Friday, December 20, 2013

Onion hoarding and profiteering cycle playing out once more

In a recent article in India Together, I had used an episode from 2010 to illustrate the typical hoarding - profiteering cycle in vegetables like onion, thus:

"A vegetable like onion that can be stored throws up another aspect of this supply chain. The winter rabi crop harvested in April - May, accounts for 60% of onion production. Part of the crop must be stored to last the lean months, typically September to January till kharif harvests arrive.  Onion growers, mostly small farmers do not have the capacity to store; storage capacity is mostly with the large traders in the supply chain. Traders build up their stocks from the rabi crop and then release them at higher prices in the retail market in the lean months when demand is inelastic because of major festivals and the marriage season. This appears to be the normal seasonal cycle in the onion market.

What happens when mandi middlemen anticipate a shortfall in production? The natural response is hoarding and tightening of supplies all along the chain. The consequent price spike is typically followed by a price collapse coinciding with the next harvest. By then, the traders have already made a killing while the farmers stare at ruin.

An episode from a few years back illustrates this pattern. Onion prices climbed steeply in the months of Dec 2010 and Jan 2011 before collapsing as suddenly as seen in the graphic below. The sharply higher retail margins during the spike point to hoarding at the terminal markets.

The trigger for this episode was untimely rain which was expected to affect the late kharif crop in Karnataka, Gujarat and Maharashtra. As it turned out, onion production that year reached 15.1 million MT, the highest annual crop seen till then! Exports too at 1.3 million MT were lower that year compared to preceding and subsequent years. It appears that this is the pattern Sharad Pawar had in mind when he spoke about the current onion crisis and predicted that price would come back to normal in a few weeks.

During the next year (May-11 to April-12) average wholesale prices at Lasalgaon, the largest onion procuring mandi in India remained in the range Rs 3.90/kg – Rs 11/kg. There were reports of onion farmers in the Nasik area attempting suicide as they could not get even Rs 2/kg. This gives a lie to claims that farmers benefit from price spikes"

The same cycle is being repeated again in 2013. Onion prices have fallen to Rs 7/kg in the wholesale markets in Nasik at a time when farmers are bringing in the new crop. ( They had touched RS 100/kg in retail sales in several cities in October/November). There are news reports of farmers protesting by blocking the Mumbai Agra National Highway. The government has cut the minimum export price of onion from $1150/tonne to $350/tonne (~Rs 22/kg). Here we see the hoarding/profiteering cycle repeating again to ruin the farmers.

Thursday, December 12, 2013

India's exploitative horticultural supply chain

India Together carries this article analyzing the reasons behind sudden rise and fall in prices of vegetables taking onion as an example. A typical 'price spike' episode is shown in the graphic below.

The article argues the following: 

  • The per capita production of the basic vegetables of mass consumption - potato, tomato and onion - is showing a healthy increase over the decade. So it is not the case that production is not keeping pace with demand in the longer term.
  • Analysis of a price spike episode shows that while weather did affect production for a part of the year in some area, the overall production that year was adequate to meet local and foreign demand.
  • It appears that weather related events are not the cause but merely the excuse for pushing up prices.
  • Farmers, mostly with small holdings, have little ability to store their crops to get higher prices
  • The ability to hoard vegetables and sell at higher prices is entirely with the middlemen - wholesale traders and commission agents - of the mandis. While middlemen make a killing when prices spike, the farmers are at the receiving end when prices subsequently fall, as they must.
  • The laws governing agricultural marketing and the middlemen-state nexus in the management of the mandis ensure that middlemen can dictate prices to both the farmer and the consumer.
  • The hold of the middlemen goes beyond the confines of the mandis and extends to credit linkages with farmers, sub-wholesalers and retailers.
  • The entry of corporate retail - Reliance, Mittals, etc - has not changed this state of affairs. Corporate retailers have not been able to break the hold of middlemen on farmers and meet most of their requirements of vegetables from wholesale traders rather than from farmers.

National Horticulture Board for price and production statistics

Monday, November 18, 2013

The pitfalls in analyzing data

The following extract warns in a light hearted manner of the dangers and pitfalls in analyzing data:

"One of the good things about open data is that the average person can verify the kind of bovine ordure that often passes for insight and inference on TV news channels. The bad thing, however, is that with more data comes the potential for a whole new wave of fallacious analyses.

For instance, has crime gone up or has crime reporting gone up? Let’s say, hypothetically, that the jail occupancy numbers from 1953 to 2012 for the State of Andhra Pradesh show a steadily rising trend with a sudden drop in the 2000s, followed by a steady rise again. You can interpret this data in many ways. 

The opposition could say that this is symptomatic of continuously deteriorating governance. The Police could say that this is proof that they are getting better at catching criminals over time. The chap in charge of prisons in the State could say that it’s indicative of his department’s commitment to increasing jail capacity all the time. The government in power during that sudden drop in the 2000s could claim that it had a Sherlockspalli Holmesreddy whose magic wand pulled the inexorable crime rate line down. The opposition then could argue that it had nothing to do with better policing but the choice to migrate government computers from MS Office to Open Office, a move that resulted in improper use of spreadsheet software thus resulting in the alleged drop in crime. I could argue that the trend correlates directly to the quality of biriyani served in prisons and that the drop in 2000 is due to a change in caterer. And finally, someone with some common sense might even ask if jail occupancy, crime reporting and crime are different things altogether."
Taken from a great piece by Krish Ashok in The Hindu

Tuesday, September 10, 2013

Gold imports - in whose hands do they end up ?

India Together carries this piece which is part of a series on the current economic crisis. It is reproduced below with links to data sources.

The price of gold is now as carefully followed by the Indian investor as the stock indices. Last year, Indians spent a staggering three lakh crore rupees on imported gold and jewelry. This year, the volume of imports has been higher so far and the import bill is set to break last year’s record.

Unable to offer the world adequate goods and services in exchange for its imports, India runs a current account deficit (CAD) every year. The growing deficit is responsible for the sharp Rupee depreciation of the last two years with its accompanying ills. Last year, gold and jewelry imports alone accounted for 2/3rd of the deficit.

According to conventional economic wisdom, such a depreciation of the Rupee is actually beneficial. It will lead to a decrease in imports (because these would have become costlier) and an increase in exported goods (which would have become cheaper and more competitive) and correct the problem which caused the depreciation in the first place.

The realty is more complex. Take the case of gold imports. The accompanying table shows imports by Rupee value (last column) and the average prevailing price (middle column). Gold imports in value terms have soared despite sharply rising prices of the metal in recent years. Gold imports can be characterized as .“price inelastic” – higher prices do not lead to curbing the overall Indian demand

Gold price and imports
Average Price
Rs/10 gm
(Rs thousand crores)

But gold imports are not an exception, in this regard. An examination of India’s imports over the last decade shows that India’s major commodity imports are all price inelastic, including petroleum and fertilizers. (Exploring the reasons for this would be another discussion.) If past history is a guide, rupee depreciation will not curtail the import bill.

Costlier imports from devaluation of the rupee however have extremely negative consequences for the common man, driving up the costs of essential items like diesel and gas, edible oil and pulses and fueling generalized inflation.

It stands to reason that to protect the citizen from imported inflation the government must take steps to restrict imports, particularly of items that are not in the nature of essential commodities or inputs for industry. Gold appears to be a prime candidate in this regard.

The government has been content with symbolic measures on gold such as increasing import duties, which as anticipated, has had the effect of increasing gold prices without effecting overall demand. The argument against tough measures restricting gold imports and sales is articulated by the governments’ economic advisors in these terms.

Gold, it is claimed, is an item of mass consumption, purchased by rich and poor alike and driven by deep seated social and cultural factors. (The gold stocks held in rural India are often brought up in this context.) It is hard to change the buying preferences of the mass of Indians. Restricting gold imports by any means will only result in gold coming in into the country through illegal channels and will increase the “criminality in the system”. Finally, it will also hurt the jewelry industry which employs a large number of people.
To examine the validity of these arguments, it is useful to understand who buys gold in India and for what purpose.

Gold ownership – the contrasting trends

Two sets of data serve to throw some light on Indians relationship with gold. The first is the phenomenal growth of loans against gold jewelry pledged as collateral and the companies in this business.
A Jan 2013 RBI study on gold reports that outstanding loans by banks and non banking financial companies (NBFC’s) have grown between Mar 2008 and Mar 2012 from 20,000 crores to nearly 160,000 crores at a compound annual growth rate of over 55%. The study observes that loans are taken for the short term – from 3 months to maximum of 1 year at interest rates ranging from 12% to 24% amounting to 60-75% of value of gold pledged. The majority of loans are of size Rs 30,000 to Rs 80,000. Loans are taken for agricultural purposes, or medical emergencies, to meet education expenses or on the occasion of marriages or deaths.

Gold loan customers are typically farmers, share croppers, agricultural laborers, small traders and proprietors of small scale industry. They are borrowing against gold as collateral because they do not have recourse to short term credit otherwise. The increasing price of gold makes it more attractive to pawn even the small amount of jewelry they possess. This is a section of Indian society that is pawning its gold to meet its basic consumption needs. The gold pawned can be estimated to be worth 2.5 lakh crores, not far short of 2013 imports of 3 lakh crores!

The second data set is on the quantity of gold imported and the total Rupee cost of those imports.
The accompanying figure shows the quantity of gold imports (left vertical axis) and the Rupee cost of those imports (right vertical axis) over a number of years. (The tonnage and Rupee cost of imports are taken from the Export/Import Database maintained by the Ministry of Commerce. The tonnage values reported in the website for 2002-03 and 2003-04 appear to be incorrect. For these two years, the tonnage is as reported by the RBI study referred above. Incidentally, for other years, RBI figures do not differ too much from the Export/Import database)

2008-09 marks a departure from the behavior of gold imports of previous years. The quantity of gold imports starts rising steadily (except for a slight fall in 2012-13) despite steeply rising gold prices reflected in the sharply increasing spend on gold imports.

How is this type of consumption to be explained?

A pointer emerges from data put out by the World Gold Council, an association representing gold mining companies. Traditionally, gold demand has been almost entirely from jewelry, except for a small requirement from industry. In recent years, there has been a new international trend. Physical gold (in the form of gold bars and coins) has become popular globally as a form of investment starting from 2008, coinciding with the global economic crisis. The investment demand has resulted in pushing up gold prices leading to a cycle of increasing demand and increasing prices.

A section of Indians with deep pockets has also followed the lead from around the world. There are no official figures for how much Indians invest in physical gold (in the form of gold bars and jewelry).  But according to estimates of the World Gold Council, the investment demand in India has grown from about 16% of total imports in 2003-04 to over 35% in 2012-13. The federation representing Indian jewelers (AIGJTF) estimates that 30-35% of gold imports are used for meeting the investment demand in the form of gold bars and coins. Of the approximately 1000 tonnes of gold being imported annually in recent years, 350 tonnes is for investment purposes with most of the rest going into jewelry.

The recent increased interest in gold purely as an investment is also evident from another statistics. Gold Exchange Traded Funds (ETF’s) have been available in India from Feb 2007 but they have seen rapid growth from 2009, increasing by nearly 10 times between Mar 2010 and Mar 2013. Of course, ETF’s represent only a miniscule part of the investment in gold, the overwhelming part being held in the physical form.

Incidentally, government policy over the last decade has actively encouraged gold as an investment through numerous measures including allowing the free sale of gold bars and coins by banks to retail customers, trading in the commodity exchanges with physical delivery and investment in gold exchange traded funds with long term capital gains tax benefits.

We can now return to the arguments of the governments advisors.

The fact is that while the poor may have accumulated jewelry in the past and the middle classes will still be buying jewelry for weddings, it is a small section with disposable income that is buying gold purely as an investment and they account for an estimated third of the imports. Investment gold (bars and coins), with no or little value add by jewelers, has no impact on employment in the jewelry industry. Even the main association of jewelers in India, clearly acting in its own self interest, has called on its members to desist from selling gold bars and coins. As for the fear of gold distribution through illegal channels, it is a bogey routinely raised by economists for whom the “free market” is sacrosanct. Any controls will always invite a few law breakers who must be dealt with according to the law.

It is interesting to note that a precedent for outlawing the possession of gold held as investment rests with none other than the United States. Under a 1933 decree citing national interest, Americans were forced to sell such gold to the US government at a price fixed by it. The limitation on gold ownership was removed only in 1974.

Investment in gold is used by a small minority of high net worth individuals to safeguard their wealth from the ravages of inflation, even as their acts stoke imported inflation further, making life more difficult for the average citizen. Investment in gold – whose price is dollar denominated - has to be treated as a form of “capital flight” that the country can ill afford. Any controls imposed on investment gold can be entirely justified to be in public interest.

Monday, July 29, 2013

Why India’s current account deficit matters for the aam aadmi

India Together carried this piece on why India's current account deficit is a matter of concern for the common man. The piece is reproduced below with some pointers to data surces.

India had a deficit on its current account of nearly $90 billion last year (2012-13).

The current account is a record of transactions relating to exports, imports and cross border income transfers for a given period, transactions that require a foreign currency. A deficit on the current account means that India has to pay out more than it receives on these transactions. The deficit can be bridged using the country’s foreign exchange reserves or from foreign capital inflows. The enormity of last year’s deficit can be seen from the fact that it exceeds the value of exports of the entire computer software and service industry.

In recent years, the current account shows an interesting variation, with a sharp inflection in 2004-05. India actually had a surplus on its current account – foreign exchange to spare – for some years, until the sharp reversal of 2004-05. Since then, the current account deficit (CAD) has increased at a very rapid rate.

The CAD has generally been balanced by the inflow of foreign capital coming in a variety of forms – direct investments, portfolio investments, corporate loans and deposits of non-resident Indians. Unsurprisingly, the capital flows have been determined not only by the opportunities available in India for profit, but also the global economic environment.

In the years before the 2008 global financial crisis, capital inflows comfortably covered the deficit and added to India’s foreign exchange reserves. The situation changed dramatically in 2008-09 with capital inflows falling short of a sharply rising CAD. India had to draw on its foreign exchange reserves to finance imports that year. In the following years, capital inflows have been just about keeping pace with the increasing CAD, except over some quarters of 2011 when there was again a shortfall with a draw down on the reserves. 

The figure below shows the quarterly changes in the foreign exchange reserves after accounting for the current account deficit and net capital inflows (blue line, left vertical axis) for the last five years. A decrease in the reserves implies that capital inflows were not sufficient to balance the CAD in that quarter.

There are immediate and longer term negative consequences for the economy from depending on capital inflows to finance a large part of the imports.

One long term consequence with a bearing on the CAD is that with the increasing debt component of foreign capital in India (now exceeding 52%), interest payouts have also increased adding to the deficit. In 2012-13, net investment income transfers constituted over 25% of the CAD.

Among the immediate consequences are the volatility and rapid depreciation of the rupee. The figure displays the quarterly average rupee – dollar exchange rate for the last five years (red line, right vertical axis).

Periods when capital inflow is inadequate to finance imports leading to a net depletion of foreign exchange reserves see sharp depreciation in the value of the Rupee. Two such recent periods were from Q3 2007 to Q4 2008 when the Rupee depreciated by 27% and then from Q1 2011 to Q2 2012 when the fall was 22%.

That the value of the Rupee is acutely dependent on the delicate balance of the CAD with capital inflows is only one part of the problem.  A large part of the capital inflow – nearly 25% of foreign capital in India as of March 2013 - is portfolio investment, money that can be withdrawn very quickly when investors perceive better opportunities elsewhere. In a recent episode, the rupee depreciated by over 13% in 8 weeks up to July 7 2013, exceeding Rs 61 to the dollar, after foreign portfolio investors started withdrawing capital from India on indications of higher interest rates in the US.

The government’s economic managers, who swear by the dictum that the “market knows best”, do not find any call for intervention. They preach that the Rupee depreciation may actually be a blessing as it will spur exports by making them more competitive.

For the average citizen, however, the sharp Rupee depreciation imposes severe hardships by making essentials such as energy, fertilizer and edible oil more expensive and fuelling across the board inflation.

Roots of the Deficit

So why is the CAD growing so rapidly?

There are five items that constitute the overwhelming part of India’s current account. These are merchandise exports, software exports, and remittances (by Indians working abroad) all of which earn foreign exchange for the country and merchandise imports and net investment income payouts which involve foreign exchange outflow. The excess of merchandise imports over exports constitutes the merchandise trade deficit.

In the period up to 2003-04, exports and imports followed a similar rising trajectory. Though there was a deficit in merchandise trade, software exports and remittances from Indian workers – essentially a form of export of labor services - compensated for it, leaving an overall surplus on the current account.

From 2004-05, even a robust growth in software exports has been unable to compensate for the rapidly climbing merchandise trade deficit.

Imports have been growing at a compounded annual average growth rate (CAGR) 4% higher than that of exports in this period. This is the cause of India’s burgeoning current account deficit. Clearly this is not an overnight problem, but has been building up for nearly a decade.

Import growth – a closer look

Why have imports grown so rapidly in value – at a CAGR greater than 22% - from 2004-05 onwards? 

There are several causes.

One is the steep rise in the global price of commodities such as crude oil and gas, gold, coal, metal ores and scrap which India imports. Commodity prices have also affected the prices of manufactures that use them as inputs, such as fertilizers and synthetic rubber which again are on India’s import list.

The import bill has also gone up because of greater imports of commodities, intermediate goods and capital goods for meeting the needs of increasing exports and higher consumption in India. Production of natural and synthetic rubber has, for example, has more or less stagnated in India, requiring increasing synthetic rubber imports to enable the increasing production of tires for local consumption and export. In the case of fertilizers and petroleum gas, there has been a rapid increase in consumption. In capital goods, there have been huge cumulative imports of items in categories such as ships and floating vessels, aircraft and parts and power plant equipment.

However, that is not all. Consumer product imports - imported whole or in parts to be assembled – have risen sharply. The telecom revolution is almost entirely based on imports. So is the case with the spread of computers and consumer electronics. High end brands of products traditionally made in India – apparel, shoes, cookware, etc - are being imported.

The government, on its part, has actively encouraged imports through policy measures.

Import duties have been progressively reduced across the board. According to Planning Commission data, the weighted average import duties for capital goods fell from 20.7% in 2003-04 to 5.6% in 2009-10 and for intermediate goods from 23.6% to 6.8%. Most remarkably, the duties on consumer goods were brought down from 51.8% in 2003-04 to 42.9% in 2004-05 and progressively down to 12.5% by 2009-10. Customs duty across the entire range of mobile phones is now only 1%.

Gold has also been favored with official largess. The duty rate on gold bars was slashed in 2002-03 and kept ridiculously low - in the region of 1% - 2.5% - till early 2012. Preferential treatment under FEMA regulations ensured a smooth and uninterrupted supply of imported gold. Investment in gold was made easy by authorizing retail sales by banks of bars and coins, trading in commodity exchanges with possibility of taking physical deliveries and through gold ETF’s ( accorded the same tax treatment as debt mutual funds even though the gold with these ETF’s served no productive purpose). In 2002-03, gold already accounted for 6.3 % of India’s import bill. By 2012-13, gold imports had gone up 8 times in value and constituted nearly 11% of the import bill.

The public interest in restricting imports

The basic imbalance in merchandise export and import growth points to serious problems with Indian manufacture and the overall pattern of economic development in India. The underpinnings of the growth of the last decade need to be carefully examined. There are serious questions about the excessive import dependence of many sections of Indian industry and its lack of its export competitiveness in all but a few areas. These are questions that the government’s economic advisors really need to dwell on.
If the CAD is to be tackled head on, there can be only two ways: increase exports or reduce imports. Increasing exports would take time, even if the government had some new ideas on how to go about it. It seems obvious that the immediate efforts should center on curbing imports.

Gold stands out as the prime candidate, constituting nearly 11% of the import bill. According to different assessments (World Gold Council, an association of gold miners and the All India Gems and Jewelry Federation, the main association of jewelers in India) fully one third of the gold imported is sold in the form of bars and coins to investors, with the rest going into jewelry (part of which is exported). Investment in gold (which has to be paid in dollars) can be looked upon as a form of ‘capital flight’ out of the country. Wealthy Indians have parked in the range of Rs one lakh crore in gold in just the last year obviously to hedge against inflation and rupee depreciation. A clamp down on investment gold would be fully justified.

Cutting down gold imports is not the only option. Last year, $5 billion worth of gold jewelry was imported into India, a country that specializes in making gold jewelry! Imports of mobile phones over the last 3 years averaged $ 5 billion annually with even the most expensive mobile phones attracting only 1% duty. India has thrown open its gates to every variety of high end foreign goods and there are pockets here which can afford these. If the choice lies between restricting access of a rich minority to high end imported consumer goods and ensuring supply of essential commodities at stable prices to all, then surely public interest lies in the former.

So what is the government doing to bring down the CAD?

Shockingly, it seems next to nothing. 

The Minister of State for Finance stated in a written reply to a question in Parliament in May 2013 that “no target has been set for the CAD”. He talked of measures taken to “boost” exports and reduce imports of gold and diesel. The measures for export are in the nature of increased subsidies to exporters and more relaxed norms for setting up SEZ’s. The import control measures, according to the Minister, are a higher customs duty on gold and higher administered prices for diesel. The government’s economic advisors cannot be unaware that both gold and diesel imports have proved to be price inelastic!

The Government has no real plans to correct the merchandise trade imbalance that is at the root of the current account deficit. Surprisingly, there is almost a conspiracy of silence on this issue. Neither the mainstream media nor major political parties have questioned the government on stance on trade.
The Government’s focus instead is entirely on “financing” the CAD by attracting more foreign investment. It spends all its energies in floating new external borrowing schemes or tinkering with existing regulations governing foreign investment.  

Leaving aside fortuitous circumstances – a sustained fall in global commodity prices, perhaps, or a steady rise in “investor sentiment” -  India’s citizens are in for many more bouts of imported inflation.