Tuesday, January 17, 2012



Who must manage Inflation?

Who must Manage Growth?

The Debate continues

There is a wide spread debate in India on Inflation and Growth.  In Europe, the discussion is more on bringing up sinking economies. Not merely the Industry, but Sovereign Governments are in deep problems there. In US, it is more a question of sustaining employment and  demand – since supply side is adequate. The Government in USA is robust and strong – though there are some differences between Congress and President right now. China stands on a different footing from all the rest. They have built up capacities in different Industry segments – and are ready to dump their products at ANY PRICE (almost) to capture foreign markets – Indian, US, Europe and so on. The countries where China dumps their products – have huge worries in sustaining their own Industries, employment etc.

Problems are therefore different in different corners of the Globe.

In India – we are seriously discussing Inflation and Growth. The most disturbing aspect of all our discussion is – we are only discussing – but doing almost NOTHING ELSE. If anything, we may be doing the opposite of what we are aiming for.

Inflation Management has become like RAIN MANAGEMENT. Do you manage RAINS? No. we take an umbrella, when rains come. We wait for rains. If they come, we do agriculture. We do water management. If rains are more, we suffer floods. If rains are less or Nil, we suffer draught. But, we do nothing for bringing in rains or stopping the rains, when we had enough of them. That is the RAIN MANAGEMENT we do. Which means, we don’t do RAIN MANAGEMENT. We do self management when rains come – a fight or flight response – not a management response.

It is more or less the same thing – with Inflation Management. Planning Commission, Finance Ministry and all other experts are telling us – that Food Inflation may come down in Dec, January etc, but may go up again from February or March and so on. But, nobody tells us – what they plan to do – to reduce the inflationary trends in food articles.

Manufactured Goods Index, the IIP, may have wild swings from Minus to Plus,  depending upon  CSO’s compiling ability, mostly, and to some extent, the statistics furnished to CSO by those in charge of that.

Everybody has started looking at IIP statistics with some amount of suspicion. Everybody- probably includes CSO as well. No one denies the difficulties in such compilation of statistics from across the whole of the country. But, when are we seriously planning to revamp our statistical methods? When is that going to happen – so that we can take the statistics more seriously – for planning and action purposes?

Not that we are not taking the IIP stats seriously.  For whatever they were worth, we went into deep gloom, when the IIP was Minus, and we have managed to come out of our gloom when the IIP stats turned PLUS. With all suspicions in our minds – we still use it at least for our mood swings.

We have Great software creators like TCS, Infosys etc – who are used increasingly by all other countries for improving their efficiencies – but, our governments are yet to take any such major decisions to improve their efficiencies. The one big decision taken – like Nandan Nilekani’s Adhaar – is now condemned and praised – alternatively, on each day.

But, IIP stats  are useful pointers, anyway. Capital Asset formation indicators are Negative for quite some time. This should be taken seriously. Future production depends on current capital asset formation.

If Capital Asset formation is not managed now – future production and Growth will suffer in a big way.

Why is capital asset formation not happening? There could be several reasons. At least one reason is – that the returns on capital are not commensurate with the Cost of capital – in India today. The Interest Rates in India are TOO HIGH, for encouraging capital formation.

Why are the Interest Rates High?

RBI wants to control the Inflation. Its Intention is laudable. But, it is like the old fable of the Donkey trying to bray and alert its master to the coming of the thief while the Dog is sour with the master and is unwilling to Bark.

The Dog that must tackle the Inflation thief in India at least – is the Government (State and Central) and not the RBI. And, the Governments are doing their best to stoke Inflation, by increasing the prices of all raw materials, oil, Gas etc – and infusing huge money into unproductive purposes. There is almost no Inflation management – planned by any Government.

Are we really looking at those products which are Inflation prone – and trying to manage their supply side? Are we moving against Hoarding? Are we creating capacities for  storage, transportation etc? Are we creating efficient marketing systems? Strangely, we are waiting for Walmart – to take care of these mundane aspects! We are talking - as if, Indians cannot do it and only Walmart can do it! Governments have to do INFLATION MANAGEMENT – especially in countries like India. There is no other way.

RBI can, in my humble opinion, encourage or discourage Growth – but cannot manage Inflation. Why so? There is a huge parallel economy running on corruption and Black money in India, which far exceeds any Bank funds. There is also the problem of counterfeit currency supply, possibly from our great neighbours, as periodically reported in media. There is also the Indian habit of keeping huge currency (and other liquid forms of wealth) outside Banks. Do we not know, for instance, that every land / real estate transaction has two aspects – a registration value, which is much, much lower than the market value at which the transaction takes place? Where does the difference between the two come from? It comes from this parallel economy.

General Inflation is a function of all these funds – but, in the market place, the real inflation happens mainly on account of two factors – demand for Product and supply of product. In real estate, movie Industry and a few others, black money plays a huge part. But, in market place, for onions, tomatoes, soaps, blankets etc – Black money is not in picture. What is in picture is demand for the product and supply of the same.

We must admit, that we must not stifle demand for these essential products. Already, as the prime minister himself has said, people are going hungry in large numbers – and the present demand for these products is actually LOW by decent human standards. We must encourage demand. Therefore, we must manage SUPPLY of these products much better. Supply of products starts from seed supply and fertilizer supply right up to marketing and placing of the products in the hands of ultimate consumers.

This, the Governments, both central and state, must be doing routinely. If they do these, they can manage Inflation, Health, productivity and other national wealth parameters. There will be no need for one third of people to go to Beds hungry.

These are not in the realm or jurisdiction of the RBI. But, classical Keynesian economics dictates that Inflation can be managed by constricting funds supply through Banks! This has many assumptions, many of which are not satisfied in India. This is the problem. RBI has raised Interest Rates, for controlling Inflation, 13 times in a span of one year. While RBI’s analysis is always admirable, the prescription for the malady is NOT. If Inflation went up, it was not DUE TO RBI. If it goes DOWN, it is also not DUE TO RBI. In Indian conditions, RBI cannot be blamed either for Inflation or for Inflation Management.

But, RBI can infuse a lot  into Growth. It can be a Great catalyst for Growth in Indian conditions.

Today, Return on Capital in most manufacturing Industries is not sufficient to go for Bank credit for expansion purposes because, credit from Indian Banks is available at very high Rate above the ROC. For working capital, there is no alternative. But for capital asset creation, many big companies are approaching Chinese banks, US Banks and even European Banks – where credit is available at much cheaper Rate.

Indian Banks cannot lend at those rates because our repo and reverse repo rates are themselves at a high level. Only Mid-sized and small sized Banks will have to approach Indian Banks for funds for capital creation. This again makes their products uncompetitive vis a vis the Chinese products etc. When we look at the Income statements of companies as they are trickling in, we find, the Interest expense has gone up hugely, and in some cases, it is responsible for turning the company’s profits into negligible or even negative numbers. The reduced profits result in reduced tax payments by them – and reduced revenues for the Government.

This in turn will result in deficit financing by Government – and stoke Inflation directly! Come March, we will know the extent of reduction in revenue numbers and the consequent Deficit financing. So, is RBI bringing down inflation or pushing up Inflation?

The Auto and Real estate sectors suffer a double whammy – the buyers have to pay huge Interest rates and so, some at least avoid buying homes / autos. Since the manufacturers and builders have to pay huge interest rates, they reduce manufacturing / building activity – and since they do take loans and manufacture / build, they do charge huge amounts for their final products, because of higher Cost of Capital. Auto companies and Real estate companies are both raising prices of their products right now. So, Inflation does not come down. But demand and production both do come down.

Government and Planning Commission are surprised that PSUs with huge cash balances are not investing in expansion. In their case also, only if the return on capital is more than the interest on their liquid funds parked with Banks, it makes sense for them to invest in expansion. If the rate of return on capital is less – where is the incentive for them to invest in expansion?

Compared to China, our rate of Industrial Growth is nothing to be pleased about. Not that funds are not available. Even the CRR of Banks, which is idle funds, is too high. A little reduction in that will release huge funds, which can expressly be channeled to fund ONLY GROWTH – and not consumption.

For funding expansion by private companies and PSUs, the primary condition that needs to be fulfilled is – we must ensure that rate of Return on capital is higher than Cost of Capital (or Interest rates charged by banks).While ROC is not in RBI’s hands, Cost of Capital is in its Hands. If RBI reduces Interest rates to the levels they were one year ago – RBI will be directly fuelling Growth. If CRR also is reduced with the express condition that the additional funds should go ONLY into production / Growth – and not for consumption, RBI will be aiding Growth in a much bigger way.

Industry and Government must seriously look at these aspects and impress on RBI to BAT FOR GROWTH – leaving Inflation to the Governments to manage.

It is not that Governments have no Role in Growth – their Role in Growth is primary. A huge amount of supportive legislation is overdue. Their taxation Policies can expressly fuel growth. But, in the immediate future, RBI can aid in the Growth process, by reducing Interest rates, by reducing CRR and by releasing additional funds only for Growth.

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