Mind the market

Markets and Policy at Cross-Roads

By

Surjit S Bhalla

(Newswire 18, Mar. 16, 2010)

Two important issues face the Indian economy, and stock market, today. First, what happens to the value of the Chinese currency? Second, what does the RBI do in its monetary policy meeting next month?

Perhaps, the most important long-term issue facing the world policy makers is the value of the Chinese yuan. By several accounts, it is a deeply undervalued currency, and my estimate is that it is undervalued by upwards of 60 percent. This cheapness from a currency backed by close to 800 million workers is a problem, for the workers and the world. The Chinese workers because they get paid considerably less than the wage that would prevail if the currency was not kept undervalued by the Chinese authorities; the world because workers in other countries lose jobs, or obtain lower wages because the Chinese worker gets too low wages, relative to her productivity. One consequence of this long running undervaluation saga was the financial crisis that the world experienced in 2008; the other side of cheap sub-prime loans in the US was the “cheap” availability of finance for the lender, the Chinese government. It is an easy call to make that if the Chinese refuse to undertake structural reform of the foreign exchange value of their currency, and system, the world is in for considerable turbulence. And India will have to take part in this turbulence.

The second major reason for being distinctly uncomfortable is the much hyped inflation-growth trade-off discussion in India. The recent WPI inflation numbers point to near double-digit inflation. But inflation as measured by the WPI. According to the CSO estimates of GDP deflator inflation in India for 2009/10, the number stands at 3.7 percent, and almost all of the inflation is due to food. The numbers are easy to grasp. Food constitutes 25 percent of GDP in India and food inflation has been around 10 percent. Add inflation due to “government and community services”, which has been high due to the Pay Commission awards, and one obtains the entire inflation experienced over the last year.  

So is there an inflation problem in India? Many analysts think so. These experts argue that now inflation is feeding through to non-food items. Going forward, this is manifestly going to be the case. It would be a most unusual reality if non-food items did not show an inflation trend of around 3 to 5 percent over the next fiscal year. The big question is what will food inflation be over the next year? With a normal monsoon, a reasonable guess is that such inflation goes nowhere and hugs close to the zero line. Procurement prices for rice and wheat are extremely unlikely to move; they will not go down, and barring a mega-shock, are unlikely to go up. Which means that overall inflation will be around 2 to 4 percent, one of the lowest India has ever experienced, along with 2009/10, a year with close to the lowest ever GDP deflator inflation, at least since 1980. So two years with the lowest GDP deflator inflation in the modern era does not, in my mind at least, constitute an inflation problem, let alone the hyped high inflation problem.

If the first event materializes i.e. movement of the Chinese yuan upward, this itself will be a (mild) deflationary (strictly, a lower rate of inflation) force in India and a not so mild deflationary force in China. If it doesn’t, inflation in India is headed southward in WPI and CPI, and flat in terms of the GDP deflator. So is there an inflation-growth trade-off in India? No. Should the RBI hike interest rates at its meeting next month? No. Should the CRR be raised? Yes, just to send the signal that the RBI is monitoring the inflation situation very closely.

The author is Chairman of Oxus Investments, an merging market advisory and fund management firm. Please  visit www.oxusinvestments.com  for an archive of articles et; comments welcome at surjit.bhalla@oxusinvestments.com

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