Tuesday, February 27, 2018

Corporate healthcare trends in India

A quiet revolution appears to be happening in India's corporate healthcare market. For long, barring a handful of large hospital chains, the Indian market was characterised by several small and family-owned multi-speciality hospital groups focused around no more than 2-3 cities, mostly the biggest ones. These small hospital groups were started by very credible and reputed physicians, whose diligence and commitment over at least 15-20 years helped their institutions acquire good name. But this landscape is changing fast.    

While I could not locate any study or report in this regard, a wave of consolidation may be underway in this market. And driving the consolidation is foreign capital. In particular, the sovereign wealth funds of Singapore and Malaysia as well as some private equity investors have been leading it. While Foreign Direct Investment (FDI) in hospitals had been permitted on automatic route since January 2000, it is only in the recent years that investor interest has spiked.  

Malaysia's IHH Healthcare Bhd, Asia's largest hospital operator, and owned by Khazanah, Malaysia's sovereign wealth fund, has invested in multiple hospitals in just one city, Hyderabad. Others like Temasek, GIC, and private equity institutions are also in the fray

In many of the investments, while the new investors have effective management control in light of their majority stake, the promoters have retained their Board positions. The original intent being that the foreign investors would bring in growth capital as well as latest technologies, and the promoters would use their proven experience, connections, and credibility to run the hospitals. 

But anecdotal evidence suggests that a power struggle is already on between promoters and investors in atleast some places. While there are no good chronicles like this, the new managements in these hospitals are over-ruling the promoters and forcing down efficiency improvements by mandating targets for doctors in terms of procedures and treating different specialities in a hospital as cost-centres competing with each other. I foresee this trend being accentuated going forward. 

A few observations

1. An examination of all the hospital names that have attracted foreign interest shows some features. All of them service the highest end of the market, are equipped with the latest medical technologies, operate predominantly in the largest urban centres, have promoters with very high credibility, and have emerged successful after a long period of struggle and winnowing of the competition. In other words, they represent the cream of private healthcare operators in the world's second largest and rapidly growing health care market. And it is this low risk and juicy assets that foreign capital is snapping up. 

So, is health care providers the latest addition to the long list of markets where the influence and control of foreign capital grows unabated? What does it reflect about domestic private capital that it does not find investing in some of the juiciest assets in a market which can be expected to grow rapidly over the coming decades unattractive? What does it say about domestic entrepreneurship that its pool has not expanded beyond the same old names Apollo, Fortis, Max, Wockhardt etc?

2. What prevents these new investors from recalibrating business plans to attract more foreign medical travellers? Is it in India's interest that the country with some of the worst access to tertiary care facilities and services, ends up being the medical procedures back-office of the developed world? What prevents the consolidation from driving up tertiary care prices, especially given the likely market power exercisable by an entity like IHH in a city like Hyderabad? 

3. The rapid growth of corporate health care and the creeping rise of public health insurance programs, the issue of regulation is never far away. Cases like this and this are likely to become increasingly common. While there are some, largely outdated, regulations, institutions and doctors operate on a virtual regulatory vacuum, and procedures and treatments have minimal or not regulation. But is a weak state likely to be in any position to be able to render effective regulation?

4. Given the poor, even Dickensian, state of government hospitals in most (but not all) states, corporate hospitals have become the default tertiary care option for all but the poorest. And now with universal health coverage being proposed for delivery through an insurance model, the neglect of government facilities and the focus on private alternatives will only increase. And we all know from all of history and documented evidence of any kind that no country has ever managed to achieve universal health coverage with this approach. What is the end-game?

5. It may only be a matter of time before health care debates are taken over by a lobby of corporate care providers, their financiers, and insurers. And in environments where regulations are grossly inadequate and state is out there to be captured, an eventuality playing itself out not just in other industries but in health care itself in state government programs involving the private sector, this danger is very likely. And even for perfectly honest bureaucrats, frustrated and despairing at the scale of the challenge and the utter dysfunctionality of the public healthcare system, the logic of private participation can look very attractive. 

6. It is nobody's case that India does not need foreign capital in health care. It sure needs foreign investors and their technologies. But given the size of the country and vast needs, such foreign capital can be nothing more than marginal contributor. It is domestic capital and entrepreneurs who have to drive this market. Unfortunately, that seems not forthcoming in anything compared to the required scale.

Or, am I being unduly pessimistic in painting this bleak picture and should instead look at the perfectly logical hypothesis around the beneficial effects from private participation. But does the evidence of private health care in India lend credence to such optimism? Also is there any other similarly placed country which has achieved universal health coverage through this approach?

Update 1 (21.03.2018)

The latest hospital to fall to foreign capital is the Gurugram-based Medanta-Medicity Super Specialty hospital. Malaysian IHH Healthcare Bhd has submitted a bid to buy a controlling stake at a reported valuation of Rs 5500-5700 Cr. Carlyle Group and Temasek Holdings Pte already own 27% and 18% of the hospital. Since entering India just in 2015, IHH already owns 51% of Continental Hospitals Ltf and 74% of Global Hospitals Pvt Ltd. Besides, it is actively pursuing buying a controlling stake in Fortis hospitals. KKR recently invested Rs 1300 Cr in Radiant Life Care.

Update 2 (04.01.2019)

Oped in Livemint expressing concern at the trend of PE investments in healthcare. The latest PE investments being KKR-backed Radiant Life Care picking up 49.7% stake for $293 m in Max Healthcare, and General Atlantic investing $130 million to take a minority stake in KIMS hospitals.

Sunday, February 25, 2018

Is corporate India failing India?

Just as I had blogged this, the Nirav Modi story broke. Do not be fooled into demonising just him and rationalising such practices as being only at the margins. 

A significant proportion of the stalled projects with non-performing loans involves big name promoters who took loans after bagging large contracts, diverted the money elsewhere, and then conveniently blamed everything from government lethargy to world economic weakness for their failure to repay the loans. 

Here are two more examples of the malaise with corporate India. 

Ananth points to this article which highlights how Indian pulse importers are reneging on contracts entered into with sellers from Myanmar, Tanzania, and Mozambique, following the sharp collapse in pulse prices after the bumper crop of 2016-17. This is the most detestable of business practices,
Sellers complained that many buyers here deliberately chose not to accept the shipping documents on arrival of the cargo. To be sure, most of the import business in pulses is done on CAD (cash against documents) terms; and often, the seller finds himself at the mercy of the buyer when the cargo reaches the destination port... default of international contracts sully the image of the country and bring disrepute to the trade.
Funnily, or expectedly, the author of the article gave this example of corporate misdemeanour the populist spin of a policy failure by the government in (believe it or not) effectively regulating private contracts! 

One of the points made in a completely different context (and as a positive reference) by Nilesh Shah about the openness of corporate India to foreign investors is disturbing,
India is the only country in the world where in the listed segment, the largest bank, the largest insurance company, the largest mortgage company, the largest FMCG company, the largest telecom company, the largest automobile company etc are majority-owned by foreigners.
This is a very surprising development for a country like India, especially given the past two decades of economic growth. Have the foreign investment and financial market deregulation gone too far? Or is corporate India again failing India? Or is it that the Indian government is so weak and apathetic compared to its peers that it has failed to help its corporates stand up on their feet and fight off foreign investors?

I am inclined to argue that while the first is less likely and the and the second are more likely the proximate causes, the mainstream narrative is likely to be characterised in terms of the third!

Thursday, February 22, 2018

India Jobs Deficit graph of the day

This blog has long advocated that India's biggest challenge is not about generating more entrepreneurship but creating more productive salaried jobs in the formal sector. 

This Livemint graphic from a World Bank report is stunning in the magnitude of the problem compared to even our peers and neighbours,

This is arguably India's biggest economic challenge!

Tuesday, February 20, 2018

More evidence on business concentration

Here is the short-history of 21st century capitalism. Despite global savings glut, ultra-low interest rates, and massive corporate surpluses, the dynamics of modern capitalism has delivered business concentration and declining competition, regulatory capture, resource misallocation away from productive investments towards financial market speculation, higher profits and wage stagnation, greater share of income going to capital and away from labour, and widening of inequality. The evidence continues to mount. 

The latest comes from Gauti Eggertsson, Ella Getz Wold, and Jacob Robbins who argue that the driving force behind this dynamic is "an increase in monopoly power together with a decline in interest rate". They find,
An increase in firms’ market power leads to an increase in monopoly rents - economic parlance for profits in excess of competitive market conditions - and thus an increase in the market value of stocks (which hold the rights to these rents). This leads to an increase in financial wealth and to what’s known as Tobin’s Q, the ratio of a firm’s financial value (market capitalization) to the value of its assets (book value)... With an increase in market power, the share of income consisting of pure rents increases, while the labor and capital shares both decrease. Finally, the greater monopoly power of firms leads them to restrict output. In restricting their output, firms decrease their investment in productive capital, even in spite of low interest rates.

Their suggestion carries great relevance,  
Greater monopoly power tends to depress economic growth and increase income and wealth inequality. With high levels of monopoly profits, it may be optimal to have higher taxes on corporate income than would be suggested by analyses that assume perfect market competition.
If businesses are anyways unlikely to invest and most certain speculate in financial markets, higher levels of taxation can both curb such speculation and also generate more public revenues without crowding out any productive economic activity. 

Sunday, February 18, 2018

Weekend reading links

1. The Economist has a fascinating survey of the harmful effects of occupational licensing in the US. Sample this,
In 1950 one in 20 employed Americans required a licence to work. By 2017 that had risen to 22%... Most studies find that licensing requirements raise wages in a profession by around 10%, probably by making it harder for competitors to set up shop... Forty-one states license makeup artists, as if wielding concealer requires government oversight. Thirteen license bartending; in nine, those who wish to pull pints must first pass an exam... manicurists are licensed everywhere but Connecticut. Louisiana licenses florists... Such examples... are not representative of the broader harm done by licensing, which affects crowds of more highly educated workers... Among those with only a high-school education, 13% are licensed. The figure for those with postgraduate degrees is 45%. More educated workers reap bigger wage gains from licensing. Writing in the Journal of Regulatory Economics in 2017, Morris Kleiner of the University of Minnesota and Evgeny Vorotnikov of Fannie Mae, a government housing agency, found that licensing was associated with wages only 4-5% higher among the lowest earning 30% of workers. Among the highest 30% of earners, the licensing wage boost was 10-24%. Forthcoming research by Mr Kleiner and Evan Soltas, a graduate student at Oxford University, uses different methods and finds no wage boost at the bottom end of the income spectrum, but a substantial boost for higher earners... In particular, licences are more common in legal and health-care occupations than in any other.
2. In the context of assessments of historical figures and events, Livemint invokes John Rawls to offer a three point Rawlsian test,
The first point Rawls made was that the giants of the past had to be understood in the context of their times rather than ours. Any moment in history should then be seen from their point of view rather than ours. It is fundamentally wrong to pass sweeping judgements, with the benefit of perfect hindsight, on people making complicated choices in real time. The next point Rawls made was that any scholar has to strive to offer the ideas of a historical figure in their strongest form. They have to be assessed in the best light possible... Rawls once quoted John Stuart Mill in this respect: “A doctrine is not judged at all until it is judged in its best form.”... The third lesson from Rawls is that one should approach the great figures in history with modesty. “I always assumed that the writers we were studying were always much smarter than I was…. If I saw a mistake in their arguments, I suppose they saw it too and must have dealt with it, but where? So I looked for their way out, not mine.”
3. In the context of the debate surrounding whether macroeconomic theory needs revision or not, Srinivas Thiruvadanthai makes a very valid point that perhaps we need to go back and construct certain stylised facts from real world data. He suggests some which are all contrary to the orthodoxy - demand shortfalls have persistent effects; fiscal policy is effective in recessions; private debt matters enough to cause recessions and worse, whereas public debt matters less so; investments are not very sensitive to interest rate changes, both reductions and increases.

I can add a few more - capital grows faster than national incomes; technology markets converge to monopoly; financial markets cause misallocation of capital and human resources; higher marginal tax rates do not appear to reduce effort or investment decisions etc.

4. This story highlighted the bruising work culture among white collar employees in Amazon. It does appear that the story is even worse with blue-collar workers.

Highlighting the fact that jobs do not translate into higher incomes as well as the features of jobs in the logistics industry, City Lab illustrates with the example of San Bernardino, 60 miles east of Los Angeles, where since establishing base in 2012, Amazon has come to employ more than 15000 full-time workers in 8 fulfilment centres (where goods are stored and packed for shipment) and one sortation centre (where packages are organised by delivery area).
In San Bernardino, the unemployment rate that was as high as 15 percent in 2012 is now 5 percent... Yet in many ways, Amazon has not been a “rare and wonderful” opportunity for San Bernardino. Workers say the warehouse jobs are grueling and high-stress, and that few people are able to stay in them long enough to reap the offered benefits, many of which don’t become available until people have been with the company a year or more. Some of the jobs Amazon creates are seasonal or temporary, thrusting workers into a precarious situation in which they don’t know how many hours they’ll work a week or what their schedule will be... the experience of San Bernardino shows, Amazon can exacerbate the economic problems city leaders had hoped it would solve. The share of people living in poverty in San Bernardino was at 28.1 percent in 2016, the most recent year for which census data is available, compared to 23.4 in 2011, the year before Amazon arrived. The median household income in 2016, at $38,456, is 4 percent lower than it was in 2011... according to a report by the left-leaning group Policy Matters Ohio, one in 10 Amazon employees in Ohio are on food stamps.
This contrast between the labour markets of two eras is striking,  
In 2012, Amazon seemed like a lifesaver. San Bernardino’s unemployment rate was at 15 percent, home values had fallen 57 percent since 2007, and the city, facing a $45 million budget shortfall, would file for bankruptcy in August of that year... The jobs that used to dominate San Bernardino were unionized ones with good benefits, at the Kaiser steel mill, the Santa Fe railroad maintenance yard, and the Norton Air Force Base. Now, jobs like the ones Amazon creates pay less and aren’t unionized, and require multiple members of a household to work, often more than one job.
In terms of the Amazon effect, this is illuminating,
According to available data from the Bureau of Labour Statistics (BLS), warehouse workers in counties where Amazon operates a fulfilment centre earn about $41,000 per year, compared with $45,000 per year in the rest of the country, a difference of nearly 10% (see chart 2). The BLS data also show that in the ten quarters before the opening of a new Amazon centre, local warehouse wages increase by an average of 8%. In the ten quarters after its arrival, they fall by 3%.
The one thing that comes to mind is that this fabulous wealth of the world's richest man has been effectively built on what should arguably constitute "slave labour" in the world's richest country!

5. After having overtaken the US in exports and manufacturing, the final frontier for the Chinese economic march may be the technology sector
In some of the cutting-edge areas of technology like artificial intelligence, facial and speech recognition, the Chinese are breathing down the Americans on most parameters.

6. Finally, the graphic below puts the Chinese debt orgy in perspective - in 2009-17 its official and shadow bank lending was more than $20 trillion during 2009-17, whereas US Fed, BoJ, ECB, and BoE together added just $13 trillion in their respective fastest ever balance sheet expansions!

This is truly scary. The only thing that would be of some comfort is the Chinese government's commitment to address the problem and its credibility in terms of translating talk into actions. As a measure of that consider two data points - the crackdown on capital outflows led to it collapsing from $640 bn in 2016 to just $60 bn in 2017; shadow bank lending in January 2018 was the lowest January level since 2009 at just $25 bn, 90% lower than in January 2017. Not too many governments anywhere can pull off such feats. 

Saturday, February 17, 2018

Corporate cash hoards invested in bonds

Rana Foroohar points to a just released Credit Suisse study by Zoltan Pozsar which documented the massive off-shore corporate savings of US S&P 500 firms invested in high yielding corporate bonds. She describes them as being as influential on the bond markets as some of the investment banks. Of the $1 trillion savings of about 150 firms, 80% belong to the largest and most intellectual property rich 10% of firms. 

The savings of the 150 firms shows that IT and pharmaceuticals dominate, with the top 10 names controlling over $600 bn of the off-shore savings, with Apple alone having a trove of over $200 bn!
The next figure shows how the total savings (offshore plus onshore, though 90% are held offshore) of the top 10 have evolved over time in terms of categories of investments.  
Observe the striking coincidence with the global financial crisis, as savings ballooned from just over $100 bn in 2008 to over $700 bn by end-2016. 

Highlighting the relevance of IT companies with their ability to shift profits across borders through IP, Pozsar writes,
Corporations that rely on booking revenues derived from intellectual property (IP) assets in tax havens are more efficient at shielding earnings from the IRS than firms that don’t (IP assets range from the integration of design and hardware into a phone to the formulas of blockbuster drugs). This explains the greater concentration of savings in the first segment. Compared to the first segment, the second segment of the universe is less reliant on IP assets – there ain’t no “killer” apps, brands, codes, designs or formulas in the auto, energy, industrial and medical equipment manufacturing sectors. The strategy to book revenues generated by a portfolio of IP assets in tax havens is not easy to apply in these industries.
The paper has several interesting graphics. There are two graphs which show how the corporate's holdings of US Treasury bond and agency debt as well as corporate bonds, ABS, RMBS etc compare very favourably with those of the largest investment banks.

Friday, February 16, 2018

Holding the mirror on corporate India

Much has been written about how government regulations have shackled private sector growth in India. While it is undoubtedly true that restrictive regulations have constrained private business growth in the aggregate, for a country of India's size this cannot explain the near total absence of world-class companies and brands from India.

Even in the much acclaimed software sector, none of the Indian companies have progressed beyond being outsourced service providers. All this despite enjoying all the textbook requirements for success - cheap supply of skilled manpower, very low taxes, preferential government policies, benefits of exclusive zones or software technology parks, a massive and voracious global market, and the strong tailwinds of recurrent technology disruptions. There are no major commoditised IT solutions nor are these companies at the cutting-edge of work on areas like data science, artificial intelligence, internet of things, cloud computing, blockchains etc.

In terms of research and development (R&D) spending, our IT titans are minnows, with nothing special to show for in the last quarter century of rollicking growth. But the IT sector is no exception in this trend of skimping on R&D.

The recent economic survey holds the mirror on India's very vocal corporate sector and shows how woefully they lag behind others in their share of gross expenditure on R&D.
Several sectors have had multiple opportunities to benefit from protectionist industrial policies. The most classic recent example is of the solar industry. Despite local content restrictions and other forms of protectionism, Indian solar cells industry can supply less than 10% of the annual domestic requirements.

Another example comes from medical devices. The government has showered the industry with several concessions over the years. Nothing of any note has emerged beyond a few copy-cats. The pricing regulations imposed by the National Pharmaceuticals Pricing Authority (NPPA) on diagnostic devices offers yet another opportunity for this industry to generate world leaders in at least some important diagnostic products.

The other example is defence, where the current government has done possibly everything it could have to promote indigenous defence production. The results so far in terms of corporate India seizing the opportunity has been an utter disappointment.

As a comparison, one only needs to look at how Chinese firms have conquered the world in industry after industry by benefiting from their large domestic market and protectionist policies, two factors that Indian companies too enjoy. We can safely assume that even if NPPA holds the line for 10 years (which was for long the case since all these items were strongly regulated for decades), nothing much would have changed in terms of domestic production.

Apart from all this, I have blogged here, here, here, and here about the failure of the country's startup eco-system to generate innovators and innovations which have had a transformational effect on the country's development or on a pervasive development challenge.

But there is one area where our corporates top - in having among the worst corporate ethics! Consider this,
India was ranked the most unethical of 13 major economies in the 2016 Global Business Ethics Survey, behind even Brazil and China. Last year, Ernst and Young’s Asia-Pacific Fraud survey found that unethical practices are rife in India’s business community with 78 per cent of Indian respondents surveyed saying that bribery and corrupt practices occur widely, while 57 per cent said that senior management would ignore the unethical behaviour of employees to attain revenue targets... Foreign investors and companies complain that Indian businessmen don’t understand the concept of good faith in negotiations. Legal agreements are routinely flouted — often in cahoots with the authorities or the court system. Creative accounting is a commonplace hazard, as is illegal diversion of profits by promoters. The non-performing loan crisis in India’s banks is largely due to bare-faced cheating and fraud by crony capitalists with the connivance of pliant bank executives.
And it appears that questionable corporate ethics has not spared even the start-up entrepreneurs

Wednesday, February 14, 2018

The volatility trade casino

Ananth points to two links that highlights the casino that implied volatility trading has become. 

The market for exchange traded products (ETPs) in equity implied volatility, VIX futures, has exploded spectacularly with handsome returns since the turn of the decade. In the turmoil early last week, short positions which had been built up in the confidence complacency arising from the recent period of extraordinary stability in VIX, despite several signatures of bubbles, unravelled over just a few hours. Sample this
The scale of the returns the trade offered dulled the risks. Buying the largest short volatility ETP — run by Credit Suisse and known by the ticker XIV — at the start of 2015 and holding it to the end of 2017 generated a return of 320 per cent. Holding it from the start of 2015 to after Monday’s eruption, resulted in a total loss of 85 per cent... There are about 40 Vix-linked ETPs, according to Goldman Sachs, and most allow investors to bet on volatility rising... many have become popular, ranking among the most frequently traded exchange products, and rivalling the stocks of companies such as General Electric. 
And the systemic consequences have been, like with commodity futures, less than benign, with futures trading fuelling feedback loops into VIX itself,
“Volatility has become both an input for risk-taking, and something you can trade,” says Christopher Cole of Artemis Capital Management. “Volatility has become a player on the field.” In turn, the behaviour of the ETPs has helped fuel the Vix contracts that form their basis. So much so that it has led to concern that the financial products built to make money from tracking the Vix are now feeding back into the ingredients from which Vix is calculated. Traders say that at the end of Monday, the ETPs that ran into trouble from an initial rise in Vix scrambled to cover positions by buying large amounts of Vix futures, sending the price of the contracts soaring. The Vix, in turn, rose further and the S&P 500 sank.
And how did the markets respond to the unravelling of short positions - by swinging to the other extreme with the biggest ever weekly change into long-positions and the highest level of net long positions as a share of open interest in VIX futures since December 2009! 

Monday, February 12, 2018

The false dawn of blended finance in infrastructure

Blended Finance is the new buzzword in international development. Nancy Lee has a new paper in the CGD website which examines the potential of blended finance to crowd in private capital to finance infrastructure projects in developing countries. It suggests reforms to the private sector windows (PSWs) of multilateral development banks (MDBs) and development finance institutions (DFIs) to achieve this objective. 

She writes
Many were optimistic when the United Nations Sustainable Development Goals were launched in 2015 that the private sector — and domestic resource mobilization — would fund much of the investment needed to achieve these goals — especially as public aid flows stagnate. As 2018 begins, we would do well to reassess these optimistic projections for private finance for development, and ask are the “billions to trillions” materializing?... Many changes will be necessary, but I would highlight two as fundamental: First, greater risk tolerance and lowered expectations for risk-adjusted returns, and second, a major cultural shift to encourage collaboration rather than competition among the MDBs... Current data do not suggest that private investment of sufficient scale will emerge under the status quo, or that poor countries have a real chance to capture a larger share.
The paper suggests several reforms to the environment as well as the structures of PSWs of MDBs and DFIs - off-balance sheet financing of riskiest projects; aligning institutional incentives to doing more stuff like credit guarantees; consolidation and rationalisation of multiple trust funds; collaboration between the PSWs of all institutions to share pipeline, harmonise and pool financial instruments; assuming more leverage and risk; specialise in high-risk greenfield infrastructure etc. 

Unfortunately, none of these reforms are likely to make any significant dent (turn "billions into trillions") on the problem and change the status quo. This naive optimism glosses over fundamental structural factors which strongly militate against the use of foreign private capital to finance infrastructure in developing countries to any meaningful extent.

For a start blended finance is not new in infrastructure. Further, the use of blended finance instruments cannot meaningfully address the deep underlying problems. My guess is that this blog alone has atleast a hundred posts which explore different dimensions of the challenge with making private capital work in infrastructure sector, except a few areas (telecommunications and power, in particular). 

The challenge facing foreign private capital financing of infrastructure in developing countries centre around questionable premises about the use of both foreign and private capital in infrastructure sectors,

1. The total volume of dry powder from all types of sources, including alternative investment funds, available for developing countries (excluding China) is very small. They are minuscule for the low income countries. The report itself says that they received just 1.7% of total private capital flows to developing countries in 2016!

2. While the revenues of most infrastructure projects are in local currency, the repayment or profit repatriation is invariably to a foreign currency (dollar). For countries prone to macroeconomic vulnerabilities, the currency mismatch risk can by itself be a major source of instability. 

3. There are limits to the foreign currency liabilities (of all kinds - debt and equity) that developing countries can assume and the desirability of assuming them. Foreign capital as a share of gross fixed capital formation  (and infrastructure is just one of the destinations) even among the East Asian economies and China during their high-growth years have rarely crossed even 10%. Many African countries are still struggling to recover from the last round of Eurobond issuances. The perils of the original sin and the risks of sudden-stops and capital flights from cross-border capital flows are recurrent and too well documented to be repeated. 

4. Infrastructure projects, especially the large ones and in sectors requiring land acquisition and right of way, invariably get delayed and suffer cost over-runs, often causing escalations which are multiples of original cost, are commonplace. Private parties cannot be expected to bear the associated construction and commissioning risks.

5. Private borrowing is far more expensive when compared to government borrowing. The cumulative costs, as the recent UK NAO report shows, can be very significant. 

6. Even in the developed economies, such infrastructure projects invariably end up in renegotiations within a few years of the concession being granted or project being commissioned. In countries with limited state capacity, weak contract enforcement mechanisms, and poor governance such renegotiations can be very tricky and impose prohibitive ongoing risks for investors.

7. Finally, for all the aforementioned reasons, the returns required to make infrastructure investments attractive enough in developing countries (for both domestic and foreign investors) would be too high for most infrastructure assets to be able to provide. 

While several more challenges can be outlined, historical experience from across the world shows that the aforementioned factors can be insurmountable.  

For sure, developing countries should try to attract foreign private capital to their infrastructure sectors and the reforms suggested by Nancy Lee should be implemented. But these efforts are unlikely to improve things meaningfully and foreign private capital is most certain to remain a marginal contributor to financing infrastructure in developing countries.

In conclusion, the premise of private capital, and foreign one at that, as a major contributor to finance greenfield infrastructure investments in developing countries is doubtful. Developing countries will have to rely on domestic savings and predominantly government revenues to finance such investments. Blending or not, there are no innovations around this stark reality! Turning "billions into trillions" through private foreign capital will remain a dream.

Sunday, February 11, 2018

Global bond market fact of the day

There are currently about 25,000 bonds on the global market, issued by both governments and corporations. According to Kirk’s data, the average yield of these bonds is a paltry 1.9%. Back in 2000, the average bond yielded significantly higher at 6%. Average current duration is seven years, quite risky considering the low yield. If rates rose at all over that time, which is highly likely – both the Federal Reserve and the European Central Bank are indicating so – you would lose money.

Thursday, February 8, 2018

The challenge with health insurance model to universal health coverage

In the context of PPPs and the recently unveiled health insurance program in India, Karthik asks the questions (in the comments here),
If the decision of public vs. insurance model of health care is a matter of comparison between the capacity to run public hospitals vs. capacity to regulate private players... are we stuck in a trap where we don't have either of these capacities? In this context, which capacity is easier to build from the current state?
It is a good opportunity to clarify my own thoughts. I naively started out as a strong believer in the insurance model to deliver universal health coverage - see this and this. I no longer subscribe to this view. 

Here is the challenge. Any insurance model is inherently suited to address secondary and especially tertiary care. It cannot be tailored to the effective delivery of non-curative preventive and primary care, especially given the public health challenges that we face. And the cost-effectiveness of insurance by its very nature depends on the ability to limit incidence of the insured events. But the incidence of secondary and tertiary treatment episodes depends on the strength of preventive and primary care. In other words, you need to build the insurance system on a very good preventive and primary care system so that disease incidence itself is minimised. But our preventive and primary care is broken. Worse still, we have a situation where the insured are the poor who are also those with the weakest preventive and primary care and therefore the population category with the highest likelihood of incidence of the insured events. In the circumstances, the insurer faces the maximum disease incidence likelihoods. 

In fact, there is an even greater practical problem with the focus on insurance approach. It takes the attention and resources away from the more important and difficult task of fixing the broken preventive and primary care system. This is not amenable to electorally popular announcements or administrative actions like empanelling insurers, Third Party Administrators (TPAs), and hospitals. It demands persistent and painstaking work which is diffuse and beyond the abilities of systems with weak state capacity. We fall into an even worse equilibrium.

Finally, there is the impossible fiscal challenge. I have written with Lant Pritchett about the problem of doubly-universal coverage - population coverage and conditions coverage - which is an inevitable slippery slope with insurance models. The move from the limited RSBY to Ayushman Bharat is only the latest example. Andhra Pradesh's Aarogyasri Program started with a token amount for just child heart surgeries and in less than a decade (by 2014-15) came to progressively cover nearly 1100 conditions and over Rs 5000 Cr for the combined state. The only reason it did not reach Rs 10,000 Cr was because the supply-side to deliver secondary and tertiary care could grow only so fast. 

It is a only a matter of time before the fiscal limits start to bind as supply expands inexorably to meet the latent demand. The squeeze on preventive and primary care was more or less proportionate to the ballooning of the insurance costs. Even a very very modest health insurance scheme that can reasonably address the secondary and tertiary care needs would easily cost 3-4% of the GDP (if not much more), a tripling or quadrupling of current expenditures. This is a clearly unrealistic expectation for a country grappling with a 11-12% tax-to-GDP ratio. 

So here is the verdict on the insurance model from one of the most authoritative sources, N Srikant, the most outstanding CEO of Aarogyasri who tried to salvage the bloated and expensive corporate give-away that Aarogyasri had become,
We found that adding an additional layer of insurance intermediary between the trust and hospitals reduced the benefit cost ratio under the scheme by 12.2 % (p-value = 0.06). Every addition of 100 beds under the scheme increases the scheme payments by US$ 0.75 million (p-value < 0.001). The gap in claim denial ratio between insurance and trust modes narrowed down from 2.84 % in government hospitals to 0.41 % in private hospitals (p-value < 0.001)... The scheme is a classic case of Roemer's principle in operation. Introduction of insurance intermediary has the twin effects of reduction in benefit payments to beneficiaries, and chocking fund flow to government hospitals. The idea of engaging insurance intermediary should be abandoned.
There is no country in the world which has developed an effective universal health coverage by focusing predominantly on secondary and tertiary coverage based insurance. 

One approach which has the potential to be effective is the capitation model followed in countries like Thailand. But this in turn too requires a strong primary health care system. 

So back to Karthik's questions. The insurance model is simply unsustainable BIG TIME for a country like India. In fact, it is perhaps the worst scenario. So we are left with no option but focus on preventive and primary care and improve public facilities. Even with the weak state capacity, this is just the only long-term way forward. This is my theoretical assessment. 

But since the insurance genie is out of the bottle and given its powerful electoral attractions, some form of insurance cannot be avoided. In fact, in Andhra Pradesh, it is widely believed that Aarogyasri was one of the main reasons for Mr Y S Rajasekhara Reddy retaining power in the 2009 elections. In the circumstances, faced with electoral battles, no government can be faulted for thinking along these lines. So a prudent compromise may be to have an insurance model which covers a basic package of catastrophic illnesses. It should be complemented with some of the following 

1. This insurance should be operated by a Trust with its dedicated TPAs and not insurers. 

2. A high quality IT system that can manage the logistics of screening, pre-authorisation, treatment, payments, and follow-up, which was a feature of Aarogyasri, should be replicated. It should be accompanied by analytics and vigilance to monitor the problem of over-diagnosis and over-treatment. 

3. The public hospitals and government doctors should be incentivized, even with positive discrimination, to attract patients, so that the insurance program does not end up being a give-away to private hospitals.  

4. The rates should be fixed on very objective considerations, free from political interference, and through transparent process of price discovery involving strategic purchasing at an appropriate administrative level. Maybe this should vary across States. 

5. There should be a mechanism to limit the creeping expansion of conditions coverage. An institutionalised arrangement like the National Institute for Health and Care Excellence (NICE) in the UK should be in control of such decisions. 

6. It is useful to demand some limited co-payment or small premium from all but the poorest. 

7. Finally, the expenditure on this insurance cannot come at the expense of primary and preventive care as well as investments in public secondary and tertiary facilities.

If it is decided to purchase from insurers (instead of using the Trust model), there is perhaps some logic in moving away from the current one-premium-for-all model to one which uses different premia for different age-groups, albeit the same for all members in an age-group irrespective of pre-existing medical conditions (community-rating).

All easier said than done! And even if done there is nothing to stop them being changed or reversed. Therefore, the best that can be done for bureaucrats to try incorporate these elements to the extent possible to the insurance program design.

Tuesday, February 6, 2018

PPPs and Value for Money?

In the aftermath of the collapse of Carillion and the NAO report, FT has been leading the sceptical scrutiny on PPPs. I am extracting a few snippets which convey the story.

The headline takeaways on value for money from PFI,
A National Audit Office report last month found schools built using the PFI are 40 per cent more expensive and hospitals cost 60 per cent more than the public sector alternative.
Investors strip assets and leave the companies indebted,
In 1989, the water industry in England and Wales was privatised with no net debt. Yet almost three decades on, it has built up borrowings of £42bn. All but three of the 10 English water companies have been taken off the stock market by private equity investors — many backed by foreign sovereign wealth funds and pension schemes. In the meantime, all the industry’s post-tax profits have been carried off in the form of dividends. Shareholders’ funds have barely budged since 1989.

The comparison with Scottish Water, which was not privatised and remained public, is instructive,
Yet unlike the English utilities, it remains relatively unleveraged. Its borrowings of £3.8bn represent just 48 per cent of the value of its regulated assets, as against the 65-80 per cent that is prevalent in England. Meanwhile, the average bill from Scottish Water was £357 last year — 10 per cent lower than the English average of £395.
And in terms of benefits to consumers, in UK 
A study by Greenwich university claims that refinancing utility debt and equity with government bonds and scrapping dividends could save £2.3bn a year. That is equivalent to a saving of almost £100 off the average £400 water bill.
... and elsewhere in Europe,
A study of French water services in 2004 found that the price of privately-delivered water was 16.6 per cent higher than in places where municipalities delivered the service.
And from the other big example of privatisation, railways,
The cost of running the UK’s railways is 40 per cent higher than it is in the rest of Europe, according to a 2011 government report by Sir Roy McNulty, the former boss of UK aviation group Short Brothers who has long experience in transport regulation... Since privatisation, the bill has mainly been shared between the taxpayer and the passenger. The contribution from the state has almost doubled from £2.3bn in 1996 to £4.2bn in real terms in 2016-17, despite a conscious decision in recent years to push more of the cost on to users’ shoulders. Ticket prices have risen: they are now 25 per cent higher in real terms than in 1995 and 30 per cent higher than in France, Holland, Sweden and Switzerland. The latest average rise in fares of 3.4 per cent, announced on New Year’s Day, was greeted with outrage. 

Like with water, operational efficiency gains and attendant cost reduction have remained elusive, and asset stripping has proceeded apace,
Despite the vastly expanded usage, the network’s costs have not obviously come down relative to its income. According to the 2011 report, unit costs per passenger kilometre were roughly 20p in 2010, much the same as they were in 1996... Critics argue that train operators are able to make returns, and pay themselves dividends, despite contributing very little in the way of risk capital. While operating margins of 3 per cent are not high, the train companies paid nearly all the £868m operating profits between 2012-13 and 2015/16 as dividends — £634m in the four year period.

A sense of the complexity of such outsourcing and private participation,
“The train you catch is owned by a bank, leased to a private company, which has a franchise from the Department for Transport to run it on this track owned by Network Rail, all regulated by another office, and all paid for by taxpayers or passengers,” says John Stittle, a professor of accounting at Essex university. “The complexity is expensive.” 
Finally, on the public mood,
An October poll conducted by the UK’s far-from-socialist Legatum Institute showed 83 per cent of respondents favoured the nationalisation of water. For energy, the figure was only slightly lower, at 77 per cent.
But who will listen, since the regulators have been captured and the liberals are blindly anti-state and pro-market,
Ofwat, for instance, has been criticised for its focus on investors rather than customers. While the watchdog sets aside two days a year to give presentations to the City of London, there is no forum for it to meet customers.
With regulatory capture and renegotiations, the original spirit of privatisation has been cast aside in railways too,
As with other privatised monopolies, competition was supposed to ensure lower prices and sharper services. But in recent years this has faded, raising questions over the legitimacy of the franchising system. A third of train operating companies now hold their franchises by so-called “direct awards” from government, rather than auction. Successive governments, out of an apparent desire to keep the private sector onside, have been reluctant to wield their powers against poorly performing franchises. Only one train operator has ever been stripped of its contract — Connex for poor performance in south-east England in 2001 and 2003. Three more have walked away after overbidding for contracts, with minimum penalties. Last month, the government allowed Virgin Rail and Stagecoach to terminate their East Coast line franchise three years early, saving them the need to write a £2bn cheque to the government under previously agreed revenue growth forecasts. Yet with only a handful of operators bidding for franchises, the duo may end up operating the line again — on more profitable terms.
This verdict of rail privatisation contrasted with public ownership comparator is striking,
There is a growing consensus among both executives and industry experts as well as the public that Britain’s unique attempt to create competition on Britain’s rail network has not delivered. While it has led to more services, and encouraged more users to pay higher prices, it has not unleashed the productivity improvement necessary both to upgrade the network and stabilise the network’s finances. Over the same period, for instance, London’s state-owned metro network, Transport for London, has grown just as quickly and delivered much more state-of-the-art investment. 
No wonder the likes of Corbyn and Trump look attractive! 

Monday, February 5, 2018

Why do DFIs support tax avoidance?

Paddy Carter uses the platform of "liberal" think-tank Centre for Global Development to make an astonishing argument in support of the use of tax havens by development finance institutions (DFIs). Consider the straw man arguments against DFIs investing through tax havens,
The argument rests on the answers to two questions: what do DFIs use tax havens for, and what are the alternatives to using them? The short answers are that tax havens are used to compensate for shortcomings in the legal systems of the countries that DFIs invest in, and that if DFIs stopped using tax havens, they would use onshore financial centres in rich countries instead. And that would not help developing countries one jot.
The two questions are the right ones but the answers to both are wrong. 

DFIs use tax havens because they go along with the preferences of their commercial co-investors and their investees, all of whom strongly prefer to invest through offshore financial centres (OFCs). I can understand the need for a holding company incorporated in a third country without the "shortcomings in the legal systems of the countries that DFIs invest in". But let's face it, the preference of commercial investors for that company to be incorporated specifically in an OFC comes from two directions - the tax benefits and the cover of opacity. The case for tax avoidance is too well know to be elaborated. But the benefits of opacity in ownership structure and governance is equally valuable for the investors and their limited partners.

This brings us to the second question of alternatives. I agree that cutting off the OFC route will only drive investors to incorporate in developed countries, maybe the onshore financial centres in the developed world or those with double taxation agreements. While this will not address the problem of tax base loss for the developing country, it opens the possibility of higher tax receipts for developed country governments, especially given the growing pressure on onshore financial centres to roll-back their beggar-thy-neighbour tax arbitrage policies. Anyways, given the burgeoning deficits and debts, developed countries could just as well do with those additional tax revenues. Equally importantly and immediately, given the much higher standards of transparency and disclosure requirements in Western onshore financial centres, it would lift the veil of opacity that covers the ownership and governance of these entities. 

The role of DFIs and their capital should also be to influence the markets into investing in ways that promote development objectives and transparency in corporate governance, and not go along with the markets in depriving developing countries (or governments anywhere) off their tax revenues and promoting opaque corporate governance standards and systems.

I find it incredulous that International Finance Corporation (IFC) does not have the financial muscle to significantly influence other commercial investors if it took the principled view that it would not co-invest in companies in developing countries which are incorporated in OFCs. And if all the major national government funded private sector investors like OPIC, CDC, KfW etc joined hands, then it would be a good start to limiting tax avoidance, boosting domestic resource mobilisation in developing countries, and bringing transparency into such investments.

Saturday, February 3, 2018

Weekend reading links

1. The proposal in the Union Budget 2018-19 to impose tax on long term capital gains is a welcome development. This blog has been a long-term advocate of this move. 

With the Mauritius tax treaty and taxation on long-term capital gains out of the way, the next target should be on the tax deduction on interest expense, at least beyond a certain limit. The short story of India's infrastructure sector this millennium has been one of firms financing projects with excessive debt, thereby leaving them with limited skin in the game. The pile of stalled projects (and banking non-performing assets) with absconding developers is in no small measure due to this distortion. 

2. A minimum support price (MSP) may be scorned upon by orthodox economists and commentators on the right. But in the case of agriculture in developing countries like India, it may actually be among the least worse option among all the alternatives available. The budget proposal offering a 1.5X MSP on input cost is therefore understandable. The challenge is with getting the right implementation design - most cost-effective, least distortionary, most light-touch etc.  

3. Can Perovskites, a compound of calcium, titanium, and oxygen replace silicone in solar cells? The Economist has a feature on the latest research.
Today 10% is quite a modest efficiency (measured in terms of how well a cell converts light into electric current) for a perovskite cell in the coddling conditions of a laboratory. For lab cells values above 22% are now routine. That makes those cells comparable with ones made from silicon, as most of the cells in solar panels are—albeit that such silicon cells are commercial, not experimental. It did, however, take silicon cells more than 60 years to get as far as they have, and the element is probably close to its maximum practical level of efficiency. So, there may not be much more to squeeze from it, whereas perovskites could go much higher. Perovskite cells can also be made cheaply from commonly available industrial chemicals and metals, and they can be printed onto flexible films of plastic in roll-to-roll mass-production processes. Silicon cells, by contrast, are rigid. They are made from thinly sliced wafers of extremely pure silicon in a process that requires high temperature. That makes factories designed to produce them an expensive proposition... 
Eventually, Mr Averdung believes, perovskites will act as stand-alone cells—and not just in conventional panels. Because they are semi-transparent, perovskite films could also be used to turn windows into solar generators, by capturing part of the incoming sunlight while permitting the rest to pass through.
4. Tyler Cowen writes about the utility of land value capture to finance infrastructure projects. In this context, it is worth keeping in mind that India has a a Land Value Capture Policy.

5. Staying on land value capture, the Times has a very good article on how being near a metro station benefits a property.
In Manhattan’s main business corridors, from 60th Street south, the benefit of being near a subway adds $3.85 per square foot to the value of commercial property, according to calculations by two New York University economists... Gov. Andrew M. Cuomo, a Democrat, has made value capture a prominent part of his plan to salvage the subway system by proposing to give the Metropolitan Transportation Authority the power to designate “transit improvement subdistricts” and impose taxes... at a moment when the subway is facing its worst crisis in decades, there is a growing consensus that property owners should shoulder more of the cost of a subway system that has nourished their bottom lines... The governor’s proposal would allow the transit agency to establish districts around new projects for value capture that could extend as far as a mile from a station.
6. Nice column by Shankkar Aiyar that charts the chequered history of India's public sector assets disinvestments. Short story, a very large share of disinvestment has been about moving money from the right hand to the left hand of the government. Someone should do a graphic of the real disinvestment away from any kind of government ownership (including by LIC, that giant buyer of last resort) and plot against the estimates. That would be the real measure of disinvestment. 

7. A very good essay in The Economist on the proliferation of higher education and its questionable benefits. South Korea is the most stunning success,
Seventy per cent of pupils who graduate from the country’s secondary schools now go straight to university, and a similar share of 25- to 34-year-olds hold degrees, up from 37% in 2000. Students scramble to gain admittance to the most prestigious institutions, with exam preparation starting ever younger. Sought-after private nurseries in Seoul have long waiting lists.
Since 1970, the share of workers with university degrees has increased in all but nine of 265 occupation categories that make up US workforce.
Occupations with bigger increases in share of university education have seen higher wage increases, though the correlation is weak. 

The article questions the value of the graduate premium - the difference between the average earnings of those with a degree and those with secondary-school education or less, controlling for fees and income foregone while studying - which is regarded as a proxy for return on education. This metric is flawed on numerous considerations - it lumps together all kinds of degrees into one category, glosses over wage-inequality levels, does not account for those who have started university education by paying fees etc but not completed it, and most importantly does not account for the reality that  on average cleverer students would anyways earn more.
Including dropouts when calculating the returns to going to university makes a big difference. In a new book, “The Case Against Education”, Bryan Caplan of George Mason University argues that the low graduation rates of marginal students, and the fact that, for a given level of qualification, cleverer people tend to earn more, mean that the return on a four-year degree in America ranges from 6.5% for excellent students to just 1% for the weakest ones.
It writes about the pernicious effects of higher education in so far as its proliferation encourages employers to look for graduates for any job, even which require no such skills. Such crude screening is a penalty on non-graduates who get locked out of decent jobs. This has resonance in countries like India,
Across the rich world, a third of university entrants never graduate. It is the weakest students who are drawn in as higher education expands and who are most likely to drop out. They pay fees and sacrifice earnings to study, but see little boost in their future incomes. When dropouts are included, the expected financial return to starting a degree for the weakest students dwindles to almost nothing. Many school-leavers are being misled about the probable value of university.
It writes about a measure of the over-education problem,
The Economist has produced a measure of over-education by defining a graduate job as one which was staffed mostly by degree-holders in 1970. We find that just 35% of graduates work in such occupations today, down from 51% 45 years ago. Judging by job titles alone, 26.5m workers in America—two-thirds of those with degrees—are doing work that was mostly done by non-graduates a half-century ago.
This is a very important insight for policy makers and opinion leaders,
Earning a degree is partly about improving productivity, but it is also about getting ahead of your peers. Policy makers should focus on the public rather than the private economic benefits of higher education. 
Its suggestions to end the education arms race to the bottom,
Governments need to offer the young a wider range of options after school. They should start by rethinking their own hiring practices. Most insist on degrees for public-sector jobs that used to be done by non-graduates, including nursing, primary-school teaching and many civil-service posts. Instead they should seek other ways for non-graduates to prove they have the right skills and to get more on-the-job training. School-leavers should be given a wider variety of ways to gain vocational skills and to demonstrate their employability in the private sector. If school qualifications were made more rigorous, recruiters would be more likely to trust them as signals of ability, and less insistent on degrees. “Micro-credentials”—short, work-focused courses approved by big employers in fast-growing fields, such as IT—show promise. Universities should grant credits to dropouts for the parts of courses they have completed. They could also open their exams to anyone who wants to take them, and award degrees to those who succeed.
8. The Times has a story which highlights how the World Bank President Jim Kim may be embracing Wall Street and its capital as the Bank struggles to get its members to make their contributions. Kim has been courting private capital to invest alongside the World Bank.

He should remember this is what happened when state and local governments in the US embraced Wall Street.

9. Finally, Ananth has sent me the findings of Harvard-Harris poll. On immigration etc, Trump is merely channeling the overwhelming public sentiment. The liberals may feel they are representing the public mood. The only problem is that they clearly are not, and representing a small self-serving elite.