Inertia or Hangover!?

Anyone who has been following the Indian economy would have noted the growth momentum slowing and high inflation having adverse affects on the lives of the poor. There are two main reasons for this slowing growth momentum:

1. External factors – US unemployment, Europe’s sovereign debt crisis and high oil prices.
2. Internal factor – incomplete or stalled economic policies within the country.

While there isn’t much that could be done to the external factors affecting the economy, definitely a lot could be done on the internal policy making. In fact, on the external front, I would say, India has managed pretty well. Due to its high savings rate and a booming middle class, India was able to sustain the domestic demand to a considerable level during the last two years of tough economic climate. Indian exports rightly diversified and penetrated deeper into the South American, African and East Asian markets, which helped offset demand sluggishness from traditional western markets. But even exports to the sluggish western markets weren’t that adversely affected – thanks to supportive policies from the government and the entrepreneurial strategy of the Indian businesses to acquire, learn, consolidate and expand (and of course, the cost saving methodology of the western companies played a role here).

But on the internal front, very much expected (and needed) reforms were not done. This has caused not just the inequality to grow during the years, but has also resulted in the stalling of the growth in the quality of living standards for many Indians – and that includes the middle class. A reason to worry is the decline or lack-of-growth in the foreign direct investment (FDI) in the country. With western markets facing a sluggish demand, India could have attracted a lot more growth-oriented FDI from western businesses who seek to tap into the booming eastern markets. But for some reason, these concerns, though well known, weren’t addressed. And if the slowdown in FDI was rightly looked into and addressed appropriately, India could have used the world’s cash resources at the right time to seek its own growth through the attractions it has in today’s world economy.

One of the cases I would like to make on this is in allowing FDI in the multi-brand retail sector. It is true that millions of Indians all over the country are in the informal retail sector, called mom-and-pop stores. But it is also true that there are even more millions who have been very adversely affected with inflation that has remained at uncomfortable levels for more than two years. And not to mention the food inflation that has remained dangerously in double digits for the last two years. Initially, the food price inflation was attributed to poor monsoon in the year 2009. But subsequent monsoon seasons in 2010 and 2011 have been successful - yet, there has been no success in bringing down food inflation that affects the poorest of the poor much. Some would now argue that this proves that it is a genuine supply-demand mismatch. While that is true, what is also true is that this mismatch is not caused just due to natural factors. Yes, undoubtedly, I sense, hoarding is taking place, where a huge industry of “middle-men” are getting benefited. Food prices have gone up by unimaginable levels, yet farmers remain poor, to the level of committing suicide sometimes, and non-farming related poor too suffer unimaginable consequences due to these high food prices.

By not allowing a 51% FDI in the multibrand retail sector, government is not helping the mom-and pop store owners, but rather, either knowingly or unknowingly, is helping domestic big shots and corporations, where their entry into virtually every field, without prior experience, is seen these days. This has only further increased inequality, apart from affecting the standard of living for the Indian consumers – since the new entrants, who were not experienced in this sector before, offer poor training to its employees, poor services to the consumers, poor quality and incompletely provide the benefits that one would expect from such big corporations jumping into businesses. Having concerns for those mom-and-pop store owners in towns and villages across the country, I would suggest starting a pilot program by allowing foreign multi-brand retailers to setup stores in tier-I and select tier-II cities across the country (and yes, the allowable limit can be 51% - with rules and regulations favoring backend and long term investments, and the 49% is for the domestic companies to learn, adopt and further invest). After all, I think its time to concentrate on improving the quality of lifestyle for many middle-class and poor Indians. And I believe foreign investment (initially in tier-I and select tier-II cities) in this sector would help India achieve this.

My personal belief is - this will also help in addressing the deficiencies India has in the farm-to-fork structure. Food processing and cold storage can be expected to come up, that would reduce the amount of grains and vegetables from getting rotten - which will help in bringing down food inflation, more income to farmers, meeting demand, more foreign technology and training to domestic youth – all of which should improve the standard of living and reduce inequality. And this will also force public investments in roads and other vital infrastructure. While I am not finger-pointing the retails sector alone here, it is also becoming true for many other sectors.

And almost the same applies for the Infrastructure sector, where more than $1 trillion is needed in the next 5 – 10 years to meet the demand. When it comes to infrastructure, the FDI limit in the insurance sector being just 26% is preventing many foreign corporations to step up investments.

It is important that India stops calling itself poor for the sake of adopting polices, which in the name of “helping the poor”, isn’t really helping. While it is a fact that India has the world’s largest number of poor people, it is also true that some Indians (or Indian corporations) have extra-ordinary amount of money, with no experience in certain sectors. With lack of FDI, and thereby the lack of foreign competition and technology, these Indian corporations are tempted to jump into sectors where the demand is enormous from the booming Indian middle class – thereby reducing quality and increasing inequality. This sometimes makes me think that, though the night-out with “License Raj” is over, its hangover remains, in form or the other.  

Inter(Euro)National Monetary Fund

As soon as it became clear that the International Monetary Fund (IMF) requires a new chief, Germany and other European council members jumped in to say, or rather assert strongly that the next IMF head should be a European (as always been). But such a public announcement of preference (or requirement) has rekindled the question of credibility and correct international representation in the IMF. With the amount of voting shares the European nations have in the IMF, it was unnecessary to go public in asking a European to be the next IMF managing director. All that they required was to talk to themselves and bring in US and few other countries on their side to select a European as the next IMF chief. And the reason that the European nations say for this - that with the amount of debt problems faced by the Euro zone countries it is only appropriate for a European to head the IMF, is inappropriate at best. No one recalls an Asian heading the IMF during the Asian financial crisis in 1990s.

IMF is an international institution with 187 member countries that is meant to be transparent to its member countries in its operations. And a single person at the top of the IMF cannot take decisions solely based on his thoughts. So why does Germany or any other European country think that only a European would fit in that post? How are the non-European countries supposed to interpret this? - 1. That non-Europeans are not capable to handle this post? Non-Europeans are not trustworthy to discharge duties without any bias? Europeans are using this institution in their favor in a biased way? Tradition should not be changed? The answer that the European nations give is that they need someone politically savvy to understand Europe's debt problems. But what happens after Europe's debt problems are brought under control?

Rather than controlling their fiscal problems within their own region (Euro) by forming strong Euro-institutions, the Euro zone countries are trying to leverage the power they have in an international institution. But anyways, all that one can say is - We knew this and we don't care for now. Now don't be surprised (or angered) if an Asian Monetary Fund (or talks of it) props up sometime in the future.

Food Security - It's Time to Act!

When I wrote my first blog article in August 2009, I touched upon the topic "food-inflation" in India. And at that time, food-inflation was expected to arrive due to poor monsoons in India that year. And as expected, food-inflation kicked in. It went up all the way to around 20% (with some vegetables hitting triple digits), held steady around that rate for quite sometime and started coming down through the year-2010. But in the last month, due to enormous rise in onion prices (and many other food-prices such as those of vegetables, milk etc that never came down in reality), food-inflation started shooting up again and now stands at around 18% in India.

In South Korea and Thailand, food-inflation is felt. In Russia, due to heat-wave and drought that destroyed wheat crops last year, food-inflation is felt. In Pakistan, due to floods that damaged wheat crops, food-inflation is felt. In United States, even when everyone speaks about the fear of deflation, corn-prices have risen. In Australia, tomato prices are expected to go up due to the recent floods. The food of the poor - "rice" is in great shortage all over the world and its prices have risen.

And to beat this food-inflation, monetary policy is tightened in many countries for the fear that this food-inflation might slip into the broader inflation. But I should say that this is like taking cover under a tree when it's raining. These monetary policy solutions are very much temporary. To beat this food-inflation, a much broader thinking and a much greater investment model is needed.

What does a monetary tightening do? - Cool down a heated economy by slowing down the business activities in an economy. So, what happens when business activities slow down in an economy? People buy less and probably save more. As a result of this, a weakening in demand takes place that bring down the prices of many commodities. And with the general prices cooling down, it is expected, that a farmer or a retail food store would sell the food produce/products at a cheaper rate. But this kind of policy action will bode well for all goods except food. I don't understand what the governments are trying to do if they keep relying just on monetary policy tools to combat food-inflation. Do they expect people to consume less food through these monetary policy actions? Sigh..sick!

Policy makers need to understand (actually they do but are just dormant) that the food-inflation felt all over the world is not due to increased liquidity in the financial system but due to global shortages of food. And the weather has been increasingly non-supportive for food-production in the past two years in many key agricultural countries, though population and prosperity (and income inequality) keeps rising in the world. Let's assume (just assume) for our analysis sake, that an entire economy comes to a halt due to maximum monetary tightening (again, just for the sake of assumption). But food, being the most essential item, will still have to be bought even if that money has to come from a savings account. And food-inflation would still be felt if there are shortages in food-supply. It is as simple as that - this is a supply-side constraint and not a demand-side pull. And remember, it is the most basic food items such as rice, onions, wheat and tomatoes that are in shortage.

To combat food-inflation on a longer term, in a world of rising population, we need investments in food-production at a global level supported by global financial institutions like World Bank to increase productivity in food-production in poor and developing nations (Admission: I see this happening to a certain extent though the pace remains slow). It is also important that agricultural markets are opened more in developed countries to encourage investments and production in agriculture in poor and developing nations - for it is in that part of the world where there are a large number of farmers producing food at a cheaper rate. And to increase efficiency, countries like India must seriously study the benefits of opening retail trade (atleast in food and food-related items) to foreign investment. But I know I am touching on sensitive subjects when I speak about opening agricultural markets further in developed world or opening retail trade in India.

It is important that not just energy-security and financial-security, but also food-security becomes an important topic of discussion in the G-20 forum and beyond. As long as we see distorted patterns in agricultural investments (and subsidies) between the developed and developing world, and as long as monetary policy tools are used to combat food-inflation instead of fiscal policy tools, and as long as agrarian economies don't enact "better" and "efficient" farm-to-fork policies, it would seem, on one side, that we are pulling millions and millions of people out of poverty, but on the other side we will also be pushing millions and millions of people who already are in poverty, further down deeper.

A Challenge for Central Bankers in 2011

Stock markets are back up! Commodity prices are surging! Retail sales have climbed up impressively in the United States this holiday season! Unemployment claims in US has come down recently to a more than expected level! Hurray! We are back to normal! - is the feeling many are having these days. I hope and wish all these improve further and are sustainable. But when some common people and business persons would start to find some relief from this news, the central bankers, while equally feeling a little relieved, would also be counting in on the hard-work (and for that matter hard-thinking) that they will have to do this year.

Currently, the interest rates are relatively and notably higher in the developing world than the low interest-rate developed world. Capital has been flowing to the developing economies from the developed world throughout last year - only to be fought back by the developing countries to prevent hot money from coming in. But despite this struggle, considerable amount of capital has found its way through to the developing economies, especially into the stock markets. One result of this - a surge in real estate prices (not that foreign money alone was responsible but definitely played a significant part).

When the US economy stabilizes this year, the central bankers in the developing countries would be breaking their head to enact appropriate monetary policies and to prevent any drastic currency volatility since they know that there is a huge possibility for considerable amount of capital, especially from the equity markets, to flow out. At the same time, central bankers in the developed world will be breaking their head to ascertain if the growth that they see in the economy is sustainable. And one of the factors that they will be looking into to assure themselves is the unemployment rate. There has been some kind of fiscal policy support from US government (thanks to some kind of measure done in this regard recently in US - whether what done was right or not is a matter for discussion at some other point in time), that should act favorably for the economy. And moreover, times are different now than what was a decade ago. Even at the setback of the US and European economies, countries like China and India have grown at impressive rates. And as these countries grow, so does the consumption of raw materials by these huge populations. Oil is trading at around $90/barrel, food-inflation is felt all over the world (as per the data released today, UN Food and Agriculture Organization's food price index rose 32% in the second half of year-2010 (not adjusted for inflation), gold prices are surging and so does copper, silver and many other raw materials.

But how much of them are sustainable? Is a commodity bubble in formation? How much inflation and price-rise is attributed to speculators and hoarders? How much is attributed to genuine supply-demand mismatch? With all this and with corruption still having a large presence in the developing world, it is going to be increasingly difficult for central bankers in the developing world to enact monetary policies. And we have to remember that there is always a lag between the time a monetary policy is adopted and when the actual effect is felt in the economy. In the meantime, when deflation was the core concern in US in 2010, 2011's concern is yet to be established - and this will be the concern of US central bankers.

Now what about our European friends?! They will spend time in trying their best to preserve their monetary union and thereby the currency - Euro.With some Euro-zone countries like Germany growing at impressive rates (which will only further grow when US economy stabilizes this year) and some Euro-zone countries adopting fiscal austerity programs due to their heavy indebtedness, it's going to be challenging for Euro-zone central bankers to come up with coordinated policies.

So, with all this, my question of the day - What's going to be the biggest challenge to central bankers in 2011? Answer: Global coordination in adopting policies. If all goes well, we can expect US interest rates to gradually rise around the end of this year, when the developing world around that time might be reducing interest rates to heat up the economy after it finishes cooling as a result of fading of stimulus and monetary tightening during the course of the year. If global macro-economic policies are coordinated, as was done at the wake of the financial crisis, then the policy actions of upward-downward movement of interest rates could be better and smoothly handled without disrupting the growth in the global economy.