Avoiding the Two Extremes- High Inflation & Deflation

One might wonder why the problem of High inflation is being highlighted in today's scenario where Deflation is the reason that Policy makers get sleepless nights.
The reason is very simple - Deflationary forces take over once and finally once and for all when monetarist expansion in the form of loose credit norms and laissez-faire banking gives way to disproportionate asset price exuberance in every sector of the economy, notably but not limited to real estate, perishable hydrocarbons and indirectly raises the rate of inflation into the uncomfortably high territory. Lax monetary policy tolerates these excesses, until social tensions spill out in the open arising due to intolerably high inflation. Taking away the punch bowl too late is the harbinger usually of a long drawn tug of war between  asset prices, credit and inflation which ultimately impacts output negatively in both quantitative and qualitative ways. The end result is always deflation as the output gap against potential output and falling capacity utilization levels hit employment and wages in a deflationary spiral.
The key lesson is that high inflation must be avoided at all costs - if not just to avoid the deflation that usually follows such monetary binges. Flashes from Phillip's curve that imply better employment figures with higher inflation must be tempered with the fact that the same Phillip's curve foretells high unemployment when deflation takes over. Moderation is indeed a very important watchword for those in control of the Monetary levers.

Uncaging the Tiger

The non-translativity of any Rate Cut into employment generation and growth

The RBI will very soon unveil its Monetary policy. Rate cuts will be good from the Banking system point of view as it will give banks the room to make provisions for NPAs from Fixed income gains. But that will not automatically translate into higher economic activity no matter what bright Bankers tell you on 24x7 media.

For growth to really pick up, India needs three things immediately. First is Investments, Second- Investments and third- Investments.

Can the Government provide the Fiscal muscle today that it did provide in 2008-09 when the US subprime crisis broke out? Not really. Fiscal numbers are in worse shape today than they were in 2008.

So how do we get the Tiger up and roaring?

Private Investment is the answer because Public investment is not available. But how do we attract Private investment. A stable tax regime for sure- but more importantly an attractive tax regime that attracts the right kind of capital -not just hot capital flows.

A. Investment Tax breaks
For far too long taxation theory and practice in India has concentrated exclusively on enlarging the tax base. Remember in a faltering economy the size of the cake reduces rapidly -the taxman will then have only a shrinking base no matter what the legislation or the enforcement.

A1. FDI(Foreign Direct Investment)
FII and FPI have again enjoyed the greatest attention from Policy makers, media and the markets. It's now high time to consider that piece of foreign investment that will actually generate growth and jobs.

A1(a) Regional incentives in areas to be classified as SEZs (Special Economic Zones)
Special incentives need to be provided for investment in non-aerable and non-tillable areas such as in Kutch, Thar, certain areas of Rajasthan, islands of Andaman & Nicobar and Lakshwadeep.  The rate of income tax levied on production-oriented foreign investment enterprises in these SEZs should not be more than 15 per cent unless it violates laws related to environment conservation. Similar reduced tax rates should for foreign investments in certain research and technological development zones (RTDZs), which could include the following-Hyderabad,Secunderabad,Vizag, Bangalore, Navi Mumbai, Ghaziabad, Bhopal, Noida, Rajkot, Haldia, Jammu, Thane, Raigad, Warangal, Porbandar, Surat and so on.

A1(b) Sectoral incentives for fresh Foreign investment enterprises in technologically advanced areas scheduled to operate for at least 10 years, and engaged in production-oriented activities, should entitled to an exemption from income tax for two years, starting with the first profit-making year. This can be followed by a 50 per cent reduction of the usual income tax rate over the subsequent three years, provided they remain technologically advanced.

A2. Domestic Investment
Fresh domestic Investment can also be extended A1(a) and A1(b) schemes above.

B. Indirect Taxation relief
So what is the average rate of taxation in the commin man in India?

Income Tax 30%
Indirect Taxes 25%
Inflation Tax 10% (Invisible Tax)
___________________
Total a cool 65%

So why doesn't saving + consumption go up? Because out of every Rupee earned, 65% goes away as taxes and only 35 paise is left. That leftover is for health , education and basic necessity like food and shelter.

So what must we do to reinvigorate savings rate? One doesn't need to be an Ivy grad to figure out that Indirect taxes has to be attacked first to give a much needed filip to the economy because workers earning below Rs 2,00,000 /- per annum do not actually have to pay income tax as per law.

Every % reduction in indirect tax will translate into equivalent growth in the savings rate and lower the cost of capital or rate if interest at which savings and Investment are at equilibrium in a stable and growing economy.

But will not a cut in indirect tax revenues bloat up Indian fiscal deficit. A 5% cut will not. In fact a 5% cut will actually generate enough growth to generate additional revenues elsewhere in direct taxation revenues to more than recoup the loss of the indirect tax revenues.

C. Debottlenecking Investment approval red tape and enabling Investments
This is purely a governance issue that has to be tackled by the PM and his team of Ministers.

No amount of writing or analysis can earn for the country in terms if growth what a proactive Government can do.

A,B and C taken together will give D- Dashing growth. Don't just pine away for cut, cut, cut -rate cut. Go for growth- a job generating growth.

Condoling Dr. John Nash and Mrs Nash

It is with great grief and shock that the World says adieu to one of the greatest men of Mathematical Science Dr John Nash and his wife Mrs Nash in an accident today.

Dr. Nash will be forever remembered in the same galactic lexicon as Newton and Einstein-such has been his gigantic contribution.

Infrastructure Creation- Fiscal Deficit led Investment & Demand Creation by China

Chinese growth, Industrial production and fixed asset investment has cooled down significantly.  

Coming at a time when the entire global economy is facing a demand deficit, adding more gloom is this Chinese tale of woe - couldn't have been timed worse.

China has been the most important growth engine for the world over the last 2 decades. Its export led growth story scripted by Deng's far sighted reforms , coupled with fortuitously concurrent technological advances in Information technology and supply chain management have taken China far - thus far.

But now the script has changed. There is an urgent need to re- engineer strategy now that advanced economies have simultaneously launched an FX war on developing countries using zero lower bound interest rates and unconventional monetary policy. Developing economies cannot afford to join this zero sum game because their per capita incomes are very low compared to the developed economies. Ideally , all Governments in developed economies should use their prevalent low interest rates to borrow and supplement collapse in private demand by spending on infrastructure-both greenfield and maintenance of depreciating works. But these geniuses refuse to even consider such a policy relook and instead continue to debase their currencies in the hope of exporting their way out of deflation. The Nash equilibrium is very simple-Developing economies ape the same strategem and world spirals down a never ending FX war.

But there's a way out -There's another solution with superior payoffs as compared to the suboptimal Nash equilibrium above. Suppose developing countries that have the fiscal and inflationary room to increase government involvement in infrastructure spending, do so, then the resultant demand generation there can reinvigorate demand slowly elsewhere(especially in the developed world). This can serve a very useful purpose-Developed nations trying to export there way out of deflation will eventually export the deflation to developing countries if the latter fall into the Nash trap. Hence it is now in the interest of developing countries to search for demand generation internally. China best fits the bill with very healthy government finances and an Imminent deflation it wants to desperately avoid.

So here's the latest brief for Multilateral Development agencies. Help developing economies,especially China to avoid the deflation trap at this critical time by enhancing fiscal participation in the domestic demand regeneration. China is key. If China falls, the western world will follow suit kicking and screaming into a bottomless pit. If the West wants to derisk their China sensitivity then they must themselves adopt healthy fiscal policies. There's no use parroting ZLB and UMP any longer now- no marginal long term benefit on output from UMP is feasible.

Greece: Only Solution is a Completely Independent Existence & Why Greeks are Not upto It

While it is amply clear that Greek survival is now obviously dependent on an independent mode of existence, the path to such'Grexism' is through a very hard and painful transition.

Such transition is up the sleeves of not any politician or economist but a very precious commodity called leadership displayed by the likes of Washington, Lincoln or MK Gandhi.

Greece is unfortunate here- Tsipras is the usual middle aged Romantic political hero who can lord it out in a Corporate board battle or a parliamentary fracas-  but the dirt and grime of battle will make him wheeze and sneeze. Washington and MK Gandhi were totally different stuff that legendary leadership is made up of. Greece does not possess any leadership that can deliver the necessary Grexit-No party has that commodity that can deliver what the nation requires immediately and urgently.

So we move from one drama to another-like a sordid tragedy getting murkier and having greater costs on human life untill violence on the street takes over in Athens. When that inevitably happens it will in itself be a complete failure of Statesmanship in Europe. What else could you possibly expect from a de facto Politburo?