ECONOMIC HIGHLIGHTS

New Delhi, 16 February 2006

Interest Rate Economy

Don’t Punish People Who Save

By Dr. Vinod Mehta

The slashing of interest rates on various saving instruments initiated in 2000 by the, then, Government continues till date.  The interest rate on savings bank deposit has been slashed from 4.5 per cent to 3.5 per cent.  The interest rate on public provident fund (PPF) as well as on GPF has been progressively reduced from 12 per cent to 8 per cent.  The interest rates on bank fixed deposits as well as on Government bonds have almost been halved in the past five years.  The latest in the series is the abolition of bonus on Post Office monthly income deposits.

The industry has been hailing these steps for the simple reason that the Government has been accepting their demands relating to the reduction in interest rates as they have all along been arguing that the cost of borrowing is higher in India.  Similarly, it also meets the Government’s desire to reduce its debt burden.                                                           

In other words, the Government has accepted, on the one hand the long standing argument of the industry that the high interest rates are coming in the way of industrial expansion and, on the other hand, its own desire to reduce debt burden.   It has also been argued that the reduction in interest rates will spur the economic activity and reduce Government deficit.  Whether it will actually lead to such results one has to wait and watch.

However, going by past experience, it is highly unlikely that it will really lead to any significant expansion in the economic activity.  Whatever buoyancy is being seen in the economy is due to factors other than reduction in interest rates.  On the face of it the argument that the economic activity is not expanding because of the high interest rates is doubtful.  Interest payment is only one component of the total cost of production.  The cost of other factors of production like labour and materials  is much higher. 

But these countries never argued that the wages and cost of materials be brought down to make their product competitive.  Therefore, to argue that interest rates in India are higher than interest rates in other countries and for that reason our production costs are relatively high do not carry much weight as the relatively cheap labour and cheap raw material offset the disadvantage of high interest rates. India as the cheap interest rates  offset the disadvantage of expensive labour and raw material in the developed countries. 

The real reason for asking downward revision of interest rates is that the Indian industry, even after 15 years of economic reforms, has not yet been able to gear itself to make efficient use of all the resources, as the foreign industry has.  They are not yet aware of the need to use economically the available resources including the borrowed funds.  In fact, a large number of our companies are in the habit of diverting the borrowed funds into unrelated channels or activities and because of their ability to window dress their balance sheet, this diversion of funds are rarely detected.  For instance, the money borrowed from banks to meet the short term working capital needs are many a times used to make speculative purchases at the bourses. 

Therefore, it is difficult to say that the increased availability of funds at reduced interest rates will give a big push to the industrial activity in the country.  It is likely that a large part of borrowed money will either be diverted to other unrelated activities to make short-term speculative gains or it will be used to retire the high cost debts raised earlier; it will seldom be used for expansion activity. 

In fact, the downward pressure on interest rates is also due to the convergence of interests of the Government and industrialists.  It is common knowledge that the Government is the largest borrower of funds in the country.  PPF, GPF and EPF as well as terms deposits with post office funds which are savings for an average citizen are in fact public borrowing by the Government; the funds collected through GPF, PPF, EPF and post office deposits go directly to the Government account. Apart from these direct borrowings, the Government also borrows from commercial banks through the medium of short-term and long-term bonds etc. to meet its current expenditure.

These borrowings and interest payments over the years have accumulated so much that the government is almost caught in a debt trap wherein it has been borrowing to repay its earlier loans.  Therefore, the government has also been very keen to reduce the interest rates as it will reduce the cost of public borrowing to the government.  One percentage point reduction in interest rates on PPF, GPF etc. and new bonds will result in savings of thousands of crores rupees on Government borrowing.  This one reason was sure enough to bring down the interest rates continuously.  

As in any game there are always some winners and some losers.  In this game of interest rate cut the winners are the industrialists and the Government, while losers are the average citizens who save money for their future needs and for their old age.  The reduction in interest rate while reducing the cost of borrowing to the industries and government will in effect reduce the earnings on savings of the general public.  The sufferers are pensioners, the old people, the widows and others who are solely dependent upon interest earnings of their savings.  The younger people may also feel that their savings are not growing as fast they should.  It is likely that the aggregate domestic savings over a period of time may also go down as some people may not find it attractive to save in the banks.

In India, provident fund and term deposits in banks are the major forms of savings as both the capital market and mutual fund sector are not highly developed.  In developed countries people invest their savings either in equities, in mutual funds or in pension funds which give them a relatively very high rate of return, much higher than the interest rates on term deposit in the banks.   In India both the primary and secondary capital markets are highly manipulated by speculators and therefore the equity market has not been able to become an alternative to savings in the banks for a large number of people.  

Similarly, the mutual funds sector is again highly dependent upon the volatile capital market and therefore cannot assure a steady and growing rate of return on investments in mutual funds.  Had there been a transparent equity and mutual fund market, people could have diverted their funds from banks to these institutions.  Since these sectors are highly manipulated, the Indian saver is condemned to keep his surplus money in banks (or invest it in gold and real estates) which offer a relatively low rate of return. 

The most important question, however, is that why should Reserve Bank of India dictate the savings bank rate to the banking industry in this era of liberalization.  Like any other central bank it should only fix the bank rate and free all other interest rates including the savings bank rate to be determined by the demand and supply of funds.  By imposing savings bank interest rates it is forcing the banks to adopt a similar pattern of interest rate structure.  The move apparently is to protect the interests of the weaker banks.  If the Reserve Bank of India were to free the savings bank rate of interest, there would be many efficient banks which would be willing to give a higher rate of interest than the one fixed by the RBI.  Similarly, the efficiently run banks would also be in a position to offer higher rates of interest on term deposits also.

Therefore, when we are talking of financial sector reform, it is high time that the Reserve Bank of India limits itself  to fixing the bank rate as well as the CRR and let market forces of demand and supply for funds determine the interest rates on various instruments savings including the savings bank deposit rate.  If the demand and supply conditions require the savings bank interest rates be below 4% or be above 4% then let it be so. 

Let the saving public decide in whatever form it would like to keep its savings depending upon the rate of interest being offered by various banks on various kinds of savings instruments.  At the same time the rate of interest on provident funds including Post Office deposits should not be reduced below eight per cent so long as the pension funds as also mutual funds are not placed on strong footing.  Reduce your debt burden, help reduce production costs but do not punish the savers especially the pensioners, old people, widows etc.  –INFA

 (Copyright, India News and Feature Alliance)

ECONOMIC HIGHLIGHTS

New Delhi, 10 February 2006

Vision 2020

INDIA A DEVELOPED NATION

By Dr. Vinod Mehta

The Sensex has crossed the ten thousand mark; the average growth rate for the first two quarters is above eight per cent.  It looks forward to participating in G-8 meetings. Most people now feel that India should shed the tag of developing country and be classified as an ‘emerging’ economy before being called a developed economy.

Some people may think of it as a cynical idea; even after 50 years of Independence we have not been able to ensure safe drinking water to every person or achieve 100% literacy, so why talk about India as developed nation? Well, this is a brute fact and should be recognized so and efforts doubled to solve these issues on an urgent basis.

However, it is the vision which is very important. Nehru had a vision of India as a developed country over a period of time. This vision led him to set up institutions like IITs, IIMs, CSIR, ISRO, Atomic Energy Commission. DRDO, Agricultural Universities, AIIMS and even research in the field of social sciences and humanities have made them known. People had at that time also laughed at him but today after 50 years, the achievements by Indian scientists, engineers, doctors, managers, social scientists are known the world over. We are at a stage now where we can talk about and think about   achieving the status of  a developed country in the coming years.

The eyes of many countries are focused on India. Each of its development or achievement is being scanned by these countries. There are some powers which would not like India to become a developed nation and so are engaged in pinpricking. The treatment meted out to our software engineers in Malaysia, Indonesia and Netherlands a few years ago, was a pointer in that direction. Even some of our drug companies had to face and are still facing legal battles against their newer drugs in some of the developed countries.

The ban on the transfer of certain kinds of technologies is also a pointer in the direction of slowing down India’s entry into the league of developed nations. Therefore, keeping in mind that other countries would like to stall or delay our march towards a developed nation, we must have a clearly defined path to achieve the goal of becoming a developed nation.

Having said that, let us now try to build on our strengths. As we know, the process of economic reforms is on for the past 15 years. During this period many new first-time entrepreneurs have emerged in the country such as Infosys, Wipro and many others. The process of economic reforms needs to be speeded up further so that we are able to complete this process in the next five years. If the economy is competitive in the international market it will automatically become strong over a period of time. Without a strong economy and a strong financial system we will not be able to keep abreast with the developed nations.

The results of economic reforms are now for everyone to see; Indian firms are becoming lean and cost effective now. After the reforms in the industrial sector we should now complete the economic reforms in the financial sector also. Steps have already been taken like the establishment of private sector banks, private insurance companies, setting up of Pension Funds, relaxation in foreign currency regulations and so on. But we must speed up the reforms in this sector and get rid of NPAs at the earliest.

Finally, we also need to have a world class infrastructure ready in the next 15 years. We need to set up world class communication system, transport system including good road, rail and air network.  All these are minimum requirements for the emergence of a developed nation which India aspires to be. ---INFA

 (Copyright, India News and Feature Alliance)

ECONOMIC HIGHLIGHTS

New Delhi, 25 January 2006

For Developing Nations

WTO MINISTERIAL: NOTHING TO CELEBRATE

By Dr. P.K. Vasudeva

There has been mixed reaction in various countries after the conclusion of the sixth Ministerial of the World Trade Organisation (WTO) at Hong Kong last month.  The 149-members of the developed and the developing countries who participated in the proceedings for six days are celebrating their victories. But the fact remains that the developing countries have not been able to achieve any concrete results.

The biggest success is that it has been able to produce a unanimous Declaration which reflects, apart from anything else, a strong desire among all members of the WTO to pursue the Doha Development Agenda in the future times to come.  The actual results of the WTO in future discussions can be gauged only the time will tell.  But the need to continue under the WTO auspices has been given more importance than the route of regional arrangement and free-trade agreements which are gaining ground among the South Asian countries, including India.

This is disappointing for the developing countries, considering the demands made by the bloc in the run-up to the meeting. Among other things, it was repeatedly said that the key to the Ministerial was agriculture and its success would be decided on whether the developing countries extract their pound of flesh in the sector vis-a-vis the developed economies (notably the US, the EU and Japan), specially in the areas of reduction of domestic subsidies (green and blue box subsidies), export subsidies and market access. Nothing of the sort was achieved in any of these areas.  This can be interpreted as a victory for the developed nations.

The greatest success for the developing countries has been getting together of 110 developing countries (including LDC) for the first time on a “common minimum platform” and act as a “development thrust” on the developed countries that made a small dent on the draft agenda.  This unity, if continues can deliver substantial dividends in the future times to come.

Among other things, the draft approved by all the 149 signatory countries decided the deadline for the elimination of export subsidies in the Agreement of Agriculture and “disciplines on all export measures with equivalent effect”.  This will be achieved in a progressive and parallel manner, to be specified in modalities, so that the substantial part is realized by the end of the first half of the implementation period.

The deadline was made by the EU for its convenience.  A close reading of the draft will indicate that there is no finality of the schedule as it has been made dependent on the “completion of modalities” – the deadline for which is April 30, 2006.  Given the record of the failed deadlines, there is no certainty that this date will be kept as final.

It has also been decided that discussions on Geographical Indications / Geographical Appellations and Biological Diversity would be further intensified so as to be completed by June 30, 2006.  The second draft is concerned with the reduction of subsidies on cotton demanded by the five cotton producing African countries.  The developed countries have agreed to reduce the subsidies on cotton after completing the modalities by April 30.

Commerce and Industry Minister Kamal Nath, who attended the Ministerial said the agreement on the elimination of export subsidies would help protect Indian farmers from unfair competition in the domestic market even while opening up new opportunities for the export of agricultural products.  This seems to be wishful thinking unless the final agreement is signed in 2008.

The Ministerial draft allowed the developing countries to declare an appropriate number of special products – that would remain outside the ambit of the tariff reduction formula – on a self-selection basis. It was decided in the Framework Agreement also on July 31, 2004 Geneva meeting, however, India has still not been able to decide and declare on the special products so far.

The developed countries had already extracted substantial concessions in the ‘July Framework’. The document had signalled acceptance of the continuation of the ‘Blue Box’ with five per cent reduction and 80 per cent of reduction of Green Box subsidies. The Declaration has completely ignored the problem of “Box Shifting” or transfer of trade distorting support into forms conveniently defined as non-trade distorting.

The only issue up for negotiations was the extent of and timeline for import tariffs and domestic subsidy reduction by different members and the date and the modalities for elimination of export subsidies on agriculture products, which has not been identified.

It also decided in this Ministerial for a Special Safeguard Mechanism under which the developing countries would be able to raise their import duties on agriculture products in the event of a surge in their imports or a fall in their prices. One has to wait and watch for this provision for its implementation while addressing the concerns, Kamal Nath said that India would draw up a list of 90 special products, which would be outside the tariff reduction formula and enable Indian farmers to safeguard their crucial crops from global competition.

On the non-agricultural market access (NAMA), the proposal submitted by ABI (Argentina/Brazil/India) has been preferred but there is no indication whether the “coefficients” mentioned in the Declaration relate to just two (the choice of the developed countries) or many (preferred by the developing countries, in particular India), which would take into account the different requirements of the poor economies, though it had been ensured that flexibilities for the developing countries would be included in the final package.

In this area, contentious issue was the degree to which developing countries would have to give up their right to protect the domestic firms in order to build and strengthen their domestic industrial base and face the threat of de-industrialization by opening up their markets to imports of industrial goods. The thrust of the developed countries was to demand that all industrial tariffs have to be bound in all countries except the LDCs and these bound tariffs must over the time cover across countries and products. The developing countries’ position was that this amounted to ignoring the implications of international inequalities in industrial history.

On services sector, the setback for the developing countries is true of the services area.  In the draft declaration Annex C, which argued for accelerating the liberalization of services, was bracketed, implying that there was no agreement on the area.  In a surprising development the whole of Annex C has been unbracketed, albeit with some changes.

This shows that the developing countries are now willing to engage in sectoral and plurilateral negotiations, though Cuba and Venezuela have formally expressed their reservations on the issue.  India’s role in mobilization of developing countries’ support for the inclusion of Annex C, driven by its own interests, was crucial.  India had asked for Mode 4 – movement of natural persons – concessions; the Declaration makes a special mention of such allowance only for the Least Developed Countries.

In sum, even at this framework stage, developing countries have given too much when they are in majority for little in return.  The exact level of the gains and the losses will be clear when the modalities have been fully worked out. ---INFA

 (Copyright, India News and Feature Alliance)

ECONOMIC HIGHLIGHTS

New Delhi, 19 January 2006

Weakest Link In Reforms

Processed Food Industry Needs Boost

                                                               By Dr. Vinod Mehta

After the opening up of the Indian economy, India has been importing agricultural products, including processed agricultural products in a small way. Over the past few years, a number of multinational companies have also started exporting processed food in the country. With the middle class growing and their living style changing, the demand for processed food will grow. Therefore, unless the Indian entrepreneurs taps this market, the foreign MNCs will take over the domestic market for processed food.

India has a cost advantage in a number of agro-based products.  The relatively lower prices on their own will not be of any help unless we make a sustain efforts in the international markets and produce goods which are in demand in those countries.  This implies increasing the productivities of various agricultural products, improving their quality, tastes, etc., application of highly efficient processing technologies and improving the packaging of those agricultural products.

The foreign countries, which include both developed and developing countries, are making sustained efforts to export their agro-based products to India.  For instance Malaysia is going full steam to increase its export of palm oil while Mexico is keen to increase its export of soybean oil to India.  Australia and New Zealand are looking for opportunities to export milk and milk products as well as other agricultural products to India.  The USA and European Union are also looking for exporting their agro-based products to India.

Since India cannot stop the entry of their products any longer it must make efforts to increase the export of its own agro-based products like basmati rice, fruit and vegetables, milk and milk products, tea, coffee, spices, meat and meat products and so on while at the same time catering to the vast Indian market.   India is not yet a major player in these products in the international market even though it has the potential; its record of consistency in quality, adherence to supply schedules is very bad which puts off the foreign importer.

Some time back, a study carried out by the Food Processing Ministry indicated that India is the largest or the second largest producer in the world of tea, milk, fruit and vegetables, eggs, rice, wheat, bananas and mangoes; it has largest population of cattle.  However, not much has been done to develop international markets for these products.  It is true that most of these items are being exported to West Asia but there is very large international market for these products outside West Asia. 

It is only recently that some of the companies have started marketing their products in the international markets under their own brand names.  For instance, till recently the Indian tea was being auctioned in bulk to foreign buyers rather than selling them in a packaged form.  It is only recently that Indian companies have started selling tea in a packaged form in the international market under its own brand names. 

Similarly, the cooperative sector producer of milk and milk products has also started marketing its product in the international market under its own brand name.  But these are only few exercises in brand building and cannot be said to establish markets for Indian agricultural products in a very big way.  Therefore what the country needs to do immediately is to chalk out a concrete programme for the development of processed food products industry so that India can become a major player in the international market in the next three to four years. The budgetary sops can make a lot of difference.  

As a first step India should concentrate on increasing the productivity of those agricultural products in which it has a comparative advantage.  It could be basmati rice or tea or coffee or it could be mangoes or bananas.  Some of the energies of our agriculture research centres should be concentrated on developing high yielding varieties of these products. This will ultimately be reflected in reduced production cost and reduced final price.

The second step should be the development of new preservative technologies, which are of international standards and can prolong the shelf life of those products without any much refrigeration.  For instance, we are producing large number of oranges including Kino (hybrid of orange and malta) yet 30% of this fruit goes waste, as we have not been able to develop any technology to preserve its juice.  Therefore, before bottled orange juice from Florida, USA enters the Indian market in a big way we must perfect the technology to preserve the citrus fruit juice in India so that we can compete effectively the US producers not only in our own domestic market but also in the international market.  Sixty five percent of the world mangoes are produced in India; India can tap the mango juice market of the world provided it perfects the technology.

The third step should be to improve the food processing technology itself and bring it up to international standards. The trend all over the world is to use such technology, which reduces wastage, and increase the shelf life of the product with little use of preservatives. For instance, milk treated with UTH process prolongs the shelf life of milk to at least six months without refrigeration. Incidentally, if we could reduce the final price of UTH processed milk, we would be relieving almost all the households in the country from the drudgery of boiling milk; UTH processed milk is better than boiled milk with a longer shelf life. Think, how much of lpg would be saved.

Finally, the food processing industry will have to pay attention to packaging of the processed food products.  At the moment the packaging of most of the processed food products is so repulsive such that even if we have very good product to offer it will not sell in the international market because of its poor packaging. 

In sum, India may have a comparative advantage in selling its agricultural products in the international markets but it will not be able to capture by itself the vast international market for various agriculture products without improving the quality of its products in every aspect.  We have a lot to learn in this respect from countries like Thailand and Philippines. We should expand our base in the domestic market as well as become a significant player of processed food in the international market.---INFA

 (Copyright, India News and Feature Alliance)