Eight-year cycle: Sensex may hit 21,000 jackpot in 2011

Yes, this is the headline in Economic Times.

Here is a excerpt from the article-
If you are a retail investor looking to make money on Dalal Street, you may have a little over 12 months left to get your portfolio Volatile mkts: Do I invest now or exit?
Risk while investing in midcaps
Follow 20-20 rule for better returns right. The Indian stock market is in the midst of a consolidation phase that will set the tone for the next bull run which, according to chartists, is set to begin in the first half of 2011.

The technical analysis, based on a classical eight-year time cycle that the market has followed since 1984, projects the Bombay Stock Exchange (BSE) benchmark Sensex to break the 21,000 barrier by early 2011 and embark on a bigger bull run. “The current rally is an upward leg of the larger consolidation pattern,” said Anup Bagchi of ICICI Securities. “In 2010, the Sensex will fluctuate in the range of 12,500 and 21,000. The next major peak is expected in 2016.”
Source: EconomicTimes

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21,000 seems like a quite bullish prediction to me. The question is that will the RBI let the FII inflow increase? There are two opposing forces driving RBIs decision making right now
1. Growth- In the past the RBI has been conservative in dealing with FII money. The sensex doubled in the last few months and now the RBI has become cautious. That is why it left the interest rates untouched last year
2. Inflation -Inflation is in double digits and increasing. Soon, RBI will have to mop up excess liquidity from the system.

Achieving the both the above mentioned objectives may not be possible.

Net-net, I think the RBI will try to tackle inflation first.

India concerned about Inflation

RBI moves to contain inflation without hurting growth
Aiming to tackle inflationary pressures, the Reserve Bank on Tuesday increased a key statutory deposit ratio for banks by one percentage point to 25 per cent but the move is not expected to push interest rates up.

Barring the hike in Statutory Liquidity Ratio, the deposits that commercial banks are to park in government securities, the central bank left other key policy rates and ratios unchanged. ( Watch )

Although the one percentage point hike in SLR could suck up over Rs 30,000 crore from the system, the average SLR of banks is already at 27.6 per cent.
More

Doing Business - Country Rankings

Here are the actual rankings

Click on the picture to see a Indo-China comparison

India to pull back stimulus package

Times of India had the following story-

Stimulus may be rolled back as recovery sets in
With the economic slowdown bottoming out, the stage could be set for a "gradual and caliberated" rollback of revenue giveaways contained in the stimulus packages, starting with a review of the 2% excise and service tax cuts announced in the interim Budget.
The confidence that the economy might have turned the corner is growing in government and its attention is turning to the fiscal deficit that has grown larger in view of Rs 70,000 crore of revenue concessions coupled with big spending plans and reduced tax collections. The fiscal deficit has been put at over 10% of GDP.
It is the excise and service tax cuts amounting to Rs 30,000 crore that may be reviewed first....continued

My 2 cents on this story-
1. Overall, it is a very bad idea to even consider thinking about
2. Its seems like the govt has become not only optimistic but also certain about the future. I think there is still time for the recovery. India's growth is not going out of control. So why dampen it??
3. Govt cannot be uncertain about the steps it is going to take. This level of uncertainty will trickle down to the other economic agents and lead to delay in decision making
4. No need to worry about the debt. We are in control. Pulling back stimulus is a very naive way of controlling debt
5. Inflation is also under control
6. I am not sure about whether the govt considers the earlier rolled out packages as a success and a key reason behind the slight growth recovery. If it does, then I would would say that govt by pulling back stimulus would be just killing the geese which had been laying golden eggs

Are we out of this crisis?

I don't know the answer to this question. The recent data shows that GDP of a few countries is growing, but the unemployment rate is not falling. Infact it is rising.This is true for both U.S. and Japan.Intutively, people would expect companies to start hiring in an expanding economy.

Economic purgatory- thats what Krugman calls this phase. He does NOT admit that there is a lag between increase in GDP and decrease in unemployment and also does not provide any reason behind this trend.

Here is an attempt to discuss the key reasons-
Please add any others reasons that you believe are leading to this jobless growth phase-
1. I feel globalization is a key dampner here. Almost every second
company's fortune are tied to fortune's of clients from other economies. It will
require a lot more countries to come out of the recession in order for the companies to start hiring. It is too soon for the companies to become confident about future demand
2. People are still uncertain about future. Every recession bring with it a feeling
of unsecurity and uncertainty about future. This feeling goes away with time
3. As a result of the crisis, the companies have become focused on increasing productivity of existing labor force. Hiring is the next logical step after this.
4. Any others?

Domestic consumption- key to sustainable growth

See below a table from an article on 'The Hindu Business Line'-



I find this table to be interesting. As expected, U.S. is at the top of the list and the South-East Asian countries are at the bottom.

I would have loved to see the effect of leverage on consumption. Consumption based on income is good, however consumption based on heavy leverage is always undesirable and risky. This is the reason why U.S. is contracting and India is still expanding.

The marginal propensity to consume has been low in India and even lower in China. However, this will definitely increase in the future.
... and yes, domestic consumption holds the key to any country's turn around; this will lead to self-sustaining growth

Most horrible correlation argument

The above is a graph that posted was by NY times for an article- SAT Scores and Family Income.
Key conclusion of the article-
"Generally speaking, the wealthier a student’s family is, the higher the SAT score."
This has sparked a debate between two of my favorite economists- Greg Mankiw and Paul Krugman.

This is straight from Mankiw's blog-
"In essence, what I said was
1. People vary in their innate talents, as measured by, say, IQ tests.

2. More talented people tend to earn higher incomes.

3. More talented people tend to have more talented biological children--that is, talent is partially heritable.

4. As a logical implication of the above three points, the raw correlation of kids' SAT scores and family income conflates the true effects of family income with the biological transmission of talent."
--
Well, I cannot disagree more with Mr Mankiw because-
1. There is ample evidence in real life that suggests the opposite. Rich people have children who do not do well in examinations.
2. The argument is flawed in assuming that IQ is representative of the talent in a person. There are people who have become rich not because of the gift of intellectual endowment. There are several examples of people who did well just because of good management skills. I don't think IQ can be indicative of such things
3. The argument seems to suggest that children of rich people will do well in exams because their parent's are talented; it does not take into account the school conditions, factors such as intention of children to become intellectuals, etc. As an analogy- How,/When/Where the seeds of a rose plant are sowed determined the quality of the rose flower. If you plant the seeds in a desert and do not give any water, then the result is obvious.
4. I assume that the author of the original article will agree with the below statement:
"Transfer of money to dumb people will make the dumb people rich and hence intelligent"

WB loan for recapitalization of Public Banks

The World Bank and India have concluded negotiations for loans worth $3.2 billion for recapitalising state-run banks and funding for the India Infrastructure Finance Company Ltd.

The World Bank board would meet in September in Washington to approve a $2 billion loan for the recapitalisation of the state-owned banks and another $1.2 billion loan for the IIFCL. - Source: Economictimes
---

Although, the intention to recapitalize the banks and spend on infrastructure is 100% right, I don't see any need for a loan from "The Bank" at this stage because-
1. In the middle of the crisis last year, the average CAR ratio of public banks was around 13%. I don't think that this ratio would have fallen drastically since then
2. Infrastructure spending is required right now. But, frankly we can't be throwing money at the problem. Effective investment strategies are required; we have spent enough. Govt should focus on following the money that it has already allocated for infrastructure and ensure that the money enters the system soon

Government spending- temporary energy injections

Here is Ken Worsely on Japanese spending-

GDP up on government spending
Despite the 0.9% rise in GDP over the April-June quarter, there remain some skeptics worried about how strongly Japan will be able to recover from multiple quarters of negative growth. The Nikkei published an article yesterday entitled “Jobs Weakness Could Slam Brakes On GDP Growth, Economists Fear“. The Nikkei puts it simply: “For Japan, the biggest challenge is whether the stimulus measures can create sufficient private-sector demand to trigger a self-sustaining economic recovery.” Of course, this is impossible, as stimulus measures are temporary and mainly serve to increase national debt. ...more
----

I am a keynesian by heart, hence I place a lot of emphasis on government spending.
On the question of debt -
Yes, govt spending will increase the govt debt, but not necessarily the debt/GDP ratio. In the medium term the benefits of the govt spending will increase the GDP, as Ken has correctly pointed out. Hence, a case of increase in numerator and denominator

Temporary energy injections?
1970s was a time when monetarists had completely dumped Keynesian explanations and theories about recession. However, fortunately people today have realised how keynesian policies are necessary along with monetary policies. Almost every country has designed and implemented a govt spending program. I am not suggesting that govt spending is self sufficient for a quick recovery, I am just trying to suggest that govt spending could lead to sustainable recovery if effectively supplemented with monetary expansion policies (assuming that there is no structural problem in the economy)

More on Infrastructure in India...

Next decade will be of infra: Nath
Union Road Transport & Highways Minister Kamal Nath has kick-started his campaign in Singapore to woo foreign players to invest in the road sector in India.

Addressing the investors at ‘Building India: India Infrastructure Summit’ today, Nath said India’s next decade would be of infrastructure. He said infrastructure would be the defining sector for India in the coming decade as was information technology in the 1990s and the present decade.
Source: Business Standard
---
Exactly what should be happening. Glad to see the commitment of the govt towards encouraging PPP in Infrasture. This is going to be the most important phase which will decide the course of the economy in the next couple of decades.

IIP still not going the right way

Story in Business Standard-
Chief Economic Adviser Arvind Virmani today said India's growth projections by international financial institutions are too low and asserted that industrial growth of 2.7 per cent in May is in line with the estimate of seven per cent this fiscal.
Industrial growth figure of 2.7 per cent in May is in line with seven per cent growth (plus-minus 0.75 per cent) for the current fiscal, projected by the Economic Survey with some riders, Virmani, the principal author of the pre-Budget document, said.
"Overall IIP growth is very much consistent and supportive of our projections...international financial institutions like World Bank and IMF are still way too low," Virmani said.
---
Here is the picture of growth rate of IIP in the last 6 months-







Source: Indicus Analytics

Thanks to indicus for collecting all the data.

Clearly, the consumer demand has been driving the growth. The 2.7% growth in May is better than 1.4% in April.
But the real question is whether this is good enough.
I don't think so. An annual average of 7% might sound fine in this econopmic environment. But I don't think that we will be able to reach a two digit growth even in a boom period. This is a concern. The primary reason behind this gap is that India does not have the right infrastructure for efficient manufacturing. This is a fact that everyone realises.

The boost will come only when the govt creates the right infrastructure. Hence, I feel the massive spending that the govt has announced in the budget is a step in the right direction. These are policies aimed at achieving long term objectives. Thumbs
up to the UPA

Debt crisis in USA

Yes, there is talk about how the large debt is having an impact on policymaking in America.The U.S. debt currently stands at US$ 11.5 trillion. No joke

Why is this bad?
1. Future spending programs would be curtailed-The U.S. govt will be very handicapped in passing future spending programs through the senate. The amount of spending (over US$1 trillion) announced in the last 10 months or so have not showed results (mainly because very small percentage of it has been actually been spent till now). Obviously, it takes time for money to enter the system through this channel. However, the impatience of people could mean more pressure on govt to spend. But, the problem will be to convince the senators to support more packages. Several of them are already crying foul.

2. No more bail-outs- If the economy dips again, the govt may not be in a position to bail out anyone. This is good for free market economists but not necessarily for the politicians.

3. Credit rating of USA will become low
4. The pressure on interest rates will not ease quickly

Add to that the fear of a falling U.S. dollar. Everyone is aware of the potential of China and Japan to trigger about a dollar crisis by mass selling of treasury bonds.

This is a real crisis. Govt needs to do much more to tackle it. However, I still support most of the spending programs that had been initiated to tackle the on-going crisis.

The mystery behind the high savings rate

Here is an interesting article on New York times on high savings rate in China.
Why Do Chinese Save? Boys Want to Marry
The high Chinese savings rate has been one of the wonders of the world. The household savings rate, as a proportion of disposable income, is 30 percent, and has been rising rapidly in recent years. That figure is twice as high as the highest rate ever recorded in the United States....
Source: The New York Times

The article writes about a working paper written by two economists-Shang-Jin Wei of Columbia University and Xiaobo Zhang of the International Food Policy Research Institute. This working paper concludes that the primary reason for the high savings rate is the gender imbalance, where families of males save more parents want their sons to marry, and they figure that girls are more likely to want to marry rich boys.
India too has a savings rate of 28%. I don't see the evidence of above in India.
I understand cultural differences do explain differences in behaviour of individuals to an extent. However, I don't think we can term cultural differences as the primary driver for such an economic behaviour.

Savings rate, according to me, can be primarily explained by the following:
1. Uncertainty-
Income (through a job or through unemployment benefits)
Inflation

2. Less support from government-
No social cover
Health insurance
Pensions

Given that China and India are expected to grow at 8-11% in the next few years, it will be interesting to see whether the savings rate remains that high. I expect it to lower to around 20-25%.

FDI inflow in India

India receives US$ 2.34 billion FDI in April 2009
The foreign direct investment (FDI) inflows in April 2009 stood at US$ 2.34 billion, compared with US$ 1.96 billion in March 2009, registering a growth of 19.3 per cent. This signals confidence in India’s economy by foreign investors amid the global financial crisis.
In the last fiscal, India attracted a total of US$ 27.30 billion FDI—due to robust trends in the first six months of 2008-09—as against US$ 24.5 billion in 2007-08. Further, cumulative FDI from April 2000 to March 2009 stands close to about US$ 90 billion.
Experts believe that the foreign investment inflow is expected to improve further with the revival of the domestic stock markets.

Source:IBEF

This is great news. Not many people are taking not of this progress. This robust inflow of FDI is reflective of the confidence that foreigners have in India

8% growth rate for India in 2010- WB

The World Bank has projected an 8% growth for India in 2010, which will make it the fastest-growing economy for the first time,overtaking China’s expected 7.7% growth.
The multilateral lender has revised upwards the growth rate for the Indian economy this year to 5.1% from an earlier projection of 4%, according to its Global Development Finance Report released on Monday. India has consistently outperformed growth forecasts by the World Bank in the past.
Source: Economic Times

Couple of interesting points-
1. Clearly, predictions of WB are really off. I had in my earlierpost mentioned how it was being pessimistic in its prediction
2. WB has revised its prediction from 4% to 5.1% in just a couple of months. Now the questions is that what has changed in the last couple of months for India?
FDI has been flowing in regularly. However, I am still not sure how/why have they changed the prediction in a couple of months
3. The prediction looks very pessimistic for 2009 and overly optimistic for 2010

50th Post!!!

6.7% and all set to grow at 9% next year

Great news for India-

India's economy is estimated to have grown at 6.7% in 2008-09, the year of downturn and global financial meltdown. While this is only a bit higher than the 6.5% most in government were expecting, it is a lot better than the 5-5.5% that independent economists and analysts had projected. Times of India

Clearly, this has come as a pleasant surprise to many economists. This is even much more than what the govt of India had projected.
So now what?

Several industrialists are asking for a rate cut. The govt needs to take steps carefully here. It is difficult to project the inflexion point in a growth curve. However, prudent policy makers need to see the long term implications of the steps aimed at tackling short term deviations.
I would recommend a wait and watch step right now. Clearly, the economy has been responding well to the fiscal and monetary measures. In addition, given the fact that the US economy is expected to do better in the next quarter, Indian policymakers should not try and pump in more liquidity.

There is no case for interest rate cuts-
1. I don't think RBI will be in a position to start increasing interest rates next year if the Indian economy picks up more steam
2. A stable long term policy insures that people/organizaztions have enough time to plan/implement steps. Frequent and unexpected changes in interest policy will only make people more undecisive

The time is right to get more efficient at doing the traditional things instead of trying out new things.

Politics and economics- just don't go together

Normally, I hate to comment on opinions of politicians, because those are always biased. But I will make an exception today.

I saw an article on Bloomberg
Here are the excerpts...
India Needs ‘Massive’ Interest Rate Cuts, Sinha Says
India should lower interest rates and accelerate economic reforms as part of a “Big Bang” after growth slowed to the weakest pace in six years, said Yashwant Sinha, a former finance minister.
“What we should be doing is release money into the system, reduce interest rates and persuade banks to lend more,” Sinha, a lawmaker of India’s biggest opposition party, told Bloomberg News in an interview in New Delhi today. “Inflation is near zero and there is no reason why the Reserve Bank of India shouldn’t be reducing the interest rates, much more massively.”
... Sinha criticized the efforts of the present government and the central bank as a “bits-and-pieces-policy,” not adequate to protect the economy from the global financial crisis. “We need a Big-Bang approach to save the economy,” he said.
... The biggest challenge for the next government “will be to take the Indian economy out of crisis and put it back on the double-digit growth path at the earliest,” Sinha said.

Here is my take on this-
1.Time for big bang is over. Economy has stabilized and now there is no reason to adopt a big bang approach

2.Interest rate reduction is a tricky thing. You cannot afford to get the timing wrong. Greenspan kept cutting rates...and look where he has brought the global economy
Mr Sinha talks about persuading banks to lend more. This is ridiculous. How do you persuade someone?
If you want somebody else to do something, then, you have set the right kind of incentives. Persuation does not work. Either you tell them (by setting laws) or you make them do (by setting incentives) what you think is right

3. Double digit growth? India can touch double digit growth may be a few years in future. But quite obviously it will not be sustainable. People should stop thinking of the economy as a corporate firm. Corporates need to grow and should grow at that pace. Double digit growth for Indian economy will not be sustainable.

I still see many people asking for more interest cuts. Given that the last interest cut happened on 21st April and the fact that reasonable estimates are putting the growth number around 6% for India, I would refrain from suggesting interest rate cuts in the short run

Spend Spend Spend...in this economy

Everyone is talking about increasing spending in the economy. In recessions like these, people prefer to hoard money. Can you blame them? No. Why will anyone spend money when his/her confidence in the economy is low. People who are short of confidence and resources, prefer to defer consumption. But the problem is that to kick start the economy, spending needs to be boosted dramatically. How to make people spend?

Well, you can make people spend money by either-
1.Making money hoarding costly
2.Making spending more attractive

Economists typically prefer the first approach.

Greg Mankiw argues for negative interest rates.
Excerpts from his article in NYtimes-
Until recently, most economists relied on monetary policy. Recessions result from an insufficient demand for goods and services — and so, the thinking goes, our central bank can remedy this deficiency by cutting interest rates. Lower interest rates encourage households and businesses to borrow and spend. More spending means more demand for goods and services, which leads to greater employment for workers to meet that demand...
... Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent.
That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 3 percent, since losing 3 percent is better than losing 10.

Ken Worsley talks about a hypothetical solution- Currency manipulation

Excerpts from his article in Japaneseeconomynews.com-
The first idea in this series should wreak havoc and cause panic spending in all sorts of sectors, while simultaneously creating millions of new jobs. To do this, the Japanese government simply needs to create new banknotes and coins that are all radically different in size to what currently exists. Ideally, notes should be larger and differently proportioned, while the size and weight of all coinage should dramatically change...
... consumers will find that the new banknotes will not properly fit in their existing wallets. Every wallet in the country now needs to be replaced, and the National Police Agency could issue a timely (and helpful) warning that using the new notes with old wallets might leave one open to a greater risk of becoming a pickpocket victim.

The above two solutions work in theory. However, the common point you will notice is that here the strategy is to make a condition (hoarding money) costly for individuals. Hence, people will have to quickly change their preferences/decisions in order to avoid being worse-off.

Let’s talk about the second approach- Making spending more attractive
I have written earlier about consumption rebates- incentives given to individuals to consume more. Here, the individuals have an incentive to change their preferences in order to become better-off.
What I am suggesting here is not something very new. The Indian tax law gives some incentive to spend(although very minimal) in the form of food/gift coupons. Yes, these coupons have an expiry date. The money people spend to buy these coupons is exempt from taxation. But the problem is that this amount is very small. What I have suggested in the past is to get a consumption rebate on a larger scale.

Now the question is that which approach is better- Making hoarding costly or Making spending attractive?
In an economy where consumer/investment confidence is low, people might not react quickly to incentives. In such a situation, I prefer the latter approach because if people don’t respond to the former approach in a timely manner then they will become worse-off very quickly. This is not true if people adopt the second approach.

Global Recession- Who Is The Culprit?

Everybody has been talking about the root cause of the financial crisis. Some blame the bankers, some blame the greedy house owners, few blame the FED, many blame the regulatory authorities. Who is the real culprit is difficult to identify. In an integrated world it is not easy to say whether 'X' led to 'Y' or 'Z' led to 'Y'. However here is my assessment-

Two primary causes-
1. Low interest rates
2. Less regulation

I believe that economics is driven by incentives. If you give the right incentives to people then there will be overall beneficial growth.

Low interest rates
The housing bubble collapse is seen as the core cause of this recession. Why do you think there was a housing bubble? Because people who didn't have the money to buy a house also became house owners. They were able to borrow money at a low rate and were encouraged by the Fed to borrow more. In other words these people had an incentive to borrow. Why were the rates so low? Well... Fed chose to keep them low. Their reasoning is that they wanted to take the economy on a growth path after the 2001 recession. But the problem was that the rates were kept too low for too long. Why?

Less regulation
Bankers and other financial institutions wanted investment vehicles where they could invest money. They could not find any. So guess what? They created their own...they created complex structures which were difficult to understand. Nothing wrong till now. Bankers are greedy like common people. They have to be profit seeking. Profit seeking behaviour of the companies is an essential condition for any economy. Innovation and technology development is an outcome of such profit seeking behaviour. It is a reality and can't be ignored or ridiculed. The problem started when the regulatory authorities were not able to (or even willing to) detect it. In other words the bankers did not have an incentive to stop such practices. Why were such practices (totally legal) not detected? Is the answer -crony capitalism

I completely blame the Fed. Alan Greenspan has admitted that he got it wrong. Fed set the wrong incentives for the people/institutions.

Fed did things that it was not supposed to be involved in. Fed is not there to boost the housing market. Today, most of the economists believe that supply of money directs the growth of an economy. Power is in the money. But, money is with the Fed. There should be no room for error by the Fed.

The following are some the responsibilities of 'The Board of Governors
of the Federal Reserve System'- Source: FederalReserve

1. The primary responsibility of the Board members is the formulation of monetary policy. The seven Board members constitute a majority of the 12-member Federal Open Market Committee (FOMC), the group that makes the key decisions affecting the cost and availability of money and credit in the economy. The other five members of the FOMC are Reserve Bank presidents, one of whom is the president of the Federal Reserve Bank of New York. The other Bank presidents serve one-year terms on a rotating basis. By statute the FOMC determines its own organization, and by tradition it elects the Chairman of the Board of Governors as its Chairman and the President of the New York Bank as its Vice Chairman.

2. The Board sets reserve requirements and shares the responsibility with the Reserve Banks for discount rate policy. These two functions plus open market operations constitute the monetary policy tools of the Federal Reserve System.

3. In addition to monetary policy responsibilities, the Federal Reserve Board has regulatory and supervisory responsibilities over banks that are members of the System, bank holding companies, international banking facilities in the United States, Edge Act and agreement corporations, foreign activities of member banks, and the U.S. activities of foreign-owned banks. The Board also sets margin requirements, which limit the use of credit for purchasing or carrying securities.

4. In addition, the Board plays a key role in assuring the smooth functioning and continued development of the nation's vast payments system [see Fedwire and Payment System Risk Policy].

5. Another area of Board responsibility is the development and administration of regulations that implement major federal laws governing consumer credit such as the Truth in Lending Act, the Equal Credit Opportunity Act, the Home Mortgage Disclosure Act and the Truth in Savings Act [see Consumer Information and Community Development].

India...creating real assets

Govt clears 22 FDI proposals worth Rs 541 crThe government has cleared 22 proposals, including those of Yamaha and Nokia, that will bring in Rs 541.25 crore of foreign direct investment (FDI) into India.

These are all positive signs. FDI is always better than FII. FDI shows that companies are confident of investing in the country. This creates 'real' assets and employment. I will anyday prefer FDI inflow of Rs 1,000 cr to FII inflow of Rs 2,000 cr

Some good news for the industry...

Core sectors rebound to hit 6-mth high growth of 2.9%

Holiday Reforms In Japan

The government is considering holiday reform to increase tourism and relieve crowding problems that often accompany vacations. In addition to creating more three-day weekends by switching holiday dates, the government is considering staggering summer breaks at schools by region.
The Tokyo Metropolitan Government and Chiba Prefecture, among others, have already created special holidays, mainly for students at public elementary and junior high schools.
The central government is discussing ways to prompt employees to take more paid holidays. One idea is to change accounting standards so that companies are required to book reserve provisions for unused holidays as debt.
Japan ranks lowest in terms of use of paid holidays, with over 50% of the total going unused annually. The government estimates that using the full amount would create about 1.5 million jobs and generate economic benefits of about 12 trillion yen.
The government plans to work out the details of its plans with the relevant ministries and industries.
Source: The Nikkei

Three day weekends...longer summer breaks. I like the idea. At a time when people are concentrating on bringing a banking reform and designing a export strategy, Japan is going to a new level to boost demand. Obviously the flow through will not be 100%, but still this is a costless policy.

More on free market theory...

I have been seeing videos and reading articles of Milton Friedman. His theory/approach about free market sounds very convincing. People should be free to make decisions. No force (govt) should be applied on them. If selfish people serve their interests then the market will reach the equilibrium state.

I agree in principle. Freedom to choose/live/eat/sleep/consume/invest should be there. But there is something that I don't agree with- Extreme freedom. Some regulation has to be there.
Friedman's theory works under the assumption that every individual is well informed and quite able to make the right (right for him/her) decisions. Is that really true? I don't think so.
There are mainly three problems:
1. Not all people are educated. How many people today understand the tax structure or incentives such as lower interest rate? Unfortunately, not all (Not in India). 70% of the population stays in rural areas.
2. Not all people are fully informed. Do you know exactly how is the govt taxation structure going to affect you next year?
Unfortunately, mostly people are misinformed and need to be guided. If they are given extreme freedom, then their inability to take right decisions for themselves can severely hamper their quality of life.
3. All people are selfish but some are also immoral. Some people don't care about others at all. They just want to pursue their personal goals...not matter what the cost to the society.
For example- Friedman has often criticized democracy. He says that in a democracy people vote for those who want power. Hence, democracy only brings powerful (and selfish) people in the government. That doesn't sound good.
Ok. Back to the example- Today terrorism is a reality. There are a bunch of people who misguide others in the name of religion. Illiterate and poor people are chosen (or recruited) as terrorists. What would Mr Friedman say to that? People are free to choose what they want to do? But Mr Friedman...their choice is wrong...they are killing those who didn't choose death for themselves

Free market theory is a principle. It (in theory) should be applied to every aspect of life. Although, I do believe that people should be free to make a choice, but govts role in the whole system cannot be undermined. Govt is life a referee in a game. Whenever there is a foul, all players should look upto it for guidance and justice.

Problems with slashing salaries in your firm ?

In this uncertain economic environment, employers have been busy with slashing salaries. Sounds like an easy solution to tackle rising costs...right? But there are problems with slashing salaries:

1. There is a mismatch in the salary and the expectation of employees: Any employee would like to earn the maximum that its employer is willing to pay. However, every employer would always like to pay the minimum that the employee is willing to work for. This mismatch gets even more clearer/evident/realistic in such uncertain times. Employers sometimes by slashing salaries reduce the salaries to a level that is below the min expectation of the employees. Employees in such situations may/may not leave in the bad times but will certainly leave their employers when the times become better. Employers in a way will always risk loosing employees at the turn of the tide

2. Employee motivation/commitment goes down
Salary slashing always brings along with it motivation/commitment slashing. Not a difficult concept to understand right?

Here is one "courageous" solution for the employers-

a. Ask every employee to bid for his/her salary. Essentially, ask every employee to indicate a salary corridor that he/she expects from the firm in such uncertain times
b. Tell the employee that the company has already fixed his/her salary, but it will not reveal it.
Rules- If the employee indicates a salary that is 20% to 30% more than what the firm has fixed, then the employee should be asked to leave the firm. But, if the indicated salary corridor is less than or equal to the salary fixed by the firm, then he/she should be paid that much

This sounds like a simple solution, but it addresses the real challenges that the companies face-
1. It filters out people who have high expectations. Anyways, these people either would have left immediately after a salary cut or would have left later when the economy would have bounced back. Clearly, firm will get rid of people it thinks have high expectations
2. Due to fear of getting fired, employees will always be a bit conservative in their bids. This will not only lower the overall payroll bill, but will also make the employees feel that they are getting paid in-line with their expectations
3. No one will blame the firm for slashing any salaries. People will be in a way negotiating their own salaries. ( I am sure that Milton Friedman would have been very happy to hear of such a solution- A solution that gives the power to the people)

Friedman On Drugs

Friedman argues for legalization of drugs.
This is a moral issue. I really don't think that there should be any debate on this.
Drinking of alcohol is illegal for minors. Should we start thinking about legalizing it just because it will bring in more revenue for the manufacturers/retailers and also government (through sales/VAT tax collection)?

Increase in South-South trade

Australia for expanding ties with India
Besides mining, agriculture, education and services, which were some of the core areas of bilateral trade and investment between India and Australia at present, Australia was keen to focus on other potential areas of business like food and beverages business, automotive sector, aerospace industry etc, informed Micheal Carter, Counsellor Commercial, Australian Trade Commission.
“India happens to be the fourth largest export destination for Australia, it is a very important strategic partner for trade, but the current export import activity between the two countries is largely confined to mining and mining resources, education, services, agriculture, and more of a resource-based relationship which can be widened. There is a lot of scope for business and possible collaboration in the areas of food and beverages particularly wine, travel and tourism,” he said.

Australia's exports to India was worth around 12 billion Australian dollars last fiscal.

With a fall in demand from the developed countries like USA, Germany, and the UK, a number of countries are beginning to look for new key trade partners. Although, India is the 4th largest destination for India, Australia is trying to expand trade. This is very critical for countries (like India and Australia) that have a robust banking system in place. For such countries, demand will either come from within (i.e., domestic consumption) or from external sources (i.e., non USA, UK type countries)
Expect to see more trade agreements in the future.

Split or Steal?

http://www.youtube.com/watch?v=p3Uos2fzIJ0

The above is a link to a video of a game show- Golden balls
I saw this video on Greg Mankiw's blog

Great video!! There are three key components- 2 participants and one large bag of money. Each player has to choose one option- Either 'Steal' or 'Split'. The owner of the money is determined based on the choices that these participants make.

Here are the rules:
1. If both the players choose steal then no one wins anything from the prize money
2. If both the players choose split then the money gets split between the two
3. If one chooses steal and the other split, then the full amount goes to the former

Sounds similiar to the prisoner's dilemna problem?

Not exactly. There is a slight difference here. In the actual prisoner's dilemna problem the two individuals are not allowed to talk to eachother. So decision making is very difficult. One has to assume what the other person will do and then take a decision based on it.
However, in this game show the participants are allowed to talk to eachother before making a choice. This does not make one's job easier but it certainly gives a chance to an individual to convince the other person to choose something (in this case 'split'). For example, if you and I are in the game, then I can convince you to split the money with me by choosing 'split'

Obviously 'split'-'split' is one option. But again this means that both the participants will have to trust eachother. You can never be sure about anything here.

In all the different videos that I have seen, i noticed, a typical style of people was to convince the other person to choose 'split'. Then, the smarter (and evil) ones, after convincing his/her opponent to choose 'split', would choose 'Steal' themselves. This is how most of the people (if not all) approach this situation. Effectively, the winner betrays the other person. I didn't see any winner enjoy his/her victory. After all adopting this strategy will mean betraying someone on the NATIONAL TELEVISION. I wouldn't like to show people that I can betray others for some money.

I can think of another strategy. Let us assume that there are 2 players in the game 'A' and 'B'. Our objective is to make A win more than 50% of the prize money (i.e., by not splitting the money).

When 'B' tries to convince 'A' to choose 'split', 'A' tells 'B' that he/she will choose 'steal' and is ready to give a share of your prize money to 'B'. How do you think will 'B' react? He/she will have two options-

1. Choose 'steal'- 99% of the people will not choose this. 'A' has already made it clear that he/she will choose 'Steal'. Now if 'B' chooses 'steal' then obviously no one will win anything...and this will also make 'B' look like an idiot on national television. Why will anyone choose 'steal' when he/she knows that the other person will also be choosing 'steal'
2. Choose 'Split'- All the Bs of the world will prefer choosing this. Obviously 'A' has made it clear that it will share a certain percentage of the prize money. B' will have no other option but to trust 'A'

Why is this approach better? This approach will make things predictable for both the parties. There is no ambiquity. Obviously player 'B' can also choose 'steal' and make sure that no one wins anything. But I don't think that anyone would do that (not on national television)
This will not make 'A' feel guilty about winning. After all it was a deal!!

Update: My friend Pooja very rightly pointed out that the game show organizers may not allow people to negotiate like that. Such an agreement between all the A's and B's of the world will reduce the game show organizer's probability to retain the prize money from 1/4 to zero

Government officials talk up country’s economic prospects

Source: Economictimes

Private banks start lowering lending rates

Source:Business-Standard

Dose of the day: Tax cuts...but with a difference

Everytime an economic crisis arisis the debate between those who advocate free market play and those who advocate state intervention becomes hot. A similar kind of debate started when this economic crisis started last year. Thankfully, now people unanimously agree that in order to come out of this crisis the state will have to play a pivotal role.

In the past few months the RBI has lowered its policy rates drastically and has urged the banks to lower their lending rates. I am completely in agreement over this. However, today I see excessive reliance by the govts on monetary policies. There is a need for fiscal policies too. It is essential to understand that in a country like India there is no liquidity crunch. We have a demand crisis.
Cheap loans will be taken up by only those who can see demand for their goods. For example: As a CEO of a manufacturing company, I wouldn’t take cheap loans to expand unless I see some demand for my goods. Why are people not buying? Is it because they are short on cash or don’t have access to cheap money? Both to some extent

Today there is a need to boost demand and increase confidence. This recession will worsen if we don’t boost demand.
How to boost demand? This is where fiscal policy comes into play. Indian govt has already announced several stimulus packages. Actually, some people have been asking the govt to stop this spending as it is leading to higher debt levels. Coming back to the point- We can boost demand if we give money to the people. We need tax cuts. But there are two problems with simply reducing taxes-
1. Tax revenue will fall –something that the govt may not want at this time
2. People will definitely welcome this step, but may not start buying. In a country where there is no proper social security, people may be more tempted to save that extra bit of money. (Makes sense- In uncertain times, I would definitely start saving more)

Can we have a plan that not only gives people more money but also gives them an incentive to buy more? I can think of one
The Income tax department gives a Rs 1 lac deduction under section 80c to income earners. This Rs 1 lac deduction is allowed for those who invest this amount in mutual funds/PF/govt securities or other money market instruments that come under section 80c. This provision allows people to subtract that amount from their taxable income and save tax. What happens with all these savings? Basically these savings are loaned out to others. Savings become investments. This is a way through which the govt incentivizes people to save and invest. This is govts way of making people save. Can there be a similar way through which the govt can make people buy and consume?

Yes, here is the plan-
Similar to giving a tax deduction for purposes of saving, the government should give a tax deduction to give people an incentive to buy more. Let’s say that govt gives an additional 50,000 tax deduction under the law to people who consume durable goods. People who buy such goods and shows receipts of such purchases to the govt will get a tax deduction for that amt (less than or equal to 1 lac). How to keep track of this consumption? Well, the govt can start manufacturing special machines that can generate a unique receipt number. Ex- For consumers in New Delhi- receipt nos may start from NDLXX___. These machines can be sold to all companies in the relevant industry.
Now this is a simple plan, but its implementation can have huge benefits-
1. Tax revenue- Yes, the income tax revenue will fall in general. However, the govt will be able to generate more sales tax revenue by expanding the tax base. Sales tax revenue leakage has been a problem for a long time. But now companies will have to buy such govt manufactured machines which will generate receipts and consequently track the sales
2. Demand- Consumer demand will increase. As I mentioned earlier, India is not in a liquidity crunch. Now people will have more money and more incentive to buy goods. Just as the govt used to make people save money by giving tax deductions, now it can make people consume more by doing the same
3. Employment in the govt sector- This new machine will have to be manufactured somewhere...and you will obviously need people to do the manufacturing, distribution, governance, etc

This plan is very ambitious and has its own shortcomings- Given that it is a fiscal policy, its approval by the parliament may take sometime and may also face resistance. Also, manufacturing & distribution of such machines will take sometime.
But I think that this is a long term solution. It is not just to tackle this recession.

Any thoughts?

India’s growth may drop to 4.3% in 2009: OECD

India’s economic growth may slow to an 18-year low of 4.3% in 2009, with falling exports offsetting expansion in domestic demand, the Organization for Economic Co-operation and Development (OECD) said on Tuesday.
Though the country’s gross domestic product (GDP) grew at a meagre 1.3% in 1991-92, the only growth rate comparable with the current projection was in 2000-01 at 4.4%.
OECD economist Sean M. Dougherty told Mint that “this is due to a fairly broad-based slowdown in global economy and less to do with the Indian economy,” adding that India’s external sector will bear the brunt of the slowdown.
Source: LiveMint

4.3% looks very pessimistic.

Here are some of the other predictions for the growth of the Indian economy in 2009-10:

World Bank-4%
CLSA- 4.6%
IMF-5.1%
UN- 6%
ADB-6.5%
Indian govt-7.1%

Free rider problem

Unfortunately, yesterday somebody stole my car stereo while the car was parked in the parking. It was not just me but there were 5 more people who were complaining about the same. Let me describe the parking in my area- We have residential colonies and the parking slots are not permanent, so people park their cars near their houses-not necessarily in front of them.
I went up to the residential welfare association president to complain about what happened. He told me that he was helpless. He described the problem to me-
Problem: There are not many guards in the area. The existing guards are also very weak and are not that efficient
Cause of the problem: There were very few guards because there were no funds with the treasury to hire more. Why were there no funds? Well, the monthly service fee for security was not being paid by a significant number of residents.
So basically, only a few residents were paying money to the association to hire security guards for the residential colonies. This sounds like a typical free rider problem. A free rider is a person who receives the benefit of a so-called public good without paying for it. Few residents were not paying because they wanted others to pay for security.
Clearly, this is a problem
Solution:
Mr president suggested one solution- Make every individual pay a fee for every car they own. This will generate enough revenue to hire more guards. I like this solution. But the problem is that this fee is not a tax on the residents. Even if they don’t pay this fee, the association cannot do anything. This will also give the residents an incentive to lie about the number of cars they own.
Typically, solution to such problems lies with taxation. But, because the residential association is not a government unit, taxation is not an option.
Here is what I would suggest- Make every household pay a fixed fee. Assign an agent for every building (the agent should be a resident from the same building) in the residential area for collecting the amount. Have an incentivized structure for these individuals so they also get some share (1%-2%) from the total collection. I believe that a significant number of individuals who were not paying earlier would start paying. This fee is still not a tax. But collection from those individuals who were not paying anything earlier will increase as now the fee collection will be more organized & incentivized; agents will chase the residents and make them pay the fee. Seeing “friendly” neighbours collect money, residents will definitely start paying the fee.
Can you suggest any other solution?

Forex reserves swells to $ 253.83 bn

Forex reserves went up to $ 253.83 billion for the week ended March 20, up $ 5.1 billion, compared to $ 248.72 billion in the previous week...
Source: EconomicTimes

Good news: Lending rate coming down

4 banks cut PLR by 25-50 bps
Source:Business Standard

Deflation mystery- Still unsolved

Deflation not a threat to economy: Bankers
With inflation fast approaching zero per cent, bankers have sought to allay fears that the country may be in the deflation mode on grounds that the consumer price index was still high and deflation was a statistical phenomenon due to base effect.
"Deflation is unlikely to have any major impact on the economy. Negative inflation, if it happens, will occur mainly on account of declining oil prices, easing monetary policy. It is unlikely to stay long," IDBI Bank Chief Financial Officer R K Bansal told media here.
Source: EconomicTimes

Totally agree with the bankers on this. Additionally, I think-
1. Inflation by definition is change in prices over a period of time. Fluctuations in demand and supply keep happening in all the markets and all the time. Deviations in prices from the equilibrium due to such fluctuations should not be taken as trends. In short- Let us wait for another couple of months to see the price trend (both CPI and as well as WPI)

2. The key point here is that WPI is near zero percent and the CPI is still around 9%Is this good or is this bad? Well...difficult to say now. Anyways, what is more important right now is to see and understand the forces that have led to a dip in WPI (still will not call it a trend)? Given that we do not seem to be in a liquidity crisis right now, falling WPI could mean that either the demand is falling or the supply is increasing in the goods market. Given the slight fall in the optimism in the economy, I think it is the former.
There can also be additional forces at work here. But, it will be interesting to see how things change from here.

The good thing is that the common man may actually start believing that the inflation in at zero percent and may start spending. However, we don't want to move into a situation where the common man starts thinking that the inflation is going to continue to fall- this will make him delay spending now.

Economy needs more stimulus in 2009-10: Ahluwalia

Mr Ahluwalia had earlier said that the economy’s growth rate would be slightly less than 7% in the current fiscal and the next fiscal. "We are likely to get a growth rate less than 7%... between 6.5% and 6.7% in 2008-09," Mr Ahluwalia had said.

Source: Economictimes

What if RBI becomes a regular corporate bank?

Here is a hypothetical situation (Although I don't know why it cannot become a reality)- What if RBI turns into a regular Bank? I am just thinking of some of the implications of such an event.

Today the banks are reluctant to lend. In India, the inflation is zero percent and the lending rate is still around 9%. The RBI has been cutting the bank rate consistently, but to no benefit. Banks are not ready to bring down their lending rate. Now the question is that is there any quicker way of giving money to people?

What if RBI also starts playing the role of any normal corporate bank. Let it lend money to people/businesses/government at a lower rate than that is present in the economy.

Here is what will happen-

1. RBI will be able to not only increase money supply but actually increase
demand by lending at a lower rate
2. The private banks will face immense competition from the central bank. The result
will be that the pvt banks will also have to start lending at a lower rate

India - Managing the Impact of the Global Financial Crisis

This is a speech delivered at the Confederation of Indian Industry's National Conference and Annual Session 2009 in New Delhi on March 26, 2009. - By Duvvuri Subbarao, RBI Governor

The article talks about the various fiscal and monetary policies that have been announced to combat this crisis. Subbarao also talks about the outlook for India.

I don't agree with one point that he mentioned in his speech-

Finally, over the years, India has built an extensive network of social safety-net programmes, including the flagship rural employment guarantee programme. These uniquely Indian versions of automatic stabilizers should protect the poor from the extreme impact of the global crisis.

I don't think the flagship rural employment guarantee programme of the UPA is an automatic stabilizer by any stretch of imagination. An article in IndianExpress shows how the plan is behind in delivering its intended benefits- In most cases, the number of job-days are as less as 25, a government-sponsored panel said.
Anyways, I don't think of this as a major stabilizer and definitely not as an automatic one

India to grow at 6% this year: UN

Source:The Financial Express

Assumption of perfect knowledge

Yes, you will find implicitly or explicitly an assumption of perfect knowledge in any economic theory or model. Obviously, the market change is always dependent on the economic agents...and for that to happen these agents have to be sufficiently informed about the state of the economy.
Now, people depend on economic indicators for that knowledge. I am just wondering whether having more economic indicators (i.e., more informed/misinformed people) can have any impact on the speed with which market forces work.
For example- Developed countries like USA and Japan have several indicators that can help investors/consumers determine the state of the economy and make an informed decision. Here are some indicators for Japan that I came across –
1. Consumer Confidence Index: 26.4 (+0.2)
2. Overall Livelihood: 29.2 (+0.7)
3. Income Growth: 31.4 (-0.1)
4. Employment: 14.2 (-1.2)
5. Willingness to buy durable goods: 30.6 (+1.2)
Source
In a country like India it will be near impossible to get these indicators. This is bound to impact the speed with which market forces work here (India). You can find interest rate numbers, GDP growth, FDI/FII, etc, but you will not be able to get those second level of economic indicators, (as illustrated above) which may have a role to play in changing expectations and hence the speed of the change in the market

RISK FREE SUIT

Jos A Bank store in Illinois has launched a 'Risk Free Suit'. The store promises to refund the price of a suit if the purchaser loses his job. (AFP)
Source: Economic Times

Unemployment in India. How much?

Despite my best efforts I have not been able to find the unemployment trend in India.
The last official numbers are for 2005-06.

However, I did find some numbers on CIA factbook
According to it-
Population of India (est for 2008) is 1.16bn
Unemployment (est for 2008) is 6.8% i.e. around 7.9 mn unemployed. I think that this number is grossly understated. The unemployment number has to be in double digits.
Here is why-

More than 70% of the population lives in rural parts of India (in approximately 6,30,000 villages)

I came across an article on Indian express that puts the unemployment rate in Urban India and Rural India at 45% and 17% respectively, per the last NSS in 2005-06

Quick maths tells me that at least (17%*70%*1.16bn) + (45%*30%*1.16bn) should be unemployed. This recession has already taken a heavy toll on employment in urban India. Real unemployment has to be much more than the above no. (i.e. 294.6 mn or 25%of the total population). Whoa! I sincerely hope that there is something wrong with my calculation.

Deflation in India?

It's disinflation, not deflation, we're facing now

Last Thursday's inflation numbers -- a drop to 0.44 per cent in the wholesale prices index (WPI) -- brought more worries that cheers. That's because deflation -- a situation where prices, jobs and incomes keep falling on a sustained basis, and the economy keeps contracting -- has become a new cause for worry. Is India on the cusp of a debilitating deflation?

Certainly not, say the experts. "These fears of deflation are unfounded," Pawan Kumar Bansal, Union minister of state for finance, told a news agency.
Read more

Coming soon: Interest rate cuts

India’s Ahluwalia Says “More Room” for Interest Rate Cuts

India’s central bank has “more room” to cut interest rates further to combat economic slowdown and a global recession, according to Montek Singh Ahluwalia, deputy chairman of the nation’s Planning Commission.

Parliamentary elections scheduled for April and May complicate efforts to boost the economy because the government is banned from announcing new fiscal policies or stimulus steps until the voting is finished. Prime Minister Manmohan Singh’s government has backed the monetary stimulus by lowering taxes and increasing spending on infrastructure.

...“The new government when it comes into place probably in early June will almost certainly continue the fiscal stimulus policies we have followed,” said Ahluwalia. “We will use the opportunity, the scope that is available for monetary policies, to support these fiscal policies.”...

.... India’s politicians are one of the “major problems,” Rogers told the Wharton India Economic Forum via videolink from Singapore. The country has the “single worst bureaucracy in the world.” If a person can deal with that, “there are fortunes” to be made by investing in India, Rogers said.
___

Some observtions:

1. Good to see that the RBI is looking to cut interest rates. With the inflation reaching near zero level the "Bank" does not have any choice left also. Borrowing has to become cheaper
2. On the fiscal expansion- I didn't realize that the govt is banned from implementing such expansionary fiscal policies. Thus it becomes more important to push for monetary expansion
3. Bureaucracy is bad for any economy. However, what bureaucracy does is that it acts as a friction against a fast moving machine. Higher the friction, slower will the machine run. If there is no friction then the machine will run smoothly and quickly- this can also make it be uncontrollable.

Bureaucracy without corruption is acceptible but bureacracy with corruption is devastating. I think the former is present in India.

Another growth prediction for India - 4.6%

CLSA sees India GDP growth at just 4.6%

Broking house CLSA Asia-Pacific Markets on Wednesday termed India as one of the riskiest markets to be invested in at the moment. The outfit has forecast a GDP growth of 4.6% in 2009-10, and expects the domestic economy to stabilise only by early 2010. Further, it has projected public sector deficit to rise to 14% of GDP in 2009-10, and the rupee to fall to 57 to the dollar by the end of this year.
The broking house, however, has said an Argentina-styled debt crisis was unlikely. “The bulk of Indian government debt is domestically held and Indian banks are eager buyers of government securities. However, not only is the government’s $500-billion infrastructure programme on the back burner, but the spread between private and public sector borrowing costs has widened, bad news for private investment spending,” the note said.
CLSA opines that capital outflows — both portfolio and FDI — could continue for some time. “A rapidly widening budget deficit, coupled with slowing growth, falling investment returns, a substantial current account deficit and growing global risk aversion (which is underpinning the flight to safety into the $) suggest that these trends will continue,” it said.
Source
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CLSA makes some astounding and ridiculous predictions. Here is my take on it-
CLSA has a forecast of 4.6% in 2009-10 and projects that deficit will rise to 14% of GDP. I strongly believe that a forecast of 4.6% is based on the assumption that India’s fundamentals are weak and are further weakening- something I strongly disagree with. Also, if the deficit actually rises to 14% (from current ~5%) then India would not be growing at 4.6% but somewhere around 7%. For the debt/GDP ratio to reach ~14%, India will have to make some huge investments and this is exactly what is required at the moment (although may be not as much predicted by CLSA). So the growth and deficit predictions are counterproductive

All in all- I don't agree with anything that they are saying and I am sure I am not the only one.

Why India should not listen to IMF

IMF wants India to fight slowdown by easing money supply

The International Monetary Fund today urged India to further ease money supply to fight economic slowdown while cautioning that
additional expenditure and more tax reliefs could raise public debt to unsustainable levels.

Commending the steps taken by the Reserve Bank to ease money policy by reducing key policy rates and ratios, the IMF in its annual review of the Indian economy said, "(there is) scope for further monetary easing, in light of projected decline in inflationary pressures and the need to reinforce confidence and sustain bank credit."

Read more

I respect IMF and its opinions. I also understand that IMF's advice will always be biased towards monetary and not fiscal policies. However, I don't think that at this stage India needs to be worried about debt levels. It is a time to invest and ensure that the economy is moving.

A high debt/GDP ratio is never good. However, instead of reducing the numerator (debt) you can also focus on increasing the denominator (GDP).
This is a very uncertain time for the economy. Every govt should adopt a mix of fiscal and monetary policies to tackle the situation.

So...don't listen to IMF- Spend and invest(at least not now)

Perception is reality

The role of expectations is very very important in economics. Expectations plays a key role in driving demand. Expectations are driven by perceptions and perceptions are driven largely by the announcements that you hear. Quite often these announcements are made by leading organizations, economists, or even political leaders.
In short- What these leaders or organizations say actually does play a key role in how the market moves.

Here is an experiment to explain this-
Consider a room with 100 people and assume that they stay there for the next few weeks.
Scenario A
Now, before letting them go tell them that the economy is in a bad shape and soon there will be a financial crisis. What would you expect from these people when they go out in the real world?
I expect them to be bearish about future and share they concern with other people, who in turn will pass on this bad/sad mood to others.
Scenario B
Before letting them go tell them that the economy is growing. Everyone is happy and bullish about future. Go enjoy life.
I would expect them to go out happy spread this happy feeling to others.
Points I am trying to make are the following:
1. If political leaders and economists show optimism/pessimism in their speeches/announcements then this will influence the rate of change (positive or negative)
2. The perceptions are taken to be reality by not some but many individuals. Not every individual will keep a check on how interest rates/inflation/GDP is moving. They will get influenced a lot by what they are hearing

A headline that caught my attention

Buy a house to save more tax
Investment in a house could be the best way to save tax. As prices of residential units have gone up in the range of Rs 50 lakh and over, tax experts say buying a second house for investment purpose will save even more tax than that over the first house you bought for personal use.

__
Thank god it was an advice from a tax expert and not from an economist!!


Demand driven by investment needs has different characteristics than the one driven by consumption needs. The demand curve is upward sloping in the former case.

In an investment scenario a vicious cycle starts- Everyone starts demanding goods for investment purposes thinking (hoping) that there will be someone out there who would be willing to buy this good at a higher price. This is also known as greater fools theory.

This is a zero sum game. Somebody has to loose and somebody has to win. Investment returns are dependent on uncertainity on future. Clearly, if everyone knew how prices would change in the future then everybody would become a bear or a bull and their would be no one on the other side.

However, these are VERY uncertain times. As an individual living in such times, I will definitely not be buying any houses in near future!

World Bank lays down the ideal plan for India

India should boost money supply, focus on infra: WB

World Bank chief economist Justin Yifu Lin on Friday, noted that by investing in the bottlenecks of the country like infrastructure, India could see pick up in demands, especially in the face of current crises, which would pave the way for a longer-term growth.

“Lin also pointed out that the monetary policy should be such that to reduce interest rates and increase money supplies, so as to spur demand. If money is invested properly, it wouldn’t lead to inflation and higher rates. Investment in infrastructure could revitalize manufacturing in India, which accounts for only 16% of the country’s total output, and contribute significantly to job creation,” said Lin who was addressing a press conference in Mumbai

Read more

Army headcount getting affected by policies

The armed forces is the greatest recruiter in India right now. Here is good example of how the government is ensuring employment for people and at the same time the army is taking advantage of the job situation/crisis. (I am refering to an article in Times of India, 16th March)

Here is another extreme example -

Taiwan to cut troops 16% over five years

Taiwan will cut troops by about 16 per cent over the next five years, officials said on Monday, in part as a streamlining measure and in part in response to a perceived lower-level threat from political rival China.

The defence ministry will reduce Taiwan’s military police to a command centre under the army, part of a long-term effort to cut troops from a 1970s Cold War high of about 600,000 to 210,500 in 2014, going for quality over quantity, military sources said.

---
Although I think the Indian govt has taken the right step in this situation, Taiwan govt's step does not impress me.
Here is why-
1. This is not any normal job. People in this job are motivated not by money but by the love for their country. You cannot/should not move people like that
2. The govt could have used the troops productively. The ones that are being laid off could be given alternate employment
3. If the Taiwan govt thinks that in times of political crisis they will be able to recruit people immediately and send them to war, then it is wrong. There is a lot of training and hardwork involved. Soldiers cannot be asked to go home and come back after a year in case there is a war

Most importantly- the soldiers should be respected

Record fiscal deficit - Not a worry, let's invest

Just to add to what I mentioned in my previous post.

This is no time for governments to curtail investment. Countries such as USA and China and also others are investing heavily in their attempt to come out of this recession quickly.

US Fiscal Deficit Projected At 12.3% of GDP In 2009

China budgets record-high fiscal deficit in fight against global crisis

Illogical prioritization

Govt should get back to 3% fiscal deficit target by 2010-11: Virmani

Chief Economic Advisor in the finance ministry Arvind Virmani said the country should aim at limiting its fiscal deficit--the gap between
total spending and most of the receipts--to the 3% mark by 2010-11.
India's fiscal deficit is projected to more than double to 6% of GDP this fiscal against the budgetary target of 2.5%. For the next fiscal, the deficit is estimated to be 5.5% of GDP. Virmani said India has provided one of the largest stimuli in the world, leaving aside countries that are directly the source of the crisis.

I agree that fiscal deficit should always be watched. But this should not stop the government from investing. Govt should not be scared to invest just because the fiscal deficit is going up.

This is a global recession. It is an exceptional time. How can we talk about containing the fiscal deficit at this time. Government should definitely borrow more and invest in public private partnerships. Ofcourse this may drive up the interest rates. But a fine balance will need to be maintained.

To maintain the deficit new measures should be put in place to stop the revenue leakage. Still a significant percentage of the revenue is lost as people fail to pay income/sales taxes.

INDIAN GOVT- DONT STOP INVESTING. THIS IS THE ONLY WAY RIGHT NOW TO MOVE OUT OF THIS SLUMP QUICKLY

U.S. jobless rate hits 25-year high, payrolls dive

The U.S. unemployment rate hit a 25-year high of 8.1 percent last month as employers buckling under the strain of a severe recession axed 651,000 jobs, government data showed on Friday.
The manufacturing sector shed 168,000 jobs in February, after eliminating 257,000 positions the prior month. Construction industries bled 104,000 jobs in February after losing 118,000 in January.
The service-providing industry slashed 375,000 positions after shedding 276,000 in January.
Read the full article here

Obama's policy on bonus cut - a good political move but a counterproductive economic policy

Treasury Restricts Executive Pay for Bailed Out Companies
http://www.thecro.com/node/770
President Barack Obama and the treasury department moved to restrict executive pay packages at financial firms receiving “exceptional financial recovery assistance.”
At such firms:
• The policy limits senior executives to $500,000 in total annual compensation, except for restricted stock awards. The stock could be cashed in when the government has been repaid
• The senior pay structure and strategy at such firms must be fully disclosed and subject to a “say on pay” shareholder resolution
• A clawback provision would permit recovery of bonuses and compensation from top executives found to have knowingly provided inaccurate information or performance
metrics to calculate their own incentive pay
• Top executives would be barred from receiving golden parachute payments
• Boards would have to adopt policies relating to approval of luxury expenditures such as aviation services, office renovations, entertainment and holiday parties
• The administration said it would host a conference on “executive pay reform at financial institutions” to identify best practices and guidelines


I don’t quite understand the motive behind this decision. Is it to punish the executives who have led the economy into the recession or ensure that future executives don’t commit such mistakes again? Some may argue that the answer to both the problems is the same. But I think otherwise.
Economy is already in recession. Time is ripe to develop new leaders. From a political point of view it is understandable that Obama wants to reduce the executive pays and bonuses of executives whose companies are receiving bail-out packages. However, from an economic standpoint I don’t understand the rationale behind the decision to reduce pays and bonuses.
Obama’s policy has its pros and cons-
Pros
1. Less money will go as compensation that means more money towards operations and
investment
2. Executives might think that this is more of a punishment for their bad decision making and might start taking less risk (I am not even sure how relevant this is in the real world)
3. Obviously more votes for the democrats

Cons
1. There will be no incentive for executives to perform better (or even stay in the firm) especially because the pay is less and the stock awards would be allowed to be cashed when the government has been repaid (which will mean much more than 5 years)
2. There will be no incentive for new potential executives to join these companies. Clearly, they will get much more outside of these companies. Hence, these companies are bound to face talent shortage

Obama’s decision is driven more from the point of reducing the inequality.
His rationale- When there are millions unemployed then how can a few enjoy the millions(in compensation)

In my mind- The compensation structure should not be changed much. Only the incentive structure should be tweaked a little bit. Instead of tying the bonuses to stock value and revenue growth a new structure should be designed that ties the bonus incentives to more fundamental things. May be reduction of % of NPAs in the book, etc
I don’t know of anyone who would like to join such firms (bailed-out) as an executive. Do you?