Saturday, April 30, 2016

Weekend reading links

1. The story that Africa, with its burgeoning middle-class and a new dawn of democracy, would be the new East Asia was always questionable. Now "over-exuberance has given way to uber-pessimism",
In its semi-annual report, the World Bank forecast growth in Sub-Saharan Africa of just 3.3 per cent this year, less than half the average of 6.8 per cent recorded between 2003 and 2008. Because of their growing populations, most African states need nearly 3 per cent growth just to stand still in per capita terms.
The biggest challenge for the African economies is their lack or slow pace of productive structural transformation, a problem not amenable to easy solutions,
Perhaps the biggest flaw in the middle class story is that, with a few exceptions, Africa hardly makes anything. For too many countries, the economic model continues to be to dig stuff out of the ground and sell it to foreign companies... Unless governments can build sustainable growth models less dependent on commodities and based more on adding value domestically, the ‘Africa Rising’ story will be just that: a story.
2. This snapshot of the reversal of commodity prices since January 2014 says it all,

3. Gavyn Davies points to the relative exchange rate movements since 2010, which marks out renminbi as being the biggest loser, in terms of currency appreciation.
The scale of renminbi's appreciation makes it a ripe candidate for an one-way bet, something which Beijing would go out of the way to dispel.

4. FT points to China's spectacular debt accumulation, rising from 148% at end-2007 to $25 trillion (163 trillion RMB) or 237% at March 2016., far higher than the emerging markets debt to GDP ratio of 175 at the end of Q3 2015. New borrowing rose by 6.2 trillion RMB in Q1 2016, the biggest three-month surge on record. As the graphic below shows, the country today has the largest corporate debt ratio among all major economies.
However, the article's reference to the concern of Michael Pettis and others about a Japan-style balance sheet recession in China may be overblown. For a start, there is a compelling argument that demographics has been the driving force behind the Japanese problems. More importantly, in terms of the space for responding, unlike Japan, the government and households in China are among the least indebted. The big worry with China would be the impact of large-scale corporate defaults and its impact on a largely public banking system, which gets amplified as the government struggles to increase consumption spending by consumers.

5. Bloomberg reports that $7.8 trillion of sovereign bonds are currently yielding negative rates, as against just $3 trillion yielding more than 2%!

To put the distortions in perspective,
Ireland’s 100 million euros ($113 million) of bonds due in 2116 were issued to yield 2.35 percent -- similar to yields that benchmark 10-year German bunds offered as recently as 2011.
And FT has country-wise break-up of negative yield debt,

Half a century ago, harvesting California’s 2.2 million tons of tomatoes for ketchup required as many as 45,000 workers... by the year 2000, only 5,000 harvest workers were employed in California to pick and sort what was by then a 12-million-ton crop of tomatoes.
7. FT has a longform on China's robot revolution, which will make it the largest operator of industrial robots in the world by the end of the year. Even as it is automating its factories with robots, its entrepreneurs have been moving very rapidly up the robot production chain. Backed by government support, Chinese robot manufacturers have been rising fast. In 2014, President Xi Jinping called for a 'robot revolution' to address labor shortages and improve Chinese manufacturing quality, and exhorted,
Our country will be the biggest market for robots, but can our technology and manufacturing capacity cope with the competition? Not only do we need to upgrade our robots, we also need to capture markets in many places.
Driving the rapid adoption of robots in China is its economics - the payback period of robots fell from 5.3 years to 1.7 years in the 2010-15 period and is expected to fall to 1.3 years by 2017. 

8. Corporates in the US may be flush with cash surpluses. But the market expectations of long-term corporate health may have rarely been as bleak as now,
Three decades ago, the club of triple A-rated American corporate borrowers was a busy place. About 60 big companies, ranging from Pfizer to General Motors, were deemed so “safe” that they held this coveted tag from the credit rating agencies. No longer. Standard & Poor’s has just stripped the mighty ExxonMobil of its triple-A rank because of understandable concerns about falling oil prices and mounting energy sector debt... This leaves just two — yes, two — American companies still in that triple-A club: the unlikely duo of Microsoft and healthcare giant Johnson & Johnson.
This further shrinks the global space of "safe assets", thereby amplifying the flight in "search of yield". In this context, Gillian Tett also points out the parched global landscape for "safe assets",
Ricardo Caballero and Emmanuel Farhi calculate, using data from Barclays, that between 2007 and 2011, the value of safe assets fell from $20.5tn to $12.2tn, equivalent to a drop from 36.9 per cent of global gross domestic product to a mere 18.1 per cent... Prof Caballero and Prof Farhi argue the imbalance is so severe that the problem confronting the world today is not a “liquidity” trap but a “safety trap”: the shortage is creating a self-reinforcing, panicky cycle that is contributing to stagnant growth.
More stringent post-GFC financial market regulatory provisioning norms, QE purchases by central banks, growing global sovereign indebtedness, and now the shrinking space of AAA rated corporate debt, have all contributed to the scarcity of "safe assets".

Thursday, April 28, 2016

Geng Yanbo and the transformation of Datong

NYT has this brilliant documentary made by Qi Zhao and Hao Zhou that captures the tenure and life of Mayor Geng Yanbo of Datong municipality, who transformed the city over a five-year period by relocating nearly half million people and overseeing the redevelopment of the city's ancient quarter.
The script is strikingly similar with at least a handful of municipal commissioners and corporations in India - intense and committed, rough and abrasive, impatient with ambitious timelines, slow-moving bureaucracies, endless inspections and reviews, haul up slacking contractors, threats to bring around defiant property owners, petitioners and endorsements, heavily overworked with early mornings and late nights, tough on families, and finally transfers, protests, and successor syndromes. Not to speak of the paraphernalia and accompanying staff. The difference is that the squatters would have a court order, the defiant citizens not so meek and have the support of some political party or other, the telephonic instructions to get work done not anywhere as effective, the instant decision making to change a pipe size impossible, the contractors still be unable to hasten beyond a point, the threats to fire or shift officials blunt, and the tenures limited to 2-3 years (so fly-overs or road widenings are more likely than relocations). More often than not such leadership goes hand in hand with controversies, which in turn increases the likelihood of faster transfers and even shorter tenures!

The outcomes are reflected in the state of Chinese and Indian cities! Whatever the enabling policy frameworks, it is the dynamics of field level implementation that makes the difference. And it is in getting stuff done that the Indian state, for whatever reasons, pales in comparison.

Tuesday, April 26, 2016

Selling stressed bank loans

Livemint reports that Stanchart's efforts to off-load $1.5 bn in stressed loans has found few takers, even with attractive haircuts. The only interested buyer, SSG Capital, is apparently offering to buy the stressed loans with a haircut of only 30%. This, as per the World Bank's latest Doing Business Survey, would be far higher than the country's average haircut of 74.3% and comparable to the OECD's average of 28.1%.
But, despite the very attractive valuation, Stanchart is apparently in no hurry to sell the asset. Livemint quotes an insider, 
The current process is aimed at arriving at a valuation. Depending on the valuation they receive, they will assess whether they can recover more internally. The bank has already taken full provisions on these loans. They are not in a hurry to get rid of these.
There have been several news reports in recent days of intense activity in the buyout market with the arrival of major global LBO firms. But there have been very few actual transactions. In 2015-16, just 15% of the total of Rs 1.1 trillion assets put for sale were actually sold. It is widely accepted that public sector banks are naturally averse to taking haircuts for fear of subsequent vigilance and other proceedings. But the apparent reluctance of the likes of Stanchart to sell their bad assets, even at very attractive valuations, may point to deeper challenges in off-loading bad assets. 

One possible reason could be that banks, public and private, are encouraged by the prevailing incentive structures to retain the loans as long as possible in the hope of recovering as much as possible or even in the belief that the asset would repair with time. Consider the pervasive practice of banks floating Asset Reconstruction Companies (ARCs) and selling their bad assets to these entities in what has been described as "right-pocket, left-pocket" transactions. Similarly, the provisioning rules too may be encouraging banks to hold out for as long as possible. 

The Government have, including in the Union Budget 2016-17, taken several steps to allow majority foreign ownership of ARCs, even 100% ownership by sponsoring entity, 100% FDI on automatic route, complete pass-through of income tax on securitization trusts to their investors, and permit non-institutional investors to invest in securitization receipts (SRs). But they may not be enough to overcome more deep-rooted structural factors. 

While the RBI has been constantly taking action to mitigate the incentive distortions from such practices, it has refrained from imposing a clean break between the bank and ARC, if at least for certain categories of loans. Unfortunately, such incrementalism is unlikely to yield the desired results. Neither do the sponsoring banks, and their subsidiary ARCs, have the competence to effectively restore the asset, nor will the ownership structure allow their respective managements to take the hard decisions necessary to achieve the objective. More disturbingly, this may also be discouraging genuine sales of assets and the emergence of a vibrant market in stressed assets. 

In fact, we may only be kicking the can down the road, with the attendant risk of having to pay a much higher cost when the sale eventually materializes, as it must in most cases. In the circumstances, a prudent strategy may be to limit such conflicts of interest and cut the umbilical cord between the asset selling banks and asset purchasing ARCs, at least for certain categories of bad assets, and allowing for structured transactions which claw back a share of windfall gains, in any, in the future.

Sunday, April 24, 2016

Weekend reading links

1. MR points to Ruchir Sharma's very bleak assessment of the Brazilian economy. He paints the picture of an economy intimately tied to the global commodity cycle and dynamism smothered by a massive bureaucracy and public spending,
Brazil’s GDP growth rate has fallen from 7.5% in 2010 to minus 3.5% last year. This decline followed the collapse in commodity prices that began in 2011... Today the average Brazilian income is about 16% of the U.S. average, with basically no gain for 100 years... Even more striking, since the mid-1980s Brazil has seen its GDP growth rate track commodity prices more closely than any other nation in the world. Brazil’s fortunes are so closely tied to the global commodity cycle in part because so little works inside the country. The private economy does produce some internationally competitive companies in auto parts, aerospace and other industries, but they thrive by dodging a growing bureaucracy that smothers the rest...
The country appears to be a classic example of a country entrapped in commodities and an over-generous welfare state, 
Spending by local, regional and national governments amounts to 41% of Brazil’s GDP, the largest for any country in its middle-income class, and a scale close to those of much richer European welfare states such as Germany and Norway. Brazilians face the heaviest tax burden of any emerging country, with collections amounting to 35% of GDP... The budget is very rigid, most of it going to salaries and legally mandated social entitlements, which are growing. Over the past 15 years, public pensions have increased from 3% to 7% of GDP. Brazilian men typically retire at age 54 and women at 52, earlier than in any major European country, drawn into the golden years by generous benefits. On average Brazil pays pensioners 90% of their final salary, compared with an average of 60% in developed countries.
The basic issue for Brazil is that heavy state spending tends to push up interest rates and borrowing costs, depress private investment and defer any shift away from commodities. Under Lula and Ms. Rousseff, Brazil has grown more reliant on soybeans, with commodities now accounting for 67% of exports, up from 46% in 2000. Brazil’s manufacturing industries remain anemic, representing only 11% of the economy, near the bottom of emerging-economy rankings.
2. Ed Morse, the head of Citi's commodities research, talks of a new oil order, where the rise of US has rendered OPEC "irrelevant",
The US is now arguably the world’s largest oil liquids producer in the world, if you take into account crude oil production and other supply like liquefied petroleum gases (LPGs), biofuels output and the incremental volumetric gains from having the largest refining system in the world. On paper the US might produce 9.3m barrels a day against Russia’s 11.1m b/d and Saudi Arabia’s 10.3m b/d. Add everything that looks and smells and is used as oil and the US is the biggest of the lot, producing 14.8m b/d versus the kingdom’s 11.7m b/d, versus. Russia’s 11.5m b/d.
And the basis for his conclusion,
US has production based on competitive decisions of hundreds of independent producers, which now, unshackled, can sell oil at home or abroad. That makes an enormous difference, especially when considering the nature of marginal production in the US, which comes from shale resources. These rocks are not only superabundant, but they can be exploited at a relatively low cost. Just compare an offshore well at $170m with a vertical shale well that costs under $5m, with a five-year payout for a successful deepwater well versus a mere five-month payout for a shale play. And multiply a single, individual shale well by hundreds of wells and hundreds of decisions and you get a new world order.
Shale, for sure, has changed the global oil market dynamics. But I am not sure that it is wise to draw too sweeping conclusions from events of recent memory. If any analyst says that an incremental 5-6 mbd in a 95-96 mbd global market has rendered OPEC "irrelevant", then I would be inclined to discount that source of research.

3. WSJ has interesting news on India's pharmaceutical companies, which are aggressively pursuing niche treatment areas, apart from generics,
Close to a third of all FDA applications in the nine months through September were by India’s multibillion-dollar pharmaceutical industry, which accounts for 40% of generic drugs sold in the U.S. That figure, the latest tally available, is up from 19% during the same period a year earlier.
For all the bad press that the pharma industry gets from US FDA actions, it ranks on par with IT as corporate India's most remarkable world-class achievements.

4. FT has a report which appears to indicate that Sun Edison's woes are likely to affect its Indian operations. The report talks of a cash transfer from the account of one of the company's yieldco TerraForm Global into its own account to pay off a margin loan in November 2015, which is now part of a lawsuit filed against the company,
It approved an $150m advance against some unfinished solar plants in India that TerraForm was planning to buy from SunEdison at a future date. The money pinged from TerraForm Global’s bank account to SunEdison’s to pay off the margin loan “mere minutes before the 3pm payment deadline”, according to the lawsuit.
In any case, given the close links between Sun Edison and its yieldcos, it is unlikely that the latter will be able to avoid being dragged into the bankruptcy process by creditors.

5. Livemint points to the newly released data from the Global Consumption and Income Project (GCIP), which suggests that the official figures may be understating the true extent of poverty in India. The poverty rate for 2011-12, at Rs 38 per day (or $2.5 per day on PPP terms), would be 47% against the 22% Planning Commission figures (for Rs 27 and Rs 33 per day in rural and urban areas respectively).
Other than the high rate, the other disturbing fact is the slow pace of decline.

6. The New York mayor has an ambitious affordable housing goal, the development or preservation of 200,000 units over the next ten years. The City Council kickstarted it in 190 blocks of Brooklyn, the first of 15 neighborhoods across the city,
The city’s tools are powerful: a new mandatory inclusionary housing law that requires developers in rezoned areas to set aside up to 30 percent of units in new buildings for lower-rent apartments. That’s a minimum — the administration also plans to use subsidies and tax breaks to extract even deeper levels of affordability from new construction. In East New York, it promises to break ground in the next two years on 1,200 “deeply affordable” apartments. Forty percent of them will be rented by families earning $38,850 or less. Ten percent will be rented by families making $23,350 or less.
India's metropolitan cities, where land valuations are astronomical, similar aggressive mandates should be associated with all land use conversions.

7. Nice article in Times on the market for the super-rich, the top 1%, where businesses are focussing an increasing share of their innovation and resources to provide premium services. To get a sense of the top 1%,
Emmanuel Saez, a professor of economics at the University of California, Berkeley, estimates that the top 1 percent of American households now controls 42 percent of the nation’s wealth, up from less than 30 percent two decades ago. The top 0.1 percent accounts for 22 percent, nearly double the 1995 proportion... From 2010 to 2014, the number of American households with at least $1 million in financial assets jumped by nearly one-third, to just under seven million, according to a study by the Boston Consulting Group. For the $1 million-plus cohort, estimated wealth grew by 7.2 percent annually from 2010 to 2014, eight times the pace of gains for families with less than $1 million... Spending by the top 5 percent of earners rose nearly 35 percent from 2003 to 2012 after adjusting for inflation, according to a study by Mr. Fazzari and Barry Z. Cynamon of the Federal Reserve Bank of St. Louis. For everyone else, spending grew less than 10 percent.
From jumping ques to exclusive zones and timings, the richest are able to purchase their convenience.

8. And staying with inequality, and its impact on life expectancy, new research by Raj Chetty and Co find a 15 year difference in life expectancy among American males at the top and bottom 1 per cent.
It is difficult to establish contributors and causal factors. Apart from wealth buying better health care, wealthier people also lead healthier lifestyles. Further, the cause and effect may go in both directions - healthier people can work more and productively and increase their incomes. And one of the implications of this life expectancy gap is that the richer people benefit more from various social security programs.

9. As the wheels are coming off the emerging markets story, with minus four per cent growth in Brazil and Russia in 2015, Dani Rodrik questions the merits of the original story itself,
Scratch the surface and you found high growth rates driven not by productive transformation but by domestic demand, in turn fueled by temporary commodity booms and unsustainable levels of public or, more often, private borrowing.
The article has this about the India story,
In a sense, all of the major emerging markets – with the revealing exception of India, where economic growth is not dependent on commodity exports – are reliving the lesson of the 2008 global financial crisis. As Warren Buffett famously summed it up: “Only when the tide goes out do you discover who’s been swimming naked.” For much of the last generation, buoyant commodity prices served as a fig leaf for emerging markets’ profound governance failures. Now the fig leaf has been stripped away, and their leaders must face the beach.
It is true that India benefits from not being a commodity exporter and having a fairly diversified economy. But the problem is that it, like all others, has not done enough on the productive transformation front, thereby raising questions about the sustainability of economic growth, especially at high rates.

10. Business Standard refers to a paper by KC Zachariah and Irudaya Rajan which puts in perspective the importance of remittances to the Kerala economy,
(Kerala) receives 40 per cent of remittances that come to India... Remittances finance as many as 20 per cent Kerala households, or 2.4 million families. Assuming a family size of three, remittances directly affect 7.2 million of 35 million Keralites... Remittances, at Rs 70,000 crore, accounted for 36.3 per cent of the net state domestic product (NSDP) in 2014. Remittances constitute a fourth - Rs 22,689 of Rs 86,180-of the per capita income of Kerala in 2014. Remittances were 1.2 times the revenue generated by the Kerala government in 2014... The number of Keralites working abroad had jumped to 2.4 million by 2014... a majority, 86 per cent , work in the Gulf countries.

Friday, April 22, 2016

Secular stagnation, corporate surpluses, industry concentration, and declining business dynamism

The widening inequality, especially driven by the out-sized compensation in the financial sector and the rising pile of corporate profits, and reflected in the stagnant median labor incomes, must count as the arguably the most disturbing social and political theme of our times.

Now Larry Summers has argued that monopoly profits, extracted by the growing concentration of market power across sectors among the top firms, is responsible for the increasing returns to capital despite the persistently low real interest rates. Profits, free-cash flows, and returns on capital are at historic highs among US corporates.
A spate of mergers and aggressive cost-cutting have boosted profitability from both supply and production sides. The persistence of high profitability and the likelihood of the same firms being the beneficiaries over time points to prohibitive entry barriers. Pointing to high levels of entry barriers, the Kauffman index of startup activity is at its lowest since the 1970s.

The Economist examined US firms in 893 industries, grouped into broad sectors, and found that two-thirds of them became more concentrated between 1997 and 2012 and the weighted average share of the top four firms in each sector rose from 26% to 32%.
The concentration is especially pronounced in sectors like Finance, Retail, and Wholesale.
In this context, MR points to the findings of a recent study by Grullon, Larkin, and Michaelly which finds an alarming decline in publicly traded US firms and attendant concentration of economic activity,
There has been a systematic decline in the number of publicly-traded firms over the last two decades. Half of the U.S. industries lost over 50% of their publicly traded peers [from 6,797 in 1997 to 3,485 in 2013, AT].... This decline has been so dramatic, that the number of firms these days is lower than it has been in the early 1970s, when the real gross domestic product in the U.S. was one third of what it is today. This phenomenon has been a general pattern that has affected over 90% of U.S. industries... The decline has increased industry concentration, as the void left by public firms has not been filled by an increase in the number of private businesses or by greater presence of foreign firms. Firms in industries with the largest decline in the number of firms have generated higher profit margins and abnormal stock returns, and enjoyed better investment opportunities through M&A deals. Overall, our findings suggest that the nature of US product markets has undergone a structural shift that has potentially weakened competition.
This US CEA study finds a significant increase in the concentration of economic activity in many industries recent decades, a reflected in record levels of mergers and acquisitions. It also finds declining new firm entry and returns that are greatly in excess of historical standards. The share of US workers requiring some form of State occupational licensing grew five-fold over the last half of the 20th century to about a quarter of all US workers in 2008. 

Nowhere is the concentration more pronounced than in the financial sector. Noted investor, Henry Kaufman, has cautioned that such concentration undermines the operation of market forces,
The number of FDIC-insured institutions fell from more than 15,000 in 1990 to a mere 6,300 today, and the ten largest U.S. financial institutions currently control some 80 percent of all financial assets... financial concentration increases the spreads for securities, drives up financing costs, increases price volatility, reduces traditional sources of liquidity, and requires greater government supervision of credit markets... Debt has been shifting tectonically as well... U.S. government debt... now equals – GDP; in 2000 it was only half of GDP. In the 1990s, corporate equity increased $131 billion while debt soared an astonishing $1.8 trillion. And the quality of corporate debt has been deteriorating... In the mid-1980s, the number of non-financial corporations rated AAA was 61; today it is 4.
The returns on capital invested, excluding goodwill, among the American publicly traded non-financial companies have become increasingly concentrated in a small segment at the 90th percentile and above, whose returns are more than five times those of the median. 
Another recent paper by Ryan Decker et al points to declining entrepreneurship, job creation and destruction, and economic dynamism in the US. It finds increased reallocation of jobs towards the more productive and more profitable sectors, which invariably require ever declining shares of workers. This has to be taken with evidence of declining workers internal mobility across occupational categories.
The opinion is divided on what are the factors driving these secular structural trends. But these trends assume significance for even developing countries which are already buffeted by adverse headwinds of premature de-industrialization and stagnation in global trade. If declining business dynamism (entry and exit), lower entrepreneurship, increased industry concentration, internal workers mobility are driven by factors that are more secular, independent of nature of economies, then they may prove insurmountable barriers to economic growth in these economies. 

Wednesday, April 20, 2016

Expansive versus expensive cities

The WSJ points to a just-released study by Issi Romem of US cities and housing affordability which finds that expansive cities are less expensive. In other words, cities which increase their footprint or expand outwards, are more likely to keep housing affordable. The standard narratives on the growth of cities have tended to present an either-or relationship between the emergence of haphazard suburban sprawls as cities expand outwards and vertical development by liberalizing zoning regulations. This study questions that conventional wisdom.   

It captures the steady expansion of US cities from the forties onwards. Cities like New York, which expanded aggressively earlier have almost stopped growing.
In contrast, others like Atlanta continue to grow outwards even today.
The difference between these two types of representative cities is captured in the graphic below on housing prices. It clearly shows that housing prices have risen less in cities which have expanded outwards, even when their populations have increased faster.
Romem explains the relationship, 
Expensive cities gained population as well, but they did so despite the constraints on housing supply, and in the absence of such constraints their population would have grown much more. Legacy cities’ populations grew only slightly or even decreased, as indicated by the absence of a circle. The chart shows that, with the exception of legacy cities, housing price growth is inversely related to cities’ outward expansion. 
At least three things are driving the relationship. One, massive amounts of housing were built on rural land in expansive cities and helped keep housing prices there in check, whereas the restricted outward expansion of expensive cities limited their supply of housing and contributing to housing price growth. Even though correlation alone does not imply causation, there should be no doubt that cities’ degree of outward expansion affected their housing prices directly. Two, land use policy impeding densification – as opposed to expansion – is likely to be stricter in the same cities whose outward growth is curbed, and such impediments to densification contributed to housing price growth as well. Three, recall that housing price growth sets in motion a sorting process that yields a more affluent population, which is prone to tightening land use regulation. This process means that housing price growth can indirectly cause cities to expand more modestly, which once again contributes to the relationship in the chart.
For developing country cities, where urbanization is only just gathering pace, the choice is not between deregulation or geographical expansion. They need both. They are like New York of 1960s or earlier. They are also like the Atlanta of today, but with far more regulated antecedent zoning regulations. 

In the years ahead, these cities will face massive immigration pressures. The more successful cities will be especially vulnerable. Business-as-usual will leave them with unmanageable sprawls and their economic vibrancy will be crushed. These cities need aggressive deregulation by way of much larger Floor Area Ratios (FARs), calibrated releases of massive extents of vacant lands currently occupied by public agencies, and gradual expansion of the city boundaries. Unfortunately, none of these are happening in any satisfactory manner. 

Tuesday, April 19, 2016

Observations on the Delhi road rationing experiment

The odd-even vehicle rationing experiment in Delhi has restarted. Much of the debate around the issue has centered around assessments of the emission reductions from the first round. Critics have been quick to dub the experiment a failure based on these estimates. In fact, they have been unwilling to countenance anything other than the first best option of the development of a world-class public transport system as the solution to Delhi's pollution and congestion problem.

In this context, going beyond the immediate impact on emission levels and so on, a few observations. 

1. The road rationing program introduced by the Delhi Government constitutes a paradigm shift in the way governments across this country have addressed pollution and congestion. They have largely revolved around emission norms and road widenings and flyover construction. This is the first time that a government in India has consciously decided to ration road usage, thereby directly address both problems. In this sense, the January experiment was India's crossing the Rubicon moment in policy making to address urban vehicle pollution and congestion. It has undoubtedly lowered the political and social bar for similar policies in other cities across the country. 

2. I am inclined to believe that governments like the current one in Delhi, despite their political populism, are more likely to be able to introduce such policies, which directly impact a very large and vocal electoral base. Such governments are as much vulnerable to reckless populism as capable of progressive policies. The nature of their evolution and network of influencers are such. Traditional political parties are less likely to be creatures of such evolution.  

3. Reflecting their growing pre-eminence in policy making, the courts, in the form of the National Green Tribunal (NGT) this time, played a critical role in forcing the Delhi Government to bite the bullet with road rationing. After all, the original thrust came from the NGT directions to improve air quality. This is a reminder that such public policy mutations (deviations from the norm) are more likely to happen when the moment is ripe, both in terms of the political and social environment as well as the coincidental confluence of supportive coalition partners (Delhi Government, NGT, and civil society organizations like Center for Science and Environment). 

4. When the program was initiated, there were apprehensions about the Delhi government's ability to enforce the ban. Critics suggested that people will forge number plates or even just ignore the ban. While this has undoubtedly happened, it has been far less than anticipated or in any case, atleast less enough not to warrant headline news. Is this evidence of much higher civic spiritedness among Delhi's population than credited? Does this mean that the citizens have the appetite to tolerate more such paradigm shifting public policy interventions.  

5. There is much to compliment about the manner in which the policy has been rolled out. Its iterative and slowly phased approach apart from diffusing discontent has also given the government valuable feedback to constantly improve the implementation design. It has been classic two-steps forward, one-step backward. 

6. Finally, unlike the first round in early January, this time, the Delhi Government has exempted vehicles running on Compressed Natural Gas (CNG). This has prompted a scramble among car owners to have their vehicles retrofitted with CNG. Given Delhi's success with CNG retrofitting of public transport buses and auto rickshaws, this may be a trigger for large-scale conversion of even private vehicles. What if the program becomes a catalyst to inculcate the habit of car-pooling among Delhi residents? What if the program works at the margins to tip over some share of car residents to embrace the metro and keep them there? What if it leads to more rationing policies like number plate licensing? Such unintended consequences of public policy are a strong reminder to critics of such policies who evaluate them on narrow and immediate quantitative parameters. Development is hard and complex. We need to be humble enough to accept this before trigger-happy assessments based on superficial considerations. 

If this policy can be sustained and bear fruits, even if unintended, over a longer time, it would be a terrific achievement for the Delhi Government. Transport related problems, apart from housing, have been the most intractable of urban problems. Governments which have successfully addressed them have captured the public imagination. After all local residents fondly remember Ken Livingston in London for the congestion pricing scheme and Enrique Penelosa in Bogota for the TransMilenio BRT system. 

Monday, April 18, 2016

Crossing the river by feeling stones

The Economist points to the urban social reforms being tried out in Chongqing, latest in the "crossing the river by feeling the stones" approach to reforms in China. The province-sized municipality (on a par with Shanghai and Beijing), with 30 million people in its urban core and surrounding villages, is experimenting with an ambitious social reform agenda that seeks to balance economic growth and urbanization with social and political stability. The Chongqing model has three initiatives,
First, the government said it would build 40m square metres of housing in the decade to 2020 for rent to the urban poor, including rural migrants. To be eligible, tenants had to earn less than 1,500 yuan (now about $230) a month. It was a big undertaking: governments elsewhere in China are reluctant to spend money on housing migrant workers. Chongqing set the rent at about 60% of comparable private properties and allowed tenants to buy their homes after living in them for five years. Next, the government said it would give full urban status to 10m migrants, meaning they would get access to subsidised urban health care and education (typically, these services are available only in the place of one’s household registration, or hukou—usually the place of birth of one’s mother or father). Third, the government announced changes to the urban-planning system to allow land left behind by migrants to be traded for use in building new houses and offices. That was a breakthrough in a country that still officially disapproves of selling farmers’ property.
The reforms are unique in scale and coherence. By providing housing, they aim to attract migrants and thus expand the urban labour force. By offering migrants better access to public services they aim to make life in cities fairer and thus more stable. By introducing a land market, they hope that migrants will arrive with cash in hand. If the reforms work, they should have a range of benefits, from reducing the loss of farm land to eroding age-old urban prejudice against farmers and, vitally for the economy, fuelling urban consumption.
The most remarkable reform involves the idea of selling farm lands through a system of trading land-use rights, a strict taboo given the still entrenched belief in "collective" ownership of rural property (villagers are entitled to use a family plot for farming and another for housing),
As people move, they often leave houses in the countryside unoccupied. Chongqing’s reform allows land used for housing in faraway villages to be converted to use for farming, and a corresponding amount of farmland near towns to be used for urban expansion. The aim is to promote urbanisation, while slowing the rate at which Chongqing loses arable land... The reform was intended to be of particular benefit to farmers in remote areas, who would otherwise have no opportunity to benefit from land appropriations, which usually occur on city margins. Sometimes the compulsory acquisition of rural land for construction is carried out violently, with farmers receiving little or no compensation. Chongqing’s system aims to make this fairer. Farmers who want to sell their rights to their village land are given what is called a land ticket, or dipiao. Developers who want to build, say, a 10-hectare (25-acre) project on farmland, can buy 10-hectares’ worth of dipiao. They do not have to be tickets owned by farmers on that very plot. The farmers get to keep 85% of the sale price of the dipiao. Their village administrations get the rest. 
And like Deng's famous Southern tour of 1992 which endorsed the SEZ experiments, the Chongqing model too appears to be finding acceptance in Beijing,
In January the finance minister, Lou Jiwei, said other places could try out dipiao trading. President Xi also paid a visit to Chongqing that month. It was the first by a Chinese president since the municipality’s reforms began, and was widely interpreted as a sign of his endorsement of Chongqing’s efforts.

Sunday, April 17, 2016

India state capability - Judiciary fact of the day

Times of India identifies the chronic state capability weakness that bedevils India's judicial system,
In 2014, the judge-population ratio (sanctioned strength) was 17 judges per million... The current sanctioned strength of the subordinate judiciary is 20,214 judges while that of the 24 high courts is 1,056 and the pendency of cases has remained abnormally high at 3.10 crore. On the sanctioned strength, there are 4,600 vacancies of judges in the subordinate judiciary which is more than 23% of the strength. The situation in the high courts is worse with almost 44% (462) judges' posts vacant. The Supreme Court too has six vacancies on a sanctioned strength of 31....
To address backlogs in justice delivery, the 120th report of the law panel (in 2014) had proposed to increase the strength to 50 judges per million people — less than the US where the judge-population ratio then was 107. In case of UK it was 51, for Canada it was 75 and Australia 42. The Law Commission study found at the current rate of disposal, HCs require an additional 56 judges to break even and an additional 942 judges to clear the backlog. This estimation was based on the sanctioned strength of the HCs at 895.
Sadly, despite this scale of demand on scarce court time, the creeping bout of populist activism that appears to have taken hold, is most certain to worsen the trends. As R Jagannathan has written here, this is seriously undermining the delicate constitutional balance of power. What else can you say when the Supreme Court of India extends its ban on registration of diesel SUVs citing conspicuous consumption by the rich, bullies a private association like the BCCI into its structural composition and its functioning, dictates prudential norms to the banking regulator, and passes populist comments conflating water-use in IPL cricket matches with drought in Maharashtra?

Update 1 (26.04.2016)
Livemint has a nice graphical summary. The High Courts, with 44% vacancy, are the worst affected. The level of pendency is most disturbing. Nearly 58% of the 21.9 million cases pending in district/subordinate courts were pending for more than two years.

Monday, April 11, 2016

More thoughts on infrastructure financing

Governments view the policy framework on infrastructure financing primarily from the lens of off-loading risks and limiting fiscal commitments. These regulations often also seek to achieve multiple other policy goals with one instrument. In this pursuit, it loses sight of its fundamental objective of creating good quality infrastructure assets with a life-cycle cost-effectiveness and burdens developers with risks that they are unable to bear.

It is no surprise, therefore, that infrastructure bond markets have remained still-born. Instead,  a more practical approach would entail the government assuming certain risks so as to make long-term infrastructure financing an attractive enough investment option for private investors. The former assumes a massive Que of investors waiting to snap up anything available while the latter assumes the need to nudge investors to bite the bullet. The underlying regulatory enablers for both are of a qualitatively different nature. 

There are at least five clear areas of reform.

1. Construction risk is far higher in India than any other large emerging economy. No private investor is positioned to bear this risk. There is, therefore, a compelling argument for supporting construction financing with some form of credit guarantee which is in turn supported by arms-length public finance. 

2. If construction financing is separated (from life-cycle financing), creditors run the risk of not being able to replace capital providers after construction is off-loaded. This should be mitigated with a form of a market buyer of last resort underwriting, supported again with partial public credit guarantees. Enabling loan syndication and takeout financing is a form of backstop that can provide the time for off-loading construction risks. 

3. Even the post-construction phase has its share of risks. The political economy of tariff increases may come in the way of toll road or power plant's commercial viability. This is another risk that may be effectively underwritten only with a public guarantee.   

4. In nascent markets, as PPP is in countries like India, given the immense risks and uncertainties involved, regulations should preferably refrain from capping the upside. This is all the more so since infrastructure projects suffer from cyclical downturns when revenues fall far short of projections.

5. Finally, it should also liberalize exit norms for capital providers, including equity holders, so that liquidity is not constrained. However, this should be complemented with adequate safeguards against skimping on construction quality and other forms of asset stripping. 

The danger with all such measures is the moral hazard it can potentially engender which would encourage reckless bidding. A well-thought-out and incentive compatible market design would be necessary this moral hazard. For example, the markets should be encouraged to offer these credit guarantees, with only the residual risks endowing on the public finances. Even here, the public support should come through entities like IIFCL and NIIF and not directly from the government. 

Sunday, April 10, 2016

Weekend Reading Links

1. The property price story in China is more nuanced now, with surging prices in certain areas of the Southern Coast and other major cities, and stagnating or declining prices elsewhere. There is a shortage in the former and excess supply among the latter. A Bloomberg news report summed it up,
At the heart of China’s property malaise is an imbalance between supply and demand -- the new building is taking place where there’s less demand, while supply is short in the most popular, largest cities. Last year, 61 percent of new-home building starts were in third- and four-tier regions, while only 5 percent were in first-tier hubs
The parallels with India's housing market are striking. Here, 95% of the supply is for the 5% of the market at the top, with acute scarcity in the affordable housing space and negligible supply in the LIG and MIG. 

Such market failures demand differentiated policy responses, instead of one-size-fits-all prudential ratios for all housing. In China's case, it would need to be geographically focused, whereas it has to be unit-size focused in India. 

2. From a Bloomberg report on India's limited success with promoting exploration and mining of gold, whose imports stood at $35 bn in 2015 and formed 43% of the current account deficit for the last quarter of the year,
Deccan Gold Mines, which hasn't dug up an ounce in 13 years because of the difficulty of obtaining permits from state governments... has no incentive to explore for gold after laws passed last year forced miners to bid for the right to mine the deposits they find. Finding mineral deposits is risky, cost-intensive business. As with pharmaceuticals, movies or venture capital, there are a long tail of failed investments behind every blockbuster... The only reason companies risk this capital is because they hope to get first refusal on the right to dig up what they've found.
India has long-standing problems with corruption around the free allocation of mining leases, which helps explain the desire to change the law. But doctors need to be careful they don't administer medicine that's more harmful than the disease itself. If a country can only stop corruption in mining by removing the industry's incentive to develop new mines, it's guaranteeing a future of rising import dependence.
The backlash from the spate of resource allocation scandals and the activism around it by various agencies of the state have left governments with limited space to manoeuvre. They are forced to view any resource allocation through the lens of public revenues maximization through auctions. This, as we know, is not always the right strategy. 

3. Highlighting the difficulties of protectionist policies like raising tariffs on Chinese imports in a world with globally integrated supply chains, Upshot writes,
A study by the Federal Reserve Bank of San Francisco figured that 55 cents of every $1 spent by an American shopper on a “Made in China” product goes to the Americans selling, transporting and marketing that product. Suppressing Chinese imports would harm shopkeepers and truck drivers. In fact, making Chinese-made goods more expensive would ripple through American shopping malls. An extra $20 for, say, children’s clothing from China is $20 not spent on a new baseball glove for a child, or a birthday gift for a grandmother. A tariff on China would dent the sales of all kinds of products, even those made in the United States. It seems likely that such a tariff would burden American consumers while doing little to create jobs for them. Gary Clyde Hufbauer and Sean Lowry at the Peterson Institute for International Economics, studying the impact of a 35 percent tariff imposed on Chinese tire imports by Washington in 2009, found that American consumers had to spend an extra $1.1 billion on tires, while the tariff protected no more than 1,200 jobs. About $900,000 for every job saved, in other words.
4. Livemint points to India's poor performance in inter-generational mobility, even compared to its neighbours, with education attainment of children being more dependent on that of their parents (higher score indicates lower inter-generational mobility). 
The causal chains may be running in all directions - poor people are more likely to suffer from poor quality schooling (in public schools) and/or unaffordable good quality schooling; are more likely to drop out of school for financial reasons; face far less domestic pressures to learn and stay enrolled; and good quality schooling is an increasingly important determinant of life incomes. 

5. Germany is the latest to suffer from the slowdown in China, with nine of the country's top 10 exports to China declining in 2015

6. Interesting findings from a very exhaustive JETRO survey in 2015 of 4635 Japanese affiliated (with Japanese investment of atleast 10%) manufacturing sector firms across 20 countries in Asia. Indian firms are among those with the most optimistic business expectations in terms of expansion and profitability. Indian firms do not enjoy much competitive advantage in terms of local production costs (as compared to their Japanese counterparts) among its main export competitors. 
Indian firms no longer have a competitive advantage with labor costs when compared to its direct competitors like Vietnam and Bangladesh, or even Indonesia.  
Indian firms are the least export-focused among all countries.
7. On the issue of manufacturing, NYT points to a BCG study which finds that Indian firms' manufacturing costs have remained the same in real terms between 2004-14. Note the contrasting fortunes of Mexico and Brazil, with the latter's cost competiveness taking a massive hit. Australia is another country which suffered, a possible reflection of the Dutch disease. 
More fascinatingly, the cost of making a pound of yarn is lower in the US than in India or China. Its success has been in controlling input costs. And this has lessons for other areas of manufacturing. 
8. Very informative slide deck on the Chinese economy from RBS Research. For an economy whose engine has been construction and infrastructure investments, the declining electricity, steel, and cement production is stark.
Investments as a share of GDP may have peaked and may be on its downward path.
Economic rebalancing between consumption and investment is happening at a very slow pace.
The biggest immediate worry is the massive pile of accumulated public (especially local governments) and corporate debt, which has risen at a staggering $6.5 bn a day since the 2008 crisis broke out. 

Tuesday, April 5, 2016

Cleaning up construction - sub-contracting and resource misallocation

The tragic collapse of the flyover in Kolkata which killed 26 people should be the right opportunity to focus on the role of sub-contracting in India's largest employment generating sector outside of agriculture. It has been reported that the main contractor, IVRCL, had sub-contracted out the affected stretch and there have been allegations of negligence by both the original contractor and sub-contractor.

Construction, especially its labor market, operates largely in the informal sector. All large construction contracts are typically executed through several sub-contractors. But regulatory layers discourages formal sub-contracting, thereby pushing it into the informal sector. Further, since informal sub-contracting helps evade many statutory obligations, apart from minimizing tax liability, it boosts the margins for both the original contractor and sub-contractor. It is no surprise that the share of construction in the total unorganized sector employment has doubled to 11.33% in the five years to 2009-10.

The vast majority of sub-contractors are local political leaders, like municipal councilors and sarpanches. Far from any engineering and construction expertise, their valued core competence is in being able to navigate the local land, labor, social and political markets at the lowest cost. Most often, they are predominantly labor contractors, leveraging their local influence with officials and in the society to supply labor and ease practical execution problems. Needless to say, the labor is overwhelmingly informal. 

In fact, a neat rent-seeking chain exists within the construction industry. While the local political leaders dominate the sub-contracting business, the bigger contractors are likely to be state level legislators, and the largest ones more likely to be national level politicians. Andhra Pradesh, with its out-sized share of infrastructure contractors among its national level political leaders, is the best example of this eco-system. 

This role of construction industry potentially presents a two-fold resource mis-allocation problem. On the one hand, capital (and entrepreneurs) is likely to find it far more attractive to invest in land-related construction-intensive infrastructure (real estate, roads, airports, power plants, ports etc) than in manufacturing. Why invest in establishing industrial units - with all the attendant labour, electricity, and regulatory problems - when you could potentially make many times more in much less time and with even less effort from construction and infrastructure? On the other hand, labor finds plentiful jobs in construction (in areas with lower living costs) and with limited incentive to exert the extra 'deferred gratification' skilling efforts required to succeed in manufacturing.

These trends square up with recent research on resource misallocation which finds labor misallocation towards financial sector and away from manufacturing etc in developed countries associated with the higher financial wages in the former.

Monday, April 4, 2016

More on the solar bubble

SunEdison, the US-based solar developer which had set the cat among the pigeons by quoting Rs 4.63 for solar power in Andhra Pradesh in November 2015, is teetering on the verge of bankruptcy with its stock being reduced to a penny share. 
The company, the poster-child of clean energy firms, was among the progenitors of the yieldco structure of financing renewable energy projects.
A yieldco is a growth-oriented publicly traded corporation formed to hold operating assets that generate long-term, low-risk cash flows. The cash flows are distributed to investors as dividends. Corporate level tax is shielded in whole or in part by the developer's retained share of accelerated depreciation and, in some cases, tax credits, and may also be offset by interest deductions on project acquisition debt. Additionally, yieldcos tend to attract investors that may be tax indifferent, such as tax-preferred pension plans. Because the yieldco sponsor is a developer, yieldcos usually have access to the developer's project pipeline through a right of first refusal. This provides the developer with a ready repository for its completed projects to replenish its capital and gives the yieldco the promise of growth...Yieldcos have drawbacks, including the high cost of an IPO and the need to keep acquiring projects to maintain cash flows and stock value... because they are publicly held, the public yieldco structure does not permit the most nimble decision-making processes.
Apart from the risks associated with such financing engineering, large solar developers may be expanding far faster for their own good. SkyPower, another one of the large investors in India, has very aggressive plans to enter other markets too. They include large investments in Panama and Kenya. These are doubtless risky investments with very high likelihood of lack of complementary (mostly public) investments and potential failures.

Finally, especially in  the US, the industry has thrived on the back of fiscal incentives - income tax credits and accelerated depreciation - which helped leverage tax-equity financing. Such incentives, while essential to catalyze the development of a market, may not be the most efficient way of financing post-maturity market expansion.

On the positive side, solar plants, unlike roads and thermal power plants, have smaller construction periods and can start generating revenues pretty quickly. But this is critically dependent on the availability of land and evacuation facilities. 

Saturday, April 2, 2016

Weekend reading links

1. Livemint on the limits to divestments in the banking sector,
The current price-to-book ratios for most PSBs is 0.2-0.4. The current market capitalization of PSBs forms just 29% of the total market cap of all the banks. Even if the government sells its stake in all PSBs, it will only be able to raise Rs.34,146 crore, which is just one-third of their capital requirement.
As I have blogged many times, the best way to approach this may be to advance the process of fixing the NPA mess, grant complete operational autonomy (including eschewing the use of banks to advance social agenda without compensating them appropriately), and then, once valuations start their upward climb, disinvest in a phased manner.

2. Eduardo Porter argues counter-intuitively that without NAFTA, the auto sector job losses in the US could have been much greater, as the entire production chain would have shifted out of North America,
The integration of production across countries with complementary labor forces — cheaper workers in Mexico to perform many basic tasks, with more highly paid and productive engineers and workers in the United States — turned out to play a central role in reviving the auto industry in North America. In the final analysis, Nafta might have saved hundreds of thousands of jobs. By offering a low-wage platform, Mexican plants increased the scale of production in North America, allowing domestic and foreign automakers to amortize their large fixed costs. Carmakers and parts suppliers tend to cluster relatively close together. So assembly plants in Mexico help sustain a robust auto-parts industry across North America. The Honda CR-V assembled in El Salto, Jalisco, for example, uses an American-made motor and transmission. Roughly 70 percent of its content is either American or Canadian. This regional integration gave the United States-based auto industry a competitive edge that was critical to its survival.
3. Bond markets are clearly off their hinges. Within three years of exiting an international bailout program and regaining market access, Ireland follows Mexico and issues century bonds at record low rates,
Ireland sold 100 million euros ($113 million) of the securities at a yield of 2.35 percent. By contrast, investors are demanding a yield of 2.66 percent to lend to the U.S. government for 30 years... The yield on Ireland’s benchmark 10-year bonds peaked at 14.2 percent at the height of its crisis in 2011. The yield on the securities has since fallen to below 1 percent and was at 0.73 percent as of the 5 p.m. London close on 30 March 2016.
No rational theory can even remotely explain such crazy gyrations. 

4. Private equity may be flowing into India, but the returns have been far from satisfactory,
Creditors in India recover only about 25 cents on the dollar in the four years or so it that takes to reorganize an insolvent company, according to the World Bank. In the U.S., the average is 80 cents in half the time... Over a 10-year period, private-equity returns have lagged well behind those in China. The internal rate of return on Indian investments made between 2004 and 2013 was 5.8 percent, compared with 22.6 percent for China, according to an analysis by the Centre for Asia Private Equity Research. The IRR for Asia as a whole was 11.8 percent. For every dollar invested in India in that time frame, an investor would have seen returns of $1.70, versus $2.30 in China.
5. The repo rate may have fallen from 8% in January 2014 to 6.75% in September 2015, but the interest-expense ratio has been steadily climbing for Indian firms across sectors. Livemint feels that the lack of demand and the resultant stagnation in revenues growth may be behind the trend.
It is also likely that the interest rates are rising due to the rising volumes of interest during construction on delayed projects. In all such cases, without any revenues streams active, delays only tend to push up the share of interests in total project cost.

6. This is an astonishing graphic. Pointing to a reason for the liquidity squeeze, Livemint reports that bank deposit growth rate for 2015-16 at 9.9% was last seen in 1962-63!
And currency in circulation, for reasons not yet clear, has been rising, thereby squeezing banking credit from the other side.

7. Very nice primer on how New York City gets its 900 MGD of water supply.
8. A primer on Brazil's Lava Jato (or Car Wash) investigations into the scandal surrounding the diversion of funds from contracts issued by Petrobras to politicians of the ruling Workers Party (PT) and its coalition partners.