Rajan's smart moves...

Article;
RBI raises repo-rate by 25 bps to 8%.

Comment;

Rajan in his latest monetary policy has again surprised those who forecasted a status quo,… We thought inflation showed a decline in the recent data therefore our Governor would wait for more data to make sure he is not over-tightening as the transmission to demand and prices takes time… the effect of tightening appears with a lag… Rajan’s decision to hike repo-rate was expected, sooner or later, because a just 50 basis-point hike after our new governor took office, apart from previous rate hikes, when inflation is consistently hovering around 10% since a decade now, since 2004, and there is an upward bias in the face of supply side problems, can not be expected to bring inflation to 6% or less (a liberal view)… A meager rise (50 basis-points) in the repo-rate can not bring inflation at 6% or below… If we have an inflation rate 9 % we need to push-up interest rates atleast 3% (Taylor’s-Rule)...  Rajan has took a good turn, a shortcut in terms of time saving… waiting for more data could lengthen the time taken for turning high interest rate into lower demand and prices… Rajan has done a smart thing to cut short prolonged low growth phase due to higher interest rates… As soon as the inflation comes to the target, the sooner we would be able to push demand and growth higher to reduce destitution locally and globally… Lower prices mean more purchasing power for our common-man… And, the CPI is the right anchor for inflation because people do not buy in the wholesale market…  

Unemployment rate indicates overheating...

Article;
Unemployment levels rising in INDIA ILO report.

Comment;

Unemployment rate at 3.6% or 3.7% or 3.8% is lower than the natural rate or NAIRU (non-accelerating-inflation-rate-of-unemployment, 4-6%) in which inflation becomes low and stable. If it is below the natural rate it is a sign of overheating, the RBI should hike key interest rates to control demand and inflation… Moreover inflation (CPI) too is above the RBI’s comfort zone but after two rate hikes the RBI is expecting inflation to come down close to target (4% with a band of 200 basis points). The RBI’s monetary policy is scheduled on Jan 28, 2014 in which economists expect it to maintain status quo and wait for more data… But with unemployment rate low below the natural rate we can not expect prices to go down too much because demand is still there… the market is experiencing scarcity of labor and to attract labor it is offering higher wages which has further put pressure on prices in the face of supply-side problems… The RBI should affect the proper threshold of interest rate to sacrifice some demand for labor, too, which only higher interest, apart from fiscal policy and taxes, can do to control prices… We can easily expect more rate hikes in the following RBI reviews… This can be said even after taking into account the Urjit Patel Committee report, which has recommend the RBI to follow the CPI as anchor for inflation. The RBI should take both, the unemployment rate and inflation rate, into account to decide the course of monetary policy… Unemployment rate is a sign of overheating…

Inflation targeting...

Article;
Retail inflation as new policy benchmark a good-idea.

Comment;

We should thank the central bank that it has not chosen 0% inflation or complete price-stability as the objective. The central bank would target 4% +/- 2% CPI... much liberal... not very hawkish…It (the central bank) has tried to make the monetary policy more predictable... The RBI has made a complete time-table for years to bring inflation close to the target... a very good move... but let us see how it is accomplished... If that is done by increasing interest rates then we will go through a downward spiral, falling demand and prices until inflation comes close to target 2-6%... or it can be done by fostering supply, especially food items... The Indian story is more about inflation and supply side bottlenecks and as far as demand is concerned the government has pumped too much money through loose fiscal policy... which gave wages and income a boost… demand is outpacing supply due to bad policy in retailing even when food and fuel prices globally are much calm... Bad Government policy is responsible for high food inflation…

Japan, against the market-mechanism...

Article;
BOJ stands pat on easing says winning deflation battle.

Comment;

Inflation targeting by monetary easing can further lengthen the recovery because people will expect that one day inflation targeting will go then they will resume spending... Prices can not fall below the lowest denomination of currency. In Japan it may be 1 yen... Prices fall but they can not be negative... If you buy you have to pay something then what could be the lowest price? It must be the lowest denomination of a currency… The higher end tends to infinity… Nevertheless we can increase the purchasing power of money if we let the prices fall and float a lower denomination of yen which will increase the space in which prices can fall… For example, in Japan if we float a 50 ney (hypothetical) a lower denomination of yen then price can fall from 1 yen to 50 ney… value of yen will go up… Nominal wages are very high in Japan, as high as 750 yen per hour, but we need to increase real wages to reduce income inequality and push growth… Without monetary easing there is a persistent pressure on prices to go down which means we have an excess of supply over demand… The unemployment rate is close to 4%, near the natural-rate which means demand is not a problem within the economy, but falling prices mean oversupply… And, prices should continue to fall to clear the market, but the policy-makers want inflation… Japan has chosen external devaluation over internal devaluation via monetary policy to give exports a push. Falling prices and wages too could make exports competitive…

Public v/s Private spending...

Article;
Interest-rates may come down without Raghuram Rajan's help.

Comment;

 If interest rate goes down private demand would kick-in... good for industries... High government borrowing crowds out private borrowing... Both public and private spending can boost growth but the public sector is constrained by deficit target and there is no such binding with the private sector they can spend higher can push growth higher... Just like the Central bank, a lender of last resort... the government should be a spender of last resort... The government should fill the gaps where market becomes inefficient... as in case of public goods... The government spends when it puts tax somewhere, because it is its revenue... This is why private spending is preferred over public spending... Nevertheless inflation remains a problem and restricts higher growth rates...

OMOs, again...

Article;
RBI to infuse Rs 10000 cr liquidity into market on Wed via omo.

Comment;

OMOs at this point of time when inflation is high will increase more money in circulation... Moreover, the central bank is buying securities which will reduce interest rate on the same. Government will borrow more and will spend more which will push inflation up... The government's fiscal situation is worsening, debt will increase... During high inflation financial innovation makes more sense because it will reduce money in circulation and will, thereby reduce demand and inflation... Why the central banks think that there is a problem of liquidity when inflation is high? The government has put enough money in circulation which resulted in demand pressure due to rise in wages and income... The monetary policy, by increasing interest rate, is the first tool to control inflation the other being the fiscal policy, the use of income-tax... If the loose fiscal policy has created demand pressures then use of taxes to control demand is more plausible... More tax means more revenue... Fiscal position would improve...

Inflation, why? The INDIA's case...

Inflation happens due to scarce resources...  we need innovations to save resources... we need to investment more in education and skills... which will result in higher technology... To avoid inflation we need to operate with capacity above demand... no doubt we need more investment... but in the short-run we experience inflation because labor is scarce... full employment is our second objective besides price stability... and when labor becomes scarce then firms start competing for labor, and, wages and income increase which in a developing economy with supply side constraints result in overheating and produce inflation which the central banks tries to control by increasing interest rates. In the short-run the Central-bank needs to restrict demand because supply is almost fixed, especially in the case of agricultural products, the market takes time to respond, supply increases only with a lag. If the farmer expects higher prices he will produce more, but that incentive is missing in INDIA, because prices are fixed by the government because it buys the produce…We need to liberalize the agriculture, too ...  This is INDIA's case itself...    

Inflation holds the expansion...

Article;
Misreading inflation.

Comment;

The cost of living has increased for everybody due to inflation in food and fuel ( transport) poor and rich alike... the general price-level will increase... everybody will demand more income... but in a supply constrained country like INDIA this increase in demand for income will result in more inflation... Therefore the RBI needs to curb demand through raising interest rate which will put breaks on labor demand and income... industry  will demand less and will  consume less labor... less demand will be created...  In the latest inflation-data we have seen a fall in the inflation indexes, WPI (6.16%) and CPI (9.87%) due to two successive rate hikes by our RBI Governor just after he took the office... therefore expecting a pause in the January 28th review...  but food inflation, i think, will resist to come down from the current levels, and has even shown an increase, will continue to remain a threat to growth because supply side improvements are not in sight in the near future. Moreover, the overall CPI inflation has remained elevated near 9-10% since 2004 and is sticky around that level, again, due to supply side constraints. The RBI now started seeing inflation and interest rate in the CPI's perspective... even it helped the government in bringing inflation-indexed-bonds indexed with the CPI… the RBI is more serious about the CPI now… Therefore sticky inflation will go either by supply side improvement or by a very-high interest rate like under Paul Volcker in the US… I wish the Government move quick and fast to address supply side bottlenecks or the country will go through a prolonged slowdown due to high interest rates. The economy can avert a prolonged downturn by reducing interest rates if inflation comes close to the Central Banks target 5-6%... The economy has two options either we reduce supply side bottle-necks or increase interest rates to curb income, demand and prices… the former looks less painful… Both, the RBI and the government has to decide… India has seen a boom cycle between 2004 and 2012 but high inflation and high interest rate ended that cycle… With a responsible central bank we always do not need to burst a bubble… INDIA could avert the down-turn if inflation was not a problem, however, even the US experienced inflation around 6% before the economy crashed in 2008, but it was largely due to oil prices.  And, INDIA is experiencing high food prices… We need to increase the supply of food… Nevertheless fuel is scarce and may pose problems for growth in any country without possible alternate sources of energy…

Chinese cycle...

Article;
China dwarfs US; Money sloshing around Chinas economy tripled since 2006.

Comment;

What will happen is everybody tries to sell at the same time... if everybody is investing in houses it means they will sell it at some future point of time... they will wait for the right signal... generally people follow investment cycle which depends on monetary policy... if people expect a tightening, a slowdown, a fall in the prices... An investment cycle generally last a few years, 10-15 years (or more). For example the US falls in recession every 10-15 years. Oil prices are an indicator of demand, especially in the US… Many of the booms in the US coincide with oil price peaks… But during the last recession the oil prices too coincided with housing prices… In China, or may be true for many other countries too, housing prices too, again, could be an indicator of demand. All prices move in the same direction. During booms interest rates fall and rise during the down turn. The Chinese economy is trying to keep a tab on interest rates to control demand and inflation which will also strain the shadow banks after all these banks too borrow from the regular banks. Liquidity will start declining and demand for houses will go down and prices will start falling and the investors will eventually start selling. Actually they will try to sell before the prices start falling. Investors decision to sell or hold the property also depend on his time frame of the investments, if they want to see more than one cycle, the longer term investor, they will hold. I think the loose monetary policy followed the recession has probably come to its end…

Who will invest in 'retail' ?

Article;
AAP government writes to dipp withdraws permissionfor FDI funded retail-stores.

Comment;

Why oppose FDI in multi-brand-retail when the companies have to source goods and services locally. Demand and supply will get a boost, income levels would improve. FDI in multi-brand retail is harmful for the economy when there is a competition between domestic and foreign companies to sell their products at low prices, especially in the form of ‘dumping’ which will crowd-out income and employment in the domestic economy. Foreign companies are generally better than their domestic counterparts in terms of investment to produce goods at low prices, especially the mature ones. But with the above clause (sourcing locally) we have shielded our domestic producer from competition. Actually there is no competition, but only competition between domestic and foreign companies to invest. Who will earn profits? Our domestic investors are showing no interest in bridging the demand and supply gap, they have shown no interest in opening shops (sorry malls!) and removing supply side bottle necks that would bring inflation down and bring relief to the “common-man”. Our economy is doing fine, but it is a developing economy and the country has not enough companies to invest in the space (retailing), especially food, which is important to bring prices down. I think many small shop owners who can not invest individually should pool the money and make investments. How many small shareholders would be able to open a mall? We needed foreign investment when our investors shied away from investment…

A pause more likely...

CPI inflation data was out on Monday and showed a marginal decline… But inflation in cereals is 12.14% and has seen an uptick of 2.15%... It is not moderating; an increase even when the government is sitting on a lot of food-grains, even for exports… The government officials see APMC Act major roadblock in the dissemination of food-grains. It is mainly a supply-side problem which only the government can handle but showing itself too busy… But what could be more important than food, not of a person, but of the whole country which is aggravated by the RBI’s stance to hold interest rates high, and investment and income, too, is not growing too fast to pace with rising inflation. It is a two-way detrimental to economic growth… First, higher prices (and low real wage and income) and second a lower income due to higher interest rate. In short lower demand for our market, less growth… The government backed growth so hard during recession that inflation touched twenty-percent and failed to roll back the measures taken to avert the down turn which kept reinforcing demand even in the face of infrastructure, especially roads, and supply-side constraints. Physical infrastructure will take time to cover but releasing food-grains from the government buffer is approachable even in the short-run. We need to show will-power. The RBI embarked on a rate hike cycle bringing inflation near to 10% but inflation is sticky around that level since 2004 which now almost have become generalized that economy will push prices 10%, if the economy grows 8%... A pause in the next RBI meet is likely…

The communist China...

Article;
China inflation hits 7-month low eases tightening fears.

Comment;

Shadow-banking reminds me of the US... Shadow banking showed a lot of potential to boost credit used for inflating housing prices in the US... We (in China) are expecting more inflation down the line which means nominal prices will diverge from real prices and would inflate bubble. Recently economists have started to think of bubbles as normal during boom... they have become common... We can not conceive a boom without a bubble... It means it has to happen… If the economy will grow it will produce bubbles… Brakes on credit, especially through shadow banking because they are loosely regulated, away from normal-banks, are difficult and not easy to apply. Shadow-banks are out of regulation. We can not control them too much. But the system in China is a bit different from the US. It is not a market economy… a communist regime… which can directly control prices by directly fixing them… different from demand-supply adjustments in a market-economy… they are very serious in controlling prices to tame inflation… However, China historically has seen a few currency-redenominations due to too high inflation. Which means historically they have relied on a loose monetary policy. But during the communist system China has become more serious for price-stability to contain real wages for the proletariat…

Deflation, again...

Article;
Eurozone economy shows glimmers of hope.

Comment;

But it is good to let the prices fall, people will purchase costly things at cheap prices, their power to buy things will increase, they will buy more… As soon as the inventories are sold people will demand more labor to increase supply, overall demand and supply will go-up. Both are affected to reach equilibrium price-level at which demand equals supply, market clearing principle. But the ECB is targeting inflation by cutting interest rates down which is the opposite of the market mechanism will lead to. The economy is trying to gain demand due to falling prices, and, rising real wages and income, but the central bank is trying to inflate the economy… But, again complete price stability, zero inflation, is more common than periods of fluctuations. Definitely people will post-pone spending till the policy of inflation-targeting is over… There is a complete reason to believe that prices will come down. The expectation is rational… The central bank (i think) is trying to negate the Germany’s example of internal-devaluation. The path the price-level (downwards) chose was different from the direction the central bank is trying to achieve, upwards... Within Europe Germany is doing best of all… unemployment at 5% and a surplus in international-trade… The central bank is defying the German evidences of growth. The purpose is to create demand either by revaluation or by devaluation, wages and incomes must increase either in nominal terms or real-terms… demand will be created… 

We are data dependent...

We are data dependent... If inflation goes up we have 25 basis points hike on the cards. According to (a moderate) Taylor-Rule perspective we need to increase key interest rates by 5 percentage point if we want inflation to come down near 5%. We have done 50 basis points so far and if inflation WPI is 7.5% we need to increase key interest rates by 200 basis points. The WPI-CPI dichotomy as index of inflation is only the first argument for price-stability… the second one being, we in INDIA have accepted 5% inflation as normal while developed countries have accepted complete price stability (zero inflation) as the objective of monetary-policy… complete price stability has become the new norm in developed countries but in our country prices are so high that a high interest rate to keep demand in check is the right policy for the time-being... If inflation goes too high we can not reject a 50 basis points hike then (probably) again a pause for more data. The data on unemployment should be the next reference point to decide for interest rate movements… Moreover Rajan has said at more than one place that he wants to reward savings a higher real-rate of return. He needs to send a strong signal to contain inflationary expectation and wage demand growth. And, to the government, too, to contain fiscal-deficit which has reached 94% in the first three quarters, and with a quarter still to go… Higher interest rates also affect bond yields and also on government bonds, and, higher interest rate will also deter government from borrowing…