Vivek Kaul
The under-recovery on diesel being sold by oil marketing companies(OMCs) for the fortnight starting September 16, 2013, has shot up to Rs 14.50 per litre. It has gone up by 42% in a period of one month. For the fortnight starting August 16, 2013, the under-recovery had stood at Rs 10.22 per litre.
So what are under-recoveries? The Rangarajan Committee report of 2006 stated that the OMCs are “are currently sourcing their products from the refineries on import parity basis which then becomes their cost price. The difference between the cost price and the realised price represents the under-recoveries of the OMCs.”
The price that OMCs charge dealers who sell diesel is referred to as the realised price or the depot price. If this realised price that is fixed by the government is lower than the import price, then there is an under-recovery. Having said that under-recoveries are different from losses and at best can be defined as notional losses. (For those interested in a detailed treatment of this point, can click here).
The OMCs need to be compensated for the under-recoveries. One part of the compensation comes in directly in the form of additional cash assistance from the government. Another part comes by the way of financial assistance from upstream national oil companies. Hence, companies like ONGC and Oil India Ltd, which produce oil, need to compensate the OMCs i.e. Indian Oil, Bharat Petroleum and Hindustan Petroleum, for a part of their under-recoveries.
The government has budgeted Rs 65,000 crore this financial year for petroleum subsidies. This is for the payment that it makes to the OMCs, for the under-recoveries they incur on the sale of diesel, cooking gas and kerosene. As per the data released by the Ministry of Petroleum and Natural Gas yesterday, the under-recoveries currently stand at Rs 486 crore per day.
The trouble is that a part of the budgeted subsidies have already been utilised for payment of under-recoveries for the last financial year. Also, most finance ministers over the years have under-budgeted for these payments.
Like in the financial year 2012-2013, the petroleum subsidies had been budgeted to be at Rs 43,580 crore. The actual subsidy bill finally came in at Rs 96879.87 crore. A similar trend was observed in the financial year 2011-2012 as well. The government had budgeted Rs 23,640 crore for petroleum subsidies. The final bill came to Rs 68,481 crore.
The Financial Express reports that “At current rate, the three oil PSUs are projected to lose Rs 156,000 crore in revenues in the financial year ending March 31, according to Indian Oil Corp (IOC), the nation’s largest oil firm.”
This number is similar to the total under-recoveries of Rs 1,61,029 crore last year. Of this the government had paid around Rs 1,00,000 crore to OMCs, the remaining cost was borne by the upstream national oil companies.
So what this means is that the government will have to incur a higher expenditure to compensate the OMCs for the under-recovery than the Rs 65,000 crore it has budgeted for. This would mean a higher fiscal deficit. Fiscal deficit is the difference between what a government earns and what is spends.
Data put out by the Controller General of Accounts shows that as on July 31, 2013, the fiscal deficit for the first four months of the financial year 2013-2014 was at Rs 3,40,609 crore. The fiscal deficit targeted for the financial year is Rs 5,42, 499 crore.
Hence, 62.8% of the targeted fiscal deficit has already been exhausted in the first four months of the year. If the government continues at this rate, by the end of the financial year it will overshoot its fiscal deficit target by a huge mark.
The finance minister P Chidambaram has said over and over again that the government will stick to the fiscal deficit target come what may. The numbers as of now tell a completely different story.
In the last financial year 2011-2012, the government had exhausted 51.5% of the targeted fiscal deficit during the first four months. To meet the fiscal deficit target, the expenditure was slashed majorly in the last few months of the year.
Given this, if the government has to meet its fiscal deficit target, the first thing that it should be doing is to raise diesel prices. Of course, it cannot raise the price of diesel by Rs 14.50 per litre at a single go. But a significant increase of at least Rs 5 per litre is due.
If it is not carried out, the chances of a sovereign downgrade of India by the rating agencies will become extremely high in the months to come. This is because the fiscal deficit of the government will bloat up. A sovereign downgrade will see India’s rating being reduced to ‘junk’ status. This would lead to many foreign investors like pension funds having to sell out of the Indian stock market as well as the bond market, given that they are not allowed to invest in countries which have a “junk” status and that will put further pressure on the rupee, which has recovered nicely over the last few days.
At the same time any increase in the price of diesel pushes up freight and transport costs. This will lead to a higher inflation, especially food inflation. Data released yesterday shows that food inflation currently stands at 18.8%. As Sonal Varma of Nomura pointed out in a note yesterday “The jump was mainly due to a steep rise in primary food price inflation, which rose to 18.2% year-on-year in August from 11.9% in July from higher inflation of vegetables, fruits and protein-rich food. Vegetable price inflation jumped 78% year-on-year in August from 47% in July, led by a steep increase in the prices of onions (245%).”
Multiple state elections are due over the next few months and any further rise in food prices is going to cost the Congress led UPA government dearly. Many an election in India has been lost on spiralling onion prices.
But if the government doesn’t increase diesel prices then there is a considerable threat of being downgraded by the rating agencies to junk status and that will put further pressure on the rupee. So that’s the catch 22 that the government finds itself in. Having said that, its a problem created by the Congress led UPA government by refusing to de-control the prices of oil products. Also, a higher inflation number will make it difficult for Raghuram Rajan, the new RBI governor, to announce any interest rate cuts in the months to come, as the government wants him to.
So what will the government bite the bullet on hiking diesel prices? Oil Secretary Vivek Rane had an answer for this. As he said yesterday”Some burden has to be borne by consuming population. That is the challenge government faces. It is a political challenge, it is an economic challenge. It is a challenge we cannot run away from.”
The article originally appeared on www.firstpost.com on September 17,2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Month: September 2013
Five years after Lehman Brothers went bust, the same mistakes are being made
Vivek Kaul
Graham Greene’s fascinating book The End of an Affair starts with these lines: “A story has no beginning or end: arbitrarily one chooses that moment of experience from which to look back or from which to look ahead.”
If the current financial crisis were a story (which it is) its beginning would be on September 15, 2008, when Lehman Brothers, the smallest of the big investment banks on Wall Street, went bust. It was the largest bankruptcy in the history of the world. Lehman Brothers started a crisis, from which the world is still trying to recover.
While the American government and the Federal Reserve(the American central bank) let Lehman Brothers go under, the got together to save AIG, one of the largest insurance companies in the world, a day later. This was followed by a spate of other rescues in the United States as well as Europe. These rescues cost the governments around the world a lot of money. As Mark Blyth writes in Austerity – The History of a Dangerous Idea “The cost of bailing, recapitalizing, and otherwise saving the global banking system has been depending on…how you count it, between 3 and 13 trillion dollars. Most of that has ended up on the balance sheets of governments as they absorb the costs of the bust.”
It’s been five years since Lehman Brothers went bust. Hence, enough time has elapsed since the financial criss started, to analyse, if any lessons have been learnt. One of the major reasons for the financial crisis was the fact that governments across the Western world ran easy money policies, starting from the turn of the century. Loans were available at low interest rates.
People went on a borrowing binge to build and buy homes and this led to huge real estate bubbles in different parts of the world. Take the case of Spain. Spain ended up building many more homes than it could sell. Estimates suggest that even though Spain forms only 12 percent of the GDP of the European Union (EU) it built nearly 30 percent of all the homes in the EU since 2000. The country has as many unsold homes as the United States of America which is many times bigger than Spain.
Along similar lines, by the time the Irish finished with buying and selling houses to each other, the home ownership in the country had gone up to 87%, which was the highest anywhere in the world. A similar thing happened in the United States, though not on a similar scale.
Housing prices in America had already started to fall before Lehman Brothers went bust. After that the fall accelerated. As per the Case-Shiller Composite-20 City Home Price Index, housing prices in America had risen by 76% between mid of 2001 and mid of 2006. The first time the real estate prices came down was in January 2007, when the Case-Shiller Composite-20 City Home Price Index suggested that housing prices had fallen by a minuscule 0.05% between January 2006 and January 2007. This fall came nearly two and half years after the Federal Reserve started raising interest rates to control the rise in price of real estate.
The fall gradually accentuated and by the end of December 2007, housing prices had fallen by 9.1% over a one year period. The fall continued. And by December 2008, a couple of months after Lehman went bust, housing prices, had fallen by 25.5%, over a period of three years. The real estate bubble had burst and the massacre had started. Similar stories were repeated in other parts of the Western world. Soon, western economies entered into a recession.
Governments around the world started tackling this by throwing money at the problem. The hope was that by printing money and putting it into the financial system, the interest rates would continue to remain low. At lower interest rates people would borrow and spend more, and this in turn would lead to economic growth coming back.
Hence, the idea was to cure a problem, which primarily happened on account of excess borrowing, by encouraging more borrowing. The question is where did this thinking come from? In order to understand this we need to go back a little in history.
As Nobel Prize winning economist Robert Lucas said in a speech he gave in January 2003, as the president of the American Economic Association: “Macroeconomics was born as a distinct field in the 1940s, as a part of the intellectual response to the Great Depression. The term then referred to the body of knowledge and expertise that we hoped would prevent the recurrence of economic disaster.”
Given this, the economic thinking on the Great Depression has had a great impact on American economists as well as central bankers. This is also true about economists across Europe to some extent.
In 1963, Milton Friedman along with Anna J. Schwartz, wrote A Monetary History of United States, 1867-1960, which also had a revisionist history of the Great Depression. What Friedman and Schwartz basically argued was that the Federal Reserve System ensured that what was just a stock market crash in October 1929, became the Great Depression.
Between 1929 and 1933, more than 7,500 banks with deposits amounting to nearly $5.7 billion went bankrupt. This according to Friedman and Schwartz led to the total amount of currency in circulation and demand deposits at banks, plunging by a one third.
With banks going bankrupt, the depositors money was either stuck or totally gone. Under this situation, they cut down on their expenditure further, to try and build their savings again. This converted what was basically a stock market crash, into the Great Depression.
If the Federal Reserve had pumped more money into the banking system at that point of time, enough confidence would have been created among the depositors who had lost their money and the Great Depression could have been avoided.
This thinking on the Great Depression came to dominate the American economic establishment over the years. Friedman believed that the Great Depression had happened because the American government and the Federal Reserve system of the day had let the banks fail and that had led to a massive contraction in money supply, which in turn had led to an environment of falling prices and finally, the Great Depression.
Hence, it was no surprise that when the Dow Jones Industrial Average, America’s premier stock market index, had a freak crash in October 1987, and fell by 22.6% in a single day, Alan Greenspan, who had just taken over as the Chairman of the Federal Reserve of United States, flooded the financial system with money.
After this, he kept flooding the system with money by cutting interest rates, at the slightest hint of trouble. This led to a situation where investors started to believe that come what may, Greenspan and the Federal Reserve would come to the rescue. This increased their appetite for risk, finally led to the dotcom and the real estate bubbles in the United States.
In fact, such has been Friedman’s influence on the prevailing economic thinking that Ben Bernanke, who would take over as the Chairman of the Federal Reserve, after Greenspan, said the following at a conference to mark the ninetieth birthday celebrations of Friedman in 2002. “I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”
At that point of time, Bernanke was a member of the board of governors of the Federal Reserve System and hence, the use of the word “we”. What Bernanke was effectively saying was that in the days and years to come, at the slightest sign of trouble, the Federal Reserve of United States would flood the financial system with money.
And that is precisely what Bernanke and the American government did once the financial crisis broke out in September 2008. The Bank of England, the British central bank, followed. And so did the European Central Bank in the time to come. Recently, the Bank of Japan decided to join them as well.
Central banks around the world have been on a money printing spree since the start of the financial crisis in late 2008. Between then and early February 2013, the Federal Reserve of United States has expanded its balance sheet by 220%. The Bank of England has done even better at 350%. The European Central Bank came to the money printing party a little late in the day and has expanded its balance sheet by around 98%. The Bank of Japan has been rather subdued in its money printing efforts and has expanded its balance sheet only by 30% over the four year period. But during the course of 2013, the Bank of Japan has made it clear that it will print as much money as will be required to get the Japanese economy up and running again.
The trouble is that people in the Western world are not interested in borrowing money again. Hence, the little economic recovery that has happened has been very slow. The Japanese economist Richard Koo calls the current state of affairs in the United States as well as Europe as a balance sheet recession. The situation is very similar to as it was in Japan in 1990 when the stock market bubble as well as the real estate bubble burst.
Hence, Koo concludes that the Western economies including the United States may well be headed towards a Japan like lost decade. In a balance sheet recession a large portion of the private sector, which includes both individuals and businesses, minimise their debt. When a bubble that has been financed by raising more and more debt collapses, the asset prices collapse but the liabilities do not change.
In the American and the European context what this means is that people had taken on huge loans to buy homes in the hope that prices would continue to go up for perpetuity. But that was not to be. Once the bubble burst, the housing prices crashed. This meant that the asset (i.e. homes) that people had bought by taking on loans lost value, but the value of the loans continued to remain the same.
Hence, people needed to repair their individual balance sheets by increasing savings and paying down debt. This act of deleveraging or reducing debt has brought down aggregate demand and throws the economy in a balance sheet recession.
While the citizens may not be borrowing, this hasn’t stopped the financial institutions and the speculators from borrowing at close to zero percent interest rates and investing that money in various parts of the world. And that, in turn, has led to other asset bubbles all over the world.
These bubbles have benefited the rich. As The Economist points out “THE recovery belongs to the rich. It seemed ominous in 2007 when the share of national income flowing to America’s top 1% of earners reached 18.3%: the highest since just before the crash of 1929. But whereas the Depression kicked off a long era of even income growth the rich have done much better this time round. New data assembled by Emmanuel Saez, of the University of California, Berkeley, and Thomas Piketty, of the Paris School of Economics, reveal that the top 1% enjoyed real income growth of 31% between 2009 and 2012, compared with growth of less than 1% for the bottom 99%. Income actually shrank for the bottom 90% of earner.”
Once these bubbles start to burst, the world will go through another round of pain. Satyajit Das explains the situation beautifully in a recent column for the Financial Times, where he quotes the Irish author Samuel Beckett “Ever tried. Ever failed. No matter. Try Again. Fail again. Fail better.”
To conclude, there are many lessons that history offers us. But its up to us whether we learn from it or not. As the German philosopher Georg Engel once said “What experience and history teach is this – that nations and governments have never learned anything from history, or acted on principles deduced from it”. And why should this time be any different?
The article originally appeared on www.firstpost.com on September 16, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Explainer: Why gold imports will go up over the next few months
Vivek Kaul
The trade deficit or the difference between imports and exports, in August 2013 was at $10.9 billion. This was a significant improvement over August 2012, when it was at $14.17 billion. The deficit was $12.27 billion in July, 2013.
This fall in trade deficit, as I pointed out a couple of days back, was largely on account of lower gold imports. The gold imports stood at 2.5 tonnes, almost down to zero. These imports cost around $650 million. Now compare this to 47.5 tonnes imported in July, 31.5 tonnes in June, 162 tonnes in May and 142.5 tonnes in April of this year.
In April 2013, the 142.5 tonne of imported gold had cost $7.5 billion, and the trade deficit was at $17.8 billion. In May 2013, the 162 tonnes of imported gold had cost $8.4 billion, and the trade deficit was at $20.1 billion.
Hence, its safe to say that the major reason for the fall in trade deficit has been a fall in gold imports. As the Indian Express reported a few days back “Gold imports stopped after July 22 due to confusion over a rule issued by the Reserve Bank of India, which required importers to re-export at least 20% of all the purchases from overseas.”
Dan Smith and Anubhuti Sahay of Standard Chartered offer a similar reason in their September 12, 2013, report titled “Gold – India’s government gets tough.”As they write “Recent weeks and months have seen aggressive government action to dampen gold demand, owing to its heavy impact on the current account deficit…the…initial lack of clarity on these measures resulted in a dramatic slump in imports in August.”
This confusion has now been sorted out, and gold imports are going to surge in the months to come. “Local traders and sources estimate that we might see an upswing in bullion imports to 35 tonnes in September. This is still modest compared with the official average import level of 59 tonnes/month last year. October is also likely to see relatively firm imports,” write Smith and Sahay.
The Indian demand for gold is seasonal and tends to pick up around the festival time and wedding season. The festival season has started and the wedding season will soon start. As Smith and Sahay point out “Over the past five years, August, September and October have been the strongest months for India‟s gold imports, accounting for 30% of the annual total as the country restocks ahead of a pick-up in demand. Key reasons for buying gold include the marriage season, which normally starts after the monsoon season in mid-September, and Diwali, which is on 3 November this year.”
What will also drive the demand for gold is a good monsoon which is likely to lead to a higher agricultural growth. As the Economic Outlook 2013-14 released today, by the Economic Advisory Council to the Prime Minister, points out “Agriculture projected to grow at 4.8% in 2013-14 as against 1.9% in 2012-13. The early and good monsoon had a huge positive impact on sowing activity.”
This is likely to lead to a higher demand for gold during the current month and the following few months. “This year the monsoon season was good and farmers planted 7% more crops, according to the Agriculture Ministry. This should feed through into higher incomes and gold demand in the weeks ahead,” write Smith and Sahay.
In a country as underbanked as India is, any increase in income ends up being invested in gold, especially in rural areas. As the Economic Survey released before the budget pointed out “Gold has been a combination of investment tool and status symbol in India. With limited access to financial instruments, especially in the rural areas, gold and silver are popular savings instruments.”
It also needs to be mentioned here that even though “official” gold imports have fallen close to zero, gold continues to come into the country through other routes. This is not surprising given that the import duty on gold bullion currently stands at 10%. Hence, for anyone who manages to get gold into the country without paying the duty on it, there is a huge arbitrage opportunity.
Smith and Sahay provide several examples of gold coming into the country through unofficial routes. As they write “There is much anecdotal evidence suggesting that increased amounts of gold are entering India through unofficial channels, which makes the official figures an understatement. Pakistan temporarily suspended a duty-free gold import arrangement in August, when gold imports doubled. According to media reports, much of this was crossing the border into India. Dubai has seen a steady pick-up in the number of passengers being arrested at airports for smuggling.”
Gold is also coming in from Nepal. “Nepal has seen an eight-fold rise in smuggling – 69kg of smuggled gold was seized by customs in the first half of this year, versus 18kg for the whole of 2012.”
Higher gold imports will obviously cancel out the recovery on the export front. Exports for August 2013, went up by nearly 13% to $26.4 billion, in comparison to August 2012. In July, exports were at $25.83 billion. Even if gold imports come in at $2-3 billion on an average, they will cancel out the bounce in exports. Given this, the trade deficit is likely to go up in the months to come.
The article originally appeared on www.firstpost.com on September 14, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
"Voters are wondering aloud how their “breakout nation” became a “breakdown nation"
Ruchir Sharma is the head of emerging market equities and global macro at Morgan Stanley Investment Management. He generally spends one week per month in a developing country somewhere in the world. In 2012, his book Breakout Nations – In Pursuit of the Next Economic Miraclebecame a best-seller. The paperback version of the book was recently published.
The book among other things pointed out that the most important factor behind decade long economic boom in the emerging markets, a worldwide flood of easy money, had been largely overlooked. That era of easy money is now coming to an end, believes Sharma. “My entire case which I have even made in the book was the fact that the entire boom of the last decade, where the growth accelerated from 5-6% to 8-9% was totally global in nature, and that had nothing to do with India specific factors. And that boom is now unwinding. Now can we undershoot 5-6% for a year or two? Yeah we can,” said Sharma. In this free-wheeling interview he speaks to Vivek Kaul.
Recently you wrote an article in the Foreign Policy magazine titled “The Rise of the Rest of India”, in which you talk about Indian states that have done well over the past few years. What are the factors that make for a breakout state among the Indian states?
A very simple definition is that the state has been able to consistently grow above the national average over a five to ten year period. Often you can associate that growth to some change in policy or leadership which has taken place. It is the same as the concept that I have used in my book Breakout Nations.
What is the concept of Breakout Nations?
It is about which are the countries that are likely to grow faster than the emerging market average and compared to other countries in the same income group, over a five year period. The same concept I have applied to the states in India. The question I have tried to answer is which are the states which have grown above the national average for a five to ten year period. Often this growth is associated with some leader who has to come power.
Which are the states right now you feel are the potential breakout states or have already broken out?
The states where the most impressive results have been seen are Gujarat, Bihar, Madhya Pradesh Odisha, Chhattisgarh, Delhi etc. These are the places where typically you have seen growth. The ones where the most impressive delta or change has taken place, have basically been Bihar, Odisha, Madhya Pradesh, Chhattisgarh etc. That area has done well.
What about Gujarat?
Gujarat has done well. But Gujarat was already doing well in the previous decade. Its impressive that it has done better from a higher base. Similarly for Maharashtra, growth rates have been okay, but in the last couple of years they have begun to fall. And Maharasthra is so dependent on the legacy industrial base or the whole golden triangle of Mumbai, Pune and Nashik, that I don’t know how to call it a breakout state necessarily.
Does the Indian constitution need to be re-jigged to give Indian state more economic power?
I’d say that maybe later but to me that is not the big thing. India has three lists, central, state and the concurrent list. And the big thing in India which has happened is that a lot of the issues which were in the state list and the concurrent list have been usurped by the the centre over time. And this has got to do with environment, mining, labour and even things like food. The whole culture needs to be a collaborative culture rather than the centre deciding or one leader deciding that okay these are the five things that India is going to do. We have had centralised leadership in the past. We have had the Indira Gandhi days. Now you can argue that is that what you want? Economic growth wasn’t great during that period. You can argue that it sowed the seeds of secessionist movements rather than bringing the country together. So I am not sure this heavy handed centralised leadership is what works for a country like India, where the polity is so diverse.
How can this be tackled?
The first thing you can start doing is by giving the power back to the states. India’s constitution envisaged a federal structure. It is just that over time particularly the 1970s and the 1980s, a lot of the state powers were usurped by the centre in the name of centralisation and in the name of the the secessionists taking over. Using that kind of cover, a lot of power was usurped. The whole point is that when you have national schemes, you have to give much more flexibility to the states. For example, the planning commission is now talking about 10% discretion to the states. That can be increased to 30% or 50%, rather than the criteria and the mandates being set by the centre.
In a recent column for the Financial Times you wrote “The irony is profound…Voters are wondering aloud how their “breakout nation” became a “breakdown nation”, seemingly overnight.”
That’s right.
Can states be breakout states when the country is in a breakdown mode?
Of course not. The national average is ultimately summation of the states. The only reason for optimism that I still find is that at the state level things are a bit better. State level leaders understand how to succeed in various parts of India rather than having a one size fits all national policy. Having said that, there are issues at the state level as well. Many states have their own crony capitalists. At times they are autocratic and anti democratic. But my entire point is that there is a ray of optimism.
Five years ago we were drawing straight lines stating that India’s GDP growth has been 8-9% and if it continues for 10 years where will we be. If it continues for 20 years where will we be and so on. Today it is hard to be optimistic on the country because there is so much negativity which is going around. To me the breakdown is a perception thing more than a reality.
Are there things that can be done to set it right?
One flaw to me is this culture of lack of accountability. If you look at India today the lack of accountability starts of from this whole separation of party and government. This has really been one of the fault lines of India which is that to run a country with a division between party and government is really very difficult. It fosters a culture of lack of accountability.
Could you elaborate on that?
There is this perception that has been for years now that there are something things which when you ask the people in the party, that why they are not being done, they say its the government’s responsibility to do this. And you ask the government and they tell you we don’t have the political power to do it. That lack of accountability then just flows down, with everyone being busy protecting their own turf and not taking any collective responsibility for anything. So that fault line to me for one needs to end, which is that you can’t have the separation of the party and the government. Also the fact is that if you look at the world what you see is that technocrats have not been very good as heads of states.
What do you mean by that?
They have been very good as support staff. But as heads of states if you look at Latin America and Asia, in the past, there are more examples of mass based leaders being successful. This is because reforms are political in nature. You can’t have them being administered by technocrats. Technocrats neither have the political understanding nor the political capital to implement reforms. Reforms need to be sold to people. Hence they are political decisions. Given this, you need a mass based leader at the top.
So that brings me to the logical question. Is that leader Narendra Modi?
See I am not sure of that. I don’t want to get into this thing about who it should be or who it shouldn’t be. My entire point is the fact that you have mass based leaders at the state level. The states are not run by technocrats. The breakout states that I speak about are run by politically smart people, who understand what needs to be done for development, and who get that connection of what is good economics and what is good politics. They see the bridge between the two. To me its about mass based leaders. Whether India can have this at the national level, I am a bit more sort of doubtful about.
But do successful state level leaders transform into national leaders?
It has never happened. Never. That’s the staggering point. Many leaders have tried to go out. The list is a long one. From Sharad Pawar to Mulayam Singh Yadav and even someone like a Mayawati, they have all tried to build a national footprint but they have never been able to succeed. Often having strong regional roots is a liability at the centre because then they begin to associate you only with one particular state. Even in the Congress I find it fascinating that there is so much talk as to who could be the next candidate for Prime Minister. I would think that logically it should be a chief minister rather than any of the national leaders.
But no one comes to my mind when I think of the Congress chief ministers…
Exactly. Logically we should argue that by any chance if Sheila Dikshit wins the next election then she should be the automatic choice for being the next PM candidate assuming that Rahul doesn’t want the top job. Someone like her should be the top person for that job. You need someone with a mass base, who understands politics.
What has suddenly gone wrong with the rupee. Between January and May it yo yoyed between 53.5 to around 55.5 to a dollar. But after that it has fallen dramatically...
A lot of it has to do with this fault line across emerging markets which is the fact that all countries with a high current account deficit have really taken a big hit as far as their currencies are concerned. The whole game began to change, as is well documented by now, after the Federal Reserve decided that it wants to think about tapering off its quantitative easing. After that the the US interest rates have risen a lot. The 10 year interest rate has gone up by 100 basis points since May. This has obviously led to people evaluating how much money they want to put up internationally.
But is the rupee falling just because of the Federal Reserve thinking about going slow on money printing?
The fact is that we have our own domestic problems which are compounding the whole thing. There is a sense that no one’s in charge and that we have an election coming up. There is a sense that it will be very hard for the government to make tough decisions to remedy this situation. Also, some of the problems have not been fully appreciated or recognised. One thing that we are just about coming to realise is that corporate India has too much leverage. It is very concentrated leverage amongst a few companies.
Do you see the rupee falling more?
We are in the midst of a panic and magazine articles have their own time cycles. In panics I just can’t say where these things will stop.
Can we say that the rupee is falling because the rupee is falling?
It’s a global panic now. The train has left the station and you can’t now catch it. And where it stops I don’t know. That is the sense I get. This is not say that this is not our problem. If we did not have a large current account deficit we wouldn’t have this problem today. But the fact that we have a large current account deficit and are being punished globally for it, is just a reality.
Should the RBI try and stop the rupee’s fall or let it find its own level?
I don’t think that we have a local solution anymore. All that the RBI can do is to moderate the fall. But we have seen with other currency attacks that when currencies are under panic foreign exchange intervention can be very ineffective. The classic case was the British pound in 1992. What India can do is to figure out how to correct these things over a period of time, which is what we should think about. RBI or whoever it was in charge in Delhi was doing much worse before. They were following this bureaucratic impulse that you come up with this one decision all the time to show that you are doing something.
Is India anywhere close to Thai crisis of 1998, where the country more or less ran out of foreign exchange?
I don’t think that it is as extreme as that. What happened in Thailand was a very extreme situation. Their short term debts and current account deficit were larger than what we have. Having said that one thing that I have known about crises is that you only know about these things post facto which is that after every crisis you come up with new factors to add to the list of the things that you should watch out for. I think that is the whole point. If you look at the past crises this does not seem as dire as what we saw in East Asia in 1997-98 or in India in 1991. But my only caveat here is that you always come up with the real reasons post the crisis.
Economic theory has it that as the currency depreciates exports go up and imports fall. But in the last two years as the rupee has fallen, our trade deficit(the difference between imports and exports) has gone up dramatically. How do you explain that?
The recent fall of the rupee has been very sharp but before this the rupee was adjusting for the high inflation we have had for such a long period of time. Exports are dependent on multiple factors, exchange rate being only one of them. Global demand which is another major factor influencing exports, has been weak. If just changing the nominal exchange rate was the game, then it would be such an easy recipe for every country to follow. You could just devalue your way to prosperity. But in the real world you need other supporting factors to come through. You need a manufacturing sector which can respond to a cheap currency. Our manufacturing sector, as has been well documented, has been throttled by all sorts of local problems which exist.
What are the other impacts of a falling rupee?
One of the factors that has been under-appreciated in this drive to see the currency go lower is that there is a negative effect also on the huge foreign exchange loans taken by the corporates. So even though there is not much that can be done to stop the rupee’s fall you can’t at the same time wish that you can just devalue your way to prosperity because there is a negative feedback loop which takes place.
And a lot of exports are import dependent…
Yes. There is a negative feedback loop because the corporate sector is heavily indebted in foreign currency. So that is the problem.
So there is a corporate debt crisis brewing up. You have pointed out in the past one in four Indian companies does not have enough cash flow to repay its debt. How do you see that playing out?
Those companies are just going to be shunned for a long period of time. People are now just investing in the 15-20 big companies and keeping away from the rest. India has lost a major competitive advantage. India’s advantage that used to be quoted to foreign equity investors, particularly portfolio equity investors, was how we have a huge number of companies to invest in. That has shrunk incredibly now. Some of these companies are not going to be able to survive, that’s the harsh reality.
Oil prices are at an all time high in rupee terms. What sort of impact will that have on the fiscal deficit. The finance minister said today(on August 27, 2013, the day the interview was taken) that come what may the government will meet the fiscal deficit target of 4.8% of GDP. Can we buy that?
We achieved the target last year. But you have to understand how that was done. The government will have to really freeze spending, and that in turn will compress consumer demand. The issue is whether they have the political appetite to do that. Or the government will have to raise diesel prices. Currently, they are Rs 9-10 behind on the under-recoveries. They need to raise diesel prices by such a massive amount to stick to the fiscal deficit target. So can the government meet its fiscal deficit target? Of course they can. But the price unfortunately in this case will be economic growth.
If they don’t increase diesel prices they have a problem. If they do increase diesel prices they have a problem.
Exactly. That’s the negative feedback loop I talked about. The days when you could just move the exchange rate from x to y and hope that exports will pick up, is a very simplistic solution. It does not take into account the negative feedback loops that can arise in terms of corporate debt denominated in foreign currencies and also the fact that the oil import bill gets considerably worse.
There is a small cottage industry that has sprung up in trying to explain why the current fall of the rupee is due to international factors. How much of the rupee’s fall is due to international factors and how much of it is due to local factors?
Probably we can divide it 50:50. As I said, the fact of the matter is that if we were not running a current account deficit today, we would not be having this panic. Sure there would be some sell off because all emerging markets are under pressure. Growth forecasts across emerging markets have been downgraded regardless of their current account deficit. Nevertheless, it is ironical that the Chinese currency is up for the year. The currencies of some of the countries like Mexico and Philippines have fallen very slightly because they don’t have current account deficits. It is a very current account deficit centric problem that we are currently seeing now.
But the current account deficit did not appear overnight.
This is the irony, that the crisis has been badly managed. These fault lines have existed for a while. The current account deficit has been going up continuously over the last two to three years above levels which most economists consider to be sustainable. And we ignored that. In our desire to keep growth artificially high in 2009 and 2010, we engaged in a lot of stimulus government spending. We let our fiscal deficit blow out. We violated the FRBM (Fiscal Responsibility and Budget Management Act) and have never ever gone back to that. The Prime Minister has ignored so many fault lines.
Could you elaborate on that?
He dismissed crony capitalism as being something which possibly is the right of passage that any country going through an early stage of development will have to go through. Every such country will have its own robber barons. So what is the big deal that India does? He dismissed the rise in inflation by saying that rise in food prices are a sign of prosperity. He kept on going on about how savings and investment ratios are so high that growth is unlikely to ever dip below 8-9%. And on each one of them any sort of serious economic analysis would suggest that these arguments were flawed.
And this had a huge impact?
We know that if you have crony capitalism it can lead to a backlash against wealth creation. Look at issues like the ban on iron ore exports, the mining of coal etc. Some of this is because we have had crony capitalism and that has led to a backlash against wealth creation and that has led to these bans to start with.
What about the inflation argument offered by Manmohan Singh?
The whole business about inflation rising because of a rise in prosperity is a real myth. Why has China not seen this massive inflation problem despite 30 years of great growth? Why did Korea and Taiwan did not see any sustained inflation pressure? Or even Japan during there very high growth phrases? Why? This is a total myth. India’s inflation rankings have deteriorated considerably. Our inflation used to be always below the emerging market average for the last 20-30 years. It’s only in the last three to four years that we have been way high than the emerging market average, not just bit higher, but way higher. Also, other countries with high savings and high investment have also seen a growth fall off. The Soviet Union’s investment to GDP ratio was 35% before the collapse. It was all bad investment. This is what happens when there is too much academic focus on things.
In a recent column in the the Financial Times you wrote “A not so funny thing happened while the world was watching for an emerging market crisis to erupt in China. The crisis erupted in India instead.” Could you elaborate on that?
For the first half of the year a lot of focus was on China. China has had a massive credit binge over the last five years. And in recent times we have seen in the US, Spain etc, typically countries which have had a massive credit binge are vulnerable because when you increase your debt over a short span of time of three to five years you accumulate a lot of bad assets. And that leads to trouble for the entire banking system. So people have been very worried about the high debt to GDP ratio in China. Even I have been concerned about it and written about it. There were people sending out alerts on a China crisis. I think very few people were sending out alerts about a India crisis.
Nobody did.
Exactly. That’s the irony to me. Everyone was looking for a crisis in China and it ends up erupting in India, first.
The Indian economic growth has fallen to around 5%. Do you see us going back to the good old Hindu rate of growth of 3.5%?
No that’s not been my case. Hopefully things have changed there. There is a lot of natural buoyancy. What I do find more impressive compared to 30-40 years ago is the quality of state chief ministers. They have improved a lot in comparison to the 1970s and the 1980s. In fact even the 1990s. The moment we think of the third front we all get a bit scared because we think of the motley crew which ran the government in the mid 1990s. If you look at the state chief ministers today, they are generally better. My entire case which I have even made in the book was the fact that the entire boom of the last decade, where the growth accelerated from 5-6% to 8-9% was totally global in nature, and that had nothing to do with India specific factors. And that boom is now unwinding. Now can we undershoot 5-6% for a year or two? Yeah we can. We overshot for a while, we can undershoot for a while. That is still my base case scenario. I am not willing to give up on India and say that India is going to go down the route of 3% growth which existed till 1980. Also it is important to remember that the aspiration levels of the people here are too high now to tolerate that kind of an outcome. They will force something to happen to change that outcome.
Any view on the food security bill which was recently passed by the Lok Sabha?
I have no strong view on that. My concern is about the fact that you can’t keep writing cheques that which the country can’t cash. We need to understand that we can only spend that much. And if we have to spend extra then we have to show stuff that we can cut elsewhere. The big damage of the food security bill is not the bill itself but the fact that why was this not used at the very minimum by the Prime Minister as an excuse to say okay, if you want to pass this, you have to raise diesel prices by an ‘x’ amount, so that we offset some of the cost.
The interview originally appeared in the Forbes India magazine edition dated September 20, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
‘By introducing cheaper iPhones, Apple will lose its high end position’
Al Ries is a marketing consultant who coined the term “positioning” and is the author of such marketing classics (with Jack Trout) as The 22 Immutable Laws of Marketing and Positioning: The Battle for Your Mind. He is also the co-founder and chairman of the Atlanta-based consulting firm Ries & Ries with his partner and daughter, Laura Ries. Along with Laura he has written bestsellers like War in the Boardroom and The Origin of Branding. In this interview he speaks to Vivek Kaul on why by introducing a cheaper iPhone, Apple will lose its position at the high end. And conversely, it won’t sell very many inexpensive phones because of competition from Chinese and Taiwanese companies.
Apple has come with a low cost iPhone 5C to appeal to the price conscious consumer. Is it a strategy that is going to work?
Yes and no. The strategy will generate additional sales of the iPhone 5C, but in the long term it will damage the iPhone brand.
You have been of the view that extensions tend to cheapen the brand. Will something like that play out in this case?
Yes, it will definitely cheapen the brand.
Why do you say that?
Here’s what normally happens when a new category develops. Apple pioneered a new category called “touchscreen smartphones” with its iPhone brand. Initially, the new product was a big improvement over existing keyboard smartphones like the BlackBerry. This made the iPhone one of the most successful new products ever launched. At one point, it made Apple the world’s most-valuable company. Then competitors entered the market, especially Samsung. Over time, the two brands (Samsung and iPhone) became quite similar, but consumers preferred the iPhone.
Why?
Because the iPhone is a better brand. Not a better product. The next development, a development that happens to every new category, is that the category divides into two categories. One at the high end and one at the low end. Any brand that tries to both ends of the market is bound to suffer.
Can you give us any examples?
Cadillac once was the largest-selling luxury vehicle in the American market. Then it tried to broaden its market by introducing lower-priced vehicles. Today, Cadillac is not considered in the same category as Lexus, Mercedes-Benz and BMW. These three brands each outsell Cadillac by a wide margin. It won’t happen overnight. But long-term, we believe the same thing will happen to the iPhone. By introducing cheaper iPhones, it will lose its position at the high end. And conversely, it won’t sell very many inexpensive phones because of competition from Chinese and Taiwanese companies.
By launching a cheaper version of the iPhone, Apple seems to have started following Samsung’s strategy of having smart phones at various price points. If it’s a strategy that works for Samsung why can’t it work for Apple? After all Samsung has 31% of the smartphone market and Apple has only 14%.
The smartphone market is only six years old. It’s early on in the development of the category. IBM was the first company to introduce a 16-bit, serious personal computer. For several years, IBM had 50 percent or so of the personal-computer market. But because of line extension, IBM’s market share gradually declined until it was less than 10 percent of the market. And so, IBM threw in the towel and sold its money-losing business to Lenovo. Will the same thing happen to Samsung? Perhaps. But it all depends on how smart the competition becomes. If competitors develop narrowly focused brands at the high end and narrowly-focused brands at the low end, Samsung will be the ultimate loser.
Some analysts are of the view that a cheaper iPhone would cannibalize sales of the expensive models. Would that be the case? And even if that is the case isn’t it better that Apple cannibalizes its own sales rather than let someone else do it?
Certainly some cannibalization will take place. But Apple could have used a better strategy than line extension. It could have introduced a cheaper iPhone with a different brand name. Take Toyota, for example. Rather than introduce an expensive Toyota, the company introduced the Lexus. At one point, Lexus was the largest-selling luxury vehicle in America. Currently it’s the No.3 brand. When a category diverges, it is much better to cover the diverging category with separate brands rather than by line extending the company’s existing brand.
When I interviewed your daughter Laura a few months back she told me very clearly that “long-term, we see Apple as the leader in the high-end smartphone category and Samsung the leader in the “basic” smartphone category. Apple would make a mistake in introducing less-expensive smartphones. That would undermine its position at the high end.” Do you see that playing out now? Or would that be too far fetched a statement to make?
That was an astute statement, but apparently Apple management didn’t take Laura’s advice to keep the brand focused at the high end. A brand needs to stand for something to become successful in today’s competitive environment. What’s an iPhone? Is it a high-end phone or a low-end phone? A brand can be successful at either end of the market but not at both ends.
A growing view seems to suggest that Apple has lost its ability to innovate after the death of Steve Jobs. Would you agree with something like that?
Yes. No brand can appeal to everyone. Steve Jobs famously said there are some customers he doesn’t want. (He was commenting on why Apple wouldn’t introduce a netbook, or inexpensive laptop computer.)
Can you give us other examples where extensions have cheapened the brand?
Motorola introduced a $1,400 cellphone called “StarTAC” that rapidly became a very popular high-end cellphone brand. Then the company introduced cheaper versions of the StarTAC phone which undermined its high-end position. (We worked with Motorola at the time and pleaded with them not to introduce the less-expensive StarTAC phones.) Today, Motorola is just another cellphone brand without much of a position. Mercedes-Benz used to be known as the world’s leading high-end automobile brand. But the company keeps introducing low-end models that undermine its high-end perception. Today, BMW outsells Mercedes-Benz on the global market.
On a slightly different what do you think of Microsoft taking over the telecom business of Nokia. Nokia has lost out on the smart phone market. Will Microsoft’s taking over help them in capturing a greater market share in the smart phone market?
Microsoft would have to create a new smartphone category to kickstart the Nokia brand. (Much like Apple did with the touchscreen smartphone.) But that’s incredibly difficult to do in a category that has had so money spent on research & development. Microsoft is unlikely to profit from its Nokia investment. But there’s a larger point to be made. Every company needs a focus for the same reasons that every brand needs a focus.
How do you explain that in the context of Microsoft?
Microsoft is a “software” company. It should not be trying to get into the hardware business. That unfocuses the company and makes it very difficult to manage. Look at Apple, a company focused on selling hardware only. Sure, the company needs software developers to create its hardware products, but that’s a different matter. Look at Apple’s competitors in the American market. Both Dell and Hewlett-Packard are hardware companies trying to get into software and services. And not very successfully. Last year, Dell’s profit margin was 4.2 percent versus Apple’s 26.7 percent. And last year, Hewlett-Packard lost $12.7 billion.
The interview originally appeared on www.firstpost.com on September 12, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)