The power of compounding – Time, Return, Amount

There is this story about the man who invented chess may years ago. It is said that the king of the land was so impressed that he summoned the inventor and asked him to take a gift from him. The inventor thought for a while and said that he wanted 1 grain of wheat for the first square, 2 grains for the 2nd square and 4 grains for the 3rd square, and 8 for the 4th square and so on – doubling the number of grains every square till he reached 64 squares. The king was offended at what he thought was a very small request and he ordered his staff to attend to it. Many hours later he was surprised to learn that his staff was still calculating. After many more hours he was told that the demand was such that whole planet would not be able to fulfill.
The monstrous number of grains required was 18,446,744,073,709,600,000 !!! That amounts to trillions of tons of wheat, which is more than what the world has produced in the history of the planet.
That is the magic of compounding. What looked like an innocuous 31 grains after 5 squares had built up to this monster figure by the time the 64th square was reached. The secret to making money also lies in using the power of compounding effectively.
Albert Einstein is supposed to have said that the most powerful force in the universe is compound interest. And it's true. Compound interest describes how investments can snowball over time. Just as a snowball gets bigger and bigger and rolls faster and faster as it tumbles down a mountain, the same can be true with your investments. Due to the power of compounding, the value of your portfolio can grow faster each year because you earn interest not only on what you invested, but also on the interest you earn. The money you make will depend on three factors:
How much money you invest
How much time it spends growing
Its rate of growth
To illustrate the above points, let’s look at a few examples. We look at three investment alternatives – Rs 10,000 per month, Rs 15,000 per month and Rs 20,000 per month. In terms of returns, we will look at three examples – 10% pa, 15% pa and 20% pa. In terms of time frame, we will look at 10 years.
What will be the final value of the investments? For starters, the simplest thing to calculate is the amount invested in each case, which will be Rs 12 lakh, 18 lakh and 24 lakh respectively. What will they amount to after 10 years? Take a look below –
· 10,000 per month at 10% pa return will amount to 20 lakh. At 15% pa it will amount to 26 lakh and at 20% pa it will amount to 34 lakh.
· 15,000 per month at 10% pa return will amount to 30 lakh. At 15% pa it will amount to 39 lakh and at 20% pa it will amount to 51 lakh.
· 20,000 per month at 10% pa return will amount to 40 lakh. At 15% pa it will amount to 52 lakh and at 20% pa it will amount to 68 lakh.
You would notice at once that the returns do not vary linearly. The difference between amount invested and returns for the best case (20,000 at 20% and 10,000 at 10%) is a huge 36 lakh. When you look at the other dimension time (just compute the above figures for 15, 20 and 25 year time horizons) the differences will compound even more.
Remember that not all growth rates are the same. If your bank is paying 6-8% interest on your savings, that's safe and guaranteed money. The stock market, however, is not a sure thing. Stock market returns fluctuate. There are good years, great years, and terrible years. Over long periods of time, though, the stock market tends to go up. Over many decades, in India, it has averaged an annual 20% return.
In general, the more certain the growth rate, the lower it will be. The more risky it is, the higher it will be.
The lesson here is that discipline in terms of amounts invested and the time invested s to be combined with risk in terms of returns to get great overall long term results. Risk alone will not do much and discipline alone will take you some way but not too far.

Nifty Volatility

Volatility is critical to risk measurement. Generally, volatility refers to standard deviation, which is a dispersion measure. Greater dispersion implies greater risk, which implies higher odds of a price erosion or portfolio loss - this is key information for any investor. We often estimate future volatility by looking at historical volatility.
The volatility of CNX Nifty is shown above.

The volatility presented above is for 30 days. It is computed using the following method
a) Ln (Closing Index value/ Closing Index value of previous day) is computed for every day = X
b) Volatility = Standard Deviation of 30 days values of X multiplied by square root of 250 (it assumed that there are 250 trading days in a year)
Just before the crash of May ’04, the volatility had soared to levels of 55-60% and it came down to levels of 20% by July. The Nifty corrected from a peak of 1833 to 1504. During the summer of 2006, the volatility again rose to 50% and above and a sharp correction followed as the Nifty went down from an intermediate peak of 3754 to 2633. The smaller fall in August this year was also preceded by higher volatility. The volatility is seen to be rising again and is pushing the 30% mark.

Human Behavior and investment

"Recently we worked on a project that involved users rating their experience with a computer. When we had the computer the users had worked with ask for an evaluation of its performance, the responses tended to be positive. But when we had a second computer ask the same people to evaluate their encounters with the first machine, the people were significantly more critical. Their reluctance to criticize the first computer 'face to face' suggested they didn't want to hurt its feelings, even though they knew it was only a machine."
Bill Gates in The Road Ahead

"Graham's conviction rested on certain assumptions. First, he believed that the market frequently mispriced stocks. This mispricing was most often caused by human emotions of fear and greed. At the height of optimism, greed moved stocks beyond their intrinsic value, creating an overpriced market. At other times, fear moved prices below intrinsic value, creating an undervalued market."
Robert G. Hagstrom, The Warren Buffett Way

Most financial theory is based on the idea that everyone takes careful account of all available information before making investment decisions. It is assumed that human beings are rational. Behavioral finance -- which examines how people's emotions, biases, and misjudgments affect their investment decisions -- is one of the less discussed and understood areas of investing. Yet, this is perhaps what impacts markets the most.

Researchers in behavioral finance have come up with some interesting theories, which are briefly presented below:

Prospect theory - People respond differently to equivalent situations depending on whether it is presented in the context of a loss or a gain. They become considerably more distressed at the prospect of losses than they are made happy by equivalent gains. This 'loss aversion' means that people are willing to take more risks to avoid losses than to realize gains. Even when faced with sure gain, most investors are risk-averse, but faced with sure loss, they become risk-takers. According to the related 'endowment effect', people set a higher price on something they own than they would be prepared to pay to acquire it. Tversky and Kahneman originally described "Prospect Theory" in 1979. They found that contrary to expected utility theory, people placed different weights on gains and losses and on different ranges of probability. They found that individuals are much more distressed by prospective losses than they are happy by equivalent gains. Some economists have concluded that investors typically consider the loss of $1 dollar twice as painful as the pleasure received from a $1 gain.

Regret theory – This theory is about people's emotional reaction to having made an error of judgment, whether buying a stock that has gone down or not buying one they considered and which has subsequently gone up. Investors may avoid selling stocks that have gone down in order to avoid the regret of having made a bad investment and the embarrassment of reporting the loss. They may also find it easier to follow the crowd and buy a popular stock: if it subsequently goes down, it can be rationalized as everyone else owned it. Going against conventional wisdom is harder since it raises the possibility of feeling regret if decisions prove incorrect. Professor Statman is an expert in the behavior known as the "fear of regret." People tend to feel sorrow and grief after having made an error in judgement. Investors deciding whether to sell a security are typically emotionally affected by whether the security was bought for more or less than the current price. Many money managers and advisors also favor well known and popular companies because they are less likely to be fired if they underperform.

Anchoring - Anchoring is a phenomenon in which, in the absence of better information, investors assume current prices are about right. In a bull market, for example, each new high is 'anchored' by its closeness to the last record, and more distant history increasingly becomes an irrelevance. People tend to give too much weight to recent experience, extrapolating recent trends that are often at odds with long-run averages and probabilities

Over- and under-reaction - People show overconfidence. They tend to become more optimistic when the market goes up and more pessimistic when the market goes down. Hence, prices fall too much on bad news and rise too much on good news. And in certain circumstances, this can lead to extreme events

People typically give too much weight to recent experience and extrapolate recent trends that are at odds with long-run averages and statistical odds. They tend to become more optimistic when the market goes up and more pessimistic when the market goes down. Researchers found that at the peak of the Japanese market, 14% of Japanese investors expected a crash, but after it did crash, 32% expected a crash. Many investment experts believe that when high percentages of participants become overly optimistic or pessimistic about the future, it is a signal that the opposite scenario will occur.

People often see order where it does not exist and interpret accidental success to be the result of skill. Tversky is well known for having demonstrated statistically that many occurrences are the result of luck and odds. One of the most cited examples is “Tversky and Thomas Gilovich's” proof that a basketball player with a "hot hand" was no more likely to make his next shot than at any other time. Many people have a hard time accepting some facts despite mathematical proof.

Two psychological theories underpin these views of investor behavior. The first is what Daniel Kahneman and Amos Tversky (co-authors of prospect theory) call the 'representativeness heuristic' - where people tend to see patterns in random sequences, for example, in financial data. The second, 'conservatism', is where people chase what they see as a trend but remain slow to change their opinions in the face of new evidence that runs counter to their current view of the world.

The bad news is that you cannot escape these patterns by giving your money to an expert to manage. The ideas of behavioral finance apply as much to financial analysts as they do to individual investors. For example, research indicates that professional analysts are remarkably bad at forecasting the earnings growth of individual companies. Evidence suggests that forecasts for a particular company can be made more accurately by ignoring analysts' forecasts and forecasting earnings growth at the same rate as the average company. The underlying reasons for the abject failure of the professionals are classic behavioral finance: they like to stay close to the crowd; and their forecasts tend to extrapolate from recent past performance, which is very often a poor guide to the future.

Release pent up demand

A college scene in TOI had a senior student pointing something to a fresher, while still talking on the mobile. Nothing unusual. At the airport, at shopping complexes, even inside theaters people are on mobile. How much can people talk?

Looks like there is no limit. And all this is new found love for talking, because just 10 years ago the same set of people were spending less than 1/10^th of the current time span in talking.

This is a classic case of supply at reasonably low prices stoking pent up demand to humungus proportions.

Wonder what will happen if ………………

The government decided to eat less in the form of taxes on petroleum products and petrol sold for about 40% lower values ………. The earth for sure would heat up faster

Or any other product for that matter.

However, there is a lesson for the government here. There is a particular segment which is very small and heavily taxed – food processing. The taxes price the processed food out of the market and these can really be articles of mass consumption. Why do people make their own curd, for example? Because packaged curd is too expensive. Ditto for ready to cook and ready to eat food, processed chicken and other articles of mass consumption. There will be no revenue loss for the government, because these segments are so tiny, that there is hardly any revenue.

No one in his right mind would like to make these things at home. No one makes pickles at home any more, for example. It is just the price point which is constraining demand.

The Key Energy Sources

The diagram below depicts the world’s marketed energy by type.

Crude oil consumption continues to rise, though its share in the world marketed energy sources is on the decline. In 2000, global crude oil consumption accounted for 39 percent of world marketed energy source at 155.9 quadrillion British Thermal Unit (Btu). By 2010, the share of crude oil in world marketed energy source is likely to fall to 36 percent or 185 quadrillion Btu.

The period depicted above shows that the overall demand for energy has grown at a CAGR of 2%. Nuclear energy has been the fastest growing segment growing at 4.6% CAGR (starting from a much smaller base), while crude oil has been the slowest growing segment growing at 1.2% CAGR(albeit from a very high base). Natural Gas and coal have grown at 2.7% CAGR and 2.1% CAGR respectively. Consequently, the share of crude oil in the energy basket has dropped from 46.6% to 36.4% over the 30-year period. It is interesting to note that the share of coal has remained virtually unchanged in the energy basket, over 30 years.

The trends suggest that while the share of crude oil will continue to decline, it will remain the most important energy source for the next few decades at least.

The following charts, based on the past data of over 30 years illustrate the trend further.

Source: OECD Factbook

The energy mix has changed significantly between 1971 and 2003. Nuclear energy, which experienced an annual average growth of 10% since 1971, increased its share of production from 0.5% to 6.4%. Renewable energy also experienced a high growth rate over the 32 years, but its share was very low in 1971, making this growth less meaningful. The share of natural gas in total production increased from 16.0% in 1971 to 21.0% in 2003, and the share of oil has fallen from 44.9% to 35.3%. The share of coal production remained at around 25%.

They want to eat their cake and have it too

It’s amusing to hear the cricket community say that endorsements do not affect performance. The argument given is that the shoot days are so few, that it cannot possibly impact performance. A second argument is that players get their endorsement value from performance on the field and hence there is no conflict of interest. These are nice arguments, but completely miss the important points where interests do conflict.

From the above arguments, it should follow that if a player has given match-winning performances regularly over long periods (say 1990 to 2006) the player should be leading in the endorsement sweepstakes. However, any casual observer can tell you that in very small windows people like Ajay Jadeja, Yuvraj Singh and Mahendra Dhoni have easily outperformed people like Anil Kumble and Javagal Srinath in the endorsement sweepstake. It is obvious that endorsement value depends on star value and not necessarily to contributions to the team’s cause.

It is evident that the things that matter in endorsements are number of centuries that a player scores, sixes hitting ability and other things that catch the public eye. These things may actually help the team, but at times they may not.

Let us take a few examples. A Pakistani team came to India. They were 2 down in a 6 match series and then went on to win the series 4-2. The Pakistanis had a simple strategy for the flat tracks – send in youngsters up the order to do the kamikaze operations (score fast). If they succeeded, the team got off to a flier, if they didn’t the experienced hands of Younis, Yusuf and Inzamam would take on the responsibility of taking the side to safety. Earlier during the 1996 world cup Sri Lanka had done the same and experienced players took the middle order.

Contrast this with the Indian scenario. Here, the team exists to play around the century record-breaking existence of a few players. The players want to bat in the top three to keep the centuries count. If they fail, it is up to the youngsters to re-build!

There is this strong desire to be the star, the Hercules. We all know that all the century projections will go haywire (and so may the star value or the endorsement value) if a player drops down the order.

Also note that the same players do not want to open in test matches. Here they want youngsters to take the responsibility of playing through 20 overs of the new ball, so that they can be in a good position to pile up centuries. They want to eat their cake and have it too.

Historical Price Behavior of oil

In the recent times, crude oil prices have hit the highest level not seen during the past 20-25 years. This is for several reasons. International factors such as Gulf war II, US-Iran tensions, Organization of Petroleum Exporting Countries (OPEC) micro-managing supply etc, have contributed significantly to the crude oil price hitting $75 a barrel mark in 2006. Since then prices have retreated but still hover above 30- year average level.

Crude oil prices behave like any other commodity with wide price swings in times of shortage or oversupply. The crude oil price cycle may extend over several years responding to changes in demand as well as OPEC and non-OPEC supply. However, crude prices also respond violently to political shocks owing to the concentration of supplies in politically sensitive regions.

The diagram below depicts the price behavior over the last 45 years. The chart is in terms of 2006 USD to factor out inflation.

Prices ranged between $2.50 and $3.00 from 1948 to the end of the 1960s. When viewed in 2006 dollars, crude oil prices fluctuated between $15 - $17 during the period, and fell below $10 levels by the end of the sixties. The 20% nominal price increase just kept up with inflation.

From 1968 to 1970 prices were stable at about $3.00 per barrel, and in real terms the price of crude oil declined from above $15 to below $12 per barrel.

OPEC was formed in 1960, which was to influence the oil industry significantly. By the end of 1971 11 members had joined the group. All this was happening while the member countries were experiencing a steady decline in the purchasing power of a barrel of oil.

The Yom Kippur War started with an attack on Israel by Syria and Egypt on October 5, 1973, and this led to the first oil shock. In 1972 the price of crude oil was about $3.00 per barrel and by the end of 1974 the price of oil had jumped to over $12.00. Several Arab nations imposed an embargo on the countries supporting Israel. Arab nations curtailed production by 5 million barrels per day (MMBPD). Only about 1 MMBPD could be made up by increased production in other countries. The net loss of 4 MMBPD extended through March of 1974 and represented 7 percent of the non Soviet Bloc production. Prices increased 400 percent in six months.

From 1974 to 1978 world crude oil prices were relatively flat ranging from $12.21 per barrel to $13.55 per barrel, in nominal terms.

In 1979 and 1980, the Iranian revolution resulted in the loss of 2 to 2.5 million barrels of oil per day. Subsequently, Iraq invaded Iran in September, 1980 and by November the combined production of both countries was only a million barrels per day which was 6.5 million barrels per day less than a year before. Worldwide crude oil production was 10 percent lower than in 1979.

The combination of the Iranian revolution and the War resulted in crude oil prices more than doubling from $14 in 1978 to $35 per barrel in 1981. Even today, Iran's production is only two-thirds of the level reached in pre revolution Iran.

From 1980 to 1986 non-OPEC production increased 10 million barrels per day, this helped prices stabilize. The price cycle then turned up on the back of a strong US economy and the great boom in the Asia Pacific region. From 1990 to 1997 world oil consumption increased 6.2 million barrels per day. Asian consumption accounted for virtually all that gain.

The price increases came to an end with the economic crisis in Asia. In 1998 Asian Pacific oil consumption declined for the first time since 1982. The combination of lower consumption and higher OPEC production sent prices into a downward spiral.

Russian production had declined significantly since the Soviet era. It started its recovery in about 2000. Since 2000 Russian production increases dominated non-OPEC production growth and has been responsible for most of the non-OPEC increases. This could have moderated the price rise, but 9/11 was the next major event which was to have a big impact on oil prices.

In 2002, problems in Venezuela led to a strike at PDVSA causing Venezuelan production to plummet. In the wake of the strike Venezuela was never able to restore capacity to its previous level and is still about 900,000 barrels per day below its peak capacity of 3.5 million barrels per day.

In 2003, just as some Venezuelan production was beginning to return, military action commenced in Iraq. Asian recovery was complete by this time and demand for crude oil was growing at a rapid pace. The loss of production capacity in Iraq and Venezuela combined with growing international demand led to the present boom in prices. During the last 5 years, India has joined the Asian party and its rapid economic growth is beginning to impact global demand significantly.

Oil Price Spurt in last Five Years

The following political events have influenced oil prices since 2000:

• September 11attack on the World Trade Center, USA.
• Gulf War II begins and ends in early 2003
• Insurgency in Iraq takes a toll on Iraqi oil production (2003 to 2006)
• Iranian Nuclear debate that started in 2005 with no end in sight.

Notable economic reasons, which prompted the price rise in last five years, are:

• Russia’s entry into the world oil market in a big way from 2000 onwards
• Hurricane season of year 2004 in the US.
• Hurricane Katrina and Rita in the year 2005.
• Rising demand, which the controlled supply could not meet.

All the above factors have played their role in pulling up the price to $75 a barrel. Some events have impacted more significantly than the others, but the net impact has been that the world’s consumers are paying a huge price for their oil consumption.

Development of alternative fuel sources is a factor that can impact oil price. Many alternative fuels are profitable if the crude oil sustains above $50/barrel

Importance of Producing Stuff

The Importance of Producing Stuff
This is nice post by Atanu Dey.
I like the build up and the conclusion is well put
"We need to distinguish between employment and production, between money and income, between aggregate production and distribution. India’s economic policies have stressed employment and not production. That, in no small measure, is why India is poor."

Indian Meat Consumption

Trends in meat consumption
Broiler meat is the fastest growing segment, whereas bovine meat is the slowest segment.

Meat consumption has grown at about 4.8% pa. Poultry (broiler) meat has grown at nearly 20% per annum from a level of 478,000 tpa to 1.4 million tpa. Mutton segment has grown at almost the same rate as the overall meat consumption, whereas pork has grown at a slower pace. The bovine meat segment is virtually stagnant.

Per capita availability has grown from 11.9 grams/ day to 14.65 grams/day during the same period (CAGR = 3.52%)

How does India’s consumption compare with the rest of the world?

There is no straight comparison to derive the potential. However a look at the values, does give an indication of the gap. India’s consumption levels are very low and malnutrition and hunger are prevalent. It can be argued that as long as income levels keep increasing, the demand is likely to keep on growing in the foreseeable future.

The diagram depicted below maps the per capita consumption of meat of India and the rest of the world, for the year 1998. It is in the form of the classical S-curve, with India yet to be at the high growth inflexion point. The diagram would indicate that the inflexion point (at which demand starts accelerating) would be somewhere around 20-25 kg pa.

The position of Japan at low consumption levels could be explained by the fact that Japan is a high fish consuming community, which inhibits its meat consumption.

India’s consumption levels (currently 5.35 pg/ annum) are so low that it can only be explained by low incomes and high relative prices.

The horizontal axis indicates per capita consumption of meat (kg/ annum)

Data source: FAO

The total world consumption of meat is estimated to be of the order of 240 million tpa and India’s share of consumption is only 2.2%. On the other hand, India supports nearly 17% of the world’s population

Crude Oil - Balance of power

Production and Consumption centers of crude oil

The United States and The EU account for 43% of the world demand. Russia and Saudi Arabia account for 23% of the production.

Data source: CIA website

The consumption is heavily skewed towards developed countries. The USA, Japan, The EU, Korea, China and India are heavily dependent on imports since the demand far outstrips the domestic production. Saudi Arabia, Russia, Iran, Mexico and Venezuela are the leading producers with a very significant part of their produce being available for exports. Asia is also the region which is experiencing the fastest growth on the back of rapid economic development of several countries including two large economies India and China.

Key players in International Trade of crude

Apart from Russia, most of the leading exporters are OPEC nations. The US, The EU, Japan, China, Korea and India are the leading importers

Data source: CIA website

The EU figures in the above list, because it consists of several countries trading amongst themselves. Norway is the most significant exporting nation in Western Europe. Most of the leading exporters are part of OPEC. China, India and Korea have emerged as significant importers and their import requirements are growing fast.

Proven Reserves of Crude oil

Seven OPEC nations control 62% of the world’s proven resources

Figures in Billion barrels

Data source: CIA website

62% of the world’s proven reserves are controlled by Saudi Arabia, Iran, Iraq, UAE, Kuwait, Venezuela and Libya. Saudi Arabia alone controls 20%, and Iran and Iraq account for 18.5% together, while UAE and Kuwait account for another 15% together.

Humans are hardwired for consistency over reason

I read this interesting post by Scott Adams

Today I Will Improve Your Sex Life

The portions that resonated were
"According to the research, humans are hardwired for consistency over reason. You already knew that: People don’t switch political parties or religions easily. What you didn’t know is how quickly and easily a manipulator can lock someone into a position."

Recommended read

The automobile industry comes of age

When Maruti started production in India, the total domestic market in India was just about 40,000 passenger vehicles. Maruti made its millionth vehicle in 1994, and at that point in time the total market size was just about 250,000 passenger vehicles per annum.

India was not known as an exporter of automobiles and no one really expected that to ever happen. However, the export growth in the last 5 years have been as stunning as the growth in domestic sales, if not more. From a mere 53,125 passenger vehicles in 2001-02, exports have exploded to 176,000 units in 2005-06 and are expected to cross 200,000 units this fiscal. That's truly amazing. We export volumes that we were consuming domestically just 12-13 years ago.

Now obviously if we are able to export such numbers, the quality of the products must be of international class. The quality and productivity improvements have delivered lower price to the consumers too. I remember Maruti Zen was introduced in 1993 with a price tag of Rs 350,000. Today superior vehicles are available at lower nominal values. If we factor in inflation, car prices have virtually halved during the last 10 years. Meanwhile salaries have gone up by a factor of 5-6.

"The small car hub" is a dream that is being realized fast.

Urbanization

Urbanization is the lifeblood of a modern economy. A modern economy does not rest on rural activities. In 1950 only a quarter of the countries in the world had more than 46 per cent of their population living in urban areas, but by 2000 nearly half had 57 per cent or more of their population living in urban areas. A UN Study forecasts that by 2030 over three-quarters of all countries or areas will have over half of their population in urban areas.

The most urbanized countries or areas are located in Europe, the Caribbean, Oceania, South America, South-eastern Asia and Western Asia. These also happen to be countries with high level of per capita income.

On the other hand, about a third of the least urbanized countries are in Africa, the rest being in Oceania, South-central Asia and South-eastern Asia. No prizes for guessing their per capita income levels, these are among the lowest in the world.

(A list of highly urbanized and less urbanized nations as per data of year 2000, reinforces the points made above – USA – 77.4%, Japan – 78.8%, Germany 87.5%, UK – 89.5%, France – 75.4%, Indonesia – 41%, Pakistan – 33%, Bangladesh – 25%, Ethiopia – 15%)

The transformation of China on the back of rapid economic growth gives us clues to what to expect in India. China had urbanization levels of just 12.5% in 1950 (India had 17.3% urbanization then). From then on it had gone up to 36% in 2000 and is forecasted to reach 59.5% by 2030. Slower pace of development in India during the last century meant that our urbanization levels were only 27.7% in 2000. This is expected to grow to 41% by 2030, or even higher depending on the pace of economic growth. This means that at least 150-160 million people will migrate to cities during the next 25 years. Clearly, our cities are not big enough for this.

The answer lies in rapid build up of urban conglomerates around existing large cities in different parts of the country and simultaneously building entirely new cities afresh. However, there is also a simultaneous large issue of building services for the rural community to control rapid influx into the cities that are not ready to take in more.

This is an interesting blog which deals with the issues of rapid transformation - A Brief Introduction To RISC — Rural Infrastructure & Services Commons. The author puts a very compelling argument for tackling the issues arising out of the transformation. It’s a pretty good recipe for the policy makers to take note of.

The changing face of India’s foreign trade

The last 5 years data for International Trade, depicts a clear trend. India’s key trade partners are changing rapidly. First of all, the volume of international trade has expanded rapidly from $95 billion in 2001-02 to $252 billion in 2005-06. This is a remarkable growth (21.5% CAGR) and is one of the key drivers of economic growth. International trade in value terms is still about 1/3 of the GDP, so there is considerable room for continued expansion of International trade.

A look at some of the leading trade partners during this period shows the remarkable growth in trade with China. China, from nowhere, is now the second most important trade partner for India (figures in $ millions).

It looks likely that in another 5 years China will be as important as The US for India as a trading partner. The diagram below shows the increase in trade with some of the leading partners.

Clearly China, Korea, Singapore are integrating much faster with India, than the erstwhile mainstays – USA, Japan and UK. The USA, is of course such a large partner, and the base effect in its case was higher. However, the trends clearly show an increased Eastward focus. This is even more apparent when one starts looking at the figures for other ASEAN countries.

The BRIC forecast

The Hindu has an interesting view on the The Goldman Sachs report on Brazil, Russia, India and China (BRIC).

“The co-author of the BRIC report, while presenting the same here, raised concerns over the levels of secondary education in India. This is an important variable in the model and in comparison to others in the report, it is an area where India stands weak”, the article states.

The article further says, “On applying the model to various economies as they stood in 1960 and comparing the current levels of these economies as against what the model would have projected, none of the Asian economies have shown parity. The actual GDPs are higher than that projected in Hong Kong and Korea and much lower in countries such as India.”

It is important to note that if India doesn’t get its act together fast, it may well under perform the expectations again. The crux of the matter lies with how the rural sector is addressed. Rural India still accounts for over 70% of the population. The real boost to the rural sector can come only through massive investment in rural infrastructure and enabling the rural population to participate in the gains of a modern economy. This will involve massive spending on rural irrigation, roads, rural education and rural marketing. These are not very glamorous areas and are not considered news worthy (or vote worthy). However, this is where the real multiplier will come from. It will create a new class of consumers for the industrial sector.

This is but one of the areas to address. There is actually no room for complacency. The old foe Murphy, is worth quoting:

• Anything that can go wrong will go wrong.
• If there is a possibility of several things going wrong, the one that will cause the most damage will be the one to go wrong. Corollary: If there is a worse time for something to go wrong, it will happen then.
• If anything simply cannot go wrong, it will anyway.
• If you perceive that there are four possible ways in which a procedure can go wrong, and circumvent these, then a fifth way, unprepared for, will promptly develop.
• Left to themselves, things tend to go from bad to worse.
• If everything seems to be going well, you have obviously overlooked something.
• It is impossible to make anything foolproof because fools are so ingenious.
• Whenever you set out to do something, something else must be done first.
• Every solution breeds new problems

Rising Inequality - The stealth Bomber

Paul Krugman made an interesting observation about the reduced egalitarianism in the American society. This is how he sees it:
“To get a sense of just how dramatic that shift has been, imagine a line of 1,000 people who represent the entire population of America. They are standing in ascending order of income, with the poorest person on the left and the richest person on the right. And their height is proportional to their income -- the richer they are, the taller they are.
Start with 1973. If you assume that a height of six feet represents the average income in that year, the person on the far left side of the line -- representing those Americans living in extreme poverty -- is only sixteen inches tall. By the time you get to the guy at the extreme right, he towers over the line at more than 113 feet.
Now take 2005. The average height has grown from six feet to eight feet, reflecting the modest growth in average incomes over the past generation. And the poorest people on the left side of the line have grown at about the same rate as those near the middle -- the gap between the middle class and the poor, in other words, hasn't changed. But people to the right must have been taking some kind of extreme steroids: The guy at the end of the line is now 560 feet tall, almost five times taller than his 1973 counterpart.”
He goes on to explode a few myths (as he calls them), namely:
“MYTH #1: INEQUALITY IS MAINLY A PROBLEM OF POVERTY.
It's not only the poor who have fallen behind -- the normal-size people in the middle of the line haven't grown much, either. The real divergence in fortunes is between the great majority of Americans and a very small, extremely wealthy minority at the far right of the line.
MYTH #2: INEQUALITY IS MAINLY A PROBLEM OF EDUCATION
The richest twenty percent are those standing between 800 and 1,000. But even those standing between 800 and 950 -- Americans who earn between $80,000 and $120,000 a year -- have done only slightly better than everyone to their left. Almost all of the gains over the past thirty years have gone to the fifty people at the very end of the line. Being highly educated won't make you into a winner in today's U.S. economy. At best, it makes you somewhat less of a loser.
MYTH #3: INEQUALITY DOESN'T REALLY MATTER.
It's easier for a poor child to make it into the upper-middle class in just about every other advanced country -- including famously class-conscious Britain -- than it is in the United States. Not only can few Americans hope to join the ranks of the rich, no matter how well educated or hardworking they may be -- their opportunities to do so are actually shrinking. As best we can tell, pretax incomes are now as unequally distributed as they were in the 1920s -- wiping out virtually all of the gains made by the middle class during the Great Compression.”

India would do well to take note of this and try and address the issues so that such an event does not occur here. If it does the results will be catastrophic. Inequalities are visible and will be manifested in rising crime rates. If unchecked, it will further lead to anarchy and breakdown. The price is way too high for comfort.

The rising inequality is like a stealth bomber. It creeps up unnoticed and then creates catastrophe.