Six reasons why the PM’s prediction of growth will be right for a change

Manmohan-Singh_0Vivek Kaul
Over the last few days a whole host of stock brokerages and financial institutions have downgraded India’s expected rate of economic growth for 2013-14 (i.e. the period between April 1, 2013 and March 31, 2014). Even Prime Minister Manmohan Singh conceded a few days back that the projected growth of 6.5% might be difficult to achieve. “We had targeted 6.5% growth at the time the budget was presented. But it looks as if it will be lower than that,” he said.
Politicians are typically the last ones to concede that things are going wrong. And when they do come around to admitting it, then that is the time one can really believe what they are saying.
So to cut a long story short, for a change, Manmohan Singh’s statement made a few days back might very well come out to be true by the end of this financial year.
Attempts are being made by the government to revive the economy (or at least that is what they would like us to believe), but they are unlikely to lead to any immediate improvement. Analysts at Nomura led by economist Sonal Varma give out some likely reasons for the same in a recent report titled 
India: turbulent times ahead. “We are downgrading our GDP(gross domestic product) growth forecasts to 5.0% year on year in FY14 (from 5.6%),” write the Nomura analysts. 
Lets look at some of the reasons:
The government’s current reform zeal isn’t going last for long. Elections in five states are to be held in December 2013/January 2014. These states are Delhi, Mizoram, Madhya Pradesh, Rajasthan and Chattisgarh. The Congress is not in power in three out of the five states. Also, the party is likely to face a tough time in Delhi. Given these things it is highly unlikely that the party will continue with the “so-called” reform process that it has initiated in the recent past.
One of the lasting beliefs in Indian politics is that economic reform is injurious to electoral reforms. Or as the Nomura authors put it “The window for reforms is fast closing…(It) will close after September…Given the negative consequence of past government inaction(on the reform front), this is a case of too little, too late (to revive growth).”
Also, as the elections approach it is likely that prices of petrol, diesel and cooking gas will not be raised in line with the international price of oil. This happened before the recently held Karnataka assembly elections as well. Hence, the fiscal deficit of the government is likely to continue to go up. “We are concerned with the government’s ability to stick to its budgeted fiscal deficit target,” write the Nomura analysts. Fiscal deficit is the difference between what a government earns and what it spends.
When a government spends more, it has to borrow more in order to finance that spending. Hence, it “crowds-out” other borrowers, leaving a lesser amount of money for them to borrow. This pushes up interest rates. At higher interest rates people and businesses are less likely to borrow and spend. This impacts economic growth negatively.
New investments have dried down: Investments made by companies to expand their current businesses or launch new ones have dried down. “New investment projects announced have fallen from a peak of Rs 2300000 crore in the first quarter of 2009 to Rs 300000 crore in the second quarter of 2013…Investments are long-term decisions and there is a lag between an investment’s announcement and its execution,” write the Nomura authors. Hence, even if a company starts with an investment now, its impact on economic growth will not be felt immediately.
What adds to India’s woes is the fact that sectors like power generation & distribution, infrastructure developers & operators, construction, telecom services etc, which drove the last round of investments between 2004 and 2007 are deep in debt, and in no position to continue investing.
The political uncertainty that prevails will also lead companies to postpone long term capital expenditure decisions till there is hopefully more certainty next year after the Lok Sabha elections in May 2014. As the Nomura analysts write “Given this political uncertainty and an already dismal starting position, we believe that corporates will choose the prudent option of delaying long-term capex decisions until there is more political certainty.”
In fact this trend was visible in the poor results of the heavy engineering and construction major Larsen and Toubro, for the three month period ending June 30, 2013.
Banks have become cautious while lending. Even if a company may be ready to invest they might find it difficult to get the loans required to get the project going. This is primarily because the non performing loans and restructured loans of banks have risen to around 10% of their total loans. This figure was at a level of around 4% four years back. As the Nomura authors write “This worsening credit quality has impelled banks to become more risk averse when lending.”
Consumer demand will continue to remain sluggish. Car sales have now fallen nine months in a row. High interest rates are often offered as a reason for the falling sales. But as this writer has pointed out in the past, in case of car loans, even a cut of interest rates by 100 basis points brings down the EMI only by around Rs 200.
Hence, people are not buying cars primarily because they are insecure about their jobs and businesses. As the Nomura analysts point out “The job market remains moribund. India does not have good employment data, but given continued job losses in banking and financial services, slowing job growth in the IT sector and sluggish manufacturing sector employment, we do not see a sustainable consumption recovery without an improvement in employment prospects.” Weak consumer demand translates into lower profits for businesses and low economic growth.
One of the main reasons for weak consumer demand has been the fact that till very recently the government did not pass on the increase in the price of oil to the end consumers in the form of a higher price for diesel, petrol or cooking gas. But that has changed now. “Consumers used to be insulated from rising fuel and energy costs (diesel, petrol, LPG cylinder, electricity), but now they are forced to bear a higher burden of adjustment, thereby reducing their disposable income,” the Nomura analysts point out. Add to that a very high food inflation of nearly 10% and you know why the Indian consumer is not spending as much as he was in the past.
Indian imports will continue to remain high. The government and the Reserve Bank of India have gone hammer and tongs after gold imports. Through various measures they have managed to bring down gold imports to 31.5 tonnes for the month of June 2013. Hence, gold imports are down by nearly 81% from the 141 tonnes that the country imported in May 2013.
The government’s hatred for gold is primarily because India’s foreign exchange reserves are at very low levels when compared to its imports. Indians foreign exchange reserves are now down to a little over six months of imports, a level last seen in the 1990s. 
By making it difficult to buy gold, the government hopes to preserve precious foreign exchange reserves. The trouble is that such an alarming fall in gold imports has led the intelligence agencies to believe that a lot of gold is now being smuggled into the country.
The government may be clamping down on gold imports but there are other imports it really doesn’t have much control on. “The commodity intensity of imports is high,” write Nomura analysts as India imports coal, oil, gas, fertilizer and edible oil. And there is no way that the government can clamp down on the import of these commodities, which are an everyday necessity.
When these commodities are imported they need to paid for in dollars. Hence, rupees are sold and dollars are bought. This leads to a surfeit of rupees in the market and a shortage of dollars, and pushes down the value of rupee against the dollar further.
A weaker rupee will lead to Indian oil companies having to pay more for the oil they import. If this increase is not passed onto end consumers (given the upcoming state elections), then it will add to the fiscal deficit of the government.
RBI can’t manage the impossible trinity: The RBI currently faces the trilemma of ensuring that the rupee does not go beyond 60 to a dollar, allowing free capital movement and at the same time run an independent monetary policy. This is not possible. Expectations were that the RBI will cut the repo rate in its next monetary policy to help revive economic growth. Repo rate is the interest rate at which the RBI lends to banks.
But at lower interest rates chances are foreign investors will pull out money from the Indian bond market. When they do that they will be paid in rupees. These rupees will be sold and dollars will be bought. When this happens there will be a surfeit of rupees in the market and which will weaken the value of the rupee further against the dollar. This will create problems for the government which will have to bear a higher oil bill. Businesses which have borrowed in dollars will have to pay more in rupees in order to buy the dollars they will need to repay their loans. Imports will become costlier and that will add to inflation, impacting economic growth further.
Given these reasons it is unlikely that India will return to high economic growth rates of 8-9% any time soon. Manmohan Singh might be finally proved right on something.

The article originally appeared on on July 23, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Why Amartya Sen is right about India's education system

Vivek Kaul 
It has become fashionable these days to criticise Nobel prize winning economist Amartya Sen. This writer has also been guilty of doing the same on at least one occasion. But there is nothing wrong with the points that Sen makes on the Indian education system and its weaknesses, in his new book An Uncertain Glory: India and its Contradictions, which he has co-authored with his long time collaborator Jean Drèze.
Several surveys conducted over the years have clearly shown the low level of learning among a wide number of students that prevails across the length and breadth of India. Drèze and Sen cite a few such surveys in their book. The ASER Survey 2011, which was an all India representative survey of school children in rural areas found that only 58% of children enrolled in classes 3 to 5 could read Class – I text. Less than half (47%) were able to do simple two digit subtraction. And only half of the children in classes 5 to 8 could use a calendar. These were not difficult tasks by any stretch of imagination.
Several such surveys with dismal levels of learning among children in rural areas keep coming out. But surprisingly even urban areas don’t seem to be doing any better.
The WIPRO-EI Quality Education Study 2011, surveyed more than 20,000 students in 83 ‘top schools’ in five metro cities (Bangalore, Chennai, Delhi, Kolkata and Mumbai). And the results were surprising. “For example, only third of these ‘top school’ students in Class 4 knew who was the alive person in a list of four: Mahatma Gandhi, Indira Gandhi, Rajiv Gandhi and Sonia Gandhi ( a small number thought, interestingly enough, that it was Mahatma Gandhi who was still alive). About two-thirds of the students in Class 4 could not master the measurement of the length of the pencil with a ruler,” write Drèze and Sen.
When compared to other countries, India comes in right at the bottom. In the PISA Plus survey conducted in 2009, the Indian performance in a list of 74 countries or economies that were a part of the survey was very bad. “And this is the case even though the two Indian states that participated in PISA Plus happened to be two of the better-schooled states, Tamil Nadu and Himachal Pradesh. In a comparison of overall reading ability of 15-year-old students in these 74 countries or economies, both Indian states figure among the bottom three (in company of Kyrgyzstan),” write the authors.
The bureaucrats and politicians like to point to the fact that India has more schools now than ever before. 
The 8th All India Education Survey which was released earlier this year found that the number of schools in the country increased by 27% between 2002 and 2009. Shashi Tharoor, minister of state of Human Resource Development writes in a column in The Indian Express today “Take education, the subject of my own ministry. Literacy rates have risen to 74 per cent; more than 75,000 schools were opened and nearly a million teachers appointed in just the last three years.”
But Tharoor doesn’t tell us anything about the learning process. Opening, more schools doesn’t really mean anything on its own. Despite this increase in the number of schools there seems to be a lot that is wrong with the way things are being taught in Indian schools. One reason often offered for the poor state of India’s education system is that the teachers are not paid enough and hence they lack the motivation to teach properly.
Drèze and Sen prove this to be wrong. “Consider primary-school teacher salaries as a ratio of per capita GDP. In 2001 this ratio of teacher salary to the GDP per head was estimated to be around one in China, somewhere between one and two in most OECD countries, and a little higher in developing countries, but not higher than three for any of the countries (except India) for which data is available. More recent data suggest similar ratios of teacher salaries to GDP in 2005 and 2009. For instance, the OECD average hovered around 1.2 between 2002 and 2009. In India, however, it seems that the corresponding ratio was already around three before the Sixth Pay Commission scales came into effect (in 2009, with retrospective effect from 2006), and shot to around 5 or 6 after that,” write the authors.
What it means that Indian teachers get paid five to six times the amount of money that an average Indian makes. In fact the ratio is higher in a few states when we compare the average teacher salary in that state with the average income in that state. In Uttar Pradesh, the ratio is at 15.4. In Bihar, it is even higher at 17.5. For the nine major states of India the ratio in 2012, stood at 4.9. This leads Drèze and Sen to conclude that “whatever may be the source of the problem of low teaching efficiency, the blame cannot be placed on any alleged lowness of salary of school teachers.”
These high salaries have forced state governments to stop recruiting regular teachers and move onto contract teachers. As Drèze and Sen point out “Faced with the cost of escalation involved in these salary hikes, many states have stopped recruiting regular teachers and have increasingly come to rely on hiring ‘contract teachers’ to do the teaching. The salaries of contract teachers are typically a fraction (as low as one fifth or so, in many cases) of what the regular teachers earn.”
A large proportion of these teachers are untrained or are trained through what the authors call en masse correspondence courses.
In fact the irony is that the contract teachers despite their lack of training do no worse than regular teachers when it comes to teaching. This has led to a dualistic system where trained permanent teachers work side by side with teachers on contract who have been hired at a fraction of the former’s salary. A good system would have been something in between. As Drèze and Sen write “It would have been nice to see some sort of a middle path emerging from this dualism: new terms and conditions for the teaching profession, with decent salaries, good qualifications and some security of employment, but not unconditional, permanent plum jobs that undermine work incentives and ruin the integrity of the profession.” The system as it has evolved is neither here nor there. A good education system cannot be built on the back of teachers whose contracts are always running out.
The Right to Education Act which came into force as on April 1, 2010, prescribes a pupil teacher ratio of not more than 30:1. This has become very difficult for state governments to fulfil given that following the Sixth Pay Commission pay scales is a very expensive proposition for a large number of states. “On the other hand, meeting them (i.e. the conditions under Right to Education) by hiring untrained contract teachers would become, strictly speaking, illegal,” write the authors.
Also, the bigger trouble is that the Right to Education allows automatic promotion from one class to the next. Board examinations are not allowed till Class 8. Imagine the consequences of a student who is not picking up things in a certain class being promoted to the next class. As Drèze and Sen put it “If a large proportion of children learn virtually nothing for years on end in a particular school, it is important to know it,well before they are sent for slaughter in the Board Examination (if indeed they reach the end of Class 8 without dropping out).”
Economist Abhijit Banerjee, who is also the co-author of Poor Economics, explained this scenario 
very well while speaking at a literature festival in Mumbai late last year. He said “Think of all the class IV children who cant read. They are learning social studies and all kinds of other wonderful things except they can’t read. They are learning nothing. They are sitting in a class watching some movie in some foreign language without subtitles…The dropout rates are high. And I am always shocked that why does anybody comes to school at all? You are sitting there in class and you can’t read, you can’t write, why are you even there? What is going on?” Now imagine what will happen to students who will keep getting promoted without any exams.
The only people who gain through no exams are the teachers, especially in a system where learning is so low and there is very little supervision of what is really going on. As Banerjee put it “
The public education education is a system for the teachers, by the teachers and in the interest of the teachers. This is a system which essentially does not want any metric of performance. The excuse they give is that we don’t want children to be tested because children feel bad if they don’t do well. Its true that children feel bad if you tell them in public that they have done badly. But there is no reason that testing means public declaration of results. In Massachusetts(in the United States) where I live, test scores are only revealed at the grade level. So, for example, all fourth graders may have done badly at some school, but I don’t have to know if someone did well or badly.”
The Right to Education is thus creating more problems. The trouble is that like all such big Acts which try to address everything, it has ended up addressing nothing. The basic thing that any Act on education should be addressing is the lack of learning among students in schools. But that is clearly not happening.
Small experiments have been carried out around this problem. And they seem to suggest that addressing the lack of learning is neither very difficult nor very expensive. As Banerjee put it late last year “
We did one experiment in Bihar which was with government school teachers. This was in summer around two years ago. The teachers were asked that instead of teaching like you usually teach, your job for the next six weeks is to get the children to learn some basic skills. If they can’t read, teach them to read. If they can’t do math, teach them to do math. At the end of six weeks, these teachers were given a small stipend. They had also been given a couple of days of training. At the end of six weeks, the children had closed half the gap between the best performing children and the worst performing children. They had really improved enormously.”
What changed suddenly? W
hy did the government school teachers do so much better? “The reason was they were asked to do a job that actually made sense. They were asked to teach the children what they don’t know. The usual jobs teachers are asked to do is teach the syllabus – which is very different. Under the Right to Education Act, every year you are supposed to cover the syllabus,” said Banerjee.
The solution to the problem is very simple. For the first few years of school the children need to be taught the basics like being able to read, write and do simple Math. Such a system is likely to lead to better results. As Banerjee put it “One thing that we forget is that the perfect is the enemy of the good. We are trying to have an education system that is perfect and that every child should come out with wisdom at the end of it and as a result they learn nothing.” 

The trouble is that small simple solutions do not seem to have enough vote grabbing potential.
The article originally appeared on on July 23, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Why Congress' new found love for FDI wont help rupee much

Vivek Kaul 
Foreign direct investment(FDI) seems to be new buzzword of the Congress led United Progressive Alliance (UPA) government. Earlier this week the government relaxed foreign direct investment norms in twelve sectors including telecom, insurance, asset reconstruction, petroleum refining, stock exchanges and so on.
This sudden love of the government for FDI after nearly nine years of sitting on their bums, can be attributed to the rupee losing value rapidly against the dollar and creating huge economic problems. The hope is that with FDI reform foreign investors will bring in dollars into India to set up new businesses, increase their investment in existing businesses or buy up businesses.
When these dollars come into the country they will have to be converted into rupees. This will increase the demand for rupees and ensure that the rupee will gain value against the dollar. That is how things are supposed to work, at least in theory.
But this is easier said than done. A foreign investor looking to get money into India through the FDI route is committing to stay invested for the long term. In comparison, a foreign investor investing money in the stock market or the bond market, can sell the stocks or bonds, take his money and leave, the moment he sees things going wrong.
An investor who has got in money through the FDI route cannot exit like an investor who has invested money in stocks or bonds. Selling a business or a factory is not as easy as selling stocks or bonds for that matter. And more than that setting up a profitable business to justify the investment being made in a foreign country is not so easy. I
t is worth remembering that the Western world in general and the United States in particular is currently dealing with the aftermath of the financial crisis. There is great pressure on companies to set up new businesses or expand current ones in their home countries. In this scenario if they do decide to go abroad and set up new businesses, it needs to be a very good proposition for them.
Given this, any investor getting in money through the FDI route is likely to look at many factors than get in money simply because FDI is the flavour of the week with the government.
Take the case of the South Korean steel company POSCO which has pulled out of setting up a steel plant in Karnataka. The company had signed 
an agreement to set up a steel plant with a capacity of 6 million tonnes in the state in June 2010. The project would have got in $6 billion worth of FDI in the state. Along similar lines ArcelorMittal, the global steel giant, has decided to opt out of a $12 billion steel plant in Odisha. So the country lost out on FDI worth $18 billion within two days of the Congress led UPA government discovering FDI.
The reasons for pulling out cited by both the companies were similar. They couldn’t get the land required to set up the steel plant and at the same time iron ore linkages weren’t in place. Iron ore is used to produced steel.
What this tells us is that it is not very easy for a foreign investor to set up shop in India. The process of acquisition of land for the Posco plant in Karnatka had been on for around two and a half years. 
ArcelorMittal also had been trying to acquire land for its plant in Odisha for more than three years now.
Every year the World Bank puts out a ranking which measures the Ease of Doing Business across countries. In the 2013 ranking, India came in 132nd on the list. India’s ranking was the same in 2012 as well. When it comes to enforcing a contract, India came in 184th on the list. When it comes to starting a business India is 173rd on the list. What this means is that foreign investors have an option of starting their business in a much easier way in 172 countries other than India. Given this, why should they be hurrying to India?
In fact ArcelorMittal had announced last year that India was no longer a priority for them when it came to making major investments. Of course these withdrawals would have had much more impact on prospective investors than the announcements made by the government welcoming FDI.
Then there is issue of corruption. Over the last few years a spate of scams from coalgate to the telecom scam have come to light. This also has an impact on the foreign investor looking to get in money into India through the FDI route.
As Ali Al-Sadig writes 
in a research paper titled The Effects of Corruption on FDI inflows written for the CATO insitute “From a theoretical viewpoint, corruption—that is, paying bribes to corrupt government bureaucrats to get “favours” such as permits, investment licenses, tax assessments, and police protection—is generally viewed as an additional cost of doing business or a tax on profits. As a result, corruption can be expected to decrease the expected profitability of investment projects. Investors will therefore take the level of corruption in a host country into account in making decisions to invest abroad.”
And empirical research shows that there is a negative relationship between corruption and FDI inflows. As Al-Sadig writes “That is, ceteris paribus, a one-point increase in the corruption index causes a reduction in per capita FDI inflows by 11 percent.”
In another research paper titled 
Foreign direct investment, corruption and democracy Aparna Mathura and Kartikeya Singh reported a similar result. As they write “We find quite convincingly that corruption perception does play a big role in investors’ decision of where to invest. The more corrupt a country is perceived to be, the less the flows of FDI to that country.”
So corruption is another factor which will continue to have an impact on FDI into India in the days to come, given that its not going to go away any time soon.
Then there is the perpetual problem of India’s infrastructure. Businesses need roads, ports, power, rails etc to function. There is a clear lack of supply on this front. And this also has an impact on the amount of money coming in through the FDI route. As Rajesh Chakrabarti, Krishnamurthy Subramanian, Sesha Meka and Kuntluru Sudershan write in a research paper titled 
Infrastructure and FDI: Evidence from district-level data in India published in March 2012 “We find that while there is indeed a positive relationship between physical infrastructure and FDI inflows, the relationship is essentially non-linear with a “threshold level” of infrastructure after which the positive effect becomes significant.”
What this means is that districts in India which have a better physical infrastructure attract more FDI. What it also means is that significant FDI inflows happen once physical infrastructure is of a certain ‘threshold’ level. So there is a clear link between physical infrastructure and the total amount of FDI that comes in. And India loses out on this front.
All these factors have led to a situation where 
FDI into India has fallen in the last three out of the four years. For 2012-2013(i.e. the period between April 1, 2012 and March 31,2013), FDI fell by 21% to $36.9 billion, as per government data. The United Nations Conference on Trade and Development (UNCTAD) in a recent release said that FDI inflows to India declined by 29 per cent to $26 billion in 2012.
To conclude, while the Congress led UPA government might have fallen in love with FDI, it is unlikely to lead to a flood of dollars in the months to come. For that to happen the country first needs better governance which will lead to better infrastructure, lower corruption and a greater ease of doing business. But governance is something that has gone missing from this country. And given this, the rupee will continue to have a tough time. It is currently quoting 40 paisa lower at Rs 59.74 to a dollar against yesterday’s close of Rs 59.35 to a dollar.
The article originally appeared on on July 20, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)

Why RBI is in a Catch 22 situation when it comes to the rupee

RBI-Logo_8Vivek Kaul 
The Reserve Bank of India (RBI) will carry out an open market operation and sell government of India bonds worth Rs 12,000 crore today i.e. July 18,2013.
The RBI carries out an open market operation in order to suck out or put in rupees into the financial system. When the RBI needs to suck out rupees from the system it sells government of India bonds, like it is doing today.
Banks and other financial institutions buy these bonds and pay the RBI in rupees, and thus the RBI sucks out rupees from the market.
The rupee has had a tough time against the US dollar lately and had recently touched an all time low of 61.23 to a dollar. By selling bonds, the RBI wants to suck out rupees from the financial system and thus try and ensure that rupee gains value against the dollar.
The RBI has been trying to defend the value of the rupee against the dollar by selling dollars from the foreign exchange reserves that it has. When the RBI sells dollars it leads to a surfeit of dollars in the market and as a result the dollar loses value against the rupee or at least the rupee does not fall as fast as it otherwise would have.
The trouble is that the RBI does not have an unlimited supply of dollars. Unlike the Federal Reserve of United States, the RBI cannot create dollars out of thin air by printing them. I
n the period of three weeks ending July 5, 2013, as the RBI sold dollars to defend the rupee, the foreign exchange reserves fell by $10.5 billion to $280.17 billion.
At this level India has foreign exchange reserves that are enough to cover around 6.3 months worth of imports. Such low levels of foreign exchange expressed as import cover hasn’t been seen since the early 1990s. Given this, there isn’t much scope for the RBI to sell dollars and hope to control the value of the rupee. It simply doesn’t have enough dollars going around.
Hence, it is trying to control the other end of the equation. It cannot ensure that there are enough dollars going around in the market, so its trying to create a shortage of rupees, by selling government of India bonds.
In fact, as a part of this plan the RBI has also put an overall limit of Rs 75,000 crore, on the amount of money banks can borrow from it, at the repo rate of 7.25%. Repo rate is the interest rate at which RBI lends money to banks in the short term.
Banks can borrow money beyond this limit at what is known as the marginal standing facility rate. This rate has been raised by 200 basis points(one basis point is one hundredth of a percentage) to 10.25%. Hence, borrowing from the RBI has been made more expensive.
A major motive behind this move was to rein in the speculators. 
As Jehangir Aziz of JP Morgan Chase wrote in The Indian Express “It has been ridiculously cheap over the last month to borrow rupees at the overnight rate, buy dollars and then wait for the exchange rate to crumble. In June, the monthly overnight interest rate was 0.5 per cent and the depreciation 10 per cent.”
Lets understand this through an example. Lets say a speculator borrows Rs 54,000 at a monthly interest rate of 0.5%. This is at a point of time when one dollar is worth Rs 54. He uses this money to buy dollars and ends up buying $1000 (Rs 54,000/54). When he sells rupees to buy dollars it puts pressure on the value of the rupee against the dollar.
After buying dollars, the speculator just sits on it for a month, by the time rupee has depreciated 10% against the dollar and one dollar is worth Rs 59.4(Rs 54 + 10% of Rs 54). He sells the dollars, and gets Rs 59,400($1000 x 60) in return. He needs to repay Rs 54,000 plus a 0.5% interest on it. The rest is profit. This is how speculators had been making money for sometime and thus putting pressure on the rupee.
By making it more expensive to borrow, the RBI hopes to control the speculation and thus ensure that there is lesser pressure on the rupee.
The message that the market seems to have taken from the efforts of the RBI to create a scarcity of rupees is that interest rates are on their way up. The hope is that at higher interest rates foreign investors will bring in more dollars and convert them into rupees and buy Indian bonds. Foreign investors have sold off bonds worth $8.4 billion since their peak so far this year.
When foreign investors sell bonds they get paid in rupees. They sell these rupees and buy dollars to repatriate the money. This puts pressure on the rupee and it loses value against the dollar. The assumption is that at a higher rate of interest the foreign investors might want to invest in Indian bonds and bring in more dollars to do so. This strategy of defending a currency is referred to as the classic interest rate defence and has been practised by both Brazil as well Indonesia in the recent past.
But there are other problems with this approach. Rising interest rates are not good news for economic growth as people are less likely to borrow and spend, when they have to pay higher EMIs. 
A spate of foreign brokerages have cut their GDP growth forecasts for India for this financial year (i.e. the period between April 1, 2013 and March 31, 2014). Also sectors like banking, auto and real estate are looking even more unattractive in the background of interest rates going up. In fact, auto and banking sectors were anyway down in the dumps.
Slower economic growth could lead to foreign investors selling out of the stock market. When foreign investors sell stocks they get paid in rupees. In order to repatriate this money the foreign investors sell these rupees and buy dollars. And if this situation were to arise, it could put further pressure on the rupee.
Hence by doing what it has done the RBI has put itself in a Catch 22 situation. But then did it really have any other option? The other big question is whether the politicians who actually run the Congress led UPA government will be ready to accept slow economic growth(not that the economy is currently on steroids) so close to the next Lok Sabha elections? On that your guess is as good as mine.
The article originally appeared on on July 18, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

The psychology of discounts

discount-10Vivek Kaul
The power discounts have over consumer spending became apparent to me on a recent visit to Delhi. An aunt of mine decided to travel nearly twenty five kilometres in a DTC (Delhi Transport Corporation) bus to have lunch in a restaurant in Connaught Place, which was offering a 20% discount. And this was a time when the heat in Delhi was killing, with the temperature being greater than 40 degrees Celsius.
After coming back to Mumbai I heard about a high end lifestyle brand putting its goods on sale. And women queued up for it from 6.30am in the morning, despite the heavy rains.
That’s the power the words discount and sale have on the human mind. They can really get people out there to shop, despite the rains and the heat.
In fact Eric Anderson and Duncan Simester carried out an experiment to test whether just labelling something to be “on sale” lead to higher sales. Jonah Berger discusses this experiment in his book Contagious – Why Things Catch on. As he writes “Anderson and Simester, created two different versions of the catalogue and mailed each to more than fifty thousand people. In one version some of the products(let’s call them dresses) were marked with signs that said “Pre-Season SALE.” In other version the dresses were not marked as on sale.”
The results were very interesting. The items on which a sale sign had been marked, saw the demand go up by more than 50%. “The prices of the dresses (i.e. the items marked to be on sale) were the same in both versions of the catalogue. So using the word ‘sale’ beside a price increased sales even though the price itself stayed the same.”
While just mention of the world ‘sale’ is likely to increase sales, the trick is not to overuse it. As Anderson and Simester point out in a research paper titled The Role of Sale Signs “if customers’ price expectations are sensitive to the number of products that have sale signs, this strategy is not without cost. Using additional sale signs may reduce demand for other products that already have sale signs.” Also, if a product is always on sale then there is a problem because people can’t compare it with anything.
Despite these negatives, the fact is that everyone wants a good deal. In fact such is people’s fascination for getting a good deal that in some cases they are even willing to pay more. Berger carried out a small experiment in which a barbecue grill is on sale. Originally priced at $350, now its being sold at $250, a saving of $100. He ran this ‘deal’ through 100 people and 75% of the people said that they would buy the grill.
There was another scenario in which the same grill was on sale but at a different store. Originally it had been priced at $255 and was now selling at $240. Berger ran this ‘deal’ through 100 people and only 22% of the people said they would buy the grill.
And this is what made things really interesting. “Both stores were selling the same grill. So if anything, people should have been more likely to say they would buy it at the store where the price was lower….More people said they would purchase the grill in scenario A (the first scenario where a $350 grill was being sold for $250), even though they would have to pay a higher price ($250 rather than $240) to get it,” writes Berger.
Discount and sales offers play tricks on the human mind leading it to make irrational decisions, which are exploited by marketers. Akshay Rao of the University of Minnesota carried out a research on discounts and offering something extra for the same price, which he published in a paper titled When More Is Less: The Impact of Base Value Neglect on Consumer Preferences for Bonus Packs over Price Discounts.
In this paper Rao came to the conclusion that “shoppers prefer getting something extra free to getting something cheaper.”He explains this through an example of coffee beans. On a normal day, 100 coffee beans are being sold for Rs 100. One day, a discount of 33% is on offer. This means 100 coffee beans are sold for Rs 67.
Another day, a 50% extra offer is on. This means 150 coffee beans can now be bought for Rs 100. But what this also means is that 100 coffee beans can be bought for Rs 67. So a 33% discount offer and a 50% extra offer are economically equivalent. There is no difference between them, at least theoretically.
But real life turned out to be different from theory as usual. Rao and his team carried out an experiment and found that they managed to increase sales of a consumer packed good by over 70% in a retail store, when they used the extra/free bonus pack format in comparison to offering a discount on the product. Rao attributes this to the fact that the human mind is not good at performing arithmetic with complex forms such as logarithms, fractions, probability and percentages.
So if you have ever wondered why everyone from biscuit companies to mobile phone operators wants to give out something extra, rather than offer a discount, you now know why.
The inability to handle basic maths leads to marketers exploiting it in other ways as well. One such way is to express discount in a way where it seems larger than it actually is. As Berger writes “Twenty percent off on that $25 shirt seems like a better deal than $5 off. For high-priced big-ticket-items, framing price reductions in dollar terms (rather than percentage terms) makes them seem like a better offer. The laptop seems like a better deal when it is $200 off rather than 10 percent off.”
Whether marketers express discount in absolute terms or in percentage terms depends on the rule of 100. If the price of a product is less than $100 (or Rs 100 or any other currency) the percentage discount will seem bigger. Vice versa is true, if the price of a product is higher than $100. “For a $30 shirt…even a $3 discount is still a relatively small number. But percentage wise (10 percent), that same discount looks much bigger…Take a $750 vacation package or the $2,000 laptop. While a 10 percent discount may seem like a relatively small number, it immediately seems much bigger when translated into dollars ($75 or $200),” writes Berger.
The interesting thing is that the rule of 100 doesn’t seem to have caught on in India as yet. This could be a killer application for discount websites, which still focus on expressing discounts in percentage terms. As I write this the Bangla version of Amish’s The Immortals of Melhua is selling for Rs 130, a 33% discount on a price of Rs 195, on one of the discount websites. Now wouldn’t Rs 65 off have sounded so much more better?
While marketers are quick to latch on to these tricks, in this case they seem to have missed out on something rather obvious. Rest assured this anomaly will be corrected in the days to come.
The article originally appeared in the Wealth Insight magazine dated July 1, 2013

(Vivek Kaul is a writer. He tweets @kaul_vivek)