Friday, August 01, 2008

Doc says "Drug all analysts for a while"

What do many financial analysts and business media have in common? A drive to talk our economy – into a depression.

To begin with, they over-research the financial services sector (FSS) and extrapolate it into their broadbased prophecies. Go tell them FSS is not the whole economy. FSS (at Rs.1.65 trillion) account for just under 14% per cent of India’s GDP (Rs.12 trillion). Ranting against RBI for its three rate hikes in two months betrays poor understanding on their part.

I ask them to set their clock back by about 5 years and take a peek. Back in 2002-03, we had rate drops in quick succession that drove up bond prices, when banks and bond funds declared phenomenal returns. Now it's just the reverse of that and such shifts in dynamics only confirm the prevalence of a cycle and hence room for hope that they will go back to where they came from. What matters at a world level and for countries is that total nominal demand should be rising fast enough to support a sustainable rate of real growth but not so fast as to generate runaway inflation. That’s exactly what Guv. Y.V.Reddy sought to rein in by hinking repo and CRR earlier this week. In spite of India’s exceptional experience in this “nice” (non-inflationary, constantly expansionary) decade, this demand expansion is rarely going to take place along a simple straight line, but it makes sense as an average over a period.

The world economy as a whole has clearly hit the buffers. Demand growth has been too high for world supply potential. This is the common factor behind the rise in oil, food and commodity prices, which has struck the OECD countries as a rise in imported inflation. At present, commodity overheating in some of the BRIC (Brazil, Russia, India, China) countries coincides with economic slack in Europe and North America. This is no more paradoxical than the situation that confronts central banks when some regions are depressed and others over-buoyant.

No one really knows what the permanent element is in the rise in oil, food or commodity prices. [Is it surging demand, squeezed down supplies or flip side of derivative positions in oil futures market?] Even if there is a long-term upward trend in these primary prices, there is likely to be a temporary fallback. Meanwhile, shall we ask the analysts to just shut up, stop staring at the screens and prognosticate?

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