Some thoughts on agriculture incomes

At a time when India’s manufacturing sector is buffeted by several headwinds that threaten a premature de-industrialisation, the services sector is predominantly informal and suffers from poor productivity, and also given India’s recent struggles with structural transformation (the latest PLFS data shows that the share of agriculture in India’s labour force has remained persistently high, even reversing course since 2018-19 to increase from 42.5% to 45.76% in 2022-23), it’s important that to achieve broad-based economic growth public debates should focus more on improving the productivity and incomes from agriculture.

But agriculture is one of the hardest areas for policy 

In this backdrop, the rapid rise of Ethiopia and Kenya as leaders in cut-flower exports and Peru as the runaway leader in blueberry exports are impressive success stories. This post will point to three similar successes of exports from India in a short time, table grapes (and wine) from the Nashik area of Maharashtra, inland shrimp farming in the Godavari and Krishna delta districts of Andhra Pradesh, and pomegranate in a few districts of Rajasthan. 

A feature of these examples is the absence of any specific efforts by the government to promote the specific sectors, beyond the provisioning of irrigation and some inputs and enablers generally available for agriculture. Instead, all of them have built on the enterprise of local farmers, especially the dynamic entrepreneurs among them. 

Sayantan Bera in Livemint has a great story about the remarkable success in a quick time of table grape production and exports centred around Nashik.

In 2023-24, India exported fresh grapes worth ₹3,461 crore, a 36% increase year-on-year, and a 3.5-fold jump over ten years. Close to half of the export volumes (45.8% in FY24) originated from just one district, Nashik, in northern Maharashtra, which has emerged as both India’s grape and wine capital. Riding on Nashik’s output, Maharashtra accounts for 67% of the country’s total production, with Karnataka (28%) and Tamil Nadu making up the rest… Grapes are a perennial crop and a plantation can be in production for up to 15 years. India primarily grows white (they are called white though they appear a vibrant shade of green) seedless varieties like Thompson, elongated varieties like Sonaka and black varieties like Crimson and Sharad… the vines require care and monitoring through the year… average production costs are around ₹2.5 lakh per acre.

You can spot Indian table grapes in global supermarkets, be it Tesco or Edeka in Europe or Choices Market in Canada, with farmers like Boraste catering to the exacting standards of fussy western buyers. The grapes supplied to Europe, for instance, have to be a certain size (berry size of 16-20 mm in diameter), be crisp and sweet (but not too sweet) besides meeting a long list of other quality parameters… a highly competitive export market for grapes has ensured lucrative prices for growers. For instance, in the 2024 harvest season (January to April) farmers received ₹65-70 for every kg of grapes they exported, much higher than the wholesale domestic price, which averaged between ₹25-30 per kg.

While there were general enablers from the government, the specific industrial success appears to have emerged from local initiatives. 

First, they are highly perishable and would perish within ten days of harvest without a cold chain. But Indian farmers and traders have cracked the storage challenge and now export grapes to distant shores—to Europe and Canada and closer home to China and the Middle East, where the fruit travels for up to a month on the seas. This is done by precooling the harvest at zero degree Celsius and then maintaining a cold chain that extends shelf-life to 45-60 days, till it reaches the consumer. Secondly, in a wild domestic market with few quality checks, farmers upgraded themselves to meet the exacting standards of western markets. They now produce grapes that are traceable (meaning, a consumer knows which field it comes from), closely monitor the sugar and acidity levels (which determine how the grapes taste), and follow stringent chemical residue limits set by global buyers… 

In 2004, Ganesh Kadam took charge of two acres of a family plot and now grows table grapes on 14 acres. In 2024, he supplied 880 quintals for export at a price of ₹70 per kg, fetching ₹61.6 lakh revenue. A smaller lot, worth ₹6 lakh, was sold in the domestic market. After spending close to ₹35 lakh on production costs, his net earnings for the season were more than ₹30 lakh (average production costs are around ₹2.5 lakh per acre). “As a visitor, one only sees the materialistic changes. How big one’s house is, how many cars a farmer owns… but it is important to understand how knowledge, technology and training drove this change," Kadam said. 

The article documents the critical role played by a co-operative society.

Sahyadri Farms, a farmer-owned company in which Kadam is a shareholder, has become the largest exporter of table grapes today. Exports would not have reached where they are today without its intervention, he said. “How else can a small farmer have access to the best technology, package of practices and an assured marketing channel," he asks. “I have been to Europe, seen how farming is done there, and how the produce is sold in supermarkets. Sarkari subsidies cannot take you there."… Farmers in Maharashtra have been commercially cultivating grapes for generations but began supplying to export markets only in early 2000. In 2010, most of the grapes shipped to the European Union were rejected due to the presence of excess levels of a growth regulator sold under the tradename Lihocin. Nearly half of India’s exporters shut shop after the tragic episode, which led to an estimated loss of ₹250 crore. But it taught farmers the importance of staying on top of global regulations and quality parameters. They were soon back in the game. 

Vilas Shinde, a farmer and exporter, was among those who went bust in 2010. But unlike most traders, he paid farmers their due by selling his land (he lost ₹6.5 crore that year). In 2011, Shinde set up Sahyadri Farmer Producer Company Ltd together with 110 shareholder farmers with the aim of exporting grapes. Farmer producer companies are like cooperatives but set up under the Companies Act to ensure little or no bureaucratic and political interference. Since 2012, when Sahyadri shipped its first containers, its grape export volumes have grown seven-fold to 21,000 tonnes (as of 2024). Because grapes are a seasonal business (peaking between January and March, during harvest and shipping) Sahyadri diversified into other crops such as tomato (it is currently the largest processor of tomatoes in India and a contract manufacturer for Hindustan Unilever’s Kissan ketchup brand), bananas, pomegranate, sweet corn, mangoes, and cashews. The company’s 120-acre campus in Mohadi, Nashik, is a post-harvest hub with packhouses, cold storages and processing lines for these crops. In FY24, Sahyadri clocked a turnover of ₹1,549 crore, a 55% increase year-on-year.

Sahyadri is now a collective of 26,000 farmers cultivating 40,000 acres. In a way, it is trying to do with perishable horticulture crops (where production and prices often fluctuate wildly) what the Amul cooperative did for small dairy farmers. What’s more, Sahyadri plans to go for a public listing by 2026—that would be a first for a farmer producer company, racing ahead of VC-funded agriculture startups… In 2022, Sahyadri purchased the exclusive rights from Grapa, a California-based breeder, to grow its patented Arra variety of table grapes for a sum of ₹35 crore. By all measures, it was a significant intervention, that too by a farmer-owned company, to get the latest global technology for its growers. In 2024, the first batch of Arra grapes sold for an eyepopping ₹250 per kg in an auction held on a Nashik farm. Growers associated with Sahyadri are gradually replacing their vines with Arra varieties, and expect farmgate price realization to double to ₹150 per kg.

Another example of a successful breakout is inland aquaculture, specifically shrimp farming, in the delta districts of Andhra Pradesh. Following the introduction of the L. vannamei shrimp variety in 2009. the state has dramatically multiplied several-fold shrimp production and aquaculture exports (which are mainly shrimp in value).

Freshwater shrimps typically yield a profit of Rs 3-4 lakh per acre, after adjusting for risks. Interestingly, state government data reveals that of the 1.35 lakh farmers doing aquaculture on 4.5 lakh acres, just 6398 farmers with more than 10 Acres and an average extent of 28.63 acres used 41% of the land area. 

While I have not come across a formal study explaining the contributors to this success, anecdotal snippets point to some important insights. One, there was no specific government scheme or focused initiative that contributed to the inland shrimp culture boom in Andhra Pradesh. In fact, shrimp production grew at a compounded annual rate of 17.9% till 2018 without any power subsidy. Incidentally, the growth rate declined to 11.7% till 2020-21 after the introduction of subsidised power at Rs 1.50. 

Further, as this study shows, lack of government support was the least cited constraint facing shrimp farmers. It also shows that the major constraints were access to good quality seeds and other inputs, and better management practices. While governments can play a role in facilitating access and provision of good extension services, there are serious limits to the quality and effectiveness of such efforts. 

Instead, conditional on the promise of the industry and a reasonable regulatory environment (shrimp culture in AP passed both these tests), these constraints are best relaxed by enterprising farmers. It’s therefore no surprise that anecdotal evidence from AP points to the same conclusion. The rapid rise of shrimp culture itself and the major contributors to steep rise in production and exports are the efforts of a handful of enterprising farmers in East and West Godavari and Nellore districts who seized the opportunity to access good quality seeds and cheaper inputs, and adopted productivity enhancing and cost optimising management practices. It helped that the region had a brief episode in the 1990s of boom in aquaculture that was disrupted by pest attacks. 

Finally, Harish Damodaran writes about the recent emergence of pomegranate farmers in Rajasthan, covering an estimated 12,500 hectares in Barmer, Sanchore, Jalore, Sirohi, Jodhpur, and Phalodi districts. He chronicles the success of one farmer who generates an annual income of around Rs 1.5 Cr from his 32 Acre orchard where he has deployed drip irrigation facilities. This is a good summary of the transformational effects of such breakouts

The 30-km stretch from Dechu to Kalau is now a major anar cluster, with all the orchards having drip irrigation facility. Mali’s land value has shot up from a mere Rs 8,000 per bigha in 2004 to Rs 1 lakh in 2017 and Rs 5 lakh now — all thanks to anar. Till about 2004, Mali cultivated only bajra (pearl millet), guar (cluster bean), moth (dew bean) and moong (green gram) during a single kharif or post-monsoon crop season. With water-saving sprinklers, Mali could now plant rabi (winter-spring) season crops — raida (mustard), chana (chickpea), jeera (cumin) and isabgol (psyllium husk) — and also groundnut during kharif.

The article points to how access to high-quality seeds and exposure visits were important triggers for generating interest among farmers.

The turning point came in August 2017. That was when the state horticulture department supplied him 12,000 disease-free, tissue-cultured plants of Bhagwa Sinduri, a high-yielding pomegranate variety developed by the Mahatma Phule Krishi Vidyapeeth University at Rahuri in Maharashtra. “They charged Rs 40 per plant and credited back Rs 16 to my bank account after I bought it. Of the 12,000 plants, 3,000 were infected by nematodes and termites. The remaining 9,000, planted at 8 ft x 12 ft spacing, survived,” recalled Mali. He further spent Rs 8.5 lakh on laying 10,000 metres of drip irrigation pipes with emitters at 2 feet distance, and got back Rs 3 lakh as subsidy on this investment as well… 

In early June, Jodhpur-based South Asia Biotechnology Centre (SABC), a non-profit, took 30 pomegranate farmers from western Rajasthan on an Anar Shodh Yatra. The 10-day field trip, supported by the NABARD’s Agri-Export Facilitation Centre in Jodhpur, involved visits to INI Farms’ integrated pack-house facility near Pune, the National Research Centre on Pomegranate at Solapur, and the Yara Crop Nutrition Centre at Pandharpur. The idea was to expose the farmers to the best cultivation and post-harvest management practices in Maharashtra, which accounts for 55 per cent of India’s annual pomegranate production of 3.2 million tonnes. 

Note how enterprising farmers like Mali seized the opportunities presented to them and also the role of non-profits like SABC. 

In light of these examples, what can the government do in agriculture? 

I have blogged here pointing to the challenges faced by public policy in agriculture. Agriculture is one of the most challenging sectors for public policy. It engages with people who are generally poor and semi-literate. It is bedevilled with incentive distortions due to subsidies, and market failures arising from the nature of the sector. Finally, it must reconcile the interests of producers (who want high prices for their produce) and consumers (who want affordability).

Therefore, the government should continue to make investments in irrigation, provision of extension services, enable access to inputs and credit, finance downstream investments like storage, and support market enablers like certification. As all three examples illustrate, access to good quality seeds is a critical contributor to raising farm incomes substantially. 

In addition, it would do well to demonstrate the possibilities and opportunities to local farmers in the belief that at least some among them will emerge as pioneers for new crops and practices. For example, there are similar opportunities for other fruits and vegetables like custard apple, guava, dragon fruit, avocado, pear, etc. There’s a need to create numerous clusters of high productivity and high incomes that have the potential for transformational local spillovers. 

Once a farmer demonstrates some interest, government extension and other services should be channelled to support these self-selected farmers in pursuing their interests. Specifically, exposure to new opportunities and identification and encouragement of progressive or enterprising farmers should become an explicit priority of agriculture departments.

Public policy can also play a role in addressing coordination failures by connecting such progressive farmers with all the market actors, especially the agriculture sector non-profits and startups, in addition to companies, who are involved in pre- and post-harvest linkage activities. Given the expanding landscape of such non-government actors, governments should enlist them as close partners and even support them financially where possible to increase the effectiveness of their engagement with farmers. 

The problem with such policy activities is that they lose their effectiveness when done in a commoditised programmatic manner. Their effectiveness lies in their organic emergence where the value proposition is made evident to all sides involved (instead of the standard approach of creating an IT platform to connect everyone, and leaving it at that). 

Supporting enterprising farmers is perhaps the highest value for money investments in agriculture, and the activities of such farmers also have the highest multipliers on the local farmers and farming practices. 

Finally, society must start to celebrate enterprising farmers in the same way as startup founders. In fact, unlike many startup founders who merely build companies with ephemeral valuations, enterprising farmers create genuine and lasting value. Their average economic multiplier or marginal value is perhaps higher than those of a tech startup founder, especially in the Indian context. Instead of being stigmatised, dynamic farminc entrepreneurship of the kind discussed here should become a livelihood that people should be encouraged and supported to pursue with interest.

Weekend reading links

1. Robert Shrimsley has a very good article questioning Keir Starmer's ability to execute the kind of reforms that the UK needs. 

But consensus is not enough... The first reason is that reform is not delivered by declamation. It is slow, detailed and difficult... It is dangerous to invest too heavily in the idea of government as a start-up. Agile work processes are effective for new and discrete projects, but organisations whose decisions affect millions of lives cannot “move fast and break things”... Whitehall reform must also ultimately mean taming the often-obstructive Treasury... The most successful reforms have come from ministers, like Gove or David Blunkett at education, who reached office with clear intent and who eschewed big bang change in favour of grappling with manageable problems one at a time. Labour arrived unprepared and with too little of its agenda worked through in detail.

This has universal relevance. 

2. On the value of using praise as a productivity-enhancing tool. 

Once you earn enough to meet what you deem to be basic needs, you are more inclined to value non-remunerative aspects of work, such as praise and appreciation. Put another way, people can stay in jobs that pay less than the market rate if they feel their work is regularly and properly valued. To be more specific, if they are recognised at least monthly, they are 33 per cent more likely to say they are not job hunting in the year to come, some research shows. Yet the share of US workers who say they have been praised or recognised in the past seven days for doing good work sank to a 15-year low this year, mirroring a slump in the percentage who say they are extremely happy with where they work. This raises a question: why don’t managers deploy praise more adroitly? It is hard to think of anything else that costs so little, takes such a piffling amount of time, and yet achieves so much, as a short email or a brief chat to praise someone’s work. For employees whose work is largely unseen, or only noticed when they muck up, this recognition can be seriously significant... even star employees on big salaries in high-profile jobs like to be praised. And there’s much to be said for being recognised by peers, too.

3. Debashis Basu echoes Joe Studwell

What is the one thing that could drive India’s economic success? Gary W Keller and Jay Papasan, in their bestselling book The One Thing, argue that there is often one action that makes everything else easier or unnecessary. For most countries that answer is clear: Double-digit export performance for years together and climbing up the global value chain... The incentive has to be linked to export, not just import substitution or higher production. Initially it will be hard, which will automatically reveal what needs to be done to make each of the sectors export-competitive. In each of the four countries that have recorded extraordinary growth, the government worked with the manufacturers to help them import technology, arranged cheap finance, culled the weaker players, and relentlessly imposed export discipline. India should learn from this and adapt.

4. McKinsey has agreed to pay $650 million to the US Department of Justice and settle an investigation into its work with the opioid maker Purdue Pharma. The consultant had worked closely with the company to turbocharge the sales of its flagship OxyContin painkiller amid an opioid addiction epidemic that was killing hundreds of thousands of Americans. Top Purdue Pharma executives have already pleaded guilty to federal crimes relating to the sales of the drug, and prosecutors have said McKinsey worked to boost its sales despite knowing the risks and dangers associated with OxyContin. The firm earned $93 million over 15 years of work involving 24 consultants.

In July 2009, McKinsey wrote that Purdue Pharma’s “top priority” should be “driving a more impactful OxyContin franchise.” In subsequent years, as the opioid crisis grew, McKinsey continued to formulate new ways for the drugmaker to increase profits, including targeting “opioid naïve” patients, a term used to describe individuals not currently using the drug or those who had used it only once... Congress held hearings in 2022 focusing on the firm’s simultaneous work with opioid makers and the Food and Drug Administration after reports in The Times and elsewhere. A congressional report found that since 2010 at least 22 of the firm’s consultants had worked for both Purdue and the F.D.A., sometimes at the same time. McKinsey’s marketing pitch to drugmakers included touting its work with the F.D.A. “We serve the broadest range of stakeholders that matter for Purdue,” one senior partner at the time, Rob Rosiello, wrote in a 2014 email to Purdue’s chief executive. While it is company policy not to identify clients, Mr. Rosiello wrote, “one client we can disclose is the F.D.A., who we have supported for over five years.”

This follows settlements by the consultant to pay $1 bn to cities, states, and others on its work with Purdue and other opioid makers. It has already paid $122 million to settle suits relating to violation of the provisions of Foreign Corrupt Practices Act relating to its work with South African government. 

I have blogged here and here on McKinsey's work with Purdue Pharma and the South African government. 

5. Good NYT article on the contrasting paths taken by venture capital funds Andreesen Horowitz (raise big money and do large deals) and Benchmark Capital (raise smaller money and do smaller deals). 

6. Forget chips, there's an even more basic area of vulnerability vis-a-vis China for the US, shipping. Rana Faroohar writes,

Mark Kelly, a Democrat Senator, told me last week. “Today there are 80. China, on the other hand, has 5,500. This is a huge vulnerability.” As Mike Waltz put it at a recent event with Kelly: “We talk a lot about China’s ability to turn off things that they now produce and we no longer do — like pharmaceuticals or rare earth minerals or . . . chips . . . but they literally could turn off our entire economy by essentially choking off that [commercial] shipping fleet and, conversely, turn theirs into warships or into levers of geopolitical influence. It’s just completely unacceptable.”

7. A report says that Solar Energy Corporation of India (SECI) has changed its renewable purchase contracting process by mandating that 75% of its new bids will be based on demand from states against the current practice of aggregating supply and then finding buyers. 

I'm inclined to think that SECI should be wound up. It had some role a decade or so back when renewable power contracting had to be de-risked. Now that its contracting is like the thermal power generation segment, state discoms should be able to make their demand-based assessments and procure power as needed. This will also ensure that the generation is close to demand centres, unlike the current practice of having massive generation concentrated in one or two states with all attendance transmission losses and evauation infrastructure requirements. 

8. Nitin Desai makes an assessment of the Nehru era. 

9. Analysis of Huawei's latest Mate 70 phones, released last month, indicates that the company has mde little progress towards more advanced chips in the past year. The chips appear to have been made using the same manufacturing process as the ones in last year's phones. If correct, this would point to the sanctions being binding constraints on the Chinese technological progress in chip technology. The chips were made by SMIC, the country's largest chip maker, but with a manufacturing process and equipment that TSMC had perfected by 2018. 

10. African countries need to open up their borders to visitors from other African countries.

Citizens from the Democratic Republic of Congo, for example, need visas to access the Republic of Congo. Yet their respective capitals, Kinshasa and Brazzaville, are separated only by the Congo river. A journey between the two takes less than half an hour by ferry. Ethiopia does not guarantee visa-free travel to all citizens of the continent despite housing the headquarters of the African Union... European and US citizens can often travel across the continent more freely than African nationals... 

Intra-African trade made up only 15 per cent of the continent’s trade in 2023, according to the African Export–Import Bank, at $192bn. The African Continental Free Trade Area was borne out of a desire to foster more deals. A key tenet of the agreement, modelled on the EU’s single market, is the free movement of people. The Free Movement of Persons Protocol of the African Union was codified in 2018 to allow African citizens to move visa-free across the continent for up to 90 days, a reasonable amount of time. Yet half a decade after the agreement, only 32 of Africa’s 54 countries have signed up to it and a measly four — Mali, Niger, Rwanda and Sao Tome and Principe — have ratified it. This falls short of the 15 nation-minimum required to bring it into force.

11. Global EV sales by car makers 

This on the challenge facing traditional car makers

It is hard to even imagine how the companies could catch up with Tesla and BYD, which accounted for 35 per cent of global EV sales last year. Rather than trying to build EV manufacturing scale, traditional carmakers should seek out a different route. They might take inspiration from the personal electronics industry, which has outsourced manufacturing to where it is cheaper and better. That would leave them free to focus on features that differentiate EV models such as software and design... 

Tariffs and general protectionism mean that a truly integrated global auto supply chain is a long way off. Carmakers, too, may be reluctant to abandon manufacturing. Factories are hard to dismantle. Should industrial competences lose their importance, design and software companies such as Apple would be well-placed to eat their lunch. Reports that Taiwan’s Foxconn — the contractor which makes Apple phones and much else besides — has been circling Nissan provide some idea about the direction of travel.

12. Chips Act balance sheet

The Chips Act has prompted a doubling of investment in factories, at a total cost to taxpayers of $39bn. The five largest global logic and memory manufacturers are now investing in the US, according to the Department of Commerce. No more than two are active in any other country.

13. The US equity markets tanked and dollar rose sharply following the Fed's 'hawkish' forecast on inflation and rate cuts next year. What are the numbers that triggered this reaction?

Wednesday’s projections showed most officials expect the policy rate to fall to 3.25 per cent to 3.5 per cent by the end of 2026... They also raised their forecasts for core inflation to 2.5 per cent and 2.2 per cent in 2025 and 2026, respectively, and predicted the unemployment rate would steady at 4.3 per cent for the next three years.

These are numbers that a country like the US should consider as representative of a healthy economy. The rates are thereabouts of where it should be given the state of affairs. The narrow goal of driving inflation down to the arbitrarily selected 2% target is distorting reactions everywhere. 

14. Alan Beattie writes that amidst all the talk of protectionism, globalisation has continued apace in 2024.

Two weeks ago, China said it was banning exports of antimony, germanium and gallium to the US, tightening up on restrictions it imposed last year. The problem with this as a threat is that, according to customs data, the US has this year already essentially stopped importing germanium and gallium from China. And yet the American semiconductor producers that use the minerals haven’t noticeably ground to a halt. China continues to export to other countries, notably including Germany and Japan, suggesting that gallium ends up in the US via one route or another. In any case, germanium and gallium aren’t uniquely found in nature in China: they’re extracted from zinc and aluminium ores. If prices are high enough, supply will come. The mining company Rio Tinto is looking to set up gallium production in Canada.

15. Finally, important data points about corporate India's tepid investments

India’s corporate sector turned from a very large net borrower to only a small deficit (to surplus) sector recently. It essentially means that corporate investment has been almost equal to or only marginally higher than the sector’s savings in the past many years (FY17-24), compared to net borrowing of as high as 6-8 per cent of GDP between FY06 and FY11. This is because while corporate savings (the sum of retained earnings and depreciation) were at an all-time high of 13-14 per cent of GDP in the past decade (which possibly picked up further in FY24), corporate investment continued to hover at around 14 per cent of GDP during the corresponding years, compared to above 17 per cent of GDP in many years up to FY16. At the same time, fiscal net borrowing is higher than in pre-pandemic years (though it has come down substantially since FY21), and the household net surplus (ie net financial savings, NFS) declined dramatically in recent years. According to the official data, household NFS were at a four-decade low of 5.3 per cent of GDP in FY23, which we estimate to have improved marginally in FY24. Overall, this suggests that India’s CAD is contained because of the highly cautious corporate sector.

Nikhil Gupta also points to an important requirement for growth to reach 8%.

Assuming that the investment ratio needs to rise by 3-4 percentage points of GDP to 36-37 per cent of GDP in order to achieve 8 per cent real growth, we do not have too much space to fund higher investment through external borrowing (or the CAD). At most, we can widen the CAD by 1.0-1.2 percentage points of GDP, which means that at least two-thirds of the rise in investment has to be funded by the rise in GDS. This seems like a tall task at this time, considering the lack of clarity on further fiscal consolidation post-FY26 and consumer spending... When we analyse the incremental capital-output ratio (ICOR), it is prudent to consider the real net fixed investment ratio rather than nominal gross investment. Compared to the nominal gross investment-to-GDP ratio of 33 per cent, India’s real net fixed investment ratio was 23.5 per cent of GDP in the past three years (FY22-24E), similar to what it was in the pre-pandemic decade (FY11-20). At an ICOR of 3.5 (the average of the 2000s decade, excluding the worst [FY09] and the best [FY04] years), real net fixed investment must rise to 28 per cent of GDP to support 8 per cent real GDP growth. Therefore, whether nominal or real, India’s investment rate needs to increase by 3-4 percentage points of GDP to support 8 per cent real growth. In order to be sustainable, it must be financed by higher GDS, which, to my mind, presents the biggest conundrum to higher growth at this time.

The forbidding trilemma of infrastructure finance

I have blogged extensively on the water privatisation in the UK. This is about the ongoing crisis at Thames Water, this and this are about the balance sheet of UK water privatisation, this is about regulatory failure/capture and returns maximisation incentives of investors, and this is about the UK’s infrastructure privatisation in general.

After teetering on the brink of default, Thames Water has managed to get a proposal from a bunch of creditors for a £3bn emergency loan, enough to cover operations till at least next October or even May 2026. The loan has received government approval. But the emergency loan comes with a headline interest rate of 9.75 per cent, and the company spent over £50mn on advisers in raising the debt. It’s also in the process of finding new equity investors, and restructuring its complex capital structure. 

This is the latest update on the Kemble Water Holdings structure.

However, the government approval for the emergency loan proposal has been criticised by Sir Dieter Helm, who believes it’s a case of endless sticking of plasters. He has instead proposed that Thames Water be placed under a Special Administrator to allow a proper restructuring and enable the management to focus on operations instead of financing negotiations. 

In a paper explaining his views, Helm makes some very important points that are of relevance not only to the present case but to infrastructure and public-private partnerships in general. He has argued that the emergency loan is not only not going to fix Thames’s problems but also risks spreading the contagion across the rest of the water industry. He writes

Thames will probably get sold at a very steep discount in a process controlled by its A-class bondholders, and will probably get broken up. Yet even if this turns out to be a potentially very profitable opportunity to purchase the business for a deeply discounted value, it does not bode well for Thames’s future. The private interests of the sellers in the short term should not be confused with the public interest that a Special Administrator would pursue… it is important to understand why Thames is not a self-righting ship; why it is unlikely to emerge as an efficient water and sewerage company over the next decade; and why the sticky plasters may serve to gradually undermine it further.

He has blamed the crisis at the Thames on a combination of bad management, bad regulation, and the failings of successive governments. He points to fundamental incentive distortions and perversions that detracted the management from working to realise the objectives of privatisation. 

Like all the water companies, Thames was privatised with zero debt (indeed a small cash injection was provided upon privatisation). It (and the other water companies) were privatised in order to run their networks and infrastructures better (bringing private sector cost disciplines) and to raise finance to pay for capital investments on the basis of borrowing so that current customers (and current voters) would not have to pay. The Thames model, like that of the other companies, was pay-when-delivered, not pay-as-you-go.

This gave two tasks to the management of all the companies: run the business more efficiently; and raise finance for capital investment. Thames has turned out not to have done the former very well; and it has used the balance sheet to securitise the business, rather than for the objective at privatisation, which was to borrow solely to invest. In both, it has been at the outer edge of water company performance and gearing… it is worth examining what the incentives have been and why cost-cutting has had priority over capital maintenance. RPI-X as a regulatory rule had the advantage of simplicity at the outset. The regulator would set the (fixed) prices ex ante every five years (originally it was supposed to be every ten), and the companies would maximise profits by minimising costs.

As was witnessed across the privatised utilities, this deceptively simple rule required regulators to be very clear about the outputs that had to be delivered as part of the fixed-price contract, and to make sure that they were actually delivered. In practice, this meant approving the business plan for the period, and having clear, measurable and enforceable environmental and social outcomes. Thames (and others) ran rings around the regulators, and provoked a process of regulatory creep with ever-more complex and detailed interventions by the regulators, which even ended up regulating Thames’s dividends. As a rough rule of thumb, regulators added at least two new mechanisms at each periodic review. The added complexity did not result in greater performance improvements…

The governments, OFWAT, the NRA/EA and the companies all implicitly worked on the basis of an approach that started with what they thought customers could afford and then agreed what could be done for these amounts, rather than starting with the environmental and other outcomes required, and then setting charges at whatever it costs to achieve them efficiently. This is the origin of a context in which a blind eye was turned to environmental failures, and the fines were so low as to be part of the cost of doing business. This affordability criterion has undoubtedly curtailed environmental improvements. All this went under the guise of the quadripartite process in the early periodic reviews… As ever, there is a mismatch between, on the one hand, the demands for higher river and water quality, and, on the other hand, the opposition to bills being raised to pay for these. The belated and relatively sudden imposition of large fines reflects this change of tone. Thames and others could have reasonably assumed that the “implicit deal” around affordability would let them off the hook. What their successive boards failed to realise is that the licence gave them the obligations, and relying on politicians and regulators being objective, rather than following public opinion and media coverage, was always a dangerous strategy to pursue.

He also writes about the egregious operational failings of Thames Water, resulting in the normalisation of untreated sewerage spillages into rivers, asset mapping of its networks, and lagging behind in the adoption of digital technologies to improve maintenance. The biggest failing was its financial engineering and asset stripping, second only to the regulatory failure to spot and prevent it.

What makes Thames more of a basket case than the others is that, in addition to failing on the capital maintenance, it was profit-maximising by gearing up its balance sheet at the outer limits of what was sustainable. This turned out to be the most profitable activity of the company. Whereas the balance sheet had been set up at privatisation to move from pay-as-you-go to pay-when-delivered, Thames (and others) used the balance sheet to mortgage the assets and pay out the proceeds in special dividends and other benefits to the shareholders. All the companies were doing this, but Thames pushed it further (though not as far as, for example, Heathrow Airport, at 95% gearing). 

The reason that this model was so profitable was the combination of very poor regulation and extremely low interest rates. OFWAT is the stand-out case of the failure to protect the balance sheets for the purposes they were intended (although OFGEM has neglected balance sheets too). Indeed, OFWAT stressed the importance of leaving matters pertaining to the capital structure and the balance sheets to the companies. OFWAT sets the cost of capital using the CAPM (capital asset pricing model) and then applies a WACC (weighted average cost of capital) to set the allowed returns. The WACC is an average of the costs of debt and the costs of equity. By definition, it will over-reward debt and under-reward equity – before any other consideration is applied to the tax and other impacts. Hence the simple opportunity: replace equity with debt by mortgaging the assets.

Thames took this to a whole new scale, engaging in whole-company securitisation and creating an offshore set of companies to facilitate this, going under the label of various Kemble entities. It was brilliantly executed, building on a strategy that had its origins back in the mid-1990s when OFWAT (and OFGEM’s predecessors: OFFER and OFGAS) decided not to act to protect the balance sheets… the owners… were simply exploiting the opportunities placed in front of them. OFWAT belatedly recognised the mistake of ignoring gearing and balance sheets, and went so far as to give indications about the sorts of gearing it might like, yet at no point did it run proper pro-forma balance sheets from privatisation setting the gearing against investments not paid for by current customers.

The upshot of this combination of failures – failure by Thames to run itself efficiently; failure by Thames to do the necessary capital maintenance; failure by Thames to understand its assets; failure by OFWAT to get a grip on the balance sheets and prevent the huge scale of financial engineering; failure by the NRA and then the EA to properly enforce environmental standards and performance; failure by governments, OFWAT and Thames to ensure that the periodic reviews provided sufficient revenues through customers’ bills; and failure by Thames to appeal against the OFWAT periodic review determinations – is the sorry mess that Thames now finds itself in.

Further, an investigation by the Office for Environmental Protection has revealed regulatory failure and excessive leniency on sewage spillage by the water companies during normal times by three authorities in the UK - the Department for Environment, Food and Rural Affairs; the Environment Agency; and the Water Services Regulation Authority, which is known as Ofwat.

The Thames Water example is an illustration of three forbidding challenges with private investments in infrastructure - the political economy of ensuring the affordability of service delivery; the incentive compatibility of investors in balancing life-cycle asset management and quality of service delivery (public interest) with maximising their financial returns (private interest); and the capability of regulators in reconciling the interests of consumers and investors. 

In the real world, politicians always face the pressure of keeping a lid on prices/tariffs and generally succumb to it; investors cannot but not subordinate all else to returns maximisation; and regulators fail to keep their eye on their primary objectives, struggle to keep up with the changing practices/trends of the industry, and end up being captured by the regulated. 

Taken together, there’s a forbidding trilemma in infrastructure privatisation and PPPs. Private investments in infrastructure struggle when faced with managing public interest, private returns, and effective regulation! It’s very hard to meet all three challenges simultaneously. 

In fact, it boils down to the fundamental and unbridgeable tension between affordability of service delivery and returns maximisation. This challenge becomes daunting with investors like private equity whose returns maximisation objectives fundamentally conflict with infrastructure assets' risk and returns profile. 

None of this should be taken to mean that we should avoid private investments in infrastructure. Instead, it’s a note of caution on the daunting challenges of making private investments work in real-world contexts. 

Given the political economy, private incentives, and weak and/or vulnerable regulatory capabilities, private investments in infrastructure must be intermediated by simple financing structures, contracts with simple and easily observed outcomes, and an acknowledgement of the real costs of capital maintenance and service delivery. Among investors, it must also be incentivised by lower return expectations (or stability and portfolio diversification objectives). 

Political connectedness and crony capitalism - US edition

Much has been written about the relationship between Donald Trump and Elon Musk, and the serious conflicts of interest it poses for both. In many respects, in both absolute and relative terms, the private benefit for Musk from this relationship, without even any pretensions that characterise such relationships, has the potential to dwarf all other examples of crony capitalism from anywhere in the world.

The potential for serious conflicts of interest are massive, as documented nicely by the Times here. See also this. Musk’s companies have benefited enormously from public contracts.

They are also exposed to regulatory oversight and investigations by federal government agencies. 

In this context, I’m reminded of a seminal and famous paper from 2001 where the economist Raymond Fismandocumented the importance of political connections to the fortunes of companies by studying crony capitalism in Suharto’s Indonesia. He found

To infer a measure of the value of connections, I take advantage of a string of rumors about former Indonesian President Suharto's health during his final years in office. I identify a number of episodes during which there were adverse rumors about the state of Suharto's health and compare the returns of firms with differing degrees of political exposure. First, I show that in every case the returns of shares of politically dependent firms were considerably lower than the returns of less-dependent firms. Furthermore, the magnitude of this differential effect is highly correlated with the net return on the Jakarta Stock Exchange Composite Index (JCI) over the corresponding episode, a relationship that derives from the fact that the return on the JCI is a measure of the severity of the rumor as perceived by investors. Motivated by these initial observations, I run a pooled regression using all of the events, allowing for an interaction between "political dependency" and "event severity." The coefficient on this interaction term is positive and statistically significant, implying that well-connected firms will suffer more, relative to less-connected firms, in reaction to a more serious rumor. My results suggest that a large percentage of a well-connected firm's value may be derived from political connections.

He compared the effect of six episodes on the share prices of firms with varying levels of connectedness (the Suharto Dependency Number 1 representing fewer connections and 5 the most). 

In quantitative terms, he found that in the event of a regime shift a very closely connected firm would suffer a 23 percentage points reduction in share price compared to that for a firm with no political connection. 

Now that Elon Musk is more closely connected with the incoming President in the US than any politician has ever been in any major country, it may be appropriate to look at the Trump Dependency Number for Elon Musk (5) compared with that for the BigTech firms, Banks, companies serving immigration and crime control, and Nasdaq and S&P 500. 

Clearly, the share price of Musk’s only publicly listed company, Tesla, has had a massive Trump bump. Stocks of companies in specific sectors likely to benefit from the policies likely to be followed by the Trump administration, like banks and those involved in immigration and crime control, too have enjoyed the Trump bump. But while their gains were mostly in the first week after the election results were announced, Tesla has continued to gain all through.

Now that the shoe is on the other foot, and the potential for egregious corruption is being normalised in the US as it has been in developing countries, it may be appropriate for American academics to do event studies like this (paper here) and quantify the extent of rents that Musk is likely to extract in the coming months from his proximity to the US President. 

Equally importantly, it might also be useful to document the declines in case when news emerges of their differences or any eventual falling out.

Corporate India struggles to contribute to broad-based economic growth

For some time, the Chief Economic Advisor has been pointing to corporate India’s failure to supplement the central government’s efforts to boost economic growth. The lack of dynamism in corporate India has been a recurrent theme in this blog. See this and this on the balance sheet of corporate India. 

I’ll point to six ways in which corporate India is (not) contributing to broad-based and long-term high-enough economic growth. They have all been discussed on various occasions in this blog itself, and there’s compelling evidence on each. 

1. Wage stagnation. Even as corporate profits have been growing at a strong pace, rising four-fold in the last four years to a 15-year high (4.8% of GDP for Nifty 500 companies in 2023-24), wage growth has stagnated. 

2. Jobless growth. Corporate India was already deleveraging before the pandemic. The pandemic incentivised them to automate extensively. All the while, as mentioned above, profitability continued to rise sharply. The net result was very slow job creation. As a representative sample, consider the statistics from FY24 of the top six groups of corporate India consisting of 69 listed companies employing 1.73 million people - revenues grew 7.3%, profits 22.3%, market capitalisation 43.8%, and headcount declined by -0.2%! And the trend is longer term - in the 2012-19 period, while the gross value added (GVA) grew at an annual average rate of 6.7% the employment growth rate was just 0.01%. Job creation in the manufacturing sector has been stagnant in recent years. 

3. Strong preference to hire workers on a contract basis instead of regular recruitments. In the 2001-02 to 2022-23 period, while the number of workers in formal manufacturing rose from 5.96 million to 14.61 million, the share of contract workers rose from 21.8% to 40.7%. 

4. Reluctance to invest, despite good profits, de-levered balance sheets, and reasonable/stable economic growth prospects. An analysis of 408 non-financial corporates who make up the BSE 500 and form 94-95% of the net fixed assets of the index companies over the 2014-24 period reveals that their share of fixed assets (as a percentage of total assets) declined from 66% to 59% and the ratio of net fixed to financial assets declined from 1.95 to 1.49. 

5. Abysmally low expenditure on R&D, even by the largest companies in the knowledge sectors like pharmaceuticals and IT. Indian firms invest just 0.3% of GDP in in-house R&D, compared to a world average of 1.5%. It has just 23 firms among the global top 2500 R&D investors, whose total spending was just 4.7 billion euros, compared to 596.15 bn euros among US companies, 222.01 bn among Chinese, 116.3 bn among Japanese, 103.77 bn among German, 37.02 bn among S Korean, 35.92 bn among British, 31.66 bn among French companies. 

6. A distinct preference to focus its efforts on expanding toplines through import substitution instead of export competition. This is borne out by the absence of any major consumer brands or globally competitive manufacturers from India. Public policy may have unwittingly played along by not insisting on export competition in the Production-linked incentive (PLI) scheme. 

Supporters of corporate India will argue that these views are efforts by the government to deflect attention from its failings and broader factors beyond its control. They’ll point to the elephant in the room: consumption demand growth. They’ll argue that unless there’s robust aggregate demand, it’s futile, even wasteful, to throw money at the supply (or investment) side. They’ll also point to the uncertainties posed by geopolitical tensions, technology developments like Artificial Intelligence etc.

Critics’ and supporters’ claims are not mutually exclusive. Both are right. Yes, there are genuine aggregate demand concerns, but that cannot absolve corporate India of short-sightedness and unwillingness to contribute to broad-based and sustainable economic growth, especially when their balance sheets are in the pink of health.

Surprisingly, there’s such a paucity of serious research examining these trends and surfacing them for public debates. It’s also due to the dominance of a lazy ideological narrative on India’s economic growth that lays all the blame and responsibilities on the government while overlooking these important failings of the private sector. It’s time that this narrative be questioned. 

Weekend reading links

1. Kerala dialysis care facts

According to data submitted in the state Assembly by Health Minister Veena George, the number of dialysis patients has gone up from 43,740 in 2020 to 1,93,281 in 2023 – an alarming growth of 341 per cent in three years... Currently, 105 hospitals under the Kerala health department, from district hospitals to family health centres or FHCs (previously called primary health centres or PHCs), besides the tertiary care hospitals, have dialysis units. Apart from the government centres, there are roughly around 200 private dialysis centres across the state... According to state-wise data of the Pradhan Mantri National Dialysis Programme (PMNDP), as on October 31, Kerala has 107 dialysis centres and 1,271 functional dialysis machines. Gujarat, a much bigger state, tops this list with 272 dialysis centres and 1,286 dialysis machines. In comparison, Uttar Pradesh has only 78 centres and 884 machines... the cost of a single dialysis ranges from Rs 1,200-2,500 in private hospitals... A patient typically needs 8-12 dialysis in a month and must shell out at least 15,000/month towards it.

2. US equity market exceptionalism

Since the beginning of 2010, in the 15 years till the end of 2024, the US markets have outperformed MSCI World equities in 14 of the 15 years. The only exception is 2017 (the first year of the Trump administration). Since 2010, US equities have outperformed MSCI Developed and EMs (ex-US) by 3.5 times. Over the past 10 years, the S&P 500 has outperformed European equities by 7.7 per cent annually and EM equities by 9.7 per cent annually. Truly exceptional numbers! The US today accounts for about 67 per cent of the MSCI World equity indices, meaning that corporate America is worth more than twice all other markets combined! The next biggest market is Japan, with an index weighting of only 5 per cent... If we look at the S&P493 (ex-Magnificent 7), and compare them to European Union equities, there is a valuation premium US companies enjoy across every major sector. This valuation premium is linked to structurally higher returns on equity.

3. The global volume of structured finance debt (which excludes real estate and traditional corporate loans) has hit $380 bn in 2024, the highest since 2007.

The boom in complex — and often riskier — deals highlights how buoyant markets and persistent US economic strength are allowing bankers to sell more esoteric products to investors keen to lock in high fixed returns... Deals in recent weeks have been tied to franchisee fee revenue of the US restaurant chain Wingstop, oil sales from ExxonMobil-backed wells and the demand for computing power and space provided by data centre operator CloudHQ... Other recent deals have required investors to scrutinise the finances of US homeowners who have installed Tesla solar panels and the music catalogues of Shakira, Bon Jovi and Fleetwood Mac... 

Structured finance has been a boon to Wall Street at a time when other parts of the investment banking business remain muted, with fees rebounding but still down from where they were a few years ago. Underwriting fees, as a percentage of deal size, for structured products tend to be higher than government bonds and plain-vanilla corporate debt. Such deals are also alluring to investors because they typically offer higher yields than traditional bonds while still locking in returns. Meanwhile, insurance companies and other professional investors have been seeking places to deploy the wave of assets coming from retirees and others seeking income-producing investments.

4. Taylor Swift wraps up her epochal Eras tour.

Through its 149th and final show, which took place in Vancouver, British Columbia, on Sunday, Swift’s tour sold a total of $2,077,618,725 in tickets. That’s... double the gross ticket sales of any other concert tour in history... Coldplay had set an industry record with $1 billion in ticket sales for its 156-date Music of the Spheres World Tour — a figure that is just half of Swift’s total for a similar stretch of shows in stadiums and arenas... Every date on the Eras Tour was sold out, and spare tickets were scalped at eye-popping prices — or traded within the protective Swiftie fan community, often at face value. According to Swift’s touring company, a total of 10,168,008 people attended the concerts, which means that, on average, each seat went for about $204. That is well above the industry average of $131 for the top 100 tours around the world in 2023, according to Pollstar, a trade publication... 

They exclude her extraordinary merchandise sales, for example, a product line so in demand that Swift opened stadium sales booths a day early in some markets to sell T-shirts, hoodies and Christmas ornaments to fans, ticketed or not... In October 2023, she released “Taylor Swift: The Eras Tour,” a nearly three-hour concert film, released through a direct distribution deal with AMC Entertainment, the world’s largest theater operator. It sold about $93 million in tickets during its opening weekend, and ended up with $261 million in worldwide grosses, according to Box Office Mojo. The next step was a streaming deal with Disney+. A 256-page hardcover tour book, released last month through Target stores, sold 814,000 print copies in its first two days on sale.

5. The US stock markets have been on a tear.

John Hussman has some words of caution

It may be surprising... that US non-financial profit margins before interest and taxes have been nearly unchanged for 70 years. The drivers of rising profit margins have been reductions in corporate tax and interest rates. Most of the impact of tax cuts was in place by the mid-1980s. Since 1990, the ratio of interest expense to gross value-added has plunged. S&P 500 operating profit margins have moved inversely to declining Baa-rated bond yields, a benchmark of corporate interest costs. A wave of debt refinancing in 2020 and 2021 has deferred the impact of the recent advance in interest rates until now. That bill is coming due. Despite all the society-changing innovations in recent decades, real US GDP growth has averaged just 2.1 per cent annually since 2000, compared with 3.7 per cent during the preceding half-century. Without accelerated population and labour force growth, even restoring the productivity growth of the pre-2000 period would boost real GDP growth by just 0.5 percentage points annually. Meanwhile, real US GDP currently stands 2.6 per cent above the Congressional Budget Office estimate of full-employment potential. Such gaps are common late in economic expansions, and their typical erosion over the next 2-4 years tends to be a headwind to growth. Given prevailing labour force demographics, trends in productivity and the current gap between GDP and its potential output, a reasonable baseline for four-year US real economic growth may be well below 2 per cent annually. The latest new era is only part of an endless cycle. Extremes such as the present have been extraordinarily rare in history, and provide investors with the opportunity to examine their exposure and tolerance for risk. At such moments, it may be helpful to exchange extraordinary optimism for a calculator.

6. Alan Beattie argues that despite all the gloom about rising protectionism and deglobalisation, countries generally remain open to trade and atleast keen on exports, and thus subject their companies to compeition. 

7. Martin Wolf has two important graphics. First on the declining economic growth rates in the developed world.

Second on the declining productivity growth rates.

8. Since opening its real estate division in India in 2007, Blackstone has risen to become the country's largest landlord, and its India portfolio is the third largest in the world (after US and UK). It has the largest office space portfolio, (111 million sq ft), second-largest shopping mall portfolio, and second-largest industrial real estate developer (50 million sq ft). 

9. Finally, for all talk of sustainable investing, investors seem to find fossil fuel companies more attractive bets than those pursuing climate change mitigation. NYT has an article that compares the contrasting stock market performances of Exxon with that of green-transition friendly companies BP and Shell.  

BP pledged in 2020 to cut its oil and gas production 40 percent by the end of the decade. Less than three years later, it backtracked and said it would increase spending on fossil fuels. The company wrote off $1.1 billion in offshore wind investments last year and recently said it wanted to sell other wind assets, though it continues to invest in renewable energy... Shell has softened or discarded some of its emissions-reduction targets, as it scaled back growth expectations for its renewable power business.