Inflation - A natural outcome of growth?

Economists would have us believe that a mild inflation is desirable for a growing economy? Is it?

As technology improves, the productivity goes up and the cost should come down. Do we not see this in electronic goods? Computers, as an example, are faster and better yet cheaper. Is that not a natural outcome of economic progress? If that is so, why are prices of most other goods continuously rising?

Where did the Electricity go?

I have always found it difficult to understand the IIP nos. Every month, i try to pour into the details of the nos to make sense out of them, yet i find it difficult to do so. One big example is simply the figures for Electricity. Broadly, the IIP is divided into three sectors, Mining, Manufacturing and Electricity. Now consider this..

Comparing August with June this year. Mining in August stood at 181.1 vs 181.3 in June, whereas Manufacturing in August stood at 313 vs 313.1. Both slightly lower as compared to two months earlier. Yet look at Electricity. It stands at 245.1 vs 234.4 in June, a good 4.5% jump. That should be good news but a question is where did this electricity go? If mining and manufacturing both were very slightly down, surely the 4.5% jump in Electricity should have eased the residential shortage. Did you notice fewer power cuts in August?

Now lets compare March with August. The figures for March were; Mining 209.8, Manufacturing 326.9. Both much higher than the figure for August. You bet Electricity must have been much higher than 245.1 in August! Did you bet? If you did, you have lost it. For Electricity in March was 241.3.

Ah! now, this is interesting. If with almost 1.5% less Electricity, we could mine and manufacture much more, it surely means that the much better performance in August on the Electricity front, must have meant much improved household supply (surely we needed less than 241.3 in August for the industrial production). If we did not notice much lower power cuts, then where did Electricity go? Any answers?

India's GDP $ 40 Trillion in year 2020?

Can you believe it? India's GDP will be $ 40 Trillion in the year 2020, that is 40 times what it is today!. You do not believe it? But that is what the stock market tells us.

From the lows of March 2009, Nifty has gone up by about 2500 points in about 6 and a half months (roughly 160 trading days). The rate is about 19 points per day. During the period 2003 to Sept 2007, in a period of four years, Nifty gained only about 3500 points at an average of 3.5 points a day. This was when there was no apparent problem with the economy and the GDP growth rate was touching 9%. Considering the rate at which stock market is growing, i.e. 16 points a day, which is about 4.5 times the rate of the previous bull run, it points to a 40% GDP growth rate. Over eleven years, this should translate into a GDP of $ 40 Trillion. WOW! And what about the market? At this rate of growth we shall see Sensex close to 2,00,000 by the year 2020..

Obviously, the above is most unlikely. This points to an absolutely irrational market today, which should see a correction sooner or later. We need to be patient.

Is it time for Nifty to correct?

Nifty touched new highs last week within touching distance of 4900. While many experts feel that the market upmove shall continue, I think it is time for a correction. Whether the correction shall be a steep one like the year 2008 or it would be a milder one which precedes the next bull run cannot be stated with confidence, but a correction nevertheless is due and should happen within the next few weeks if not the next few days.

The reason why I am so confident is that the markets have run up ahead of the fundamentals. A look at the fundamentals tells the following story.

Real Estate

At the peak of the market crash last year, real estate construction had come a virtual grinding halt. There was little or no construction activity in the period Sept. to Nov 2008. Since then construction has indeed picked up. But the activity is nowhere near what it was in the frenzied months of 2007 and the first half of 2008. Any Civil Engineer worth his salt will tell that the pace of construction is very slow and many projects would take much more time than what the builders claim. There are certain projects where not even a single worker can be seen. Yet, new projects are being launched at a frenzy that suggests that the construction activity was in full swing. However, I suspect that it is not so. In many cases, funds raised from the launch of new projects are likely to be diverted towards the completion of older projects. The new projects are most likely to take much longer than what the builders are promising. In some cases builders are promising to pay a small sum per month in case they are unable to complete the projects in time. A CA friend remarked that raising funds by launching new projects would perhaps be a cheaper than borrowing from banks and financial institutions. To say the least real estate remains in trouble as of yet.

Exports

Exports continue to fall year on year. The rate of fall is about 30% give or take a couple of percent. An improvement in the rate of fall by a percent or two here or there cannot be treated as green shoots. By this time, last year, the major world economies had already fallen sharply and imports were falling, which means Indian exports were already falling. A 28% odd reduction from there in exports cannot be said to be better than a 30% odd fall a couple of months earlier on the grounds that the rate of fall has fallen. Since the major economies of the world are still experiencing deflation, revival of exports is a long way off.

Agriculture

A deficient monsoon, especially in North India has already hit the Kharif crop. A 20% odd fall in the sowing of Kharif crops, is definitely going to hit rural economy and income. A late surge in monsoon in the last week of August and first week of September cannot compensate for the fall in sowing of Kharif crops as the sowing time is well past. At best it would help improve the yield of the standing crops and save a potentially disastrous Rabi season. With a fall in rural incomes, demand is bound to fall too.

Inflation

India calculates inflation using WPI. Besides the point that the basket of goods that represent WPI needs revision, a negative WPI only points to a poor demand for wholesale products vis-a-vis a year earlier. The WPI is now inching up back towards zero and prediction of RBI as well as other economists is that it shall reach 5% towards the end of the year or the end of the financial year. But what is of concern is the CPI. The CPI has been going up and is closing on to 12% (look at the chart below). If WPI goes up to 5%, what will happen to CPI? Could it go closer to 15% or 20%? Indeed the inflation faced by consumers is uncomfortably high already. A move to 15-20% could really impact demand. Not only this sooner or later RBI would be forced to tighten the monetary policy by raising interest rates to control the inflation. That would have a direct bearing on the businesses, real estate as well as markets.

CPI-Chart courtesy tradingeconomics.com (Click on chart for a larger view)

Fiscal Deficit

Fiscal deficit for the first four months stands at 1,55,000 cr. At this rate the fiscal deficit target should be comfortably burst. A deficient monsoon is likely to add to the woes. Part of the deficit could be covered by disinvestment, but disinvestment is not a solution towards managing deficits. Disinvestment should be part of liberalization policy only, though it would help cover deficits a bit. As anybody would know, selling fixed assets for the purpose of raising working capital is not a sign of a vibrant company, similarly selling assets (PSUs) for the purpose of covering deficits does not indicate a vibrant govt. financial condition. If indeed fiscal deficit breaches the target of about 4 Lakh crore for this fiscal, expect trouble. Rating agencies may downgrade India, govt. may have to raise taxes and of course markets may react negatively.

The graph below shows the rise in fiscal deficit in absolute terms. Economists argue that fiscal deficit should be seen as a ratio of the GDP to see whether it is a cause for alarm or not. As a percentage of GDP fiscal deficit is targeted at 6.8% for the year, which is likely to be breached. But this figure is only for the central govt. If state govt. deficits and off balance sheet items are added we are looking at around 11% of the GDP, which is high. The graph below shows the deficit in absolute terms. What needs to be noted is the sharp rise to about 4 times as earlier in the last year and a half after having been stable for about 6 years before that.In my view the absolute amount of fiscal deficit is equally important as it shows how much needs to be financed.

(Click on the chart for a larger view)

The above are some of the issues that seem to me as obvious reasons why markets should not go up from here. We seem overheated. It is time for a correction.

Fiscal Deficit - April-July 2009

The Period of April-July 2009 saw a fiscal deficit of Rs. 1.55 Lakh crores. This is about 39.5% of the target for the full year. At this rate we will comfortably burst the full year target. Considering the monsoon failure, it is more than likely we will indeed go past the target. However, there is a silver lining, though one should not react to one data point very quickly. The addition to fiscal deficit in July was about 0.31 Lakh crores. This does show that the deficit was controlled better in July. Why was it so? We need more data to be able to see how this happened and whether this is sustainable. The detailed data is yet to be released by the govt.

More details on release of detailed data

Fiscal Deficit - Now it is Pranabda who speaks

Pranabda has said that high fiscal deficit is unsustainable. Well, what does that mean? An end to further stimulus? If so, the govt. sponsored improvement in economy is likely to die out soon. Watch out for green shoots withering and turning brown.

Agriculture - An area of concern

India may be a long term growth story, but we do have our areas of concern. One such is agriculture. No, i am not going to write on the failure of monsoon, but what is evident if we do some data analysis.

India, with about 160 million hectares under agriculture has the second largest land under agriculture, just behind the United States. This area is larger than the area in Europe or the area in China devoted to this activity. So what is the problem?

Consider the following.
1. Agricultural growth in India has been much slower than our population growth in recent years.
2. Despite being the second largest producer of wheat and rice in the world, our productivity is way behind many countries.
3. With increasing industrialization and urbanization, the land under agriculture will reduce in the coming years.
4. Population in our country is likely to grow by about 30-40 crores in the next 40 years.
5. Population of the world may grow by about 150 crores in the world during the same period.
6. In view of 5 above, do not expect availability of much food through imports.
7. With better standards of living in the country, per capita consumption of food is bound to go up.

Should we worry? I think yes. If we do not improve our yields soon, we may see food problems in the years to come, monsoon or no monsoon.

Why great economies and nations fail?

History has shown us that nations and economies often fail, soon after they have become so strong that nothing seemed to come in their way. In recent history, the United Kingdom lost its position of the global leader as well as its empire in a matter of decades. Earlier, history is replete with stories about the decline of other empires, notably the Roman empire. Our own country, was perhaps the most important place in the entire world just a few centuries ago, a place of great learning, resources and wealth. By the time the British left in 1947, we stood almost 180 degrees away from our position a thousand years earlier. So what destroys great nations? What makes them so weak that others can steam roll them over?

The answer perhaps lies in the inability of a nation to recognize slow but definite changes in the environment. Failure to adjust to these changes and sometimes overconfidence in one's own abilities lead to a nation's downfall.

I am reminded of a story i heard at school. A frog thrown into boiling water would jump out quickly in order to save itself, but if a frog is put into cool water placed on a fire, it would not react. As the water heats up, the frog adjusts to it, never realizing that the water temperature is changing. By the time realization dawns on the frog, it is too late.

Are economies and nations like that? I think so. The Romans perhaps failed to foresee changes around them. That led to their downfall. Indians were busy amongst themselves, not realizing the growing power and the aspiration of the people in middle east. Later they, failed to see the changes in Europe and thus failed to ward off the British. The British themselves, at the pinnacle of their power, failed to see a changing world and lost their position by the time the Second World War ended. Now it seems, it is the time of the Americans? Would they be able to meet the challenges of a changing world in the future? I think not. History has a funny habit of repeating itself. My bet is that a few decades down the line, US shall no longer be the leading nation of the world.

Perhaps, it is time for India to rise again. Lets hope we do and become at least one of the leading nations of the world over the next few decades. Lets hope we take the bull by the horn and make use of all the opportunities. A few decades to enjoy prosperity and power, before history once again repeats itself.

Where does the money come from?

Keynesian economists conveniently ignore this question when they preach govt spending/stimulus to revive economies out of downturns. Now Warren Buffet has raised this question. Not necessarily always right (nobody can be always right), nevertheless, when Warren Buffet speaks, one must listen.

The link is
http://www.fortunewatch.com/warren-buffet-america-has-hit-the-panic-button/

We must also stop and take stock. Should India be on the path of high deficit? Mind you Krugman suggested just a few days back that in an interview suggested that the plan to balance the budget can wait till the next year. Do we want to follow his advise and reach a stage where somebody like Warren Buffet reminds us that things are no longer good?

Excerpt of Krugman's interview published in Economic Times dated 11th Aug 2009 is pasted below

What will be your advice to India as our budget balance is fairly scary, but the FM has said: I’ll worry about it later and play for the growth now?
I think that’s right. You do have to have a plan in place to restore a healthy budget but not this year. Not with the world economy still so fragile, not with so much excess capacity still out there.

Is Nifty headed for a crash?

I think so. The chart patterns do not look good. Economic scenario does not look good. Expect a substantial correction in the next month or two. Of course, the path down may not be a straight one.

IIP Growth in June 2009

The IIP index for the month of June 2009 stands at 290.2. This is an advance estimate subject to two revisions. When compared to last year, this amounts to a 7.8% jump, but compared to the previous month is a lesser 3.4% jump.

Yet, if this figure does not get revised seriously downwards and the index sustains and grows in the coming months, it does represent a possible positive for the economy. But as of now i remain a little skeptical. Lets examine why..

The figures for IIP for the last 15 months are given below. Note that figures are revised twice, so figures upto April 2009 are final. The figures of May and June are subject to revision.

A line chart followed by the detailed table are below:

(Click on the images to get a sharper view)

Note that the spike in March 2009 seems to be an outlier. In March 2009, electricity, mining and manufacturing all spiked up. Mining has clearly not sustained its spike after March. The interesting thing is that the advance figures for manufacturing in June 2009 show another spike but electricity dips. How is that possible? Does it mean that we have used less electricity for manufacturing more? Note mining has risen ever so slightly in June 2009. So what is the explanation?

I for one would wait to see if this "stupendous" performance repeats itself in the coming months. I would also wait to see if the figures for June 2009 get revised downwards (two revisions are forthcoming). Only then will i jump to conclusion that there has been an improvement in the IIP.

Baltic Dry Index - Does it tell a story

Baltic Dry Index indicates the price of moving raw material by sea. Note that a higher price indicates high demand for movement of raw material by sea and hence a higher level of economic activity around the globe.

The chart below is very insightful.

(click on the image to get a sharper view)

Note that the index started rising around 2002-03, a time when most of the economies around the world entered a boom phase. The index peaked in 2007 before falling sharply, indicating a contraction in economic activity post 2007. In recent months the index again rebounded. What was the cause for it? Apparently, the Chinese have been building reserves of coal and steel, using their huge forex reserves, just when the prices of commodities were low. Smart of them! Their action helped global economy too to a certain extent.

Note that in the past few weeks the index has fallen roughly 35%. Perhaps the Chinese have eased buying coal and steel. Does this mean that the world economies shall soon show another round of slump? While it would be too early to comment on that, i think this may be so. So expect the next quarter GDP figures to fall around the world, commodity prices to fall again and the stock markets to plunge once again.

Real Estate

The Times of India on date carries a huge supplement on real estate. I do not remember having seen anything like it before. I think it is a desperate bid to sell real estate. Does not look good to me. The real estate sector in India has some time to go before it can recover.

It also means that the Indian economy is not yet out of the woods.

Monetary Policy Review

Writing after a fairly long time.

The Monetary Policy Review released a couple of days ago by the RBI makes interesting reading. I will make no comments. The figures speak for themselves. Just go through all the tables. The link is

http://rbi.org.in/scripts/NotificationUser.aspx?Id=5190&Mode=0

Govt. spending - The multiplier effect

Just a passing thought on govt spending.

Modern Economic theories tells us that govt. spending has a multiplier effect. In other words, if govt. spends Rs 100/-, the GDP goes up by more than Rs. 100/-. Really?

If that were true, should not the socialist economies have been very rich?

Budget 2009-10

In my view the budget and the Economic survey can be summed up in two words.

POLES APART.

Negative Deposit Rates

Ever heard of a situation where you have to pay interest to a bank for keeping your money in a savings account rather than the bank pay you interest? The first time i heard such a thing was at IIM, Kozhikode, where my finance prof. (a goan), told us that in pre 1961 Goa, one had to pay interest to bank for their deposits.

Well, we have a more recent example in the modern world. Seems that the Swedes have decided to follow the pre liberated Goan (portugese) system. Their central bank has cut repo rate by 25 basis points bringing the deposit rate to a whopping MINUS 0.25%.

It would be interesting to see the consequences.

Economic Survey 2008-09

The Economic Survey 2008-09 have just been released. The highlights of the survey and some quick observations are

The Economic Survey 2008-09 presented to Parliament today by the Finance Minister Shri Pranab Mukherjee says, the speed at which the Indian economy returns to the high growth path in the short term depends on the revival of the economy, particularly the US economy and the Government’s capacity to push some critical policy reforms in the coming months.

The govt. says recovery of the Indian Economy does depend upon the recovery in US economy. That is living in the hope that others will do well in due course of time. What is US economy does not recover for years?

The Survey goes on to note that there are early signs of recovery in the global economy manifested in rising stock prices and increasing price of commodities.

Green shoots do not take time to turn brown.

It is however, debatable whether rising prices are an indication of green shoots of recovery or a result of position taken by financial investors seeking to benefit from global recovery expectations.

Very true. Take an adverse possibility into account rather than just be an optimist based on hope.

It says despite the slowdown in growth, investment remained relatively buoyant growing at a rate higher than at the rate of the GDP. The ratio of the fixed investment to GDP consequently increased to 32.2 per cent in 2008-09 from 31.6 per cent in 2007-08. This reflects the resilience of Indian enterprise, in the face of massive increase in global uncertainty and risk aversion and freezing of highly developed financial markets.

This needs to be examined in detail. Is it because of bouyant investments or because prior committments/projects necessiated that they be completed.

The Survey expresses concern over the existence of hunger and widespread malnutrition despite the country achieving self-sufficiency in food production and with mounting public food stocks at its command. It says it is time that various interventions at the State and Central level addressing these issues are reviewed and redesigned.

Mounting food stocks? They will not last if we do not take adequate steps to improve productivity in agriculture as well as water management. Agri growth falls short of population growth. Of course lop sided growth is an issue and hence poverty still exists. While tackling equality, the govt must not loose site of problems in agri sector or else ten years later we will be in deep trouble. Agri sector would not grow just by providing incentives and credit. What it needs is technology, water management and consolidation of land holdings.

According to the study FDI investments into India went up from US Dollar 25.1 billion in 2007 to US Dollar 46.5 billion in 2008, even as global flows decline from US Dollar 1.9 trillion to US Dollar 1.7 trillion during the period.

Higher FDI in 2008 is partly because of strong flows in first half of 2008, which came down to normal levels in second half. Remains to be seen whether, the trend would continue. Another issue is whether these figures come anywhere near say, China. A third issue is that a major portion of FDI is in service sector. While service sector is fine, a country of the size of ours should ideally be a manufacturing stronghold. These issues would need to be addressed.

While fiscal policy plays a dual role as a short-term counter-cyclical tool and an instrument to maintain microeconomic stability and promote growth in the medium term, the Economic Survey underlines the need to restore Centre’s fiscal deficit to the FRBM target of 3 per cent of GDP at the earliest. It says a number of factors will make it possible. They include reversal of much of the decline in business and corporate tax collections when growth accelerates from the second half of the year and the expected introduction of GST in 2010-11.

Good that there is a recognition that high fiscal deficit is unsustainable. But the control in deficit is linked to revival of economy. What about control on govt expenditure?

On the monetary policy front the Survey says that high deposit rates have now come in the way of cutting lending rates at a pace which is consistent with the current outlook on inflation and the need for stimulating investment demands.

Let the market set interest rates.

It says that as the low prices of oil has provided a temporary window for decontrol of petrol and diesel, this window must be utilised at the earliest.

Plan complete de-regulation. That will ensure that consumption of petroleum products moderates when prices increase, besides reducing the fiscal deficit. There is a catch though. High fuel prices would impact food prices and essentials, thus impacting the common man. Again a pointer towards why agri growth is a must and must have focus in the coming years.

The Economic Survey for 2008-09 says that the outlook for the trade sector in 2009 is not very encouraging with IMF projecting a negative growth in world output at -1.3 per cent and world trade volume projected to growth at -11 per cent.The subdued global outlook calls for efforts at both national and international levels to revive growth. While efforts to promote exports are needed, the Economic Survey emphasises the need to guard against protectionist measures originating from our trade partners. The Survey says, we also need to desist from any protectionist tendencies and proceed on the reform path.

True! Focus on productivity improvement and cost reduction and fight protection. no amount of stimulus will help in these conditions.

The Survey says, besides short-term relief measures and stimulus packages, some fundamental policy changes are needed. For the merchandise trade sector these include continuation of the reduction in customs and excise duty to make our exports and industry competitive, streamlining of existing export promotion schemes, giving special attention to export infrastructure alongwith rationalisation of port service charges, weeding out unnecessary customs duty exemptions and checking the proliferation of SEZs.

Agreed.

Overall, the economic survey seems to have pointed to the right issues. The only exception is the agricultural sector, which one would have thought was important enough to have seen a special mention.

Stocks - Distribution on?

Looks like a distribution pattern to me as far as the broader indices, Nifty and Sensex are concerned. Of course, there is another possibility that the markets hit new highs, but at the moment i would prefer to believe that we are in for a correction. Economic conditions do not support new highs.

Since markets can surpise the best investment decisions should be taken carefully after due study and not on the basis of recommendations.

Inflation figures negative!

Inflation figures are negative now. A first in the last 30 odd years. Time to do a detailed analysis.

Watch this space for a detailed analysis to follow soon.

Green Shoots Turning Brown

Big banks still not lending. Loan volume at the 21 largest recipients of government funding fell 7% during the month of April, according to a survey by the Treasury Department.

This is a headline from CNN Money. Surprised?

The Federal Reserve Bank of New York’s general economic index fell to minus 9.4 in June from minus 4.6 the previous month, while economists had expected the gauge to stay unchanged. Readings below zero for the index signal manufacturing is shrinking.

This one is from Bloomberg.

A little more time before all "Green Shoots" turn brown. There is no reason yet to believe that the US economy is recovering.

Warren Buffet on Diversification

"Diversification is a protection against ignorance. It makes very little sense for those who know what they are doing"

The above quote is by Warren Buffet.

IIP Growth in April 2009 1.4% over April 2008

The details of the IIP nos (from the press release of the govt) makes an interesting study.

A quick review tells us the following .

1. Eleven out of seventeen industry groups showed a positive growth. Seems good so far.

2. The industry group ‘Wood and Wood Products; Furniture and Fixtures’ have shown the highest growth of 31.4%, followed by 12.6% in ‘Wool, Silk and Man-made Fibre Textiles’ and 10.2% in ‘Non-Metallic Mineral Products ’. Furniture and Fixtures with the highest growth. Should that enthuse us?

3.On the other hand, the industry group ‘Food Products’ have shown a negative growth of 34.4% followed by 12.4% in ‘Leather and Leather & Fur Products‘ and 5.1% in ‘Other Manufacturing Industries’.

4. As per Use-based classification, the Sectoral growth rates in April 2009 over April 2008 are 4.6% in Basic goods, (-)1.3% in Capital goods and 7.1% in Intermediate goods. The Consumer durables and Consumer non-durables have recorded growth of 16.9% and (-)10.4% respectively, with the overall growth in Consumer goods being (-)4.7%.Negative growth in capital goods is a pointer to industry confidence. Growth in intermediate goods does not tell us story till it is clear for which products these intermediate goods are used. Growth in consumer durables may be seen as encouraging.

5. Alongwith the Quick Estimates of IIP for April 2009, the indices for March 2009 have undergone the first revision and those for January 2009 have undergone the second (final) revision in the light of the updated data received from the source agencies. (It may be noted that revised indices (first revision) in respect of February 2009 have already been released in May 2009 and these indices shall undergo final (second) revision in July 2009). This is the best part of it. So the final figures for April 2009, shall not be known till August 2009. How much would it differ from the quick estimates is anybody's guess.

Now for a comparison with the previous months.

1. The general index is at 270.1 for April 2009, down from 302.6 for March 2009. Of course, the figure for March 2009 will only be finalised next month, so its prudent to compare with earlier months.

2. The general index stood at 274.2 in Feb 2009 (higher than April 2009), 284.8 in Jan 2009 (higher than April 2009), 284 in Dec 2008 (higher than April 2009) and 267.6 in Nov 2008 (marginally lower than April 2009). In short, April 2009 figures indicate a contraction with respect to the previous quarter.

3. The index is lower in April 2009 as compared to May 2008 (274.6) too. So we may see negative nos in May 2009, until and unless there is real growth soon.

4. In the latter half of 2008, the index fell to 262.9 in Oct 2008. So in Oct 2009, expect positive growth in nos. even if there is stagnation.

We seem to be far away from economic recovery.