Hygiene doesn’t make it too often to the media. However, as anyone who’s spent more than 24 hrs in India knows, the lack of adequate toilets is a huge, huge issue.

Two links on that subject: Bloomberg – India Failing to Control Open Defecation Blunts Nation’s Growth and a more rigorous analysis from Nimai Mehta -The Preference Bias in Sanitation: Explaining Failures in Public Provision

In the Wall Street Journal, Peter Wonacott says India Defies Slump, Powered by Growth in Poor Rural States.

Rama Lakshmi of the Washington Post said as much last month: Vast Rural India Sparkles As an Expanding Market

About 72 percent of India’s billion-plus people live in rural areas. For years, the poverty of rural India was seen as reining in the country’s economic growth. But today, analysts say, rural India is a critical audience for marketers because it has been relatively insulated from the crippling blow of the global slowdown.

India’s rural destiny still depends on good monsoon rains and robust agricultural production, but four years of bumper crops and heavy government investment in rural infrastructure have given birth to what some analysts call an emerging economy within India.

Last month, Patrick Barta of the Wall Street Journal called it The Rise of the Underground.

Given this, it’s not entirely coincidental that The American, the journal of the American Enterprise Institute wonders how Lalu Yadav managed to turn around the Indian Railways, the world’s 2nd largest employer (the Chinese Army is #1) and in doing so, morph from Huey Long to Jack Welch — The Indian Railway King

A table of inflation rates in many countries around the world is beginning to reveal a disturbing picture. The lowest rate is found in Germany – at 3.0%. Many emerging countries that seem to be doing a truthful job are reporting inflation rates in excess of 10% and some in excess of 20%. Others, either out of deliberate intent or methodological deficiencies, report far less. India belongs to the latter category.

Inflation is the world’s number one problem. Governments are pretending to respond. In the UK, Mr. Gordon Brown wants to assemble experts to debate solutions. The Indian finance minister says that western nations are diverting land for producing expensive bio-fuels to replace the expensive crude oil. Surely, that is part of the problem. But that does not explain the jump in the price of rice. Rice is not diverted to bio-fuel production.

In India, the response has been to reduce import duties, impose export caps and accuse manufacturers and distributors of collusion and cartel-like behaviour. Different ministers speak in different voices. Together, these pronouncements do not constitute a policy whole.

In simple terms, prices reflect the balance of supply and demand of something. When prices go up, it is a reflection – and not a consequence – of supply going down or of demand going up or both. When it happens for just one or few commodities, it is possible to blame middle-men of hoarding or manufacturers of cartel-like behaviour. When it happens in many commodities, it is futile to blame one industry or a few producers.

Usually, the source lies in some policy measures and their implementation. To make it clear, we are not dismissing the importance of factors like climate change, diversion of land for production of bio-fuels and more importantly, stagnation or even outright decline in agricultural productivity in countries like India and China. Again, they explain inflation in food and agriculture commodities. These factors do not explain inflation in crude oil and copper, for example.

If we have to identify a single or the most important explanation for the recent development in prices of many commodities, the answer lies in examining the behaviour of global central banks.

Of course, in any broad-brush analysis or conclusions, there is the risk that we miss the exceptions who behaved differently and correctly. For example, within the constraints imposed by the political system, Reserve Bank of India has done a very good job of trying to shield the Indian economy from the cycles of boom and bust. Similarly, if the Australian and New Zealand economies still face the risk of boom and bust, it is not because of their central banks but in spite of their best efforts.
The bulk of the blame has to be assigned to the American Federal Reserve and the People’s Bank of China. In the case of China as in the case of India and in many other developing countries, the central bank is not independent. It is subject to political influence. The Federal Reserve Board of America is, in some ways, a similar predicament. It is subject to the oversight and pulls and pressures of the democratically elected Congress members. Further, since it was founded by banks actually, it ends up coming to the rescue of banks sometimes to the detriment of the public.

In 2001-2003, it cut the Federal funds rate to 1.0%. It thus rescued the economy from the collapse of the technology bubble in 2000. Thus, it replaced the stock market bubble with a housing bubble. When the housing bubble appeared to be weakening, it refused to tighten regulations and allowed it to continue. Too many loans were made to people who should not have been lent. That is the root cause of the present problem.

In order to address the resulting loan defaults, stress on banks and their balance sheets, the Federal Reserve has allowed banks to borrow at cheap rates from it. Money is available to banks in the open market but at higher cost. Some of the banks might not have survived. But, that would have also left a lesson for other banks that they would not have forgotten for a long time. Excessive risk-taking would have been curbed. Instead, the cheap money is perhaps being channelled into speculation on commodities prices. After all, banks are not going to create more mortgage loans at least for quite some time.

Somewhat different has been the behaviour of China but it achieves the same result. China has kept its currency cheap. Keeping the currency cheap requires interest rates to remain low, in comparison to other countries but also in relation to economic growth. China has done that. Low interest rates means capital is plenty. So, capital-intensive growth has flourished. That has placed tremendous demand on resources worldwide such as crude oil, coal, steel and other industrial metals. It continues to import rising quantities of iron ore, copper and crude oil. Incidentally, it has also led to China supporting many tyrannical regimes in Africa including that of Zimbabwe. Recently, it sent a shipment of arms to Zimbabwe but faced an avalanche of protest and had to recall that shipment.

Perhaps, it is possible that American banks know that there won’t be any change in China’s demand for commodities in the near future, at least until the end of the Olympics. China may be reluctant to change course fearing unknown and uncertain consequences. If so, it argues for further rise in the price of commodities. Both their behaviour and bets might be feeding off each other. That is not good news for the rest of the world.

After all, we cannot influence the Federal Reserve. So, how should policymakers respond? Unfortunately, the answer is that they should respond differently from what they have done until now. Banning exports of agricultural commodities exposes the hollowness of farmer-friendly policies. Farmers should be allowed, with appropriate guidance, to sell to the highest bidder – local or global – and derive the maximum gains from the global shortage. Such a price signal would also encourage productivity improvement in farmland and hence boost crop production. More land would be brought under cultivation. At the same time, poor households – rural or urban – could be directly subsidised with cash transfer to be able to pay the higher price.

The same principle can be extended to the price of hydrocarbon products such as petrol, cooking gas, diesel and kerosene. Consumers and producers should receive the price signal. Without that, their respective behaviours would not change and shortages or glut would persist.

At the same time, since supply of food and other commodities would take time to respond to price signals, central banks should be allowed to restrain demand in the short-run with tight monetary policy. That means higher cash reserve ratio or higher interest rates or both. That might be unpopular or politically unacceptable. But, effective medicines never taste sweet. Only placebos do.

The chances of such sound policies being pursued are close to nil particularly as many democratic governments, including India, approach elections soon. Authoritarian governments do not care much for public opinion.

Given such a low chance for sound economic decision-making, prospects for a sustained decline in inflation should be judged remote. That is not good news as it is a stealth tax on the public and erodes their purchasing power. Consequently, it reduces affordability for many assets. As demand drops, inflation affects revenues for companies and squeezes margins through cost pressures. That does not augur well for the stock market.

The stock market in India has performed well in recent times. Many other global markets have staged a similar recovery. That is due to misplaced optimism on the American economy. As discussed above, right policies would be missing and hence the anticipated quick economic turnaround in America would be elusive. Consequently, risky assets globally would retrace their recent gains. Therefore, Indian stocks would fail to build on their recent gains. On the other hand, the likelihood of continued high global and local inflation would result in a resumption of the uptrend in gold price that has been recently disrupted. Therefore, investors who do not expect inflation to recede know exactly what they should be selling and what they should be buying.

Swaminathan Iyer took the words out of this bloggers mouth. The UPA government, he writes “has suddenly shifted from protecting Indian farmers against cheap imports to protecting the consumer by cheapening imports”. He is referring to the ban on rice exports (which follow the export of wheat late last year, followed by the ban on export of maize and pulses).

The April 2008 issue of Pragati called for the government to free the farmers. The UPA government did just the opposite—far from allowing Indian farmers to benefit from selling their produce at record prices, the government is forcing them to sell at artificially low prices. So who is hurting the farmer? And why is silence replacing Sainath? And next year, when farmers find themselves unable to repay their loans, the UPA government—if it is in power at that time—will simply increase payouts and write-offs.

In the end the consumers pay the farmers: only the government gets itself into the equation causing unnecessary leakage and wastage.

Unnecessary? Why, isn’t it at least helping curb inflation? Not quite. As Mr Iyer explains:

The lesson is clear. Curbing exports is a form of national hoarding. If every country tries to hoard food, food prices will naturally rise. Governments would like to believe that hoarding by traders is terrible, whereas hoarding by governments promotes the public interest. But the impact on prices is exactly the same in both cases. Indeed, when governments start to hoard food out of panic, the panic itself stokes further inflationary fears.

That is why I am not optimistic about the Indian government’s anti-inflation package. The government thinks it is improving domestic supplies and hence bringing down prices. In fact the government is adding to the global hoarding problem, and stoking panic too. So, expect food inflation to keep rising in coming months. [TOI]

It’s all very well, you say, but what should the government do when poor people can’t afford food? Well, it should buy food grain at market prices and distribute it to those who need it. That way it will least distort the price signals that farmers receive and allow them to benefit from the good times. And by spending taxpayers money in a targeted manner—only the poor will enjoy cheap food—it will spend less. That is, if the government actually wanted to address the policy challenge, and not flail about paranoid of losing votes.

Here lies the crux of the matter. If use of new seeds, fertiliser use, irrigated land, cropping intensity, and private capital stock growth are not rising fast enough, then where is this credit going? To put it another way, what is the Indian farmer doing with the extra credit if he is not using it in seeds, fertiliser, water, capital or land? [IE]

Yes, I understand this is counterintuitive. How can you expect to make more by selling less rather than selling more? How can you expect to make more money by destroying what you’ve produced after investing thousands of rupees? Here is my take on the same. I’ll start with the necessary conditions for this kind of a situation, and then proceed to try and explain why this works. And then I’ll try and explain how some policy changes can help avoiding wastage.

1. Monopoly: A monopoly is essential for implementation of this kind of a situation. It is easy to understand why. Suppose there are multiple independent suppliers. Who is going to dump their stock? What is the incentive for you to dump your stock? You would rather that your neighbor dump his stock which is going to increase your profits. The only way out of this is in collusion. All producers get together and decide to dump stocks. Which effectively creates a cartel, and thus a monopoly.

2. Inelastic demand: For dumping to work, the additional revenue we make out of the un-dumped stocks should be more than the revenue we would’ve made from the dumped stock if we hadn’t dumped it. So basically the demand needs to be inelastic – around the region where we are going to dump. What i’m saying is that for a small change in quantity supplied, the price should increase by a large amount. As long as this keeps happening we can dump.

Going back to textbook monopoly economics, what we do to price is to maximize quantity * price. In other words, we supply the quantity where the total revenues are maximized. And it usually happens that this particular level is below the total amount we have produced. So we introduce into the market only as much produce that will maximize our revenues.

But what about the effort that has gone into production of this excess? Just look at the examples that I’ve mentioned. In all of them, you have already spent whatever amount that you had to spend. The costs have already been sunk. Apart from a couple of minor expenses (transportation, facilities, etc.) all expenses have been incurred before we made this decision. In other words Revenues are almost equal to profits. So we maximize revenues, not profits.

Now, taking the case of tomatoes, what do we do with the stock that we don’t want to sell? One option is to store it. That again, we’ll need to do based on how much the stored tomatoes will fetch us in the future, costs of storage et al. Given the facilities in India, it usually turns out that the costs of storage would be much higher than the expected revenues from it. So we only lose money by doing so. So what do we do? Dump them on the highways. Or if they take my suggestion, organize a Tomatina.

The other thing with tomatoes is that farmers don’t cooperate when they are making the decision regarding what to plant. If they did back then, some land that would’ve otherwise been used to sow tomatoes would be diverted to some other crop, which on the margin would yield more. Interestingly, the farmers seem to come together in a cartel only after the tomatoes have been produced!

So what are the policy implications from this? Firstly, infrastructure has to be improved. We need to be able to make storage of tomatoes cheaper, so as to encourage storage rather than throwing away. We need to encourage building of cold storages, and refrigerated transport systems. We need more investments in warehouses. Intuitively, it may appear as if these warehouses are just going to add to the cost of production, and thus push up inflation. If you see the larger picture, they are effectively encouraging efficient usage of land – which in my opinion is the most precious resource.

Second, the farmer needs to be able to easily estimate the revenues he will get by storing his goods. More importantly, he should be able to have a good idea about the revenues he will get from each crop even before he sows. And should be able to lock in the revenues before sowing.

We need to extend futures markets into all agricultural commodities. And keep the lot size reasonable so that it is accessible to small farmers. It is not as if the farmers won’t be able to use technology. Make it accessible to them, and they’ll easily take to it. The cell phone revolution is proof of that. Yes, small lot size could be a problem when it comes to settlement. Cash settled futures need to be explored.

Throwing tomatoes on the highway may be economically efficient when looked at in isolation. Looking at the larger picture, it only points to certain amounts of land and water and other inputs that have been wasted. That have been wasted growing tomatoes which no one needs, when they could’ve been used to grow something else. Agricultural commodity prices have been going up all over the world. Agricultural land and water are precious inputs, and need to be utilized judiciously if we have to continue feeding everyone. Futures markets help us allocating these resources efficiently.

In the last five to seven years, India has grown on the basis of its knowledge economy and consumerism. The IT industry, and its related industries, provided jobs for Indians. As Indians earned more, they spent more, and that’s how consumerism drove economic growth as a whole and also led to a huge growth in the retail-credit and consumer-credit business in India. As we peak today, this growth in consumerism is leading to a huge investment cycle in India. Because manufacturing capacities have been fully utilized, and infrastructure needs to be established, people are now investing in manufacturing capacities and infrastructure. I estimate the Indian corporate sector has plans today to invest about $700 billion in manufacturing and infrastructure, which will be spent over the next three years. The next wave of growth for India is going to come out of capital investment.[IK@W]

The Indian government has already accepted a little dent in its prospective growth rate this year. It is widely believed that India’s internally driven growth, has increasingly decoupled its fortunes from the US economy. It is certain that an US slump will impact India to a lesser extent now, than it might have done a few years ago. Indian companies are more resilient than ever to a global downturn these days, with lower borrowing costs and healthier debt-equity ratios. Nevertheless, there are some challenges.

Inflationary pressures loom on the horizon. Inflation triggered by higher food and oil prices could deflate the rapid economic growth curve in India. The tight monetary policy of the RBI is related to inflationary pressures. With large-scale credit contraction in the Western markets, the growth plans and capacity expansion at Indian companies will find it difficult to access overseas credit .

The uneven growth in the middle to short term, with the states of Madhya Pradesh, Orissa, Uttar Pradesh and Bihar having seen lesser growth than others, has led to increased social and political tensions. The increased spending on social sectors and populist largesses in the election year, including recommendations of a new pay commission, can also impinge on the growth story. This spending, however, can be met by the dramatic increase in direct tax collections (by over 40% in each of the last two years).

As a banker, Kochar can probably view certain propitious omens that most other economic commentators in this country cannot. The jury is, however, still out on her hypothesis and previsions of a sustained growth rate for the Indian economy.

And the main reason for all this is heavy intervention by the state; in my opinion, heavier intervention than what we saw in the bad old days of Indira Gandhi. Back then, the state fixed a price and said “take it or leave it”. Here, even that option doesn’t exist. When the sugar mills didn’t like the state-fixed price of Rs. 125 per quintal, they decided to stop procurement and production. However, the state intervened and didn’t even allow them to do that, and now the HC has ordered them to start production, albeit after sourcing at a lower cost.

The difference between procurement in sugarcane, and that in other commodities is that in the others, the government effectively writes an option to the farmers by fixing a “minimum support price” (MSP). If no one else is willing to pay the farmers that much, the government buys it from them. However, in case of sugarcane, the government doesn’t buy anything. It is the private mills that need to procure the sugar at the stated price.

The problems don’t stop there. For example, currently, you can’t export sugar, which effectively pushes down its market price. So on one hand you have controlled prices for input, and on the other you have a suppressed price for your goods. Not a good situation to be in, unless Mulayam Singh is in power. The SP uses the sugar mills as a huge vote bank, and consequently used to set a lower price for sugar procurement in UP. So as long as it was in power, the industry was happy. Now, Mayawati depends on the votes of the sugarcane GROWERS, and her coming to power has turned things completely upside down.

Let us assume that in the absence of a state advised price, market fundamentals would determine the price of sugarcane. The reason a state advised price exists is that if things are left to the market, the mills would squeeze out the farmers, and set an extremely low price for procurement. And not having much choice (due to another bizarre set of laws, you can’t sell sugarcane grown here in another state), the farmer would have no choice but to accept this abysmal price.

Now, what is the market solution to this problem? Under normal market circumstances, more people would set up sugar mills, and thus compete with the existing producers, which would result in higher revenues for farmers. However, the uncertainty caused due to heavy state intervention takes out all incentives to invest.

So, is there a way out of the current mess? Due to the current political situation it is unlikely. Each government in UP supports one part of the sugar supply chain or the other, and hence, would like to retain control over the industry. Then at the central level, the agriculture minister Sharad Pawar is himself from the sugar industry, and represents Baramati, which is in the powerful sugar belt in Maharashtra. He too has a vested interest in the industry, so policy changes at the central level can be ruled out.

One hope might be that the movement of sugarcane across states might be liberalized, but given that the current government rolled back the NDA’s attempts to dismantle the Essential Commodities Act, one is also not very hopeful of this.

Abi is right. Dweep didn’t go far enough. What India needs to do is to say “to hell with the WTO” and unilaterally, completely, dismantle trade barriers. For that matter, so does everyone else.

Here’s Sauvik Chakraverti on the topic on TCS Daily:

Unilateral free trade is a very good idea for a huge country such as India. If subsidized grain enters the market, poor marginal farmers, subsistence agriculturists and day laborers get cheap food. They will move away from subsistence farming as grain will be cheaper to buy in the market. They will move ‘from subsistence to exchange’, in Peter Bauer’s words, and integrate themselves with the urban exchange economy. Instead of grain, Indian farmers will produce fruits and vegetables or even flowers — solid cash crops. And this benefit will be paid for by US and EU taxpayers. [TCS Daily]

Moreover, dropping trade barriers for imports from Pakistan is the real peace process.

India and Brazil blamed the US and Europe for not lowering their collossally high agricultural subsidies enough. But the question to ask is why India is even campaigning for lower farm subsidies?

India just floated a tender to buy 530,000 tons of wheat on the international market. Driven by supply constraints and record demand from India, Japan, and others, wheat prices are at an all time high. Barring a miracle in Indian agricultural productivity, it is likely that India will remain a net importer of wheat for the foreseeable future. So why ask the US to cut farm subsidies, when it is in effect subsidizing Indian bread?

The same logic applies to other agricultural products too. As pointed out last year by G. Chandrashekhar, “in none of the four major world commodities would India stand to benefit substantially even if developed economies eliminated subsidies.” What is more, the share of agricultural produce in India’s trade exports is falling – it was 20.55% in 1996-97, 18.05% in 1998-99, and 13.36% in 2000-01 (PDF, Medium Term Export Strategy).

There is, of course, the argument that lower subsidies will raise prices and thus raise farmer incomes. But this reasoning is egregious in so many ways, I don’t know where to begin.

First, it ignores the fact that while there are several million farmers in India, there are over 1 billion consumers too. This is the classic problem with farm subsidies in general – they benefit a strong, well organized group of producers, but against the interests of the much larger, but disorganized majority of consumers. Worse, the result will be incentives for farmers to stay in farming – just when they should be encouraged to move into other forms of production.

The biggest problem with this argument, however, is that it takes responsibility of the failure of Indian agriculture away from the government and places it on the US. Farm subsidies take attention away from the very serious failure of the government, through its monopoly on procurement and intervention in distribution, to provide a supply chain and market that work. This, in fact, explains why the Indian government is so keen to fight for farm subsidy cuts - because it involves little effort to keep a major vote bank happy. Actually doing something about the pitiable state of Indian agriculture is a far less enviable proposition.

The countries that will truly benefit from steep cuts in farm subsidies are mostly in Africa. While helping them is indeed a noble cause, the WTO trade negotiations are not about scoring brownie points with Africa. At the WTO, India should let the US fund its bread while bargaining for things such as looser intellectual property controls, greater access to labor markets, and service industries. And at home, it should get its own house in order, rather than blame external forces for its failures.