Sunday, April 19, 2015

India and the AIIB

Last week the Chinese government announced that 57 countries, including India, have agreed to join the Asian Infrastructure Investment Bank (AIIB). The process of preparing the institution's shareholding pattern, governance framework and lending rules will soon start. So what should be India's strategy?

Foremost, India should realize that it is second only to China in all the parameters - GDP, population, actual infrastructure investments, financing needs and so on. But the politics and economics of joining AIIB pulls in different directions for India. 

Politically, it is undoubtedly in India's interest to not to be not part of the founding of an institution which now holds some global geo-political significance. India should aspire to a seat at the top of the table in an institution that has the potential to become one the leading multilateral financing institutions. But economically, India could well stay out of AIIB and not lose much. Its infrastructure investment needs are massive, nearly $ 1 trillion targeted for the 2012-17 period. The AIIB's contribution can, at best, be just a drop in the ocean. In fact, given its modest initial capital ($50 bn) and the perception discount (among investors and countries) associated with an institution that is clearly dominated by China, one could argue that economically the institution would benefit more from India's presence than India would. It is therefore safe to argue that the AIIB needs India atleast as much as India needs AIIB. India needs to leverage this to its advantage as it negotiates the Articles of Agreement (AoA) of the AIIB. It should not become just another invitee to a Chinese triumphal party.

Given the deep Chinese interest in displaying how the new institution will be fairer and more equitable than the Bretton Woods twins, India has the opportunity to play ball with China over negotiations on the AIIB's governance framework. Furthermore, given China's dominance in AIIB (its initiative, headquarters, leadership position etc), a framework which is fairer and more equitable than the Bretton Woods institutions would involve considerable sacrifices by China and gains for countries like India. 

Apart from the limited financing opportunities, what should be India's possible takeaways from an AIIB? 

1. India should push the AIIB away from multilateral sovereign lending and towards project finance lending. A country like India should have limited interest in sovereign loans and should be more concerned about using all potential sources to leverage international long-term capital to finance its, predominantly, privately financed infrastructure projects. For example, like with the case of World Bank and IFC, even a small AIB share in a project could serve as a credit enhancement and help crowd-in international capital at lower cost than otherwise. 

2. India should advocate issuance of bonds by the AIIB in not just dollar and renminbi (as is most likely, since China would not lose this opportunity to promote the renminbi as a reserve currency), but also rupees. This would help in the internationalization of the rupee as well as help Indian borrowers more cost-effectively hedge their losses and thereby lower the cost of their foreign capital. 

3. India should strive to use the AIIB as an instrument to promote the interests of its own infrastructure firms. It should not be a surprise if China uses the cover of AIIB lending to promote contracts for Chinese firms. There is a strong likelihood of this given the perception that China could use the AIIB to formalize the massive lending currently being undertaken by institutions like the China Development Bank, all of which are conditioned on awarding contracts to Chinese firms. In that case AIIB could become an extended arm of Chinese aid diplomacy. Instead, India should negotiate hard to ensure a level-playing field for Indian firms.

4. The bonds issued by the AIIB could be a potentially good source of risk diversification as well as earning higher returns for India's growing foreign exchange reserves, a large share of which are currently invested in low-yielding US Treasuries. In fact, India should use its reserves and unilaterally match any Chinese contribution either by subscribing to bonds or equity capital. 

China high-speed rail fact of the day

From Forbes,
An average kilometer of HSR track in China costs between $4.8 million USD (Jiaoji Line) to $32.7 million USD (Zhengxi Line), which is significantly less than the estimated $380 million USD to $ 625 million USD it will cost for laying down the British HSR2 project.
The cost variation is a truly stunning differential, which defies all conventional explanations. 

My guess is that the Chinese estimates do not cover many requirements ('right of way' procurement etc) and excludes the massive subsidies (cheaper land and other inputs, cost of capital, tax concessions etc) enjoyed by Chinese equipment makers. Even with these and assuming the highest efficiency standards among Chinese developers, there is still a lot of explaining to do. 

Saturday, April 18, 2015

The declining capital intensity and secular stagnation

Barry Eichengreen (via Mark Thoma) examines the various explanations for secular stagnation,
Four explanations for secular stagnation are distinguished: a rise in global saving, slow population growth that makes investment less attractive, averse trends in technology and productivity growth, and a decline in the relative price of investment goods. A long view from economic history is most supportive of these four views. 
The same investment projects can be pursued, it is hypothesized, by committing a smaller share of GDP, and any additional projects that might be rendered attractive by this lower cost of capital are not enough to offset the decline in the investment share. With less investment spending chasing the same savings, the result can be lower real interest rates and, potentially, a chronic excess of desired saving over desired investment.
He has this graphic which highlights the declining relative price of investment goods. 
While this may be true of many developed economies, where the services sector predominates, it may be less so with developing economies. In these countries, manufacturing still makes up a significant share of the GDP and services a less dominant one. This is one more reason for appreciating the international dimension of secular stagnation hypothesis. Once we assume an open economy, the potential for mutually beneficial outcomes from international trade and cross-border capital flows are immense. 

Friday, April 17, 2015

The case for universal social safety net for job creation

The Times points to a new study from the US which highlights how the tax-payers subsidize low-wage paying employers,
Poverty-Level Wages Cost U.S. Taxpayers $152.8 Billion Each Year in Public Support for Working Families... state and federal governments spend... on four key antipoverty programs used by working families: Medicaid, Temporary Assistance for Needy Families, food stamps and the earned-income tax credit, which is specifically aimed at working families... Taxpayers pick up the difference, he said, between what employers pay and what is required to cover what most Americans consider essential living costs... About 48 percent of home health care workers are on public assistance... So are 46 percent of child care workers and 52 percent of fast-food workers.
This carries important lessons for India, where nearly 90% of the employment is in the informal sector, with all its inefficiencies. These are predominantly low-paying jobs and covers all sectors - construction, services, manufacturing etc. An important reason for such pervasive informality is the high cost of going formal. Mandatory contributions to pensions, insurance, and so on make labor prohibitively expensive for most employers. 

The overwhelming majority of the recipients of the (informal) market determined compensation get just about subsistence wages. Since it does not cover the requirements of secondary and tertiary health care, children's education, old-age pensions, etc, they have to fall back on public systems. But our social safety nets are both too weak and inadequate to meet this demand. Mandatory contribution requirements are legislated to cover this deficiency.        

The government therefore faces a dilemma. Whereas not making contributions mandatory would be politically incorrect, especially when public systems cannot satisfactorily meet all social safety responsibilities, doing so would be the surest way of driving more employment underground. This can be resolved only with a basic universal social safety system that covers atleast all the essential requirements for a dignified life - assurance against catastrophic life illness, scholarships for children to pursue higher education, and old-age pensions. 

Apart from this, as I have blogged on several occasions, a universal safety net also provides the political cushion to push through several important labor, taxation, subsidy, and liberalization reforms. The biggest obstacle however is that the government is fiscally strapped to finance such a program. In the circumstances, the best strategy is to consolidate existing social safety interventions and gradually expand their scope and coverage. 

Thursday, April 16, 2015

China graphics of the day

1. Max Roser tweets this stunning graphic that captures the change in night lights over Beijing area over the 1992-2009 period, reflecting the region's rapid pace of development.
2. Zero Hedge points to the potential headwinds faced in sustaining this pace of development. The country's latest trade data appears alarming. Trade surplus has nose-dived,already sluggish exports have fallen into the red, and imports continue to remain deeply in the red.
This graphic should ring alarm bells in India about a potential devaluation by China with its adverse consequences on India's exports, especially important given the country's ambitious 12% targeted annual exports growth till 2019-20. And it is not just a trade imperative that could drive the renminbi's devaluation. For a country exiting, and swiftly at that, massive credit and housing bubbles, and where deflation looms large, a prolonged duration of monetary accommodation, even multiple rounds of quantitative easing, looks inevitable. This too would add to the downward pressure on the renminbi. Given that Chinese exports compete with that of its larger emerging market peers, the prospects of currency wars are not far-fetched. 

Wednesday, April 15, 2015

The risks with courting Chinese investments

I had blogged earlier here and here urging caution with accessing loans from countries like China and Japan. In this context, Foreign Affairs has a nice cautionary tale about Chinese investments in Sri Lanka, totaling nearly $5 bn in loans since 2010, which describes them as 'predatory lending', 
Chinese investment loans are top-down. They are mostly designed to narrowly curry favor with the leadership, particularly with officials who served under the recently ousted President Mahinda Rajapaksa. These investments rarely generate downstream economic returns and thus breed tremendous resentment among the Sri Lankan public... most of the loans China offered were for “white elephants” masquerading as productive infrastructure investments. In other words, they are mostly vanity projects—a new cricket stadium, airport, and seaport (all built in Rajapaksa’s home district), as well as a new theater and a partially built communications tower in Colombo—that are considered frivolous, poorly planned, and debt generating... 
construction projects largely financed by China’s Export-Import Bank often come with a caveat: that contracts be awarded to Chinese state–owned companies, which then bring their own labor and raw materials... They force Sri Lankans to borrow at high rates for projects that economically benefit the lender, China... high (sometimes floating) interest rates of three to six percent; undisclosed conditions such as exclusive usage rights; and the absence of competitive bidding, transparency, or accountability, which sometimes results in low-quality products... China has also been blamed for saddling Sri Lanka with unnecessary debt, saturating it with tens of thousands of Chinese workers, and treating the country as a “colony” and Sri Lankans as “slaves.”
Though some of these concerns are not so much relevant to India, many are. Fundamentally any Chinese loans are sovereign debt of India. In a world awash with credit, and at a time when India stands apart as the most attractive emerging market investment destination, does it require such Chinese loans? Especially with the exchange rate, interest rate, and political risks associated with Chinese lending, not to speak of the procurement and contracting conditions? 

But turning away cheap creditors may not be the wisest thing for an investment starved economy like India. A more appropriate strategy may be to encourage the Chinese creditors to lend to Indian corporates or specific project entities. The Government of India would do well to create the enabling conditions for India's private sector and project developers to access financing from entities like the China Development Bank. The Chinese could potentially become one more credit channel for private entities. 

The Chinese creditors too are likely to find India's largest corporates and big commercially viable infrastructure projects more attractive lending targets than those elsewhere. But whether the Chinese are willing to play the ball on this remains to be seen. 

Monday, April 13, 2015

On lateral entry into civil service

I have an oped in Indian Express today advocating a nuanced approach to allow lateral entry into leadership positions in Government of India.