Thursday, April 30, 2020

Market failures in infrastructure contracting

Ritesh Kumar Singh writes in the Nikkei Asian Review about the Indian telecoms saga,
The government wrongly views the telecom spectrum as a cash cow, rather than acknowledging its contribution to the digital economy. That must stop. The cause of the financial stress for India's telecom sector in general and Vodafone Idea in particular is a race-to-the-bottom pricing war unleashed by Reliance Jio. The country's telecom regulator did not rein it in early enough, arguing that Reliance Jio's market share was too low to invite investigations into its pricing practices. High regulatory charges and taxes that consume as much as 30% of revenue, compared with 11% in China, have further squeezed the telecom companies. Shortsighted actions such as denying the refund of taxes paid on inputs or refunds from the goods and services tax, which will cost the sector 360 billion rupees ($4.9 billion), are adding to the predicament of Indian telecom companies. If that were not enough, a February ruling from the Supreme Court's means telecom companies cannot defer paying $13 billion in historic levies to the government. It was this in particular which has ruined any real chance of Vodafone Idea, which owes $7 billion now, surviving.
When the history of India's telecoms market is written, the regulator's reluctance to bite the bullet and crackdown on Reliance's predatory pricing would perhaps be seen as an important factor. 

This race to the bottom has happened with alarming consistency across sectors. Telecoms is the most salient example. A sector which was the epitome of market competition with 12 operators is now down to three, perhaps two, thanks to reckless race to the bottom with tariffs. 

In case of the bidding for the ultra mega power projects (UMPPs), the bidders had the option of quoting fuel price pass through or offering fixed tariff. All of them preferred the latter for each of the four UMPPs.

The road projects have witnessed developers volunteering to pay the government in tenders with viability gap funding as the bid parameter. Even the first round of road securitisation contract has seen the successful bidder offering unreasonable commitments to the government.

The solar power tenders have seen tariffs being quoted which are clearly unviable. It is only a matter of time before these unravel. Covid 19 may well prove one of the triggers.

The airline industry, along with telecoms the exemplars of success of private enterprise in the Indian economy, is another example of free market activity leading to race to the bottom with pricing and boom and bust cycle.

The common factor in all these is the failure of the market mechanism, on sides of both the businesses and their financiers, to undertake rational pricing decisions in the face of competition. In fact, perversely, competition itself has been the cause for market failures. It is a testament to the failure of the so-called disciplining powers of free market competition as well as of corporate India. 

There is another dimension to many of this, the entrenched urge to go for the cheapest and do so with pride.

Wednesday, April 29, 2020

Socialising losses in Covid times - Disney edition

I had blogged earlier about how Marriot was living its Business Roundtable commitment to worker's welfare by furloughing workers even as shareholders were being paid out dividends and executives fat bonuses.

Now FT has a good article on how Disney is living the same set of ideals by socialising losses even as dividends and large executive bonuses are business as usual.

More than half its staff have been furloughed on unpaid leave. But guess, who's paying for them?
Across its parks in California, Florida and France, Disney staff will draw at least $400m in state benefits every month, according to FT calculations based on average weekly rates. That would exceed $1bn of direct and indirect government support for Disney if, as expected, its sites stay closed until July.
Even as the workers were being furloughed, the company was piling up record cash balances and it appeared business as usual with dividends and bonuses,
Reserves, recent fundraising efforts and its revolving credit facility give Disney about $30bn in cash, while it has some $12.5bn in debt obligations over the next two years. “That leaves them with net liquidity somewhere in the neighbourhood of $17.5bn,” says Neil Begley, a senior analyst at Moody’s. “It is a lot.”... Mr Iger has given up the remainder of his $3m base salary for 2020. But his performance-related incentives, worth more than $40m for Mr Iger last year, remain in place... Unlike some other big multinationals, Disney has yet to comment on plans for its dividend, which it has paid regularly for the best part of six decades. The 2019 payments totalled around $3bn — which covers almost six months of salaries for park employees... Even before the coronavirus crisis, Disney’s executive compensation policies had been a source of dispute with many shareholders... For the past three years, at least 40 per cent of Disney shareholders have voted against Mr Iger’s remuneration package, which was reduced on three separate occasions last year to placate investors. Those investors who raised concerns included the five biggest US pension funds... Mr Iger’s $47m pay package last year was worth 911 times that of Disney’s “median worker”.
This raises the issue of whether the US model of lay-offs and furloughs with government picking up the tab for them is more distortionary than the wage subsidies that many European governments have been offering as part of Covid 19 rescue packages.   

The US model de-links the government support for the furloughed or laid-off employee from the employer. Besides the business has no requirement to make any co-payment or contribution for the support given by the government. It leaves the business to continue with its plans without incurring the worker fixed cost. In simple terms, it externalises the costs and appropriates everything privately.

In contrast, the European model obliges the company to pay a share of the wages, and the government also has the ability to impose other conditions on the companies that receive such subsidies, including mandates that they don't pay bonuses or dividends. While the costs are externalised, it also comes with both some sharing of costs and a binding commitment to good practices.

Sunday, April 26, 2020

Covid 19 - The economic imperative for India now

On March 25, 2020, V Ananthanageswaran and me had written arguing in favour of burning the playbooks and called for unprecedented fiscal and monetary actions, despite all its implications. Evidently, as with all such complex policy choices, it requires time for the political economy to play out and explore various options before biting the bullet. But the time may have come to make those choices for both the government and the RBI.

As the pandemic disruption endures, it is increasingly clear that the Indian economy will contract this year and will suffer large drop in revenue collections, thereby worsening an already bad fiscal position. As Mr Subhash Chandra Garg has very eloquently demonstrated in a series of blog posts, Covid 19 has questioned all the fiscal projections of the government. While the medical mitigation and basic relief measures are well underway, the challenge now is to ensure that recovery is managed in the quickest possible time. 

The developed countries have thrown the kitchen sink at the pandemic with extraordinary stimulus spending. Apart from direct income transfers, they have included wage subsidies to prevent lay-offs, debt forbearance and very generous lending programs to businesses, and even equity infusions into private businesses. The major share of stimulus measures have been in the form of tax deferrals and loan guarantees. This is apart from the unlimited liquidity taps opened by their central banks.

While developed country governments have been profligate with their stimulus responses, with several attendant problems likely in the days ahead, anything even remotely close to the same fiscal space is not available to developing countries. Besides, it is an institutional flaw of the global financial markets that developing countries, even the best managed ones, do not enjoy the same market confidence as enjoyed by even the likes of Greece or Italy with history of massive and unsustainable debts. 

Be that as it may, all major economies, developing and developed, have announced significant stimulus measures. 
Interestingly, among the major economies, the Indian government's stimulus has been among the smallest.

The Rs 1.2 trillion stimulus package of the government, when stripped off all revenue deferrals and front-loading of expenditures, has been estimated by the Citibank economist Samiran Chakraborty (HT: Ananth) to be just 0.55 percent of GDP. They estimate the fiscal slippage due to Covid 19 to be about 2.3%, thereby pushing the fiscal deficit for 2020-21 to 6% of GDP. Combined with a 4% FD of state governments, they see space for a 1.5-2%of GDP fiscal stimulus space. 

In recent days, several other notable people too have called for higher stimulus spending. Arvind Subramanian and Devesh Kapur have proposed five options to mobilise 5% of GDP in additional fiscal stimulus spending required - eliminating wasteful or “un­spendable” expenditures; borrowing from multilaterals and non-resident Indians (NRIs); borrowing from public (via markets and financial repression); printing money; and raising “solidarity resources” via increasing taxes or cutting subsidies. They estimate 2.5% of GDP to come from public market borrowings, and 0.5-0.75% of GDP to come from each of the remaining four.

Unfortunately, again as Mr Garg has shown, while they provide a framework for thinking in theory, they are perhaps not well-thought through in details and unlikely to yield much given the scale of additional spending required. Further, expenditure compression as a means to find space for fiscal stimulus, while necessary to some extent with certain kinds of low-multiplier expenditures, may also be counter-productive with capital expenditures. This is especially important given that recovery is the top priority now and government is the only game in the town in these times to lead the economic recovery. 

Andy Mukherjee has argued against "excessive virtue signalling" and in favour of the Indian government burning the fiscal rectitude playbook and deficit financing by the RBI. He suggests that the government complement deficit monetisations with a big-bang privatisation of public sector units. The approach,
For a start, Prime Minister Narendra Modi’s government should sell stakes in every company that’s on the block for privatization — as well as some that aren’t — to a special purpose vehicle run by, say, the National Investment and Infrastructure Fund Ltd., which has demonstrated fund-raising clout with global investors. The SPV will finance the purchase by issuing sovereign-backed debt. When market conditions improve, it will sell its stakes and redeem the bonds. Whatever is raised should be deployed in an infrastructure plan that has health at its centerpiece. This will boost construction and create jobs. Subsidized loans should be made available, but only to businesses that keep at least as many people on their payrolls as they had in February and make suppliers’ invoices available on a bill-discounting platform so vendors can get paid. It’s the workers and small and mid-size enterprises that are getting hammered by large companies passing on the painof dislocation. In some private firms, such as airlines, the government will have to infuse equity.
Given the extraordinary situation, C Rangarajan, the RBI Governor who put an end to deficit monetisation from April 1997, has now called for RBI to directly finance the fiscal deficit. He suggests a doubling of the fiscal deficit target from its current 3% limit under the FRBM Act. With that doubling and another 4% from states, he estimates the general government deficit to therefore be 10%. He's not alone in this, there have been calls from several prominent people in this regard. The Kerala Finance Minister has called for the RBI financing even the state government debt issuances. And Dr Rangarajan has suggested that even states too be allowed additional borrowing beyond the FRBM 3% limit.

The problem with this analysis is that the starting point, the real current fiscal deficit, is more likely 5-6%. Then there is the revenue decline which would add at least 2-3 percentage points. Coupled with the 4% state government deficits, which too is perhaps being conservative, we are starting with a 11-13% fiscal deficit. Any stimulus space will have to be on top of this. A 3 percentage points stimulus package would entail a general government deficit of 14-17% of GDP. Now, that's some number!

On the credit policy side too, he also felt the need to go beyond mere rate cuts, liquidity provision and temporary forbearance to get banks to lend to distressed businesses. He points to the need for some guarantees to certain types of businesses. More on this latter.

The government faces one of its toughest choices since the financial liberalisation. On the one hand, its fiscal spending demands are massive, while its space is limited. Foremost, such spending is required to mitigate the suffering of people who have lost their incomes and livelihoods. Further, as the country exits lockdown and starts the recovery journey, it is inevitable that there will be demands for fiscal spending to support businesses. Recovery has to be expeditiously managed to ensure that businesses don't become insolvent and recovery does not become long-drawn. While debt forbearance and additional lending can help, it cannot completely make up for the losses incurred by businesses due to the force majeure event. Some of the losses will have to manifest on the balance sheet of the government. It could be by way of greater defaults by borrowers (which hits public sector banks, and thereby forces recapitalisation) and lower revenues (due to slower recovery).

On the other hand, there is the challenge of how to plug the fiscal gap. The standard practice of issuing Treasuries has hard limits given the low level of national savings. Further, as Mr Subhash Garg has written in another separate series of posts, there are reasons to feel that the various proposals for revenue mobilisation pathways suggested are based on optimism and theory than practical assessment. 

It is here that, breaking ranks from orthodoxy, several prominent people have in recent times called for deficit monetisation. As per this, the government would request the RBI to skip the financial market and directly purchase Bonds issued by it and provide credit (or "print" money). Indian Express has a primer on deficit monetisation here. This has the advantage of not crowding out private investors or raising the general cost of capital in the debt markets. This path may well have to become the primary, even predominant, source to bridge the fiscal deficit.

(Note that while local experts have made several constructive suggestions, none of the reputed academics ensconced in top US universities have had anything but inane platitudes - this and this - to offer as suggestions in this regard.)

If the RBI finances the government directly, then it would purchase Treasuries from the government directly and issues credit to the government's account held at the RBI. Government's expenditures will be made through the commercial banks, in turn driving up their (banks') reserves with the RBI, probably not proportionately. This earlier post outlines all the issues on deficit monetisation.

In this context, there is a need for some costs-benefits assessment required. How do the long-term benefits of fiscal rectitude balance with the political cost of immediate suffering and the economic cost of a long-drawn recovery?

So, what are the consequences of higher fiscal deficit. One, it would immediately cascade into the foreign exchange market, and rupee will fall. This is only to be expected since all the major EM peers of India have undergone 10-25% exchange rate depreciation over the last month after their respective announcements. While India's fiscal deficit position is weaker than that of peers, its external exposure situation is superior to peers. However, unlike peers, India is not vulnerable to sovereign bond exposures and its short-term public and private combined external exposures are smaller. Besides, it is sitting on nearly half a trillion dollars of foreign exchange reserves. So, while a stimulus amounting to 5% of GDP will most likely lead to a 10-15% fall in Rupee. 

This is perhaps even desirable given the trends with other peer currencies and the resultant issue of export competitiveness. The problem will be with the unhedged ECB exposure of corporates which is over $200 bn. These are mostly the larger corporate groups, who are perhaps among those best placed to manage the risks. However, in recent months NBFCs and HFCs too have picked up exposures, and this would have to be carefully considered and mitigated. This is an important challenge requiring attention. But, given the stakes involved and the lack of alternative courses of action (to finance the stimulus), this risk will have to be assumed.

Further, while the rupee depreciated 28.2% between May 1 and August 28, 2013 (taper tantrum) (HT: Ananth, FRED) and it did doubtless trigger its set of immediate problems, its consequences were soon left behind. Given the nature of the shock, even a 20-25% post-stimulus announcement hit, as has already happened to the currencies of countries like Mexico and Brazil, is unlikely to be of the same effect as would have been the case in other more normal times. Also, the universal impact of the pandemic and the universal over-shooting of fiscal deficit targets, and that too by large percentages in the developed economies, means that the consequences of FD excess of 5% of GDP are likely to be less damaging. As I blogged earlier, when everyone is in the same boat, even the credit rating agencies will have to recalibrate their models.

Another concern is that government's borrowing cost will go up, as was the case with the other EM peers in the aftermath of their stimulus announcements and currency drops. Again, here too unlike the other EM peers, the local treasury market is not too reliant on the foreign institutional investors. In fact, foreign portfolio investors hold a mere Rs 4 trillion out of the total Rs 140 trillion of government debt. Further, a significant share of their investments have already fled, with $15.9 bn fleeing the equity and debt markets in March 2020, of which around $5 bn were from debt markets. This concern, as mentioned earlier, can be mitigated by having the RBI directly finance the government through deficit monetisation.

The final concern is that it can be inflationary. This, however, is unlikely to be an issue for atleast the immediate future given the deeply deflationary nature of the Covid 19 shock. The economy was anyways in a disinflationary path even before the Covid 19 struck. It is likely to take atleast a couple of years for economic normalcy to be restored and purchasing powers regained in a broad-based enough manner to trigger demand-pull inflationary pressures. In this context, given the accumulation of debt stock, it may actually make some sense to have a mild dose of inflation after the two years. In fact, before the Covid 19 struck, the economy was already feeling the pinch from low inflation and attendant low nominal GDP growth.

As to the specific stimulus measures, given the fiscal constraints, loan guarantees are a good strategy to generate value for money from public spending. This assumes greater relevance given the nature of the shock, the demands for working capital especially for SMEs, and the general reluctance of already embattled banks to pass on interest rate cuts and open their lending taps. This could be used to finance SMEs and MUDRA loan-holders with working capital loans, with a lending limit of twice their last working capital loan availed in the previous six months. Larger businesses in certain other sectors, especially those worst affected by the pandemic (HORECA), too could be considered for inclusion.

This could be operated in a couple of ways. One, the government could set apart Rs 25000 Cr to guarantee loans by banks with a first-loss buffer of say 10%, which could help unlock bank lending of about Rs 2.5 trillion. Second, would be for the government to set up an entity with 10% equity and have the RBI providing the remaining fund, and the same being administered through banks. The option to be selected would depend on the constraints faced by banks in unlocking its own capital. 

The government should mandate that any business or bank benefiting from stimulus should necessarily register on the factoring receivables platform, TReDS. Further, it should not be confined to mere registration, but active participation. This can be monitored in terms of their activity, transactions or volumes. Beneficiary banks would need to finance small businesses, and larger businesses would need to provide the support required for their payables being financed for their suppliers. Some incentive structure can be framed to expedite the growth of TReDS. Some measures are suggested here.

In fact, TReDS should become the default platform for small business to access working capital loans availed through the guarantee fund. Similarly, for MUDRA loan beneficiaries availing such loans, some of the reforms suggested here could be considered. 

In any case, to sum up on the fiscal policy side, the government has actually initiated a stimulus of only 0.55% of GDP. It could immediately announce on-budget measures for upto 2 percentage points (and additional 1.45 percentage points), which could include measures aimed at small businesses, corporates in general, and also on the guarantee funds. All measures aimed at providing the backstops required to support a swift recovery. It should then keep the powder dry for quickly unpacking more stimulus spending as required to support the emergent requirements in the post-lockdown exit period. 

As a strategic choice, it is important to announce any fiscal breach with a time-bound medium-term plan for fiscal consolidation. The rating agencies will be interested in this, though the history of reneging on such commitments means that they may not take these at face value. For whatever it is worth, this is required. 

It may therefore be useful to supplement it with a detailed reform plan with milestones and timelines (along the lines of the National Infrastructure Pipeline) both to commit the governments, both at central and state levels, to these reforms as well as thereby signal to investors and other stakeholders about the commitment of the government to undertake these reforms. This may be helpful not only in partially addressing the concerns from the higher fiscal deficit, but also in creating a positive sentiment among investors about India. The latter could be especially valuable in an environment of global economic despair. And India’s unquestioned economic potential makes it uniquely positioned to make this offer.

Finally, while the government does the fiscal heavy lifting, the RBI may have to borrow from the playbook of the western central banks and step in with measures that go beyond its traditional toolkit.  The credit squeeze is already binding and will devastate the financial markets and spill over into the real economy.

A proactive role by the RBI assumes even greater importance given the perilous state of the banking sector and the uncertainties surrounding the NBFCs. The unprecedented decision by Franklin Templeton to shut down six funds with Rs 31000 Cr of assets under management is certain to exacerbate the credit squeeze. The resultant liquidity crunch can lead to insolvencies. For example, the Franklin decision can spook MFs with exposure to NBFCs, besides also spooking investors in MFs themselves. 

In a very good article, Mr UK Sinha warns about the dangers,
The liquidity released by the RBI is just not reaching the desired beneficiaries. Banks have instead parked huge amount with the RBI under reverse repo. Insurance companies are, reportedly, out of the bond market right now. Today, no HFC is getting any repayment from home loan buyers, no SME is able to service its Non-Banking Financial Company (NBFC) loans and no MFI can hope to get any repayment from its low-income borrowers. Banks are reluctant to lend and refusing to apply the moratorium facility to them. Part of the reason could be the bankers’ worry about punitive action even if honest mistakes are made. But the problem of the mutual fund industry can swiftly migrate to the entire financial services industry and might then soon spread to the real economy. The All India Manufacturers’ Organisation predicts the closure of 25 per cent of MSMEs if the lockdown is extended. Microfinance clients may not have a place to go for fresh support whenever the lockdown is lifted and similar will be the fate of home loan buyers. According to a McKinsey report, in case of a 25 per cent default by the MSMEs, there will be solvency issues for the entire financial system.
He also points to the prevailing credit squeeze,
In the week ending April 9, state development loans of Rs 37,500 crore which were put for auction had to be either cancelled or reduced in size — and that too at a yield almost 70-75 basis points higher than the previous week. This was in spite of the rate cut by 75 bps by the Reserve Bank of India (RBI) and injection of liquidity in the previous week. Even highest rated Public Sector Undertaking (PSU) bond issues faced a gripping problem. Rural Electrification Corporation (REC) had to withdraw one of its issues and National Bank For Agriculture & Rural Development (NABARD) could not get the full amount it had sought. ‘AAA’ rated private sector issuers met similar fate and lower rated (investment grade) wouldn’t even consider entering the market. RBI came out with a second package on April 17, where 50 per cent of the Rs 50,000 crore was earmarked for smaller Non-Banking Financial Company (NBFCs) and Microfinance Institutions (MFIs). But, no bank is willing to entertain this. In the first such auction made by RBI on April 23 for Rs 25,000 crore, only half the amount was subscribed. Another booster shot from RBI by way of refinance through NABARD, National Housing Bank (NHB) and Small Industries Development Bank of India (SIDBI) is yet to take off.
The RBI has been providing liquidity and credit to banks by lowering the CRR and through its Targeted Long-term Refinancing Option (TLTRO) window for lending to SMEs, NBFCs etc. But spooked by market uncertainty, recent auctions have not received enough takers and banks have been unwilling to on-lend and have been keeping the money with RBI as excess reserves (more than twice the volume of liquidity off-take has returned to RBI as excess reserves in recent days). This makes a case for direct lending by RBI to NBFCs through the TLRTO window, a mandate that RBI already has. This assumes importance also because the NBFCs are now experiencing Rs 50000-60000 crore funding gap, which is only certain to increase in the coming weeks.

Besides NBFCs, the TLTRO operations may have to target other worst impacted sectors and those where impacts are likely to remain significant even after exiting the lockdown. Here too, if the banks hesitate to lend, taking a leaf out of the Federal Reserve, the RBI may have to consider directly providing them credit. 

Direct purchases by the RBI of solvent and top rated corporate bonds, which too run the risk of being caught up in the liquidity crunch, is most likely to become inevitable. This would ensure that these markets (which are solvent and good businesses) do not get disrupted by a pandemic shock and sink into insolvency. 

Strong co-ordination between the market regulators and government, with perhaps daily calls between the heads of the main regulatory agencies among themselves as well as with the political leadership for some days may be necessary to also create market confidence. These are truly extraordinary times, a perfect storm of real economy and financial markets in synchronised turmoil, and that too globally.

Update 1 (03.05.2020)

Widening CDS spreads of overseas bonds issued by Indian companies. See also Manish Sabharwal here.

Update 2 (08.05.2020)

As they discuss the next stimulus package, ratings downgrade is the elephant in the room for India's policy makers.

C Rangarajan and DK Srivastava does the fiscal arithmetic for India,
Financing of the fiscal deficit poses a major challenge this year. On the demand side, the Central (6.0%) and State governments (4.0%) and Central and State public sector undertakings (3.5%) together present a total public sector borrowing requirement (PSBR) of 13.5% of GDP. Against this, the total available resources may at best be 9.5% of GDP consisting of excess saving of the private sector at 7.0%, public sector saving of 1.5%, and net capital inflow of 1.0% of GDP3. The gap of 4.0% points of GDP may result in increased cost of borrowing for the Central and State governments. This gap may be bridged by enhancing net capital inflows including borrowing from abroad and by monetising some part of the Centre’s deficit. Monetisation of debt can at best be a one-time effort. This cannot become a general practice.
M Govinda Rao argues for empowering states with more resources to fight the pandemic,
it is important for the Central government to provide additional borrowing space by 2% of GSDP from the prevailing 3% of GSDP. This is the time to fiscally empower States to wage the COVID-19 war and trust them to spend on protecting lives, livelihoods and initiate an economic recovery.
Update 3 (21.05.2020)

Vivek Kaul argues that the liquidity support measures enacted by the Government may be pushing at a string. 

Saturday, April 25, 2020

Covid weekend reading links

1. One of the challenges with exiting the lockdown is about managing the normalcy restoration path for different types of economic activities. This is a very good graphic in the US context about the likelihood of infection risk across different occupation categories.

Having something like this for India would be useful.

2. Interesting snippet about the influence of Arabs in Israeli medical field,
Arabs make up only a fifth of Israel’s population, but represent half the country’s pharmacists, a quarter of its nurses and just under a fifth of its doctors, according to the Central Bureau of Statistics. Some of the nation’s largest hospitals have Arab doctors heading major departments, and the country’s leading virologist is Arab.


Arabs are disproportionately represented in the medical community because attaining professional qualifications has been one way to push back against political marginalisation, Arab doctors said. Many trained in Jordan after the two countries signed a peace deal in 1994 and Israel’s Arab community continues to hold medical workers in high regard.
3. More on the Kerala's Covid 19 response here and here

4. For those recommending mass testing, here is a reality check on antibody testing,
The first problem with antibody tests is there aren't any that work at scale, but even if they did there are potential issues. There are no guarantees that if you have antibodies against the coronavirus that you are completely immune. And even if your antibodies do protect you from becoming sick, then you may be able to harbour the virus in your body and pass it to others. There will be many challenges before immunity passports - when if you pass the antibody test you can go back to life as normal - will be practical. This is the problem with a virus that has only been around for a couple of months - there is still too much we do not understand. However, the main appeal of antibody testing is to find out how many people have really been infected with the virus.
5. Fascinating graphics on the traffic from various transportation modes in New York in the backdrop of the Covid 19 outbreak.

6. The story of how ventilators, a device invented in the 1920s, have proved so difficult to mobilise in the aftermath of the pandemic is instructive (HT: Mostly Economics),
In fact, in 2006, following the 2003 SARS outbreak, the Biomedical Advanced Research and Development Authority (BARDA), a newly created division within the US Department of Health and Human Services... produced a design for a ventilator that would be affordable, mobile, and simple enough to be stockpiled and quickly deployed... Soon thereafter, a private company was awarded a multi-million-dollar government contract to develop a more affordable and usable ventilator, and by 2011, it had presented a prototype to US government officials. In 2012, however, the company was acquired by a large medical-device manufacturer that produced “traditional” ventilators, as part of a wider process of industry concentration that has raised questions related to competition and antitrust law. The prototype project was eventually terminated, raising suspicions among government officials and other device manufacturers that the takeover bid had been motivated by precisely that goal. 
Owing to our reliance on market forces to allocate resources for innovation, we now only produce ventilators that are expensive, immobile, proprietary, highly technical, and difficult to use, when what we really need are affordable, mobile, simple, user-friendly machines. In attempting to develop such a device, the US government relied on market mechanisms and profit-driven private firms whose incentives turned out to run counter to the interests of public health... We also need new international mechanisms to promote innovations that make technology more affordable, easier to produce and maintain, and simpler to use, rather than merely more profitable and more complex. A technology that was invented a century ago should not still be beyond the reach of most countries in the world.
7. Ajay Shah outlines a testing strategy - clinical detection with PCR tests, pooled PCR testing at workplaces, panel measurements of random samples to test incidence and progression with both PCR and antibody testing, individual-driven demand-based PCR or antibody testing.

The caution against one-size-fits-all exit strategies is very important. Government of India should outline the principles and then let go of the exit implementation and leave it to states to pick and choose and support them.
Some things you can say flatly for the whole country. I think we are pretty certain that there should be no [opening of] places of worship, no weddings; there are some things we understand all over India. But the complexity of reopening the economy is about local questions, local conversations, local trade-offs, and local discussions. Now, on top of that, in my opinion what we are going to see all over India is a chequerboard pattern of different disease episodes and events happening in different parts of the country. Once again there is a need for local data, local thinking, and local response. Maybe my district will see an incipient flare-up. I will need good data about my district. So all the four strategies of testing need to be there. Then a municipal commissioner, district collector, local political leadership of the district of all parties need to come together and look at the data and think: do we need to go into a more extreme lockdown now because we are at the beginning of a disease surge?


... So think of a chequerboard map all over India, where there will be different stories of this disease and we need the local government to lead the way on the kind of social distancing procedures. Imagine there is a kind of red, blue, green manual in Kolhapur district, in Parbhani district saying that based on local conditions, local trade-offs on our livelihood, our activities, we will have a red manual, blue manual and a green manual. Then the local leadership will look at the data on an ongoing basis and keep making decisions all through the year. I think that is the way we should think about reopening the economy... During the Second World War, there were German bombers going over London. And there is this irresistible imagery of people wearing a business suit, carrying a briefcase, walking on the street, going to work while the bombers are going overhead and the bombs are going off. And I think that is the worldview we have got to bring for two or three years.
Largely agree. But on the local response, it is unrealistic to expect cities and local regions to have the capacity to do this in any reasonable degree of satisfaction at the local level. So the local response would largely have to come by way of being reactive to spikes in cases (as observed in local hospitals) and responding with varying degrees of tightening of restrictions on movement of people and conduct of economic activities. The mandatory practice of wearing masks will have to become a constant of life for the foreseeable future.

This is a good summary of the confusion that has surrounded the Covid 19 response - in terms of problems with co-ordination between the centre and states. Unless sorted out, this will worsen things as the country exits the lockdown, when such co-ordination is critical.

8. Good graphic that captures the destination of out of pocket health care spending in India.
9. Pratap Phanu Mehta writes about the Tacitus Trap facing many governments, especially China and also the US,
But when the dynamics of the Thucydides Trap were being analysed, few had imagined that this competition would break out when both the Chinese and the American political systems would be facing deep internal challenges. This opens up the possibility of overlaying what is known as the Tacitus Trap over the Thucydides Trap. The Chinese coined the term, “Tacitus Trap,” in homage to the great Roman historian, Tacitus. This trap describes a condition where a government has lost credibility to the point where it is deemed to be lying, even if it speaks the truth. President Xi Jinping himself used this term as a call to arms to the Chinese government to maintain its credibility... But even the Chinese coiners of the term could not have imagined that the Tacitus Trap might not just be a challenge facing China. It could become the defining political condition of our time. Authoritarian governments would face a credibility crisis because of their propensity to control information. Many democratic governments face a different credibility crisis: Hyper-partisanship would simply make truth or lies a function of which side was saying it, making sober collective action difficult. The existence of a possible Tacitus Trap exacerbates the risks of the Thucydides Trap.
10. A SIR model predictions for several countries points to the Covid 19 pandemic in India having peaked now and easing off by mid-May.

Thursday, April 23, 2020

The coming China reset?

After having originated the SARS-Cov-2 virus, suppressed information, allowed its spread across the world, and then ruthlessly controlled it internally, China has been pursuing a very crass and unsubtle diplomatic and commercial agenda which is most likely to only exacerbate the fast growing global distrust of the country. See this detailed chronology of events.

It has tried to score diplomatic brownie points by offering supplies of protective gears, masks, testing kits and the like. Sample this and this about the ham handed nature of such efforts,
Often, Chinese officials tell counterparts abroad that they must publicly thank China in return for the shipments, say Western officials, executives and analysts with knowledge of the exchanges. “What is most striking to me is the extent to which the Chinese government appears to be demanding public displays of gratitude from other countries; this is certainly not in the tradition of the best humanitarian relief efforts,” said Elizabeth C. Economy, the director for Asia studies at the Council on Foreign Relations. “It seems strange to expect signed declarations of thanks from other countries in the midst of the crisis.”Commercially too, the Chinese have been too aggressive for their own good. In the hurry to reclaim lost ground on their profitability, Chinese companies have cut corners in quality and resorted to price gouging in their bids for large tenders called by various national governments.
The Spanish, Dutch, Turkish, Australia, Canadian, and Finnish governments have recently returned Chinese manufactured masks. The Chinese government have in turn come in public support of their companies, accusing the foreign governments of not "double checking" the products before their purchase.

There are reports of Chinese manufacturers indulging in price gouging on tenders issued by different countries for large scale purchases of N95 masks, PPEs, testing kits, ventilators etc. Further, the Chinese government too have been manipulating the compliance with orders placed on Chinese manufacturers in return for diplomatic .

The pandemic induced economic crisis looks increasingly likely to be the trigger for the unravelling of the massive debts accumulated by many African and other developing countries in recent years, of which the Chinese lending for the One Belt One Road (OBOR) projects form a major share. As the debt restructuring talks begin, it will be interesting to see how the Chinese react and how much willing they would be to take haircuts on their loans and the costs incurred. This assumes great significance given the scale of lending, especially last decade,
According to the China Africa Research Institute at U.S.-based Johns Hopkins University, the Chinese government, banks and contractors extended $143 billion in loans to African governments and their state-owned enterprises over a 17-year period from 2000.
The economic reliance on China was starkly brought out in the aftermath of the pandemic. There is now a growing urgency among developed countries to diversify away and reshore production facilities. Japan has taken the lead with making its policy explicit in this regard,
On... the postponement of Xi's Japan visit was announced, the Japanese government held a meeting of the Council on Investments for the Future. Abe, who chairs the council, said he wanted high value-added product manufacturing bases to come home to Japan... "Due to the coronavirus, fewer products are coming from China to Japan," Abe said. "People are worried about our supply chains." Of the products that rely heavily on a single country for manufacturing, "we should try to relocate high added value items to Japan," the leader said. "And for everything else, we should diversify to countries like those in ASEAN." Abe's remarks were clear. They came as disruptions hit the procurement of auto parts and other products for which Japan relies on China, seriously impacting corporate Japan's activities. And they asked for something more than the traditional "China plus one" concept, in which companies add a non-China location to diversify production. Abe was forming a "shift away from China" policy...

Such a trend would shake the foundation of China's long-standing growth model. In its emergency economic package adopted on April 7, the Japanese government called for the re-establishment of supply chains that have been hit by the virus's proliferation. It earmarked more than 240 billion yen (about $2.2 billion) in its supplementary budget plan for fiscal 2020 to assist domestic companies to move production back home or to diversify their production bases into Southeast Asia.
If the US too follows up with similar moves, a tipping point could happen with respect to exodus of businesses from China.

The ground is ready for strong post-coved 19 backlashes against Chinese even in countries like Italy. Sample this by Giacomino Nicolazzo about how the government of Matteo Renzi ended up virtually selling important parts of the Italian economy to the Chinese,
A blind eye was being turned to the way the Chinese were buying businesses in the financial, telecommunication, industrial, and fashion sectors of Italy’s economy, all of which take place in Milano. To be brief, China was getting away with purchases and acquisitions in violation of Italian law and EU Trade Agreements with the US and the UK - and no one in either of those countries (not Obama in the US or Cameron in the UK) said a thing in their country’s defense. As a matter of fact, much of it was hidden from the public in all three countries. In 2014, China infused the Italian economy with €5 billion through purchases of companies costing less than €100 million each. By the time Renzi left office (in disgrace) in 2016, Chinese acquisitions had exceeded €52 billion. When the dust settled, China owned more than 300 companies, representing 27% of the major Italian corporations.


The Bank of China now owns five major banks in Italy, all of which had been secretly (and illegally) propped up by Renzi using pilfered pension funds! Soon after, the China Milano Equity Exchange was opened and much of Italy’s wealth was being funneled back to the Chinese mainland. Chinese state entities own Italy’s major telecommunication corporation (Telecom) as well as its major utilities (ENI and ENEL). Upon entry into the telecommunication market, Huawei established a facility in Segrate, a suburb of Milano. It launched is first research center there and worked on the study of microwaves which has resulted in the possibly-dangerous technology we call 5G.
China also now owns controlling interest in Fiat-Chrysler, Prysmian and Terna. You will be surprised to know that when you put a set of Pirelli tires on your car, the profits are going to China. Yep, the Chinese colossus of ChemChina, a chemical industry titan, bought that company, too! Last but not least is Ferretti yachts, the most prestigious yacht builder in Europe. Incredibly, it is no longer owned by the Ferretti family. But the sector in which Chinese companies invested most was Italy’s profitable fashion industry. The Pinco Pallino, Miss Sixty, Sergio Tacchini, Roberta di Camerino and Mariella Burani brands have been acquired by 100%. Designer Salvatore Ferragamo sold 16% and Caruso sold 35%. The most famous case is Krizia, purchased in 2014 by Shenzhen Marisfrolg Fashion Company, one of the leaders of high-priced, ready-to-wear fashions in Asia.
Throughout all of these purchases and acquisitions, Renzi’s government afforded the Chinese unrestricted and unfettered access to Italy and its financial markets, many coming through without customs inspections. Quite literally, tens of thousands of Chinese came in through Milano (illegally) and went back out carrying money, technology, and corporate secrets. Thousands more were allowed to enter and disappeared into shadows of Milano and other manufacturing cities of Lombardy, only to surface in illegal sewing shops, producing knock-off designer clothes and slapping ‘Made In Italy’ labels on them. All with the tacit approval of the Renzi government. It was not until there was a change in the governing party in Italy that the sweatshops and the illegal entry and departure of Chinese nationals was stopped. Matteo Salvini, representing the Lega Nord party, closed Italy’s ports to immigrants and systematically began disassembling the sweatshops and deporting those in Italy illegally.


But his rise to power was short-lived. Italy is a communist country. Socialism is in the national DNA. Ways were found to remove Salvini, after which the communist party, under the direction of Giuseppe Conte, reopened the ports. Immediately, thousands of unvetted, undocumented refugees from the Middle East and East Africa began pouring in again. Access was again provided to the Chinese, under the old terms, and as a consequence thousands of Chinese, the majority from Wuhan, began arriving in Milano. In December of last year, the first inklings of a coronavirus were noticed in Lombardy - in the Chinese neighborhoods. There is no doubt amongst senior medical officials that the virus was brought here from China. By the end of January 2020 cases were being reported left and right. By mid-February the virus was beginning to seriously overload the Lombardy hospitals and medical clinics. They are now in a state of collapse.
This has lessons for India too. Chinese investments in Indian startups have been on the rise,
In the final quarter of 2019, deals involving Chinese investors totalled a record $1.4bn, according to figures from Refinitiv. Data provider Tracxn said Chinese funds invested in 54 funding rounds last year — the largest ever number — compared with just three in 2013 and more than double what it was in 2017. This has helped turn China into one of the biggest sources of funds for start-ups in India, joining well-established investors like Sequoia and SoftBank. Two-thirds of India’s start-ups valued at more than $1bn now have at least one Chinese VC investor. Alibaba has invested in payments group Paytm and food-delivery service Zomato, while fellow Chinese internet giant Tencent has backed car-hailing app Ola and Byju’s, an education start-up. Funds like Shunwei Capital and Morningside Ventures have also become more active, investing in start-ups including bike taxi app Rapido and ShareChat respectively.
India is an obvious market for Chinese entrepreneurs and businesses. Its similarity, size, and stage of development are attractions,
In years past, China’s entrepreneurial diaspora fanned out around the world, opening service businesses like restaurants and laundromats, and more recently selling a range of China-made consumer products. Today, companies like Club Factory embody the next iteration: entrepreneurs exporting innovative tech business models such as micro-lending platforms and short video apps. As the Chinese economy slows and domestic competition grows fiercer, the country’s tech entrepreneurs are looking increasingly to emerging markets.
A timely Brookings report by Ananth Krishnan estimates that Chinese investments in India has risen sharply since 2014, till when net investment was just $1.5 bn. It has since risen more than three-fold to $8 bn over the next three years in the formal Chinese Ministry of Commerce estimates, though the real Chinese origin investments are much higher. Infrastructure, automobiles, energy, real estate and consumer goods formed most of these investments. Interestingly, the Indian Commerce Ministry (DIPP) pegs the Chinese investment till end of 2017 to be just $2 bn!

Further, unlike pre-2014 sales-only approach, trade relationship has started to deepen with investments being made by Chinese companies, including controlling stakes, and a flow of funding, in particular, to the start-up sector. He writes,
When announced projects and planned investments are included, the total current and planned investment is three times the current figure, crossing at least US$26 billion. In greenfield investments and capital invested in acquiring or expanding existing facilities in India, Chinese companies have invested at least US$4.4 billion. Chinese companies have also invested in acquiring stakes in Indian companies, mostly in the pharmaceutical and the technology sectors, and participated in numerous funding rounds of Indian startups in the tech space. Another US$15 billion approximately is pledged by Chinese companies in investment plans or in bids for major infrastructure projects that are as yet unapproved. 
The report urges caution and the need for Indian government and regulators to keep watch on Chinese private investments given the close links between state and the private sector and the former's use of the latter as an instrument of foreign policy and state power projection. But it also points to the opportunity of engaging strategically with the Chinese private sector, which have extensive links to the Party, so as to promote India's own interests. 
So far, the focus of capital-hungry Indian startups and a foreign investment-seeking government has understandably been on attracting investment as well as know-how from China in helping them scale up. This has, however, arguably led to inadequate attention on the specific challenges of regulating investments from China. Chinese companies have escaped the kind of scrutiny in India that their investments have attracted in the West, despite several high-profile investments and acquisitions. Besides the current emphasis on investments, another likely reason is the assumption that investments from the Chinese private sector are entirely different from state-led investments. As we have established, the separation between the Chinese state and private business is blurry. Within China, the Chinese private sector, and particularly tech firms, work closely with the government and the Communist Party in pursuing many of its goals at home. This is especially true of the technology sector, which is widely seen as playing a key role in the party’s enforcement of digital authoritarianism at home, from surveillance to censorship.
India's consumer technology start-up scene has a very strong Chinese presence. Chinese entrepreneurs, startups, and investors have been rapidly expanding their presence in India. This is in addition to the dominant presence of majors like Alibaba, Tencent, and ByteDance (of TikTok fame).

Another report by Gateway House had this to say,
Such is their success that over the five years ending March 2020, 18 of India’s 30 unicorns are now Chinese-funded. TikTok, the video app, has 200 million subscribers and has overtaken YouTube in India. Alibaba, Tencent and ByteDance rival the U.S. penetration of Facebook, Amazon and Google in India. Chinese smartphones like Oppo and Xiaomi lead the Indian market with an estimated 72% share, leaving Samsung and Apple behind.
In the days ahead, as the relations between China and the west thaws and regulatory barriers mount, Chinese businesses and investors will find India among the most attractive of options. The democratic set-up, especially with state governments having considerable autonomy, will create the conditions for

In a recent development, People's Bank of China (PBoC) has picked up a 1.01 percent stake in HDFC. The bank itself is 73% owned by foreign investors. Alarmed by this, the Government of India amended the FDI policy by incorporating a clause which makes government approval mandatory for such investments,
"A non-resident entity can invest in India, subject to the FDI Policy except in those sectors/activities which are prohibited. However, an entity of a country, which shares a land border with India or where the beneficial owner of investment into India is situated in or is a citizen of any such country, can invest only under the Government route."
The restrictions cover even change in FDI or exits from it. It will provide the government with the check on Chinese investments in startups and other sectors.

Update 1 (25.04.2020)

In the latest purge to remove those criticising his rule, Xi Jingping has removed Sun Lijun, the Vice-Minister at the Ministry of Public Security, one of the important leaders in the national police force.

NAR also has a good article on how Chinese influence over Djibouti is increasing and plunging the country into a debt trap.

Update 2 (06.05.2020)

Andreas Kluth writes about how China has been losing Europe on the back of its ham-handed and clumsy disinformation and intimidation campaigns. 
Bejing’s minions instead began spreading disinformation, apparently intended to paint the EU’s democracies as effete and authoritarian China as comparatively strong. In France, the Chinese embassy posted on its website a wild accusation that French retirement homes leave old people to die. In Italy, Chinese sock puppets disseminated tales that the coronavirus had in fact originated in Europe, or doctored video clips to show Romans playing the Chinese anthem in gratitude. In Germany, Chinese diplomats (unsuccessfully) urged government officials to heap public praise on China.

In response, the EU’s diplomatic service assembled a report on the disinformation campaigns being waged by China and that other usual suspect, Russia. China promptly made a bad situation worse, leaning on the publication’s authors to tone it down. At this, members of the European Parliament took even more umbrage and demanded assurances that the EU will not self-censor under Chinese pressure... Somehow, Chinese officials have managed to offend Europeans across the continent who usually agree on nothing. At the beginning of the year, the calendar for 2020 was filled with Sino-European summits celebrating ever deeper ties. Instead, the pandemic is likely to be the occasion for Europeans to begin emancipating themselves from a bad relationship.

Wednesday, April 22, 2020

Meddling in US domestic politics - Chinese style!

FT's long-time Beijing bureau chief and its Asia Editor Jamil Anderlini narrates a remarkable story,
When Roger Roth received an email from the Chinese government asking him to sponsor a bill in the Wisconsin state legislature praising China’s response to coronavirus, he thought it must be a hoax. The sender had even appended a pre-written resolution full of Communist party talking points and dubious claims for the Wisconsin senate president to put to a vote. “I’ve never heard of a foreign government approaching a state legislature and asking them to pass a piece of legislation,” Mr Roth told me last week. “I thought this couldn’t be real.” Then he discovered it was indeed sent by China’s consul-general in Chicago. “I was astonished . . .[and] wrote a letter back: ‘dear consul general, NUTS’.”... China’s goal was to publicise the resolution in state propaganda to validate party rule back home. But now the Wisconsin senator plans a very different bill. While praising the Chinese people, it will “strip the brutal Chinese Communist party naked for the world to see . . . as well as the damage it has done to the whole world through covering up this coronavirus,” Mr Roth said. It is likely to pass with a hefty majority.
Pls do read the resolution draft that was sent (yes!!) to the legislator here. Read in particular the last paragraph. 
Now, therefore, be it resolved by the Wisconsin State Senate that... (2) the Wisconsin State Senate encourages the United States government to continue to follow the WHO recommendations and work together with the WHO and other countries toward the goal of preventing the virus from taking more lives.
The audacity and diplomatic chutzpah are stunning. 

This is no proxy effort like that allegedly by the Russians, this is state-sponsored interference in US domestic politics. 

It's staggering that the diplomat has not been expelled. It's also telling that but for some articles with stray references, the liberal media like the NYT and Washington Post have hardly highlighted this. Imagine the counterfactual if this were a correspondence by a Russian diplomat praising Trump.

Do we need any more proof as to why events like Brexit and Trump happen?

Tuesday, April 21, 2020

The problems with the Xi Jinping turn

I had blogged earlier arguing that the changes undertaken by Xi Jinping may have sowed the seeds for the eventual collapse of the Chinese model of economic growth as well as the authoritarian one-party rule in the country.

Now Minxin Pei writes that the internal stresses generated by Xi Jinping's actions may be getting exacerbated by the tensions with the US and its consequences. This, he argues, may be a

He summarises the actions of Xi which have contributed to these stresses,
In 2018, Xi decided to abolish presidential term limits, signaling his intention to stay in power indefinitely. He has indulged in heavy-handed purges, ousting prominent party officials under the guise of an anticorruption drive. What is more, Xi has suppressed protests in Hong Kong, arrested hundreds of human rights lawyers and activists, and imposed the tightest media censorship of the post-Mao era. His government has constructed “reeducation” camps in Xinjiang, where it has incarcerated more than a million Uighurs, Kazakhs, and other Muslim minorities. And it has centralized economic and political decision-making, pouring government resources into state-owned enterprises and honing its surveillance technologies. Yet all together, these measures have made the CCP weaker: the growth of state-owned enterprises distorts the economy, and surveillance fuels resistance. The spread of the novel coronavirus has only deepened the Chinese people’s dissatisfaction with their government.
This has broken
The economic tensions and political critiques stemming from U.S.-Chinese competition may ultimately prove to be the straws that broke this camel’s back. If Xi continues on this trajectory, eroding the foundations of China’s economic and political power and monopolizing responsibility and control, he will expose the CCP to cataclysmic change. Since taking power in 2012, Xi has replaced collective leadership with strongman rule. Before Xi, the regime consistently displayed a high degree of ideological flexibility and political pragmatism. It avoided errors by relying on a consensus-based decision-making process that incorporated views from rival factions and accommodated their dueling interests. The CCP also avoided conflicts abroad by staying out of contentious disputes, such as those in the Middle East, and refraining from activities that could encroach on the United States’ vital national interests. At home, China’s ruling elites maintained peace by sharing the spoils of governance. Such a regime was by no means perfect. Corruption was pervasive, and the government often delayed critical decisions and missed valuable opportunities. But the regime that preceded Xi’s centralization had one distinct advantage: a built-in propensity for pragmatism and caution.
In the last seven years, that system has been dismantled and replaced by a qualitatively different regime—one marked by a high degree of ideological rigidity, punitive policies toward ethnic minorities and political dissenters at home, and an impulsive foreign policy embodied by the Belt and Road Initiative (BRI), a trillion-dollar infrastructure program with dubious economic potential that has aroused intense suspicion in the West. The centralization of power under Xi has created new fragilities and has exposed the party to greater risks. If the upside of strongman rule is the ability to make difficult decisions quickly, the downside is that it greatly raises the odds of making costly blunders. The consensus-based decision-making of the earlier era might have been slow and inefficient, but it prevented radical or risky ideas from becoming policy.

Under Xi, correcting policy mistakes has proved to be difficult, since reversing decisions made personally by the strongman would undercut his image of infallibility. (It is easier politically to reverse bad decisions made under collective leadership, because a group, not an individual, takes the blame.) Xi’s demand for loyalty has also stifled debate and deterred dissent within the CCP. For these reasons, the party lacks the flexibility needed to avoid and reverse future missteps in its confrontation with the United States. The result is likely to be growing disunity within the regime. Some party leaders will no doubt recognize the risks and grow increasingly alarmed that Xi has needlessly endangered the party’s standing. The damage to Xi’s authority caused by further missteps would also embolden his rivals... creeping discord would at the very least feed Xi’s insecurity and paranoia, further eroding his ability to chart a steady course.
This, in turn coupled with economic slowdown due to the Covid 19 induced global economic recession and the exhausting of the easy growth pathways, could potentially trigger "middle-class discontent, ethnic resistance, and pro-democracy protests". This would erode President Xi'a authority and embolden his critics, which in turn would make him become more repressive.

His assessment of the likely denouement,
... a regime beset by economic stagnation and rising social unrest at home and great-power competition abroad is inherently brittle. The CCP will probably unravel by fits and starts. The rot would set in slowly but then spread quickly.
I had blogged earlier exactly on these lines that China's biggest problem will be, ironically enough, Xi Jinping. He has shrunk the internal and external space that is central to the "crossing the river by feeling the stones" approach that has in turn been central to maintaining internal stability and a hospitable external environment. Both are now under threat.

Monday, April 20, 2020

The miracle of financial engineering - CLO edition

Bloomberg has a primer on the market for leveraged loans and collateralised loan obligations (CLOs). This illustration of a CLO that converted underlying junk loans into investment grade securities is stunning.
Unlike the more famous collateralised debt obligations (CDOs) which cover a wide array of debt, CLOs are made from leveraged loans. The market for leveraged loans has topped $2 trillion, and in the US 60% of loans to sub-investment grade firms (leveraged loans) end up as CLOs. The money raised by leveraged loans have been used to finance private equity buyouts, pay dividends and refinance borrowings.

Saturday, April 18, 2020

New trends and possibilities post-Covid 19

By the time Covid 19 is behind us, several things would have changed in the world economy. Here is a list of a fourteen intriguing possibilities. I will keep updating this.

1. The massive rescue packages announced by national governments mean that the remorseless accumulation of debt that has been a feature of the world economy since the early eighties may be about to enter a new phase of acceleration. As with many trends in the world economy, Japan again may be the pointer.
Tokyo has run large fiscal deficits for decades and seen its debt balloon to 240 per cent of economic output, but continues to enjoy some of the lowest borrowing costs in the world. That is largely because the Bank of Japan has gone further than other central banks, buying as much debt as it needs to keep yields below certain thresholds under a policy known as “yield curve control”. Yields on 10-year Japanese government bonds (JGBs) have steadily fallen from nearly 2 per cent in 2006 to less than 0.02 per cent today. The futile trade of betting against the bonds has been dubbed “the widow-maker”.
The FT article points to the Fed being ready to set out on its tryst with "yield curve control".

2. As both the stock and flow of debt mounts, governments in the developed world will grapple with the issue of avenues to mobilise resources. If its advocates can push the agenda on it, with a bit of luck, higher marginal tax rates on the richest will become a reality. The moment has never been riper on this. Thomas Piketty's suggestions will no longer look fanciful.

The example of World War II when taxes surged to finance the war effort is a case in point. Morgan Hausel quotes FDR from 1942,
Are you a businessman, or do you own stock in a business corporation? Well, your profits are going to be cut down to a reasonably low level by taxation. Your income will be subject to higher taxes. Indeed in these days, when every available dollar should go to the war effort, I do not think that any American citizen should have a net income in excess of $25,000 per year after payment of taxes [roughly $375,000 adjusted for inflation].
Emmanuel Saez and Gabriel Zucman call for an excess profit tax,
The government should impose excess profits taxes, as it has done several times in the past during periods of crisis. In 1918, all profits made by corporations above and beyond an 8 percent rate of return on their capital were deemed abnormal, and abnormal profits were taxed at progressive rates of up to 80 percent. Similar taxes on excessive profits were applied during World War II and the Korean War. These taxes all had one goal — making sure that no one could benefit outrageously from a situation in which the masses suffered.
The excess profits tax is something which makes great sense. After all a world-wide force majeure event applies just as much to Amazon as it does to Delta Airways. And Amazon has not done anything to deserve the current business growth and post-pandemic head start that it would stand to benefit from. 

3. For governments struggling to bridge fiscal deficits, as Andy Mukherjee writes, another avenue can be to ease out the favourable treatment accorded to debt over equity. Apart from raising additional revenues, this would also serve the purpose of throwing sand on the wheels of corporate debt accumulation, which has worsened the crisis. The debt bias is for real.
For historical reference, the tax exemption on interest expenses was supposed to have been a temporary measure,
It was in 1918, when economists were likening the global spread of an excess profit tax on wartime corporate income to the deadly outbreak of the Spanish flu, that the U.S. relented and allowed all interest paid to be deducted from taxable profit. It was a temporary measure to give firms relief, but although the extra tax burden went away in 1921, the favorable treatment of interest income stayed and was copied around the world.
He writes about a 100-year opportunity for reform on tax deduction on debt expenses, 
The additional corporate value garnered with cheap debt isn’t a free lunch. An International Monetary Fund staff discussion note warned in 2011 that “costs to public welfare are larger — possibly much larger — than previously thought.” The 2017 overhaul of the U.S. tax code restricted interest deduction to 30% of earnings before interest, tax, depreciation and amortization as an offset for slashing the corporate rate to 21% from 35%. The U.K., too, put a limit... With industries of all hues begging governments for survival capital, rebates and even employee wages, bargaining power of firms is at rock bottom. The unfinished tax reform agenda has a chance. Given that suppliers of debt financing are spread all over the world, a withholding tax on interest payments could cause dislocations. “A less disruptive option,” as law professors Michael Graetz and Alvin Warren, Jr. argued in a 2016 essay, “might be to deny deductions for all or part of interest payments at the corporate level.” 
A post-coved work which at least partially removes the preferential treatment accorded to debt could be a step in the right direction.

Robert Armstrong in FT too agrees.

4. In response to the UK Government's latest £60 bn rescue package announcement, which would have widened its fiscal deficit to over £200 bn, the rating agency Fitch  downgraded the country by a notch to AA-.

In the coming days, rating agencies will in all likelihood be forced to recalibrate their models, as every country in the world undergoes an unprecedented simultaneous steep recession coupled with a steep increase in fiscal spending to mitigate the downturn.

This could turn out to be a blessing in disguise for countries like India as it weighs its own fiscal deficit options.

5. Most countries started the pandemic with weak economies and an already high debt burden. This will only worsen significantly due to the rescue packages announced. This creates a dilemma.
On the one hand, with debt burdens soaring (estimated to reach 130-140% of GDP in US against 120% reached after WW II), governments and central banks will be keen to keep rates low so as to prevent debt sustainability problems. Low rates, already a feature over the last decade, will have to get further entrenched as the new normal. But this demands continuation of the current extraordinary monetary policy actions for a long period of time, for the foreseeable future.

Central banks will have to navigate completely uncharted waters, with all the unpredictabilities and uncertainties. The consequent accumulation of distortions will not come without costs, and huge ones at that, down the future. As the Economist writes, it could have laid the path towards revival of inflation.
The crisis could weaken structural forces weighing on demand. Take inequality, for instance, which concentrates income in the hands of the thrifty rich. More generous post-pandemic safety-nets, or progressive taxes enacted to pay down large government debts, could redirect income towards freer spenders, creating inflationary pressure. So could a change in policymaking attitudes. The economic traumas of the early 21st century may push governments and central banks to prefer high economic growth and low unemployment to low and stable inflation, as happened after the second world war. Inflation is not certain to return after covid-19. But its re-emergence seems less fantastic a possibility.
6. An interesting thing about the crisis has been sheer scale of economic policy responses in the US by both the Federal Reserve and the Treasury. Both have accredited themselves with the most far-reaching measures upfront in response to the emerging crisis, measures which dwarf those during the 2008 crisis. Interestingly, those at the helm were acclaimed for their actions then and latter. It has since often been held out as an example of how experts could be trusted to address such crises.

In contrast today, Jerome Powell who heads the Fed is a lawyer. And President Trump's Treasury has long been accused of not having or heeding star economists. But their performance, at least till date and to the extent of the rescue measures announced, has been truly impressive. Will the likes of Steve Mnuchin and Jerome Powell be acclaimed by the same people who have written that Lloyd Blankfein, Tim Geithner and Ben Bernanke "saved the world"?

Gillian Tett has glowing praise for Jerome Powell,
When he was named chairman of the US Federal Reserve two years ago, some observers, me included, suspected he might be distinctly dull. Unlike his immediate predecessors, Mr Powell was no economics luminary; nor was he much of a performer, or “maestro”, as author Bob Woodward dubbed Alan Greenspan. Mr Powell had forged most of his career in the camera-shy world of corporate law. Colleagues described him as “pragmatic”, “self-effacing”, “genial”, “humble” and “cautious”. However, Mr Powell is fast becoming the least cautious — or dull — Fed chair in history. As the coronavirus pandemic shuttered the global economy, he scrambled to deploy and build on tools created by his predecessors to fight the 2008 crisis: cutting rates, buying Treasury and mortgage bonds and supporting the commercial paper market. Now the Fed is moving into new territory: it has pledged to purchase municipal and corporate bonds, along with exchange traded funds, and organise a so-called Main Street bank-lending programme for the first time. Mr Powell is not just crossing traditional red lines, but deliberately sprinting over them... In one area, Fed officials have already scored a huge success: they narrowly averted a market meltdown last month. As historian Adam Tooze tweeted, they “flattened the curve” of the initial coronavirus financial panic. The scale of this achievement is outlined in a new Bank for International Settlements report. It describes in chilling detail how much stress was created when leveraged hedge funds stampeded for the exit in the Treasury market and threatened to create cascading shocks. That Treasury prices are now relatively stable is a big victory. So is the easing of conditions in the municipal, corporate and mortgage markets.
A healthy recalibration away from individuals and experts is much needed. However, I am not very sure this can become a trend.

7. Whatever the support measures from governments, the Pandemic will leave a landscape filled with distressed businesses. Besides valuations would have been shattered - in March 2020 alone the 500 biggest public companies in the US lost $3 trillion in valuation. These are great conditions for distressed asset buyers and private equity. Sitting on over a trillion dollar of raw powder, private equity firms, especially the top tier ones, will be in pole position to benefit from the Pandemic. Similarly, hedge fund giants too have started mobilising funds to be ready to invest when the market hits bottom.

On the other hand, any removal of the debt bias will remove the ingredient that alternative investment funds use to juice up their returns, thereby weakening their prospects.

8. Globalisation, already under assault from protectionist trends, will become more defensive. The Covid 19 Pandemic may have hastened slowbalisation, atleast for the medium-term. Sample this and this for just two articles on the bleak prospects for globalisation.

Nowhere is this protectionism more evident in medical supplies. The Global Trade Alert project at the University of St Gallen in Switzerland says that at least 69 countries ave banned or restricted the export of protective equipment, medical devices or medicines. 

9. The lockdowns will provide a big boost to online activities of all kinds. In education personalised learning instruction through adaptive learning softwares will invariably improve and become common. Similarly telemedicine technologies will be expedited. Tools to make remote work more practical and effective will emerge and hasten the 'work from homes' trend.

10. One of the most critical legacies of the pandemic may be on the area of digital data privacy. In the quest for quick-fix solutions to enforce lockdowns, private information about patients have been shared on the media and doctor-patient confidentiality has been breached. The Economist writes that the data tools being used to fight Covid 19 may provide the slippery slope for erosion of privacy in the guise of collective good.
11. One of the biggest shifts could be with attitudes towards the government, especially in relation to the private sector. The stimulus measures, sovereign debt, expansion of welfare state, and surveillance are only some of the reasons for the return of the big government.

12. On the positive side, Covid 19 may have brought down the curtain on the era that Ronald Reagan inaugurated with his  derisive caricature of the government, pointing to the most scariest thing in the world - “I’m from the government and I’m here to help”!

For example, no UK government can now afford to not strengthen and build on the NHS for the foreseeable future.

This is just as much relevant for opinion makers and researchers on development. For those advocating private sector, cash transfers and other innovations to deliver public services, the pandemic should be a cautionary note. The public distribution system, primary health care facilities and their field personnel, panchayat administration, ICDS centres etc have been at the frontlines of the crisis fighting. 

13. One of the features of the modern economy is the emergence of large integrated networks or systems of economic activity. So we have large chains in retail, healthcare, education, hospitality, and so on which have displaced the small, owner-operated, and stand-alone establishments. But while the former is economically more efficient, it also comes up with its set of concentrated risks, which become so evident in times of such pandemics.

Sample this about India's kirana shops compared to e-commerce establishments,
Despite significant growth in e-commerce’s reach and sales during the Covid-19 crisis, the local kirana stores have emerged winners. The traditional trade channel that serves over 1.3 billion people, compared to some 120 million by e-commerce, has fared significantly better when it comes to availability of essential goods like rice, wheat, pulses, milk, sugar and salt. Obstacles faced by delivery personnels during the initial days of the lockdown might have played a key role in its poor service and a sudden dip in availability of essential items on online channels also impacted many.
Both policy makers and businesses will have to give greater weightage to the issue of risk management and resilience in the trade-off with economic efficiency and profitability.

See also this on the resurgence of kirana shops from NAR.

The struggles faced by Amazon's famed supply-chain management system is now widely acknowledged.

14. Finally, the pandemic may be the tipping point for efforts to end the regulatory arbitrage enjoyed by internet companies, especially the independent contractor status of the employees of sharing economy companies. Out of their jobs and without any economic safety net, they have been among the worst affected by the pandemic.

Update 1 (11.05.2020)

Arun Maira lays down seven principles for a new order - reduce the obsession with GDP growth; resurrecting boundaries between nations; government is good; market is not the best solution; citizen and not consumer welfare should be the objective of progress; competition must be restrained; intellectual property belongs to the public.