Month: May 2013

Gold fever accelerates, never mind the trade deficit

gold

Vivek Kaul

The law of demand in economics states that all other things remaining the same, the demand for a good is inversely proportional to its price. So if the price falls, the demand goes up and vice versa.
This identity holds on a lot of occasions but not on all occasions.
Allow me to elaborate.
Indian gold and silver imports for the month of April 2013, were at $7.5 billion. This was 138% more than imports during April 2012. This has come across a surprising development for many. “The rise in gold imports is surprising,” Trade Secretary S.R. Rao told reporters at a press conference after the import numbers came out. “It wasn’t expected,” he added.
In fact predictions made by people who follow the gold market closely were exactly the opposite. Mohit Kamboj had told PTI in middle of last month that “the imports of the yellow metal is likely to be 25 per cent less than the corresponding month last year as the gold prices are declining steadily.” He has been way off the mark. Kamboj is the President of the Bombay Bullion Association.
So why did Rao find this sudden increase in the import of gold surprising? Or why did Kamboj expect gold imports to fall?
The rise in gold imports is in line with the law of demand. As gold prices fell, people got out and bought more of it. The trouble is that people were buying more gold even when its price was going up. As economists Sonal Varma and Aman Mohunta of Nomura wrote in a report titled India: Correlation between gold prices and demand released on April 23, 2013, “The correlation between the gold price and gold demand (import volume) in India shifted from being negative pre-2008 to positive since 2009. This means that in recent years a rising gold price was accompanied by rising demand, and vice-versa.”
So people were buying gold when its price was going up and now people are buying gold again, when its price has crashed. Also in between gold imports fell as gold prices crashed. Between January and March 2013, India imported 200 tonnes of gold which was around 23.7% lower than during the same period in 2012.
Let me rephrase the entire argument again then. People were buying gold when its prices were going up. People went slow on buying gold when its prices were coming down. And people are now buying gold again with a vengeance, when the prices have crashed and have started to go up again.
How do we explain this? What is happening here? Maggie Mahar has some sort of an answer for this in her book Bull – A History of the Boom and Bust, 1982-2004. As she writes “In the normal course of things, higher prices dampen desire. When lamb becomes too dear, consumers eat chicken; when the price of gasoline soars, people take fewer vactations. Conversely, lower prices usually whet our interest: colour TVs, VCRs, and cell phones became more popular as they became more affordable. But when a stock market soars, investors do not behave like consumers. They are consumed by stocks. Equities seem to appeal to the perversity of human desire. The more costly the prize, the greater the allure.”
Replace the word ‘equity’ with gold here and the argument stays the same. When the price of gold was going up, people were looking to make a quick buck because they expected that the price of gold will continue to go up, and so they bought. Hence, higher prices of gold, led to higher demand and thus to higher imports in the Indian case. It is important to remember here that those who were buying gold at higher prices were looking at it as a mode of investment/speculation.
When the price of the yellow metal started to fall, the speculators got out of the race. And thus the demand fell, and so did the imports. After the price had fallen sufficiently enough, only then did the consumers of gold start to buy it. It is important to remember that world over gold is looked upon as a hedge against inflation but in India it is a hedge against inflation as well as a consumable good. Gold jewellery is a very important part of the Indian way of life. And once prices had fallen to the levels they have in the last one month, it is this demand that has come in and pushed up gold imports by 138%.
Hence, those making predictions on gold, should well remember that in India, it is both a mode of investment/speculation as well as a consumable good. And when prices fell, it is those who look at gold as a consumable good, start buying.
As Sonal Varma and Aman Mohunta of Nomura write in a report titled India: Trade deficit worsened sharply in April on higher gold imports released on May 13,2013 “The recent fall in gold prices suggests that gold import volumes should moderate this year. This is not yet happening, but we see the recent rise in gold imports as a bunched up rise in consumption demand, which should fade over the coming quarters.”
Of course this is assuming that the price of gold continues to remain flat. If it starts to rise (in fact it has already risen by more than 5% from the low of $1360 per ounce (1 troy ounce equals 31.1 grams)) then investor/speculator demand will come in again. In fact, if the price of gold falls further, the speculators/investors might come back in again, sensing a good trade.
What this means is that despite massive efforts by the government to bring down gold imports, Indians have continued to buy gold. And since India produces very little amount of gold, it has to import almost all of what it consumes. This is reflected in the trade deficit (or the difference between imports and exports) for the month of April 2013, which has come in at $17.8 billion. This is a jump of 72% from March 2013. Gold and silver imports at $7.5 billion, formed a major part of it. The gold import numbers for May are likely to be high again, given the festival of Askhay Tritya which is being celebrated today (i.e. May 13, 2013) will trigger a rush for the yellow metal. Askhay Tritya is considered to be an auspicious day to buy gold.
Since gold is imported, a demand for gold triggers a demand for dollars, which are used to buy gold. And this leads to the rupee losing value against the dollar. This in turn makes other imports like oil and coal also expensive. Hence, efforts have been made by the government in the past to limit gold imports.
To conclude, in March, the finance minister P Chidambaram had told CNBC TV 18 “On gold, I can only appeal to you and through your channel to the people that to not demand so much gold.”
Of course people have gone ahead and done exactly the opposite. Chidambaram had also told CNBC TV 18 “However, I am not sure too many people will listen to me on that.”
Not many did, it seems.
The article originally appeared on www.firstpost.com on May 14, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Why food prices will rise even with record procurement

india-wheat-2011-5-5-8-51-9Vivek Kaul

When the production of any commodity goes up, its price falls.
That’s Economics 101.
But economics is not physics. And what sounds true, may not be true at all.
Take the case of the report in The Times of India edition dated May 12, 2013 which points out “US agricultural department and…the Food and Agriculture Organisation(FAO) have predicted record global output of cereals…raising hopes of snapping the trend of worryingly rising food prices.”
The US department of agriculture expects the global production of wheat to rise by 6.9% to 701 million tonnes in 2013-2014 (i.e. the period between April 1, 2013 and March 31, 2014) from the previous year. The production of rice is expected to rise by 1.9% to 479 million tonnes.
This rise in production The Times of India feels will bring down cereal prices in particular and food prices in general. The cereal inflation was 4.62% in March 2012. But it had shot up to 18.36% in March 2013.
Will this inflation come down? Another reason in favour of increased production is the fact that the India Meteorological Department has said that the South West Monsoon will be normal this year. The South West Monsoon is very important for the production of rice given that half of India’s area under cultivation is still at the mercy of monsoons. Irrigation wherever its available is also dependent on rainfall.
While increase in production of a commodity does have an impact on its price, but there are other bigger factors at play in the Indian case. Every year the government of India sets a minimum support price for rice and wheat. At this price, it buys rice and wheat from farmers, through the Food Corporation of India(FCI) and other state government agencies.
This price is declared in advance in order to give the farmer an idea of what he is likely to get for his produce. While the idea behind MSP is noble but it has essentially become a tool of give-aways in the hands of politicians. The MSPs for both wheat and rice have been raised dramatically over the last few years.
In 2009-2010 (i.e. the period between April 1, 2009 and March 31, 2010), the MSP for rice paddy was Rs 1000 per quintal (i.e. 100 kilograms). This was increased to Rs 1250 per quintal in 2012-2013. For wheat this went up from Rs 1080 per quintal to Rs 1350 per quintal.
So MSPs have gone up dramatically over the last few years. This has resulted in more and more rice and wheat being produced and landing up with the FCI and other agencies which operate on its behalf. The way the current system works is that FCI is obligated to buy all the rice or wheat that the farmer wants to sell as long as a certain quality standard is met. This has led to a situation where farmers find it favourable to produce rice and wheat because they have a ready buyer for all their produce, at a price they know in advance.
Hence the stocks with the stock of rice and wheat with the government has gone up dramatically. At the beginning of March 1, 2013, the total rice and wheat stock stood at 62.8 million tonnes. Now compare this with the minimum buffer of 25 million tonnes that needs to be maintained. So the government is buying much more rice and wheat than it actually needs to maintain a buffer and distribute through its various social security programmes. As an article in the May 26, 2013, edition of Business Today points out “A few years of high minimum support price (MSP) – floor price at which government buys all the wheat and rice offered by farmers – has led to the massive procurements. This, however, has not been followed through with regular releases into the market.” So the prices of rice and wheat has gone up, as more of it lands up in the godowns of FCI and not in the open market. Or as Madan Sabnavis, Chief Economist at credit rating agency Credit Analysis & Research Ltd told Business Today “Excess procurement is leading to an artificial scarcity.”
This is something even the government agrees with. A December 2012, report brought out by the Commission for Agricultural Costs and Prices, which comes under the Ministry of Agriculture points out “Since 2006-07, the procurement levels for rice and wheat have increased manifold…Currently, piling stocks of wheat with FCI has led to an artificial shortage of wheat in the market in the face of a bumper crop. Wheat prices have gone up in domestic markets by almost 20 percent in the last three months alone (in the three months upto December 2012, when the CACP report was released), because of these huge stocks with the government that has left very little surplus in markets.”
The procurement of food grains increased from 34.3 million tonnes in 2006-2007 to 63.4 million tonnes in 2011-2012. Due to this the total stock of food grains in the central pool went up from 25.9 million tonnes as on June 1, 2007 to 82.4 million tonnes on June 1, 2012. The total stock of food grains that is held by the FCI, state governments and their agencies, is referred to as the central pool.
As on March 1, 2013, this number stood at 62.8 million tonnes. Analysts expect this to touch 100 million tonnes after the current procurement season gets over. FCI estimates put the carrying cost for this inventory comes at Rs 6.12 per kg. At 100 million tonnes, the cost works out to over Rs 60,000 crore.
And all this has happened because of high MSPs being set by the government. What is interesting is that the Comptroller and Auditor General (CAG) of India in a recent report titled “Performance Audit of Storage Management and Movement of Food Grains in Food Corporation of India (FCI)” questions the logic behind how the MSPs are being set.
The report was presented to the Parliament on May 7 ,2013. As the report points out “No specific norm was followed for fixing of the Minimum Support Price (MSP) over the cost of production. Resultantly, it was observed the margin of MSP fixed over the cost of production varied between 29 per cent and 66 per cent in case of wheat, and 14 per cent and 50 per cent in case of paddy during the period 2006-2007 to 2011-2012. Increase in MSP had a direct bearing on statutory charges levied on purchase of food grains by different State Government… All this resulted in rising of the acquisition cost of food grains.”
The high MSPs have led to another distortion. FCI majorly procures its rice and wheat from states like Punjab and Haryana. But over the last few years high MSPs have motivated various state governments to set up more and more procurement centres. A good example is Madhya Pradesh, which emerged as the second largest procurer of wheat last year by having set up more procurement centres over the years and by also offering a bonus to the farmers over and above the MSP. This year Bihar seems to have got into the act. As a recent editorial in the Business Standard points out “Bihar, only a marginally wheat surplus state, has this year set up more grain procurement centres than the major wheat-growing states of Punjab, Haryana and Uttar Pradesh put together.”
So the moral of the story is that both the central and state government are procuring more and more of the rice and wheat that is being produced, distorting the rice and wheat market totally. As V S Vyas an economist with the Prime Minister’s Economic Advisory Council told Business Today “Stock in the market is important, not the total stock.”
It is unlikely that the MSP are going to come down this year given that Lok Sabha elections are due next year and hence the Congress led UPA will continue to offer ‘boon-dongles’ to citizens of this country. And even though the global production of rice and wheat is likely to go up as suggested by The Times of India, there will be no relief for the Indian consumer.
The article originally appeared on www.firstpost.com on May 13, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek) 
 
 

As yen hits 100 to US$, get ready for more currency wars

1000-yen-natsume-soseki
Vivek Kaul 
Ushinawareta Nijūnen or the period of two lost decades for Japan(from 1990 to 2010) might finally be coming to an end. Or so it seems.
And Japan has to thank Abenomics unleashed by its current Prime Minister Shinzo Abe for it. Abe has more or less bullied the Bank of Japan, the Japanese central bank, to go on an unlimited money printing spree, until it manages to create an inflation of 2%.
The Japanese money supply is set to double over a two year period. And all this ‘new’ money that is being pumped into the financial system, will chase an almost similar number of goods and services, and thus drive up their prices. Or so the hope is.
The target is to create an inflation of 2% and get people spending money again. When prices are rising or are expected to rise, people tend to buy stuff, because they don’t want to pay a higher price later (This of course is true to a certain level of inflation and doesn’t hold in the Indian case where retail inflation is greater than 10%). As people go out and shop, it helps businesses and in turn the overall economy.
In an environment where prices are stagnant or falling, as has been the case with Japan for a while now, people tend to postpone purchases in the hope of getting a better deal. The situation where prices are falling is referred to as deflation.
In 2012, the average inflation in Japan was 0%, which meant that prices neither rose nor they fell. In fact, in each of the three years for the period between 2009 and 2011, prices fell on the whole. This has led people to postpone their consumption and hence had a severe impact on Japanese economics growth. To break this “deflationary trap”, Shinzo Abe and the Bank of Japan have decided to go on an almost unlimited money printing spree.
A major impact of this policy has been on the Japanese currency ‘yen’. As more yen are created out of thin air, the currency has weakened considerably against other major currencies. One dollar was worth around 78 yen, on October 1, 2012. Yesterday, yen weakened beyond 100 to a dollar for the first time in four years. As I write this one dollar is worth around 101.1 yen.
This weakening of the yen has helped Japanese businesses which have a major international presence spruce up their profits. As the news agency Bloomberg reports “The weaker yen helped Mazda, Japan’s fifth-largest car company, post a profit of 34 billion yen for the fiscal year that ended March 31, compared with a loss of 107.7 billion yen the previous year. A one-yen change against the dollar, euro, Canadian dollar and Australian dollar has a 9.1 percent impact on Mazda’s operating profit…That compares with 4.7 percent at Fuji Heavy Industries Ltd, which makes Subaru cars, and 3.1 percent at Toyota.”
When yen was at 78 to a dollar, a Japanese company making a profit of $1 million internationally would have made a profit of 78 million yen. Now with the yen at 101 to a dollar, the same company will make a profit of 101 million yen, which is almost 29.5% more.
This increase in profit it is hoped will also encourage Japanese companies to pay their employees more. Albert Edwards of Societe Generale writing in a report titled Thoughts on Asia – will a yen slide trigger an EM currency crisis? 1997 redux dated April 17, 2013, cites a survey which suggests that Japanese companies may be short on labour. “This suggests that Prime Minister Abe will indeed get his way on a rapid return of wage inflation to boost consumption,” writes Edwards.
And this boost in consumption will get the Japanese economy going again. So does that mean Japan will live happily ever after? Not quite.
As the Japanese central bank prints more and more yen, the returns from Japanese government bonds are expected to go up. As Edwards writes “if the market really believes that it is committed to the 2% inflation target (and I certainly do), then Japanese bond yields(returns) will quickly attempt a move above 2%.” In early April the return on a ten year Japanese government bond was at 0.45% per year. Since then it has risen to around 0.69% per year.
And this can lead to a major crisis in Japan. If returns on existing bonds go up, the government will have to offer a higher rate of interest on the new bonds that it issues to make them interesting enough for investors.
As Satyajit Das writes in a research paper titled The Setting Sun – Japan’s Financial Miasma “Higher interest rates will increase the stress on government finances. Even at current low interest rates, Japan spends around 25-30% of its tax revenues on interest payments. At borrowing costs of 2.50% to 3.50% per annum, two to three times current rates, Japan’s interest payments will be an unsustainable proportion of tax receipts.”
Now that’s just one part of it. If the government has to spend more of the money than it earns towards interest payments that means there will be less left for meeting other expenditure. So it will either have to borrow more or ask the Bank of Japan to print more money to finance its expenditure, given that there is a limit to the amount of money that can be borrowed. Either option doesn’t sound good. Das estimates that Japan’s gross government debt will reach around 250-300% of its gross domestic product by 2015, a very high level indeed.
Also as things stand as of now it looks like the Bank of Japan will have to finance a major part of Japanese government expenditure in the years to come by printing money. As Dylan Grice wrote in an October 2010, Societe Generale report titled Nikkei 63,000,000? A cheap way to buy Japanese inflation risk “Japan’s tax revenues currently don’t even cover debt service and social security, persistent and growing fiscal burdens. Therefore, once the Bank of Japan is forced into monetisation of government deficits, even if only with the initial intention of stabilising government finances in the short term, it will prove difficult to stop. When it becomes the largest holder and most regular buyer of Japanese government bonds, Japan will be on its inflationary trajectory.” And this is not an inflation of 2% that we are talking about.
The yen weakening against other international currencies is making Japanese exports more competitive. A Japanese exporter with sales of a million dollars in early October, would have made 78 million yen (when one dollar was worth 78 yen). Now the same exporter would make 101 million yen.
The weakening yen allows Japanese exporters to cut their prices in dollar terms and become more price competitive. If a price cut of 20% is made, then sales will come down to $800,000 but in yen terms the sales will be at 80.8 million yen ($800,000 x 101). This will be higher than before. Also a cut in price might help Japanese exporters to increase total volumes of sales.
The trouble of course is that this will hit other major exporters like South Korea, Taiwan and Germany. As Michael J Casey points out in a column on Wall Street Journal website “Japan might be a hobbled economy but it is still the third largest in the world, accounting for almost one-tenth of world gross domestic product. So when the Bank of Japan prints as much yen as this, it provokes a worldwide adjustment in relative prices. Electronics producers in South Korea, Taiwan and, to an increasing degree, China, automatically face a price disadvantage versus their Japanese competitors, for example.”
Also interest rates on American and Japanese bonds are currently at very low levels. And this has sent investors looking for return to other parts of the world. Take the case of New Zealand. Foreign money has been flooding into the country. When foreign money comes into a country it needs to be exchanged for the local currency (the New Zealand dollar in case of New Zealand). This leads to a situation where the demand for the local currency increases, leading to its appreciation.
One New Zealand dollar was worth around 64.6 yen on October 1, 2012. It is currently worth around 84.4 yen. An appreciation in the value of a country’s currency hurts its exports. On Wednesday (May 8, 2013), the Reserve Bank of New Zealand, decided that it will intervene in the foreign exchange market to weaken the New Zealand dollar.
How does any central bank weaken its currency? When a huge amount of foreign money comes in, it increases the demand for local currency. The central bank at that point floods the foreign exchange market with its own currency, to ensure that there is enough of it going around. This ensures that the local currency does not appreciate. If the central bank floods the market with more local currency than the demand is, it ensures that the local currency loses value against the foreign money that is coming in.
The question is where does the central bank get this money from? It simply prints it.
The thing to remember is that if Japan can print money to cheapen its currency so can other countries like New Zealand. It is not rocket science. Its what Americans call a no brainer. In fact, yen started appreciating against the dollar once the Federal Reserve of United States, the American central bank, started printing money to revive economic growth. And this has also been responsible for Japan starting to print money. As Casey points out “Together, the U.S. Federal Reserve and the Bank of Japan will print the equivalent of $155 billion every month for an indefinite period.” This will spill over to more countries printing money to hold the value of their currency or even cheapen it.
The currency war which is currently on between countries as they print money to cheapen their currencies will only get worse in the days and months and years to come. Australia is expected to join this war very soon. Countries are also trying to control the flood of foreign money by cutting interest rates. The Australian central bank cut interest rates on Tuesday (i.e. May 7, 2013). The Bank of Korea, the South Korean central bank also cut interest rates on Thursday (i.e. May 9,2013). China has put measures in place to curb foreign inflows.
As Greg Canvan writes in The Daily Reckoning Australia “So as the US dollar moves above 100 yen for the first time in four years…Get ready for an escalation in the currency wars.”
To conclude, it is important to remember what H L Mencken, an American writer, once said “For every complex problem there is an answer that is clear, simple, and wrong.” If only creating economic growth was just about printing more money…
The article originally appeared on www.firstpost.com on May 11, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
 

Of Subbarao, inflation, gold and Saradha scam

Subbarao
 
 
Central bank governors rarely indulge in any plain speak. You have to always read between the lines to understand what they are really saying. They never say what they mean. And they never mean what they say.
But D Subbrarao, the governor of the Reserve Bank of India, indulged in some plain speaking on Wednesday and questioned the logic of the Mamata Banerjee government in West Bengal setting up a Rs 500 crore relief fund to compensate the losses of those people who had invested in deposits raised by the Saradha Group in West Bengal.
A part of this relief fund will be funded by a 10% tax on cigarettes and the rest of the money will be raised through other sources. “If you go back to the West Bengal Saradha scheme, the Chief Minister said ‘I will levy additional taxes on cigarettes and some other things to compensate the people who have lost money’ … Is it fair?” Subbarao asked.
Why should people who smoke fund those whose money has gone up in smoke, is a reasonable question to ask. It is like robbing Peter to pay Paul.
Subbarao also dwelled into why Ponzi schemes like Saradha have become fairly popular. “The reason it (the Ponzi schemes) is happening because ordinary people… the low income people are not sufficiently aware of where they can put their money. They don’t have enough avenues to put their money. They can’t get into the banks like we all do. They face both formal and informal barriers…So they fall prey to these fraudulent schemes,” Subbarao explained.
This is an explanation similar to the one his deputy K C Chakrabarty had come up with a few days back when he said: “The need of the hour is to ensure that our unbanked population gains access to formal sources of finance, their reliance on informal channels and on the shadow banking system subsides and, in the process, consumer exploitation is curbed.”
This is a very one-dimensional explanation of why Ponzi schemes have become so popular in India in the last few years. Ponzi scheme is a fraudulent investment scheme where the money being brought in by newer investors is used to pay off older investors. The scheme offers high returns and it keeps running till the money being brought in by the newer investors is greater than the money needed to pay off the older investors whose investment is up for redemption. The moment this breaks, the scheme collapses.
This writer has explained in the past that lack of a bank in their neighbourhood is not a reason good enough to explain why people invest money in Ponzi schemes. Many of the Ponzi schemes over the last few years have been very popular in urban as well as semi-urban areas, where there are enough number of banks going around. At the same time some of the Ponzi schemes have even needed bank accounts to ensure participate. So saying that people invest in Ponzi schemes because there are not enough banks going around, is not good enough. There are other bigger factors at work.
Ponzi schemes have become a big menace in India over the last few years. There numbers have gone up many times over. While there is no hard data to support the claim, but there is enough anecdotal evidence going around. Be it Speak Asia or Stock Guru or MMM India or Emu Ponzi schemes etc, there has been endless list of Ponzi schemes hitting the market.
This has also been a period of high inflation where interest offered on fixed deposits and postal savings deposits, has been very low or even negative once it is adjusted for inflation. There are other reasons as well why people find fixed deposits and postal savings deposits unattractive.
As Ila Patnaik wrote in a recent column in The Indian Express “Even those who have access often find it unattractive. Interest rates paid to depositors have been pushed down through years of policies of administered interest rates and lack of competition in banking. Regulatory requirements for priority sector lending and holding of government bonds have further resulted in lower returns. The result is low or negative real interest rates for depositors.”
It has been an era where bank fixed deposits have offered around 9% interest before tax when the inflation has been at 10% or more. The returns from post office savings deposits have been even lower than bank fixed deposits. Hence, in the strictest sense of the term, money deposited in banks or post office, has essentially been a losing proposition, given the high inflationary scenario that has prevailed.
And not surprisingly in this situation people have been looking at other investment avenues where there is a prospect of making higher returns. Gold has been one such investment avenue. As the Economic Survey released by the government in late February this year pointed out “Gold imports are positively correlated with inflation. High inflation reduces the return on other financial instruments… This observation, in line with global trends, is easily explained by the declining real returns on the gamut of financial instruments available to the investor and soaring ones on gold (23.7 per cent annual average return between April 2007 – March 2012 versus 7.3 per cent return on Nifty and 8.2 per cent on savings deposits).”
So money came into gold because there was a prospect of earning a high real return instead of bank and post office deposits where the individual would have actually lost money after adjusting for high inflation.
A similar explanation can be offered for people investing their hard earned money in Ponzi schemes like Saradha. They were looking for a higher return which helped them at least beat the rate of inflation. And this is where Ponzi schemes like Saradha came in. These schemes offered deposits which promised higher returns than bank or post office deposits.
As an article in the Business Standard pointed out “Sen(in reference to Sudipta Sen who ran Saradha) offered fixed deposits, recurring deposits and monthly income schemes. The returns promised were handsome. In fixed deposits, for instance, Sen promised to multiply the principal 1.5 times in two-and-a-half years, 2.5 times in 5 years and 4 times in 7 years. High-value depositors were told they would get a free trip to “Singapur”.”
In case of Saradha, the credibility it had built through its media empire as well as being seen closely aligned to the ruling Trinamool Congress, also helped. The deposits being raised may have even been seen as very safe, by those investing.
The other thing that has happened over the last few years is that household savings have come down. In 2009-2010 (i.e. the period between April 1, 2009 and March 31, 2010), savings stood at 25.2% of the gross domestic product (GDP). In 2011-2012 (i.e. the period between April 1, 2011 and March 31, 2012) the savings had fallen by nearly three percentage points to 22.3% of the GDP.
This has primarily happened because of high inflation which has pushed up expenditure as a proportion of total income. But incomes haven’t gone up at the same pace. And this has led to a fall in savings.
Given that savings of people have come down, there might be a temptation to invest them in avenues where they thought a higher return could be earned so as to ensure that investment goals continue to be on track, even with a lesser amount of savings being invested. This might have increased people’s appetite for taking on investment risk.
Hence, high inflation may have had a big role to play in people investing their money in Ponzi schemes. And we all know who is to be blamed for that.
Inflation has had Subbarao worried for a while now. “There is an important constituency in the country that is hurt by inflation. Their voice also needs to be heard. It is the responsibility of public policy institutions like the Reserve Bank to go out of our way and listen to silent voices,” the RBI governor said on Wednesday.
To conclude, it is very easy to argue that more Ponzi schemes spread because people people lack access to basic banking. But the reality is a little more complicated than that. As they say, truth is often stranger than fiction.
The article originally appeared on www.firstpost.com on May 9,2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)

 

Food Security Bill: What PM, other jholawalas can learn from Indira Gandhi

Agencies.
Vivek Kaul
Prime Minister Manmohan Singh tweeted yesterday saying that “the Food Security Bill is a very important legislation for the Govt. The UPA is committed to make this law after considering all opinions.” But the hurry in which the Congress led UPA seems to be to get the Food Security Bill passed, largely negates Singh’s statement.
Nevertheless, since Singh has stated that he is in the mood to consider all opinions, here are a few points that he as an economist and the Prime Minister of India, should take into consideration.
These points are over and above the points that this writer made in a column yesterday. (10 reasons why Amartya Sen is wrong about food security bill)
The Bill envisages to distribute highly subsidised food grain to almost two-thirds of India’s population of 1.2 billion and in its current form is a sheer recipe towards financial disaster and consequently very high inflation. Here are a few points that suggest the same:
1. Currently the government procures rice and wheat from farmers at mandis throughout the country. The state governments are allowed to implement a mandi tax, which the procurer of grains, in this case the government working through the Food Corporation of India (FCI)) or any of the state agencies, has to pay. The central government meets the entire expenditure incurred by the state governments on procuring rice and wheat.
Punjab has a mandi tax of 14.5% on top of the minimum support price. In case of Haryana the mandi tax is around 11%. This is a major source of revenue for these governments. As Sunil Jain pointed out in a recent column in The Indian Express “The mandi taxes accounted for nearly 18 per cent of the state’s(i.e. Punjab) taxes. In the case of Haryana, mandi taxes accounted for around 7 per cent of the state’s own tax revenues.”
The possibility that states might increase the mandi tax, exists. In fact it is already happening. “Orissa hiked its mandi tax on paddy from 8.5 per cent to 12 per cent,” writes Jain.
In fact, it is in the interest of states to increase their mandi tax. One reason, as already pointed out, is the fact that mandi tax is an easy source of revenue. The second reason is that implementing a mandi tax on the minimum support price allows states to give out a bonus to its farmers over and above the minimum support price(MSP) which the central government sets.
As an editorial in Business Standard points out “Madhya Pradesh has gone a step further and has begun offering hefty bonuses – Rs 100 a quintal last year, hiked to Rs 150 this year – on top of the minimum support price to maximise procurement. Though the fiscal burden of the bonus is borne by the state government itself, this is offset to a large extent by the higher tax collection from increased procurement as a result of this incentive.”
This is something that Jain also writes about in the Indian Express “Typically, the state government buys the grain on behalf of the FCI and then bills it for this. So if a state now announces a “bonus” of 20 per cent, it promises to buy the grain brought by the farmers at Rs 120 per unit. This is not just fiction, Madhya Pradesh offers farmers 11 per cent more for wheat and Chhattisgarh 22 per cent more for paddy (i.e. rice).”
Now how does this link up with the Food Security Bill? Nearly two thirds of the Indian population is expected to be eligible for subsidised rice and wheat under the Food Security Bill, as and when it becomes an Act. This means that the procurement of rice and wheat by the government will have to go up. As the procurement goes up, so will the total amount of mandi tax being collected by the state governments.
This will mean higher expenditure for the central government. A higher expenditure will mean the government running a higher fiscal deficit. Fiscal deficit is the difference between what a government earns and what it spends.
It is in the interest of the state governments to increase mandi tax and thus award a higher bonus to farmers on top of the minimum support price. “Little wonder that Madhya Pradesh last year emerged as the second largest procurer of wheat, after Punjab, relegating Haryana to the third spot…Taking a cue, Chhattisgarh, which has now become surplus in rice…has stepped up market levies on these purchases,” the Business Standard points out. With the Food Security Bill becoming an Act this phenomenon is likely to increase.
2. With Food Security Bill becoming an Act, the government will have to procure more rice and wheat than it does now. The trouble is that FCI does not have economies of of scale i.e. its cost of procurement goes up as it procures more. One reason for this is the increasing cost of labour.
As a report titled titled National Food Security Bill: Challenges and Options authored by Ashok Gulati, Jyoti Gujral and T.Nandakumar (with Surbhi Jain, Sourabh Anand, Siddharth Rath, and Piyush Joshi) belonging to the Commission for Agricultural Costs and Prices (CACP), which is a part of the Ministry of Agriculture, points out “For the quarter ending March, 2012, FCI employed 1.55 lakh workers out of which 1 lakh are contract workers, 19441 are departmental labour, 30112 are Direct Payment system (DPS) workers…The average handling cost per metric tonne for FCI for 2010-11 for contract labour was Rs 41.4 while for departmental labour, it was Rs 311.1 (7.5 times the cost of contract labour) and for workers under the DPS it was Rs 136.9 (3.3 times the contract labour). This indicates contractual labour of FCI were the least expensive. However, the Ministry of Labour and Employment, has prohibited employment of contract labour in the depots of FCI.”
So what this means that in the years to come contract workers and direct payment system workers are likely to be regularised. This will raise costs of labour by three to seven times. This extra cost will have to be borne by the central government. This again means higher expenditure for the government and hence a higher fiscal deficit.
Expenditures like this one are not taken into account when the jholawalas in favour of food security point out that the right to food security will cost Rs 1,00,000 -1,20,000 crore per year. As this writer mentioned in a column yesterday, the CACP find this estimate of the government, just the tip of the iceberg. This expenditure does not take into account “additional expenditure (that) is needed for the envisaged administrative set up, scaling up of operations, enhancement of production, investments for storage, movement, processing and market infrastructure etc.” The CACP estimates that “the total financial expenditure entailed will be around Rs 682,163 crore over a three year period.” Imagine what this will do to the fiscal deficit of the government along with fuel and fertiliser subsidies and NREGA. What do the jholawalas have to say about that?
3. The right to food subsidy is currently structured as an unlimited subsidy. The government will buy as much rice and wheat the farmer can bring to it to sell. In fact, given the scope of the right to food security the government may have to buy as much rice and wheat that it can lay its hands on. But with the government buying huge amount of rice and wheat, what will it do to the availability of these grains in the open market? What will be the impact on their price? Are these questions even being considered?
In fact this is already playin out over the last few years. As the CACP report points out “Since 2006-07, the procurement levels for rice and wheat have increased manifold…Currently, piling stocks of wheat with FCI has led to an artificial shortage of wheat in the market in the face of a bumper crop. Wheat prices have gone up in domestic markets by almost 20 percent in the last three months alone (in the three months upto December 2012, when the CACP report was released), because of these huge stocks with the government that has left very little surplus in markets.” CACP expects this phenomenon to get more pronounced if Right to Food Security Bill becomes an act.
4. Increasing nutrition is a major goal of the Right to Food Security Bill. But the way it is currently structured it will work against this goal. As an editorial in the Indian Express points out “In fact, the food security bill will do little to genuinely address the real nutritional needs of the nation, but will distort the grain market, and saddle the system with yet another legal entitlement that cannot be undone. NSSO (National Sample Survey Office) data shows that per-calorie food consumption is falling not because large parts of India cannot feed themselves basic grain, but because they are turning to better food like protein, vegetables, tea etc.”
But with the farmers getting a fixed price for rice and wheat they are less likely to produce other food products. As the CACP report points out ““Assured procurement gives an incentive for farmers to produce cereals rather than diversify the production-basket…Vegetable production too may be affected – pushing food inflation further.”
5. In fact state governments are already trying to procure more and more grain than they had in the past. As the Business Standard editorial referred to earlier points out “Bihar, only a marginally wheat surplus state, has this year set up more grain procurement centres than the major wheat-growing states of Punjab, Haryana and Uttar Pradesh put together. These, obviously, are trends that need to be restrained. One of their untenable fallouts is the mopping up of the wheat surplus in the peak season by the government, which is tantamount to virtual nationalisation of the foodgrain business.”
This is something that even Indira Gandhi, the biggest political socialist that India has ever seen and the biggest jholawala of them all, tried to do in 1972-73 and failed miserably. She nationalised the wholesale trade in food grains, a decision which had to be reversed in a few weeks as it lead to escalating prices and total chaos. Indira Gandhi made big blunders as Prime Minister of India, ramifications of which are still being borne, but this was one prospective blunder she corrected quickly. This can be a source of inspiration for Manmohan Singh and the jholawalas who advise Sonia Gandhi, because the virtual nationalisation of foodgrain business will be disastrous.
As the CACP report points out “The government already procures one-third of the cereals production and any increase in procurement will have enormous ramifications on the cereal economy/markets and would crowd out private sector operations with a consequent effect on open market prices.”
6. The jholawalas in favour of right to food security keep pointing out towards the success of public distribution systems in states like Tamil Nadu and Chattisgarh. What they do not realise is that if Right to Food Security Bill becomes an Act, the central government will prevail over the state governments. “Once the Act comes into effect the existing schemes pursued by the states will suffer considerably…The National Food Security Bill(NFSB) however creates a new statutory framework governing the public distribution system (PDS). PDS systems in states will have to first comply with the NFSB and in the event of a conflict…the provisions, rules, regulations and orders issued under the NFSB will override.” Hence, systems which have been successful in states may not be in operation anymore.
To conclude, the right to food security will usher in an era of very high food inflation ( as if its not high already). It will also push up government expenditure and in turn its fiscal deficit. This will add to inflation. As Ashok Gulati, the Chairman of the Commission for Agricultural Costs and Prices and Shweta Saini an independent researcher, write in a research paper titled Taming Food Inflation in India “Based on the empirical results of the econometric analysis, it is suggested that the policies to rein-in food inflation will foremost require winding-down fiscal deficit, which has gone (above 8% of GDP for Centre and States combined).”
The right to food security will work exactly in the opposite way and push up food and overall inflation, which in turn will hurt those it is expected to benefit.

The article originally appeared on www.firstpost.com on May 9,2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)