India- An Examination of another Emerging “Miracle”

From Say hello to China's Price/Wage spiral


Inflation in emerging countries is higher, demand-pull in nature, and advanced to the stage of a wage-price spiral; in developed countries, it is lower, cost-push in nature, and not advanced to a wage-price spiral.


This the reason for the unwinding of the secular growth stories of the emerging countries. When central banks in the west let the deflationary forces of the stagflation slow the economy to deflation, as they did in July 2008- September 2008 and as Fed is doing now (Q.E has stopped), until Q.E 2.0 comes with vengeance.


But demand pull inflation and wage-price spirals tend to be more stubborn. Taming them usually requires a substantial tightening of monetary policy. Emerging countries have mismanaged their economies to the extent they killed off their vaunted secular growth stories. And they are not the first: in the 1980s, Japan was said to be on a path to overtake the U.S. but then it fell into a two-decade deflationary period.


Like Japan in its heyday, China and India have been enhancing export competitiveness by maintaining artificially low currency rates. Their well publicized growth trajectories will be proved to be chimeras.

From Australia’s Housing Bubble- Past the Point of No Return:

So the big next crisis will be outside the U.S, with the key being inflation and dollar liquidity. With all the world depending on helicopter's Ben dollars falling around on all who is too big to fail, a short squeeze in the dollar(like what is maybe happening now with the potential collapse of the Euro) will bring all the "emerging world" to its knees. Another thing that could happen, with or without a dollar rally is a pickup in inflation which will force those central banks to tighten. In India, China and Australia it seems like it is happening and in Israel it is happening for sure.


From Understanding the Dollar Standard

So, when the Fed embraced on Q.E, it not only liquidated the U.S financial system, it liquidated the whole world, since it enabled all central bankers around the world to print money. As long as the FED is not embracing on Q.E 2.0, then no central bank can affectively print money, and world money supply is shrinking, which is profoundly deflationary. The core principal of this system, is that all fiat currencies are derivatives of the U.S dollar; If the U.S inflates, the whole world will inflate with it, and if decides to tighten (even for a short period) then all the world is forced to tighten with it.


The subject of the dichotomy between the deflationary forces in the U.S, Europe and Japnan, and the inflationary forces in the emerging world was a subject of a recent article by Ambrose Pritchard:


World splits in two as East tightens while West stays super-loose

The central bank raised its reverse repo rate a half point to 4.5pc, still far below the level of inflation. Food prices have been rising at 16pc.
"Inflationary pressures have exacerbated and become generalized. Real policy rates are not consistent with the strong growth that the economy has been witnessing. It is imperative that we continue to normalise our policy," said the bank, which also raised its repurchase rate a quarter point to 5.75pc.
"The bank is fiddling while Rome burns: this is little more than a token gesture," said Maya Bhandari from Lombard Street Research. The combined fiscal deficit of the central government, states, and hidden subsidies has been running at 11pc, despite a boom that has flattered the deficit figures when adjusted for the cycle.
Ms Bhandari said rises in public wages have increasingly been "monetised" by the ultra-loose policies of the central bank. Inflation is now at risk of spiralling out of control. Primary articles inflation, watched as a leading indicator, is already at 16.5pc.
India has run into serious capacity constraints, relying on rickety infrastructure and an outdated energy grid that cannot sustain break-neck industrialization.


The influence of the easy money in the west was subject to a recent IMF report as well:

Research by the International Monetary Fund confirms that liquidity in developed nations (Advanced Economies, AE) indeed flows into emerging markets (EM), thanks to today's global financial market linkages.
Thus the easy money policy of the West becomes the easy money policy for the world, even when the developing world is trying to tighten its policy.

Why?

Well, if emerging markets tighten monetary policy too much, by raising their interest rates, it will increase the flow of capital into their economies since interest rates will still remain low in developed nations. (Money tends to chase higher returns via interest rates)
Thus as they try to reduce domestic liquidity by tightening monetary policy with higher interest rates, they will be hit by a counter-productive inflow of global liquidity chasing higher interest rates, which sort of kills their attempt to tighten. Higher relative interest rates also lead to currency appreciation, which many emerging markets are loathe to endure since it hurts export competitiveness.
That's how easy money in America and Europe becomes easy money everywhere, and it's already priming potential emerging market asset bubbles:

IMF:
Capital inflows have resumed in EMs that came out relatively unscathed from the crisis. Such flows could be driven by a combination of push and pull factors. Historically, accommodative monetary policies in AEs have been associated with rising capital flows to EMs [See the chart above]. Continued easy policies in the near term in AEs could thus push even more capital to EMs. At the same time, EMs that are recovering briskly from the crisis with better fiscal sustainability indicators than AEs may continue to pull capital by offering promising investment opportunities in a high growth macroeconomic environment. Overall, such inflows are just returning to pre-crisis levels. Although they do not generally pose a problem yet, surges in such flows going forward may complicate policy challenges for EMs recovering quickly from the crisis.


In March 2010, Waverly Advisors worte a nice report that aritculated how India’s inflation problem is destroying the low and middle class:

February Wholesale Prices in India registered at an annualized 9.89% versus 8.56% in January according to a Ministry of Commerce release this morning, with the critical food component of the basket climbing by 17.79% over last February. Although February’s Y/Y food price inflation has declined sequentially from December’s high of nearly 20%, the pressure on the government to act will be tremendous.


Factory gate prices are not a true reflection of cost-to-consumer, but these WPI figures, as the best available data, seem to indicate that the Singh Administration grossly underestimated the potential for inflation as the desired stimulus led output and investment gains have exacerbated the agricultural complex after last year’s disastrously dry monsoon season. The public assurances of Singh’s administration and Central bank Governor Subbarao that food prices will moderate in the new year (March to March) is meaningless if this year’s monsoon rainfall disappoints. Note that ,with agriculture accounting for nearly 20% of GDP but employing over half the population, water is the most volatile commodity in the Indian economy.


Even the Reserve Bank of India admits they have an inflation problem (Too bad it is keeping interest rates at a negative 8%):

Inflationary Pressures

Regrettably, though, inflationary pressures have been visible in the economy even in the early stages of the recovery. Chart 2 indicates that the turnaround in headline inflation, as measured by the overall Wholesale Price Index (WPI) began in June 2009. This was clearly a period in which the recovery was in its very early stages, with the economy growing at an annual rate of around 7.5 per cent, significantly below the pre-crisis rate. It was logical to attribute the rise in the inflation rate to supply-side factors.
The validity of this inference is evident from the same chart. The prices of primary articles began to rise in March 2009 but the rate of increase accelerated sharply around August. A significant contributor to this was the rapid escalation in food prices as a consequence of a weak monsoon. Later in the year, as prospects of a global recovery looked brighter, commodity prices continued to rise. The combination of rising global commodity prices and domestic food prices contributed to a sustained increase in the inflation rate for primary articles until April 2010. There has been a plateauing since then. This is partly attributable to a global softening of commodity prices, as uncertainties about the sustainability of the recovery have arisen. If this continues, it will help to reverse the trend in this component of the index. But, the most significant cause of reversal is likely to be a moderation in food prices over the next few months in response to a reasonably good monsoon.


So did Minister of State for Finance, Namo Narain Meena:

India has the highest rate of inflation among major developing economies, Minister of State for Finance Namo Narain Meena informed the Lok Sabha today.
In June, 2010, India's inflation based on the Consumer Price Index for Industrial Workers (CPI-IW) stood at 13.7 per cent, much higher than that of Indonesia, Brazil, China and Russia.
The corresponding figures for Indonesia, Brazil, China and Russia are 5.1 per cent, 4.8 per cent, 2.9 per cent and 5.8 per cent, respectively, Meena told the Lok Sabha in a written reply.
"In India, inflation based on CPI-IW remains in double digit since July, 2009. The reason behind double-digit inflation was high food inflation and industrial growth," he said.
Prices in India are rising more steeply than even neighbouring countries like Pakistan (12.7 per cent), Sri Lanka (4.8 per cent) and Bangladesh (8.5 per cent in April).
The CPI-IW came down to 13.7 per cent this June in the wake of measures taken by the government and a continuous decline in food inflation since January this year, Meena said.
Inflation of food articles declined to a 13-month low of 9.53 per cent for the week ended July 24 from the peak level of 21.05 per cent prevailing during the week ended November 28, 2009.
In another reply related to inflation, Meena said, "It is expected that measures initiated by the Reserve Bank of India will help moderate inflation by reining in demand pressures and inflationary expectations."


Unlike China, India also suffers from a current account deficit:

                                                             Source: Tradingeconomics




Lacking the courage to truly fight inflation, India’s policy makers are hoping the Monson season may save them:

 India’s officials are splitting over how to quell the inflation hammering the 828 million people who live on less than $2 a day, with the government counting on monsoon rains to end a debate that risks policymaking paralysis.
Finance Minister Pranab Mukherjee Aug. 4 warned growth will suffer if interest rates rise too fast, after the Reserve Bank of India last week accelerated its pace of increases. A central bank official was stripped of some powers this week after saying the RBI hasn’t gone fast enough, The Economic Times said, and opposition parties have stalled parliamentary proceedings over the government’s failure to stem inflation.

At stake for Prime Minister Manmohan Singh is sustaining support for his coalition government, which aims to sell $8.7 billion of stakes in state-owned companies and ease investment rules for foreign insurers including Aviva Plc. Mukherjee said that inflation is poised to recede as the year’s monsoon resuscitates an agriculture industry that was hobbled by last year’s sub-standard rainfall.
“The government is hoping rains will help drive prices down,” said Jagannadham Thunuguntla, chief strategist at SMC Capitals Ltd. in New Delhi. “If rains aren’t good, food prices will remain high, and we will see stronger political protests and public backlash.”

Inflation Impact

In the past decade and a half, Indians have ousted at least two national governments after inflation eroded the spending power of the nation’s poor. Price increases of more than 6 percent between 1994 and 1996 helped eject Prime Minister P.V. Narasimha Rao. His Congress party-led government lost to the Bharatiya Janata Party, which was voted out in May 2004 after prices rose in eight of the 12 months that preceded the poll.


The interest rate hikes are simply not enough:

The accelerated pace of interest- rate increases by India’s central bank may fail to quell the fastest inflation in the Group of 20 as the nation suffers the consequence of underinvestment in electricity and transportation.
Reserve Bank of India Governor Duvvuri Subbarao boosted one of the benchmark rates by a half point yesterday for the first time since 2008, and pledged to review borrowing costs at meetings every six weeks, up from once a quarter. The steps followed five months of wholesale inflation exceeding 10 percent.
Subbarao’s efforts are hampered by what he said yesterday are capacity limits across a “wide range” of industries, a trend likely to leave inflation undermining the purchasing power of a population where the poor outnumber those in Sub-Saharan Africa. An even faster pace of rate increases would risk curbing the credit needed to invest in power, roads and railways.
“Inflation is likely to remain uncomfortably very high for a long time,” said Jahangir Aziz, the Mumbai-based chief economist for India at JPMorgan Chase & Co., who previously worked at the finance ministry. “What they are trying to do is to ensure that capacity constraints are eased with some amount of investment,” while at the same time trying to prevent inflation expectations from getting “out of hand,” he said.

                                                           Source: Tradingeconomics

                                                              Source: Tradingeconomics 


Like in China, there are also signs of food price inflation in India: (For more on China’s Inflation problem please read If They Can’t Afford Wheat Let Them Buy Real Estate? Why the Price of Food Will Guarantee a Chinese Real Estate Crash)


After dipping for two straight weeks, India's food inflation rose again to double digits at 11.4 per cent for the week ended July 31, as prices of cereals, milk and fruits went up, official data released on Thursday showed.


Food inflation was 9.53 per cent a week earlier.


The fuel prices index, however, declined to 12.66 percent in the week under review as against 14.26 per cent recorded in the previous week, data released by the commerce ministry showed.


Two weeks ago, food inflation had dropped to single digit at 9.67 per cent for the first time in over a year.


The primary articles index also rose at a faster rate at 15.66 per cent, compared to the previous week's increase of 14.36 per cent.


Following are the rise and fall in prices of some of the main commodities that form the sub-index for food articles over the past 52 weeks:


Cereals: 6.97 per cent


Rice: 6.89 per cent


Wheat: 7.93 per cent


Pulses: 20.74 per cent


Vegetables: (-) 6.09 per cent


Fruits: 7.42 per cent


Milk: 19.03 per cent


Potatoes: (-) 42.18 per cent


Onions: 0.32 per cent





 Just like  China, India has its own housing bubble:



From the Wall Street Journal:


The Indian version of Forbes magazine lists the 100 richest Indians. Apart from the usual suspects, what intrigued us was that most of the new entrants in it were from the real estate industry. India is a services-based economy and a lot the people were from technology or other export services and products. But real estate?
It is a bricks and mortar industry that caters to the local market. Yet it is so vast that it is creating untold riches. As people move to cities to build their careers, builders are fueling their aspirations for a dream home. The builders themselves have built their companies with successful initial public offerings and by attracting foreign investment. It's a good time to be in Indian real estate, with buoyant prices and never-ending demand
Most large developers in India are today aiming to build their own "integrated townships" to skip the infrastructure woes of the city. But a number of these communities are already facing a crisis of basic infrastructure like water and power which can't be privately delivered. If the overall infrastructure of India's cities doesn't improve, the real estate industry can't escape it.
Moreover, the License Raj might have vanished from other sectors of the economy but it is well and truly alive in Indian real estate. From buying land to receiving building permits, the ordeal that the real estate industry has to go through to get a project going is irrational. Mumbai, for instance, has a multi-stage building approval system and requires over 50 certificates before completion of a project, which can take anywhere from 24 months to 36 months.

The Reserve Bank of India is worried about a housing bubble but not doing much:


The RBI sends out its key observations on the macro economy before its Monetary Policy review. This observation ranges from topics like inflation to capital markets to GDP growth. This quarter's issue has an interesting note on the central bank' view on housing in metros. It was accompanied by statistics on how the 4 metros in India have witnessed an inexplicable rise in housing prices since the last 4 quarters. Taking 4QFY09 as the base the RBI has shown the rise in housing prices in each of these cities. And Delhi tops the ‘house inflation index' (if you will). The union territory has seen 27% rise in housing prices over the past 4 quarters! The fact that it is the host to the upcoming Commonwealth Games seems to be the obvious explanation. But not enough to justify the disproportionate price rise. The price rise in low teens in Mumbai and Ahmadabad are certainly not comforting. But pale in comparison to Delhi. Bangalore on the other hand shows a negligible rise, probably reflecting the city's chocked infrastructure.


Coming to all-India numbers, the central bank itself sounds quite worried. So much so that it has no qualms about tightening liquidity further. Taking FY03 as the base, housing prices have gone up 2.5 times until the fourth quarter of FY10! The number of transactions of purchase of residential houses has gone up 4.5 times in the last 7 years.


Readers may recall that in was in FY03 that interest rates had started falling and led to a huge surge in home loan demands. The accompanying fiscal sops encouraged Indian middle class to leverage and buy homes. The presentation by HDFC does show that Indians are far better off than their global peers. However, this it recognizes is not the whole truth. There are pockets in Indian metros where buyers are making the same mistake as their peers in US and Europe did.



Up until July, prices in India were soaring:


Property prices across the metros are soaring. In key markets, residential property prices are well past the 2007 peaks. Even land deal valuations have skyrocketed, report CNBC-TV18’s Vivek Law and Shubhro Sen.
A dip in demand, soaring prices and building stock pile-up has kept home buyers at bay, especially in South and Central Mumbai.
Prices here have soared more than 40% since 2009. The national capital region is not far behind, with the price increase well over 30%. Bangalore too has seen a price rise of 10-15% in the first half of FY11.
That's not all, land prices have spooked analysts who have begun indicating that a property bubble is gradually building in cities like Mumbai and NCR. In what is being touted as the largest auction, Mumbai based Lodha Developers bagged a Rs 5700 crore deal recently. Several auctions by national textile corporation are being rescheduled as the company is re-considering an increase in reserve prices
Pranay Vakil, Chairman, Knight Frank India said, “People are buying land for the price of finished product, which surprises all of us and no amount of calculation can justify the price that some of them are paying.”


Initial signs of weakness


From India Express:

A staggering 96.3 million square feet of residential space — or about 80,000 homes — is lying unsold in the Mumbai Metropolitan Region (MMR), the highest-ever inventory pile-up for the area. Sales are down 38% over last year.
Data compiled by real estate research firm Liases Foras show that at the end of June 2010, the unsold residential space in Mumbai, Navi Mumbai, Mira-Bhayander and Thane was nearly twice the 58.9 million sq ft that was available in the MMR in June 2008. Liases Foras CEO Pankaj Kapoor said if flats that are currently lying with investors, which will eventually return to the market are taken into account, another 50 million sq ft will be added to the unsold space.
Analysts see in the glut a throwback to the circumstances that led to the realty slowdown of 2008-09. Builders are again looking to raise money through IPOs, and the pricing of flats is valuation- rather than sales-driven.
Picture!!


“Besides high valuations, the 4% VAT and service tax on under-construction flats, and the huge difference between carpet area and notional super built-up area have created an unfriendly environment for home buyers,” Kapoor said.
R V Verma, executive director of the National Housing Bank, said the recent increase in home loan disbursements has been offset in the metros, and particularly in Mumbai, by rising property prices. “The investor-centric approach is fueling speculation in prices,” he said.
The average price of residential property in the MMR works out to Rs 7,747 per sq ft; in Mumbai itself it is an eye-popping Rs 13,798 per sq ft. A 1,000-sq ft carpet area flat in Kandivli, which cost Rs 70 lakh 15 months ago today costs Rs 1.6 crore, Kapoor said.


Meantime, in In Mumbai, flat sales drop 30-50% in 4 mths due to inflated rates

Mumbai’s builders seem to have priced themselves out of the market. Sales of apartments, on an average, have dropped between 30% to 50% over the past four months as end-users, discouraged by the high rates, are staying away or postponing their decision to buy their dream house.


But developers are not perturbed. Except in 2008, at the height of the global economic meltdown, they have been riding high on the real estate boom that started seven years ago.


According to sources, most builders have a good staying capacity and can afford to hold on to their prices despite the drop in sales.


A property expert said sales in the suburbs had fallen by more than 40%. "Investors from certain financially rich communities have formed a cartel and are driving up prices. They are trading in real estate by buying flats in bulk and selling in retail. On the other hand, the genuine purchasers are not buying flats at these inflated rates."


It is learned that many developers artificially jack up their rates by, say, more than Rs 1,000 a sq ft, and then play out the charade of giving a discount of Rs 1,000 a sq ft to a potential buyer. Moreover, in many residential projects, the difference between the built-up area and the carpet area is now almost 50%.


"Prices have reached their peak levels. Any further increase from here onwards will seriously affect the demand," said Anuj Puri, chairman and country head of Jones Lang LaSalle Meghraj, a global property consultancy firm. "Inquiries are slowing down, although commercial sales have been picking up."


Developer Sunil Mantri, also president of the Maharashtra Chamber of Housing Industry (MCHI), admitted that sales had dropped 10% to 20%, depending on the project and location. "Prices have shot up beyond the reach of the common man. The average rates have shot up by 20% to 30% since the past one year," he said.


However, Mantri claimed that sales were generally slow during the monsoon season. "We are working to boost sales in this slack period up to Navratri by way of promotions," he said.


Another developer from the eastern suburbs, who did not wish to be named, said sales had been down by as much as 50% below compared to last year. "The reason is the high prices, and the last three months have been pretty bad," he said.


Knight Frank (India) chairman Pranay Vakil said there had been a drop in volumes of outright sales. "There is resistance to high prices. In central Mumbai, a residential project which was quoting Rs 21,000 per sq ft and doing brisk sales last year, has now shot up to Rs 30,000 per sq ft with barely any transaction," Vakil said.


From Money life:

After the huge hike in property rates in Mumbai, developers are now offering discounts on properties, at least in the suburbs. Royal Palms, a property owned by Mumbai-based developer Royal Palms India is offering 1BHK (bedroom-hall-kitchen) of 526 sq ft; 2 BHK (815 sq ft) and 3 BHK (1,082 sq ft) at Rs4,930 per sq ft for its two new towers - Crystal and Diamond Island, both based at Goregaon, a western Mumbai suburb. Earlier, these properties at Royal Palms were available at Rs5,300 per sq ft.
Earlier, Moneylife had reported that Orchid Woods, a residential project by DB Realty, was offering customers through ICICI Home Search, (a division of ICICI Home Finance Company) flats ranging from 2 BHK (1,420 sq ft); 2.5 BHK (1,635 sq ft); 3 BHK (1,820 sq ft) and 4 BHK (2,465 sq ft) at Rs9,500 per sq ft (plus Rs45 per sq ft for floor rise). The flats in Orchid Woods were priced earlier at Rs10,881 per sq ft.
"Property prices have started showing correction as sales are not happening. After the first quarter of the current fiscal, property sales are down by around 15% in Mumbai. End-users have disappeared from the market," said Pankaj Kapoor, founder, Liases Foras, a real-estate research agency.

An Indian blogger had some interesting observations on the commercial side:


Mumbaikar's have seen skywalks mushroom all over the city and as with every other thing some have been a success whereas others have not.


I regularly pass thru the Bandra (e) skywalk and notice that there are very few people on it, however I recently made a trip to Santacruz(w) and lo behold the skywalk was packed with people going in both directions. I looked at the stores below and not surprisingly they were empty. More and more people are shopping in malls and skipping small niche shopping locations like Santacruz(w) and now with these skywalks any foot traffic which could venture into these shops is now eliminated.


I was real surprised to see most shopkeepers whiling their time looking at the traffic and wonder how they must feel about this contraption over their heads which is eating into their livelihood and property values.


In fact I think the only thing keeping these commercial prices high is the redevelopment syndrome which seems to be prevalent in all older neighboorhoods. I believe builders will have an upper hand when they negotiate as the shop keepers would rather cash out then endure the rapid decay in their profits.



Conclusion

India is faced with the problems that China is faced with, high inflation and a housing bubble. Fighting inflation will eventually pop the bubble, and there seem to be a lot of signs that the time of a the crash is approaching. Aside from those two problems, India also suffers from a current account deficit which will make it harder for policy makers to keep the bubble inflated(inflation will translate faster to a weak currency in the international markets).

However, in the long run, the future could be bright for India. Unlike China, it does have a democracy, and part of its population is well educated (although a large portion is not.) India could become the low cost alternative for China, and if it manages to reform its political system and fight corruption it could turn out to be one of the true growth engines of the 21st century. But that is a subject for a different article…