Beware of Mid September blues

Rajan Effect : Sensex soars 400 Points on Thursday

Dr.Rajan welcome to the Governor’s post of the central bank(RBI). You have a challenging job ahead. The reasons are Federal reserve might be tightening its money supply. The details of it is discussed below.

 If you look at the quantitative easing(QE) the Federal Reserve has undertaken, it runs to trillions of dollars. This was undertaken to kickstart a dull economy(USA primarily) from 2008. Now that the economy is showing signs of reviving it is likely to cut the QE.

http://en.wikipedia.org/wiki/Quantitative_easing

The first recall of the easy money will spook the markets in a jiffy. I might seem very pessimistic but when the first tranche of QE is recalled every developing market will catch a cold, when the Fed sneezes. More importantly a first sign of Fed indicating reversing the money flow has had catastrophic effect on the emerging economies. Just imagine the effect when it will actually turns it off.

http://www.moneycontrol.com/news/rupee/dr-rajan-try-convincing-us-that-rupee-is-worth-holding_945311.html#toptag

Dr.Rajan,  RBI Governor feels rupee can be defended. Agreed but if you take into consideration the enormity of the Fed’s actions can have, RBI might be a David not a Goliath. In the market Goliaths usually win and not the Davids.

Regarding the action taken by the Indian government, it is on a overdrive to make up for the lack of action by it in the last 3-4 years. Although the realty developers are not getting sleep but atleast the government has made its stand clear. The government is going overboard to please the landowners. You cant expect anything better than it in the election year.

http://www.moneycontrol.com/news/real-estate/why-land-bill-is-giving-sleepless-nights-to-developers_944879.html#toptag

Regarding downgrade, about 11 Indian Banks were downgraded recently. The downgrade is not for the 11 banks but for South and South East Asian region.

http://www.moneycontrol.com/news/economy/bank-downgrade-for-apac-region-not-just-india_945503.html#toptag

As predicted the nation’s status will soon become junk if the rupee is devalued like it did this August.

There is more data coming from United States which has decreasing unemployment rates. This makes the inevitable to come a little sooner rather than later.

http://www.nytimes.com/2013/09/07/business/economy/us-economy-adds-169000-jobs-as-unemployment-rate-falls.html?ref=business

Come middle of September and we will know what is the storm in store for us. We can say the worst is yet to come. Federal reserve is likely to act in mid September.

Growth in GDP is 4.4% this quarter

This shows the sorry state of the economy India is in. While the economy was performing badly was anyone’s guess. But the growth of 4.4% was unexpected. Most analysts were betting on 4.7%. The lower growth rate means India might have the lowest growth rate in about 5 years. Whats more worrying is that planned expenditure might be cut to bring the fiscal deficit under control. As growth slows down the taxes will also come down which means the government will have less to spend.

Manufacturing slumps and so does Mining

The negative in manufacturing is mainly due to slump in demand from Europe, USA and Japan. But with USA showing signs of recovering and also Europe, India does see a growth in manufacturing soon. Mining and quarrying will grow when the iron ore and coal export resumes ( Currently there is a ban on export of both because of litigation).

Next quarter will show better growth if we are to believe the government. What is alarming is elections are due to take place in May 2014. No government is going to take tough decisions before that. Congress led UPA is unlikely to return to power. The opposition is demanding an early election scenting that it is in its (BJP’s) favour.

All said and done growth in India is going to be less than 5% this year. Share prices of all companies are coming down. The only exception is IT and Pharma companies which rely on export revenue. Once the nation’s rating comes down we will see more exodus of FII money. So we have a grim month ahead for investors now.

Low interest rates, High Inflation and low growth – A potent mix for run on the currency

Dear Mr.Chidambaram,

This blog below makes interesting reading on how to shore up the rupee.

http://blogs.reuters.com/india-expertzone/2013/08/23/how-to-rescue-the-falling-rupee/?pfrom=home-reuters

Premise : Low interest rates are in line with Keynesian theory for government to give impetus to kick start an economy especially in a recession.

The low interest rate is to allow industries to borrow and make productive use of the resources (here money).

When does this premise fail?

When people do not make productive use of their money and buy gold or silver which is usually high priced during recession. They can accentuate the problem.

When there is high inflation, low interest rates (it is a potent mix when growth is low) add to the problem by increasing  money supply. Thereby fuelling inflation which pushes down growth (in real terms).

At what times is Keynesian  theory valid and when it is not?

http://en.wikipedia.org/wiki/Keynesian_economics

If the nation is already in recession keeping the interest rates low for some time works. But it is not a long term solution. When the going is good in the economy it is better to take a ‘laissez faire’ attitude and let the market forces take over.

When do we fall back to Austrian Business Cycle Theory?

http://en.wikipedia.org/wiki/Austrian_business_cycle_theory

If the nation is on the verge of getting into a recession (from Boom period) then ABCT works. This is because the industry can afford to pay for the loans taken. But it does not work when loan rates are very high leading to default meaning if in recession it does not work. A tight balance between ABCT and Keynesian theory needs to be followed depending at what part of the business cycle we are in.

How does ABCT work?

ABCT means short term pain long term recovery. It is a bitter pill doctor had ordered. It is the reverse of Keynesian Theory. Not lowering the interest rates mean business will have to pay for loans and they have the capacity to pay. When the first manufacturing signs say recession is round the corner then this bitter pill needs to be given. Just like Keynesian theory this also holds for special circumstances and cannot be applied at every point by the central banks.

As I have argued Keynesian theory works when the nation is in recession and Government makes effort to discourage non essential trade like Gold and silver.

ABCT works when in boom time when first signs of recession is coming.

Downgrade not far off

Dear Mr.Manmohan,

With the currency falling like nine pins and stock market in a downward spiral the next stop is going to be a downward revision of the credit rating of India. One does not know when it is coming but it seems like a certainty now more so if the run on the rupee is not stopped and reversed.

The Government might have woken up from a slumber and have given the green signal for large projects. But that may not be enough to stop the downgrade. Now with Rs 70 for the dollar not far off panic selling is the norm at the Indian stock market. With this being the norm India is staring at junk status in credit rating.

Manmohan is in no mood to bite the bullet, more so as parliament is in session. Moreover the hike in Diesel is likely to be not more than Rs 5 per litre. This is very small increase compared to the increase needed to cover the cost of Crude.

This brings us to the question as to whether we are in 1991-92 status or like ASEAN in the late 1990s? If the Federal Reserve reverses(by September) the stimulus then we are in 1991-92 situation. If it reverses the stimulus by December then Mr.Manmohan has some time to tackle the problem on hand.

With the Food security bill likely to impact the finances of the Government there is a lot Mr.Manmohan and Mr.Chidmabaram have to do. Even though Mr. Chidambaram says that every thing has been factored in this year’s fiscal. Not many are willing to buy that argument . With the imminent strike of Syria also looming large on the Crude oil price there is a lot the Government need to take care about.

Mr.Chidambaram, Mr.Manmohan and Ex-Finance minister (Current President) Mr. Pranab are equally responsible for this mess the economy is in!

Bloodbath again in Emerging markets

This morning the Rupiah, Ringgit and Rupee(nearly hit 66 against the dollar) has hit historic lows. This  means the tapering of support is coming soon and we can hear from the Federal Reserve. Banks are the most hit among the Stocks in Dalal street. India’s worsening macroeconomic scenario and the probability of Nato’s expected action in Syria is hurting us.

Meanwhile a TV channel speculated that the Indian government may reverse the capital control norms which was announced around  two weeks back. For those new to this the dollar remittance limit for individuals was reduced from $200000 to $75000. If it is true then there will be a dollar outflow – rather panic outflow from Individuals (this is my assumption). Only time will tell as to how RBI and the Indian government handle this as it will accentuate the problem we have on hand.

Concerns of the food security bill that has just been passed also could cause a strain on the finances of the Indian government. As mentioned in my earlier blog unless Mr.Manmohan bites the bullet and raises the price of Diesel and Kerosene this problem will not go. If the Government does not raise the price of diesel and kerosene it will continue to rob peter and pay Paul.

As suspected the RBI would have intervened when (the rupee) was near 66 against the dollar. But coming again to my earlier blog – Why should RBI bail out speculators? The value of the rupee could also have been under pressure because of the need for dollars as it is month end ( from Oil Marketing Companies in India)

Meanwhile the Government is on a overdrive to clear big ticket projects that will bring in Dollars. What is surprising is the Government has slept for 4 years and a pressure on the rupee has made it wake up from the slumber. Maybe better late than never.

Mr.Manmohan are you ready to bite the bullet?

Dear Mr.Manmohan Singh,

Both India and Indonesia have seen a steep fall in the value their currencies this month. But between Indonesia and India many Banks like HSBC have advised investors to stay away from India while they feel Indonesia will recover fast. The New York Times carried an article about Asian economies being in trouble.

http://www.nytimes.com/2013/08/23/business/global/currencies-drop-as-dollars-flee-asia.html?src=un&feedurl=http%3A%2F%2Fjson8.nytimes.com%2Fpages%2Fbusiness%2Fglobal%2Findex.jsonp

Although it did not predict the 1997(Asean) like situation in India, they have given a better rating for Indonesia. The reason being Indonesia has increased the Gas prices this June in an effort to bridge their deficits. They expect it (deficit) to be shrinking soon for Indonesia but that is not the case for India. While the article says China and Japan are reasonably safe meaning it is the smaller economies like India and Indonesia are likely to be in trouble – more so India.

Meanwhile emerging Economies like Turkey are also facing the heat like India. It looks like a real estate bubble is (about to burst) in Turkey and it is sponsored by the cheap dollar loans from USA.

http://www.nytimes.com/2013/08/21/business/global/turkish-skyline-foreshadows-emerging-market-slowdown.html?pagewanted=1&_r=0&src=me

The above article in New York times also makes interesting reading. It talks how Turkey is next in line like India and Indonesia.

http://www.nytimes.com/2013/08/23/opinion/krugman-this-age-of-bubbles.html?src=recg&_r=0

In the above article Krugman says India and Brazil are learning from the bubble like the ones earlier in USA and Europe. We cant but nod in approval to his hypothesis.

Now we are looking at two scenarios – India has to bite the bullet and increase the price of diesel and kerosene or else pray so that the Federal Reserve does not roll back the stimulus before May 2014. Mr.Manmohan the Economist would prefer the former but Mr.Manmohan the politician will prefer the latter.

Mr.Chidambaram it is not just the FEDERAL RESERVE but it is also the internal factors

Finance Minister gave an interview at around 5 PM on Thursday

Mr.Chidambaram said communication is the one that will revive the economy( at least he meant that). He said the policy needs to be communicated properly.  Communication is best when actions speak for you.

1.      1.  Mr.Chidambaram is a very good communicator but FIIs feel action speaks louder than words. That’s the reason they have withdrawn from the Indian market this month. When Mr.Chidambaram partly reversed the outflow limit for individuals they were seeing capital controls coming again they withdrew.

2. Finance Minister(FM) has made his stand clear that gold is something he doesn’t like. But the entire Indian fraternity loves it. That’s the problem FM if you increase the duty the smuggling with have a thriving business. You need to play by the rules not change the rules to suit you.

.       
3... The FM said coal imports were taking place due to the decisions made by the Courts. You knew ahead that the decision could come one way or the other. So you had not planned for the eventuality. Bad planning and not communication is the culprit.

4.       Another point is that the actual value of the rupee is higher than what it is now. FM if you know how the exchange rate is fixed it is more perception of the participants and stake holders and not the actual value of the currency.

5.       If the FEDERAL RESERVE is the only culprit then why should the rupee fall also against the Pound sterling? The assessment that the internal factors are not responsible for the value of the rupee is wrong.

6.       The summary is that the investors’ confidence is lost and the FM needs to act to assuage them. We need action that speak not empty words.

7.       Why is the dollar gaining in strength -  One reason is FEDERAL RESERVE is likely to withdraw the stimulus. I have dealt with it in another paragraph.

8.       The rupee has fallen to the lowest (below 65) and RBI is likely to have intervened to bail out the currency. Does the RBI have the resources to intervene every time the rupee falls. I guess no.

9.       Finally policy matters a lot. You have not brought the labour reforms, infrastructure and land reforms which will bring in FDI. But why are you rushing the food bill now? Do you have the resources with you to see it through ? – I guess no.

The FEDERAL RESERVE’s decision on when to withdraw the stimulus – it gives conflicting signals

Regarding the FEDERAL RESERVE’s decision to roll back the stimulus there seems to be some caution because of some members (of FEDERAL RESERVE) were not confident of the numbers that are likely to come soon(read before September). Thus FEDERAL RESERVE did not indicate clearly when the withdrawal of the stimulus will be ( mid-september or Mid –December). Thus FEDERAL RESERVE’s decision also keeps the emerging markets in uncertainity. If the FEDERAL RESERVE withdraws the stimulus in September the emerging markets i.e India has some time before they can tackle the rupee valuation problem. If the action to withdraw stimulus takes place in December then time is not with Mr.Chidambaram because elections are in May 2014.

http://www.nytimes.com/2013/08/22/business/economy/fed-closer-to-easing-back-stimulus-but-still-no-consensus-on-timing.html?_r=0&adxnnl=1&adxnnlx=1377190933-BbioH0fXWpg42YdXL0Snog

The New York times article on Federal Reserve is above.

Hot money is too hot Mr.Chidambaram

Between the time 1991 to 2013 the major change is the way ‘Hot money’ has dominated the Indian market ( read stock market) – meaning the fluid way the capital moves in and out through the FIIs. While FIIs are always welcome, though the communists are always wary of them, it is they who are orchestrating the run on the rupee. While FIIs are causing the ‘run on the rupee’ they are comparable to friction meaning they are a necessary evil. Too much of friction causes the vehicle to stall, too little causes breaking problems.

While the earlier blogs were critical of Mr.Chidambaram this blog is exploring the way the nation (India) needs to act now. Between hot money ( of FIIs) and FDI the more preferable one is FDIs. For FDIs to come in we need to concentrate in Manufacturing and infrastructure where India trails far below China. For FDI to come in we need to have manufacturing hubs like Chennai, Pune and Delhi for automotive ancillaries. More such hubs needs to come and urgently so and for different industries is a must and also different areas in the nation this will ensure equitable growth. Although the China story is disputed as lopsided development, which is agreed , infrastructure is the major difference between the two.  There is no question that China has provided the infrastructure to the people where India is lagging far behind.

Better infrastructure would mean more FDI comes to the country. Better FDI would mean the exchange rate is less volatile as FDI is long term commitment compared to FIIs’ short term ‘fair weather friends’.

Why is China far ahead of India in terms of infrastructure?

While it is conceded China’s communist leadership is steamrolling its way to remove the bottlenecks in infrastructure projects India has only itself to blame in the form of corruption and state versus centre bottlenecks. I am not saying Chinese policies are better than India’s, but in infrastructure development it is better than India.  If you look at the latest news about the port of Mumbai – Nhava Sheva at New Mumbai. It has slipped behind the port of Colombo. Colombo has taken Chinese help and modernized their port to compete with the likes of Singapore. This is no mean achievement because Colombo was rated below Mumbai and it has overtaken the Indian port this year. This is even more remarkable if you see the Island  nation was in ethnic turmoil as recently as in 2009. More importantly the population of Srilanka is much less than the population of Tamil Nadu an Indian federal state.

So the final lesson the Indian state needs to learn is that if Sri Lanka could boast of a port of higher caliber than Mumbai then we need to sit up and listen……….are we listening Mr. Chidambaram?

Say yes to FDI and moderately say no to ‘Hot Money’.

Bloodbath at Dalal Street

Between my writing the earlier blog and now there has been a bloodbath in Dalal Street(it has tanked more than 800 Points). The restrictions on the limit of capital transfer (remittance to foreign entities from India ) has increased the fears of more restrictions and has backfired (as of now). The action taken restricts residents and companies fear larger restrictions is on the anvil as told by Finance minister that he has many instruments to control the value of rupee. This has created a fear among foreign investors and they are fleeing with their Dollars. Here comes the question we raised while saying the currency has stabilized against the Dollar. Does RBI have the resources to counter a falling Rupee? The answer seems to be NO. The RBI would be better off making the rupee find its own value rather than artificially prop it up.

The NRIs who are the hope for Indian government have also withdrawn net 1.1 Billion Dollars in the last two months. The Rupee has hit 62 against the Dollar today and could still go down further.

I guess it is beyond redemption (at least for now) and the RBI has to learn its lessons. Are we in 1991-92 mode or are we on ASEAN late 90s mode? The answer will come to light in a week or two. Either way it is not picture perfect for Mr.P.Chidambaram or Mr.Manmohan Singh.

Back to square one

The government has imposed a ban on import of Gold coins and reduced the external remittance to $75000 from $200000. It is going back to the erstwhile Capital controls before 1991-92. While these measures are welcome in view of Current Account deficit , these measures are only short term medicine. The real culprit is Diesel decontrolling and kerosene subsidy which I mentioned is not likely to happen before May 2014 or after the general elections.

Mr. Manmohan Singh said in the independence day speech that the phase of slow growth will not last long. There was no mention of the Current Account Deficit or the excess fiscal imprudence.  That was very much along the expected lines. Meanwhile for the time being the government has stopped the rupee slide in the markets. But how long can it support the rupee which is going against the exporters is one which needs to be seen. The magical mark the RBI waited to act looks like 61 to the dollar but does the RBI has the resources to hold it for long (meaning the General elections next year at that point needs to be seen).

The new Governor of RBI has his task cut out as there will be a clamour for reducing the interest rates to boost growth. How independent the RBI Governor is needs to be seen as there is likely to be an acid test very soon.  If he reduces the rates now he can show growth within the next 6 months and that is what the government wants. But that will go against the prescription that the Doctor ordered( meaning long term pain over short term relief).

The petroleum minister seems to indicate that the Government is looking at a one time increase in diesel prices. This will be a welcome move if the Government has the courage to bite the bullet. As usual there will be a call for rollback of the prices if done and there will be a minor price reduction that will follow (that is Politics Indian Style).

Attacking the Symptoms instead of the root cause

According to major newspapers the finance ministry has been unable to stop the slide of the rupee against the dollar. The UPA government is actually fighting the symptoms and not the root cause.

The root cause is Current account deficit (CAD) which is Petroleum products and Gold imports. The government is in an unenviable situation as it cannot take the bull by its horns as General elections is just less than a year away ( I mean decontrol of Diesel prices). The lure of gold as an investment has always had its charm for Indian households and decontrol of diesel is not possible before May 2014 (unless elections are held before that). Although import of gold has fallen this month (july) but petroleum products  (read Diesel)are the biggest enemy of CAD.

So the Finance Ministry is left with only tools to increase foreign exchange investment in public sector enterprises to fund CAD. This is more like attacking the symptoms rather the root cause. Hence the tough balancing act by the finance ministry will continue till May 2014. Meanwhile let the RBI and Finance ministry hope its efforts will contain the CAD. I pray that the balancing act should give fruits else we are in 1991 mode or worse it will be like the ASEAN countries in late 90s.

Do we need to bail out the speculators

Do we need to bail out the speculators‏

RBI has embarked in a series of measures to suck out the liquidity in the market in order to defend the value of the rupee. The net effect is that it will bail out the speculators when it defends the value of the rupee. This is against the policy of letting the currency find its own level. Actually we really dont know how effective the effort is going to be. We need to wait and watch but in the guise of helping the importers the RBI will also bail out the speculators in the process. The best method is to let the rupee find its own level even if it means it will hurt the importers. It will also act as a negative for the exporters.

The reason RBI should not intervene is the culprit is CAD (mainly petrol products and Gold imports). And there needs to be a sea change in the policies of the government to change it. Some of the measures we need to do is to completely decontrol the price of Diesel as soon as possible which the government is reluctant to do.

The method RBI is using to take out the liquidity from the market is it is selling cash management bills in the market for 22000 crores.

Economics in India - An argument to increase the interest rates

An argument to retain the interest rates as it is or make it higher ( in the short term)

 Today there is an argument to reduce the interest rates so that we can get over the recession. But if we reduce the interest rates we will fall into a bigger recession later on in say 5 years time as against a mini recession in about 6 months time. If we increase the interest rates now there is a possibility of having a micro recession in about 3 months.

Thus between the choice of having a mini recession , micro recession and a full fledged depression. We should opt for a micro recession or a mini recession in the near term rather than have a depression in the long term say 4 to 5 years from now.

The premise that we are looking at is that an increase in interest rates will make the businesses to re-look the unproductive investments now and reduce the pains of a depression. This in essence is the logic that is proposed by the Austrian Business cycle theory.

Effect of increasing the interest rates : It takes away excess cash from the hands of the businesses and makes cash availability little more difficult.

Effect of decreasing the interest rates : It makes excess cash available in the hands of the businesses and makes cash a little cheap meaning availability is a little easier.