The cancer of inflation - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
The cancer of inflation A  A  A

14 JULY 2012

In early '50s Harry Belafonte sung a song, written in the 30s, called 'Matilda'. The song laments the theft of cash, stashed under his pillow, by his girlfriend, Matilda, who ran away with it to Venezuela. The money was to 'buy me house and land'. The amount was $ 500!

So in the '50s (or '30s) a sum of $ 500 was sufficient to buy house and land. Today, thanks to the gnawing cancer of inflation, it is now barely enough to buy a bed.

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Perhaps Belafonte sang $ 500 instead of $ 5,000 because of phoenetic necessity. But, the average cost of a house was $ 3,920 in '30s, $ 23,450 in '70s after which it started shooting up, going to $ 68,700 in '80s and to $ 238,880 in 2008 (see here)

Why did the prices shoot after the '70s?

In August 1971, Richard Nixon did three things to aid the US economy from the effects of a costly and foolish war in Vietnam. He imposed a 90 day wage and price freeze, a 10% import surcharge, and, most importantly, removed the assurance given by the US Government that the US$ could be exchanged for gold at a price of US$ 35/ounce. Prior to that, countries like Switzerland and France had demanded the conversion, and US gold reserves had fallen.

Shorn of the obligation to convert $ into gold, and, being the global currency, the US started printing money to fuel economic growth. A part of that money went into asset price inflation, including real estate prices. The subsequent bursting of these bubbles causes problems, as they have in Spain, recently bailed out by the EU, and as they will in China. Oversupply of anything debases its value, and that is what has happened to money.

Every action, they say, has an equal and opposite reaction. After Nixon renounced the obligation to convert US$ into gold, the Arabs lost faith in the US$, the currency in which they sold their oil. So, later in the decade OPEC severely hiked the price of crude oil, giving the first of several oil shocks.

Belafonte would be safe today. He would be unable to stash the amount required under his pillow. Besides, there are plenty of banks he could keep it in. And thirdly, Venezuela would hardly be the place Matilda would run to, for his; it has far toe many problems of its own.

Yet the US$ continues to remain the sole global currency, in the absence of any other. Because of this, the US continues to work its currency printing press on three shifts. The Euro, which many had expected to pose a challenge, is mired in Eurozone recession and is likely to assume a new shape. The Chinese renminbi is gearing up to play a larger role, but China has its own challenges. Ruchir Sharma, of Morgan Stanley, explains them beautifully in an Economic Times article.

Given the continuing pump priming, interest rates are 0.25% in the US, providing little incentive to save. If only common sense prevailed amongst our political leaders, we could have attracted a lot of this money. As it happens, we only take steps to spurn it.

Steps such as the introduction of GAAR (General Anti Avoidance Rules, which, had they been introduced in our missile defence systems, would have been widely welcomed). Investors fear the discretionary powers granted to tax officials under the GAAR rules.

Maxis, of Malaysia, which has established Aircel as the telecom brand in India, is reportedly looking to quit, citing regulatory uncertainties and the investigation against its promoter, as reasons. Norwegian telco Telenor, has mandated Citi to look for another partner in place of Unitech. Telecom, once an example of a successful economic liberalisation in India, is now mired in controversy.

The Supreme Court has stated that natural resources must be auctioned, in a transparent manner. The Government has made a Presidential reference to the Supreme Court on this, and other, issues. It believes that auctioning is not always the best process to allocate scarce resources. This columnist agrees.

Spectrum was initially auctioned, at high prices, making mobile telephony unaffordable to but a thin sliver of India's population. Call rates were Rs 16/minute, payable both ways, ergo Rs 32/minute. It was only when the system was changed to revenue sharing, and spectrum allotted at a lower cost, that telephony charges fell to Rs 0.50/minute, or even lower, and payable one way. The flaw in this system was that the Government permitted the sale of spectrum, or of a controlling stake in the company that owned it, and so the successful bidders of spectrum got to make gains from simply owning and squatting on it. The solution thus lies in granting usage, and not ownership, rights to spectrum, and in making subsequent sale of spectrum or of the company owning it, subject to clearance by Government (and upon payment of a fee for allowing it).

The Government could also suggest to the Supreme Court an alternative method. It can allocate spectrum at a reasonable cost, in order to benefit users, and allot it, via an auction, to the entity that bids the lowest telephony cost for obtaining it. In this manner, the consumer would get the benefit of lower call charges, as he should, and there would be a transparent method, through auction, of allocating the spectrum.

This is not a new solution; it has been mooted before. The reason why it has not been pushed by the Government is, perhaps, because it still wishes to retain administrative discretionary control.

Discretionary control was exercised by the Government when it offered amnesty to 100 account holders of HSBC having secret offshore accounts. This is subject to them bringing the money in into India, and paying tax on it. The article does not spell out how the computation of tax would be done, whether there would be a penalty imposed, and what action the Government would take if, after granting amnesty, the money does not come in. Also unclear is if the HSBC account holder were to bring in, say 10% of the money, retain his immunity, keeping the balance, as has been reported, in high denominated Swiss currency, in safe deposit boxes (which is, apparently, exempt from scrutiny!).

Juxtaposed with the GAAR rules, it suggests that the tax department is wanting discretionary powers to go after foreign tax evaders, but willing to treat domestic tax evaders benignly, in the spirit of 'saat khun maaf'.

In corporate news last week, Securities and Exchange Board of India (SEBI) permitted MCX-SX to commence trading in all asset classes, including equity, on the condition that the promoters, Financial Technologies and MCX, bring down their combined holding in it to under 5%, within 18 months of the permission, in order to comply with MIMPS regulation (method of increasing and maintaining public shareholding). Entrepreneurs would have no incentive to start, and build up, a business, if they have a mere 5% stake, equal to that of 19 others who are, most often, merely financial investors. Thus the grant of an 18 month period (which could have been longer) to encash the reward if their enterprise succeeds, is eminently sensible. It is expected that the increased competition would help increase the base of those investing in equities in India, which, being below 5%, is woefully inadequate.

Last week the BSE-Sensex slipped 207 points to end at 17,213, and the NSE-Nifty fell 89 to close at 5,227.

There are several concerns of investors. The monsoon is 25% below normal, and a failure could impact GDP growth by upto 0.5%. The Indian rupee is sliding, widening the current account deficit and causing a balance of payments problem. Things like GAAR and retrospective tax amendments are nettlesome to Foreign Institutional Investors (FIIs). For foreign direct investors, the Government is not bold enough to usher them in because it has to rely on coalition partners.

The Government would await Presidential elections, next week, before embarking on a series of steps to counter these problems. It is expected that the Prime Minister cum Finance Minister would considerably ease GAAR rules to reassure foreign investors that they would not be used indiscriminately. Perhaps he may even announce that retrospective changes in law would not be made once the Supreme Court has opined in the matter.

Prices of subsidised petro products such as diesel would be raised, probably end of next week. To attract single brand retailers such as IKEA, the norms requiring local sourcing, would be eased (what an IKEA, Sirji!).

If, alongwith all this, the 100 HSBC account holders start to bring in the money stashed abroad, in its entirety, paying tax on it, then the Government could start paring down its foreign debt and show a better fiscal picture. Should all this happen, the markets would take off.

One hopes, and believes, that it will!

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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13 Responses to "The cancer of inflation"
Apr 26, 2014
Since i have not gone thoroughly .But overall while searching i am recommending this and looks useful article . Like 
P R Roy
Jul 21, 2012
A really informative article. The 100 HSBC accounts episode tempts me to request an answer to the greatest riddle of this decade;-- where did the queen abscond with her entire brood in the recent past and for what purpose? Given the fact that the entire country is their property she could have got the best of the medical care the world can offer sitting in in number 10. Even assuming it is not not locally available what was her affliction that could be remedied within such a short time with no apparent after effects? Incidentally a demand for high denomination currency and safe bank boxes of a certain country rocketed thereafter. Also the worthy and loyal ex-FM did not bring in the scrutiny of bank vaults in that country under the repatriation of black money. Is the template of citizen no.1 a reward for that? If anyone has the answer please share. Like 
Jul 17, 2012
Harry Belafonte was not singing this song about buying a house in the U.S. or any other developed country.
He was singing this song supposedly living in a Caribbean country where $500 went a long way compared to the US.
Jul 17, 2012
INFLATION is a lifestyle affliction of an economy. The more faster you grow, the faster u are followed by inflation. It is bound to catch u no matter how u do it. In a open society it could be suicidal for some and euphoric for few who hold the levers of money. Like 
Ragini Ghanekar
Jul 16, 2012
Sale of spectrum and amnesty to HSBC customer are examples of how government deliberately keeps loopholes in the law to benefit vested interests while pretending to do good things. As to the single brand retailer like IKEA, I would like to point out that local sourcing is a good idea as these people can set up facilities in India and procure goods to their high standard which will be beneficial on employment and technology front. Like 
Jul 15, 2012
Really good article.Basic cause of inflation is absolutely right. Arabs lost confidence in US Dollar after Richard Nixon's action. Very few know this since it is almost 43 years old.Then started the Chain reaction of Global inflation . Crude Oil is utmost important element like Oxygen for any human being . Tensions & wars are created in different parts of world by US & unfortunately they are supreme power today after disintegration of USSR.War leaves nation poor & US economy flourishes. This phenomenon exists for last so many decades. Sino-Indian war, Indo Paak conflicts three times North Korea & south Korea, Iran-Iraq war, Iraq-US via Soudi conflict about Kuwait & now under preparation (Iran & it's Nuclear weapons ? ).Our own country is adding fuel by hiking MSP for food grain & oilseeds annualy to please POOR ? farmers. Grains procured by govt. is getting rotten in open spaces & poor Indian people cannot afford two meals ! Vested interests are making hey of the situation & pocketing huge sums. Refer to recent interview with Dr.Bimal Jalan- Former RBI Governor. Less said is better about Curruption at different levels.Now 25% less average rainfall till July 15th 2012.Seeds of further high inflation are sown & yield will be superb by Diwali.Natural reasons are nothing Man made shortages will play havoc. Like 
sudhir apte
Jul 15, 2012
Great sense of humour, Ikea Sirji!
Do u really believe that Diesel prices will be jacked up
when 2014 elections are just round the corner?
sultan fazelbhoy
Jul 15, 2012
There are a few fundamentals of inflation which are being over looked -- population growth resulting in increased demand. Increase in minimum salaries and to Govt employees resulting in increased demand. Needless to some extent, expense on defence. We don't really need over 100 nuclear warheads for our safety when just 2 or 3 would be enough to cause devastating damage to the enemy Corruption and black money which are sucking away much needed resources
I suggest the way to convert black into white is to enforce that 80% of remittance of black should be used in charitable RURAL projects in a state not of the owners of black money -- this is to build the concept of ONE INDIA. The remaing 20% should be treated as normal income and taxed accordingly. The owner of black has already enjoyed avoidance of tax and most likely has had an income of the black amounts stashed in other countries
The charitable projects will bring blessings over long term to the donor. They should be supervised by an appropriate Govt authority More in a longer response ... sultan fazelbhoy

Paramjit singh
Jul 15, 2012
Good and knowledge information about inflation.It also tell us how and when the inflation started Rising. Like 
Anupam Garg
Jul 15, 2012
Thanks for sharing the link to Ruchir Sharma's article which appears very logical...

and of course, thanks for writing another gr8 piece
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