Monday, January 30, 2012

The Value of Indian Rupee

The Economist recently published the Big Mac Index that shows Indian Rupee as most undervalued currency contrary to the popular perception of its value. The Big Mac is priced at $1.62 in India vs. $4.2 in the US thereby giving undervaluation of 2.6x.

It raises some hard questions:
  1. Has Indian Government absorbed substantial part of costs? Indian government subsidizes diesel and that could show up as mark down. This bloats the government balance sheet but keeps inflation from showing up in consumer goods prices. This has double effects, when high oil prices are absorbed by the government, Indian prices languish. Further, when the global prices start correcting, Indian prices tend to remain firm.
  2. INR is undervalued because Indian government finances are not in good shape. India's government finances look more like developed countries than developing countries. To compound the problems, Indian export basket is quite price sensitive while import basket is not. So then does it mean Indian inflation has substantial way to go? 
  3. Does it mean that Big Mac Index works better when government budget is nearly balanced?
  4. Another important thing is that the price of entry-level burger at McDonalds has been coming down since McDonalds came to India. Part of the reason is product development, but significant part is because of raw material efficiency. This latent competitiveness has not yet been harnessed, but if done so, will make India more resilient to global factors. It may even make Indian exports more competitive.



Saturday, January 21, 2012

Sticky Wages, Prices and effects of pouring money


Scott Sumner has a post about pouring of money - i.e. effects of expanding money supply. He disagrees with the metaphor that money pours into certain asset classes. While I agree with the principles behind Scott Sumner's post, I find most of times the metaphors send better signals for interpretation. But my main point is about prices and wages.

Prices and wages are embodiment of information - historical, present and future. If they change too quickly then the historical aspect is lost. For better or worse, our scale of value are anchored to the past. It does get influenced by present and to a less degree by expectations of future. But if we lose our anchor point or the reference scale then our mental models collapse and we lose our sense of reality. Thus, if we get paid $30,000 in year 1, $3,000 in year 2 and $3million in the next year, we will develop a sense of confusion.

Then comes the question of pouring. What pouring refers to is change in the relative value of asset classes. Imagine a spread of assets along a value spectrum, sort of a hierarchy (with sometimes assets jointly occupying a hierarchal position). 

If money increase does not modify the hierarchy then it does not impact much. If it does then it creates gainers and losers just because money is created. For example, if a really thirsty person would rather be just under the tap than away where water will eventually get to him. 

The argument therefore is whether the government or central bankers be allowed to create such distortion that has no grounding of productivity or real value creation.

One can argue that over long term the asset hierarchy goes back to a certain mean. But during the time a distortion is set in motion and the time we get back to time-tested mean we can extract advantage. Finance is prepping to do just that.

Saturday, January 14, 2012

United States of Europe

In principle, there is not much difference between United States of America (as it was intended) and United States of Europe (as it is perceived as of date). 
  1. USA was a federal structure in a true sense. Barring money, national security and foreign policy, not much role was envisaged for the central government. However, just like in the case of USA, USE must be wary of tendency of the central government to start hijacking things to itself. Sometimes there are legitimate reasons for doing so, for example:
    1. Inter-state issues of national security and policy. For example, establishing of FBI, DEA etc.
    2. Creating economic efficiency. For example, inconsistent laws between states creates problems and there is good argument for center to create a unifying law.
  2. Other times, central agency takes up power at times of crisis when collaborated and concurrent action is required by all the states together. Naomi Klein in Shock Doctrine, highlights some of the instances where disaster was used to by-pass checks and balances of the system.
Implication
So I don't see any problem when there exists a possibility of politically uniting Europe. If handled properly, it could be successful. However, odds are always stacked against it. Pursuing it at this moment will be a mistake. I am reminded of the quote, friendship always exists among equals. In today's Europe, there is no equality and hence no friendship.


Aside
If you have enough decentralization, then any aggregation at the top level has little or no effect. It is the centralization that starts creating the problem. It belittles the citizen and magnifies the government. 

Friday, January 13, 2012

Types of Investment and India's low-hanging fruit

I think India is much better placed at the moment primarily because there is lot of low hanging fruit. I attempt to list a few. When it comes to investment we have two kinds of investment. 
  1. The first represents fairly well understood investments where there is ample evidence of cost and benefit and technology is available from the experience of the first world countries. The road-map for development of such infrastructure, its costs, pay-off timelines etc. is well known.
    • Agricultural productivity
    • Basic Infrastructure - roads, power
    • Second-level infrastructure like cold chains, transportation hubs etc.
  2. The second is complicated and more like venture capital where risks are higher. Here the objective is to invest in areas that will value-drivers of the future. Here we are breaking new ground and the pay-offs are not clear. US and first world countries are required to invest in such type of infrastructure.
    • Alternate energy
    • New types of infrastructure including 4G telecom and other related such as NFC payments
    • High-end infrastructure e.g. intelligent Highways etc.
  
For India, substantial opportunities exists in the first part. This is what makes India an attractive destination. Starting around 1995, a lot of attempts have been made in estimating this demand. Most have been unsuccessful, but a substantial body of knowledge has emerged in this process. Today is the best time of all for companies to undertake massive infrastructure building projects. The question really is, will government facilitate the process balancing protection of citizen's rights and goals of developments.