Thursday, May 29, 2008

"Inflated" Worries?

"Oil Nymex USD 135 per barrel"

"Inflation touches 8% for week ended May 10"

"Prices of essentials like Edible Oil, Pulses, vegetables rise by 30%-60%"

These are the kind of headlines that we have been seeing for the past few weeks in the papers, on TV news channels and in panel discussions throughout India. The world is witnessing a slowdown and India is no exception. Increased supply pressures are pushing up costs and companies are finding it difficult to sustain in a price sensitive global market.

India, and the world, is witnessing a recession to a certain degree. This has mainly been fuelled by the sub-prime crisis in the USA. As they say, when the US sneezes, the world catches a cold. Well, India has caught this cold to a certain extent and is running around for a tissue to wipe its running nose!

The sub-prime crisis took force in the USA in the early part of August 2007. At that point, it freed up a lot of liquidity in the foreign market as people did not want to invest in USA and turned to emerging markets like India. This in turn brought in a lot of money through FDIs and FIIs. As a result, the stock market sky rocketed to 21000 and the USD weakened against the Rupee to a low of 1 USD = INR 39.30. On the face of it, all looked hunky dory. But on the face of "IT", the story was far from hunky dory. The IT companies were crying bloody murder due to the losses they were sustaining due to the weakening of the USD and the biggies like TCS resorted to hedging to consolidate their position. Several smaller players found it extremely difficult to compete.

Post January 2008, everything changed. The stock market plunged to a low of 14000 in a space of 30 days and several investors were wiped out. Especially those who banked on the Reliance Power stock to make a quick buck. The banking sector lost significant ground along with IT and other sectors and the market is still trying to recover from this setback.

The country is now gripped in a situation of industrial growth slowdown and extreme levels of inflation which stands at 8% as per the latest revised numbers. Let us look at this scenario. Keeping your money in a Fixed Deposit will yield u a maximum return of 9.5% per year, which JUST about covers inflation. Scary??.See the next one. At the current rate, you are losing money by keeping it in a savings bank account. The interest rate is 3.5% and inflation is 8%. Consequently, your money loses 4.5% of its value every year! This is forcing people to look for higher payout option like Mutual Funds and the equity market which yield average returns of 25% per year. But have a greater risk associated with them.

The government recently adopted several measures to control the rising inflation. Banning cement exports, steel exports being some of them. But the most ludicrous of measures was increasing the CRR rate of banks, thus making borrowing more expensive. Now this method is adopted to control demand driven inflation. The rise in lending rate reduces demand for borrowed funds and thus reduces the market demand over a period of 2 years, consequently curbing inflation. However, the inflation in India right now is pretty much supply driven. Deficient production, hoarding by wholesalers and retailers, rampant corruption etc are the causes. Not high demand!

There is NO magic pill to curb inflation. There just isn't. But there are way and means by which it can be controlled. Reducing government expenditure is one way. No you would ask me what does that have to do with inflation? Let me explain.

Income = Expenditure + Saving

Reducing expenditure frees a larger component of Income for saving/investment purposes and there is no need to raise direct and indirect taxes, thereby reducing inflation and keeping the sentiment positive.

I would like to end this blog by the following line:

"Inflation may or may not sink this country. But politicians will definitely will!"