The Problem with Animal Spirits

In today's newsletter we talk about the problem with raising animal spirits and the sudden rise in onion prices. Yes, you read that right — onion prices.

On to it then...

A Recap

On Saturday we wrote about corporate taxes and Animal Spirits. In the article, we posited that this move might revive investments, improve wages and in the process help spur consumer demand.

Aaaand it did not go down well with a lot of people.

For one, they contested that there isn’t an automatic link between people’s wages and corporate taxes, that it’s foolhardy to think that companies would part with their profits by paying people better salaries.

Even others suggested that we wouldn’t see prices drop across the board simply because companies will take this opportunity to fix their finances. Maybe pay back some debt, stock some extra cash for a rainy day etc etc. It’s not like this money will be used to make products cheaper and renew demand in the process no?

Well, these are obviously very persuasive arguments. And without solid academic evidence, we can’t refute any of them. Yes, we might not agree with the assessment, but for now, it’s simply our opinions versus theirs and we don’t believe either one is in any way authoritative. So let’s leave it at that.

However, what we do know for certain is that the government is likely going to stretch itself very thin. They have already made it clear that they won’t be cutting down on their spending. So how exactly does the government make up for the shortfall in tax revenues?

Short answer — You don’t.

Long answer — You borrow some more. That’s what the government almost always does. And the problem here can be best summarised by what we wrote a couple of weeks back.

The fiscal deficit (read as total money spent by the government in excess of the total income earned) last year stood at 3.4% of the country’s GDP.

It’s a pretty decent figure overall. However, this is the government’s version of the fiscal deficit.

If you include all the money borrowed by other government-owned entities like Food Corporation of India and NHAI (the guys that build roads), fiscal deficit shoots up to a whopping 5.8%. Now technically all this is still government borrowing, but they refused to admit this much. And with Saturday’s move, this number might shoot up to ~7%.

And this can’t go on forever.

The most obvious impact of government borrowing is that it reduces the pool of available funds for others. Everybody wants to borrow and if the government walks in and borrows a whole lot of money, it crowds out other corporates. They might have to pay a higher interest rate if they still want to fight it out.

So the work that went into reviving the investment engine could be undone if the government continues with its reckless borrowing program.

Hopefully, the government figures out a way to reign in the fiscal deficit before then.

It would be a terrible shame if all those animal spirits die out in the process no?

Onion prices start climbing

The Indian consumer does not keep track of inflation by looking up the CPI (consumer price index) numbers on financial news websites. The Indian consumer keeps track of inflation by looking at onion prices in his neighbourhood retail shop.

Unfortunately, it seems that onion prices have been trending upwards in the past couple weeks and is now testing dangerous waters. We are talking ₹70–80/kg.

But before you get too ahead of yourself and whip out the protest banners, we must confess that prices are unlikely to stay at these exaggerated levels.

Here’s the thing, despite what people may think about agriculture in this country, we’ve made progress. There are more onion producers in this country than ever before. Farmers are producing more onions per acre. And to reduce nasty surprises like these, we’ve also been importing onions from outside.

So the real question is this—despite all this supply, how on earth do we still have such large price spikes?

Well, although we have all this excess produce, onion production has become increasingly concentrated in a few states. And when bad weather hits, say a state like Maharashtra, it becomes ridiculously hard to move agricultural produce across the country. Add to the fact that we still have poor storage facilities and sneaky traders who try and hoard onions to artificially inflate prices, even small disruptions can affect prices a lot.

So hopefully once the weather calms down a bit, we will have the supply routes restored and prices can return to nominal levels.

That's it from us today. And we will see you tomorrow.

Until then......