Today is Friday. But twenty years back it was Monday, October 19, 1987. The day when the Dow Jones Industrial Average (DJIA) witnessed a fall of 508 points or 22.6% - biggest percentage drop ever on a single day in Wall Street. It almost resembled the crash occurred on October 28, 1929, which set in Great Depression. The month of October is notoriously famous for crashes in stock indices.
The difference between these two crashes is that fortunately in 1987, the fall was arrested in the next few days though it took almost two years to regain its glory. There was no significant fallout on the long term investors.
The significance of the crash of 1929 lies in the fact it lead to economic depression followed by shifting of economic and financial power from Europe to the United Sates of America.
Similarly, in 1987, the crash had lead to transfer of economic power to Japan from the US. Reasons are not far to seek. Japan was producing more than its consumption, whereas US was consuming more than its production. Japan was amassing assets abroad whereas US was incurring debts on its assets. The US dollar was depreciating, albeit slowly. Japan assumed the role of banker, accepting deposits at lower rates, and lending at higher rates.
US companies were happy to borrow; indulged in leveraged buyouts, believing that companies would grow exponentially simply by constantly purchasing other companies. Investors were caught in a euphoria. The euphoria made people believe that market would always go up. When the crash took place, within one day $500 billion worth of wealth was evaporated from the Dow Jone index. Some individual investors started shooting their brokers and some committed suicide. The majority of the investors, who were selling, did not even know why they were selling. Everyone was selling so they sold their holdings. Of course, when they purchased these stocks, they did not know why they were doing it, except that everyone else was buying.
Half of the thirty stocks which constituted DJIA in 1987 are not only still retaining their place in the index but have enhanced the wealth of investors substantially. Procter & Gamble is approximately up by 1800% since October 19, 1987 with least returns coming from General Motors, which is up just by 82% (excluding dividends). Rest of the companies took leave from the markets on account their merger with other companies. Some had been replaced by new entrants like Microsoft, Intel, Walt Disney etc. This data clearly shows that long term investors have been fairly rewarded.
What happened in the last two days in the Indian stock markets is quite similar to the crashes described above. However, similarity begins and ends there. Here is a stock market trying to catch up with the economy, which is at ‘take off’ stage, with lot of potential for sustained economic growth in the coming years. How many working democratic countries are there today, that are growing at above 9% growth rates, inflation at decade low, strong currency, robust financial markets, growing tribe of entrepreneurs coupled with the need for building infrastructure requiring approximately $600 billion? Most of these figures are arrived at without taking into account the contribution from the unorganized sector, both in manufacture and services.
The fall in the stock markets occurred following the release of a draft paper by SEBI to make registration mandatory for foreign investors (mostly hedge funds), who are so far taking the easy way in the form of Participatory Notes. The effort by the SEBI is understandably a step in right direction. What is sought now is mere registration. SEBI being the securities market watchdog is entitled to know the credentials of market participants. ‘Know your participant’ is very much essential for the regulator to discharge its statutory function of regulation of securities market and protection of investors. Of late, large amount of foreign money is entering India in the form of P Notes. However, FIIs who are creating sub-accounts to issue these P Notes, do not have any details about their foreign clients. Two years back, when SEBI asked UBS for details of its clients, it was not able to furnish. It was then barred from investing in India. Section 20 of SEBI’s FII rules clearly says every FII shall, as and when required by SEBI or RBI, submit as the case may be, any information, record or documents in relation to its activities as required by the regulators.
For the orderly conduct of stock markets, safeguards must be put in place. The timing and quantum of safeguards are always open for debate. There is always scope for improvement of the system. Any number of suggestions can be made in this regard. Foreign portfolio investments are always welcome but not the kind of money, whose colour could not even be investigated by the regulator. What is welcome is white money. Neither black money nor terror money. In the short term, there may be fluctuations both in capital markets and forex markets. But SEBI’s latest initiative will go a long way in ensuring stability in the bourses.
Friday, October 19, 2007
Sunday, October 14, 2007
Mr Market
What a ride? It is time of records in the history of Indian stock markets. Records are being rewritten on a regular basis. Almost a journey of 1,000 points from the day’s low on Tuesday last. Mind-boggling feat indeed on a single day. In the process, it not only crossed 18K but appeared invincible to cross 19K too. For the last couple of days, the so-called pundits from the business channels have been shouting from the rooftops that markets might take a U turn going forward. Mr. Market gave no cognizance to their opinions.
Why this is happening? Is it possible to predict the movement of broad market indices simply on the basis of technical analysis or with aid of probability techniques or for that matter with that of quantitative methods.
No doubt, stock markets in the emerging markets like
The resurgence started with the Ben Bernanke’s Feb Reserve rate cut intended to avert subprime housing crisis in US. After that stock markets in the emerging markets stopped looking back. Funds flow continues. As if the phenomenon of globalization suddenly dawned, capital started to find new areas relentlessly. With the gradual integration of financial markets across the globe, financial capital moved around internationally. Being the the essential ingredient of production, it will seek to go where it is best rewarded.
Besides, there is one more factor that might be adding to the dollar flows. The recent surge in crude oil prices made several entities in the west
Front line stocks led by Reliance are the first beneficiaries. Their appreciation in prices fueled Sensex and Nifty to record new highs. I feel in the next round, second rung stocks will go up, though bellwether index may remain more or less at the current level. This is apparent taking into consideration the prices of blue chip stocks reaching their life time highs almost vertically; going forward, upside potential seems difficult unless major surprises surface.
Given the rosy economic fundamentals, Mr. Market will love to play the role of Santa during the current festive season. Notwithstanding our views on the market, it will continue to teach us how to value businesses in the changing scenario and think about market prices.
Monday, July 30, 2007
Body Retention
It is now almost six months Selvi joined as maid. She is smart, literate and punctual-five-days-a-week. Just last week returned from her summer holidays. She went to her hometown along with her hubby and two school going children. Unlike earlier maids, she has got one good quality. Though she works at 2-3 houses, she never tells us anything about other employers’ inside stories. There is a common trait in most of the maids. Even if you don’t like listening, maids tell you all the rubbish and they expect you to listen too. If you don’t, that is treated as an insult. In turn, they spread all the bad things about you. To cut the story short, maids do spread/leak out stories of your personal life. One has to factor this before employing one. Even if you put a condition that he/she should not do this/that, that is difficult to enforce/monitor. Don’t be under the impression that if you pay more, they remain loyal to you. That’s generally not done. If you like them, keep them; if you don’t, fire them. There are no binding contractual obligations on either one. Even if there is one, it rarely works.
Recently I came across a news article in Financial Express, which informs that one IT major, while giving increment to their employees, put a condition that they should not join specific rival companies after they resign their present jobs for a specified period. Given the high attrition rates across the corporate sector in general and IT and ITES sectors in particular, employers make all possible efforts to keep the talented flock within their fold. If needed, they put caveats in the job agreements, known as ‘non-compete’ clauses. For the unwary and uninformed employees, this clause acts as a proverbial hanging sword.
The validity of non-compete clause has come up for judicial scrutiny in a number of cases. In almost all the cases, the verdict is against the employer. The judicial rationale is that any action, which restrains trade, is void. The agreement of restraint is unfair, as they impose an undue restriction on the personal freedom of a contracting party. The famous Coca-Cola Vs Pepsi case in 2000 is a one such case.
Demand for the skilled is growing at a rapid speed, whereas the supply is not picking up at commensurate levels. Latest data shows that at the top three IT firms TCS, Infy and WIPRO, the attrition rates are varying between 13-16. That speaks of the seriousness of the issue from the point of view of IT firms. In financial services sector too, the entry level salaries have been skyrocketing owing to the shortage of skilled and experienced professionals. The situation in other sectors is not so terrible, but it is putting HR guys under tremendous pressure.
There are no hard and fast rules as far as retaining the skilled is concerned. Every firm has to adopt a strategy which suits it. More viable option will be to come out with an employee-specific HR policy instead of generic policy. Given the high quantity of personnel employed in an organization, such a policy requires larger resources. But this is the price one has to pay to retain the skilled. Inclusion of non-compete clause in the employment agreement is of no use, unless HR policies are structured to retain the skilled within the fold.
Recently I came across a news article in Financial Express, which informs that one IT major, while giving increment to their employees, put a condition that they should not join specific rival companies after they resign their present jobs for a specified period. Given the high attrition rates across the corporate sector in general and IT and ITES sectors in particular, employers make all possible efforts to keep the talented flock within their fold. If needed, they put caveats in the job agreements, known as ‘non-compete’ clauses. For the unwary and uninformed employees, this clause acts as a proverbial hanging sword.
The validity of non-compete clause has come up for judicial scrutiny in a number of cases. In almost all the cases, the verdict is against the employer. The judicial rationale is that any action, which restrains trade, is void. The agreement of restraint is unfair, as they impose an undue restriction on the personal freedom of a contracting party. The famous Coca-Cola Vs Pepsi case in 2000 is a one such case.
Demand for the skilled is growing at a rapid speed, whereas the supply is not picking up at commensurate levels. Latest data shows that at the top three IT firms TCS, Infy and WIPRO, the attrition rates are varying between 13-16. That speaks of the seriousness of the issue from the point of view of IT firms. In financial services sector too, the entry level salaries have been skyrocketing owing to the shortage of skilled and experienced professionals. The situation in other sectors is not so terrible, but it is putting HR guys under tremendous pressure.
There are no hard and fast rules as far as retaining the skilled is concerned. Every firm has to adopt a strategy which suits it. More viable option will be to come out with an employee-specific HR policy instead of generic policy. Given the high quantity of personnel employed in an organization, such a policy requires larger resources. But this is the price one has to pay to retain the skilled. Inclusion of non-compete clause in the employment agreement is of no use, unless HR policies are structured to retain the skilled within the fold.
Sunday, July 22, 2007
ICICI Bank
I have got special attachment with ICICI since my days in college. We were participating in a general quiz competition; one of the questions, which in fact made us win, was about the abbreviation of ICICI. In early 90s it was neither a bank nor a popular brand. Incorporated as Industrial Credit and Investment Corporation of India way back in 1955, at the instance of World Bank, Government of India and Indian industry, to work as a developmental financial institution, is now a private banking behemoth, showing phenomenal growth in the financial sector, whether it is banking, insurance, mutual funds, securities brokerage, venture capital funding etc
Why suddenly Sekhar started singing ICICI number? Generally, I don't have the habit of sleeping full day on Sunday. But this Sunday I made an exception. Slept till 5 in the evening and got up to read weekend news papers. HT does not give a bit of financial news on Sundays and Mint is a six-day pink paper. So I am left with only Indian Express, which very kindly gives thumbnails on business world. What caught my attention is the quarterly results of ICICI Bank. Recently I was allotted shares in its follow-on public offer. So in the capacity of a shareholder, I began reading between the lines also. I put down below some of my thoughts on it.
Salient features of the quarterly results are as follows:
Why suddenly Sekhar started singing ICICI number? Generally, I don't have the habit of sleeping full day on Sunday. But this Sunday I made an exception. Slept till 5 in the evening and got up to read weekend news papers. HT does not give a bit of financial news on Sundays and Mint is a six-day pink paper. So I am left with only Indian Express, which very kindly gives thumbnails on business world. What caught my attention is the quarterly results of ICICI Bank. Recently I was allotted shares in its follow-on public offer. So in the capacity of a shareholder, I began reading between the lines also. I put down below some of my thoughts on it.
Salient features of the quarterly results are as follows:
- operating profit increased 58% to Rs.1,524 to Rs.965
- profit after tax increased by 25 per cent to Rs.775 from Rs.620
- fee income up by 35% to Rs.1,428 from Rs.1,055
- Total advances increased by 35% to Rs.198,277($48.7 billion) to Rs.147,184($36.2 billion)
- Provisions gone up by 156% to Rs.552 from Rs.216, in line with the provisions made during FY07. This includes impact of the higher proportion of non-collateralized loans in the retail portfolio
The numbers are quite promising. In spite of growing in size, it is still able to maintain the sizzling growth momentum on quarter on quarter basis. When RBI hiked interest rates in the wake of high inflation, the general view was that banking sector would face tough time on credit front. Yes, it indeed slowed down the credit growth. The latest data shows that overall credit has shrunk by Rs.14,386 cores since April, against a rise of Rs.33,818 crores over the same period last year. However, ICICI Bank's overall advances showed no signs of weakness. A look at the results reveal that retail credit is up by 29%, whereas the overall advances increased by 35%. Given the consensus that RBI may not change the rates in its ensuing Credit Policy and the healthy credit growth rate, the Bank may be able to perform reasonably well in the near future. The worrying factor is the raising bad debts, on the retail front in particular. Adequate provisions are made, but then one has to pull up socks and control and contain before they blow out of proportion.
As far as valuation of the stock on the bourses is concerned, the closing price on Friday is at Rs.985.15, after touching intra-day high of Rs.1003. Its life time high is Rs.1009. This quarter, EPS is little above 8. Annualised EPS would be between 32-35. Price by Earning (PE) ratio then works out to be upwards 30. My view is that the share price is fairly valued. It will be unfair to expect 100 per cent returns, it delivered during last one year, in the short to medium term, unless additional information relating to growth in existing or emerging areas flows into markets, or markets go on frenzy in the wake of relentless inflow of foreign money into country's capital markets. Having said that, I would like to put a 'hold' on it with annual returns' expectation in the range of 20-30.
Tuesday, April 24, 2007
Fresh Mint
RBI Governor has announced Annual Policy Statement for the year 2007-08 around noon today. Allaying fears of the market, key rates have been left unchanged. The earlier CRR hike of 25 basis points to 6.25, announced on March 30, 2007, will come into effect on April 28, 2007.
A perusal of the Policy shows that the objective of RBI is to progress the war on inflation without hurting the growth momentum. This is significant keeping in view the recent past when RBI rushed ahead with stringent measures to tame inflation, least bothered about the overall growth.
It is stated that the aim is to bring down the inflation to 5 percent during 2007-08. Going forward, the resolve is to condition policy and perceptions for inflation in the range of 4.0-4.5 percent over the medium term. It is a welcome measure. The earlier tolerance band was set at 5.0-5.5.
M3 money expansion will be pegged at around 17.0-17.5 per cent, which is currently hovering above 20%. In order to achieve this target, RBI has adopted following measures for accelerating outflow of funds:
i. the overseas investment limit of Indian corporates is enhanced from the existing 200 per cent of net worth to 300 per cent of net worth
ii. the limit for portfolio investments abroad in listed overseas companies by listed Indian companies is enhanced from 25 per cent of net worth to 35 per cent of net worth
iii. Prepayment of external commercial borrowings (ECBs) allowed upto US $ 400 million as against the existing limit of US $ 300 million by authorized dealer banks
iv. Permitting remittances on account of donations by corporates for specified purposes, subject to 1 per cent of their foreign exchange earnings during the previous three financial years of US $ 100,000 whichever is lower.
v. Permitting Indian companies to remit up to US $ 10 million as against the current limit of US $ 1 million for consultancy services for executing infrastructure projects
vi. the aggregate ceiling on overseas investment by mutual funds to be increased from US $ 3 billion to US $ 4 billion.
vii. remittance limit of US $ 50,000 to be enhanced to US $ 100,000 per financial year for any permitted current/capital account transaction or a combination of both by individuals.
How much bearing these measures will have on reducing the domestic availability of funds is a million dollar question. The measures at (i), (iii) & (vi) may, to some extent, aid the RBI’s initiative. Ceiling on the rate of interest payable on Foreign Currency Non Resident (FCNR) accounts have been reduced by 50 basis points. This is a bad news to NRIs, who have been taking advantage of the higher interest rates on their FCNR accounts. Inflow of funds may reduce a tad.
Notwithstanding, the larger picture emerging is that RBI has been preparing the stage for full float of rupee, albeit gradually.
Commercial banks can now heave a sigh of relief. Risk weight on domestic housing loans to individuals for loans upto Rs.20 lakhs has been reduced to 50 per cent from 75 per cent as a temporary measure, allowing flexibility to banks to extend loans to retail housing sector, with reduced provisions.
Non Banking Financial Companies (NBFCs) now onwards can pay upto 12.5 per cent interest on deposits.
Overall, it is a growth-oriented Credit Policy. Pragmatism is writ large across the fine print. Globally, financial risks have increased on account of various reasons including the behaviour of oil prices, adverse development in the US housing market and large leveraged positions in the financial markets. The scope and role of central bankers, particularly in the emerging markets, is increasingly coming under threats in the wake of global funds relentlessly chasing assets in the rapidly developing markets.
Cheers to Reddy Saheb for coming out with a feel-good Credit Policy in the midst of inflationary pressures
A perusal of the Policy shows that the objective of RBI is to progress the war on inflation without hurting the growth momentum. This is significant keeping in view the recent past when RBI rushed ahead with stringent measures to tame inflation, least bothered about the overall growth.
It is stated that the aim is to bring down the inflation to 5 percent during 2007-08. Going forward, the resolve is to condition policy and perceptions for inflation in the range of 4.0-4.5 percent over the medium term. It is a welcome measure. The earlier tolerance band was set at 5.0-5.5.
M3 money expansion will be pegged at around 17.0-17.5 per cent, which is currently hovering above 20%. In order to achieve this target, RBI has adopted following measures for accelerating outflow of funds:
i. the overseas investment limit of Indian corporates is enhanced from the existing 200 per cent of net worth to 300 per cent of net worth
ii. the limit for portfolio investments abroad in listed overseas companies by listed Indian companies is enhanced from 25 per cent of net worth to 35 per cent of net worth
iii. Prepayment of external commercial borrowings (ECBs) allowed upto US $ 400 million as against the existing limit of US $ 300 million by authorized dealer banks
iv. Permitting remittances on account of donations by corporates for specified purposes, subject to 1 per cent of their foreign exchange earnings during the previous three financial years of US $ 100,000 whichever is lower.
v. Permitting Indian companies to remit up to US $ 10 million as against the current limit of US $ 1 million for consultancy services for executing infrastructure projects
vi. the aggregate ceiling on overseas investment by mutual funds to be increased from US $ 3 billion to US $ 4 billion.
vii. remittance limit of US $ 50,000 to be enhanced to US $ 100,000 per financial year for any permitted current/capital account transaction or a combination of both by individuals.
How much bearing these measures will have on reducing the domestic availability of funds is a million dollar question. The measures at (i), (iii) & (vi) may, to some extent, aid the RBI’s initiative. Ceiling on the rate of interest payable on Foreign Currency Non Resident (FCNR) accounts have been reduced by 50 basis points. This is a bad news to NRIs, who have been taking advantage of the higher interest rates on their FCNR accounts. Inflow of funds may reduce a tad.
Notwithstanding, the larger picture emerging is that RBI has been preparing the stage for full float of rupee, albeit gradually.
Commercial banks can now heave a sigh of relief. Risk weight on domestic housing loans to individuals for loans upto Rs.20 lakhs has been reduced to 50 per cent from 75 per cent as a temporary measure, allowing flexibility to banks to extend loans to retail housing sector, with reduced provisions.
Non Banking Financial Companies (NBFCs) now onwards can pay upto 12.5 per cent interest on deposits.
Overall, it is a growth-oriented Credit Policy. Pragmatism is writ large across the fine print. Globally, financial risks have increased on account of various reasons including the behaviour of oil prices, adverse development in the US housing market and large leveraged positions in the financial markets. The scope and role of central bankers, particularly in the emerging markets, is increasingly coming under threats in the wake of global funds relentlessly chasing assets in the rapidly developing markets.
Cheers to Reddy Saheb for coming out with a feel-good Credit Policy in the midst of inflationary pressures
Saturday, April 14, 2007
Bellwether
Much awaited numbers of Infosys Technologies Limited (Infy) are announced this morning. Beating the bearish sentiments of the street, which has been expecting a slowdown in the prospects in the wake of appreciating rupee, Infy has come out with stupendous performance, lifting the markets by nearly 170 points (at the time of writing this piece). Infy is up by 4 percent.
Income for the year ending March 31, 2007 was up by 46% to Rs13,893/- crores and net profit (after tax) was Rs.3850 crores showing a growth rate of 56.6%. Annualised EPS was up by 53% to Rs.69.11 from previous year’s Rs.45.03. The Board recommended a final dividend of 130%.
It has in fact become a custom for the company to come out strong figures quarter after quarter. The results have even beaten its own guidance by a big margin.
The company forecasts conservative growth for the immediate quarter and for the whole of financial year. It indicates in its guidance that income will grow at 29.2% – 29.8% and EPS will grow at 24.2.%. Lower estimates are understandable on account of premature withdrawal of tax holiday to IT companies and the imposition of MAT and the rising rupee.
Despite these, I am upbeat about the actual performance of Infy. It will be higher than the forecasts on account of various factors stated in its press release. Acquisition of 34 new clients, prized one being European aerospace giant (guess it is EADS); Infosys BPO continued its growth momentum and has been strengthening its operations by entering into lucrative markets and sectors. It was recently ranked fourth globally in the first ever FAO (Finance and Accounting Outsourcing) worldwide ranking of service providers. One of the world’s largest media and entertainment conglomerates has reportedly signed up for providing a range of services across the media process outsourcing spectrum. Infosys Consulting Inc. has been well positioning in the highly competitive business of consulting and has been fairly successfully in transforming the business of its clients winning the trust in the process; is likely to join the big four very soon.
Though share price-wise, it may not do wonders in the short term, it promises to deliver fair returns in the medium to long term horizon. A look at the balance sheet shows that reserves and surplus of Rs.10,876 crores, whereas share capital stands at Rs.286 cores. Infy may reward its shareholders with a bonus issue in the near future.
Income for the year ending March 31, 2007 was up by 46% to Rs13,893/- crores and net profit (after tax) was Rs.3850 crores showing a growth rate of 56.6%. Annualised EPS was up by 53% to Rs.69.11 from previous year’s Rs.45.03. The Board recommended a final dividend of 130%.
It has in fact become a custom for the company to come out strong figures quarter after quarter. The results have even beaten its own guidance by a big margin.
The company forecasts conservative growth for the immediate quarter and for the whole of financial year. It indicates in its guidance that income will grow at 29.2% – 29.8% and EPS will grow at 24.2.%. Lower estimates are understandable on account of premature withdrawal of tax holiday to IT companies and the imposition of MAT and the rising rupee.
Despite these, I am upbeat about the actual performance of Infy. It will be higher than the forecasts on account of various factors stated in its press release. Acquisition of 34 new clients, prized one being European aerospace giant (guess it is EADS); Infosys BPO continued its growth momentum and has been strengthening its operations by entering into lucrative markets and sectors. It was recently ranked fourth globally in the first ever FAO (Finance and Accounting Outsourcing) worldwide ranking of service providers. One of the world’s largest media and entertainment conglomerates has reportedly signed up for providing a range of services across the media process outsourcing spectrum. Infosys Consulting Inc. has been well positioning in the highly competitive business of consulting and has been fairly successfully in transforming the business of its clients winning the trust in the process; is likely to join the big four very soon.
Though share price-wise, it may not do wonders in the short term, it promises to deliver fair returns in the medium to long term horizon. A look at the balance sheet shows that reserves and surplus of Rs.10,876 crores, whereas share capital stands at Rs.286 cores. Infy may reward its shareholders with a bonus issue in the near future.
Thursday, April 12, 2007
Frostbite
When I returned from Sunday evening walk, Venky was commenting ‘you are back dear so early; need to toil a lot if you want to cut down your flesh’. Yeah he is right. If one is serious to get back to usual size, one needs to work out more seriously, but not so seriously that limbs develop cramps. Only last month I embarked on weight reduction program, after my body turned bulging. Till a few summers back, I was a regular freak at the Sanjay Gandhi Park jogging either in the morning or evening; time permits. But with increasing official and personal commitments, I slowly veered away from my regular. The result is protruding belly.
Similar is the problem with Indian economy. After struggling with Hindu rate of growth for nearly four and a half decades, with the advent of liberalization and globalization, economy had finally taken off well and had become a darling in the emerging markets. When the party is going on well, comes devil in the form of inflation. You might say this is a known devil. The point is why we have not put the lid. The problem with mortals particularly we Indians is that we don’t take anything seriously until and unless it threatens seriously.
The reasons for galloping inflation are said to be raising food and commodity prices, acceleration in credit growth and M3 money. The focus of this article is only on monetary aspects, leaving supply side constraints for discussions on some other day. Till November last, inflation was not on our radar at all because of the solace derived from the fact that it had been hovering within RBI’s tolerance band 5-5.5. We raised alarm only when it shot up by 100 basis points. Ruling party’s rout at the hustings in Punjab and Uttarakhand is attributed to high inflation. The role historically played by anti incumbency factor had been forgotten this time. A look at the past twenty years’ state election results show that voters cutting across regions rejected the incumbent party. Exceptions are left wing’s rule in West Bengal, Digvijay Singh’s return to power in 1998, Chandra Babu’s nine years innings during 1995-2004 and Delhi’s Shiela Dixit government for the last eight years. However, this time most of the analysts had conveniently chosen inflation as the culprit for ruling party’s defeat. No doubt, inflation like indirect taxes hits aam admi heavily, owing to its regressive nature. But to squarely blame the State Governments for macro economic nuances is a bit unfair.
RBI has already raised panic buttons. It is under tremendous pressure to bring the inflation back to the prescribed threshold limits. But the moot question is why RBI is rushing to crush inflation by applying ‘air brakes’; steeply raising interest rates and Cash Reserve Ration (CRR), whereas our law makers recently empowered it to reduce CRR. Does not it suck much liquidity and starve a shining economy in the process? Visible signs are already there to witness across the spectrum of economic activities. The hardening interest rate regime in the meanwhile has fully become functional and taking its toll heavily on retails borrowers, who are feeling the heat by forking out fat EMIs month after month. The fear of defaults may force banks to reduce their exposure to housing and retail sector.
See, I can cut down my belly either by cutting diet (like Adnan Sami) or by arresting myself for four hours a day in a nearby gym. Would you recommend such a course of action? Anyone with average intelligence and basic common sense would suggest that a judicious mix of both, applied steadily over a period of time, would yield the desired outcome without any collateral damage. This is precisely the point RBI missed this time. Rising repo rate coupled with hiking CRR expectedly cripples the credit growth. The classical economic theory supports such a course aimed at bringing down the demand for goods, which eventually weaken prices and thus inflation. But the context has changed. Globalization had ushered in open markets. Big and not so big corporates have been resorting to external commercial borrowings, available at much cheaper rates. (Hope, ceiling on ECBs now at $500 million is not brought down as part of war against inflation), Adding to the problem of money supply is the inflow of foreign funds, which have been chasing rapidly progressing markets like India. The unintended consequence of the whole process thankfully is the restricted role of central bankers. The leeway available to central bankers is fast receding.
One of the principal jobs of central bankers is to keep money supply growth in line with the real GDP growth. Real GDP remained at 5.2 during 1990/91-2002/03, went up to 8.1 during 2003/04-2004/05 and then to 8.3 during 2005/06, and current year estimates for fiscal 2006-07 vary from 9.2. to 9.6; whereas the money supply growth at nearly 20% has been far ahead of 15.5 per cent target set by RBI itself. They say ‘trend is your friend’. In this case, the trend is clearly on the wall. The widening gap between the GDP and money supply is telling for the last few years. But attention was not given to address this issue appropriately. The inescapable conclusion is that the system either failed to catch the evolving trend much earlier than it becomes reality OR became ineffective to treat the symptoms.
Furthermore, the RBI is hell-bent on holding the appreciating rupee for the sake of safeguarding exports, particularly IT and IT enabled services, in the process purchasing foreign exchange and pumping rupees in the local market. Was it not aiding inflation to accelerate? There lies the quandary. Why don’t you allow appreciation of the rupee, at least temporarily if you are so serious about taming inflation? Our goods and services anyway have saleability in the international market on account of comparative advantage. Mind you, appreciating rupee has its benefits. Imports become cheaper. Secondly, non-intervention by RBI in rupee’s upward and downward movement against greenback, at least temporarily, constricts the money supply, which will soften inflationary pressures.
Economy is no doubt heating up. If the intension is to slow down the pace of growth, sprinkle water but don’t pour water. It takes not months but years to even warm it up again.
Similar is the problem with Indian economy. After struggling with Hindu rate of growth for nearly four and a half decades, with the advent of liberalization and globalization, economy had finally taken off well and had become a darling in the emerging markets. When the party is going on well, comes devil in the form of inflation. You might say this is a known devil. The point is why we have not put the lid. The problem with mortals particularly we Indians is that we don’t take anything seriously until and unless it threatens seriously.
The reasons for galloping inflation are said to be raising food and commodity prices, acceleration in credit growth and M3 money. The focus of this article is only on monetary aspects, leaving supply side constraints for discussions on some other day. Till November last, inflation was not on our radar at all because of the solace derived from the fact that it had been hovering within RBI’s tolerance band 5-5.5. We raised alarm only when it shot up by 100 basis points. Ruling party’s rout at the hustings in Punjab and Uttarakhand is attributed to high inflation. The role historically played by anti incumbency factor had been forgotten this time. A look at the past twenty years’ state election results show that voters cutting across regions rejected the incumbent party. Exceptions are left wing’s rule in West Bengal, Digvijay Singh’s return to power in 1998, Chandra Babu’s nine years innings during 1995-2004 and Delhi’s Shiela Dixit government for the last eight years. However, this time most of the analysts had conveniently chosen inflation as the culprit for ruling party’s defeat. No doubt, inflation like indirect taxes hits aam admi heavily, owing to its regressive nature. But to squarely blame the State Governments for macro economic nuances is a bit unfair.
RBI has already raised panic buttons. It is under tremendous pressure to bring the inflation back to the prescribed threshold limits. But the moot question is why RBI is rushing to crush inflation by applying ‘air brakes’; steeply raising interest rates and Cash Reserve Ration (CRR), whereas our law makers recently empowered it to reduce CRR. Does not it suck much liquidity and starve a shining economy in the process? Visible signs are already there to witness across the spectrum of economic activities. The hardening interest rate regime in the meanwhile has fully become functional and taking its toll heavily on retails borrowers, who are feeling the heat by forking out fat EMIs month after month. The fear of defaults may force banks to reduce their exposure to housing and retail sector.
See, I can cut down my belly either by cutting diet (like Adnan Sami) or by arresting myself for four hours a day in a nearby gym. Would you recommend such a course of action? Anyone with average intelligence and basic common sense would suggest that a judicious mix of both, applied steadily over a period of time, would yield the desired outcome without any collateral damage. This is precisely the point RBI missed this time. Rising repo rate coupled with hiking CRR expectedly cripples the credit growth. The classical economic theory supports such a course aimed at bringing down the demand for goods, which eventually weaken prices and thus inflation. But the context has changed. Globalization had ushered in open markets. Big and not so big corporates have been resorting to external commercial borrowings, available at much cheaper rates. (Hope, ceiling on ECBs now at $500 million is not brought down as part of war against inflation), Adding to the problem of money supply is the inflow of foreign funds, which have been chasing rapidly progressing markets like India. The unintended consequence of the whole process thankfully is the restricted role of central bankers. The leeway available to central bankers is fast receding.
One of the principal jobs of central bankers is to keep money supply growth in line with the real GDP growth. Real GDP remained at 5.2 during 1990/91-2002/03, went up to 8.1 during 2003/04-2004/05 and then to 8.3 during 2005/06, and current year estimates for fiscal 2006-07 vary from 9.2. to 9.6; whereas the money supply growth at nearly 20% has been far ahead of 15.5 per cent target set by RBI itself. They say ‘trend is your friend’. In this case, the trend is clearly on the wall. The widening gap between the GDP and money supply is telling for the last few years. But attention was not given to address this issue appropriately. The inescapable conclusion is that the system either failed to catch the evolving trend much earlier than it becomes reality OR became ineffective to treat the symptoms.
Furthermore, the RBI is hell-bent on holding the appreciating rupee for the sake of safeguarding exports, particularly IT and IT enabled services, in the process purchasing foreign exchange and pumping rupees in the local market. Was it not aiding inflation to accelerate? There lies the quandary. Why don’t you allow appreciation of the rupee, at least temporarily if you are so serious about taming inflation? Our goods and services anyway have saleability in the international market on account of comparative advantage. Mind you, appreciating rupee has its benefits. Imports become cheaper. Secondly, non-intervention by RBI in rupee’s upward and downward movement against greenback, at least temporarily, constricts the money supply, which will soften inflationary pressures.
Economy is no doubt heating up. If the intension is to slow down the pace of growth, sprinkle water but don’t pour water. It takes not months but years to even warm it up again.
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