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.

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 rupee strength

Let me state at the outset that I am all for a strong currency PROVIDED economic fundamentals back it up. Strong capital inflows do not constitute ‘sound economic fundamentals’. They are hardly mirrors to fundamentals but of perceptions and that too of the relative variety. So too is the exchange rate. India’s economic growth is middling. It is unbalanced. Private capital formation is still missing. Savings rates have not risen.

So, the currency strength seems to be driven more by perception of India’s strength especially in comparison to other emerging economies, including China, rather than due to intrinsic strengths. That is why, perhaps, RBI has been intervening and that India’s foreign exchange reserves are rising.

This comment is not to take exception to Mr. Ninan’s Op.-Ed today in Business Standard. But, to raise one minor quibble. He had written:

The solution, suggested in this column seven months ago, is to focus on the source of the dollar surpluses: capital inflows, and debt inflows in particular.

Data do not support him – except for the last few months – that India’s dollar debt and equity flows had gone up. If anything, up to December 2016, India’s external debt and Net International Investment Position (IIP) positions have only improved. More repayments (outflows) than borrowings (inflows). Since February this year, India has witnessed strong Foreign Portfolio Investment (FPI) – both debt and equity.

Therefore, the point remains and he is right that India has not earned the right to have a strong currency. Most important of all fundamentals for a strong currency is productivity. India does not have the data because the bulk of the employment in the country is informal. Whether it is 75% or 92%, it does not matter. It is too high.

India is currently not facing headwinds or competitive disadvantage in a big way because other countries, including China, are not actively seeking to depreciate their currencies. That is something to keep in mind and watch out for. Chief Economic Advisor has indeed produced a chart of rising Indian rupee versus the Chinese yuan in his recent VKRV Rao Memorial Lecture. India does have a big bilateral trade deficit with China.

A friend helpfully points out that the focus on the INR/CNY bilateral exchange rate might be a road or bridge to nowhere. He said,

Between 2005 and 2015 the INR depreciated almost 90% against the CNY on nominal basis and about 60% on real effective basis while the bilateral trade deficit went up 24 times from around USD2bn to USD48bn. Not saying currency does not matter but in such cases global supply chains and productivity differentials seem to matter much more than currency divergence.

It is an excellent point. He is very right. I am reminded of what BIS wrote in its 2016 Annual Report on the declining usefulness of exchange rate depreciation for export growth:

Recent studies generally suggest that trade exchange rate elasticities have
declined in response to changes in trade structures, including currency denomination, hedging and the increasing importance of global value chains. For instance, a World Bank study finds that manufacturing export exchange rate elasticities almost halved between 1996 and 2012, with almost half of this decrease due to the spreading of global supply chains. [page 53 – Link]

Second, India’s overall REER has appreciated by about 7% to 9% in the last one year, depending on the metric that one chooses, from among the several that RBI publishes on a monthly basis.

We must remember that REER adjusts for inflation in India relative to that of other countries (trading partners). Inflation is an indirect measure of productivity. Therefore, REER is productivity adjusted in that sense. Even so, the rupee has appreciated in the last one-year or so. That could be a concern for whom export quality or excellence is not a core strength.

But, it has not hurt India much because crude oil has not sustained its price recovery of last year into 2017. This might persist for quite some time. If anything, the risk of further downside for crude oil price is higher than upside for crude oil. That is a good news for India. That is one reason India’s current account is not showing any strain from the rupee strength. Of course, the strength has been somewhat recent only.

It might be then that the Indian interest rates are still too high, relative to that of other countries. Perhaps, RBI is too tight. But, then who knows if India’s inflation has become sustainably low? RBI has not lowered rates because liquidity is otherwise ample, both in domestic financial institutions and from overseas. Their monetary policy might be tight, temporarily, but it has to be shown over time that it has become unsustainably too tight for too long, before the blame can be fully laid at its doors for the strength of the currency.

In sum, the situation calls for observation. The traffic light is amber. It is not red, signalling danger. Those were the days when Germany and Japan could become export powerhouses despite currency strength. It is true that no country depreciates its way to economic prosperity.

In the days of financial globalisation, it is unfortunately and equally true that no country can appreciate its way to external sustainability.

Grouchy Gold Standard

Thanks to James Crabtree, I learnt a new word in English today.  He had called me ‘grouchy’. You can see his tweet here.

I googled ‘grouchy’ and it gave this as the top hit:

irritable and bad-tempered; grumpy; complaining

That seems like a disproportionately liberal compliment to my blog post. If I said more, James would tweet again saying, ‘QED’.

I am prepared to ‘forgive’ him for calling me ‘grouchy’ for the pointer to this article in this tweet. The two images of India in 2012 and in 2016 would be heartwarming both to the Indian Chief Economic Advisor and his employer!

So, James shall have the last word on being grouchy.

It can and should be stopped

There is an interview of Dr. Arvind Subramanian (AS for convenience), the Chief Economic Advisor to the Government of India in FT. The interviewer is James Crabtree (‘James’). I know James a little better than I know AS. I had met the latter once in 2010 when we both were invited to the preparatory meeting for the Indo-Chinese Strategic Dialogue, by Mr. Shivshankar Menon, the then National Security Advisor to the Government of India. Of course, he had given a nice blurb to my co-authored book, ‘The Economics of Derivatives’ with Dr. Somanathan. He knows Dr. Somanathan well and respects him.

James now lives in Singapore and I have interacted with him in person and exchange emails from time to time. He is an easy-going chap. He was nice enough to tweet my critical analysis of his analysis of the Uttar Pradesh election results in India in March.

When AS was being considered for the post of CEA, I had checked my own blog posts that referenced him. There were quite a few. I had been blogging for little over six years then. Almost all of the posts had only approving references to his works or views or both. So, I mentioned it to some people whom I thought were closer to the powers-that-be in the ruling dispensation in Delhi.

He has done a very decent job so far. He has made very useful contributions to the progress of the Goods & Services Tax legislation in the country. His annual Economic Surveys are thoughtful and useful for the most part, although I disagree with the consensus view on this year’s Economic Survey, especially with respect to the idea of Universal Basic Income for India. India does not need it. India cannot afford it. Even for the West, it is more a romantic than a useful idea and it is a salve for the consciences of the technology billionaires who are facilitating its destruction of life and society, as we know them. Work is much more than about salaries and handouts are poor substitutes for them. I have more to say on technology later because AS had chosen to mention it, in the interview. Indeed, that is the main and  a large portion of this post.

The only time I disagreed with him and sharply too was on the joint column he wrote for ‘Bloomberg Views’ with Dani Rodrik on the ‘whining’ of Emerging economies on the spillover from the Federal Reserve monetary policy. I thought they were completely on the wrong path. Subsequent research, even from sources like the International Monetary Fund, had confirmed that spillovers are a painful and inevitable reality even for well-run and well-managed emerging economies with sound fundamentals.

Now, back to this interview. It has nice pictures of his pad in New Moti Bagh in Delhi. His Pooja shelf features Shri. Ramana Maharishi. Nice. He has cassettes. So, do I. I do not know what to do with them these days. Even CDs have quickly been replaced by other means of listening.

For the most part, in his interview, he hits the right notes on his boss. That is to be expected. He hits the right notes on India too. The interview is a bit thin on substance though.

James refers to Modi as a leader who brooks no dissent. It would be rather useful to know if any political leader brooks or has brooked public dissent. The real issues are about how they dispose of the dissenter rather than if they allowed them to thrive and that too in public view. So, I am not sure as to the point of it. No politician who makes it to the top in competitive democratic politics will be a front-runner in the competition for the ‘Mr. Nice Guy’ award. That includes the former U.S. President Barack Obama.

For the most part, journalists are either naive or take their readers to be so or it is a bit of both. I am disappointed that James is doing that here.

As for AS’ remarks,

“’Hyper-globalisation is dead, long live globalisation,’ is how I like to put it,” he says. “If you look crudely at the post-war period, 80 per cent of globalisation is driven by technology, 20 per cent by policy. And that 80 per cent, you can’t stop.”

I take issues with that. Well, I winced. At a very philosophical level, many things in the world are processes over which humans have very little or no control. We are mere cogs in the wheel. But, modern societies and governments are organised on the principle that humans are in charge. They choose and decide. Blaming technology is a bit like blaming terrorism or saying that the West is at war with terrorism. That is seemingly clever but a bit daft and stupid.

The world cannot be at war with terrorism. It is at war with terrorists. Period. Nothing more. Nothing less. Narrowing it down further to geographical markers or specific religious markers is also necessary to focus efforts. Euphemism is part of denial and it helps to lull people into believing that something is being done while nothing worthwhile is being done. That is why my eyebrows went up when I read an article in Bloomberg that McMaster advised President Trump against using the phrase, ‘radical Islamic terrorism’ in his Presidential address to the Congress.

Back to technology from terrorism, even though both could be terrorising humans and societies. Technology is deployed and advanced by leaders – political, commercial and scientific – making choices. It does not advance by itself. Some technologies have been shelved and some have been abandoned because their negative externalities were judged to exceed vastly their private benefits or even public benefits.

Several examples would help. The decision by President Nixon to open up to China was a choice. The decision to admit China into WTO even before it became a ‘market economy’ was a choice. The decision to sign the NAFTA was a choice. The decision to repeal Glass-Steagall Act was a choice and so was the decision to legislate the Commodities Futures Modernisation Act in the United States. All of them had consequences. Financial and technological innovations amplified the consequences greatly. Some of the decisions were made without awareness of their fallout on communities, on families and on society. Only economic and commercial considerations, at the aggregate level, were the decisive actors.

That is why Bill Gates was right to propose taxing robots. Obviously, robots do not pay taxes but the companies that are behind them do. The tax may and could even be punitive enough to stop some of the research and advance in the technology. That is not being Luddite. That is being careful about consequences. That is about being honest and humble about forces that one is about to unleash, about which one has no ideas and over which one has no control. That is about recognition of human limitations.

“High-tech hubs were among the five metropolitan statistical areas where the gap between the highest- and lowest-income households expanded the most: two in California, San Francisco and San Jose, as well as Austin and Seattle.” [Link]. The article’s header is a tell-all tale: ‘America’s rich get richer while the poor get replaced by robots’.

Predictably, Larry Summers has objected to Bill Gates’ proposal. Mr. Summers is a very useful weathervane for the direction in which conventional wisdom is blowing. It is usually wrong. Summers’ views are useful for many of us to make up our minds – usually in the other direction. Here is another example. But, that is a different topic.

Political correctness prevents many from admitting to their inability to comprehend the present and the future, especially with respect to such obviously disruptive developments. There is more disruption than progress about them. Tyler Cowen’s article in Bloomberg in February is an example of this unfortunate political correctness. He concludes on that note despite advancing all useful and important arguments against precisely such a stance.

Perhaps, Tyler Cowen, AS and Summers should read an article that appeared in ‘Quartz’ last month. The article is headlined, ‘No one is prepared to stop the robot onslaught. So what will we do when it arrives?’.

The article notes, “In February, the European Union did consider rules that, while not stopping the robots, would have the force of discouraging automation by compelling companies to pay compensating taxes and social security payments for jobs that their robots wipe out. But, EU parliamentary members balked even at this, adopting much milder language that exacts no retribution on the robots or the companies that use them. A pivotal dynamic in the vote seemed to be a reluctance on the part of the deputies to expose themselves to possible ridicule as Luddites.”

That is the problem. Andrew Feenberg, who teaches the philosophy of technology at Simon Fraser University in Vancouver, says, “Doing trade deals and robotics without consideration of the people displaced is insane. The backlash is understandable.”

Feenberg notes, “Societies do have choices with respect to technology.” He is very right.

In sum, this long post is a message to AS that it can be stopped and we, humans, would do well to make choices because we can make them. It is both fashionable and wrong to say that technology cannot be stopped.

Trivially important

This is trivia: Looks like it is not good news for King’s XI Punjab if Hashim Amla scored centuries. They lost both the matches in which he scored centuries in this IPL season. One is random. Is two a pattern? Kidding. He is a class act, no doubt.

Journal of Economic Perspectives (JEP) has recommended ‘Can India Grow?’ for reading in its Spring 2017 issue. Its Editor Tim Taylor had blogged on our book in detail, earlier. I had probably flagged it already.

Anna Cieslak and Annette Vissing-Jorgensen have a terrific new paper on the Economic Meaning of FED Put. Will blog on it separately. I think these authors would  trigger a reform of the Federal Reserve. All strength to them.

The Volatility Index on S&P 500 (VIX) had breached 10% and closed at 9.77% yesterday. It is a historical low. The previous low was 9.89% on January 24, 2007. Ahem.

Looks like Presidential impeachment in a market classified as emerging is a BUY signal. Brazil stocks had breezed through a recession and Presidential impeachment. It is being repeated in Korea. I suppose one gets ready to buy Venezuela shortly?

Will Obama’s USD400K speaking fees have attracted the critical attention that it has, but for the issues that were thrown up during the American Presidential elections?

This is important.