Sunday, January 31, 2016

Weekend reading links

1. Despite concerns about its decline, Apple dominates the global smart phone market,
Among leading smartphone manufacturers, Apple takes 60 percent of the sector's revenue on just 20 percent of the sector's unit sales (or about 14 percent of the world's overall smartphone market). Samsung, on the other hand, snares 26 percent of the sector's revenue, on 43 percent of the sector's unit sales.
2. The WSJ captures the increasing weakness among emerging market economies as reflected in the successive downward revisions of their growth projections by the IMF.
3. For all talk of China's debt stricken corporates, India's corporate debt servicing problem is worse than that of Chinese firms, and has remained at that level for more than three years.
4. An OECD policy note finds that financial expansion fuels greater income inequality, and advocates the use of macro-prudential instruments to prevent credit over-expansion and eliminating the tax bias against equity (interest payments are deductible from income tax payable, whereas dividends are not). It also "supports measures to reduce explicit and implicit subsidies to too-big-to-fail financial institutions through break-ups, structural separation, capital surcharges or credible resolution plans". Underlining the skewed nature of its effect, a 10% of GDP expansion of financial sector credit has a positive effect on incomes of only the top decile of households.
5. Thomas Piketty's book elevated the problem of widening inequality to the center of public policy debates across the world. However, the consensus on its contributors, leave aside how to mitigate it, elides us. Skill-biased technological change, automation of middle-class jobs, greater financialization, weakening unions, greater returns to capital complemented with stagnating labor incomes etc have been blamed. In this context, Mathew Rognlie (paper here) has this compelling graphic which spotlights attention on the role of housing prices as contributing to the inequality wedge.
As the graphic shows, Rognlie argues that "recent trends in both capital wealth and income are driven almost entirely by housing". It does not depreciate whereas modern technology investments depreciate rapidly. He, therefore, advocates liberalization of zoning and building regulations to lower property prices. Irrespective of whether it is the leading contributor to widening inequality or not, its can be safely presumed that greater deregulation of the property market has so many beneficial effects. 

6. The latest NSSO data draws attention to India's chronic under-employment problem. Though there were 62 million graduates and post-graduates in 2011-12, formal unemployment rate was less than 5%, since a large share of them are employed in occupations which clearly do not need such educational qualifications. Livemint has the followin graphic about the occupation patterns of Indians.
Underlining this, just 35.4% of graduates and above have regular salary paying jobs.
7. There are very few large low-hanging fruits with public sector reforms in India. One exception may be Indian Railways and the potential benefits and savings from a series of cumulative operational reforms. Rationalization of trains and routes, increasing speed by reducing stoppages, radically improving its IT systems, outsourcing services, more efficiency manpower deployment, and so on have massive potential for unlocking value. This is apart from more macro and policy-oriented reforms like private participation, PPPs in the development of railway stations, high-speed rail etc. 

The challenge is with the political economy of these reforms. One strategy may be to undertake a devolution of far greater powers to the eighteen zones, especially operational powers, leaving the Railway Board with minimal co-ordination responsibilities. Letting zones develop as cost-centers and fostering competition among them in both commercials and service delivery quality is more likely to create the conditions required to overcome the political economy obstacles. Allowing a few mutant General Managers to change the rules of their game is a more likely strategy for change. 

Oil industry - this time is no different!

Commodities markets are prone to the classic boom and bust cycle - economy booms/demand increases, prices rise, capacity expands, production soars, excess supply/economy weakens, prices fall, capacity expansion halts, and so on. The US shale market is the latest to fall victim. Shale oil production in the US soared on the back of rising global oil demand (China effect), rapid technological developments (hydraulic fracturing and horizontal drilling), and cheap capital. The FT writes,
Companies have achieved remarkable gains in productivity by optimising production techniques and drilling only in the “sweet spots” that generate the most. They have also been driving down the prices they pay their suppliers and contractors. Jim Burkhard of IHS, the research group, says the cost of drilling and completing a typical shale well fell 35-40 per cent last year...

US crude production rose from 5.1m barrels a day at the start of 2009 to 9.7m b/d in April last year, a surge that has few parallels in the industry’s history... The small and medium-sized companies that led the shale revolution raised $113bn from selling shares and $241bn from selling bonds during 2007-15, according to Dealogic... Low rates drove investment in marginal US shale projects “that are uncompetitive at lower prices and now need to be unwound”...

The boom years left the US oil industry deep in debt. The 60 leading US independent oil and gas companies have total net debt of $206bn, from about $100bn at the end of 2006. As of September, about a dozen had debts that were more than 20 times their earnings before interest, tax, depreciation and amortisation... Almost a third of the 155 US oil and gas companies covered by Standard & Poor’s are rated B-minus or below, meaning they are at high risk of default...

Private capital funds raised $57bn last year to invest in energy, according to Preqin, an alternative assets research service, and most of that money is still looking for a home... Bankruptcies, a cash squeeze and poor returns on investment mean companies will continue to cut their capital spending. The number of rigs drilling oil wells in the US has dropped 68 per cent from the peak in October 2014 to 510 this week, and it is likely to fall further... The US oil and gas industry has lost 86,000 jobs over the past year, about 16 per cent of its workforce, and many of those people will never return. When the industry does want to expand again, it will need to offer attractive wages and training, which will raise costs.
This is all predictable history, exactly the same storyboard as earlier episodes. There is nothing which warrants a belief that this time will be different with the rebound. The most compelling arguments in favor of a long period of low oil prices are secular stagnation in developed economies, the continuing decline of Chinese demand, and the full return of Iran and Iraq. All first is only a marginal contributor to the decline in demand, the second vastly over-played, and the third marginal and one-off. So the question is not whether oil prices will stay long for a long period or not, but when, over the next 1-3 years, will it start its rebound. 

Thursday, January 28, 2016

Cushioning the victims of global trends

There are atleast three drivers of displacement of people from the labor market - technology, free trade and globalization, and immigration. All three also have the effect of depressing wages, widening inequality, and fostering social and political discontent. 

But conventional wisdom and orthodoxy advocate unambiguous support for such policies. Their arguments are based on the view that the aggregate effect of these forces are a net positive. While this may be so, it cannot be denied that all of them creates losers in addition to winners. In the circumstances, it is facile, even disingenuous, to argue in favor of free-trade without complementary policies that compensate the losers or at the least mitigate their suffering. A generous and robust social safety net is one of the primary requirements to cushion the losers against these trends and proceed ahead with them. 

It is in this context that Steve Rattner makes the moral and political case for compensating the losers of globalization. While the US loses manufacturing jobs, its consumers benefit by way of cheaper imports and greater disposable incomes. 
A similar challenge is faced by European countries as they grapple with hordes of immigrants fleeing the civil war in the Middle East. The spectre of immigrants displacing locals, especially in lower skilled jobs, looms large.
Much the same applies to embrace of technology. In all these cases, the concerns of those likely losers cannot be simply brushed aside on ideological and humanitarian (to refugees) grounds. Unfortunately, as Martin Wolf writes, the politics of the elites on both sides of the spectrum miss this 
The projects of the rightwing elite have long been low marginal tax rates, liberal immigration, globalisation, curbs on costly “entitlement programmes”, deregulated labour markets and maximisation of shareholder value. The projects of the leftwing elite have been liberal immigration (again), multiculturalism, secularism, diversity, choice on abortion, and racial and gender equality. 
I am inclined to the opinion that the political leaders have been ill-served by thought leaders and opinion makers in addressing such challenges. The latter have let their ideological predilections cloud their judgements. Instead, a prudent appraisal of the outcomes of these trends would have led to the advocacy of a more nuanced approach towards them. In its absence, the ideological space has been occupied by extremist political ideologues who peddle protectionist, anti-immigrat, and neo-Luddite policies, all of which corrode the country's social and political fabric. 

Tuesday, January 26, 2016

Make for India?

Sometime back I had blogged highlighting the differences between making in India (for external markets) and making for India. In this context, a Project Syndicate article, which points to the possibility of China emerging as a global innovation hub, highlights the point,
Chinese companies have prospered in customer-focused industries because they have learned to tailor their goods to the needs of their country’s emerging consumer class. Whereas Chinese companies used to focus on designing products that were “good enough” – not quite matching the standard of Western products, but offering huge cost savings – they are now out to create products that are cheaper and better, in order to satisfy wealthier consumers. The sheer size of China’s market – comprising more than 100 million mainstream consumer households – also helps, as it enables companies to commercialize new ideas rapidly and on a large scale.
As numerous studies - SECC, Credit Suisse, Pew, and the government's own income tax database - show, India simply does not have a large enough, less price sensitive domestic consumer class that can sustain learning by doing involving world-class innovation. Given this country's narrow and deeply price-sensitive consumer base, that vast majority of manufacturing has to be stripped-down, less-than-world-class, and frugal to be competitive enough for the domestic market. In the circumstances, in the medium-term, even with the headwinds of competition from Chinese exports and weak domestic manufacturing competitiveness, a more realistic approach would be to promote making for India.

Update 1 (07.02.2016)
Arun Maira is the latest to talk about "Make for India".

Sunday, January 24, 2016

Weekend reading links

1. The latest Oxfam report on global wealth distribution points to worsening inequality. Just 62 people own the same wealth as 3.6 billion people in the poorer half of world population, down dramatically from 388 five years ago. The report also finds that their wealth rose 44% since 2010 to $1.76 trillion, whereas that of the bottom half fell by 41% in the same period! In fact, since the turn of the century, while they received just 1% of the total increase in global wealth, the top 1% of population, whose wealth now exceeds the rest of the world, received half the increase!
This is part of a secular decline in the share of labor income across the world.
2. Livemint points to Ambit Capital's Keqiang index of real economic indicators (auto sales, cargo volume, capital goods imports, and power demand), which exhibits a striking correlation (81% positive correlation) with the old GDP series and a very weak (35%) correlation with the new series. As per this index, which has consistently declined over the past year, the September quarter GDP estimate would be 6% against 7.4% in the new series.
3. More signatures of corporate distress come from the rising proportion of shares pledged by India's business owners. Promoter share pledging rose 14% in the last quarter to reach Rs 2.03 trillion, or 46.35% of promoter holdings. There were 25 companies where promoters had pledged 100% of their holdings, 79 with more than 90%, and 208 with more than 50%.
Unsurprisingly, infrastructure firms dominate the list of those who have pledged their shares.

4. Livemint points to a WEF report on labor market disruption based on survey of executives across 15 countries which points to a loss of 7.1 million jobs due to redundancy, automation, or disintermediation, especially in white-collar office and administrative roles.
5. Solar power tariffs continue their sharp downward trend, with the latest round of reverse bidding under the National Solar Mission resulting in Rs 4.34 per unit. Finnish firms Fortum Energy bid that rate for 70 MW, with US firm Rising Sun Energy quoting Rs 4.35 per unit for two projects of 140 MW, and French Solairedirect bidding Rs 4.36 for the same capacity. NTPC had bid out a total of 420 MW in its solar parks across Rajasthan in this round.
Softbank, along with its joint venture partner SBG Cleantech had quoted Rs 4.63 for 350 MW in Andhra Pradesh earlier. Under the NSM, the Government of India provides viability gap funding of Rs 1 Cr per MW as well as land and transmission corridor. 

6. Arvind Panagariya has flagged off a debate on the merits of having a two per cent inflation lower bound for India arguing that none of the developing countries have had 2-3 percent inflation rate on a sustained basis. 

7. The financial market problem facing the Chinese economy is a teachable moment in foreign exchange management policy. In recent months, even as the dollar has strengthened against other currencies, the renminbi's dollar peg has had the effect of keeping the Chinese currency over-valued, and making it appear as an one-way bet. The Chinese government's recent apparent tolerance of depreciation, if only motivated by considerations of external trade competitiveness, by way of widening the renminbi's trading band may have lend further credence to this perception. This has had the effect of encouraging domestic capital flight from China in anticipation of weakening renminbi, circumventing tight capital controls. In 2015, there was $676 bn in net capital outflows from China. 
The outflows put pressure on foreign exchange reserves which fell by $512.7 bn last year, the highest ever. The Chinese government's clumsy response to equity market volatility, rising public and private non-financial debt, and uncertainties about economic growth numbers have naturally spooked the markets and fuelled a belief that things may be far worse. As the graphic below shows, capital outflows by domestic investors have been the driving force behind the reversal of capital flow trends.
In such situations, market reactions are far from rational and are easily swayed by perceptions and more often than not over-shoot its repsonse. In this context, a gradual easing of capital controls and transitioning to a floating exchange rate may have the effect of triggering an irrational run on the currency. Given the recent precedents, its response from the Chinese government is more likely to exacerbate the concerns and deepen the devalution spiral. 

In the circumstances, where markets have taken control, for good or bad, the best that Chinese government can do is to reassure the markets and gradually depreciate. Some form of capital controls, despite the difficulty of its enforcement, during this transition may be useful. 

Thursday, January 21, 2016

Monetizing road projects

Conventional wisdom would have it that infrastructure contracts should be structured in a manner that bundles construction with long-term maintenance so as to minimize life-cycle costs and maximize efficiency gains. Accordingly, the orthodox approach for PPP contracting in roads, that hitherto pursued by India, has been to allot projects as long-term Build-Operate-Transfer (BOT) concessions. It was hoped that this would align the incentives of the concessionaires to construct the project in a manner that minimizes maintenance costs. 

But this search for first-best contract structuring betrays an ignorance of the complex dynamics that drive long-term infrastructure contracting, especially in certain sectors like transportation and urban infrastructure. I have written about incentive distortions that detract from the achievement of desired objectives and how it squares up with global experience. This blog has therefore consistently, for a very long time now, held the view that infrastructure contracts should preferably be constructed through arms-length public procurement, construction risk off-loaded, concessioned out as long-term contracts, and be supported with an incentive compatible renegotiations framework.  

The Ministry of Road Transport in India embraced the public procurement based EPC model last year after the classic PPP BOT models failed to generated bidder interest. Now, the Ministry has apparently identified 104 commissioned toll roads for monetization and hopes to earn Rs 800-1000 bn from these public funded projects over the next 20-25 years. What remains is the adoption of enabling renegotiation frameworks. 

As to the present proposal to monetize toll roads, there are certain concerns that should be addressed. I had co-written earlier about them here, describing them as second generation issues. One in particular assumes significance. A 20-30 year operation and maintenance (O&M) concession naturally raises the issue of mid-term upgradation of the asset. There is ample evidence that concessionaires generally tend to skimp on this or demand renegotiations when the time comes. It is therefore essential that the bids can accommodate the resources required for such capital investment. Further, project lenders should ensure that the project cash-flow waterfall be structured accordingly. 

Sunday, January 17, 2016

Weekend reading links

1. Is this the tipping point in the growth versus sustainability debate with regard to energy? From the Times
Last year, Germany, the world’s fourth-largest economy, reached a milestone by reducing its overall energy consumption while still recording modest economic growth of 1.5 percent, breaking a traditional pattern in which nations see their energy use fall only during recessions. The share of renewable energy use has continued to rise as the use of fossil fuels has fallen — all while tempering the concerns of industry about rising costs and maintaining global competitiveness...
Germany has already realized its goal of increasing the share of power generated by solar, wind and other renewable sources, without hurting industry or plunging the nation into darkness. Last year, those energy sources accounted for 27.8 percent of all power consumed, for the first time edging out lignite, or brown coal, the country’s favorite fossil fuel. The national goal for renewables is 35 percent by 2020.
But the immense political and social consensus required for this may not be possible in many countries,
Since 2000, across party lines, German governments have passed laws and set regulations encouraging the production of solar, wind and bioenergy, in a program known as the Energiewende, or Energy Transition. At the same time, businesses, enticed by subsidies and prodded by Berlin, have worked with researchers on new ways to improve efficiency. The foundation for the entire effort has been the support of German citizens, who have been willing to shoulder the burden of increased costs in the short-term, in the long-term hope of leaving their children with a cleaner, more sustainable system... German consumers are being asked to bear much of the price of the energy transition, which the government projects will be at least 550 billion euros, or about $597 billion, by 2050, in order to shield energy-hungry heavy industry from higher costs. This has left households with far higher electricity rates than their counterparts in most other countries... electricity prices for a three-person household have risen 68 percent since 1998...Yet public support remains strong. A survey by TNS Infratest pollsters this year showed a strong majority of Germans continue to back the energy transformation effort, with 67 percent saying they favored the government’s policies.
In most countries, including all developing ones, since consumers are loath of pay the associated higher costs and businesses fear losing their competitiveness, governments prefer to stay away from such policies.

2 Amidst the stories surrounding El Chapo's dramatic recapture, the Times has a fascinating expose of the rising trend of violence against Mayors by Mexico's drug lords,
Hired killers, known as sicarios, have killed almost 100 mayors in Mexico in the last decade... The cartel makes telling demands of the mayors — for example, contracts for valuable building projects or the right to name the town police chiefs. And they are forcing mayors to give them 10 percent of their annual budgets. As Mexico’s government provides much of the financing, this means the cartels are feeding from the federal pot.. a year in drug-war aid. Corruption in Mexico is as old as the country itself, and traffickers have been bribing politicians during the century that they have been smuggling drugs to Americans. Mayors, governors and federal officials have turned a blind eye to opium fields and meth superlabs... 

But now gangsters are flipping this century-old deal. Instead of handing out bribes, they are making the mayors pay them. Politics is not just a way to help their criminal businesses; it is a business in itself. And as they take control of these politicians, the cartels transform themselves into an ominous shadow power, using the tools of the state to affect anyone who lives or works in its jurisdiction. With more than 2,000 mayors in Mexico, most of whom have little protection, the cartels have a big market to tap. The combined booty is potentially worth billions of dollars a year... Sometimes cartels cut out the middleman and put one of their own directly in the town hall. This was allegedly the case in the Guerrero city of Iguala, whose mayor, José Luis Abarca, is now in prison on organized crime charges, accused of being a member of Guerreros Unidos. Dozens of his police officers are also in jail, accused of being sicarios in uniform.
3. The graphics below captures the scale of China's explosive surge the debt to GDP ratio among non-financial corporates,
... and financial sector corporates.
The charts also show that local government debt has been driving up Chinese debt ratio; worsening balance sheets of local government state-owned enterprises; and raising the debt burdgen of commodities-related firms so much so that they rose from very few firms with interest payments higher than earnings in 2007 to more than half the firms having interest payments twice their earnings. 

4. Edward Glaeser reviews Robert Gordon and asks,
Will the best brains of the future build anything resembling our past innovations, or will they dedicate their time to tasks like making Twitter more user-friendly?
He also captures Gordon's central finding, 
He splits American lifestyles into core categories—food, shelter, clothing, health, transportation—and shows the revolution in the lives of ordinary Americans. Concentrating on the core needs of human existence rather than on coarse GDP statistics, he... helps us to understand the magnitude of the shift between 1870 and 1940... The world of 1940 is much closer to the world of 2010 than it is to the world of 1870. While almost every aspect of life changed between 1870 and 1940, the alterations from 1940 to 2010 came in particular areas.
5. Fascinating profile of Richard Posner which captures his concept of 'legal pragmatism' (as against 'legal formalism') as a 'judicial balancing of costs and benefits' through an 'economic analysis of law',
Posner describes legal pragmatism as a “practical and instrumental” application of that attitude. It is: “forward-looking, valuing continuity with the past only so far as such continuity can help us cope with the problems of the present and of the future;” “empirical,” focused on facts; “skeptical,” doubtful that any decision, legal or otherwise, represents “the final truth about anything” because frames of reference change over time; and “antidogmatic,” committed to “freedom of inquiry” and “a diversity of inquirers”—in other words, to the “experimental”—because progress comes through changes in frames of reference over time, “the replacement of one perspective or world view with another.”
6. Praveen Chakravarthy and Rajeev Gowda strike a note of caution on Startup India arguing that start-up scene in India is already flourishing without any government role,
Over the last 10 years, in India, $60 billion has been invested in more than 3,000 new start-ups. Indian start-ups received nearly 50 times more venture capital in 2015 compared to 2000. In 2015, venture-capital investments in India were higher than net foreign investments in stock markets for the first time in history, leaving out the global financial crisis years. Venture-capital financing for Indian start-ups has grown at a compounded rate of 30 per cent over the last 15 years. India already has the third largest start-up ecosystem in the world, boasting of more than 12,000 active start-ups. That there is a thriving and growing private venture-capital industry for providing risk capital to start-ups in India is quite evident. It is then inexplicable that the government should seek to squander away scarce tax rupees in the garb of providing a funding impetus to the start-up ecosystem — when, clearly, there are worthier claimants such as issues of rural distress, bad loans in the banking sector, and distraught power sector finances.
7. Times reports on the perils of rapid expansion with the example of Chinese ship-builders,
Up and down the Chinese coastline, in harbors and along coastal rivers, companies bought big plots of land, purchased cranes, and hired large numbers of welders. China expanded from one-fifth of global shipbuilding capacity in 2008 to two-fifths by last year. Quality control was a problem from the start. “In China, building what are supposed to be two identical ships in two adjacent slips, you get two different vessels,” said Basil Karatzas, a Manhattan ship broker. “In Japan, they can build 10 ships and they are all the same.”
With many Chinese shipyards dogged by complaints, competition was fierce. Japanese and South Korean shipyards demanded 20 percent down payments for orders, plus a guarantee from an international bank to pay the rest of the cost if the buyer defaulted. Although Chinese shipyards demanded the same deposits, they did not require the guarantees, and accepted orders from what were effectively shell companies with weak finances. That put Chinese shipyards at risk... F
or the 58,000-ton bulk freighters that Chinese shipyards were churning out, prices have plunged from nearly $30 million in 2013 to just $16 million now. Buyers who bought at the high end chose to forfeit their deposits instead of paying for finished vessels worth less. Chinese shipyards are now littered with half-finished shells, like immense steel earthworms cut in two. Many shipyards lack the money to complete vessels and sell them at a discount that might allow them to recover some costs.

Saturday, January 16, 2016

Shipping industry fact of the day

As the Baltic Dry Index hits historic lows, this spells more trouble ahead,
Owners of so-called capesize vessels (the largest type) reckon it costs $8,000 a day to run these ships at sea; however, shipping costs for users are so low that they only receive $5,000 in fees.
And this with fuel price declining continuously!

Thursday, January 14, 2016

Judiciary and self-regulation

Among the many contributors to weak state capability and the difficulty of doing business in India, one of the least discussed is snowball litigation, whereby higher courts entertain appeals, often indiscriminately. This frustrates businesses and officials alike, encourages dubious appellants, and over-burdens the judiciary. 

The Article 136 of the Constitution empowers the Supreme Court to "grant special leave to appeal from any judgment, decree, determination, sentence or order in any cause or matter passed or made by any court or tribunal in the territory of India". Its sweeping nature, institutionalized in the form of Special Leave Petitions (SLPs), evidently means that it has to be exercised in cases involving a substantial question of law or a gross miscarriage of justice. But, as this Livemint article shows, this extraordinary jurisdiction appears to have been reduced to a regular appellate one - 34,500 SLPs were filed in 2014, of which 43% were admitted, in a Supreme Court with case-load of just over 60,000! 

A stark example of courts' tolerance for snowball litigation comes from the fate of Tribunals. A few years back, Tribunals were initiated as a progressive alternative redressal mechanism, a step to minimize litigation and reduce the case load on the higher judiciary. Accordingly, numerous Tribunals were established as part of State and central legislations. But unfortunately, instead of lowering the caseload, Tribunals have become another institutional layer of litigation, since the losing party invariably ends up going on appeal before the courts. The courts have tended to entertain even petitions ostensibly on procedural issues on cases being heard by the Tribunal and go beyond points of law in appeals on Tribunal decisions. If these trends persist, it is only a matter of time before any alternative dispute redressal mechanism, including those enshrined in the proposed Arbitration and Conciliation Act, gets reduced to being another layer of judicial bureaucracy. 

In this context, the Supreme Court's refusal to prescribe tighter norms for accepting Special Leave Petitions (SLPs), on the ground that any effort to limit the powers under Article 136 would be tantamount to disturbing the "basic features" of the Constitution, is disturbing. It is today well known that the acceptance rates of SLPs vary widely across judges and their individual discretion is arguably the critical factor in many cases. This naturally erodes its credibility and generates perverse incentives. Therefore, far from diluting its importance, rigorous due-diligence, as outlined in a clearer set of internal guidelines which limit the range of individual discretion, would go a long way towards strengthening the Supreme Court's power under Article 136. 

It is a sign of mature institutions that they acknowledge their failings and put in place mechanisms to rectify them when they come to notice. In a country where such institutional maturity is unfortunately very scarce, it is only appropriate that the highest court of the country shows the way with self-regulation.

Tuesday, January 12, 2016

A health insurance model for India

I have written earlier about why health assurance for India that revolves around any insurance model may be fiscally unsustainable. But given the political popularity of health insurance, it may be difficult to put the genie back in the bottle. So what is the least damaging health insurance model? 

I'll propose a five-pronged approach. First, given its fiscal unsustainability, a more realistic compromise may be to ration coverage by limiting insurance to a set of catastrophic medical conditions, ones that contribute the largest share to the country’s high OOP spending. This standard benefits package can be offered as a basic plan by all insurers. Second, it may be useful to consolidate all the public insurance schemes offered to different categories of people under one umbrella, with a basic insurance plan and different types of top-ups, including those which provide premium care. They would include central government schemes like those offered by the Ministry of Labor and Employment, various public sector units for their employees, departments for population categories like weavers, the flagship RSBY, and the various state government schemes. Like in the continental Europe, the basic plan should be community-rated (same premium for everyone in an age cohort, irrespective of pre-existing medical conditions) cover a very basic set of high-incidence catastrophic medical conditions and no more, and have the same premium across insurers within a region.  

Third, instead of unrestrained consumer choice, there should be rigorous enough gate-keeping to ensure both the referral chain and also that it does not become a channel to enrich private multi-specialty hospitals. Patients should not be entertained at tertiary care facilities for simple secondary care treatments and instead be directed to the revamped first referral units. For patients under publicly financed insurance, private facilities should not become the default first choice. Instead, some form of public facility default should be designed, which, while strongly encouraging the use of public facilities should not end up completely eliminating choice. Service standards and cleanliness in public secondary and tertiary care facilities should be improved and their value proposition enhanced. But all this assumes efforts to improve service standards at public secondary and tertiary care facilities. 

Four, such an insurance architecture will provide enormous monopsony power, at the least to the extent of those conditions covered in the basic plan. Strategic buying centered around this plan, done possibly at regional or state levels, can keep costs down. Finally, foster competition among different insurers through transparent purchasing through exchanges. While they would have to offer the basic plan at the same (regional) rates, private insurers should be allowed to differentiate based on the top-ups and the quality of their services. 

But before designing any such plan, it would be necessary to have the requisite administrative and regulatory framework in place for its effective implementation. An independent body like the NICE in the UK, instead of the Ministry of Health and Family Welfare, should be entrusted the responsibility to decide on the basic plan conditions subject to the fiscal constraints. The quality of care delivered should be strictly monitored, with clearly defined treatment protocols and outcomes, through a mix of occupational self-regulation and public regulation. Information asymmetry regarding care and insurance choice and their respective pricing should be bridged through information dissemination efforts revolving around mobile phone apps etc so as to allow informed purchasing. Finally, this opportunity should be used to start developing a robust IT network that can support electronic medical records. Given the concerns about privacy and portability, public policy intervention may be necessary to formulate enabling data management rules, and even support some form of basic IT system that underpins medical records.   

Monday, January 11, 2016

LNG fact of the day

The first cargo of LNG exports from the United States is set to sail this week from Cheniere Energy's Sabine Pass LNG plant on the coast of Louisiana, "marking the arrival of US as a gas supplier to the world". The Sabine Pass terminal is one of the 54 projects under consideration or execution in the US, with capacity to liquefy nearly 60% of US gas production. 
It comes at a time of deep flux in global energy markets,
The price of LNG delivered in north-east Asia, including Japan and South Korea, the world’s two largest markets... has dropped to about $6.65 per million British thermal units, just a third of its price of almost $19 per mBTU two years ago... At that price, with benchmark US gas at about $2.40 per mBTU, plus liquefaction costs of $3 to $3.50 per mBTU, plus transport at about $2 per mBTU, LNG from Louisiana or Texas does not look commercially attractive. Similar calculations apply in Europe. Benchmark UK National Balancing Point gas has dropped by almost a half since 2013 to about $5.20 per mBTU, meaning that LNG exports from the US to Britain are unlikely to cover all of their costs.
Since 2013, most of the new LNG projects launched worldwide have been in the US. However, the deteriorating economics make it unlikely that any new plants will be approved for a while. The plants that have already started construction, though, are highly unlikely to be stopped. This is because the companies buying LNG from one of these plants have typically made firm commitments for 20 years under which they have to pay the charges they have promised, even if they do not use the capacity. The US LNG projects will add to global oversupply. Bernstein Research has estimated that the world’s liquefaction capacity will in the next three years rise by 90m tonnes per annum, which is about 35 per cent of present demand... US LNG should help hold gas prices down for a few years at least.
Its more fundamental impact will be in terms of setting in motion forces that would lead to the creation of a unified global natural gas market. In the current deeply fragmented global energy markets, price discovery is done on the basis of oil price and there are no spot markets for natural gas. In India, it raises more questions about the logic behind the current gas pricing formula.

Update 1 (14.02.2016)

The Economist says that a global market with a market pricing mechanism is emerging in natural gas and a bear run in its prices is to be expected. Massive capacity expansion - an expected increase in global LNG availability by a third over the next three years - will push over-capacity to about 10%. A surge in demand for LNG from Japan, S Korea, and China, in the aftermath of 2011 Fukushima tragedy drove the investments in liquefaction trains and regassification terminals. But the demand has since waned, leaving capacity idle and plunging spot prices.

Update 2 (25.03.2016)
Bloomberg points to the converging natural gas price with coal prices in China, more signs of the emergence of a single global market in natural gas.

Sunday, January 10, 2016

Nudging the taste-buds with audio-visual and other perceptions

Nicola Twilley has this profile of the work of experimental psychologist Charles Spence who studies how sensory responses influence our assessments of physical products. In particular, his studies have shown that apart from conventional olfactory sensibilities, various audio-visual perceptions play an important role in perceptions about the quality and taste of food products. These insights from neuroscience carry great relevance for packaging of food products,
His results show that the Pringles that made a louder, higher-pitched crunch were perceived to be a full fifteen per cent fresher than the softer-sounding chips. The experiment was the first to successfully demonstrate that food could be made to taste different through the addition or subtraction of sound alone... Afterward, Spence’s lab began studying the crunch of apples, the fizz of carbonated water, and the rustle of potato-chip bags... Spence has found that a strawberry-flavored mousse tastes ten per cent sweeter when served from a white container rather than a black one; that coffee tastes nearly twice as intense but only two-thirds as sweet when it is drunk from a white mug rather than a clear glass one; that adding two and a half ounces to the weight of a plastic yogurt container makes the yogurt seem about twenty-five per cent more filling, and that bittersweet toffee tastes ten per cent more bitter if it is eaten while you’re listening to low-pitched music... a cookie seems harder and crunchier when served from a surface that has been sandpapered to a rough finish, and that Colombian and British shoppers are twice as willing to choose a juice whose label features a concave, smile-like line rather than a convex, frown-like one.
Some of these insights have applications far and wide, like increasing the appetite of old-aged people,
He noted that... the elderly, when eating tomato soup, must add more than twice as much salt as a young person does in order to achieve the same taste. Why not mitigate that increased salt consumption, and its attendant health hazards, by presenting the soup in a blue container, a color that Spence has shown can make food seem significantly saltier? Similarly, experts estimate that sixty per cent of eighty-year-olds have an impaired sense of smell, sharply reducing their enjoyment—and thus, often, their intake—of food... Spence found that when people were served a scoop of bacon-and-egg ice cream accompanied by the sound of sizzling bacon they described the taste of the ice cream as much more “bacony” than subjects whose consumption was accompanied by the clucking of chickens. This insight—that the appropriate soundtrack can intensify the flavor of a food—inspired Blumenthal’s iconic “Sound of the Sea” dish, for which diners at his restaurant, the Fat Duck, in Bray, are presented with an iPod loaded with a recording of crashing waves and screeching gulls to listen to while enjoying an artfully presented plate of seafood. The effect could be used similarly, Spence said, to design soundtracks that replace some of the lost flavor of food for the elderly.
His research findings go beyond food,
In 2006, with funding from Unilever, Spence conducted a study to see whether altering the volume and pitch of the sound from an aerosol can would affect how a person perceives the pleasantness or forcefulness of a deodorant. Based on Spence’s findings, the company invested in a packaging redesign for Axe deodorant, complete with new nozzle technology. The underarm spray, which is targeted at young men, now sounds noticeably louder than the company’s gentler, female-targeted Dove brand... sounds originating from behind a driver’s head will direct attention forward more quickly than sounds that come from the side—has found its way to market with the introduction of headrest-mounted speakers in 2015 Volvo FH trucks.
Apart from their commercial utility, behavioral framing like Spence's and this generate significant social externalities. They are important last-mile gap bridging measures, which are often the difference between success and failure of large public policy interventions. But these are far from low hanging fruits and require huge amount of carefully constructed, and possibly expensive, research, which unlike commercial beneficiaries, public stakeholders have limited incentive to pursue. In this context, dedicated behavioural units, like those in the UK and US, assume significance.

The risk with such sensory manipulation is, as the author identifies, its potential for "sensorial enrichment and nutritional impoverishment", whereby products are shaped to maximize sales and profits at the expense of health and well-being. Given the skewed information and cognitive balance between sellers and consumers, it is most likely that its effects end up being not so benign, even socially harmful, more so for the poorest.  

Friday, January 8, 2016

Weekend reading links

1. It is no surprise that ideological or political leanings can cloud our judgement about various apparently objective issues like the state of the economy. Accordingly staunch supporters of a party are less likely to acknowledge bad economic or other news when their party is in power. Times points to recent studies which show that it may be possible to overcome this partisan bias if we pay people responding to these questions, 
When survey respondents were offered a small cash reward — a dollar or two — for producing a correct answer about the unemployment rate and other economic conditions, they were more likely to be accurate and less likely to produce an answer that fit their partisan biases. In other words, when money was added to the equation, questions about the economy became less like asking people which football team they thought was best, and more like asking them to place a wager. Even a little bit of cash gets people to think harder about the situation and answer more objectively... 
The effect was even more pronounced when respondents were rewarded for honestly answering “I don’t know” when they didn’t have enough information. Otherwise, it appears that people will respond objectively to questions when they know the answer, but revert to their partisan biases when they don’t. The paper by Mr. John G Bullock, Alan S. Gerber, Seth J. Hill and Gregory A. Huber found that offering a $1 payment for a correct response and a 33-cent payment for an answer of “Don’t know” eliminated the entire partisan gap between Democrats and Republicans on questions about the economy.
Interestingly, in the paper by Mr. Prior, Gaurav Sood and Kabir Khanna, the cash payments became less effective at coaxing an accurate answer if the question mentioned the president by name. George W. Bush was president at the time of the survey, but by extension it appears that Americans can be more objective answering a question like “Is the unemployment rate lower or higher than it was seven years ago?” than a question like “Is the unemployment rate lower or higher than it was when Barack Obama became president?” even though as a factual matter those are the same question.
Among other things, these findings highlight the critical importance of framing and decision architecture while making surveys. Given that most surveys miss such nuances, it may be a good reason to take their findings with a pinch of salt.

2. The Eurasia group has this striking map of the growing influence of anti-immigrant nationalist parties in Europe on the back of economic weakness and surge in migrants fleeing the civil wars in the Middle East.
This can be a very important politically destabilizing factor in the region.

3. Spicejet, which was close to being grounded by end-December 2014, has engineered a dramatic turn-around, with three consecutive quarters of profits. The Economist has a fascinating description of the Spicejet turnaround, starting with the firms change in management,
He started by negotiating with aircraft-leasing firms for better terms and with lenders for fresh finance, and by injecting equity capital of his own. He cut jobs—and managers’ pay—and scrapped unprofitable routes. Then came a slew of efficiency measures which added up to big improvements in the performance of the carrier’s fleet. Pilots of its Bombardier Q400 turboprops, which serve second-tier cities, were told to step on the gas to shave a few minutes off each flight, making it possible to squeeze in one extra trip each day. The steel brakes on the wheels of its Boeing 737s were replaced with lighter carbon brakes, cutting fuel consumption. The number of in-flight magazines on each aircraft was reduced, and attendants began serving meals in cardboard boxes instead of on plastic trays—again, trimming the aircraft’s weight and cutting fuel burn.
More attention was paid to filling each plane’s tanks with just enough fuel, with a suitable safety margin, but no more. Pilots now lower their planes’ landing gear 7-8km from touchdown, instead of 14km as before; and on the ground they often now taxi on just one engine. Stocks of spare parts were improved at the carrier’s main bases, to get planes back in the air faster. SpiceJet’s aircraft spend roughly 13 hours a day in the air, whereas for other Indian airlines the figure is just 10-12 hours... On the revenue side, the airline has boosted its earnings from ancillary services such as on-board meals and seat selection.
4. Livemint points to the latest CMIE data which show a rise in the value of stalled projects and declines in both public and private sector capex plans and new project announcements. Both the absolute volumes as well as proportion of stalled projects have been rising. 
Interestingly, in contrast to 19.42% of private projects just 4.82% of public projects are stalled. This four-fold differential may point to the far greater difficulty experienced by private sector in managing construction risks with its attendant challenges of site acquisition and permit clearances. One more to the growing list of reasons for adopting the model of public arms-length procurement followed by private contracting. 

5. This blog has long held the view that the concern with infrastructure projects is not that projects get delayed, because they get delayed everywhere. FT draws attention to a UK National Audit Office report which says that a third (37) of the large government projects (106) due for delivery over the next five years are unlikely to fully deliver or will remain unfinished due to high staff turnover, skills shortages and poor risk management. The more fundamental concern is the lack of flexibility of restructure those projects and complete them at the earliest, conditional on them getting stuck. 

6. FT points to the rapid growth of quasi-sovereign bonds, assumed by state-owned entities, which thought not on the sovereign government's balance sheet has implicit government guarantee and therefore adds to the net sovereign liability. While the stock of EM quasi-sovereign bonds rose from $710 bn in 2014 to $839 bn by end-2015, the total stock of all external EM sovereign debt was just $750 bn at end-2015. Such shape-shifting is bound to further increase concerns about sovereign debt positions among EM economies.

But India has not been one of the major destinations for EM bond inflows. Despite the attractively priced low interest rates, reflecting their weak investment intentions, Indian corporates raised just $35.7 bn through domestic and off-shore debt markets in 2015, a drop of 28% over 2014 and the lowest in six years. Of this, just $8.9 bn was raised off-shore through 34 deals, compared with $18.8 bn and $35 bn over the previous two years. 

7. Spurred on by the cheap credit and corporate cash hordes (still $1.8 trillion with S&P 500 companies in the US) with limited investment opportunities, M&A deal-making scaled its highest ever volume at $4.59 trillion eclipsing the earlier record of $4.13 trillion in 2007, including 137 mega deals involving more than $5 bn.
In times of economic weakness, businesses see M&A as a susbstitute to organic growth. In sectors like pharmaceuticals, businesses have come to see M&A as a means to avoid the costs and uncertainties associated with conventional drugs discovery process. The FT writes that unlike 2007
... there is greater availability of cheap financing and the healthier state of corporate balance sheets. In 2007, the benchmark US 10-year Treasury yield sat at 4.6 per cent compared with 2.2 per cent today. And even after record levels of share repurchases in this cycle, companies in the S&P 500 index are still holding more than $1.8tn of cash, compared with $0.8tn back then. Both facts suggest there is ample firepower for companies to pursue transactions. Companies are also increasingly using their own equity to pay for deals. This year, 47 per cent of all takeover activity has been at least in part financed with stock, compared with 21 per cent in 2007.
8. Even as India's makes a massive manufacturing push, its exports have tanked big time, declining continuously for twelve months.
9. Livemint has another graphic that points to the skewed nature of bank credit allocation across sectors - housing makes up more than a third of total incremental credit, seven times industrial credit; personal consumption loans made up 58.4% of total incremental credit.
Note the small volumes - less than $2 bn of bank loans to manufacturing!

10. Finally, this puts in perspective the scale of decline in commodities prices,
As a result of reduced Chinese demand, 42 of the 46 commodities that the World Bank tracks traded at their lowest level since the early 1980s in 2015.

Wednesday, January 6, 2016

Renegotiating infrastructure contracts

Contract renegotiations are passé. The challenge today is not so much to prevent renegotiations by trying to write complete contracts, but to manage them effectively. It is an acknowledgement of this reality that the Union Budget has proposed the enactment of a Public Contracts (Resolution of Disputes) Act.

Experience from several decades of concession contracts from across the world and in different sectors shows that incomplete contracts are the norm. In a famous analysis of over 1300 concession contracts in Latin America, World Bank economist Luis Guasch has shown that 54% of them ended up being re-negotiated within 18 months. In India too, the vast majority of national highways and all the ultra-mega power projects (UMPP) which were allotted through competitive bids are now being re-negotiated. 

This should come as no surprise given the deep uncertainty that is sought to be tamed by such contracts. It is extremely difficult, even impossible, to conceive of all possible contingencies which can possibly derail a contract over a 20-30 year period of time. There are simply too many unknown unknowns for anybody to write a reasonably credible contract for such a long duration. Renegotiations become inevitable. 

Concessionaires demand tariff increases, extension of concession tenure, back-loading or reduction in their investment obligations, and adjustment of periodic fees payable. But re-negotiations detract from the sanctity of the original contract and generate moral hazard. 

In the circumstances, the objective should be to minimize the distortion of incentives, given the strong likelihood of renegotiations. Adhering to a few principles during contracting can minimize moral hazard, align incentives, and reduce uncertainty. 

One, the rigor of technical and commercial feasibility analysis of the project should not be compromised for constraint of time. Unrealistic demand and traffic forecasts, tariff assumptions, and maintenance estimates – most often the result of hurried project preparation - are the commonest causes for renegotiations. 

Two, any contracting process should focus on prudent risk allocation. It should not encumber concessionaires with risks whose realization is high and which cannot be diversified. The example of Case I bids for UMPPs, where aggressive developers passed over the option of imported fuel price pass-through and preferred to quote levellized tariffs involving fixed-price for fuel is a case in point. It was ex-ante evident that developers were assuming a huge price risk they could not control. Similarly price-cap regulated contracts (tariff is regulated), though politically acceptable because they shift risk allocation from consumers to operators, are more vulnerable to re-negotiations than cost-plus regulated (tariff calculated based on rate of return) contracts. 

Three, sanctity of contracts should be protected. Contract re-negotiations should be explicitly prohibited in cases where the risks were clearly defined and voluntarily borne by the concessionaire. This of course raises the important issue of clear risk allocation in public private partnership (PPP) contracts. In the aforementioned case of UMPPs in India, the concessionaire knew about the real risks and consciously chose to quote the risky option. Any renegotiations then become untenable. One way to approach this problem would be to have a negative list of considerations which cannot merit re-negotiations. 

Four, the concessionaire should internalize the cost of re-negotiations. For example, in annuity or toll-based highway contracts which go for renegotiations, any changes to the contract tenure or schedule of payments should not modify the contracted net present value of the payments payable or receivable. A toll contract where the successful bidder is one who bids the lowest net present value of revenues (to recover his investments and make a profit), for example, allow for such renegotiations. 

Five, the Guasch study shows that contracts which have investment obligations and those under price-cap regulations are most vulnerable to renegotiations. They generally result in either delays or reduction in investment obligation targets and tariff increases. Transport, water and sewerage sector contracts dominate these. Such contracts would benefit from a built-in provision for periodic reviews, with clearly defined contingencies that demand such reviews as well as their scope. In such projects, the British model of price-cap regulation – where tariff increases are capped based on inflation, efficiency improvements and capital investments, where the bid values are valid for only the initial few years, and is followed by regulatory reviews over 5-7 year periods - may be more appropriate.

Six, the process of renegotiations should be apolitical and institutionalized. The original mandates of regulators should clearly outline the scope, terms, and protocols for any re-negotiations. The legal basis of the entire renegotiations and its appellate processes should be clear and strong and insulated from the government. And all this should be reflected in the contract. Further, regulatory autonomy is critical to curbing both political opportunism and corporate greed, besides creating institutional credibility surrounding such contracts. This credibility can be enhanced by involving a panel of reputed sector specialists in the renegotiations process. 

Seven, in cases where the project valuation is clear, governments should also consider buying out the developer’s investments and then re-contract it out. In such cases, in order to avoid the moral hazard, the amount payable for termination should be contingent on the bids received during the re-tenders. 

Eight, cost over-runs during construction phase is a common cause for renegotiations. Since many public transit and utilities contracts are price-cap regulated, cost over-runs invariably result in demand for price/tariff increases. The case of Mumbai metro is just the latest. In this regard, the practice in Australia and UK of adjusting for an “optimism bias”, calculated based on the history of cost over-runs in all projects in the sector, while writing contracts can be useful. Scenario planning that accommodates various contingencies of risk materialization and the action thereon would help mitigate its adverse consequences. 

Finally, renegotiations are more likely when competition is intense and on contracts negotiated in good times when plentiful credit is available. Just as investors pour money into asset classes driving up valuations and inflating bubbles, developers throw caution to the wind and low-ball bids with excessively optimistic revenue projections that reflect the euphoria of the boom. In such times, financial markets fail to do the due diligence that prevents excessive risk-taking by euphoric developers. Once the business cycle turns downward, affecting the project’s commercial viability, the developer is left with no option but seek renegotiations. Governments would therefore do well to be cautious with excessively attractive bids that get made in such times and when competition is high. The real cost of such apparent “free lunches” follow, but much later.