Thursday, April 22, 2010

Exchange Rate Conundrum

There is a great deal of talk about pressurizing China to appreciate its currency. The talk is bunk. The idea behind Chinese currency appreciation is not simply about China but it is about an exchange rate regime change. Asking China to let its currency appreciate in isolation will achieve nothing.

The old regime, dominated by US Dollar and other western currencies, was installed through higher savings and purchasing power (ability and intent). The intent to consume remains strong in the western economies. But the ability is seriously impaired due to lack of savings. So the old regime is falling unless we do something about it.

On the other side, a new regime is yet to emerge. China and eastern countries have higher savings rate (ability to spend), but seem to be lacking the intent. It is believed that the savings rate is excessive and may translate into consumption. Michael Pettis, professor from Peking University, believes this savings rate cannot rapidly translate into consumption. The savings are earmarked for social security, pension and education. Thus the demand that we expect from China or other eastern countries will not be that high. In other words, to be a strong consumer for the world, China will need much higher savings and purchasing power.

A rising currency can reinforce purchasing power for any economy. Importing capital goods becomes cheaper. Importing key raw materials becomes easier. There are lot of cost efficiencies that are generated. However, it exposes the economy to competition from overseas. It means employment is threatened. If economy has large population at lower incomes then it reduces consumption at national level. This is a good move for an economy where income pyramid is fatter in middle. It is natural that China would feel threatened by such a move.

There is other way to sustain the economy in appreciating currency environment. This stems from Porter’s competitive advantage of nations. Economies should start building sustaining competitive advantages. Low labour cost is not a sustainable advantage; rather it is a self-cancelling strategy over long term. The answers lie in Germany, in all likelihood.

In sum, it is time to establish a new regime based on fundamentals rather than managed currencies.  In such a regime, those with purchasing power will have stronger currencies than those without. There has to be global agreement on this regime to make it effective. Without it, we are going to wander aimlessly as far as exchange rate scenario is concerned.

My book "Subverting Capitalism & Democracy - Systemic faults that caused the financial crisis" is available on Amazon.

Wednesday, April 21, 2010

The RBI policy

The reserve bank of India (RBI) announced its annual monetary policy yesterday. The RBI increased repo, reverse repo and CRR by 25 basis points. The reasons were as follows:
  1. Inflationary concerns are dominant. The RBI is keenly watching the change in the structure of inflation. Rising food prices triggered inflation last year (weak monsoon effect).  However, it quickly moved to non-food price increase. This, coupled with abundant liquidity has given inflation a substantial resilience. It is imperative to highlight that food prices have eased since January.
  2. The Indian economic recovery is yet to get proper traction. The direction is right but credit off-take (bank and non bank) and other indicators are still wobbly.
  3. The policy rates in India are about 100-150bps below the normal rates.  So this is a process of normalization.
  4. Global factors continue to remain weak due to impending sovereign crises and playing out of asset deflation. The potential impact of sovereign crises is not fully clear and it is better to be circumspect than sorry.
The step change moves and cautious certain trajectory reminds one of Greenspan era policy changes. We know how that ended in bubbles. However, there are two reasons, intended or unintended, that makes the move a good choice.

There is still a lot of uncertainty in Indian economy. The way to counter uncertainty is by introducing certainty in controllable variables. The RBI has indicated a clear direction towards normalization and given us exactly this.

The RBI is also facing challenge of managing exchange rate regime. Any changes to relative exchange rates, interest rates will trigger a capital inflow into India affecting Indian domestic and export competitiveness. While it is not correct to promote export competitiveness through weak currency, the global exchange rate regime does not allow RBI that flexibility. With many countries following weak-currency approach, RBI will risk exposing domestic industry to unfair competition.

Thus, moving steadily while constantly watching the global scenario will serve the RBI and Indian economy better. The RBI has shown prudence, intelligence and resolve in combating the crises. Overall, this policy reinforces the RBI’s credibility.

My book "Subverting Capitalism & Democracy - Systemic faults that caused the financial crisis" is available on Amazon.

Thursday, April 15, 2010

My book "Subverting Capitalism & Democracy" Launched!

My book "Subverting Capitalism & Democracy" is now available on amazon (kindle version and paperback version). I am not yet sure why kindle and paperback version are shown as two different books but I think it will be sorted out soon. Here is a brief introduction:

Subverting Capitalism and Democracy

What caused the current financial crisis? A lot of answers have been proposed.  But do we know the root causes? This book looks at the causes behind the causes we know. The micro-faults that subverted capitalism and democracy are still overlooked.

Today, finance dominates our socio-economic hierarchy. Sadly, we know less about finance and economics than we like to believe.  We must relook at the basic concepts of finance and economics. We need to know how large pools of money create systemic weakness. We need to ask why the media and the regulators were sleeping at the switch.  

We have to go beyond lobbying, beyond “intellectual capture”, beyond exotic financial instruments and ask the next level of questions. Only then we will reach the root causes. Now is the time to set the system right. I hope this book will extend the discussion towards a solution.

Now that it has shipped I can see a million mistakes in it, a billion ways I could have made it better. But what the hell! I look forward to your feedback to make second version a better one.

Tuesday, April 13, 2010

The challenges facing Indian IT

Indian IT companies are not fully cognizant of the challenges facing them. There are many forces at work here:
  1. The terms of exchange rate contribution will be adverse. Going forward, I expect the INR to appreciate closer to 35 (INRUSD). The only variable is exactly when. At the moment, financial analysts have lulled the managements into thinking that these levels are not possible in near future. I am not so sure.
  2. Exchange rate will trigger further competitive pressures from global IT majors.
  3. The need for cost cutting and efficiency is driving demand for IT companies. This may not remain as strong as expected. There should be some pressure on margins in this area.
Overall I would be keen to have in-depth session with top managements of Indian IT majors.

Sunday, April 11, 2010

Debt Repudiation

After a long time we have come back to essential question. Is it ok for households to walk away? Naked Capitalism has a post by Edward Harrison titled Guest Post: Is Debt Repudiation a Good Thing or a Bad Thing? « naked capitalism.

I do not see why not. I think households should be allowed to walk away from non-recourse mortgages and no one has any business trying to create social pressure into paying more. Banks and financial institutions have played this as an economic game, no emotions. So why blame individuals when they make economic decisions.

Second, writing debt off is also used as a trick. You write off the debt but hold on the portfolio. Whatever the household pays back is then directly added to the profits. It might seem idiotic, but I have seen banks do it with ill intention.
Third, The written off portfolio is, in some cases, sold to "recovery agents". These agents follow up and try and recover as much from this as possible. In principle this is not wrong. But with inflated loans and deflated incomes this can be harsh. 

These steps will impede recovery of consumption in developed countries.