Tribal protection or Poverty Preservation

The article with the above title has appeared in Financial Express of May 16, 2018.

Link: https://www.financialexpress.com/opinion/tribal-protection-or-poverty-preservation/1169401/

 

Conversations with an Ex-Naxalite

Warning: I have generally decided that Grammar and spelling are useless appendages. If you are not in that genre, pl pardon. Naxalism, for the uninitiated is domestic militancy or localised terrorism.

This was about 8-9 months back. My driving licence had been suspended and i had to rely on Ola and Uber on holidays.
It was twilight and i had hailed an Uber to get back home from Noida. When the cab arrived, I tried to put 3-4 bags with me beside the front seat before taking the front சleft seat as I always do.
‘How is the day treating you Sir’ Came a confident voice – more of a CEOs than a cab driver. I must have murmured some response since i was still at tucking in the bags between my foot/legs and seat.
Once he started driving, i said everything was fine; the day had treated me all fine. I was looking into his face which had the rediance and lustre of say a Kabir Bedi with a 4-5 day cultivated bread which always stays that way.
Me: Are you from Bihar? (I have generally found that people from Bihar and Jharkhand are loquacious and keep yapping and many times excessively to my discomfort dishing out advice on advice even if unsolicited.
No Sir. I am from south- western orissa -Korapur district.  We have a factory in the adjoining district and so know something about the district and naxalite movement in adjoining areas within Orissa, northern Andhra and Chattisgarh.
Somethings I learnt from him about naxalites during the ensuing conversation:
1      It is not like you people think – that naxalites live a life of complete seclusion from the rest of society – in a demarcated land island with boundaries. they move in and out of society. Most of them do farm work during sowing, transplanting or harvest times in the adjoining villages. during slack or non season (or people permanently unemployed work) their activities peak. Most people know them and their families and activities. people in the vicinity dont have the same level of animosity towards them as people distant from the scene.
2      It is only the top 2-3 who dont mix with or expose themselves to the rest of society. They are nearly completely cut off – and some more people who are not known to move around. But mostly they move in and out of the society.
3      The recruits are drafted based on 3 criteria: Physical strength, ability to execute gruesome pain or crime and thirdly loyalty.
4       There are pay scales and cadre depending on the skill levels and experience and years with the movement and of course ‘performance’. They are all trained in their assigned activities.and there is specialisation.
5       the area under their influence has shrunk slowly. It is more or less finished in Andhra Pradesh. (as someone else confirmed in the late 1990s prominent guys in AP from the affected areas felt unsafe or scared even in Hydrabad; now you can drive thru the areas even at night). In Orissa and southern tip of Cgarh their is a marked downscaling of activities.
6      Many of them have moved into Government contracts – road construction, etc. The Govt knows it and has been helping it along. The local politicians and MLAs (who help them with some moneys sometimes) and sometimes even the police help them along.
7       Govts also dont make too much of their past crimes or issues or hound them or their families. there has been a practical approach in the last 10-15 years which helps in normalising their relationship and rehabilitating.

My mind started weighing the new insights with my pre-existing ones item by item saying yes, no , possibly, unlikely and likely as so on. And i muct have fallen silent for a while.
Driver: ‘Kya hua Ji suddenly completely silent’
‘No No just getting frustrated with the jam. I must have reached home by now. We are not even half way through. By the way can i ask you a personal question?’
Yes

Me: Haven’t you thought of joining the naxalite movement yourself. By what you say, it is not as dishonourable as i once thought it was.
He turned and sized me up for may be 20-30 seconds. I was unnerved for those few moments. Not knowing what was in store.
‘Yes I was’.
Hmmmm… i was a bit relieved now.
‘I was a good student normally topping my class and school right thru. suddenly at the 10th std board exam much to the surprise of my teachers, family and self i plugged in 2 subjects. I gave the papers again 12 months later but failed again. I realised my heart was not in it any more. I was loitering around, no work and leaning on poor parents during the time. almost for a year and more. It singed me that i should earn something and thats when i decided i will take it.

But then i was short on physical parameters. But then since i was good with my science, they agreed to train me as a ‘doctor’ (their brand). The training lasted for 3-4 months. I used to stay with my family and they used to pick me up whenever required.
But then it was mostly during night times at whatever time … 10 pm one day and nothing for a few days and then 3 am – very erratic. It took a toll on my health, outlook and general wellbeing. I was getting disillusioned even while the money was OK.
I must have been on duty for 9-10 months – say about 15 months with them.

I was looking around and a sardar offered migration to Canada and i went to Toronto. There it was … I was hold up for 45-50 days. I didnt have money … so was hardly moving out … mostly confined to the garage level shelter. It was not that the sardar wasnt trying but then it was not easy. I lost hope and decided to forget the Rs 2 lacs i had spent from my familys and self savings and loans and came back to India.
As luck would have it, i found employment as a travel desk operator with a French MNC office in Delhi. I looked decent and spoke good English so i guess i was lucky with that one.
Me: So do you know Mr Nathan?
Him: How can i not know him. He was a top boss. He used to live here only in Mayur Vihar somewhere. (actually the Gman was our beighbour for 4-5 years and moved to deep south on voluntary retirement).
Him: I was with them for about 3-years or so.

So why did you quit such a cushy job?
I thought i knew travel management well and so thought of starting a cab service and after some trials and errors started driving for Uber and Ola. For the last 3 years.

Me: So whats the status of Naxalism now?
Him: Havent really been following. Hardly visit my home town these days. Next time i go there i will find out. Meet them. may be some of my friends will be there.

And then there was a long pause.
I looked at him and now asked him ‘So its your turn to go silent now?’.
Him: After some long pause. In a completely different tone now. The gleam and glitter in his eyes gone and voice not exhuberant or decidedly hopeful like in the beginning.
Dont know sir. I manage to make Rs 15-20,000 a month doing this driving and my wife makes some 10-12 doing some office work. (some catering or some such thing). We have a daughter in 3 std and one 3 years old.

But dont know where i am going in life or what next. feeling lost not knowing what to do. I am just 34 and have so many years ahead. Not a great feeling. And saddled with responsibilities.
Me: Oh nothing new. Sounding bouyant  and pontificating (dont know if thats the proper way to respond). Welcome to the world of people trying to figure out their place under the Sun. It happens to everyone … between 32 and may be continue for you for the next 4-5 years.
even Vivekananda could not escape it. (he didnt seem all that convinced and i wasnt sure if he was taking in what i was saying).
even if you thought you had figured out, many other thoughts and doubts will wash that clarity in no time and you will feel desolate again. You will try to figure out the meaning of life, your purpose and so on. (That was the Philosopher myself for his benefit. Lucky he didnt say Enough. Shut up now and wait till we reach the destination).
I dont think much conversation took place for the last 7-8 minutes. he must have gone deep into introspection.
We reached home may be in 45-50 minutes where it should have taken 20-25 minutes normally. I paid him.
Him:“Hope we meet again soon. Hope fursat milega apko. Please store my number.
Yes I will. You too.
‘Sir you are brilliant conversationist. I enjoyed it with you”. (what a lie. he must have spoken for 90% of the time. and i became a brilliant conversationist!). In any case i rarely am at at the receiving end of such compliments and hence gracefully took it saying ‘No it was all because of you”.
And forgot to store his number.

Make in India spoilt by persistent low manufacturing inflation

A Copy of this appeared in Financial Express on 12-03-2018. Link: http://www.financialexpress.com/opinion/make-in-india-delivery-patchy-heres-why-rethinking-is-needed/1094828/

V Kumaraswamy

Make in India is one of the key cornerstones of the current government to raise growth rates and create employment. It has been almost 4 years since the Make in India was launched with much hope and fanfare. The Government has initiated several useful steps and reforms to actualise it. The most recent upgrade in credit rating and 30-odd points jump in Ease of Doing Business will get us some mileage.

But it is clear that the delivery of Make in India is rather patchy. Several reasons have been advanced for its lacklustre show – highly overvalued currency, unfavourable ASEAN FTA, tight and unyielding monetary policies, very high real interest rates, high logistics costs etc. All of them have a degree of truth.

But it has to be recognised that beyond all these, an entrepreneur or corporate will invest only if they get remunerative prices returns are competitive to what the other sectors yield. This last aspect has not been addressed at all by the Government or inflation conscience keepers. Had this single factor been corrected, Make in India would have had a far better report card to show.

Nature of Indian Manufacture

Indian manufacturing is not high tech where heavy engineering, high end electronics, aircraft and space crafts, ship building etc. dominate. It is relatively low to medium grade in its maturity. It has a heavy dominance by industries which prepare or convert produce from agriculture for domestic consumption.

To give a few examples: Textile sector (the biggest industry by employment) is dependent on agriculture for cotton supplies and silk which can account for about 60% of final product costs, Sugar industry on sugarcane, Cigarette on tobacco, Beedi industry on Tendu leaves and tobacco, Vegetable/ cooking oil industry on sunflowers, groundnut, sesame, Food processing industry on wheat, maize, fruits, fish, poultry and Dairy industry on milk. Roughly 40-45% of Indian manufacturing sector depend on agricultural for their inputs. And a few more for inputs from Mining.

It is important to maintain a balance between input and output prices in these sectors and they should ideally move in tandem, if the manufacturing sector has to stay attractive for investments.  In India since agriculture feeds industry and industrial final goods are sold to those in rural and agriculture areas, any persistent imbalance could hurt both.

Our Manufacturing Prices are down 41% since 2004-05 in relative terms.

Terms of trade in international trade means the prices a country gets for its basket of export goods versus what it pays for its imports and how the relative price moves over a period of time. In domestic trade it means how the prices which a sector gets for its output moves in relation to the prices it pays for its inputs from other sectors.

From 2004-5, the terms of trade have been relentlessly moving against Manufacturing. If the manufacturing sector has had to pay 165% more for its key inputs from agricultural sector, it has been able to recover just about 57% from its customers. If Agricultural input prices are taken as the base, the manufacturing sector is getting nearly 41% less today for what it sells to other sectors compared to what it pays for agri inputs. (see Chart)

WIN_20180312_21_17_06_Pro

At one level it helps transfer of income from non agriculture sectors to rural and agriculture sector and thus corrects income skewedness. But a consistent increase of this magnitude has continuously eroded the margins of the manufacturing sector to unattractive and unsustainable levels leading to lack of enthusiasm in investing.

Reasons

Year on year for almost a decade and half, Agri inflation has been more than parity. This has come about by steep and arbitrary increases in Minimum Support Prices (MSP) announced by the Centre for many crops, especially in 2009-10, 10-11, 12-13 and 13-14 possibly due to electoral compulsions (see Table). Although MSPs are restricted to certain crops, farmers tend to gravitate towards higher MSP yielding crops till the yield per hectare for other crops equalises with those under MSP. Thus MSPs impact transmits with a lag on other crops as well. One has witnessed a similar phenomenon in rural wages consequent upon implementation of NREGA.

On the other hand,  ASEAN FTA agreement has more or less put an effective ceiling on the prices that manufacturing can recover for its end products. Free trade has more or less made recovering cost inflation through domestic price increases an impossibility over the years. India’s over-valued currency has played a spoil sport on top of these.

Need for Correction

India’s growth story to continue requires Indian manufacturing to expand and diversify and create employment for those released from rural and agri sector. As the sector saddled with the responsibility of creating jobs for those entering the market, it should be the one which is relatively more attractive. Unfortunately, things are exactly the opposite for the last decade and a half relentlessly.

Ease of doing business can contribute to encourage entrepreneur by making the state machinery less intimidating but it cannot alter the base investment arithmetic of Return on Investments (ROIs).

Year Wise Inflation for Mfg and Agri Products                     (2004-05 = 100)
Year Mfg Inflation Agri Inflation Agri Inflation / Mfg Inflation
2005-06 2.4% 3.4% 140.3%
2006-07 5.7% 8.8% 155.4%
2007-08 4.8% 8.0% 167.0%
2008-09 6.2% 9.9% 160.9%
2009-10 2.2% 13.1% 589.6%
2010-11 5.7% 17.0% 297.9%
2011-12 7.3% 7.8% 107.6%
2012-13 5.4% 10.0% 185.5%
2013-14 3.0% 11.2% 370.7%
2014-15 2.4% 4.7% 195.8%
2015-16 -1.1% 3.4% NA
2016-17 2.6% 5.0% 195.0%

 

The approach announced in the recent Budget for MSP fixation might lend stability and certainty. If the MSPs are linked to the input prices which should include manufactured items like fertilisers, pesticides, seeds, etc. the inflation of manufactured products would have a decisive say in the agri inflation and hence MSPs. They would get inter locked.

Details are awaited on the exact scheme. Even if a margin of 50% is built in (which should take care of imputed interest, rent and profit besides inflation of inputs), it would build some parity and hence rein in persistent deterioration of adverse terms of trade against manufacturing.

Even so the heavy backlog built up since 2004-05 would need to be corrected if manufacturing is to see green shoots again. The States also should have a say in the future FTAs; they should have a choice of what industries and products to offer for free imports and what products to seek exemption from our overseas importers. States should also have a say in the fixation of MSPs.

A Rebalancing Budget – bottom up from the poorman’s kitchen

An edited version of the article appeared in Financial Express on Feb 21. Link:

http://www.financialexpress.com/budget/how-this-years-union-budget-reflects-a-great-grip-on-and-an-understanding-of-the-poor-mans-budget/1073485
This is perhaps the Budget with the widest sweep since independence – in terms of the % of people whose lives it will impact: mostly positively. Our budget pre or post reforms have shown excessive focus on industries, stock markets, and standard deductions and personal investment incentives for the salaried class. Not many of them would have had an impact on more than 20% of the people.Budgets have mostly been elitist; the economists’ macro sense stopped with fiscal deficits and growth numbers and hardly cared of how benefits were delievered at the door step of the common or poorer man.
Budget – a link in the chain: Poverty and what is being done within and outside budget.
The problems of the poor are (i) low incomes and (ii) high variability even in that limited income, and (iii) very high interest rates which kills all commercial ventures by them.
The Government has announced a MSP pricing formula, which will hopefully push more incomes into rural areas more systematically. Gas connections and proposal to buy surplus electricity from solar sytems will add to their comfort and income. Healthcare in rural areas will also create good employment and enterprise opportunities. And as Dr Devi Shetty (of Narayana Health) points out (TOI, Feb 1), there is great opportunity for paramedics and nurses with 2-3 years’ education after 10th and 12th capable of creating jobs for 5 million of them. This budget will create the demand for such services. If only we had tackled healthcare first thing after independence, may be even population would have stabilised by now.
In the last 2-3 years, the Government has tried to substantially tame the volatility in rural incomes. Crop insurance has already increased significantly -may be to 40% of farm produce during current year from negligible levels 3 years before. Life insurance of 2 lacs (for Rs 12) is already taking effect. The Budget has laid out a blue print for tackling the next most significant reason for debt trap of poor – health emergencies. With these the variability of poor family’s cash flows will come down sharply over time..
GST is formalising the economy. A more formalised economy widens the reach of cheaper formal credit from Banks. This can in turn bring down the interest rates facing the poor. It will come down from 750 – 1000% (the interest rates facing pushcart vendors according to RBI ex-Governor Dr Subba Rao. Page 266, Who Moved My Interest Rates) to a more sanguine number. Imagine what can be achieved if the costs for them comes down to 30-40% per annum which is what a Rs 3 lac crores additonal allocation and Mudra initiative, direct delivery mechanisms, Aadhar authenticated loans, Jan Dhan, etc. can achieve. Entrepreneurship can bloom in rural areas.
The Government has to work on a few more things. One is animal health, which also throws rural poor into debt traps. Agri productivity has been increasing year on year by 2-3 % on average but bumper crops only play spoil sport due to high price elasticity. MSP helps, but food-processing and exports are the real solutions.

Rebalancing gains and losses

The Government’s actions in the last 18 months is fundamentally re-balancing the economy – bringing in large sections into the formal fold by GST, DBT, Jan Dhans and Digitisation, into the tax net (both direct and indirect), and in the manner of intervening into poor households’ family budgets and welfare and most importantly bringing in the rural sector to mainstream economy. This is happening at a rapid pace and is bound to throw up some gainers and some losers. It is but inevitable that the rich 1% who are garnering 73% of annual incremental wealth (Oxfam) will lose to the balance 99% who garner a measly 27% of the wealth as of now.
But this rebalancing will also open up great opportunities. Even if it is just a transfer of wealth and income from rich to poor, since the marginal propensity to consume (MPS) of the tranferee poor is 90-100%, instead of the 50-60% of the rich, it will still create conditions ideal for consumption led growth.
Those who doubt the growth potential of the budget are missing the long term potential. Our consumption base is far too low. Its only the top 20% of population (income wise) who count for anything. When the penetration level of a basic hygiene item like sanitary pads is as low as 17% and that of adult diapers in low single digit, there is a compelling need to expand the base. This budget kickstarts the cycle. Better incomes at rural and urban poor levels will enable better FMCG growth in the immediate 2-3 years. Healthcare products and services will follow suit and create significant opportunites in the ensuing 6-7 years. Without this expansion, our growth would have been slave to a minuscule % of population which it has been so far during reforms.

Critics and their failure to see opportunities

A persistent fiscal deficit of over 4-6% (see accompanying table) seemed alright to tackle the global meltdown whose effect on India proved to be marginal, but a marginal slippage while effecting very fundamental structural changes seems unpardonable. How myopic and hippocritical!.
Fiscal Deficit as % GDP
Year        %
2007-08 2.5
2008-09 6.0
2009-10 6.5
2010-11 4.8
2011-12 5.9
2012-13 4.9
2013-14 4.5
2014-15 4.1
2015-16 3.9
2016-17 3.5
2017-18 3.5
Source: Economic Surveys

Little do those who lament lack of tax cuts appreciate that their economic efforts are rewarded by the society by higher incomes and wealth. The nation has given them access to market and the consumption basket and they need to pay or this access. Without this access, their wealth can never come about – it is two way transaction. Its sad that so much noise is being made about LTCG, when a retired pensioner cannot index his interest incomes and pay tax only on real interest rates.
Of course some of the initiatives will take 7-8 years to clear the cobwebs of culture, habits and bureaucracy to take full effect.

This budget reflects a great grip and understanding of the poorman’s budget and constraints on his reaching ‘escape velocity’ out of his hunger and poverty. It has constructed a national budget from the common man’s – women and men – kitchen upwards and each of his budget line items, so that inclusion of various kinds, delivery of programmes, poverty and hunger removal become integrated with budget making.

The usual commentators including the economic fraternity have scarcely picked up the fundamental directional shifts. They have dusted and delivered the same old cribs. In Cricketese, they are playing hook shots to yorkers because that is the only one they know.

(The writer is CFO JK Paper and Author of Making Growth Happen in India)

 

 

 

 

 

 

 

 

 

With Due Apologies to Pensioners

This appeared in Financial Express on 13th December, 2017 http://www.financialexpress.com/opinion/myths-on-pensioners-busted-check-out-the-real-and-false-arguments/971509/

Inflation Proofing Pensioners – the real and the false arguments

V Kumaraswamy

Our tight inflation targeting in the last 6-7 years are sought to be justified on (i) stable prices being a pre-requite for sustained growth and (ii) that pensioners who largely on interest income should be protected. Such targeting is being achieved by RBI through higher interest rates regime. Similar argument is advanced against correcting our over valued currency.

That the pensioners have suffered in the last few years and will suffer heavily if we loosen controls on interest is a big myth at this point in time when coming out of low growth inertia and near nil new employment creation seems so vital.

Have they suffered in recent times?

The main argument is that the pensioners with fixed income will suffer capital erosion through inflation and will have less and less real capital base to earn their future incomes. If interest income remains constant but expenditure keeps going up year on year due to inflation, progressively they will be left with smaller amounts to consume.

Table 1 clearly shows that this argument is clearly overdone in the last 4-5 years. Ever since the 4% CPI inflation target has been articulated and rather doggedly pursued by maintaining higher interest rates, inflation has fallen steeply whereas the interest rates have not traced the same trajectory.

From 2005-06 till 2011-12, the interest on Bank Term deposits were 1.5% more than the WPI inflation and 0.7% less than Consumer Price inflation. Since then, interest earners have had it good and the interest rates have been more than both – by a whopping 5.6% over WPI and 1.5% over Consumer Inflation.

 

Table 1: Interest Rates and Inflation – Pre & Post 2012
Period WPI Inflation @ Inflation Consumer Prices # Interest on Term deposits @
Ave 2005-06 to  2011-12 6.6 8.8 8.1
Ave since 2011-12 2.3 6.4 7.9

Source: @ from RBI; # from World Development Indicators.

But why the all-round feeling of being left out by the Pensioners now as the social media would have us believe when in real terms their income is 3 times compared to the period before 2012. In the years since 1991 except for a brief period between 1998 to 2002 asset prices have always been going up, in many years faster than inflation. When there is asset price inflation there is the wealth effect which makes us feel wealthier and prone to spending more, as articulated by economists. But once again in the last 3 years, real estate prices have hardly gone up. Without this illusory wealth effect backing, pensioners may be feeling poorer off.

Class of Interest Earners and Pensioners

People in agriculture tilling the land are unlikely to be living on interest income. They till as long as they can and then reply on family as the social security net on reverse mortgage of sorts – family supports them on the understanding that on death, his property will pass onto them. This is 50-60% of rural population. Landless labour are unlikely to be hit due to interest rate variations; they would need a safety net of a different kind. Non- farm rural labour is unlikely to be living off bank deposits.

People who are largely living on interest income are most likely urban or middle class. Most of them hedge their bets and have houses, gold etc. as safety nets and only a portion of their savings is in interest bearing instruments.

Amongst these are retired Government employees, whose pension is adjusted for inflation from time to time if they have been in service before 2004. They are a substantial proportion among pensioners. Those who joined after 2004 are unlikely to have retired by now.  Those who are most likely sufferers are those who retired from private service. Let’s see what proportion these are.

The total term and savings deposits of the banking system as of Sept 2017 is about Rs 114 lac crores and with the MF, Small savings and Public deposits it would be about Rs 130-135 lac crores, which is about 80% of our GDP. The comparative figures for US is more than 150%.  At an average rate of 6.6% this would give an income of Rs 8.91 lac crores or 5.5% of GDP.

From the above, we have to deduct the interest accruing to people still in service and Government pensioners. The income accruing to those who are surviving on interest alone is likely to be less than 2% of population.

Effect of Currency Devaluation

One of the strident and stubborn arguments against correction of our overvalued currency is that it will lead to inflation and hurt the interest of pensioners. The Urjit Patel Committee has summarised the several studies (see Table 2) on India estimating the inflation over the short term and the long term from a 10% movement in Rupee versus USD. With the singular exception of Ghosh and Rajan, the resultant incremental inflation (from currency alone) is likely to be 0.6% in the short term to about 1.5% over the long term. This is hardly worth the scare given the real income of pensioners have risen 3 times since 2012.

 

Table 2: Impact from 10% Depreciation of Re vs US $
Author Period Covered Short Term Inflation Long Term inflation
Khundrakpam (2007) 1991 – 2005 0.5% in WPI 0.90%
Kapur and Behera (2012) 1996 – 2011 0.6% in WPI 1.20%
Patra and Kapur (2010) 1996 – 2009 0.5% in one qtr WPI 1.5% in 7 qtrs
Patra et al (2013) 1999 – 2013 1.5% before 2008 crisis 1% after Crisis – WPI
Ghosh and Rajan (2007) 1980 – 2006 4.5%  to 5% in CPI  
Bhattacharya et al (2008) 1997 – 2007 1% – 1.1% in CPI 0.4% to 1.7% in CPI
Source: RBI – Urjit Patel Committee Report

 

Pensioners Vs Job Seekers 

Should our monetary system be so sensitive to such a small proportion of GDP and the group of people behind that (less than 2%). A 2-3% drop in interest rate in line with inflation would help the investment climate substantially especially in utilising capacities lying idle. The number of new job seekers is about 0.75 – 1% of total population each year.  For years on end the job creation has suffered and they will far outnumber Pensioners and its time their aspirations are also met.

Deposits till death.

If term deposit interest rates spread inflation had been same post 2012 (as between 2005/6 to 2012), Banks would be now saving Rs 164,000 crores on the incremental deposits of Rs 40-odd lac crores. If similar reduction had accrued on Central Government’s net additional borrowings, it would be an additional Rs 74,000 crores. These amounts saved would be sufficient to take care of those who purely depend on interest for survival.

The real sufferers can be taken care of by special deposits which can yield 2 % over CPI inflation s.t minimum of 5%. The deposits can be on joint names of spouses and on death of the latter to die, the deposits can be given over to the designated nominees after deducting tax. If prematurely withdrawn by depositors, the interest can be recalculated as per past prevailing interest rates and the balance of deposit paid to the depositor. Those who are entirely dependent on interest alone could be easily taken care through this mechanism from the potential savings as earlier estimated.

The writer if CFO of JK Paper and Author of Making Growth Happen in India (Sage).   

 

Shape of Economy – Interview with CFO Magazine

 

V Kumaraswamy, CFO, JK Paper Ltd says the new indirect tax law will bring rural economy into the formal fold and, thus, help create an inclusive economy

Is it Time to rework our Monetary Policy Framework?

http://www.financialexpress.com/opinion/what-should-rbi-give-weightage-to-decide-policy-rates-all-you-want-to-know/941225/

My article with the title above (different in title between the Print version and e-paper version) appears in Financial Express today.

 

The government seems to be in a bit of bind over both employment and growth, not for all its as own making. One of the chief contributory to this morass is the inappropriate way the objectives of our monetary policy have been fixed or evolved over the last 6-7 years. The Chart shows clearly the increasing misalignment between the inflation, external value of Rupee (as reflected by REER) and the interest rates caused by the recent shifts in our monetary policy. The Chart uses the WPI instead of the new found CPI which is 57% out of control of RBI’s policies as the report itself admits.

Two main components as it operates in our Monetary Policy Framework are (i) to target a consumer price inflation of 4% with a tolerance of 2%. Both the variable and its levels are recent developments, and (ii) to aim at orderly conduct of the forex markets without seeking to target any particular rates.

Fundamental flaws

Firstly, in both these, the targets are fixed without reference to any end goals in mind. As if these are desirable self-actualising end-goals in themselves. In economics everything is interconnected – inflation, interest rates, growth, employment, productivity, cost competitiveness, etc. To seek a deterministic nominal goal in a web of influences looks naïve at best.

Secondly, the objective that the economy desires to achieve may vary depending upon the stage of growth. It can vary for the same economy from time to time. For EU it is kick-starting growth now, for China is to stabilise it at a high rate, for Japan it is to grow – any growth – even if very low by international standards. For US it was achieving any growth after the meltdown but now slowly crossing over to stabilising inflation. A nominal fixed target does not address these contextual concerns.

Thirdly, economics is mostly about balance and trade-offs between what in general are opposing interests – buyers and sellers, producers and consumers, workers and producers, savers and investors, inflation and growth and so on. One isn’t sure how a nominal deterministic inflation number can work towards an optimal or at least desired equilibrium between savers and investors, between domestic investments and imports at all times even in the medium term.

Lastly, as is explained below, there is excessive and suicidal reliance on the nominal rather than real variables, which is what may be causing the current problem.

No basis

There seems no theoretical basis for the inflation targeting or its levels – not from IMF, not from Basle norms which aims at financial stability or RBI. While nothing can be exact about economics and hence a band is necessary for targets, a 2% tolerance on 4%, is like permitting Usain Bolt to run on his track or the adjacent tracks on either side and the penalties for trespass being imposed 2 Olympics away.

Just orderly movement of forex rates is no policy. When it is clear that it has a significant impact on domestic capacity utilisation, jobs and growth to just aim to only curb the volatility but not be concerned with the values is naïve shirking, much like driving without violating any traffic guidelines or speed limits but towards a wrong destination. By keeping the currency over valued for far too long (over a decade now), we are re-creating conditions of 1991 crisis.

Way forward

Keynes had brought out the true nature of the real and the nominal economy, the rigidities exhibited by the real and how to tweak it by using the nominal to achieve real goals. The current constant 4% inflation (nominal) target can in no way balance the interests between savers and investors, forever. The government should move to a 2% +/- 0.25% real interest rate regime. Whether the inflation is 4% or 9%, such a real interest spread of 2% will be a fair compensation to savers. It will also not curb investment urges if what investors have to pay out is in line what they recover from the market through inflation in prices. This is a sort of inflation proofing both savers and investors.

Such a floating nominal interest (but largely fixed real interest rates) regime will largely ensure that fresh investments and savings do not grind to a halt.

But the existing outstanding stock of savings are in fixed nominal interest regime, which poses problems. It is therefore necessary to move to a floating nominal rate regime and increase its proportion. In the last few years, Bank loans have largely become floating rate with optional repayment and a significant progress has been achieved. It is necessary to increase the proportion of floating rate bank deposits from the savers side as well.

The second thing that is capable of derailing growth and employment in an open economy is the forex rates. An overvalued currency makes imports cheaper, exports far less remunerative which affects domestic employment and growth. A 20-22% overvalued currency as on date is a killer. Government should mandate RBI to walk it along in an orderly manner along the real values. RBI and Government should agree to maintain exchange rates within a band of 97 -103 REER. This REER should be calculated on a base year that is sound when most economic parameters (CAD, fiscal deficit, inflation, growth, etc.) are as close to our desired objective. As it stands now, 2004-05 is one such year. The government should also tailor its inward investment policies accordingly and the degree of capital account convertibility tuned appropriately.

Currently policy rates it appears are decided mostly or solely on inflationary expectations. This can result in fear mongering. In deciding the policy rates, perhaps the actual for the past 2 quarters should be given equal weightage.

By moving to the real from the nominal on both interest and forex accounts, we may have learnt the right lessons from Keynes. Excessive reliance on the nominal on both accounts have made India underperform its potential in the last 4-5 years.