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