Weekend reading links

1. In an excellent article Praveen Chakravarthy highlights the resource misallocation happening in India's capital markets with disproportionate flows into the tertiary derivatives markets, at the cost of primary and secondary markets. He examined SEBI data on capital raising in these markets for the 2005-15 period and found that the apparent success of India's capital markets can be traced back to speculative derivatives trading,

The value of derivatives trading has risen 30 times in this period while the amount of resources raised by corporates from the capital markets has remained flat in this period... In the capital markets, resources to corporates are not growing but are volatile and at best, have stayed flat for a decade. Yet, the Sensex is at an all-time high and foreign investors are flooding in. In other words, all that money that flowed into the stock markets did not necessarily go into funding Indian industry but instead fuelled trading in derivatives... In 2015, Indian corporates raised only one-tenth (as US) – $21 billion from BSE and NSE. India’s exchanges traded twice as much in equity derivatives volumes as the United States in 2015...

The classic example of India’s penchant with derivatives can be found in the currency derivatives markets which was introduced in India only in 2008. Typically, currency derivatives are intended as a hedging tool for exporters and importers that have exposure to foreign currency. Hedging foreign capital flows is the other major reason for currency derivatives. India’s share of world trade is 2.3 percent but its share of exchange-traded currency derivatives is nearly 50 percent. India traded 6 times more currency derivatives than the United States in 2015, whose share of world trade is 12 percent!

This is instructive and draws attention to the limited reach of capital markets in India's financial intermediation,

Indian households save about $400 billion a year on average. Indian mutual funds received just $100 billion in net inflows in an entire decade.

2. Is Crossrail an example of a best practice for constructing large infrastructure projects?

Crossrail, as the £14.8bn ($19bn) infrastructure project is known, is on track to deliver other small miracles. With 85% of the work completed, the project is on-budget and on-time, in spite of its size and complexity. The programme required ten new stations, some with passenger tunnels linking them to existing Tube lines... When service begins in December 2018, it will increase rail capacity in central London by 10%, thanks to the longer trains.

Or, have I asked this question too early?

3. Fascinating article about the problems faced by antiquated signalling systems in New York Metro. The Metro, started in the 1930s, touched a record 6 million commuters on weekdays, has initiated a $29.5 bn five year modernisation plan. for a network that spans 472 stations,

Most of New York’s subway system still relies on antiquated technology, known as block signaling, to coordinate the movement of trains. A modern system, known as communications-based train control, or C.B.T.C., is more dependable and exact, making it possible to reduce the amount of space between trains. A computerized signal system like C.B.T.C. is also safer because trains can be stopped automatically. New York’s quest to install the new system began in 1991... More than 25 years later, the authority has little to show for its effort to install modern signals. The L line began using computerized signals in 2009 after about a decade of work. A second line, the No. 7, should have received new signals last year, but the project was delayed until the end of this year.

The process is complicated. It requires installing transponders every 500 feet on the tracks, along with radios and zone controllers, and buying new trains or upgrading them with onboard computers, radios and speed sensors. The authority also had to develop a design and software that was tailored to New York’s subway. Over the years, the authority has kept pushing back the timeline for replacing signals. In 1997, officials said that every line would be computerized by this year. By 2005, they had pushed the deadline to 2045, and now even that target seems unrealistic. Upgrading the signals is expensive, but an even bigger challenge is scheduling work on such a vast system where ridership is always high, even on weekends... (In London) The rollout of modern signals on four lines has significantly reduced delays, making travel across this huge city of nearly nine million people more efficient. This month, the Victoria line will reach a peak of 36 trains per hour — compared with 27 trains per hour a decade ago, and among the highest rates in Europe. In New York, the Lexington Avenue line, the nation’s most crowded subway route, runs a peak of 29 trains per hour.

In contrast, London, whose metro started in 1863, has installed computerised signal network on four of its 10 main subway lines, and work is underway on four more. Modern signalling helps increase train frequency by lowering the distance between two successive trains.

4. Puerto Rico has filed for bankruptcy relief before a federal court, the first ever occasion by a American state or territory. The territory's debt at $123 bn ($74 bn in bond debt and $49 bn in unfunded pension liabilities) dwarfs Detroit city's $18 bn obligations when it filed for bankruptcy in 2013. This would lead to pension cuts, pruning down public services, and lead to the more qualified Puerto Ricans leaving for the mainland.

The region has been in recession since 2006 and has been borrowing heavily in recent years to finance operating expenses. The decision to file for bankruptcy was expedited by the several suits filed by creditors. The bankruptcy now gives Puerto Rico leverage in negotiations to impose haircuts on creditors. The court proceedings will not technically be called bankruptcy since territories (unlike cities and counties) are not covered by Chapter 9 of the Bankruptcy Law, but by the Title III of the Promesa law which contains certain Chapter 9 bankruptcy provisions.

Does this mean that the first step in ushering in the possibility of sovereign defaults in the US has been taken? Will States be next, especially with the overhang of pension liabilities?

5. After tur dal and onion farmers in Maharashtra comes the turn of red chilli farmers in Andhra Pradesh to face the harsh realities of the market. Consider this,

Last year, as prices of dry chilli hit Rs 12,000 per quintal, lakhs of farmers in Telangana and Andhra Pradesh sowed the crop hoping for good returns this year. Production increased by 14% in Telangana and 25% in Andhra Pradesh. In Telangana, against an average of 2 lakh metric tonnes every year, nearly 7 lakh MT of chilli has been produced in 2016-17. In Andhra, production increased from 7.93 lakh MT last year to 9.22 lakh MT this year. As bags of chilli began to cause a massive glut in market yards in the first week of April, prices crashed by 50%. With prices still between Rs 5,000 and Rs 6,000 per quintal around April 25, frustrated farmers who had been holding on in the hope of getting Rs 10,000-12,000 per quintal, also started to sell. Last Friday, as the Khammam Market Yard opened after 2 consecutive local holidays, stock that is usually around 60,000 bags, had swollen to nearly 2 lakh bags. As the auction began, there were no takers at even Rs 5,000 per quintal — the chairman and secretary then fixed prices at between Rs 3,000 and Rs 4,000 per quintal, depending on the variety of the chilli. Infuriated chilli farmers went on the rampage, vandalising the offices of the chairman and secretary, and setting furniture on fire. They accused officials of being hand-in-glove with commission agents to keep prices low.

Four lakh farmers in the two state are affected. The Centre has announced that it would procure 1.22 lakh tonnes under the Market Intervention Scheme, and both states have also announced price support for upto a certain quantity from each farmer.

One can spin any number of stories arguing that distortionary policies by governments are responsible for such cycles and price volatility. But even without such distortionary interventions, there is enough evidence from across the world to show that agricultural market will remain vulnerable to such volatility.

6. City Lab points to gentrification in New York, 

While businesses increased citywide... New York City has gone in the wrong direction on black-owned businesses—a steep 31.4 percent decline from 2007 to 2012, compared to the national average of 2.4 percent increase, as indicated in the table below.

7. The latest Pew study on public attitudes towards government finds that just a fifth of Americans trust the federal government to do what it right just about always or most of the time, an all time low. 

8. Economic Times reports that India's banking sector is facing up to the reality of job losses arising from automation (ATMs) and digitisation. A Citi report estimates that nearly 30% of global banking sector jobs will be lost in the 2015-25 period.

This is a good example of our industrial promotion policy priorities. ATMs and digital technologies benefit from capital investment subsidies whereas hiring labour face the full brunt of taxes. A country with an abundance of labour ends up taxing the use of this cheap resource and subsidising expensive technologies that end up displacing labour!

But even if the industrial promotion policies were reversed, would that be enough to leave aside reverse even stem the labour displacement tide. More importantly in a global market place, with more deregulation likely in the banking sector would the Indian banks be able to stand up against foreign competitors without embracing these productivity improving technologies. Would these banks be able to withstand the digital onslaught? We are caught in a remorseless global treadmill that throws people off a fast moving platform at a rapidly increasing pace.

9. Livemint has nice summary graphics on India's banking sector bad assets status. As on September 2016, the gross NPAs stood at Rs 6.7 trillion of 9.55%. Further 40% of the debt lies with companies having interest coverage ratio of less than one. But this graphic is striking. It shows that while large borrowers formed 56.5% of the gross advances of scheduled commercial banks, they formed 88.4% of the gross NPA.

Banks face a perilous situation. On the assets side, as the NPAs continue to rise, it forces greater provisioning requirements, leading to six continuous quarters of losses. This in turn necessitates capital erosion or recapitalisation by the government.

10. Finally, staying with banks, Ananth has everything that you need to know about the latest government step on banking sector NPA resolution. The Government of India promulgated an ordinance to amend the Banking Regulation Act 1949 by introducing explicit enabling provisions to allow the Reserve Bank of India to issue specific directions to banks to resolve their stressed assets. 

I am broadly in agreement with Ananth here. Though there could have been specific circumstances which necessitated the amendment, I fail to see why there was a need to issue this given the broad sweep of supervisory powers already available under Section 35A. For example, the provision in the new Section 35AB(2) can be interpreted as a subset of possibilities under Section 35A. In fact, over the last three years, the RBI has issued several different policy directions under the existing Section 35A to resolve bad assets, which conveys its broad sweep. And the actions of the Committees to be established under Section 35AB(2) are advisory in nature, leaving decision making power still with the individual banks. 

I am inclined to believe that the ordinance has been promulgated more as a layer of comfort for RBI to pursue a more active asset disposal agenda. This is a classic example of how, when faced with the decision paralysis problem, bureaucracies (and this is true of public and private, in fact any human being) tend to prefer the status quo and be reluctant to take high-stakes decisions that involve exercise of judgement. Unfortunately, even with this comfort, nothing changes substantively as regards the overhanging cloud of potential CIC-CBI-CVO-Court interpretations and actions. 

More important issues remain about the actual implementation of asset disposal - narrow supply side, actual taking over of the stressed company, limited appetite for banks to offer significant haircuts, resources to recapitalise if extensive haircuts are offered, and decision-making itself on haircuts. The Insolvency and Bankruptcy Code 2016 is just getting operational and will take years before it can meaningfully contribute to addressing a massive problem like this. Yes, the amendments to Prevention of Corruption Act, especially Section 13(1)(d)(iii) can be a great psychological cover to bite the bullet on taking losses. But the amendment itself will take time and clearing the psychological scars from the legacy even more time.

The only difference from pre-amendment days is that now the world will see the ball as squarely being in the RBI's court.