Imagine! Russia's raising interest rates!

People of talking of possible deflation.

People of talking of falling interest rates in banks and financial institutions.

But what is Russia doing. Precisely the opposite.

Since 2008, it has been raising it interest rates for the 6th time! The question that we next ask what about its economy. Well, we need to understand the Russian economy for this. 

Russia is supported by the enormous natural resources it possesses. It ranks 3rd globally in oil production, has 2nd largest coal reserves and 2nd largest consumer of energy. 

Its economy was supported by the boom in the commodity prices of natural gas, oils, metals and timber that make up 80% of the exports.

The raising of rates helps the economy in stabilizing the fund outflow, thereby averting a steep appreciation in the currency. The bank is also trying to artificially to value its currency to keep its exports competitive.

The solution for Russia lies in lowering their dependency on oil and focusing on investment in agriculture, science and innovation. Russia should also build the entrepreneurial spirit in the students that help them in creating small scale industries that responsible for job creation and growth in any economy.

GM's next!

Guys!

Don't get carried away by the recent stock market bull run seen in the past week. The Sensex has reached the 10500 mark and the Dow at 8000, it may be too early to say that the economic crises is over. 

GM will be the next to go in two months from now.. This is not my supposition. But that is what the market demands. The consistent flow of tax payers funds cannot keep the company going for long. The end has to come in some way or the other. 

The major problems that GM faces are

1)      Major Cost Disadvantage : Pension and health benefits for all its past employees

2)      Government imposed restrictions : Corporate Average Fuel Economy (CAFÉ) standards of 1975, Cap-and-trade regulation imposed by Obama administration

While the restrictions are good for the American economy as a whole, it the first problem that is causing most of the troubles. The assured benefits to all its previous employees is causing the operating margins to go down and even into losses as seen for the past couple of quarters. 

In this situation, a Chapter 11 filing that will help in the restructuring of GM and its operations seems to be the only possible solution. It will not cause the company to cease to exist but help it in recovering the lost ground to Toyota; and who knows, we might see a better GM in the future!

From "3-6-3" to "10-8-out"

During the lore days, bankers typically had a 3-6-3 formula. This essentially meant "borrow at 3%, lend at 6% and be at the golf course by 3 PM!" Those were however, those good times when the stocks were rising, consumption was high fueled by the emerging economies by maintaining high surpluses and huge forex reserves and the economies growing at an astonishing rate. 

Slowly this model began to change. With rising inflation, interest rates rose. So the new formula that emerged was 4-7-3! Following this was 5-8-3, then 6-9-3, and so on and so forth. 

This continued till the time was 9-12-3 (perfect combination of 3 multiples to send the global economies into a recession for a period of atleast 3 years). 

Then came the defaults! Failing economies and pressure of governments to reduce interest rates. 

Mind you, till now the borrowing has been fixed at 9 to 10% and that is in the form of fixed deposits! This means, bankers now are obliged to pay 10% rates atleast till the FD term. 

This phenomenon explains why banks are reluctant to lend. Lowering the interest rates to 8% will essentially mean only one thing for a banker, that is, 10-8-out. This means " borrow at 10%, lend at 8% and then be fired by the bank heads for maintaining such scrupulous lending and borrowing procedures!"

Why stimulus packages fail?

Since 1929, Governments have had one policy for tackling recessions - commonly known as 'anti-depression' arsenal of government policy. Those have been

1) Prevent or delay liquidation

2) Inflate the economy in a period of decreasing rising artificially

3) Keep wages high

4) Stimulate consumption and alter savings

With the probability of defaltion high in the current scenario, governments are trying their best to avoid a credit contraction. 

However, as it is known, every boom comes with a set of evils that is corrected in a bust. The same is seen in the current scenario. The excessive lending and leveraging was the evil that is now getting corrected across businesses and industries. 

The longer the boom, the sharper the bust is. 

In fact, deflation is the best cure in the current scenario as it would bring prices to the corrected level that would help spur the economy again.

With the government aids to the "too big to fail" institutions, the depression is only getting prolonged. Organizations like GM that are not being managed effectively have to let to fall. 

Government should maintain the system of laizzez faire, let the market correct itself and take the role of a regulator.

What the government can do is to set up a system of effective governance to keep regulations in place and avoid cases like Satyam emerging in the economy.

Seeds of future crises being sowed!

The government fiscal deficit is expected at 10% levels of the GDP!

What does this mean for the future (once the sand has settled down)

The high deficits would mean higher interest rates and we would witness crowding out by private players. 

But what about the existing private players who already have a large number of future investments. 

Take the case of Reliance Power. With 3 UMPP's, it is expected to spend about 55000 crores in the next 5 to 7 years period. With no operational project, it will have to meet the requirements only by debt. (The IPO bogus issue cannot be supplemented by another bogus FPO). 

Taking the average interest levels then to be around 8-9% (or probably more), it is a matter of concern of how it would be in a profitable position. 

An example of this, now takes us to a graver problem. 

All the investments are usually in power sector, infrastructure projects or capital goods. Given the imperative role they play in the economy, the Government has to ensure that these do not go into a failure or they would be the source of the next recession

Fall in agricultural development in India

Its official. 

The GDP figures have been reported at 5.3 % year-on-year basis for the 3rd quarter.

The IIP fell to 0.8% points from 4.7% in the previous quarter.

Fixed investment fell to 5.3% from 15.1%.

Private consumption weakened to 5.4% from 6.9%.

Exports increased to 11.4 from 10.6%.

Government consumption increased to 24.6% from 7.9%

Most of these figures were predictable.

 

 Whats alarming in this is the fall in agricultural output. Agriculture contracted by 2.2% (year-on-year) points from the past 6.9% level. 

A contraction is what is alarming here. Government had predicted the output at 6.1%!

I believe, its only the agricultural sector that can help India in the present crises. The exports are expected to fall given the hilt the rupee has reached to. Rupee cannot be expected to fall further given the present low levels. In addition to the weakening demand, a fall is certainly in sight. Industrial Production also cannot be expected to rise anytime soon. 

What can help India reach the 7.1% mark (set by the Government) is a rise in agricultural output. Food is one commodity that is the last to be affected during recessions. Being an essential item for living, its demand is expected to be maintained. 

Government has to play its role in promoting agriculture by providing more incentives and trying avoiding the internal migrations that we have seen in the past decade.

I think there lies a solution for India to maximise on its efforts in trying to out beat the crises and pave the way for future sustainable growth.

China's concern

After a spate of growth for the past 30 years, China had immense internal migration from the agricultural states to the towns. It is estimated that nearly 250 million farmers had come to industrial towns in hope of a better living. 

China is a country that is predominantly dependent on exports. This January, its exports sunk by 17.5% compared to last year. With the current economic downturn, there have been reports that the unemployment may be at 10%! This means that the newly working age group of youngsters and middle age group people will now be out of jobs, with no income. 

What's important is that this can be wide civil unrests and violence in China. The mob may take to robbery, stealing and other forms to earn their living. 

It is also estimated that the agricultural villages get nearly 30% of their remittances from the people in the towns. Even this now shall vanish. 

China will have to deal with the issue given the seriousness of the crises. Its economic stimulus plan of $586 million that plans to provide 650000 new jobs in the next two years may have to be further increased.

One good sign of the present situation is the rise of entrepreneurism in the country, not only in China but also in France. This situation calls for 'out of the box' thinking that shall be provided by the laws created.