Why zero inflation is bad for the economy

zero

Vivek Kaul

The wholesale price index (WPI) for the month of November 2014 was flat. Hence, wholesale prices in November 2014 were at the same level as November 2013.
For an economy that has been batting a very high rate of inflation, an inflation of zero percent, should come as a welcome relief. Only if things were as simple as that.
The devil, as they say, lies in the detail. The question to ask here is why is inflation at zero percent?
The price of food products which make up for around 14.34% of the index rose by just 0.63% in comparison to the last year. Onion prices are down 56.3% from last year. Vegetable prices are down 28.6%. Nevertheless, potato prices have gone up by 34.1%.
But this seems like a temporary trend and may soon reverse. The kharif (summer-autumn) season has seen a decline in production of most crops, due to a poor south-west monsoon this year. Over and above this, recent data from the ministry of agriculture points out that the total area coverage under rabi (winter) crops has fallen. It stood at 470.74 lakh hectares while last year’s sowing area was at 503.66 lakh hectares.
Several important
rabi crops have seen a fall in total sowing area. As the ministry of agriculture press release points out: “Wheat`s sowing area is at 241.91 lakh hectares as compared to last year’s 251.32 lakh hectares…The area under sowing of Gram is at 71.51 lakh hectares this year while the last year’s figure was 85.75 lakh hectares. Area coverage under Total Pulses is at 111.13 lakh hectares while the last year’s sowing area coverage was 124.78 lakh hectares.”
And this is a worrying sign, which could push food prices up in the months to come.
Another major reason for zero inflation in November is a fall in oil prices. Petrol and diesel prices have fallen by around 10% and 3% respectively in comparison to November 2013. In fact, the government increased the excise duty on diesel and petrol twice since October, else inflation as measured by the wholesale price index would have been negative for the month of November 2014.
Falling food and fuel prices are good news because they leave more money in the hands of people. Nevertheless, its in the third and the biggest component of the wholesale price index where the bad news lies.
Manufactured products make for around 65% of the wholesale price index. The inflation in this case was minus 0.3% in November 2014, in comparison to October 2014. Since the beginning of this financial year, the manufactured products inflation has been at 0.8%. And in comparison to November 2013, the number is a little over 2%.
What this tells us is that manufactured products inflation has more or less collapsed. A major reason for the same lies in the fact that people are going slow on buying goods. This becomes clear from index of industrial production(IIP) for the month of October 2014, when looked from the use based point of view. IIP is a measure of industrial activity in the country.
The consumer goods number is down 18.6% from October 2013. It is down 6.3% since the beginning of this financial year. The consumer durables number is down 35.2% from last year and 16% from the beginning of this financial year. And finally, the consumer non-durables number is down by 4.3% from last year and up only 1% from the beginning of this financial year.
What this clearly tells us is that despite falling inflation, people still haven’t come out with their shopping bags.  When consumers are going slow on purchasing goods, it makes no sense for businesses to manufacture them. Also, that explains why manufactured goods inflation has almost been flat through this financial year.
This is a worrying sign. If consumer spending is slower than usual, businesses suffer and this translates into slower economic growth. Further, businesses have no incentive to expand also in this scenario. The capital goods number in the IIP is down 2.3% from last year.
So why are consumers not spending? A possible explanation lies in the fact that inflationary expectations (or the expectations that consumers have of what future inflation is likely to be) continue to be high. The wounds of high inflation are still to go away. People need inflation to stay low for a while, before they will really start believing that low inflation is here to stay. As and when that happens, they will come out with their shopping bags all over again.
As per the previous Reserve Bank of India’s Inflation Expectations Survey of Households, the inflationary expectations over the next three months and one year are at 14.6 percent and 16 percent. In March 2014, the numbers were at 12.9 percent and 15.3 percent.
Interestingly, today the RBI put
out a press release stating that the October to December 2014 quarterly round of the inflationary expectations survey was being launched. Once the data for this survey comes in, we will come to know where the latest inflationary expectations stand.
If inflationary expectations fall, then it is likely that the consumer demand will improve and the broader economy will pick up as well. If inflationary expectations fall to very low levels, then consumers might also start postponing purchases, in the hope of getting a better deal. Whether that happens, we don’t know as yet. Until then, we will have to wait and watch.

The article originally appeared on www.FirstBiz.com on Dec 15, 2014

(Vivek Kaul is the writer of the Easy Money trilogy. He tweets @kaul_vivek)

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Rajan and RBI have done their bit, now the ball is in government’s court

ARTS RAJANOne of the laws of forecasting is to publicize the forecasts that you get right. On November 17, 2014, I wrote a piece titled Raghuram Rajan won’t cut interest rates even in Hindi.
In the Fifth Bi-Monthly Monetary Policy Statement released yesterday (December 2, 2014), Raghuram Rajan, the governor of the Reserve Bank of India (RBI), kept the repo rate unchanged. Repo rate is the rate at which the RBI lends to banks.
This was along expected lines. Rajan unlike many other central banks believes in clear communication. As Alan Greenspan, the Chairman of the Federal Reserve of the United States, the American central bank, from 1988 to 2006, once said “I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I’ve said.” Rajan does not believe in this school of thought and what he writes and says is normally very clear.
And that’s true about the latest monetary policy statement as well. He lays out very clearly what the Indian central bank is thinking at this point of time.
Let’s look at a few statements that Rajan made in the monetary policy statement. These statements are italicized and what follows is my interpretation of the statements.
Further softening of international crude prices in October eased price pressures in transport and communication. However, upside pressures persist in respect of prices of clothing and bedding, housing and other miscellaneous services, resulting in non-food non-fuel inflation for October remaining flat at its level in the previous month, and above headline inflation.”
What Rajan means here is that overall inflation(i.e. rate of price rise) has been falling. But the prices of a part of the consumer price index which consists of non food and non fuel items haven’t been falling as fast as the overall inflation has been. Given this, its not yet time for the RBI to cut the repo rate or the rate at which it lends to banks.
Survey-based inflationary expectations have been coming down with the fall in prices of commonly-bought items such as vegetables, but are still in the low double digits. Administered price corrections, as and when they are effected, weaker-than-anticipated agricultural production…could alter the currently benign inflation outlook significantly.”
Inflationary expectations (or the expectations that people have of what future inflation is likely to be) have been coming down. This means that people expect the rate of price rise to come down in the days to come. Nevertheless, the inflationary expectations are still on the high side, given that they remain in the low double digits.
Further, agricultural production is likely to fall as well. “It is reasonable to expect some firming up of these prices in view of the monsoon’s performance so far and the shortfall estimated for kharif production,” the statement read. This could push up inflation in the days to come. The RBI needs to wait and see how these factors pan out, before deciding to cut the repo rate.
Inflation has been receding steadily and current readings are below the January 2015 target of 8 per cent as well as the January 2016 target of 6 per cent. The inflation reading for November – which will become available by mid-December – is expected to show a further softening. Thereafter, however, the favourable base effect that is driving down headline inflation will likely dissipate and inflation for December (data release in mid January) may well rise above current levels.”
A large part of the above statement is self explanatory. The Rajan led RBI expects the rate of inflation to have fallen further for November 2014. Nevertheless, a large part of this fall in inflation is because of the favourable base effect feels the RBI. What this means is that inflation in November 2013 was at a high level. This high inflation in November 2013 will make the inflation in November 2014 look small. (For a detailed explanation of the base effect click here). The RBI expects this base effect to go away after November and inflation to rise. Hence, it wants to wait and watch and see how the situation turns out by early next year.
This statement is also important from the point of view of inflationary expectations. They start to come down only once the people see low inflation being maintained for a while. And if inflation actually has to be controlled, the inflationary expectations need to be controlled first.
Risks from imported inflation appear to be retreating, given the softening of international commodity prices, especially crude, and reasonable stability in the foreign exchange market. Accordingly, the central forecast for CPI inflation is revised down to 6 per cent for March 2015.”
In this statement the Rajan led RBI acknowledges that one of the reasons for the falling inflation is a fall in oil prices. The RBI also says that it largely expects the inflation not to spike from here but is not totally sure about it. And given that they have revised the inflation number for March 2015 to 6%. Earlier it was at 8%. This statement reaffirms the fact that the RBI wants to wait and watch and be sure that the low inflation environment is here to stay. In short, it doesn’t want to jump the gun.
With deposit mobilisation outpacing credit growth and currency demand remaining subdued in relation to past trends, banks are flush with funds, leading a number of banks to reduce deposit rates.”
Some easing of monetary conditions has already taken place. The weighted average call rates as well as long term yields for government and high-quality corporate issuances have moderated substantially since end-August. However, these interest rate impulses have yet to be transmitted by banks into lower lending rates.”
In these statements Rajan points out that interest rates on deposits have fallen despite the RBI not reducing the repo rate. He also acknowledges that RBI plays a limited role in influencing interest rates. Further, the overall rate of loan growth for banks has been falling. Given this, the government and big corporates have been able to raise money at lower interest rates since the end of August 2014.
This quip is aimed at the businessmen who have been asking Rajan to cut interest rates. Further, this slowdown in the loan growth for banks has not transmitted into lower interest rates for everybody as yet. The government and the big corporates are the only ones who have benefited from it.
The Reserve Bank has repeatedly indicated that once the monetary policy stance shifts, subsequent policy actions will be consistent with the changed stance. There is still some uncertainty about the evolution of base effects in inflation, the strength of the on-going disinflationary impulses, the pace of change of the public’s inflationary expectations, as well as the success of the government’s efforts to hit deficit targets. A change in the monetary policy stance at the current juncture is premature. However, if the current inflation momentum and changes in inflationary expectations continue, and fiscal developments are encouraging, a change in the monetary policy stance is likely early next year, including outside the policy review cycle.”
This is the crux of the monetary policy statement. What Rajan is saying here is that the RBI is still not totally convinced about cutting the repo rate. It doesn’t feel comfortable in declaring that the battle against inflation has been won.
It feels that if the rate of inflation continues to remain low, the inflationary expectations continue to fall and the government is able to meet its fiscal deficit targets, only then would have the RBI achieved what it set out to, after Rajan took over as the governor in September 2013.
Fiscal deficit is the difference between what a government earns and what it spends. The difference is made up through borrowing. If the government borrows more, it pushes up interest rates because it leaves a lower amount for others to borrow.
Once the RBI sees these three factors under control it will start cutting the repo rate and it will do that at a rapid rate. This, the central bank feels is likely to happen early next year. It has also made it clear that once it is convinced about the need to cut the repo rate it will do that without waiting for the days on which monetary policy is scheduled.
The phrase to mark here is “early next year,” which is open ended. Since Rajan has talked about waiting to see if the government is able to maintain its fiscal deficit target, the repo rate cut is likely to happen after the budget is presented in late February.
There are a couple of other points that I would like to make:

a) It was nice to see Rajan stick to his guns and not fall for the pressure to cut interest rates. This, despite the fact that Arun Jaitley went on an overdrive demanding that the RBI cut interest rates. He even met Rajan on December 1.

b) Further, Rajan has always maintained that if inflation is controlled economic growth will follow. As he wrote in the 2008 Report of the Committee on Financial Sector Reforms: “The RBI can best serve the cause of growth by focusing on controlling inflation.”

He repeated the same statement while talking to reporters yesterday. As he said “There is a major misconception in the industry that the RBI is not concerned about growth. The central bank is concerned about growth and the way to sustainable growth is to have a moderate inflation…RBI wants the strongest growth for India that is possible. We’re talking of years of sustainable growth for which you need to fight inflation.”
This statement should go a long way in countering those who had been trying to portray RBI’s efforts at countering inflation in a negative way and trying to hold it wrong for the low growth environment that prevails in the country these days.
In the end, like good central bank governors often do, Rajan acknowledged that there is only so much that the RBI can do. If economic growth has to be revived the government needs to get its act together. As he said towards the end of the monetary policy statement “A durable revival of investment demand continues to be held back by infrastructural constraints and lack of assured supply of key inputs, in particular coal, power, land and minerals. The success of ongoing government actions in these areas will be key to reviving growth.”
The RBI due to its own efforts and with some luck(like oil prices crashing) has brought inflation under some control. Now it’s over to the government.

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 3, 2014

Raghuram Rajan won’t cut interest rates even in Hindi

ARTS RAJANAt a recent function, Raghuram Rajan, the governor of the Reserve Bank of India (RBI), spoke in Hindi. The joke going around in the social media after that was that even in Hindi, Dr Rajan refused to cut the repo rate. Repo rate is the interest rate at which the RBI lends to banks. Nevertheless, four pieces of data that came out last week, will increase the pressure on Rajan to cut the repo rate. These four pieces of data are as follows:

  1. Inflation as measured by the consumer price index fell to 5.52% in October 2014. It was at 6.46 % in September 2014 and 10.17% in October 2013. 

  2. Inflation as measured by wholesale price index fell to 1.77%. It was at 2.38 % in September 2014 and 7.24% in October 2013. 

  3. The index of industrial production, which is a measure of the industrial activity within the country, grew by 2.5% in September 2014, in comparison to September 2013. The IIP for August 2014 was only 0.4% higher in comparison to August 2013. Interestingly, some economists believe that this marginal recovery in the IIP will not hold for October 2014. The reason for this lies in the fact that indicators of industrial activity like car sales, bank loan growth etc., have slowed down in October 2014. 

  4. The bank loan growth for a period of one year ending October 31, 2014, stood at 11.2%. This had stood at 16.4%, for the period of one year ending November 1, 2013. The loan growth year to date stands at 4.6%. It was at 7.6% last year.

These four data points have got the Delhi based economic experts and industry lobbyists brushing up their economic theory again. “It is time that the RBI started to cut interest rates,” we are being told. Chandrajit Banerjee, the director general of the Confederation of Indian Industries, a business lobby said “This provides sufficient room to the RBI to review its prolonged pause in policy rates and move towards policy easing in its forthcoming monetary policy especially as investment and consumption demand are yet to show visible signs of a pick-up.” This was a sentiment echoed by A Didar Singh as well. Singh is the secretary general of Federation of Indian Chambers of Commerce and Industry (FICCI), which is another industry lobby. As he put it “The inflationary expectations are fairly tamed and we see no immediate upside risks with regard to prices. Given that, it is important to reiterate that demand remains subdued. The consumer durables segment reported negative growth for the fourth consecutive month in September. It is imperative that all levers are used to pep up demand.” The idea here is simple. If the RBI cuts the repo rate, banks will cut the interest rates they charge on their loans as well. If that were to happen, people would borrow and spend more, and businesses would borrow and invest more. And this will lead to faster economic growth. Economics 101. QED. Banerjee and Singh are not the only ones asking for an interest rate cut. Sometime back industrialist Anand Mahindra had said that “It might be time for the RBI to think of a rate cut…The need of the hour has changed and its time to start to look to support growth.” Sunil Mittal, chief of Bharti Airtelalso suggested the same when he told CNBC TV 18 that the finance minister Arun Jaitley “had spoken for the nation,” when had asked for an interest rate cut. In an interview to The Times of India in late October Jaitley had said “Currently, interest rates are a disincentive. Now that inflation seems to be stabilizing somewhat, the time seems to have come to moderate the interest rates.” While all this sounds good in theory, things are not as simple as the businessmen and the politicians are making it out to be. It is worth recounting here what Rajan had said in a speech in February 2014: “But what about industrialists who tell us to cut rates? I have yet to meet an industrialist who does not want lower rates, whatever the level of rates.” And what about the politicians? Alan Greenspan, the former chairman of the Federal Reserve of the United States, recounts in his book The Map and the Territory that in his more than 18 years as the Chairman of the Federal Reserve, he did not receive a single request from the US Congress urging the Fed to tighten money supply and thus not run an easy money policy. In simple English, what Greenspan means is that the American politicians always wanted lower interest rates. The Indians ones aren’t much different on that front. Nonetheless, the question is will lower interest rates help in reviving consumption and investment? Let’s tackle the issues one by one. Let’s say an individual wants to buy a car. He borrows Rs 4 lakh to be repaid over a period of five years at a rate of interest of 10.5%. The EMI on this works out to Rs 8,598. Let’s say the RBI cuts the interest rate and as a result the interest rate on the car loan falls to 10%. The EMI now works out to Rs 8,499 or around Rs 100 lower. Now will an individual go out and buy a car because the EMI is Rs 100 lower? Even if interest rates fall by 200 basis points (one basis point is one hundredth of a percentage) to 8.5%, the EMI will come down by only around Rs 400. For two wheeler and consumer durables loans, the differences are even smaller. Hence, suggesting that lower interest rates lead to higher consumption isn’t really correct. The real estate experts think that cutting interest rates will help revive the sector. The basic problem with the real estate sector is that prices have gone totally out of whack and a cut in interest rates is not going to have any significant impact. What about corporate investment? As Rajan had asked in his speech “Will a lower policy interest rate today give him more incentive to invest? We at the RBI think not…We don’t believe the primary factor holding back investment today is high interest rates.” So what is holding back investment? The answers are provided in a recent report titled “Will a rate cut spur investments?Not really“, brought out by Crisil Research. As the report points out “Investment growth, particularly private corporate investment, plummeted in the fiscals 2013 and 2014, despite low real interest rates. During this time, the policy rate in real terms – repo rate minus retail inflation – has been negative, and real lending rates averaged 2.4%. This is significantly lower than the 7.4% seen in the pre-crisis years (2004-2008). Yet investment growth dropped to 0.3%, down from an average 16.2% seen in the pre-crisis years.” The accompanying chart makes for an interesting read. 

After 6 years, real repro rate (adjusted for CPI inflation) turns positive

Source: RBI, Central Statistical Office, CRISIL Research Note: Nominal repo rate at the fiscal year-end minus average CPI inflaction , F= Forecast

As Crisil Research points out “During fiscals 2013 and 2014, when investment growth slumped to 0.3% per year, the real repo rate was still minus 2.1%, while the real lending rate was only +2.8%. Only in June 2014, for the first time in six years, did the real repo rate turned mildly positive.” So companies were borrowing and investing at higher “real” interest rates earlier but they are not doing that now. Why is that the case? This is primarily because the expected rate of return on investments has fallen “because of high policy uncertainty, slowing domestic and external demand, and rising input costs driven by persistently elevated inflation.” “The rate of return on investments – as proxied by return on assets (RoA) of around 10,000 non-financial companies as per CMIE Prowess database – have fallen sharply to 2.8% in fiscal 2013 and 2014 from 5.9% in the pre-crisis years,” Crisil Research points out. Moral of the story: Corporates invest when it is profitable to invest, and not simply because interest rates are low. Indeed, the other factors that are likely to revive investment are in the hands of the government and not RBI. Hence, a cut in interest rates is neither going to revive consumer demand nor corporate investments. Having said that, high food inflation has been a big factor behind high inflation. And the RBI really cannot control that. Also, food inflation has come down considerably in the recent past. So why not just cut interest rates? Rajan explained it very well in his February speech where he said “They say the real problem is food inflation, how do you expect to bring it down through the policy rate? The simple answer to such critics is that core CPI inflation, which excludes food and energy, has also been very high, reflecting the high inflation in services. Bringing that down is centrally within the RBI’s ambit.” Further, food prices might start rising again. The government has forecast that the output of kharif crops will be much lower than last year and this might start pushing food prices upwards all over again. Also, recent data showsthat vegetable and cereal prices have started rising again because of the delayed monsoon. To conclude, despite falling inflation, the inflationary expectations (or the expectations that consumers have of what future inflation is likely to be) are on the higher side. As per the Reserve Bank of India’s Inflation Expectations Survey of Households: September – 2014, the inflationary expectations over the next three months and one year are at 14.6 percent and 16 percent. In March 2014, the numbers were at 12.9 percent and 15.3 percent. Hence, inflationary expectations have risen since the beginning of this financial year. And for inflationary expectations to come down, low inflation needs to stay for a considerable period of time. As Rajan said “A more important source of our influence today, therefore, is expectations. If people believe we are serious about inflation, and their expectations of inflation start coming down, inflation will also come down…Sooner or later, the public always understands what the central bank is doing, whether for the good or for the bad. And if the public starts expecting that inflation will stay low, the central bank can cut interest rates significantly, thus encouraging demand and growth.” If inflationary expectations are controlled only then will consumer demand revive and that in turn, will lead to revival of corporate investments as well. Given this, it would be surprising to see Rajan start cutting the repo rate any time soon. The article originally appeared on www.equitymaster.com on Nov 17, 2014

Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He has just finished writing a trilogy on the history of money and the financial crisis. The series is titled Easy Money. His writing has also appeared in The Times of India, Business Standard, Business Today, The Hindu and The Hindu Business Line. 

Inflation dips, but here’s why Indians don’t believe it will stay low


deflationHere is the good news—the inflation as measured by the consumer price index for the month of October 2014 came in at 5.52%. It was at 6.46 % in September 2014 and 10.17% in October 2013. The price of food products which make up 42.71% of the consumer price index rose by 5.59% in October 2014, in comparison to the same period during the previous year.
A major reason for the fall in inflation has been a global fall in food prices.
The Food and Agriculture Organization’s Food Price Index averaged at 192.3 points in October 2014. It was lower by around 0.2% in comparison to the September number. In comparison to a year earlier, food prices fell by 6.9%. Global food prices have now fallen for seven months in a row, and this has been the longest slide since 2009.
While food prices on the whole haven’t been falling in India, vegetable prices fell by 1.45% during October 2014 in comparison to October 2013. Interestingly, they had risen by 45.7% in October 2013 in comparison to October 2012. Cereal prices during the month went up by 6% in comparison to 12% a year earlier. Also, only two food products showed an increase in price of greater than 10%. The price of milk went up by 10.8% and the price of fruits went up by 17.5%.
Nevertheless, food prices might start rising again. The government has forecast that the output of
kharif crops will be much lower than last year and this might start pushing food prices upwards all over again. As the Business Standard reports “As per very preliminary estimates, India’s food grain production in 2014-15 kharif crop season is expected to be around 120 million tonnes, nearly 9.5 million tonnes less than last year, but officials have said that there could be a further downward revision in the estimates as arrivals gather steam from middle of November onwards.”
And this could push up prices in the days to come. As As Rupa Rege Nitsure, Chief Economist,
Bank Of Baroda told Reuters “recent data shows that towards the end of October we have seen spikes in vegetable prices as well as in cereal prices because of delayed monsoon. So there’s a big question of sustainability of these readings.”
Falling food inflation has come as a big relief given that half of the expenditure of an average household in India is on food. In case of the poor it is 60% (NSSO 2011). Over and above this a fall in global oil prices has also helped. Fuel and light inflation in October 2013 was at close to 7%. In October 2014, the number came in at 3.3%.
Hence, it can clearly be seen that there has been some relief on the inflation front.
For more than five years, inflation in general and food inflation in particular was very high. High inflation ate into the incomes of people and led to a scenario where their expenditure went up faster than their income. This led to a cut down on expenditure which was not immediately necessary.
With food inflation coming down, this should leave more money on the table for people to spend and at least theoretically should lead to a revival of consumer demand and hence, industrial activity. It is worth remembering here that when people cut down on expenditure, the demand for manufactured products falls as well. This is in turn reflected in the index of industrial production (IIP).
The IIP for the month of September 2014 was 2.5% higher in comparison to September 2013. This is a little better than the IIP for the month of August 2013 which was only 0.4% higher in comparison to August 2013. The IIP is a measure of the industrial activity in the country.
The manufacturing sector which forms a little over 75% of the IIP, grew by 2.5% during the course of the month. The number had fallen by 1.4% in August 2014. Hence, there seems to have been some recovery on this front. Nevertheless, it is highly unlikely that recovery will sustain in the months to come.
As Nisture put it “What really matters is that all other indicators of economic activity actually have slowed in the month of October, whether it is PMI, or credit demand or auto sales. So I don’t think that today’s reading of industrial production is sustainable.”
Further, what is worrying are the consumer goods and the consumer durables sectors. The numbers representing these sectors are both down in comparison to last year. When we look at the IIP from the use based point of view it tells us that consumer durables (fridges, ACs, televisions,computers, cars etc) are down by 4% in comparison to September 2013. The consumer goods are down by 11.3%.
What this clearly tells us is that despite falling inflation, people still haven’t come out with their shopping bags.  When consumers are going slow on purchasing goods, it makes no sense for businesses to manufacture them.
Why is that the case despite falling inflation? A possible explanation is the fact the wounds of a very long period of high inflation still haven’t gone away. People are still not ready to believe that low inflation is here to stay. Hence, inflationary expectations (or the expectations that consumers have of what future inflation is likely to be) are on the higher side.
As per the Reserve Bank of India’s Inflation Expectations Survey of Households: September – 2014, the inflationary expectations over the next three months and one year are at 14.6 percent and 16 percent. In March 2014, the numbers were at 12.9 percent and 15.3 percent. Hence, inflationary expectations have risen since the beginning of this financial year.
The only possible way to bring them down is to ensure that low inflation persists in the months to come. Only then will people start to believe that low inflation is here to stay. And once that happens, it won’t take much time for some consumer demand to return. As Shivom Chakrabarti, Senior Economist at HDFC Bank told Reuters “The real improvement in industrial production will be seen next year when inflation comes down, which will spur consumer spending and exports will be higher.”

The article originally appeared on www.FirstBiz.com on Nov 13, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek) 

Yes, inflation is lower, but Arun Jaitley should not be happy about it just yet

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010Vivek Kaul

The wholesale price index (WPI) inflation for September 2014 came in at a five year low of 2.38%. In a statement released yesterday, after the WPI inflation number was published, the finance minister Arun Jaitley said “It is heartening to note that we have been able to bring food inflation under control. Growth in vegetable and protein prices that have been contributing to the recent increase in inflation rates have shrunk thanks to the steps taken by the government. We are committed to continuing reforms in food markets that will improve supply responses and keep inflation low and stable.”
Food inflation, which forms around 14.34% of the wholesale sale price index, stood at 3.52% during September 2014. In comparison it had stood at 18.68% during September 2013. The price of the politically sensitive onion crashed by 58% in September 2014, in comparison to a year earlier. Vegetable prices have fallen by 14.98%. But potato prices rose by 90.23% during the same period. Fruit prices were up by 20.95% and milk by 11.55%. Nevertheless, the overall rise in food prices has slowed considerably in comparison to the last few years.
The government deserves some credit for this, but there are clearly other factors at work as well. The global food prices have also fallen in the recent past.
The Food and Agricultural Organization of the United Nations said in a recent statement that the “the decline” in food prices “in September marks the longest period of continuous falls in the value of the index since the late 1990s.” Food prices in September 2014 fell by 2.5% in comparison to August 2014 and 6% in comparison to September 2013. Hence, global food prices have also had an impact.
While Jaitley is quick in taking trading for controlling inflation, he offers no explanation for the low manufacturing products inflation. Manufacturing products make up 64.97% of the wholesale price index. Inflation in this group was at a low 2.84% during September 2014. This was not significantly different from the 2.36% inflation that prevailed during the same period last year.
A low manufacturing products inflation is a reflection of the low consumer demand that has been prevailing in India for a while now. For more than five years, food inflation in India was at very high. High inflation ate into the incomes of people and led to a scenario where their expenditure went up faster than their income. This led to a cut down on expenditure which is not immediately necessary.
As I have often pointed out in the past, half of the expenditure of an average household in India is on food. In case of the poor it is 60% (NSSO 2011)
When people cut down on expenditure, the demand for manufactured products falls as well. This lack of demand is also visible in the index of industrial production(IIP) number, which rose by a minuscule 0.4% in August 2014 in comparison to August 2013. The IIP is a measure of industrial activity in the country.
Nevertheless high inflation can no longer be an explanation for lack of consumer demand. Inflation has constantly been falling over the last few months. So why isn’t the Indian consumer in the mood to get his shopping bags out again? One possible explanation is that despite falling inflation, inflationary expectations still remain high (or the expectations that consumers have of what future inflation is likely to be). Or as economists like to put it the inflationary expectations have become firmly anchored.
A good data point to look at is the
Reserve Bank of India’s Inflation Expectations Survey of Households: September – 2014 which was a survey of 4,933 urban households across 16 cities, and which captures the inflation expectations for the next three-month and the next one-year period. The median inflation expectations over the next three months and one year are at 14.6% and 16%. In March 2014, the numbers were at 12.9% and 15.3%. Hence, inflationary expectations have risen since the beginning of this financial year.
The RBI points out that these inflationary expectations “are based on their individual consumption baskets and hence these rates should not be considered as benchmark of official measure of inflation.” Nevertheless, “the households’ inflation expectations provide useful directional information on near-term inflationary pressures.”
What these numbers clearly tell us is that the Indian consumer is still not convinced about the fact that low inflation is here to stay. As the RBI Survey points out “The survey shows that housewives and retired persons have marginally higher level of inflation expectations based on median inflation rates…About 72.8 per cent (72.0 per cent in the last round) and 78.7 per cent (74.0 per cent in the last round) of respondents expect double digit inflation rates for three-month ahead and one-year ahead period, respectively.”
These expectations have ensured that the low consumer demand scenario has continued despite a fall in inflation. This also explains why many analysts are downgrading the economic growth expectations for this financial year.
JP Morgan recently predicted an economic growth of only 5.1%, instead of the earlier 5.3%.
The only way the Indian consumer will get his shopping bags out again is if inflation continues to stay low for a while. Whether that happens remains to be seen. Some economists are still not convinced that the spiral of food inflation has been broken. They feel only after November 2014, the real picture on the food inflation front will start to emerge, once the impact of the below normal monsoons on summer crops becomes more visible.

The article originally appeared on www.FirstBiz.com on Oct 16, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

If only Raghuram Rajan could control onion prices too

ARTS RAJANVivek Kaul

On November 12, the rupee touched 63.70 to a dollar. On November 13, Raghuram Rajan, the governor of the Reserve Bank of India (RBI) decided to address a press conference. “There has been some turmoil in currency markets in the last few days, but I have no doubt that volatility may come down,” Rajan told newspersons.
Rajan was essentially trying to talk up the market and was successful at it. As I write this, the rupee is quoting at at 63.2 to a dollar. The stock market also reacted positively with the BSE Sensex going up to 20,568.99 points during the course of trading today (i.e. November 14, 2013), up by 374.6 points from yesterday’s close.
But the party did not last long. The wholesale price inflation (WPI) for October 2013 came in at 7%, the highest in this financial year. In September 2013 it was at 6.46%. In August 2013, the WPI was at 6.1%, but has been revised to 7%. The September inflation number is also expected to be revised to a higher number. The stock market promptly fell from the day’s high.
A major reason for the high WPI number is the massive rise in food prices.
Overall food prices rose by 18.19% in October 2013, in comparison to the same period last year. Vegetable prices rose by 78.38%, whereas onion prices rose by 278.21%.
Controlling inflation is high on Rajan’s agenda. “Food inflation is still worryingly high,” he had told the press yesterday. In late October,
while announcing the second quarter review of the monetary policy Rajan had said “With the more recent upturn of inflation and with inflation expectations remaining elevated… it is important to break the spiral of rising price pressures.”
If Rajan has to control inflation, food inflation needs to be reined in. The trouble is that there is very little that the RBI can do in order to control food inflation.
A lot of vegetable growing is concentrated in a few states. As Neelkanth Mishra and Ravi Shankar of Credit Suisse write in a report titled
Agri 101: Fruits & vegetables—Cost inflation dated October 7, 2013, “While the Top 10 vegetable producing states contribute 78% of national production, the contribution of West Bengal, Orissa and Bihar is much higher than their contribution to overall GDP. For example, despite being just 2.7% of India’s land area and 7.5% of population, West Bengal produces 19% of India’s vegetables, dominating the production of potatoes, cauliflowers, aubergines and cabbage. In fact, for almost each crop, the four largest states are 60% or more of overall . In particular, Maharashtra dominates the onion trade (45% of national production by value), while West Bengal produces 38% of India’s potatoes, 49% of India’s cauliflower and 27% of India’s aubergines (brinjal). ”
The same stands true for fruits as well. As the Credit Suisse analysts point out “Maharashtra (MH) dominates citrus fruits (primarily oranges), Tamil Nadu (TN) produces nearly 40% of India’s bananas, Andhra Pradesh (AP) is Top 3 in all the three major fruits, and Uttar Pradesh (UP) produces a fifth of India’s mangoes.”
Hence, the production of vegetables as well as fruits is geographically concentrated. What this means is that if there is any disruption in supply, there is not much that can be done to stop prices from goring up. Given the fact that the production is geographically concentrated, hoarding is also easier. Hence, it is possible for traders of one area to get together, create a cartel and hoard, which is what is happening with onions. (
As I argue here). There is nothing that the RBI can do about this. What has also not helped is the fact that the demand for vegetables has grown faster than supply. As Mishra and Shankar write “Supply did respond, as onion and tomato outputs grew the most. But demand rose faster, with prices supported by rising costs.” Hence, even if food inflation moderates, there is very little chance of it falling sharply, feel the analysts.
This is something that Sonal Varma of Nomura Securities agrees with. As she writes in a note dated November 12, 2013 “
On inflation, vegetable prices have not corrected as yet and the price spike that started with onions has now spread to other vegetables. Hence, CPI (consumer price inflation) will likely remain in double-digits over the next two months as well.” The consumer price inflation for the month of October was declared a couple of days back and it was at 10.09%.
Half of the expenditure of an average household in India is on food. In case of the poor it is 60% (NSSO 2011). The rise in food prices over the last few years, and the high consumer price inflation, has firmly led people to believe that prices will continue to rise in the days to come. Or as economists put it the inflationary expectations have become firmly anchored. And this is not good for the overall economy.
As Varma puts it “For a sustainable decline in inflation to pre-2008 levels, the vicious link between high food price inflation and elevated inflation expectations has to be broken. The persistence of retail price inflation near double-digits for over five years has firmly anchored inflationary expectations at an elevated level. The role of monetary policy in tackling food price inflation is debateable.”
What she is saying in simple English is that there not much the RBI can do to control food inflation. It can keep raising interest rates but that is unlikely to have much impact on food and vegetable prices.
Varma of Nomura, as well as Mishra and Shankar of Credit Suisse expect food inflation to moderate in the months to come. But even with that inflation will continue to remain high.
As Varma put it in a note released on November 14, “
Looking ahead, we expect vegetable prices to further moderate from December, which should lower food inflation. However, this is likely to be offset by other factors. Domestic fuel prices remain suppressed and the release of this suppressed inflation (especially in diesel) will continue to drive fuel prices higher. Also, manufacturer margins remain under pressure and hence the risk of further pass-through of higher input prices to output prices, i.e., higher core WPI inflation, is likely.”
What this means is that increasing fuel prices will lead to higher inflation. Also, as margins of companies come under threat, due to high inflation, they are likely to increases prices, and thus create further inflation.
All this impacts economic growth primarily because in a high inflationary scenario, people
have been cutting down on expenditure on non essential items like consumer durables, cars etc, in order to ensure that they have enough money in their pockets to pay for food and other essentials. And people not spending money is bad for economic growth.
If India has to get back to high economic growth, inflation needs to be reined in. As Rajan wrote in the 2008
Report of the Committee on Financial Sector Reforms “The RBI can best serve the cause of growth by focusing on controlling inflation.” The trouble is that there is not much that the RBI can do about it right now.

The article originally appeared on www.firstpost.com on November 14, 2013

(Vivek Kaul is a writer. He tweets @kaul_vivek)

 

As yen nears 100 to a dollar, Mrs Watanabe is back in business

 

Japan World MarketsVivek Kaul 

The Japanese yen has gone on a free fall against the dollar. As I write this one dollar is worth around 98.5 yen. Five days back on April 5, 2013, one dollar was worth around 93 yen. In between the Japanese central bank announced that it is going to double money supply by simply printing more yen.
The hope is that more yen in the financial system will chase the same amount of goods and services, and thus manage to create some inflation. Japan has been facing a scenario of falling prices for a while now. During 2013, 
the average inflation has stood at -0.45%.
And this is not a recent phenomenon. In 2012, the average inflation for the year was 0%. In fact, in each of the three years for the period between 2009 and 2011, prices fell on the whole.
When prices fall, people tend to postpone consumption, in the hope that they will get a better deal in the days to come. This impacts businesses and thus slows down the overall economy. Business tackle this scenario by further cutting down prices of goods and services they are trying to sell, so that people are encouraged to buy. But the trouble is that people see prices cuts as an evidence of further price cuts in the offing. This impacts sales.
Businesses also cut salaries or keep them stagnant in order to maintain profits. 
As The Economist reports “A survey by Reuters in February found that 85% of companies planned to keep wages static or cut them this year. Bonuses, a crucial part of take-home pay, are at the lowest since records began in 1990.”
In this scenario where salaries are being cut and bonuses are at an all time low, people will stay away from spending. And this slows down the overall economy.
For the period of three months ending December 2012, the Japanese economy grew by a minuscule 0.5%. In three out of the four years for the period between 2008 and 2011, the Japanese economy has contracted.
The hope is to break this economic contraction by printing money and creating inflation. When people see prices going up or expect prices to go up, they generally tend to start purchasing things to avoid paying more for them in the days to come. This spending helps businesses and in turn the overall economy. So the idea is to create inflationary expectations to get people to start spending money and help Japan come out of a more than two decade old recession.
The other impact of the prospective increase in the total number of yen is that the currency has been rapidly falling in value against other international currencies. It has fallen by 5.9% against the dollar since April 4, 2013. And by around 26.5% since the beginning of October, 2012. The yen has fallen faster against the euro. As I write this one euro is worth 128.5 yen. The yen has fallen 7.5% against the euro since April 4, 2013, and nearly 28% since the beginning of October, 2012.
As the yen gets ready to touch 100 to a dollar and 130 to a euro, this makes the situation a mouthwatering investment prospect for a certain Mrs Watanabe. Allow me to explain.
In the late 1980s, Japan had a huge bubble in real estate as well a stock market bubble. The Bank of Japan managed to burst the stock market bubble by rapidly raising interest rates. The real estate bubble also popped gradually over a period of time.
After the bubbles burst, the Bank of Japan, started cutting interest rates. And soon they were close to 0%. This meant that Japanese investors had to start looking for returns outside Japan. This led to a certain section of Tokyo housewives staying awake at night to invest in the American and the European markets. They used to borrow money in yen at close to zero percent interest rates and invest it abroad with the hope of making a higher return than what was available in Japan.
Over a period of time these housewives came to be known as Mrs Watanabes (Watanabe is the fifth most common Japanese surname) and at their peak accounted for around 30 percent of the foreign exchange market in Tokyo. The trading strategy of Mrs Watanabes came to be known as the yen-carry trade and was soon being adopted by some of the biggest financial institutions in the world.
Other than low interest rates at which Mrs Watanabes could borrow the other important part of the equation was the depreciating yen. Japan has had low interest rates for a while now, but the yen has been broadly been appreciating against the dollar over the period of last five years. This is primarily because the Federal Reserve of United States has been printing money big time, something that Japan has also done, but not on a similar scale.
Now the situation has been reversed and the yen has been rapidly losing value against the dollar since October 2012. And this makes the yen carry trade a viable proposition for Mrs Watanabes. In early October a dollar was worth around 78 yen. Lets say at this price a certain Mrs Watanabe decided to invest 780,000 yen in a debt security internationally which guaranteed a return of 3% in dollar terms over a period of six months.
The first thing she would have had to do is to convert her yen to dollars. She would get $10,000 (780,000 yen/78) in return. A 3% return on it would mean that the investment would grow to $10,300 at the end of six months.
This money now when converted back to yen now when one dollar is worth 98.5 yen, would amount to around 10,14,550 yen ($10,300 x 98.5). This means an absolute gain of 234,550 yen (10,14,550 yen minus 780,000 yen) or 30% (234,550 expressed as a percentage of 780,000 yen). So a gain of 3% in dollar terms would be converted into a gain of 30% in yen terms, as the yen has depreciated against the dollar.
This depreciation is now expected to continue and hence expected to revive the prospects of the yen carry trade. As Ambrose Evans-Pritchard 
writes in The Daily Telegraph “The blast of money is expected to reignite the yen “carry trade” and flood global markets with up to $2 trillion (£1.3 trillion) of pent-up savings, giving the entire world a shot in the arm.”
This money is expected to go into all kinds of investment avenues including stock markets. As Garsh Dorsh, an investment letter writer, 
writes in his latest column “Most recently, the key driver that’s lifting stock markets higher around the world is the massive flow of liquidity via the infamous Japanese “Yen Carry” trade.”
Over a period of time the yen carry trade feeds on itself further driving down the value of yen against the dollar. As one set of investors make money from the carry trade it influences more people to get into it. These people sell yen to buy dollars leading to a situation where there is a surfeit of yen in the market in comparison to dollars. This further drives down the price of yen against the dollar. The more the yen falls against the dollar, the higher the return that a carry trade investor makes. This in turn would mean even more money entering the yen carry trade. And so the cycle, which tends to get vicious, works.
As George Soros, 
the hedge fund manager, told CNBC: “If what they’re doing gets something started, they may not be able to stop it. If the yen starts to fall, which it has done, and people in Japan realise that it’s liable to continue and want to put their money abroad, then the fall may become like an avalanche.” And this can only mean more and more yen chasing various investment avenues around the world and leading to more bubbles.
But that’s just one part of the story. The Japanese yen has been depreciating against the euro as well. This has made Japanese exports more competitive. A Japanese exporter selling a product for $10,000 per unit would have made 780,000 yen ($10,000 x 78 yen) in early October. Now he would make 10,14,550 yen ($10,300 x 98.5) for the same product. In October one dollar was worth 78 yen. Now it is worth 98.5 yen.
A depreciating yen means higher profits for Japanese exporters. It also means that the exporter can cut price in dollar terms and make his product more competitive. A 20% cut would mean the Japanese 788,000 yen ($8000 x 98.5 yen), which is as good as the 780,000 yen he was making in October 2012.
This increased price competitiveness has already started to reflect in numbers. Japan reported a current account surplus of 637.4 billion yen ($6.5 billion), for the month of February 2013. This was the first surplus in four months and was primarily driven by increased export earnings.
The trouble of course as Japanese exports get more competitive on the price front it hurts other export oriented countries. The yen has lost nearly 28% against the euro since October. This has had a negative impact on countries in the euro zone countries which use euro as their currency. 
For January 2013, seventeen countries which use the euro as their currency, in total logged a trade deficit (the difference between exports and imports) of 3.9 billion euros.
Japan also competes with South Korea primarily in the area automobile and electronics exports. Hyun Oh Seok, the finance minister of South Korea, said last month that the yen was “
flashing a red light” for his nation’s exports.
Of course if Japan can resort to money printing, so can other nations in-order to devalue their currency and ensure that their exports do not fall. It could lead to a race to the bottom. As James Rickards author of 
Currency Wars: The Making of the Next Global Crisisputs it “we are well into the third currency war of the past 100 years….I am certain that we are closer to the critical state than we ever have been before ”

The article originally appeared on http://www.firstpost.com on April 8,2013

(Vivek Kaul is a writer. He tweets @kaul_vivek)