How to Boil a Frog

I am sure you have heard of this before: if you throw a frog (a cold-blooded amphibian) into boiling water, it will immediately jump out. But if you put the said frog into cold water and slowly heat it, it will quietly sit in the rising temperature and die.

Assume we could choose the country we wanted to live in, and some of us do. Now imagine looking down at a country with a 4 per cent current account deficit (dependent on oil and gold prices), a negative BOP, a rising Gini co-efficient (which impacts where you put your savings), high and unrelenting food inflation, a 9 per cent overall fiscal deficit (half of which goes into various scams, thereby raising real estate prices), a 10 per cent tax to GDP ratio and inadequate gross fixed capital formation (<30 per cent). The only saving grace is what you and I, the population of India, contribute: despite high inflation, a huge savings rate that manages to fund both the government and private investment, drawing enough investment demand to add some new jobs and consequently, new demand into the economy.

Probably the only leg on which this economy has stood is the savings rate. Earners like you and me, born in the 'frugal 60s and 70s', have earned well, paid taxes and still managed to save enough to keep this country's real estate and equity markets where they are.

Now imagine that the deteriorating conditions of the second paragraph show no improvement; they continue on the back of unchanging behaviour from each of the 'vested interests' that benefit from such behaviour: you know, the regular suspects, i.e. the government and its vote banks, the rich, a farmer lobby that is actually made up of politicians, and so on. Ranged against this, is the middle class of India (you and me) who don't benefit from scams, higher MSPs, crony capitalism, etc. We struggle against this, saving whatever little we earn with a frugality that is woefully missing in Europe. The frog (again, you and me) slowly starts to boil in his own water. And since it is his own water, the slow, inexorable rise in temperature is not noticed.

For a couple of generations now, Indians have lived with high and unrelenting inflation. The humble carrot used to cost 1 paisa per kg when my mother used to go to college (1955); a pure commodity has gone up 4,200 times in the 60 years since. My mother married a 3rd division, B.Com Pass graduate who started life as a stenographer (in today's language, a BPO executive) at a salary of `275 per month. Her MBA-from-a-top-institute son, now the CEO of a mid-cap company, would have to earn about `12 lakh per month to retain the same purchasing power (vis-à-vis carrots) that his father had. You decide whether this is fair. The humble carrot has beaten me.

The point is, most of us have made up for this loss of purchasing power by doing jobs much above where our parents were. If I had ended up as a BPO executive (or its equivalent), I don't know how often I would have had carrots for dinner. But I used the extra earnings from a superior career to buy a house very early (thereby saving rent, some of which now goes into buying carrots); I drove a small car all my life, and saved enough from that to pay for my childrens' school.

We are now about to lose this battle (where the savers of India finally see their savings lose value through a massive loss of purchasing power, embedded in a continuously and deeply depreciating currency). The not-so-slow, inexorable progress of inflation now eats into our savings rate, bringing down our ability to fund the profligacy of government. When we run, we go to gold as a bulwark against inflation, and look what happens: that very trend was the last straw that broke the rupee's back.

So let me be the first person to say it in these columns: we are headed into being Indonesia '97. Do you remember the story? A peak-to-trough depreciation of 83 per cent (similar to our own 60 per cent in 1991). Because that was sudden, it destroyed the economy, which took 8 years to get back its nominal numbers.

The Economist has projected a 5-8 per cent negative growth rate for most of Europe in case of a disorderly Euro-wide break-up. Many of you may not think it is likely, but that would create a -2 per cent growth rate in the US, and maybe India would be down to 1-2 per cent growth.

How are you going to manage this? The first is to accept it: the last decade has seen an unprecedented rise in purchasing power for most of the readers of this magazine, at least. That is, while the currency has stayed in a range of 20 per cent (40-48), our salaries have gone up by 100-500 per cent. Most of us have used this well: the extra money has mostly gone into savings and taxes. This saving has created investment demand, the produce of which has allowed the poorer people to get products cheap enough to buy. Those are the exceptions to my carrot story above: mobile phones, cars, TVs, ACs, air travel, etc. Even real estate construction has not been able to beat the rise in purchasing power of the Indian middle class. The exceptions: oil, coal, power, etc.

All of this is going to see a reversal now. The long-term correction in purchasing power that this currency 'readjustment' will now see needs to destroy a lot of import demand. There is not enough latent demand in the West, nor enough purchasing power there, for Indian exports to take off. The only answer is import compression (unless solar, that great, bright hope of mine, kicks in quickly enough), which will create demand destruction.

I am contributing in a small way. In my (economic) position, it was not possible to do more, but I have returned my company-maintained Honda Civic, in favour of my own little Santro. Left to myself, I would have shifted to an electric scooter, except that the people around me don't read my columns. When (and why) will this change? Not by government action, most certainly. The Minister concerned has just clarified that the pass-through of oil prices is not being extended to diesel, kerosene and LPG. So the rest of India will continue to burn a hole through the taxes I pay (which, by the way, have reached 9 times my household expenditure). So I give 9 times to the government what I spend on myself: think of what the Republicans are saying in the US…at this rate, does it make sense to work at all? Remember: the money I save at the end of these taxes, is wasting away at the rate of 4,200 times per generation (if the prices of carrots are any yardstick). Do I have a chance?

All rational economic choice (theory) would tell me that with such loss of purchasing power, it no longer makes sense to carry out any enterprise at all. The only mitigant is that the cycle will (someday) turn, and no fault of the government. With all this in place, there will suddenly be a new (energy) technology, which will drop this cost out of the household budget, returning a sharp jump in purchasing power to our hands. So let us turn all our savings firepower into those companies that will bring about an energy revolution into India. Do you see them around? At least the state of Gujarat has used its own funds to put up 900MW of solar capacity. If this becomes an annual habit, then we finally know which government to choose: the country called Gujarat.

The day we hit an annual run rate of even 3,000-5,000MW of solar capacity coming up through internally generated funds, we will see a sudden change in attitudes across India. It might happen because of a pass-through of rising coal prices (unlikely, given this government's attitude), or because our savings end up funding solar capacity with lower interest rates. That would be something to hope for.

Meanwhile, look to invest in companies that are net exporters, with Indian cost structures and Indian Rupee debt. Most of Indian industry is positioned exactly the opposite: net importers, competing with the landed cost of imports and with highly dollarised balance sheets. The market downturn is because of the latter; the comeback will be driven by the former.

This article was originally published on July 14, 2012.