Economic Highlights

New Delhi, 12 April 2007

Reserve Bank’s Role

Controlling Inflation Canadian Style

By Dr. Vinod Mehta

Inflation has been a worldwide problem and most of the governments across the world have to tackle it one way or the other as it not only erodes the real incomes of the people but also hurts the economy over a period of time. Moderate Inflation rate of two to three per cent may be tolerable but inflation rate going beyond five per cent  becomes a political hot potato.

President Jimmy Carter was seriously bothered about inflation during his Presidency.  In a televised speech on October 24, 1978, he said: “I want to have a frank talk with you tonight about our most serious domestic problem. That problem is inflation. Inflation can threaten all the economic gains we've made, and it can stand in the way of what we want to achieve in the future. “This has been a long-time threat. For the last 10 years, the annual inflation rate in the United States has averaged 6-1/2 percent. And during the 3 years before my inauguration, it had increased to an average of eight percent.

“Inflation has, therefore, been a serious problem for me ever since I became president. We've tried to control it, but we have not been successful. It's time for all of us to make a greater and more coordinated effort. “If inflation gets worse, several things will happen. Your purchasing power will continue to decline, and most of the burden will fall on those who can least afford it. Our national productivity will suffer. The value of our dollar will continue to fall in world trade.”  Inflation continued and Jimmy Carter did not get the second term.

China has also been bothered by this problem.  In Vietnam, which is considered to be “emerging China”, consumer prices in the first eight months of 2006 rose from 4.8%, mainly prompted by high fuel prices and interest rate-driven high production costs, to 7.5%.

In India too the rate of inflation was around 17% in 1991, which was brought down to the level of seven per cent in 1993.  As recently as 2004 the rate of inflation was around six per cent.  And most of the time the Reserve Bank of India has responded by restricting money supply as all the Central Bankers do.

The problem at the moment is that inflation has raised its ugly head at a time when the economy is growing at the rate of about nine per cent and the Government fears that any hike in interest rates and credit curbs would lead to a decline in growth rates.  For instance, a hike in the interest rates for home loans or car loans will lead to decreased demand for homes and cars which in turn will affect the growth rate of vehicle and construction industries.  Higher interest rates would also add to the cost of production when the loans are taken by the business and finally affect the growth rate.  It appears that in India the Government and the Central Bank do not see eye to eye on the ways to curb inflation; this is also true of many other countries.

But the Central Bank and the Government in Canada have found a way to cooperate in keeping the inflation under control.  The Government of Canada and the Central Bank of Canada have developed “inflation-targeting framework”  Instead of working at cross purposes both the Government  and the Central Bank have signed a kind of MoU to keep the inflation under control.  This has been going on for the past 15 years and this agreement is signed every five years. 

To quote from their recent Joint Statement: “The primary objective of Canada's monetary policy  is to enhance the well-being of Canadians by contributing to sustained economic growth, rising levels of employment and improved living standards. Experience has clearly shown that the best way monetary policy can achieve this goal is by giving Canadian households and businesses confidence in the value of their money.

“It has been 15 years since Canada adopted an inflation-targeting framework to guide its monetary policy. During this time, Consumer Price Index (CPI) inflation has been reduced to a low, stable and predictable level of close to 2 per cent, real output has expanded at an average rate of 3 per cent per year and the unemployment rate has fallen to a 30-year low. Although a generally supportive international environment, coupled with significant domestic economic reforms and a prudent fiscal policy track, has played an important role in these positive developments, a key contributor has been Canada's monetary policy under the inflation-targeting framework.

The joint commitment of the Government of Canada and the Bank of Canada to the inflation targets has helped anchor inflation expectations. It has also provided a more stable and certain economic environment in which Canadians can make their investment and spending decisions.”

This agreement has been further extended by five years up to 2011.  As per the renewed agreement, the target will continue to be defined in terms of the 12-month rate of change in the total CPI (Consumer Price Index) and the inflation target will continue to be the 2 per cent mid-point of the 1 to 3 per cent inflation-control range.

The first such agreement was signed in 1991 when the rate of inflation in Canada was 5.9 per cent.  The  rate now ranges around two per cent.  Canada has found that  inflation-control target assists the Central Bank in determining what monetary policy actions are needed in the short and medium term to maintain a relatively stable price environment.  To achieve a rate of monetary expansion consistent with the target range, the Bank of Canada uses its influence on short-term interest rates.

If inflation is moving towards the top of the 1 to 3 per cent target range, that is usually a sign that demand in the economy for goods and services needs to be restrained through a rise in interest rates. If inflation is moving towards the bottom of the range, it is often a sign that demand is low and needs some support through a reduction in interest rates.

In this way, Canadian experience shows, monetary policy tied to an inflation-control target tends to act as a growth stabilizer. Ensuring economic growth at a sustainable pace means preserving past gains by avoiding a recurrence of the inflationary "boom-and-bust" cycles of the early 1980s and 1990s. It also means encouraging long-term investment in future growth and job creation by maintaining a stable, low-inflation environment.

The lesson from the Canadian experience is that the Reserve Bank should not act only when the inflation rate goes out of hand but act throughout the year by way of  inflation-control target shows.  This is a sure way to avoid recession which tight money policy (severe curbs on credit creation, higher interest rates etc.) may bring. 

The Ministry of Finance and the Reserve Bank of India should sit across the table and develop inflation targeting framework. The need of the hour is to preserve higher growth rate with moderate inflation over a longer period of time.  In the 1990s the tight monetary policy of the RBI to control inflation, which was raging at seven per cent, led to severe recession; that needs to be avoided now.---INFA

 (Copyright, India News and Feature Alliance)

Economic Highlights

New Delhi, 5 April 2007

Remove Barriers

Indo-Pak Trade Should Grow

By Dr. Vinod Mehta     

After the 2004 SAARC summit in Islamabad and the meeting between the Prime Minister of India and the President of Pakistan, there were positive indications that direct trade between the two countries would grow in the coming years.  At that time Pakistan was reported to have said that it was willing to give MFN plus  (whatever it may mean) status to India. But till date Pakistan has not moved an inch in that direction.

After nuclear tests by the two countries, while India has been able to maintain its growth rate at around six per cent then and increase it to nine per cent today, Pakistan suffered a decline to 3.1 per cent in 1999 against 5 per cent in 1998. Pakistan’s GDP growth rate in the year 2002 was placed at 2.8 per cent. The steep fall was attributed to fall in exports and in investment.  The economic sanctions imposed by the Western countries following nuclear tests had affected Pakistan the most, as compared to India. 

According to a report prepared by the Centre for Strategic and International Studies, Pakistan, the nuclear test precipitated a balance of payment crisis and near default on its external debt.  It further stated: "The Pakistani economy, unlike India’s, faced an immediate foreign debt crisis. A US dollar 1.56 billion loan from the International Monetary Fund helped stave of default and stabilize the country’s external financing position." 

But now Pakistan’s economy is also growing at a very fast pace, overcoming the debilitating impact of economic sanctions. According to Dawn, “Pakistan’s economy is on the up and business is booming. In 2005, the GDP growth rate hit 8.4%, which was the fastest growth rate achieved in over two decades, and per capita income has now surpassed the US$ 700 mark.

Adding to the buoyancy is the fact that growth is taking place across all sectors of the economy, including agriculture (7.5%), manufacturing (12.5%) and services (7.9%). As a result, Pakistan is now counted among the fastest growing economies in Asia.”  According to Pakistani newspapers, Pakistan is the third fastest growing economy in Asia after China and India.

In 2002 Pakistan exported goods worth US $ 11 billion and imported goods worth US $ 11.6 billion.  As for India, it exported goods worth 65.2 million US $ and imported worth 73.7 million US $ in the same year. Pakistan's major export items are cotton, fabrics and yarn, rice and other agricultural products while its imports consist of machinery, petroleum products, chemicals, transport equipment, edible oil and grains, pulses and flour. 

As far as trade between India and Pakistan is concerned, it is not much by world standards. According to available data, the bilateral trade between the two countries has increased almost 14 times between 1987-88 and 1998-99; in absolute terms it increased from Rs 47.15 crore to Rs 463.92 crore during this period. This is what is legal trade between the two countries either on Government to Government basis or between two private organizations of the two countries. 

However, much of the trade between India and Pakistan is being routed through a third country generally countries from the middle-east are South-East Asia. It is estimated that the trade between India and Pakistan through a third country has increased from about US $ one billion to US $ two billion in the past few years.  If this could be converted into direct trade both would gain a lot.

The older generation would recall that before the partition, the fertile agricultural areas, which are now in Pakistan, were areas which produced surpluses in the agricultural sector and supplied them as raw materials to industries which were in this part of undivided India. This complimentarity relatively speaking still stands. If this was to be revived India would get the raw materials still relatively cheap at international prices as the transport costs between the two countries will be much lower.

In fact, since the two countries are contiguous, freight charges of any commodity that moves between the two countries will be much lower whether they are transported by ship or by rail.  Therefore, if they open up their economies to each other, they would be able to satisfy each other's demand at much lower prices.

It is common knowledge that there is a great demand for commodities like tea, tyres and iron ore in Pakistan.  India is well placed to sell these items directly to Pakistan.  But Pakistan at the moment imports tea from countries as far as Kenya, iron ore from Australia and Argentina while Indian tyres are either smuggled or imported via Dubai and Singapore. All these items can be easily purchased by Pakistan from India directly at much lower prices. India on the other hand would still be interested in procuring apart from Sugar goods such as cotton and textiles, moulded plastic goods, fresh and processed agricultural produce, spices, cooking oil etc. directly from Pakistan.

If one goes beyond this India can meet Pakistan's demand for various kinds of machinery and equipment, including transport equipment, extend help in the modernization of its railways while India in turn can buy power from Pakistan.

Apart from trade in merchandise both the countries can benefit from trade in services, especially in the tourist sector.  As a confidence building measure why not start one day conducted tours from Amritsar to Lahore and vice-versa.  One day inter-country-inter-city tours are quite common in Europe.  The tourist industry of the two countries too will gain much from the regulated movement of tourists.

It has been generally argued in Pakistan that opening up of its economy would hurt its industry and business.  But one can counter-question Pakistan that if opening up of its economy to China has not hurt it, how could opening up to Indian economy will hurt its economic interests? The argument as advanced by some groups in Pakistan in defence of its industry is not valid.  India has already extended MFN status to Pakistan.  It is now for Pakistan to decide whether it wants to reciprocate in the same manner. The sooner the better.

Apart from Iran-Pakistan-India gas proposed gas pipeline, If the business grows India and Pakistan may also think of a gas pipeline from Turkmenistan via Afghanistan. The Turkmen gas will be the cheapest even after paying to Afghanistan and Pakistan the royalty/fee for transit to India. Similarly Pakistan has a number of products to offer, including dry and fresh fruit to India. It is also interested in selling electricity to India.

According to a report prepared by Indian Council for Research on International Economic Relations (ICRIER), trade between India and Pakistan could increase manifold, to US $ 6.6 billion, if barriers are removed and Pakistan implements the requirements of the South Asia Free Trade Area (SAFTA) agreement. The World Bank Chief believes that the trade between India and Pakistan has the potential to grow to US $ nine billion.

The sectors identified by the ICRIER report for trade between India and Pakistan are textiles, agriculture, engineering, chemicals, pharmaceuticals, electronics, metals and minerals, rubber and plastic. In addition, there is scope for trade in several services such as health, entertainment, IT, energy and tourism, the report concludes.---INFA

 (Copyright, India News and Feature Alliance)

Economic Highlights

New Delhi, 29 March 2007

Despite Reforms…

Small Sector Survives Competition

By Dr. Vinod Mehta

More than a decade ago the Abid Hussain Committee had recommended de-reseravation of the small sector on the economic consideration of efficiency, economies of scale and use of modern technology.  The Committee never recommended the wounding up of the small sector, but still doubts persisted.  As for as the small scale sector is concerned there are always the same stereotyped stories like the entry of large sector and multinationals will spell ruin for them.

After one and a half decade of economic reforms one can say that the small, as well as the tiny and the unorganized sectors have responded and are responding well to the challenges not only of the large domestic industrial sector but also of the multinational corporations. Short of entering into an expensive and sometimes unwinable advertising wars, the small, the tiny and the unorganized sectors are concentrating on quality aspects of marketing to retain and expand their share of the market.  These are the stories coming out of small and medium towns of India.

Before we dwell on this, let us be clear about three points.  First, as the economic historian would say that when the market is growing, in a very general way every manufacturer finds that the absolute demand for its product is also growing whether the manufacturer is a multinational company or a small-scale sector firm; putting it differently, along with an increase in the demand of a commodity, the demand for its substitutes also grows.  For instance, if the demand for multinational soft drink grows, the demand for lemonade produced in the small sector also grows; if the multinationals advertise for biscuits, the tiny sector finds that its sales of biscuits are also growing.

Second, we always perceive one monolithic market for one kind of product.  But reality is somewhat different.  For practical purposes market can be broadly divided into two categories---market of individual or family buyers and market of institutional buyers (like hotels, hotels, canteens, offices, establishments etc.). The individual buyers usually buy things in small quantities while institutional buyers buy in bulk; the institutional buyer is relatively more cost conscious than an individual buyer.  Again in the case of an individual or a family buyer it is the carry home pay which generally determines its demand pattern.

Finally, within these two broad categories of markets, namely individual and institutional, there are various layers of markets catering to different segments of people and institutions.  For instance, both a five star hotel restaurant and a dhaba need edible oil for cooking purposes but both will use different quality of edible oil, and hence their sources of procurement would be different.  The products of multinationals and large industrial houses may appeal to the people of upper income brackets and to the institutions patronized by them, the vast majority will still be attracted to goods which are relatively cheaper and produced in the small sector.

With these initial observations, we can now go into the changes that are occurring in the small scale sector. One of the consequences of liberal economic policies has been that both the consumers and the manufacturers of producers have suddenly become conscious of quality. The consumers from all income brackets are now demanding quality products at competitive prices.  The small scale sector including the tiny sector have started responding to this by improving the quality of their products. 

From biscuits and other bakery products to readymade garments to food processors and coolers one can see significant improvement in the quality of their products---in some products the improvement is more and in some others it is less.  But the most important fact is that the small-scale sector has come to realize that it cannot survive without improving the quality of its products and that it has to be constantly innovative.  Since these units cannot advertise their products, one has to see for oneself the quality of their products in actual shops.

The second consequence of liberalization for the small-scale sector has been that it has now started playing serious attention to packaging.  The goods are now being packed by the small-scale and tiny sector in colourful attractive packages whether it is biscuits or bread, a shirt or a jean, a bath soap or detergent powder.  The individual shopkeepers of groceries can now be seen cleaning bulk products like pulses and packaging them in convenient packs for retail sale.  Similarly, new garments being sold on the roadside are being packed in a way they are packed in big stores.  Many of the things which the shopkeepers used to weigh in front of us are today sold in a pre-packaged form.

Thirdly, the small and the tiny sector has also started using brand names for their products even if they find difficult to advertise them.  That is to say the small-scale sector has also started attempting product differentiation.  Though these brands are seldom advertised, yet the small-scale sector is attempting to build its own brand following, even though in many cases it is limited to a particular territory.  For instance, a few years ago the citizens of Delhi could buy bread made either by one of the two big manufacturers or from one of the numerous small bakeries.  But in the past ten years apart from the two big manufacturers in Delhi, a large number of other branded breads from the small-scale sector are being sold in large numbers.

Fourthly, the concept of neighbourhood provision stores is slowly giving way to supermarkets of all kinds where all the products for sale are displayed on the shelves and one finds the products of small-sale sector getting the same exposure as the products of large sector leaving it to the consumer to make up its mind. 

This was not possible under the old provision store concept where one had to demand an item by name. The arrival of the concept of supermarket has brought the unadvertised products of small sector on the open shelves for the public to choose from. 

There are some problems with the small-scale units in rural areas as their demand base is limited to a few nearby villages and have almost no forward linkages with large companies to sustain them  There is an urgent need to study the impact of economic reforms on small scale and tiny units in rural areas and then devise policy measures to help them to sustain themselves.

Therefore, generally speaking, the small scale sector, far from being overawed by the multinational corporations and by the large domestic sector has not only changed but is still continuing to change with the times, adopting new approaches and strategies to stay put in the vast Indian market.  Going by the experience of past 15 years, competition from MNCs and large domestic companies has not spelt death knell of the small sector and if the country were to fully dereserve the small sector, it would not only survive but become more robust.---INFA

 (Copyright, India News and Feature Alliance)

Economic Highlights

New Delhi, 22 March 2007

Exploit Opportunities Galore

Open Market to Neighbouring Countries

By Dr. Vinod Mehta

The Fourteenth SAARC Summit will be held in India next month. But it is a pity that South Asia Free Trade Area (SAFTA) is yet to take off.  ASEAN and EU are reaping the benefits of a common market but South Asian countries are lagging behind.  Since the beginning of liberal economic policies we have been opening up our market to foreign goods. We have opened up to China, South East Asia and have signed FTA with Thailand but SAFTA is yet to take off. With Pakistan unwilling to extend MFN status to India as yet should India go on waiting for Pakistan to act? Or considering the fact that India is a large country, should it unilaterally become more liberal towards imports from small neighboring countries?

The relatively strained relations between India and Pakistan, which now appear to be thawing, should not come in the way of trade and economic relations between India and other SAARC countries. The potential of trade and economic links with Nepal, Bhutan, Bangladesh, Sri Lanka and Maldives are very high. The current political situation in Nepal is only a temporary phase and things are likely to improve in the near future. As for Pakistan, its attitude towards India also appears to be changing but very slowly. However, we can afford to be a little bit more generous towards smaller neighbours.

Let us not become hyper-sensitive on being labelled as ‘big brother’ by some quarters in these countries. Both territory-wise as well as population-wise India is relatively much bigger than all the SAARC countries taken together. In economic terms also India is very large; it is one huge market perhaps of the size of EEC. Its GDP is much higher than those of its neighbours and at the moment India is enjoying a very large and comfortable volume of foreign exchange reserves that it had not seen in the last fifty years. The Indian economy is by and large growing at an average rate of 9 to 10% per annum which is a reasonable rate of growth. Therefore, at this stage India can afford to be more liberal towards its neighbors than what it had been in the past.

Apart from economic gains India is looking for, it should also aim to earn the goodwill of the people of these nations by being more accommodative to them. Two years ago, the then Indian Foreign Minister on his visit to Bangladesh announced that India will allow duty free import of forty Bangladeshi products to India. More recently India is considering duty free import of jamdani sarees and hilsa fish from Bangladesh. At the moment Bangladesh is having adverse trade balance with India. Whether these measure will help reduce the adverse trade balance of Bangladesh vis-à-vis India, but it will have good impact on the relations between two countries.

One would like to say that India should show similar gesture to other neighbouring countries especially Nepal, Bhutan, Sri Lanka and Maldives and allow their products to have an access to Indian markets in a big way. Let’s not get paranoid by the fact that the goods from these countries would flood the Indian market. Their production bases are so small that it will call for huge investment before they can produce goods on a scale, which can flood the Indian market. In fact after the liberalization many of the Indian companies have shifted  their production bases to some of these countries.

At the moment, India’s external trade is mainly oriented towards OECD countries and some West Asian countries. ASEAN countries would come second. The trade turnover between India and the individual SAARC countries is so small that it does not attract attention even in our annual Economic Surveys.

A few years ago it was being said that the cheap Chinese goods would swamp the Indian market when India would open up its economy. The Chinese goods entered the Indian market in a big way but had to beat a retreat as the quality of Chinese goods was low that the Indian consumer did not accept it even though they were relatively cheaper. Compared to China, our South Asian neighbours are small in every respect and unlike China would not be able to dump their goods on the Indian market.

There are also many additional opportunities to expand cooperation with the SAARC nations. For instance, the tourist sector within the SAARC region has been neglected for a very long time. Tourism sector has low capital investment but relatively high earning potential. At one point of time there was an idea to start daily air services to link the capitals of all the SAARC countries. This idea can be again revived. We can learn from the ASEAN experience. All the ASEAN capitals are linked by air and they have special low airfares for travel within ASEAN countries.

Apart from this wherever possible rail, road and sea links must be strengthened among the SAARC countries. With Pakistan, Nepal and Bangladesh we can develop world class road and rail links for speedy movement of goods and people. With Sri Lanka, Maldives and Bangladesh we can develop sea links

India must also take a lead in admitting more members.  It may be a good idea to allow other countries like Afghanistan and Burma to become full members while Central Asian countries should be admitted as dialogue partners. It is India which can again take initiative in this direction by lobbying with SAARC countries. Even if it calls for amending the original SAARC charter Indian should be able to carry the other members along with nit on this issue.

Afghanistan at the moment is engaged in reconstructing its economy. It not only needs humanitarian aid but also trade to put its economy on a strong footing in the long run. If Afghanistan is admitted as a member of SAARC it would be easier for countries like Nepal, Bhutan, Bangladesh and India to send goods by road through Pakistan.  It would then be difficult for Pakistan to block transit facilities to Afghanistan.

As for the land locked Central Asian nations like Uzbekistan, Tajikististan, Kyrghistan and Kazakhstan, they are also looking for trade opportunities through land routes with India. If they become dialogue partners or associate members of the SAARC then it would again be difficult for Pakistan to stop the movement of Central Asian goods to India, Nepal and Bangladesh through its territory and vice-versa.

It is high time India becomes active in the SAARC by winning over its small neighbouring countries by allowing duty free to India some of their goods which they feel are important for them. Let these countries also share India’s higher growth rate. In the long run Indian will benefit by large trade turnover within the region.---INFA

(Copyright, India News and Feature Alliance)