Philippine Political Dynasties: Learning From How Capitalism Undermines India’s Caste System

Here is an interesting study on how capitalism has contributed to the erosion of the India’s caste system 

From Swaminathan S. Anklesaria Aiyar at the Cato Institute Blog (bold mine)

Karl Marx was wrong about many things but right about one thing: the revolutionary way capitalism attacks and destroys feudalism. As I explain in a new study,  in India, the rise of capitalism since the economic reforms of 1991 has also attacked and eroded casteism, a social hierarchy that placed four castes on top with a fifth caste—dalits—like dirt beneath the feet of others. Dalits, once called untouchables, were traditionally denied any livelihood save virtual serfdom to landowners and the filthiest, most disease-ridden tasks, such as cleaning toilets and handling dead humans and animals. Remarkably, the opening up of the Indian economy has enabled dalits to break out of their traditional low occupations and start businesses. The Dalit Indian Chamber of Commerce and Industry (DICCI) now boasts over 3,000 millionaire members. This revolution is still in its early stages, but is now unstoppable.

Milind Kamble, head of DICCI, says capitalism has been the key to breaking down the old caste system. During the socialist days of India’s command economy, the lucky few with industrial licenses ran virtual monopolies and placed orders for supplies and logistics entirely with members of their own caste. But after the 1991 reforms opened the floodgates of competition, businesses soon discovered that to survive, they had to find the most competitive inputs. What mattered was the price of your supplier, not his caste.

Many tasks earlier done in-house were contracted out for efficiency, and this opened new spaces that could be filled by new entrepreneurs, including dalits. DIOCCI members had a turnover of half a billion dollars in 2014 and aim to double it within five years. Kamble says dalits have ceased to be objects of pity and are becoming objects of envy. They are no longer just job-seekers, they are now job creators.

Even in rural areas, dalits have increasingly moved up the income and social ladders in the last two decades.  One survey in the state of Uttar Pradesh shows the proportion of dalits owning brick houses is up from 38 percent to 94 percent, the proportion running their own businesses is up from 6 percent to 36.7 percent, and the proportion owning cell phones is up from zero to one-third. Some former serfs have now become bosses. A rising proportion have become land-owners, and sometimes hire upper-caste workers. Even more revolutionary, say dalits, is the change in their social status. Once they were virtually bonded laborers, and could not eat or drink with the upper castes. Today the bonded labor system is almost gone, and dalits operate restaurants at which upper castes eat and drink. They remain relatively poor and discriminated against, but economic reform since 1991 has revolutionized their social and economic status.

If capitalism can influence an alteration of culture and politics in India, then why shouldn’t this affect political dynasties that persist to plague the Philippine political economy? 

For all the legislation to contain dynasties, the result has been to increase its presence. This just shows how interventionist politics has driven the economy than vice versa.

Legislation will hardly change this (as most of these will center on increasing the politician’s grip over the local economy. Will those in power vote to undermine their current privileges?)

However, economic freedom will. Grassroot economic freedom can always start with the informal economy.

In India, Child Labor Ban Leads to More Child Labor

Just one of the many examples of how noble-sounding statutes backfire when faced with economic reality. 

From the Wall Street Journal Real Times Economic Blog

A ban on child labor sounds like a policy move that would yield nothing but favorable results. But a new paper on the fallout from such a measure in India finds that isn’t the case.

The title — “Perverse Consequences of Well Intentioned Regulation: Evidence from India’s Child Labor Ban” — captures the conclusion that families’ welfare diminished rather than improved after India’s 1986 prohibition against labor by children under age 14.

The authors focused on particular jobs that the ban prohibited children from doing, such as working in mines, handling toxic substances, making cigarettes or providing food at rail stations. The ban didn’t extend to agriculture or family businesses, but the legislation set forth limits on how many and which hours children could work. Penalties for flouting the law included fines or prison time.

After the ban, the authors found, child labor actually increased — while wages for children, relative to those of adults, decreased. In addition, since fewer children were being paid, families became poorer, consumed and spent less and all told, found themselves struggling more financially than they had before the ban.

The abstract of the NBER paper by Prashant Bharadwaj, Leah K. Lakdawala and Nicholas Li (bold mine)

While bans against child labor are a common policy tool, there is very little empirical evidence validating their effectiveness. In this paper, we examine the consequences of India’s landmark legislation against child labor, the Child Labor (Prohibition and Regulation) Act of 1986. Using data from employment surveys conducted before and after the ban, and using age restrictions that determined who the ban applied to, we show that child wages decrease and child labor increases after the ban. These results are consistent with a theoretical model building on the seminal work of Basu and Van (1998) and Basu (2005), where families use child labor to reach subsistence constraints and where child wages decrease in response to bans, leading poor families to utilize more child labor. The increase in child labor comes at the expense of reduced school enrollment. We also examine the effects of the ban at the household level. Using linked consumption and expenditure data, we find that along various margins of household expenditure, consumption, calorie intake and asset holdings, households are worse off after the ban

At the end of the day, arbitrary edicts intended to safeguard certain constituents end up going on the opposite direction. Such is the law of unintended consequences

Warren Buffett & co. Abandons ‘Buy India’ Theme

Former value investor and now Obama crony Warren Buffett cut losses from his investments in India along with other major investors.

From the Bloomberg: (bold mine)

Little more than two years after Warren Buffett labeled India a “dream market,” the economy is expanding at the slowest pace in a decade and the nation’s debt ratings are at risk of being cut to junk.

In the last three months, ArcelorMittal (MT) and Posco scrapped plans for $12 billion of investments, while global funds pulled $12.6 billion from Indian stocks and bonds. The exodus drove the rupee to a record low and caused short-term borrowing costs to soar, sending the government’s two-year bond yield to the biggest premium to the 10-year rate in Bloomberg data going back to 2001. Even Buffett packed up and left, with Berkshire Hathaway Inc. (BRK/A) exiting an insurance distribution venture.

Earlier the legendary investor Jim Rogers said that he has shorted India, while Greed and Fear author CLSA’s Chris Wood sees India as highly vulnerable to a sovereign debt crisis.

Despite the sharp rebound of India’s markets, India’s problems has been structural, has been intensifying and has been highly dependent on a risk ON environment

From the same Bloomberg article: (bold mine)

Investors see little prospect of India tackling budget and current-account deficits that drove the rupee down 20 percent in two years as Prime Minister Manmohan Singh boosts food subsidies to woo voters before a May 2014 election. Standard & Poor’s said this month there is more than a one-in-three chance the nation will lose its investment-grade rating within two years, while Pacific Investment Management Co. sees a “large” chance of a cut in as little as 12 months. Last year’s economic growth of 5 percent compares with an average 7.6 percent in the previous decade…

Weakened by corruption scandals and the loss of allies, Singh’s government has passed the fewest bills ever by an administration sitting a five-year term. That is allowing imbalances to build in Asia’s third-largest economy.

The current-account deficit widened to a record 4.8 percent of gross domestic product in the fiscal year ended March 31, while the 4.9 percent shortfall in public finances was the highest among the four largest developing nations. The World Bank estimates more than 800 million people live on less than $2 per day in India, where consumer-price inflation has held close to 10 percent for more than a year.

Data this month showed gains in wholesale prices unexpectedly accelerated to a six-month high of 6.1 percent in August. Every 10 percent decline in the rupee adds as much as 80 basis points, or 0.80 percentage point, to wholesale-price inflation, Nomura Holdings Inc. estimates show.

The emergence of bond vigilantes has only exposed on the structural defects of highly politicized economies as India. 

India’s war on gold for instance is a symptom of shrinking real markets due to expansive political controls.

Yet fickle foreign funds stampede in and out of Indian markets

Raghuram Rajan outlined a plan to give concessional swaps for banks’ foreign-currency deposits when he took charge as the 23rd governor of the Reserve Bank of India on Sept. 4. That, along with the U.S. Federal Reserve’s decision this month to continue monetary stimulus that has buoyed emerging-market assets, has helped the rupee pare some losses. Foreign funds have bought a net $2.04 billion worth of Indian shares in September and outflows from debt have slowed to $594.6 million.

The rupee has rallied 5.8 percent in September, after a 14 percent slide in the previous three months that was the worst performance among 24 emerging-market currencies tracked by Bloomberg. The S&P BSE Sensex (SENSEX) of local shares has climbed 6.8 percent this month as Rajan’s measures and the Fed’s policy boosted inflows. It fell 5.8 percent in the June-August period.

Those ‘financial tourist dollars’ flowing into India of late represents the throng of frantic yield chasing players, in the words of CLSA’s Chris Wood "crowded into quality, albeit expensive stocks that have outperformed".

And proof of this has been the wide divergence between blue chips and small companies, again from Bloomberg:

India’s smallest companies are trailing its biggest corporations by the most since 2006 in the stock market. The S&P BSE Small-Cap Index, a gauge of 431 companies with a median market value of $91 million, has tumbled 26 percent this year, compared with a 2.4 percent advance in the Sensex, where the median value of 30 firms is $16.9 billion, data compiled by Bloomberg show.

The most important development has been in India’s bond markets, which appears to be signaling a forthcoming recession or even a crisis via an inverted yield curve, again from the Bloomberg (bold mine)

A cash crunch created by the RBI to shore up the exchange rate caused short-term interest rates to exceed long-term ones, inverting the yield curve that gauges the length of investment against returns. Three-month government debt costs jumped to as high as 12 percent at the end of August, from 7.31 percent three months earlier. Two-year bond yields exceeded 10-year rates by as much as 272 basis points on July 31. Notes due in a decade pay 8.72 percent, compared with 2.63 percent in the U.S., 0.69 percent in Japan and 3.98 percent in China. 

Inverted yield curves typically reflect investors’ lack of confidence in an economy and presaged bailouts in Europe in the past three years. Greece’s two-year debt started paying more than 10-year securities a month before the government sought financial aid for the first time in 2010, while Portugal’s curve inverted a week before it sought a rescue.

Inverted yield curves are manifestations of the transition from policy induced inflationary boom to a deflationary bust.

As Austrian economist Gary North explains (bold original)

This monetary inflation has misallocated capital: business expansion that was not justified by the actual supply of loanable capital (savings), but which businessmen thought was justified because of the artificially low rate of interest (central bank money). Now the truth becomes apparent in the debt markets. Businesses will have to cut back on their expansion because of rising short-term rates: a liquidity shortage. They will begin to sustain losses. The yield curve therefore inverts in advance.

On the demand side, borrowers now become so desperate for a loan that they are willing to pay more for a 90-day loan than a 30-year, locked in-loan.

On the supply side, lenders become so fearful about the short-term state of the economy -- a recession, which lowers interest rates as the economy sinks -- that they are willing to forego the inflation premium that they normally demand from borrowers. They lock in today's long-term rates by buying bonds, which in turn lowers the rate even further.

An inverted yield curve is therefore produced by fear: business borrowers' fears of not being able to finish their on-line capital construction projects and lenders' fears of a recession, with its falling interest rates and a falling stock market.

An inverted yield curve normally signals a recession, which begins about six months later. The stock market usually begins to fall six months prior to any recession. So, the appearance of an inverted yield curve normally is followed very shortly by a falling stock market. Fact: The inverted yield curve is an anomaly, happens rarely,and is almost always followed by a recession.

So while the yield chasing manic crowd may drive India’s frothy markets to even higher levels, the emergence of the inverted yield curve implies of a escalating risk of a market shock.

India epitomizes what has been going on globally; manic yield chasing punts pushing up markets, even as unsustainable imbalances have become more evident and more prone to violent adjustments.

Phisix: Will the Global Equity Meltup be Sustainable?

I believe the market is topping. The stock market predicted seven out of the last three recessions; I predicted seven out of the last three bear markets. I started in a bear market, so I have a bearish bias. Where I am on the market is if you gave me a stock I really like, I will buy it. If you give me a stock I really hate, I’ll short it. In terms of having some big position, long or show index, or some exposure to the stock market right now, I am lost. I don’t play when I am lost. I know in the future I won’t be lost. Stanley Druckenmiller, billionaire investor in a Bloomberg Interview

In a snap of a finger, global equity markets dramatically transformed from Risk OFF to Risk ON.

Some equity markets have even reached or are nearly at new highs.

The Boy Who Cried Wolf; The Mania in US Markets

The consensus have come to treat equity markets as “the boy who cried wolf”, ever dismissive of the risks of the emergence of the market’s equivalent of the “wolf” in Aesop’s parable[1]. Each time the market sold off, the consensus sees this as a ‘false positive error’[2] or a false alarm and thus has been interpreted as buying opportunities.

The consensus have been conditioned or programmed to believe markets operate only in one direction: the quasi-permanent boom. Fundamentals both good and bad have been seen as positive for equity markets. Bad news is even better, because the flow of central bank steroids is assumed as assured[3].

Wall Street’s schadenfreude mentality seems to have become the norm. Such appears to have been shaped by repeated guarantees by central banks in support of the financial markets through the Greenspan-Bernanke Put of the zero bound negative real rates policy (ZIRP)

Wall Street and their global counterparts furtively desires to see tepid or stagnant real economic growth to justify central bank policies that transfers resources from the main street to them while paradoxically promoting such policies as “pro-growth”.

In the Philippines where only 21 of every 100 households have access to the formal banking system[4], zero bound rates, which has generated a credit driven statistical boom, means that less than 21% of the every 100 households has benefited from central bank subsidies/transfers stealthily financed and channeled through the loss of purchasing power of the Peso. The other major beneficiary has been the Philippine government whose artificially suppressed or low interest payments have signified as an implicit subsidy from taxpayers and from the peso holders: the financial repression

Last week’s powerful stock market rally in the US (Dow Jones 3.04%, S&P 500 1.98%) has partly been fueled by faltering economic data that has been viewed as potential restraint to the US Federal Reserve purported “tapering”. Much of these optimism stems from this week’s September 17-18^th meeting by the Federal Open Market Committee (FOMC).

In the US, equity market Pollyanna have become so certain or overconfident about the sustainability of the current bullmarket such that they have begun to patently mock or heckle at cynics, e.g. “Every Year Since The Financial Crisis Has Looked Like '1987 All Over Again'[5], “Is doomsaying out of fashion?” and “consumers are interested in shopping and not politics”. 

Such cockiness has even been captured by magazine covers. For example, Time’s September issue features “How Wall Street Won” or even Barron’s latest “The Bull’s in charge” or Barron’s in last April’s “Dow, 16,000!”[6]

Ironically there is such a thing called the “magazine cover indicators” where excessive sentiments or the “crowded trade” phenomenon embodied by faddish themed magazine covers herald a significant turnaround or an inflection point as the above example shows[7].

Time Magazine’s “death of the euro” in November of 2011 foreshadowed the eventual recovery of the Euro in 2012 and Time Magazine’s Super Abenomics last May had been followed by the crash of the Nikkei, the latter which despite the current rally remains distant from the May 2013 highs[8].

For the consensus, risks have been shelved for good. The stock market has reached “a permanently high plateau” to quote the late American economist Irving Fisher[9] prior to the 1929 stock market crash, who like all the others thought that “this time is different”—a central demarcation of pre-crisis episodes.

Finally it’s nice to know that the current US bullmarket has been revealing of a vital shift in the character of investors. As one would note from the US Equity flow of funds[10], the household sector have become Net buyers of US equities for the first time since 2009 (top most pane) as institutional investors (second to the last box) have been reducing their scale of purchases and as foreign investors have turned NET sellers (lowest pane).

This seems to validate actions of Warren Buffett, John Paulson and George Soros whom all have been raising cash by substantially reducing equity exposures on the equity market[11].

Meanwhile equity mutual funds appear to be neutral while Equity ETFs continue to register substantial but slightly less buying activities. Both mutual funds and equity ETFs are most likely proxies of retail or household investors.

In other words, Smart money have been on a defensive while HOUSEHOLD or RETAIL momentum/punters have increasingly become the driving force for the current bull run. Said differently, what SMART money sells RETAIL money buys.

In Aesop’s Fable, the big bad wolf eventually does appear.

ASEAN Rally and Indonesia’s Fuel Subsidy Dilemma

Asia and many emerging markets resonated with the global equity market melt-up. 

Two of the three ASEAN’s bellwethers which recently entered bear market territory posted the best gains. Indonesia’s JCI and Thailand’s SET soared by 7.45% and 4.85% respectively.

The Philippine Phisix (the third ASEAN market to have touched the bear market zone) and Singapore’s STI had unimpressive 2.65% and 2.36% gains. Meanwhile Malaysia’s KLCI, which had been the least affected during the recent turmoil, has also been sharply up 2.73%.

Whatever positive reaction seen last week by ASEAN markets[12] [Philippine Phisix- PCOMP red-orange, Singapore’s STI- FSSTI green, Indonesia’s JCI orange, Thailand’s SET- red] has hardly eradicated the earlier steep losses. Instead last week’s rally appear to resemble the violent upside response to the June lows.

The sharp rally in ASEAN equity markets has partly been reflected on ASEAN currencies. I say “partly” because the degree of rebound in the currency market has not been commensurate with those of the stock markets.

The Singapore dollar (upper right pane) and the Philippine Peso (lower left pane) posted the best gains. The Thai baht (lower right window) recovered only marginally.

Importantly, one of the ‘tinderboxes’ or candidates for a crisis among Emerging economies, Indonesia via her currency the rupiah barely budged from the elevated levels (upper left pane). This despite the monster stock market rally and in spite of the Indonesian central bank, Bank Indonesia’s fourth interest rate increase this year, implemented last Thursday[13]. 

And so with Credit Default Swaps (CDS) where Indonesia’s 5-year premium are at the highest level of the year[14]

My interpretation to this is that the currency market and the CDS market, as well as the Indonesian bond markets which modestly rallied have largely been unconvinced by the actions of Bank Indonesia.

Such market response has been understandable.

Aside from homegrown bubbles, one of the biggest problems facing the Indonesian government has been fuel subsidies. Fuel subsidies poses as the same major obstacle to India.

The Indonesian government cut fuel subsidies last June. This effectively raised gas and diesel prices by 44% and 22% respectively which also signified as the first fuel increase since 2008. Despite the sharp increases in fuel prices, Indonesia has still one of the lowest fuel prices in the world. Attempts at further reducing subsidies by the Indonesian government have been stalled due to the violent public protests. Subsidies still cost the Indonesian government some $20 billion per year or 3% of GDP, according to the Asian Investor[15].

Meanwhile, India’s fuel subsidies have been estimated by the IMF as accounting for 1.9% of the GDP. Fuel subsidies in India according to an IMF study benefits the wealthy more the poor.

Rallying stocks will hardly eradicate on what has been a structural political economic problem for nations providing significant fuel subsidies as Indonesia and India in the face of a transitioning environment.

Should oil prices continue to rise or should real economic growth slow (meaning lesser taxes) or a combination of both, these factors are likely to compound on the already strained fiscal conditions of Indonesia and India. And rising rates amidst slowing economic growth and high debt levels would not only put a crimp on the economy but likewise raise the risks of credit defaults that may impact both the banking system and their respective governments that also increase the risk of a sovereign crisis.

The ill effects of these subsidies had been camouflaged by credit driven economic growth from the previous easy money regime. Such unsustainable imbalances have been exposed by the bond vigilantes and by rising oil prices. And a return to the salad days brought about by easy money policies is unlikely anytime soon.

Yet unless these governments undertake the unpopular reforms of dismantling fuel subsidies, the risks to a credit event remain significant.

Sure, yield chasing may lead to higher stock markets in Indonesia or India, but unless such reforms are implemented or unless oil prices fall substantially from current levels and or unless economic growth surprises materially to the upside given the current milieu of rising interest rates amidst relative high debt levels, then equity markets may be confronted with heightened risks of a market shock.

And with a high degree of market volatility which aggravates on the uncertainty from the current economic environment, and equally, from the opacity of government responses, market participants seem to have been reduced to scalpers or to short term punters.

Some institutional analysts appear to be lost or confounded with what to do or what to recommend to the public with regards to investing under the present Emerging Market dilemma. Here is a noteworthy quote from Societe Generale’s Benoit Anne[16]

To those EM investors that captured the full risk-on move in EM, hats off and well done. To those that have missed the rally and are now thinking of jumping on, please don’t.

Reading this gave me a vicarious feeling that I was in conversation with fellow bettors in a horse racing Off Track Betting (OTB) station.

---

[1] Wikipedia.org The Boy Who Cried Wolf

[2] Wikipedia.org False positive error Type I and type II errors

[3] see Bad News is Good News: Best Week for US Stocks Since January September 14, 2013

[4] See The Flaws of BSP’s Real Estate Monitoring and Banking Stress Tests May 20, 2013

[5] Business Insider Every Year Since The Financial Crisis Has Looked Like '1987 All Over Again', September 12, 2013

[6] Barron’s Online Dow 16,000! April 22, 2013

[7] John Mauldin Nothing But Bad Choices Goldseek.com September 15, 2013

[8] see Will Time Magazine’s ‘How Will Street Won’ signify as the Magazine Cover Indicator?

[9] Wikipedia.org Irving Fisher

[10] Yardeni.com US Flow of Funds: Equities

[11] Money News.com Billionaires Dumping Stocks, Economist Knows Why September 14, 2013

[12] Bloomberg.com Asia-Pacific Stock Indexes

[13] Bloomberg.com Indonesia Raises Rate to Four-Year High as Rupiah Extends Slide September 12, 2013

[14] Deutsche Bank Sovereign default probabilities online

[15] Asian Investor Why Debt Investors in Asia should worry September 2, 2013

[16] Sujata Rao Emerging markets: to buy or not to buy Reuters Global Investing September 12, 2013

India Crisis Watch: Is it Panic Time?

Have the average Indians been in a panic?

Sovereign Man’s Simon Black says current indicators point to a yes:

For the last 24-hours, banker and fund manager friends of mine have been telling me stories about oil refinery deals in North Korea, their crazy investments in Myanmar, and the utter exodus of global wealth that is finding its way to Singapore.

My colleagues reported that in the last few weeks they’ve begun seeing two new groups moving serious money into Singapore– customers from Japan and India.

Both are very clear-cut cases of people who need to get their money out of dodge ASAP.

In Japan, the government has indebted itself to the tune of 230% of GDP… a total exceeding ONE QUADRILLION yen. That’s a “1″ with 15 zerooooooooooooooos after it.

And according to the Japanese government’s own figures, they spent a mind-boggling 24.3% of their entire national tax revenue just to pay interest on the debt last year!

Apparently somewhere between this untenable fiscal position and the radiation leak at Fukishima, a few Japanese people realized that their confidence in the system was misguided.

So they came to Singapore. Or at least, they sent some funds here.

Now, if the government defaults on its debts or ignites a currency crisis (both likely scenarios given the raw numbers), then those folks will at least preserve a portion of their savings in-tact.

But if nothing happens and Japan limps along, they won’t be worse off for having some cash in a strong, stable, well-capitalized banking jurisdiction like Singapore.

India, however, is an entirely different story. It’s already melting down.

My colleagues tell me that Indian nationals are coming here by the planeful trying to move their money to Singapore.

Over the last three months, markets in India have gone haywire, and the currency (rupee) has dropped 20%. This is an astounding move for a currency, especially for such a large economy.

As a result, the government in India has imposed severe capital controls. They’ve locked people’s funds down, restricted foreign accounts, and curbed gold imports.

People are panicking. They’ve already lost confidence in the system… and as the rupee plummets, they’re taking whatever they can to Singapore.

As one of my bankers put it, “They’re getting killed on the exchange rates. But even with the rupee as low as it is, they’re still changing their money and bringing it here.”

Many of them are taking serious risks to do so. I’ve been told that some wealthy Indians are trying to smuggle in diamonds… anything they can do to skirt the controls.

(This doesn’t exactly please the regulators here who have been trying to put a more compliant face on Singapore’s once-cowboy banking system…)

The contrast is very interesting. From Japan, people who see the writing on the wall just want to be prepared with a sensible solution. They’re taking action before anything happens.

From India, though, people are in a panicked frenzy. They waited until AFTER the crisis began to start taking any of these steps. As a result, they’re suffering heavy losses and taking substantial risks.

Indian’s financial markets have been in a terrible mess.

The rupee has been taking it to the chin down by 21.6% year to date and counting.

Yields of the Indian government’s 10 year bonds has touched US crisis 2007 highs but has retraced. 

If the panic in the rupee escalates, India’s bonds will take more damage.

India’s equity markets the Sensex has been under pressure but has not encroached into the bear market yet, unlike ASEAN peers

The run in the rupee comes amidst India’s huge forex reserves. Another proof that reserves alone are not enough to prevent a run.

The reason for the rupee’s fall, desperate government unwilling to undertake reforms but has instead turned the tables on the private sector via gold sales prohibition and expanded capital controls. Thus the panic.

With free market champion Raghu Rajan assuming office only in September 4th, media has been optimistic that the new governor will be able to institute reforms. One of the early reforms which will supposedly be undertaken by Mr. Rajan has reportedly been to allow trade settlement in rupees. But mainstream media repeatedly calls for “expansionary policies” which ironically has been one of the main causes of India’s predicament.

Mr. Rajan will be faced with a huge stumbling block as I previously noted.

While it may be true that Mr. Rajan has a magnificent track record of understanding central banks and the entwined interests of the banking system coming from the free market perspective, in my view, it is one thing to operate as an ‘outsider’, and another thing to operate as a political ‘insider’ in command of power.

Mr. Rajan will be dealing, not only conflicting interests of deeply entrenched political groups, but any potential radical free market reforms are likely to run in deep contradiction with the existing statutes or legal framework from which promotes the interests of the former.

The other source of media optimism has been in reports that the BRIC will forge a $100 billion currency swap pool. All these arrangements will be futile and only symbolical unless the real sources of India’s economic malaise are dealt with.

But if the panic in rupee will spread and incite major damages in the domestic banking system, where loans from the banking system represents 75% exposure on the economy, a crisis may be in the offing

And considering what appears as skyrocketing bond yields globally led by the US, time may be running out. 

No wonder the legendary investor Jim Rogers has been short India.

Yet if the rupee meltdown persist and worsen, such will compound on the gloomy environment for Asia. 

Caveat emptor.

India Bans Gold Coin Imports, Imposes Capital Controls

I may be right, newly appointed free market central banker Raghu Rajan either has failed to oppose his colleagues from expanding interventionist policies or has succumbed to powers of the dark side as the Indian government moved not only to ban all gold coin imports but impose rigid capital controls as well.

First capital controls, from the Times of India:

Amid continuing pressure on the rupee, the RBI on Wednesday announced stern measures, including curbs on Indian firms investing abroad and a reduction of outward remittances, to restrict the outflow of foreign currency.

The central bank reduced the limit for overseas direct investment (ODI) by domestic companies, other than oil PSUs, under the automatic route from 400 per cent of net worth to 100 per cent. Oil India and ONGC Videsh are exempt from this limitation…

The RBI reduced the limit for remittances made by resident individuals under the liberalized remittances scheme (LRS) from $2 lakh to USD 75,000 a year. Resident individuals are, however, allowed to set up joint ventures or wholly owned subsidiaries outside under the ODI route within the revised LRS limit.

Next, expanding gold curbs via total import ban…

Seeking to reduce the import of gold, the Reserve Bank Wednesday prohibited inward shipment of gold coins, medallions and dores without license. "From now onwards, import of gold in the form of coins and medallions is prohibited and henceforth all import of gold in any form or purity shall be subject to a licence issued by DGFT prescribing 20-80 scheme," economic affairs secretary Arvind Mayaram told reporters here.

The latest measures are part of the series of steps taken to curb gold import, the single biggest contributor to the widening current account deficit (CAD). After a dip in June, gold imports again surged in July with 47 tonnes of inward shipments compared to 31 tonnes in the previous month. Import of gold in April-July rose 87 per cent to 383 tonnes.

Not satisfied with scapegoating gold, the Indian government has vastly expanded political controls over the financial system. Such actions will not only hit India’s economy hard as economic activities will be suppressed, but likewise  will sink the financial markets and worsen India’s financial conditions. 

As the great Austrian economist Ludwig von Mises warned;

State interference in economic life, which calls itself "economic policy," has done nothing but destroy economic life. Prohibitions and regulations have by their general obstructive tendency fostered the growth of the spirit of wastefulness. Already during the war period this policy had gained so much ground that practically all economic action of the entrepreneur was branded as violation of the law. That production is still being carried on, even semi-rationally, is to be ascribed only to the fact that destructionist laws and measures have not yet been able to operate completely and effectively. Were they more effective, hunger and mass extinction would be the lot of all civilized nations today.

Ironically despite the earlier gold curbs, India’s gold imports soared in July with smuggling as one major route. But these has forced India’s neighbors to impose their own controls 

These absurd actions by the Indian government validates Jim Rogers’ short position on India. Expect more weakness in India’s rupee (chart from XE.com)

The Indian government’s dilemma has truly been due to their insatiable profligacy. Yet, this is another example of the ratchet effect, or the mission creep of interventionism.

Also since the Indian government has been fighting the Indian tradition, it is not far fetched to expect social upheaval as repercussion from such gold sale prohibition. 

Also I expect emergent fissures in the relationship with her foreign trade partners and neighbors as the interventionism by the Indian government spreads.

Why Jim Rogers is Shorting India

In an interview at Wall Street Journal’s Livemint, the legendary investor Jim Rogers says that he is shorting India…

I used to own tourist companies in India at a time. India should have had the greatest tourist companies in the world. If you can only visit one country in your life, my goodness, it should be India—it is an astonishingly spectacular place to visit. There is no place that has the depth of culture that India has. Yes, I have new reasons to short India—just read its newspapers everyday and you will see why.

The government goes from one mistake to another—no matter what the controls are, no matter how much the debt keeps rising, Indian politicians are only looking for scapegoats. Look at the latest thing with gold—Indian politicians want to blame the problems of their economy on someone else, and now it is gold. Gold is not causing India problems, but it is quite the contrary. Exchange controls in India are absurd, the regulations that India puts in place result in foreigners going through 70 loops before they can invest in India. Foreigners cannot invest in commodities in India.

India should have been among the world’s greatest agriculture nations—you have the soil, the people, the weather, but it is astonishing that you have not become one—it is because Indian politicians, in their wisdom, have made it illegal for farmers to own more than five hectares of land. What the hell—can a farmer with just five hectares compete with someone in Australia or Canada? Even if you put together the land in all your family, it is still not possible to compete. Much as I love India, I am not a fan of its government. Every one year, they (Indian government) come up with more reasons for me to be less optimistic about that country.

India’s major equity benchmark the BSE 30

The more a country’s economy becomes politicized and the more their government engages in bubble blowing activities resulting to inflated asset prices, this usually makes for an attractive ‘short’ opportunity.

On University of Chicago’s Raghuram Rajan as India’s Central Bank Governor

Austrian economist Peter Klein cheers the appointment of University of Chicago’s finance and banking professor as the Governor of the central bank of India, noting of Mr. Rajan’s familiarity of the Austrian Business Cycle.

Writes Professor Klein at the Mises Blog

Raghu Rajan is a very good neoclassical economist who has made important contributions to banking, finance, the theory of the firm, corporate governance, economic development, and other fields. He is also taking over as head of India’s central bank. Rajan is no Austrian, but he has a quasi-Austrian take on the financial crisis, and far greater appreciation for free markets in general than any of the key US or European policymakers. As I tweeted this morning, Rajan is about 1,000,000 times better than either Summers or Yellen. I’d gladly trade him for any US central banker.

Consider, for example, Rajan’s take on the financial crisis:

The key then to understanding the recent crisis is to see why markets offered inordinate rewards for poor and risky decisions. Irrational exuberance played a part, but perhaps more important were the political forces distorting the markets. The tsunami of money directed by a US Congress, worried about growing income inequality, towards expanding low income housing, joined with the flood of foreign capital inflows to remove any discipline on home loans. And the willingness of the Fed to stay on hold until jobs came back, and indeed to infuse plentiful liquidity if ever the system got into trouble, eliminated any perceived cost to having an illiquid balance sheet.

As I wrote before, I’d reverse the order of emphasis — credit expansion first, housing policy second — but Rajan is right that government intervention gets the blame all around.

Rajan also wrote an interesting theoretical paper with Peter Diamond that echoes the Austrian theory of the business cycle: “[W]hen household needs for funds are high, interest rates will rise sharply, debtors will have to shut down illiquid projects, and in extremis, will face more damaging [bank] runs. Authorities may want to push down interest rates to maintain economic activity in the face of such illiquidity, but intervention may not always be feasible, and when feasible, could encourage banks to increase leverage or fund even more illiquid projects up front. This could make all parties worse off.”

Read the rest here

Having a free market proponent in the belly of the beast can both be a blessing or a curse. Although like Mr. Klein, one side of me wishes Mr. Rajan all the luck, another side of me tells me not to expect anything substantial.

While it may be true that Mr. Rajan has a magnificent track record of understanding central banks and the entwined interests of the banking system coming from the free market perspective, in my view, it is one thing to operate as an ‘outsider’, and another thing to operate as a political ‘insider’ in command of power.

Mr. Rajan will be dealing, not only conflicting interests of deeply entrenched political groups, but any potential radical free market reforms are likely to run in deep contradiction with the existing statutes or legal framework from which promotes the interests of the former.

Moreover, other political agencies, whose interests has been to promote the status quo, may run roughshod with Mr. Rajan perspective of reforms.

It would be interesting to see how Mr. Rajan will deal with  the present repressive “war on gold” policies by the Prime Minister’s Economic Advisory Council (PMEAC) whose interventionists actions has expanded to cover not only gold imports, but on gold transactions at every distribution level of the Indian economy.

In short, assuming the central bank governorship won’t just be about monetary, or banking policies but about the politics of bureaucracy, the welfare state and crony capitalism. 

Mr. Rajan will also have to deal with the huge resistance-to-change attitude from these groups.

In addition, in assuming the role of the proverbial hammer, where everything would look like a nail, the allure of the possession of the extraordinary power of political control over society risks overwhelming Mr. Rajan’s principles.

A great precedent would be former Fed Chair Alan Greenspan. Dr, Greenspan used to be an ardent Ayn Rand fan and a Ms. Rand influenced objectivist who embraced free market principles. Mr. Greenspan even authored the splendid, Gold and Economic Freedom in 1966. 

However upon assuming the Fed Chairmanship, Mr. Greenspan eventually abandoned free market principles to become a rabid inflationist or a serial bubble blower. Yet today’s lingering problems have, in effect, been a legacy of Greenspan-Bernanke actions.

True Mr. Rajan may not be Dr. Greenspan. But with the manifold challenging tasks ahead coming from different fronts, Mr. Rajan may want to take heed of Yoda’s advice to Anakin Skywalker: The fear of loss is a path to the dark side.

More Signs of the End of Easy Money: Following Brazil, the Indian Government Raises Interest Rates

The return of the bond vigilantes has prompted the Brazilian government to  set the trend of hiking interest rates, now it seems as India’s turn.

From Businessweek-Bloomberg:

India stepped up efforts to help the rupee after its plunge to a record low, raising two interest rates in a move that escalates a tightening in liquidity across most of the biggest emerging markets.

The central bank announced the decision late yesterday after Governor Duvvuri Subbarao earlier in the day canceled a speech to meet the finance minister. The RBI raised two money-market rates by 2 percentage points and plans to drain 120 billion rupees ($2 billion) through bond purchases.

Indian rupee forwards jumped the most in 10 months, and the RBI’s move yesterday left Russia as the only BRIC economy to not have reined in funds in its financial system. Brazil has raised its benchmark rates three times this year and a cash squeeze in China sent interbank borrowing costs soaring to records last month.

Media recently cheered on the one month contraction from record trade deficits largely due to gold import and trade curbs.

Yet if the rupee-US dollar exchange ratio continues to decline or if the USD-rupee persist to ascend as shown above, then statistical data may not reflect on the real state of affairs.

Gold restriction mandates have only been diverting India’s gold trade underground. Gold smuggling has massively risen, partly channeled through Nepal. 

Decline in India’s rupee has equally been reflected on consumer price inflation which increased to a three month high.

A curious mind would ask why, given India’s relatively low inflation and interest rate levels, has these been prompting alarm on Indian authorities for them to act to tighten?

Well, the obvious answer is that today’s systemic debt have reached epic proportions as shown by domestic credit % to the economy.

It’s not just domestic debt but also India's external debt has sharply risen to record highs.

All these has made India’s economy and financial system highly vulnerable to interest rate increases. (above charts from tradingeconomics.com)

But these governments sees the risks in the currency spectrum as potential tinderboxes for a crisis, and thus opt for the interest rate medium to effect policy changes.

As I have been pointing out, one cannot just compare with past data in analyzing economic events, that’s because, there are multitude of changes happening real time. 

So what may seem as relatively “low” interest rates and “low” consumer price inflation today, may be “high” relative to the changes in the debt position.

Nonetheless, theoretically the bigger the debt, the more sensitive debt conditions are to interest rate increases, which likewise implies of the amplification of credit risks.

So far India’s stock market, represented by the BSE 30, after falling 9% in reaction to “tapering” fears, from the May’s peak, appears to be challenging the record highs. Dr. Bernanke’s "put" has put an oomph to the latest rally. 

In contrast, stock markets of Brazil, China and Russia continues to flounder.

Also I pointed out that Turkey's officials previously announced measures to use record foreign currency reserves to combat the bond vigilantes, they seem to have a change of heart, after the initial forex measures, as predicted, have apparently failed to stanch the decline of the lira. 

Now, Turkish monetary officials are contemplating to likewise tighten via the interest rate channel.

Brazil and India’s tightening, brought about by the return of the bond vigilantes, which will likely to be a trend for many more emerging markets as Turkey and Indonesia and possibly too on developed economies, are deepening signs of the transition from easy money to the tight money. 

It would be reckless to ignore the risks of disorderly market adjustments should bond vigilantes continue to run berserk.