between a government demanding growth and ‘inflation warrior’ RBI. It is high time to bring a decisive end to it.

Taming inflation is important even at the cost of growth because the virtuous cycle wheeled by a controlled inflation will spontaneously infuse growth in the economy; but the vice versa is not possible. Therefore, the recommendation by the high level RBI committee must be worked upon with urgency and earnestness without losing time.

Divestment Dilemma

Government will have to understand that   

diluting government control on PSUs by stake sales or getting them to divulge their profits as bonus is not the way to fund fiscal deficit.

With another fiscal year coming to an end in three months, the government is staggering hard to achieve its divestment target in public sector undertakings. Divestment in PSUs is important for maintaining the budgeted level of fiscal deficit but given the unfavorable market conditions at present and general elections looming in, a successful divestment program is highly unlikely. That government has 5,000 crore in its kitty with 40,000 crore to garner before the end of FY 14, is of ample proof how serious it has been to achieve this target.

Ideally the purpose behind divestment is to scale up the efficiency of firms by privatization. As per Anshuman Tiwari, the economic analyst and financial editor of Dainik Jagaran, “There is history of debates in India on purpose of PSU divestment. Divestment is the process to infuse efficiency in PSUs via reduction in government control and making them widely held but lately governments have been employing it to raise funds when they fall short of revenues to meet its fiscal deficit target.”

Taper proof

Thanks to RBI and FM, the specter of imminent fed taper couldn’t haunt markets as it did back in May. 

In what served as a nightmare for Indian economy back in May, when turned real was treated as a business as usual. The much discussed and feared US dollar tapering by Federal Reserve, first announcement of which shook the cores of rupee is finally set to begin from New Year.  Dollar inflows are to be narrowed down in the markets but thanks to the improved level of Current Account Deficit, the difference between outflow and inflow of the foreign exchange, rupee wouldn’t lose its stand against dollar. 

US Federal Reserve Chief Ben Bernanke on Thursday announced to cut down on its monthly dollar minting program by $10bn, bringing it to $75bn dollar. Fed, with an effort to spur growth, had been pumping in cheap money to the tune of $85bn in its economy on monthly basis which in turn also benefitted emerging market economies wherein US investors parked that cheaply acquired money for better returns. India was one of the beneficiaries of this program. However, Fed Chief announced to taper off liquidating dollars in May 2013. Mere his words were enough to scare the investors though final decision was yet to be taken. Foreign Institutional Investment (FIIs) began flocking out depreciating rupee’s value against dollar, which touched its all time low in August at Rs. 68.85 per dollar. It is only after drastic measures taken by Reserve Bank of India and Finance Ministry to attract dollars and cut down on imports that rupee could be strengthened.

In this background, it is surprising that panic-stricken response shown by markets back then didn’t come to pass now, now when taper is certain and just round the corner. To compare the current scenario from May, India is better placed at all fronts. First, the time and pace of taper was uncertain then which is not only clear but bearable at $10bn reduction a month. Secondly, India’s foreign reserve and CAD have improved a lot. The unprecedented surge in gold imports of earlier times could be controlled including few other non essential and expensive imports. CAD narrowed sharply to $5.2 billion, or 1.2 per cent of GDP, in the July-September quarter of 2013-14 which hovered around 4-5% in the previous quarters. In addition, RBI’s move taken in Sep 2013 to ease it for banks to run Foreign Currency Non-residents (banks) deposit scheme has also played out well. Under FCNR (B) scheme NRIs do not face currency risk; the currency risk is borne by banks. RBI had helped banks reduce this risk so that they attract more of NRIs to make use of this scheme and don’t stay away from offering it in the tight domestic currency scenario. 

These measures apart from turnaround in exports have made Indian economy resilient enough to face imminent outflows of dollars. Initially rupee might lose traction against dollar but that wouldn’t be severe and wouldn’t sustain for long. Considering US economy is back on growth trajectory, fed taper can instead be positive for India in a sense that demand boost in US will drive export growth of Indian export enterprises having business in US. That is double dose good news for them as lately they are already reaping benefits of surge in exports.

The specter of Fed Reserve taper is no more there to haunt. India’s external front is under control for now. It is time that all efforts are put to reduce notoriously high inflation, the pivot of economic growth cycle and thus boost industrial production bringing jobs and growth in the country.

Trinity Trick

While Rajan’s monetary policy review did ensure to handle two of the trinity trilemma i.e. sinking rupee and rising inflation but the last one i.e. meek growth demands Government action.

With US Federal Bank postponing quantitative easing withdrawal and with debutant RBI-Chief Raguram Rajan coming up with pragmatic monetary policy, positivity seems to have enthused in Indian economy. On one hand the breather given by Fed-Chief Ben Bernanke has ensured that Foreign Institutional Investments (FIIs) will remain intact till December, on the other, RBI-Chief’s move to hike repurchase (repo) rate has signaled that notorious inflation will also be guarded. Consequently with external and internal stability, the rupee-volatility will soon be the thing of passé.

RBI has raised repo rate i.e. the rate at which banks borrow from RBI for short-term credit to 7.5% from 7.25%. Simultaneously, it has reduced Marginal Standing Facility rate, a special and expensive borrowing window for banks, to 9.5% from 10.25%. Usually hike in repo rate translates into increased borrowing cost for banks but considering that MSF is the effective policy rate since July which has been lowered, cost of borrowing for banks has actually come down. The idea behind this move is to provide fresh air to banks currently suffocated with cash dearth but at the same time prepare them for the ensuing normalcy when repo rate will regain its position as effective policy rate. In that case, during normal circumstances, even if repo rate is increased from current level of 7.25%, it will be less than the present rate of MSF, thus there will not be any dramatic impact on banks’ cost of borrowing.

Another positive implication of repo-rate hike is that the subsequent arbitrage advantage in interest rates will attract more foreign investors, something which is needed to shore up foreign reserves. Increase in repo-rate also suggests RBI’s hawkish stand on inflation front. Fighting inflation through increased rates is justified as it is undoubtedly notoriously high inflation which fuels the vicious cycle of economic slowdown. Though it will hurt the already languishing growth with expensive loans and all but lower inflationary pressure is required even if it comes at the cost of short-term growth.

The so called impossible trinity trilemma of sinking rupee, rising inflation and meek growth has to be dealt with now. While Rajan’s monetary policy review did ensure to arrest sinking rupee and control rising inflation but meek growth cannot be strengthened solely by RBI. It does need policy-push and legislative reforms something which demands Government action. Effective monetary policy will come to a copper as long as it is not backed by prudent fiscal and legislative policies and expecting fiscal and legislative prudence on the part of Government in an election year is like asking for moon. Therefore, thumbs up to Rajan, a question-mark on Government’s intent!

                          

Raghu Reform Rajan

 Mr. Rajan’s beginning is definitely commendable. He might have travelled across the half way too quickly but covering the other half would not be easier.

“If you can trust yourself when all men doubt you, But make allowance for their doubting too” following lines from the poem ‘If’ by Rudyard Kipling is probably the best message newly appointed RBI-Chief Raghuram Rajan could convey to everyone bewildered with current economic turmoil. Through his maverick maiden speech, he effectively addressed the hopes of each stakeholder but how much walk of his talk will take place is something yet to be seen.

Slew of measures, in order to provide fresh breather to banks, have been proposed by Rajan. For instance, well-run scheduled commercial banks do not have to acquire permission from RBI in order to set-up new branches. Also, no fees will be charged for this purpose. That underserved areas don’t remain neglected, RBI will make sure that banks open up branches in those areas in proportion to their expansion in urban areas. Apart from this, he also emphasized to expedite the process for issuance of new banking licenses. A committee chaired by former RBI-Chief Mr. Bimal Jalan will be looking into the applications after an initial review and compilation by RBI staff. The process is stipulated to be completed by Jan 2014 i.e. the new licenses should be issued by then, if the deadline is not extended any further. In a bid to set up robust banking structure in the country, differentiated licenses will also be issued to small banks and wholesale banks. Large urban cooperative banks will be converted into commercial banks.

Rajan also took into consideration the growing Non Performing Assets of the banks due to loan-defaults and subsequent Corporate Debt Restructuring. He took a hard line on owners of those companies and said they do not have the divine right to stay in charge unmindful of how badly they mismanaged their enterprises. Banks aren’t supposed to bear the brunt of their bleak business scenario. Thus CDR norms are certainly going to get tougher now. To the relief of cash-strapped banks, Rajan intends to reduce their requirement to invest 23% of their deposits in Government securities which is known as Statutory Liquidity Ratio. It reduces the amount of cash available with banks to make loans.

For the benefit of citizens, finally an RBI-Chief will be launching Inflation-indexed savings instruments pegged with Consumer Price Inflation (CPI), not WPI as it is former which reflects the actual inflation being borne by consumers. A national grid-based Indian bill payment system will also be launched, where households will be able to use bank accounts to pay school fees, utilities, medical bills etc. This will make payment anytime anywhere a reality. Also, a pilot will be conducted to enable cash payments using prepaid instruments issued by non-banking entities and Aadhar-based identification. An application for encrypted SMS-based funds transfer that can run on any type of handset will also be examined by a technical committee.

Acknowledging that access to finance for the poor and for rural small and medium industries is hard, Point of sales devices and mini-ATMs will be set up by even non banking entities so that financial inclusion leading to inclusive growth can be feasible.

As monetary policy is the first and foremost responsibility of RBI, a committee under the chairmanship of Urjit Patel, in three months, will be suggesting measures to strengthen the monetary policy framework. Measures such as liberalization in forward market and internationalization of rupee etc. have certainly spurred the confidence of investors that India is not afraid to take bold decisions concerning with financial markets.

They say that ‘well begun is half done’. Mr. Rajan’s beginning is definitely commendable. He might have travelled across the half way too quickly but covering the other half would not be easier. All eyes are now set on 20^th Sep i.e. the day when he will be coming up with his first monetary policy as RBI-Chief. All the best Mr. Raghuram Rajan!! Hope you setting-off to tread on the other half-way is a success. 

Seeing the Silver-linings

India’s export business is bleak and currency depreciation is a tried and tested formula to boost it, rupee’s fall CAN be translated into export-growth, CAN turn out to be a positive for Indian economy. 

And the rupee goes past 66 per dollar! An all-time low! Its swinging motion in the range of 61-66 per dollar has become a cause of concern for Finance Ministry and Reserve Bank of India. Though their panic-stricken remedies adopted to cure rupee’s free-fall do suggest that economy might go down into dumps if currency doesn’t stabilize but considering that India’s export business is bleak and currency depreciation is a tried and tested formula to boost it, rupee’s fall CAN be translated into export-growth, CAN turn out to be a positive for Indian economy.

Scrambling to tame burgeoning CAD and thus halt rupee’s slide, Chidambaram hiked import duty on gold, silver and platinum to 10% and also hinted to raise duties on non-essential luxury items such as air-conditioners, refrigerators and expensive watches. It has also asked state-run financial institutions to raise funds abroad through quasi-sovereign bonds, and liberalized rules on overseas commercial borrowing so that more dollars can be brought in India. Not only FM, but monetary policy supremo RBI is also up with its efforts through its liquidity tightening measures. It restricted banks’ easy access to money so that bank-financing for speculators who create pseudo dollar-demand in currency market, can be curbed. Apart from these, RBI also put drastic capital controls on Indian residents and companies to stem the dollar outflow. Now only $75000 can be remitted by resident-individuals which is a steep fall from earlier limit of $200,000. Also, no Indian company can invest more than 100% of its net worth in foreign countries which could earlier invest 400% of their net worth.

Unfortunately nothing translated into rupee’s stability and it went beyond 66 per dollar. What was supposed to work for rupee didn’t help it, rather backfired hitting the economy with collateral damage. On one hand increased lending rates due to liquidity tightening is eating on the already dilapidated growth, on the other recent capital and import controls have fuelled the panic arose out of rupee’s fall. Not only foreign but even Indian investors are now losing faith from Indian economy.

Now that much has been tried to stem rupee, it is time that it is left to take its own course. Rupee’s fall is just a phase of wheeling vicious cycle which by itself would come down to a stable level. Indian credit rating agency CRISIL has in fact predicted that rupee will stabilize at rs. 60/dollar by March 14.

It is time RBI and Govt. accept that they are short of arsenal to protect rupee. They must instead look for ways to make the best use of rupee depreciation. Japan and South Korea in sixties and China in nineties had deliberately weakened their currency in planned manner to boost export, which actually paid them well. In fact, rupee’s fall has begun making positive impact on India’s export-business.  Exports rose by 11.64% in July. Also, rupee’s value against dollar is at a level which gives it competitive advantage in exports as compared to currencies of other countries including China. The most important point to consider is that export-boom, if it at all it happens, can eventually ease pressure on rupee through an increased flow of dollars.

Hence it is time that cheaper rupee is converted into export-drive. It would not only perk up India’s internal sustenance but also help restore investor-confidence in Indian economy.

Oh Onion!!

All you need to know about onion-price-rise

If you can’t imagine your meals without onions, get ready to either loosen your pocket or learn to not loosen your tongue!! The spectre of rising onion-prices is back to haunt and will keep haunting for at least few more weeks to come. Here’s a look at what you need to know about your favorite kitchen-ingredient:

Why the price-escalation?

Last year, drought in Maharashtra, the biggest onion producer in the country, already led to production-shortage and this year due to untimely rain in the same state including Rajasthan, Andhra Pradesh and Karnataka destroyed the liliaceous plants whose edible bulbs i.e. onions are the major mainstay of Indian cuisine. However, an internal note prepared by the Ministry of Consumer Affairs says "It was observed that there was only 5 per cent lower production of onion during 2012-13 as compared to 2011-2012 and storage was less by only 2 lakh tonnes. But there was a sharp decline of market arrivals by around 20 to 40 per cent during June-July, 2013 as compared to 2012. It seems that the stored onion was not released to the market timely and either farmers or traders are making undue profit by creating artificial scarcity. Accordingly, prices increased almost double the level as compared to 2011-2012."

Thus hoarding by opportunist suppliers and farmers is another major reason behind prices going north apart from shortfall in production.

What is being done by Govt?

Government has imposed export restriction on regular variety of onions by setting Minimum Export Price at $650 a tonne. It has also eased quarantine norms, especially those of fumigation so that onion-imports from Pakistan, China and Egypt can be facilitated. Anti-hoarding drives are also on at wholesale markets, thanks to which supply in the last couple of days has improved. Apart from this onions are being sold at less than Rs 5-6 from retail prices in Government fair-shop outlets.

Will the prices go down any time soon?

Yes but marginally! As recent exponential price-rise has resulted in demand-slowdown and measures taken by Govt. have led to improved supplies, prices will surely stabilize but merely at measly lower peak than today. It will hover around between Rs 50-80. They will come back to normalcy only after new produce lands in market and which is likely to happen by October 2013.

Economic impact:

Consumer Price Inflation, the one being borne by us, has come down to 9.6% in Jul 13 from 9.9% of the previous month. But due to surge in onion price including other vegetables, CPI is likely to go beyond 10% in the months to come as food articles account for 50% weightage in CPI.

Political Impact:

Political cost of onion is too much to afford for Government. Given that Assembly elections in many states including Delhi are looming and Lok-Sabha election is also in the offing, onion price rise is likely to become a significant election issue. Government will try its best to not let people shed onion-tears but its efforts won’t pay out much given the agitation and furore created by opposition. For instance, major opposition party BJP is selling onions at Rs 10 per kg in Odhisa in order to raise protest against Government.

It is notable here that it was the failure of BJP to control spiralling onion prices in 1998 which led to the victory of Sheila Dixit, current Chief-Minister of national-capital, in Delhi assembly polls. One never knows how things will turn out after 15 years in November!! Victory-cause itself might prove to be the failure-cause for the Delhi Chief-Minister.

Thus, onion, historically being a politically sensitive commodity, will give a tough time to Congress in coming elections.

Collateral damage:

As onion is one of the two trend-setter vegetables in food basket, other being potato, onion price rise automatically leads to escalation in prices of other vegetables.

 Tidbits:

Ø  Lasalgaon at Nasik in Maharashtra is the largest wholesale onion market in Asia. Currently    onions here are trading at Rs. 42 per kg.

Ø  Delhi Govt. has facilitated onion-sale at Rs.50 per kg from 1000 points across the city.

Ø  Few restaurants in B’lore have taken onion-dosa off-the-sale for time being.

Ø  A tyre-seller in Jamshedpur is providing free onions on the purchase of a truck/car tyre.