Saturday, February 27, 2021

Weekend reading links

1. Tamal Bandopadhyay describes the PMC Bank scam,

The bank had lent close to 75 per cent of its loan book — around Rs 6,500 crore — to just one entity: Real estate firm HDIL. PMC’s former managing director, along with six key officials, including a few board members and chairman Waryam Singh, sanctioned these loans which were not captured by the bank’s system. The gang of seven — now behind bars — had created 21,049 fictitious accounts to ensure that the balance sheet would reflect the loan disbursed to HDIL group companies without revealing their identities. The money borrowed from PMC Bank through 44 loan accounts was used to settle loans taken from other banks by HDIL.

2. C Rajamohan writes on the role of semiconductor manufacturing in the strategic importance of Taiwan. TSMC has more than 55% share of the global market for high-end custom made chips. 

3. Business Standard reports that Government of India is studying various models for establishing a company to monetise vacant government lands. It reports of the model of Canada Lands Company, established in 1956 as a self-financing federal government corporation to ensure orderly disposition of selected surplus properties with best value. 

When the body was set up, government departments were incentivised to dispose of their holdings with no immediate benefits, paving the way for private sector to make a better use of such assets. It also maintains ownership or management of certain properties, which benefit from government presence such as the tourist attraction destinations, the famous one managed by the company being Canada’s National Tower. The company also purchases strategic surplus properties at fair market value and then improves, manages or sells them for the benefit of local communities and its shareholder — the Canadian government. Since 1995, the company has developed nearly 2,000 affordable housing units and 12 school sites, among others.

4. The 15th Finance Commission has made 57% of its grants conditional of certain requirements, relative to just 17% for the Fourteenth Finance Commission.

5. Copper prices breach $9000 a tonne mark for the first time since 2011 on the back of speculative bets on higher prices in China. The market faces a significant supply deficit as production fails to keep pace with rising demand in China. 

This is also part of a broad-based shift upwards in commodities prices. Nickel rose above $20000 a tonne for the first time since 2014 and iron ore traded above $175 a tonne and close to a 10-year high.

6. Paul Krugman on how excessive deregulation brought about the recent collapse of the Texas power grid.

It has, however, pushed deregulation further than anyone else. There is an upper limit on wholesale electricity prices, but it’s stratospherically high. And there is essentially no prudential regulation — no requirements that utilities maintain reserve capacity or invest in things like insulation to limit the effects of extreme weather. The theory was that no such regulation was necessary, because the magic of the market would take care of everything. After all, a surge in demand or a disruption of supply — both of which happened in the deep freeze — will lead to high prices, and hence to big profits for any power supplier that manages to keep operating. So there should be incentives to invest in robust systems, precisely to take advantage of events like those Texas just experienced.

7. NYT points to latest study by BLS on labour market trends in the aftermath of Covid 19 pandemic.

The 10 occupations with the biggest increase in projected employment relative to the baseline projection are all in medical, health-science and technology fields. The 10 occupations with the largest declines relative to the baseline projection include restaurant, hotel and transportation job... The decline in projected employment growth because of the pandemic is almost entirely concentrated in jobs requiring only a high school diploma or no diploma.

One more data point about how labour market trends are adversely impacting the poor and less qualified, thereby widening inequality. 

8. Nice graphic about the rise of digital advertising and the complementary decline in print advertising in the US.
Underlining the rise of digital advertising, this oped writes,
... for every Australian $100 of online advertising spend, A$53 goes to Google, A$28 to Facebook. The remaining A$19 is what all other media companies get. The figures may vary but across the world this duopoly dominates digital advertising. It accounts for over 52 per cent of all digital advertising in the US. In India, Google and Facebook walked away with over 70 per cent of the Rs 22,100 crore advertisers spent online in 2019. A bulk of what readers search and read is legacy brands.

9. Q3 2020-21 Indian corporate results point to a healthy recovery and significant improvements in the financial health of corporates,

Year-on-year (Y-o-Y) comparisons with Q3 of 2019-20 (October-December 2019) show low expansion in net sales alongside higher profits. A study of 2,814 listed companies (with a minimum of Rs 1 crore in net sales) shows a 2.2 per cent rise in sales Y-o-Y at Rs 25.46 trillion, a 15.25 per cent rise in operating profit, and a 62 per cent rise in profit after tax (PAT). Removing volatile sectors such as banks, refineries, and non-banking financial companies, the remaining 2,495 companies have registered sales growth of 5.86 per cent, and a 7.8 per cent rise in income, with a 47.1 per cent rise in other income. Operating profit is up 26 per cent, PAT has increased 58.5 per cent. Interest costs are down 5.7 per cent for all non-financials, and lower by 29.7 per cent for refineries, thanks to Reliance Industries’ drive to become debt-free. Interest costs, ex-refineries and ex-financials, went down by 2.8 per cent. Employee costs have risen by 6.75 per cent, indicating a welcome workforce expansion.

And this from Axis Bank research,

Sales of a set of 736 companies which we track (excluding finance, petroleum and trading companies) have grown 8.5 per cent (year-on-year), driven largely by manufacturing and IT companies, as against largely flat growth in the second quarter and a 25 per cent contraction in the first quarter. Even more noticeable is the rise in the operating profits of these companies — 34 per cent overall (and 51 per cent for manufacturing) due to a rise in operating profits margins for companies across sectors (given that raw materials costs have not risen as fast). Add to this a further (although more muted) increase in salaries and employee costs, and the presumptive GVA of these sets of companies had increased 18 per cent (y-o-y) in the third quarter (versus 6 per cent in the second quarter, after a contraction of 14 per cent in the first quarter). This will be reflective of non-agricultural (industrial and services sector) growth for the first three quarters of 2020-21. These nominal growth rates then need to be adjusted for inflation by using “GDP deflators”, which are a weighted average of the wholesale price index and the consumer price index. For the third quarter, the deflator computes to 3.2 per cent using a broad 40:30 share mix of the respective WPI:CPI inflation prints. The real growth in the companies’ results in the third quarter will, therefore, have been 14.8 per cent.

While the larger corporates have recovered and increased their profitability, it's the smaller companies and informal sector that's the matter of concern,

To get an approximate sense of the asymmetry in performance across larger, medium and smaller companies, we segmented the set of about 2,200 non-finance companies whose results are available for the second quarter. We ranked the financial results of companies segmented by sales — the largest with sales greater than Rs 250 crore in Q2, the smallest being less than Rs 5 crore and multiple segments in between. The results are unsurprising. Both profits and employee expenses follow an ordinal drop in magnitude as indeed does sales growth. This drop is likely to be even more accentuated once data on smaller companies, particularly small and micro enterprises, becomes available over the next couple of years.

10. AK Bhattacharya does a useful analysis of petroleum taxes on central and state government revenues. Consider this snippet underlining the importance of excise taxes on oil,

The share of the combined indirect tax revenue from oil in the Centre’s gross tax revenue has gone from about 10 per cent in 2014-15 to over 14 per cent in 2019-20 (for which the latest numbers are available). Of course, this increase was largely driven by excise, whose share in the Centre’s gross tax revenue increased from about 8 per cent to 11 per cent in the same period... In 2014-15, the share of the Centre’s indirect oil taxes in gross domestic product or GDP was about 1 per cent and this went up to 1.4 per cent in 2019-20. But the overall share of the Centre’s gross tax in GDP actually went down in this period — from 9.96 to 9.90 per cent. Take out the indirect tax revenue from the oil sector, the Centre’s overall tax efforts look even more unimpressive — going down from 8.95 per cent of GDP to 8.49 per cent...
In contrast, the states have not exploited the oil sector the same way as the Centre has in the last six years. Indeed, the share of oil taxes in the states’ own tax revenues has declined quite significantly — from about 20.5 per cent in 2014-15 to 16.5 per cent. Even in terms of the share of combined state oil taxes in GDP, the states did not do well with the share coming down from 1.28 per cent to 1.09 per cent in this period.

Another article in Business Standard highlights the increased role of excise taxation. The last time the Brent crude was $65 a barrel, a litre of diesel in Mumbai cost Rs 70-72, which is Rs 15-20 more per litre. It quotes the RBI Governor,

“CPI inflation excluding food and fuel remained elevated at 5.5 per cent in December, due to inflationary impact of rising crude oil prices and high indirect tax rates on petrol and diesel, and pick-up in inflation of key goods and services, particularly in transport and health categories. Proactive supply side measures, particularly in enabling a calibrated unwinding of high indirect taxes on petrol and diesel – in a co-ordinated manner by centre and states – are critical to contain further build-up of cost-pressures in the economy.”

11. A Business Standard report has this about Adani Group's purchase of Mumbai International Airports Limited (MIAL),

People tracking the sector said the acquisition of MIAL had come at a “great price” for Adani. Adani Group paid Rs 1,685 crore to the minority partners for a 26 per cent stake while it has valued GVK Airport Developer’s 50.5 per cent stake at zero value. Instead, it takes over the debt of GVK of around Rs 2,507.95 crore, which, on full conversion, will be 95 per cent of the paid-up capital of the company. “Groupe ADP acquired 49 per cent in GMR Airports for Rs 9,720 crore, compared to that Adanis got a marquee asset like MIAL at an unbelievable price,” the person said.

It's almost like getting a nearly Rs 10,000 Cr asset for free! 

Wednesday, February 24, 2021

Is private equity merely maximising private benefit at social cost?

The role of private equity in welfare and public goods is a matter of intense debate. The ideologues on the right are as ardent supporters of it as those on the left are equally vehement critics. The empirical evidence on the effects of PE in these sectors is clear. It leads to operational efficiency improvements and higher profits for the owners, but at the cost of those these service providers are supposed to serve. In other words, private profiteering at the cost of its customers!

Jonathan Ford points to two exhibits in this regard from nursing care homes and higher education in the US. The first is a study by Atul Gupta, Sabrina Howell, Constantine Yannelis, and Abhinav Gupta (see also this paper version) on the impact of private equity investments in old aged care and nursing home business. They examined 118 US PE deals involving 1674 care homes covering seven million unique patients between 2000 and 2017 and found that while the PE firms gained by enhancing efficiencies, they came at the cost of patients. 

Their rigorous empirical study paints a disturbing portrait of private equity ownership in healthcare in the context of nursing homes, a $166 bn and rapidly growing industry in the US. They write,

The past two decades have seen a dramatic increase in private equity investment in healthcare, a sector in which intensive government subsidy and market frictions could lead high-powered for-profit incentives to be misaligned with the social goals of quality care at a reasonable cost... We find that going to a private equity-owned nursing home increases the probability of death during the stay and the following 90 days by 1.8 percentage points, about 10% of the mean. In the context of the health economics literature, this is a large effect. This estimate implies about 21,000 lives and 205,000 life-years lost due to private equity ownership of nursing homes during our sample period. The mortality effect is concentrated among older patients, especially those with relatively low disease burdens. This effect is robust to a battery of specification checks... Hence, we interpret this as the effect of a change in ownership, and not driven by consolidation or corporatization. Using a conventional value of a life-year from the literature, we value this mortality cost at about $27 billion in 2016 dollars. To put the magnitude of this mortality cost in perspective, it far exceeds the total reimbursements received by private equity nursing homes from Medicare in our sample (about $17 billion). In contrast with a narrative in which private equity ownership improves the efficiency of care provision, we find that the amount billed per stay increases by 19%, the vast majority of which is billed to taxpayers... our results suggest that private equity owners may breach implicit contracts with stakeholders to maximize profits.

They examined three channels to identify the possible mechanisms driving this mortality effect,

The first is composed of measures of patient well-being. We find that going to a private equity-owned nursing home increases the probability of taking anti-psychotic medications by 50%. These drugs are increasingly discouraged in the elderly due to their association with greater mortality. We also find differential worsening of pain and declining mobility for patients at private equity owned homes. The next two channels employ facility-level data, where we use a differences-in-differences research design... We find that private equity ownership leads to a 3% decline in the per-patient availability of front line caregivers such as Certified Nursing Assistants (CNAs) and Licensed Practical Nurses (LPNs). These nurses provide the most time-intensive caregiving, for example helping patients to use the toilet and cleaning to minimize infection risk. The fact that older but relatively less sick patients drive the mortality result is consistent with a decline in low-skill caregiving. The elevated use of anti-psychotics discussed earlier may also be partly explained as a substitution response to lower nurse availability... Finally, we find negative effects on facility Five Star ratings, which are constructed by CMS to provide summary information on quality of care. For all the facility-level results, we provide evidence on dynamic effects to support the parallel trends assumption.

Another paper by Charlie Eaton, Constantine Yannelis, and Sabrina Howell looked at private equity investments in US higher education institutions. They too find private profiteering but with very large costs on pretty much all fronts among students and taxpayers - "higher tuition and per-student debt". They write,

We employ novel data on 88 deals in which private equity firms acquire independent, privatelyowned schools. These deals are associated with 557 school-level ownership changes, of which 218 occur after the deal through acquisitions. Private equity-owned school systems establish an additional 437 new schools. Using regressions with school and year fixed effects as well as a matching estimator, we confirm findings from the existing literature that private equity ownership leads to higher profits; in our data, profits triple after a buyout... The higher revenue that we observe comes partly from a $1,600 increase in tuition, which is approximately half average total tuition at community colleges. It also comes from almost 50 percent higher enrollment. Reliance on federal aid increases after private equity buyouts and approaches the 90 percent of revenue threshold that is the statutory limit. Per-student borrowing and per-student federal grants increase by about 12 and 14 percent of their respective means... We find sharp declines in student graduation rates, loan repayment rates, and labor market earnings after private equity buyouts (the declines are 13, 5.6, and 5.8 percent of their respective means). Enhanced recruiting and reduced instructional quality can reconcile the otherwise puzzling combination of higher enrollment despite higher tuition and deteriorating student outcomes. Private equity-owned schools have twice the share of employees in sales as other for-profits. We show that education inputs, including the ratio of faculty to students, the share of spending devoted to instruction, decline after the buyout. 
One of the most attractive feature for PE investments in such sectors comes from their taxpayer support and the potential to maximise the capture of that support,
We exploit a 2007 student loan borrowing limit expansion to test whether private equity-owned schools are more responsive to changes in federal loan guarantees. Relative to other institutions, private equity-owned schools respond to the increase by raising tuition faster than other for-profit schools, which induces higher levels of borrowing. Superior capture of government aid is thus a channel through which high-powered incentives of private equity ownership translate to higher profits. This is a purely rent-seeking phenomenon and is unambiguously not in students’ or taxpayers’ interest.
Worst off all, PE ownership is associated with law breaking,
An important further piece of evidence is that we find dramatic increases in law enforcement actions after buyouts, most of which stem from accusations of recruiting rule violations, such as quotas for sales staff, and misrepresentations of student loan terms, graduation rates, and student employment outcomes.

On PE's value creation and how they continue to attract customers despite declining quality of service delivery, they write, 

Our results shed light on how private equity creates value. This is an especially interesting question in the context of private-to-private transactions, which make up over 90 percent of private equity deal value and 99 percent of volume. When a private equity investor takes a public firm private, agency conflicts decline as control becomes more tightly bound to ownership. The mechanisms may be more nuanced in a private-to-private transaction. Compared to the pre-existing, private owners, private equity owners have higher-powered incentives to maximize firm value because fund managers are compensated through a call option-like share of the profits, employ substantial amounts of leverage, usually aim to liquidate investments within a short time frame, and do not have existing relationships with target firm stakeholders. 

Private equity is often treated as a monolith, either praised for creating value or maligned for supposed “strip and flip” strategies. Together, the existing literature and our results suggest that there is important heterogeneity. When incentives between investors and consumers are aligned, quality improvements should accompany firm value creation. In contrast, for-profit colleges feature severe information frictions and misaligned incentives. There is low price elasticity of demand, in part because tuition is not salient; students often enroll with zero up-front costs. Education quality is extremely opaque, allowing for reducing instructional resources while pursuing misleading marketing and recruiting strategies. The for-profit target population is vulnerable to these approaches because it is extremely socioeconomically disadvantaged. While dropouts may increase when instructional resources decline, rolling admissions enable rapid enrollment of new students. The required recruiting expenditures, especially with new sales technology adoption, may be lower than the cost of retaining existing students. The sector also features intensive government subsidy, separating revenue from the consumer. 

In particular, the expansion of federal student loan programs since the early 1990s created opportunities to increase firm value through implicit contract violations. As a new owner, the private equity investor may be well-positioned to take advantage of these opportunities for value creation. In order to establish the school, previous owners may have had to commit to implicit contracts with stakeholders; in exchange for government revenue, they would provide a valuable education. Their inability or unwillingness to take advantage of new opportunities is related to the reason why in settings such as healthcare and education, where consumers depend on implicit contracts with the firm, many service providers are nonprofit. Glaeser and Shleifer discuss how in such settings weaker incentives to maximize profits or increase value for investors can make nonprofit status optimal. This mechanism requires consumers to rationally choose nonprofit firms over for-profit ones. It may be infeasible for consumers to make this choice when subsidy separates revenue from the consumer and quality is hard to observe.
All this increasingly leads to the conclusion that large private investors and large private enterprises cannot be trusted to deliver high quality public services (health, education, prisons, skills training, court services etc). The goal of marrying high-powered for-profit incentives with the social goals of quality care at a reasonable cost may be an impossible challenge. This also means that ESG investing (leveraging large pools of private capital) and private equity (large chains) are more likely to be value subtracting and detrimental to the cause of development.

In light of the above, the case for philanthropic and concessional capital, and smaller social impact enterprises (both non-profits and for-profits), leading the private sector side in the development cause could not be more compelling.

Tuesday, February 23, 2021

Bond market graphic for the day

From Robin Wigglesworth in FT

While there are about 41,000 stocks in the world, there are millions of bonds, almost all of them with unique characteristics. Many trade only by appointment, if at all. Of the 21,175 corporate bonds outstanding in the US in 2018, only 246 of them traded at least once a day that year, and a sixth did not trade at all, according to Citi.

Monday, February 22, 2021

Capitalism and shale industry

Derek Brower and Myles McCormick from FT have a story for the ages on the rise and fall of the shale industry. It is classic capitalism. 

A new idea emerges at a time markets are primed for growth, entrepreneurs strike out in droves, the confidence fairies are everywhere, capital flies in, investment soars, finance loses its discipline, corporate governance gets tossed out of the window, and growth at all costs becomes the mantra. Then the music stops. Markets tank, animal spirits disappears, investors flee, and the whole edifice comes crashing down. 

Sample this,

Operators drilled more than 14,000 shale wells in 2019, according to Rystad, an energy research company. It helped the US hit record-high oil output near 13m barrels a day, a level unmatched even by Saudi Arabia and Russia, the world’s next biggest producers. That was a rise from 5m b/d just eight years earlier — a surge that sparked booms from Texas to North Dakota and helped drag the US economy out of the mire of the global financial crisis, adding one percentage point to GDP between 2010 and 2015, according to the Federal Reserve Bank of Dallas. But it required huge infusions of cash offered at basement interest rates. Rystad says the sector spent around $400bn capital in those years, but by 2019 free cash flow arrived only once, in 2016. 

“The fundamental problem with the shale model over the past decade has been the pursuit of growth over return on capital employed or returning capital to shareholders,” says Ben Dell, managing partner at Kimmeridge, a private equity firm that has built up an activist position in the sector. Investors that rushed to finance shale’s recovery from the 2014-15 price crash — an earlier Saudi price war to capture market share — were fleeing by 2019. As capital markets began to close for shale companies, operators were forced to trim spending plans, reducing new drilling activity. With profits still absent and growth prospects diminishing, the shale patch entered 2020 in distress. A reputation for flagrant corporate misgovernance and excess — from colossal executive bonuses earned by hitting oil output growth targets, not profits, to flashy office developments and rumours of company-funded hunting trips — didn’t help. 
Then came last year’s price crash, including the symbolic moment in April when West Texas Intermediate, the country’s benchmark crude contract, traded below zero for the first time. “Covid hits, oil prices collapse, everyone has to cut their capex, valuations crash,” says Aaron DeCoste, an equity analyst at Boston Partners, an institutional investor. “And it’s effectively reset the entire industry.”

The article describes a wave of consolidation and return to cautious growth in the industry in the aftermath of the bust. Investments are rising slowly, being sourced from free cash flow than from debt.  

Early this month, Chesapeake Energy, which embodied the excesses of the shale revolution, emerged from Chapter 11 bankruptcy,
Chesapeake’s debts as it filed for bankruptcy last year were more than $9bn. The court-approved deal struck with its creditors last month eliminates about $7bn of debt and will permanently reduce $1bn of annual operating costs. The company has also secured $2.5bn in exit financing, and lenders have agreed to backstop a $600m rights offering. Chesapeake will end 2021 with just $500m in net debt — less than the annual interest payments it was making in recent years — and generate $2bn worth of free cash flow in the next five years... The company would in future reinvest 60 to 70 per cent of its cash flow into production... Chesapeake lost its New York Stock Exchange listing after its bankruptcy last year, but will begin trading on Nasdaq on Wednesday. The Houston court that approved the company’s reorganisation last month valued the company at about $5bn, although some analysts now say it could be worth almost $8bn.

Sunday, February 21, 2021

Weekend reading links

1. Indian Express has this on the challenge facing FCI,

The Food Corporation of India’s (FCI) “economic cost” of wheat sold through the public distribution system (PDS) is budgeted to go up to Rs 29.94 per kg and that of rice to Rs 42.94 per kg in 2021-22, from their corresponding current levels of Rs 27.40 and Rs 39.99 per kg. These numbers are significant, given that under the National Food Security Act (NFSA) of 2013, 81.35 crore persons, accounting for over 67% of the country’s population, are entitled to receive 5 kg of PDS wheat or rice per month at Rs 2 and Rs 3 per kg, respectively... The economic cost is what the FCI incurs in procuring, transporting, storing and distributing every kg of wheat or rice. The estimated Rs 29.94/kg economic cost for wheat in 2021-22 includes a “pooled cost” of Rs 19.21 (roughly what the farmer gets); “procurement incidentals” of Rs 3.20 (gunny bags, market fee, arhtiya commission, labour and other mandi-level expenses); and “distribution cost” of Rs 7.53 (freight, handling, storage, interest and other administrative charges). In the case of the Rs 42.94/kg for rice, the pooled cost is Rs 27.90, with procurement incidentals at Rs 4.85 and distribution cost at Rs 10.19.

2. A good summary of the school reforms in Delhi. This is impressive,

A recent study by consultancy firm BCG has found that perhaps the biggest reform pulled off by AAP is the sea change in the mindset of the most important resource in the city's government schools: Teachers and the headmaster. Teachers have been made to feel human and are being treated with respect and dignity... Headmasters (over 1,000) have been sent overseas, including to Cambridge and Singapore, or to institutions like the IIMs for training... One, instead of keeping parents out, schools are now sending invitation cards for parent-teacher interactions. Many parents contacted for the study expressed surprise, awe and delight at being offered a cup of tea at their child’s school... The change in the school’s attitude towards parents has reflected in a change in the parents’ attitude towards schooling, education and its benefits. The parents have begun to take whatever the school says more seriously, rather than brushing their children off when they mention what the school requires of them.

These are all low investment but high human engagement activities. Don't know how much of this has translated into learning outcomes improvements. But hard to not feel that this is a more promising and essential pathway to improving learning outcomes than mere inputs.

3. Dani Rodrik makes four important points about the new social contract, one which goes beyond the older welfare state paradigm,

We can do much better on our active labour market policies, in terms of linking them up with employers to ensure that training programmes are . . . supplying the hard and soft skills that employers need. Second, [in] industrial and regional policies, we must target the creation of good jobs and maybe de-emphasise a little the traditional focus on capital investment, global competitiveness, innovation and so forth. Because even when those work they don’t necessarily create good jobs. Third, we need to rethink our innovation policies. We’re doing nothing right now to invest in technologies that augment rather than replace labour. Fourth, our international economic policies have to be those that enable countries to carry out these policies without them being overwhelmed by forces of international arbitrage.

As to what can be done in this regard, he say,

Move away from these open-ended subsidies or tax incentives and engage in attracting investment from good firms to distressed areas by essentially providing them with the customised services that they need most. That could be improving some brownfield area for their investment, providing infrastructure, investing in specific kinds of skills, providing technology, marketing assistance or help with business plans. On innovation, I’m really trying to countervail against this view that you always hear [that] technology is rapidly changing the kinds of skills needed on the job and workers need to adjust to increased education and continuous training. Here is this inexorable train that is moving and the rest of our society has to adjust. There are norms, private and public, that are embedded in innovation systems and the narratives in Silicon Valley, and that are very much about saving on labour. Finally, there’s relative power. When workers have more voice in the workplace they might either militate towards the adoption of technologies that are more complementary to their skills or, at least, ensure that when new technologies are adopted, the consequences for workers are less severe.

He refutes the evidence-based policy making crowd and channels FDR in calling for "bold and persistent experimentation",

Many of my colleagues respond by saying . . . show me what evidence-based policy you’re supporting — show me what has actually worked. I feel that is inadequate for the time. It is sort of like saying FDR should have been forced to take on policies only for which there had been evidence. That’s like a recipe for not trying anything new and FDR very explicitly said this is a time where we have to experiment.

4. Tom Peters has a scathing takedown of MBAs and the modern corporate culture in the context of McKinsey,

... business schools typically emphasise marketing, finance, and quantitative rules. The “people stuff” and “culture stuff” gets short shrift in virtually all cases. McKinsey is loaded with high-IQ MBAs addicted to spreadsheets and PowerPoint presentations. So are many other places that have fallen apart... Furthermore, McKinsey’s typical assignment is to improve market share and profitability. That combination, taken too far, is a poisonous combination in my opinion... Milton Friedman... introduced the idea that maximising shareholder value should be a company’s raison d'ĂȘtre. That led to an insane push for profitability at all costs. Investment of corporate profits in people and research has fallen through the floor ever since. One rigorous study found that the share of profits apportioned to people and R&D dropped from 50 per cent in the 1980s to 9 per cent in the 2000s. I loved my Stanford and McKinsey years. But I do not remember even a single moment directly related to the moral responsibilities of enterprise.

This comes as McKinsey just paid almost $600m to 49 states to settle, without admitting liability, allegations that it urged Purdue Pharma to “turbocharge” OxyContin sales via tactics that included the rebate formula. 

5. In order to change perception of public toilets as dark, dirty, and unsafe spaces, Tokyo is experimenting with see-through toilets made with a special glass which becomes opaque when the lock is turned. 

6. Adani Ports (APSEZ) acquires 100% stake in Dighi Port Ltd (DPL) for Rs 705 Cr, making it the 12th port to join the company across the eastern and western coasts. 

7. Interesting intervention by the government in the residential housing sector. In order to complete the large stock of nearly $63 billion stalled real estate projects, in November 2019, the Government of India established an alternative investment fund, 'Special Window for Completion of Construction of Affordable and Mid-Income Housing Projects' (SWAMIH). It appointed SBICAP Ventures Ltd to be the fund manager, and contributed 50% of the Rs 250 billion ($3.5 bn) fund, with 10% each from LIC and SBI and remaining from private investors. 

The fund has so far approved investments in 159 projects involving Rs 145 billion investments to complete around 100,000 projects. The Fund has first charge on assets and cash-flows, over other earlier creditors, and invest via zero-coupon non-convertible debentures and at a standard 12% IRR across projects. 

In an interview, Irfan Kazi, CIO at SBICAP says, 

When you look at parameters like setup time, fundraise time, we are probably the fastest. The fund was set up in a month after the official announcement (2019), capital was raised in a month. No real estate fund, I believe, has done more than 100 deals probably in their lifetime. We are close to almost 150 deals now... In many cases we are dealing with the bottom rung of companies, which have lost manpower and some even no longer have a finance team, so due diligence can be hard. A no-objection certificate from existing lenders has come only in some cases and takes an exceedingly long amount of time. Then there are also pending court cases or home buyers demanding compensation.

8. Business Standard has a Reuters report on how Amazon lobbied the US government to influence the Indian government as well as how just 35 sellers make up more than two-third of the sales on the platform in India. It questions the companies claim that it provides a platform for over 400,000 producers and traders in India. 

Indian traders, both brick-and-mortar and smaller online sellers, have long alleged that Amazon's platform largely benefits a tiny number of big sellers and that the American giant engages in predatory pricing that has crushed legions of retailers. Amazon rejects this: It says it complies with Indian law, which stipulates that an e-commerce platform can only connect sellers to buyers for a fee, unlike in the United States, where Amazon can both act as middleman and sell goods directly to consumers. The company also says it runs a transparent online marketplace and treats all sellers equally. The internal Amazon documents contradict those claims, revealing how the e-commerce giant has helped a small number of sellers prosper, giving them discounted fees and helping one cut special deals with big tech manufacturers such as Apple Inc. The documents also show that the company has exercised significant control over the inventory of some of the biggest sellers on Amazon.in, even though it says publicly that all sellers operate independently on its platform...

Because foreign investment regulations in India bar e-commerce firms from holding inventories of goods and selling them directly to customers, companies like Amazon can only collect fees from vendors selling products on their marketplace. Globally, about 58% of Amazon sales of physical goods in 2018 came from third-party merchants; the rest come from direct sales to consumers, the company has disclosed. The ability to sell straight to people in the United States and elsewhere packs big benefits. It means Amazon can deal directly with manufacturers, for one, giving it greater control over its product range. It is this barrier - the regulatory wall around the consumer - that Amazon has been trying to overcome for much of the past decade in India.

This about Narayanamurthy owned Cloudtail raises several questions, 

But Amazon has been deeply involved in expanding Cloudtail - often referred to as "SM," or "Special Merchant," in the documents... Amazon had big plans for Cloudtail. The target was to ensure Cloudtail accounted for 40% of Amazon.in sales, "and build this into a $1+B business" in 2015, according to the report. To that end, the report reveals, Amazon helped Cloudtail "acquire key relationships" with major tech companies, including Apple, Microsoft and OnePlus. This included exclusive deals with these companies to sell their products, such as smartphones. The tech companies got a big new sales channel, while Cloudtail got coveted products that it listed on Amazon.in... The deals Amazon facilitated with smartphone makers, coupled with deep discounts Cloudtail was offering on the Amazon website.

9. NYT writes about the rise of dividend payouts by private equity owned companies by borrowings,

In the second half of 2020, private equity-owned companies borrowed some $27 billion to pay for dividends or debt restructurings, according to a report by S&P Global Market Intelligence’s Leveraged Commentary & Data. That was the most active period for these loans in nearly three years. And the borrowing hasn’t slowed down this year: $4.7 billion in the first six weeks. That was the second-highest amount for any comparable period since the firm began tracking that data in 2000... When private equity firms take dividends from their companies, the money doesn’t entirely go straight into its coffers. Rather, the payment goes to the investment fund that technically owns the company and in which the private equity firm’s clients — including charitable foundations and big pension systems — hold a stake. That makes dividend recaps a crucial tool for private equity firms to keep clients happy — and a way to deliver returns to clients even if a company isn’t turning a big profit. “Dividend recapitalizations are occasionally used to return funds to the pension fund investor so they can reinvest in another asset and ultimately strengthen retirements,” said Drew Maloney, president of the American Investment Council, the association for private equity industry.

10. Finally, the one reason being cited why equity market valuations may not be that far into the excessive bubble territory, the ultra-low interest rates. This graphic adjusts valuation for the interest rates.

But this assumes rates are going to remain low forever, which is most unlikely.

Wednesday, February 17, 2021

Summarising on the DFI for India

India has a long history of DFIs. A comprehensive analysis of previous experiences, including with private participation, and the reasons for their failures is documented in the comprehensive study here.

In light of these learnings as well as global experiences, some factors to consider while designing a DFI are outlined below.

1. Ownership - The experience of European, East Asian countries and BNDES in Brazil points definitively to government ownership and control as an essential requirement for the DFI to prioritise its development objectives. India’s own experience with the likes of IDFC points to the limitations of privately-owned entities performing the role of a DFI in maintaining focus on the development objectives. The incentives and requirements of private investors are incompatible with the need for a DFI to be a catalytic institution to boost investment in infrastructure.

2. Source of funding - If it is to deliver on its mandate, a DFI should have access to both fiscal support as well as cheaper sources of capital. As examples, whereas the European DFIs source capital from the market at cheaper rates leveraging public ownership, DFIs in East Asia and BNDES obtain significant budgetary support apart from being able to raise cheaper capital. A wholly government owned DFI would benefit from being able to access capital at cheaper rates. It should be allowed the benefits of other concessions in the form of tax exemptions for their bond issuances, some form of interest subvention subsidy in certain cases, eligibility for SLR considerations, preferential lower risk weights for DFI bonds in various portfolios and so on. The Government of India should also solicit funding from the multilateral and bilateral lending agencies. 

3. Where to invest?

a. The financing priority should be projects in water and sewerage, solid waste management, urban mass transit, electricity distribution, and social infrastructure (riskier sectors) which face challenges with commercial viability and will struggle to attract commercial capital on their own. Direct lending operations of the DFI should prioritise such projects. Lending to such projects should have an element of concessionality so as to de-risk and make the residual investment opportunity commercially attractive enough for private investors. 

b. Greenfield projects involving construction is the highest risk phase of infrastructure projects and therefore should be a priority for DFIs. In general, private capital is loath to finance greenfield projects given the risks and uncertainties associated with both construction and the revenues forecast. It is an area where DFI capital can act as a bridge to finance the construction and pass on the asset to private capital post-construction, as well as to act as a risk-mitigating capital for private investors during construction.

c. In addition, DFI could undertake financing of projects in telecommunications, power and gas generation and transmission, highways, ports and airports (all mainstream sectors) in very rare cases for exceptional reasons, where private capital is otherwise not forthcoming. In general, they should avoid direct lending to such projects because they would effectively be displacing private capital. Accordingly, direct lending as the primary lender should actually be of secondary importance in case of mainstream sectors. It should be done only to keep its overall balance sheet a little less and get some net interest income going. 

d. The DFI should not compete to invest in projects where there is already private interest. In this context, the role of NIIF is illustrative. Since its inception, it has consistently sought to compete with private investors in completely de-risked mainstream sectors. Its current portfolio consists exclusively of projects which could have been financed by commercial investors. This goes against the crowding-in role expected of a DFI. It then functions as a Sovereign Wealth Fund, instead of a DFI.

4. Manner of financing

a. In less commercially viable projects, DFIs will sometimes have to perform the role of being the lead financier to de-risk the project, especially in the construction phase. It may also have to assume concessional financing role to attract private capital, especially in the O&M stage. In these projects, a far greater additionality than senior lending can arise, as required, from subordinate financing. 

b. In addition to sub-ordinate lending, the DFI should prioritise the use of guarantees and different forms of debt back-stops or buffers to de-risk lending to riskier sector projects. Partnerships with banks and other financial institutions to support such financing would be a very good use of DFI capital.

c. Further, equity financing will be something which private capital, even in case of brownfield projects, will be less willing to commit. The DFI can play a role in bringing in equity capital, especially subordinated equity, so as to crowd-in debt from private sources, in certain important types of riskier projects.

5. Governance

a. Given their role, management and governance depends on the way in which the DFI interacts with its owner (government), its clients (market), and its regulator. Arms-length relationship with the owner, rigorous project appraisal and prudent lending practices and robust regulatory oversight are essential requirements.

b. There should also be strong internal controls that separate the loan appraisal and lending activities and the respective personnel involved. The appraisal staff should be incentivised to undertake rigorous due diligence.

c. It is also important that the true economic cost of the concessions provided by DFI are captured and that financial models reflect them. The costs could be assessed for reasonableness with respect to appropriate benchmarks. This should also be prominently reported and monitored to ensure lending discipline. This also has a critical role to play in assessing the performance of the DFI with respect to achieving its stated objectives.

6. Capacity

a. The DFI should develop very strong internal capacity to appraise projects. In fact, other creditors, especially banks, could rely on its appraisal in their lending decisions to those infrastructure projects. However, this would require being able to recruit and retain qualified professionals. In this context, the experience with IIFCL is instructive. Despite being a large infrastructure lender, it piggybacks on the project appraisal conducted by others in the lenders’ consortium. While this passivity has allowed it to remain a lean organisation, perhaps even book profits, it has come in the way of acquiring the internal expertise to appraise and evaluate project risks. This deficiency of expertise evidently comes in the way of true risk assumption – the vast majority of its assets are secured loans. More importantly, this is a big detriment to the DFI realising one of their most important objectives, in setting industry standards.

The GoI could try to get some professionals on deputation from the World Bank or Asian Development Bank, especially for some important leadership positions like the appraisal division. This would also likely make the appraisal division work more independently from the investment division of the DFI. 

b. Since one of the most important problems that bedevil infrastructure projects is the poor quality of project preparation, the DFI should support the development of a shelf of projects. In fact, they should actively support with project development and help create a pipeline of procurement and financing-ready projects. This will also help the DFI build a robust pipeline of deals for financing. This would require the use of grants. The India Infrastructure Project Development Fund (IIPDF) facility available with Department of Economic Affairs (DEA) could be leveraged to support project development. 

c. The DFI could become the implementation agency for the Government of India’s Viability Gap Funding (VGF) scheme, currently administered by DEA. This would help the DFI, especially in its initial stages, quickly build up a portfolio of projects. Besides, the DFI is better placed than the DEA in appraisal of PPP projects. 

The paper has details about each of these suggestions above. 

To summarise, there are perhaps five essential requirements for any DFI:

1. Full government ownership.

2. Fiscal support and access to low-cost funding sources.

3. Confine to de-risking of less commercially viable and riskier projects, where private capital is unwilling to invest. Never compete to invest in commercially viable projects.

4. Robust governance mechanism, especially important given the areas targeted for investment, the lack of market-based discipling mechanism, and government ownership of the DFI.

5. Acquire strong capacity to appraise projects.

Monday, February 15, 2021

The dynamics behind dual-nature manufacturing economies

Dani Rodrik and co-authors have a very important paper that has several lessons of relevance to countries like India. I have blogged earlier about the dual nature of the Indian economy, a small formal sector co-existing with a very large informal sector.

The paper highlights a dual nature of the manufacturing sectors in Tanzania and Ethiopia, 

Recent growth accelerations in Africa are characterized by increasing productivity in agriculture, a declining share of the labor force employed in agriculture and declining productivity in modern sectors such as manufacturing. To shed light on this puzzle, we disaggregate firms in the manufacturing sector by size using two newly created panels of manufacturing firms, one for Tanzania covering 2008-2016 and one for Ethiopia covering 1996-2017. Our analysis reveals a dichotomy between larger firms that exhibit superior productivity performance but do not expand employment much, and small firms that absorb employment but do not experience any productivity growth. We suggest the poor employment performance of large firms is related to use of capital-intensive techniques associated with global trends in technology.

As to its reasons, they question the conventional wisdom, 

We find no evidence of a “missing middle” in the size distribution of firms in Tanzania and Ethiopia. The distribution of firm size is heavily right skewed, with a predominance of small firms and generally a smooth decline in frequency over the firm size distribution. There are no indications of a bimodal distribution... high labor costs (relative to productivity) are often cited as constraints on employment growth in Africa. But as we will show below, payroll shares in total value added in both Tanzania and Ethiopia are exceedingly low, even in the more labor-intensive sectors... explanations that posit a “poor business environment” are belied by the high dynamism in Tanzania’s and Ethiopia’s manufacturing sectors, as captured by our analysis of entry and exit rates... entry rates during the two countries’ high-growth periods have been as high, if not higher, than the levels observed for Vietnam.

Comparing Ethiopia and Tanzania with a much richer country like Czech Republic, they find, 

We note in particular that the 10% most capital-intensive large firms, producing around a quarter of manufacturing value added (but employing less than 10 percent of the manufacturing workforce), have particularly high capital to labour, K/L, ratios. In Ethiopia these large firms are at 72 percent of the K/L ratio for Czech manufacturing. Tanzania’s large firms actually have K/L ratios that significantly exceed those for Czech manufacturing... the increase in capital-intensity in large manufacturing firms in both Tanzania and Ethiopia has far outstripped economy-wide capital deepening. By contrast, in the Czech Republic not only is capital intensity lower in manufacturing than in the economy as a whole, the two measures have moved more or less in parallel in recent years. 

Another striking indicator of low levels of labor-intensity in African manufacturing is the payroll share in total value added. In the Czech economy, the payroll share in aggregate manufacturing is slightly below 50 percent and rises to 57 percent for garments & textiles. In Tanzania and Ethiopia, by contrast, the payroll share is in the range of 11-12 percent and rises merely to 20-24 percent in garments & textiles. It is generally known that labor shares in value added are overstated in developing countries because of the predominance of owner-operated firms. Even accounting for that downward bias, the low payroll share in Tanzania and Ethiopia is striking... This evidence on payroll shares also suggests that high labor costs – in relation to per capita incomes or level of productivity – cannot account for the capital intensity of our African firms.

Their conclusions are important,

In sum, we draw four conclusions from this evidence. First, while K/L ratios in African manufacturing are lower than in much richer comparator nations, these ratios are still much higher than would be expected based on their relative labor abundance and low per-capita income levels. Second, if we focus on the largest firms, K/L ratios in Tanzania and Ethiopia are actually comparable to those in much richer OECD countries. Third, exporting firms or the traditionally labor-intensive textiles and clothing firms do not exhibit lower K/L ratios than other manufacturing firms on average. Finally, K/L ratios have increased much more rapidly in Tanzanian and Ethiopian manufacturing than in the economy as a whole.
For a small sample of countries, they find that the trend of decline in employment due to 'premature deindustrialisation' is almost completely concentrated among low-skill labour category.

A World Bank study found that both the direct and indirect employment created per dollar of exports have halved between 1997 and 2011 for a sample of 30 countries,

So, Rodrik et al posit an alternative explanation for the dual-nature economy,

We argue that the broad patterns we have observed with respect to productivity and employment can be explained by excessively capital- intensive modes of production in manufacturing in our two African economies... Since the bulk of technological innovation takes place in the advanced countries where factor proportions favor automation and skills, the direction that technological change has taken is not surprising. Producers in developed countries have tried to save on labor costs, especially as competition from low-wage exporters became more intense. But for developing countries, who are technology importers, the consequences are hardly salutary. Even if the new technologies disseminate rapidly and poor nations can easily acquire them, the declining low-skill intensity of manufacturing implies a reduction in comparative advantage in simple manufactures, less labor absorption by manufacturing, and lower growth possibilities... 
In short, the manufacturing technologies on offer on world markets have moved steadily away from the factor proportions of labor-abundant countries. This has made it difficult for African firms to simultaneously enhance productivity and increase employment. Adopting new technologies has meant adopting mostly capital- and skill-intensive technologies and has resulted in less price-responsive supply curves. As a result, only the less productive firms retain the ability to absorb significant amounts of labor. 

Its long-term implications are deeply disturbing,

From the standpoint of trade theory, our interpretation amounts to an argument that African and other low-income countries have been losing comparative advantage in traditionally labor-intensive manufactures due to a trend reduction in their labor intensity. This implies a loss in the gains from trade. It also lowers the ceiling on industrialization and constrains the capacity of African manufacturing to absorb labor productively.

Dani Rodrik writes elsewhere of the revival of an old dilemma for African economies,

Their manufacturing firms can either become more productive and competitive, or they can generate more jobs. Doing both at the same time seems very difficult, if not impossible. 

The dual nature economy contrast between African and East Asian countries is captured in the two graphics. The share of formal sector in employment is tiny in case fo Tanzania and Ethiopia.

In contrast, the share of formal sector dominates employment distribution in Taiwan and Vietnam.

The paper decomposes labour productivity growth to within and across sectors and compares them for 10 year periods before and after growth acceleration. 

The graphic is interesting. In the case of India, while the productivity boost due to structural transformation is significant and as large as those of Asia as a whole, the change within agriculture is negligible and within non-agriculture small. Incidentally, in Asia, the major boost to productivity in growth acceleration period came from productivity increases within non-agriculture sectors. 

Saturday, February 13, 2021

Weekend reading links

1. MS Sahoo, Chairperson of the Insolvency and Bankruptcy Board of India (IBBI) has a good assessment of the IBC,

On the face of it, 25 per cent of companies were rescued and 75 per cent proceeded for liquidation. In value terms, however, 75 per cent of the assets were rescued and 25 per cent of assets proceeded for liquidation. Importantly, of the companies sent for liquidation, 75 per cent were either sick or defunct, and of the companies rescued, 25 per cent were either sick or defunct. The companies rescued had assets, on average, valued at 25 per cent of the amount of claims against them, while the companies ordered for liquidation had assets valued at 5 per cent of the amount of claims against them. In terms of these facts, the extent of liquidation under the code does not appear worrisome...

About 30,000 applications have been filed for initiation of CIRP. Of them, 10,000 are yet to be disposed of. Of the balance 20,000, the stress underlying 16,000 applications were resolved before admission, and the stress underlying 4,000 applications entered CIRP for resolution. Of these, 1,900 are ongoing, while 800 got resolved, through settlement, review, mediation, or withdrawal. The remaining 1,300 have completed the process. At this stage, the value of the company is substantially eroded, and hence some of them (300) were rescued, and others (1,000) liquidated. That works out to a rescue rate of 25 per cent of CIRP. Another way to work out the number of companies where the stress was resolved (before admission plus midway closure and resolution plans) as a percentage of the number of applications concluded, that is, 17,000/18,000, which gives a rescue rate of 95 per cent. Thus, only 5 per cent of companies seeking resolution through the code end up in liquidation. Of these, 75 per cent are defunct to start with.

2. Neelkanth Mishra has a good summary of the production linked incentives (PLI) scheme of the government. It provides 2-6% of the revenues as time-bound incentive to firms in 10 sectors whose production is above a certain level and have some threshold for additional investments. 

The incentive is on value of output, and not value-added, making it attractive for downstream companies, as assembly costs are generally not more than 10 per cent of manufacturing value. For a product where assembly is 10 per cent of value, a 5 per cent incentive would mean a 50 per cent support to the assembler. Thus, assembly, the most labour-intensive part of most supply-chains, can be attracted to India in sectors like electronics and textiles. In food processing, it may help raise India’s share of global exports and thus provide an outlet for rising food surpluses.

The concerns are,

... risks that a more interventionist state can engender: Crony-capitalism (the scheme details can be designed to benefit some firms), resource misallocation due to lack of knowledge (who decides which sectors must get the incentives?), scope creep (as news of the PLI schemes has spread, there appears to be intense lobbying to expand these), requests for relaxation of targets (some firms are already requesting an extension to timelines, given the lockdowns during Covid), and rent-seeking (are targets sufficiently objectively defined to minimise discretion in paying out incentives?). 

3. The idea of clubbing a profitable asset with a less profitable one and monetising the combination is logically appealing. But in the real world, investors are unlikely to be enthused by such combinations. The latest example of such bundling is the proposal of Government of India to combine a loss making remote airport with a profit making one.

4. An important explanation for the equity markets bull run is the cost of capital. Michael Mauboussin points to some numbers in this regard,

Aswath Damodaran, a professor and valuation expert, estimates that the equity risk premium dropped from 5.2 to 4.7 per cent over the same period as the rebound in stock prices implied lower future returns. The yields on corporate bonds followed a similar trajectory. These figures imply that the cost of equity declined from 7.1 to 5.6 per cent during the year. When used in valuation calculations, this boosts the current worth of expected future earnings of companies as the future income stream is discounted at a lower rate. Companies therefore received a richer valuation on greater current or prospective earnings. Companies that gained from trends arising from the pandemic, such as those that enabled working from home, particularly benefited.

5. NYT reports that precious metals in catalytic converters of cars is spawning a market for car thieves,

Stricter car emissions rules around the world — particularly in China, which has scrambled in recent years to get its dire air pollution problem under control — have sent demand for the precious metals in catalytic converters surging. That has pushed up the asking price for some of the precious metals used in the device — like palladium and rhodium — to record highs... Required in all gasoline cars and trucks sold in the United States since 1975, the converters have a honeycomb-like interior — coated with precious metals like palladium, rhodium and platinum — that scrubs the worst toxic pollutants from the car’s exhaust... catalytic converters now make up a much larger proportion of a gasoline-powered vehicle’s cost than they did even just a year ago. The metals prices, in turn, are fueling a black market in stolen catalytic converters, which can be sawed off from the belly of a car in minutes, and fetch several hundred dollars at a scrapyard, which then sells it to recyclers who extract the metals.

6. A summary of farm subsidies in India,

More than three-fifths of the 1.3 billion population is stuck on the farm, and kept there with a $11 billion fertilizer subsidy; $9.5 billion in unmetered electric power; about $4 billion annual expenditure on periodic loan waivers; and of late an $80-a-year income supplement, which adds up to $9 billion. For the landless, there’s a rural job guarantee, which cost $15 billion after migrant workers lost their urban jobs to the Covid-19 lockdown and returned to their village homes.

7. A NBER working by Fancesco Decarolis et al find that women are less prone to corruption in public bureaucracies,

We examine the correlation between gender and bureaucratic corruption using two distinct datasets, one from Italy and a second from China. In each case, we find that women are far less likely to be investigated for corruption than men. In our Italian data, female procurement officials are 34 percent less likely than men to be investigated for corruption by enforcement authorities; in China, female prefectural leaders are as much as 75 percent less likely to be arrested for corruption than men.

As the authors point out, the results may be complicated by women having greater risk aversion or being less targeted by anti-corruption agencies. 

7. Anusha Chari et al find that the RBI's forbearance measures that lowered capital provisioning rates for loans under temporary liquidity stress in the aftermath of the global financial crisis, led to banks spieling firms facing serious solvency issues. 

Perversely, in industries and bank portfolios with high proportions of failing firms, credit to healthy firms declined and was reallocated to the weakest firms. By incentivizing banks to hide true asset quality, the forbearance policy provided a license for regulatory arbitrage... Our findings imply that regulatory forbearance can function as an implicit subsidy from the government that postpones costly bank recapitalization. Asset quality forbearance in particular can allow banks to effectively “extend and pretend” distressed loans masking the underlying bank capital erosion. Loan-loss recognition would undoubtedly weaken bank balance sheets and warrant recapitalization.

The million dollar question is whether there is an ongoing redux of this in the aftermath of the Covid 19 pandemic. 

8. It is one of the enduring narratives of development and progress that each generation is better off compared to their predecessors. But, at least in terms of wealth, evidence points to a secular decline.

The blog post itself by Scott Galloway is, as always, excellent. He highlights four factors in the algebra of wealth - focus, stoicism, time, and diversification. 

Focus on what matters. Be a Stoic in the face of temptation. Use Time to your advantage. Diversify your investments.

This is a much overlooked fact,

One study found that over a 12-year period, only 5 percent of active retail traders made any profit at all. This time around, apps including Robinhood, with its dopamine-triggering confetti, and 24-hour-a-day, volatile crypto trading are the drugs of choice.

9. The brilliant Morgan Housel on the power of stories,

Tesla is worth seven times more than GM and Ford combined, not because it built a good business but because Elon Musk is good at getting people’s attention. Customers. Investors. Twitter followers – he’s told them all a good story, and the best story wins.

He quotes Rory Sutherland,

Making a train journey 20 per cent faster might cost hundreds of millions, but making it 20 per cent more enjoyable may cost almost nothing... It seems likely that the biggest progress in the next 50 years may come not from improvements in technology but in psychology and design thinking. Put simply, it’s easy to achieve massive improvements in perception at a fraction of the cost of equivalent improvements in reality.

10. Loren Brandt and Thomas Rawski have a good paper on China

Long before the recent boom, Qing-era Chinese society harbored elements favorable to economic growth. Wide dispersion of entrepreneurship, commercial acumen and sophistication, universal regard for education, informal contract enforcement mechanisms and competent local administration all contributed to the initial reform response and its subsequent extension... John Fairbank described China’s political culture and governing institutions as resting on “ancient structures of social order and political values that are too deep for rapid change.”189 These foundations, which shape both the strengths and the limitations of China’s recent economic boom, have survived the transition from empire to People’s Republic. Spanning Qing, the Republic and the PRC, these arrangements weave authoritarian hierarchy and personalist networking into a fabric that binds citizens to the state, motivates vigorous support for official policies and priorities, and enhances security for both rulers and citizens. This system provides essential protection for individuals and private business investment, but its economic costs embed permanent tension between the demands of political stability and economic development... In both the pre-1949 treaty ports and in the aftermath of the Cultural Revolution, the retreat of central control enabled episodes of economic openness and dynamism built upon ‘bottom up’ initiative and decentralized innovation.

11. A sobering reality check on India's private sector, a recurrent theme of several posts in this blog. This on startups is very relevant,

Attracting large PE investments for building businesses built on purveying, say, education services or payments online is more a testimony to the operational capabilities of these entrepreneurs — no small achievement in India’s chaotic business environment — than their innovative capacities.

12. Celebrity tweets, the herd runs. This is the new world of equity market investing. Sample this from Jason Zweig,

At 10:32 a.m. Eastern time on Jan. 26, Mr. Palihapitiya tweeted that he had bought call options on GameStop, adding: “Let’s gooooooo!!!!!!!!” By the end of the next minute, GameStop’s price had jumped 9.6% as trading volume quadrupled, with nearly 10,200 lots of 100 or fewer shares changing hands, according to a Wall Street Journal analysis of market data from DTN. 

At 4:08 p.m. Eastern time the same day, Mr. Musk tweeted, “Gamestonk!!” More than a quarter-million shares traded immediately and, by the time 10 more minutes had elapsed, GameStop had shot up 31%. The shares, at roughly $144 before Mr. Musk’s tweet, surged to nearly $348 the next day, then fell to about $50 by this week. 

On Feb. 3, Mr. Cuban tweeted, “If I had to choose between buying a lottery ticket and #Dogecoin .....I would buy #Dogecoin.” Over the next 12 hours, the digital currency shot up roughly 50%.