Inflation-Manan Vyas

Food Inflation continues the North ward spiral with latest figures revealing inflation to be at 17.56%
RBI seeks to coordinate the fledging growth with monetary and fiscal policy.

As food inflation rises at alarming rates the RBI walks a tightrope between tightening credit policy and the nascent recovery. At the quarterly credit policy review the RBI increases the CRR by 75 basis points (0.75%) rather than the expected 50 basis points. The RBI however leaves the repo rate unchanged though it was expected to be increased by 50 basis points. The current inflationary situation however is supply side based, affecting the Consumer Price Index. The credit policy however has a larger impact on the Whole Sale Price Index (WPI). The CRR rise shall phase out Rs 36,000 crores ($7.2 billion) worth of liquidity from the system. The RBI has further initiated a phased rollback of fiscal expansionary policy by increasing the Statutory Liquidity Ratio to the pre-crisis level of 25% from 24%. Stronger inflationary measures may however damage the recovery.

Food inflation is however being joined by wider system inflation driven by demand side factors as expansionary factors work their way through the system. The RBI must coordinate the fiscal and monetary policies to achieve the fiscal deficit target and yet keeping the stimulus in place to allow the recovery to strengthen. However increasing global commodity prices, principally crude oil prices are threatning to affect the fiscal deficit and the Wholesale Price Index. The Kirit Parikh Committee recommended a drastic increase in the prices of the primary petroleum products. While petrol and diesel must be be allowed free pricing the kersosene subisdy must be decreased by Rs 6/litre and LPG subsidy be decreased by Rs 100/litre according to the recommendations of the committee. While these recommendations are too drastic as short term measures the 6th February Chief Minister’s Meeting with the PM may see a price hike of Rs3/litre in petrol and Rs3-4/litre in diesel. This shall reduce the fiscal deficit pressure on the government and allow the oil companies more headroom to increase profit margins , but it shall lead to a dramatic increase in the wholesale price index. To service the fiscal deficit target without jeopardizing the WPI the government must fast track the disinvestment programme as the increased cash flow situation shall allow it postpone increases in the basic crude commodities that have amongst the highest weightage in the WPI.
While the current growth in the WPI is demand based showcasing the positive impact of the exapansionary fiscal policy the global oil prices threaten to turn the WPI growth into a supply side inflation that shall lead to decceleration of industrial growth that is presently the highest in 18 months. It is therefore essential to postpone increases in the petroleum prices till industrial growth recovers fully.
Increasing the rates shall not help the problem as it will increase bond yields and will increase the interest payement on debt thus further affecting the fiscal deficit position. Thus keeping the growth, the WPI and fiscal deficit in mind it is essential for the central government to accelerate the disinvestment process that shall allow the Union government to maintain commodity prices at current levels leaving the industrial based inflation constant at the current 8.5% year on year.

In the meantime however the Union and State Government must act in coordination to increase the supply of essential grains in the country. To combat the supply side inflationary pressures the government must actively mobilise the Public Distribution System and release the grain supplies into the open market. Sharad Pawar has said that he believes that the inflation is supply side based and that credit policy shall have little impact on the Consumer Price Index, he believes the Chief Minister’s Meet shall be crucial. The annual budget may see an increased allocation for the farm sector, rural infrastructual developement and tax incentives to food processing industries with the aim of increasing supplies in the long term. In the year 2008-2009 Rs 58,000 crores of agricultural food items were affected by infrastructure deficit.

In conclusion the RBI and the Union government need to coordinate the priorities of industrial and wider based GDP growth with comparision to the supply side food inflation affecting the common man and the demand side Wholesale Index inflation that threatens industrial recovery. Furthermore fiscal deficit and monetary policy need to be reviewed with the disinvestment programme being accelerated to augument the government expenditure on petroleum subsidy and expansionary credit policy.

The Global Financial Crisis  exposed the excesses of Wall  Street giants as murky details of risky transactions running into billions of dollars came to light. Investment banks  had precarious over- leveraged positions and the  collapse of the mortgage  bubble brought the banks into full media glare. Suddenly the wall street giants were knocked down from the high pedestal they were placed on.

Riding on this wave of distaste for capitalist greed Barrack Obama and the Democrats won a landslide electoral victory promising change and regulation. Six months after his victory however Obama’s presidential approval ratings started slipping as the American citizens realised that radical financial and regulatory change was not possible in a $14 trillion economy. Furthermore bail outs of investment banks by the Democratic government were seen as a sign of betrayal by the average American populace. Investmentbankers continued to prosper receiving obscene bonuses in recessionary times.

American citizenry was boiling over as the new Democratic government worked together with Wall Street to lift the economy out of the recession. Repeated explanations by top government ministers and prominent economists proclaiming that bail outs were essential for stability and the prevention of a depression failed to placate a nation sunk in unemployment, job cuts and falling salaries. Obama’s approval ratings had fallen below the 50% mark.

Unexpectedly  however the Obama presidency is presented with a similar opportunity – The British Petroleum Oil Spill off the coast of Florida.

7 of the world’s ten largest companies are petroleum companies. Exxon Mobil earned a world record profit of $44 billion in the year 2007-2008. After Wall Street, the media glare has swung onto the Oil & Gas companies. Running massive operations throughout the globe, regularly buying assets running into tens of billions of dollars and constantly exploring the deep seas for larger deposits, Oil & Gas is a behemoth that overwhelms Wall Street. British Petroleum is the world’s 4th largest company and yet only the third largest petroleum company having revenues exceeding the nominal GDPs of more than a 150 countries.

The clean up and rehabilitation processes following the Exxon-Valdez spill took over a decade to arrive at a semi-satisfactory conclusion. And the Exxon-Valdez spill is said to be a mere fraction of the Deep Water Horizon spill.

In his dealings with bankers following his landslide election victory in the midst of the worst recession since the 1930s, Obama had his hands tied behind his back. Firstly he was handling policy framework related to trillions of dollars of credit default swaps and collateralised debt obligations (refer to ‘The Global Financial Crisis’  for details). The financial system was precariously placed, rash decision making to please the electorate would have had catastrophic results. In the above circumstances Obama acted cautiously and responsibly and authorised continued government support to banks severely affected by the liquidity crisis. In the process however the Obama-led Democratic government suffered political consequences, a prominent example of which was the loss of Edward’s Kennedy’s seat in Massachusetts, long considered a Democratic stronghold.

The Obama government has however brilliantly governed the nation at the peak  of the financial crisis and now as the economy emerges out of the woods the Obama administration has passed a Financial Reform Bill that seeks to increase regulation and government intervention in the financial markets. Ironically Scott Brown,the Republican that won Ted Kennedy’s seat voted FOR the bill. While the medium term political impact of this bill for Democratic government is hard to predict, the short term presents a opportunity for Obama to gain some quick political points.

BP is a British company and strong action against the company is unlikely to affect the American economy. In his dealings with Wall Street Obama was dealing with globalised American corporations and strict sanctions on those giants would have mired the economy further into a depression. That is not however the case with BP. Investigation has revealed that the oil spill though unfortunate, could have been prevented and the responsibility lies largely with the company itself. Furthermore BP has a poor safety record and smaller incidents in the past are now coming to light.

Obama may now fully assert the authority of the world’s most powerful economy. Americans are viewing petroleum profligacy in the same light as Wall Street greed and Obama may sense an opportunity in this situation. BP’s insolvency would have only a marginal effect on international oil supply as BP accounts for less than 1% of global supply. Obama would seek the maximum compensation possible and the Democratic legal team is already scanning the Constitution for possible legislation to be used in the circumstances. Presently reports suggest an escrow fund being set up with a balance of $20 billion. Obama would seek to increase that figure and more importantly stress on accountability of international corporations. Through determined negotiations he can send out a strong message of accountability to all Multinationals. Tony Hayward’s (CEO of BP) vacation and the ensuing public uproar bears a direct resemblance to the public uproar over banker’s bonuses amidst the recession. Taking strong decisive action and stressing on the message of accountability Obama may gain much political mileage.

A positive off-shoot of the oil spill is the intensified focus on the Research & Development of alternative fuels. In the days following the spill Barack Obama had announced renewed government support towards development of clean and sustainable fuels. Following this announcement shares of solar development companies across the Silicon Valley, Germany and Japan rose significantly on the prospects of increased demand from USA.

In conclusion I would like to say that the Democratic government has been responsible in governance in the midst of a severe global crisis and the Wall Street reform bill is a positive step towards transparency and regulation. The BP spill gives the government a chance to further stress on accountability and liability of major corporations. Acceleration of R&D of green energy is major positive from the Deep Water Horizon Spill.

On March 31 2009 L.K. Advani the then leader of opposition and prospective Prime Ministerial candidate    raised the issue of Indian black stashed in Swiss Banks and numerous other tax havens. He quoted the  massive figure of $1.4 trillion (more than India’s nominal GDP) as the amount being illegally held abroad in  numbered accounts. The BJP quickly scaled up the issue throwing figures of Rs 71 lakh crores around in the  media and promising to bring back the money if they were elected as the ruling party. The ambition was  noble doubtless, but what needs to be examined is:

‘Was it just blustery election rhetoric?’  OR  ’Is it actually possible to bring this sum back into our nation, a sum that can instantly transform the economy and possibly eradicate poverty as we know it?’

Germany applied pressure on Liechtenstein (a European tax haven, famous for banking and numbered accounts)  in 2008 to obtain details with regard to more than 400 suspected tax evaders. After sustained pressure Liechtenstein succumbed and handed over details that uncovered a tax evasion scam running into billions of euros. Germany however borders Liechtenstein and is a major trading and manufacturing partner of the small principality having a population of only 45,000. Germany thus had significant leverage to force The Liechtenstein Global Trust (owned by Liechtenstein’s ruling family, also Liechtenstein’s largest bank) to bypass banking secrecy laws and disclose confidential client information.

In a similar but more significant case the Government of the largest economy in the world guided by their Internal Revenue Service (IRS) applied intense pressure on Switzerland to disclose confidential banking information related to 4,450 US citizens suspected of tax evasion. The Swiss have since long prided themselves on their independence and neutrality. They remained neutral and independent during both the World Wars, an island of calm amidst a raging ocean of violence and destruction. The Swiss have however faced intense criticism from some quarters for their stand especially during the Nazi era. The neutral status of Switzerland and their banking secrecy laws helped many Nazis stash away huge sums of loot during their decade long domination of Central-Eastern Europe. The Swiss however are staunchly independent and pride themselves on this status. They have stayed out of the European Union, have maintained the currency Swiss Franc though surrounded by nations carrying the Euro and joined the United Nations as late as 2002. Furthermore Swiss banking and secrecy is regarded by Swiss citizens as a flag that represents their trust-worthiness, independence and neutrality.

In this context therefore it is extremely tough to put leverage or pressure on the Swiss, especially in relation to Swiss Banking Secrecy. The United States however threatened to cancel the banking license of UBS (Switzerland’s biggest bank) with respect to it’s role in helping US citizens commit income tax fraud and tax evasion. UBS has a significant presence in the     USA with office skyscrapers in New York and Chicago. 38% of UBS staff is employed in the USA.       Furthermore UBS is struggling in the global financial crisis racking losses quarter-on-quarter. In this  context USA was able to apply considerable leverage on UBS to disclose account details of 4,450 suspected  evaders.

Now examining the Indian economic and political scenario that presents multiple contradictions. In the year 2006 a study was undertaken by the Global Financial Integrity Survey that revealed that India had   lost an estimated $136 billion between the years 2002-2006 through money laundering activities. After several estimates undertaken under various assumptions the grand figure of Rs 71 lakh crore was announced taking into consideration all money laundering activities that had been taking place in the post independence years. The list announced that India had a sum of $1,456 billion in Swiss Banks that accounted for more than 50% of all the money kept in Swiss Banks. The Swiss categorically denied the figures. They said that it would be a primary violation of their secrecy norms if they compiled a list based on the nationalities of their customers. They said that no external financial entity had access to banking facts and figures and the list was a hypothesis not backed by substance.

Examining the Swiss reaction it is obvious to find the logic in what they say. Firstly it would be not be possible for any external entity to examine banking information, secondly it would be impossible to arrive at the figure of $1,456 billion as most of the confidential records would not contain any information with regard to the nationalities of the depositor. That in itself would violate their basic secrecy laws. Therefore serious questions may be raised on the figures announced by the Leader of Opposition.

However continuing the analysis on the assumption that the figures are accurate: The figures state that Indian citizens hold more than 50% of all deposits in Swiss Banks. If this is indeed true then revealing information to the Indian government would have disastrous consequences for the Swiss banking industry. It would be a direct threat to their largest customer base and would lead to an immediate collapse of the banking industry. Secondly, the Swiss are facing increased competition by numerous other tax havens across the globe including the Cayman Islands, Liechtenstein, Cook Islands, Barbados and many more spread all across. In the face of increased competition the Swiss would guard their reputation for secrecy ferociously. They are even more cautious now after revealing account details to the US as they look to, firstly reassure their customers world wide that Swiss secrecy is indeed still intact and secondly they look to prevent a potential cascade effect with other countries also joining the fray and asking for account details. The Indian investment and priority banking industry is still in its nascent stages and Swiss banks do not have significant exposure to the Indian economy. In this case therefore India has no direct leverage on Swiss Banks. We have examined the significant leverage possessed by Germany and USA that allowed them to access a specified number of accounts under special scrutiny. India however does not possess noteworthy instruments of pressure on Switzerland.

Considering all of the above factors and the present context of Swiss banking, I feel that it would not be possible for the Indian government to access Indian wealth locked away in numbered accounts.

Now reexamining the question:

‘Was it just blustery election rhetoric?’  OR  ’Is it actually possible to bring this sum back into our nation, a sum that can instantly transform the economy and possibly eradicate poverty as we know it?’

The BJP government was in power from 1998-2004. The question of black money was not effectively raised at that point. Secondly the issue was not actively raised in the years from 2004-2009. However come April 2009 L.K.Advani decided to use black money as a primary election plank and publicly declared that the BJP government would make it their top priority to get the money back.

In my opinion BJP should have concentrated solely on eradicating corruption and tax evasion in the future. A focussed approach and an election campaign based primarily on the cleansing of the bureaucratic system would have won the BJP more seats in the national elections. It is necessary to focus on the efficient and clean running of the bureaucratic system and legislative expansion of the power of the Income Tax Department of India to actively pursue suspected tax evasion cases.

‘Was it just blustery election rhetoric?’

Yes it was, and it cost the Bharatiya Janata Party the national elections.