Beware, inflation could get much worse!

May 17, 2012

In this issue:
» India's not the worst when it comes to black money
» Contraction in China's money supply
» Are we staring at another 2008 style crisis?
» Warning on commodity prices by sector giant BHP Billiton
» ...and more!

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Indian economy really is in dire straits. Its currency is in a freefall. Its accounts are bent out of shape. And there no strong reforms worth their name anywhere close on the horizon. It is no surprise then that foreign investors are exiting in droves from the Indian market, leaving a huge wreckage of wealth destruction behind them.

After all this, one would certainly expect India's policymakers to wake up and smell the coffee. And to introspect as to what exactly is going wrong with the once fancied India growth story. Unfortunately though, this does not seem to be the case. If the latest rhetoric out of Delhi is any indication, we seem to going down the wrong path on yet another occasion. So, what exactly is the Government's plan to fix the economic muddle that we are in? Well, the solution answers to the name of austerity measures. In other words, there will either be a cut in spending and/or an attempt to raise revenues, more likely the latter than the former.

It certainly goes without saying that in the absence of reforms, the Government's efforts to boost its revenues could eventually mean higher taxes on goods and services and would thus lead to an increase in inflation. In fact, the other option of cutting the spending also has inflationary connotations to it. As we all know oil subsidies account for one of the biggest chunk for Government spending. And if the axe falls on the same, higher fuel prices will be the outcome, thus opening up another avenue for inflation to seep in. To make matters worse, we have not even considered another potentially inflationary outcome like increased prices of goods and services made largely from imported raw materials.

Thus, it appears as if the Government wants to do nothing more than rob Peter to pay Paul. Rather than expand the current economic pie by introducing meaningful reforms, the Government just wants to redistribute the existing pie through the stealth tax of inflation. Certainly not expected from the Government that held great pride in its reformist outlook.

Do you think Indians should brace themselves for still higher inflation? Share your views with us or you can also comment on Facebook page / Google+ page.

 Chart of the day
We all get occasional feelers on how retail participation in the stock market has come down significantly over the years. Today's chart of the day confirms the same with the help of numbers and graphs. As the chart shows, average daily turnover of retail and HNI investors combined is virtually half of what it was in the year 2008. The slide began in 2011 when global uncertainty led to the fall in Indian markets and the trend has continued till this day. The fact that fixed income instruments have been giving high yields in the region of 8%-9% has also not helped matters we believe. With the global environment still uncertain, looks like the retail participation may not rise significantly anytime soon.

Source: Business Standard

Growth has become a word that has eluded the best of economies. The developed world has slowed down. The fiery nation, China too has started showing signs of a cool off. And this has hurt nearly every asset class. Commodities are no exception. Prices of all major commodities have dipped southwards. Even the world's largest commodity miner, BHP Billiton, does not expect prices to recover anytime soon.

In its latest release, the company has explicitly put its expansion plans on hold. This is a clear sign that they too are mindful about the falling prices. And it makes sense too. Unless they have some clarity of what the future would be like, it makes no sense to invest heavy money in the business. But it is bad news for other commodity players. If commodity prices do not recover soon, then they are looking at an extended period of slump.

Hunting for authentic data on Chinese economy is akin to hoping for mummies to spring out from Egyptian pyramids. The secrets about troubles brewing in Chinese banks have been closely guarded for decades. The Oriental economy has, however, managed to camouflage those with some rosy economic details. Its GDP growth and forex balance have always been held in awe. Its tactics are working no more. Not just the likes of hedge fund manager Jim Chanos are shorting Chinese stocks. But investment managers the world over are expressing their scepticism about China. In fact as per the Telegraph, if Chinese economic data were slightly more accessible, the economy would have been pushed to the wall by now.

China's economic growth is now shrinking faster than during the 2008-09 crises. Now that is a surprise for us since growth slowdown has caught up more with India as well this time around. However, it seems the liquidity situation is worse in China than it is in Spain currently. That certainly paints a scarier picture. What is most worrying is that for an economy of China's size, a sudden hard landing will be extremely painful for the entire world.

A lot has been said about the black money menace prevailing in India. It is believed that the tax evasion resulting from black money transfers has virtually choked the economy. However, it is worthwhile to note that when compared to most of its BRICs peers India has fared relatively better in curbing the black money menace. A recent study by researchers from Bogazici University indicates that the size of the shadow economy in India is declining. A shadow economy is that part of the economy where transactions happen in cash. And such transactions circumvent tax.

The research shows that the size of the Indian shadow economy has fallen in the last 40-50 years. In fact, it has contracted from about 40% of the GDP in 1950 to about 23% in 2008. Most BRIC peers have also seen their shadow economy contracting. But the absolute size of their shadow economy is much higher than India. China is the only country that has fared better than India. However, we believe that a lot needs to be done from here on to curb black money trafficking. Aggressive tax planning devices can help. Measures like General Anti Avoidance Rules (GAAR) are also suitable.

This is just a gentle reminder. If you think the financial collapse of 2008 was a once-in-a-century crisis, chances are that you are going to be proved wrong. For there are even bigger crises waiting to blow up. Why so? What were central planners doing all this while? Be assured that they have done nothing to solve the original problems that led to the crisis in 2008. Even worse, by pumping cheap liquidity into unscrupulous financial institutions they have made the problem even worse. Unfortunately, their efforts were aimed more at delaying the crisis instead of solving it.

But no crisis can be delayed indefinitely. In fact, many global indicators are giving signals akin to the ones witnessed prior to the 2008 crisis. The only difference is that while the previous crisis involved major financial institutions, this time it is the sovereign debt of the weaker Eurozone nations. Investors would be better off if they ready themselves for a full blown crisis that could strike very soon.

Meanwhile, indices in the Indian stock markets have come off their day's highs with the Sensex trading just above the break even at the time of writing. Heavyweights like ITC and Reliance Industries were seen supporting the index. Major Asian indices closed in the green today. Europe though has opened mostly on a negative note.

 Today's Investing mantra
"Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't, pays it." - Albert Einstein

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4 Responses to "Beware, inflation could get much worse!"

Biraja Shankar Hota

May 27, 2012

You are right-rob Peter to pay Paul, what the govt. is doing without taking steps for reform.Do you know(must be knowing,of course)who is the most anti-reformist in the Congress establishment or the UPA? It is none other than Sonia Gandhi herself.MMS, being more loyal than the king, is coolly presiding over the demise of the Congress, let alone UPA.But it is beyond my fathom, that being an economist how he is witnessing the melt-down of Indian economy.


sunilkumar tejwani

May 17, 2012

didn't you ever realize that the two year bull run form early 2009 to late 2010 was led by fake liquidity from the west? smarter are the people who sold every stock in late 2010 and have not bought any thing since then.

Like (1)

g r chari

May 17, 2012

The economic management of the country is far worse than expected, particularly, when we have a PM whose very credentials as an economist is at stake. Given our eternal dependence on oil, the govt. should have made out an all-out effort to improve export revenues through proper policy action as well as introduce measures to conserve oil and also ensure it's optimum use. In the absence of a proper policy framework, inflationary pressures automatically get built-into the price of goods and global woes are only making the matters worse. An ostrich-like response to the present crisis is no solution.

Like (1)


May 17, 2012

"Thus, it appears as if the Government wants to do nothing more than rob Peter to pay Paul. Rather than expand the current economic pie by introducing meaningful reforms, the Government just wants to redistribute the existing pie through the stealth tax of inflation. Certainly not expected from the Government that held great pride in its reformist outlook."

It seems that even savvy folks like you have been fooled by this govt. It's all a charade my friend. The govt continues to tax us to death -- income tax, sales tax, service tax, VAT, petrol tax, airport tax, stamp duty, customs duty, property tax, etc., etc., etc. And now inflation tax. I think Pranab Mukherjee should be made President and replaced with a competent finance minister who will actually do something to address the situation, instead of simply mouthing off inanities.

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