India’s aspirational bottleneck: its private sector

This is one of Shri. Ninan’s best and most thoughtful columns. India’s private sector is part of the problem. I had said so more than once in my columns. It always has been and it still will be. He does not have answers nor do I. But, some of these things are probably evolutionary and that there are no external interventions or neat/magical solutions
that can be applied.

It is a fact, world over, that in the new millennium, cronyism, corporate malfeasance and short-termism had grown exponentially. India is not only not an exception but has also been prominent in displaying such a trend. In the West, we had the financial services industry, predominantly. From Brazil to South Africa to China, businesses have been mired in controversies.

Shri. Ninan mentions the House of Tatas. Accounting and auditing firms and consultancy firms like McKinsey have also been found sorely wanting in their conduct in several parts of the world.

Governance by global (think EU) bureaucrats from remote locations – unaccountable and unelected – combined with brazen short-term greed at the expense of public interest on the parts of businesses have created a governance vacuum that has been filled by politicians that the mainstream is quick to characterise as ‘populist-nationalist’.

But, that glosses over the problem of fixing accountability for the circumstances that created them in the first place. Indeed, to be blunt, that is dereliction. That is why Shri. Ninan’s piece stands out. It is an important first step in identifying and calling out the source of the problem.

But, answers are not straightforward. Clearly, in the Indian context and, may be, in the global context too, a better answer to political funding is the urgent need of the hour. But, we are no closer to it than we were, five years ago. That will break the nexus and dependence of the political class on businesses that make them discriminate between businesses unfairly and discriminate in favour of narrow and private interests over public interests.

Competent and unbiased regulation, regulators and consistent application of those by regulators are necessary conditions but not sufficient conditions. But, that too appears more conceptually sound than being practical because regulators are also gamed by the
same private sector participants. It is a universal problem.

There is a third answer which not many would want to see. Revolutions by those who are shortchanged it by all will be destructive, chaotic and disorderly. Revolutionaries too do not have answers. They know how to overthrow and destroy but not to replace and construct.

Come 2019, India does run the risk of what has happened to Brazil in recent years. That country has lost its way for now. In a way, the combination of the pre-crisis boom, the post-crisis uncertainties combined with the fallout of cronyism have brought them to this pass.

Same is the story with China except that the news is not prominent as in the case of Brazil, India and South Africa. Indeed, it is a travesty and tragedy that the mainstream global media is holding up China as the paragon of so-called liberal values, liberal trade and governance!

So, like these countries, India had a pre-crisis boom which was mistaken to be permanent. The boom covered up the cronyism that was very much in play then. The post-crisis growth stasis was the withdrawal of the tide that exposed the cronyism in the Indian economy. Its most visible manifestation is the banking bad debt crisis that shows no signs of ending.

In the next twelve months, politicians will hardly be focused on addressing this issue. Indeed, if anything, these unholy ties and practices will be more in vogue and invoked more often than during normal times.

Post-2019, depending on the dispensation that comes to office, either the situation gets much worse almost beyond the point of redemption or that there is an acceptance and acknowledgement of the problem leading to concerted, concrete an sustained efforts to move towards a better and fairer governance regime.

It is hard to bet on the latter outcome right now.

GDP and welfare index

In 2016, two economists created a welfare index. GDP growth and that index correlated well. Recently, IMF economists had extended that welfare index to include environmental sustainability. Again, GDP growth correlates well with this expanded welfare index too.

GDP growth is the best welfare policy and the best redistribution policy too.

A succinct blog post by IMF Research. Links to the underlying papers are there in the post.


Industrial Recovery through indigestion

There has been semi-serious and semi-funny news-stories on how the sale of antacids and digestive enzymes including PPI drugs (part of the five digit product code: 21002) had contributed to industrial production growth in India in November. The official press release of IIP for November 2017 is here.

For example, in November, the Index of Industrial Production (IIP) rose 8.4% y/y. Nearly 2% of was contributed by goods in the five digit categories 21001 to 21009. They have a combined weight of just under 5% in the IIP. In other words, nearly 25% of IIP growth in November came through the sale of products encompassing the five digit product codes 21001 to 21009. Interested readers can check out the document put out in March 2017 for the goods that are part of the five digit codes 21001 to 21009, when the revised IIP with a new base year was introduced.  But, the story of antacids and digestive enzymes is more interesting.

Digestive enzymes and antacids (incl. PPI drugs) are part of these products with a weight of 0.22% only. Yet, it has been punching way above its weight in recent months. ‘PPI’ stands for Proton-Pump Inhibitors.

If one went to the website of the Ministry of Statistics and Project Implementation and click on the link to IIP, one can download the last eight monthly press releases of the IIP from April 2017 to November 2017.

In the last eight months, this category has figured every month among the highest contributors to industrial production growth.  Here is the table:

Indigestion contribution to IIP growth

The figures in the second, third and fourth columns are taken from the monthly press releases of IIP. The fifth column is column (3)/column (4).

Well, demonetisation, introduction of GST, the Insolvency and Bankruptcy code, Real Estate Regulation Act, Benami Transactions Act, Introduction of Aadhaar and the insistence on linking Aadhaar to everything else and the rumours spread by mischief makers that the government was angling for depositors’ money in bank accounts could have all contributed to a lot of indigestion and hence the rise in the sale of antacids and digestive enzymes!

Or, it could be that political leaders – that of BJP included – might be suffering from a lot of indigestion because of frequent elections and the anxieties they generate.

Jokes apart, the overall two digit category, ’21’, stands for pharmaceutical products, medicinal chemicals and medicinal shampoos, etc. Its weight is 5% in the IIP.

6-month MA of annual growth in '21' of IIP

In general the annual growth in production of ’21’ – Manufacture of pharmaceuticals, medicinal chemical and botanical products – has picked up since the NDA came to office. It is not as if this big surge in production in pharmaceutical products is to meet exports. Export growth in the category, ‘Chemicals and Related Products’ was 3.0%, 1.4% and 2.4% for the fiscal years 2014-15, 2015-16 and 2016-17.

So, the bulk of the production of medicines is for internal consumption. That is bad news, in a way.  Indians need to pay attention to preventive health – hygiene, sanitation, eating out, eating late, eating fat and rich food, sweets, eating unhealthy food, kept in the open, near open drains with swarming flies, etc. The multiplier benefits of good health for the economy will be tremendous. Even if the product category ’21’ does not contribute to growth in IIP because of that, it will show up in other categories of IIP.

The government too, on its part, should become mindful of the almost unceasing stream of uncertainties and stress it can cause with its excessive zeal on tax revenue mobilisation, on change of rules and regulations midstream (solar industry is a case in point), etc. All these cause stress, indigestion and hence the rise in the sale of antacids and digestive enzymes!

Good health is linked to good governance, stable regulatory environment and ease of doing business.

Schumpeter and creative destruction

As we approach the end of the year, one is tiring of many things. Blogging is one of them. My friend Gulzar Natarajan alerted me to a couple of sentences in the article by Ricardo Hausmann on R&D in large corporations:

Joseph Schumpeter stumbled on to these two approaches at different points in his life. When he published The Theory Of Economic Development in 1911 at age 28, he emphasized that innovation came from the spirit of entrepreneurs in a process of creative destruction. By 1942, when a 59-year-old Schumpeter published the book Capitalism, Socialism, And Democracy, he realized that a lot of the innovation was coming from very large corporations that faced rather limited competition. [Link]

Public policy must be relentlessly focused on enabling firms to start reasonably ‘big’ and to be able to grow bigger. Subsistence entrepreneurship is romantic but will not move the economic growth needle much at all. It is disguised unemployment.

Demonetisation update 34: from the annual report of OCL India

India’s installed cement production capacity is 450 million metric tonnes (MMT) – second largest cement producer and consumer in the world. Actual production has grown from around 230 tonnes in 2012 to around 280 MMT in 2016-17. That is 21.7% growth in five years and it is 4% CAGR. In fact, in 2016-17, there was a slight decline from 284 MMT in 2015-16 to 280 MMT.

Given these, numbers – cement and tyre production in 2016-17, one can deduce that there has been a considerable growth slowdown.

Wrong message from Financial Conditions

Goldman Sachs has come up with its new revamped G-10 Financial Conditions Index (sorry, no link is possible). The biggest problem is that it is pro-cyclical. A bit like the Credit Rating Agencies whose ratings are the best when the asset valuations are the highest and hence the risk is at the highest.

If the strength in the bond market and in the stock market is very high  – lofty valuations and tight spreads (credit spreads) – then the risk of a correction and financial conditions becoming tighter is also the highest at these levels. Therefore, as asset prices keep rising, financial conditions going forward come under increasing risk.

Financial conditions are the most favourable for growth when they are extremely tight. In other words, they cannot get any worse. They can only keep getting better. That is why 2009 was the best to invest and was also heralding the recovery (no matter how tepid it was).

This is a bit counter-intuitive. But, it needs to be grasped. Mainstream institutions have not grasped them because their incentives are not aligned to grasping this truth. Their business models would collapse, if they did so, perhaps. I do not know.

Unjustified Indiaphoria

A friend sent me a message this morning on WhatsApp:

“Rupee at 63 handle, Sensex over 30k, nifty over 9300! Too good to last? Methinks not!”

My response:

“Sorry, Sir. I am afraid so. Economic fundamentals do not justify them. I will be happy to short them all, if I can.”

That response was given as someone who was the Chief Investment Officer of a Wealth Manager and one who is a natural contrarian (with all its attendant risks and pitfalls) when it comes to investing.

In other words and in the interests of brevity, I belong to the school that believes in buying when no one has a good word to say on the market and sell when everyone is a cheerleader for a market. India, more or less, belongs to the second category.

In fact, its fundamentals are not great too. Its economic growth rate is exaggerated. The current real GDP growth is close to 6% or slightly lower. I had a blog post on it yesterday. Corporate earnings are improving but gradually.  On that, this is what I heard from a stock broker six weeks ago:

Despite an improvement in the economy after the demonetisation shock, the earnings downgrade cycle has continued. In the past month, consensus Nifty EPS for FY18 has seen 6% downgrade and that for the wider BSE100 has seen 5% downgrade. Commodity sector companies have seen the highest upgrades whereas the large downgrades were concentrated in sectors such as banks, telecom, and consumer discretionary. Consensus estimates still imply doubling of profit growth (ex-PSU banks and metals) to 15% in FY18, which looks optimistic to us, given limited scope for margin expansion.

Leather industry hubs in Uttar Pradesh have recently come under a cloud. Someone should visit them and check out the fallout of the ‘Cow Protection’ movement. Hotels are beginning to feel the fallout of the alcohol ban. See this article in FT (could be behind a paywall).

Then, the government’s orders on stents are backfiring. Pharma companies are fighting back. The government order on price controls and its rediscovery of the price controls as a public policy tool is rather unfortunate. My column in MINT yesterday was largely built around this. The consequences are not so much unexpected as they are unintended.

Reliance Jio has placed the financial health of many of its competitors under a question mark and the Reserve Bank of India has warned the banks of the risk of exposure to the telecom sector. Usually, public warnings mean that the situation is no longer a risk but a reality. It has asked banks to set aside higher provisioning.

E-Commerce start-ups are seeing big erosion in valuation and investors are marking them down in their portfolios. Further, there are other stories that sap investor morale and sentiment. In general, Indian PE/VC investing is a bit like Hotel California. You can check out but cannot leave.

Overall, bank credit growth to industry is contracting. Non-performing loans are holding back credit growth and the revival of capital formation in the country. This story is not an exaggeration. The extradition order on Vijay Mallya is a sideshow. Non-banking sources of finance are picking up market share, surely. But, they cannot be accessed by smaller firms. Not surprisingly, this article mentions that the International Monetary Fund, in its latest World Economic Outlook (April 2017), does not expect a big jump in India’s investment share of GDP.

Government’s tax and black money collection drives – laudable though they are as to purpose but condemnable as to process – are unlikely to help investment sentiment.

Notwithstanding (or, because of?) the Bharatiya Janata Party (BJP)’s political successes in elections including in Delhi, there is actually economic malaise in the country.

Financial markets and asset prices are largely a sideshow, supported by an equally unjustifiable and myopic global market sentiment. That is a separate story, however.