Inflation - The Core Issue

Inflation has dropped to a 13 month low of 4.3% recently. Not long ago the inflation rate skyrocketed to levels of 6.2% and kept the finance minister frantically trying to bring it down. Inflation – the rise in prices of essential commodities is a factor which has a key role in deciding the fate of incumbents in elections. Nothing works up the electorate so much as inflation. The government often does its part to curtail inflation, often as a knee jerk reaction like banning trading in wheat futures. The uncomfortable fact however is that food prices are rising the world over and inflation is not a problem faced only by India. Can the inflation rate be sustained at levels of 4%? Are the lower levels achieved now merely an aberration? Well, only time will tell. China which has a highly regulated economy has been able to do very little to control inflation. Mexico faces a similar problem. Even in developed economies like UK the consumer price index rose by 2.5% and food prices have gone up by 4.8%. Food inflation in the United States was 3.7%. Inflation is a natural consequence of economic growth and prosperity and is not always a serious problem. However a high rate of inflation, almost invariably leads to a squeeze on economic growth. One factor which has shot up the food prices in the Americas is the increasing use of bio-fuels. A large amount of corn has been diverted from the kitchen to the fuel tanks. It is estimated that 1% of the world’s arable land is being used for bio-fuels and this figure will go up to 3.5%. Brazil already runs a substantial amount of its vehicles on ethanol based fuels. With the bio-fuel technology gaining popularity, a new species – vehicles will start eating away our share of food. This however is not the only reason for spiraling prices. The supply of quality land has been shrinking. Expanding cities in India, which is the most densely populated country in the world, has already devoured large tracts of agricultural land. Higher industrialization and special economic zones have brought in more agricultural land under the ambit of industrial activity. With increasing prosperity people eat more and eat better. More land is required to produce a unit of energy from meat than it is needed to provide than same amount of energy from wheat. Growing consumption of meat thanks to prosperity is an addition to the cocktail of factors. Add the vagaries of monsoon to this, and we have a perfect recipe. All this boils down to a core issue – the rise in food prices will continue to be a knotty problem. Concerns of inflation shoot up, always, if it is concerned with food prices. People are less anguished by the rice in car prices than by the rise in the price of potatoes. This in turn would lead to a demand for higher wages and start a chain reaction. A pertinent question stares at us now. What if there is consistent food inflation? Ricardo, the 19th century English economist, famously predicted that as demand for food rose, so would prices. This was simply because less fertile land would be brought under cultivation so the costs of production would rise; this is diminishing returns. Ricardo further said that a stage is inevitable when the rise in food prices would affect profits to such a level that economic growth is strangled. This however has never happened in the past as the world in general and more specifically India was leapfrogging in agricultural advancements. The green revolution brought Indian agriculture back on its feet. Also, more land was consistently brought under cultivation. The supply of arable land today is shrinking. So what is the solution to the inflation conundrum? All that has been done so far are only short term solutions and a proactive agricultural policy is the need of the hour. There is a definite need to bulk up agricultural production in India. Reforms are needed to improve productivity and competitiveness of the farmer. One of the main problems faced today is that of rural micro credit. Probably the only successful model for micro financing was the model of the Grameen Bank in Bangladesh. There is a need to improve the credit system in India. Ensuring monetary supply is one of the key factors. The World Bank in a recent study has said that agricultural trade reforms are vital to reduce poverty in developing economies. Developing countries have been improving agricultural productivity, but the impact of these gains on poverty reduction will not be fully realized unless richer countries reduce their agricultural trade protection. Without such liberalization, increased productivity will lead to overproduction and price declines for many commodities. On the other hand a liberalized free market would lead to resource reallocation. Agricultural trade liberalization would create winners and losers. As an effect of the resource reallocation there would be substantial effects. For example, production of groundnut products in India would likely contract as would vegetable oil production in China, but dairy production and exports would expand in India, and rice production and exports would expand in China. Liberalization of value-added activities is crucial for expanding employment and income opportunities beyond the farm gate. Other winners and losers would also emerge. Multilateral trade liberalization erodes the benefits from preferential bilateral trade agreements and pits low-cost producers in some developing countries (such as sugar producers in Brazil and Thailand) against less efficient producers in the least-developed countries who are currently helped by preferential access. Agricultural reforms have been unduly delayed in India, but policy makers seem to have realized the urgent need lately and we can expect to see affirmative action in these areas. Till then it will be worth watching how food prices affect inflation and profits.

Will the Indian Media and Entertainment Industry finally come of age?

The Indian entertainment industry is on the threshold of emerging as a large market globally. Future growth of the industry is expected to be led by rising spends on entertainment by a growing Indian middle class, regulatory initiatives, increased corporate investments and the industry's dynamic initiatives to make strategic structural corrections to grow. In addition to the Indian middle class’ enhanced spends projected towards entertainment, the rising global interest in Indian content is expected to fuel growth in this industry.

The spend on entertainment in India is significantly lower than most advanced countries, yet the growing middle class exhibits a greater propensity to spend on entertainment, when we consider the entertainment spend as a percentage of per capita spend. As the Indian economy grows, the rest of the population is moving towards a higher standard of living. It is this growing consuming class with the propensity to spend that will drive the growth of the Indian entertainment industry.

The entertainment industry in India has the potential to be the next 'sunrise' industry and is undergoing significant changes. Increasingly, the Indian entertainment industry is being influenced by international trends and developments. The industry is steadily moving towards corporatisation and globalised markets.

Over the last few years, there have been discussions on the Indian entertainment industry being on the verge of take-off, powered by new delivery platforms and technological breakthroughs, increasing content variety and favourable regulatory initiatives. This is expected to transform the entertainment landscape, with more players entering and traditional players being forced to adapt or perish. One can already witness changes that have the potential to alter the industry structure.

Increasing penetration of new delivery platforms is one of the key drivers of the media and entertainment industry today, that has the potential to change the way people receive content. These platforms, resulting from fundamental technological breakthroughs, are likely to see most of the action in next few years. For example, the spread of inexpensive and stable storage media will also enable people to store content and view it at their convenience. Some other examples are:

• Introduction of DTH and IP-TV
• Digital distribution of films
• Immersive content media like IMAX theatres
• Coming of age of Satellite Radio and FM Radio
• Emergence of new technologies like podcasting, etc

Together, these are expected to change the viewing habits of people.

New forms of content will emerge to cater to select viewers, as the industry evolves. Content like community radio and local television, that were unviable earlier, will also emerge stronger through new delivery formats. Moreover, content innovation will be necessary to sustain the interest of the increasingly jaded urban population. A few instances of rising content diversity are:

• Newer programming categories like reality television,
• Crossover content in music and films,
• Niche programming on radio like sports and comedy,
• Newer genres like lifestyle television, religion channels, etc.

The regulatory framework for media is still evolving. Looking at the policies announced by TRAI, it seems that a liberal framework is likely to be developed in order to allow the industry to flourish. Alongside regulating broadcasting and distribution, it will be important to create stronger protection mechanisms for copyrights and royalties. If intellectual property is protected to a fair extent, the industry could capture far greater value, giving its growth rate a significant boost.

A few examples of such regulatory actions are:

• An implementable regulatory framework for introducing addressability of cable television
• Policy framework for DTH, satellite radio and community radio
• Migration to a revenue sharing regime in FM radio
• Superior copyright protection for films, music and home video, etc

The entertainment industry is thriving on the current economic upswing and is currently estimated at INR 222 billion. Due to its sheer size, television has been the main driver for the industry's growth, contributing 62 percent of the overall industry's growth. Films contributed another 27 percent, while other segments like music, radio, live entertainment and interactive gaming constitute the balance 11 percent.

Propelled by innovation across its value chain and a series of enabling regulatory actions, the entertainment industry is expected to grow annually at almost 18 percent to reach around INR 588 billion by 2010. However, even with such growth, it could be just scratching the surface of the Indian market's true potential. Reaching this targeted growth rate will not be easy for the sector. Television sector has witnessed a significant bit of transparency, process orientation and discipline, except for the last-mile which is completely fragmented. The film sector, on the other hand, still remains relatively opaque and persona-driven. Over the past few years, the film industry has made some progress in getting institutional and corporatised funding. However, the progress on this front has notbeen as dramatic as had been expected when the institutional funding norms for films were relaxed a few years ago. Even though different sources unanimously agree that the entertainment industry is a sunrise sector, it has seen no major fund-raising efforts, apart from television content and broadcasting where the impact of professionalism and organised financing is evident.

Over the past decade, India has been the second fastest growing economy in the world. In 2004, it grew by 8.2 percent, breaching the psychological 8 percent barrier for the first time. In terms of purchasing power parity, it is already the fourth largest economy in the world. Most major global companies are of the opinion that it will become a key market in the years to come. As the Indian economy continues growing, the Indian middle class will also expand significantly. Compared to other nations, the 300 million strong Indian

middle class allocates a higher percentage of its monthly expenditure on entertainment. The increasing consumerism of middle-class India is seen from the sharp growth in the sales for various products like automobiles, colour television sets and mobile phones and the burgeoning increase in credit cards and personal loans. There is an increase in the direct consumer spends on entertainment and advertising revenues have also been on the rise. With the average Indian getting younger, and hence more likely to spend on nonessentials, the entertainment industry has the potential to grow explosively in the future.

Rip van Winkle's Guide to Indian Aviation

India's civil aviation passenger growth stands at 20% -- among the highest in the world -- saturating most metro airports and a handful of fast-growing smaller cities. Many airlines are bulking up on capacity as well: Ten Indian carriers recently placed orders for about 400 aircraft worth $15 billion. But this good news is marred by looming overcapacity along with the fact that, given new competitive pressures, most airlines are losing money.

So what exactly is happening in the Indian aviation sector?

For many years the Indian aviation market had been grossly underserved with only 0.01% of the total population using air transport. But in the past few years, a rash of new low cost carriers has been tapping into the growing passenger traffic. We have seen the newspapers replete with ads trumpeting air tickets for less than a hundred bucks. ‘Visionaries’ who wanted to make every Indian fly expected that the railway ac passenger would gravitate to the skies if the costs of flying were lower. Thus was born the low cost model – a no frills airline can substantially cut costs by operational efficiencies like a quicker turnaround time which enables them to fly longer hours, all economy seating configuration which means more seats per aircraft, no free catering etc.

While axing the embellishments off full service carriers and creating a new low cost carrier seems to be a sane idea the numbers definitely narrate a different story. Reason – the aviation sector has been plagued by stiff competition, resulting in ridiculously low pricing and airline companies emasculating each other.

One of the key parameters in analyzing the state of any airline is the cost and revenue per available seat kilometer (ASKM), which is the total seats available multiplied by the number of kilometers flown by the airline in any given period of time. Another metric is the seat factor, which is the number of seats for which tickets were sold divided by the total number of available seats expressed as a percentage.

An analysis reveals some intriguing facts. Firstly every airline manages only a seat factor of 70 – 80%, which means that unbridled expansion has led to overcapacity and tickets which were not sold translate directly into losses. Secondly, the revenue generated per ASKM is much lower than the cost per ASKM, which means every ticket is sold at a loss. For example the cost per ASKM of Air- Deccan is 46% more than the revenue generated, i.e. they lose 146% of what they make. This means that while the ticket costs are lower, the cost incurred by the airline is not really low and tickets are given away for a pittance only to avoid bigger losses and not to make profits owing to an intelligent business model.

The recent consolidation in the industry is considered by many as the only optimal solution to prevent the bloodbath. The consolidation culminated with the marriage of Air Deccan and Kingfisher with the latter picking up a twenty six percent stake of the former. The other merged entities are Air India–Indian Airlines, and Jet-Sahara. There are still some small players existing like Go-Air etc. but given the market dynamics and scale of the behemoths they will either be gobbled up by them or will have to merge amongst themselves. So in a matter of time we can see four or five large players in the industry.

When this in itself could end the price war this could also lead to cartelization of the industry. A cartel is when these airlines (except the national carrier of course) sit together and decide not to undercut each other’s fares. This type of a cartel among companies in a free market is illegal but nevertheless is bound to happen as they will do it covertly and not overtly. Probably one of the best known cartels in the world is OPEC. An organization consisting of the world's major oil-exporting nations, OPEC was founded in 1960 to coordinate the petroleum policies of its members and to provide member states with technical and economic aid. OPEC is a cartel that aims to manage the supply of oil in an effort to set the price of oil on the world market, in order to avoid fluctuations that might affect the economies of both producing and purchasing countries. Legal or not, we can clearly expect the consolidation to perk up the profitability of the airline companies.

In what can be seen as the beginning of the convalescence, airline stocks have started to improve slowly on the bourses. Spicejet has been the favorite and it is not quite surprising if we look into some data. The cost per ASKM of Spicejet is Rs. 2.60 and the revenue per ASKM is Rs. 2.04. These are by far the best figures in the industry in the worst of the times. What do these numbers mean? Given that Spicejet is a low cost carrier and it has the lowest cost per ASKM, it evidently is the only airline to execute the low cost model rigorously. The lower costs are obviously due to the operational efficiencies of Spicejet and if the health of the industry improves as a whole Spicejet will win in a big way.

As for Air Deccan which is suffering serious injuries it will take some more time (maybe around two years) recover. The high costs in spite of being a low cost carrier is a serious issue for Air-Deccan and it needs to change a lot if its profitability is soar ahead of the industry average.

Here is the key takeaway: After some teething problems Indian aviation has changed for the better. Sit up and take note.