Friday, November 30, 2012
Slowdown…Its Effect on us…The way out…
There is absolutely no question about the fact that the slowdown is upon us. He following effects is eminent specific to our company:
Retail Segment: The purchasing power of people has taken a hit because of the austerity fiscal measures taken up by the government. The decrease in subsidy in oil as well as reduction of LPG subsidy has taken its toll on the pockets of the common people. What this mean for the retail segment is that we have to be careful in terms of appraisal when we looking at the savings accounts of the client because they have lesser amount to spend in their hands.
Challenges in terms of SME:
1) The Iron & Steel Sector has already taken a big hit due to the immense rise of the raw material like iron ore. The sensitive situation in the Europe region as well the global slowdown added with fluctuating dollar rates are causing external pressure on the iron ore prices. This has forced many big players in the market to downsize their capacity. Apart from that lot of smaller clients have been forced to shut down shop. This possesses a serious worry and caution needs to be taken.
2) The Textile & Hosiery sector is under worry as the FTA between India and Europe has not fallen through. This would mean charging of import duty on their material being exported to the region causing lowering of profits for the Indian Textile Industry.
Good Sectors
1) Gems & Jewellery is a sector that has good prospects. With the rising prices of gold lot of emphasis has shifted for the investors from highly volatile stock market to ‘safe asset’ of gold. In Europe as well with the volatility investors are looking to park their funds in gold.
2) Apart from those other Sectors like Pharma, Food Products i.e. the ones that have inelastic demand will have good prospects.
A Way Out
I firmly believe that we are at the moment stuck in the viscous ‘whirlpool’ cycle the only way out of which is through immediate monetary policy affect from RBI. They should bring down the interest rates right away. I believe the effect on inflation at the moment is due to supply side underutilization rather than demand side. The rising cost of funds is putting the projects to back burner. This is causing pressure on the classical component of the demand curve forcing prices to rise which is causing for supply side cost push inflation. This inflation coupled with rising oil prices is putting pressure again on the demand side. Now the demand pull inflation is already under control so this move will directly cause an improvement in the Capital Component investment of GDP increasing the growth.
Monday, July 18, 2011
Can two contradictory policies exist hand in hand?
The problem our country is facing at the moment is the threat of high inflation. Apart from that it is important to reduce the government deficit as well. Question is whether it is possible to control the fiscal deficit and the inflation at the same time.
Recently, the RBI has consistently been going for contractionary monitory policies by increasing the repo and the reverse repo rates which stands at 7.5% and 6.5% respectively. This policy is intended to draw out money from the economy helping it to cool down. How? That is simple: The rising rates mean the banks have lesser money to lend and thus money is lesser for investments leading to lesser money flow in the economy and thus lowering inflation.
While this is a long term approach to tame inflation the contradiction to this policy is the raising of fuel and LPG prices. Theoretically, this leads to rise in the costs and is expected to eventually raise the prices in the economy fuelling inflation. But the government seems to believe it is not so. Their view is that higher price rise would also help to tame inflation by giving the consumer lesser money to consume. Their theory rests on the assumption that eventually decreasing the consumer expenditure would lead to lowering of aggregate demand and thus bringing down the prices in the market.
But it is almost always seen that when there is a rise in fuel prices it leads to direct impact on the supply side. The cost-push inflation leads the production cost to raise leading to eventual rise in the prices which again will be borne by the consumers. So, ideally the consumers will be affected on both fronts. Firstly, the direct impact due to rising of the gas and fuel. Secondly, indirectly as the producers partially transmits the burden on to them by including the rising prices in the final product. It has to be said that the government has taken adequate steps to protect the producers to some extent by reducing import and excise duties on certain important commodities because of which the government have to sustain heavy revenue losses. If this kind of subsidies are continued to be provided by the government then there is lesser scope of improving the government fiscal deficit.
One important concept that is required to be discussed right now is the policy lag. Now, whenever the RBI goes for any monetary policy there is a certain lag that thus exists from the day the policy has been announced and the time period when the policy actually starts to take effect on the economy. My argument is that if it was already expected from beforehand that the RBI is going to take contractionary steps then it might have already been incorporated into the prices even before the policy was allowed and thus the lag would cause further problems. On the other hand the unexpected rises in the prices of commodity prices like fuel will cause a direct impact on inflation fuelling it further. Eventually when the policy measures of the RBI would kick into the economy it might be so that inflation might have further increased. Thus, it will only cause the markets to settle back again at either higher than prices existing now or back to current prices, but will not do much to bring the inflation down. This is why the unexpected monetary policies were adopted by Fed chief Ben Bernanke during the period of recovery for the States. Unexpected changes in monetary policy actually have larger impact on inflation at this point in time for the country.
Again if the RBI’s objective is to tame inflation and long time price stability then the government needs to act very carefully. Their elusive want to reduce the fiscal deficit cannot be tamed as the inflation should be the higher priority. It is actually a viscous spiral. If you ask me, I would say fiscal deficit and inflation are actually inversely correlated. Therefore, to have policies to tackle both at the same time would lead to contradictory results. I would back my point of view by this example: If the government wants to reduce the fiscal deficit then they have to either continue with taxes on imports and customs on the commodities. The only way the deficit is going to come down is if the taxes are raised higher and positive revenues are generated. But the problem is by doing so again the prices would eventually be affected as the rise in the taxes will get translated into higher prices in the market for commodities. Another point to back my argument is even if the inflation is being caused due to supply constraints, is it justifiable for the government to burden the producers with further taxation?
Therefore it is not possible for two contradictory policies to coexist simultaneously. The counter argument is in the case of Brazil where at one hand the government development bank is providing huge amount of capital to the sectors and on the other hand raising the rates of lending to tame inflation. But in their case the story is different to certain extent because the private banks there are anyways not willing to take the risk to sponsor long term projects and the government is worried that this will translate into lack of progress of the economy. In our scenario this rule does not apply.
I believe there is a need for further stringent policy adaptation by the RBI to control inflation and thus further rate increases are to come in the near months. If the RBI does not come up with stringent unexpected rises in the repo and reverse repo rates then the inflation is sure to cross double digits within the coming six months.
Recently, the RBI has consistently been going for contractionary monitory policies by increasing the repo and the reverse repo rates which stands at 7.5% and 6.5% respectively. This policy is intended to draw out money from the economy helping it to cool down. How? That is simple: The rising rates mean the banks have lesser money to lend and thus money is lesser for investments leading to lesser money flow in the economy and thus lowering inflation.
While this is a long term approach to tame inflation the contradiction to this policy is the raising of fuel and LPG prices. Theoretically, this leads to rise in the costs and is expected to eventually raise the prices in the economy fuelling inflation. But the government seems to believe it is not so. Their view is that higher price rise would also help to tame inflation by giving the consumer lesser money to consume. Their theory rests on the assumption that eventually decreasing the consumer expenditure would lead to lowering of aggregate demand and thus bringing down the prices in the market.
But it is almost always seen that when there is a rise in fuel prices it leads to direct impact on the supply side. The cost-push inflation leads the production cost to raise leading to eventual rise in the prices which again will be borne by the consumers. So, ideally the consumers will be affected on both fronts. Firstly, the direct impact due to rising of the gas and fuel. Secondly, indirectly as the producers partially transmits the burden on to them by including the rising prices in the final product. It has to be said that the government has taken adequate steps to protect the producers to some extent by reducing import and excise duties on certain important commodities because of which the government have to sustain heavy revenue losses. If this kind of subsidies are continued to be provided by the government then there is lesser scope of improving the government fiscal deficit.
One important concept that is required to be discussed right now is the policy lag. Now, whenever the RBI goes for any monetary policy there is a certain lag that thus exists from the day the policy has been announced and the time period when the policy actually starts to take effect on the economy. My argument is that if it was already expected from beforehand that the RBI is going to take contractionary steps then it might have already been incorporated into the prices even before the policy was allowed and thus the lag would cause further problems. On the other hand the unexpected rises in the prices of commodity prices like fuel will cause a direct impact on inflation fuelling it further. Eventually when the policy measures of the RBI would kick into the economy it might be so that inflation might have further increased. Thus, it will only cause the markets to settle back again at either higher than prices existing now or back to current prices, but will not do much to bring the inflation down. This is why the unexpected monetary policies were adopted by Fed chief Ben Bernanke during the period of recovery for the States. Unexpected changes in monetary policy actually have larger impact on inflation at this point in time for the country.
Again if the RBI’s objective is to tame inflation and long time price stability then the government needs to act very carefully. Their elusive want to reduce the fiscal deficit cannot be tamed as the inflation should be the higher priority. It is actually a viscous spiral. If you ask me, I would say fiscal deficit and inflation are actually inversely correlated. Therefore, to have policies to tackle both at the same time would lead to contradictory results. I would back my point of view by this example: If the government wants to reduce the fiscal deficit then they have to either continue with taxes on imports and customs on the commodities. The only way the deficit is going to come down is if the taxes are raised higher and positive revenues are generated. But the problem is by doing so again the prices would eventually be affected as the rise in the taxes will get translated into higher prices in the market for commodities. Another point to back my argument is even if the inflation is being caused due to supply constraints, is it justifiable for the government to burden the producers with further taxation?
Therefore it is not possible for two contradictory policies to coexist simultaneously. The counter argument is in the case of Brazil where at one hand the government development bank is providing huge amount of capital to the sectors and on the other hand raising the rates of lending to tame inflation. But in their case the story is different to certain extent because the private banks there are anyways not willing to take the risk to sponsor long term projects and the government is worried that this will translate into lack of progress of the economy. In our scenario this rule does not apply.
I believe there is a need for further stringent policy adaptation by the RBI to control inflation and thus further rate increases are to come in the near months. If the RBI does not come up with stringent unexpected rises in the repo and reverse repo rates then the inflation is sure to cross double digits within the coming six months.
Saturday, June 11, 2011
PERFECT COMPETITION TO PUT IT SIMPLY
This article is my attempt to explain the characteristics and faults of a perfectly competitive market in terms of the dhabas that are set outside my college. Now, I am not talking about the dhabas that are selling chicken butter masala and shisha. I am only talking about the stalls selling maggi and alloo paratha !!!
I know that it might not exactly fit into the traditional economic analysis aspect as in practise a perfectly competitive market is really hard to exist. It is completely theoretical. But I could not help but notice that there exist certain striking similarities:
Homogeneous products – This characteristic of perfectly competition states that any market good or service do not vary across suppliers.
Well...All the dhabas are selling the same menu (more or less) consisting of pakoras, parathas, magi, cha, cigs.
Zero entry and exit barriers – There any no restrictions in terms of entering into the market. It is an important criterion that separates this market from imperfect forms of market.
Now, if this characteristic is taken into consideration it is true because any one of us can actually set up a dhaba by the side of the road with an initial capital investment of 12 grand. Get some “chotu” and “anna” to look after the shop, keep studying and reap a certain percentage of the income in the shop!!! Simple isn’t it?
Perfect information – All the buyers and sellers are assumed to have perfect information regarding the quality and the price of the product. This is actually the characteristics that make a perfectly competitive market to exist in real life scenario because in practise it is not possible to fulfil this criterion.
But just for the purpose of this analysis let us assume that we have been to all the dhabas and tasted their products and know exactly how each one tastes thus having a clear idea about the quality and the prices in each stall. Is that not what we do to know which one is our favourite stall?? So, maybe it is possible in our scenario to have these characteristics.
Firms are price takers – This is another very important characteristic of a perfectly competitive market. The firms operating in this market are not at liberty to set their prices but the prices are decided externally via interaction of market supply and demand. Google “perfect competition” graphs and whole set of images pop up. So, I have not put it in this article.
Actually, if you think about it for a moment, these dhabas are performing in such a competive market scenario. It is the demand for the aloo paratha and the fact that the other stall is charging twenty rupees for a paratha makes them price at the same price. If they charge higher in any case no one will come. If they charge lower the other firms will get into a price war simultaneously making all of them out of business. So this is the similarity aspect I was talking about.
On the other hand remember how I said that there is a homogeneity in terms of the products and services, that characteristics might fail. The aloo paratha at one place can taste better to us than the other. May be dhaba “A” paratha, even though has the same pricing as dhaba “B”, has that extra something from somewhere and has been cooked in just the right way to remind you of the paratha made at home for breakfast. Thus, it will make dhaba “A” to you more preferable than “B” even though same product is being sold. This is consumer preference and exactly why a perfectly competitive market fails. In the real world this is an important factor to consider.
So how can dhaba “ B” fight back??Dhaba “B” can identify certain customers that are have preference to their place and provide that extra incentive that other place does not which while give them the edge.
One thing to be remembered here is the moment the homogeneity of the services provided ceases to exist, perfect competition might not be there anymore, which is another important reason why it fails and remains as a mere comparison tool and benchmarking to other important imperfect markets. Unfair isn’t it? considering if there was a perfect market in existence then there will not the any exploitation at all, no greed, no “jhamelas” at all !!!
Fierce Competition – Another characteristic for perfect competition is that there is immense amount of competition that will exist clearly because there are no barriers to entry. I will explain with a simple example:
I actually have my favourite dhaba named “D” plainly because of the credit facility that they have allowed me to have. Now, the stall owner “X” gets a new fellow, let’s call him “Y” from his hometown to help him in his shop. As days went by “X” taught “Y” all the tricks of the trade that were required to run the dhaba. What happened next is extremely critical even in the modern world today.
“Y” after learning the tricks of the trade opens his own dhaba right next to the “D”. He not only provides me credit facility and occasional freebies but also provides me added service.
So the big question remains can a perfectly competitive environment prevail anywhere around the world without its flaws? The answer is no according to me. We might find a market that has certain characteristics of the perfectly competitive market but will not be so. This is plainly because as the global environment becomes more and more competitive it becomes important for all firms to differentiate their product or services, just to have that added competitive advantage. So, what does the dhaba example teaches us?
It is exactly as “Y” replied to the owner of the dhaba “D” ..... “IT IS JUST BUSINESS”.....
I laughed and thought what a “Crisp, short and cut throat” reply!!!!!!
I know that it might not exactly fit into the traditional economic analysis aspect as in practise a perfectly competitive market is really hard to exist. It is completely theoretical. But I could not help but notice that there exist certain striking similarities:
Homogeneous products – This characteristic of perfectly competition states that any market good or service do not vary across suppliers.
Well...All the dhabas are selling the same menu (more or less) consisting of pakoras, parathas, magi, cha, cigs.
Zero entry and exit barriers – There any no restrictions in terms of entering into the market. It is an important criterion that separates this market from imperfect forms of market.
Now, if this characteristic is taken into consideration it is true because any one of us can actually set up a dhaba by the side of the road with an initial capital investment of 12 grand. Get some “chotu” and “anna” to look after the shop, keep studying and reap a certain percentage of the income in the shop!!! Simple isn’t it?
Perfect information – All the buyers and sellers are assumed to have perfect information regarding the quality and the price of the product. This is actually the characteristics that make a perfectly competitive market to exist in real life scenario because in practise it is not possible to fulfil this criterion.
But just for the purpose of this analysis let us assume that we have been to all the dhabas and tasted their products and know exactly how each one tastes thus having a clear idea about the quality and the prices in each stall. Is that not what we do to know which one is our favourite stall?? So, maybe it is possible in our scenario to have these characteristics.
Firms are price takers – This is another very important characteristic of a perfectly competitive market. The firms operating in this market are not at liberty to set their prices but the prices are decided externally via interaction of market supply and demand. Google “perfect competition” graphs and whole set of images pop up. So, I have not put it in this article.
Actually, if you think about it for a moment, these dhabas are performing in such a competive market scenario. It is the demand for the aloo paratha and the fact that the other stall is charging twenty rupees for a paratha makes them price at the same price. If they charge higher in any case no one will come. If they charge lower the other firms will get into a price war simultaneously making all of them out of business. So this is the similarity aspect I was talking about.
On the other hand remember how I said that there is a homogeneity in terms of the products and services, that characteristics might fail. The aloo paratha at one place can taste better to us than the other. May be dhaba “A” paratha, even though has the same pricing as dhaba “B”, has that extra something from somewhere and has been cooked in just the right way to remind you of the paratha made at home for breakfast. Thus, it will make dhaba “A” to you more preferable than “B” even though same product is being sold. This is consumer preference and exactly why a perfectly competitive market fails. In the real world this is an important factor to consider.
So how can dhaba “ B” fight back??Dhaba “B” can identify certain customers that are have preference to their place and provide that extra incentive that other place does not which while give them the edge.
One thing to be remembered here is the moment the homogeneity of the services provided ceases to exist, perfect competition might not be there anymore, which is another important reason why it fails and remains as a mere comparison tool and benchmarking to other important imperfect markets. Unfair isn’t it? considering if there was a perfect market in existence then there will not the any exploitation at all, no greed, no “jhamelas” at all !!!
Fierce Competition – Another characteristic for perfect competition is that there is immense amount of competition that will exist clearly because there are no barriers to entry. I will explain with a simple example:
I actually have my favourite dhaba named “D” plainly because of the credit facility that they have allowed me to have. Now, the stall owner “X” gets a new fellow, let’s call him “Y” from his hometown to help him in his shop. As days went by “X” taught “Y” all the tricks of the trade that were required to run the dhaba. What happened next is extremely critical even in the modern world today.
“Y” after learning the tricks of the trade opens his own dhaba right next to the “D”. He not only provides me credit facility and occasional freebies but also provides me added service.
So the big question remains can a perfectly competitive environment prevail anywhere around the world without its flaws? The answer is no according to me. We might find a market that has certain characteristics of the perfectly competitive market but will not be so. This is plainly because as the global environment becomes more and more competitive it becomes important for all firms to differentiate their product or services, just to have that added competitive advantage. So, what does the dhaba example teaches us?
It is exactly as “Y” replied to the owner of the dhaba “D” ..... “IT IS JUST BUSINESS”.....
I laughed and thought what a “Crisp, short and cut throat” reply!!!!!!
Thursday, February 24, 2011
SHOULD CHINA APPRECIATE ITS’ CURRENCY?
China unlike India follows a fixed exchange rate system which means that it does not let its currency rate to be decided by the market forces. By keeping it fixed the central bank of China wants to have complete control on its’ currency much like everything else in their country. I think they just hate the concept of freedom! Starting from blocking their citizens to ‘Google’ certain sites to shooting dead families having more than one child, the Communist Party of People’s Republic of China hate to lose their control on anything. Why is USA bothered about this exchange rate policy of China? The answer to this is very simple. China is an export based economy with most of the goods being exported to United States. Thus, what happens is China keeps getting more and more US dollars. So, it should not come as a surprise to anyone when I tell you that China has the largest treasury or foreign reserve in the world which stands at around 3 trillion with Japan coming distant second with a little more than 1 trillion. As the Chinese Yuen does not appreciate their exports never become expensive thus they keep on accumulating USD without letting go anything. But this year the Chinese have a little bit of respite due to their import, export figures for the December period. The imports have shown stronger figures than the exports which have been lower than that was expected. Their current account though is at HUGE surplus still. One might say that the figures of December are nothing but a minor set back for the Chinese rolling capital account. It is enough for now to keep America off their backs for a while.
The advantage of having huge treasury is simple: You can buy out other countries! Well, if you don’t believe me then you should read the report where China and Japan have decided to buy out bonds from Spain and Portugal worth around 6 billion euros. The official report says that China and Japan actually want to show their support and faith in euro denominated countries and they have full faith in their economy. But here is the real truth: Ireland and Greece are sold out to World Bank and IMF
(which are nothing but US friendly bodies) and Spain and Portugal has been bought by China and Japan. You see where I am getting at? Well of course there is no proof of this fact just like there is no proof that Obama is in Pakistan
But people still believe 9/11 was caused by terrorists and President JFK was shot dead by Henry Oswald. (Please don’t kill me.)
So, if India wants to buy a country, they need to do the following:
i) Go for fixed exchange rate policy again
ii) Export more to States
So the truth is: CHINA WILL NOT APPRECIATE THEIR CURRENCY because if they do so then they might not have enough money to buy Africa. Oh!! I forgot it is an economic article!!
So, here is the ECONOMIC REASON why China will not appreciate their currency. As long as China is expert of producing cheapest goods they are going to dominate US consumer market. Why will someone want to let go of competitive advantage? If US is going to sit on large barrels of oil for themselves by invading Iraq then China has every right to sit on large bundles of USD, because guess what? They will later use that USD to buy oil from USA itself. Now, who do you think is smarter?
Chinese or Americans? Well, I have lived close to them for three years and believe me when I say that Chinese are the smartest ones !
The advantage of having huge treasury is simple: You can buy out other countries! Well, if you don’t believe me then you should read the report where China and Japan have decided to buy out bonds from Spain and Portugal worth around 6 billion euros. The official report says that China and Japan actually want to show their support and faith in euro denominated countries and they have full faith in their economy. But here is the real truth: Ireland and Greece are sold out to World Bank and IMF
(which are nothing but US friendly bodies) and Spain and Portugal has been bought by China and Japan. You see where I am getting at? Well of course there is no proof of this fact just like there is no proof that Obama is in Pakistan
But people still believe 9/11 was caused by terrorists and President JFK was shot dead by Henry Oswald. (Please don’t kill me.)
So, if India wants to buy a country, they need to do the following:
i) Go for fixed exchange rate policy again
ii) Export more to States
So the truth is: CHINA WILL NOT APPRECIATE THEIR CURRENCY because if they do so then they might not have enough money to buy Africa. Oh!! I forgot it is an economic article!!
So, here is the ECONOMIC REASON why China will not appreciate their currency. As long as China is expert of producing cheapest goods they are going to dominate US consumer market. Why will someone want to let go of competitive advantage? If US is going to sit on large barrels of oil for themselves by invading Iraq then China has every right to sit on large bundles of USD, because guess what? They will later use that USD to buy oil from USA itself. Now, who do you think is smarter?
Chinese or Americans? Well, I have lived close to them for three years and believe me when I say that Chinese are the smartest ones !
IS SENSEX A TICKING TIME BOMB Or IS IT JUST GOING THROUGH A RALLY?
Before this question can be answered it would be interesting to look into the fact as to why and how did the Indian BSE hit the 20,000 points mark so fast after stooping as low as 7000 during year end 2008. In that period Indian stock markets which were cruising in January ’08 around higher 20,000 came crashing down by end of December. It will be interesting to see why such a dip took place. Was it due to the fall of Lehman Brothers? Was it the credit crunch? Was it due to falling investor sentiments? Lehman Brothers which outstood the period of Great Depression during 1930’s in States fell in 2008 due to subprime crisis. So does this mean the subprime crisis effect was an even worse scenario than the Great Depression? Well, according to me, subprime crisis was even worse but the similarities between the scenarios are noteworthy1.
The key to understanding as to why the Indian markets are falling now will be realised if the period after the market crash in end 2008 is studied. During the period of 2009 the Indian government in accordance with the rest of the world decided to introduce stimulus package into the economy and reduced the key rates like repo and reverse repo rates. The package for India was more effective than the west due to a simple reason. Indian markets had much lesser exposure to the debt laden high risk mortgage like the west. Therefore, the recovery for the Indian markets was much faster pace than the west. The time lag related to policy implication got narrowed as well as the stimulus directly got transferred into the economy within 2 months of introduction. As it is well known that when there is an introduction of the stimulus package it gets translated into the autonomous component of the IS curve causing it to shift right and leading to an overall output increase. Now, if the IS curve is shifting it leads to higher interest rates which leads to a huge capital inflow. This is exactly what happened for India, huge amounts of FII’s came into the Indian stock markets.
This was primarily due to high investors’ confidence in Indian economy which was due to multiple reasons. Firstly, Indian growth rate continued to be robust at almost 8% during that period. Secondly, unlike the West, Indian domestic market was very sound with the PSU’s showing exceptional potential. Thirdly, the political condition was sound in the country as well. Huge amounts of money came into the market. The growth actually became so robust that due to inflationary pressures, the RBI had to intervene sooner than expected, as early as Jan 2010. The RBI actually said their focus had shifted from providing further recovery to containing the recovery.
Over the period of 2 years as large as 27 billion USD flowed into Indian markets through FII’s. Actually though everyone might think this is excellent news but this is not entirely true. It is not good for an economy in the long run if no control can be kept on the capital inflows into the economy. If by some reason along with robust capital inflows there is positive current account then the economy tend to get heated up too fast. Another reason is the huge capital inflows generally gets translated into the asset markets which could lead to asset bubble. But the most important problem is the stock exchange might not be showing a true picture i.e. to say as the shares gets bought the prices starts rising and the SENSEX sees green while the reality is all the money is invested by foreign investors.
The problem with this is as the money is drawn out, the market would go BOOM! This is exactly what the case is now!
Due to rising inflation in the country, scams one after the other is giving investors the jitters leaving them with no choice but to withdraw? The thing is as the inflation continues to rise the real interest rates continues to fall. So, investors fear lesser returns. Thus, when only 2.2 billion of the 27 billion FII’s gets drawn out over the period of two months the market falls from 20,000 to 17,000 points. So, only an 8% withdrawal of their money by the foreign investors has led the SENSEX to fall by almost 3000 points. Are you thinking what I am thinking? IMAGINE WITHDRAWL OF UPTO 10 BILLION MORE! BOOOOM!!! There goes SENSEX RED and bleeding.
Well, on the other hand, the scenario might not be so dramatic. Even though food inflation in the country is on a rampage, core inflation level is still stable. The only problem is with the scams that are taking place. But that is not much of a worry for the investors. The growth rate predictions which have been revised to show more than expected growth may draw investors back. The consumer demand in the country remains still very strong and if FII’s goes out there are still possibilities of large numbers of FDI’s to take place via mergers and acquisitions. The fact is as the Western Economy starts to recover the foreign investors want to place their funds in their local markets than abroad as the risks get much lowered with moderate returns. There seems chances are quite low of such huge amount of withdrawals taking place in the economy as the confidence of the investors still remain intact on Indian future. The deal between BP and Reliance shows the kind of potential that still exists in Indian markets. A 9.2 billion dollars deal by the petroleum giants is sure to give a boost and increase investor confidence in India. The deal clearly shows the opportunities that exist in the energy sector of the country. Hence, experts are only saying that the SENSEX is going through a rally and will recover very soon. If you are a rational investor then that is in fact great news for you!
So, you know what to do! Go there and START INVESTING
The key to understanding as to why the Indian markets are falling now will be realised if the period after the market crash in end 2008 is studied. During the period of 2009 the Indian government in accordance with the rest of the world decided to introduce stimulus package into the economy and reduced the key rates like repo and reverse repo rates. The package for India was more effective than the west due to a simple reason. Indian markets had much lesser exposure to the debt laden high risk mortgage like the west. Therefore, the recovery for the Indian markets was much faster pace than the west. The time lag related to policy implication got narrowed as well as the stimulus directly got transferred into the economy within 2 months of introduction. As it is well known that when there is an introduction of the stimulus package it gets translated into the autonomous component of the IS curve causing it to shift right and leading to an overall output increase. Now, if the IS curve is shifting it leads to higher interest rates which leads to a huge capital inflow. This is exactly what happened for India, huge amounts of FII’s came into the Indian stock markets.
This was primarily due to high investors’ confidence in Indian economy which was due to multiple reasons. Firstly, Indian growth rate continued to be robust at almost 8% during that period. Secondly, unlike the West, Indian domestic market was very sound with the PSU’s showing exceptional potential. Thirdly, the political condition was sound in the country as well. Huge amounts of money came into the market. The growth actually became so robust that due to inflationary pressures, the RBI had to intervene sooner than expected, as early as Jan 2010. The RBI actually said their focus had shifted from providing further recovery to containing the recovery.
Over the period of 2 years as large as 27 billion USD flowed into Indian markets through FII’s. Actually though everyone might think this is excellent news but this is not entirely true. It is not good for an economy in the long run if no control can be kept on the capital inflows into the economy. If by some reason along with robust capital inflows there is positive current account then the economy tend to get heated up too fast. Another reason is the huge capital inflows generally gets translated into the asset markets which could lead to asset bubble. But the most important problem is the stock exchange might not be showing a true picture i.e. to say as the shares gets bought the prices starts rising and the SENSEX sees green while the reality is all the money is invested by foreign investors.
The problem with this is as the money is drawn out, the market would go BOOM! This is exactly what the case is now!
Due to rising inflation in the country, scams one after the other is giving investors the jitters leaving them with no choice but to withdraw? The thing is as the inflation continues to rise the real interest rates continues to fall. So, investors fear lesser returns. Thus, when only 2.2 billion of the 27 billion FII’s gets drawn out over the period of two months the market falls from 20,000 to 17,000 points. So, only an 8% withdrawal of their money by the foreign investors has led the SENSEX to fall by almost 3000 points. Are you thinking what I am thinking? IMAGINE WITHDRAWL OF UPTO 10 BILLION MORE! BOOOOM!!! There goes SENSEX RED and bleeding.
Well, on the other hand, the scenario might not be so dramatic. Even though food inflation in the country is on a rampage, core inflation level is still stable. The only problem is with the scams that are taking place. But that is not much of a worry for the investors. The growth rate predictions which have been revised to show more than expected growth may draw investors back. The consumer demand in the country remains still very strong and if FII’s goes out there are still possibilities of large numbers of FDI’s to take place via mergers and acquisitions. The fact is as the Western Economy starts to recover the foreign investors want to place their funds in their local markets than abroad as the risks get much lowered with moderate returns. There seems chances are quite low of such huge amount of withdrawals taking place in the economy as the confidence of the investors still remain intact on Indian future. The deal between BP and Reliance shows the kind of potential that still exists in Indian markets. A 9.2 billion dollars deal by the petroleum giants is sure to give a boost and increase investor confidence in India. The deal clearly shows the opportunities that exist in the energy sector of the country. Hence, experts are only saying that the SENSEX is going through a rally and will recover very soon. If you are a rational investor then that is in fact great news for you!
So, you know what to do! Go there and START INVESTING
Thursday, February 10, 2011
Depreciation of currency : A Boon in disguise or An Evil ?
Before talking about depreciation of currency it is important to point out that there are two kinds of exchange rates that exist: A fixed exchange rate and a flexible Exchange Rate. For example: China follows a fixed exchange rate system while India
The main difference in the two systems is that in case of fixed exchange rate system (as the name suggests) the exchange rate of the currency is fixed and can be changed only by the government and not by the market forces. A government if it wishes then can either revalue or devalue its currency. But in the case of flexible exchange rate system the value of the currency is determined externally via the market forces i.e. by the demand and the supply of the currency in the market. Now it is here the concept of depreciation comes in.
A currency is said to depreciate when its value declines or falls against another currency i.e. when more of domestic currency is required to buy one unit of another foreign currency then the domestic currency is said to have depreciated against that foreign currency. For example: If the exchange rate of INR against USD yesterday hypothetically was 46.40/ 47.20 and today is 48.50/ 49.30 then the INR is said to have depreciated against the US dollars. Exact opposite to depreciation is the concept of appreciation where lesser units of domestic currencies are required to buy one unit of foreign currency. It is to be remembered always that it is not in the hand of a government to control the currency as such. Though there are ways to do so but for now let’s assume that it is only the market forces that decides when a currency should appreciate or depreciate. It is important to talk about depreciation or appreciation of a currency due to its implications.
The following implications that I am going to talk about is not immediate i.e. it is not that all this would happen on the same day when the currency depreciates. The implications are due to persistent fall of the currency over a period of time. Now let’s see what happens:
INR depreciates against USD à For people in US it is cheaper to buy INR goods à India’s export becomes competitive à Exports to US risesà Imports from US falls as it is expensive to buy goods from there àTrade Account improves à Net Exports rises àY (output) rises as Y = C + I + G + NX à increase in GDP
When the currency is cheap and interest rates are highà Investors willing to investà more FII’s and FDI’s à capital inflow à money supply increaseà LM curve shifts to the rightà output increases
Before I continue I will like to point out one reason why the currency might depreciate. But the big question is if this is the case that the external market forces are the reason for a currency to depreciate then that will mean that there is no control and the economy should continue to grow infinitely. But this is not the case as there exists automatic stabilizers in the economy. To explain this I would need to take help of the IS-BP-LM model or the Mundell-Fleming model for currency exchange in a floating exchange rate system. Let’s see how: (Of course as always there are lots of assumptions that I am making to simplify the model for understanding)
Let us say that initially we are at E1 with interest rate at iw and output at Y1. Now the government has introduced a new expansionary monetary policy for which the LM curve has shifted to the right from LM to LM1à equilibrium shifts to E*à interest rates fall to i*à there is huge capital outflow as investors see lower returns à this leads to lower demand for INR as the investors sell INR and convert currency to USDà lower demand for INR in the currency market leads INR to depreciate. This withdrawal of money from the economy also to certain extent helps to curb inflation.
MUNDELL – FLEMING MODEL
FALL IN DEMAND FOR INR (leading to depreciation)
This is one way how a currency may depreciate.
Now as seen above, the converse is also true as the currency starts to depreciateà exports become more competitiveà exports rises and imports fall à there is a change in NXà in case of IS curve the NX lies in the autonomous component of the equationà Y = m(A0 – br) where m = multiplier and A0 the autonomous componentà As the A0 increases it causes in Y which is larger due the presence of the multiplierà this is what is causing a larger increase in Y in the figure (Mundell- Fleming Model)àIS curve shifts thus from IS to IS1à equilibrium shifts from E* to E2 à Y increases from Y1 to Y2à increase in output and thus GDP.
The automatic stabilization that I was talking about before has been achieved through the rightward shift of the IS curve. The interest rates have been restored to the original level along with which the output has increased.
Therefore it may seem like that the ultimate benefits achieved from depreciation of a currency are larger for the economy as there is a rise in the output and lowering of inflation as well. So through depreciation two birds can been killed with one stone. But there is a big catch:
As we all remember: Money Supply = money multiplier * High Powered money i.e. Ms = mm * H
But this H has two components: one is domestic (Hd) and one is foreign (Hf) i.e. Ms= mm * (Hf + Hd)
The central bank can control the Hd component of the high powered money as it is domestic but the Hf component is not in their control and is determined primarily by the market forces. So, if the Hf component goes into a spiral then it would really hard for the central bank to control the money supply in the economy. A frequent fluctuation of the money supply in the economy can be disastrous as it may lead to hyperinflation. As the currency continues to depreciate for longer period of time the value of the domestic currency will fall which spells gloom for the economy. On the other hand as the currency persistently depreciates it will be much expensive for the country to import goods like crude oil which is primarily traded in USD. This would lead cost push inflation in the economy. It might happen that as inflation level raises unemployment level also starts rising. Thus the economy would fall into a stagflation scenario. Thus a country has to decide whether it is worth it to let the currency depreciate for a long period of time and enjoy short term benefits at the cost of long term doom. This is exactly why no country wishes to face this problem and does not deliberately depreciate their currency.
Monday, November 1, 2010
DECOUPLING ….IS IT TRUE? Or JUST A MYTH? DECOUPLiNG and GLOBALiZATION can they simultaneously exist?
Let me start my discussion with a simple statement that was there in The Economist. It goes like this:
“Many nasty words begin with the letter D: death, disease, depression, debt (when you drown in it) and deflation. “Decoupling”, on the other hand, has a nicer ring to it, even if it is the source of a great deal of controversy.” What is decoupling and why is it causing so much controversy? Well… Decoupling basically states that emerging economies in Asia and Europe have broadened to the point (backed by domestic demand) that they no longer depend on United States for their growth.
It all started with the financial crisis that hit the world recently. It was believed that as United States went in to recession the whole world will follow suite. It was thought that developing economies will be hit very badly and will take longer time to recover. This was more importantly thought so because of globalization. It is true that there is more global interdependence than ever before which was evident from the fall of BSE SENSEX which at the end of 2008 had lost 52% and had fallen 10,640 points. SENSEX which had hit record high of 21,206.77 on January 10 was at 9647.31 at the end of the year. On the other hand inflation was also on the higher side. At this point of time it was not thought of that India would even get a near close growth of 9% in which they were growing previously. But on the contrary Indian economy expected to grow at near 7 percent went on to grow at almost 8 percent backed by robust industrial growth and within 23 months again SENSEX hit record breaking heights. At one point of time even RBI commented that they were no longer worried about recovery but were worried about controlling the rate of recovery. Though Japan and some Asian countries hit recession along with US but India and China showed strong resilience. One main reason for this fact is the strong domestic demands in India and China. In US consumer spending is a big factor to their growth but with recession this fell big time. This is because the US consumers depend to a large extent on foreign goods available there. So a fall in exports was inevitable which eventually happened.
Exports to America stumbled while because of strong domestic demand in emerging economies it surged. One important factor to note is even though there is large dependence of emerging nations on US market there is also interdependence among countries in the Asian region. This is why during the period of US recession even though exports to US by China slowed drastically, exports to India, Brazil and Russia was up more than 60% and to oil exporters by 45%. Similarly, South Korea’s exports to US fell by 60% but overall exports rose by 20% during the period due to trade to other developing countries. Another important factor is that countries like India and China have large scope of infrastructural development. Because of this fact large amount of money could go into government spending in terms of building new roads, highways, housing and other infrastructure helping them to grow. Therefore, it is believed that indeed the emerging economies to certain extent have decoupled from the West.
But then what will explain the fall in the stock market? Though stock market is not a perfect economic indicator it does to certain extent explain one thing. Most of the investment in our country is through FDI’s and FII’s. Thus, a global downturn and bearish market would most definitely draw out most of the money from the market causing a sharp fall in the market. Thus this has let to a belief of a new concept: Coexistence of globalization and decoupling simultaneously.
This concept is natural to understand if the simple flow is understood:
Liberalization of emerging economies à globalization à interlinking of economies à interdependence of economiesà higher fund flows à helping faster growth for emerging economiesàfaster growth of emerging economies has led them to boost domestic income and savingà leading to development of higher domestic demand à eventually this has lead to higher consumer spending in domestic economies for developing countriesà thus making domestic economies self sustained à making them decoupled from the west.
The concept of decoupling has become ever clear in the present time when US is still battling low consumer spending, high unemployment rate with higher priority to make sure that their recovery does not falter, India is trying curb the effects of fast recovery. RBI at the moment is battling with three headed monster of interest rate, inflation and the currency.
Due to overheating of immense amount of foreign fund inflow the Indian currency has strengthened against the dollar causing the exports to take heavy toll.
On the other hand is the inflation. If RBI intervenes in the foreign exchange market to buy back dollar and purposefully devalue rupeesà more money in our marketsà rise in inflation
If the reverse repo rate (the rate which banks get to park their money with RBI) is increased à banks might put more money with RBIàless amount of money to loan out à corporate who are expected to take more funds due to strong growth will not be able to get loans à will not have enough funds to invest à lower growth for the country.
After all this discussion… is decoupling good or bad? Only time will tell. But one thing is for certain…WE ARE NO LONGER SLAVES OF THE WEST. There is definite shift of power taking place and INDIA is undoubtedly is a recurring force.
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