Will the lessons from the recession help to prevent another one?

(The write-up below is a review of three articles from The Economist. The three articles are:

1. Briefing: The danger of the bounce, Once again cheap money is driving up asset prices, January 9^th 2010

2. Curb your enthusiasm, A welcome recovery-but an uneven one, with dangers both for sluggish Europe and bubbly economics, 24^th April 2010

3. Unemployment benefits, A titanic struggle to decide whether the jobless should get the money for longer, July 22^nd 2010)

The global recession that engulfed almost the entire world is over now. The world economy is on a recovery path. But is the recovery sustainable? An unsustainable recovery will lead the globe to another burst. The recession essentially provides a scope to learn new lessons. But whether the lessons are being incorporated in policy decisions needs to be analyzed. This review is an attempt to connect three distinct articles of the Economist to focus on the drivers of current recovery, its distinct patterns and the direction this recovery heading to.

The article “The danger of the bounce” provides empirical evidence that the cost of borrowing money has fallen in the US in last three decades. As a result the firms and the consumers have been borrowing the cheaply available money. Understanding of FMGD reveals that firms employ this money to generate more income for future cycles. Hence, they employ this money on opportunities where they expect a positive return on investment. In absence of suitable investible opportunities firms as well as rich individuals start buying newer assets in financial markets to increase their profit. This leads to increase in asset demand and price. This increase is demand and price is because of the availability of cheap money exaggerated by the inherent design of the stock markets and do not reflect the true economy. Eventually the investors withdraw money from assets to pay off the debts. Suddenly there comes a credit crunch in the market. The market bursts.

Central banks have deliberately kept the interest rates low during this recovery. They aim to increase consumer spending by providing money at lower rates. Consumer spending power is essential in a private enterprise based market economy (PEBME) to ease resilient constraint. However, low interest rates don’t ensure easing out of resilient constraint. First, though the cheap money may provide purchasing power to the consumer, it also increases the pumping of money for the firms and puts pressure on firms to generate higher profit out of the cheap money available. Second, the possibility of hoarding of the cheap money can’t be ruled out. Third, the borrowed money eventually has to be paid off. Hence, too much reliance on low interest rate to fight out the issue is not tenable. Had it been the problem of lack of money, it would have worked. But the problem here is imprudent application of the surplus money. In the problem of surplus of money, low interest rate to pump more money is like paving the way for another bubble. The Economist believes that there is a need to raise the interest rates. However, the authorities concerned with the fragility of recovery are unlike to do so. As a result the low interest rate triggered cheap money will keep pumping into the market. The problem of surplus and pressure of higher profit will force the companies as well as rich individuals to invest in risky assets.

The article tries to fit the current market situation to the model of market madness proposed by Hyman Minsky. As per the model bubbles occur through some distinct stages. It starts with a shock in financial system because of new assets like new technology, internet etc. which attracts the faith of investors. The second stage is characterized by growth of credit that inflates the bubble. Investors borrow money to fiancé their assets. In the next stage, investors move away from the fundamentals. Assets are bought because the price has been growing. In the process the financial economy gets disjuncted with the real economy. Eventually due to excessive high price the asset runs out of new buyers. Price slumps.

Due to the low interest rates, the economies of developed nations (PEBMEs) are witnessing a shock to financial system as the investments in riskier assets are growing. The low interest rate is encouraging investors to take their money out of cash to risky assets. At the same time the small businesses in PEBMEs are facing difficulties to find bank loans. It is crucial to realize that the small businesses are employment generators. Despite the low interest unavailability of money for small business indicates lack of growth in employment.

To drive the point further the Economist reveals that the Wall Street is offering a dividend yield lower than the long term average. This indicates that firms in their relentless pursuit of higher profits are not distributing the profit adequately. This distribution in turn could have increased the consumption power. Hence, the chances of resilient constraint to choke the system are going up.

After dealing with the recovery of the PEBMEs, the article shifts its focus to emerging economies. Emerging economies are more plausible candidates for bubble status. The emerging economies survived the crisis better than the PEBMEs. These economies enjoy two advantages over the PEBMEs: first, higher potential rates of growth; second, stronger fiscal positions. But the credit growth in emerging market, increasing investment by westerner investors of PEBMEs in financial market of emerging economies increase the chances of bubbles in emerging economies. The pegging of currency in such economies ties them with the economies of PEBMEs. But what is right in the PEBME context may not be right for emerging economies. The article here may be referring to inherent difference in the two economies like state of charging, extent of capitalism, nature FDI, export orientation etc. Due these difference the right action for PEBMEs can’t be followed blindly in emerging economies.

The article unequivocally opines that due the surplus of credit and western investments in financial markets the emerging economies will develop bubbles as long as a combination of low interest rates and pegged currencies continue. But the bigger question unaddressed by the article is whether the emerging economies can come out this combination. The excessive foreign reserve of the emerging economies indicates that they are aware of their vulnerability. They intend to interfere in the foreign exchange market to keep the pegged exchange rate pegged to avoid adverse effect on export. Despite better growths they will not allow their currency to appreciate. As a result they are trapped in a non-charging loop. There is no sign of coming out of this loop in near future. This combined with the article’s stand indicates that emerging economies will continue to develop bubbles time and again.

The logic discussed in the previous article “The danger of the bounce” is taken further by another article of the Economist - “Curb your enthusiasm”. The article deals with the justified and not so justified aspects of the optimisms of the current recovery. It brings in new dimensions like difference in recovery path of the PEBMEs and the emerging economies, possible measures to tackle the budding bubble.

The healthier financial market is facilitating the recovery. Consumer spending is getting propped up due to the rising asset prices. IMF’s reduction of the banks’ total estimated loss due from the crisis by $500b indicated the justification of the enthusiasm associated with the recovery.

The article details the unequal sharing of the good fortune. Emerging economies which were least affected by the recession are demonstrating a faster recovery. The worst-hit PEBMEs have a sluggish rate of recovery. In case of the emerging economies the fast recovery is not just because of the low impact of the recession. The effective use of the fiscal and monetary policies in emerging economies paved the way for fast recovery. The article reasons structure of bank dependence, economic flexibility and effectiveness of policy stimulus as for such differences. The same reasons also hold for slow recovery in Europe than America. Productivity has increased in the US and slumped in Europe. This could be because of the difference in flexibility in the US caused by the structure of finance. Europe is more bank-driven. Banks lack flexibility and are conservative in nature. The US is more stock-market driven. Stock market has the ability to speculate and respond quickly to the future of economy where as banks are more conservative by nature. In comparison to Europe, America enjoyed better fiscal latitudes due to dollars currency reserve status.

The gap between the growth rate of the PEBMEs and emerging economies will definitely hamper the future growth of emerging economies.

The article is positive with the capability of the economies, both PEBMEs and emerging ones to deal the unstable, unsynchronized recovery rate of the globe. The PEBMEs could aim at deficit reduction, tax reforms, and freer job markets. The emerging economies could aim at control on foreign inflow, flexible exchange rates etc.

But the practical implementations of the measures suggested by the articles are questionable. The PEBMEs could reduce their fiscal deficit by increasing the tax rates. However, from the patterns of decision making of the US reveals that the economy has deliberately reduced tax from 1970s and has increased debt since then. Reduction of tax has provided greater surplus with the firms and rich section. In the charged stage, in lack of suitable investible option this money has always gone to the financial market upto such an extent that the financial market disjuncts from the real economy leading to crash. The boom-slump cycle caused by tax reduction in the US indicates its orientation to force the market for a controlled crashing. It is not expected that US in short run will change its orientation and increase the tax rate.

The third article “Unemployment benefits” provides insights on how America instead of moving its charged economy to an ever more maturely charged economy, steering it to an economy with controlled recession.

Recession in the US is over, but unemployment figures have not improved. Millions of unemployed are losing employment benefits. In some cases Congress has been able to extend the unemployment benefits. But the long-term help for unemployed workers is still an issue. The article mentions two reasons proposed by the Republicans against the benefits: lack of affordability and benefits act as an incentive to stay out of work. It is notable that unless the consumption power of population increases the US will find it difficult to recover from indebtedness. FMGD suggests that the Republican arguments that unemployment benefits act as an incentive not to work is not tenable. The example of benefits provided by Denmark to the unemployed section to make the nation ever more maturely charged state worked in favour of both the public and the firms. The Economist also suggests in line with FMGD citing one recent study at San Francisco Federal Reserve Bank that confirmed that long-term benefits do not keep unemployment high. America is not moving towards the ever more maturely charged state may be because it knows such a move will be sustainable only if entire world follows similar mechanism.

Lack of job creation despite the recovery could create structural unemployment. However, America’s labour market policies are not addressing the issue. America has the option to tax the corporates and rich section to extend the benefits of the recovery to the poor section. America is not willing to take this decision to increase tax rate and moving the economy to the ever more matured state. On one hand firms and the wealthy people have excess of money, on the other, unemployment is killing the consumtion power of millions of Americans.

The article suggest job search and matching assistance would typically be the quickest way to handle unemployment. Retraining worker with obsolete skills can be effective in long-term. The problem has no quick fix solution. But the failure to deal the problem of unemployment would have long-term repercussions. The frustrated unemployed section of the so called developed USA may chose paths that may cause social unrest. The cost of keeping its own citizens underprivileged might prove costly to the US.

From the review of the three articles of the Economist, it is evident that the lessons from the recession are not being considered to prevent a future recession. Rather the cheap money and unsustainable recovery is leading towards another recession. The pattern of recovery provides good base to conjecture the coming recession. The PEBMEs despite being aware of this future are not taking measures to avoid it. The recovery path has actually turned into the path of another recession.

Can the new business models of emerging markets withstand the unfavourable labour-market dynamics?

(This is a combined review of two articles (Here be Dragons: The emerging world is teeming with new business models Apr 15th 2010 and Socialist Workers: Is China’s labour market at a turning-point? Jun 10th 2010) from the Economist)

On one hand the emerging economies are being viewed as role models for the western market, on the other they are witnessing unfavourable labour market conditions. Whether the emerging economies will be able to tap its potentials due its typical business model and be able to weather out the labour problems is a matter of concern.

As per an article titled “Here be Dragons” of The Economist two typical business models are gaining grounds in Today’s emerging markets of Asia, Latin America and Middle East: the highly diversified conglomerates and the hybrid state-owned enterprises.

The diversified conglomerates are best reflected by the models of India’s Tata Group and Reliance Industries. Similar models are being followed by small and medium enterprises of China as they are gradually entering different domains. These large conglomerates are believed to be the best to utilise the limited resources of capital and talent in addition to tackle situations of political and financial risks. In a global marketplace, the Westerners see these firms as results of inefficient capital market that forces companies to diversify and such firms will cease to exist as the capital market improves. However, it is crucial to internalize that talent shortage and brand-building are also equally important reasons for existence of such large corporate. Hence, the model will survive even with an improved capital market.

State owned enterprises are typical hybrid forms of government and private business models. They are amphibious by nature- they borrow money from global markets in one moment and plunge money to global market the next moment. China and Russia are the homes to many such hybrids. Middle East and Latin America are also joining the league. Authoritarian governments can use these hybrids to direct economic activity and to maintain their economic influence. Local entrepreneurs can utilize them to explore new business opportunities. Western multinationals can gain access to new markets by help of such organisations. In a global market place such organisations could create confusion- an arm of government or an independent business. Political interference, commitments to state could hinder them to respond appropriately to the market.

The author of the article advises the Westerners to learn from both these typical forms of business models. The three most useful learning could be:

- Replacing scaling up with scaling out. This means participation of a wide range of people in the business processes. Clinics on wheels are examples of such scaling out.

- Replacing “push” model by “pull” model. In the “push” model resources are allocated to the areas of expected demand. In the “pull” model resources are mobilised only when the need arises. In the pull model firms that had fixed armies looking for opportunities become loose networks- reconfiguring themselves in response to a rapidly changing marketplace.

- Applying mass production techniques to sophisticated services. Services that are highly fragmented and geographically rooted could also harness the benefits of economies of scale and scope. This was demonstrated by India’s outsourcing firms. Indian consultancies are also bright example where complex services are delivered despite addressing the need to achieve economies of scale and scope. Henry Ford’s principles are being applied to health sector in India. Lifespring and Aravind eye hospitals are examples where mass production techniques are applied in specialised services.

Though the typical business models provide an advantage to the emerging economy, the article titled “Socialist Workers” describes how China- an emerging country is facing the issues related to labour market which could dampen its advantages in a global market.

China is known for its cost-effective and huge workforce. However, some recent issues related to labour market in China are indicating at a striking change. Recently strikers of a rubber factory in China clashed with the police on issues related to pungent smell of rubber. In the same day Honda faced a strike. Honda had settled the previous dispute with a 24% pay hike only a few days back. Foxconn had to raise its pay by 100% due to workers’ demand. Some economists believe that this indicates to an end of surplus worker in China. Many researchers have predicted that though China’s workforce is growing, the growth rate will be negative within a decade. Thus the faulty assumption that China has an unlimited supply of labour will get washed away.

In 1954 a development economist noted Asia’s overmanned farms, its surfeit of dockworkers and petty traders, and “the young men who rush forward asking to carry your bag”. It was concluded that “over the greater part of Asia, labour is unlimited in supply.” As a result the capitalists had an option to grow without any wage rise. But once the limits are reached the labour had to fall short. Further growth had to demand a wage raise.

Economist Mr Cai believes that China has reached this turning point. Assertive workers and wage rises are symptoms of the turning point. However, the author of the article feels it would be too early to conclude that such a point is reached. Unlike Mr Cai, he reasons the hike freeze of the recessionary market of 2009 for the big pay rises in 2010. He also argues that China has a vast labour force working in agriculture. Their productivity is one-sixth of the rest. Hence, China has a labour pool which could be used for a decade or more.

The wage rise being noticed could also be because of migrants that are less willing to leave home because conditions in China’s hinterland have improved. A government survey of returned migrants found that 30% were not sure whether to venture out again, compared with 24% two years ago.

If we take the case of India, it is also witnessing the wage hike despite a huge labour force. Extrapolating the logic applied by the author for China to India, India also has not reached the turning point where the labour force falls short of demand.

Emerging economies will continue to grow and its typical business models will be able to withstand the changing dynamics in labour market in short runs. But no doubt there is a long-run future where the labour force in the emerging economies will fall short of labour demand. At that time such economies will no longer remain as emerging economies. The capital will shift to new economies with abundant labour making them the new emerging economies.

Maruti: How the story started from scratch

Automobile Sector in India prior to Maruti’s Entry

Automobile manufacturing industry in India started in 1948. Upto 1948 cars were being assembled and sold in India. The assembling started in 1926 by G Mackenzie and Co., followed by General Motors in 1928. However, due to government policies related to manufacturing many foreign companies left India. The players who remained in Indian market were Hindustan Motors, Premier Automobiles and Standard Motors.The Padmini premier was a preferred car till early 1980s. The waiting time for the car was 5 years. In 1968, the demand for cars outstripped the supply taking the waiting list to 82,000. People used to wait for more than two years to get a car. The huge demand created scope for black marketing. Bureaucrats influenced to get special quota to get cars and sold their used car at a huge profit. Due to lack of competition the price of the cars were high in those days (Rs 14,000 to Rs16,000). The quality of the cars was not up-to the mark. Government policies didn’t focus on the problems associated with the industry. The regulators tried to control price and neglected attention on the huge supply-demand gap.

Due to foreign exchange constraints government disallowed further import of technology to upgrade or change the models. The car manufacturers did not invest in any engineering base to develop models with technology upgrades. The license on production volume stole the motivation for investment in the sector. Foreign collaborations, consultancies and import of capital goods and components were barred. The situation of the entire industry was grim.

The adverse conditions forced the government to think of nationalize all the three car manufacturers in India.

Establishment of Maruti Udyog Limited

Maruti Suzuki India Limited started its journey as Maruti Udyog Limited as a public sector company. The motivation behind the establishment of the company was to manufacture small low cost cars that can cater to the needs of the Indian consumers. In 1980, an ordinance was passes to acquire Maruti Motors Limited which was later legitimized through the Maruti Limited Act, 1980. Maruti Motors Limited was incorporated in 1971 by Mr Sanjay Gandhi, son of Indira Gandhi. Due to the political power Mr Gandhi enjoyed, Maruti Motors Limited could easily avail 297 acres of prime land for Rs 35 Lakh from the Haryana government. The officially stated reason of nationalisation of the Maruti Motors was modernization of automobile industry, more economical utilization of scarce fuel and ensuring a higher production of motor vehicles.

Maruti Udyog Limited (MUL) was incorporated in 1981 as 100% government own company. The initial plan was to set up a capacity of 100,000 passenger cars and 40,000 light commercial vehicles. However, there was a shortage of technology in the country. Government had decided to technology would be obtained through foreign collaboration.

Human Resource Acquisition

Government decided to bring the best talent from both the private and public sector to run the company. Mr Sumant Moolgaokar of TELCO was offered the post of non-executive chairman of the company. This model is considered as the base of PPP (Private-Public Partneship) in India. Other notable management talents who shifted to Maruti Udyog Limited are: V. Krishnamurthy of BHEL, D.S. Gupta from IIM, Ahmedabad, R.C. Bhargava (IAS) from BHEL etc. The management of MUL was provided with free access to Mr Rajiv Gandhi so that the constraints related to the project could be dealt with apt. Mrs Gandhi selected Mr Arun Nehru as the single point contact for the project.

MUL recruited several managers from BHEL, Indian Railways and other public sector units. The strategy was not to employ people who have already worked with any of the existing car company of India. The motive for such move was to prevent duplication of the existing culture of companies in Maruti. People who are new to the industry will find it relatively easier to learn the Japanese culture and the SMC system.

Most of the engineers in MUL were fresh engineering graduates. There was only a minor group of experienced engineers from Tata Motors and Eicher Motors.

Foreign Collaborator

MUL had a target to hit the road by December 1983, around 2.5 yrs from its inception. In order to get a foreign collaborator the Heavy Industry Ministry had contacted several car manufacturers in the US and Europe. The companies contacted included British Leyland, Peugeot, Renault, Volswagen, Man AG, Daimler-Benz, Daihatsu motors, Toyota Motors, Mitsubishi Motors, Honda Motors, Suzuki Motors, Isuzu Motors, Subaru, Nissan etc. The general response for collaboration was poor. Since the management of MUL was convinced that the small car model of Japan will well fit into the Indian conditions they focused on getting a Japanese collaborator. Daihatsu was the only company that had responded positively to MUL. However, later it was disclosed that the company only wanted to understand Indian market better through talks with MUL and had no intention to manufacture cars in India. Suzuki Motors Corporation (SMC) which was not in the landscape, suddenly expressed its desire to partner with MUL for car production in India.

Initially SMC subscribed to a 26% share in MUL.

MUL and SMC signed agreements to import CKD kits and other technology based auto components.

Location of the plant

The MUL plant was in Gurgaon. Since MUL had acquired Maruti Motors Limited it saved time in location selection and land acquisition. The location had many disadvantages especially if MUL had to export cars in future. At the same time proximity to Delhi, being on national highway were its biggest advantages.

Import Duty Reduction

The import duty on automobile components was 120%. This was to demoralise imports due to shortage of foreign exchange in India. Premier Padmini and Ambassador did not need any imported part for their cars. They imported only some spare parts if needed. But this high import duty was not tenable for MUL which had to import huge quantities of spare parts and kits. MUL managed to convince the government that imported parts will save energy and will reduce import of oils. Government reduced the import duty to 40%.

Learning the SMC way

From the very beginning of the MUL-SMC deal, Osamu Suzuki, the SMC president had made it clear that if MUL wanted the same quality as being achieved by Japan, MUL must act as SMC works. SMC offered acceptable terms to Maruti to train its employees in Japan. SMC ensured that the MoU of the deal included a clause on profit making as one of the objectives. This was to ensure that the functioning of MUL would be different from the functioning of any other PSU in India.

The training of supervisors in Japan started with learning of industrial culture before learning the job related training. SMC insisted for intensive training at all levels. Training was seen as the building blocks to ensure productivity and quality. The management of Maruti was advised to focus on employee training and development. SMC advised the management that disciplinary action or intimidation will never yield the same results as training and development will yield.

Engineers, supervisors, managers all were sent to Japan in batches for training- both about the culture and the job requirements. Nearly 230 people from MUL were sent to Japan for training.

In the year 1988-89 SMC accepted to deploy MUL workers on SMC’s production line for six months. The scheme was operative for 15 years. In these 15 years 979 workers of MUL were trained in Japan.

Suzuki Quality Management System

MUL adopted a system by which the quality of cars dispatched from the factory was measured on a daily basis. This was in accordance with the system followed by SMC in Japan. MUL also adopted Suzuki’s global customer audit index. This helped the company to provide a customer-oriented focus to the entire organization and also steered the channel resources towards customer complaints for rapid response.

Implementation of Kaizen

MUL also followed continuous improvement, i.e., Kaizen activities to improve its quality orientation. Participative management style to discuss problems relating to operations has helped the company to achieve better commitment from its employees. Quality circles, suggestion schemes etc. have helped the management to keep the focus on quality.

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Uncovered Interest Arbitrage

As per uncovered interest parity (UIP) conditions, the difference between the interest rate of two countries equals the expected change of exchange rate between the currencies of the two countries. This means a country with higher interest rate with respect to another country is expected to depreciate in future. Absence of UIP would give birth to carry trade. Investors will borrow money from the country with lower interest rate and will invest in countries with higher interest rate due to the possibility of arbitrage. In carry trade money is borrowed in currency with low interest rate, converted to currency with high interest rate, invested in an asset with maturity date of the borrowing period, after maturity is converted back to the borrowed currency and debt is repaid. Due to the difference in exchange rate in borrowed money and invested money, the investor enjoys a surplus. Since, there is a foreign exchange risk associated with carry trade, the surplus (deficit) is considered as the risk premium. Thus, the return from arbitrage in absence of UIP has three components: a) the interest rate differential, b) spot rate change over investment period can add to or subtract from returns and c) gain or loss in funding currency has to be brought back into base currency

UIP is based on the premise of risk- neutrality and rationality. Hence, under UIP the interest rate differential is an unbiased predictor of future exchange rate. The expected future exchange ensures that the gain from interest rate difference is neutralized from the exchange rate differential.

Literature Review

Empirically, the UIP theory is usually rejected, and explanations for this rejection include that expectations are irrational whereas UIP is based on rational expectation. In 1984 Fama tested for UIP at distant horizons and found that interest rate differentials tend to be negatively, rather than positively, correlated with future currency movements, thereby wrongly predicting their direction[1]. Some of the widely accepted literature that prove absence of UIP are the publications of Frankel and Froot, Mark and Wu, Domowotz and Hakkio, Nieuwland, Bekaert and Hodrick, Baillie and Bollerslev etc. Other than irrational expectations the other reported reasons for absence of UIP are time-dependent risk premia, policy behaviour and structural parameters. McCallum has argued that monetary-policy behavior can be responsible for the apparent empirical failure of uncovered interest parity (UIP)[2]. Peter Ankel has investigated whether optimizing policy behaviour can account for the observed regime-dependence of UIP evidence[3]. In some of the literature at higher frequency doubtful statistical interference is considered as the cause of deviation from UIP. Some of the literatures have revealed that UIP holds in long horizon than short horizon (Chin and Medith-2005). Flood and Rose (2001) in their study found considerable heterogeneity across countries. Their findings detected signs that UIP at the short horizon holds better in crisis countries where exchange as well as interest rates display high volatility[4]. In the short run, a disequilibrium in the foreign exchange market leads to arbitraging opportunities. Without instantaneous adjustment a market in short-run remains in disequilibrium. Traders exploit the short run market inefficiency to generate arbitrage profits.

Studies of Cochrane (1999), Alexius (2001), Chinn (2006) and Zhang (2006) also reveal that UIP tends to hold for financial instruments of longer maturities. Lothian and Wu (2005) studied the validity of uncovered interest-rate parity (UIP) by constructing ultra long time series that span two centuries[5]. They found that The forward-premium regressions yield positive slope estimates over their whole sample period and become negative only when the sample was dominated by the period of 1980s. They also found that large interest-rate differentials have significantly stronger forecasting powers for currency movements than small interest-rate differentials. Their results indicate that uncovered interest-rate parity holds over the very long haul but can be deviated from for a long period of time due to slow adjustment of expectations to actual regime changes or to anticipations for extended periods of regime changes or other big events that never materialize.

The broadly followed specification (i.e. the approximate UIP) is usually written in the following approximate form of linear regression:

∆S_t+k= α+ β (i-i^*)+ error_t+k

Here,

· ∆S_t+k is the first difference of nominal exchange rate expressed in terms of domestic currency per unit of foreign currency,

· (i-i^*) is the interest rate differentials between the domestic interest rate i and the foreign interest rate i^*.

Null hypothesis: α=0 and β =1. The same hypothesis will be used in this study.

Testing of the approximate UIP hypothesis using this specification generally proceeds with a theoretical value of unity for the slope coefficient β in the above regression.

Froot and Thaler (1990) have reported that the average value of β across 75 published studies is−0.88. Numerous other studies have also confirmed that the relationship between the nominal exchange rate changes and interest rate differentials (or forward premium) is negative rather than positive as expected from the hypothesis of UIP.

Objective of the analysis here is to examine the empirical validity of the UIP hypothesis for 3 different countries- India, UK, and Canada. In the analysis US has been considered as the home country. The sample range covers more than 6o data points in term of month, emerging economies in this period witnessed increasing financial liberalization. Here the validity of the UIP hypothesis is tested by using the commonly used form of the UIP equation in a panel estimation of combination of emerging and developed nations.

Further, to study the effect of Consumer Price Index (CPI) and Industrial Production on exchange range, these parameters were factored to the existing UIP equation. This study was carried out considered Canada as the foreign country and US as the domestic country.

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[1] Fama, E.F., 1984, ‘Forward and spot exchange rates,’ Journal of Monetary Economics, vol.14 (3) November: 319-38.

[2] McCallum, B.T., 1994b. Monetary policy and the term structure of interest rates. NBER Working Paper

No. 4938

[3] Peter Ankel, Uncovered interest parity, monetary policy and time-varying risk premia, Journal of International Money and Finance, 18 (1999), 835–851

[4] Kenneth Froot and Richard Thaler (1990), Foreign Exchange, Journal of Economic Perspectives, 4(3): 179-92

[5] Lothian and Wu, Uncovered Interest-Rate Parity over the Past Two Centuries, Frank J. Petrilli Center for Research in International Finance CRIF Working Paper series

Effective Supply Chain Management through Alignment, Agility and Adaptiveness

Unfortunately the understanding and implementation of supply chain management concepts are at a crude state. Many firms view supply chain a way to achieve high speed and low cost. But supply chain is a broader concept and covers multiple business dynamics beyond high speed and low cost. Firms that focus only on speed and efficiency may lose out due to piling inventory. On the other hand companies like Amazon, Dell and Wal-Mart have cracked the codes of SCM.

Only speed and efficiency are not sufficient to provide firms competitive edge. Effective SCM also requires Alignment, Agility and Adaptability[1].

Alignment

Alignment within the supply chain requires the firms to establish incentives for the supply chain partners to improve performance of the entire chain. The roles and domains of activity of each partner have to be clarified. This will avoid conflict. The risk and rewards in the chain should be shared proportionately in the chain. Information sharing and collaborative planning and forecasting provides scopes to align the supply chain for a common goal.

Agility

Agility refers to the ability to respond to short term changes in demand dynamics quickly and effectively. It requires timely sharing of information amongst supply chain members. Agility in supply chain is agility of all the members of the chain. Collaboration with customers, supply chain partners, academicians to improve the agility of the chain provides an edge over the rivals. Precise information on customer preference is prerequisite for effective SCM. But when customer demand changes in short term, the chain should be able to achieve to deliver the customer expectations. Producing finished product only when customer preference is accurate and reliable saves obsolence cost. The response time for unpredictable change in customer demand could be minimized by keeping a balanced inventory of basic components.

Adaptability

Adaptability of a supply chain is its ability to track market changes and to adjust with the evolving market dynamics. Supply chain has to undergo a continuous organizational mutation to be adaptive. Tracking economic changes, technological breakthroughs, sensing the social-political-cultural morphism of the market helps in the process of adaptation. Supply chains need to identify their resource base, ability to use the same resource base in future needs are crucial.

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[1] Hau L Lee, The Triple A Supply Chain, Havard Business Review, Oct 2004

India's Competitiveness

India ranks 49 out of the 133 nations in the Global Competitiveness Index.

India performs abysmally poor in Health and Primary Education with a rank of 101. Alarming sanitary situation, insufficient quality and quantity of education drags India down in competitiveness. Energy and transport infrastructure ranked at 76^th needs improvement. Corruption and Securities issues remain to be addressed.

India has better position when it comes to efficiency indicators. India’s financial system ranks 16^th indicating development in this system. India has a strong banking system ranked at 25^th. Due to huge population and growing purchasing power of consumers, India ranks 4^th in market size. Presence of a number of competitors makes India’s market efficiency reasonably good (rank: 48th). India still needs to work on lowering the entry barriers in certain markets. Rigid hiring and firing policy earns a low rank in labour market efficiency (rank: 83). Low penetration rate of internet and communication technology has resulted in poor rank (83) in technological readiness. Despite a strong and reliable higher education system, the rank of India in Higher education is 66 due to the lack of sufficient accessibility to all.

It is remarkable to notice India’s rank in innovation drivers. India ranks 27^th in business sophistication and 30^th in innovation.

When compared to other nations India lacks behind in several parameters. China is ahead of India in 10 out of the 12 pillars of competitiveness. India enjoys competitive advantage in financial market sophistication, market size, business sophistication and innovation.

India’s performance could be analyzed on the basis of each of the 12 pillars of competitiveness.

1 Institutions

India stands out much ahead of the countries of same income group and region when it comes to institutions. Business communities perceive India positively when it comes to institutions.

Government: Government efficiency and ability to nurture a business-conducive environment is evaluated encouraging by entrepreneurs.

Judiciary System: The independent and well functioning judiciary system provides India a sound scope to implement rule of the law.

Intellectual Property Rights: India is also ranked low in Intellectual Property Rights (IPR) related issues. Considering the importance role played by IT and communication technology it is imperative to strengthen the IPR related laws in India.

Corruption: Business communities rank India poor on trust on politicians and administrative/bureaucratic corruption. Transparency International has ranked India 85 out of 180 nations in Corruption Perception Index. India is still considered as a nation where business is affected by bureaucratic red tape. May be a second round of reforms to eliminate the red tape is demand of the time now.

Terrorism: Threat of terrorism has been always associated with India. The serial bomb blasts in various cities of the nation followed by the Mumbai terrorist attack stains negative colours on the business environment of India.

Crimes: On a positive note India ranks much better when it comes to other forms of crimes scoring well above its comparative nations of same income group and region.

Private Institution: India’s rank in private institutions is at a reasonable number of 51. Unfortunately the rank has shown a negative movement which might be assigned to Satyam episode. India needs to improve its accounting and corporate governance practices in order to unmask such scams.

2 Infrastructure

Indian competitiveness is adversely affected by the poor state of infrastructure and lack of it. Shortage of power, water and transportation facility etc. hold back India. The country ranks 76 in infrastructure. Some economists opine that lack of infrastructure prevents India’s transition from an agrarian economy to a manufacturing economy.

Electricity: Electrification is the biggest infrastructural challenge faced by India. Electricity production per unit of GDP has started falling after 2000. The electricity loss during distribution and transportation remain s a major problem to be tackled. High government regulation and dominance of public players have added to the wounds of power sector.

Road Transport: India ranks below Pakistan and China when it comes to road communication. 65% of freight and 85% of passenger traffic are carried by the road. Hence, Improvement of road connectivity is imperative. Road accidents are also high in India. This underscores the need of road safety.

Port Infrastructure: India’s port infrastructure suffers from low turnaround time, insufficient handling capacity, and frequent human intervention. Low productivity and bottlenecks make the situation worse. It is reported that India’s ports operate at more than 90% of their capacity. This emphasizes the need of upgrading the existing ports and building new ports to meet the business and trade requirements. Indian government’s attempt to encourage public-private partnership (PPP) is expected to bring reforms in port functioning. Government is also planning to provide more autonomy to major ports to increase their performance.

Air transport: India is out-forming many of its comparative countries in terms of air transportation. Government’s decision to end state monopoly in aviation sector has paid up. Competition among private and public players, emergence of low cost airlines has demonstrated the dynamism of India’s aviation sector. Governments initiative to modernize 35 airports are and privatization of Mumbai, Delhi, Hyderabad, Cochin and Bangalore airports are expected to increase the efficiency and performance of aviation sector.

Railroad: With 14 million passengers daily, India’s rail is the largest rail of the world. Indian ranks an impressive 20^th position in rail infrastructure. However, the high density road corridors face capacity constraints.

It is widely accepted that India’s infrastructure development would be possible through investment. Lack of sufficient public funds emphasized public private partnership (PPP) in this sector. Allocation of more than 40% of budgetary outlay to infrastructure development in the 2010-2011 budgets is positive signal at long-term orientation for competitiveness building.

3 Macroeconomic Stability

Indian ranks 96 in macroeconomic pillar. Fiscal deficit is the primary reason for this low rank. However, the 2010-2011 budget aiming at reducing the deficit from more than 6% to 5.5% over might increase India’s rank in this parameter in future. The Fiscal Responsibility and Budget Management Act (FRBMA) 2003 have helped India to achieve some fiscal discipline. Balance budget is still a distant dream.

Government borrowing: The high government debt of around 75% of the GDP is detrimental to the state of economy. It is estimated that Indian government borrows 34% of the money it spends. Regulations forcing the commercial banks to invest in government bonds divert the money from the more productive sector of the economy.

Inflation: India is facing severe challenges to curtail the increasing inflation rate. Particularly the food inflation rate is a matter of concern. With the increase in oil and petroleum prices as an outcome of 2010-2011 budget it is expected that the price of commodity products will continue to increase as more inflationary pressures.

India has been exploring the options of coming out populist budgets to cut back subsidy and to for reforms in tax structure. Withdrawal of subsidy in some sectors like IT corroborates the fact that government is giving priority to reduce fiscal deficit.

4 Health And Primary Education

India ranks 101 in health and primary education. The situation is linked to lack of government funds to invest in such sectors, lack of skill manpower and infrastructure.

Sanitation and diseases: Only 28% of India’s population has access to sanitation facilities. A sizeable portion of Indian population suffers from diseases like tuberculosis; malaria etc. 21% of Indian suffers from malnutrition.

Primary Education: India has achieved more than 90% of enrollment in primary education. Since many countries have achieved universal literacy at primary education level India still lags behind. Quality of primary education remains a problematic area. Poor spending is the primary reason for such abysmal performance. Indian has increased its planned allocation to schools from Rs 26,800 Crores to Rs 31,036 Crores in 2010-2011 budget.

5 Higher Education and Training

With a rank of 66 Indian has higher enrollment rate then its comparative countries, but has lower quality of education. Enrolment rate in secondary education is at 55% which is low. Quality is far better in higher education. On a positive note India performs better in quality of higher education and provision of on the job training. In the last few budgets India had the provisions to create more IIMs, IITs and NIFTs to give boost to the higher education sector.

6 Goods/services Market Efficiency

According to a World Bank report starting a business in India takes 30 days. Though the number has reduced, it needs further reduction. Costs associated with starting a new business are high in India.

Tax structure: World Bank estimates that on an average Indian firms pay 76% of their profits as tax. Widening tax base is an option that could be exercised by the government to lower tax rates.

Market Competition: Lowering barriers for foreign players will helps to improve market efficiency through more fierce competition.

Formal Sector: India needs to encourage its players to switch from unorganized informal sector to organized formal sectors. This will improve productivity and will help to handle the critical issues of tax base increase as many informal sectors are outside the tax structure.

7 Labour Market Efficiency

Labour market has been a problem for India’s competitiveness. India ranks 83 in these parameters.

Firing cost: In India it is difficult to dismiss employees. The cost of firing is also very high.

Employer and Employee Relation: Employee and employer relation is not considered as confrontational in India

Labour efficiency: Labour efficiency level of India is encouraging. Educational attainment gap has also prevented adequate participation of female workforce.

Brain drain: India faces lesser brain drain than the countries of similar growth rate. This is expected to increase India’s competitiveness as India is being able to retain and attract talent.

8 Financial Market Sophistication

Indian ranks 16^th in financial market sophistication. Despite financial crisis of recessions of 2008-09 India’s rank has improved on this parameter.

Equity market: India has an extremely dynamic equity market. A jump from $387 billion to $1811 billion in total market capitalization of the companies listed in equity market from 2005 to 2008 corroborates this fact. Obtaining funds from domestic markets of India has become easier.

Decreasing government regulation on matters of allocation of funds, simple policies for foreign capital investment etc. are some of the improvement areas in this sector.

9 Technological Readiness

India Ranks 83 in technological readiness. India’s compound annual growth rate in technology is around 65% from 1998 to 2008. Broadband access, use of computers etc. lags in India. However, when it comes to firms in adopting technology, Indian firms outperform many of its competitors in technology adoption. Greater diffusion and spread of ICT is a priority area for India.

10 Market size

Indian ranks fourth in market size. The US is the first followed by China and Japan. Consumption in Indian market still faces the problems of low income. Increasing annual disposable income has increasing the consumption capacity of Indian consumers over the year.

Sales Tax: Movement of goods and services within states of India is governed and sales tax imposed by state governments. As a result price of the same product varies in different states. In addition regulations like Essential Commodities Act restrict free movements of goods within the nation. Deregulation in these areas will give a boost to India’s competitiveness.

Export Market: India is world’s 26^th biggest exporter with just 1% share of total exports of the world. This underscores the room of growth in export market for India. Improvement in trade openness will increase exports.

11 Business Sophistication

India ranks 27^th in global sophistication parameter. Nation’s competence in Business Process Outsourcing, Information technology, telecommunication, consumer retailing, automobile sector, pharmaceutical and air transport could be the reasons for higher business sophistication.

There are seven Indian companies in fortune magazine’s global 500 lists of biggest companies by revenue. Financial Times list includes 5 Indian financial companies on the basis of their revenue.

12 Innovation

Spending in research and development is crucial to foster innovation. The provisions of budget 2010-2011 encouraged higher investments on R&D.

Academia: National Institutes of Technology, Indian Institutes of Technology and Indian Institute of Science etc. focuses on research and development activities.

Research organizations: research organizations like ISRO, ICAR, BARC, ICSR etc. have been instrumental in fostering innovation in India.

Private Spending: Private spending on research and development in India is low. This is a negative trend and needs attention.

IPR: Intellectual property rights in India are believed to be not par with other nations. In order to nurture innovation India needs increase the purview and enforceability of Intellectual Property Rights.