'Sticky pricing' in pharmaceuticals

Econ 101 informs that competition lowers prices. In reality that's not always the case. 'Sticky pricing' is an example of deviation from the norm. Consider the case of Gleevec,

When Gleevec came on the market, its list price was about $26,000 a year. Today, there are several highly effective drugs in the same family on the market (sometimes called “sons of Gleevec”). The list price for each is about $150,000 annually. What happened is that each new entrant cost more than its predecessors, and their makers then increased their prices to match the newcomer’s. When the first generic version entered the market in 2016, its list price was only slightly less, about $140,000. This phenomenon, what economists call “sticky pricing,” is common in pharmaceuticals. It has raised the prices in the United States of drugs for serious conditions including multiple sclerosis and diabetes even when there are multiple competing drugs. The problem is that companies have decided it is not in their interest to compete.

The article identifies behavioural response and not collusion as the reason for such pricing, 

In situations where there can be only one winner, competing is a given. But a lot of life and a lot of business just isn’t like that, especially when a group of companies are all doing good business by selling a type of drug for a very high price. There’s cover in numbers. When you’re driving on the highway where a speed limit is 55 and most everyone’s going 70, you’re likely to increase your speed, too. Why should you feel bad? Why would the cop single you out? Someone else in a flashy car is probably doing 90. (For drug makers, Mr. Shkreli would be the hot-dogger who gives others cover.)

The parties are not really colluding. Drivers aren’t calling one another up to agree to drive too fast; no manufacturers (one hopes) are sitting at a country club agreeing to keep their prices high. This makes drug makers difficult to prosecute under racketeering or restraint of trade laws. And shaming is in the eye of the beholder. The companies’ “stakeholders” are not really, after all, patients, but shareholders, who most likely will support attempts to make as much money as possible.

How do countries deal with Pharma pricing? 

But while drug prices in America are going up, many of the same drugs are cheaper — and repeatedly have their prices lowered — in other developed countries, where governments step in to regulate costs. These countries conduct large-scale negotiations to set a national price or price ceiling that its government or hospitals or citizens will pay — a kind of speed limit. Some stipulate that prices decline as a drug ages... This is true of countries that have a national health system and those that do not. And price regulation can coexist with that American value, competition. Armed with an assessment of a drug’s utility, Britain’s National Health Service sets a price it is willing to pay pharmacists for medicines they dispense. The pharmacists, who are in business for themselves, can then source the medicine from any wholesaler. The more cheaply they can procure the medicine, the more they profit. Patients pay only a small portion of the cost and there is overview to correct for “market failure” — a situation in which pharmacies are making too much or too little from this arrangement.

Eli Lilly's decision in 2019 to reduce the price of its best-selling insulin brand, Humalog, to $137.35, is a good example of price gouging by Pharma companies. Even if the decision was packaged as a new generic version, the drug is being produced in the same factory where the original Humalog is being produced. The same Humalog retails at $45-55, inclusive of all taxes and markups, in Germany, and its price in the US has risen from $35 when it was launched in 2001 to $275, a rise of over 600% in less than two decades.

More inconvenient truths on the private equity industry

I have blogged earlier on several occasions about the distortionary influence of private equity practices on financial markets and their physical investments. In terms of performance, Oxford Professor Ludovic Phalippou has shown that private equity funds have done no better than public market indices since at least 2006, but have enormously enriched their fund managers.

One such practice is that of subscription-line financing, which artificially boosts the fund manager's returns. 

New money pledged by investors is widely used by private equity managers as security for bank loans that are then used to pay for buyout deals in advance of receiving the clients’ capital. This technique, known as subscription-line financing, helps private equity managers earn lucrative performance fees because a key assessment metric, the internal rate of return (IRR), is based on the date when an investor’s cash is put to work. Delaying the date when client money enters the fund boosts the IRR but it also reduces the ultimate cash flow to investors because they pay the fees and interest on the bank loans... Subscription lines historically had a maturity of one year or less but they have now evolved beyond such short-term financing. Ultra-low interest rates have encouraged many private equity managers to extend subscription lines over several years and even to use this borrowed money to make repayments to investors in advance of realising profits on any of their deals. Since it is possible for distribution of profits to begin before clients have paid a penny, the IRR can, in theory, be infinite. However this financial engineering does not raise the actual amounts earned by investors...

ILPA (a body representing investors in buyout funds) said managers should report net IRRs both with and without the use of subscription lines and also provide a clear explanation of their calculation methodology. No universally accepted method exists for calculating IRRs, which has encouraged managers to extend their use of subscription lines in an effort to flatter performance comparisons with their competitors... Private equity managers routinely use “since-inception IRRs”, which measure their lifetime performance as part of their marketing to investors. Early PE funds performed well and this ensures since-inception IRRs remain at an artificially high level, provided private equity managers avoid major disasters.

An example of how since inception IRRs distort the picture is below, 

Apollo reports its since-inception IRR as 39 per cent gross (excluding fees). This would transform an investment of $100m made in 1990 when Apollo launched into $2.3tn. Apollo’s assets under management stood at $316bn at the end of March. “In 50 years, assuming no major disasters, Apollo’s gross since-inception IRR will still be 39 per cent. Since-inception IRRs are an absurd measure of performance,” says Mr Phalippou.

Recently the US regulators allowed 401(k) plans to invest in private equity. This opens up $6.2 trillion in assets to the PE industry. A recent study of pension plans by Richard Ennis found that diversification into alternative investments have not only not helped but has also been a drag on performance,

The diversification of public pension funds and educational endowments is explained by a few stock and bond indexes alone. Alternative investments ceased to be diversifiers in the 2000s and have become a significant drag on institutional fund performance... The cost of institutional investing is 1.0% to 1.7% of asset value annually. Public pension funds underperformed passive investment by approximately 1.0% a year for the 10 years ended June 30, 2018; the shortfall of educational endowments was 1.6% a year... Given the extent of institutional diversification, the diminished effect of alternatives, and the funds’ prevailing cost structure, institutional investors face the prospect of continuing significant underperformance in the years ahead.

The author advocates "much greater use of passive investment management as a way to bring cost into line with the characteristic diversification of institutional investors".

All this assumes significance in light of the rapid growth of the PE industry in recent times. PE firms have amassed $3 trillion in dry powder, make up nearly 40% of the M&A deals in the US, and the five biggest listed PE firms are collectively worth more than $250 bn.

Weekend reading links

1. Andy Mukherjee on the over-burdened NCLT,

Across the country, 27 tribunals are being run by 29 judges; at least 25 short of what’s required. Many have no experience in financial matters. One judge, M.B. Gosavi, sits on four benches. Cases from Noida, a suburb of Delhi where big builders have defaulted to homebuyers, land before a single tribunal member 300 miles away. The insolvency courts also adjudicate unrelated matters under the Companies Act, overwhelming an already strained system.

2.  The Insolvency and Bankruptcy Code may be a good example of iterative adaptation,

The IBC is a road under construction. The Insolvency Law Committee continuously reviews its workings to identify issues impacting efficiency and effectiveness, and makes recommendations to address them. In less than five years, the Code has witnessed six major legislative interventions.

3. Forward guidance by Bank of England about how it plans to exit the monetary accommodation,

The BoE’s main interest rate that is currently 0.1 per cent — known as Bank Rate — will rise first. But when it reaches 0.5 per cent, the BoE will switch its focus and start to reduce its balance sheet by not reinvesting the funds it receives as its holdings of government and corporate bonds mature. If that proceeds smoothly, the central bank might start raising rates above 0.5 per cent. When this main rate reaches 1 per cent it will consider actively selling some of its bonds, leading to a quicker reduction in the balance sheet.

There is an important difference in the BoE's strategy, 

Note that this exit strategy prioritises reducing the BoE’s balance sheet, a very different plan to the one the central bank put in place after the financial crisis. Back then, it did not emphasise balance sheet reduction, instead wanting its Bank Rate to reach 1.5 per cent before it considered unwinding its asset purchases. Reading between the carefully crafted lines of the policy statement, the BoE seems less concerned about reducing the balance sheet, so long as it is conducted in periods of market calm.

The Fed, with a $8 trillion balance sheet, continues to purchase $80 bn of Treasuries and $40 bn of mortgage backed securities a month, same rate as at the height of the pandemic. 

4. FT article about the success of the technology cluster around Cambridge University in UK,

The Cambridge cluster is now home to more than 5,000 knowledge-intensive companies with £18bn in turnover. Their nearly 70,000 employees account for three in 10 jobs in the area, according to Cambridge Ahead, which brings together academics and business.

Among the reasons,

A 1970 decision to set up the first UK science park helped spark a wave of entrepreneurship dubbed “the Cambridge phenomenon” but the broad growth took much longer... The attitude of Cambridge Enterprise, which began to commercialise the university’s intellectual property in 2006, was also key. While many universities promote spinouts, entrepreneurs and investors say that Cambridge is especially easy to deal with, even the most “founder-friendly” in Europe... In short, Cambridge is “a safe place to do risky things”, in a phrase coined by serial entrepreneur Andy Richards. As in much larger Silicon Valley, entrepreneurs feel comfortable striking out on their own because they know they can get a job somewhere larger if the effort fails. The bigger companies also provide a natural customer base for the start-ups. And investors take heart from the fact that many new groups have co-founders, advisers and board members who have succeeded before.

5. It's reported that KPMG has bid Rs 1 to win a seven-cornered bid competition to be the transaction advisor for the strategic disinvestment of IDBI Bank. 

Firms have been placing near-zero bids to manage privatisation of large public sector undertakings as a means to improve their portfolios and establish credentials in respective sectors. Deloitte had recently bid Re 1 to manage the privatisation of Bharat Petroleum Corporation (BPCL), and was appointed as the transaction adviser.

These bids are a matter of concern and should be discouraged. It's hard to believe that it would not impact the process. Even assuming the strategic advantage to the consultant in winning the bid in an emerging area (disinvestment and asset monetisation), it's difficult to imagine the consultant putting their best resources in managing this contract. I am inclined to believe that, for the consultant, winning the bid and being part of the early disinvestment has much greater signalling value than being seen as having contributed to a successful disinvestment. In our mainstream discourse, the failure of any disinvestment is attributed almost entirely on the bureaucrats and politicians, leaving consultants and others unscathed. This creates perverse incentives which encourage such ridiculous bids. 

In this context, there is also the danger that the big consultants collude to parcel out the bids and monopolise the emerging market area. 

Interestingly, while the government holds 45.48% share in IDBI Bank, LIC owns 49.24%. The latter too will apparently offload its stake to the new buyer. In theory LIC, therefore, should have a greater stake in the success of this. 

6. Stunning statistics about the challenge faced by the present generation of youth,

In the UK, people aged under 30 are now four times as likely to rent than they were two generations ago. In the US, a 2015 survey found home ownership among those aged 25 to 34 was 37 per cent, compared with an average of 45 per cent for the same cohort in previous generations. Analysis of US Federal Reserve data by the economist Gray Kimbrough shows the proportion of household wealth held by each generation has fallen over the years: at 35, baby boomers held 21 per cent of US wealth, compared with 8 per cent among Generation X, who were 35 in 2008. Millennials, who reach an average age of 35 in 2023, own 5 per cent of national wealth despite representing 22 per cent of the population.

And it reflects in their political views - satisfaction with democracy has declined and political preferences are changing.

According to a 2020 study by Cambridge university, faith in the democratic system had already experienced its steepest decline ever among 18 to 34-year-olds on the eve of the pandemic. They were the first generation to have a global majority dissatisfied with democracy in their twenties and thirties... According to a recent study by the Harvard Kennedy School, the proportion of 18 to 29-year-olds in the US who think the government must do more to stop climate change increased by 26 percentage points to 55 per cent between 2009 and 2021; the proportion who supported universal health insurance rose 17 points to 64 per cent; and those who believe immigration is a force for good rose 14 points to 37 per cent.

7. Fascinating article about how good private schools are distorting the property market in Chinese cities. 

Chinese property developers... have a tradition of building high quality private schools near residential projects to make the latter more appealing to home buyers... parents have long been drawn to the city by the quality of its private schools, most of which have been funded by property developers and have garnered reputations for academic excellence.

8. FT long read on the rise of private equity investments in affordable housing sector in the US to take advantage of affordable houses built with housing tax credits. 

9. Madan Sabanvis shines light on the state of the Indian economy. 

10. After its tech companies and private tutoring firms, the NYT points to a Chinese crackdown on idol worship and celebrity culture.

The Chinese government has taken a series of steps in recent days to rein in celebrity worship and fan clubs, amid growing concerns among officials that the relentless quest for online attention is poisoning the minds of the country’s youth. On Friday, the Cyberspace Administration of China banned the ranking of celebrities by popularity. The authority called for greater regulation of what it called the “chaos” of fan clubs and the power they wield over music, movies and television programs. The government also took a swipe at celebrities themselves... The move to clean up unruly fan clubs and discipline celebrities is the latest example of the increasingly assertive role that China’s governing Communist Party under Xi Jinping, an authoritarian leader, wants to take in regulating culture... the authorities have been alarmed by more extreme behavior on fan forums, like mudslinging between rival fan clubs and doxxing, which involves digging up personal details of individuals and publishing them online.

11. Times has an article on the plans to open a new coal mine in the northwest England town of Whitehaven which has been received with enthusiasm by the locals as an economic stimulus but is facing opposition on climate grounds. 

The proposal by West Cumbria Mining calls for investing 160 million pounds, or $218 million, in a mine that would create more than 500 well-paying jobs, ranging up to £60,000 a year. The coal would be used not in power plants, but instead in the making of steel, an industry still heavily reliant on coal. The mine would ease the reliance of British steel makers on imported coal to run their mills.

Sample the two sides of the debate. The environmental critics,

The mine’s opponents are gearing up for a fight. The organization Friends of the Earth recently held a meeting in Cockermouth, about a half-hour drive from Whitehaven, with a small group of volunteers to talk about how to discuss the issue with decision makers and prepare a door-to-door campaign. “From the Cumbrian point of view, having a coal mine doesn’t make much sense,” said Ruth Balogh, a local representative of Friends of the Earth.

The locals who see it as a stimulus,

“To me, it’s an opportunity to start creating an industry locally,” said Danny Doran, who works at a nuclear research institution. “Kids come up, and there is nothing available,” he added, speaking outside his home not far from the site of a former chemical plant where the mine’s processing plants would be built. Mr. Doran and others said they were resentful at what they considered outsiders trying to take away a golden opportunity. “I think there are too many do-gooders putting their nose in that don’t live in Whitehaven,” said Barry Patrickson, a trash hauler. He said that there used to be many places to work in Whitehaven, but that most had shut down. “It is a ghost town now.” Some so-called outsiders live in nearby communities on the edges of the scenic Lake District National Park, a magnet for tourists and people moving out of Britain’s cities.

This debate mirrors that taking place between developing and developed countries about mining and thermal plants in the latter. 

12. Fascinating long read about the businessman and human being that is Roger Federer,

... earn $1 billion during his playing career, a milestone he reportedly surpassed this year, joining Tiger Woods, Floyd Mayweather, LeBron James, Cristiano Ronaldo and Lionel Messi. Federer’s two decades of on-court achievements only begin to account for that stunning total: About $130 million of Federer’s earnings has come from official prize money, a figure that puts him second on the all-time list in tennis to Djokovic’s $152 million. The rest has come through sponsorships, endorsements, appearance fees at tournaments and lucrative exhibition events around the world... Some might still claim that he is the greatest player of all time... What is undeniable, though, is that no tennis superstar has ever built a financial empire comparable to Federer’s — and that this, more than his greatness as a player, might well be his most enduring legacy. If the bedrock of that billion-dollar brand has been his phenomenal on-court talent and graceful game, what he has built off the court has also been based on some extremely rare qualities: impeccable strategic instincts, along with the sort of personality that might be more suited to a boardroom or a political campaign than to a pro-sports arena, all combining to make Roger Federer the greatest player-mogul the tennis world may ever see.

This about his personality,

The French have a fine expression that applies to Federer: “joindre l’utile à l’agréable,” which translates loosely as “combining business with pleasure” but is actually broader in scope, encompassing the tasks of daily life. If you wonder how Federer managed to remain in the top 10 until age 40, part of the answer lies in his ability to embrace what some other prominent athletes might consider drudgery. That applies to long-haul travel, news conferences in three languages and mundane one-on-one interactions with various corporate partners. It is in that last category of task — his knack for delivering personalized service with sponsors — that Federer’s performance has been especially remarkable. Even in his early years, he would endeavor to visit all 20 of the sponsor suites at the Swiss Indoors to meet and greet. He has stuck with that philosophy. “He’s just so good if you’ve seen him with sponsors, with C.E.O.s,” Eisenbud said. “He just has the ability to make you feel like he really cares what you are saying and he has time for you. He’s never rushing you. If you’re a fan at a hundred-person event that one of his sponsors puts on and you are talking to him, he makes you feel he has all the time in the world to talk to you and hear what you have to say. I think it’s genuine, and I’ve never seen another athlete like that, and I think it has a lot to do with how he was brought up.”

Mike Nakajima, who was a director of tennis at Nike, remembered Federer coming one year to the company’s headquarters in Beaverton, Ore., for shoe testing at Nike’s research lab. They walked out of the building and were headed for their next meeting when Federer stopped in his tracks and said, “I’ve got to go back.” Nakajima asked him if he had forgotten something, and Federer said he had forgotten to thank the people who helped him with the shoes. “So we ran back into the building, downstairs, through security so he could say thanks,” Nakajima said. “Now what athlete does that?”

13. Srinath Reddy makes the case for abandoning the eliminate Covid 19 strategy and instead adopting one of co-existing with the virus through a combination of measures like masking and distancing, and vaccination. 

14. Matt Stoller (HT: Ananth) points to the role of management concepts and services contracting in the failure of the US strategy in Afghanistan. This from an Afghan General, 

Contractors maintained our bombers and our attack and transport aircraft throughout the war. By July, most of the 17,000 support contractors had left. A technical issue now meant that aircraft — a Black Hawk helicopter, a C-130 transport, a surveillance drone — would be grounded. The contractors also took proprietary software and weapons systems with them. They physically removed our helicopter missile-defense system. Access to the software that we relied on to track our vehicles, weapons and personnel also disappeared. Real-time intelligence on targets went out the window, too.

The US military like the corporate world appears to be another example of the pursuit of efficiency taken to its extremes - management consultants and their ideas being applied indiscriminately and outsourcing to keep costs down and harvest efficiency gains.

Some observations on the National Monetisation Pipeline

Much will be written and talked about the Rs 6 trillion National Monetisation Pipeline (NMP) of the Government of India to monetise revenue generating infrastructure assets through long-term concessions. (instead of outright sale). It'll complement the Rs 111 trillion National Infrastructure Pipeline (NIP). There is no doubt that both are welcome steps. 

This blog has written on multiple occasions on the need to signal intent and shape markets by announcing upfront the list of assets proposed for PPP financing and monetisation. This post will point to certain important requirements for successful execution of the NMP. 

As with PPPs, its implementation will be the real test. And like PPPs, there are no short cuts and implementation capacity and governance will be the critical challenges. This is especially so given the political economy and the generally deficient corporate governance standards. 

On the former (capacity), apart from isolated pockets, the state's ability to value, structure, tender, and contract assets is weak. The latter (governance) assumes even greater relevance given the general experience (and not just from India) of infrastructure service providers reneging on contractual obligations, stripping the assets, and seeking constant renegotiations at ever more favourable terms. Further, political economy concerns are never far away from infrastructure contracts. And controversies related to governance failings and crony capitalism can bring disrepute and derail the entire program.

There will be several suggestions to set up new institutional structures and the like to implement this. Most of them are likely to be superfluous, some (like an excessive focus on Dashboards etc) can even detract from the objective. This is an example of an oft-repeated suggestion which has little evidence and which is most likely a costly digression.

“If the Specific Relief (Amendment) Act 2018 is effectively implemented across India creating special courts for fast-track dispute resolution in PPP projects, it could significantly address some of these concerns.”

This, arguing for creation of a holding company to own and monetise all assets, is another one. 

There are some important requirements for the success of the NMP.

1. A clearly defined, stable, strong institutional mechanism is essential to implement this. It'll require a team of professionally competent officers with reasonably stable tenures, supported by professional experts, to ensure its effective implementation. There will also have to be clearly defined sets of procedures and protocols for approvals within Departments and Government of India at large.

The team's responsibility would be to assist Departments by responding swiftly and clearly to clarifications on processes, decisions on new concerns or issues, and facilitating inter-Departmental co-ordination. It should also create the principles and guidelines on which valuation approach to use where,  templates for different valuation approaches, project structuring templates, model tender documents, contracting principles, and model contract documents. The procedures and protocols should be clear enough and have equally clear accountability norms so as to ensure that approvals happen in a time-bound manner. The entire process should be reviewed at least once a quarter in detail by the Cabinet Committee of Economic Affairs. 

2. Given their very nature and the politically challenging environment, many of the NMP transactions, even if done with the cleanest intent, will most certainly ignite controversies, trigger litigation, and lead to vigilance and other investigations. Officers, especially those leading the monetisation, will be vulnerable to accusations, media trials, disciplinary proceedings, and even witch hunts. Even when the decision is clear, officers will resist taking them for fear of such repercussions. It's most certain to be one of the biggest deterrents to objective decision-making. 

There are no easy ways out. It'll require leaving officers to do what they do best, having higher institutional mechanisms to validate decisions, and for the political leadership to assume accountability where they should. In simple terms, there should be a distinction between due-diligence and process, and high-stakes decision-making.

Bureaucrats should be responsible for managing the process and sub-ordinate decisions. Given the importance of virtue signalling in such endeavours, a high level Committee, headed by a judge with unimpeachable integrity and professional repute, and consisting of similar others from diverse areas and public and private sectors, should be constituted to give the final stamp of approval on certain important decisions, especially relating to valuation. Policy and potentially politically fraught decisions should be the responsibility of the political executive in an appropriate forum - Minister, Group of Ministers, Cabinet Committees, and Cabinet. 

3. There should also be a clear escalation protocol for decision-making. For example, if there is lack of consensus and uncertainty within the bureaucratic and high-level Committee on the methodology to be followed for valuation of an asset, the decision should get escalated to the political executive, and they should be held squarely accountable for the decision. The escalation protocol should also have clear timelines. In this regard, the monitoring by the CCEA will help. 

4. Then there is the issue of getting the projects ready for monetisation. Many assets will have legacy issues, centre-state factors, and so on, which will require changes in rules and laws, some even legislative revisions. Resolving legacy issues relating to employees, land, and pre-existing contracts will be very challenging. There cannot be any comprehensive predefined and unambiguous guidance for resolving them. Discretion and judgement will be required to be applied on a case-by-case basis in many transactions. Again, in order to overcome the fear of subsequent investigations and disciplinary proceedings deterring officials, the political commitment and accountability is essential. 

5. It may be a tactically sound approach to confine the first round of monetisation to a few very easily monetisable assets, which are likely to be free from disagreements on valuation approaches or valuation itself, or without complicated legacy factors. The national highways are a good example of de-risked asset class. Pluck the low hanging fruits of assets with precedents of successful monetisation. Apart from helping establish credibility of the process, this would also help build internal capacity and assess market demands and capabilities. 

6. Any pipeline signifies a long-term nature of the asset monetisation program. That should be the case with NMP too. There should be an iterative approach to this involving constant improvements in the processes and documentations depending on emerging evidence and market conditions. This should be a major responsibility of the implementation team. The long-term nature also means that signalling intent and shaping market expectations, which are critical to attracting deeper pocketed infrastructure funds.

7. Valuation of any asset is tricky and an art. Most revenue generating infrastructure assets are regulated assets with stable and low returns profile. This also means that book value and enterprise value approaches are appropriate methods, depending on the nature of the asset. Further, given the political economy, incentives of governments to raise revenues for fiscal expenditures, and the volatility and irrational exuberance with public market valuations, the market value approach may not be a good method and should be deployed only under exceptional circumstances.

8. There are several likely risks with developers stripping assets through high dividend payouts and loading the asset company with debt, skimping on investment and other statutory obligations etc. Consider this. 

Given the operation and maintenance (O&M) interest in these long life-cycle projects and the public interest involved, any change in management that results from a financial restructuring would distort incentives and necessarily raise important regulatory concerns. For example, outright sale would limit the role of the original project operator in a long-term concession into that of a construction contractor. Or the original contractor could dilute his equity gradually... Both trends raise concerns about O&M commitment.

The nature of today's infrastructure financing market encourages these actions and more. This paper discusses the second generation issues of infrastructure contracting in detail and offers several suggestions to limit them. 

9. Finally, the cautions with privatisation and monetisation of infrastructure assets are well-known. Foremost, the government should avoid the urge to privatise to only raise money for fiscal expenditures. Instead, the primary objectives should only be to enhance economic efficiency and limit political economy inefficiencies due to public ownership. In the process, revenues will get generated. 

Update 1 (30.08.2021)

The track record on asset monetisation has been not very encouraging.

Fiscal federalism in graphics

Very informative Livemint graphics on fiscal devolution from central government to states in India.

The central government transfers 55% of its revenues to the states, as both tied and untied transfers, and they form 38% of the state's total revenues.

The state's self-sufficiency varies widely.

About 60% of central transfers are untied transfers, while the remaining 40% constitute central sector program funds.

Since the 11th Finance Commission, allocations are determined on the basis of ten parameters, with the 15th using six of them. 

The role of cess collections is interesting,

About 18% of taxes collected by the Centre are in the form of cess and surcharge. These are essentially a tax on a tax, and these collections don’t go into the divisible pool. This has peeved states, who complain they effectively get 42% of ₹82 and not ₹100. Post-GST, even as the number of cess items have reduced from 42 to six, their total collections have increased over the years... Seen another way, even as the Centre distributes money to states, it is using the cess route to safeguard its own financial interests.

On the sources of different tax revenues,

GST alone accounts for 44% of states’ own tax revenues, and 29% of Centre’s total tax revenues. Five items alone account for about 75% of states’ own tax revenues: state GST, state excise, taxes on vehicles, taxes on property and capital transactions, and taxes and duties on electricity.

Some thoughts from Jonathan Haidt

Finally got around to completing Jonathan Haidt's The Righteous Mind. Not a review, but some snippets. More as a record for reference. I had blogged earlier here and here.

Mind is not a black slate at birth. Haidt quotes Gary Marcus

The initial organisation of the brain does not rely that much on experience... Nature provides a first draft, which experience then revises... Built-in does not mean unmalleable; it means organised in advance of experience.

There are six foundational elements/dimensions of morality (or six systems of moral intuition)

1. Care/harm

2. Fairness/cheating or reciprocity/cheating

3. In-group loyalty/betrayal

4.Authority/subversion

5. Sanctity/degradation

6. Liberty/oppression

However, in their moral calculus, while conservatives use all six elements, liberals use only three - the first two, and the last element above. Therefore in any society the moral differences are about loyalty, authority, and sanctity (or purity).

This is what the Zen teacher Seng-Ts'an said,

If you want the truth to stand clear before you, never be for or against. The struggle between "for" and "against" is the mind's worst disease.

Liberals crave for openness and new experiences. Conservatives are exactly the opposite. Open individuals have an affinity for liberal, progressive, left-wing views. Closed individuals prefer conservative, traditional, right-wing views.

Social Entropy - order tends to decay over time

Our righteous minds were designed to

• Unite us into teams
• Divide us against other teams
• Blind us to the truth

We cannot go about our work in the world with the attitude that we are right and they are wrong, because everyone thinks they are right and the others are wrong. So to engage successfully with the world, we need to get out of the morality matrix or our self-righteousness.

Eastern religions avoid the binary view of the world. Instead, it talks about the co-existence of opposites - the Yin-Yang, Shiva-Vishnu-Brahma trinity etc.

Some takeaways from an interview with RSA:

1. Democracies suffer from atleast two problems. One, they create factions. Two, they promote short-sightedness. The Federalist Papers number 10 discusses how factions are bothered only about defeating each other, don't care about the social good, and can kill democracies.

The leaders in democracies face skewed incentives. They have little incentive to engage with problems which are likely to manifest only years ahead. Politicians are not rewarded for spending money for the future!

This problem cannot be fixed with electorate's education and literacy, but can be fixed only with institutions and policies. We need a system where political leaders should be explicitly mandated to solve long-term problems. One where the government's main job is framed as that of risk protection, to put in place the money and talent for contingencies which are unlikely to ever materialise.

2. Social media is a threat to democracy, in so far as it amplifies democracies' weaknesses more than it amplifies its strengths. Social media has emerged as an "outrage media", a wild-west where outrageous lies travels much faster than robust truths. Social media amplifies the trend that Mark Twain pointed to, "Bad news travels around the world by the time good news puts its boots on!" 

3. Even before the age of social media, the importance of story-telling or narrative was well known. People connect with narratives and stories. Social media helps people package ideas around narratives and disseminate far and wide. Further the nature of the platform allows fringe theories to easily get propagated and gain traction.

Haidt refers to 2009-12 as the period when the Tower of Babel fell. God said, "Let's go down and confound their language so that they don't understand each other".

Human reasoning does not take place in a logical world based on facts, instead it takes place in an emotional world based on stories. We don't write them. But we imbibe these stories. We may not be even able to tell them. When we hear a story which sounds familiar, we tag it as true.

4. There is a need to recapture the digital public square in the age of social media. Nobody can get away by throwing acid or stabbing people in a public square. But in case of social media, people hurl the vilest abuses and use despicable language and do that repeatedly at virtually no cost. There is a massive negative externality problem.

There is a need to have some kind of identity verification. Nobody should be allowed to create hundreds of fake identities and go about disseminating abuses and falsehoods. No democracy can survive with such a platform.

5. The conventional left-right divide has been transforming into a globalist-nationalist divide. The globalists are knowledge workers who favour openness. The nationalists are rural, real economy workers and more parochial.

The problem is amplified by the fact that the universities and the mainstream media are dominated by globalists. These thought leaders and opinion makers show contempt for the nationalists and consider them stupid. Some among these thought leaders are experts.

What makes it even worse is that experts often get it wrong. This is understandable given that on public issues there are rarely any right answers or solutions. But experts don't have the epistemological humility to acknowledge their limitations. We should follow the experts, but only as an input into the decision-making process.

6. The distinction between idealism and signalling. On issues, most people engage on social media platforms less for reasons of idealism and more for reasons of signalling to their audiences their  support for that issue. They do it out of some form of a duty to be supporting their group, an in-group loyalty.

In such cases, activists cannot win over their opponents through anger. Anger only reinforces the us Vs them mentality and widens the alienation. Examples from history show that activists who have succeeded have been those who have appealed to people's nobler instincts with messages of love and inclusion, and not by spewing anger and demonising the opponents.

7. The fragility of the Generation Z. They are not adequately prepared for democracy. They are too much protected.

Tax cuts and investment

One of the foundational beliefs of Econ 101 is that tax cuts put more money in the hands of businesses and investors, and thereby boost private investments. But there may be little empirical evidence to support this belief. This post points to evidence to the contrary, especially due to tax cuts on financial market incomes. 

I had blogged earlier questioning the conventional wisdom on lowering corporate tax rates. 

In one of her columns, Rana Faroohar had pointed to this graphic from a McKinsey study capturing the trends in investment and labour and capital incomes with changes in corporate tax rates. 

The empirical evidence from the last three decades show that contrary to conventional wisdom, tax cuts, as in UK and US, actually lowered investment whereas tax increases boosted investment.

Noah Smith has a very informative article that questions another version of this belief. It holds that if public policy encourages financial investment with financial market deregulation and rewards it with the likes of lower capital gains and dividend taxes, people will save more, envelope of financial market capital will expand, cost of capital will decline and business investment will increase. 

However, the reality has been very different. While corporate bond yields have been on a secular decline, net domestic private investment as a share of GDP has not only not risen but may actually be also tapering down. 

There are three assumptions. One, deregulation and lower taxes will boost financial capital. Second, the expanded supply of capital will lower cost of capital. Third, the lower cost of capital will boost investment. 

The first two are accounting realities. However, it's debatable as to how much of lower cost of capital is due to the deregulation and lower taxes, and how much is due to structural factors in the world economy. The long secular decline in interest rates pre-date the monetary accommodation of the last thirteen years. 

The third assumption, as the graphic below from the St Louis Fred shows, is not borne out by reality. 

The findings of two studies quoted by Noah Smith go against the conventional wisdom. This study on dividend tax cut,

This paper tests whether the 2003 dividend tax cut—one of the largest reforms ever to a US capital tax rate—stimulated corporate investment and increased labor earnings, using a quasi-experimental design and US corporate tax returns from years 1996-2008. I estimate that the tax cut caused zero change in corporate investment and employee compensation.

And this on capital gains tax cut,

But the case for large investment effects of lower capital gains rates appears overstated. First, preferential capital gains treatment incentivizes some income sheltering that may cause misallocation and prevent capital from being employed in its most productive use. Second, the majority of venture capital comes from large institutions like pension funds, endowments of universities, charitable foundations, and sovereign wealth funds, which are already tax-exempt. Third, it is hard to imagine entrepreneurs making decisions about investment and risk on the basis of the capital gains tax regime: Mark Zuckerberg was not focusing on the capital gains tax when he was in his dorm room coding up Facebook. Bell, Chetty, Jaravel, Petkova and Van Reenen reach the same conclusion based on comprehensive data on U.S. inventors, arguing that tax cuts do not produce more Einsteins. Finally, in a related context, empirical evidence suggests that dividend tax cuts that decrease firms’ cost of capital in similar ways to the capital gains tax do not affect investment.

Smith has this definitive conclusion,

In other words, making asset markets more attractive, in the hopes that this will entice businesses to invest, has been a bit like pushing on a string. It’s likely that when capital costs get low enough, big business finds financing to be less of a constraint. The broken link in trickle-down economics — even the smart kind of trickle-down — is the one between financial investment and business investment. We may use the same word for both of those activities, but rich people and mutual funds buying up stocks and bonds simply isn’t the same thing as companies purchasing equipment, building buildings or training workers. The economic theories that draw a link between the former and the latter are simply not good descriptions of the way the business world makes decisions.

Instead of tax cuts, he argues in favour of public investment and industrial policy to spur private investment. 

As I blogged here, I am inclined to take a nuanced view on this. For long tax rates were high and it indeed constrained investment decisions. However, over the last two decades, financial market and business tax rates globally have come down. In this changed circumstances, tax rates are no longer a constraint on investment decisions. In the present situation, arguments in favour of lowering tax rates are purely self-serving and serve little public interest or aggregate economic welfare.

Fortunately, in recent times, the trends on corporate tax rates have reversed and there is a genuine belief that corporate tax rates should increase. It may only be a matter of time before the same winds of change reverse the conventional wisdom on tax rates on dividends and capital gains.  

Weekend reading links

1. NYT has a feature on the flood of venture capital into artisan ice creams in the US. Like elsewhere in the startup world, this too has had its corrosive effects,

... “angel investors” were everywhere, offering large investments to incubate the transition from small store into juicy acquisition target. Few owners could resist. “People are like, ‘I’m going to be the next Ben & Jerry’s because I listened to whatever that podcast is,’” Ms. Freeman said. Going down the acquisition path meant a frantic scramble for exposure as well as access to freezer shelves, an expensive enterprise that, people say, can be more about connections than how good the ice cream is... The industry shifted from multiple distribution channels to a “warehouse-driven model” dominated by packaged food corporations, he said. As a result, he added, “artisanal brands have to go to retailers and pay an enormous amount of slotting” — industry speak for fees to get placement on store shelves, which can run as high as $40,000 per flavor... 

“Too much money and a lack of business expertise,” Mr. Bucci said when I asked him what had gone wrong. “It’s disheartening,” he added. “The waste blows your mind.” Quoted in an article that dissected the collapse for Medium’s Marker publication this year, an Ample Hills co-founder, Brian Smith, called the business “a runaway train of raising and raising and growth and growth.”... “Investors have urged us to grow,” Ms. Gallivan said. “It’s tempting because they’re dangling all this money and saying, ‘We’re going to get you in supermarkets across the United States.’” She was skeptical. “We’ve seen a lot of people fall in that trap,” she said. “They grow way too quickly, get overextended and ultimately collapse.”

Finance loses its disciplining powers when it becomes plentifully available.  

2. Contemporary Amperex Technology Ltd (CATL), the world's largest electric car battery maker, based in the Chinese coastal city of Ningde, has unveiled a new battery which runs on the cheap and abundantly available Sodium instead of Lithium. CATL dominates the global production of lithium iron phosphate batteries which use iron and phosphate instead of the more expensive nickel and cobalt. However, its global dominance is based largely on its presence in China, outside of which CATL is only one of the challengers to the South Korean and Japanese battery makers. 

3. As the amendments to the Electricity Act 2003 is being debated, the Business Standard has a graphic which categorises different states based on their tariffs.

4. The Covid 19 period have seen a steep rise in gold loans, a proxy for economic distress,

Gold loans have surged nearly 85 per cent over the past year, to Rs 60,464 crore… The outlier growth in gold loans compared to any other segment was also aided by the Reserve Bank of India’s (RBI’s) move to hike the loan-to-value (LTV) ratio for such loans from 75 per cent to 90 per cent… Take a look at the gold auctions. Mannapuram Finance had auctioned Rs 8 crore worth of the yellow metal in the first three quarters of FY21. This shot up to Rs 404 crore in the fourth quarter and further to Rs 1,500 crore in the June quarter.

5. In the context of the perception of stock market dominance by the tech giants, Ruchir Sharma draws attention to the tenuous nature such leadership, 

Data going back to 1970 shows companies that finished a decade in the top 10 saw median earnings gains of around 330 per cent over the course of that decade, and their stocks beat the market by more than 230 per cent. The top 10 of the 2010s were not that different from the norm: earnings were up 350 per cent and their stocks outperformed the market by 330 per cent. By the end of the 2010s, the top 10 accounted for 16 per cent of global stock market value, which was similar to the top 10 share at the end of the 1970s and 1990s. Given how popular US tech brands have become, it is widely forgotten that a decade ago Amazon and Facebook were not in the world’s top 100 companies by market value. Yet their meteoric rise is not that unusual, either. On average, companies that reach the top 10 rise by around 75 places over a decade to get there, then fade. Since 1970, companies that finished a decade in the global top 10 have had a less than one in five chance of finishing the next decade there. Oil companies ruled the list in the 1970s, followed by Japanese banks in the 1980s. Tech names reached the top in the 1990s, but the cast keeps changing. Only two European tech companies, Deutsche Telekom and Nokia, have ever cracked the top 10, flashing into that club during the 1990s before quickly falling off. Only one company, Microsoft, has reinvented itself often enough to stay in the top 10 club for three decades…

In the decade after companies reach the top 10, they typically see earnings growth fall over the next 10 years from 16 per cent a year to 4 per cent. As earnings growth slips, so does profitability and market appeal. After finishing in the top 10, the giants usually see returns turn negative, and their relative performance shrinks by 70 per cent over the next decade. In effect, they give back all of the gains they made in their run to the top. On average, top 10 companies slip over the next decade by around 60 places in the rankings — an outcome that should not be mourned.

He points to unwieldiness of large companies, capitalism’s dynamic of creative destruction, regulatory attacks, technological disruptions, declines in earnings growth etc as reasons for these trends.  

6. Gideon Rachman writes about the geopolitical consequences from the uncertainty and instability caused by Taliban's takeover of Afghanistan. The quick surrender of the US-trained Afghan army without any fight has been remarkable. This should count as a rare bloodless rebel victories in history. 

The billions spent by the US arming and training the Afghan army appears to have been wasted, and the ultimate beneficiary appears to be the Taliban who've now captured the weapons and equipment from the fleeing Afghan army. The amount of money spent by the US in Afghanistan is massive,

Of the approximately $145 billion the U.S. government spent trying to rebuild Afghanistan, about $83 billion went to developing and sustaining its army and police forces, according to the Office of the Special Inspector General for Afghanistan Reconstruction, a congressionally created watchdog that has tracked the war since 2008. The $145 billion is in addition to $837 billion the United States spent fighting the war, which began with an invasion in October 2001. The $83 billion invested in Afghan forces over 20 years is nearly double last year's budget for the entire U.S. Marine Corps and is slightly more than what Washington budgeted last year for food stamp assistance for about 40 million Americans.

The Taliban’s track record evokes deep concerns, 

When the Taliban previously ruled Afghanistan from 1996 to 2001 it enforced a literalist interpretation of Islamic law, carrying out public executions, stoning women accused of adultery and cutting off the hands of accused thieves. It was subsequently driven from power by a US-led invasion following the terror attacks of September 11 2001.

C Rajamohan examines Afghanistan's history in recent decades and examines its geopolitical implications. He urges India to wait and watch, and engage opportunistically.

Profile of Mullah Abdul Ghani Baradar, the Taliban leader who's expected to takeover as President.   

7. John Taylor argues that technology businesses are fleeing California for places like Texas, due to the state's high personal and corporate tax rates, high property prices, restrictive land-use regulations, progressive labour regulations, stricter occupational licensing etc. He writes, 

According to the Pacific Research Institute, California has the second-highest regulatory burden on employment of all 50 states. The ranking is based on a composite score of seven labour regulatory categories: Worker compensation, occupational licensing, the minimum wage, lack of right-to-work laws, mandatory medical benefits, unemployment insurance, and short-term disability regulations. Each regulation — even hidden ones like occupational licensing — creates compliance costs, the burden of which is relatively greater for small start-ups.

In simple terms, Taylor appears to be arguing against progressive labour regulations. Or is it a case of such regulations having gone too far?

8. The Government of India has unveiled a jobs subsidy scheme which offered to cover the full 24% mandatory employee and employer contributions to EPFO for new hires with salary upto Rs 15000 per month. The scheme is from 1 October 2020 to 31 March 2022. Its uptake till date

9. TT Rammohan writes about the findings of the Parliamentary Standing Committee that examined the working of the India Bankruptcy Code (IBC). 

In India, creditors decide the future of an insolvent firm with the help of an administrator called the Resolution Professional (RP). The National Company Law Tribunal (NCLT) is the adjudicating authority. The idea is that with banks having messed up in a big way, it is better to carry out resolution under the auspices of independent authorities. Alas, it turns out that the RP is a weak link in the chain. The Parliamentary Committee has scathing observations to make about RPs. Many are graduates. The regulatory authorities have pursued disciplinary actions against 123 RPs in a total of 203 inspections carried out so far. The Committee wants a self-regulatory body to oversee professional standards for RPs akin to the Institute of Chartered Accountants of India. As for the NCLT, its processes are plagued by delays. There are delays of over 180 days in 71 per cent of cases. The NCLT takes a long time to admit cases in the first place —the Committee wants cases to be admitted within 30 days. One reason for that is, as in the judiciary, several positions on the NCLT bench remain unfilled. The NCLT is 34 members short of the sanctioned strength of 62 members.

On the critical issue of haircuts, he argues for some reforms,

It is more important to get the estimate of liquidation value right and to get as many parties to bid as possible. Let there be an independent evaluation of a sample of liquidation values and auction processes. Were the estimated liquidation values appropriate? Was every effort made to open up the auction to a large number of bidders? The answers will shed light on the effectiveness of the IBC process and help address infirmities. It may be useful to create an Office of Independent Evaluation at the Insolvency and Bankruptcy Board of India (IBBI) similar to the one that obtains at the International Monetary Fund.

10. FT points to a study which analysed 104 companies from N America, W Europe, and Australia that started with a market capitalisation between $150 m and $10 bn, and generated a total shareholder return of at least 350 per cent in 2015-20 period. It excluded all companies in energy, materials and financials sectors, and required companies to have positive revenue growth and EBITDA for previous 12 months.

Its findings of the study run against significant amounts of received wisdom about the dire lack of fast-growing companies in Europe compared to the US. Of the 104 companies to make the final cut, those in western Europe made up 55.7 per cent of the total compared to 32.7 per cent in North America, with Australia accounting for the rest.

The study finds,

The S&P 500 returned 55.45% from June 2015 to June 2020 while the average return of the set was 922% and the highest performer returned 9,199%.

11. Container shipping industry's windfall year,

AP Moller-Maersk A/S, the world’s biggest container shipping line, was expected to make around $4.5 billion in operating profit in 2021, according to estimates at the start of the year by the financial analysts who follow the company. Their estimates have turned out to be totally wrong. Due to surging freight rates stemming from global supply chain snarl-ups, the Danish shipping giant is now predicted to make around $14.5 billion this year. Maersk’s extraordinary financial results are being repeated across the industry. If freight rates keep rising, the container lines could collectively make $100 billion in operating income in 2021, according to Drewry Maritime Research. For context, that’s more than 15 times the profits they generated in 2019 and nearly as much as Apple Inc. makes in a typical year... Germany’s Hapag-Lloyd AG has earned more in the last six months than in the previous ten years combined.

The industry is heavily concentrated with top 10 liners, forming three alliances, making up 80% of the traffic. 

12. Vivek Kaul has an excellent article on the perils of concluding with partial information and survivorship bias. He points to deficiencies in an analysis of HDFC Bank that uses its housing loan data to conclude that housing affordability in India has increased over the years. Instead, the data only highlights that HDFC is becoming ever better are self-selecting itself to attract only the better-off and most credit worthy housing mortgage applicants. 

13. FT has a long read on the disruption happening in the $548 bn (2019) global remittance transfers business due to fintech startups. 

The conventional model was to transfer money cross-border using the correspondent banking approach, whereby a remittance sent by a customer of a domestic bank went through three other banks, each of which took a fee and a foreign exchange mark-up. Into this entered startups like Wise with their "netting" approach,

Kristo Kaarmann, an Estonian, was working in London for Deloitte. Taavet Hinrikus, a UK-based friend, was toiling in Estonia as a financial consultant. “I was sending money to Estonia and he was sending money to the UK. We were both losing thousands in hidden foreign exchange mark-ups,” Kaarmann says. “So we set out to do transfers without banks. Every month we looked up the exchange rate. I topped up Taavet’s UK bank account and he topped up my Estonian account by the equivalent amount.” The beauty of the arrangement was that no money needed to cross borders... Wise claims its money transfers are up to eight times cheaper than UK high-street banks. A transfer of £1,000 costs just £3.75. Wise also aims to be faster, with four out of five payments arriving in a day or less. Remittances via the correspondent banking network can take two to five days, with each link in the chain settling on consecutive days... Kaarmann and Hinrikus originally hoped their “netting” — reciprocal payments in matched countries — would be the bedrock of their business. In practice, it constituted only around 15 per cent of $74bn in transfers via Wise last year, because flows between two countries are typically lopsided. Chief technology officer Harsh Sinha says the efficiencies that make Wise price competitive come largely from bulk dealing in currencies and connecting domestic payments systems in each country where it operates.

14. Finally, Bloomberg has an article on China's property bubble. It has continued to remain elevated despite several measures like suspension of property auctions by cities and talks of introduction of property tax in recent times to cool the market. 

Despite Xi’s admonishment that “housing is for living in and not for speculation,” and the government’s regular entreaties to banks to scale back property lending and increase the flow of credit to small business, the share of funds directed to the industry has risen. Real estate loans have increased to more than 27% of total yuan advances, from less than 20% a decade ago, according to People’s Bank of China data. Moreover, this is certainly an understatement — at least according to the country’s head banking regulator, who ought to know. Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission, wrote last year that the real share of property-related loans is more like 39%, or 70 trillion yuan ($10.8 trillion)... With yields so low and no ongoing taxes to pay, many investors choose to keep their apartments vacant. China had more than 60 million empty dwellings as of 2017, with the biggest cities (tiers 1 to 3) having vacancy rates of 17% or more, according to a 2020 paper by Harvard University’s Kenneth Rogoff and Yuanchen Yang of Tsinghua University.

Startups and risk capital

I admit that I've been pleasantly surprised by the positive momentum change in private capital flows into India. The decoupling from China has been an unexpected development. But it also is perhaps a tipping point effect with the maturity of India's startup scene. Even if these are all mostly entrepreneurs copying tried and tested ideas from developed markets, the size of the Indian market (even if much smaller than expected) is large enough to absorb large volumes of capital to support local champions, especially since most of these are services.  

For a capital starved economy, this spurt of foreign risk capital is a much welcome trend. First, for the last few years, there has been a consistent upward trend of private equity investments which now dominate the total foreign direct investment in India. In the last two years, there has been a surge in foreign venture capital in Indian start-ups, a trend accelerated by the developments in China. Now recently, mature Indian start-ups have started the to go public with their IPOs, a trend which looks likely to gain momentum in the months ahead. While these are all largely foreign capital, the wealth generated by successful Indian founders may be amplifying the start-up boom. Consider each of these. 

I have written here about the growing dominance of private equity in India's FDI composition and here and here about the IPO boom. The current year looks likely to set a record on capital raising through IPOs,

India Inc has raised over Rs 42,000 crore though 28 IPOs in seven months till date... this could easily cross Rs 1 lakh crore by December should the secondary market maintain its tempo. Besides companies in traditional businesses, the bumper listing of Zomato is set to trigger a host of IPOs from other new-age companies including Paytm, PhonePe, MobiKwik, Grofers, PolicyBazaar, Flipkart Internet, Delhivery among others that have shown their intention to list this year... Data compiled by Prime Database shows that 34 more companies have already filed offer documents with Sebi, and are estimated to raise over Rs 71,000 crore through IPOs. Further, 54 companies have announced their intention to tap the primary market this year, and just 21 of them are estimated to raise over Rs 70,000 crore.

And this,

In calendar 2021, 58 companies have already filed draft red herring prospectus (DRHPs), which exceeds the combined tally of initial public offers (IPOs) in calendar 2019 and 2020. The number of IPOs can easily exceed 100 in 2021 if this trend lasts.

See also this and this on the IPO boom. 

Akash Prakash writes about the flood of foreign venture capital into startups in India, 

In the first six months of calendar 2021, $10 billion was raised by start-ups and private companies in India. In July, another $10 billion was raised, led by the mammoth $3.6 billion by Flipkart, the single largest fundraise by a private company in India. Contrast this with a total of less than $10 billion raised in all of 2020. At this rate, in 2021, we may see almost $40 billion being pumped into the Indian private company universe by global capital. This trend is further reinforced as even the unicorn IPOs are raising mostly fresh capital (not just secondary sale)... For perspective, $40 billion is Rs 3 trillion, almost 2 per cent of GDP, that is being effectively pumped into our economy by foreign funds.

However, a majority of these capital raising are intended to provide an exit to existing PE/VC investors instead of growth capital for companies,

Investors and promoters raised around 62.5% or ₹17,140 crore through offer-for-sale (OFS) out of the total money raised through IPOs, according to data from primary market tracker Prime Database. The remaining ₹10,278 crore, or 37.5%, went towards fresh capital raising by companies. The dominant contribution of secondary share sales in the overall fundraising in the first six months of 2021 is a continuation of a trend seen in the past few years, with PE or VC funds, which have invested large sums of capital in Indian companies in the past decade, increasingly using the primary market route to exit their mature investments... It was the same story in the past two years. In 2019 and 2018, too, the proportion of OFS in the total IPO fundraising was 73.8% and 72.5%, respectively. 

Malini Goyal in Livemint on the recycling of risk capital by the successful startup firms, especially the unicorns,

According to a data analysis by Zinnov, Indian unicorns have invested in 90 plus startups in more than 110 deals over the last decade. 19 of the 50 unicorns in India have made at least one investment in an Indian startup. A majority of the investments have been made by Zerodha, Paytm and Zomato, which account for more than half of all equity investments by active unicorns. Interestingly, despite the pandemic, the investment pace of these unicorns has remained consistent. This year has already seen 14 investments in the first half from the likes of Zerodha.

Take Zerodha’s Rainmatter funds for instance. Last year, it set up a dedicated team to focus on fintech startups. The Bengaluru-based fund functions more like an incubator that provides well-equipped workspaces and a funding of $100,000 to $1 million to innovative startups in the space of capital markets... Besides, being part of the Zerodha stable also helps these startups forge new connections in the industry and get relevant advice and mentorship to grow their product... Zerodha has invested in a range of startups including Streak (an end-to-end platform that creates, back-tests and deploys algos without coding), GoldenPi (India’s first online marketplace for fixed income instruments like bonds and debentures), Digio (bringing paperless documentation to business and consumers), Finception (aims to simplify all things finance for millennials from financial news to financial planning), Smallcase (a thematic investment platform that helps investors build a diversified low-cost portfolio) and Tradelab (builds cutting edge technology for capital market businesses). Through its fund, Zerodha’s attempt is to tap into adjacencies and focus on nurturing a vibrant ecosystem in the capital market with it at the centre.

Lenskart’s $20 million Vision Fund plans to invest up to $2 million each in startups that are synergistic to the eyewear, eye-care and omni-channel retail sectors. With 5,000 people, 750 plus stores and a daily processing rate of 20,000 for eyewear products, “startups that engage with us will have the potential to leverage all of this," says Lenskart co-founder Peyush Bansal... In 2019, Paytm had set aside ₹500 crore to invest in early-stage startups for the purpose. While each deal varies in its construct depending on the entrepreneur’s comfort, typically, Paytm prefers to take large strategic stakes (of 50% or above) and lets these startups leverage its platform to reach customers... Dream Sports has invested in FanCode, a sports content and commerce platform. This aligns well with the parent’s ambitions to become a one-stop solution for sports... Though no longer a startup and part of retail giant Walmart, Flipkart too has set up a $100 million fund called Flipkart Ventures. Over the last decade, the home-grown e-tailer has taken minority stakes in over 12 startups, including Blackbuck, Ninjacart and Shadowfax... The fund, managed by a dedicated team of experienced investment professionals, will do early-stage investments with a cheque size of $1-3 million for the first round which can go up to $5 million.

The attractions for unicorns and other successful startups to recycle capital,

Catching them young and investing in startups at an early stage through funds offers these unicorns a good entry point. Of course, the valuations are much lower. However, it helps them enter the fray from a position of strength. With a large user base and a deeper understanding of the digital landscape, the unicorns can spot emerging trends far ahead of others. Their young discerning founders think about risks very differently than the large traditional corporates whose risk appetite is constrained. Also, culturally unicorns can relate to these startups and their entrepreneurial energy a lot better.

The dynamism of the startup market as reflected in the soaring valuations, rising numbers of unicorns, flood of foreign capital, and surge in IPOs has also started to attract Indian domestic investors.

Domestic investors, including family offices and high net-worth individuals (HNIs), are pouring money into pre-initial public offering (IPO) funds to get early access to India’s major tech companies, which are getting ready to hit the stock markets... These include Edelweiss Wealth Management’s Crossover Opportunities Fund, which has raised ₹1,500 crore so far and plans to take the corpus of this fund to as much as ₹7,500 crore in the next 12-18 months. Trifecta Capital has raised ₹1,000 crore for its late stage and pre-IPO venture capital fund, while Kotak Investment Advisors has raised ₹1,386 crore and IIFL Wealth is raising up to ₹2,000 crore for its pre-IPO fund that will focus on tech companies... “Of the billions that are invested in India by private equity and venture capital firms, not even 10% is domestic capital. Most of our new-age technology companies are majority foreign owned with very little Indian capital. Why shouldn’t Indian investors have access to these companies? There is a strong demand and hence these pre-IPO funds are doing well with HNIs and family offices," said Anshu Kapoor, president and head, investment management, Edelweiss Wealth.

These positive developments provide an unexpected boost for the Indian economy. Akash Prakash makes an important point,

The reality is that all this money is being raised by the start-up/private ecosystem to spend. Money raised will be spent or burnt, such is the nature and the stage of life cycle of most of these companies. The money will be spent to hire people, build infrastructure, strengthen the core tech, accelerate demand and build the brand. None of these companies will just sit on the money raised. Mind you, this money is entirely equity, most of these unicorns do not raise debt... This may be the stimulus that the government was unable to provide due to a lack of resources. The stimulus will come from foreign funds, not the central government. Frankly, how does it matter where the money comes from as long as it is spent in our economy and is not debt?

Clearly foreign investors are becoming confident about India's economic prospects. I am inclined to believe that this flood of venture capital is more the "large market effect" at work, a driver of growth which China benefited enormously in its early stage where foreign investment played an important role.  With China becoming increasingly out of bound, foreign investors perceive the fear of missing out on the large Indian market. 

But, as Prakash cautions, it's important for India to keep doing the right things (or not take wrong steps) to keep the momentum going,

First of all, the proposed pricing and valuation of some of the new issuances in this space seem quite rich. It is inevitable that a few issues will fail and investors, including retail, will lose money. It is critical for our regulatory authorities to hold their nerve at this point. Just because some issues may fail, we cannot shut the door to IPOs by the start-up ecosystem or raise significant hurdles to listing. Any change in regulatory stance will only make monetisation more difficult or push eligible companies to list overseas, neither of which helps our markets or the economy. We must also be careful to guard against the perception of a lack of a level playing field. Many global investors are continually worried that domestic lobbies can make the operating and regulatory environment difficult for foreign funded companies. Hopefully, there will be no discriminatory treatment of such companies. If investors feel the odds are stacked against them, they will not commit money. This perception must be nipped in the bud.

Then there is the critical role of what's happening in the US. This comment, made in the context of frothy valuations in the market for Active Pharmaceutical Ingredients (APIs) applies just as much elsewhere in the startup sector, 

“To say that valuations are frothy is an understatement," said Vishal Nevatia, managing partner at True North, a home-grown PE fund. “The key call that people need to take is how long will the liquidity that has been pumped in by the US Federal Reserve and other central banks continue. If inflation in the US picks up and interest rates increase, then there will be a huge question mark on valuations. That is a very difficult call because nobody knows what will happen. We are in uncharted territory," Nevatia said. “This kind of stimulus, both fiscal and monetary, has never been seen before."

As I blogged earlier here, the challenge for India is to manage the continuation of the existing hype around startups. 

There is the window for both attracting new risk capital and for recycling existing venture capital towards other newer enterprises. While countless retail investors are likely to eventually lose their shirts at such inflated entries, it's also likely to create a generation of wealthy local investors with both the capital volumes and the appetite to assume risks. Equally important, it has the potential to change the investor culture in India and thereby expand both the envelope and, equally importantly, the share of risk capital (among all financing savings) available in the country. This is one of the most important requirements for the sustainability of high national economic growth rates. However, this requires the party to go on for some more time. And that critically depends on what the US Fed does with its monetary policy actions. Indian startups should egg the Fed to keep the monetary gravy train going on. This, and not any real innovation in their activities, may well be the real creative destruction from the startup bubble.

It still remains to be seen how long the momentum can sustain, especially given the frothing secondary markets (globally too) and the questionable profitability of many of the startups. It also remains to be seen whether such foreign capital can be a significant substitute for the deficiency of domestic risk capital. Or whether the startup boom can significantly expand the envelope of domestic risk capital. But while it's on, this remains a very important and rare bright spot in the Indian economic horizon.