Inflation at 2,000,000% & more...

Aug 18, 2008

In this issue:
» High inflation in India, and in Zimbabwe
» Pay commission's recommendations to hurt fiscal deficit
» India policymakers' wishful thinking
» Economic benefits of industrial development
» and more...

  Inflation at 12.44% is high...
"Indians are getting stronger. Twenty years ago it took two people to carry Rs 100 worth of groceries. Today, a 5 year old can do it." This is an Indianised version of Henny Youngman's quote on the Americans. No other quote on inflation can be more practical than this. And it is very true in context of the inflationary situation that India is facing currently, which has seen consistently higher prices for items like food, clothing and shelter (roti, kapda aur makaan). If this were not enough, the inflation number continues to rise showing no real signs of stabilising!

As was announced late last week, India's inflation (as measured by the wholesale price index or WPI) climbed to its 16-year high of 12.44% for the week ended August 2. This rise in inflation was on the back of soaring prices of commodities like pulses, fruits, spices and aviation turbine fuel. In fact, the fuel price inflation stands at 17.99% (-2.1% same lime last year).

All this gives the Reserve Bank of India (RBI) little choice but to raise interest rates further, the timing of which is still uncertain. The RBI has already raised interest rates three times over the past three months, with the last rate hike happening in July when the central bank raised its benchmark rate (repo rate - rate at which the RBI lends to banks) by 0.5% to a seven-year high of 9%.

  • Also read - RBI's lethal strike

      ...until you read this!
    If you think 12.44% is a high level of inflation, how high is 2,000,000%? People in the African nation of Zimbabwe are facing this level of inflation (year on year increase in prices). Simply put, a chocolate bar that you buy at Rs 10 today will cost you Rs 200,010 one year down the line, at an inflation rate of 2,000,000%! One way the Zimbabwean government has helped citizens cope with this menace is by issuing currency notes of Zimbabwean $ 100 bn (approx. Rs 326 bn or Rs 32,600 crore). Now, that's not too big cash for a country which faces the prospect of issuing ever more cash!

      Graham's value in Asia
    As per Bloomberg, some of the most renowned US based asset management companies including the Vanguard Group and Fidelity Investments are finding stock bargains in India, Taiwan and Japan that would make the legendry investor, Benjamin Graham proud. The reason being that each of those fund managers are able to find attractive value picks after the erosion of US$ 2.3 trillion (US$ 2,300 bn) worth of value from Asian stocks this year.

    Bloomberg suggests that the decline in Asian stocks, spurred by the fastest inflation in a decade, the biggest increase in commodity prices in three decades and rising borrowing costs, have reduced share prices in the MSCI Asia Pacific Index to 13.9 times trailing 12 month earnings, the cheapest in at least 13 years and the lowest versus the Standard & Poor's 500 Index since 2002. Further, lower exports from Japan and Singapore and the collapse of the US mortgage market - saddling the global financial industry with more than US$ 500 billion in credit losses, led to apprehensions about the stability of the Asian markets.

  • Also read - Lessons from Graham's favourite student

    Another reason why global investment firms are finding value picks in Asia attractive is because Asian financial firms, which have accounted for less than 5% of global credit loss, slid 25% this year, the biggest drop among 10 MSCI Asia Pacific industry groups. Not to mention the fact that this includes many of Indian financial sector behemoths which have lost nearly half of their market capitalisation since the high of January 2008. To put things in perspective, in Asia, foreigners have sold more than US$ 69.4 bn worth of shares since the start of this year (including US$ 6.5 bn net FII outflows in India). As per Bloomberg records, the sell-off has reduced the prices of Asian financial stocks to 12.6 times average earnings, which is 77% below financial stocks in the S&P 500. The difference is the biggest on record going back to 1995. So much for value!

      In the meanwhile...
    Stocks in India closed weak today. This followed a lacklustre performance recorded by other key Asian stockmarkets. Stocks in China were the biggest losers as the benchmark index closed with a 5% decline. This was followed by Taiwan and Hong Kong markets, which ended with losses of 3% and 1% respectively. Growing risk of a sharp global economic slowdown was seemingly the factor behind today's fall across these markets. As for India, stocks were also weighed down by last weekend's inflation numbers and the risk of fiscal deficit overshooting the government's target. Stocks in Europe are trading weak currently.

    In a major political development in South Asia, Pakistan's beleaguered President Pervez Musharraf has announced his resignation in the face of an impending impeachment motion by the ruling coalition government. Incidentally, as reported on Reuters - "investors in Pakistan's financial markets while appreciating Musharraf's investor-friendly rule which until this year saw strong growth and surging stocks, were expected to welcome his resignation as heralding an end to political uncertainty."

      Will a bang follow this buck?
    The government's approval to the Sixth Pay Commission's recommendation of an average 21% pay hike for public sector employees has once again turned the spotlight on how the fiscal deficit would be impacted. The implementation of the commission's recommendation means that the government is expected to shell out a staggering amount of Rs 220 bn this year. This means that it will have to dig deeper to find various means of garnering resources for footing this huge wage bill. It is important to note that nearly 90% of the states' revenues are drained away by salaries with only a minuscule portion left for the fulfillment of the people's needs! Also, in the aftermath of salary hikes following the Fifth Pay Commission, nearly half of the states almost went bankrupt without the money even to pay salaries!

    Most of the economists agree that these wage hikes would not really impact inflation, which has touched 12.44%, in a big way as the latter has been largely driven by supply side factors. However, a burgeoning fiscal deficit is likely to put pressure on interest rates. Given the rising inflation, interest rates and likely slowdown in growth, an expanding fiscal deficit will only compound the government's woes further.

    And, by the way, is anyone talking about improving the productivity of employees directly benefiting from the pay commission's recommendations?

      Easy recommending, hard implementing
    The last time the Indian government increased the price of petrol and diesel, it also set up the B.K. Chaturvedi panel to study the financial health of public sector oil companies. The panel has recommended, among other measures, an increase in petrol prices by Rs 2.5 per litre and diesel prices by Rs 0.75 per litre every month to align them with international prices by March 2009 and March 2010 respectively.

    It has also recommended that refineries should sell petroleum products to the marketers at export parity prices (i.e., excluding elements like freight, customs duty and insurance) rather than at trade parity prices. The oil minister has scheduled a meeting with the chiefs of the PSU refiners to discuss how, if at all, these recommendations can be implemented.

    We believe that oil price hikes are not realistic at this point in time. With inflation crossing the 12% mark and state and national elections looming large, higher fuel costs would be politically disastrous for the government. It is another matter that the enormous subsidy burden threatens to derail its fiscal plans. It is likely that economics will play second fiddle to politics and the recommendations will not be implemented.

  • Also read - Fuel price hike: Impact on OMCs

      Economic benefits of industrial development
    Singur, the sleepy town in the eastern state of West Bengal in India was in news recently for many right as well as few wrong reasons. Many right reasons because this is where the revolutionary product from the Tata Motors' stable called the 'Nano' will roll out in about a few months from now. Besides having the potential of providing employment to hundreds of its impoverished residents, it can also become a catalyst for future such projects in the country, thus ensuring that the hinterland also benefits from India's economic progress. But the project was also mired in a huge controversy over forced acquisition of land by the government. In fact, the spat reached such proportions that the very existence of the plant was threatened.

    However, a recent report in one of India's leading business dailies is likely to provide much needed relief to the people who have fought against all odds to ensure that the project remains in Singur. As per the daily, first signs of economic benefits to the residents are already visible with quite a few people going on record to state that their lives have indeed improved for the better. Some of the youths in the town have also enrolled for special training courses provided by Tata Motors and have been absorbed by the company. Many more jobs lie in store once the ancillary units of the company are ready to roll. Citizens are also benefiting by way of the indirect benefits like higher rates for land, more mouths to feed and hence more income for roadside vendors, etc. Its time many more companies and politicians take a leaf out of this and ensure that there is a trickle down effect of the economic growth that is sweeping across India currently.

      Weaving nuclear dreams
    Last Thursday (August 14), the US proposed to waive all restrictions on the critical nuclear power trade with India in a draft circulated to the nuclear suppliers group (NSG). This draft, which is supposed to be discussed in the 45-nation NSG meet in Vienna next week, proposes to lift the 34 year block on nuclear power trade with India. As per a leading business daily, if the trade opens up, it would give India a hope to double its target to 40,000 MW (megawatts) of nuclear capacity by 2020. India currently has seventeen nuclear plants with an installed capacity of 4,120 MW, while six plants with a capacity of 3,160 MW are under construction.

    In fact, India's state-run monopoly nuclear power generator, Nuclear Power Corporation of India Ltd., has already chalked out a plan for augmenting its generation capacity. It has identified sites in four states - Gujarat, Andhra Pradesh, Orissa and West Bengal - for setting up eight reactors of 1,000 megawatts (MW) each. The company has short-listed global players such as Westinghouse Electric Co., General Electric Co. and Hitachi Ltd., Areva SA and Rosatom Corp. for supplying reactors.

      Today's investing mantra
    "The genius of investing is recognizing the direction of a trend - not catching highs and lows" - Anonymous

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