Before I start I would like to tell you that this is a humble attempt to explain to you the latest plague that is eating into our marvelous growth story. The plague's name is overheating and the disease carrier is dollars. How? For that you will have to read and understand what I have to say.
Overheating economy is one which has too much domestic demand. That is, when an economy is growing too fast and its productive ability cannot keep up with demand or in Keynesian economics when its productive ability is unable to keep pace with growing aggregate demand. When this happens the excess demand is met with the over employment of the resources. This can be achieved by employing workers for extra shifts or using machinery beyond their recommended working shifts.
There is a simple way to explain the causes. Growth is a function of savings and investment. Savings invested and output produced for each unit of investment is economy’s growth. This investment creates jobs, puts more money into the hands of more people. An economy rapidly growing overtime run short of workers. Employees bid up wages which leads to even more money in hands of people. Example- 1990s IT boom in US. So, extra money creates greater demands for goods and services. Investments typically take time to bear fruit and increase supply at home, so this demand for goods is serviced by importing them. This distorts the current account. And there is a chain reaction but let’s see all this in the Indian context.
You don’t have to be a genius to figure it by yourself that there are strong signs of overheating in this country. Clearly our productive ability is not able to produce enough goods and has resulted into large increase in imports. So, much so the trade deficit has reached a record level. Just take a look at our classic aviation or shipping industry. The infrastructure is bad, the airports and ports are just trying to fulfill the formality of physical existence. A perfect example of sectoral overheating. Result is heavy loses to airline industry and to our export competitiveness (turn around times at port are in days while it is in hours in Singapore).
Even a blind man can tell you how people are stuffed with money today. Suddenly the middle class income has exploded (if you are into economics then monetary aggregate M2 is measure of that). Why? Well, this is because rupee is pumped into the market for every dollar that is coming into India through foreign investment. This , rupee pumping, is done by the RBI to keep it pegged at a desired level set by RBI. So as not to hit our exports. Remember the hardening of rupee is bad for exports. This is precisely the reason our forex reserves are swelling. And as a topping to the cake, there is a manpower crunch hovering over the horizon in all the tier 1 cities. This has compelled companies to go to tier 2 or tier 3 cities for hiring. But you cannot substitute the teir 1 workers, who all have experience and better skill sets. So as a result there is increase in wages. Wage hike in our country is one of the highest in Asia. Of course only in skilled manpower. Above this we have banks. Which till recently have been distributing loans as if there is no tomorrow. The credit expansion by financial institutions has been phenomenal. But what overheating has to do with money and why am I talking about it. Because as earlier said, this money ends in savings and consumption. Savings in turn are invested and we see India flying and India poised campaigns. What happens next will be clear if I will explain about the goods which this money ends buying.
There are two types of goods. One is tradable and other nontradable among countries. As the word suggest tradable goods can be exported during the glut and imported during the shortage. But nontradable can’t. Like - houses, restaurants, hotels. So all the tradable goods (you can substitute tradable goods by importable goods if you want for simplicity), like- mobile phones are not going up in prices fast. But all the nontradable goods prices are reaching dizzying heights ( so if you are into stock markets then choose companies dealing in nontradable goods, the real profits are there). Take hotels for example, they are costlier than the hotels in New York. Real estate has no parallel and all must know it by now. You go on a date with your girlfriend and you will realize what I am talking about.Now coming back to money. Since the money buildup at the consumer level is massive and the nontradable goods are not matching that growth. The result is people are ready to give more for the same good . So there is a mismatch between the price growth of tradable and nontradable goods and our economic fabric is tearing apart . All this leads to high inflation which is bad. How high inflation? Because the prices of the nontradable goods shoots up. What our esteemed government does? They increase the interest rates. Stops pumping rupee in the forex markets or stops buying the excess dollars. This leads to rupee appreciation, rupee hardening, Infosys bleeding and blah-blah.( by the way if you are thinking of 1-year horizon, Infosys is a good bargain at 2000 levels) But all these are short-term measure. The root of the entire problem is Infrastructure. Why? Well remember the productivity talk. Our infrastructure is proving to be a bottleneck in our productivity and until and unless that improves, our productivity will lag demand. So, now you know the reason behind the “300 billion $ investment in infrastructure” talks by our ministers. Infrastructure building takes time but interest rate hardening has a quick but unhealthy effect on the economy. Government is trying both but it needs to put more money into our infrastructure if it wants to bring down the inflation and at the same time jack up growth rate. (If you are planning to buy a cement stock for a long-term perspective then you can because infrastructure needs cement more than anything, accumulate at dips).
So this disease is affecting the star of the Indian growth story, the IT sector. The profit margins are falling and the exports houses are finding it difficult to bear losses. You should know that this is a short-term measure. If government is an iota serious about our IT and export sector then it has to do something about the rupee (yeah ECB restriction was a positive step in that direction but not enough). It should realize that this is just the starting. India has proven itself as a competitive, professional and economical business destination. Dollar is going to flow like monsoon rains and worst of all this monsoon is going to be perennial. That’s why the great Manmohan Singh has proposed fuller convertibility which India will have to embrace sooner or later. It’s not a cure but it is the best shot we have. There is no running from it. Either we have to accept it or watch the jewel corrode under the acidic influence of the Dollar rain.
Overheating economy is one which has too much domestic demand. That is, when an economy is growing too fast and its productive ability cannot keep up with demand or in Keynesian economics when its productive ability is unable to keep pace with growing aggregate demand. When this happens the excess demand is met with the over employment of the resources. This can be achieved by employing workers for extra shifts or using machinery beyond their recommended working shifts.
There is a simple way to explain the causes. Growth is a function of savings and investment. Savings invested and output produced for each unit of investment is economy’s growth. This investment creates jobs, puts more money into the hands of more people. An economy rapidly growing overtime run short of workers. Employees bid up wages which leads to even more money in hands of people. Example- 1990s IT boom in US. So, extra money creates greater demands for goods and services. Investments typically take time to bear fruit and increase supply at home, so this demand for goods is serviced by importing them. This distorts the current account. And there is a chain reaction but let’s see all this in the Indian context.
You don’t have to be a genius to figure it by yourself that there are strong signs of overheating in this country. Clearly our productive ability is not able to produce enough goods and has resulted into large increase in imports. So, much so the trade deficit has reached a record level. Just take a look at our classic aviation or shipping industry. The infrastructure is bad, the airports and ports are just trying to fulfill the formality of physical existence. A perfect example of sectoral overheating. Result is heavy loses to airline industry and to our export competitiveness (turn around times at port are in days while it is in hours in Singapore).
Even a blind man can tell you how people are stuffed with money today. Suddenly the middle class income has exploded (if you are into economics then monetary aggregate M2 is measure of that). Why? Well, this is because rupee is pumped into the market for every dollar that is coming into India through foreign investment. This , rupee pumping, is done by the RBI to keep it pegged at a desired level set by RBI. So as not to hit our exports. Remember the hardening of rupee is bad for exports. This is precisely the reason our forex reserves are swelling. And as a topping to the cake, there is a manpower crunch hovering over the horizon in all the tier 1 cities. This has compelled companies to go to tier 2 or tier 3 cities for hiring. But you cannot substitute the teir 1 workers, who all have experience and better skill sets. So as a result there is increase in wages. Wage hike in our country is one of the highest in Asia. Of course only in skilled manpower. Above this we have banks. Which till recently have been distributing loans as if there is no tomorrow. The credit expansion by financial institutions has been phenomenal. But what overheating has to do with money and why am I talking about it. Because as earlier said, this money ends in savings and consumption. Savings in turn are invested and we see India flying and India poised campaigns. What happens next will be clear if I will explain about the goods which this money ends buying.
There are two types of goods. One is tradable and other nontradable among countries. As the word suggest tradable goods can be exported during the glut and imported during the shortage. But nontradable can’t. Like - houses, restaurants, hotels. So all the tradable goods (you can substitute tradable goods by importable goods if you want for simplicity), like- mobile phones are not going up in prices fast. But all the nontradable goods prices are reaching dizzying heights ( so if you are into stock markets then choose companies dealing in nontradable goods, the real profits are there). Take hotels for example, they are costlier than the hotels in New York. Real estate has no parallel and all must know it by now. You go on a date with your girlfriend and you will realize what I am talking about.Now coming back to money. Since the money buildup at the consumer level is massive and the nontradable goods are not matching that growth. The result is people are ready to give more for the same good . So there is a mismatch between the price growth of tradable and nontradable goods and our economic fabric is tearing apart . All this leads to high inflation which is bad. How high inflation? Because the prices of the nontradable goods shoots up. What our esteemed government does? They increase the interest rates. Stops pumping rupee in the forex markets or stops buying the excess dollars. This leads to rupee appreciation, rupee hardening, Infosys bleeding and blah-blah.( by the way if you are thinking of 1-year horizon, Infosys is a good bargain at 2000 levels) But all these are short-term measure. The root of the entire problem is Infrastructure. Why? Well remember the productivity talk. Our infrastructure is proving to be a bottleneck in our productivity and until and unless that improves, our productivity will lag demand. So, now you know the reason behind the “300 billion $ investment in infrastructure” talks by our ministers. Infrastructure building takes time but interest rate hardening has a quick but unhealthy effect on the economy. Government is trying both but it needs to put more money into our infrastructure if it wants to bring down the inflation and at the same time jack up growth rate. (If you are planning to buy a cement stock for a long-term perspective then you can because infrastructure needs cement more than anything, accumulate at dips).
So this disease is affecting the star of the Indian growth story, the IT sector. The profit margins are falling and the exports houses are finding it difficult to bear losses. You should know that this is a short-term measure. If government is an iota serious about our IT and export sector then it has to do something about the rupee (yeah ECB restriction was a positive step in that direction but not enough). It should realize that this is just the starting. India has proven itself as a competitive, professional and economical business destination. Dollar is going to flow like monsoon rains and worst of all this monsoon is going to be perennial. That’s why the great Manmohan Singh has proposed fuller convertibility which India will have to embrace sooner or later. It’s not a cure but it is the best shot we have. There is no running from it. Either we have to accept it or watch the jewel corrode under the acidic influence of the Dollar rain.
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