India's Inflation is a lot like Julia Robert's role in "Runaway Bride"(1999) ...and is catching global attention for refusing to be tied down despite several measures over the last 9 months or so. I happened to read Mike's latest post on Indian Inflation...it talks about how India's inflation has been driven up by food and fuel prices, how faster growth in Bank credit (the amount banks give away as loans to corporates and individuals) than in Bank deposits (the amount banks receive as deposits) has led to liquidity crunch, and how India (along with China) is going to "overheat and crash or their economic growth is going to slow dramatically, quite possibly both."
Before we move ahead on this, please note that Mike Shedlock (popularly known as Mish) is one of the world's best and arguably the most read blogger on global economy. So much so that he was even covered in NY Times recently as one of the ideas / trends for 2010. Check that link out, it talks about how post 2007 DIY (Do-It-Yourself) Macroeconomics - ordinary citizens as econo-bloggers have flourished on the internet, many with their own hypothesis and conclusions on how global data should be read and understood !
Having said that, I think while the analysis is correct, the conclusion being drawn here that India and China are overheating and will crash, is flawed...(and no, I'm not taking it personally !) Let's first start by understanding where we're coming from... Here's a chart of interest rates movements over the last couple of years...
(Click for a larger image)
Notice a clear trend...how post 2008 crisis, the rates were sharply pulled down in anticipation of a slow-down in economy, which did happen, along with a minor to sharp correction in real estate prices across the country. Also notice how the rates were kept low for an extended period of time till Mar 2010, before realizing that the economy was in the danger of overheating and the interest rates needed to be moved up...Despite almost 6 rate hikes since then, the inflation is still quite high...(Nov WPI inflation was reported at around 7.5% which is drastically lower than Oct's WPI figure of 8.58%).
There are several reasons for inflation not responding to the interest rate hikes the way it is supposed to:
- Fuel Inflation: Fuel is a crucial component in the inflation, and Crude Oil has gone from near 70$ / barrel just 4 months back to over 91$ as of now, an increase of approx. 30%. From the time government has decontrolled the fuel prices (though diesel, kerosene and LPG is still not completely decontrolled), these prices are being effected almost instantly by the OMCs (Oil Marketing Companies).
- Food Inflation: Food inflation has significantly impacted India with Onion prices shooting through the roof, along with the rest of the veggies. In India, its probably cheaper to snack on fruits than vegetables. Even non-vegetarian items are seeming relatively cheaper to consume, along with dry-fruits ! The government, as usual, has woken up late, but just in time to avoid getting toppled (survival is the objective, improvements are optional) and has cut import duties, banned exports, and prevented hoarding.
- Lending borrowing Spreads: Interest rate hikes are not getting passed in full to consumers, thereby preventing the full impact of increased rates being passed on. So much so that RBI recently had to request banks to narrow their lending-borrowing spreads...some banks acted on it in good faith...all this has happened less than 30 days back.
- Time: Interest rates take time in bringing the inflation down, typically a quarter or so...
- Credit - deposit growth ratio has exceeded 1, which is also pumping in a lot of liquidity in the system, thereby fanning inflation (like Mish has also pointed in his post).
- Real Estate Sector: The curbs on Real Estate sector, which has regained the peaks attained at the boom time in 2008, have been modest, to say the least. This sector is fairly likely to be the area where liquidity and credit is giving rise to huge speculation and further liquidity...to avoid a hard landing in housing prices and thereby a US-equivalent scenario, the regulators here are being overly cautious (I think all lobbyists from Realty sector must be having at least 1 slide in their pitch titled "Look what happened in US"). Probably (and its only my guess), this fear is keeping regulators away from taking the necessary steps to reign in the price rises...which, if true, is a fallacy on their part in my view.
Despite these issues, I believe there are good reasons why India and China can't be painted by the same brush, even though China is also facing almost exactly similar issues as listed above (in terms of containing inflation). And so even if China is at a danger of overheating and crashing, India has far lesser chances of that due to the following reasons:
- Banking System: India has a far more robust and transparent banking system as compared to China. Indian banks do and are perfectly capable of raising money from abroad, though at fairly high rates (read my earlier post on Indian Companies raising International Debt).
- Cushion in Housing: Besides, in India, a whole lot of black money goes in into the house for down-payments, so much so that a lot of buyers actually own 20% -50% of their houses by the time their mortgage payments start. So the banks have a good cushion even in the case of price drops. (Black money payment keeps the official registration value of the house down and helps in reducing the registration tax down which is a percentage of the house's value).
- Infrastructure Requirements: While China has put in place a cap on domestic consumption through over capacity in almost every area possible, whether it is high steel or cement production capacities, or already well-built infrastructure including ghost cities (Kangbashi) and empty malls. Contrast this with India's dire requirements for all kinds of infrastructure...right from ports, roads, bridges, railroads, dams, power, military spend & upgrades and housing. India can comfortably raise debt and ride the growth path for the next decade, if not more...and note that this is Productive Growth, not equivalent to building Ghost Cities, which do not contribute anything to the exchequer, but over a couple of years will become huge liabilities which will need to be maintained at massive expenses. The difference is between building a bridge that can rake in toll-tax, saves hours of commute & wear & tear for people and trucks, thus contributing really well to GDP growth, and building a bridge that generates little or no revenues, doesn't save time and will need to be maintained irrespective.
- Political Will: In India, all that's lacking is political will, which too is slowly turning a new chapter...its being made to - by the public that's voting in performance and growth and voting out caste based politics. Scams are toppling one after the other from inside corporate and political cupboards, but the response its getting this time around is that of serious concern and not that of indifference from the general public. Consider a scam in 2G spectrum auction which could have potentially wiped out nearly 50% of India's fiscal deficit ! These scams are a blot on India's image, but are being reported and followed by general public far more than ever before...Compare this with China, where corruption is probably as rampant if not more, but nothing ever comes out...and you'll never know how much garbage is behind an opaque curtain...
- Transparency, Lack of Investment Avenues: This transparency in India is going to give investors that additional comfort in putting their investments as investment avenues keep reducing worldwide. If Europe is on the edge, and US is next, Japan is uncertain, and China can't contain inflation and most definitely can't keep growing at this rate much longer, how many other investment avenues are you left with? Currency, Gold, Platinum and such asset classes are increasing being interlinked to sovereign stability, and need to be invested in with proper hedges being in place...'coz for all the analysis in the world, you still don't know which variable is going to play-up first !
- Demographics: Like its often said, India is a young country, demographics are skewed quite positively towards India. Millions of people are currently on the verge of making it to great Middle Class of India...and for us, that translates into all kinds of requirements, from housing, to cars, from luxury products (like conditioners, deos, perfumes, watches, shoes, etc. - for people below the Middle class level, even these are luxuries!) to clothes and general groceries. Just to give you an example of how young India spends, can you take a guess as to which FMCG product is registering the highest growth in India? Its deoderant !! Now, I dont' see too many old people using that...to me (stats apart) is a sign of young people getting more disposable income...the kind of people who think using a deo is more a necessity than eating breakfast...its just a sign, but it sure is that. Language comfort is another important plus for India over and above China.
To me, these factors seem quite supportive of the view that India may be down for some time (correction) but it sure won't be out (crash)...I'm not saying there are no risks or they are minor enough for us to ignore...India's poor education system, lack of identity, corruption, lack of planning and coordination among various government agencies, fiscal deficit (though not too bad), failing to cash-in on the opportunity of increasing domestic consumption, etc. are all risks...but I believe they can be and will be overcome in some time...its not going to happen overnight, but the framework of India is changing and that change will enable all these to happen.
The bride (inflation) is going to get reigned in in some time, provided proper steps are taken by the regulators...and I believe they will be...no one is giving kudos to Indian regulators for being pragmatic during the boom times and keeping the interest rates high, which prevented the bubble from becoming too big in India...they did that right then, they'll do right now.
Have a Happy New Year ! And make some resolutions, some will be broken, but then for some that aren't, its still worth the effort !
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