Does this mean the inflation will come down?

In this issue:
» India Inc's external commercial borrowings coming down?
» FM optimist on India's economic growth potential
» India's power sector headed for trouble?
» Will Asia get stuck in a 'middle income' trap?
» ...and more! ----------------------------- Don't Miss! Best of The Daily Reckoning... -----------------------------

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00:00

Higher inflation rates have been smouldering a hole in most of our household budgets. The prices of nearly everything have been trending upwards. Food, fuel, commodities, everything has seen prices go up. As a result, the Reserve Bank of India (RBI) has adopted a hawkish stance on monetary policy. However, despite the fact that the central bank has raised interest rates several times, inflation has not really cooled off. In fact in September 2011, inflation rates (WPI) actually went up to 9.72% as compared to 8.98% during the same period last year.

But the government is still optimistic that the stance adopted by the RBI is the correct one. The Economic Affairs Secretary actually expects inflation rates to trend downwards in the coming months. He has given a forecast that the inflation rates would come down to 7% by March 2012. And as unbelievable as it sounds, experts actually agree with him.

However, the reason for this is not because the prices would come down. It is simply due to the base effectt. So what does this mean? It means that due to the high rate of inflation recorded during March 2011, the percentage change in prices for March 2012, would appear to be low. It is just a statistical phenomenon. Nothing more than that. And other than the fact that it will make the government look in a better position, it would not really be of any help for the 'common man'.

The supply side constraints still continue to haunt India. Unless those are removed, it is unlikely that the prices of core commodities would ease up too much. This in turn would add pressure to the margins of the manufacturing firms. As a result, the latter would find it difficult to reduce prices anytime soon. So even though the inflation rates may start to signal the end of tough times, the reality will actually be far from it. Higher prices would continue to trouble us. At least till such time as the Government steps up on the reforms.

Do you think that lower inflation rates would actually mean lower prices? Share your views with us or you can also comment on our Facebook page.

01:20		Chart of the day

Higher interest rates in India had forced India Inc to look outwards to meet their borrowing needs. Little wonder that most companies turned to ECBs (External Commercial Borrowings) for their funding requirements. However, as shown in today's chart of the day, India Inc's ECBs have started to trend downwards. One reason for this is that with the financial crisis gripping the world, most banks outside of India are cutting down their lending. At the same time, with increasing interest rates, most companies have postponed or cut down their capex plans. As a result, most of them have been able to meet their investment needs with their own cash balances.

Source: Reserve Bank of India (RBI)

02:10

Against the current backdrop of high interest rates as well as inflation, there have been doubts galore on whether India would be able to maintain its high growth momentum in the medium to long term. However, not so for a gentleman who is in charge of the country's finances, the finance minister. Addressing a public gathering, the finance minister, Mr Mukherjee exuded confidence that the country will maintain a high growth trajectory of 8.5% to 9% in the medium to long term. He however opined that increase in agriculture production on a sustainable basis and increasing infrastructure development are the key issues that need to be looked into if the desired growth is to be achieved. We couldn't have agreed more. Another important issue that needs attention is that of equitable growth. Only when the current difference between the haves and have-nots comes down, will the growth have real meaning. Otherwise, it could lead to the disillusionment of the common man and also result into large scale protests like the ones happening in the west currently. And at this stage of development, instability is something that the country can hardly afford.

02:55

Diwali, the festival of light may not be that bright this year as long blackouts may soon remind the country of its energy insecurity. As per a report of a leading brokerage, the power sector could face dark times ahead as coal, the key raw material for the sector is in acute shortage. To give you a feel of the crisis, 34% of the coal based power projects are operating with less than 4 days of inventory while 51% have less than a week's stock left. The main reasons cited are strikes in key producing companies, transportation issues and heavy rains in Orissa. However, these are immediate causes. While the power minister has assured of an improved power supply situation in next 4-5 days, it will be a folly to let it ease concerns. What we are facing today is a potential long term problem of stagnation in domestic coal production. Hence, the Government too needs to work towards policies that offer long term solutions. This will include letting Private companies participate in mining and selling coal so that the power companies are not left at the mercy of just Coal India. The next step should be to move towards reasonable pricing for coal as subsidy scheme cannot continue forever without its potential 'dark' implications. But this will need a strong political will that has not been summoned in all these years. Had these steps been taken earlier, the story of India emerging as a growing economy would have seemed far more convincing, as for any growing economy in the current times, energy will be the key driving factor.

03:40

There are several challenges confronting emerging economies like India and China in recent times. Income inequalities, inflation, slowing growth are just few of these. Nevertheless a 9 to 10% growth rate in the long term can ensure that these economies put together account for nearly half of global GDP. Also the per capita income levels are expected to eventually touch that in the Europe currently. However, the same cannot be achieved without some significant policy actions. The chief of Asian Development Bank (ADB) opines that India and China could well get into the 'middle income trap'. Technically it means that where national productivity and income growth stall after per capita income hits US$ 3,000 to US$ 6,000. Growth spurred by exports and investments cannot sustain unless domestic consumption demand remains strong. In India consumption has been one of the key drivers of growth so far. However, the ADB believes that volatility in food prices and inability to control inflation could wreck havoc to India's consumption potential. Thus all things said and done, India's long term economic prosperity hinges on the country's ability to keep necessities affordable to the middle and lower income population.

04:10

Despite Reserve Bank of India (RBI) resorting to a series of rate hikes in recent times, there was not much movement in bond yields. But the latter received a jolt when the government announced a massive borrowing plan for the second half of this fiscal. The government aims to increase its borrowings by around 32% during this period and this led bond yields on the 10 year bond to reach a new three year high of 8.79%. This has then demonstrated that the fiscal authority appears to have a larger influence on interest rates in India than the monetary authority (read RBI). One of the reasons for this could be that the central bank has taken the rather predictable path of raising rates by 0.2% every quarter. These small steps do not seem to have had much of an impact on bond yields. Whereas the surge in the government's borrowing plan could be said to have come out of the blue and hence the impact on bond yields as well. While the government aims to reduce its fiscal deficit, borrowings may still not come down as it has to contend with lower cash balances and likely drop in small savings. Whether banks will want to buy more bonds is the question. Most of them have enough in bonds already and do not want to be in a situation whether they do not have liquidity if there is demand from the private sector. What is clear though is that the RBI cannot fight a lonely battle on the monetary policy front and the government will have to tidy up its finances to take care of the fiscal side.

04:45

In the meanwhile, after opening on a positive note, the Indian stock market lost their initial gains and closed the day in the red. The Sensex closed 57 points below the dotted line. Energy and consumer durable stocks were the biggest losers. However, most other Asian indices closed on a positive note with Hong Kong leading the gains. Europe has opened the day on a mixed note.

04:55

Today's investing mantra

"Risk is a part of God's game, alike for men and nations." - Warren Buffett