Category: Economy

This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at [email protected]

I think retail investors in India can never make money out of any market-linked financial asset, be it stock market or debt market or forex market or gold. Our past experience in the stock markets has been very bad and even with extremely difficulty, you’ll hardly find any Indian investor who is 100% convinced that there is a scope for the retail investors to make money in the Indian stock markets.

It is quite natural that most of the investors will always invest their additional surplus in an asset class which has given highest returns to them (or general public) in the recent past. Investment in gold is the best example. Gold prices have crashed dramatically in the last 3-4 months. Around Diwali last year, gold prices crossed Rs. 32,000 and people in India have this mindset that gold prices always rise. They also have a view that around festivals like Diwali and marriage season during October-November, gold prices usually rise even more. Even after a sharp fall from its all-time high of $1917.90 in August 2011 to $ 1223.54 in today’s trade, you could still find many people having these kinds of views.

After a sweet & swift rally in the Indian bond markets, the Indian retail investors had just started investing in the long-term debt securities like gilt funds or income funds in an anticipation of a further rate cut. A mild economic recovery in the US and Japan has once again shattered the hopes of Indian retail investors.

Indian Rupee has been falling like never before. The rupee today breached an all important psychological mark of 60 against the US dollar and now it has fallen by approximately 12% in the last 2 months itself. Reason – Fear of foreign institutional investors (FIIs) pulling money out of Indian debt and equity markets even faster, which they have been doing very fast in the past 3-4 weeks.

At a time when we badly require foreign investments to pour into Indian markets due to a very high current account deficit (CAD), FIIs have decided to turn their taps off.

After pumping in $15 billion in the Indian markets in 2013, FIIs have decided to book their profits here in India (and also some other emerging markets) and switch their investments to their own countries or to those economies where they are foreseeing more stability in terms of economic and political decision-making. FIIs have pulled out some $5 billion from the Indian debt markets since May 21st this year.

The situation is so bad that the analysts who, at the start of this month, were expecting the RBI to cut its policy rates on June 17 to help economic growth recover somewhat, have started issuing reports stating that RBI may even be compelled to raise rates in its efforts to protect the falling rupee.

It is a vicious cycle. One factor is playing its role in the other factor becoming worse and then itself getting worst due to some other factor coming into the picture. Slow economic growth, high current account deficit and poor economic decision-making are putting huge pressure on the Indian currency and thus forcing FIIs to pull their money out of the Indian equity and debt markets, thereby putting even more pressure on rupee.

A falling rupee would make our imports costlier, which would again fuel inflation on a higher side and thereby forcing the RBI to increase its policy rates in order to reduce liquidity from the system and save the rupee from a further fall. Ultimately, it would result in a higher yield on Indian government securities (G-Secs) and more losses for the retail investors.

India 10-year Govt. Bond Yield

US 10-year Govt. Treasury Bond Yield

Japan 10-year Govt. Bond Yield

Look at the charts above. If we are able to keep the Indian rupee stronger, clearly our debt markets have been extremely attractive to the foreign investors as there is a huge yield difference between Indian govt bonds, US treasury bonds and Japanese govt bonds.

At the beginning of April this year, the 10-year Indian govt. bonds yield was ruling at around 8%, the 10-year US treasury bond yield was at around 1.75%, a huge gap of approximately 625 basis points (bps) and the Japanese bond yield was at around 0.57%, an even bigger gap of approximately 743 bps.

After that, Indian govt. bond yield fell sharply to touch 7.09% in May, whereas US treasury yields rose to 2%, thereby narrowing the yield gap to just 509 bps and Japanese yields inched closer to 1% mark, thus making Indian govt bond yields extremely unattractive to the foreign investors amid USD and Japanese Yen becoming stronger and Indian rupee losing its value.

By late May & June, after the announcement of QE tapering by the US Federal Reserve, the US bond yields have jumped even sharper, crossing 2.60% mark on June 25th, making it more attractive to the long-term US investors and the yield gap has gone below 500 bps. Moreover, US and Japanese investors would like to invest in their own country in order to avoid risks related to currency and other geopolitical factors.

At this point in time it is the topmost wish of our finance minister P Chidambaram that Indians should stop purchasing gold for some time and thereby help our country fight the continuously rising current account deficit. I think it becomes our duty to listen to his appeal and stop purchasing gold till the time we are able to stem this huge current account gap.

It is yet to be seen when and where this yield rise will stop, but India badly requires a benign interest rates regime in order to kickstart the economy again.

Nagu43 posted the following comment today, and I thought these are interesting questions that are relevant to today’s economic environment.

I have few questions, haven’t come across post on these topics, Pls share links to post incase I have missed.
What’s wrong with Indian Economy
Why is Indian GDP low than that of other developing countries
Does stopping gold import will improve Indian Economy
Why is rupee depreciation continuing, what would help rupee to gain

These are all big questions and a lot has been already written about them but I think it is worthwhile to look at them again, and today I’m going to take up the question on gold imports, why it is perceived to be bad for the Indian economy, and why they say that reducing gold imports will be better for the economy.

Let’s start at the start.

How do we pay for imports?

The most important thing that India imports is crude oil – we  import crude oil from countries like Saudi Arabia, Iraq, Venezuela etc. and these countries don’t accept the Indian Rupee for payments, they want us to pay them in an internationally accepted currency like the USD or Euro. It would have been great if these countries accepted the Indian Rupee because India can print as many Rupees as they want but India can’t print the USD or the Euro, so we have to rely on other means to get US Dollars.

How do we get US Dollars?

There are three main ways in which India gets USD. The first one is obvious enough, when we export goods and services – we get paid in USD. The second one is also fairly obvious which is investment. When foreign investors invest in India – they bring in USD and that’s another way to get USD.

The third way which is not very apparent is remittances. I did a post some time ago in which we saw that remittances were as much as 46% of India’s total services exports, and this means that NRIs sending in money to India is also a big contributor to foreign exchange reserves.

What do these two things tell us?

These two things tell us that it is absolutely essential for us to have a steady flow of USD or other big currency coming in the country in order to finance our oil bill and pay for our other imports, if we run out of foreign exchange, we will be in big trouble because without oil, nothing else will function.

The measure for whether this equation is fine or not is called CAD (Current Account Deficit), which is largely the difference between exports and imports and in India’s case, the CAD is becoming higher and higher with each successive month, and this means that India’s foreign exchange reserves are diminishing.

One of the big factors worsening India’s CAD are the ever increasing gold imports. The festival of Akshaya Tritiya contributed to heavy imports recently, and that in turned made the CAD even worse. If India spends USD on gold then that reduces the forex reserves for other important commodities like oil.

Theoretically, if there were no gold imports then that would eliminate the burden on forex reserves, and in a way it will help the Indian economy. However, you can’t eliminate gold imports completely because a lot of people depend on gold jewelry and investments for their livelihood, and India has always imported gold.

So, the problem then is not so much gold imports but the great pace at which these imports have increased in recent years, and the pressure it is putting on the foreign exchange reserves, and the worsening CAD.

Will stopping gold imports help the Indian economy?

The answer to this question is simple – no, simply stopping gold imports will not help the Indian economy because a lot of people depend on gold for their livelihood, and they need gold imports to remain in business and survive.

Will slowing down gold imports help – yes I believe they will help because they wouldn’t be such a big drain on our forex reserves and that will be great.

However, the recent rise in gold imports have been investment driven and that is largely due to the rise in gold prices, and a lack of other investment alternatives available to Indians.

Simply increasing duty on gold does nothing to alleviate either of these causes and that won’t do anything to help the economy. What we need is a better investment climate that helps people get other alternates to gold for investment, and that also helps with the other factors that I wrote about above related to bringing in foreign exchange in the country. You want a climate where exports rise (services exports declined last month), foreign investments come into the country – both in the form of FDI and FII, and all that in turns help the CAD.

Conclusion

To conclude, I’d say that what the problem that these huge gold imports cause is a worsening foreign exchange position, and the way to help the foreign exchange reserve is not to increase duty on gold imports to discourage them but attack the root and look for long term solutions to problems lowering exports, FII, FDI flows, and a sluggish stock market.

I’ve wrote about the Rupee fall yesterday, and I also described the factors causing the Rupee fall more than a year ago. I think the factors listed in that post are still valid, but due to the political process, and short term thinking, not much is being done about it.

There have been some short term measures that have been taken to reduce the Rupee slide and in this post I’m going to talk about two such measures and say why I feel they are counter productive.

Gold Imports

The government is citing gold imports as a big reason for the trade deficit and indeed it is the second biggest import item after crude oil.

Anything that leads to outflow of USD causes the Rupee to depreciate and the government has zeroed in on gold imports as one item where they want to discourage Indians from buying gold and draining forex as a result. They have increased the duty on gold to 8% to achieve this.

I think this is not going to achieve anything and may just work to counter what they are trying to do. We’re in a situation where the US listed Gold ETF GLD is down about 18% YTD (Year to Date), while India listed GOLDBEES is down only 9% in that time frame.

What is the difference due to?

Due to exchange rate depreciation and taxes, and that’s a problem right now.

People aren’t buying gold because the prices are low, people are buying because it is getting higher. The higher it goes, the more people make in notional gains in their gold investments, and increasing taxes isn’t going to do anything to dampen that. Gold demand has gone from consumption led to investment led, and higher prices will only fuel this.

The other aspect of this is where do people invest if not in gold?

The stock market is going nowhere, fixed deposits give negative real returns, debt mutual funds are doing well but for how long? And to add to all that, the Rupee is rapidly losing its value due to high inflation.

To me, the two big factors that are driving gold demand are the rise in gold prices, and lack of alternative investments and raising duty on gold addresses neither. It is better to go back to the lower duty that used to prevail earlier.

Allowing foreign investors to buy government debt

The Finance Minister has recently talked about allowing foreign institutional investors to own $30 billion of government debt, this limit was $5 billion and SEBI has increased the limit to $30 billion now. 

I’m not too sanguine about the efficacy of this step either.

You are allowing FIIs to buy but then are also assuming that they won’t sell during times of stress. How does that make any sense?

It is great that the limit is increased and there will be more participation from FIIs but that in itself won’t do anything to reduce the ease on the Rupee. Is it realistic to think that when there is strain on the Rupee which is usually due to structural problems, FIIs will be queuing up to buy government debt?

I feel that this step can also backfire as the FIIs who do own Indian debt may sell off along with other investors and accelerate Rupee slide when the wave comes next time.

Conclusion

I think we’re mired in short term thinking and the short term measures aren’t doing any good. They may give some immediate relief but that may just be making the situation worse because it takes away the focus from more long term measures that will reverse this trend of continuous depreciation.

The rupee fell to all time lows yesterday, and while on the face of it — that is great for exporters and people earning in dollars, I don’t think NRIs should be too happy about this recent fall.

A little more than a year ago I wrote a post explaining why the Rupee is falling, and in that I mentioned the Rupee’s fall is more a symptom of underlying problems rather than being the real problem itself.

I had listed down some of the problems in this fish bone diagram, and if you haven’t read my earlier post, then I’d recommend reading that here: Rupee slide is a symptom, not a problem.

I was reminded of that post when I was reading a great op-ed written by  Dr. Shankar Acharya about this. Here is an excerpt from that:

The real cause of the rupee’s weakness is the relentless deterioration in our economic policies in recent years. A falling rupee is simply a symptom of the underlying disease: unsound economic policies. After hovering around one per cent of GDP or less since 1991-92, the current account deficit in our balance of payments exceeded 2.5 per cent of GDP in 2009-10 and 2010-11 and is likely to have swelled to a new high of four per cent in 2011-12.

If you are a NRI and send money to India periodically, the lower Rupee might make you feel good, and make you feel that you are richer, but this feeling is pointless not because of the daily movement, but the direction that this Rupee fall has taken. It has been depreciating steadily, and the depreciation is both the effect and cause of several problems that make living in India that much more expensive.

I’ve spoken about the causes earlier, and you can read them again, but on the other hand, with the Rupee fall — the oil bill will increase, gold import bill will increase, and it will fuel our trade deficit, which is already in very bad shape.

Bad economic policies are already leading to lower growth, lower stock market and a high inflation, and more of these policies are likely to continue this situation. If you ever plan to come back to India then these conditions are not good for you. Of course, if the current government starts fixing the problems, and the Rupee goes back to 45 – 50 range, then the current rate would’ve been great. I don’t see a situation where the economy improves and the exchange rate continues to depreciate.

What if you were just buying real estate or assets in India and just intended to own them as assets? In that case, when you convert them back to USD eventually – Rupee depreciation is even worse. Just ask the people who opened NRE fixed deposits. The interest they get is lower than the depreciation so they are net losers.

The current context of Rupee depreciation is bad economics, and there is nothing to rejoice in that.

The Prime Minister is currently in Japan where he was asked when GST (Goods and Service Tax) will be implemented and he responded by saying that GST will not be implemented by the current government.

GST is one single tax that will replace all existing indirect taxes, and it is supposed to simplify the tax structure quite a bit. Currently there are several different types of taxes and compliance is relatively difficult and time consuming. GST will replace all these taxes and make it simpler for companies and individuals (it will also replace service tax) to comply.

Currently, the central and state governments charge taxes like excise duty, customs duty, VAT (Value Added Tax), Import Duty and Sales Tax but GST will replace all of these.

The problem with the implementation is that states will lose control on some of the taxes they impose and this may result in a tax loss for them. Because of this – negotiations about GST have become so difficult that the PM has accepted that his current government won’t be able to implement it. At this stage, it doesn’t look like the present government will be able to implement DTC (Direct Tax Code) either, and they might as well accept that.

Different countries have implemented GST for different reasons, and they take different forms as well. Some countries have a uniform rate for every thing while other countries have a few rates that are applied across the board. Two things however are clear from their examples – implementing GST has not been easy for anyone, and once implemented, no one has tried to go back so it must work well. For example, Australia first tinkered with the idea in 1980s when it got shot down, and then the idea was re-floated  in 1991 by the opposition, but the opposition had so much difficulty in explaining the tax that they lost the ‘unloseable’ election.

It is difficult to imagine that GST will be implemented easily in India, and when it does get implemented, it will most likely be a complex structure because nothing simple can replace the current structure.

The other important aspect of GST is that it is a Value Added Tax and at every step of the process producers get tax credit with the end customer getting no credit at all.

So to summarize, GST is a simpler tax system that seeks to replace the several types of taxes that currently exist, a lot of countries in the world have some form of GST already implemented, implementation has not been easy for any of them, and GST is a type of Value Added Tax.

I was surprised to read that Pakistan is contemplating importing 1,000 MW of electricity from India as I wasn’t aware that this has been discussed once earlier in 2012 as well.

Pakistan faces shortage of electricity regularly, and needs some short term measures to bridge the gap between demand and supply, but the surprising part to me was that India is not a surplus electricity generator itself, so how can India export electricity to Pakistan or for that matter, any other country?

I started by seeing if India exports electricity to any other country, and it appears that India does export electricity to Nepal with plans to start electricity exports to Bangladesh as well.

I think these are the only two countries that India exports any electricity as I couldn’t find any information on exports to other countries.

Among its neighbors, India imports electricity from Bhutan and that’s because Bhutan has surplus electricity generation.

According to MOSPI data – India consumed 6,12,645 GWh of electricity in 2010 – 11 so the 1,000 MW electricity export is a rather tiny amount, and I think this is more of a diplomatic step aimed at improving relationships rather than a measure that will have any meaningful impact on India’s overall trade or electricity production and consumption.  In that sense this is probably similar to the 1000 metric tons of onion imports from Pakistan back in the early part of 2011, except that Pakistan didn’t have an onion shortage of its own.

Update: As xyz has pointed out in comments below, we can’t estimate how much electricity we will end up exporting based on the information currently available and therefore my conclusion is inaccurate. I have canceled out that part of the post, and I apologize for my oversight. 

India and China have a very skewed trade relationship in terms of relative importance of one to the other. China is by far India’s largest trading partner with a total trade of $75 billion between the two countries in 2012, but India doesn’t feature very high in China’s list.

I was curious to see how big a trading partner is for China, and I wasn’t able to get to 2012 numbers, but I did find China’s trading partners for 2011, and here is how that list stands:

Country or Region	Exports	Imports	Total Trade	Percentage to Total
European Union	3560	2112	5672	22.14%
United States	3245	1222	4467	17.44%
Hong Kong, China	2680	155	2835	11.07%
ASEAN	1701	1928	3629	14.17%
Japan	1483	1946	3429	13.38%
Republic of Korea	829	1627	2456	9.59%
India	505	234	739	2.88%
Russia	389	403	792	3.09%
Taiwan, China	351	1249	1600	6.25%
Grand Total			25619

Numbers in 100 Millions USD

This is how it looks like in a graph.

A lot of people have the misconception that since India and China have similar populations, the trade numbers are also the same, but this is simply not true. Like it or not, India is a lot more dependent on China for trade than China is on India. India also runs a massive trade deficit with China, and that’s the reason why India has been and needs to push China to allow import of more Indian goods and services to even out the trade balance between the two nations.

IOC announced today that petrol prices will be reduced by Rs. 3 per liter from midnight because international crude oil prices have come down from around $116/bbl to $107/bbl since the last price change (16^th April 2013).

With this, the current petrol price will come down to Rs. 63.09 per liter in Delhi and Rs. 70.35 per liter in Kolkata.

Currently, the petrol price at Panjim is Rs. 51.48 per liter, and I think this might be the cheapest in the country since Goa eliminated VAT on petrol in their last budget.

I think this is very interesting because a few months ago I remember seeing a lot of Tweets from people about petrol prices in the US being cheaper than in India, but at Rs. 51.48 per liter, Panjim’s prices are cheaper than some US states.

Like India, prices in American states vary a lot, and the state of South Carolina has the lowest price, which is $3.19 per gallon – this translates to Rs. 45 per liter and is lower than Panjim price, but about 12 US states have a price of more than $3.64 per gallon which is more than the Goa price.

This also made me wonder how petrol prices in India compare with the rest of the world and finding that out was a lot harder than I expected.

The best that I could do is to look at this Bloomberg list from August of last year, and then adjust it for prices based on the price changes in US.

Here is what that list looks like:

Petrol Prices Around the World

Country	Rupees Per Liter
Venezuela	1.19
Saudi Arabia	6.44
Kuwait	11.8
Egypt	22.94
UAE	25.06
Nigeria	30.76
Iran	37.12
Malaysia	42.83
Mexico	42.96
Pakistan	47.07
USA	46.41
Russia	49.72
Indonesia	51.05
Philippines	58.6
Thailand	59.8
China	64.84
India	65.9
South Africa	70.27
Canada	72.39

Venezuelan prices are just incredible and they are pretty much handing out petrol for free there. The other countries at the top are also petrol exporting nations, and I wonder if citizens there look at Venezuelan prices and feel envious like the rest of the world looks at their prices.

Let me emphasize that this is not a very accurate list because I took data from last year’s Bloomberg’s list and adjusted it according to the price change in the US, and the utility of this list is mainly to judge how countries are relative to each other rather than the absolute value.

Also, I did a post on how much do taxes contribute to the high prices of petrol a few months ago, and that may be a useful read to understand how petrol is priced in this country.

Update: Updated the Saudi Arabia price based on information sent by Dr. Koustubh Chakraborty. 

Mr. Ramamurthy posted the following comment a few days ago:

Do you have the breakup of invisible imports? I presume it includes remittances made by Indians working abroad who send money to India? I think you did a post showing this? I cant access this?

I think he meant invisible exports, and this is a simple question, the answer to which is slightly complicated because of the way you have to get to the numbers.

Let’s quickly address what “invisibles” mean before looking at the numbers. Invisibles are that part of trade where no physical goods are exported or imported.

So, IT Services are one example, and remittances by NRIs are another.

To get to these numbers you have to look at the BoP (You can read more about this in my detailed post on Balance of Payments) data that RBI releases every quarter.

I got hold of the April – December 2012 provisional numbers, and from that I see that personal transfers which are defined as current transfers between residents and non – residents households constitute $48.5 billion for that time frame. It is hard to understand what this number means without viewing it in the right context.

The context in this case is how do these transfers compare to India’s overall exports?

Let’s start with services exports. The services exports for that nine month period was $105.8 billion which means that remittances were the size of about 46% of total services exports.

Telecom and IT services are the biggest services exports from India, and in that period those amounted to $49.6 billion so at $48.5 billion, remittances are almost as big as IT exports.

The next step is to see how these compare to overall exports, and for that we have to consider our goods exports. For that period, the goods exports were $218.3 billion, so remittances were about 22% of that amount.

So, by any measure, these are significant contributions, and you can see this by visualizing India’s current account receipts which is nothing but the income India earned from abroad for that quarter.

This is broken up into four heads (figures in Millions USD:

Goods	218,382
Services	105,840
Primary Income	7,636
Secondary Income (Remittances are 96% of this)	50,864
Total	382,721

 

 

As the chart above shows secondary income (which is mainly transfers) form about 13% of India’s current account earnings, and while significant, this is still a lot less than total goods exports, of which petroleum products form the major chunk, but that’s a post for another time.