Wednesday, April 15, 2009

India in the Great Recession

Ila Patnaik and I have an article in Financial Express today on this. See a gloomy take on India's elections by Anand Giridharadas. If we get `five years of tragic banality', economic conditions will get difficult. And, see Michael Walton on this.

1. Loved it!!! Please keep writing such great articles

2. 1. "The first is about positive feedback loops. Faulty policy structures have positive feedback loops. In India, when times are good, interest rates tend to go down in real terms. When times are bad, interest rates tend to go up in real terms. Figure 4 shows the policy rate of RBI, expressed in real terms [methodology] The graph shows big values of the real rate in the dark days of 1999 and in recent months. It shows small values in the boom times of 2004 and 2008. Through this, monetary policy makes good times better and bad times worse. Such sources of pro-cyclicality need to be identified and blocked."

My comments: I reiterate my point. Real rates are not an ex-post concept.

You need to tell me where inflation expectations stand. Without that, this assertion is meaningless.

2. "Institution building in fiscal, financial and monetary policy will enable stabilisation. But this can only yield results in the medium term. In the short term, the only tool for stabilisation that is easily accessed is a floating exchange rate. In good times, the rupee should appreciate and in bad times the rupee should depreciate. This will be a potent force in favour of stabilisation. Many people in India believe that RBI helps matters by reducing the volatility of the rupee-dollar exchange rate. However, such efforts exacerbate the boom and bust cycle of the market economy."

My comments: For policy purposes, what matters is a broad-based real effective exchange rate. Discussions about the bilateral exchange rate do not serve the purpose.

3. "Under institution building are the long-standing problems of reforming law and institutions. This includes problems of RBI's transparency, the merger of all securities markets functions into SEBI (including the commodity futures work that is presently at FMC and the interest rates and currency work that is presently at RBI), the establishment of the Bond-Currency-Derivatives Nexus, and removing entry barriers in banking."

My comments: BCD nexus again. I have brought up this topic time and again. Your answers have not been intuitive to me. I shall follow up with a detailed post so that you can respond to specific issues.

Your responses so far are pasted below. I am not posting the response from our email conversation. I will do that only if you are okay with that.

1. "For the monetary policy transmission to work, when there is a change in the short rate, arbitrageurs must transmit it all across the curve (this requires a monetary policy rule). And it must transmit into all credit curves. Bank lending rates must move similarly to the corporate
bond market. Stock prices must go up.

All this requires an intricate system of arbitrageurs carrying small changes in the short rate all across the system.

Derivatives and currencies are integral to this.”

2. "Derivatives on the yield curve are essential to getting an arbitrage free yield curve. It can be done without it, but that is not how it's done."

My comments: I am not convinced by these responses. I shall follow up with something detailed. For starters, it would be a great help if you could explain to me:

1. What is the problem with the Indian risk free yield curve currently?

2. Where does the arbitrage exist?

3. And how would a deep treasury futures and options market correct the current deficiencies in the yield curve and make it arbitrage free?

3. With all apreciating Business Analytics standard, this article sounds like an analyst personal views on how to fabricate the facts to promote the company (here animal spirit of corporations). But wrongly targeted to policy makers or think-tanks, if authors wish to do so. Barring the fact that fundamentally all lopsided and truncated presumption to present the biased arguments, do you want promote growth with "Animal Spirits" or "Human Spirits"?

4. Ajay, attended your talk yesterday and read this FE article today. Great stuff, and I know that everyone in the audience was talking about it.

5. According to me Fiscal strategies imply correct when you have a sound infrastructure.

According to me the Demand rules the market.
As the demand increases so as to maintain level in demand supply environment.

But what about Deflationary environment where the system reduces the Rates.
Is it the same in a dis-inflationary environment.

In all the reports I have heard the scenrio in india to be deflation but it is not so.

Disinflation is the prevailing situation here in India.

So is it apt to reduce such rates during deflation?

6. thanks for the link on NYTIMES about the "great election". So True. Also, it must be pointed out, that having a demographically "young" country is very stupid to live in if you are a thinking person.

All movies are teeny bopper dandy dating oriented. All "news" is hype. There is no national "dialogue" at all. Period. Just a dinner at McD! This is the electorate. And their doting paretns obsessed with their offspring are too tired to do anything else.

In short India is braindead. Except where passing stodgy exams to get "great" 12 hour jobs crunching spreadsheets in an MNC with chance to go abroad.

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