Fibonacci ratios and the Sensex

The ET carries Sensex 2008 target estimates made using the Fibonacci ratios - 0.382, 0.618, 1.618, and 1. The estimations of the yearly closing target, done based on the difference between the lowest and highest monthly closes, multiplied by the Fibonachi ratios, and then added to the highest monthly closing of the previous year, revealed striking similarity with the actual performance for four years from 2004 to 2007. In fact, at least one among these Fibonacci ratios has given a target that is in a range of +/- 5% of the final realised value of the Sensex for the next year.The table below reveals the similarity



The graph below charts the highest-lowest monthly closing trends for the past four years.



With this method of technical analysis, the Sensex 2008 is estimated to be 23094.27, 24828.61, 27635.89 and 32177.51 respectively, for the four Fibonacci ratios. Let us revisit this post on 31, December 2008!

A case for easing monetary policy in India

In a meeting with all bank chiefs last week, the Finance Minister requested them to soften interest rates, so as to maintain the current growth rates. The economic conditions present an interesting picture. While oil prices continue to move upwards, the inflation trends are more benign. Central Banks have to exercise their monetary policy levers by keeping a balance between the two, at times competing, concerns - growth and inflation. There are opinions both in favor and against easing the monetary policy. I will list out a few reasons as to why monetary policy should be eased.

In early 2007, with inflation threatening to touch 7% and beyond, and the Government facing coalition uncertainty, RBI was facing a difficult situation. The rising inflation in the early part of the year, coupled with the surge in foreign investments, both FDI and FPI, resulting in rising forex reserves raised major concerns within both the RBI and the Government. The RBI responded with a series of monetary tightening measures. The repo rate (at which RBI lends to banks) rose to 7.75% in three instalments, starting October 2006, the CRR went up to 7.5% in the same number of instalments from April 2007. It also raised the limit set on the amount of money that could be removed from the system by short-term (reverse repo) and long term (market stabilization) borrowing.

This monetary tightening has yielded results in the last six months, as WPI inflation has been brought down below 4%. With inflationary concerns allayed, the time has certainly come for growth concerns to take over. This means the RBI should ease the monetary controls and encourage investment. It is the time for aggressively cutting rates.

Monetary policy decisions are increasingly dependent on the global macroeconomic picture. Monetary policy autonomy has diminished to the extent that Central Banks have to factor in the fundamentals and the expectations in the global economy, atleast in the major economies of the world. It is in this context that India may be standing at a favorable position in the global growth cycle.

The US and Europe are easing their monetary policy out of compulsions arising from the sub-prime mortgage related credit squeeze and the imminent dangers of a recession. In contrast, India can afford to loosen monetary policy from a position of strength. A loose monetary policy is critical for continuing the rise in investment rates, at 35% of GDP, which is essential for sustaining the high 9-10% growth rates. In an increasingly integrated global economy, any US recession and low interest rates presents a great opportunity for India to sustain high economic growth without inflationary pressures.

A hard landing in the US and recession elsewhere in the developed world, will cause a fall in global aggregate demand, which will adversely affect the export-led growth economies. The high degree of integration between US and the Asian economies will only exacerbate any consequences of recession in the former, thereby triggering off a global slowdown. This will in turn dampen global oil, energy, food, and other commodity prices, and force down inflationary trends and lower import costs. Though these external shocks will definitely have an impact on our economic growth, India is uniquely positioned among the major economies to ride out this tide. Its low trade dependence, forming 23.5% of GDP, as compared to 36.6% for China and 72% for the ASEAN countries, and a large and fast growing domestic economy, ensures that the Indian economy will continue to remain largely decoupled from rest of the world. Its growing domestic savings rate, at 34% of GDP, and robust financial markets will only increase its ability to withstand external shocks.

There are no dangers of a credit flight or out of control inflation for the foreseeable future. A balanced play of the Impossible Trinity, by way of stable exchange rates and a gradual easing of capital mobility controls, will ensure that we are able to maintain interest rate autonomy.

I will list out a few reasons as to why monetary policy should be eased.
1. Low interest rates are critical for sustaining the rapidly increasing investment rate. It stood at 35% of GDP for 2006-07. Apart from reducing the cost of capital, it will also contribute towards sustaining the bull run in the equity markets.
2. Indian economic growth is extremely interest rate sensitive, given the large number of small and medium businesses, who depend heavily on bank credit. Further, the limitations imposed on accessing external borrowings, also increases the dependence on local bank credit.
3. A recession in the US and elsewhere will reduce consumption demand and hence lower aggregate demand, which in turn is likely to put downward pressure on import prices. A fall in global aggregate demand, is likely to also depress energy, commodity and foodgrain prices, thereby further lowering inflationary pressures.
4. The WPI is already at a very low 3.65% for the first week of December, and declining. Given that CPI follows the WPI, with a lag, the CPI is also set to fall in the coming weeks. Inflationary pressures are therefore well under control.
5. With declining rates elsewhere, prompted by the credit crunch, higher rates in India will open up carry trade like arbitrage opportunities, which are not necessarily desirable.
6. In the event of a recession in the US causing drop in FII inflows into emerging markets, a loose monetary policy could help provide the internal thrust to sustain and stabilize the stock markets.
7. In contrast, in the event of a capital flight into emerging markets, the low interest rates will reduce the incentives for financial market distortions that could encourage undesirable, hot money inflows.
8. By making rupee investments less attractive compared to the other currencies, low interest rates will reduce capital inflows and thereby control the exchange rate appreciation of rupee.
9. A low rate will leave the RBI with enough flexibility to manoeuvre without compromising on growth concerns, when the economy starts overheating, as it will frequently do.
10. The prevailing high interest rate regime had crowded in the overwhelming share of domestic savings into bank deposits, and crowded out the development of alternate investment avenues in the financial markets. The result is that such investments, including the equity markets (only 7% of population invest in shares), lack from adequate depth and breadth. A low rate regime could provide the opportunity for development of such market.
11. A lower rate will ease the demand for External Commercial Borrowings, which crossed $30 bn in 2007. India has emerged as the largest issued of foreign currency convertible bonds (FCCBs) in Asia, outside of Japan. While ECBs are to be welcomed as a source of investment alternatives, an over reliance on them, especially on certain categories, can have harmful medium and long term implications. We only need to look back at the East Asian currency crisis of 1997.
12. The low interest rates will give a filip to consumption growth as hire purchase and home loan markets will go up. The importance of the consumption driven growth multiplier for the economy is enormous.

More fundamentally, for far too long, interest rates in India have remained higher than the global average. It was understandable given the developing and closed nature of our economy, and high inflation rates. But these high rates had introduced many distortions into the economy. Now with economy opening up, financial markets getting integrated with the global markets, capital mobility restrictions being slowly eased, inflation coming under control despite the galloping oil prices, and global interest rates being eased, it is natural that our monetary policy be eased at the slightest opportunity.

As it is our interest rates are high enough to make the cost of capital for our corporates higher than their global competitors. At this stage of our economic growth, when we are stabilizing the high growth trajectory, it is important that we use every opportunity to lower the cost of capital for our corporates. Besides the immediate advantages, it also expedite the painless convergence of our economy with the global financial markets and also provide the Central Banks with greater flexibility to manoeuvre in times of inflationary pressures, economic downturns and financial crisis.

Age of risk

It did take the genius of Donald Rumsfeld to wake us up to the fact that we are living in an age of "known unknowns and unknown unknowns"! Uncertainty and risk are today the primary concern for everyone - individuals, businesses, governments, and society itself. The sources of uncertainty have multiplied and encompass every dimension of life. The importance of risk management is underlined by the emergence and growing salience of an exclusive Chief Risk Officer (CRO) in major private companies.

Globalisation has thrown up in its wake numerous risks arising from outsourcing, free movement of labor and capital, reduction of tariffs and opening up of economies etc. Globalisation and the resultant integration of markets, has rendered individual national policies on many issues ineffective and considereably reduced national autonomy in economic policy making. As the benefits of globalisation becomes cornered by a handful few, the overwhelming majority of those left-out are beginning to make their voices heard, often violently so. Economic globalisation is leaving behind an ever widening inequality gap, both within and between nations. And democratically elected governments can fail to hear the voices of the losers only at their peril.

Thanks to globalization, capitalism, as we understand it, is facing a crisis of confidence. While the consumers and investors are prospering, the employees are facing uncertain times. The unprecedented choice available across all categories of consumer goods, and that too at unbelievably low prices, have led to consumers shopping away to glory. Similarly among investors, the diverse portfolio of investment opportunities and an equity market that seems to be moving in only one direction, barring a few blips, has generated a feel-good wealth effect. But citizens as employees are facing uncertain times, with massive lay-offs, proliferation of low paying temporary jobs, de-skilling and need for re-skilling, falling real wages, reduced and even no benefits, and diminishing job security.

The recent collapse of the sub-prime mortgage market, made us realize that the global financial system, far from diversifying and mitigating risk, had become ever more opaque and complex. The real impact of globalisation and its attendant risks are being felt in the global financial markets. The success of securitized lending over the past decade has seen impressive feats of financial engineering, seeking to diversify risk and increase liquidity. This has resulted in the emergence of a veritable cornucopia of financial instruments and market players. But the proliferation of such instruments, instead of reducing systemic risk, appears to have increased it in the global financial system.

As Paul Krugman wrote, "The innovations of recent years — the alphabet soup of CDO’s and SIV’s, RMBS and ABCP — were sold on false pretenses. They were promoted as ways to spread risk, making investment safer. What they did instead — aside from making their creators a lot of money, which they didn’t have to repay when it all went bust — was to spread confusion, luring investors into taking on more risk than they realized." Though risk is today omnipresent in our financial system, we are in no position to identify it and and worse still do not have any clue about mitigating it! As Goldman Sachs have showed, the only way to make money appears to be to locate a risk and then transfer it to unsuspecting investors, and there are plenty of them around, and make money when the bet succeeds.

Beyond the financial system lurk even more dangerous risks arising from the challenges posed to our environment. This affects not only us, but has repercussions on the future of our children and grandchildren, and beyond. As the developing world, led by China and India, march towards catching up with the developed West, the opening act of an environmental nightmare appears to be unfolding. Negative externalities, be it by way of pollution or over exploitation, is taking its toll on our environment.

The biggest challenge is posed by the ever increasing threat of global warming arising from carbon emissions with its consequent impact on climate change. If the entire planet emitted CO2 at the rate the US does today, global emissions would be almost five times greater. As As Martin Wolf recently pointed out in the Financial Times, if there are to be limits to emissions, then there may also be limits to growth. But any limits to growth will have serious political consequences with resource distributional dimensions, both within, and more dangerously, between nations.

The issue of climate change is intertwined with the challenge of development itself, and about how the world will look like if the currently impoverished five-sixth of humanity catches up with the remaining sixth. At a time when development itself is increasingly energy dependent, the biggest scare scenario is painted by the "peak oil" theories, pointing to a world of high oil and energy prices, even as energy resources become ever more scarce. The story is no different with other commodities, all of whom are experiencing their highest prices. In the last five years, prices of gold has gone up 150%, zinc 250%, uranium 750%, copper four times, and nickel three times.

The recent fashion with bio-fuels is taking its toll on global food security. The massive demand for corn and other biofuel producing crops has resulted in diversion of the fixed land resources away from foodgrains and also exploitation of virgin forest lands. Generous subsidies have produced internal distortions that have only exacerbated the trend. This in turn has led to steep rises in food grain prices, manifested by "pasta strikes" in Italy, "tortilla riots" in Mexico, "tomato boycott" in Argentina, to "onion crisis" in India. The Economist's food price index is now at its highest since its introduction in 1845. Food inflation is affecting the rich and more critically the poor across the globe, and is an important political issue everywhere.

The changing consumption patterns, with a shift towards meat, eggs, and dairy products have also contributed towards straining the food supply chain. Despite all the technological breakthroughs, agriculture continues to remain vulnerable to the vagaries of weather and other natural forces. The surging global demand for foodgrains has depleted global food reserves, and send food prices soaring to historic highs. The high costs of inputs like seeds, fertilizers and pesticides means that the high prices for agriculture commodities are not translating into higher profits for farmers.

Geo-political risks are intensifying in an alarming manner. After having prematurely proclaimed the "end of history", Francis Fukuyama must be surely looking for cover, as the events of the past decade has shown that change, and very violent and unpredicatable one at that, is running as strong as ever. To the volatile cocktail of strife in West Asia, sub-Saharan Africa, Iran-Iraq, Afghanistan, North Korea, and sub-national threats to nation-states across the world, has been added the more dangerous, uncertain, and faceless threat posed by terrorism. In fact, terrorism has fast replaced threats from neighbours and other countries as the primary security risk for many countries.

The spectacular emergence of China, and to a lesser extent India, has surely rocked the geo-political balance of power. Kremlin watching has been replaced with deciphering the signals from Beijing as the popular pastime for political commentators.

The triumph of democracy has proved elusive as the story has not followed the script written in Washington. The experiments with democracy in various parts of Asia, Eastern Europe and Africa, have not gone much beyond the holding of elections, and have even slipped back to retrograde authoritarianism. In its own backyard, America is facing a strong ideological rebellion from Hugo Chavez. The Chavez inspired Bolivarian Revolution has swept through Latin and South America, overthrowing US-backed, right-wing leaders and replacing them with indigenous and left leaning governments.

Unfortunately, even as all these risks mount, we seem to be not fully aware of the gravitas of the problems staring at us. We are still squabbling with each other, busy running each other down, thereby even failing to acknowledge the problem. Many of these are issues which need to be tackled now and immediately, failing which its costs are too high to be imagined. Nobel Laureate Prof Kenneth Arrow, has an insightful cost-benefit analysis of the climate change problem in the latest Project Syndicate column, The Case for Mitigating Greenhouse Gas Emissions.

Risks have been ubiquitous throughout life, but what makes the present day risks more dangerous are their global dimensions. Nation states have become powerless in combating these changes. These risks do not respect national boundaries. Be it, climate change, terrorism, increasing inequality, food security, economic globalisation - all these risks can be addressed only by collective action, by summoning the will of all the nations of the world, big and small. Successfully addressing them demands that the big and richer nations should take the lead. This is partly because a major share of the solution to these problems lies there and more importantly only these nations have the resources and the capability to take the important leadership role on any meaningful efforts to tackle these challenges. Unfortunately, as seen by the tame conclusion of the recent UN Climate Change Conference in Bali, this leadership seems to be as scarce as ever.

All these challenges are both inclusive and global, as Ulrich Beck calls it "cosmopolitics", and it is time all nations come to the table and start tackling them before it is too late.

My Mint Article on pricing public services

Here is my op-ed piece in Mint about how differential pricing can reduce corruption in public service delivery.

Why obesity is more prevalent among the poor?

The NYT reports about a study by University of Washington researchers, which has found that calorie for calorie, unhealthy, energy-dense, junk food is much more cheaper than low calorie vegetables and fruits. This coupled with the fact that junk food prices are less likely to rise as result of inflation, makes the researchers conclude that the poor are more susceptible to obesity.

A survey of 370 foods sold at supermarkets in the Seattle area found that higher-calorie, energy-dense foods are the better bargain for cash-strapped shoppers. Energy-dense munchies cost on average $1.76 per 1,000 calories, compared with $18.16 per 1,000 calories for low-energy but nutritious foods. The survey also showed that low-calorie foods were more likely to increase in price, surging 19.5 percent over the two-year study period. High-calorie foods remained a relative bargain, dropping in price by 1.8 percent. The study also found that a 2,000-calorie diet would cost just $3.52 a day if it consisted of junk food, compared with $36.32 a day for a diet of low-energy dense foods. The average American spends about $7 a day on food, although low-income people spend about $4.

Dr Adam Drewnowski, Director of the Center for Public Health Nutrition at the University of Washington claims in an article, "Diets composed of refined grains, added sugars, and added fats are more affordable than diets based on lean meats, fish, fresh vegetables and fruit. There is an inverse relationship between energy density (kJ/g) and energy cost ($/MJ), such that energy-dense foods also provide the most dietary energy per dollar. Good taste, high convenience, and even more important - the low costs of sweets and fats may indeed lead to over eating and weight gain. Not surprisingly, the highest rates of obesity are found among population groups with the highest poverty rates and least education."

It is easier to overeat junk food, both because it tastes good and because eaters must consume a greater volume in order to feel satisfied. Still, even those who consume twice as much in junk food calories are still spending far less than healthy eaters. Dr. Drewnowski says, "Not only are the empty calories cheaper, but the healthy foods are becoming more and more expensive. Vegetables and fruits are rapidly becoming luxury goods."

There have been numerous arguments made in favor of an obesity tax obesity tax that would penalize such high energy, junk foods. Dr. Drewnowski's studies support the claim and reinforces the socio-economic explanation for obesity. There is a case for using this tax to partially finance food subsidies.

But any imposition of an obesity tax will have to be seen in the light of the impact of the consequent price rise on the poor, given their dependence on such foods. This in turn has to be balanced with the resultant health benefits and savings on health care costs, which will reduce the total cost incurred by the poor.

Craze for Indian schools in Japan!

The NYT carries an article about how Indian schools are fast becoming a craze in Japan. The Japanese see India's demanding learning schedule, with its focus on learning more at an earlier age, memorization and cramming, and emphasis on the basics, particularly in math and science, as the reasons behind its success in knowledge-based sectors like software, biotechnology and finance.

Rating NGOs

India is home to some of the largest number of NGOs working in social and other charitable causes. It is estimated that there are between 1 to 2 million NGOs operating in diverse fields like education, health, housing, micro-finance, disabled and old aged welfare, agriculture, environment, disaster reilef etc. Most of them are involved in the development arena and are active participants in poverty mitigation and eradication efforts. Though the majority of NGOs are funded by private capital, a significant number of them receive some form of government grants. Except for a few large ones, the overwhelming majority of NGOs are small.

Despite the large number of NGOs working in every sector, there is very little information about the effectiveness of these organizations in achieving their goals. Numerous studies have shown, and I have seen a number of them, that NGOs are not immune from the usual malaise that afflicts government agencies. Further, given their small size and limited reach, NGOs are most effective when they are able to establish successful demonstration examples for effective delivery of a welfare service or a development activity or indulge in awareness creation and capacity building activities. Such experiments senitize local citizens, build awareness and develop demand side pressures, and help Government agencies identify the weaknesses in their delivery channels and systems. Instead we find numerous examples of NGOs trying to replicate the role of Government and compete with Government in delivering development related services and activities, thereby failing to achieve their desired objectives.

It is therefore important that we develop mechanisms to judge the performace of NGOs against their stated objectives. How effective are they? Have their actions had the desired demonstration effect? How scalable are their activities? Have their activities increased the awareness among the target group? What has been the impact of its performance on the effectiveness of Government? How have the outcomes improved in the area and the sector, since the NGO started activities? How much value for money do the NGOs activities deliver? How do charities compare in their spending on administration?

If we have credible enough rating of the performance of NGOs in each area and sector, we could indeed have a market in raising donations for charitable causes. Wealthy and willing donors would not need to scout around before donating their money. In fact, they can choose the location and activity of their choice and be rest assured that their contributions are well spent.

It will also go a long way in generating healthy competition between NGOs and improving the performance of many inefficient NGOs. Such competition will improve the economic efficiency of NGOs and ensure that they spend more of their resources on addressing their main objectives than on administration. The ineffective and inefficient ones will not be able to attract funds and will slowly leave the field, while the effective and well run NGOs will be able to attract more funding and expand their activities. Governments will also find it easier to channel scarce Government grants to the well functioning NGOs. A rating agency will be the first step, but probably the most improtant one, in ensuring proper regulation of the NGO sector.

The NYT carries a story of hedge-fund analysts, Holden Karnofsky and Elie Hassenfeld, who have floated the world's first charities rating agency. GiveWell, with only these two employees, studies charities in particular fields and ranks them on their effectiveness. It is in turn supported by a charity they created, the Clear Fund, which makes grants to charities they recommend in their research.

Do not be surprised if we have in the near future, income tax deductible charity funds, floated by organizations like Clear Fund, with the specific objective of raising philanthropic contributions for a specific cause or a bouquet of charitable causes. How about a Primary Education Fund, floated by Education Foundation, aimed at soliciting philanthropic contributions from those interested in helping improve primary education!

Update 1
Peter Singer has this in the Project Syndicate about the difficulty in evaluating charities, "Evaluating charities can be more difficult than making investment decisions. Investors are interested in financial returns, so there is no problem about measuring distinct values – in the end it all comes down to money. It is more difficult to compare the reduction of suffering brought about by correcting a facial deformity with saving a life. There is no single unit of value. "

With about $200bn given away to charities by individual donors, the importance of rating charities is bound to increase.

Update 2
How about rating micro-finance institutions? Especially since Daniel Akst feels that the best way to donate $1 is to give to micro-finance institutions.