Wednesday, November 19, 2008

Unviable Suggestion!!

The present crisis over turned the basic idea of the capitalism that "the state should assume the role of facilitator rather than the role of regulator". It is quiet evident from the recent acts of the notable 'leaders of capitalism' as United Kingdom nationalized the private commercial and investment banks (pearls of capitalism), United States embarked on entering into the governing bodies of yesturdays corporate kingdoms. With the yesturday's statement, the Government of India took the anti-capitalist movement to the next levels.  Given the status of the economic environment, i propose to critically evaluate the Govt of India's move in asking the industry to cut the prices of the goods produced by them.

During the last couple of months, the Govt of India infused Rs. 2,80,000 crore through a host of monetary measures and another Rs 1,00,000 crore through various fiscal measures. Thanks to the cordinated efforts by Ministry of Finance and RBI, the inter bank rates have (virtually) came down to the normal levels (though i suspect the normalcy in terms of transactions among the banks). Here, one should question the effectiveness of the measures so far taken by the MoF and RBI. These have been initiated at a time when the transactions among the banks were virtually non-existent, call money rates were at their hights of around 23% and most importantly the banks were no where near the position of either continuing or renewing the expired credit lines to the corporates. As noted by the pink papers, these measures are successful as they claimed to be drived down the inter bank rates. Here one should understand the real picture  what made the inter bank rates to reach the normal levels?.  It would have been appreciated if the RBI & MoF measures improves the confidence among the banking community over the solvency of their peer and if they transferred the newly infused liquidity to the real economy through continuing and extending the credit lines to the industry. Hardly there is no evidence on this front, there is no evidence of either new or renewed credit lines (without additional restrictions) to the industry; there is no evidence of healthy inter bank transactions. Hence, it is very clear that the RBI & MoF measures reduced the demand for call money (thereby interbank rates) by boosting  the banks with the large chunk of easy money which has no signs of reaching the proposed ends (moreover it is reaching back to government coffers as banks are now heavily purchasing the government securites). Essentially, these measures so far taken have neither yielded  fruits to the (real economy) industry nor to the banking sector as they failed to improve the confidence among the ultimate economic agents (consumers).  Moreover, the steep fall in retail sales have jeoparadized  the industry (which never had the chance of earning super normal profits given the fierce competition resulted from opening up of the economy) prospects by resulting in accumulated inventories, and increased credit bills. At this stage, the viability of the earnest Minster of Finance statement may be questioned? It makes me to suspect that the Govt of India is still in the dreams of "strong fundamentals" and not yet ready to accept its vulnerability to the crisis. 

In this situation, the government should have the sole goal of 'improving the confidence' among the economic agents.  It may be effectively achieved by relying heavily on fiscal policy measures. That is 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.!! (as i blogged for quite some time ago).

(Constructive comments and suggestions are encouraged!!)


Swapnil said...

Surrendra start publishing articles on Newsprint... Nothing more to comment!!!


Yogesh said...

Mr. Rao

I dont completely agree with ur argument, since i see valid reasons and points why the FM has made such a statement, and probably just to support him and the present cause i can say from that point of view that its ok to ask the industry to reduce the price of goods(products and services) where ever possible(its the company's call whether to do it or not, its just a request).

The reasons being
> The economy needs to bring back the consumer confidence, which i think is high when the consumer buys more.
> Consumer will buy more only when he has money, so all those liquidity enhancing steps (assuming the steps taken would actuallu work)were taken earlier
> If the consumer has some money but everything is costly, he would instead like to either use it for essential stuff or save
> So may be if the industry reduces the prices of certain goods, the consumer may not be that hesitant to buy stuff, which would help to reinstate confidence in the economy as a whole
> Plus if the consumer does not buy due to all these factors including high prices, low income, no liquidity etc etc, the companies have 1000's of employees to take care of, if it is not able to sell its goods, it may have to lay them off or pay them for doing nothing (highly unlikely).

So keeping in mind all such things which are inter connected and which dictate other happenings, such statement from the FM must be looked as a request from the GoI to re-instill confidence in the economy by keeping the consumption part active, which may hit the profitability of the companies temporarily (i know that it is already hit) to help the economy stand and avoid situations of Bailouts and other life saving needs.
There are many other benefits and reasons i can think of for the above argument i made. Just my view of why such a statement could have been made. !!

Surender Komera said...

Dear Yogesh,

Your comments are well taken, I will certainly address them in due course of time, through my forth coming posts in this blog. Here i would like to address one of them:

1. No rational firm will go for cutting its production and laying off its employees as long as it can cover its variable costs and any portion of fixed costs. The current economic environment is not able to accept the current prices which just cover variable costs. Any further cut in the prices will force the firms to bear even the variable costs. Hence, the firms are forced to cut their production and lay off its employees at least to avoid the variable cost.

You may find the answer to some of your arguments in the links provided in my today's update "Similar thoughts" and remaining will be addressed in due course of time.

Thanks for your interest and comments.

With regards,