Tuesday, October 21, 2008

Break the Path Dependent Ideas!!

Eversince sub-prime crisis  initially unearthed during April 2007 in United States, it has been widely written and extensively discussed by the independent scholars, policy makers and so on saying that: the fundamentals of the Indian economy are extremly strong, India has not yet been integrated to the world economy. Hence, the possible impact of the crisis in the western financial system will be very mild on the Indian economy.  By naively subscribing to this view, RBI has maintained the real interest rate as high as 4% (three month rates), SEBI continued to control capital inflow by many ways such as restricting Paricipatory Notes untill early September 2008. Where as the central bank of US (Federal Reserve) kept the credit policy so loose that short term interest rates are in the negative territory during the period.

Almost a year later now after September 2008 which experienced the major collapse of financial system in the western world, we are now feeling pinch and observing the worst part of the effect in our economy.  Our stock markets have fallen steeply by almost 40%, inter bank call rates touched the peak of 23% unearthing the worst ever credit crunch. This resulted in either fully or partially abondened credit lines to the corportes and there by affected the indusrial production. The real estate markets in India have slowed down and the home prices in most of the cities are falling sharply.  In a way high degree of distress has been witnessed in the overall economy. This has disproved the perception of our policy makers over the 'strong fundamentals' and 'decoupled of the economy with the rest of the world', that is based on the position of India 10 years ago. 

 Coordinated effort of RBI, SEBI and Ministry of Finance:

Similar to most of central banks of the developed world, Ministry of Finance and SEBI led by the Indian central bank has now (after realising the true picture) come out with a series of positive steps to correct the system during the last three weeks. a 250 bps cut in CRR, a special window of Rs 20,000 crores to MF to ease the redemption pressure, reliease of Rs 25,000 crores under the loan weaver scheme, a 100 bps cut in the (repo rate) policy rate, a de facto 100 bps cut in SLR, the reversal of the mistakes on PNs of October 2007 and ease of FDI norms. All these measures seems to bringing back the normalcy in to the system as they resulted in bringing down the call rates to around 6% and reduced the panic selling in our stock markets (Indices have taken the northward direction!!) In a way RBI and SEBI exhibited the greater maturity in dealing with the present borrowed crisis without resorting to possible politically motivated measure of "banning of short selling".  Hence, it may be highly commendable to break the subscribing to the path dependent thinking process and accept the Indian economy as nascent market economy in arraiving at policy decisions !!

(The author has highly benefitted from the writings of Ajay Shah, Ila Patnaik and Arthur M Okun)

Comments and suggestions are encouraged!!

Monday, October 20, 2008

New dimension to Trade theory

You might be well aware of David Ricardo's 'Theory of Comepetitive advantage' which advocates that the countries which are relatively competitive enough in producing different goods/services should participate in trade ( E.g. you are a better baker and i am a better shoe maker, the trade between us improves the prospects of both of us). This basic idea of trade relevence dominated the thought of International economics and trade, in a way it laid the path of economic thinking of international trade.  

Paul Krugman is one of the first to realize that those kinds of path dependent models only explained about half of the trade in the world, and he became the first one to explain economicially why it (also) made sense that countries that are similar should trade as opposed to courtries that are differnt. He explains that  such trade between the countries that are similar, enables specialisation and large-scale production, which results in lower prices and greater diversity of commodities. The development of large scale production for the world market has contributed significantly for the enhancement of standard of living of most of the countrymen (mostly in developing counries)  by the way of attracting more people to cities and higher wage rates.  Paul in his path breaking work on trade theory showed how economics of scale influence trade and urbanization.

(The author has greatly benefited from the writings of Simon Kennedy and Rich Miller)

Comments and further contributions are encouraged!!

Saturday, October 18, 2008

Current Recession: Policy Implications

Before going ahead with this weekend blog let me Congratulate PAUL KRUGMAN who has been honoured with the Noble prize for the year 2008 in Economics. His theoretical contributions to International trade and economic geography are detrimental in bagging the highest honour. In his recent piece in Newyork Times, the 2008 Noble Laureate in economics said that "it is politically fashonable to rant against government spending and demand fiscal responsibility.  But right now, increased government spending is just what the doctor ordered, and concerns about the budget deficit should be put on hold". In the following piece of my blog, i will try to relate his statement with the current global financial condition (I dislike to call it as "crisis").

Stock markets are finding new depths in most of the days, money markets, credit markets are vitually shut down. In addition to that we saw the falling retail sales so as the industrial production. All these prevailed conditions makes me to remember the recent recession of late 1990s resulting from technology bubble. The policy response to such recession was a success story.  The Federal Reserve could engineer that recession by cutting interest rate which resulted in the increased employment opportunites. But the current prevailing situation is different from that of the situation prevailed during late 90s in many ways. For quiete sometime Federal Reserve has been resorting to  interest rate cut to prevent the unemployment rates from raising for several other reasons of global slow down. This brought us to see the fed rate at around 1%, but there is no sign of declining trend in unemployment rates. Moreover, the decline in the retail sales caused the accumulated inventores, forced reduction of the industrial production and further retrenching of jobs. As per the old dated economic text books the current economic situation is precisely referred as the "Economic down turn" as a synonym to "recession".  How long our markets have to suffer from such epidemic? , is the trillion dollor question!!

In this situation there is not much can be done by the central banks. On the other hand, as J.M. Keynes advocates a lot that government can do through its fiscal measures - increasing the benefits to the unemployed (social security measures), infrastructure spending  to boost the aggregate demand. The agrument against infrastructure spending in the prevailing situation is that they take too long to show the impact, but such an arument has no validity as the chances that this slump will be over anytime soon are virtually zero.  Hence, it may be reasonable to get such projects get rolling and slowly injecting the confidence among the economic agents.!!

Constructive comments are honoured!!

Friday, October 17, 2008

Right time to embark on "TRADING"!!

"Be fearful when others are greedy, and be greedy when others are fearful," Buffett .

Economic news is scaring,  with the financial markets are in a mess, raising unemployment figures and faltering of business activities , everywhere pessimism and fear component is at its helm among the investment community.  Taking cue from Buffett, the smart young lad has entered into the market purely with greedy and took a position on a scrip which recently got the beating at bourses purely to have a feel of market.   Let us wish him the "Vibrant experience!!".

Comments are encouraged!!

Mild Thunder!!

We are at the end of the crucial week which saw greater turbulance in the financial markets in the early phase. But towards the end, it looks like we are approaching the normalcy.  As noted by Mr Kamath, ICICI is heading towards normalcy and now focus has shifted from ICICI and Reliance com to RIL and TCS , the scrips of which were bashed at the boarses. The present normalcy may be attributed to the Indian central bank efforts to fight the liquidity crunch by slashing the CRR by 250 basis points and the special window offered to the MF.  These measures also accompanied by the Ministry of Finance release of long standing refinance of loan weavers amounting to Rs 25000 crores into the system.  These measures eased the liquidity situation and brought down the inter bank call rate to 6.9%.  

Given the positive surge set in yesturday all over the global markets, our markets are expected to open positively and hope mild upward surge!!

Comments are encouraged!!

Thursday, October 16, 2008

Basic Statistics: Hypothesis Testing

Hypothesis is a tentative assumption about the population parameter.  Such a tentative statement is called Null hypothesis and the one opposite to such tentative statement is alternative hypothesis. Usually the research hypothesis is expressed as the alternative hypothesis.

Type I and Type II errors: As hypothesis tests are based on sample information there will be the possibility of errors.

Type I error: Rejecting the null hypothesis when it is true
Type II error: Accepting the null when it is not true or false

Level of significance: It is the probability of making a type I error when the null hypothesis is true. The applications of hypothesis testing that only control for the type I error are called as "significance tests".

Most of the hypothesis tests control for the probability of making type I error, they do not control for the probability of making type II error.  Hence, though we decide to accept null, we can't determine how confident we can be with that decision. Because of the uncertainity associated with making a Type II error, it is suggested that the use of the statement "do not reject null" instead of "accept Null".  In effect by not directly accepting null, one can avoid the risk of making Type II error.  

Whenever the probability of making Type II error is not controlled, the optimal conclusions should be 'do not reject the null' or 'reject the null'.

The constructive comments and additions are encouraged!!

Wednesday, October 15, 2008

Derivatives and Monetary policy


1. How the growth of derivative markets affecting the influence of monetary policy?

My arguments will be posted during this Diwali holidays (I deeply regret for the delay)!!

Constructive comments/arguments are encouraged!!