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Do inflation control initiatives actually work?
March 10, 2007
For the week ended February 24, inflation stood at 6.10 per cent versus 6.05 per cent the previous week. The market estimate was at 6 per cent.
Surjit Bhalla of Principal Oxus Investments and N Jayakumar, MD of Prime Securities express their concerns on inflation.
Bhalla is shocked at the way the government is handling inflation. He feels that none of the moves by the government to curb inflation make sense. In his view, the government move on wheat and cement is irrelevant.
According to N Jayakumar, history has shown that excise cut has led to lower prices. He feels that talks like curbing profiteering is similar to Licence Raj. He also adds that commodity companies are facing uncertainties of not getting full upside.
Excerpts of CNBC-TV18's exclusive interview with Surjit Bhalla and N Jayakumar:
What's your sense of how the government should approach inflation because it seems to be targeting one sector after another and trying to cool prices directly with intervention?
Surjit Bhalla: I have been rather surprised, or shall we say, shocked at the way the government has talked about handling inflation. Afterall, this was a dream team - they had the best and the brightest, the Prime Minister is a very famous and very distinguished economist. So none of these, what they have said about - and I literary mean none - make any sense, whatsoever, to fight inflation.
The second point, which I think the government knows, is that inflation is already a happened event, that is we had the inflation and if you will, certainly according to our calculations, inflation is on its way down, back to the 4.5-5 per cent level.
So why make rather stupid noises and stupid policies ostensibly to fight inflation. I think we have to move away from markets and economics into the realm of psychology to try and explain what the government has tried to do and said, including starting off from the Budget speech and afterwards; there is no economic content.
Banning wheat and rice futures has nothing whatsoever to bring down inflation especially since wheat prices are already on the way down, not to say that they would have had anything to do with when the wheat prices are going up. Internationally wheat prices went up, so you couldn't have done anything. So that has nothing to do with it.
Then, we have the whole fiasco on cement pricing, where you are telling firms to hold the prices. We all know that prices maybe held for a day or two maybe a month, two months and then finally it pops. So that doesn't make any sense. But these are the two major policy initiatives, outside of the monetary policy, which is not ostensively in the domain of the Finance Ministry. But even then, the Finance Minister had felt compelled to talk about how interest rates should be held at a certain level.
So I think all in all, none of the measures have had anything to do and will have anything to do with inflation, when and if, in our view, it will come down.
What are your thoughts on what the government has been trying to do with a few specific sectors to cool prices by intervening directly?
N Jayakumar: To begin with, the disclaimer is I am not a psychologist. So if it has meant to come from this part of the country, the solution isn't coming here. But I go slightly differently which is that there is the age-old adage of KISS principle, Keep It Simple Stupid. While that applies to many situations in many walks of life, I think the simplest most direct measure to communicate a lowering of price is cutting input prices or cutting excise duties; and that comes from not today, not yesterday but 50 years of empirical evidence.
If one goes back to Budgets of a few years ago, you had direct communication with customers saying prices have come down of A, B, C, D, literally price tags being put on the newspaper to indicate how they had passed on the benefit because the underlying logic is when you cut prices, a higher demand at a lower price is probably significantly better than companies trying to maximize by selling it at a higher price. That's one of the KISS principle that we should have taken.
The second is, cutting corporate taxes. In some sense, I think corporates are becoming extremely responsible citizens in the overall framework of what we are trying to achieve, which is that I do not believe in words like profiteering etc. Therefore this entire approach of a company trying to profiteer and we must stop literally goes back to almost the License Raj where pricing and distribution curbs become rampant in an economy, which today, is breaking loose in a free end economically liberalized world.
So from that perspective, I think taxes whether direct taxes or excise duties, indirect taxes, would have been and should be the only way to do it in addition to the RBI, which you may not always agree with in terms of being ahead of the curve and cutting money supply.
So from that perspective there are economic measures that are available but I believe there is bit of the schoolmaster teaching his school children errand school children what to do. Just look at the kind of pronouncements that have happened, shocking, absolutely shocking.
The cement industry has been told to learn from the steel industry on the way they have cut prices. I am quoting these are economic snippets, which we have taken off from the last few days. We will continue to talk and bring them to reduced prices or in the Budget saying I saw Rs 190 per bag, is a good price to sell cement. Are we sitting and talking about controlling balance sheets of individual corporates? Where have we gone back to?
It is almost because you feel you have the power that you can almost dictate pricing and distribution curbs and some of these pronouncements seem to be from that mindset rather than from an economic mindset, which says let's make the conditions conducive. So from a psychological perspective, I have been probably uncharitable in one-two pronouncements earlier where I say there is a bit of socialism in terms of hurting or leveling out people who are making extraordinary profits.
Is it less psychology and more politics and where do head to heads like this end up because at the end of the day its anyone who has been holding a cement stock who sufferers the most perhaps?
Surjit Bhalla: It reflects a certain arrogance and that's all psychology, arrogance, power which we have heard about, the idea that you can't do anything wrong. This government feels that three years of growth that has come about and the industry that has really broken out, is because of something they did. The simple fact is that they did nothing and perhaps that was the best thing.
Now they are beginning to do something and that's very bad. So I really think it comes from a real arrogance, it's a feudal mindset, its not the license-Raj mindset, it goes prior to that, it's a feudal mindset and I think he has been bit charitable when he says schoolmaster. This is a feudal lord trying to tell people what to do.
Now that's bad news. The good news is the government doesn't seem to be able to get away with it. That's the silver lining that the government and the politicians as usual will be the last people to see it because they are losing out on what they were able to do so effectively in the past.
They all visualised themselves as Mrs. Indira Gandhi and not to say that she was a very good politician, but this is their mentor and this is the mindset in which they operate 'I will say this and it shall happen'. But the funny thing is its not happening and maybe a few more eggs on their faces and they will realise.
But I think the entire way the cement thing has been approached has been purely as an egotistical act on the part of the government. The cement companies in my view correctly called the bluff, they are after all exporting and importing, and the government was really surprised and shocked and peeved - how dare you not listen and still Kamal Nath comes out and says we will ban exports this is somebody gone mad literally.
Is there serious collateral damage that might happen to the earnings of some of these companies because we have seen it happened to sugar, might it happen to cement or even steel?
N Jaykumar: In all fairness, I think sugar has happened because internationally prices have collapsed. Yes, we banned exports when that could have been a good release mechanism but it's also arguable that when India starts exporting large quantities of sugar, international prices in any case may come under pressure.
So I think sugar has suffered because of singular reason that the kind of capacities that mushroomed in the last one year, not just here, but this entire business of ethanol and downstream ensuring that people go crazy in terms of capacity creations. So I think that has resulted in the sugar price problem.
Sugar at the end of the day, it is unsustainable that Rs 20-21 ex factory prices could sustain and that clearly has to come down. So this is the kind of overshoot of that which is happening. But I genuinely believe that in terms of collateral damage the damage is not so much in terms of earnings of specific commodity companies.
It is the fact that anybody holding a commodity stock, now sits back and says I hold this stock which anyway was commanding low PEs, I was hoping that when the cycle turns up these guys will make significantly more money than I can imagine, therefore there is a quote unquote unlimited upside kind of thesis which are underlining some of these valuations.
At one stroke what you have done is you have said wait a minute, anytime any of these commodity companies make supernormal profits, we the government will come down and sort of clamp down on it. Take the case of singular export oriented companies like the iron ore companies - a single company, Sesa Goa has loss Rs 300 crore (Rs 3 billion) or 250 crore (Rs 2.5 billion) at the EBITDA level which is virtually the PBT level in one stroke of an export tax.
Now that's a serious contribution that one company has made to a single budget or a single stroke. So I believe that the big collateral damage that commodity companies now face the added uncertainty.
Other than market uncertainties, the added uncertainty of not being able to command an upside or get the full upside because you could come down and be accused of profiteering, you could have pricing and distribution curves, which could be extremely detrimental.
So I think that's the collateral damage which essentially means taking one step further that in the downside you don't really protect them because sugar companies are now thrusting for some action which you are not really keen to provide, the upside is going to be taken away. So I think the collateral damage is for a whole host of commodity and commodity linked companies.
Do you sense any kind of political risk to this market right now because a lot of people have begun talking about it, Sonia Gandhi's statement that they might have lost couple of elections because of high prices - is there an apprehension that as we get closer to elections, the government will do more populist things, which go against the market and its sentiment?
Surjit Bhalla: Yes and no. I think, to a certain extent, the correction that we had precipitated by some of the nonsense coming out from the government. But I think this is a dangerous game that the government has been playing. It has been wanting to play a 'good cop-bad cop' game.
Again, it has come out from a certain mindset that you can actually control expectations, you can control markets and you can control elections. They found out that they can't really control elections, with the resounding defeats that they got in these two elections.
I think it was an explosive move downwards from the government's point of view, which came out a few days ago when they said about that there would be banning or might be considering ban on cement exports. I think that was an idea, that was the absolute bottom. So from now on, it might be just good news. I think the expectation clearly is that the government won't follow through on its stupid ideas.
Now if it does, then I think you have got a genuine both short-term, medium-term and long-term risk to the market and I think they have pushed the envelope about as far as it can be pushed. So am I surprised by what has happened?
Absolutely, I never expected even for them to say some of these things or to put into practice, some of their stupid rules and regulations that they have recently brought about. Do I think it will get worst from now on? No. Do I think it will get better from now on? Yes, but with a caveat that I think it really cannot get worst than this.
How do you expect this stalemate to end between the government and the cement manufacturers because it's a litmus kind of a test which a lot of market watchers are watching closely. What kind of a compromise do you think will be struck finally?
N Jayakumar: My sense is that perhaps some kind of value based excise which means a percentage rather than absolute amounts maybe one way to get there. I think the government needs to demonstratively show prices have come down. I think it is in the long term interest of the cement manufacturers too that if they can agree to a a percentage, advalorem sort of excise formula, it may be a lot better which means a percentage.
So as prices go up, the government collects more as prices come down, excise per bag kind of drops because of the percentage involved here. To my mind, something like that may work well.
I don't believe earnings are necessarily affected. Ultimately, commodity prices will be a function of demand and supply clearly, there is no rocket science. At this point in time, demand whether from the Middle East or from within is extremely robust, people are able to pass on cost and the ultimate panacea if you will for inflation to come down is actually demand peaking out and there will come a time when higher prices will lead for instance pronouncements are already in based on EMIs etc that the housing demand for instance, demand for housing loans has already peaked and has started dipping. If those kinds of things happen demand for money on the monetary side and demand for products and services in the real economy will drive prices down. That's the only way it will finally happen.
You got to allow this to play out but in the interim, unfortunately the government does not have the benefit of time, you are walking into elections where you need to demonstratively show that prices have come down. I think this would have to be this time more than just cosmetic because compare to any other time, the cement industry is now truly consolidated and the big few players are able to pass on price hikes.
So if either an actual excise cut per bag or an excise cut in a percentage sense or excise formula in a percentage sense could well be a solution to end this stalemate.