Monday, December 28, 2020

Global textiles industry facts of the day

FT has a long read on the global textiles trade. Outsourcing and offshoring of manufacturing has doubtless helped hundreds of millions of people out of poverty. The textiles industry has been one of the biggest beneficiaries. 

But it has come with its costs. And it goes beyond the commonly cited example of sweat shops. For a start, like elsewhere the industry has become more concentrated.
In 2019, 97 per cent of profits in the industry were generated by just 20 companies.
Similarly, the industry is characterised by an exploitative contract manufacturing business model, whereby retailers and fashion brands in developed markets contract with large manufacturers in developed countries. The former captures a disproportionately large share of the profits from the sale of a cloth. 

Further, as the Covid 19 pandemic has demonstrated, the business model itself transfers risks to the contract manufacturer,
Elizabeth L Cline, an author on labour rights and environmental practices in the fashion industry, argues that outsourcing has enabled retailers to distance themselves from risks in the supply chain. “Even though brands control everything about the supply chain, they’ve set it up so that workers cannot ask for what they need,” she says. The system is designed to operate similarly to the business model of gig economy companies such as Uber: “Let’s pretend our essential workers are not our employees and leave risk with people least equipped to deal with it.”
And the bargaining power with these manufacturers, even among the biggest ones, is very small, even when the retailers have defaulted on taking delivery and making payments on orders placed by them, as has become widespread during the Covid 19 lockdowns,
Mostafiz Uddin, boss of Bangladeshi clothes manufacturer Denim Expert says he will not take legal action against clients that have left him with hefty bills. “If I sue, I will forever be known as the supplier that sued its client. I would likely be finished as a business,” he says.

Saturday, December 26, 2020

Weekend reading links

1. A new NBER paper highlights another example of capitalism with Chinese characteristics, in the faster growth of private firms with connections to state-owned firms,

We use administrative registration records with information on the owners of all Chinese firms to document the importance of “connected” investors, defined as state-owned firms or private owners with equity ties with state-owned firms, in the businesses of private owners. We document a hierarchy of private owners: the largest private owners have direct investments from state-owned firms, the next largest private owners have equity investments from private owners that themselves have equity ties with state owners, and the smallest private owners do not have any ties with state owners. The network of connected private owners has expanded over the last two decades. The share of registered capital of connected private owners increased by almost 20 percentage points between 2000 and 2019, driven by two trends. First, state owned firms have increased their investments in joint ventures with private owners. Second, private owners with equity ties to state owners also increasingly invest in joint ventures with other (smaller) private owners. The expansion in the “span” of connected owners from these investments with private owners may have increased aggregate output of the private sector by 4.2% a year between 2000 and 2019.

2. Former Secretary Agriculture T Nanda Kumar has an article here with very practical suggestions to amend the agriculture legislations and break the deadlock. 

3. Following its decision to counter-sue a participant in the clinical trials who had sued Serum Institute, the company's high-profile founder has now demanded government indemnification against all lawsuits. 

4. Reetika Khera, Sudha Narayanan, and Prankur Gupta separate the wheat from the chaff on the issue of MSP. Using FCI data on procurements, they find,

One, the proportion of farmers who benefit from (even flawed) government procurement policies is not insignificant. Two, the geography of procurement has changed in the past 15 years. It is less concentrated in traditional states such as Punjab, Haryana and western UP, as Decentralised Procurement Program (DCP) states such as Chhattisgarh, Madhya Pradesh, and Odisha have started participating more vigorously. Three, perhaps most importantly - it is predominantly the small and marginal farmers who have benefited from the MSP and procurement, even if the size of the benefits may be larger for larger farmers. This is true not just in the DCP states, but also in the traditional states. 

5. Twenty20, the Charity registered by Kerala's largest private employer, Kitex, and which had been ruling Kizhakambalam Panchayat of Ernakulam district since 2015, has now expanded its political base by retaining the Panchayat and winning three more in the same district and becoming the largest party in another in the recent local body elections in the state.  

6. Good explainer in Indian Express on the findings of the recently released NFHS-5 survey. 

The article points to this paper by John Hoddinott and two others which has an assessment of the benefits-cost ratio (in terms of potential increments in future incomes) for interventions that reduce stunting.

7. As the pandemic broke out, governments across the world stepped in with, among other things, loan guarantee schemes to support small businesses. In US, the Paycheck Protection Program distributed about $525 bn to 5.2 m companies in the April-August period. In UK, £43.5 bn has been distributed to 1.4 million businesses, and it is still ongoing and expected to reach about £87 bn.  

The efforts to quickly push out these loans was always going to be difficult and ran the risk of serious frauds. Unsurprisingly, both the US and UK loan guarantee schemes have seen massive frauds. The US PPP program has even been described as "legalised fraud". See also this and this on the US fraud and this on the allegations of fraud with the UK program. 

8. Excellent NYT photo feature on how Russia may end up benefiting from global warming as it makes its cold northern parts amenable to agriculture. 

A great transformation is underway in the eastern half of Russia. For centuries the vast majority of the land has been impossible to farm... But as the climate has begun to warm, the land — and the prospect for cultivating it — has begun to improve... Across Eastern Russia, wild forests, swamps and grasslands are slowly being transformed into orderly grids of soybeans, corn and wheat. It’s a process that is likely to accelerate: Russia hopes to seize on the warming temperatures and longer growing seasons brought by climate change to refashion itself as one of the planet’s largest producers of food... for a few nations, climate change will present an unparalleled opportunity, as the planet’s coldest regions become more temperate. There is plenty of reason to think that those places will also receive an extraordinary influx of people displaced from the hottest parts of the world as the climate warms.

And what does it mean for global geo-politics in the years ahead,

No country may be better positioned to capitalize on climate change than Russia... Russia is rich in resources and land, with room to grow. Its crop production is expected to be boosted by warming temperatures over the coming decades even as farm yields in the United States, Europe and India are all forecast to decrease. And whether by accident or cunning strategy or, most likely, some combination of the two, the steps its leaders have steadily taken — planting flags in the Arctic and propping up domestic grain production among them — have increasingly positioned Russia to regain its superpower mantle in a warmer world.

9. The persistent low interest rates and pandemic induced buying opportunities meant that private equity industry had a record year, with buyout groups striking deals worth $559 bn in 2020 with more than 8000 deals, the highest since records began in 1980.

10. Fascinating article in NYT about Japan's centuries old businesses. The article covers Ichiwa, a shop which makes grilled rice flour cake and which has been in existence for 1000 years.
Japan is an old-business superpower. The country is home to more than 33,000 with at least 100 years of history — over 40 percent of the world’s total, according to a study by the Tokyo-based Research Institute of Centennial Management. Over 3,100 have been running for at least two centuries. Around 140 have existed for more than 500 years. And at least 19 claim to have been continuously operating since the first millennium... The businesses, known as “shinise,” are a source of both pride and fascination. Regional governments promote their products. Business management books explain the secrets of their success. And entire travel guides are devoted to them. Most of these old businesses are, like Ichiwa, small, family-run enterprises that deal in traditional goods and services. But some are among Japan’s most famous companies, including Nintendo, which got its start making playing cards 131 years ago, and the soy sauce brand Kikkoman, which has been around since 1917.

Such old businesses cannot survive merely by maximising profits, but need to have a higher purpose. This is called 'kakun', or family precepts which have guided such companies business decisions for generations. These businesses offer useful pointers for those look at an alternative to free-market capitalism. 

11. The Economist on the importance of waste pickers,
The world’s cities produce over 2bn tonnes of solid waste every year. Even before the covid-19 pandemic local governments in poor countries struggled to keep their streets clean, clearing less than half the rubbish in urban areas and around a quarter in the countryside. Informal workers, who make up around 80% of the 19m-24m workers in the waste industry, have helped plug that gap. They both haul rubbish and scour municipal dumps and public spaces for things which can be re-used or sold, normally through middlemen, to recycling companies. In India waste-pickers divert over 40m tonnes of refuse away from landfills and into recycling every year, a task that would cost municipalities 15-20% of their annual budget. In South Africa they are responsible for recovering 80-90% of packaging.

12. In recent weeks regulators in US have opened anti-trust investigations against Facebook and Google, and in China against Alibaba. The markets in the US appeared to have hardly taken any notice of the actions against the two tech giants. But in stark contrast, the markets in US reacted strongly by clipping over 13% from the share price of Alibaba

Does this mean that anti-trust investigators in China have greater credibility than their US counterparts? Or is it a case of markets pricing in the resolve of Chinese regulators to go after this particular offender?

At one level, these actions may be another example of capitalism with Chinese characteristics. 

Regulators must consider the broader economic and strategic picture while implementing the law... What prompted the regulator's shift may not be that monopolistic abuses have gotten particularly bad lately, but rather that tech giants are thought to have gone astray in the directions they have pursued. For example, Alibaba and Tencent are criticized for leveraging their dominant digital platforms to repeat their tried and true winner-take-all approach in the local community fresh produce group buying sector. Once again using subsidized user acquisition and rapid scaling via online traffic diversion, tech giants are seen as greedy profit harvesters squeezing small Chinese businesses and potentially causing instability. In the eyes of China's anti-monopoly regulators and the central government, it is equally important to both curb such bad behavior and to point the tech companies to the right place to target, or even to monopolize.

And this

A researcher at a Chinese government-affiliated think tank explained the clampdown on Alibaba this way: "Ant was like a loan shark. If the authorities did nothing about Ma, who led Ant, the public could rise up against the government."

13.  Finally, after years of acrimony and months of intense haggling, EU and UK have closed a Brexit deal. While Britain leaves the customs union and single market, it is still a £660 bn trade deal which avoids the potential disruptions from a complete divorce. The preferential access deal means that imports from either side would be free of tariffs and quotas, a provision that goes far beyond any trade deal EU has with another country. This is a good summary of the provisions of the deal and this about the progress of the nine month long talks. 

14. Interview of the NHAI Chairman here about the latest with the agency's road construction program. The agency is planning to use a mix of securitisation of toll revenues, InvIT, and toll-operate-transfer models for asset monetisation. 

Two things, which this blog has long since been advocating and which goes against the commentary in mainstream media, stand out. 

One, the vast majority (over 90%) of the projects are being built with significant upfront public investment, either through HAM (where 40% viability gap funding is given during construction) and EPC. The share of BOT-toll and even BOT-annuity projects has declined to negligible proportions. 

Two, the vast majority of financing is coming from domestic capital, with bank loans being the major contributor (on the developer side in HAM projects, their debt will be mostly bank loans). It's good that NHAI are able to issue a significant share of bonds. Foreign capital will remain negligible in greenfield projects. Even in case of asset monetisation, the share of foreign capital will be small. 

15. A big challenge as fiscally strapped governments, including states in India, navigate the post-pandemic world will be with managing the fiscal balance. Historically governments have sought to respond to such situations by cutting down on capital expenditures. This RBI report on state government finances has a graphic which shows that states have consistently scaled back Capex.

Interesting also that India has the highest Capex decentralisation among a sample of countries. 

16. A not so flattering report card by the RBI on UDAY, the power sector reform initiative.

17. The heavily over-subscribed IPO of Bectors Food has drawn attention to the surprisingly under-reported story of Mrs Rajni Bector. She started her banking business in the seventies with an investment of Rs 300 and has now gone to raise Rs 541 Cr in the IPO. Sandeep Goyal writes,

By 1990, the business was clocking a respectable Rs 5 crore in turnover under the Cremica (cream-ka because of Mrs Bector’s lavish use of cream) brand she created in the 1980s. Business grew quickly to Rs 20 crore by the mid-1990s. But the big leap forward came with McDonald’s signing up Mrs Bector to bake the buns for their burgers in 1995. Today, Mrs Bector’s business, largely run by her sons, counts ITC, Mondelez, Hindustan Unilever, Big Bazaar, Spencer’s, Taj Group, Air India, Indian Railways, Barista, CafĂ© Coffee Day, Pizza Hut, Domino’s and Papa John’s as large institutional customers, besides a vast direct-to-customer sales network that retails breads, buns, biscuits, dips, spreads and sauces, and ice-creams under her own brand names... 12 per cent of all of India’s biscuit exports today come from her.

As Goyal writes, it is surprising that she's not received any recognition for her achievements.  

18. Finally, as this NAR report points to (HT: Ananth), the Covid 19 is a great window for some vaccine diplomacy by India to enhance its soft power.

Friday, December 25, 2020

More on the role of middlemen in development

I had blogged here earlier on the misleading obsession in development with eliminating middlemen.

In this post, I thought of drawing attention to two BREAD working papers which highlight the point that intermediaries perform an important role and efforts to completely eliminate them will only backfire. 

The first paper by Dilip Mookherjee et al examined the impact of a Bangladesh government decision in 2011 to ban financing intermediaries, Delivery Order Traders (DOTs), from the wholesale and retail market for edible oils on concerns that they were responsible for rising consumer prices since 2008. Their findings,

The standard model... predicts that the pass-though of oil price shocks to the downstream consumer price should have risen after the reform, owing to the de-concentration induced by elimination of an intermediate layer. As crude import prices were falling after the reform was implemented, a higher pass-through rate should have resulted in faster decline in downstream price of edible oil... However, we find that the regulatory effort to reduce market power of financing intermediaries ended up raising consumer prices by restricting access to credit of downstream traders... 
We discuss supplementary evidence consistent with the credit rationing hypothesis, based on case-studies, as well as data on aggregate crude import volumes which contracted sharply (at a time when import prices were falling). The lower passthrough and higher prices following the DOT ban capture the effects of higher interest rates on bank loans in the post-reform period in addition to the tighter credit constraints lowering the volume of oil trade. The wholesale traders faced substantially higher marginal costs which lowered the passthrough rate, and the tightening of credit constraints effectively lowered the price elasticity of the derived demand functions faced by upstream refiners, resulting in higher refiner markups. These disruptions overwhelmed whatever reductions in market concentration resulted from the elimination of the DOTs from the market.

It can be argued that this is a partial equilibrium reaction and if the markets are allowed to operate, the formal financial channels will replace the intermediaries. However, I am inclined to reject this. Even in a general equilibrium, the replacement of intermediaries is unlikely to happen due to challenges of credit worthiness assessment, natural of the financial transactions (instalments and receivables), the inconvenience and difficulty of accessing formal finance, the limited base of formal finance and so on.

In another paper, Mookherjee with another set of co-authors used a clever experimental design to compare the effectiveness of two different types of schemes to select local commission agents for an agricultural credit program in West Bengal. The objective of the program was to select local agents so as to leverage their specialised information and connections with local residents, while also avoiding pitfalls of elite capture. The agents recommended village households for individual liability loans design to finance cultivation of the local cash crops and potatoes, and received a commission 75% of the interest payments made by each borrower. 

In the Trade-Agent Intermediated Lending (TRAIL) scheme, the intermediary was randomly chosen from among private traders within the community with a track record of lending to, and selling and buying from farmers in the village. In the Gram Panchayat Agent Intermediated Lending (GRAIL) scheme, the agent was randomly selected from a list provided by the elected village council.  

The authors examined the relative impacts on farmer cultivation decisions, output and incomes, and the reasons for variations across the two groups. They found,

Given their experience lending and trading farm inputs and output within the community, the TRAIL agents may be better informed about borrowers’ farm productivity and reliability. They could also expect to earn middleman profits from trading the farmers’ output, and so may have chosen to direct credit and business advice to their most productive farmer-clients. GRAIL agents, on the other hand, would have likely acted in line with the priorities of their political party, for example, selecting poor beneficiaries to further their party’s pro-poor agenda. They may also have been motivated differently vis-a-vis their beneficiaries’ projects: they were unlikely to benefit directly if their borrowers had large harvests, and instead could have faced the blame if the borrowers’ projects failed and they fell into economic distress...

Our estimates show that TRAIL loans were more likely to be taken up than GRAIL loans. Among the loans taken up, repayment rates were a similarly high 93 percent in both schemes. In both schemes, beneficiaries borrowed more, cultivated more area and had larger potato harvests. However, potato profits and farm incomes only increased for beneficiaries in the TRAIL scheme (by 40 percent and 21 percent, respectively). This is because TRAIL farmers’ expansion of cultivation was accompanied by a reduction in unit production costs, whereas GRAIL farmers continued to produce at previous (high) costs per acre...

We... find that the TRAIL agent selected more productive farmers than the GRAIL agent did. And yet, this selection difference accounts for less than 10 percent of the TRAIL–GRAIL difference in the average treatment effects on farm income... our analysis indicates that most of the difference can be attributed to the TRAIL scheme generating larger treatment effects on farm income, conditional on farmer productivity. Specifically, our findings suggest that a beneficiary in the TRAIL scheme produced more output at significantly lower per-unit cost and earned larger profit, than a GRAIL beneficiary of the same productivity. Since the loan product and hence borrower incentives were identical in the two schemes, this suggests that the key difference was the borrower’s relationship with their agent...
Since TRAIL agents are also middlemen in the potato trade, they are motivated to increase their profits by helping their clients produce and sell more. In our model, they advise farmers on ways to lower unit costs of production, inducing them to cultivate more potatoes, and earn larger profits per kilogram. This advice is most effective for the most able farmers. On the other hand, the GRAIL agent is motivated by the objectives of the political party controlling the village council. His primary goal is to minimize loan defaults, and accordingly he may intensively monitor poor, less able borrowers and induce them undertake actions and expenditures that ensure crop success, but also lower expected profits. As a result GRAIL borrowers would incur higher costs than TRAIL borrower... the TRAIL agents... increased their interactions with treated farmers, and to a greater extent with more productive farmers. GRAIL agents also interacted more with treated farmers, but to a greater extent with less productive farmers; this appears to have caused them to default less than their TRAIL counterparts.

This summary highlighting the importance of intermediaries is important,

Our results indicate the importance of looking beyond the architecture of local networks, and incorporating the effects of policy treatments on relationships within the network. Our work also sheds light on the specific role that intermediaries play... this paper finds that selection differences explain very little of the difference in the outcomes of the TRAIL and GRAIL schemes; accordingly we focus on the role of interactions between the agent and farmers. Interestingly, the large profits that the traders earn as middlemen appear to be the precise reason why their incentives are aligned with increasing farmers’ output... The more general lesson is that the role of the intermediary was not confined to selecting beneficiaries and achieving better targeting. The differences in the nature of network connections with the intermediary mattered significantly for the eventual success of the program. In particular the endogenous change in this relationship resulting from the intervention accounts for most of the differences in impacts on beneficiary incomes. Policy interventions that employ local intermediaries could benefit from considering this mechanism at the time of intervention design.

The point is that intermediaries, for all their problems, are an important player in informal markets and social systems. Any policy that seeks to eliminate them, as against acknowledge, formalise, and regulate them, is likely to be counter productive.

Wednesday, December 23, 2020

Some facts on the London sewerage system

Alongside antibiotics, water closets and sewerage systems must sit as being the two biggest contributors to lowering deaths due to epidemics. This post briefly covers the 19th century sewer systems constructed in London and New York.

Fascinating lecture by Stephen Halliday on how the London's sewerage system was built within a decade from 1859 to 1868 (its major parts) under the leadership of Chief Engineer to the Metropolitan Board of Works (which was London's first metropolitan government), Sir Joseph Bazalgette. It cost £4.2 million to build and was triggered by the Great Stink of 1858, arising from the accumulated sewer on Thames, which drove members of Parliament out of the chambers of House of Commons. 

For a times ravaged by frequent eruptions of Cholera epidemics, which used to kill thousands, the sewer system was transformational. The Times wrote on March 16, 1891, on Bazalgette's obituary,

Of the great sewer that runs beneath Londoners know, as a rule, nothing, though the Registrar-General could tell them that its existence has already added twenty years to their chance of life.

London had no cholera since 1866, even as the disease continued to claim lives in other cities without such sewer.  

Carliss Lentz has this review of three books about the New York sewer system by Joanne Abel Goldman (and also Halliday's book on London) and the Channel Tunnel. 

Bazalgette was given taxing authority by the Parliament and given powers to borrow £3 million to complete his sewer system. He also adopted very strict quality audits of the new Portland cement and concrete used for the works. The New York system, again driven by the fear of epidemics, was modelled on London.

The Channel Tunnel consists of three 50 km long tunnels, one for each direction and a small service tunnel, and started in 1987 and carried its first trains by 1994. It was built by a consortium of five each of French and British firms. It was completely private financed. 

Monday, December 21, 2020

The discretion trade-off with public procurements

Public procurements face the classic problem of any principal-agent framework. Discretion that utilises the informational advantage of agents leads to efficient decision-making. But it also comes at the cost of abuse of the discretion by agents. Getting the trade-off right and allowing the right level of discretion is a big challenge. In bureaucracies where the risk aversion is high, it is generally the case that bureaucrats err on the side of limiting discretion.

This manifests egregiously in the form of the unqualified preference for least price auctions/tenders which, as I have blogged here and here in the context of decision paralysis within the Indian bureaucracy, leads to sub-optimal outcomes.

Francesco Decarolis, Raymond Fisman, Paolo Pinotti, and Silvia Vannutelli have an excellent paper which does an empirical examination of this problem using the example of infrastructure procurements in Italy and establishes several important insights. While most of these are widely known, it's perhaps the first time it has been established using rigorous evidence.

The authors use a unique and rich database on over 200,000 procurement tenders in Italy during the 2000-16 period covering civic buildings, and roads, bridges and highways. The database has information on whether firms that participated and won the tenders were under investigation for corruption and whether the administering officials were similarly being investigated for corruption charges. The size of the database allows the authors to examine several dimensions of contracting and discretion and come up with very robust results. 

They compare two broad categories of tenders, based on awarding process (open auction and negotiations) and selection criterion (lowest price or scoring rule). The so-called scoring rule (or quality based) auctions also involve (potentially subjective) non-price criteria in selecting a winner. On the firm characteristics based on corruption allegations and the level of discretion in the tenders, they find, 

We begin by examining the types of auctions that are most often won by investigated firms. We show that two auction arrangements are significantly more likely to lead to a contract being awarded to an investigated firm: first, so-called scoring rule auctions, which involve (potentially subjective) non-price criteria in selecting a winner, are 1 percentage point (6 percent) more likely to be won by investigated firms, relative to first-price (non- discretionary) auctions. Auctions that use “negotiated” procedures in which procurement officials invite bidders (rather than allow for open bidding) are no more likely to be won by firms investigated for corruption, relative to open auctions. However, when we look at the subset of negotiated auctions in which officials fail to invite the requisite number of bidders (which we take to be an indication of abuse of discretion), we find a 1.9 percentage point (11 percent) higher probability of an investigated winner. While more at risk of selecting investigated firms, we also find that scoring rule auctions are associated with lower cost overruns and higher award prices, while negotiated procedures are associated with lower delays and higher award prices... we interpret these features as an indication of improved contract execution.

They also looked at whether the choice of discretion is affected by whether the auction was administered by or associated with an individual flagged as suspected of corruption. They examined whether individual procurement officials prone to corruption and areas where suspected corruption is present (proxied by municipalities with at least one official accused of corruption) are more likely to select discretionary (corruptible) tenders.  

Our results show effects that go in opposite directions: public officials suspected of corruption are 2.9 percentage points more likely to use one of the two discretionary auction types we flag for concern (discretionary criteria or discretionary procedures with too few invited participants). By contrast, discretionary auctions are 1.9 percentage points less common in “corruption-suspected” municipalities.

Their summary is important,

In our context, greater discretion allows for more efficient implementation of government projects by well-informed and well-intentioned procurement officials, which must be traded off against the higher prob- ability of leakage by corrupt officials. If the choice of auction design is one of the primary means of oversight by a (non-corrupt) central monitor, then less discretion will be allowed in locales where the probability of corruption is higher. When possible, however, corrupt officials deploy discretion, to the benefit of corrupt firms.

They also look at two methods often used to contain corruption, rotation of procurement officers and tighter limits on subcontracting (seen as the main channel for funnelling public money into bribes and kickbacks), both of which also come with efficiency costs. They find that both these are more commonly used in "corruption-suspected" municipalities. 

The implied effect of suspected corruption on turnover is very large, with a 22 percent (6.82 percentage points) lower fraction of contracts managed by an average official in “corrupt” versus “non-corrupt” municipalities (and a nearly identical effect on the value of the con- tracts managed)... Indeed, we show a series of results indicating that firms investigated for corruption sub- contract more often and – conditional on subcontracting – they are more than 60 percent more likely to delegate subcontracts to other investigated firms and to award a larger share of all subcontracts to investigated firms. But subcontracting is also a tool for the efficient allocation of job tasks, especially for more complex projects. When inspecting regional procurement regulations on subcontracting rules, we find that regions in which corruption is less of a concern are more apt to loosen regulations on subcontracting, whereas regions where corruption is more of a concern implement tighter subcontracting rules.

They also show that government systems tend to err on the side of caution and impose excessively strict constraints on discretion by lower officials. They examined the consequence of a mid-2000s reform which loosened regulations governing negotiated tenders. 

Whereas such contracts could only be deployed for relatively small projects (under €300,000) in the early 2000s, by 2011 the limit had been raised to €1,000,000. This change, motivated by the government’s desire to stimulate the economy by reducing the procedural times to award public contracts, led to a massive increase in the share of auctions held via negotiated procedures, from 10 percent in 2006, to 60 percent by 2012. Yet the vast majority of these were conducted with the legally required number of bidders, and hence the loosening of rules had at most a very small effect on the fraction of contracts awarded to firms under investigation for corruption. And in locations in which officials might have exploited discretion, their use was relatively limited. Indeed, calculations based on our estimates imply a 0.05 percent increase in investigated winners overall between the periods before and after the increase of the threshold for using negotiated procedures. This appears to be a small cost when compared to improvements in contracting quality from discretion, such as a 14 percent reduction in delays.

This points to the scope for allowing greater discretion in procurements which is likely to be net welfare enhancing. 

The paper assumes significance in light of the Government of India considering amendments to the General Financial Rules (GFR), 2017 to shift away from the lowest-price auctions towards more quality (or scoring rule) based tenders. The paper offers a ringing endorsement for any such move. 

Saturday, December 19, 2020

Weekend reading links

1. Sidharath Kapur has a very good oped which raises important issues relating to solar power procurement in India. In a rapidly evolving market with sharply declining cost, the developers and buyers face significant risks. The early moving developers face the risk of being left with higher cost power sources which will struggle to find buyers. And buyers entering into long-term PPAs will be left with buyer's remorse of high cost power they would want to replace.

He proposes some alternatives,

One option could be the long term PPA is at a de-escalating tariff. The bidding can be at a base tariff x which de-escalates at say 3-5% a year. This would mean that the starting tariff as a headline number being bid may be higher but the levelised cost of tariff would be lower. While the starting tariff may be a bit higher it will improve long term sustainability of the PPA in a downward sloping cost of power. Indian lenders would also like it given they lend for 10-15 years. The PPA can also be structured in a way which permits part of the committed capacity to be installed and sold in the open market. A base committed volume on long term PPA provides comfort to lenders while the market saleability reduces mutual obligation to buy and sell on producer and off taker. This will also bring more power to exchanges and deepen the market. This option can be strengthened by a contract of difference with the off taker underwriting to meet shortfall in revenue coupled with clawback of excess revenue on market power sales. This would bring PPA tariff down in case market is offering higher and vice versa. A 70/30-PPA/Non PPA mix will only impact the off-taker by 9p/unit in case the market price varies by 30p up or down over a PPA tariff of say Rs 2.50.

Another option would be to change the bidding criteria. Instead of bidding on lowest tariff the option can be to bid for the lowest project cost to be recovered at a target project IRR. Operating costs are very low at 5-10% of the overall cost. A cap can be imposed on operating cost recovery as part of bid criteria to avoid gaming. Upon meeting target project IRR, the obligation on off taker to purchase power drops off. The developer is freed from the obligation to supply power and can sell power to the market. An interesting twist would be to have a twin bid criterion with appropriate weightage spread between lowest project cost and a stipulated range of lower target project IRR. This will theoretically result in a lowest cost of power based on project cost and target project IRR which will drop off once the latter is met. This should occur much before a 25-year PPA period. While this would entail annual computation of the recovered IRR, this should be a fairly easy arithmetical calculation. Going ahead this will bring to the market projects with recovered capital and thus can supply power to the market at extremely low cost given that only operating costs are to be recovered. 

This again highlights the impossibility of trying to write complete long-term contracts, especially in a rapidly evolving area like renewables generation. Some form of revisit of the contract, within pre-defined boundaries and terms should be part of all such contracts. 

Couple of graphics from Max Roser on the decline in solar prices. This about the levellized cost of energy, which captures the cost of building and operating plants with fuel costs,

And this about trends in the cost of electricity from various sources over the 2010-19 period

Another option in addition to the two suggested by Kapoor is to adopt a regulated tariff approach. Instead of a 30 year PPA, like with utility contracts under the RPI-X regulation, there should be a mechanism to periodically revise the rates downward (X) once every 5-7 years, based on the trends associated with tariffs of new plants coming on line. Even though fixed costs are incurred upfront, this type of contracting can provide greater discipline and align incentives towards developers taking a life-cycle returns perspective.  

2. John Mauldin points to the Washington Post graphic about how large businesses cornered a disproportionate share of the Paycheck Protection Program (PPP) loans in the US.

He points to the unique confluence of favourable factors facing large companies - they have inherent economies of scale advantage (amplified by network effects in case of digital markets), low-cost Fed financing, and weakened competition because so many smaller companies are struggling. This opens the window for 'monopoly rents'. 

3. From The Economist on the spectacular drop in coal-based power generation,

In Britain the share of electricity generated by coal fell from 40% in 2013 to 2% in the first half of this year; the country now burns less coal than it did when the first coal-fired power station was built in 1882. In the EU coal-fired power generation nearly halved between 2012 and 2019.

And the impact of China,

Asia is currently home to nearly 80% of coal consumption. Most of that—52% of the global total—takes place in one country: China. India, Asia’s second-biggest market, consumes less than a quarter as much. The growth in China’s coal-fired generating capacity between 2000 and 2012 helped reshape the global economy and drive a 200% increase in Chinese GDP per person. It also nearly tripled the country’s carbon-dioxide emissions, making it the largest emitter in the world. Its effects on air quality hastened millions of deaths... Yet coal-plant construction shot up in 2019. And in the first five and a half months of 2020 provincial governments, keen to boost employment and economic growth, gave companies permission to add a further 17 GW of new coal capacity... Chinese-financed coal plants in other countries are on course to add 74 GW of coal capacity between 2000 and 2033, according to Kevin Gallagher and his colleagues at Boston University.

This about the country's cost curve for various energy sources

4. From Businessline on PSU dividends, value capture or asset stripping?

Over the years, PSUs have been among the Centre’s major benefactors, contributing a significant portion of non-tax revenue in the form of dividend payouts. Between FY15 and FY19, they collectively paid ₹2.04-lakh crore in the form of dividend and other investments. Of this, mega PSUs (Maharatnas and Navaratnas) alone contributed over ₹1.66-lakh crore, or 82 per cent of the total.

And from Business Standard,

Over the past five years, a sample of 55 listed PSUs in aggregate paid over 70 per cent of their profits as dividend. The pay-out ratio for PSUs was more than twice that of Nifty50 firms.

5. On intergenerational mobility in India from Mathieu Ferry,

See also this paper. 

6. Harish Damodaran points to Punjab farmers being stuck in a middle income trap.

The average monthly income of agricultural households, according to the NABARD’s All-India Rural Financial Survey in 2016-17, was the highest in Punjab. At Rs 23,133, it was more than 2.5 times the national average of Rs 8,931 and ahead of Haryana (Rs 18,496) and Kerala (16,927), with Uttar Pradesh (Rs 6,668) and Bihar (Rs 7,175) far behind.

6. Sunita Narain's article on how widespread adulteration by large companies of honey with imported (and FSSAI test beating) Chinese sugar syrups was detected. 

7. Rana Kapoor should be the next in the Netflix series on Bad Boy Billionaires. 

8. Disturbing story about Big Tech spending large money in lobbying European legislators, raising fears of Washingtonization of Brussels. 

Meanwhile Rana Faroohar thinks that with the anti-trust action initiated against Facebook for buying WhatsApp and Instagram, the regulators in the US may have finally come to appreciate the dangers of network effects and resultant monopolies.

See also this by Jayati Ghosh.

9. On the Indian economy, Jahangir Aziz makes the point about demand destruction during Covid and the challenges it poses to recovery. This is an important point

If the level of GDP was 100 in 1Q, then it fell to 75 in 2Q and recovered to about 92 last quarter, it is still about 8 per cent lower than the level in 1Q20. In fact, we expect GDP growth in FY22 to recover to 12 per cent from -9 per cent in FY21, which implies that six quarters from now it will still be about 7 per cent below the pre-pandemic path, or roughly $300-billion-a-year of income losses across two years, compared to the pre-pandemic path. Imagine the havoc this can wreak to household and SME balance sheets, to income inequality, to poverty, and to women’s employment, since much of the economic shock has been borne by services, where female employment is much higher than in manufacturing.

Mahesh Vyas on the problems faced by women in the labour market

Although the labour force participation rate (LFPR) for women is very low, at less than 11 per cent compared to 71 per cent for men, they face a much higher unemployment rate of 17 per cent compared to 6 per cent for men. The much fewer women who seek work find it much harder to find work compared to men... Women accounted for 10.7 per cent of the workforce in 2019-20, but they suffered 13.9 per cent of the job losses in April 2020, the first month of the lockdown shock. By November 2020, men recovered most of their lost jobs, but women were less fortunate: 49 per cent of the job losses by November were of women. The recovery has benefited all, but it benefited women less than it did men.

He points to LFPR for urban women in 2019-20 being 9.7% as against 11.3% for rural women. A reason,

Given that men continue to be considered as the principal earning member of a household, women are unlikely to accept poor quality jobs. Household incomes have risen to a point where employment for women as a second earning member of a typical household is not as much of a necessity as it is a choice. Such a choice will be exercised only if the job on offer is of good quality without punishing working conditions or prohibitive transaction costs. But, good jobs are on the decline.

The Urban LFPR has fallen to 6.9% in November 2020. The article has some very interesting, and disturbing, trends on female LFPR.

10. A review of the new guidelines issued by Government of India on ride hailing services. State governments to make their respective regulations based on this.

11. AK Bhattacharya on India's problem of very high share of unrealised direct tax revenues,

The disputed amount under this head (direct tax raised but not realised) doubled to Rs 8 trillion at the end of March 2019, compared to Rs 4 trillion at the end of March 2014. In other words, the share of unrealised direct tax revenue in total direct taxes collected went up sharply from 64 per cent in 2013-14 to 71 per cent in 2018-19... These disputes have remained unresolved for a long period of time— from more than a year to about 10 years... The problem arose in the last five years of the Manmohan Singh government. The total amount of direct tax arrears because of disputes was just about Rs 54,000 crore in 2008-09, or 16 per cent of total direct tax collections that year. In the following five years, the arrears kept mounting and ended up at as high a level as 64 per cent of total direct tax collections of Rs 6.38 trillion in 2013-14.

12. The latest round of NFHS-5 survey results point to a stagnation and even decline in child nutrition levels measured in terms of proportion of underweight children and stunting. This is just one more signature of the increasingly evident problems with India's economic growth model. Unlike the East Asian economies, where growth was accompanied with dramatic improvements in human development indicators, India's does not seem to be doing so. The survey found that at least one aspect of child undernutrition - underweight, wasting, stunting - had gone up in 14 out of 17 states.

There are two particular disturbing features. One, it is not that the pace of improvement in human development indicators has decline, but they are reversing. Second, India's low baseline should have meant that these indicators should be improving at rapid pace. 

The survey's funding of increase in overweight children points to the importance of making the distinction between hunger and nutrition. While the former may be getting addressed, it is the later that is the concern. It appears that family incomes are not keeping pace with being able to afford basic nutritional food items like pulses, eggs, vegetables, fruits, and meat. It all then boils down to incomes. 

This is a vicious circle. The long-term consequences of these in terms of being able to support broad-based economic growth is deeply disturbing. 

13. New SEBI regulations opens the door for the likes of fintech companies to become asset management companies (AMCs) and offer mutual funds. In this context, it's important to keep in mind that fintech companies' expertise is on the transactions side (accessing customers and managing transactions), which is only a small and secondary part of the AMC's core activity of investing and managing the funds raised from its investors. Fintechs have no expertise whatsoever on the latter.

14. DK Srivastava analyses the budget prospects for the coming years and argues for favouring capital expenditure. His assessment of the gross tax revenues of the centre for 2020-21 to be Rs 17.2 trillion, exactly the same as that in 2016-17!

15. From a PRS report on state budgets,

During the period 2012-20, Centre’s cess and surcharge revenue nearly doubled from 0.9% of GDP to 1.7% of GDP. In comparison, GTR declined from 10.4% of GDP in 2012-13 to 9.9% of GDP in 2019-20.

16. Finally, an excellent graphical story highlighting how Delhi's air pollution differentially affects the rich and poor children.

Friday, December 18, 2020

More on the evidence-generation industry in development economics

Lant Pritchett points to the example of this RCT which shows that "reducing proximity to schools increases enrollment for boys and girls, increased enrollment leads to increased learning and the effect was differentially larger for girls" and describes such evidence generation as "feigned ignorance". 

I have blogged here and here about a big problem with academic research and the evidence-based policy making movement in international development. One of marginalisation of priors and the emergence of evidence as an ideology.

Development tourists fly-in, observe a problem, imagine/invent a solution (read this), then try to generate evidence for the same so as to attract funders and scale the solution. Never mind, no such invention has ever reached scale.

As if not happy with such success, there is new direction of emerging research. Again the same tourists find something intriguing (sometimes it is stuff which is commonplace in their own countries, like this), formulate a theory of change or hypothesis, try to generate evidence to attract funding for scale-up. Never mind that the natives have been using the same for centuries or decades, and nobody there seriously dispute the hypothesis.

Both are held-up as examples of evidence-based policy making. It begs the question. Evidence for whom? And for what purpose? And the answers appear to be - for the outsider, and for research publication.  Or to meet the bureaucratic requirements (what is the evidence?) of the donor. Not for those living with the problem or the solution, nor for those practitioner trying to address the problem or scale-up the solution.

One exhibit, forwarded by a friend, is this paper which discovers that threat of disconnections of utility services is effective in enforcing bill payments, and that it is superior to soft-encouragement that merely informs tenants about their delinquency.
Public utilities afraid that service disconnections will have political consequences are reluctant to enforce payment with service cutoff. We test this hypothesis using a field experiment in the slums of Nairobi with two interventions intended to improve repayment for water and sewage services: a soft encouragement that informs tenants about landlord’s payment delinquency and, second, a hard threat of disconnection for nonpayment with enforcement if landlords do not pay. While we find no effect of the soft encouragement intervention, we find very large effects of the disconnection intervention on repayment. Moreover, there seems to be no effect on landlord and tenant perceptions of utility fairness or quality of service delivery, on community activism, on the relationships of tenants with their landlords, or on child health... These results suggest that strict enforcement through disconnections increases payment and the financial position of the utility without incurring political costs.
Did the effectiveness of disconnections and its superiority to soft encouragement really require any evidence at all? Also, can any experiment, howsoever rigorous, convince any practitioner that disconnections don't bring political costs? Leave aside the ethical concerns with "studying" disconnections. 

Another exhibit is this paper on footbridges. What was the need to evaluate the value of footbridges in remote areas? 

Sample these revelations,
Floods decrease labor market income by 18 percent when no bridge is present. Bridges eliminate this effect. The indirect effects on labor market choice, farm investment and profit, and savings are quantitatively important and consistent with the predictions of a general equilibrium model in which farm investment is risky and the labor market can be used to smooth shocks. Improved rural labor market integration increases rural incomes not just through higher wages, but also through these quantitatively important indirect channels.
If you go to the remote interiors anywhere in the world which has a forested terrain and is criss-crossed by rivulets and streams, one of the primary demands of villagers living in isolated small habitations are footbridges to cross the streams. In rainy seasons, when the streams are full, the villages get cut-off from the outside world for weeks/months, and the villagers suffer badly. 

Did we need evidence to show that footbridges are a useful thing? Is qualitative evidence (or self-evident realities) about the suffering of the people not enough to make the case for footbridges, and there is a need for a rigorous quasi-experimental study on labour incomes? Do we need evidence to show that "farm investment is risky and the labor market can be used to smooth shocks"? Or that rural market integration has "indirect channel effects"?

Isn't this all so plain obvious? Clearly not for the two development tourists who were the PIs in this paper.

It is the same naivety or self-centredness that drives people into wanting to test the efficacy of public spending on rural roads and rural electrification! Imagine if Eisenhower had researchers using the logic of value for money (from partial equilibrium analysis) to question building inter-state highway system (as against spending on welfare or even local roads).

Like someone from developing country demanding rigorous evidence to be convinced that Londoners, including the well-off, use public transport, or use bicycles, or normally buy breakfast from Prets (and not make at home).

In case of the footbridges paper, I guess the methodological neatness arising from the naturally available dataset explains the Econometrica publication. But its natural extension to the serious pursuit of international development is a travesty. 

Thursday, December 17, 2020

India state capability fact of the day - RBI edition

From Rakesh Mohan, on the RBI,

It is surprising that as the financial sector has grown in both complexity and size over the last 10 years, the strength of RBI professional staff has actually reduced by a third from around 9,400 in 2009 to 6,670 in 2019. Of these, about 1,300 or so are entrusted with banking regulation and supervision. In comparison, the US Federal Reserve has around 22,000 professional staff, which are in addition to the many other financial regulators that exist in the United States. It is not surprising then that the financial sector has been subject to various regulatory and supervision failures in the last few years.

Tuesday, December 15, 2020

Kinky development - impact investing edition

Lant Pritchett has written about kinky-development, which involves focusing on solutions which are marginal to addressing important development challenges. See also this

Sample another example of kinky development from Jacqueline Novogratz, the founder of Acumen, 

Take chocolate. It's a hundred-billion-dollar industry dependent on the labor of about five million smallholder farming families who receive only a tiny fraction of that 100 billion. In fact, 90 percent of them make under two dollars a day. But there's a generation of new entrepreneurs that is trying to change that. They start by understanding the production costs of the farmers. They agree to a price that allows the farmers to actually earn income in a way that will sustain their lives. Sometimes including revenue-share and ownership models, building a community of trust. Now are these companies as profitable as those that focus solely on shareholder value? Possibly not in the short term. But these entrepreneurs are focused on solving problems. They're tired of easy slogans like "doing well by doing good." They know they have to be financially sustainable, and they are insisting on including the poor and the vulnerable in their definition of success.

Let's try to understand the problem. I have a graphic here (and here) which decomposes the distribution of income shares in the $100 bn chocolate industry along the value chain. 

Farmers get just 6.6% of the value of chocolate sold. Processors, manufacturers and retailers, all based outside of Africa, capture nearly 90% of the value. Whatever impact investors and entrepreneurs do in terms of "revenue-share and ownership models", in the absence of local manufacturing (or even processing), any incremental gains are tiny. And local manufacturing demands large capital investments, which require the mainstream capitalism of the big multinational companies. 

The publicity and feel-good factors associated with the efforts of impact investors and young western entrepreneurs (the Novogratz video is a great example) detracts attention from the more serious issues of development - structural transformations, persistent unfavourable agricultural terms of trade, grossly disproportionate value capture by western companies, and so on. These efforts end up giving the impression that a lot is being done to address the problem of poverty in Africa.

In fact, when Ivory Coast and Ghana (which make up 60% of global production) decided to add a $400 per tonne "living income differential" (LID) to the price of cocoa harvested this year, "the US Group Hershey took the rare set of sourcing cocoa beans from the futures market in New York", instead of traders sourcing it from the two countries, so as to avoid the LID. The same Hershey conducts high publicity sustainability programs in these countries on issues like deforestation and child labour, in partnership with international NGOs. Compared to the higher cost LID, these programs are low cost and gives the likes of Hershey an after-glow of responsible corporate citizenry. 

The Ivorian and Ghanian governments did the right thing by cancelling these initiatives of the big companies. The irony cannot be missed,

By cancelling the initiatives, they wanted to hold more cards “when we sit down and solve this big problem: why do countries who produce 60 per cent of a commodity have no real power in setting its price?” But ultimately, said a Ghanaian official speaking on condition of anonymity: “Your negotiating position is not that strong, so you’re entirely dependent on public sentiment, environmental sustainability concerns, child labour concerns, income inequality concerns, to make the other party feel a little guilty so they contribute more.”

In the end Hersheys agreed to give the surcharge. 

In these contexts, the local investor who can invest in building a local processing, much less manufacturing, facility, creating productive jobs and an associated eco-system, retain profits in the country and pay local taxes is the biggest impact investor of them all! The likes of which Ms Novogratz points to are merely virtue signalling and distracting attention. 

On similar lines, I am inclined to argue that efforts like Fairtrade, while certainly laudable in drawing attention to a problem, may actually have done more long-term harm than good. It may have had the effect of avoiding addressing fundamental inequities in the commodities market and global trade, and more proactive measures to support private investments in Africa.

As I blogged earlier here, I cannot imagine impact investing (as it stands, with its venture capital based approach) contributing in any significant manner to addressing serious and persistent development challenges and poverty alleviation. 

Monday, December 14, 2020

The scramble in debt markets

It is now widely acknowledged that the pandemic has unleashed a global debt "tsunami"
The total level of global indebtedness has increased by $15tn this year, leaving it on track to exceed $277tn in 2020, said the IIF, which represents financial institutions. It expects total debt to reach 365 per cent of global gross domestic product by the end of the year, surging from 320 per cent at the end of 2019. Debt burdens are especially onerous in emerging markets, having risen by 26 percentage points so far this year to approach 250 per cent of GDP, the IIF said. The share of EM governments’ revenues spent on repayments has also risen sharply this year, according to IIF data. This week Zambia became the sixth developing country to default or restructure debts in 2020. More defaults are expected as the cost of the pandemic mounts... Debts in advanced economies rose by more than 50 percentage points this year to hit 432 per cent of GDP by the end of September. The US accounted for nearly half of this; its debts are set to reach $80tn this year, from $71tn at the end of 2019.

This is only the latest in the series of triggers over the last three decades which have resulted in a steady rise in global indebtedness. 

Morgan Housel writes about how the Fed's actions since the GFC have upended conventional wisdom among investors,
The Federal Reserve learned how to keep the financial system from falling apart. That’s both kept a lot of the economy humming and ruined a lot of assumptions people had about how the economy works... In 2008 Bernanke, as Fed chairman, flooded the financial system with an unprecedented amount of liquidity. It worked, which is why we call 2008 the Great Recession and not the Second Great Depression. It also paved the way for Bernanke’s successors to open the monetary floodgates when the economy tumbles... people have a new set of expectations about what the Fed can and should do... a lot of what we thought we know about what economies do during recessions has been upended.
I would only qualify everywhere with "appeared to have been upended", atleast for some time. How much longer will the appearance persist is the point. 

Finance 101 teaches us about the disciplining powers of debt. Equity holders feel that the need to service debts incentivises effective management by executives. Lenders too are comforted by the legal structure that protects their interests.

But over the years, these assumptions have come under attack, thereby weakening debt's disciplining powers.

Consider some. One, the binary between equity and debt has been replaced by a continuum of cash waterfall, from equity to the junior most debt, with everything in between being some or other form of debt. Not only is this waterfall complex, with a bewildering array of complicated and opaque conditions behind the priorities, the seniority preferences also change with time.

Second, banks and bond markets are no longer the only providers of debt, with banks in particular having receded due to increased post-crisis regulatory oversight. Private debt is occupying an increasing share of the debt market. They jostle for space in the continuum between equity and senior most debt. They do not have legal protections that have historically been a feature of debt. The share of covenant lite loans are at historic highs.

Third, the persistence of abundant cheap capital, complex financial engineering, and emergence of private debt providers have made it easier for firms to leverage up excessively. Policies like tax deduction on interest expenses too favour leverage. Unsurprisingly, the shares of leveraged loans and aggregate leverage are at historic levels. The share of zombie companies too have reached alarming levels.

Four, amplifying all these distortions and creating more are the actions of central banks to keep rates at zero bound for an extended period of time and backstop the equity and debt markets, including through outright purchases of sovereign and corporate bonds.

One manifestation of the problems associated with these trends is being played out in the private equity market. As the share of private debt has grown in a market unrestrained by any regulatory restraints, private equity firms are suddenly finding that they are at the receiving end of practices that they used to inflict on others. The FT has an article which chronicles them,
Reaching for new funds to see it through the pandemic, mattress company Serta Simmons Bedding took $200m in new loans from a slim majority of creditors who, in addition to putting in the fresh money, saw their existing loans move up in seniority in the capital structure. Holders of the other 49 per cent of Serta’s loans, including Apollo, effectively had their claim on the company’s assets become subordinated to the favoured debtholders. Apollo sued, alongside other disgruntled creditors including Angelo Gordon and Gamut Capital. In a tart response, Serta, owned by private equity group Advent International, noted that the claimants had “sponsored and participated in numerous transactions structured similarly to this transaction”. A New York judge denied Apollo’s attempt to halt the deal.
Private equity funds are realising that payback happens in unexpected forms, and everyone is in the same boat,
In the Caesars case, for example, where Elliott Management, founded by ex-lawyer Paul Singer, owned $1bn worth of debt, had filed a lawsuit accusing the Caesars’ co-owner, Apollo, of “unimaginably brazen corporate looting” for selling casinos that creditors including Elliott believed had belonged to them. (Elliott eventually settled with Caesars and Apollo)... Elliott... now finds itself in the crosshairs of credit hedge funds that bought one of its portfolio company’s debt. Travelport, a booking software company acquired by Evergreen and Siris Capital, has been accused by existing lenders of “asset stripping” after it secured $500m in debt financing from its two owners to ease a liquidity crunch, in a deal that moved intellectual property collateral away from other creditors. Travelport selected the Elliott/Siris financing over a proposal from existing creditors including Blackstone’s credit arm, GSO, and, in the face of grumbling from the aggrieved side, Elliott has asked a New York state court to affirm that the transaction is proper. Ironically, Blackstone had previously owned Travelport, taking money out of the company in 2007 through a dividend recapitalisation that sparked a clash with bondholders in 2011.
The GFC led to tightening of regulations on banks, which insulated them from certain damaging trends in the debt market. The non-bank and alternative capital debt markets have in turn risen to take the place of banks. But as the size of private debt market has grown and its systemic effects more evident, questions are being raised about the need for its greater regulation. In a world economy where balance sheets of corporates and financial institutions are both overladen with debt, troubles in any part of the credit market can generate an amplified response.

A BIS study found that even something more regulated like the corporate bond markets, with its innate illiquidity, can freeze up suddenly, as happened in early March this year. This, as the FT writes, can have consequences across the markets,
“Issuance in primary markets stopped, mutual funds saw sizeable outflows, and secondary market yield spreads to government securities widened very rapidly,” the BIS says... Worse, the ETF market went haywire — seemingly confirming the fears. Most notably, in early March, the price of ETFs collapsed so dramatically that the funds lost their link to the prices of the underlying corporate bonds. Some traded at a 5 per cent discount to the value of their underlying assets, in the most extreme moments of dislocation. That seemed utterly bizarre at the time. However, analysts have subsequently re-examined events with cool heads and two curious points emerge. These are that ETF price swings preceded other market moves, albeit in a more extreme way. Plus, this volatility did not occur because trading dried up; on the contrary, daily ETF trading volumes exploded, running 250 per cent higher than before the crisis, and investor redemptions were very modest in March compared with other asset classes. Thus, it seems that investors reacted to the corporate bond market freeze by using ETFs to hedge risks, conduct price discovery and dump exposures they disliked. ETFs were thus an investor crutch, not a market block.

Saturday, December 12, 2020

Weekend reading links

1. Ashok Gulati has a good article putting in perspective Punjab's agriculture. The state's typical farming household receives Rs 1.22 lakh per farmer as subsidy in 2019-20, the highest in the country. But in terms of agriculture GDP per hectare of gross cropped area, the state came out only 11th ranked. The concentration on wheat and paddy is clearly the reason and points to the need for crop diversification to sustain farm incomes.

2. Debashis Basu writes about the proposal on allowing corporate houses into banking. The real issue is one of regulation, specifically the capacity to regulate effectively also given the political economy issues. The mainstream criticism appears influenced by the worry that the likes of Ambani or Adani will be one of the licencees, and the likelihood of regulating them meaningfully. 

3. Discom dues mount by 29% to Rs 1.38 trillion by end-October 2020. Granted Covid has been a major contributor, but this is in line with a long-term trend. This problem continues to elude solutions. 

The fundamental problem is that discoms are unable to recover costs and the state governments unable to reimburse the subsidy incurred. So gencos and discoms assume debts, mostly from banks and from REC/PFC. The only meaningful way to address the problem is to take the long-route to change and squeeze credit supply. 

4. On India's solar manufacturing,

Almost 75 per cent of India’s solar power capacity is built on Chinese solar cells, which is a component of a solar panel) and modules (the entire panel). India’s solar cell manufacturing capacity stands at 3 Gw and for modules it is 5 Gw, whereas the country’s solar power generation capacity stands at 32 Gw... It is no exaggeration that Chinese solar cells and modules have been instrumental in the growth of Indian solar power generation. Chinese solar equipment imports jumped nearly six times in 2013-14 when tenders for solar power projects were gathering momentum in India... Analyst reports show that China has reduced the benchmark price of solar photovoltaic panels by more than half to a global low of $0.15-0.20 per kwh in the past eight months.

India may have lost a manufacturing industrial policy opportunity with panels and modules. Industry argues in favour of higher tariff barriers - basic customs duty (BCD), safeguard duty, and anti-dumping duty for a few years, and treatment of manufacturers in SEZs on part with domestic companies (63% of cell and 43% of module makers are in SEZs, who also get levied duties imposed on imports). They also feel the Rs 4500 Cr PLI allocation for solar PV modules is inadequate.

5. From FT here a graphic on the status of foreign fast food retailers in India. 

The numbers of KFC, McDonald's and Subway outlets in India should serve as a note of caution. After nearly two decades, their numbers are surprisingly small. One more signature that raises questions about the size of the middle class.

6. It's a testament to the times that people with extremely dubious track records manage to raise billions for their companies. Latest exhibit is electric truck manufacturer Nikola and Trevor Milton. Milton has a long history of "overstating technology and lying to customers", both central allegations against him in the context of Nikola. 

It's stunning that the army of advisers who conducted due-diligence on the company could have missed the problems raised in the linked FT article. It also raises questions about the Special Purpose Acquisition Companies (SPAC) route that Nikola took to list instead of the more rigorous IPO route. 

The company which once had a valuation of $30 bn, greater than Ford, has never manufactured a truck and is expected to do so only by late 2021, if at all.

7. A silver lining in the dismal economic scenario is the performance of India's corporates. Many of them appear to have used the opportunity presented by the problems of the last decade to deleverage, cut costs, and focus on their core competencies. This is great news going forward for corporate India. 

This trend has accompanied pervasive economic weaknesses induced by various negative shocks, whose adverse impact appear to have been borne by the informal sector and the not so well-off. 

It also raises the intriguing possibility of a new version of the India-Bharat divergence. This time, a formal India which races ahead, and an informal India which suffers and falls behind. It has implications on inequality, broad-based sustainable growth, and socio-economic stability.

8. Jean Dreze proposes an urban employment guarantee program. It's about issuing job stamps at minimum wage which can be distributed to urban poor and used by various government institutions for small works they need to undertake in routine course. 

9. The staggering rise of Adani Green stock, growing 40 fold since June 2018 to reach a capitalisation of $23 bn! Besides it's one of the most illiquid stocks with not even one analyst rating.

10. India has emerged as a top destination for SWFs, surging ahead of China,

According to data by New York-based Global SWF, which tracks over 400 sovereign wealth funds, in the year 2020 to date, these funds deployed capital worth a record $14.8 billion in India, which is nearly three times more than what they have put in China ($4.5 billion). The gap between the capital deployed in the two countries widened this year, but the trend started in 2019, when sovereign wealth funds invested $10.1 billion in India, surpassing the $6.4 billion it did in China. This is a far cry from the period between 2015 to 2018, when China was way ahead in the game and sovereign funds invested a total of $46 billion in that country. In contrast, they invested only $24.6 billion in India over the same period... According to VCCEdge, in 2020 to date, top west Asian sovereign funds, including Abu Dhabi Investment Authority (ADIA), Public Investment Fund (PIF), Mubadala Investment Company, Kuwait Investment Authority and Investment Corporation of Dubai and Qatar Investment Authority, together put in $ 7.38 billion in 14 deals in India. These accounted for more than 20 per cent of all private equity investments in the country. In 2019 the same big boys had put in a mere $0.98 billion in 10 deals, accounting for less than 3 per cent of all PE money. However, the story is different when it comes to Singapore’s sovereign funds such as Temasek and GIC. They reduced their exposure to India, and invested $1.6 billion in 16 deals — a drop of 30 per cent compared to 2019, when they had invested $2.1 billion in the country.

11. A Business Standard editorial expresses concern at the large corporate bond issuance of over Rs 8 trillion this year on the back of low interest rates and high liquidity. It feels that policy is encouraging this releveraging which could become unstuck when rates rise.

12. In its efforts to combat the growing Chinese aggressiveness, the Australian federal government has been taking several steps in recent times. The NAR writes,

On Tuesday, parliament passed a law that empowers the foreign minister to scrap agreements between foreign countries and Australia's local governments or universities that are deemed detrimental to national foreign policy. About 130 agreements could potentially be affected by the law, 48 of which are with China, Australian media report. Under Australia's federal system, each state has the authority make its own rules on such issues as education, property management and the environment. Local governments also tend to handle cultural exchanges with foreign entities, like sister-city agreements... The legislation was drafted partly in response to a contentious memorandum of understanding signed by the state of Victoria in October 2018 in support of China's Belt and Road infrastructure-building initiative... Parliament followed up by passing legislation Wednesday requiring all foreign acquisition of land or businesses that could affect the country's national interest to be screened first by the Federal Investment Review Board. Previously, deals valued at 275 million Australian dollars ($205 million) or less were exempt from review. The change was likely intended to hinder Chinese investments in ports and other important infrastructure.
13. The Economist points to an analysis of 910,000 journal articles from 1990-2019 in EconLit which generated this graphic of which countries were the focus of economics research,
14. Even as economies struggle, businesses have been undertaking a record equity raising spree on the back of booming stock markets. Globally, a record $800 bn of equity has been raised by non-financial firms in 2020. 
Besides, companies are sitting on large cash surpluses, with the world's 3000 most valuable listed non-financial firms holding $7.6 trillion, up from $5.7 trillion last year. 
15. Finally, James Kynge and Jonathan Wheatley point to a new study by Boston University researchers which highlight the rise and fall of China's Belt and Road Initiative (BRI) projects. They examined the 858 BRI projects and found that lending by China Development Bank and the Exim Bank of China, the two banks which function as arms of state and form the overwhelming majority of China's overseas lending, fell from a peak of $75 bn in 2016 to just $4 bn in 2019. Such sharp decline in overseas infrastructure funding constitutes a massive blow in the world of development finance. 

The pullback from BRI appears to be driven by two factors. One, the borrowers have struggled to repay the loans, necessitating restructuring and political backlash within borrowing countries. As an example, even as China lend $40 bn between 2007 and 2017 to Venezuela. Now China is struggling with rival creditors to recover its loans from Venezuela's pile of over $150 bn of defaulted debt. Two, within China too, as part of the dual circulation policy, itself motivated by growing disputes with the external world, the government has sought to focus more on internal development and scale back external engagement. 
Between 2008 and 2019, the two Chinese banks lent $462bn, just short of the $467bn extended by the World Bank, according to the Boston University data. In some years, lending by the Chinese policy banks was almost equivalent to that by all six of the world’s multilateral financial institutions — which along with the World Bank include the Asian Development Bank, the Inter-American Development Bank, the European Investment Bank, the European Bank for Reconstruction and Development and the African Development Bank — put together... A report by Rhodium Group, a consultancy, says at least 18 processes of debt renegotiation with China have taken place in 2020 and 12 countries were still in talks with Beijing as of the end of September, covering $28bn in Chinese loans.

The fate of BRI was known well in advance, and the emerging evidence only validates the same. One more in the list of Bad Emperor failings that Xi Jinping is rapidly accumulating.