It was Milton Friedman who famously quipped, “Inflation is always and everywhere a monetary phenomenon.” If the quantity of money grows at a pace greater than warranted by the growth of the economy, then the excess money supply drives up prices.
We take a look here at data to find out whether too much money supply growth is behind the current inflation.
(EXCESS SUPPLY) The chart, which plots nominal gross domestic product against M3, a broad measure of money supply, shows that while the stock of money has been increasing steadily, nominal GDP growth has not kept pace. Assuming the velocity of circulation to be constant, that is assuming that money changes hands at the same pace, the data suggests that money supply growth has been more than what was necessitated by the pace of economic growth. The only caveat to be kept in mind is that with India becoming a developing economy, it’s very possible that part of the growth in money supply may be due to greater monetization and deeper penetration of the banking system. But it’s clear that the rise in money stock as a proportion of nominal GDP from 0.63 in fiscal 2000 to 0.92 in fiscal 2008 is too large for it to be merely due to these effects.
A large part of the increase in money supply happened between fiscal 2005 and fiscal 2008, not very surprising because this is the period in which foreign fund inflows zoomed, bloating M3. Some of the increase in money supply found its way into the asset markets, boosting stocks and sending the price of real estate skyrocketing, while some of it spilled over into the product markets, leading to inflation.
The Reserve Bank of India (RBI), of course, has been very much aware of this trend, which is why it started to tighten monetary policy as early as October 2004. Clearly, however, they should have done much more, although we’re saying that with the benefit of hindsight. Few observers would have predicted the runaway rise in commodity and fuel prices that, together with lax monetary policy, is responsible for the current very high inflation rate.
Moreover, it’s not only primary products and fuel that are seeing a rise in inflation—inflation in manufactured products is now 8.7% year-over-year. And while it’s true that the biggest increases are being seen in commodity prices, such as basic metals and alloys, up 27.5%, or food products, up 12.9%, other products too have seen a sharp rise in prices. For instance, why should dairy products rise 10.7%, or beer and alcohol 9.5%? Other products that have seen high inflation are wires and cables (up 8.3%), transport equipment and parts (up 6.1%), chemicals and chemical products (up 5.9%) and several other categories. The data show that inflation is not just supply-driven but is also the result of higher demand.
To cut a long story short, the data show that RBI clearly needs to tighten further.
Aban Offshore rides high on rising crude
Shares of Aban Offshore Ltd were among the worst hit in the January-March correction, halving from about Rs5,400 a share in early January to Rs2,700 in late March. But having risen by nearly 40% since, the recovery in the company’s shares has also been among the sharpest.
Aban offers drilling and oil field services for offshore exploration and production to the oil industry both in India and internationally. Rising crude prices have lead to a rise in exploration activity, which in turn have caused hiring rates for Aban’s services to soar new heights. Analysts tracking the company had feared that high capacity addition this year by the industry would lead to a correction in hiring rates. But rates, which had risen substantially in the past few years, have held.
Now, with crude prices soaring to new heights, some analysts feel that rates can only go up. It’s no wonder Aban shares are in demand all over again. According to Macquarie Research, “Aban is best placed to benefit from the current shortage of rigs and the resulting rise in day rates.” It explains that India has the fourth largest number of offshore rigs operating in the world and Aban is ideally poised since more than half of its fleet is positioned in this region.
But note that there is generally a large time lag between a rise in crude prices and new exploration activity. In case crude prices don’t sustain at current levels for some time, the expected jump in exploration activity may not materialize. Having said that, even the fact that rates have sustained at record levels augurs well for the company. When its two-three year contracts come up for renewal, realizations will improve substantially and so would profit.
What’s more, as Macquarie Research points out, Aban trades at a 24% discount to the average price-earnings valuation of global peers. Based on the consensus estimates published by Bloomberg for fiscal 2009, Aban trades at 11.5 times its earnings.
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