Expectation – Speculation and Real – Unreal Inflation: The Gross – Subtlety Conundrums of Indian Economic and Industrial Policies

The Reserve Bank of India (RBI) has refused to adopt a soft money policy once again, though the Indian GDP growth rate has decelerated to 4.5 percent, and despite cries for affordable money to fuel growth. Raghuram Rajan, the dapper Governor of RBI has stated that inflation is a greater concern than anything else. As students of economy know, inflation erodes the purchasing power and leads to a spiral of wages chasing prices. Inflation affects the export competitiveness of Indian products, and erodes India’s claim to global cost competitiveness. A major component of the Indian inflation scenario has been the high food inflation. This has hit the vulnerable sections of the Indian society, especially the daily wage earners, who are affected by only a partial inflation-indexing of annual salaries and lack of inflation-indexing of the daily wages.

The squeeze on real living conditions is contrasted sharply by the huge increase that has happened in the prices of real estate. Recent papers, for example, have been flooded with advertisements for apartments and villas that claim price tags of Rs 10 crore plus for downtown apartments and Rs 3 crore plus for apartments and villas in outlying suburbs, even in a conservative city like Chennai. The saga of galloping real estate prices against a backdrop of unsold housing stock is frustrating and enigmatic. There is no doubt that there is a huge element of speculation in the rapid increases of certain asset classes such as real estate and gold in India. Speculation, however, appears to be a larger cultural phenomenon, given the rapid fluctuations that occur in the Indian stock market and the fanciful nature of fancied stocks, euphemistically referred to as momentum stocks.

Banking on banks

Indian governments have conventionally treated inflation through fiscal policies, more specifically banking policies. Increase of interest and deposit rates on one hand, and mopping up of or release of liquidity into and from the banking system have been the specific tools.  Deployment of these tools has led to alternate cycles of high growth and low growth, accompanied by low inflation and high inflation in the better times. The current situation, however, seems to be a more disparate combination of high growth and low inflation, set in a cultural background of speculative trends. Classic banking solutions are unlikely to provide the required solution.  The other way of looking at this is in terms of demand-supply equation; the more goods and services are generated, the greater will be the price competitiveness leading to greater demand fulfillment with lower prices. As discussed earlier, the conundrum in India is one of more products and services at higher prices.    

In India, the banking sector has played an enormous role, incomparable in any other country, of supporting the industry across a broad spectrum, playing a variety of roles. The banks have been the angel investors of sorts to set up, and support, micro and small enterprises. They have been lenders of first resort for medium scale enterprises unable to or unwilling to obtain private equity investments. They have been bank-rolling large enterprises in their expansion, diversification and globalization plans. And most importantly, they have been hugely risk-friendly in supporting gigantic infrastructure projects. Without the banking system, especially the national and nationalized banking system, industrial growth in India would not have been what it has been. Yet, the banking system has got in return been a specter of bad debts, non-performing assets and delinquent or defaulting accounts. It is a moot point if this high level of bad returns is due to the gross insufficiency of risk capital for the industry on one hand and the expedient dependence of the industry on the interest bearing loans on the other or due to a combination of poor industrial management, loose loan monitoring or high interest rate regime.

Expectation and speculation

It is perfectly natural and logical for the industry and bankers to have mutual expectations. However, if expectations are not based on solid forecasts, and if results are not reviewed against expectations, any transactional relationship moves into a zone of speculation. Speculation, as can be appreciated, is the act of forming opinions about what has happened or what might happen without knowing all the facts. Speculation is nothing but guesswork without a basis of facts; speculation is also engaging in a physical or financial transaction in the hope of a profit; the more usurious the hope of profit is the more speculative the transaction becomes. Expectation, on the other hand, is a belief that an outcome will happen because it is likely. Expectation is based on refined human capabilities of logic and rationality while speculation is based on primal human characteristics of greed or fear. It is important that economic and industrial management of India is based on sound expectations and not on shaky speculations.

It is perfectly logical for the experts and laymen to expect that the RBI will raise or lower interest rates, or tighten or liberalize liquidity each time the monetary policy is announced. It is, however, pure speculation (pardon the oxymoron!) if the stock market investors and operators indulge in massive selloffs or buyouts in anticipation of, or within minutes of, any particular movement in policy. It is important that all stakeholders base their judgments and actions on expectations, and eschew any preemptive or presumptive judgments and actions that are built on speculations. It is, therefore, commendable that Raghuram Rajan has been forthright in setting expectations on inflation and growth, and not fueling speculative trends.  He discourages the widely held notion that low interest rates magically lead to high growth rates and advocates that the best way to promote growth is keeping inflation low. He is very clear, rightly so, that there is no tradeoff between inflation and growth.  That said, India faces a threat from two hues of inflation, which hopefully will be addressed by authorities with similar objectivity and candor.

Real and unreal inflation  

In any society, there cannot be a perfect match of demand and supply or of factors of consumption and factors of production. It is this mismatch that primes the drive for growth (potential demand outstripping physical supply) or leads the quest for competitiveness (physical demand lagging potential supply). The virtuous economic management seeks to develop and utilize factors of consumption and production to balance demand and supply at continuously increasing levels. The not so virtuous economic management seeks to tolerate inflation and curb consumption in times of short-supply of products and services. While this is a natural economic characteristic, proactive economic management and industrial management require that growth and competitiveness are always pursued as twin sides of the same coin. Clarity in fiscal and monetary policies set the stage for this. An integral part of this approach is the accessibility for continuously improving factors of production such as technology, talent and investments.

The economic mismatch generates real inflation as discussed above, but can be managed with emphasis on factors of production and other instruments of economic policy. However, it is the unreal inflation that tends to be a more dangerous scourge for the economy. Unreal inflation occurs when prices rule high, in some cases usuriously high, even when products and services remain unsold. The state of real estate mentioned in the beginning of this blog post (threefold increases in real estate prices when more than two-thirds of housing stock is remaining unsold, as an example) is an example of unreal inflation. There could be several other examples such as luxury hotel rooms being pricey despite low occupancy, luxury brands commanding unearthly prices  or leading smart phones costing more than computers despite increased competition and lower per manufacturer sales. The unreal inflation is a fight between firms with erstwhile monopolies and deep pockets and the new generation resource constrained firms with follow-on products. In the unequal tussle, more often than not, the economy and society tend to be squeezed in and lose out.

Philosophical issues

The discussion on inflation and speculation as well as on real and unreal inflation brings forth several philosophical issues and guideposts. Firstly, it is clear that there should be a healthy balance between risk capital and borrowed capital in an industry so that each firm optimizes its cost of capital (disregarding for a moment the invisible and long term cost of equity capital). Secondly, the industrial comity, investor community and the banking sector must anchor their transactions around expectations rather than on speculations. Thirdly, the balance between demand and supply on one hand and the factors of consumption and those of supply must be dynamically optimized, with focus on continuous growth and competitiveness. Fourthly, economists and industrialists must learn to differentiate between real inflation (which is inescapable but can be managed cyclically) and unreal inflation (which is irretrievably erosive and needs to be rooted out). Fifthly, and most importantly, economic and industrial policies require a culture of trust, transparency, forthrightness, logic and rationality amongst all the stakeholders that consider growth and competitiveness as two sides of an integrated economic and industrial strategy.

Posted by Dr CB Rao on February 2, 2014   

      

 

‘Post Bank of India’: The Next Economic Revolution!

Generations of Indians, more particularly the home birds such as the housewives and senior citizens and expectant students and job seekers, have experienced the Indian post office system as an integral part of their lives. The bright red post box found at every street corner, the humble neighborhood post office, and the energetic post person with his or her cycle have been ubiquitous symbols of tireless public service. The colorful stamps periodically brought out  by the Indian philately system has contributed to remarkable integration across the country. The money order system which was almost the only way to transfer money a few decades ago had an interesting aside; the white message card at the bottom to be torn off and given to the recipient along with the money meant more than the money itself to the recipient. Listening to the shout of the postman announcing “post” or the anticipation of opening the house mail box had been the daily triggers of joyousness, and in some unfortunate cases, occasional pathos too for all individuals. The telegrams were the instant messengers of all news, good and sad.

The post office system was especially empathetic to the indigent rural and poor citizens. It pioneered the savings habit amongst them with very low minimum balance requirements. The advent of superior telecommunications and the surge of national banking as well as emergence of other mailing alternatives have, no doubt, challenged the dominance of the Indian postal system. That said, the Government owned post office system is not to be written off yet. In fact, its core competence of delivering the mail at the door step in every nook and corner with a personal connectivity by the postman with the people and homes he serves is not matched by any other competing service provider. The Indian postal system can reinvent itself and continue the glorious tradition of inimitable and personalized public service by becoming the Post Bank of India, as this blog post argues.      

Infrastructure and services

Even more than the Indian Railways, India Post (previously the Indian Posts and Telegraphs Department),  which falls under the Ministry of Communication and Information Technology amazes any resident or observer of India, for its reach and service. With a network of nearly 155,000 post offices, nearly 90 percent of which serve the rural population (rural population being 70 percent of India’s 1.3 billion population), with an area coverage of one post office for every 22 square kilometers and population coverage of one post office for every 9000 people, India Post has a formidable presence all across the vast country (of 3.287 million square metres). With the telecommunications and Internet revolution, India Post has also kept pace with the introduction of electronic versions of its physical services to an extent. Over time, India Post moved into savings bank operations as well as other financial services.  Today, it has 233 million post office savings account holders and a formidable deposit base of Rs 5.5 billion.

Whatever India Post has done to keep pace with the changing times has been commendable but not transformative, relative to its infrastructure, organization and reach. Time has now come for India Post to plan a paradigm shift in its vision, strategy and structure in terms of its products and services. In every sense, India Post has the ability to touch the lives of every Indian, and also connect every Indian nationally and internationally. With growing population and globalization, and the need for increased connectivity, India Post can leverage its core competence of mailing platform to consolidate itself into a communication hub and ultimately transform itself into a multifaceted economic hub. In this process, India Post can render a host of communication and economic services, with innovative products, that can ensure inclusivity for the vast rural and semi-urban population as well as the indigent sections of the society. This requires a reinforcement of existing services and diversification into new ones. Global communication and national banking would be two of India Post’s principal hubs which it can interleave with a wide range of social, essential and educational services too.

Global communication hub

India Post has in it the historical capability to continue to be the dominant mail agency of India for decades to come. At the same time, India Post has to recognize that it has lost substantial ground to private national and international courier services. India Post has, in the past, underestimated five critical competency levers that are required in a changing millennium. Firstly, it underestimated the growing need for safety and surety in mail and parcel services. Secondly, it underestimated the importance of a collection organization to supplement its delivery organization. Thirdly, it underestimated the need for dedicated transport infrastructure to ensure speed and flexibility in delivery. Fourthly, it underestimated the extent of information technology upgradation that is required to not only trace and track physical mails but also to convert physical mails into more cost-effective and time-effective electronic mails. For example, it never occurred to India Post that like Gmail and Yahoo it could also offer “Indiapost.com” mail service, for example. Fifthly, it never engaged itself with the changing trends of social communication with its own platforms.

All is not lost, however. Each of the above shortfalls can be taken care of with appropriate infrastructural, technological and organizational initiatives. In fact, it can convert the disadvantages into advantages by being ahead of the competitive curve. It can, for example, implement Good Transportation Practices for not only safety and surety for all universal mailing applications but also to enter into newer mailing services customized for multiple industries. It can restructure and refocus its delivery organization to double up as a collection organization as well. With superior transportation support for door to door travel and multiple shifts for personnel India Post can achieve enhanced customer contact. India Post also needs to modernize and diversify its transport fleet and also outsource mail and parcel transportation to achieve overnight delivery. Information technology can be leveraged to develop and offer India’s own multi-language dedicated email service. And, finally from developing applications suitable for the three operating systems of computer, tablet and mobile devices, India Post needs to develop its own operating systems and networking platforms for Indian needs.

Not too many years ago, people wanting to send greetings in India used to rely on the several telegraphic messages of India Post to communicate the wishes. Today, everyone relies on 123Greetings or a similar Internet portal, most of which are structured and executed by Indian software engineers! India Post can resurrect its historical role as a communication hub by providing communication connectivity for all requirements of the Indian population, which is both resident and non-resident in India. India Post can also tie up with appropriate multi-product gifting agents globally to participate actively in the global social networking. With each day of the year being observed as a special day internationally, special messaging and gifting could become a recurrent source of additional business for India Post.

This leads us to the hypothesis that India Post can no longer see itself as an India-centric communication entity. The more India Post globalizes by establishing physical infrastructure in other countries, executing international mail sharing arrangements and setting up global mail delivery objectives, the more effective will India Post will be as a global communication hub. As India Post moves from a business model of being a predominantly physical mail deliverer in India to a business model of globally present Indian communication hub, the organization has a lot to strengthen itself and fulfill its national mission in an international setting.     

National banking hub  

One of the simpler thoughts has been that India Post should diversify itself into banking operations. Given that post office savings schemes have been popular, banking is a logical extension. India’s Finance Minister P Chidambaram has proposed modernization of the country's postal network to make the post offices become part of the core banking solution and offer real time banking services. He has desired that the ubiquitous post office should morph into a neighborhood bank, proving a major boon for villages. The Reserve Bank of India (RBI) has recently formulated certain guidelines, including making all entities with a credible track record eligible for a banking licence. India Post has a strong rural presence and is already into the small savings scheme. It has, by itself, around 155,000 local post offices and around 24,000 district offices against a total of 90,000 bank branches (all banks included).  The new guidelines for setting up private banks issued by the RBI, among other things, makes it mandatory for new banks to open at least 25 per cent of branches in unbanked rural centers. India Post will handsomely win on this score.

India Post is already into various financial services, including small saving schemes, postal insurance, foreign exchange services, money remittance services etc as alluded to earlier. That said, India Post needs to do more than what it has been doing to become a full-fledged bank, competing with the likes of SBI or ICICI Bank. This requires India Post to implement very robust banking systems and Internet based high capacity servers and information technology backbones. India Post also needs to induct top flight banking and information technology professionals into its organization. Government also needs to support India Post with the integration of the post office banks with the direct cash transfer schemes and preferential interest rates for rural based savings and lending schemes. India Post has to evaluate the desirability of spinning off its financial services arm into a full-fledged bank to provide the requisite autonomy and competitiveness to the banking operations while providing access to the available infrastructure.

Compared to the Indian banking services which are still oriented towards the urban and semi-urban clientele in India, the Indian post office system is very well poised to facilitate and promote financial and economic inclusivity to the rural population in India. This, however, can be reinforced and supplemented with providing a range of community and economic services to the population. Each post office can offer an Internet centre which can act as an e-choupal popularized by ITC as an information and commercial exchange platform in the agricultural and aquaculture domains for the rural population and farmers. If ITC could set up 20,000 e-choupals as a private sector initiative and touch the lives of 15 million farmers in 100,000 villages, one may imagine what India Post with its 155,000 post office network all across India can achieve in financial and economic inclusivity, covering the billion rural citizens. In fact, taking advantage of complementary nature of communication and banking, of local production and national/global markets, post office network could even emerge as the new educator of information technology for the vast indigent population of India.

Structure to support strategy

The concept of India Post morphing into Post Bank of India synergizing global communication with national banking is a great strategic value proposition. For the strategy to succeed, structure must support strategy. While continued ownership by, and policy support from, the Central Government is essential, it would be necessary to move India Post from a departmental structure to corporate structure, with requisite empowerment and accountability.  As Alfred Chandler proposed in his landmark book published in 1962, structure must follow strategy. A new strategic direction for India Post to elevate its communication and financial services to an entirely new (and high) trajectory will require several structural inputs such as definition of strategic business units, creation of new organizational structures, induction of new technologies and talents, re-training of current talent base, incorporation of market competitive strategies and processes, and payment of market competitive salaries with services and tariffs that are aligned to benchmarks of social integration and economic inclusion. With an integrated strategy and structure, India Post which is famous for its evocative and colorful stamps, among others, is bound to put an indelible and pervasive stamp of integration and inclusivity on the Indian social and economic canvas.

Posted by Dr CB Rao on May 12, 2013