Inflation riddle

How often have we heard our parents and grandparents complaining “mehngai toh aasman choo rahi hai” (Inflation is touching sky)…I am sure we would be using same quote very soon (some would have already started using it)…

So, when was the last time you wondered about rising prices? – wouldn’t have been long for sure; it could very well be the last time you bought vegetables and realised that prices quoted by the vendor are higher than the previous week (or even previous day).

So why are prices galloping towards the sky? The principal cause of inflation has been attributed to food products and oil. International crude oil prices have skyrocketed in last one year fuelling energy costs of industries and hence the product prices. Higher crude oil prices have also fed into prices of agricultural products due to higher fertilisers and irrigation costs.

So is oil the primary cause of all price rises? Not really, food prices have risen on account of other reasons as well – demand supply imbalance, indulgence in bio-fuels production, commodity hoarding and trading in commodity futures.

Agriculture in many parts of the world is almost on the verge of a crisis. Although green revolution has enabled higher production of some food commodities, the long term impact of modern agricultural practices on soil fertility, water conservation and ecological environment have long been debated. In many developing countries, many farmers have shifted from food crops to cash crops production in lure of better realisations. Basic food production has been rising year-on-year but number of mouths has been rising as well…and adding to the deficit is the massive intake of basic food products by food processing companies (this phenomenon has picked up pace in India in recent times).

Another phenomenon that has received thrashing from several corners is the government policies in Europe, Brazil and USA wherein bio-fuels are being actively promoted for energy generation as an alternative to petroleum. It may sound as an interesting idea but root problem of this technology innovation lies in the shift of food acreage into production of ethanol, thereby reducing the land for food production – a definite feeder to the food deficit in medium-long term.

Several politicians (yes, not economists) have displayed anguish on commodity futures citing their tendencies to cause inflation. The ban on commodity futures trading in several agricultural commodities (placed by government in May 2008 on soy oil, chickpea, potato and rubber) is a testament to that. The argument is that futures trading in agricultural products enable speculators in the market to manipulate prices (more often in an upward direction). In some people’s view, traders often purchase products at low costs through futures contracts and then raise the prices by creating artificial scarcity. (However, many experts have given counter-arguments to such viewpoints and several studies have found no correlation between inflation and ban on futures trading.)

This is the situation when Agricultural income is not even taxed in India – Are you wondering how much would the price rise be if the government one day decides to tax farmers’ income as well? – Well, I am not even contemplating that for the next 100 years because in our vote-driven political economy, a thought to directly tax rural farmers is forbidden…

Globalisation Chronology

The WTO's World Trade Report 2008 brings out an interesting chronology of events that have shaped up the globalised world today.

1940s:

Economic
Establishment of Bretton Woods System (1944-71)
Establishment of GATT (in force Jan 1948)
Soviet Union establishes Council for Mutual Economic Assistance (CMEA) for economic co- operation among communist countries (1949-91)

Political

Foundation of United Nations (1945)
Launch of Marshall Plan (1948-57)
Founding of Organisation of European Economic Co-operation (1948)
Decolonisation starts (1947-1962) Independence of India, Indonesia, Egypt, etc
China becomes a socialist republic in 1949
Technological

Expansion of plastics and fibre products (eg. First nylon stockings for women in 1940)
Discovery of large oil fields in Middle East

1950s:

Economic
Treaty of Rome establishes European Community (1957). EC and European Free Trade Association (1959) favour West European integration
Major currencies become convertible (1958-64)

Political

Korean War (1950-53)
Increased use of oil from Middle East in Europe and Japan
Suez Crisis (1956)
Decolonisation in Africa (15 countries become independent between 1958 and 1962)

Technological

Just-in-time production implemented by Toyota

Increasing usage of jet-engines in air transport (1957-72)

1960s:

Economic

Foundation of Organisation of petroleum Exporting Countries (OPEC) in 1960
Development of Eurodollar market in London which contributed to the expansion of international liquidity
Kennedy Round, 6th session of GATT (1964-69)
Rapid spread of automobiles and highways in the North accelerates demand and shift in fuels consumption - from coal to oil
Trade policies of East Asian countries put more emphasis on export led development than on import substitution
Elimination of last customs duties within EC (1968)

Political

Erection of Berlin Wall (1961) and Cuban Missile Crisis (1962) - sharp confrontation between East and West
Technological

First person in space (1961) and first man on moon (1969)
Green revolution - transforming agricultural products in developing countries (1960s onwards)
First line of Japan's high-speed train system (shinkansen) opened in 1964
Mont Blanc Road tunnel (1965)
Increasing usage of containerisation in ocean transport (1968 onward)

1970s:

Economic
Departure of US dollar exchange rate gold standard (1971)
Tokyo Round of GATT (1973-79)
Oil price shocks (1973-74 and 1979) reverse decades of real oil price declines
Rise of Asian newly industrialises countries
China's Economic Reforms (1978)

Political
Yom Kippur War (1973) helps to triggr oil price hike
EU enlargement to nine members (1973)

Technological

First single chip microprocessor (intel 4004) introduced in 1971

1980s:

Economic

Volcker Fed successfully extinguishes US inflation
Developing country debt crisis
Mexico starts market reform and joins GATT in 1986
Louvre Accord promotes stabilisation of major exchange rates (1987)
Political
Enlargement of EU to 12 members
Fall of the Berlin Wall (1989)

Technological

IBM introduces first personal computer (1981)
Microsoft Windows introduced (1985)

1990s:

Economic
Indian Economic Reforms launched in 1991
Establishment of North American Free Trade Agreement (NAFTA) in 1994
Establishment of the WTO (1995) following Uruguay Round (1986-1994)
Asian Financial Crisis (1997)
Adoption of Euro by 11 European countries (1999)

Political
Dissolution of Soviet Union (1991) leads to formation of 13 independent states

Technological

Eurotunnel opens in 1994 linking UK to continent
The number of mobile phones increases due to introduction of second generation (2G) networks using digital technology
Launch of first 2G-GSM network by radiolinja in Finland (1991)

2000s:

Economic
Dotcom crisis (2001)
China joins WTO (2001)
End of Agreement on Textiles and Clothing in 2005 (quantitative restrictions lifted)

Political
Enlargement of EU to 27 members

Technological

Container ships transport more than 70 per cent of seaborne trade in value terms
Number of internet users rises to 800 million in 2005

The rupee mayhem!!!

A year back exporters were crying over rupee’s unprecedented rise against the dollar…foreign investor’s money flooded Indian market and strengthened rupee to unseen heights (since a long time) of almost 39 per USD. While exporters were the worst hit as stronger rupee made their exports costly and thus lowered export revenues, many experts took the rupee rise a reflection of India’s strides and growing economic strength…

Today, the crying continues but reasons are just the opposite – rupee has seen sharp depreciation this season due to rising demand for dollar (by oil companies to make payment for costlier imports) and the outflow of the same FII money that had flooded India (due to capital market crisis in international market) – reaching the lowest levels in last two years at nearly 47 per USD.

Despite the rupee depreciating, not all exporters are excited – going by the last year’s trend, many players had hedged their export revenues at higher levels (around 41-42) compared to the current spot prices and thus they are losing out on the possible gains that they could have made today. Adding to the woes is the slowing US economy, which is still the largest export market for Indian exporters.

The good thing is that inflation may cool down as oil prices stabilise between 90-100 dollars per barrel. The relative closeness of Indian financial economy with rest of the world would also help the economy sail through the worst global financial crisis being witnessed today.

Glittering Gold!!!

Cherishing time for Indian women (including me) – After all, festivities have begun and adding icing to the cake is the recent fall in gold prices. Naturally, I am going to do some gold shopping even though I expect a huge rush in jewellery stores.

Gold prices in India have fallen to an eight-month low (on 11-Sep-2008) – gold prices in Mumbai stood at Rs 11,190 per gram (similar levels were last seen in January 2008).

Why have Gold prices fallen?
There are two main reasons:
a) Easing crude oil prices – gold and crude prices go hand in hand…rise in oil prices fuels inflation while gold serves as a hedging instrument for inflation. Off-late crude oil prices have fallen (and are expected to remain around $100 per barrel), thus easing global inflation worries. This in turn has lowered demand for gold and thus led to fall in gold prices.

b) Strengthened dollar – Gold prices are generally inversely related to US dollar movements as investors prefer to buy gold as an alternative asset (to hedge inflation) when the dollar falls and reverse the scenario when dollar picks up. As US dollar has strengthened considerably, gold prices have eased.

What about future movement?
EIA (Energy Information Administration) of US Department of Energy expects a slowdown in world petroleum demand growth. WTI crude prices are projected to average $116 per barrel in 2008. But demand is projected to improve in 2009, thereby increasing the crude price projections to $126 per barrel in 2009.

In light of the current scenario, experts believe that gold would trade at lower prices for some time and have thus lowered their earlier forecasts for gold prices (Standard Chartered’s Metal Analyst has revised down his gold forecast from $925/oz in the fourth quarter to $850/oz, and reduced his 2009 forecast from $944/oz to $875/oz).

With lower price forecasts in the short term, the yellow metal is definitely going to see high purchases in the Indian markets.

So, should I wait for few more weeks for prices to fall further? - Not this time – Better make hay while the Sun shines…..