Despite slowing from highs of 8% to 9% growth, India’s economy will grow close to 6% in 2009. Amid domestic and global liquidity crunch, large domestic savings and corporate retained earnings are financing investment. Sluggish labor market and wealth effects have hit urban consumption. But low export dependence, a large consumption base and the high share of employment (two-thirds) and income (one-half) coming from rural areas has helped sustain consumption. Pre-election spending, especially in rural areas, and high government expenditure, are also pluses. Timely monetary and credit measures have played a key role in improving private demand, liquidity and short-term rates and reducing the risk of loan losses. Credit is largely channeled by domestic banks, especially state-controlled ones, which have low loan-to-deposit ratios and little exposure to toxic assets….link

Given Roubini’s track record over the last three years, he’s certainly built some cred. Do you agree with his assessment on India, though?

“For what it’s worth, a key conclusion from the IMF’s new World Economic Outlook is that recessions caused by financial crisis typically end with export booms, with the trade balance improving,on average, by more than 3 percent of GDP. I find this a disturbing result: we’re now suffering from a global financial crisis, which means that the usual driver of recovery will only be available if we can find another planet to export to.”
Paul Krugman

With results still coming in, projections show the United Progressive Alliance is likely to win about 250 seats, making it a shoo-in to form the next government and provide continuity, a stable administration and progress on key economic and corporate reforms.
Wall Street Journal, May 16 2009

Prime Minister Manmohan Singh’s electoral victory, the biggest any Indian politician has scored in two decades, may loosen political shackles that have restrained the country’s economic growth as it struggles to free half a billion people from poverty…..Political stability will make India a more attractive investment destination as Singh, 76, seeks the funds to stimulate Asia’s third largest economy.
Bloomberg, May 18 2009

Many are called, but few are chosen, as the saying goes. But could it just be that this time around, and on a one-off, never to be repeated basis, India might find itself right there in the midst of things, with a 50-50 opportunity to add its name to that select and noble band, the chosen few. After all, someone has to lead the next global charge? The majority of the developed economies are either bogged down in the substantial quantities of debt that they desperately need to pay off, or weighted down by those elderly populations who are weakening consumption growth and leading to export dependence (Germany, Japan…). And as Krugman humorously points out, someone will have to add the extra demand which will allow global trade to start to grow again, so why should India not supply a significant part of this new demand, after all we are more likely to find consumers in India than we are on Mars. (more……. )

Two academics evaluate the returns of the art markets in India, Russia and China over the last decade, using a portfolio theory/ CAPM framework.

Investors constantly hunt for alternative assets that might improve the risk-adjusted returns on their financial portfolios. When stock markets experience a downswing, investors search for more profitable alternatives. Financial newspapers fill headlines with record prices paid for certain works of art, giving rise to the idea that investing in art might be a profitable pursuit. Moreover, Artprice recently reported a booming emerging art market for Russia, 780% growth for the Chinese
15 (contemporary) art market since 2001, and 830% for the Indian (contemporary) art market in
the past decade.

To determine if these reported returns are feasible and indicate reasonable investment alternatives, we analyze whether investing in emerging art markets yields a competitive risk-adjusted
return in comparison with other, more traditional asset classes that could be used optimally to
diversify a financial portfolio.

India exhibits the strongest Sharpe ratio of all three emerging art markets and by far the strongest average annual return. Moreover, the Indian art index has a negative market beta and a nearly zero correlation with the S&P 500, which makes it another interesting investment for a well-diversified portfolio. Link

I know very little about art or art markets, since my “right brain” never progressed beyond those sunsets and sunrises in 4th grade, and hence can’t really offer any opinions here. Perhaps some readers are better informed?

HT: Felix Salmon

On September 19th, the U.S. Treasury Secretary Paulson issued a statement in which he said that the Federal government “must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy”. He called it the ‘Troubled Asset Relief Program’. Many have taken to abbreviating to TARP and from there, it is a short leap of imagination to call it a TRAP. The government had sent the legislation to the Congress for approval and it might be approved any time soon. We have something to say about it later.

But, even before the bill is passed and its ramifications known, stock markets around the globe heaved a sigh of relief and rallied hard towards the end of last week. It is a delightful irony that most markets showed a flat profile from Friday, September 12th to Friday, September 19th at the end of an unprecedented week. It is not so much the news of the proposed U.S. government bailout that stock market investors welcomed. The squeeze on short-sellers that regulators around the world applied worked its magic.

Short-selling banned but SEC created the conditions

Bulls are taken by their horns but I do not know how bears are tamed. Try banning short selling. Well that is what authorities in the U.S. and the UK did on Thursday. UK banned all short-selling of financial stocks up to January 2009. The Securities and Exchange Commission (SEC) in the US banned all naked short-selling in all stocks. Hedge funds have to swear under oath their short positions. Canada, Germany, Ireland, Holland, Taiwan and some others have joined. That is a shame. There was no reason for many authorities to impose restrictions on short-selling. It is not only unprecedented but also largely unnecessary. Even now, with history and experience behind us, human beings remain capable of making collective mistakes. That is scary.

Forgotten in this persecution of short-sellers is a matter of tiny detail that in 2004, the SEC made two important changes to its rules on the amount of leverage that broker-dealers could take on. One, it removed the discounts (haircut) it applied on the assets that these institutions own, in calculating their net capital. Two, it allowed five broker-dealers to increase their leverage from 12:1 to 40:1. Those five were Merrill, Lehman Bear Stearns, Goldman and Morgan Stanley. Three of them are not around any more.

(Source: The Big Picture)

It is not clear what role the institutions themselves played in this rule change. It appears that the retribution for the egregious errors of the regulators and the regulated entities would be paid by the shortsellers who seek to throw a spotlight on such behaviour. Strange are the turns that American capitalism has taken in the last few years.

Banning short-selling is to akin to blaming the mirror for the ugly image. But then, these days, one is a suspect capitalist if one does not cheerlead rising asset prices even if the means are not exactly fair. Steve Randy Waldmann asks if selling short into a financial panic was not done, then isn’t going long into an asset price bubble equally wrong. In their defense, of course, authorities are justified in doing so if they suspect financial terrorism akin to the unusual activity seen in airline and financial stocks before the 9/11 terrorist attack in New York. But, Carl Sagan, as quoted by Paul Kedrosky of ‘Infectious greed’ says that extraordinary claims require extraordinary evidence. The authorities have not produced any.

However, for this writer, conviction remains firm that any recovery in global equities and the U.S. dollar would eventually turn out to be a comic interlude in an, otherwise, tragic drama except that the comic interlude could last long enough to make us all feel like we were watching a new play all over again.

Incentives to take on excess risk remain

Some argue that there is nothing called a stable financial system. As long as human greed and fear exist, financial systems would periodically become unstable. According to them, it is just in the nature of things for financial systems to fall into crises. The only avoidable cause, in their view, is to avoid reckless monetary and credit expansion that many central banks either deliberately or unconsciously permitted in the last several years (See, for example, Michael Pettis). Such excessive monetary and credit expansions do not end without extracting their price in terms of financial institutions’ failures and economic stagnation or worse.

Of course, while monetary policy and regulatory prudence is at the heart of the stability or instability of the financial system, that does not mean that other known or identified problems should not be addressed. Some of them might end up vastly amplifying the consequences of monetary excesses. One such problem is the role of incentives and reward-punishment structures in the financial industry. Simply put, far too little punishment is directly borne by the wrongdoers for their errors. Most executives are rewarded for successes or with golden parachutes if they fail while losses are borne by the shareholders and the society at large. That applies to executives at the top and at other levels. Returns are rewarded while risk is socialized and worse, since it appears with a lag, it is not even recognized and traced back to the acts of omission and commission. Even in late-2007 well after the crisis had broken out, compensation packages were not tailored to incorporate risk considerations in evaluating executive performance.

In fact, incentives in the financial industry need to be addressed not just for reasons of financial system stability alone but also to ensure a fair deal to shareholders and clients of such institutions. Nick Leeson, who was responsible for the collapse of the Barings bank in Singapore, writes that he was offered five credit cards as soon as he had returned from Singapore, having been responsible for incurring GBP862 millions of losses in 1999 (See The Guardian).

U.S. Treasury announces a plan on Saturday

In an email exchange with friends in the industry in April, when I was asked whether the world would unravel via inflationary boom and bust or through a straight deflationary bust, I said that the outcome would eventually be deflationary and that, in the interim, inflationary solutions would be attempted. In other words, we would get there finally but through an inflationary route.

In that sense, the Paulson plan is not a surprise. It was always on the cards. Policymakers are not going to give up without a fight. Under the plan known informally as TARP, the Treasury is authorized to purchase USD700 billion worth of mortgage-backed securities from U.S headquartered institutions at an unspecified price and price mechanism. Decisions made by the Treasury under this special legislation have no judicial recourse. The Treasury would buy assets issued or originated on or before September 17th. By Monday (Sept. 22nd), this has been extended to non-America headquartered institutions and to many types of assets including commercial mortgages and non-mortgage assets. Macroman might succeed in selling his wooden cabinet to the U.S. government, after all!

For now, the proposal has no provision to help homeowners who are struggling to keep up with their mortgages. Also missing is any proposal to re-capitalize institutions that might find themselves undercapitalized once the Treasury buys its assets over at a price that could be less than the price at which the institution carried the assets on its books. Those wanting to understand these issues better could see here and here.

Further, the stunningly simple and yet sweeping nature of the authorization sought from the Congress has made many compare this to the “Authorization for Use of Military Force, the infamous bill that gave the Bush administration the green light to invade Iraq” (see NYT). In fact, some find it plausible that the U.S. government allowed Lehman Brothers to fail to bring the system to the point of total collapse so that Congress could be steamrolled into authorizing the Treasury to do as it pleases, without judicial review.

Regardless of the merits of such a hypothesis, the mere possibility of it should make Congressmen move cautiously on the proposal and build in safeguards against abuse of power.

Different problems if the plan works

Even as a plan that focuses on the financial system, it is incomplete. The million-dollar question is if this plan would boost loan demand. The hope is that as mortgage rates come down, households would be able to refinance their mortgages and thus find the wherewithal to continue to spend. U.S. households have zero savings rate and those born around the World War II face immediate retirement. They need to save. To the extent any reduction in rates alleviates their conditions without a change in behaviour, global imbalances would remain. The U.S. would be saving too little and Asia too much. Second, return to spending habits by U.S. households would boost commodity prices and thus raise the specter of inflation all over again. Even if inflation were to return slowly in the U.S., it might return faster in Asia where the economies have barely cooled and where policy, on average, is still too loose. The world has, for the moment, run out of resources to support synchronized growth. Oil and gold have jumped already on Thursday and Friday.

If, unfortunately, inflation returned to the U.S., what happens to interest rates and would households really benefit then?

Then, there is the question of how the Treasury would find the money to do this. As a perceptive hedge fund insider pointed out, it was one thing for Asian nations to buy Treasuries and mortgage agency debt and accumulate reserves when they were deemed AAA credits. Can they do so even now and how would their public react? Of course, it is a stretch to think that most East Asian nations respect popular wish but it is not a stretch to state that they would fear the inflationary consequences of going back to reserves accumulation and thus entrench currency weakness.

Truth and reconciliation in America

Steve Randy Waldman’s two thoughtful pieces on his blog, ‘Interfluidity’ titled ‘To whom and for what’ (September 19, 2008) and ‘Inequality and credit crisis’ (August 31,2008) are worth reading. He also makes a compelling case for truth and reconciliation in America. Not just billions of dollars have been lost but also trust in America. He says that the process of rescuing financial institutions with government money should be transparent and institutions must come clean on the models and the prices that they had used in their books until the Treasury bought them over. This would enable the world to know whom to deal with in future and whom to avoid. He is right but the chances of this happening are fairly slim, however.

The mood in the financial market now is not to ask these uncomfortable and important questions. Whatever makes them live for another day is good enough now, for the industry and for investors. Once Congress approves this bill, investors, instead of feeling chastened, might feel that they have survived a bad crisis and that could embolden them to take on more risks unless regulators begin to take their jobs seriously. That is why I feel that stock markets, in the next few months, would do well. Reality would begin to bite again in 2009, as expectations are too high for economic growth and corporate profits. Enduring floor stock markets is a long-way off. Hopes over the miracles expected of the plan would turn to disillusionment. Market turmoil would return.

It is important to remember that what have been impaired are not just mortgage related assets but also trust in the U.S. financial system and capitalism, across the world. The consequences of that are not easily identifiable and would linger on long after this crisis is over. It is equally important to remember that the Treasury rescue plan contains nothing to repair the impaired trust and integrity.

A year ago, in an interview to Bloomberg, I had said that, by the time the crisis ended, the world of investors would be sick of stocks and real estate. Judging from the market reaction in the last two days, we are far from that point. I stand by that forecast. To that, I would add two more: by the time this is over, the U.S. dollar would no longer be the world’s reserve currency and America would have lost its AAA credit rating.

(These are Dr Anantha Nageswaran’s personal views)

Indian companies have on the whole risen above the meanderings of government, and in so doing have provided a platform for their shares to do likewise.
………

Granted, unlike some of its Asian cousins, India will remain a frustrating place for investors, as sensible policies one week are followed by emotional, knee-jerk decisions the next. But India has never really been a top down story, and anyway, the corporate world has learnt to deal with such vacillation.

Investors should focus on areas that are not dependent on reforms to come but those that have benefited from achievements attained. In essence, these are the general embrace of capitalism over the past 15 years and the state’s change of focus, from monopolising wealth creation to a focus on its redistribution.

Do you agree with Young’s optimism?

(A thanks to reader Vijay Dandapani, who forwarded us this article)

What is interesting in Daniel Yergin’s FT piece is that he deftly sidesteps the question of predicting the future for oil price—near-term or in the long-term. In recent years, he has been proven wrong. His Cambridge Energy Research Associates (CERA) has been bearish on oil since 2004-05.

More important rather than interesting are his comments on the skyrocketing cost of everything from rigs, to ships to technical and skilled personnel. Clearly, for many reasons, the world needs to slow down. Central banks (or more precisely, governments) are unwilling to let that happen. The result is going to be more inflation (for a year or two) and less growth and eventual deflationary bust.

There is no dearth of commentary that predicts an imminent end to oil price. Usually, things happen unexpectedly, just as the rise of oil price itself to present levels. Now that every one and his dog is praying for or predicting a collapse in oil price, I wonder if it would happen now.

In any case, here are two samples of commentaries that call the oil price unsustainable:

In fact, John Hussman finds the contango in crude oil futures as heralding a big slump just as it did in 2006 when the price of oil dropped from around USD 80 to USD 55 per barrel.

He has exited his position in crude oil and has reduced his position in precious metals to 2%. How he proposes to reconcile that with his bearish stance on equities in the U.S.A is something that I have not been able to ask since I do not have his email address. Then, there are the comments by Mr. George Soros. He blamed it on speculators. One Michael Master in his testimony to the US Congress on the oil price spike. He has said that it is caused by index investors.

I do not recall hearing of him before this testimony. Suddenly, his name is everywhere.

It is not clear if these prognostications confuse wishful thinking for forecasts, for buried within its crevices, the Wall Street Journal carried an article on the oil producers shipping less crude than before.

This article refers to the rising consumption in Saudi Arabia and the rapidly declining export from Mexico. It is an interesting read and manages to finish on an optimistic note, somewhat inexplicably (i.e., that is falling oil price). Brad Setser makes an interesting point that this article was buried too deeply in the inside pages of WSJ than it deserved to. See this interesting post by Brad Setser.

Talking of inexplicable conclusions that did not flow from the discussions that preceded it, this paper by researchers by the Federal Reserve Bank of Dallas does the same thing. It argues, explains and convinces us that oil prices are justifably high. Then suddenly it concludes that sustaining triple-digit prices would be difficult.

It is funny and a different story that different people have different persons in mind for “speculators”. If you add them up, just about every one would be deemed a speculator while, of course, all those who invest in stocks that sustain Wall Street are fundamentally driven, analytical and rational.

I think America does not want to see the price of oil to drop so much that it angers the Sheikhs in the Arabian sands so much that they stop writing cheques for bankrupt Wall Street institutions.

See this article for confirmation on America speaking with forked or multiple tongues on this matter. And see this too.

The first line is a gem: “Hank Paulson, the US Treasury secretary, will invite oil producers to invest their petrodollars in the US while urging them to take steps to curb the price of oil in the medium term on a tour of the Gulf that begins on Friday”.

Once America has finished re-capitalising its financial institutions, it would not be averse to seeing the oil price collapse. In fact, it might even actively conspire to bring that eventuality about for biting the hand that fed them is part of longstanding Western tradition.

Geopolitical gains are not trifle if the price of oil continues to remain high, it would also put paid to any fledgling ambition of China (or even the distant India) to overtake America. At the very least, it would push the time-frame out by a few years and with some luck, few decades:

Credit Suisse’ s Dong Tao wrote in their “Emerging Markets Economics Daily” dated May 30, 2008 that Xu Xianchun, deputy director of the National Bureau of Statistics, has suggested that inflation might not peak until 2009 (p. 15).

The longer the oil stays elevated, the longer the persistence of inflation in China and the greater the policy challenge. In the meantime, more money would keep coming into China in search of appreciation.

Brad Setser estimates the rise in monthly reserves in China at USD 74 billions in April. Given that dollar appreciated in April, the actual sum could be about USD 82 billion, nearly a trillion dollar annual rate! There is no need to analyse this. China’s policy is totally and utterly rudderless. Brad Setser is way too polite on this one.

So, for what it is worth (you might be better off tossing a coin to decide), my forecast is that the price of crude oil would drop to about USD 110-115 or so. That is about it. It would then go back to 150 to drive one final nail into Asian economies, shower riches on West Asia and re-capitalise America. Then, once it has done its damage, the missile would be allowed to extinguish itself or burn itself out (pun intended).

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.

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.