The Indian Economy Blog

September 26, 2008

Guest Post: Is America Ready For Truth And Reconciliation?

By V Anantha Nageswaran

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. (more…)

September 20, 2008

The Cesspool Of Crude Oil Cess

Filed under: Business,Energy,Fiscal policy,Politics,Regulatory reforms — Pragmatic @ 6:35 pm

Did you know that the Indian government imposes a cess on indigenously produced crude oil? The Oil Industry Development Act, 1974 based on which the cess is being charged, states that “the cess collected under this provision would be made available to the development of petroleum sector”. The cess was introduced to provide financial assistance to state-owned oil companies, and is not applicable to private oil producers.

Since then, the government has collected Rs.74972.36 crore as cess, but only Rs.902 crore has been allocated to the Oil Industry Development Board (OIDB) that is supposed to disburse the money to the industry.  In fact, the last allotment of Rs. 95 crore to the OIDB was done in 1991-92. The balance money has gone to the Consolidated Fund of India and added to other revenue accruals.

The cess was doubled in 2002 from Rs. 900 per tonne to Rs.1800 per tonne, and further increased to Rs. 2500 per tonne in 2006, on the ground of providing subsidies to LPG and kerosene. As per the Oil Industry (Development) Act, the amount collected by levying cess on indigenous crude is to be utilised for the development of petroleum sector; the cess was never intended to cover subsidies – either directly or through oil bonds.

Cess is only applicable to pre-NELP [New Exploration Licensing Policy] blocks or acreage given to national oil companies (NOCs- ONGC and OIL) on a nomination basis in which the licensee may be one of the NOCs. The blocks that pay cess on oil are: nomination blocks held 100 per cent by NOCs (for example, Mumbai High), joint venture blocks that were awarded as field development contracts (such as Mukta, Panna, Ravva), and exploration blocks that went on to production (such as PY-3, CB-OS/2).

Now that the petroleum sector has been deregulated and opened for private sector, there is no justification of continuing this cess at all. The private companies still pay about half the cess not paid to the government as increased profit oil [amount of production paid to the government under the production sharing contract] and corporate taxes. Recent newsreports indicate that-

The government is obtaining legal opinion for imposing a special oil tax on the domestic crude oil production under the New Exploration Licensing Policy (NELP). The proposed tax is supposed to kick-in after price of domestically-produced crude oil crosses the $75/barrel mark. While public sector oil producers like ONGC and Oil India would have to fork out to the government 100% of additional realisation beyond the cut-off price, private companies like Reliance Industries (RIL), Essar Oil and Cairn India would be required to pay 40% of their windfall gains.[ET]

Cess, customs duty, excise duty, sales tax, education cess, pollution cess and now a special oil tax. Considering the amount of revenue collected by the government[central and state], the net subsidy provided  to the public on petroleum products is only a political statement, with insignificant net financial entailment.

Coupled with the charade of Oil Bonds, the cess imposed on the indigenous crude oil produced by NOCs is an implicit arrangement of meeting the subsidy burden and artificially containing government’s budgetary deficits. All these measures are but an indicator of the byzantine and befuddled nature of the government budgetary process. It is time someone took up cudgels to streamline and simplify the convoluted government fiscal setup, both of revenue collection and of expenditure.

September 16, 2008

Organized Retailing In India

Filed under: Business — Arjun Swarup @ 8:10 pm

An article of mine got published in the TCS Daily on organized retail in India (The article was first drafted in late ’06- early ’07, so parts of it might appear slightly dated) Here is the link.

Some of the comments are interesting. Here are a couple that I thought I should highlight –

With around 65% of India’s population in about half a million villages – which translates to an average of just 1400 people per village – it is very uneconomical to provide infrastructure services, barring telecommunication services (thanks to the cell phone).

India needs to move its villagers into (newly constructed) towns and villages.

5,000 new towns and cities with an average of 140,000 people per town would surely afford economies of scale. The very creation of these new towns and cities leads to lot of beneficial economic activity.

September 12, 2008

Advent Of The Indian Business Houses

Filed under: Business — Kiran @ 5:42 am

Do Indian business houses have cultural advantages that could help them trump their global counterparts?

In 1988 the Japanese economy was probably at the peak of its glory period. Many years after moving from a low-income to high-income nation within a generation, a feat unsurpassed in history, Japanese businesses were buying high-profile chunks of corporate America. Moreover the Japanese economy was posting much stronger growth rates that the US, which it was widely touted to takeover as the largest economy in the world.

It was against this backdrop that Akio Morita, the legendary co-founder of Sony, published Made in Japan, an autobiography of himself and his company. Being born in the ashes of WW-II Japan, Sony probably reflected the rise of Japan as best as any company. Thanks to its humble and conversational style, the book was a best-seller and reached millions. Importantly Morita makes several comparisons between the corporate culture in Japan, the US and even the Soviet Union, based on his own experiences.

Morita rightly predicted that the manufacturers in the Soviet Union, would not amount to much. But the comparison between the capitalist industrial societies of Japan and the US was most interesting, and not just because the US economy since then has proved more dynamic than the Japanese economy.

September 4, 2008

Resuscitating Indian Retail Industry

Filed under: Business,Human Capital,Labour market,Real estate,Retail,Trade — Pragmatic @ 9:35 pm

Unorganised and organised retail must coexist and flourish in India…

After almost scaring the Tata Motors away from West Bengal, Mamata Bannerjee has now trained her guns on Reliance Retail. Well, Reliance Retail should be used to being targeted by feisty women politicians. Immediately after coming to power in Lucknow, Ms. Mayawati had earlier undertaken a similar exercise in UP.

All this is taking place when behemoths of international retail are trying to enter the Indian market. Tesco has chosen to come with Tatas, while Reliance has tied up with Wincanton. The big daddy of them all, Wal-Mart is coming to India courtesy the Bharti group.

In the September edition of Pragati-The Indian National Interest Review, Prashant Kumar Singh makes significant observations about the confusion surrounding retail industry in India. He rightly notices that-

The debate over retail in India has been fixated on the growth of organised retail, entry of international retailers and concomitant demise of the traditional retailer. The spectre of ogres like Wal-Mart gobbling small retailers has completely paralysed the government on the policy formulation front; not because of any real concern for small retailers but more out of their perceived political clout. This lack of policy initiatives for boosting and regulating organised retail is unfortunately based on the fallacy that modern retail and unorganised retail are necessarily antagonistic.

…Available data provides sufficient evidence that traditional retail is under no immediate threat from organised retail. With the present rate of growth of organised retail of 45 percent per annum, any structural changes brought about by gradual policy shifts will take at least a decade before unorganised retail feels the heat. This assessment is not to condone continued government stupor towards the unorganised sector on the issues of credit availability, access to distribution channels, and realisation of fair price for the produce. It is, instead, meant to spur the government to initiate concrete measures to support the traditional retailers.

…Given the benefits of organised retail, the role of foreign direct investment (FDI) needs to be analysed. It is fallacious to prescribe FDI as the panacea for all the ills plaguing organised retail. The eagerness of international giants to enter Indian markets can be attributed to saturation of the developed markets and low penetration of formal retail in India. The entry of FDI in retail will tilt the balance between suppliers and retailers, force smaller players to adapt and differentiate, and bring consolidation in the sector. The accompanying direct benefits are substantial: increase in exports due to high level of sourcing from India, incorporation of global best practices, investments in the complete supply chain–especially in technologies relating to cold chain, food processing and IT, increase in product variety and categories, increase in employment, and secondary benefits of modern agriculture and shopping tourism. Moreover, this FDI in retail will arrive without any sops and tax breaks from the government, unlike IT and auto-manufacturing sectors, where state governments have been bending backwards to attract investments.

Prashant Kumar Singh makes a strong case that with the right government policies in place, “the ecosystem of the retail industry in India will then adapt itself to accommodate the two seemingly divergent strands of retailing, evolving into an indigenous Indian retail model”. To read the complete piece titled “Retail in Doldrums“, download the community edition(pdf) of the latest issue of Pragati-The Indian National Interest Review.

September 2, 2008

Oil Subsidies Now Get Real

Filed under: Business,Energy,Fiscal policy,Politics — Pragmatic @ 3:34 am

Now, this one is an interesting situation. The Indian government likes to tom-tom the oil subsidy bill as a proof of its socialistic credentials; the media targets the government for unfairly subsidising the expenditure of the middle class; and most economists lay the blame at the door of the government for distorting the free market mechanism of price determination via these subsidies.

There are three duties/ taxes collected by the government on the sale of petroleum products. The state governments collect the sales tax while the excise and custom duties go into the kitty of the central government.


Product Excise Duty Customs Duty(%)
Crude 2500 (Rs/MT) Cess


Petrol Rs. 14.35/litre


Diesel Rs 4.60/litre


Now, let us take a look at the actual revenue collected by the government from excise and customs and subsidies provided via the oil bonds and direct subsidies on LPG and PDS kerosene. During the last three years:

(In Rs. Crores) 2004-05 2005-06 2006-07
Revenue from customs and Excise 54738 61221 68864
(i) Fiscal subsidy for PDS kerosene and domestic LPG 2956.34 2682.96 2606.17
(ii) Oil Bonds —- 11500.00 24121.00
Total (i +ii) 2956.34 14182.96 26727.17
Subsidy as a % of revenue 5% 23% 39%

The government has now announced that it will issue oil bonds worth Rs 94,600 crore in the fiscal year 2008-09. If the revenue collection rises at the same rate, it would be to the tune of around Rs 77,000 crore in 2008-09. The subsidy for kerosene and LPG is at around Rs 3000 crore. So, the government will suffer a net loss of nearly Rs 20,000 crore in providing petroleum products to the citizens of India. Phew! 0.4% of GDP wiped out in one go.

These figures might themselves portray a wrong picture. For the first quarter of 2008-09, the government had decided to issue bonds worth Rs 24,500 crore while estimated losses of the Oil Marketing Companies (OMC) were at Rs 52,000 crore during the period. Moreover, the government’s share of meeting under-recoveries through oil bonds is now 57% from the earlier 42.7% of the total under-realisation on fuel sale. Another 33 per cent comes from upstream companies like the ONGC, GAIL and OIL. The remaining losses are borne by the OMCs themselves.

These oil bonds are a very neat short-term solution that pledge our tomorrow for a cosy today. The interest rates at these bonds are estimated at around 8.75 to 9.5% and reports suggest that the RBI has now stopped purchasing them under the special market operations(SMO). Under the SMO, the central bank used to buy the oil bonds directly from the OMCs and pay them the equivalent amount in dollars, allowing them to buy supplies. In the current year, the interest burden on the oil bonds is budgeted at Rs 5520 crore. With the  issue of oil bonds this year, this burden will become onerous and will cost the exchequer around Rs 13,000 crore in the next fiscal.

All this will add to the burgeoning fiscal deficit this year. But the finance minister, with his wizardry, of keeping the oil bonds out of the official fiscal deficit, will still be able to peg the the fiscal deficit at 2.5% of the GDP.

The more prudent mechanism of granting statutory liquidity ratio (SLR) status to the oil bonds has also not been accepted by the government. The SLR status gives immediate relief to OMCs by way of liquidity induced by participation of bigger players like banks, gilts and mutual funds, apart from existing pension, provident fund and insurance players that trade less and hold on to the papers till maturity (around 10 years). The SLR bonds are highly secured and liquid in nature as they are sovereign guaranteed. SLR bonds are those issued by the government at market rates to fund its various borrowing activities every year. Banks are required to subscribe to them, as they are mandatory requirement stipulated by the Reserve Bank of India. Currently, banks maintain 25% of their net demand and time liabilities in SLR.

Thus, while free pricing mechanism for oil products in India remains a pipe dream, granting SLR status to oil bonds seems to be the judicious course of action. However, the bonds that typically come under SLR, or statutory liquidity obligation, form part of the fiscal deficit. The government, bound by the FRBM act, is thus avoiding the SLR status for oil bonds like a plague.

There is big trouble with this sanctimonious approach of the government towards maintaining the fiscal deficit within the stipulated target. A similar exercise at fudging the balance sheets by a corporate house would have attracted the ire of the government auditors. Keeping the ethics of governance apart, the present approach has far-reaching implications for the oil industry. OMCs will continue to bleed and the cost of burden-sharing on the part of the upstream companies will rise. Both will become victims of a serious financial crunch, which will adversely hit their plough back and investment plans.

The government, too, will not emerge unscathed. This resort to oil bonds, besides being blatantly unethical, is neither fiscally prudent nor does it tackle the problem posed by spiralling oil prices, falling growth rates and rising inflationary pressures effectively.

Update – Vikram S Mehta in today’s Indian Express asks some pertinent questions on oil pricing:

…why does the government persist in appointing committees comprised of professionals to address what is essentially a political subject? Surely they must know that no individual worth his professional salt can help the government skirt the political conundrum of volatile petroleum prices. Why does the government not now contemplate kicking the ball into the court of the politicians? After all if there is to be progress it can only be if the politicians resolve somehow the political dilemmas of oil. My suggestion is that the next committee on petroleum should comprise of politicians and should be asked to come up with bold and practical suggestions on ‘how’ to implement what everyone knows must be done.

Update 2 (September 04) – Urjit Patel, writing in the Business Standard, highlights the dangers of RBI acting as an oil spigot and contends that the scenario is emblematic of the insidious distortions in virtually the entire energy chain.

It is estimated that oil bond issuance over the current fiscal could be about 2 per cent of GDP; therefore, the money due to the oil companies from the Union government is expected to be huge for the foreseeable future. Unless there is a sharp correction in oil prices or a policy combining adjustment in domestic retail prices and reduction in government duties, the oil companies will continue to require help to source the foreign exchange to import crude oil (although the SMO has been ascribed as a temporary facility). If demand does not adjust, supply will; reports of long lines at diesel pumps in several states show that the oil companies are responding in a manner that is feasible for them. In some parts of the country, demand for diesel for generation sets has increased after the recent price hike because electric supply shortages have intensified. The whole scenario is emblematic of the insidious distortions in virtually the entire energy chain in India.

Several conclusions and observations can be made. First, the dire fiscal situation that the central government finds itself in has now sucked the RBI in its vortex, but it is to be hoped that a durable alternative mechanism will be put in place with alacrity to ensure that the SMO is not further resorted to; it can be argued that some of the hard work over the past decade to ensure that the RBI’s proximate objective for conducting monetary policy is not compromised — by getting stuffed with government paper — has been undone. Secondly, we would be hard-pressed to name another country (even among those that subsidise fuel) that has had to resort to the central bank in this manner. Thirdly, praying for international crude prices to adjust sharply downwards soon does not constitute government policy, sound or otherwise. Fourthly, the proceeds of the oil bonds upon maturity will be in rupees, hence the RBI, if it wants to rebuild official foreign currency assets to make up for the decline on account of the SMO, will have to intervene in the market at the time and buy foreign currency at the ruling market exchange rate (the central bank shoulders an exchange rate risk if rebuilding foreign currency reserves is an objective).

August 19, 2008

Entrepreneurship Vision India 2020

Filed under: Entrepreneurship — Pragmatic @ 7:29 pm

Sramana Mitra, entrepreneur and strategy consultant in Silicon Valley, has a very interesting series of essays on future of multiple entrepreneurship in India. It is currently on to its seventeenth running segment and one can do no better than introduce it by quoting from Sramana’s preface to her Vision India 2020 Series:

I invite readers to take a journey with me into the future through the minds of multiple entrepreneurs, who by addressing the opportunities I see today, will perhaps shape the future of India.

It is a novel effort from Sramana. Wouldn’t it be great to engage more Indian entrepreneurs’ imagination around this series?


Other segments of the running series can be accessed at MIT India, Urja, Lucid, Darjeeling, Renaissance, Gangotri, Maya Ray, Elixar, Bioscope, Thakur, AdiShakti, Framed Ivory, OishiDoctor At Hand, Doctor On Wire, and NCTV.

August 5, 2008

Coals To Newcastle… And Bengal?!

Why is Bengal, one of the largest sources of coal in the world, importing coal from abroad?

Long-time reader and IEB friend, Joydeep Mukherji sent us this article with a comment:

The West Bengal government has decided to import one lakh tonne of coal at higher rates to fuel the thermal power plants which have not been able to meet the power demand recently for wet and substandard coal.

The resulting rise in the cost of power would have to be borne by the consumers, State Power Minister Mrinal Banerjee said when replying to a motion moved by the Leader of the Opposition Partha Chatterjee in the Assembly today. (ET link)

This article highlights the lunacy behind the intersection of economics and politics in India. India has the third largest deposits of coal in the world, and much of that is in Bengal. However, India imports coal since it is easier to procure and cheaper to buy abroad. Even Bengal is now importing coal since its own coal industry is hopeless.

The problem lies with the monopolies granted to Coal India and other public sector companies, leading to government restrictions and pricing policies that breed black markets and shortages. The coal sector has barely been liberalized despite nearly two decades of reform.

Politically, any ambitious politician from Bengal, Jharkhand or Bihar imemdiately seeks the Coal Ministry (or the Railways as a back up). The goal is not to develop the coal sector to make Bengal and Eastern India a prosperous region based on ample energy. On the contrary, the goal is squeeze as much bribery out of that industry and employ as many party workers in it as possible.

With such an outlook, is it a surprise that Bengal is importing coal? The fact that few people in India even see the irony of this situation shows how deeply the rot has set in.

Strategic fools occasionally write about Indian energy companies buying or investing abroad, often in competition with Chinese firms, describing such actions as if they were epsiodes of combat in a ‘Great Game’. Note that no one points to the reasons at home that lead firms to look for supplies abroad.

July 15, 2008

Caste And The Gentleman Class

Filed under: Human Capital,Miscellaneous — Karthik @ 8:28 pm

Writing in his latest book A Farewell To Alms UC Davis Professor Gregory Clark provides insight into the possible reasons why the English (and Europeans in general)  are on the whole considered “gentlemanly” and more “polished” (except while watching football, of course). Clark’s reasoning can also be extended to explain why India didn’t develop in the same fashion.

Clark writes:


The Darwinian struggle that shaped human nature did not end with the Neolithic Revolution but continued right up until the Industrial Revolution.




… economic success translated powerfully into reproductive success. The richest men had twice as many surviving children at death as the poorest. The poorest individuals in Malthusian England had so few surviving children that their families were dying out. Preindustrial England was thus a world of constant downward mobility. Given the static nature of the Malthusian economy, the superabundant children of the rich had to, on average, move down the social hierarchy in order to find work. Craftsmen’s sons became laborers, merchants’ sons petty traders, large landowners’ sons smallholders.

This framework possibly explains the classification of the English as “gentlemanly”. An extremely high proportion of the population in England has its backgrounds in “gentlemanly” famlies. Over the generations, their professions may have changed but they still retained their basic cultural traits – which were once gentlemanly.

On the same lines, one wonders why this kind of development didn’t happen in India, and the answer lies in the caste system. Given the rigid caste system here, it wasn’t possible for people to “downshift”. Given its tight linkage with profession, what the caste system did was to freeze the proportion of various castes in the total workforce.

Hence, even if the upper caste/class people managed to produce more surviving offspring, these offspring weren’t able to migrate to other “lesser” professions.  In other words, the survival of the fittest happened within castes. It was not until much after the industrial revolution and urbanization and the development of modern medicine, that people of different castes started professionallly competing with each other.

July 8, 2008

Guest Post: Mukesh Ambani Under Fire

Mohit Satyanand

Though I have never invested in the shares of Reliance Industries, my recently gleaned understanding of the world petroleum scenario has made me respect the company’s vision in its refining projects. As I mentioned once earlier, RIL’s existing refinery, and the one nearing construction, reportedly have unparalleled flexibility to process heavy, high-sulphur (so-called sour) crude, especially that emanating from Iran. This crude sells at a huge discount to other crudes; once it is refined into diesel, though, RIL is able to sell the resultant distillates, especially diesel, into a world market which is thirsty for such products.

Most mature consumers, the US especially, have made no investment in refining capacity over the last 2 decades, and strategic thinkers in the petroleum industry go so far as to say that RIL’s investments are changing the pattern of world flows in petroleum and petroleum products.

For this reason, I have recently turned from a bear on RIL to a mildly positive neutral. Until last week, that is. With Mulayam Singh and Amar Singh all but in the ruling coalition, suddenly life has become difficult for Mukesh Ambani. The first salvo across his bows was a minor irritant, namely the questioning of concessional import duty paid on two private jets.

More significantly, there are now calls for a ‘windfall tax’ on profits RIL is making on its refining operations. Nothing could more arbitrary than such a tax; windfall taxes have been discussed in the US, on the extra profits oil companies make when commodity prices suddenly ramp up – the implicit logic being that the companies have done nothing to earn this extra profit. I disagree with such taxes, in any case, since anyone who invests in an industry, resource-based or otherwise, runs the risk of prices being lower than he anticipated – in which case he is not compensated by the exchequer.

But in the proposal that RIL be taxed, all one sees is the vindictiveness of those opposed to him. If RIL is making higher profits than other refineries, this is due to its far-sightedness in investing in a more complex and sophisticated refinery. The profits accruing from such an operation are far from a ‘windfall’, a term normally used to describe a lottery win, for example.
If this nonsensical suggestion is accepted by the government, it will send out a signal that Indian governance is of the banana republic variety.

Mohit Satyanand is consulting editor at Outlook Money

Economic Illiteracy

Filed under: Basic Questions,Education,Human Capital,Media & Economics — Prashant @ 7:06 am

Mukul Asher, a professor at the LKY School of Public Policy in Singapore and Amarendu Nandy, a research scholar at the same university, have a thought-provoking guest post:

A recent ASSOCHAM Business Barometer Survey of 258 faculty members of MBA programs in India found that most professors did not know basic facts about the national and global economy.

“89 per cent of the teachers were unable to tell the GDP growth rate scaled by the Indian economy in the financial year 2006-07.

The survey further divulged that hardly 6 per cent of the lecturers surveyed read any business newspaper on regular basis. Moreover, persistent readers of business magazines were negligible”.

The appalling ignorance of these faculty members is symptomatic of an endemic financial and economic illiteracy among wide sections of Indian society, including intellectuals, media, politicians, policymakers, and the bureaucracy.

India’s economic illiteracy explains the pedestrian quality of most discussions about the economy — they rarely reflect an appropriate mental picture of India’s economic structure, its sources of growth and competitiveness, its vulnerabilities and challenges.

As we explain at more length in our Pragati essay, in terms of immediate public policy priorities, incorporation of economics in the education curricula is essential for multiple reasons – to increase the employability of graduates, to help manage social change better, to ensure more effective design and delivery of public services, to obtain a better ROI from budgetary outlays and ensure better governance.

Speaking of governance, for instance: policymakers are not sufficiently held accountable for their poor decisions which display a shameful and at times, willful, ignorance of basic economic principles. A prime example (just one of many) is the National Rural Employment Guarantee Scheme, which ignores the vital concepts of opportunity cost and moral hazard, and is not based on robust empirical evidence.

India’s hopes of moving into the 21st century and its dreams of reaping the so-called demographic dividend are unlikely to fructify unless the education establishment at the Centre and the States rethink the curricula and its priorities.


1) Do you agree with Asher & Nandy? If so, how does that square with Ramesh Venkataraman’s view that “today’s electorate is starting to view government less as a mai-baap granting entitlements — seats in colleges, jobs in the public sector, subsidies — and more as an enabler of opportunities.”

2) At first blush, I would have assumed that an economically literate populace was a prerequisite for sound economic policy decisions. However, is that really true of the other developing countries, especially the Asian tigers? Can someone with first-hand experience of those countries comment? And, if they’re as bad as (or not much better than) India in terms of economic illiteracy (as I suspect), what explains their economic decision-making? The East Asian countries’ economic policies may be far from ideal, but I find it hard to believe that they’ve managed to come so far and so quickly on the basis of worthless economic policies.

June 24, 2008

Guest Post: An Exercise in Damage Assessment

Filed under: Business — Nitin @ 7:34 am

By V Anantha Nageswaran

For a while, at least, Asian currencies are caught between rocks and hard places. We struggle to construct realistic scenarios under which Asian currencies rally. Only a credible and reasonably aggressive policy response to the inflationary impulse washing through the region would do that. It would restore policy credibility, improve local currency returns for domestic savers, and slow import growth, thereby acting to restore trade surpluses. The actions of most regional central banks thus far, however, fall short of what is needed.

While exports in some countries have softened of late, the negative impulse from global slowdown remains modest. Policy, however, has for some time been set for a sharp growth slowdown and fears about imminent export slowdown have dominated policy announcements for quite some time. While more recently this has been joined by verbalized concern about inflation, the relative inaction of central banks suggests that concerns about future growth still dominate. The effects of this policy loosening were compounded by the food price shock, and the existence of price control regimes in a number of markets, which concentrated the adjustment in a way which did not occur in countries with freer pricing regimes.

Our economists, therefore, argue that not only is inflation in Asia generally likely to remain high over the next few months, and even increase further in a number of countries, but it is likely to be much slower to come down than most expect. It is no coincidence that Taiwan and Singapore have had the strongest performing currencies this year, and they are the only central banks that are tackling this issue reasonably proactively.

The key here is that it would be a mistake to argue that high commodity prices are the only reason policy settings have ended up being too loose. Policy was set for recoupling in almost all markets in Asia, and yet decoupling in exports and GDP growth has persisted. Chart 3 (see below) shows an average core CPI for Asia ex-Japan. Clearly, once we account for the contributions of food and energy price inflation, Asia’s inflation issues are not settled. Along with concerns about policy being too loose, growth decoupling has contributed to a surge in imports, which has been compounded by the rise in commodity prices, to result in sharply worse trade balances. Decoupling has ended up not being all that it cracked up to be.

Source: Emerging Markets: FX Road Map (June 2008), HSBC Global Research

Certainly, the independence of central banks is an issue. As well, the political environment in many countries is doing little to help central banks respond to the inflation threat in a way which is most prudent from a longer term perspective, but also most uncomfortable from a shorter-term perspective.

[All of the above capture our views on Asian macro-economic policy rather well and are excerpted from the following publication: “Emerging Markets: FX Road Map (June 2008)” from HSBC Global Research]

Realistic to have assumed no de-coupling
To be clear, it was realistic on the part of Asia not to have assumed de-coupling on the part of Asia from the ongoing troubles in America. But the mistake was in setting “no decoupling” policies proactively without waiting for slowdown to set in, in American consumer spending. American consumer is yet to flinch and, perhaps, is acting with even higher than usual optimism in visiting shopping malls. They are trying to drown their blues in shopping and, in the process, setting themselves up for deeper blues in the years ahead.

But, policy was set in anticipation of slowdown
The important point here is that consumer-spending weakness in the U.S. is yet to set in. But, global monetary policy is too loose already as this chart below from JP Morgan shows. The global policy rate is far below where it ought to be, according to the simple rule devised by a U.S. academic John Taylor teaching in Stanford University.

Source: Global Data Watch, Economic Research, JP Morgan Chase Bank, New York, June 20, 2008

Be prepared for deeper and longer downturn
The troubling message from the chart above is that there is not much room to ease policy (and we include fiscal policy too) when they are likely to be most needed in 2009 – when the consumer in the U.S. wakes up to the reality. The absence of policy lever should lead to the acceptance that the economic impact on Asian households and the earnings impact on Asian corporations would be deeper and longer.

Where is the floor for Asian asset prices? – lower than you think
What is clear is that the price for these policy errors has to be paid in the form of lower asset values. That means weaker currencies, higher bond yields and declining stocks. The process is currently under way. Most of the Asian stock markets have yet to breach the previous lows reached either in January/February 2008 or in July 2007. That has to happen first. Hence, prices must first reflect bad news. Second, the flow of bad news must stop. Since much of the bad news is in the form of policy errors, the turnaround must start there. That is, policymakers must acknowledge their mistakes, promise a credible timetable for reversing them and begin to implement a few steps. Frankly, we are far away from that in Asia as admitting mistakes in public is not very Asian. Therefore, the floor for Asian assets is probably lower than it is for other regions, particularly in the West.

(These are the author’s personal opinions and do not necessarily reflect those of his employer)

June 9, 2008

Don’t Write Off India Inc?

Filed under: Business,Capital markets,Growth — Prashant @ 5:56 am

So says Hugh Young in the Financial Times

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)

June 6, 2008

5% Cut Not For Defence Expenditure

Filed under: Basic Questions,Fiscal policy,Monetary policy,Politics — Pragmatic @ 6:14 pm

Let us rejoice at the government’s consideration for the defence services. As per the finance ministry’s directive on austerity measures for the government,

All non-plan expenditure heads excluding interest payment, repayment of debt, defence capital, salaries, pensions and the finance commission grants to states will be subjected to a mandatory 5 per cent cut.[IE]

Does it really matter? After all, the unutilised amounts of defence expenditure for the tenth plan [2002-2007] were 14.46% of the total allocation.

Chicanery, in its purest, unadulterated bureaucratic form…

June 3, 2008

Upsetting Oil Pricing Conundrum

Filed under: Energy,Growth,Politics — Pragmatic @ 11:31 pm

Earlier post on the subject: Oil Pricing in India

Vikram S Mehta, chairman of the Shell Group of companies in India, provides the structure of the price build up for petrol and diesel by the public sector companies in India.

Indian Oil Corporation (IOC) calculates inter alia the landed import duty paid price of petrol and diesel every fortnight. This calculation is based on a formula that is linked to international prices. IOC’s landed price of petrol in Mumbai for the second fortnight of May was, for instance, Rs 38.1 per litre and for diesel Rs 48.8 per litre. The marketing companies had to, in other words, pay this amount to the refiners to buy the products. Next, the Central government imposes an excise and educational cess on the purchase cost. In May, this was Rs 14.4 per litre and Rs 0.4 per litre for petrol and Rs 4.6 per litre and Rs 0.1 per litre for diesel respectively. The total cash required by the marketing companies to purchase petrol and diesel in May was, therefore, Rs 52.9 per litre for petrol and Rs 53.6 per litre for diesel. The companies then sell these products at the ministry of petroleum mandated price of Rs 49.7 per litre for petrol and Rs 35.6 per litre for diesel (Mumbai prices). As such, they lose Rs 3.2 and Rs 18 for every litre of petrol and diesel sold respectively.

That, however, is not their total loss. They have to also pay sales tax to the state governments. In Mumbai, this tax is Rs 10.6 per litre and Rs 7.1 per litre for petrol and diesel respectively. Thus, the total cash loss suffered on account of the sale of 1 litre in Mumbai is Rs 13.7 and Rs 25.1 for petrol and diesel respectively. This is, in other words, the amount by which prices would have to be increased at the retail outlet for the companies to simply break even on a cash basis. Such a hike is, of course, out of the question.[Indian Express]

Many in the public domain believe that the imbalance can be redressed by reducing the central and local taxes to make the public sector oil companies profitable. However, it is actually not about reducing the taxes to bring the prices down. That is just an indirect way of maintaining the subsidies. On one hand, the balance sheets of the oil companies might look healthier and higher profits might allow theme to disburse handsome dividends. On the other hand, the government revenues would come down and higher revenue deficits will bring the finance ministry into the FRBM dragnet. It is not a Morton’s fork but a Hobson’s choice for the government — to link the retail rates of petroleum products with the market rates.

In case of most other commodities, the high consumer price checks demand. This helps restore the supply-demand balance. As prices are not linked to the rising market rates, oil demand is not checked commensurate with the price change. It obviously creates an asymmetry in the supply-demand balance and can be only restored at much higher prices. By then, it might be already too late for the Indian economy.

Now let us look at two sensible, yet asynchronous, viewpoints on resolving this pricing conundrum. In the same piece, Vikram Mehta prescribes the policy framework for a comprehensive petroleum policy.

First, we should accept that high oil prices are here to stay. This does not mean we will not see sharp declines from present levels. What it does mean is that we will not see prices stabilising at levels significantly below a triple digit number. Second, we must create a mechanism that leads to a ‘graduated’ reduction in subsidies, an orderly alignment of domestic prices to international levels and a more efficient disbursement of financial support to the poor. Third, we must reverse ‘dieselisation’. And finally, we must recognise that the sine qua non of energy security is a robust and competitive domestic petroleum and energy sector.

Fellow blogger Atanu Dey has a much simpler, but more innovative solution to offer to redress this perverse subsidy for the rich.

The basic economic truth is that there is really no such thing as a free lunch. Today’s subsidy comes at a cost that will only grow larger the longer the delay in pricing petroleum products at full cost. It is fairly simple to remedy the situation. Raising the price at the pump is the simplest but the most politically risky. The UPA government knows that and will definitely not risk losing power even if raising prices is for the larger benefit of the economy.

But those subsidies have to be reduced, if not totally abolished overnight. A start could be made immediately to reduce the subsidy to the rich while continuing it for the poor. A mechanism for doing so would be to impose a tax on car owners which would reflect the full cost of the petrol they use. Depending on the size of the engine and average fuel consumption, an annual fee could be assessed which has be paid to maintain registration. So if a particular make and model of car typically consumes, say, 1,000 litres of petrol a year, the tax could be Rs 10,000.

This type of a mechanism would leave all two-wheelers, three-wheelers, and buses untouched. Since it is usually the common man who uses public transportation, the common man would continue to enjoy the subsidy.[Deeshaa]

One can only wonder if Rs 200,000 crore in oil subsidies, nearly 2% of India’s GDP, is not alarming enough for the government to pay heed to such sensible opinions.

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