Rupee is what rupee does!

Exactly, headline is derived from economic definition of money, "money is what money does", which is applicable to Rupee too. As per economic definition, value of Rupee is determined by its purchasing power parity (PPP) compared to international standards. But is this definition holds true in this turmoil markets? I don't think so.

In recent days Rupee depreciation or speed of depreciation has not only become big issue domestically but also international commentators are expressing their opinions. There are various research reports available in markets now on Rupee’s next target. Some brokerage houses are predicting it will touch 70+ against Dollar and some are telling it will go back to 60/Dollar. Now everybody is watching whether Rupee will touch 70 before 60 or 60 before 70.

Most of us by now know the macroeconomic issues India is facing due to which currency is moving in this fashion. But here I am trying figure out how things change in the micro level or ground level.

Till early May of this year currency wasn’t our big news or concern, analysts were thinking about macro issues like current account deficit, fiscal deficit, inflation, RBI’s stance on monetary policy and etc. By this logic nothing substantial happened on macro front, which wasn’t priced in the market at that time.

But in May U.S. Federal Reserve chairman Ben Bernanke first time talked about scaling back the monetary stimulus (Fed is buying $85 billion worth of bonds every month) because of moderate growth in U.S. economy. Immediately after his statement bond markets reacted very sharply and bond yields started spiking. At that time U.S. Benchmark 10 year bond yields where trading roughly around 1.6% and Indian benchmark yields where around 8% as shown in the below two graphs.

Investors were coming to India as there was arbitrage opportunity or interest rate parity due to yield spread between the two countries. Even after incurring currency hedging cost of around 6% foreign investors were making 2% (8% bond yield – 6% currency hedging cost) risk free return.

But once U.S. bond yield crossed that crucial 2% level investors thought investing in U.S. bonds is more profitable than investing in India with less risk. So funds from bond market started flowing out of India and till now roughly $4 billion went out of India according to one estimate.

At the same time U.S. stock markets started regaining their historical highs and were touching new highs due to which money from equity markets also started changing hands. Because of outward movement of money Dollar demand increased and Rupee started depreciating as shown in the third graph. But after initial sell-off in the currency market, sentiments drove the markets with more speed and quantity leading to panicking situation making policy makers nervous! Policy makers did take some half hearted measures and did not convince the markets either through their communication or from their actions leading to rout in the markets!

After this heavy sell-off Finance Minister and some analysts are saying Rupee is undervalued due to overshooting of currency markets. One of the popular indexes to measure the valuation of the currency is Big Mac Index. It gives a rough picture of how a country’s currency is trading in real exchange terms or purchasing power parity. It compares cost of Big Mac of McDonalds in U.S. with other countries.

McDonalds’ Big Mac not sold in India since beef is not common; but it is replaced by Maharaja Mac made up of Chicken. As per latest available data cost of Big Mac in U.S. is $4.56 and Maharaja Mac in India is Rs. 100. So PPP of India is 21.93 (100/4.56). According to Big Mac Index Indian Rupee is undervalued 68% [(21.93 – 67.5)/67.5]. Here I have taken 67.5 as exchange rate of Rupee. Indian currency is the most undervalued currency as per Big Mac Index. 

Good articles...

While browsing through Ajay Shah's blog, found couple of articles are good, so thought of sharing with you guys...

Mr. Deepak Lal's article in Business Standard regarding "Capital Controls" is very good reading material on interlinked macro economics. One piece of the article is as following...

"The current account deficit is by definition the difference between a country’s savings and investments, matched as a matter of accounting by equivalent net inflows or outflows on the capital account of the balance of payments. Current account deficit worries are, therefore, about the size of the capital inflows, which, Ceteris Paribus, will supplement domestic investment and raise it above what could be financed by domestic savings. This should raise growth rates, if the investment is productively employed. It clearly was not the case in the US, where the inflows primarily went to finance the politically-determined entitlements in the sub-prime housing market to Ninjas (borrowers with no income, no job and no assets). But, in India, which has vast infrastructure investment needs, capital inflows would be productive and the size of the corresponding current account deficit should not be a matter of concern to policy makers."

Ila Patnaik's article in Indian Express on GDP growth and Inflation. Will be a good reading on presently going on hot topic of Indian Economy Overheating. For more posts on Indian economy overheating, click here: 1, 2 and 3.

India needs purchasing power rather than subsidies

Recently Tamil Nadu faced state elections and both the main parties were talking about 1 kilo rice for Rs. 1 and other subsidized food products. I have taken Tamil Nadu's example because of recent elections, otherwise subsidies are abundant everywhere in India.

What I wonder is, governments fix the minimum support price for the food article to support the farmers, buys it from the farmers for the support price and same governments sell them to its citizens in a subsidized prices like of Rs. 1. Its same for the oil and its by-products also. So who is going to take care of the deficit of these transactions and how long is it going to work on just blame-game?

India faced a severe Balance of Payment (BOP) crisis in 1991 due to higher fiscal deficit and some external shocks like oil crisis and wars. At that time India had forex reserve of 1 billion dollars which was sufficient to import for just one week. Since oil and wars were/are not in our control totally, no point to elaborate on those issues. But what Indian central and state governments could have controlled is the deficit problem. Due to socialistic era and combined with populist budgets like above mentioned ones (particularly started in southern and eastern states) caused irreversible deficit to the exchequer. And surprising fact is still we are following the same old route towards a possible BOP crisis even after seeing other countries taking development mantras.

Now, in this LPG (Liberalized, Privatized and Globalized) era, India's much publicized recent problems are PDS (Public Distribution System) and Inflation. Due to subsidies, majority of the PDS quantity is sold in the black market without letting the targeted person to claim it.

To avoid the PDS problem central government has started an ambitious project called Unique Identification Number (also called as Adhar) under the leadership of Mr. Nandan Nilekani. But the fundamental problem of "deficit" remains the same even after UID or Adhar project.

India aspires to overtake the China, over a period of next 25-30 years, but with the kind of policies is it possible? India's debt to GDP is more than 70% where-as China's is about 20%. India's foreign reserve is about 300 billion dollars where-as China's is more than 3 trillion dollars. According to recent IMF data available, China's GDP at PPP (Purchasing Power Parity) per capita is more than 35,000 dollars per year where-as India's is around 3,300, thats almost one tenth of China!

Governments should really think of improving the PPP- instead of subsidies. And PPP can be improved only if everybody gets regular jobs to contribute towards the GDP. Again jobs require education, different skill sets and more, which in turn can generate jobs. Governments should think about taking up projects like converting Narrow Gauge to Meter to Broad and single line to double to four line railway tracks, not just increase the trains. Why I am mentioning railway project is because projects like National Highway (by Vajpayee government) and railway track doubling are through out India and can generate lot of employment and at the same time can improve the infrastructure of the country.

Today's Mint Column On Similar Note of My Last Post About Indian Economy Overheating

A losing bout with inflation

With high-inflation expectations and an unceasing march of prices, India is close to a wage-price spiral

Since the new year began, the Indian stock market has fallen 8% below its December peak of 20,509 points. Long bond yields have risen by more than 20 basis points, touching 8.2%. Foreign investors have reduced their weights on Indian investments and capital inflows have turned into a trickle.

Effectively, India stands derated. The persistence of inflation is triggering the rethink. As the feeling that policymakers have no control over inflation gathers force, their macroeconomic stewardship is under question: It didn’t help when the government indicated that usual regulatory measures were ineffective in containing inflation, expressing its helplessness. For these reasons alone, the central bank has to now raise its hand and say “I can”.

There are other reasons, too, for further monetary action. While 36% (3.1 percentage points) of the 8.4% year-on-year rise in the Wholesale Price Index (WPI) in December resulted from food prices, manufacturing inflation accounted for 34% (2.9 percentage points). The persistence in food price inflation, however—a 13.5% increase over December 2009—is now prompting doubters to suspect that strong demand factors could be at play: The prices of vegetables, fruits and other food items are flexible and what if rapid economic growth is also pushing up prices? After all, this year has been nowhere like 2009 when the worst drought in three decades caused temporary supply disruptions. Price spikes due to some vegetable crops harmed by excessive rainfall—which is the case in the last two months of 2010—are temporary and should not be reflected in higher prices of other food items.

Ahead, accelerating commodity prices abroad are a serious risk to core inflation. Some domestic prices—auto and consumer durables— have already risen, following higher input prices; other final prices are likely to follow as margin pressures build up. There’s little spare capacity as utilization levels reached 98% in October, according to a National Council of Applied Economic Research survey. The momentum in bank credit growth indicates strengthening economic activity; the annualized, three-month moving average (deseasonalized) almost doubled to 30.9% between October and December 2010 while year-on-year growth averaged 23% in the same period. Though deposit rates have picked up—deposits grew at 19% year-on-year in December—savers are still getting little returns in real terms. The money multiplier shrank further to 4.8%. The action, therefore, remains in gold and real estate: Bloomberg reported recently that gold imports into India rose to a record high in 2010 and property prices escalated beyond pre-2007 levels in some places.

Public spending continues to be expansionary and it’s unrealistic to expect cuts, given the pattern this year. Even though the fiscal deficit target will be met this year, the inflated nominal gross domestic product (GDP) and tax revenue targets do not fool anybody, nor do the contributions made by one-time, non-tax revenues. The pity is that some of this could have been diverted towards productive investments in agriculture to signal strong determination to tackle food prices; just a beginning— however small—to address the infrastructure deficit and market imperfections in the farm-to-fork supply chain. Such action would be far more credible and effective in quelling inflation expectations instead of periodic assertions that prices will cool in a couple of months. What we have instead is further stimulation through a 17-30% wage hike through indexation of the Mahatma Gandhi National Rural Employment Guarantee Scheme wages to the Consumer Price Index for agricultural labourers.

Unsurprisingly, inflation expectations look set to be entrenched at higher levels, only a step short of triggering a price-wage spiral. The central bank’s own survey for July-September 2010 showed household inflation expectations to rise further—from the current perceived 12.1%—to 12.3% in the next one quarter (Oct-Dec 2010) and to 12.7% one year ahead. Though the Reserve Bank of India (RBI) raised interest rates five times, and cash reserve requirements twice in 2010, nominal GDP grew at 19.5% and 18% in the first two quarters of 2010-11, rendering the policy rate at 6.25%—too low a floor. And real interest rates—the difference between the 10-year bond yield and WPI inflation—again turned negative in December.

It is no surprise that RBI has already signalled an increase in interest rates, asserting its determination to restrain inflation. The rise—largely expected to be 25 basis points—will be accompanied by an upward revision to the central bank’s end-year forecast of 6.0% (6.5 or 7.0%?). Recent comments by RBI governor D. Subbarao that the central bank is desperate to control inflation make one doubt that the hike may be even 50 basis points though the declining momentum in industrial production may offset this. Even so, the average 8.9% GDP growth in the first half of 2010-11 may prompt RBI to revise its growth projections as well.

Later, RBI will also have to take the blame for slowing growth. But then, central banks are always the whipping boys for others.

Historic Move From Government In Oil Price Deregulation

Today EGoM (Empowered Group of Ministers) headed by Mr. Pranab Minister agreed(Partially) for Kirit Parikh recommendations of oil price deregulations.

Today EGoM decided that, Petrol price will be fully decided by the market forces & other petroleum products like Diesel, Kerosene & LPG prices by partially depending on international oil price movement.

Today during market hours only this news came in & all oil marketing stocks closed very high even though market closed in negative.

According this deregulation,

1. Petrol will cost around Rs 3.5 more
2. Diesel price will be hiked by Rs. 2
3. Kerosene by Rs. 3
4. LPG by Rs. 35

This is one of best move as compared to longer time future of the country's economy, even though in short term it will leads to inflationary pressure as present inflation itself is very high as compared to RBI's comfort level. One more advantage is in shorter term, fiscal deficit of the country will be reduced due to less subsidizers to oil companies.

Now coming to stock market point of view, this move is good for longer term as ratings of the companies & country will be stronger as compared to past & present ones. And as I told earlier, almost all oil marketing companies closed with more 5% jump to their previous closes. But at same time stocks from Auto, Banks, Shipping & etc started falling as in the anticipation of oil price hike leads to

1. Less demand for auto sales
2. RBI's interest rate policy team may increase rates anytime sooner than later
3. Increase in the cost of shipping & transportation & etc.

The New International Currency

From 2nd world war there is a constant approach towards a new international currency. But every time it was opposed by the MAJOR INDUSTRIALIZED COUNTRIES. Now in this crisis time also there is this talk is going on. And this got substantial boost after the G20 meeting.

Here are the some of the opinions...

Mr. Swaminathan's article in STOI

Mr. Nageswaran's article in mint

Financial Express article

In related to this see what Mr. George Soros thinks about the US economy.

I am back!!!

Yes guys I am back! Almost I took a break of 2 weeks from posting due to various reasons. Lot of things happened in this due-course in National level, International level, Political front, Economic issues like Inflation, IIP numbers, Stock market... Of course I cant cover all the things happened in this 2 weeks but I tried brief what all happened & my views about those...

Starting with my favourite topic "Inflation", it came down to historical low level of 0.44% from 2.43%. Here you can see the drop level is almost 200 basis points which is not a good sign for economy point of view. But is this sign of contraction in demand or just I was arguing with many days like "High Base Effect".

Till today[& now also] I argued that its a High Base Effect which is causing the Inflation to fall so drastically. But If you the see the today's fall of almost 200 basis points & 0.4% drop in WPI may indicating future fall in the demand to various economic conditions. So now the country is going to sustain the growth levels? How the governments create the jobs when Fiscal Deficit is already crossing 8% of the GDP!

And if it is only Base Effect problem what is remedy for this problem? Remember this is not going to end here in this year! Since next couple of months we are going to face deflation [speaking statistically] next year same period is going to high inflated zone. In addition to that next year overall world economy is will be in revival mode so crude oil, commodity prices & by default manufacturing products starts zooming out. So what we will do at that time? How our monetary policy will be?

Now coming back to stock market, last week only 3 days were trading days & I think it gave much needed gap to the falling market. BSE Sensex almost touched 8000 levels & from their we are seeing a bear market rally now. I can say market is trying to find out the bottom around 8000 levels, even though it sounds very early & optimistic looking at present conditions. But if you see the bear market patterns, all bear markets almost lasted for 18 to 24 months. And here from last 15 months we are in bear market, I can say we are at least near the bottom of the market if at not at the bottom! And one more supporting point is till now FIIs have been major sellers & DIIs have been buyers, once the redemption pressure from FII side zero, I think FIIs will return to Chinese & Indian markets.[Already Chinese markets have given 20%+ returns in this year].

Now coming to National Politics front now a days there is too much talk going on about so called "The Third Front". According to me media is giving unnecessary giving too much importance to this circus for bunch of unhappy divorced parties. Actually in Kannada there is one phrase "AATKKUNTU LEKKAKKILLA", that means there are in the play but dont count them! They can never form a stable government & they will not do this time also. If you see the leaders of third front you see all the people are rejected by either by Congress or BJP! See Devegouda who calls himself as secular, allowed his Younger Son Mr. Kumarswami to take over the party & join the hands with so called communal BJP in Karnataka for 20 months. At that these same CPI & CPM leaders threaten Gowda, warned about his end of carrier in national front. And now all are together. And coming to Chandra Babu Naidu, Jayalalitha & Mayawati I think they are playing opportunistic politics rather than doing any ideology! And if you see today's speech of Mr. Karat he is ready to talk to Congress after the election, what is the need to join hands with the 3rd front? And particularly I fail to understand why people like Karat, being a highly educated from JNU behaves like that? And in which era they are living, compare China & India, we are lagging 20 years behind to china in in all developments!

Good Articles

Yesterday I read an article in rediff which talks about India's growth in these 5-6 years & present problems in agriculture sectors. Its a good article from Kunal Kumar Kundu, COH, Global Market Research, Infosys BPO Ltd. Click here to read that article.

As I have written in my yesterday's post about the rate cuts by RBI, business standard got an article which almost talks about the issues which I raised in post. To read that business standard article click here.

Bloomberg's article on RBI's rate cut...

Newspaper Articles

Guys please read the article regarding "learn to live with slowdown" in swaminomics in TOI...

Read the article in Financial Express,"Buffett, the lender of last resort"

News Paper Articles

There is an article in Financial Express about Money Multiplying which talks about the RBI/Banks role in economic development by creating credit flow. And presently how banks are playing safely by investing in more than specified minimum limit of SLR & Reverse repo, about which I have mentioned many times...

Mr. Ajay Shah has an article in FE about our standards in monetary & debt policies. He compared the present fiscal & revenue deficit to 1991 & analyzed the things which lead to S&P to downgrade the Indian ratings. Go through comparison between the UK's debt repayment standards for centuries as compared to ours & standards. And also have look at the solutions he has mentioned like scrapping the present subsidies [Even though I dont fully agree with his idea giving Rs. 100 to each person of BPL family]& asset sales & RBI reforms.

I got good article about FRBM (Fiscal Responsibility & Budget Management. In that article it is clearly explained the vision of FRBM, need of fiscal deficit in crisis time, proper using the funds, accrued from borrowing [public/private].