Sunday, December 30, 2018

Year-end graphical summary

1. A summary of what to look out for in 2019 - Donald Trump (what the President does on trade, squeezing China, foreign policy, stand-off with Fed, domestic policy, Mueller investigations, and anything new always likely with him), China (the uncertainties on credit flow and debt sustainability coupled with the impact of trade wars), Europe (Brexit end-game, the fate of the Italian Job and its influence on others), EMs (elections in Nigeria, India, Indonesia etc; domestic growth), and geo-politics (Iran and Middle-east on oil, China in its near abroad).

There are likely other side-events - regulatory actions on technology companies in the US, . The equity prices and bond yields will respond accordingly.

2. At 114 months, the current US economic expansion is the second longest since the War, and will break the record if it survives 2019. One model predicts an impending recession.
3. As a turbulent December ends and uncertainty looms, this progression of IMF's forecasts of the world economy and its constant downwards revision is instructive.

4. The equity markets tanked in the last quarter, but not before continuing its run that catapulted Apple to the top of the charts. Reflecting on the froth in the tech market, this from Ruchir Sharma is stunning,
For the price of Apple you could have bought all the companies in three of the largest markets of Southeast Asia: Indonesia, Malaysia and the Philippines. Or all the public companies in the three largest markets of Eastern Europe — Poland, the Czech Republic and Hungary — nearly three times over... the markets of the Philippines, Malaysia and Indonesia together trade less than $1 billion a day, compared with about $6 billion a day for Apple alone.
5. Cash and Treasuries emerged as the best performing asset categories. EMs slipped from top of class last year to bottom of class!
6. This graphic captures Argentina's periodic efforts to sharply devalue its currency.
7. How the chart below plays itself out on the actual implementation of the proposed trade sanctions will be critical for the fortunes of the global economy.
8. Like it has been each of recent years, what happens in China will perhaps be the most important contributor to the prospects for 2019. Credit growth (led by steep decline in shadow banking credit), land sales, manufacturing activity, and consumer sentiments are all facing headwinds and showing downward trends.

9. The stock market story of 2018 was the "de-faanging" of the FAANG stocks. All of them under-performed the S&P 500.
10. EM Currencies had a bad year, falling against the dollar. India was the worst performing Asian currency.
11. All the major indices returned negative for the year.
12. Finally, capturing the near complete partisan nature of political debates in the US is the graphic below.

Wednesday, December 26, 2018

Central banks and independence from politics and Wall Street

The year may have initiated a decisive debate on the issue of central bank autonomy. And if it ends up upending the conventional wisdom, then the central bankers and their supporters in the financial media have none but themselves to blame. 

In the aftermath of the taper-tantrum I had cautioned about the dangers of central banks' hankering for technocratic independence from the political economy. More recently, after the RBI Deputy Governor's speech, I had questioned the empirical basis for the claims of the superiority of pure technocracy over democratic political economy in macroeconomic decision-making. 

Robert Skidelsky hits the nail on its head and makes a clarion call, 
Monetary policy is neither particularly effective nor politically neutral. Since governments, not central banks, are accountable for the results of policy, macroeconomic management cannot be outsourced to central banks. The two arms of policy, fiscal and monetary, need to be integrated. The experiment of independent central banks has to be brought to an end.
Let's examine the balance sheet of central banks from two dimensions - macroeconomic stability and financial market stability. The first demands independence from politics and the second independence from financial markets. 

It is impossible to credibly assert that central bankers and their actions have been major contributors to the Great Moderation with its low inflation basis. It's just that there have been too many structural things going on - trade liberalisation, globalisation, wage restraints, technology, EMs and China etc - which undoubtedly kept inflation down and helped the world economy chugging along. The only thing that we can definitively say is that they did not screw up things or played along. 

At no point during the quarter century did they face the sort of political economy trade-offs that Paul Volcker undoubtedly faced in early eighties. Central banks played along to keep the party going - invariably being behind the curve in deflating bubbles (and engendering bubbles) and tightening late, and rarely being behind the curve during recessions to loosen the strings. Why would therefore the political masters have had any problem with central bank policy stances? What did the rockstar central bank governors actually do to enjoy their current reputations, beyond being actors in a narrative that has limited empirical basis? It also begs the question whether central bankers' aura of importance is just a legacy of the memory of Volcker's rate hikes to slay inflation?

So the central bankers did little to earn independence from politics. In fact, there was nothing in their actions for politicians to demur. 

On financial market stability, it cannot be denied that they have to take a good share of the blame for the financial instability engendered by both erring on the side of caution to keep credit taps loose at all times and in offering the monetary policy 'put' to backstop equity markets. Sample this from John Mauldin,
The last three Federal Reserve Chairs have acted like the Fed has three mandates: the two official ones (low inflation and full employment) and an unofficial third one: making sure asset prices rise as the market wants. Not just the stock market, but real estate and all other investment assets. It started with the Greenspan “Put” which morphed into the Bernanke Put (remember the taper tantrum?) and reached its apex with the Yellen Put. And what did we get? A series of bubbles. As Stan Druckenmiller says, the really big Fed mistake was when Greenspan kept rates too low for too long in 2003–2004, setting up the housing bubble and Great Recession. He clearly helped the massive bubble in 1999–2000. Then Bernanke’s reluctance to raise rates above zero in 2012–2013, when the economy was manifestly recovering, refueled the asset price bubble. Yellen continued that course. Her reluctance to raise rates until Trump won the election, the economy was booming, and unemployment clearly falling was inexcusable. The Federal Reserve should be just as concerned about Main Street as it is about Wall Street.The serial bubbles of the last 30 years all had serious negative consequences.
So, in terms of independence from financial markets, the central bankers have shown a remarkable consistency in responding to its concerns even at the cost of all others. As Mauldin highlights, they have had their opportunities to break-free and squeeze the credit taps to pre-empt the build-up of bubbles. That would have a demonstration of true independence, from both the politicians and the financial market. But nothing of that sort happened.

If their role in the Great Moderation was neutral and in engendering financial bubbles was negative, then on the net, how do we explain the superiority of technocratic wisdom which has had a free-run over the past quarter century in the developed economies? They have exhibited independence from neither politics nor financial markets.

In fact, the true test of the mettle of a critical decision-maker like a central bank Governor is how they respond in difficult times. To follow the models and conventional wisdom in good and bad times (and generally, or always, in terms of expanding) is perhaps the easiest thing to do, especially for an academician or a technocrat. Further, it is unlikely to trigger opposition from politicians. The difficult thing is to constructively engage with the government in responding to difficult situations, where there are trade-offs to be made. Sadly the last two Governors of RBI have fallen short in this regard, in stark contrast to their predecessors.

In contrast, and especially in light of what their rockstar counterparts in the West did, in India, the RBI, manned by mere bureaucrat Governors, did a remarkably good job in the lead-up to and in the management of the global financial crisis. Their scepticism about excessive financialisation, caution with capital flow liberalisation, and application of a heterodox toolkit to address financial market stability has now come to be applauded

Then too the poor bureaucrats were criticised for their conservatism. Many leading economists, including Raghuram Rajan, and organisations like the IMF have long called for India to allow capital account convertibility in varying degrees. The financial media opinion makers had been assailing the government for dragging its feet. As an aside, when I wrote urging caution with capital account liberalisation, one worthy among India's opinion makers showered ad hominem on bureaucrats,
When some Indian bureaucrats have argued in favour of a closed capital account at international forums, they have faced amusement from the audience. No country has taken this idea seriously.
As a perfectly plausible counterfactual, it would have been very easy for Dr YV Reddy to have accepted the superior wisdom and ease capital flows. Given the prevailing global market trends and the domestic growth momentum, capital would have rushed in. The markets would have doubtless cheered. The politicians too would have been happier.

And we would have been picking up the pieces from an even bigger banking crisis. But thank God, these bureaucrats did what they do best and did not fall into the thrall of the supposedly superior wisdom of academic scholars. 

Given all this, ironically, doesn't it make sense to say that one of the signatures of a good monetary policy action during boom times is the "wrath of markets"? Then it is more likely that the central bank is actually doing its job. 

Mauldin applauds Jerome Powell and writes that his words and actions are a reminder to everyone that the Federal Reserve is regaining its independence from Wall Street. Powell's determination to put sand on the wheels of financial markets and stabilise market activity comes out looking like a breath of fresh air. If he survives and continues with what he would be doing, this would perhaps become a neo-Volckerian moment in central bank history. But it is not a good reflection on central bank independence that it has a taken almost three decades of rockstar Fed Governors to have someone actually indulge in a substantially high-stakes trade-off monetary policy stand-off (with both the politicians and the markets). 

This by TT Rammohan is a very balanced commentary on the debate in India about RBI's autonomy.

I feel that the Indian financial media commentators and academic researchers (especially the foreign-based ones), the former feeding from the latter, have completely lost their objectivity in assessing the issue of RBI autonomy. Captured (to varying degrees) by the hegemony around the superior wisdom of central banking technocracy, they appear blind to the empirical evidence.

It is perhaps not incorrect to say that they have become a self-serving clique which feed on each other. Once someone who fits the narrative becomes the Governor, the hosannas begin, the 'confidence fairy' rises, stocks boom, the Governor is praised even more, and central bankers start behaving like infallible rockstars. In this environment, anything that government disagrees with the central bank, irrespective of the merits, is scorned on. Governments are criticised. The central bank    plays along conveniently. Some of the articles in Indian media in recent days disparaging the appointment of bureaucrats and endowing some other-worldly wisdom on economists are downright pathetic.

Forget this government in Delhi, the opinion makers would be shrill with anything seen (and actually pretty much anything can get projected so in today's world) as an attempt to encroach on the so-called central bank independence. This government only makes the noise shriller.

In conclusion. There is nothing superior about the technocracy of central bankers compared to the rough-and-tumble of democratic politics. There is also nothing superior about the wisdom of academic researchers that endow them to be better central bankers. These are narratives that have no empirical basis. 

Tuesday, December 25, 2018

The development value proposition of consultants

The NYT had this takedown of McKinsey accusing it of shoring up the stature of authoritarian governments and indulging in dubious business practices.

Now Tyler Cowen of Marginal Revolution springs to the support with this article. He writes,
One of the biggest, most positive (and most neglected) global trends over the last 30 years has been the spread of managerial and technocratic expertise to what used to be called “third world governments.” In most countries, the central banks, the public health authorities, the treasuries and many other public-sector institutions now collect good data, hire Western-educated advisers, and try to implement good solutions. This is true in both the democracies and most of the autocracies, with North Korea a notable exception. Although there is still a long way to go, this spread of technocracy has helped bring amazing increases in life expectancy and declines in child poverty, while making the world far wealthier and freer... these developments are what McKinsey stands for and has tried to accomplish, and any highlighting of the negative should be counterbalanced by this positive trend.
Well, this is a teachable moment in terms of regurgitation of an entrenched narrative. Talk about evidence-free claims. Where is the evidence that the public bureaucracies in developing countries have internalised some new expertise which has contributed to their achievements? Where is the evidence that it is this "managerial and technocratic expertise" that has contributed significantly to all that great progress? Even assuming the value of such expertise, where is the evidence that they have seeped into public bureaucracies from management consultants? 

In countries like India, where consultants nowadays roam around freely across government corridors dispensing largely spurious damaging wisdom, I am inclined to think that the net balance is now increasingly negative. Sample this on their impact on international development.

Sunday, December 23, 2018

Weekend reading links

1. Mumbai just needs to prioritise its transportation infrastructure resources on its commuter rail and buses. Sample this,
Many more commuters (150,000) arrive in South Mumbai by train in one hour than the number that travels by car on the Sea Link (100,000) all day. In just three hours during the morning rush, the trains ferry many more people (450,000) than all four road arteries do (400,000) all day.
2.  Fascinating article in The Economist on the idiosyncrasies associated with American cities. Sample this,
Los Angeles is a striking example. The county is home to 88 incorporated cities, ranging in population from 76 (Vernon) to 3.9m (Los Angeles itself). Beverly Hills (population 34,506) is its own city, with its own police force, fire department and school district. So is Santa Monica (92,495). Even Vernon has a police department, with some 50-odd staff. All told, the county has about 30 fire departments, more than 40 police departments and 80 school districts. Los Angeles is extreme but not unusual. Alabama’s Jefferson County, which is one of seven counties in the Birmingham area, is home to 35 municipalities, including Cardiff, population 45.
The reason,
America’s constitution goes to great lengths to demarcate state and federal powers. The Tenth Amendment explicitly reaffirms that “powers not delegated to the United States by the constitution, nor prohibited by it to the states, are reserved to the states respectively, or to the people.” Cities derive their power from state governments... All but 11 states follow “Dillon’s Rule”, named after a 19th-century judge, which holds that municipalities only possess powers specifically granted to them by state law... Most states make it difficult for a city to force its neighbours to join it. Only eight states allow municipalities to annex territory unilaterally. Eight require the state legislature to change municipal boundaries. The overwhelming majority, 29 states, require a referendum in the areas to be annexed, according to an analysis by Greg Lindsey of the University of Minnesota. These votes often fail. Residents of unincorporated areas resist annexation, fearing a greater tax burden. Those in already rich suburbs fret about sharing their taxes with the poorer core city and merging of school districts. Municipalities avoid annexing poor neighbourhoods because they cost more to service than they provide in revenue. In places like Birmingham, blacks worry that rich, white suburbanites will usurp their hard-won power.
The result,
A map of the incorporated areas of Jefferson County clarifies matters somewhat: dozens of independent cities slot neatly into the gaps around Birmingham like a tricky jigsaw puzzle. From the air, it may appear that Birmingham sprawls but, in an administrative sense, the city is constrained. This is a problem. Cities that are unable easily to expand their boundaries are poorer, more segregated, have higher concentrations of poverty, lower growth, worse municipal bond ratings and less well-educated workforces... 
The result is duplication and waste as municipalities each pay councillors, police and fire departments, waste-collection agencies and school administrators to perform the same services. Cities are reluctant to co-operate even on menial things like waste collection, fearing an erosion of their independence. Fragmentation is one of the main reasons that many cities are poor at providing public transport. Businesses use fragmentation to their advantage, making known their interest in moving to a metropolitan area and playing its constituent cities off against each other... Firms win tax breaks and other enticements; employees’ use of infrastructure puts a further burden on the whole conglomeration. 
And this about how it deepens inequality,
The jigsaws also deepen inequality. Small, wealthy cities can afford better schools. No matter how much young white couples enjoy living in restored downtown lofts and strolling to artisan coffee shops full of reclaimed wood, they eventually move to suburban houses in superior school districts when they have children, taking their taxes with them. Struggling cities get poorer; comfortable ones get richer. It is, for families, a sensible decision: four of the five best school districts in Alabama are in the suburbs of Birmingham, according to Niche, a website. Mountain Brook, a Birmingham suburb, is home to the highest-ranked school system in the state. Its median household income is four times that of the mother city. Its poverty rate is one-seventh.
3. A new paper finds evidence of what was always suspected, that corporate philanthropic donations often carry a business agenda. The authors examined a comprehensive sample of public commentary made by firms and non-profits within US federal rule making in the 2003-15 period and the IRS data on those firms' donations. They analysed the interaction of non-profit organisations and large corporations within the US federal regulatory environment across a wide variety of sectors ranging from banking to environment and found,
First, we show that, shortly after a firm donates to a non- profit, the grantee is more likely to comment on rules for which the firm has also provided a comment. Second, when a firm comments on a rule, the comments by non-profits that recently received grants from the firm's foundation are systematically closer in content similarity to the firm's own comments than to those submitted by other non-profits commenting on that rule. This content similarity does not result from similarly-worded comments that express divergent sentiment. Third, when a firm comments on a new rule, the discussion of the final rule is more similar to the firm's comments when the firm's recent grantees also comment on that rule. These patterns, taken together, suggest that corporations strategically deploy charitable grants to induce non-profit grantees to make comments that favor their benefactors, and that this translates into regulatory discussion that is closer to the firm's own comments...


The paper presents evidence that corporate foundations’ charitable grants reach targeted non-profits just before those same non-profits engage in public commentary... the content of the messages simultaneously communicated by non-profits and by corporations appears systematically closer in terms of textual and semantic similarity in presence of a charitable contribution provided immediately before those comments are filed. While circumstantial, the evidence seems to point to potential concerns in the assessment of prima facie independent information on the part of targeted regulators, who may be unaware of the philanthropic grants that realize in the backdrop and may interpret similar comments stemming from different segment of the public spectrum as indicative of merit.
4. As this NYT investigation on Facebooks user's private data sharing partnerships with corporate clients without the prior informed consent of its users show, the company's management (and that is effectively two  people) continues to plunge new depths in demonstrating its incompetence in management.
For years, Facebook gave some of the world’s largest technology companies more intrusive access to users’ personal data than it has disclosed, effectively exempting those business partners from its usual privacy rules... The exchange was intended to benefit everyone. Pushing for explosive growth, Facebook got more users, lifting its advertising revenue. Partner companies acquired features to make their products more attractive. Facebook users connected with friends across different devices and websites. But Facebook also assumed extraordinary power over the personal information of its 2.2 billion users — control it has wielded with little transparency or outside oversight. Facebook allowed Microsoft’s Bing search engine to see the names of virtually all Facebook users’ friends without consent, the records show, and gave Netflix and Spotify the ability to read Facebook users’ private messages. The social network permitted Amazon to obtain users’ names and contact information through their friends, and it let Yahoo view streams of friends’ posts as recently as this summer, despite public statements that it had stopped that type of sharing years earlier... They also raise questions about whether Facebook ran afoul of a 2011 consent agreement with the Federal Trade Commission that barred the social network from sharing user data without explicit permission.
These violations go much beyond poor management and border on personal data theft and malfeasance. It is staggering that the Chairman and COO of Facebook are still ensconced on their jobs. Like earlier instances, in keeping with incompetence in crisis management, the company delayed, denied, and deflected in responding to the latest exposure.

As Rana Faroohar has written here, the management disasters at Facebook and Tesla demonstrate the challenges when businesses grow too fast and continue with the culture and ownership structure of growth-seeking start-ups, and its owners and managers do not have the talent and expertise required to develop robust management capacity needed to run big businesses. 

It's one thing to invent a new technology. It's an altogether different thing to make a sustainable commercial business out of that. This is one of the best known axioms among investors. The how did they trust the likes of Zuckerberg and Musk (and continue to do so with their ownership) to manage large companies?

5. Finally, Anil Swarup lays the blame on Vinod Rai for decision-paralysis in Indian bureaucracy. He tears apart the presumptive loss audit on coal blocks. And I concur completely on his role, but think it goes much beyond Vinod Rai.

Friday, December 21, 2018

Mass transit project woes

Triple-blows before the year end for transportation projects in UK.

The smallest one was the delay in the £1 bn Northern Line extension to the Battersea area by a year to 2021, with attendant, as yet unassessed, cost over-runs.

But the bigger blows came by way of similar assessments of HS2 high speed rail project and Crossrail. The former is expected to significantly overshoot its £56 bn budget. The project has been constantly under the spotlight over questions about the reliability of its project reports and estimates. 

The latter, expected to increase London metro's network by 10%, had been showcased as an example of Britain's ability to deliver large infrastructure projects on time and was expected to have opened this month. Instead the £16.8 bn project is expected to open atleast two years late and with a cost over-run now of £2.2 bn. The project which involved digging 26 miles of tunnels below London's honeycombed soil and clay and 10 large stations was initiated in 2008 and was being executed autonomously through an SPV under the Transport for London (TfL). 

The news comes as a surprise given the aura of private sector efficiency which the project has projected till date,
Crossrail was supposed to be a state of the art scheme, transforming travel in London by adding more than 10 per cent to the capacity of the network. Delivered by a commercially savvy team insulated from politicians’ meddling, it would show that private-sector discipline could deliver public-sector projects on time and to cost... The mess has claimed the scalp of Terry Morgan, who stepped down as Crossrail and HS2’s chairman this month amid allegations of mismanagement... Keen to insulate a publicly funded project from political tweaking, protections were wired into Crossrail’s governance. While the project remained within its new tight budget “envelope”, its sponsors — Transport for London and the government — would have no rights of intervention. They were confined to one board member each with limited rights to receive information, TfL officials claim. They had no say in hiring, contracts or the salaries and incentives paid to staff. The deal gave Crossrail’s bosses great freedom so long as they lived within their budget. They took full advantage, paying themselves handsomely. When Mr Wolstenholme left this year, he received £765,689, including a £160,000 bonus, and £97,000 for “loss of employment”, despite numerous signs that the project was unravelling. The previous year, he banked £950,000, including a £481,460 bonus.
The delays have been caused by power supply installation failures, and integration of five different signalling systems across different metro lines and network rail. There have been reports of work being done in silos, poor co-ordination among the numerous contractors, badly managed management changeovers at contractors and suppliers, turnover among officials supervising the project, suppression of bad news, and so on. All this was compounded by rising costs, 
“It feels as if they clung on to the schedule they had until it became clear that it absolutely couldn’t be delivered,” Daniel Moylan, a former Crossrail Director, says. “But when they dropped it, it seems that they had nothing left to work to. That would explain what looks like a sudden collapse.”... Mr Shepherd says the issues with the system — where much of the modern signalling and control equipment is on board the trains — could have been predicted up to seven years ago had proper consideration been given to the programme and cost risks arising from its complexity. A shortage of senior signalling engineering experts (part of a global shortage) may also have added an extra challenge to the project, he adds.
This by Philip Shepherd, an industry consultant, nicely sums up the story of large infrastructure projects,
“People are always adventurous on costs and time because they don’t want to tell the truth. Industry often doesn’t want to tell politicians the true story as they want the work, the politicians don’t know enough so take the view of the salesmen, who are going to push the latest, new technology even if it’s untested. And the management often doesn’t care because they know they won’t be there when the project isn’t delivered on time and to budget.”
Germany, the paragon of engineering efficiency, is apparently the worst culprit in recent years of cost and time over-runs. The Stuttgart station has cost €9bn instead of the planned €6.5bn and was delayed by three years. The Berlin’s Brandenburg Airport (BER) has so far cost €6.9bn instead of €2bn and is nine years late, and is expected to open only in October 2020. Last week news emerged that another €1billion may be required. 

But the award for delays and cost overruns has to go to Hamburg’s just opened publicly financed 2100 seat philharmonic concert hall, the Elbphilharmonie, part of the Hamburg Hafen City regeneration project which when completed will almost double the city centre's size. Budgeted at €77 million, the hall’s final cost eventually ballooned to €789 million, an over-run of 925%!

Wednesday, December 19, 2018

Mid-week reading links

1. David Pilling writes about Aliko Dangote's $12 bn new refinery being built just outside Lagos,
When it is up and running — if it gets up and running — it will process 650,000 barrels of oil a day, a third of every drop Nigeria produces and approaching 1 per cent of planetary production. That will make it the biggest oil refinery of its type in the world. As a sort of side concern, it will pump out all the plastic Nigeria’s 190m people need (or imagine they need), plus 3m tonnes of fertiliser a year, more than all its farmers currently sprinkle on their fields. To make things more interesting, Dangote is building the whole thing on a swamp. (It’s a tax-friendly swamp, at least.) That requires sinking 120,000 piles, on average 25 metres in length. No port in Nigeria is big enough to take delivery of the massive equipment, which includes a distillation tower the height of a 30-storey building, and no road is strong enough to bear its weight. Dangote has had to build both, including a jetty for which he has dredged the seabed for 65m cubic metres of sand. There is not enough industrial gas in the whole country to weld everything together, so Dangote will build his own industrial gas plant. There aren’t enough trucks, so he’s producing those in a joint venture with a Chinese company. The plant will need 480 megawatts of power, about one-tenth of the total that electricity-starved Nigeria can muster. You guessed it. Dangote is building his own power plant too.
2.  FT's Person of the Year, George Soros makes this very pertinent point about the European project,
“The EU was built by visionaries who knew the weaknesses of what they were doing but had reason to believe that when the moment comes the political will can be summoned to take the next step forward.”
3. While nominally EM currencies have lost value, in a reaffirmation of the Balassa-Samuelson effect, adjusted for interest rate and inflation differentials, borrowing in developed country currencies (equal amounts of dollar, euro, sterling, and yen) and going long on an equal-weighted basket of twenty most liquid developing country currencies may be a good long-term bet,
Using this measure, EM currencies have actually strengthened, by 28 per cent since 1997, while the real interest rate differential has added 47 per cent.
4. A NYT investigation sheds light on McKinsey's consulting work which has burnished the image of governments in China, Saudi Arabia, Malaysia, Russia, Ukraine, and South Africa,
At a time when democracies and their basic values are increasingly under attack, the iconic American company has helped raise the stature of authoritarian and corrupt governments across the globe, sometimes in ways that counter American interests... In China, it has advised at least 22 of the 100 biggest state-owned companies — the ones carrying out some of the government’s most strategic and divisive initiatives, according to a review of Chinese-language material by The Times... McKinsey helped polish the battered image of Mr. Yanukovych and pitch him as something else: a forward-thinking leader with an economic vision of a better future for all Ukrainians.
Its roles in the $13 bn East Coast Rail Link project in Malaysia which had China Communications Construction Company, which had been black-listed by the World Bank, as the contractor was rife with conflicts of interest,
In 2015, as China Communications was building the artificial islands and still under World Bank sanctions, McKinsey signed it on as a client, advising it on strategy. Months later, McKinsey won another contract: this one with the Malaysian government, to review the feasibility of the rail line. In a confidential PowerPoint report, McKinsey told Malaysian officials that the rail line could increase economic growth in parts of the country by as much as 1.5 percent. It was a figure that the prime minister at the time, Najib Razak, who now has been charged with corruption, liked to cite. In bullet points, McKinsey also said the project would help improve ties with China — “build the nation-to-nation relationship” — because of its importance in China’s Belt and Road Initiative. And McKinsey endorsed the idea of heavy borrowing from China, referring to it as a “game changer” elsewhere in the region.
And its role in unabashedly promoting the Belt and Road Initiative,
Dominic Barton, McKinsey’s managing partner at the time, made Belt and Road the theme of a keynote address in Beijing in 2015. McKinsey’s in-house research group, the McKinsey Global Institute, sprang into action, producing reports — widely cited in the Chinese state news media — extolling the benefits of the Belt and Road Initiative... “The world is waiting for the ‘One Belt, One Road’ grand blueprint to move from dream to reality,” Mr. Barton and his colleagues wrote in a report published on the company’s Chinese website in May 2015, expressing McKinsey’s enthusiasm to work on it... Nine of the top 20 Belt-and-Road contractors are or have been McKinsey clients, according to research by The Times and figures from RWR Advisory Group, which tracks such projects.
5. Manish Sabharwal and Sandeep Agrawal have this excellent compilation of India's "regulatory cholesterol"
The recommendations for easing business environment, especially for SMEs is very welcome,
India’s next wave of EODB should have three vectors—rationalization (cutting down the number of laws), simplification (cutting down the number of compliances and filings) and digitization (architecting for true paperless, presence-less and cashless). Rationalization could start with clustering our 44 labour laws into a single labour code and should include reviewing levels (do we really need the peak goods and services tax or GST rate and payroll confiscation of 45% for low-salary levels) and increasing competition (the lowest-hanging fruit is competition for mandatory employer payroll deduction monopolies like provident fund and Employee’s State Insurance that offer expensive products and treat customers badly). Simplification would include replacing our 25-plus different numbers issued by various government arms to every employer with a unique enterprise number (an Aadhaar for enterprises). Finally, we must move away from the current approach to digitization as a website, where you log in with a password and upload files (the equivalent of an ATM machine with a teller physically sitting behind the fa├žade and handing out cash) and shift to open architecture-based API frameworks, where multiple players compete in providing services to employers (GST Network is a good template).
6. Srinivas Thuruvadanthai makes the perceptive observation that the crisis of 1991 was caused less by burgeoning fiscal deficit than by "a confluence of negative developments, which led to a decline in investor confidence and capital flight".

7. Ananth points to more tax-terrorism, this time on domestic firms,
Proposal to treat banks’ free services as taxable service income by imputing a value to them and to levy tax on them. A ruling by ‘Authority for Advance Ruling’ that back-office operations of IT companies will be deemed domestic service and not exports and subject to GST of 18%. This boggles the mind. Some of the proposals are so stunning that one wonders if they are aimed at neutralising the government’s economic agenda.
He also has a set of very practical recommendations.

8. Finally, this mid-term evaluation of UDAY, the power distribution sector debt rescheduling plan in return for commitment to lower distribution losses, is along expected lines,
Using UDAY portal data, we find that the average AT&C (Aggregate Technical and Commercial) losses that should have been 15% for all the participating states by 2018-19, presently, on average, stand at 25.41%. Yet another financial indicator, ACS-ARR gap (the gap between Average Cost and Average Revenue) has also widened for many UDAY participating states. The power tariff revisions have also not been implemented in the States - due to political economy reasons - and the operational parameters in our analysis indicate widening inefficiencies across States in power infrastructure.
Financial engineering is no substitute to resolve problems that demand deep and long-drawn engagement.

Use-cases for aid spending

Lant Pritchett makes the case that extended periods of economic growth and cross-border labour migration trumps any kind of targeted development intervention in reducing poverty.

Two thoughts

1. I am inclined to agree that getting people out of poverty is best done by the dynamics of economic growth than by targeted interventions. I struggle to find one example of a targeted development intervention that can be applied as a de-risked instrument to lift people out of poverty.

When thinking about poverty elimination, the international development community has tended to view it in terms of interventions that can act directly to increase the incomes of the poor. Unfortunately, there are no such silver bullets to do that in any reasonable scale. Sustainable increase in incomes require active support from the eco-system in which the poor person lives and works. Call it whatever you like - markets, institutions, state etc - it cannot be denied that such support systems are weak, unstable, and not mature enough to support the human and physical capital formation required to realise high incomes. In fact, aid agencies should spend more effort and resources supporting the development of such "invisible" infrastructures including foremost state capacity.  

The vast majority of self-employment schemes like providing cattle or small grocery stores or sewing machines are mostly poverty alleviation efforts. The so-called Graduation programs, cash transfers etc are also just the same. The best that can be said about all these are that they take people to the starting line in being able to meaningfully engage with opportunities that are likely to come their way. But in countries where those opportunities themselves, like productive formal sector jobs, are limited, there is only so much to be had with this privilege.

2. Two more appropriate areas for targeted interventions would be poverty alleviation and preventing people at the margins from falling back into poverty.

Poverty alleviation interventions of the kind discussed above are well known. This leaves us with preventing fall-back into poverty.

Take the arguably three biggest sources of reversal to poverty - catastrophic medical illness, natural disasters, and larger credit defaults. Governments could underwrite these risks for all but those well-off (market solutions are already available for the middle class and above) through health insurance, disaster relief and rehabilitation, and some form of credit insurance against certain risks. Some form of means tested social safety nets would be required. Notwithstanding the challenge of implementing, and that too in scale, such safety nets, this presents a distinct area of engagement.

There is scope for innovation, especially with financial instruments which are supported with public subsidy. I have blogged earlier (see this, this, and this) about how the extant debates about financial inclusion is entrapped in the quest for expanding access to existing financial instruments (which service people like you and me) without realising that the poor may actually need very different sets of financial instruments. Bar micro-finance, the landscape is barren and littered with quackery.

Fintech offers opportunities to offer multi-tier accounts and other solutions which address human cognitive failures. Or, what would it take to have credit insurance for loans given to farmers and micro-entrepreneurs? 

Friday, December 14, 2018

On Trump Presidency, online shopping, logistics sector etc

A few snippets from The Economist's The World in 2019 report.

The Trump Presidency has been a dream-run for corporate America,
The boom in 2018 was a dream come true. As of October, 90% of firms in the S&P 500 index enjoyed growing sales, compared with a ten-year average of 69%, and a low of 36% in 2009. Some 52% of firms experienced rising margins. Overall, S&P 500 profits grew by 25% compared with the prior year, or 16% if you strip out the tax cut. The bullish mood spurred firms to bet more on investment. Including capital spending and research and development, it increased by 18%.
San Francisco's cost of living threatens the very future of the city 
The cost of living in San Francisco is now the highest in America; a family living on less than $120,000 is considered "low income" by the Department of Housing and Urban Development.
Online shopping fact of the day,
Online clothes-shoppers return more than 50% of the garments they order because they do not fit, coasting the global apparel business around $62 bn a year.
Latest in the problem of infrastructure construction challenges,
For all of Germany's teutonic efficiency, Berlin's new airport, which was meant to have opened in 2011, has yet to do so, hampered by over 65,000 errors in its construction.
In the context of the latest problems that have hit Crossrail, Economist writes,
Cost overruns on megaprojects are common around the world. McKinsey, a consultancy, has estimated that more than 98% of construction projects worth over $1bn are late or over budget. The average delay is nearly two years. The average cost overrun is fully 80%.
As Charles Read writes, the efficiency gains possible in global logistics business are enormous,
Amazon, an e-commerce giant, now delivers orders within an hour or two in 50 cities. More than 90% of deliveries by JD, an up-and-coming Chinese rival, are now made within a day. But getting larger loads delivered remains painfully slow and expensive. It still takes most firms two or three days to get a quote to move a pallet or container by air or sea. The speed of delivery is unreliable: it can take between 30 and 90 days to move a container between China and Europe by ship. And air freight is shockingly expensive. Sending a 70 kg parcel from Shanghai to London with DHL Express, a delivery firm, takes three times longer, and costs four times as much, as buying an airline ticket for a human of the same weight.
Much of the problem relates to dealing with all the legal documents, customs clearances, insurance contracts and other paperwork relating to trade. Maersk, the world's biggest container-shipping line, found that a single shipment of avocados from India to the Netherlands in 2014 required 200 communications involving 30 parties to straighten out all the bumf.
And its likely impact?
Ditching paper will reduce transport costs, which should stimulate trade and economic growth. The UN reckons that the full digitisation of trade paperwork in Asia could boost the region's exports by as much as $257 bn a year, slashing transport times by 44% and costs by 31%. Some economists think that the potential gains are greater than those from getting rid of all the region's remaining tariffs. 

Thursday, December 13, 2018

On being smart Vs wise, and the power of hegemony

There are two surprisingly recurrent themes across cultures and geographies. 

1. People confuse being smart with being wise and use them interchangeably. It is a travesty. 

Smartness is a far inferior manifestation of human intellect than wisdom. Wisdom is about the ability to process knowledge and exercise good judgement, whereas being smart, for all practical purposes, is merely about processing knowledge using logical reasoning and analytical frameworks. Wisdom is smartness plus - it is much more than just being smart. 

While God was very generous with bestowing the former on as many as possible (a child born in an upper middle class family today will really have to struggle to be not smart), he was equally parsimonious with the latter. Very few of the smartest people ever end up being wise. These two people are among the smartest, but if this is how they react to adversity, how wise are they really?

2. The most debilitating and binding form of captivity is ideological, that of hegemony of grand narratives. Such mental captivity is much more difficult to surmount than physical captivity. See this and this

The smartest of people struggle to overcome hegemony. It requires rare wisdom and strength of character to be able to break out of a hegemony. 

Sunday, December 2, 2018

Winners Take All - philanthrocapitalism at work

Anand Giridharadas's new book, Winners Take All - The Elite Charade of Changing the World, is   an excellent read. 

It is essentially about how a reductionist view of important public issues and problems, which suits the interests of the global cosmopolitan elites (or MarketWorlders, as he calls them), has helped sweep under the carpet deep-rooted structural issues, shrunk the space for political debates and actions, and engendered the feel-good-do-good world of non-government and philanthropic activities. 

This is more like a manifesto which describes symptoms and offers diagnosis. But thankfully, it stops short of offering prescriptions. 

Sample this description of Sean Hinton, late of McKinsey, Goldman Sachs, and Rio Tinto, then the Chief Executive of Soros’ Economic Advancement Program in 2016. Early in his youth, Hinton had moved to Mongolia to study traditional music and lived there for nearly a decade.
In Mongolia, Hinton’s approach was to learn from the people he was studying by hanging back, observing, realising all he didn’t know. Success required letting other people lead him, as he remembers it: “The tools that I used to bringing were largely to do with perceiving and sensing; they were largely to do with intuition; they were largely to do with creativity and looking for connections; and they were very much to do with the people”. For years on end, Hinton had had the experience of resisting easy assumptions, avoiding the certitude, hunting for cues, letting others lead. “You turn up in a tent where you put your legs, when you give the gift that you’ve brought with you – I just became so attuned to all of those things. The body language – am I doing right? What are other people doing? You become just absolutely, completely attuned to reading those signals from people around you”. This approach to an alien environment was what he called humility. “If you think about the skills of living in a tent, in a foreign culture, in a foreign language, in a certainly foreign environment, you don’t have a choice but to get taught humility every day,” he said. “You’re surviving on that, and your very survival is based on recognising that you don’t know, and being absolutely open to everything – being absorptive of every influence around you and listening.”

At McKinsey, he realised, he was expected to operate very differently… Instead of listening, absorbing, trying to decipher slowly and respectfully the dynamics of the space one had entered, the high-flying, high-priced consultant was expected to jump in and know things... They offered a powerful way of stepping into a world you didn’t know and reconstituting its reality so that the solution became more obvious to you than it was to the client’s native executives. The protocols allowed for a strange kind of earned presumptuousness. Equipped with a special way of chopping up problems, parsing data, and arriving at answers, the consultant constructed authority. His job was, as Hinton put it, “the bringing to bear and the championing of the religion of facts – incontrovertible, scientific, unemotional, unencumbered-by-people facts.”

The protocols that allowed for this certitude were, as Latin once was, a mother language that had birthed many vernaculars. These vernaculars shared a common purpose: Having arisen not so much within industry as among the insider-outsiders of the business world – consultants, financiers, management scholars – they offered a way to get smart on other people’s situations. The banker trying to come up with the initial share price of a soon-to-be-listed chemical company wasn’t necessarily an expert in fertiliser. The hired-gun corporate strategist for a pharmaceutical company wasn’t necessarily an expert on drug-delivery vehicles. The protocols some specific to domains like finance or consulting, some more cross-cutting – allowed such figures to sweep in and break down a problem in a way that surfaced new realities, produced insight, sidelined other solvers, and made themselves essential.

Hinton learned the McKinsey vernacular of the protocols. In the book, The McKinsey Mind, by Ethan Rasiel, the firm’s protocols are distilled: Consultants first find the “business need”, or the basic problem, based one evaluating the company and its industry. Then they “analyse”. This step requires “framing the problem: defining the boundaries of the problem and breaking it down into its component elements to allow the problem-solving team to come up with an initial hypothesis as to the solution”. This is the insta-certitude at work – hypothesis-making comes early. Then the consultants must “design the analysis” and “gather the data” to prove the hypothesis, and must decide, based on the results, whether their theory of the solution is right. If it is, the next step is “presenting” in a crisp, clear, convincing way that can win over clients understandably wary of fancy outsiders’ big ideas. At last, the solution comes to the ‘implementation’ phase, through “iteration that leads to continual improvement”…

It (this approach to problem-solving) was not about drawing on knowledge, and often sneered at doing so; it was, rather, about being able to analyse a situation despite ignorance, to transcend unfamiliarity… It was to demonstrate how you reason, based on the assumptions you make. The idea was “if you break the problem down into small enough pieces that are logically related and make educated guesses combined with facts where they’re available, or at least you join the dots from the facts that you’re able to put together, you can construct a logical and compelling answer to pretty much any problem.” In other words, Hinton’s initiation into McKinsey and the protocols more generally was being urged to spit out a preternaturally confident answer to something he knew nothing about…

Hinton picked up the little rules and figures of speech of… consulting… For example he learned it was best to speak in lists of three, based on research about how people absorb information. If you have two important points to make, you add a third; if you have four, you combine two or just lose one. Hinton also learned the commandment against taking on excessively large problems. Do not “boil the ocean”, one versed in the protocols might tell another. The protocols tell you to reduce the scope of what is considered, limit the amount of data you drink in, to avoid becoming overwhelmed by the volume of reality you confront. And lest you worry that this shrinking of your purview will harm your ability to solve the problem, the protocols offer the eighty-twenty rule… the business maxim that 20% of many systems generates 80% of the results – one-fifth of one’s customers providing most of one’s revenue, to cite the most common example. The protocols told the problem-solving swashbuckler that it was possible to swoop in, find the 20%, turn some dials in that zone, and unleash great results. These tricks were not about looking at a problem holistically, comprehensively, from various human perspectives; they were about getting results without needing to do such things.

At McKinsey, Hinton learned to make so-called issue trees – visual maps to help you break down a nicely scoped, eighty-twentied, pond-sized problem into its elements. It starts with a challenge such as making a bank more profitable. That increases in profitability can come through raising revenues of lowering costs, the first layer of subcategories. Each rung of subcategories must be, in firm parlance, ‘MECE’ – mutually exclusive and collectively exhaustive. In other words, raising revenues must be entirely different from lowering costs, and all routes to the ultimate goal should passthrough them. Now each subcategory can be broken down into sub-subcategories – the increase in revenue, for instance, can either come from existing businesses or new ones. And so on, until there are sub-sub-sub-subcategories. To be fair, this kind of exercise can allow one to see, with a clarity that is impossible when looking at the whole, the dials that might be turned relatively easily and yet have outsize effects – for example, closing those three high-rent bank branches in Manhattan might generate 80% of the savings required. Yet this schematising, whether in the McKinsey vernacular or others, can at times be limited by its arbitrariness. Categories are made that may or may not correspond with reality. Divisions are carved between things that might be connected rather than mutually exclusive. Things are broken down in the way that happens to be most obvious or useful for the parachute, and sometimes this smashing of reality into hundreds of little pieces makes a solution seem apparent while in fact obscuring the true problem. Those who could set the parachuter right, those with valuable traditional and local knowledge, cannot speak the new language of the problem, illiterates in their own land…

The protocols had grown out of corporate problem-solving, but increasingly MarketWorlders were employing them to elbow into the solution of social problems traditionally considered in other ways, by more public-spirited actors. And the more people accepted the ideal of the protocols as essential to public problem-solving, the more MarketWorld was elevated over government and civil society as the best engine of change and progress… They have evolved from being a specialised way of solving particular business problems to being, in the view of many, the essential toolkit for solving anything. The protocols are increasingly seen as vital training for working in charity, education, social justice, politics, health care, the arts newsrooms, and any number of arenas that used to be more comfortable with their own in-house apprenticeship. Organisations like the Gates Foundation hire the protocol bearers to solve the problem of education for poor children in America. Civil rights organisations put protocol bearers on their Boards, taking not only their money also their advice… young people… are persuaded by the surrounding culture that only by learning the protocols can they help millions of people.

Wednesday, November 28, 2018

Mid-week reading links

Anand Giridharadas's twitter feed points to several very powerful pieces

1. From the man himself on the dubious Amazon HQ2 saga,
When combined with existing incentives, Amazon might receive three billion dollars in breaks in New York alone, the equivalent of every city resident Venmoing $348 to Bezos... It was the game-show quality of this bidding, the spectre of cash-starved governments begging to give money to a billionaire, that left some critics fuming. Richard Florida, the urban-studies theorist, told me that Amazon’s HQ2 competition “captures the zeitgeist of early 21st century American late capitalism.” He added, “The very idea that a trillion-dollar company run by the world’s richest man could run an American Idol auction on more than two hundred thirty cities across the United States (and Canada and Mexico) to extract data on sites and on incentives, and pick up a handy three billion dollars of taxpayer money in the process, is a sad statement of extreme corporate power in our time.”


...there is an opportunity cost to luring the world’s richest man by letting him free-ride on the public services that other New Yorkers must pay for—whether it’s the failing subway system, the troubled and segregated school system, or... critical renovations at public-housing complexes like Queensbridge, the largest in the United States, which will soon be down the street from Amazon’s New York headquarters... There is also the particular question of why Bezos, of all people, needs to play this way. After the announcement, David Heinemeier Hansson, the founder of the software firm Basecamp, published an open letter to Bezos, who is one of his investors... He urged Bezos to consider shaping his legacy “into something more than the man who killed retail, extracted the greatest loot from its HQ cities, and who expanded the most monopoly holdings the fastest.”
This captures the essence of it all, especially given Bezos's recent decision to become a philanthropist, 
Build a company from the ground up. Do whatever it takes to survive and grow, regardless of the consequences for your customers and workers. Consolidate a monopoly if you can, first in one arena, then in multiple. Use that power, that leverage, to exact concessions from governments, so that you pay even fewer taxes and grow even faster, even bigger. And then, with the wealth that was accumulated by underpaying workers, by avoiding taxes, by lobbying against regulations, by amassing uncompetitive levels of market power—then, with that wealth, you give back. You make a difference. You become a philanthropist, a lover of mankind. You salve by philanthropic moonlight the wounds you may have cut by operational daylight. You solve the very problems you have helped to cause.
2. Almost exemplifying this trend among America's richest is this Washington Post investigation on Carlyle Group, which has spawned some of the largest philanthropists and donors like David Rubenstein,
Under the ownership of the Carlyle Group, one of the richest private-equity firms in the world, the ManorCare nursing-home chain struggled financially until it filed for bankruptcy in March. During the five years preceding the bankruptcy, the second-largest nursing-home chain in the United States exposed its roughly 25,000 patients to increasing health risks... The number of health-code violations found at the chain each year rose 26 percent between 2013 and 2017, according to a Post review of 230 of the chain’s retirement homes. Over that period, the yearly number of health-code violations at company nursing homes rose from 1,584 to almost 2,000. The number of citations increased for, among other things, neither preventing nor treating bed sores; medication errors; not providing proper care for people who need special services such as injections, colostomies and prostheses; and not assisting patients with eating and personal hygiene.


Counting only the more serious violations, those categorized as “potential for more than minimal harm,” “immediate jeopardy” and “actual harm,”... the number of HCR ManorCare violations rose 29 percent in the years before the bankruptcy filing. The rise in health-code violations at the chain began after Carlyle and investors completed a 2011 financial deal that extracted $1.3 billion from the company for investors but also saddled the chain with what proved to be untenable financial obligations, according to interviews and financial documents. Under the terms of the deal, HCR ManorCare sold nearly all of the real estate in its nursing-home empire and then agreed to pay rent to the new owners. Taking the money out of ManorCare constrained company finances. Shortly after the maneuver, the company announced hundreds of layoffs. In a little over a year, some nursing homes were not making enough to pay rent. Over the next several years, cost-cutting programs followed... the number of violations at HCR ManorCare homes rose about three times faster than at other U.S. nursing homes.
On the business model and trends,
The firms profit by pooling money from investors, borrowing even more, and then using that money to buy, revamp and sell off companies. Their methods are geared toward generating returns for investors within a matter of years, and this has led to criticism that they merely plunder company assets while neglecting employees and customers. During and after the recession, as returns became scarce, private-equity investors began to explore industries they had once overlooked, and some invested in businesses that largely cater to the poor: payday lenders, nursing homes, bail bond providers, low-income homes for rental and prison phone services...
In December 2007, it bought HCR ManorCare for $6.1 billion plus fees and expenses. Most of the purchase price was borrowed money — about $4.8 billion — and Carlyle put up $1.3 billion... From the start, Carlyle’s acquisition of HCR ManorCare made the company’s finances more risky because the purchase burdened it with billions in long-term debt. But in April 2011, Carlyle made another critical move at HCR ManorCare, one that would enrich investors and imperil the financial footing of the chain.


Carlyle took HCR ManorCare’s vast real estate empire — the hundreds of nursing homes and assisted living facilities as well as the land underneath — and sold it to HCP, a real estate investment company. HCR ManorCare then had to pay rent to HCP for the use of the nursing homes. This kind of deal, known as a sale-leaseback, is a common tactic of private-equity firms, and it generated financial benefits for Carlyle and its investors. Carlyle got $6.1 billion from the sale, an amount that roughly matched the price that the private-equity firm had paid to buy the company just four years prior. With that money, Carlyle paid off billions in debt that it racked up buying HCR ManorCare... Crucially for Carlyle and its investors, the deal allowed them to recover the $1.3 billion in equity they put into the deal.
Carlyle made money from its investment in other ways, too. It took at least $80 million from the HCR ManorCare venture in the form of various fees, according to interviews and financial documents. Most of that was a “transaction fee,” which is money Carlyle receives when it buys a company, typically 1 percent of the purchase. The $6.1 billion ManorCare purchase yielded Carlyle $61 million, Carlyle officials confirmed. That money was distributed to Carlyle and its investors. In addition, Carlyle receives annual “advisory fees” from the companies that it purchases — essentially, Carlyle pays itself to manage the companies it owns. At ManorCare, those fees averaged about $3 million a year from 2007 to 2015, or about $27 million, according to documents and interviews. That money was also distributed to Carlyle and its investors. Finally, there was one other person who made a lot of money despite the company’s financial woes. After the bankruptcy, longtime chief executive Paul Ormond was awarded $117 million under a deferred compensation agreement...
The real estate deal... meant that HCR ManorCare had to make massive rent payments to its new landlord, and these, according to the company’s accounting, raised the company’s long-term financial obligations to $6 billion. The rent HCR ManorCare was obliged to pay — to occupy the nursing homes it had once owned — amounted to $472 million annually, according to legal filings. The rent was set to escalate at 3.5 percent a year, and according to the lease, HCR ManorCare also had to pay for property taxes, insurance and upkeep at the homes.
3. David Leonhardt lays bare the case for revival of an anti-trust movement in the US. 
This consolidation of business concentration data by Open Markets Institute is awesome!

This from Louis Brandeis, the US Supreme Court Justice, is very apt,
“We may have democracy, or we may have wealth concentrated in the hands of a few, but we can’t have both.”
4. Finally, FT has an article which sums up the problems with modern financialisation-based capitalism with the illustrative example of GE, the 126 year-old company, whose share price is back to its 1994 level,
There are five key lessons. The first is that debt always catches up with you. While GE has long had strategic problems, its immediate troubles are around a credit crunch. In the boom days, GE used a top credit rating to raise debt to fund its global manufacturing operations and GE Capital arm. This year, when its credit rating was downgraded, borrowing costs went up and a negative spiral began, with investors selling off both the company’s stock and its bonds... GE would not have these problems today if it had not done so many share buybacks in the good times. This is the second lesson. Companies have carried out record amounts of share buybacks in recent years, frequently at the top of the market — moves that are often much more about getting another quarter or two of share price increases to enrich top executives than changing any real business story on the ground. Lesson three is to be careful of growth through acquisition. Over several decades, GE became so large and complex that it could not manage its own business model — witness the company becoming a “too big to fail” bank in the Welch era, a problem his successor Jeff Immelt had to deal with by spinning off the Capital division. Too many companies today, including big tech groups, are growing by acquiring, not innovating. Streamlining is not a bad idea, but the sale of GE’s lending division also exposed lesson four: financial engineering is not the same as real engineering. Once GE Capital, which could be used to hide myriad accounting high jinks, was spun off, the depth of trouble at the company became clearer. After a decade of easy money, it is a fair bet that there are corporate numbers games waiting to be discovered at many companies. The final lesson is that the nature of the economy has fundamentally changed in recent decades from industrial to digital... Companies that cannot make the transition from an economy based on tangibles to one based on intangibles are likely to face the same fate as the once-mighty GE.

Tuesday, November 27, 2018

Infrastructure financing market graphics

This blog has written on numerous occasions in support of financing infrastructure construction with bank loans and then re-financing operation and maintenance of commissioned assets using capital markets.

Construction risks are idiosyncratic, its financing draw down schedule is over the construction period, and the asset will generate cashflow to pay off debts only after construction is completed. Bank loans, which are far more easier to restructure, stagger, and back-load repayments, therefore becomes more appropriate compared to bonds.

In the context of bond market issuances in Asia, this paper points to some interesting insights.

The graphic shows that infrastructure bonds form a very tiny share of the total non-financial corporate bond market.
And syndicated loans dominate bonds themselves in financing infrastructure projects
The default rates of infrastructure bonds come out very favourably compared to non-financial corporate bonds.
And the same applies to relative recovery rates too.


On the average coupons and maturities of bond offerings across different regions.

Saturday, November 24, 2018

Weekend reading links

1. Interest rates may be inching upwards, but the rate at which it is happening appears not to be having much impact on leveraging. Ananth points to this FT Alphaville article on the unabated rise in the share of Covenant-lite loans, or loans with weak lending protections, among loans given to riskier borrowers (leverage loans).
The robust economic growth in the US makes everyone lower their guard and borrow more and lend less prudently.  

2. Oil prices are declining again reflecting good and bad signs for the Indian economy. Good in terms of likely lowering the twin deficits and bad in terms of its portends for weaknesses in the global economy. 

One of the features of the oil market in recent times has been the rise and rise of US oil production. Sometime between May and June this year, US became the largest crude producer at 11.65 m barrels per day, the first time since 1973.

3. The cost of US sanctions on China, at least for now, appears to being borne by the Chinese exporters than US consumers. Bloomberg points to a new paper by Benedikt Zoller-Rydzek and Gabriel Felbermayr appears to point out that US companies and consumers will only pay 4.5 percent more due to the 25% tariffs on $250 bn Chinese imports and the other 20.5% will fall on Chinese exporters.  
The reason being the smart choice of goods for the first round of tariffs, those with the highest "price elasticity" or availability of substitutes which can replace the Chinese imports. This in turn prevents importers from passing through the tariffs to consumers in the US. They find that total welfare gain to US consumers to be $18.4 bn. Further, they show that this would cut US imports of affected Chinese goods by more than a third and lower the bilateral deficient by 17%.

The challenge will be when the basket of goods expands to those with lower elasticity. But for now, give Trump some credit!

4. The issues raised by Carlos Ghosn arrest in Japan on charges of fraud from an internal enquiry for having deceived Nissan by consistently under-reporting on his pay package and benefits claims and using company assets for personal purposes is symptomatic of executive culture in the corporate world. It is only a surprise that more such demeanours do not come out to the open. Perhaps the reason this came out in the open is because it happened in Japan, which, unlike in the US, has less cultural tolerance for such corporate excesses.  

The Nissan-Renault alliance, which was expanded in 2016 to include Mitsubishi, produces 10.6 million cars annually, making it the world's largest car maker. 

Rest assured that in the coming days, more stories will come out about the details of the power-struggle between the French and Japanese parts of the Nissan-Renault empire. Nissan's Japanese employees had long resented the dominance of Renault's French owners. For long, Ghosn's dominating presence had papered over differences. This FT article may only be the preview to what could come out in the open.

All this again raises questions about the alleged superiority of the "efficient" US business management style and culture over the "inefficient" Oriental one. The argument in favour of this comes from the market performance of US firms compared to their Japanese counterparts, especially the stock market performance and bottomline growth. The idea of cutting costs aggressively (Ghosn built his larger-than-life image on being the "Le cost killer") and promoting performance payments with eye only on the financial reporting bottomline imposes significant long-term costs besides corroding corporate culture. Ghosn compensation was a massive outlier in Japan - Takeshi Uchiyamada, chairman of Toyota, for example, was paid ¥181 million in 2017, compared to Mr. Ghosn’s reported ¥735 million.

But, as we all know now, these things come at considerable costs. Not just on the corporate governance and ethics, but even on business practices (sample Nissan's grow-at-all-cost discounting strategy in the US market which alienated stakeholders like its dealers) the claims of superiority appears questionable. On the net, and taking a long-term view, one cannot but not get the impression that the adoption of western management and business practices may have come at a net cost to Japanese companies.

5. Staying on the theme of corporate governance, there are growing signs that the 1MDB-Goldman Sachs scandal involved the topmost leadership of Goldman. It now emerges that Jha Low, a financier with close ties to the then Malaysian PM, Najib Razaq, and the alleged mastermind in the plot to siphon over $6 bn of Malaysian public funds, met one-on-one with Goldman Chairman and CEO, Lloyd Blankfein in December 2012. This seriously weakens Goldman's efforts to spin the scandal as the work of a few rogue employees.

Sample this,
In the three years before the 2012 meeting, the bank’s compliance staff had repeatedly rejected Mr. Low’s attempts to become a Goldman client because it was unclear how he had amassed his wealth... The compliance team also identified Mr. Low as someone Goldman should avoid working with on any 1MDB transactions...  But when Mr. Blankfein’s aides sought information about Mr. Low in preparation for the meeting, a senior investment banker in Asia praised Mr. Low and did not mention the compliance concerns, according to a person who has reviewed internal Goldman emails about the meeting. Nor did the compliance red flags stop the bank from doing extensive business with 1MDB, which Malaysia’s prime minister at the time had set up in 2009 ostensibly to invest in infrastructure and other projects to improve Malaysians’ daily lives. Goldman ultimately helped 1MDB sell more than $6 billion in bonds to investors, earning about $600 million in fees.
It is hard to believe that a deal like this, an that too one which was bagged without any competitive bidding and on nomination, and especially one which earned the firm $600 million in fees, did not involve not just the knowledge but the active support of the top leadership. Btw, if this were government, it would be impossible to not have loud public demands for resignations and the like.

6. Finally Paul Romer makes good suggestions about the role of governments in the promotion of innovation,
First, government needs to take a more active role in creating scientific infrastructure... Congress can help without any additional spending by letting recipients of research grants use those funds to support open-source projects, which make their blueprints publicly available... Take Python, the open-source programming language that has become the language of choice for software developers in the fields of artificial intelligence and data science. Programmers have used Python to power innovation in everything from the detection of gravity waves (resulting in last year’s Nobel Prize in Physics) to reducing the cost of developing new drugs... Second, Congress should look for opportunities to extend scientific transparency to the private sector. It could draw on the principles that guided the design of our patent system; the law protects a private right to charge for the use of a discovery, but mandates public disclosure of its details so others can learn from it. To see how this could work, consider hydraulic fracturing, or fracking, for oil and gas. Regulators in North Dakota forced firms to disclose how much water and sand they used to frack each well and how much oil it produced. This let a different firm drilling a well nearby select a better mixture for its well. Over time, the entire industry optimized the mix used in various geological conditions and substantially reduced costs.