Wednesday, February 20, 2008

PPP

Economists say that Purchase Power Parity is a good measure to understand the actual buying power of a currency. Simply put if you are coming from USA to India and you have 1 USD, you will get Rs 40 on exchange rate but with this 40 rupees you can buy in India what you could buy with 2 USD in the US. Conversely, what this means is that the actual purchasing power of the USD if you travel from India to USA is only Rs 20. If you look at the Big Mac Index (which compares the rate of the Big Mac across countries and gives an index like PPP) it appears that the 1 $ can buy in the US stuff worth Rs 29. So I guess the range is around Rs 20 to 30 and therefore it is fair to say that the rupee is still undervalued and should continue to strengthen.

This was just the background. The purpose of this post is to comment on PPP and the Indian opportunity really, so let’s get to that. While shopping in the US to do a mental check if some thing is expensive or not, I always use the PPP conversion to understand the true price, as otherwise things appear to be expensive. For e.g. when I see a shirt for 30 $ in a US store, the first instinct is to see it as Rs. 1,200 (40 X30) but then when I apply PPP, I can see that its price is only Rs. 600 and hence I may choose to buy it. It works in most areas such as food, clothing, packaged goods etc. and US actually seems like a fairly inexpensive place to shop in PPP terms.

What really struck me last week was how some things have become so expensive in India. Typically, the PPP concept does not seem to work well when we look at goods and services that are domestically produced and not traded globally.

I am leaving for the US today for a short business trip. While I was making my hotel reservations and flight reservations, I was also making an estimate of expected expenses for this 5 day trip. Flight tickets Rs 45,000, 4 Star Hotel (90 $ per day X 5 days= 450 $ = 18000). Cost of travel and stay = Rs. 63,000. Lying next to this estimate was the travel voucher of my recent trip to Bombay for 5 days. Here was the breakup Flight tickets Rs 10,000, 4 Star Hotel (250 $ per day X 5 days= 1250 $ = 50000). Cost of travel and stay = Rs 60,000. WHOA! A business trip in India for 5 days costs the same including air fare as it costs to the US. Look at the hotel rates. For a comparable room the rates are 90 $ vs. 250 $. When you apply PPP the 250 $ is actually 500 $ (assuming the US $ can buy stuff worth Rs 20/- in India). 90$ vs. 500$ !! More than 5 times more expensive than USA. Look at cars. A Toyota Corolla in India costs 11,00,000 which is 27,500 $. In PPP terms it is 55,000 $. I am told that in USA the car costs around 17,000 $, at least 3 times more expensive in India. You can see this happening in Housing Purchase (Not in rental though), office Rental and many other areas that require strong domestic production and domestic supply.

As the Indian economy flies I think while the US $ exchange rate will come closer and closer to the actual buying rate, what will also happen in the short term is that items that are only locally manufactured and not traded globally will be more and more expensive when compared globally. And this is why India is the most exciting destination and the most promising economy in the world. The sectors like Infrastructure, Hospitality and all other sectors that require domestic production will need and get capital influx. Why ? Because this is where we are 5 times over priced. This is where there is most money to be made. This is where the most action is - and is this action that makes this country an intoxicating opportunity. People say is the action in India now going to slow down? I say, the migratory Halcyon bird has only just left the cold Antarctic Shore !

15 comments:

Anonymous said...

Dev,

Thank you for "stepping out of the box", a little. It is imperative that Indians start thinking in global terms, and not just with what is happening only in India. In fact, if anything, we have to start seeing India not only organically (i.e. internal dynamics that are happening in India -- and you have made reference to some of those points in your post) but also, we have to start seeing India vis-a-vis rest of the world.

One of the main reasons the Indian rupee seems strengthened is, obviously because of a ridiculous GDP increase (rate of around 9% - phew!) but also (and this is important), the US Dollar has gotten so cheapened -- the US Fed continues to lower interest rates here that undervalues the dollar, the US economy is not exactly gangbusters in the last year or so, the US is piling up huge amounts of debt (thanks to the Arabs and Chinese buying up US Tresuries, esp), their fiscal policies are rampant and there is no control on spending here, the recent credit market crisis here has not helped at all. In short, post Richard Nixon's 1971 move to remove the gold as standard and replace it with the US Dollar, all we have to bank on is the fact that the US GOvt has never faltered in repaying its debt in the history of the nation. However, that is under severe threat esp with their socialist programs (Medicare, Medicaid, Social Security) that are going to get pummelled in the next few years with the Baby Boomers approaching retirement age. In short, Dev, the US is going to face the mother of all financial crises and they have no one else to blame but their own Big Govt programs (thanks to FDR and LBJ ,esp). Why do I go into all this detail? Because, Dev, that is why from your perspective, when you step out of India and come to the US, you see things that are "cheap". Believe it or not, on the Canadian border with the US, in the past few months with the Canadian 'looney' having achieved parity (1 Canadian $ used to be around $0.67 USD last Feb. Today it is around $0.98 USD approx), people drive across the border to the US and buy cars!! They drive in droves to the US and buy clothes in Walmart and other stores. Believe it or not, there are European tourists who are travelling all the way to the US, specifically for shopping only!!! New York City, esp, has benefitted tremendously. I am not the least bit surprised that when you come to the US, you are finding stuff inexpensive. Absolutely, man!!! Plus, I must say this -- when US retailers buy stuff from Chinese exporters/manufacturers, they have an excellent supply chain system at hand that most definietly makes things cheaper, man. Walmart is an awesome eg in this regard. They use the dual power of supply chain and bargaining ability to keep prices low man. I do not believe, we, in India, have reached that ability to shave prices off yet, vis-a-vis imported goods. Another reason, why I feel you find India more expensive is the ridiculous taxes and surcharges that we have, esp on big ticket services and goods. It goes back to the old Nehruvian socialist mindset that anything rich is bad and let us tax the hell out of it. That is another reason why you are finding hotels in urban India to be so ridiculously expensive. And, don't forget the crazy inflation rates that exists in India today. You have to factor that in, too, man. That should be an explantion for the goods and services too that do not have that much global risk exposure, as you have implied.

You have drawn an estimate of your respective US and Mumbai vists -- Dev, it is NOT the PPP only that is the reason, dude. It is taxes and inflation in India too!!! Isn't it a matter of exterme concern that your trip to Mumbai which is a couple of hours away is almost the same as the US, which is almost 20 hours or so away! Logic should dictate that our ability to travel within India ought to be cheaper than going to another land thousands of miles away. But our crazy inflation and our crazy surcharges neuter that assumption! And you think there is not going to be a spillover impact on essentials like cooking gas, vegetable, fruits, milk, etc?!! How can one ignore inflation within India itself?!!

Your last para -- I plain don't get it!! If I were a consumer in India, I'd be crapping bricks if locally manufactured goods are the only goods available to me. I'd rather buy cheap imported stuff from Bangladesh, Vietnam and China man. I'd pray for a Walmart to come to India and make relatively high ticket items, relatively affordable to me. Plus, if manufacturing in India gets more and more expensive, our garment exporters (and small business manufacturers) would get screwed in the global economy. God forbid that ever happens man. I'd rather pray for our goods and services to be affordable to customers (retail and institutional) both in and outside India. I do not get your logic at all, I'm sorry!!! If you ask me, the costlier India becomes, the less people would want to spend their money (USD, Euros, Pounds, Yens, Yuans, you name it...) in India AND, more importantly, the less people would be inclined to INVEST in India, Dev!! Do we want potential investments that would've come to India, go to other countries like Phillipines, China, Brazil, Ireland, etc simply because some of these other countries could have better business climates (i.e. less costs to do business), less corruption, educated population, less corporate taxes, etc?!! (I'm not saying that's the case but I'm saying we ought to be concerned about our competition. This kind of crazy growth is not going to go on forever, after all, Dev)

Dev, coming back to your PPP analogy, if anything, it will be easier for Indian companies to gobble up other foreign companies, it'll be easier for tourists like you to buy stuff in foreign lands. I do not and I PRAY NOT that India ends up being so expensive that people will stay away form it and Indian citizens will find it very diffcilut to have access to basic goods and services (as evidenced by millions of lower middle class folks, senior citizens, etc in India). Dev, thank heavens that you and your peers/colleagues do not feel the pinch of rising costs in India. But, I urge you to step out of your bubble and talk to someone (anyone) not necessarily in your socio-economic group. They are screwed and will continue to get scrwed thanks to the high cost of living in India! If I were an international investor, why would I invest my money in India if it is going to getting so ridiculously expensive (assuming I have other cheaper alternatives)??!!

Maybe I am missing something...........

Sri

Sudhir syal said...

Hi Dev,

I agree. This is a brilliant observation, and is completely true.

Subliminally these are the sectors which are seeing the massive growth in the country as well. Over the next 10 years, the dollar will keep weakening and keep getting closer to what its actual value should be.

Couldn't quite understand a few of the numbers though..

"For a comparable room the rates are 90 $ vs. 250 $. When you apply PPP the 250 $ is actually 5000 $ (assuming the US $ can buy stuff worth Rs 20/- in India)."

The room you stayed at in bombay was Rs.10,000, using PPP i.e USD 500. How does 250$ become 5000$ don't quite get that. It does finally become 90 Vs 500 though.

Enjoyed this post. Keep it up!

Anonymous said...

Dev,

You say,

"....what will also happen in the short term is that items that are only locally manufactured and not traded globally will be more and more expensive when compared globally. And this is why India is the most exciting destination and the most promising economy in the world. The sectors like Infrastructure, Hospitality and all other sectors that require domestic production will need and get capital influx. Why ? Because this is where we are 5 times over priced. This is where there is most money to be made."

If that were true, NO jobs would be outsourced out of US and Europe and into Asia and other parts of the world. Detroit would still be full of auto industry jobs, instead of being so dilapidated. If goods/services are going to be 5 times overpriced, then, believe me, you'll run out of customers because no one will buy your goods/services.

Sri

Abhinav said...

hi dev,
was referred to your post by sudhir. i found it really interesting, and i think you make a really good point about the compartive expenses of the hospitality industry in india and US.

but i tend to feel that this phenomenon is limited only to the top brow segments, such as the hospitality industry, where the customers typically can afford to pay that much. lets not forget that the rich/poor divide in india is quite severe, tho i think and hope this is changing.
when it comes to the basics, stuff in india is still way cheaper - im a student in UK, and the rent i pay for a ridiculously tiny room, and sharing a toilet with five other people, is roughly 12 times what i would pay for the same thing in india - so even if you apply PPP.... same goes for food, clothes.

and if you don't mind, i have to take issue with what the anonymous commentor has said here - i don't think we are stuck in a mindset of "anything rich is bad".
in fact i think it makes perfect sense - in a society where there is a large gap between the rich and the poor - to tax luxury items, so as to bring some sort of equlibrium, and to pour some of the money that our millionaires are making into trying to prevent farmers in AP from committing suicide becuase of their extreme poverty.

cheers.

Dev said...

Sudhir - Thanks. Also, there was a typo, I meant 250 $ becomes 500$ and 5000 $ was a typo. Have fixed that now. Thanks.

Sri - Wrt your first comment - Please read the post again mate. You are not getting my point. Wrt your second comment - Since sectors that need domestic production "AND" those that cannot be traded globally are expensive, there is a huge opportunity for investment here. Since there are very good margins in these areas, a lot of players will invest in those sectors to cash on and in no time those sectors will have huge price reductions. Consumers are not going to go away, they will stay and enjoy the reductions in prices. The Detroit Auto example is the wrong one (Actually its exactly the opposite case)- as the car Industry is one where cars and its parts can be globally manufacturesd and traded. However, in case of Hotels You cannot use global capacity - spare Hotel capacity in USA cannot be shipped to India to meet demand, neither can free space on your freeways can be used to our highways. Hence building Hotels & Roads in India is the only option. Since these sectors were not getting the price premium that an underdeveloped sector needs there was not much investment. Not that they are getting the prices andhence the margins, in no time investment will come in to meet the opportiunity and then volume of scale and free market pricing will drive prices down. The number of Hotel rooms being built today in India is eqal to the number of rooms that exist - the price of a room that is Rs 15,000 today will come down to 5 to 6000 by 2010. This is also true for roads, ports and infrastructre in general. All these investments in Infrastructre are getting me excited as that is the sector that allows standard of living and wealth creation to take off. Look at the Airline Industry. Today the Air tickets in India are amongst the cheapest in the world due to the same reason.

Hope you understand.

Abhinav - Thanks for visting and your kind words. I agree with all your observations. Except one - the rich poor divide in India being the most and the disparity here being very high. You have inspired me to write on this subject and I will do so after doing some research on the ginni coeffecinet which studies excatly this disparity. You will be surpirsed by this upcoming post and I will point it out to you once done. I will share some data about rural wealth creatiuon in India and how the fruits of the economic growth are reaching the bottom of the pyramid. There is indeed a fortune getting built upo there due to the right balacing in our economic policy.

Anonymous said...

Hey Abhinav,

It is exactly that type of guilt mentality that you have spoken about (well intentioned, obviously) that has screwed our country in the last 60 years or so. It is that type of socialist Nehruvian nonsense that allowed our political class to take up the cause of the "common good" and adopt a higher "moral stand" that involved a tax and spend mentality. The gist of your arguments rings echoes from the Communist Manifesto, with all due respect. In essence, what our governments have repeatedly done is tax anyone who is successful and in the name of "income redistribution" have been stealing money from people who work, and not even provide pro-rata goods/services. This statement of yours is why we have been screwed : "in fact i think it makes perfect sense - in a society where there is a large gap between the rich and the poor - to tax luxury items, so as to bring some sort of equilibrium, and to pour some of the money that our millionaires are making into trying to prevent farmers in AP from committing suicide because of their extreme poverty." India has had some of the highest tax rates in the world -- by now, some of that money ought to have reached the poor, right?!!

Do you honestly expect the govt to have solutions? And why do you automatically assume that millionaires and corporations are "evil"? By that measure, Azim Premji and Narayan Murthy are the Frankensteins of Bangalore,man. The Tatas and Birlas are perennial bloodsuckers. The farmers in AP commit suicide not because of millionaires. If anything, there is no proper distribution channel for their produce (farmers have excess produce, they kill themselves. Farmers have less produce, they kill themselves. Since the govt is in charge of food supply distribution channels, as I understand it in India, look at what their inefficiencies have resulted in. Why don't you ever question them?), the govts have repeatedly failed to ensure good irrigation in the past 60 years (how miserably bad have our socialist Five Year plans failed? There are thousands of so-called project to build dams and roads that never even took off the ground. Where did that tax payers' money go?) and all sorts of govt subsidies have ensured inconsistencies and inefficiencies that the little guy has to ultimately bear. The ruling class does not care two hoots, buddy. And you want to have more of the same?!! If Dr Singh (in 1990/91) and PM PVN Rao were not forced to open the economy, we would still be limited to driving Fiats, Ambassadors and Marutis. As Ronald Reagan had once said, "Govt is not a solution to our problem, govt is the problem." Think about it. Do not get trapped in guilt trips. Income disparity exists and we all know it. But, have you thought about millions of lower middle class people and those in rural areas, who, thanks to the fruits of economic liberalization, are moving into higher economic levels? Is this seismic shift going to take lpace overnight? No. But give it a decade or so and let us see then. How is that the know-it-all govts of post-independent India failed to ensure that in 50 years or so, when, just, in the last 15 years or so, we have had massive upward mobility, thanks to less regulation, freer market economies and better business climates overall? Think about this -- companies like Coke and Pepsi were banned in India from 1977 or so to 1990. This was done to encourage local companies and protect local labor. Can you believe it?!! If it were not for this crazy tax code and excess regulation that we have in India, people would not create an alternative "black money" economy that exists. Why should excess power be handed over to the few political elite? Wouldn't you rather have a more laissez faire society? If socialism was such an efficient model, the former Soviet Union would still be the most powerful country in the world.

By the way, have you thought about why the UK is so expensive? Because, it is a welfare state. When you have a nationalized health care system, when you have some of the highest rates of taxation and when you have a mentality of tax and spend, what else can one expect? Someone has to pay for all that -- and ultimately it is goods and services used by ordinary people like us, that get exorbitantly expensive? It never comes out of the rulers' pockets, if you have noticed. It doesn't make a difference to the elite in the UK but as long as they can condescendingly decide what is relevant for the "common good", guys like you will continue to pay through your nose.

Sri

Anonymous said...

Dev,

I just feel the wording in your initial post was conveying the exact opposite message and/or it was not completely expressing your point of view. And that is why I was scratching my head. Basically, you and I are talking about the same thing. Except that your post seemed to convey that you were happy that goods/services were five times more expensive (and, as a result, that high "margins" would encourage businesses to invest in India). I was advocating exactly the opposite of what I thought your post conveyed. After reading your response to my post and re-reading your initial thread starter, I now understand where you were coming from. But the interplay of words gives a very different meaning in that post man. In fact, if you had replaced your response to my post as the original post, it would make complete sense (and not be so cryptic). I am looking forward to your response to Abhinav's rich/poor divide point of view. I see where he is coming from, man. But, I am not sure I agree with his approach/solution/rationale to tax more and more.

Sri

Dev said...

Sri - Thanks for pointig out that the cryptic style of writing is a bit confusing. But see, this is happening for the second time, where the comment (Which is worded more simply and more to the point) is making it clear while the post is making you scratch your head. Dont know if its the writign style which has an issue or is it the manner in which you are used to reading stuff. I will reflect on the part that I control and I would request u to think about the part that you control. Just that I feel that if I lay out the premise and the point in a very simple manner the "art" part of writing will go away. I am still learning and experimenting with the concept of layers in my writing and I request you to please bear with me - if this bearing becomes unbearable (oun unintended :-)), please do let me let me know.

Yes, I have a perspective on the thread that Abhinav has raised and will write soon on that, I am travelling in USA right now and do not have too much time to do the research that I need to complete before I give shape to that article. But, rest assured there will be some interesting data that will hopefully, help deal with the question whether the fruits of the economic growth are actually reaching the masses..

all I can say at this stage is that there is merit in what both of you have had to say

Dev said...

sri - can u also help me understand what in my post gave you the imprssion that I was happy that the prices are high ? And what made u miss out that " therefore I am happy that investment will come in as prices are high > " ...just so that I understand better !

Anonymous said...

Guys,

It is becoming really long winded. In any case, we are forgetting the impact of the same in case of EMPLOYEE INFLATION i India. Even in absolute terms (PPP is even more scary) people costs are comparable to the ones in developed world.

This has huge implications on Indian business models that traditionally work on relatively lower margins.

Anyways do also look at http://indianmaze.blogspot.com

Anonymous said...

Sri - I think u r sriraj

Dev said...

PPP incorporates labour costs as well, and therefore the cost of services. If you were to avail of many services in the US - you'd realise that the PPP rings true. However, if you predominantly consume goods - the PPP numbers look skewed.

You'd have noticed that the four star hotel in India was expensive (and there's no denying hotel prices in India are a scam) - there would have been excellent room service at the Indian hotel - while almost next to nothing at the US hotel.

A maid, a dentist, laundry, chaueffeur - anything involving labour in an advanced country is very expensive - so, the PPP index is somewhat justified. In fact, given the aging demographics, goods would have been a lot pricier in the US if they couldn't import doctors, engineers from Indian and China, and blue collar workers from Latin American. Yeah, the Corolla is pricey in India - but how about the driver, cook, maid, the press-wallah, and the guard?

When I visit the US, many colleagues asks me why I didn't try to migrate to the US, that's the point I make. Most of us consume both goods and services. Some of us consume more goods, and some less. Others prefer more services. My own preferences tend towards services - so even with half the money I could make in the US (converted directly - not PPP), I'm much better off in India.

Dev Abhishek

Dev said...

You are right of course !

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