Confusion that brings tears

A story in ‘BusinessLine’ published in September suggests that the Government of India was not keen on establishing a floor price for the export of onion. Quite why the Government should set a floor price on agricultural produce is another matter. After all, the export price is what the market is willing to pay for India’s onions given quality, transportation costs and other considerations. What role does the Government have in this matter is beyond me. Be that as it may, the stance was reversed just in two months. See here.

Clearly, India has two conflicting policy goals. Doubling farm income and keeping inflation in check are incompatible at least in the short-term. If farmers have to become productive and respond to price signals, it is far better for the government to let price signals – domestic and international – pass through to them and to consumers and let the RBI target consumer prices excluding food.

In the short-run, if I were the government, I would rather raise the inflation target and/or target CPI excluding food than shackle farmers in many ways. India’s pulses strategy has been a tragedy. Prices rise in one year, the government imports plenty the next and farmers resort to excessive sowing. Prices crash. Farmers are trapped. Without price signals being allowed to pass through impeded, chances of farm productivity enhancement are slim.

In the short-run (may be, even five years), I would focus on ensuring farmers getting price signals without government intervention and distortion and then target inflation. Once farm productivity picks up, the trade-off between farmers’ remuneration and inflation target too would disappear.

Fifth largest economy

I have been away from Singapore since the afternoon of December 14. A journey that took me to Delhi (transit), Udaipur, Chennai, Kumbakonam-Mayiladuthurai (Temples), Chennai (December South Indian Classical Music Festival) and now finally in Coimbatore. It was time to give blogging a break. Now, it is time to slowly get back into the familiar routine.

I wrote on the FRDI Bill in India for the MINT on December 12. Even gave an interview in Tamil on that. You can find them here and here.

Donald Trump named China a ‘strategic competitor’ and he is dead right. I just finished reading John Pomfret’s ‘The Beautiful Country and the Middle Kingdom’.  When Trump said that previous Presidents had let America down, he was spot on.

This article in Bloomberg Quint on the implications of U.S. tax laws for outsourcing and offshoring operations of American companies in India and elsewhere suggests that the impact of U.S. Tax Reform Bill is mostly negative for India.

President Donald Trump delivered on his pledge to lower taxes for American companies, reducing and even eliminating the need for many American companies to resort to complicated structures in multiple overseas jurisdictions to avoid paying high American corporate income tax. There is also the reduction in the amount of interest that can be charged to taxable profits. The same goes for mortgage interest deduction. These are welcome provisions in the Tax Bill. See here and here. Foreign exchange markets are not pricing in the positive impact on the U.S. dollar correctly, IMO.

One would hardly have expected even this grudging acknowledgement from the FT on Trump’s first year. Could be behind a firewall.

This story in Wall Street Journal about China, in its most recent economic strategy document, talking of slowing down the delta in debt stock rather than bring down the stock of debt should not surprise anyone, except those who chose to ignore historical evidence in China on debt reduction vs. economic growth targets.

What do all of these have to do with the title of the post? Well, India is expected to overtake the GDP sizes of France and the UK in 2018 to become the world’s fifth largest economy – based on the size of the economy (Gross Domestic Product) measured in U.S. dollars. Indian newspapers were breathless on this development, this morning. Only America, Japan, China and Germany will be ahead of India. But, the reality is a bit more complicated than that. More on that in the coming days and in the coming year.

Sinopec sues Venezuela and other links

Sinopec USA, a subsidiary of Chinese oil and gas conglomerate Sinopec, has sued Venezuela’s state oil company PDVSA in a U.S. court, claiming it never received full payment for an order of steel rebar. [Link]. Countries that are part of OBOR, beware.

Undeterred, Sri Lanka signs a 99-year lease with China for the latter to operate the Hambantota Port. [Link – FT]

China’s ‘Yin-Yang’ contracts in the property market should remind investors of sub-prime and worse. A long story in Reuters.

The unexpected regional player in the Balkans: China [Link]

Brussels rattled as China reaches out to Eastern Europe [Link – FT]

China Sentences Taiwanese Human Rights Activist in subversion case [Link]

This Beijing-Linked Billionaire Is Funding Policy Research at Washington’s Most Influential Institutions [Link]

New Zealand’s security chiefs have called for a more vocal government response to national security threats after a spate of spying incidents highlighted Beijing’s attempts to influence the country’s growing Chinese community. [Link]

Sam Dastyari, Australian Labour Politician resigns amidst mounting questions over his ties with businessmen linked to China. [Link]

China censorship drive splits leading academic publishers [Link – FT]

Beijing vies for greater control of foreign universities in China [Link – FT]

China inflames U.S. ire by refusing to act in cutting oversupply. This article says that both the U.S. and Europe acted in concert at the WTO to deny China the status of a non-market economy. [Link]

America ‘self-initiates’ an anti-dumping inquiry against China Aluminium sheets.  [FT]​

“US seeks to deny China market economy status in WTO” – that is the header of a FT article. The header of the article is mischievous and misleading. EU has already noted that China is a non-market economy and the United States, in a sense, is supporting the EU position.  The title makes it out that as though the United States is acting alone to deny China the status of a market economy. Unfortunate and unnecessary.

America’s comprehensive economic dialogue with China has stalled. The last round of talks in July ended without any progress and America has no plans of reviving them. [Link – FT]​

Anjani Trivedi says ​(in WSJ) ​that China is making a concerted attempt to tackle shadow banking. But, Bloomberg says that the Chinese are not buying it yet.

IMF Blog has a post on how China’s zombie firms are holding back productivity and growth. Well, must be true of many emerging economies. The blog post is based on this paper which I am yet to read.

IMF’s Financial Stability Assessment Report for China has attracted attention for its reasonably dire conclusions. See here and here. The IMF blog post on the report is here.

This is a fitting finale to this post. China’s new bank loans in November blow past estimates. [Link]


On bailouts and bail-ins

In a post done two weeks ago, I had noted that the proposed Bill (it has gone to the Parliamentary Standing Committee) on Resolving Financial Institutions did not really hold much terror for depositors and that some of the fears that were being expressed were exaggerated – over the top.

But, on closer reading, I realised that, prima facie, concerns were not wrong. The wording was vague and sloppy. Bailing in Indian bank depositors was flawed on many counts. That prompted my MINT column published today.

This morning, as I was searching for my column online (it was uploaded only this morning due to some technical glitches), I came across a piece by Monica Halan in ‘Hindustan Times’. She writes:

It is the bail-in clause that is causing all the panic in the minds of the depositors. Will my deposits be used to reduce the liability of the bank? No, you do not need to worry that your deposits will be lost in a bail-in. Your deposits will be insured, just as they are today and there is an additional protection for depositors because the bail-in can be invoked, and your deposits be lost, only if you have given your consent for this to the bank when you signed the deposit forms.

Well, it is not that simple. The wording of Clause 52 (5) is not that clear. Here you go:

(5) The appropriate regulator may, in consultation with the Corporation, require
specified service providers or classes of specified service providers to maintain liabilities that may be subject to bail-in and the terms and conditions for such liabilities to contain a provision to the effect that such liabilities are subject to bail-in.

It cannot be optional. If so, it will be a non-starter. Why would anyone opt to be bailed in? Further, as one can see, the wording is not omnibus. It does not simply say that depositors would be excluded from being bailed in for all their present deposits and, in future, they will be, subject to some enhanced deposit size being covered by deposit insurance. It is not that well worded and, perhaps, deliberately so.

Shankkar Aiyar wrote that this Bill is a consequence of the G-20 commitment:

WhatsAppically, the bill is the brain-child of this regime. Factually, bail-in owes its genesis to the financial crisis of 2008. In November that year, the G20, of which India is a member, met in Washington and resolved to strengthen global financial architecture, and expanded the Financial Stability Forum to create the Financial Stability Board (FSB). The concept of ‘bail-in’ made its appearance in a consultative paper of the FSB in July 2011. The proposal (echoed in a RBI report of May 2014) was ratified at the Brisbane G20 in November 2014. The bill was introduced in August 2017. [Link]

But, there is a domestic angle to it. It is part of the recommendations of the Financial Sector Legislative Reforms Commission.

The Finance Minister has issued a clarification but the important thing is to ensure that the Bill reflects such clarifications and assurances unambiguously. Neither this government nor the ruling party nor the economy need this uncertainty right now.

Jaggi goes for the jugular

Jaggi’s piece in Swarajya on the Monetary Policy Committee of the Reserve Bank of India contrasts with the Edit in MINT on RBI.

To an extent, strictly going by these two pieces, Jaggi’s piece struck a better chord than the MINT Edit.

Of course, I still believe that too much is made of India’s real rates. That diverts attention from the many failures of omission and commission on the part of elected governments.

Plus, I am a sucker for ‘tough love’ in micro or  macro matters. Examples abound:

  • Volcker with monetary policy in the USA from 1979 to 1981
  • Germany and Japan with their appreciating currencies and export growth built on productivity and quality
  • Rangarajan’s high real rates in 95-97 that ‘persuaded’ Indian corporations to de-leverage between 1998 and 2001 and be ready and hungry for re-leveraging and unleashing a capex cycle since 2002 (it turned excessive later)
  • Hong Kong’s real estate cycle deflation after the Asian crisis that lasted nearly a decade
  • Singapore’s approach to the real estate bubble since 2013, up to now

On balance, MINT Edit came across as a ‘gratuitous’ praise. Not wholly disproportionate but partially.

In other words, I am not sure RBI has done enough to deserve this praise. It may well, down the road. But, for now, it struck me as early days.

India’s growth rebounded or did it?

Rajan Govil wrote a good piece on India’s growth rate rebound to 6.3% (y/y) in the fiscal second quarter of 2017-18 (July to September).  Rajan raises three issues with the growth statistic:

(1) Bank credit growth and GDP growth
(2) IIP growth and growth in Gross Value Added (GVA) manufacturing
(3) Inferring GVA manufacturing from corporate data

I think these are important questions. If tax collections suggest vigorous economic activity, then at least a majority of indicators should point in a similar direction.

For instance, the output of core industries does not exactly offer reassurance that GDP growth could be of the order of magnitude reported. [Link]

GVA Manufacturing and IIP can and should be closely related, if measured correctly. Also, Rajan questions the use of data from corporate conglomerates to infer  manufacturing GVA. That is a valid question too.

Another friend – who would prefer to remain anonymous, I guess – responded to Rajan’s critiques. His substantive points are:

I strongly believe India’s industrial production figures are useless since it adopts a fixed factory approach for most sub sectors (i.e. fixing the factory from which data is collected), and not a flexible capacity/sector-based approach. This methodology is flawed for two reasons. First, if the capacity expands by the introduction of new competitors, it should Be counted as extra production, but it happens only in some sectors, such as Electricity production. Second, if a company shuts down or stops production, it shows activity falling sharply. This happened when Nokia shut down its Chennai factory, leading to a collapse in telecom equipment IP, at a time when India was probably selling more than 50mn phones a year, and is happening recently with Havells shutting production in one of the sample factories, which led to the fittings IP falling dramatically, at a time when LED bulb production in India has grown probably by millions in a short period.

The Index of Industrial Production does not also distinguish between a Mercedes and nano, which the GDP does. Indeed the value addition is different. That is precisely the reason why looking at financial statements of corporates by sectors is more useful, since it does actively track what the corporate sector is producing and profits it is generating, rather than by an old school soviet way of measuring heads.

To link bank credit growth as a way of financing economy is a very old school idea. If one splices up banks into public and private, its public sector which has shrunk massively, private sector lending continues. Second, with the renewal and resolution of several projects and the government moving to an EPC based infra model rather than PPP, private sector demand for credit has dried up, but it does not mean activity has slowed down. Further, government agencies are actively tapping the corporate bond market, and I think it is time RBI needs to consider a total social financing indicator a la China for India.

Bank lending to industries is not happening at all. It is contracting. Private sector banks lend to consumers. That is why personal loans are advancing at a double-digit rate. Yes, there are non-banking sources of financing. Over the last five years, they have always been there in India. There is no evidence that they have taken up the slack in bank credit growth. That said, you are absolutely right about the need for a total measure of financing, and not just bank credit data. See here and here.

The RBI Annual Report for 2016-17 has a Table (Table II.6) on ‘Total Social Financing’ (TSF) for India [Link]. It is not called as such, though.

RBI_Flow of financial resources to the commercial sector

As you can see from the table above, total financing fell in 2016-17 and the flow has been negative in the fiscal first quarter of 2017-18. Non-banking sources have not been able to offset the banking credit deceleration.

My biggest reason to remain suspicious of the GDP data (new series) is that it revised up the growth rates for 2012-13 and 2013-14 when things were quite bad and the government was massively shrinking the current account deficit. There is absolutely no reason to think that real GDP growth was 5.5% and 6.4% respectively in those two years. I had relied on many sources of other real economic data to show that the GDP growth for those two years appears overstated considerably. Since it is the same series that we are working with now, my scepticism remains.

Incidentally, Sajjid Chinoy of JP Morgan has also mentioned, in passing, the disconnect between the growth rate of  GVA in Manufacturing and the growth rate in industrial production.

Finally, one thing that no one seems to have mentioned is the decline in the share of Gross Fixed Capital Formation in the overall GDP. In constant prices, it came down to 28.9% from 31.0% in 1Q2016-17. In nominal terms, it was down to 26.4% from 29.2% in 1Q2016-17. Government Final Consumption Expenditure as a share of GDP has risen in this period.

Not the stuff of sustained high growth rates.

Postscript: For the sake of completeness, I must mention this interview of TCA Anant, India’s Chief Statistician, by THE HINDU. It is useful and thoughtful. His point on why the fiscal deficit had already hit 96% of the projected annual deficit for 2017-18 is obvious, in hindsight, but many (including Yours Truly) did not think about it:

A lot of people have picked on the CGA report saying that the fiscal deficit is 96% of the total. They have, as usual, jumped to all sorts of conclusions which in my judgment are wrong. This is something you should have expected. Why? What did the government do this year? It preponed the Budget calendar to allow government expenditure to start from April 1. There is enough evidence to suggest that that did happen. The Q1 government expenditure compared to last year was much better.

Therefore you would expect that by the end of Q2, the average government expenditure level would be higher than what it was last year. Many expenditure management committees have pointed out that the earlier tendency of delayed bunching expenditure in the last quarter is very bad for both the quality of expenditure and fiscal management.

There were a number of recommendations about how the government should better manage its expenditure so as to minimise the amount of expenditure that takes place in the last quarter and last month.

One consequence of this is that, during the year, the fiscal deficit is going to rise because the revenue profile has not changed due to this manipulation of budget dates. The government has made some efforts to push the revenue profile back by changing the advance tax rules. Some of that was done this year too, but those effects will be small. By and large, the revenue profile would remain the same as last year but the expenditure profile has changed, so the logical implication is that the fiscal deficit will rise at this stage. The surprise it generated befuddled me.

The question is, will the government meet its revenue targets. Nobody has made any analysis so far to suggest that it won’t.

Economists or politicians?

On December 2nd, Times of India reported the following:

“To equal the UPA’s 10-year average, the economy will have to grow at 10.6 per cent in the fifth year. I would be happy if this were to happen, but frankly, I don’t think this will happen,” Singh quipped. [Link]

Statistically, he may be correct. But, as an economist, he is not speaking the truth. As a politician, he would get high marks.

The truth: India experienced high economic growth rates between 2003 and 2008 when the United Progressive Alliance happened to be in office. There is no link between the two. Post-2008, India experienced high growth again because of a strong, front-loaded fiscal stimulus, easy monetary policy and fairly aggressive bank lending. India is still paying the price for all of that.

Hence, strictly speaking, UPA growth performance should include post-2014 period too.

A friend shared this tweet by Kaushik Basu, Chief Economist of the World Bank:

[12:46, 12/3/2017] Dr. Gautam Sen: India’s growth rate is now 6.3%. It had reached a rate of 9.5% from 2005 to 2008. Now with oil prices so low, the growth should have been back at over 9%. This massive slowdown needs to be properly diagnosed. [Link]

Again, it is a politically loaded tweet. As an economist, I am not sure he should be proud to own this statement. The phenomenon that drove India’s growth rate to 9.5% and the oil price to above USD140 was one and the same: synchronised global growth, copious capital inflows and a domestic credit boom . Some of the forces that drove the growth rate to 9.5% are the ones that are now contributing to slow and stagnant growth in India. Oil price has little to do with it.

I read Mr. Basu’s piece in the Indian Express published on November 10. There are two problems with that.

One is this:

Both as a consequence of Donald Trump’s dismal performance and Xi Jinping’s remarkable leadership, China is beginning to rival the United States’ global political influence.

The media is making the horrible mistake of identifying China and its leader with benign openness and globalisation even as many facets of openness are being rolled back. Not a squeak can escape from anyone in China on the President. Contrast that with the relentless critical (and vitriolic) commentary on President Trump in the U.S. and elsewhere. That alone should make any thinking and reasonable human to be sceptical of China’s rising influence. It is a matter of wrong perceptions and wholly unsustainable.

Second, the performance of the American economy under President Trump has been better than that of China’s under President Xi and that of the American economy under President Obama. We should be clear-headed enough to separate our distaste for the personality of President Trump and his administration’s economic performance.

Second problem with his piece:

India’s big risk is the rise of right-wing religious vigilantism in recent years.

Right-wing religious vigilantism exists. But, I have problems in calling it a big risk for India. There is a slim chance of it growing into one in India. But, it is slim. It deserves to be condemned, punished, reined in, etc., There can be no two opinion on that. The latest hacking incident in Rajasthan does buttress the argument of Kaushik Basu. It is savage, brutal and so unfair. It is sickening and even depressing. But, to call it a risk big enough to hold India back is a matter of opinion which is hard to substantiate.

Demonetisation update 37 – short-term costs and medium term benefits

Q: On demonetisation, its costs and benefits a year on:

A: I am going to make an objective assessment of where we are. Whenever you have large interventions in the economy, there is a trade-off: there is always an immediate, short-term cost, and there are medium-term benefits. Firstly, we must appreciate that GDP growth was slowing well before demonetisation, so this notion that the entire slowdown is only because of demonetisation or GST is not borne out by the data. As we have written extensively, India benefited from the huge terms-of-trade shock from lower oil prices — that was a one-time windfall for the economy in 2015-16, so despite it being a drought year, growth picked up from 7% to 8%. But when oil prices stabilised, it was inevitable that GDP growth would begin to slow. That, in conjunction with the fact that policymakers were pushing hard on the deleveraging, meant that between March 2016 and September 2016, GDP growth had already slowed by 200 basis points. It was a pretty sharp slowing. So, in a way, one has to separate how much of that slowdown would have continued, and how much was incrementally added by demonetisation.

Looking at the government’s own numbers, the CSO every January puts out its advance forecast for growth in that year, and last year, they actually said that we are basing our advance estimate on data that stops in October. So they were using all the pre-demonetisation data to say what GDP growth in 2016-17 would actually be. For us economists, this is fantastic — this is the counterfactual, this is what GDP growth would have been, absent demonetisation. You update that for the eventual strength of agriculture and exports, which are largely exogenous, and you get the counterfactual. You compare that to the actual printed number, and that’s your delta. Our own sense was, somewhere between 0.8% and 1% of full year GDP was the slowdown because of demonetisation. That was one near-term cost.

There was a second, less obvious cost. See, the whole idea of these reforms is to push small and medium enterprises into the formal economy, and that process is necessarily disruptive. So, one puzzle over the last year has been that even as GDP growth has slowed, imports have been surging. This is not oil, this is not gold, these are manufacturing imports — growing at 18% a year for the last 8 or 9 months. These imports were contracting the year before, how do you explain strong, broadbased manufacturing import growth when domestic demand is slowing?

The way we see it is, both demonetisation and GST imparted an adverse supply shock, where domestic supply chains, which involved SMEs, got disrupted temporarily, and therefore, rather than those domestic inputs, larger firms were relying on imports. So the second manifestation of demonetisation was the fact that the current account deficit quadrupled — in the quarter in which growth slowed, the current account deficit went from 0.6% of GDP to 2.4%, 80% of which was manufacturing imports. For me, those are the two near-term costs.

Gems and jewellery, electronic items, some capital goods, leather, textiles — the hypothesis is that a lot of these would have been manufactured by SMEs and the informal sector. And because those supply chains got disrupted, you had to temporarily rely on imports. That’s gone on for three quarters now, the hope is that this is a temporary supply shock, and therefore, at some point, imports will come down. But till the last data point in September, imports were still very strong.

But to be fair, there were benefits as well.

As we proceed to the second or third anniversary (of demonetisation), there are three objective benchmarks to measure: cash in the economy, the quantum of digitisation, and the tax base. On cash, the right comparison is, what would the outstanding stock of cash in the economy have been today absent demonetisation? Every year, it was growing by between 10% and 15%, the day before demonetisation, this was about Rs 17.5 lakh crore. Given that the typical increase every year is Rs 1.8 lakh crore to Rs 2 lakh crore, if demonetisation hadn’t happened, by this October the cash in the economy should have been Rs 19.3 lakh crore — but today it is Rs 16 lakh crore. That is almost a 20% reduction in cash and, I think, a big benefit.

On taxes, you are seeing that new tax filers grew 26% in 2016-17 over the previous year, much higher than the previous year. So let’s be patient, there was a short-term cost and there will be medium-term benefits; just because we can’t quantify those benefits does not mean that they don’t exist. But they are already beginning to show up.

Q: On the possibility of growth numbers not accounting for small manufacturers, who were hit badly by demonetisation:

A: A famous governor once said that in India not only is it hard to predict the future, it is hard to predict the past as well, because of sharp data revisions. I think when the annual survey of industry comes out, the last year’s data will be revised, and it is very likely that GDP growth will be revised down. This is because we essentially use formal sector indicators to extrapolate to the informal economy. That relationship clearly broke down during demonetisation, when the formal economy was a very bad proxy for the informal economy. So it is very likely that about 2 or 3 quarters from now, the 2016-17 numbers will be revised down retrospectively. There will be multiple revisions, but in the first pass we will have a good sense. Again, the key is to separate what slowing would have happened even without demonetisation, because to the extent that we were already on a slowing path, it is the delta that matters. [Link]

China and the Minsky moment

The Chief Strategist at Alpine Macro thumps the table to argue that a Minsky moment is impossible in China. He makes far too many conceptual mistakes.

It is not only the scale of debt but also the speed of debt accumulation that matters. Second, higher savings and higher debt/GDP ratios go together because higher savings mean lower interest rates, according to the author.  But, there is also the concept of risk premium which should be demanded by creditors at higher levels of debt. That is missing. Of course, not just in China. In China, that is partly because of financial repression. Savers are thus deprived and, in the context of China, have far too few choices to register their protest.

Debt brings growth forward. It cannot go on for ever. That is the point that Mervyn King makes in his book, ‘The End of Alchemy’. That applies to China.  Further, too much debt means much of the future growth goes to debt servicing and not productive investments. There is an opportunity loss here.

Too much debt will have created too much excess, idle and wasteful capacity.  It is evident in China. That is why the incremental GDP/debt ratio keeps falling.  Assets can and do drop in value especially if too much of them have been created whereas debt obligations are legal and fixed. Hence, to talk of the concept of Net Debt is not exactly relevant.

Finally, Japan has a net positive international investment position and that is not due to the size of its foreign exchange reserves. China’s net positive IIP turns negative once foreign exchange reserves are taken out of the equation.  In such a situation, the size of the domestic debt raises the risk of a substantial exchange rate depreciation down the road, if capital flees.

The Minsky moment arose in the Western world in 2008 after twenty five years of debt-financed growth. Given its financial repression and other controls, it is possible that the Minsky moment is some time away in China.  But, delay is not the same as denial.

No information; no accountability

Andy Mukherjee’s piece in Bloomberg on how HDFC Bank has likely understated its impaired loans based on research done by Hemindra Hazari. That is a bit unfortunate and sad too. It has been easy for all of us to criticise governments partly because (and correctly too) governments are elected and they are deemed accountable. Therefore, we feel that we have a moral right to question the government. With private sector, it is a different ball game. We are afraid of reprisals and it might have to get more specific. Criticism directed at the government is general and there is no specific ‘naming and shaming’.

But, if private sector chose not to live by the rules of transparency and truthfulness that one expects of government, then government over-reach, controls and more scrutiny will be inevitable. Countries will have the worst of both worlds. People are poorer for it.

I checked out a blog post by Hemindra Hazari on independent research on large cap companies. He mentions how he has been denied access by ICICI Bank and Axis Bank and how another analyst was put through the police wringer for his piece on Indiabulls. There is so much outrage in public space world over about rising intolerance and authoritarian populism. But, what does one make of such behaviour in the private sector? is indeed an interesting platform.