China banks top the list and other links

China banks are leading the world in assets rankings just as Japanese banks did in 1988 and American and European banks did in 2007. Ahem. [Link]

China – US trade spat is the start of the cold war, says Conor Sen. I agree.

There is loan fatigue on the part of lenders and borrowers in China. That is something to watch for. That spells trouble.

China underestimated Trump and also over-read the trans-Atlantic fissures. Well, not just China made that mistake. Many did and very few are willing to admit to it and correct themselves. They are digging deeper.

David Fickling compares the OBOR infrastructure spending (or loans to other countries) with the Soviet Union’s Siberia infrastructure buildout that strained their finances.

Not a speech of isolationism

Two days ago, America’s Secretary of State Rex Tillerson made a very important speech. That it was delivered on the same day that China’s President Xi Jinping delivered his address to the 19th National People’s Congress is, may be, an interesting coincidence. May be not.

The full speech is here. ‘Trust but verify’ AND ‘Verify but trust’ have very different implications. Should India go for the latter with the US now or is it already doing  that? I think India should be inclined towards the second.

The word, ‘responsibly’ used in two different contexts:
“China, while rising alongside India, has done so less responsibly, at times undermining the international, rules-based order even as countries like India operate within a framework that protects other nations’ sovereignty.”
“It is indeed time to double down on a democratic partner that is still rising – and rising responsibly – for the next 100 years.”
“We need to collaborate with India to ensure that the Indo-Pacific is increasingly a place of peace, stability, and growing prosperity – so that it does not become a region of disorder, conflict, and predatory economics.”
“We also must recognize that many Indo-Pacific nations have limited alternatives when it comes to infrastructure investment programs and financing schemes, which often fail to promote jobs or prosperity for the people they claim to help. It’s time to expand transparent, high-standard regional lending mechanisms – tools that will actually help nations instead of saddle them with mounting debt.”
Role in the Regional Architecture
“India and the United States should be in the business of equipping other countries to defend their sovereignty, build greater connectivity, and have a louder voice in a regional architecture that promotes their interests and develops their economies. This is a natural complement to India’s “Act East” policy.”
I doubt if any other Secretary of State has said this as forcefully as before:
“Security issues that concern India are concerns of the United States”
Does this speech sound like the speech of an administration that is isolating itself?
There is lot of ‘breast beating’ about the U.S. withdrawing and isolating itself. Not at all. Whether we agree or not, they have come to the conclusion that the architecture that they created post-WW II is no longer helping them advance  their goals but somebody else’s. Hence, they are walking away from it in order to weaken it. That is strategic withdrawal and not isolation.
Mind you, Reagan took the U.S. out of UNESCO before. I do not think Reagan enfeebled America. No, I am not saying that the outcome would be the same this time too. I have no idea and I avoid getting into the prediction business.
But, I think that the intent is not isolation but re-making, which may not be and is not to the liking of some. But, that is different from calling it ‘isolation’.

The clamour for fiscal stimulus

A very detailed article in ‘Economic Times’ on the various Japanese assisted infrastructure schemes. It is welcome, in more ways than one.

Once again, the same old hackneyed arguments about whether India needs Bullet trains had cropped up. There is a deliberate conflation of arguments that the money could be used elsewhere. That is patently false and a lie. That money – on very concessional terms – is available from Japan only for this project. I had blogged on some of these patently misleading and mischievous arguments in December 2015. There are likely strong and sizeable multiplier effects. I am glad Ajit Ranade agrees with me. He makes the right arguments on India’s space missions and on India’s public transportation projects.

A friend shared this piece by Gordon Chang on how India and Japan are encircling China.

A Deloitte report that paints India in brighter light than China is briefly reported here in Bloomberg.

If the previous link set you up for listening to or reading only ‘Feel Good’ stuff on India, this could make you ecstatic. It is a speech by Nilesh Shah of Kotak Mutual Fund.

Merryn Somerset Webb ‘Editor in Chief’ of Moneyweek provides a stiff competition to Nilesh Shah, in print. I hope it is not behind a paywall.

Swaminathan Anklesaria Aiyar relishes the prospect of promoters leaving and workes staying as bankruptcies become de rigueur in India. Debashis Basu has a more detailed article on how the Bankruptcy resolution of Synergies-Dooray was handled. It is more lucid than some of the other press articles on the ‘sham’ resolution. I had covered this case in my blog post here.

If the sceptic in you rears its head, then here are the links for you on the failure of National Skill Development Mission to hit its targets. One is based on a research report by (which, in turn, is based on the Sharada Prasad Committee report,  I think) and the other is a news-story. The first link is more about Skill Development Franchisees that failed to deliver in terms of placement. Both appeared in ‘Business Standard’:

Data shows that the NSDC, through its partners, only managed to skill around 600,000 youth till September 1, 2017, and could place only 72,858 trained youth, exhibiting a placement rate of around 12 per cent. Under PMKYV 1, the placement rate stood at 18 per cent.

We should probably look for the Sharada Prasad Committee report and read it ourselves since newspapers can choose to highlight some aspects and not others, etc.  The report was submitted in December 2016 and made public in April 2017.

Business Standard reports on a research report by the State Bank of India research team. It calls for a boost to public spending, disregarding the potential concerns that credit rating agencies would express on fiscal slippage.

Ajit Ranade writes a brief and clear article calling for fiscal boost to the economy. Spells out three areas where they can go – affordable housing, pensions and labour costs to be borne by government to boost hiring and enhanced support for manufacturing and export service support schemes. I am not sure of the third. I am fully behind the second and on the first, I am neutral. Enough policy boost has been given for the first.

If I were recommending, I would boost public sector banks’ capitals in return for some stringent accountability and wholesale changes to their governance and accountability.

India missed the boat on fiscal boost to economic growth in 2014-15 when the new government, thoughtlessly, engaged in pro-cyclical fiscal consolidation to the extent of 1.1% to 1.8% of GDP in 2014-15 by inheriting implausible assumptions and accepting expenditure postponement of the outgoing government. The target of 4.1% for fiscal deficit/GDP ratio in 2014-15 was an impossible one. The previous achievement of 4.5% in 2013-14 was not a real achievement. UPA II’s economic misdeeds of omission and commisison would take years to show through.

Given all that, the government should have come out with a White Paper on the economc situation and proceeded to tighten fiscal policy more gradually. It should have used the oil price crash windfall to reform banks, recapitalise and clean up balance sheets and get private sector credit growth going. Instead, it was used to achive fiscal deficit targets in the hope that a credit rating upgrade would be coming. It has not. India missed an opportunity to provide the needed boost to growth when private sector balance sheets were (and are still) being mended.

On 8th September 2015, I was one of the few people invited for a conversation with the Prime Minister at 7, Race Course Road. I had said that a specific 0.5% fiscal stimulus earmarked for banking recapitalisation would be desirable, at that stage. Evidently, it was not heeded.

I am not viscreally or intellectually opposed to a fiscal stimulus now. But, I am guarded. I can react better when I see the details. That would make all the difference between another wasted effort with negative consequences and a smart growth multiplier. I am concerned that one could commit the mistake of thinking that two wrongs make a right.

I am als concerned that the calls for fiscal stimulus do not take into account the fiscal stimulus already in motion. The State governments have managed to spend even more than their much improved revenues under the generous Fourteenth Finance Commission. They have, as usual, promised fiscal prudence from 2017-18 onwards. But, fiscal years 2015-16 and 2016-17 have seen slippages. No major asset creation has happened.

In 2016-17, state governments spent less than budgeted by about 7% as per Credit Suisse estimates. Capital expenditure is a small portion of the overall expenditure and there too, they spent less than budgeted. But, note that it does not mean that their deficits would be lower. They spent less than what they budgeted. We have to wait for deficit numbers to see if there was any meaningful reduction in overall State fiscal deficits in 2016-17 compared to 2015-16 or a further slippage.

Farm loan waivers announced by eight states would amount to 1.3% of GDP spread over 2-4 years, as per Neelkanth Mishra of Credit Suisse. That too is a fiscal stimulus. But, he noted,

loan growth could be affected: the slowdown by banks in April may last several quarters. (Credit Suisse Asian Daily 13 June 2017)

This is what happened from 2009 onwards. When loans are waived and even prudent borrowers take the wrong hints, loan growth actually takes a hit. It is not good for borrowers and lenders. So, it is bad fiscal stimulus and unsound economic policy. But, the train has left the station.

That is why when one comes down on the side of  fiscal stimulus, the questions of what for, how, how much and for how long and economic quid pro quo (accountability, outcomes and productivity, to name just three) matter.

Then, there is the Seventh Pay Commission recommendations that are not yet fully impelmented by the Centre and then States would folow suit. So, I am not sure if the calls for fiscal stimulus (SBI, Ajit Ranade) take into account these expenditure already in motion.

One of the most useful set of policy recommendations with as much specifics as is possible in a newspaper column is to be found in this article by Shankkar Aiyar, published on 10th September 2017. This is not high altitude platonic stuff but specific action areas are pinpointed.

Sometimes, the more effective stimulus is leadership that understand, accepts and acknowledges the problems and is focused on resolving them. The problem may not be money but all the uncertainty that unco-ordinated and thoughtless sequencing of policy actions and reforms with no heed for the short and medium term side effects. Listening to the so-called intellectuals who are willing to speak truth to the power, at least once in a while, will do more good than harm. Throwing money at problems may not solve and may, on occasions, worsen the situation.

Think of UPA I and II. They were not afraid to throw money at the problems. What did they leave behind for India? A big mess. What were they missing? Credible, sincere, competent and focused leadership.

[Postscript: Those who clamour for fiscal and monetary stimulus and yet claim that the economy is in fine fettle must stop and accept that they canot have it all!]

Government-Central Bank interaction

What do other central banks do?

(1) This is what happens in England:

“A representative from the Treasury also sits with the Committee at its meetings. The Treasury representative can discuss policy issues but is not allowed to vote. The purpose is to ensure that the MPC is fully briefed on fiscal policy developments and other aspects of the Government’s economic policies, and that the Chancellor is kept fully informed about monetary policy.​” [Link]

(2) This is what happens in Japan (from the Bank of Japan Act)

Article 4 The Bank of Japan shall, taking into account the fact that currency and monetary control is a component of overall economic policy, always maintain close contact with the government and exchange views sufficiently, so that its currency and monetary control and the basic stance of the government’s economic policy shall be mutually compatible.

(Attendance of Government Representatives)

Article 19 (1) The Minister of Finance or the Minister of State for Economic and Fiscal Policy prescribed in Article 19, paragraph 2 of the Act for Establishment of the Cabinet Office (Act No. 89 of 1999) (referred to as the “Minister of State for Economic and Fiscal Policy” in the following paragraph; in the case where the office is vacant, it shall be assumed by the Prime Minister) may, when necessary, attend and express opinions at Board meetings for monetary control matters, or may designate an official of the Ministry of Finance or the Cabinet Office, respectively, to attend and express opinions at such meetings.

(2) The Minister of Finance, or a delegate designated by him/her, and the Minister of State for Economic and Fiscal Policy, or a delegate designated by him/her, may, when attending the Board meetings for monetary control matters, submit proposals concerning monetary control matters, or request that the Board postpone a vote on proposals on monetary control matters submitted at the meeting until the next Board meeting for monetary control matters.

(3) When a request has been made to postpone a vote as prescribed in the preceding paragraph, the Board shall decide whether or not to accommodate the request, in accordance with the Board’s practice for voting.

(Publication of Transcripts, etc.)

Article 20 (1) After each Board meeting for monetary control matters, the chairperson shall promptly prepare a document describing an outline of the discussion at the meeting in accordance with the decisions made by the Board, and make public the document following its approval at another Board meeting for monetary control matters.

(2) The chairperson shall prepare a transcript of each Board meeting for monetary control matters in accordance with the decisions made by the Board, and make public the transcript after the expiration of a period of time which is determined by the Board as ​appropriate. [Link] and [Link]

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.

Japan stagnation no more

The Cabinet Office has just revised the official GDP data in December to adopt the latest
System of National Accounts 2008 (SNA2008) international standards. The most significant change under the new methodology is that research and development costs are now recognised as capital expenditure. This revision has had the practical consequence of increasing Japan’s aggregate nominal GDP by over Y30tn. Thus, the 3Q16 nominal GDP figure has been revised up by 6% from an annualised Y506tn previously reported in November to Y538tn (see Figure 15). The Cabinet Office has, as a result of this revision, increased its official estimate of Japan’s potential growth rate from 0.4% to 0.8%.

The above revisions to the official GDP data also follow an extended discussion prompted by the publication of a BoJ research study last year, which employed a different methodology for calculating GDP than that traditionally used by the Cabinet Office (see BoJ working paper: Estimating Japan’s Gross Domestic Income Based on Taxation Data, December 2016. Japanese version was published earlier in July 2016). The BoJ study relied on data from the tax office while the Cabinet Office has traditionally estimated GDP by calculating aggregate supply and demand using a variety of statistical surveys. As discussed here last September (GREED & fear – Kuroda fading, 15 September 2016), based on the BoJ methodology Japan experienced a significantly higher growth rate over the past ten years than that recorded in the official data, most particular in fiscal 2014. Thus, under the BoJ methodology the economy expanded by 2.4% in real terms in FY14 compared with a 0.4% contraction based on the latest official data (revised up from a 0.9% contraction reported in mid-2016). Over a longer time frame the Japanese economy would have achieved average real GDP growth of 1.2% between 2004 and 2014 based on the BoJ methodology, not the 0.7% reported by the Cabinet Office (see Figure 16).

The above findings were embarrassing to the statisticians in the Cabinet Office, most
particularly as the weak data in 2014 provided the rational for Abe to delay a scheduled sales tax increase for the second time in October 2015. The sales tax is now due to be increased in October 2019. Meanwhile ongoing discussions between the Cabinet Office and the BoJ as regards the GDP data, discussions apparently requested by Abe, appear to be at least one reason motivating the latest revisions to the official GDP data. The result is that aggregate nominal GDP has now exceeded the previous high reached in 1997 (see Figure 15). This is another sign of easing deflationary pressures.

As also previously discussed here, yet another signal that life in Japan is not as grim as was the case ten and more years ago is the remarkable collapse in the suicide rate. Thus, the number of suicides in Japan peaked at 34,427 in 2003 and has since declined to 21,898 in 2016, the lowest level since 1994 (see Figure 17). It is not a coincidence that this data series peaked out in 2003 and has now returned to the levels prevailing in the early 1990s. It is even the case that the fertility rate has picked up in recent years, bottoming out at 1.26 in 2005 and since recovering to 1.45 in 2015 (see Figure 18). Indeed the Japanese fertility rate is now running above levels prevailing in Hong Kong (1.20), Singapore (1.20) and Korea (1.17). Meanwhile the Abe government’s target is to boost this to 1.8 in the medium term.

Source: ‘Riding the Donald’, ‘Greed & Fear’ Weekly by Christopher Wood, CLSA (February 23, 2017, pages 8-9).

Philosophically, it also tells us that it is next to impossible to divine the true state of the macroeconomy, much as The Absolute is unfathomable through rational methods of enquiry!

This is relevant to the current debate on India’s 3Q2016-17 GDP growth estimate where some inappropriate comparisons to China have been made. That is silly. In China,there is an official systematic attempt to mis-state GDP. In India, it is still about methods and not mala fide.

Take, for example, this paragraph on inflation calculation in the United States and Japan, from the same source cited above. Whether the country is in the throes of inflation or not is captured by how the statisticians account for rental costs:

The rental component in Japan probably understates inflation whereas, of course, in
America rising rents have been the key upward driver of reported core CPI inflation. This is because in Japan there is no allowance made for the depreciation of housing in the rental component whereas the opposite is the case in America. Thus, Tokyo CPI for rents, accounting for 24.5% of the Tokyo core CPI basket, declined by 0.6%YoY in January (see Figure 13), contributing an estimated negative 15bp to Tokyo core CPI deflation. By contrast, US shelter CPI, which accounts for 42% of the core CPI basket, rose by 3.5%YoY in December while core CPI rose by 2.3%YoY. Excluding shelter costs, US core CPI rose by only 1.3%YoY in January.

News that matter

American politicians and intelligence agencies are making too big a deal out of their claims that Russia interfered with their elections. Their interference in democratic processes in other countries is well known. Russia could not have influenced the vote. This comes across – whether intended or not – as an attempt to cast aspersions on the legitimacy of the victory of President Trump. This blog post by a blogger Michael Kreiger of the Liberty Blitzkreig blog is an important read.

Incidentally, Mr. Michael Kreiger has good posts on Trump’s cabinet picks. Read them here. They are critical observations and legitimate too. They echo my observations in my recent MINT column:

Indeed, whether the swamp is drained or allowed to remain would be very much determined by the actions taken with respect to the financial sector. Reining in financialization is the key to tackling income and wealth inequality and distortions caused to the real economy by debt (leverage, in general) and leverage-backed surges in asset prices. [Link]

Of course, in my MINT column, I had referred to a Wall Street Journal article that mentions that Trump appointees favour a higher bank capital ratio. That is a good thing.

Indonesia has chastised and cut off business with JP MOrgan for the latter has downgraded Indonesian sovereign bonds to underweight. Some wrote that the Indonesian stock market had been downgraded. I do not think that is right. In either case, it is an over-reaction. Needless. Only if there is a clear case of malintent as was between Morgan Stanley and Kazakhstan, then there is a need for governments to react. The former accumulated CDS on Kazakh bonds and worked to trigger a credit event. Read Gillian Tett commentary in 2009 on this.

When governments do this, they  attack the analysts’ integrity and independence. Then, when they do the same with stocks, governments lose their moral rights to pull them up or punish them in the name of good governance.

Apple deferred to China and pulled New York Times from its app. in China. It could not have happened to a more objective and balanced newspaper (?!)

China has further tightened the screws on foreign non-governmental organisations operating in China:

The legislation requiring the China offices of charities and foundations to find an official sponsor and file regular and detailed activity plans to the police is seen as one of the ways the ruling Communist party intends to cement its rule by asserting control over a burgeoning civil society.

China’s Ministry of Public Security (MPS) waited until last week to publish a list of eligible sponsors, meaning that almost none of the thousands of foreign non-profits in China — ranging from charities such as Greenpeace and Oxfam to funds such as the Ford Foundation — will meet the law’s conditions before the January 1 deadline. [Link]

This is a sequel to what was done last April.

In an article peppered with unverified and anonymous comments, FT writers blame Brexit and Theresa May for China cooling off towards Britain. For all we know, it might be a good thing for Britain.

Further, China is squeezing South Korea hard because it had chosen to deploy a US missile defence system on its soil:

China has threatened some of South Korea’s largest companies over Seoul’s decision to deploy a US ballistic missile shield, according to several people briefed on the conversations.

Samsung and Lotte Group were among companies warned by a foreign ministry official during a visit to Seoul last week that their China business could suffer because of the Korean stance.

South Korean officials labelled a visit by Chen Hai, the ministry’s deputy director-general of the department of Asian affairs, as “highly irregular”. They said he ignored requests to postpone the trip until the new year and did not pay a courtesy call to his counterparts at the foreign ministry in Seoul. [Link]

One would have thought that this would bring South Korea and Japan closer. Is it bad diplomacy or is it a case of bad times for South Korea? Apparently, a non-governmental organisation set up a statue of a ‘comfort woman’ outside the Japanese consulate in the port city of Busan. Japan has recalled its Ambassador to Seoul. May be, who knows, some NGOs are still useful for Beijing?

May be, I am repeating it. This news about Indonesia is important too. The title of the article is appropriate. May be, this is justification enough for JP Morgan downgrade?

I wonder about the presumptive logic of the inevitability of Asian rise in the 21st century.