Moody’s downgrades China

Moody’s downgraded China’s sovereign credit rating from Aa3 to A1 and upgraded its outlook for the rating to ‘stable’ from ‘negative’. That is, it does not expect to downgrade China again anytime soon.

As soon as it happened, many dismissed it. China government does not borrow in foreign currency and hence, a credit rating action by an international agency does not really matter. Well, not so fast. Even Indian sovereign does not borrow in foreign currency. Yet, its credit rating is just above junk bond rating and is often cited in many commentaries on India’s fiscal health. So, let us not be too nonchalant about it, on behalf of China. Certainly, the Chinese government won’t be.

The fact is that this is the first China rating change by Moody’s in nearly thirty years. It does make people sit up and take notice. Second, China has just come off the OBOR conference where it assembled many foreign leaders. It was almost an emperor’s durbar with the little chieftains in attendance. Hence, to have this happen within a week of that jamboree is a bit of an embarrassment that China could have done without.

For China, ‘face’ matters a lot and hence, a foreign credit rating agency from a country that is, in its view, fast losing its pre-eminence is a reminder to China that the world order had not changed yet. That would be quite annoying.

For India, it would be a bit of a Schadenfreude because India had raised questions about the debt burden it would create for the countries involved. Moody’s downgrade vindicates India in a way.

Second, Arvind Subramanian, the Chief Economic Advisor to the Government of India had been fiercely critical of the credit rating agencies for their lopsided credit rating of India and, say, China. He called the chasm between the sovereign credit ratings of both countries indefensible. India was just above junk bond rating and China’s credit rating was Aa3. He might be somewhat mollified or feeling vindicated although he was batting for an upgrade for India and not so much a downgrade for China.

As for China’s economic fundamentals, they had justified more than a one-notch downgrade long time ago. In its Article IV report last year, the International Monetary Fund had pointed out that China’s ‘augmented fiscal deficit’ was slightly above 10% of GDP in 2016 (p.43). Its public debt ratio too is correspondingly much larger and rising. Even then, no one has the faintest idea of how much debt China’s local governments have taken on and how much of it would devolve on Beijing.

Further, China’s banks are swimming in a sea of bad debts to local government funding vehicles, to State-owned enterprises and, further, on their part, have sold these debts as Wealth Management Products to their private clients, looking for a higher yield with no risk. Their official non-performing asset ratio is less than 2%. But, private estimates range from 5% to 25%. Fitchratings, another credit rating agency, puts it at 15%. Therefore, objective fundamentals warranted a lower credit rating for China.

A colleague had a legitimate question as to why this downgrade did not come earlier, when China’s fundamentals were dodgy as in, say, at the beginning of 2016 or in August last year, etc. The answer is simple. It is that the credit rating agencies did not want to pour oil into the fire and turn China’s turbulence into a self-fulfilling rout. It is better to do it when times are quieter.

Second, the scale of the estimates being touted for the ‘One Belt One Road’ initiative might have influenced Moody’s. It is our guess. The number is variously estimated at USD900bn to USD1.0trn. Hence, this downgrade could be a pre-emptive warning.

The downgrade, while being meaningfully negative for those borrowers that rely on the sovereign rating to price their own debt, may also make the Chinese government think a bit harder about the next round of debt-funded reflation once it gets bored or frightened of the current round of de-leveraging that it is supposedly pursuing.

In all, Moody’s downgrade of China’s sovereign debt might not be a surprise but its timing was unexpected, surely. If anything, the surprise is that it took so long for them to act and the question is why only one notch down.

This article in the Wall Street Journal comparing China and Japan is a good read. Moody’s rates both countries alike now.

Stuff that caught my attention (STCMA) – 23 May 2017 edition

MINT Edit on Conventional politicians and why they are useful

Philippine President says China President threatened war if Philippines explored South China Sea for oil

President Trump’s speech at the Arab-Islamic-American summit

Tulsi Gabbard not pleased with Trump speech in Saudi Arabia.  A sample here.

Spanish government debt again above 100% of GDP

Key achievement of ‘Department of Economic Affairs’: Improvement in India’s macroeconomic stability – say it again, please?

Ministry of Finance of the Government of India has discontinued the mid-year economic appraisal and the monthly economic reports too have not been updated since August 2016. Pity.

Anil Padmanabhan on the political significance of the GST Council meeting in Srinagar

Scott Greet in ‘Daily Caller’: The Predictable catastrophe of firing James Comey [Link]. I checked out his tweets last night. Seems worth following.

Populists-nationalists: their inevitability and their usefulness

After I published this piece on America tearing itself apart in this morning, a friend flagged this G-30 lecture by Raghuram Rajan last month.

I thought that the flow was somehow not there in the speech. I can understand that at one level. He is trying to understand the world. It is work in progress for him and for all of us. It is not a facile topic.

Issues he flags are very well documented, by now. For example, I had blogged extensively on the Chairman’s letter of M&T Bank. Not many could have explained the situation better.

On answers, Raghu is very thin. But, that is not his fault. Societies always figure out what not to do. But, what to do is the tricky question. That takes much longer to evolve and involves luck and extreme circumstances.

In a sense, that is what populists-nationalists offer: ‘Extreme Circumstances’. Yes, they would fail to solve the problem. One cannot redistribute without growing the pie.

Populists-nationalists will probably not grow the pie. Of course, it is a different matter that the globalists grew the pie but also grew debt much more than that. So, perhaps, one could argue that they have a worse record!

But, that said, I do agree that eventually populists-nationalists would fail. They would neither succeed in re-distributing nor in growing the pie for THREE reasons: One is what I said earlier. There are no easy answers. Second, they have to face the constant backlash from those who feel threatened and who are losing their privileges. Taking the country and the world back from them is not going to be easy at all. Status quo and incumbency have their advantages.

Third and perhaps most importantly, sometimes it is impossible to undo and ‘restore’. [Even Microsoft Windows 10 does not do that properly despite users having the theoretical option of doing so.] There is no second chance. Once something is lost, it stays lost.

However, they (populists-nationalists) do serve one useful purpose. They serve as a rallying cause. A lightning rod. Humans and nations always need the ‘other’ – an Opposition/opposing force – to survive and focus minds. The ‘others’ impart a sense of urgency to the problems that have festered for long and they help focus minds on the problem.

Once we know that their answers are not the right answers, the rest of us are compelled to come up with solutions that are better than what they offer. Of course, it would involve sacrifices – sacrifices of the privileges that elites have gotten accustomed to and grown to take for granted.  But, they will have come to the conclusion by then that they are better off making those sacrifices for the sake of preserving the chance to remain in the game and re-gaining those privileges again.

That is the very useful purpose that populists-nationalists serve.  That is why I had argued that populists-nationalists were not only inevitable but that they would well be necessary for the world to arrive at its answers, eventually. For now, we are a long way off from this seemingly happy ending.

The good thing about GST and other links

Good to know that cars would be more expensive after GST rates were announced. One should welcome it. A country like India cannot be encouraging personalised mode of transportation. It is a small step to making both producers and buyers pay for the externalities of hydrocarbon based travel in India.

India’s 5-star hotels are already quite expensive, given the overall level of purchasing power in the country. They have a plethora of taxes. But, now they will become even more expensive.  That is not a good thing. May be, I am wrong.

Revenue Secretary Hasmukh Adhia has said that GST would lower the inflation rate by 2%. I am not sure if there is any mileage to be had in saying that. The margin for error is huge and second, international experience is that there is an initial jump in the inflation rate as businesses round off prices to the next higher level. It will be quite likely to happen in India.

Aparna Iyer had a good story on SBI 4Q results. Has the problem of NPA peaked? She is not sure. Neither am I. Notice how the GST rates would raise mobile phone tariff and prices for devices too at a time when the sector is facing a huge wave of competition from Reliance Jio.

Her earlier articles on the credit culture (or, its lack thereof, to be more precise) of companies in India are worth following. This is a classic understatement:

Corporates need to vastly improve their credit culture. [Link]

In the second part of her series on credit culture, Aparna Iyer argues that companies have been biggest beneficiaries of the culture of loan forbearance in India than farmers. One should not be surprised. Most Indian professed policy goals are mostly symbolic in nature – pro-poor, pro-farmer. In reality, they are not helped but hurt, both short and medium term.

But, the problem with such stories is that they would be used to argue the case for loan waivers but not against forbearance in general. Further, providing cash support to farmers to repay loans and waiving loans are two different things. The optics matters a lot.

In the third and final part of her series on credit culture, she again makes the point that banks have been far more lenient towards companies. Obviously, a lot remains unsaid. It is about unholy nexus and second, it is about the ethical foundations of corporate promoters.

Tadit Kundu has a good article on the Investment Proposals turning into actual investments in India. This is based on DIPP data. Actually, I track it regularly. The pick-up in ‘Implemented Investments’ in 2016 could be deemed ‘green shoots’ for manufacturing. Or not.

It was good that the Prime Minister has called for better data on the labour market. Not a day too soon. But, this government by Pronob Sen bears repetition:

“NSSO has a capacity of 3,200 people and its Chinese counterpart has 29,000 people. How will you conduct comprehensive employment data collection with this?,” he asked .

“We had demanded an increase in the headcount to around 5000 and also that the jobs survey should be expanded and made comprehensive. But the then government (the previous UPA government) did not agree. We need comprehensive jobs data,” Sen added. [Link]

Good to see that NASA will be collaborating with ISRO – an organisation that was on America’s banned list. Times, they do change.

Bibek Debroy has a good interview with Business Line. He does make a good case for taxing agricultural income. I endorse it:

The Centre has no plans to tax agricultural income. Constitutionally, it is a State subject. About seven States tax certain kinds of agriculture. I do think agriculture income should be taxed, in a way similar to personal income taxation, based on a threshold. In his taskforce on direct taxes, Vijay Kelkar had computed that given the levels then, 95 per cent would be below the threshold. Agricultural income is subject to year-to-year variations but you can do an average of three-four years and tax on the basis of that. [Link]


NPA resolution: the details that matter

Caught up with Andy Mukherjee’s Bloomberg Gadfly columns, as I always do, from time to time. As always again, he has something that is important and that is often overlooked by others. This blog post is dedicated to three of his recent columns surrounding the issue of non-performing assets in the Indian banking system.

As of last month, the National Company Law Tribunal was looking for four judges and 12 technical members, all of whom are required to be at least 50 years old with 10 years of legal or 15 years of accounting practice behind them. Five years spent adjudicating labor disputes is also acceptable.

In a footnote, Andy Mukherjee adds, Hopefully, the 65 vacancies the company law tribunal advertised a month earlier — for court officers to typists — have been filled, and the court’s headquarters in New Delhi has selected its tech support vendor for the phone lines. [Link]

This is par for the course with information efficiency of markets, of course:

At the end of 2015, when concerns over Indian lenders’ balance sheets reigned supreme, ICICI Bank Ltd. had around 214 billion rupees ($3.33 billion) in gross nonperforming assets. The bank announced a 78 percent jump in NPAs for just the first three months of 2016, and shell-shocked investors pushed the stock down almost 10 percent in three days.

That was last May. Fast-forward a year, and investors rewarded ICICI Bank’s freshly revealed bad-loan pile of 425 billion rupees — twice as large as the end-2015 stock — by pushing the shares up as much as 9 percent Thursday. [Link]

This is sad and must count as one of the most important collateral damage of the demonetisation drive. But, the benefits are yet to be counted and, one hopes, that someone is working on making the benefits happen. Or, too fond hopes?

What monoline lenders lack in deposit muscle, they make up for in their superior knowledge of borrowers and risk management. It’s a shame that policy whimsy and cynical politics mean the specialists can’t survive except as part of conventional banks. [Link]

On the deadly viruses of political correctness and victimhood in America – great weekend reads

(1) The Media Bubble is Real — And Worse Than You Think [Politico].

The only quibble I have with the article is that it concludes that journalists respond best when their vanity is punctured. But, far from trying to figure out why they were so vain as to miss what was happening to America, their vanity is making them tilt at the manifestation of their failure – Donald Trump. So, they are pitting their vanity against his and are directing their energies at getting him out. Russia is their trump card (pun intended). If they succeed in removing him, they think that they can exculpate themselves of the failure to anticipate his rise. Then, it would be difficult for the authors of this wonderful article to come up with another explanation as to how the media could do worse than they did in 2016.

(2) Professors moved Left in the 1990s. The rest of the country did not. Great read although it is from 2016.

While the data confirms that university and college faculty have long leaned left, a notable shift began in the middle of the 1990s as the Greatest Generation was leaving the stage and the last Baby Boomers were taking up teaching positions. Between 1995 and 2010, members of the academy went from leaning left to being almost entirely on the left. Moderates declined by nearly a quarter and conservatives decreased by nearly a third.

What is it about the boomers that they turned so irredeemably Left? Is it their success or is it guilt conscience that they achieved so much success at so high a cost to the world at large, to Planet Earth, etc.,?

(3) Heather Mac Donald’s experience at Claremont McKenna College in April 2017. It is positively scary and despairing. David Brooks is right to call it a tale of ‘chilling intolerance’.

(4) A great title: ‘Freedom from speech’ and a great line (George Will – Nov. 2015):

Campuses so saturated with progressivism that they celebrate diversity in everything but thought [Link]

(5) David Brooks is unfortunately likely to be proven right here:

These days, the whole idea of Western civilisation is assumed to be reactionary and oppressive. All I can say is, if you think that was reactionary and oppressive, wait until you get a load of the world that comes after it. [Link]

(6) On a hopeful note: this video has more than seven million views on YouTube

(Most of the links above were picked from the Twitter handle of Jonathan Haidt)

Anna and Annette on the Fed PUT

Anna Cieslak and Annette Vissing-Jorgensen had written another terrific paper – this time on the Fed PUT.

The highlights of the paper are as follows:

(1) Reaction of actual economic output (GDP growth) to excess stock market returns is small and is symmetric for stock market gains and losses.

(2) Reaction of unemployment to excess stock market returns is asymmetric. That is, unemployment rises more when stock market records losses than it falls when the stock market posts gains. But, the Federal Reserve expectations for unemployment change much more than actual unemployment changes themselves!

(3) Sensitivity of actual private consumption to negative stock market outcomes is small, especially in the 1994-2016 period. But, the focus of the Federal Reserve on the stock market is driven a lot by its concern over stock market declines on consumption.

(4) Before 1994, going back to September 1982, there is no significant relationship between the stock market and updates to Fed growth expectations.

(5) The Fed updates its macroeconomic expectations (about growth and unemployment)
in a way that is highly sensitive to stock market outcomes during the inter-meeting period. This relationship is pervasive starting from the mid-1990s, but is largely absent before that.

This paper and their earlier paper, ‘Stock returns over the FOMC cycle’ (with a third author) could very well be the harbingers of the long overdue reform of the monetary policy framework of the Federal Reserve or that of the reform of the Federal Reserve itself.