Vivek Kaul
What do you do when you cannot solve a problem? You try and postpone it.
The finance minister P Chidambaram is trying to use the principle of postponement to ensure that the government meets the fiscal deficit target of Rs 5,42,499 crore or 4.8% of the gross domestic product, set in the annual budget. Fiscal deficit is the difference between what a government earns and what it spends.
The Controller General of Accounts puts out fiscal deficit data every month. During the first five months of the year, the fiscal deficit of the government was at 74.6% of the annual target. Interestingly, the fiscal deficit of the government for the first six months of the year came in at 76% of the annual target.
Now what does it mean? The simple explanation here is that the government has started to control its expenditure, and that in turn has helped it control the burgeoning fiscal deficit and ensure that it rose at a very slow rate, month on month, between August and September.
That is the straightforward explanation of the fiscal deficit moving from 74.6% of the annual target at the end of five months to 76% of the annual target at the end of six months. The fiscal deficit of the government at the end of five months was Rs 4,04,651 crore. This rose marginally to Rs 4,12,088 crore at the end of six months.
So how is the government controlling expenditure? By simply not recognising it.
As The Financial Express points out in an article published on November 11, 2013 “At least Rs 43,000 crore in food subsidy costs may be carried forward to the coming years’ budgets, as the Centre is determined to keep this year’s accounts within budgeted limits.”
Food subsidies form a major part of the government expenditure. In fact, the amount of Rs 41,560 crore released by the finance ministry during the first six months of the financial year (i.e. between April 1, 2013 and September 30, 2013) has largely been used to pay the arrears that have accumulated from last year, reports The Financial Express.
The government declares a minimum support price(MSP) for rice and wheat. At this price, the Food Corporation of India and other state agencies buy grain from the farmers. This grain is then supplied at a subsidised price significantly lower than the MSP, through ration shops. “So while the MSPs of paddy and wheat are fixed at Rs 1,310 per quintal and Rs 1,350 per quintal, respectively, this season, people below the poverty line are sold rice (after milling the paddy) at Rs 565 and the winter grain at Rs 415 per quintal,” The Financial Express article referred to earlier points out. Hence, the rice and wheat are sold at a loss.
Other than this loss, FCI also needs to bear the cost of procurement, storage and transportation of grains. The government needs to refund the FCI for these costs. And these costs together constitute the food subsidy.
Along similar lines Reuters in an article published on November 11, 2013, suggests that nearly Rs 30,000-40,000 crore of oil subsidies could be moved to next year. As the article pointed out “Preliminary calculations show that the finance ministry could defer subsidy payments to oil firms of Rs 30,000-40000 crore ($6.39 billion) until the next fiscal year, a senior finance ministry source with knowledge of the numbers said. There was a similar roll-over into this year’s budget from 2012/13.”
Oil subsidies are on account of the fact that oil marketing companies(OMCs)(Indian Oil, Bharat Petroleum and Hindustan Petroleum) need to be compensated for under-recoveries. 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.
Hence, FCI in case of food subsidies and OMCs in case of oil subsidies, need to be compensated by the government. But the government does not compensate them immediately and takes its own sweet time to do so. Reuters columnist Andy Mukherjee explained this best in a column he wrote on October 25, 2013. “India’s government recognizes revenue and costs not when it actually incurs them, but when it writes or receives cheques. By simply delaying payments, New Delhi can therefore give the impression it is sticking to its promise of keeping this year’s budget deficit within 4.8 percent of GDP,” wrote Mukherjee.
So FCI can run up the costs of providing cheap food to people in 2013-2014. But it will be compensated for the same only in 2014-2015. Along similar lines OMCs will be compensated in 2014-2015 for expenditure that they incur in 2013-2014. Meanwhile, they need to borrow from the market to keep running their operations.
This ensures that even though the government incurs expenditure during a particular year through its various arms, it recognises the expenditure only next year. If a company were to do so, it would be held for accounting fraud. But that is not the case with the government.
To conclude, the principle of postponement is at work big time in case of the government of India because that is the only way it can meet its fiscal deficit target. Of course, that would mean a big headache for the next finance minister and the next government. But then who is bothered about that? Clearly not Chidambaram.
The article originally appeared on www.firstpost.com on November 12, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Month: November 2013
The illusion of control
Vivek Kaul
By the time you are reading this my first book would be out. Writing a book is an extremely strenuous and lonely exercise, with huge opportunity costs. And very few writers actually make any money out of their writing. Even fewer writers become famous.
Nevertheless, despite the near zero chance of success, people continue to write and publish books. Why is that?
I have been thinking about this for the past few weeks. What made me leave my job, sit at home and slog away on my laptop for the last 18 months to write a book, which possibly very few people are going to read?
Nassim Nicholas Taleb has answer in his book Anti Fragile. He attributes this to what he calls the fooled by randomness effect. As he writes “Information has a nasty property: it hides failures. Many people have been drawn to, say, financial markets after hearing success stories of someone getting rich in the stock market and building a large mansion across the street – but since failures are buried and we don’t hear about them, investors are led to overestimate their chances of success.”
This is precisely the way it works with people who go about writing books as well, feels Taleb. As he writes “The same applies to the writing of novels, we do not see the wonderful novels that are now completely out of print, we just think that because the novels that have done well are well written(whatever that means), that what is well written will do well.”
This explanation clearly summarises my state of mind when I decided to write a book. There was a confidence in my ability to write a good book, which would do well. But as has been proven time and again there is very little link between the quality of a product and how well it does.
Hence, it is safe to say that those who write books are “mildly delusional” and at the same time have an “illusion of control”. Given that the odds of a book succeeding are close to zero, anyone in their right mind would never get around to writing a book.
But that is not the way it works. People take on risks like these because they often underestimate the odds of success. As Daniel Kahneman, a Nobel Prize winning economist, writes in Thinking Fast and Slow “The evidence suggests that an optimistic bias plays a role – whenever individuals or institutions voluntarily take on significant risks. More often than not, risk takers underestimate the odds they face, and do not invest sufficient effort to find out what the odds are.”
And this is what leads to individuals taking the plunge inspired by the stories of success they see all around them. As Spyros Makridakis, Robin Hogarth and Anil Gaba write in Dance with Chance – Making Luck Work For You “We hear a lot about people who are successful, but very little about those who fail to realize their dreams. The press makes sure that we’re all familiar with the achievements of Sir Richard Branson, Warren Buffett, Bill Gates, Tiger Woods,or Nicole Kidman. While we’re dimly conscious that these people are exceptional, we rarely hear about the entrepreneurs, sports people, or actors who fail – or the sheer scale on which they do so.”
Entrepreneurship is another good example. People continue to take the plunge despite the odds of success being very low. “For example, did you know that in the USA there were more than 55,000 bankrupt firms and over 1.4 million bankrupt individuals in 2009? And the great majority of these involved believed it would never happen to them,” write Makridakis, Hogarth and Gaba.
In fact, a majority of the entrepreneurs are convinced that they will make it big. As Kahneman points out “ A survey found that American entrepreneurs tend to believe they are in a promising line of business: their average estimate of the changes of success for “any business like yours” was 60% – almost double of true value. The bias was more glaring when people assessed the odds of their own venture. Fully 81% of the entrepreneurs put their personal odds of success at 7 out of 10 or higher, and 33% said their chance of failing was zero.”
This optimism helps keep capitalism going as people try and launch new businesses, and some of them ultimately succeed. But there are situations when the illusion of control comes with costs attached to it. An excellent example is when a lot of people in the United States stopped taking flights and started driving, in the aftermath of what happened on September 11, 2001.
Flying remains the safest form of travelling. And the numbers prove it. In 2001, nearly 483 people died in the US in air crashes. Of this nearly half of them died on 9/11. In 2002, not a single person died in an air crash. And in 2003 and 2004, the number of deaths stood at 19 and 11, respectively. Now lets compare this to the number of deaths in car accidents. “In the same period, however, 128,525 people died in the US in car accidents. Moreover, it has been estimated that – in the year following 9/11 – some 1,600 deaths could have been avoided if people had not driven but instead carried on taking the plane as usual,” write the authors of Dance with Chance.
This happened because drivers have an illusion of control. They have more faith in their driving than they have in the ability of the pilot to fly a plane safely. What also does not help is the fact that any plane crash makes it to the top of the news headlines whereas most car crashes don’t.
Also, no media reports about the thousands of planes that land safely every day. Given this, people have a tendency to think that flying is riskier in comparison to driving, and that is clearly not the case.
The dotcom bubble which ran from the late 1990s to the turn of the century is another brilliant example of the negative effects of the illusion of control. As Robert Shiller writes in the second edition of Irrational Exuberance, “Using the internet gives people a sense of mastery of the world. They can electronically roam the world and accomplish tasks that would have been impossible before. They can even put up a website and become a factor in the world economy themselves in previously unimaginable ways…Because of the vivid and immediate personal impression the Internet makes, people find it plausible to assume that it also has great economic importance.” While using the internet people felt in control. And then they bought dotcom stocks, thinking that the companies would make a lot of money in the days to come. That never happened and most of the companies went bust.
The illusion of control plays a very important part in our lives. And hence, it is important to figure out which it is leading us to.
The article originally appeared in the Wealth Insight magazine dated November 1, 2013
(Vivek Kaul is the author of Easy Money. He tweets @kaul_vivek)
What Nokia could have done to prevent its fall
Vivek Kaul
Companies like human beings have a limited lifespan. Professor Richard Foster of the Yale University estimates that the average lifespan of a company listed in the S&P 500 in the United States is only around 15 years now. This has fallen from around 67 years in the 1920s.
Why has the lifespan of companies shortened so dramatically in the last 100 years? Marketing guru Al Ries and his daughter Laura have an explanation in their book War In the Boardroom. As they write “The biggest mistake of logical management types is their failure to see the rise of a new category. They seem to believe that categories are firmly fixed and a new one seldom arises.”
The most recent example of this phenomenon is Nokia. The company was the largest seller of mobile phones in the world until Samsung overtook it in 2012. Even now it sells nearly 15% of the world’s mobile phones, but has only 3% share in the lucrative smart phone category.
Despite being the largest player in the market, Nokia did not see the rise of smart phones. In fact, this lack of foresight allowed brands like Micromax and Karbonn to rise in the Indian market. Nokia’s failure is not surprising, given that the history of business is littered with many such examples. RCA, America’s leading radio company, did not see the rise of battery powered pocket transistors which were first made by Sony in 1955. Sony changed the way the world heard music by launching the Walkman and the CDman. But it handed over the digital music player market on a platter to Apple and other companies.
Some of the biggest minicomputer companies did not see the rise of the personal computer. None of the big airline companies around the world thought there was a market for low cost airlines, until Southwest Airlines walked away with the market.
Closer to home, Hindustan Lever (now Hindustan Unilever) did not believe that there was a market for a low cost detergent. Nirma captured that market, though to its credit Hindustan Lever fought back brilliantly with its Wheel brand. Bharti Beetel, changed the entire landline market in India by selling phones which had buttons on them. But by the time it entered the mobile phone market it was too late.
So why do established companies fail to see the rise of a new category? Clayton Christensen, a professor at the Harvard Business School has offered an explanation for this, in the research that he has done over the years. Established companies have a way of doing things (their existing resources, processes, profit model, value proposition they offer and so on). Anything new that comes along threatens that status quo.
Take the case of Sony. The rise of digital music threatened the vast music catalogue that the company owned. And if it launched a digital music player, people would simply copy music instead of buying it. Kodak was the first company to make a digital camera. But it did not take the concept seriously because any camera that did not use “photo films”, threatened the ‘existing’ business model of the company.
What also happens at times is that the initial market is too small. Smartphones have been around since the late 1990s, but they only took off in the last few years. This ensured that Nokia did not take the new category too seriously because there was money to be made elsewhere.
Christensen feels that the only way big companies can be serious about the rise of new categories is to create a separate organisation within the organisation. He gives the example of IBM, which was the only big company around to benefit from the rise of the personal computers(PCs).
IBM set up a separate organisation in Florida, with the mission to create and sell PCs successfully. The organisation had its own engineers and its own sales channel, and thus did not threaten IBM’s existing way of doing things. When minicomputers went totally out of fashion in the late 1980s, IBM was the only big company around to compete in the PC market.
The moral of the story is that big companies in order to survive need to keep making small bets, which are not a part of the existing organisational set up, and see what works.
The column originally appeared in the Business Standard Strategist dated November 11, 2013
(Vivek Kaul is the author of Easy Money (Sage, 2013). He can be reached at [email protected])
'Simplicity is the ultimate sophistication'
Vivek Kaul
Stefan H. Thomke, an authority on the management of innovation, is the William Barclay Harding Professor of Business Administration at Harvard Business School(HBS).He is chair of the Executive Education Program Leading Product Innovation, which helps business leaders in revamping their product development processes for greater competitive advantage, and is faculty chair of HBS executive education in India. He is also author of the books Experimentation Matters: Unlocking the Potential of New Technologies for Innovation and Managing Product and Service Development. In this interview he talks to Forbes on the various aspects of innovation.
Innovation is a very loosely defined term these days. How do you define innovation?
When I started looking at innovation more than 20 years back, it seemed to be a little crisper then, in terms of definition. Now its all over the place. Interestingly, Wall Street Journal did an analysis sometime back where it counted the number of times the word innovation appeared in the quarterly and annual reports in the United States in 2011. They counted more than 33,000 times. Its just a much overused word.
So what does the world really mean?
The word innovation itself really means two things. It means novelty and value. The value requirement is a really important point. And that makes it different from the word invention. Invention is a more legal term. It is about getting patents. If you have a name on your patent you know that value is not a requirement to get a patent. It just has to be new and non obvious to get a patent. There are companies that have lot of patents which have no value for anybody. So its an input to innovation.
Innovation at times can be a really simple idea as well?
I was working once with a company in the area of in vitro diagnostics. Basically they made equipment to do blood analysis. So when you go to a hospital they draw blood from you and put it into a machine. The machine analyses your blood and gives printouts. One of the biggest innovations for their customers was an algorithm, which was essentially a piece of software that ensured quality control. That was one of their main selling points and customers would basically buy their equipment because they highlighted that. They said that I have this insurance that when I run these tests that the equipment automatically checks for quality and is actually very reliable. And they marketed that. From an R&D perspective it was one of the easiest things that they have ever done. It was really just an algorithm that they figured out using data.
That’s really interesting…
Yes. So sometimes you know the most expensive things are not necessarily that provide the greatest value to the market and vice versa as well.
I came across a blog you had written on product innovation where you questioned putting more and more features into a product. Tell us something about that?
I wrote an article together with Donald Reinertsen and in this article we talk about myths. This was one of the myths. He is also an expert on product development. And we have been in many meetings where the entire meeting is dedicated to discussing more and more features. There seems to be an assumption that in a lot of teams that we are basically done when we can no longer squeeze more features into a product. Presumably assuming that more features that a product has, the customer actually sits there and counts the features, and that somehow drives our ability to price it.
And you don’t agree with this approach?
Sometimes you can actually add value to a customer experience by taking features out, by de-featuring. But that rarely happens. I have rarely been to meetings where the main purpose of the meeting was to remove features from a product with the intent to add value. Usually when we sit around and discuss to remove features, it is usually because it is too expensive, it is not manufacturable. Maybe what teams should do is think about when they can no longer take things out of a product rather than when they can no longer add things to it. It’s a very different way of thinking about it.
Making things simple is difficult…
We often talk about it as a quote attributed to Leonardo da Vinci that simplicity is the ultimate sophistication. To make things simpler is very hard because that requires you to have a very deep understanding of what the user really wants. And once you have that deep understanding you have the confidence. Mark Twain once said if I had more time I would write a short letter. In fact that should be true in your field as well?
Yes, longer pieces are easier to write.
Exactly. And the same is true about innovation. Creating something out of a lot of bells and whistles is a lot easier to do sometimes than actually creating something that has the essential features because that requires a lot more thought and a lot more research.
Can you give us an example on this, other than Apple?
A small example is the Danish company, Bang & Olufsen. They make very very high end speakers, stereo systems etc, which are beautifully designed. These speakers are one of the most expensive speakers that you can buy. But there are no buttons for adjusting the frequencies, you just have the volume button. That’s it. What they have done is that they have created products that are very expensive and they have taken away all the controls that normally you would like to have.
How did they get away that?
They set themselves a very interesting standard. They said, when you listen to something on our speakers it should sound like the real thing. And we believe that no user will be able to get close to that by tweaking a few buttons than the way we set up. So they set their standards to be very high and said we don’t want the users to fiddle with it because we are getting as close as we can. All we want you to do is turn the volume button up and down. It’s quite contradictory. You would imagine that if you are charging all that money you would want to give more control to the customers.
But a lot of people love fiddling with features…
Yeah. There is always a market for everything.
If you look at mobile phone marketing, the selling point seems to be features…
Look at Japan for example. If you look at Japanese mobile phones they have more features than anything you can imagine. You can watch television on them. They have got everything on these phones. But when you ask Japanese consumers, one of their problems is that they are so complicated to use. Not surprisingly, the iPhone has one of the highest penetrations in the Japanese markets. So the question is how can that be? It is more expensive. It has less technology in it. It has fewer features in it and yet it has one of the highest penetrations in terms of growth.
That’s an interesting example…
The reason why I came up with this observation is because I bought this toaster, which came with a manual and had a little LCD display on it. And it set me thinking. I bought an iMac and it had no manual and I bought a toaster and it came with a manual that thick.
There is no manual with an iMac?
No. There is no manual with an iPhone. You just get a little leaflet in there in terms of what to do if something goes wrong. In fact when Steve Jobs came back to Apple one of the first things he did was he took manuals away from developers. The belief was that manuals are for developers who don’t know how to make it intuitive. So as a developer if we don’t know how to make it intuitive we think that’s there is always the manual where we can write down and explain how it works. The problem is that nobody ever reads a manual. So the perfect solution was lets just take away the manuals from the developers. If you cannot explain it, if you cannot make it intuitive, then don’t it.
Do organisations become less innovative as they become large?
I wish I could give you a yes or no response. There are actually certain advantages that come with size and there are some disadvantages that come with size. As you get bigger., you have a momentum. You have an established customer base. Sometimes you can take a long term view as well because you have got an ongoing business and you can afford to wait a little bit. But you have some disadvantages as well. You have got a customer base, that may hold you back and drive you in a different direction. As you get a bigger, you need to have processes and procedures for coordination that are often then viewed as bureaucratic.
Can you give us an example of a large company that is innovative?
Take a company like BMW. It is very innovative. Right now they are launching the i3 which is an extremely innovative car. Its a fully electric car. But that’s not the only innovation. They also figured out how to actually make the entire body shell out of carbon fibre. This is an example a great innovation in all dimensions. They had to come up with a process innovation. Carbon fibres are basically carbon bodies, very light structures that go into very high end automobiles. For example, Formula 1 cars are typically made from re-enforced carbon fibre bodies. You need to bake them. Its a very labour intensive process.
And BMW changed that?
They couldn’t follow a manual process for a car like this because they want to mass manufacture it. It would be way too expensive. So they had to actually innovate in manufacturing. They had to automate the production of carbon fibre. And it changes everything. Once you make the body of your car from carbon fibre, things like crash dynamics totally change. Then there was the electric side of it as well. So the i3 which is coming out this fall. The whole project was more expensive than any of the car platforms that they have developed recently. Estimates are of around $1-5-2 billion. Its a huge risk and they don’t know whether the car is going to sell in enough numbers. It is going to be priced pretty close to $35,000-40,000 in the United States and close to around 35,000 euros in Europe. This is a huge bet that they are placing.
And they are able to do it because they are big?
BMW is a very big company . A small company may not be able to take that bet because they don’t have the expertise. They may have the expertise in one area but they don’t have all the different knowledge bases that this will require to put something like this together. So BMW has the deep expertise. They are very profitable. So they can afford. Whether they can afford to let the i3 fail that remains to be seen. If it fails that will be a big dent. But they can afford to put $2 billion into something like this which could really change the future not just for BMW but for the car industry as well. So large companies can be innovative.
I was reading one your research papers in which you talk about the fact that you cannot treat R&D like manufacturing and unleash techniques like six sigma….
There is a real danger right. I was working in the quality field when six sigma first came out. Six sigma was essentially designed to address production variability in Motorola’s semiconductor factories. It was adopted by others. And at GE it became a big change management programme. But we should also fundamentally understand what Six Sigma is all about. Six Sigma is about reduction of variability. And that is very suitable for tasks that are very repetitive. Variability is actually a bad thing and you want to drive it out. If I am at a bank and I am processing transactions then I want to these transactions to go through with zero mistakes. Any kind of variability is bad. That’s true…
But if you take a concept like this to innovation where we talk about experimentation, creativity and all these sort of things, variability is something that is quite natural. You take a technique like this and you are trying to drive out variability you can kill the entire process. The more upstream you go the more dangerous it is. Something by the way 3M found out the hard way. Jim McNerney became CEO of 3M. Having come from GE he was a master of six sigma. He drove it in at 3M. It initially helped them because there was a lot of variability at 3M. Fifty five divisions there was not enough co-ordination. When six sigma was implemented in upstream R&D driving out variability, they killed a lot of good things that they were working on. This frustrated a lot of people and later on when the next CEO came he really had to correct that.
Ideas often come at the edges.
It is also sometimes not predictable. If I am a developer and I am developing something new I don’t know exactly what I am going to be doing three weeks down the road. I don’t know the tests I am going to run one month from now because that is the whole point of innovation. Its uncertain. If I had all these answers, I probably wouldn’t be innovating. There wouldn’t be novel because I already know everything about what is going to happen. So inherently there is uncertainty that is built in and we just have to be comfortable living with that uncertainty. That is why I talk about business experimentation.
Can you tell us something about?
One of things that executives need to understand is that most assumptions/hypothesis that they make about novelty turn out to be wrong. The real danger for an executive is that if they feel they have an assumption about novelty and they go out without running the experiment, it could be quite disastrous. I don’t know if you have been following the JC Penney story.
What’s happened there?
It’s a fascinating story. Ron Johnson was the person responsible for Apple stores. More than 1 million are walking through Apple Stores everyday now. He was hired by J C Penney as their CEO, with the mission to revolutionise retail for JC Penney. So that was his job. He was one of the most admired executives in the retailing space for having done what he had at Apple. He tried to innovate retail for JC Penney and it turned out to be a disaster. I think sales were down 25-30% or so. And he didn’t run the experiment.
What happened?
He basically made an assumption of what the future of JC Penney retail should look like and he did away with discounts. He was very confident because he was right in the past. And turned out to be wrong. He should have taken some 20 stores and run randomised field trials. A lot of executives get hired for their expertise and they have a lot of confidence. If you were right ten times in the past. You believe that you will be right the 11th time as well. Sometimes its a curse if we are right all the time. Sometimes the kinds of things we learn in one context we may not be able to move it to another context, when the context changes.
No interview around innovation is complete without talking about Google. The company keeps doing many things, but other than there AdSense business nothing really has been a big money spinner.
That’s been making a lot of money.
Innovation should also lead to some profit. How do you explain the disconnect in case of Google?
I am no expert on Google. There are two ways to look at. One way to look at it is the way you describe it. They have got one business model essentially and they are trying all these things. None of it, at this point seems to be able to create another business model or another source of significant revenue for them. Another way of looking at it is that all the things they do drive more traffic towards them. I don’t know how much money they are spending on Google Glass. But that in itself is driving so much traffic to their site, which then increases the costs of the ads. They can probably pay for the whole project and more, just from the addition of the incremental traffic and the incremental ad revenue that one project created.
This makes tremendous sense…
When you use Gmail, you are actually giving them information. They can actually use it to place customised ads. Its the same thing with Android, which they give away for free. But by making Andorid available for free, its all on the mobile phones and gives them access to mobile phones, which then allows them to do ads on mobile phone. You can kind of see the whole logic. All these things ultimately lead back to their fundamental business model which is the ad model. I bet they are trying really hard to think of other ways at one level, but at another level they are probably thinking about an eco system that they are trying to create that ultimately drives people back into the ad space, and gets more information about them.
So basically they won’t allow any other search engine to come up…
They won’t want to do that. Of course not. They want traffic. The worse thing that can happen to them is traffic going somewhere else and the ad revenue falling .The whole business model will go away.
The interview originally appeared in the Forbes India magazine dated November 15, 2013 with a different headline
Where are the green shoots Mr Chidambaram?
Vivek Kaul
A few days back the finance minister P Chidambarm said that green shoots are sprouting up everywhere. Green shoots is a term propagandistically used by politicians to indicate that signs of economic recovery are visible during a period of economic downturn.
As The Hindu reported on November 1 Chidambaram said ‘green shoots’ were visible on multiple fronts. “A bumper harvest is expected, core sector growth numbers are encouraging, and a strong rebound in exports as well as reduced imports on the back of a fall in gold imports are likely to bring the CAD(current account deficit) down significantly.”
Chidambaram expects the CAD to come down to below $60 billion this year against $88 billion last year. This is already reflected in the value of the rupee against the dollar. Rupee is currently quoting 61.85 to a dollar. This after it almost touched 70 to a dollar in late August this year. Hence, things have clearly improved on that front. There is no denying that.
The Reserve Bank of India(RBI) has taken steps to defend the value of the rupee successfully. But a major reason behind the recovery of the rupee against the dollar is the fact that the Federal Reserve of United States has decided to continue printing dollars for the time being. The day that decision is reversed rupee will start coming under pressure again. Hence, Chidambaram’s optimism needs to be taken with this factor in mind.
The finance minister also talked about a bumper harvest. This has been on the back of a very good monsoon season. As Ashok Gulati, Shweta Saini and Surbhi Jain of Commission of Agricultural Costs and Prices write in a research paper titled Monsoon 2013: Estimating the Impact on Agriculturereleased in October, “Monsoon showers in 2013 have been one of the best the country has experienced during the last two decades or so. The June to September rainfall has been 5.6 percent higher than the Long Period Average (LPA). But if one counts the continuing rains in early October (till October 10th), the excess rains turn out to be almost 7 percent above LPA, the best since 1995.”
This is widely expected to boost rural demand. As the CACP authors point out “This can imply enhanced demand for credit to buy seeds, fertilizers, farm machinery, and after the harvest, the demand for several consumption goods in rural areas, besides propelling logistics, agro‐processing and retailing.”
So far so good. But what the authors as well as Chidambaram do not take talk about is inflation and the impact it has started to have on rural wages. Rural wages after adjusting for inflation fell in August 2013. As Sonal Varma of Nomura points out in a note dated October 24, 2013 “Growth in the average daily wage rate for agricultural labourers moderated to 13.1% y-o-y in August 2013, significantly slower than 18.5% y-o-y in 2012 and 23.4% in 2011. After adjusting for inflation, the decline was even more stark: real rural wage growth moderated to -0.1% y-o-y in August from 9.3% y-o-y in 2012 and 13.4% in 2011.” (y-o-y = year on year)
A real rural wage growth of -0.1% basically means that the income is growing just about at the same speed so as to match inflation. And this can’t be a good sign for consumer demand of any kind. The inflation devil has caught up with rural India as well.
Consumer demand remains subdued in urban areas. Car sales haven’t grown in almost a year now. Sales for the month of October were expected to be robust given the festive season that was on. But the numbers that have come in are largely disappointing. The sales of Maruti, the biggest car marker in the country, were more or less flat at 96,062 units against 96,002 units in the same month last year. The sales of Hyundai, the second largest car marker, fell by 0.6% to 36,002 units. The sales of the third largest car maker Mahindra fell by 15% to 22,924 units. And that of Tata Motors, the fourth largest car maker, fell by 33% to 14,133units.
Car sales are not a theoretical construct unlike many other numbers which tell us which way the economy is headed. They give a real indication of the state of the economy. Floyd Norris writing in The New York Times explains it best: “New-car sales can be a particularly sensitive economic indicator because few people really need to buy a new car, and thus tend not to do so when they feel uncertain about their economic prospects. Even if a car purchase can no longer be delayed, a used car is an alternative.”
And people are not buying cars because they are having a tough time trying to make ends meet, given the high inflation. This lack of demand is also reflected in the slowing down of consumer durables output. As Sonal Varma of Nomura wrote in a research note dated October 11, 2013 “consumer durables output growth remained in the negative, possibly due to a sharper slowdown in white goods production.” Consumer durables output fell by 7.6% in August 2013. This after falling by 8.9% in July. This is a clear reflection of the fact that people are not interested in buying things.
A massive increase in food prices has been a major driver of wholesale price inflation. Onion prices rose by a huge 323% in September 2013 in comparison to the same period last year. Vegetable prices were up by 89.4%. Fruits were up by 13.5%. Food prices as a whole went up by 18.4%.
As I have constantly pointed out in the past, half of the expenditure of an average household in India is on food. In case of the poor it is 60% (NSSO 2011). In this scenario it is more than likely that people have been cutting down on expenditure on non essential items like consumer durables and cars, in order to ensure that they have enough money in their pockets to pay for food and other essentials.
Unless, this cycle is reversed, consumer demand cannot be revived. And if consumer demand cannot be revived, there is no question of the economy growing at the pace that it was over the last few years.
A major reason for high inflation is the high fiscal deficit that the government has run over the last few years. And it continues to do so. Data released by the Controller General of Accounts shows that in the first six months of the financial year (i.e. the period between April 1, 2013 and September 30, 2013) the fiscal deficit was already at 76% of its annual target. Fiscal deficit is the difference between what a government earns and what it spends. It makes up for the difference through borrowing. The government has targeted a fiscal deficit of 4.8% of the gross domestic product (GDP) during the course of this financial year (i.e. the period between April 2013 and March 2014).
The high fiscal deficit can have serious repercussions in the days to come. The government is most likely to meet this target by not recognising some expenditures in this year’s budget, even though it will incur them. As a finance ministry official told Reuters some time back “It’s a given” that the government will have to use this strategy. “The worst-case scenario as of now is that $15 billion in costs will have to be rolled over into next year’s budget,” the Reuters article pointed out.
Even though, creative accounting will ensure that the government will meet its fiscal deficit target, the problem of excess fiscal deficit will essentially be postponed to the next year and will become a headache for the next government and its finance minister. Also, it remains to be seen whether international rating agency fail to see through the accounting gimmicks that the government is likely to indulge in.
Meanwhile, there will be other serious repercussions as well. As economist Shankar Acharya wrote in an article in the Business Standard in October 2013 “In the first five months of 2013-14, the Centre’s fiscal deficit ratio has been running at a whopping 8.7 per cent of GDP. Bringing it down to 4.8 per cent in the remaining seven months looks impossibly difficult, without recourse to seriously creative accounting ploys.”
These creative accounting ploys may help the government meet its fiscal deficit target of 4.8% of the GDP, but there will costs attached to it. As Acharya wrote “In any case, it is worth pointing out that a deficit that stays high through most of the year imposes the associated costs of higher inflation, higher interest rates, more crowding out of private investment and greater pressure on the current account deficit during the period, even if “miraculously” corrected in the final months.”
All in all the situation remains difficult, even though the finance minister P Chidambaram wants to give a positive spin to it by using a couple of positive data points. But then, that’s his job.
The article originally appeared on www.firstpost.com on November 9, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)