Expert Zone

Should the RBI delay a rate cut?

(The views expressed in this column are the author’s own and do not represent those of Reuters)

With the return of inflation, there are doubts whether the Reserve Bank of India (RBI) will go in for the next cut in repo rate any time soon. In April, inflation was up at 7.2 percent, 2 percent more than in March.

What is more disturbing — the food component of inflation was in double digits. With the extreme sensitivity of the RBI to inflation, it is difficult to expect it to take kindly to the fall in industrial production and cut the repo rate.

Food inflation, however, is not the parameter for the RBI to go by because it is outside the impact area of RBI policy. No one buys food by borrowing from the bank and, whatever the interest rate, the expenditure on food will not be reduced and food inflation will not ease.

It is more relevant for the RBI to look at the core inflation or principally, inflation in the industrial sector. No doubt, prices of industrial products have also been rising but at a much slower rate. In April, prices of industrial products were up 1 percent over prices in March. Inflation in the industrial sector was 5.1 percent over the year, well within the RBI’s tolerance limits.

Industry is the major sector that responds to RBI policy. An increase in the interest rate will most certainly crunch investment and a cut, stimulate it. In March, for instance, investment was down 21 percent   because 142 projects involving an investment of 1,553 billion rupees were shelved, being rendered unviable due to the high rate of interest and absence of market for equity.

But the RBI’s single target is inflation. Even on April 17, the cut in repo rate was done quite reluctantly though it was a good beginning. It is critical that it has to be carried forward before it can regenerate investment and revive growth. The RBI had done that in 2008 when the economy had slowed down. The repo rate was 9 percent in 2008 and the RBI cut the rate by 1 percent in October, in spite of inflation raging at 12 percent. That cut was followed by another in November and once again in December. In just three months, the repo was down 2.5 percent from 9 to 6.5 percent, with inflation dropping to 5 percent.

What the Euro means for Asia

(The views expressed in this column are the author’s own and do not represent those of Reuters)

The Euro should not exist. In a perfect world (run by economists) the Euro would never have been created. Sadly, however, the world is not perfect — and it is run by politicians. The result is an entirely dysfunctional monetary union.

The Spanish economy has youth unemployment approaching 50 pct. The Greek economy is in its fourth consecutive year of negative GDP growth and will embark on a fifth year of negative growth later in 2012. Euro area countries have to share a common interest rate and a common exchange rate with Germany — where unemployment is at a 20-year low and growth is positive if unspectacular around 2.5 pct. This is an unworkable situation — what Greece needs is very different from what Germany needs.

Will the Euro break up? We must hope not. The consequences would be devastating (a weak country could see its economy halve in size on exit). The social unrest we have today is minor compared to what could take place if the Euro were to fragment. As the Euro was essentially a political creation, it must be political will that keeps it together — and it would be wrong to underestimate that political will.

So what will happen? Because so much rests on political decision making, the path for the Euro area is hard to determine. But it seems highly likely that there will be a recession this year. How bad that recession is depends on what happens to the banking sector. Euro area banks are increasingly reluctant to lend money — and with all the risks that they have been through over the last six months, this is hardly a surprise. Slower bank lending growth will hit some economies particularly hard.

Fiscal austerity is being urged by Germany. In the wake of France’s downgrade (and with the UK outside the Euro and unlikely to ever join) it is Germany’s voice that is loudest in setting the Euro policy agenda. When the slowing credit creation is combined with further fiscal austerity, the consequence is likely to be negative GDP growth. Not all countries will be negative, of course, but Italy, France and Spain all seem likely to see a drop in economic activity.

So why do the convulsions of the Euro area matter to Asia? There are three reasons why Asian companies and investors need to follow the Euro drama.

Market reform in China: Should we believe it?

(The views expressed in this column are the author’s own and do not represent those of Reuters)

The first step in solving a problem is admitting it. For years, the Chinese government and their defenders overseas insisted first that China was still reforming, then that state-led economic development was superior to market-led development. Evidence to the contrary came as news to many.

There has always been a reform camp in China; it just happened to lose every major political battle in the past nine years. Now the reform camp is trying again.

They’re not going to succeed this year or next, but they at least have a chance — for the first time in a decade.

The current Chinese government, led by Communist Party General Secretary Hu Jintao, took office in late 2002. At that time, China had been pursuing genuine market reform for 23 years, was growing at a sustainable 8-9 percent, and had a balanced economy.

At some disputable point under Hu’s regime, but no later than 2006, the market was shunted aside in favour of the state. Chinese growth actually became a bit more rapid but also wildly imbalanced and, with the financial crisis, dependent on unsustainable levels of stimulus.

Global Economics: When China is not just China

(The views expressed in this column are the author’s own and do not represent those of Reuters)

The People’s Republic of China’s (PRC’s) relationship with Iran receives a good deal of attention. As the U.S. considers how to stop Iran’s nuclear weapons program short of military action, the PRC is considered vital in ensuring economic sanctions are effective. But it has been difficult to win Chinese cooperation in applying sanctions. One mistake the U.S. may have made is treating China as a unified entity.

It is true, of course, that the PRC has a tightly controlled political system. There is one ruling party, a powerless legislature, and muzzled debate. Even so, distinct interests have emerged.

State-owned enterprises rarely operated internationally a decade ago and, if they did, unfailingly followed the central government line, as when China Unicom was nationalised in 1999. One outcome of state-led development since 2003 is powerful growth by state firms. By some measures, State Grid is the world’s biggest power company, China Mobile the biggest telecom, and ICBC the biggest bank.

The PRC’s global presence is also much greater. Chinese firms are the world’s biggest exporters. From 2005 to 2011, Chinese outward investment exceeded $300 billion, even excluding bonds.

China’s corporate kings are the two largest oil companies, both state-owned: CNPC and Sinopec. Both rank in Fortune’s top 10 globally. They are the two biggest owners of foreign non-bond assets, accounting for more than 25 percent of outward investment — more than $80 billion — by themselves. CNPC and Sinopec own stakes in Canadian oil projects; CNPC sends Venezuelan oil to the U.S. for refining; and Sinopec has just made a sizable U.S. shale deal. They also have made large acquisitions in Europe.

Iran has been an important target, with CNPC and Sinopec each having multibillion-dollar projects. However, there are indications that both, along with smaller cousin China National Offshore Oil, have slowed recent work. Why? It probably wasn’t orders from Beijing. Rather, proceeding with their considerable business in Iran in the face of sanctions would put much more of their global business at risk.

China’s economic data (still) not credible

(The views expressed in this column are the author’s own and do not represent those of Reuters)

China today announced that GDP growth for 2011 slowed to 9.2 pct. Over the coming days and weeks, there will be a stream of pontificating about what this means. There’s a good chance that everyone involved will be pontificating about nonsense.

China’s economic statistics are usually inconsistent, occasionally wildly inconsistent, and do not seem to be improving in quality. For 2011 GDP in particular, Beijing is very likely exaggerating growth (some years it understates). Rather than focusing on reported figures, the U.S. should prepare for a weak Chinese economy but one that may begin to rebalance in 2012. It should also engage in long-overdue independent estimation of China’s performance.

IMPEACHING THE GROWTH RESULT There is a cottage industry that gains directly or indirectly from insisting that Chinese numbers are fairly accurate and far better than the bad old days of 15 years ago. But reasons for scepticism abound.

On one side are 9.2 pct growth last year and 10.4 pct in 2010. On the other is evidence of a far sharper slowdown. Auto sales, for example, plunged to 2.5 pct growth last year from 32 pct growth in 2010. There are also figures which can be corroborated with foreign partners. More than four-fifths of China’s shipbuilding tonnage is for export. New ship orders plummeted 52 pct outright in 2011. Growth in imports of crude oil slipped to 6 pct growth last year from 17.5 pct in 2010.

There are indirect indicators of much slower GDP. Monetary policy has long been extremely loose, featuring negative real interest rates. Yet the central government began loosening further several months ago, a strange reaction to growth still over 9 pct. China still boasts the world’s largest foreign trade surplus and net inward investment. Foreign exchange reserves fell in the fourth quarter, suggesting capital flight. That would translate to a sluggish world economy being more attractive than China’s own.

PREMIER SKEPTICS Problems go well beyond 2011 GDP. It has been over a decade since former Premier Zhu Rongji wondered how all provinces could grow faster than the country as a whole. The problem persists and, in fact, was worse in 2011 than 2008. The trends in national and provincial growth clearly match, but provinces remain unwilling to report accurate numbers. Such unwillingness extends deeply into Chinese statistics.

Critical steps for a faster recovery

(The views expressed in this column are the author’s own and do not represent those of Reuters)

The economy seems to be heading for a hard landing. The problem is not entirely of our making; partly it is the spillover of the crisis in Europe. Other Asian countries have also been affected but we were hit the hardest.

Surely, the economy was exposed to inflation for nearly 25 months now. The RBI initiated conventional measures. The repo rate was raised in 13 instalments from 4.75 to 8.5 pct. It made no change to inflation. The high cost of credit only inhibited investment. New investment, for instance, dropped from 6 trillion rupees per quarter to 3 trillion rupees.

Inflation was initially confined to select food articles. The increased expenditure on food diluted demand for manufactures and slowed down industrial growth. Further, food inflation increased wages and salaries since these are linked to cost of living, spreading inflation to all sectors.

The stock market was hit initially by the European crisis. Investors lost appetite for risk and the scramble for liquidity led FIIs to disinvest. Stock prices tanked and with the increase in demand for dollars depreciated the rupee.

These trends drastically distorted corporate finances. The fall of the rupee which increased external debt servicing and the hike in domestic interest rates took a big bite of profitability. In the July-September quarter, the margin was the lowest in the past seven years.

The problems are many. Inflation is high, stock market is down, interest rates are excessive, investment has dropped, trade deficit is too large, the rupee is low, and industrial production is nearly static. The only silver lining is a 3 pct increase in agricultural production. With these inputs, GDP growth in 2011-12 will be less than 7 pct.

If the U.S. slips into recession

(The views expressed in this column are the author’s own and do not represent those of Reuters)

In his testimony to the Joint Economic Committee of Congress, Federal Reserve Chairman Ben Bernanke described the U.S. economy as “close to faltering”. That is disconcerting enough. But with the EU also on the edge of a financial crisis, the threat to the world economy can be enormous.

The U.S. is on the brink of recession with GDP growth already down to less than 0.5 percent.

Greece will not be able to escape default in its sovereign debt repayment unless the hesitant European Central Bank finds an instant solution. In 2008, in spite of the U.S. being the only country dipping into recession, the impact on the rest of the world was extensive. In India, GDP growth had dropped from 9 to 6 percent. The silver lining was that it also brought down inflation from 8 to 3 percent.

It will probably be the last quarter of 2011 when the U.S. economy will sink into recession. If simultaneously Europe gets into a financial straightjacket, the combined impact on the rest of the world may be stronger than in 2008. For, the U.S. and EU together make up about half of the world economy.

What the sinister effect of U.S. and EU recession will be on any country will depend upon how closely it is tied up to the U.S. and the EU. Indian banks do not hold much of foreign debt.

Hence, our banking system will remain almost insulated from the secondary effect of the possible bank failures in Europe. However, India has fairly strong trade ties with the U.S. and EU which take up 30 percent of India’s exports. In 2008-09, our exports had actually declined 3 percent following U.S. recession. Since then there has been diversion of exports to Asia and Africa. As such, the fall in exports this time will be somewhat cushioned.

Gold prices: Bubble or fundamental

(The views expressed in this column are the author’s own and do not represent those of Reuters)

Suddenly all eyes have turned to the yellow metal. Some say that it’s a bubble while others give a lot of demand-supply reasons. Fall of the dollar and other economic reasons suggest that it has miles to go.

Let me try a more fundamental way to analyse this. But before that, I need to first take you through the basics of share price valuation. Why is that necessary? Hopefully the dots will be joined in due course.

Basic finance taught us that the value of a corporate is nothing but the present value of all its future profits, till infinity. Although this model has a lot of assumptions, conceptually this seems logical.

Simultaneously, a corporate also has assets — namely, its book value. That is nothing but the value of its existing contracts, fixed assets, inventory — to name a few. The third major component for the corporate is the total outstanding borrowing.

Just to summarise, we have now created 3 variables — the value of the company (P), the price of its outstanding debt (V), and the value of the existing assets (B).

Now imagine what happens when the expected future revenue of the corporate drops. The obvious answer — a drop in the market value of the company (i.e. P). What happens next? The people who have lent money start getting panicky whether the company will be able to repay the money they have borrowed. How will that affect the total value of outstanding debt? The answer can be given in two ways. For the technically savvy, it just means that the rate at which investors discount the bond increases (due to its lower credit-worthiness) and therefore reduces the value of V. For the intuitive guys, it means that the probability of the company defaulting goes up and so I, as a lender, am happy getting back a lower amount today rather than waiting till maturity and run the risk of getting nothing.

Signs of cooling in Indian economy

(The views expressed in this column are the author’s own and do not represent those of Reuters)

This was not unexpected. The RBI has taken every care to cool down the economy with successive increases in interest rates. The results are now beginning to show.

But ours is not the only economy that is slowing down. Almost every large economy is under pressure for one reason or the other and the IMF was consequently compelled to slice off its own estimate of world GDP growth by 20 bps.

Unemployment in the U.S. has climbed to 9.1 pct and Dow Jones sank for six consecutive weeks, the longest losing streak since 2002. The investor, however, expects the fall to be short lived in the hope that the Fed, which is too eager to pump in money, will intervene. Even that is not going to lift up the economy.

Growth continues to be weak in Europe. Spain is sinking deeper into the debt crisis. With the impact of tsunami, the Japanese GDP may drop 0.7 pct in 2011. The Chinese economy is cooling down after inflation at 5.5 pct and new loans down 12 pct.

It is no wonder that the Indian economy is also losing pace. The original sin is food inflation which, in spite of the costlier credit, persists. At the end of May it perked up to 9 pct.

GDP growth in the first quarter of 2011 slumped to 7.8 pct in spite of good agricultural production. It was industry that let growth down.

What ails the UK and western economies

(The views expressed in this column are the author’s own and do not represent those of Reuters)

The industrial revolution which missed India eventually resulted in this once developed and rich country being placed on the receiving end of a ruthless colonial enterprise.

Those engaged in indigenous trade and crafts were coerced into producing primary goods for export at prices convenient to the United Kingdom.

Thanks to newly found mechanised facilities, their industries were now capable of producing far more and better finished products than the artisans in India. These value-added goods were then dumped in India and other markets of the vast British Empire.

England enriched itself substantially because without input cost escalations and those associated with overcoming hurdles to market entry, its industry never really faced the challenges of a normal business environment.

Such undisputed control on the sea routes, the sources of raw material and also the end market could ensure that inflation and margins never really mattered in their scheme of things.

The vast profits generated in these colonies found their way back into the UK, transforming it into possibly one of the richest economies in the world. Obviously, its navy and armed forces gained the prowess to aggressively push forth with its colonial agenda to perpetuate its usurious economy.