Thursday, October 6, 2022

Some thoughts on PLI as industrial policy

Two recent articles in Business Standard drew attention to the apparent success of the Government of India's Production Linked Incentive (PLI) scheme, at least in mobile phone manufacturing. 

The first was about the transformation being brought about in Koothanapalli, a village about 20 km from Hosur in Tamil Nadu, where Tata Electronics is setting up a factory to design and manufacture mechanical parts for iPhones. The second article is about Pegatron joining Foxconn and Wistron in setting up iPhone manufacturing facilities in India, and about Apple's plans to have a quarter of all iPhones manufactured in India by 2025. 

This is a teachable example of the complex nature of public policy which often conflict with the classical theories of industrial development and evidence-based policy making. In many cases, the substance of the policy is far outweighed by the stories and narratives that emerge around the policy. 

When compared to the task at hand, relocating supply-chains especially from China and attracting global contract manufacturers in various sectors to establish facilities in India, the PLI scheme outlay at Rs 1.97 trillion (~$25 bn) over five years is modest. The scheme extends 4-6% subsidy on incremental sales. However, this is only a small share of the at least 18-20% cost advantage, not to speak of several other locational and supply-chain advantages, enjoyed by manufacturers in China and Vietnam. This coupled with stiff production expansion targets the inevitable bureaucratic difficulties with accessing these benefits mean that the substantive benefits from PLI Scheme are limited. In fact, a recent Bloomberg Intelligence report estimates that it would taken about 8 years to move just 10% of Apple's production capacity out of China. 

In theory PLI is a good example of an incentive compatible industrial policy. However, in practice, purely by itself the PLI is unlikely to be substantive enough to be a game changer for India's manufacturing sector. 

It's therefore not surprising that despite the success of Apple's manufacturers, the Scheme itself is facing several problems. As I have written on multiple occasions, the success of the Scheme will depend on how nimble, flexible, and courageous are the relevant Ministries of Government of India in responding to emergent problems and trends and adapting the scheme guidelines(say, in calibrating import duties up the value chain). Policy making will have to become entrepreneurial in being able to reap gains from the PLI Scheme. 

However, I'm inclined to believe that despite the modest outlay and incentives, when compared to its objectives, and even if it does not achieve its quantitative targets within the scheme period, the PLI Scheme has the potential to move India's manufacturing ecosystem to the next level in both value addition and scale. I feel that PLI Scheme provides the policy instrument complement to the marketing campaign of Make in India, which is required to trigger animal spirits and investor confidence. It may be enough to attract the critical mass of a few big contract manufacturers to establish massive manufacturing facilities in the country, a crucial missing element (also here and here) in India's industrial landscape. 

These initial large manufacturers not only create jobs and bring technology, they also signal to prospective large foreign manufacturing investors that India is a serious and credible investment destination. Also, large manufacturers bring along with them the ecosystem of component and ancillaries manufacturers, which in turn both expands the base and productivity of manufacturing sector in the country. This is the catalytic effect of large manufacturers, an acutely felt deficiency in India's manfacturing sector. 

Independent of its own outcomes, if the PLI Scheme can help push India's manufacturing sector to its next level as mentioned above over this decade, then the Rs 2 trillion is more than well spent. It would be one of the highest Return on Investment (RoI) industrial policy examples. 

This is perhaps an example to avoid evaluating policies based solely on their substantive merits. The circumstances and their externalities matter, and are often more important than the policies themselves. To put this in perspective, if India's manufacturing sector moves to the next level in scale and productivity towards the later part of the decade, I'm inclined to argue that while the PLI's contribution by itself would be small (say, less than a tenth), it could not also have happened without the PLI Scheme. 

When examining policies, researchers and commentators fail to see the larger context in which they are being implemented. They are blind to the complex theory of change associated with major policies. More often than not, transformational changes in health, education, nutrition etc are not brought about through technocratically designed and targeted policies. Instead they are brought about by community and stakeholder mobilisation, which engenders a virtuous cycle of ownership and engagement, and which can in turn be triggered by standard policies and programs which are effectively implemented. The entire process has space for improvisation and innovation to improve design and implementation quality.

On the issue of attracting investments, assuming a reasonable level of development and macroeconomic stability (as in the Southern and Western Indian states), the argument in this post also draws attention to the importance of signalling intent and commitment by governments more than any hard fiscal subsidies. I had blogged last week on the stability premium which countries like India and Indonesia currently enjoy. I had also blogged earlier on the issue of signalling and ensuring hassle-free set-up and operational environments for investors. 

Monday, October 3, 2022

State capture by consultants

I had blogged earlier highlighting the concerns at the increasing role of consultants in advising governments. There are at least two problems. One, consultants typically consider efficiency or revenues maximisation as their primary, often sole, objective to the exclusion of others like equity, fairness, electoral mandates etc. I have again blogged extensively that this pursuit of efficiency to the exclusion of all else is extremely harmful. Two, consultants typically end up simultaneously advising both industry and government on the deeply questionable basis that they have Chinese Walls that ring-fence the engagement with both sides. 

In what will become an iconic example of consultants gone rogue is McKinsey's engagement with both the opioid and tobacco industry and the regulators. 

In late 2020, just before the Presidential elections, McKinsey agreed to pay nearly $600 million in settlements with attorney generals of all American States and its five territories on an opioid use investigation being pursued against it. The settlements helped McKinsey avoid full exposure and possible criminal indictments (with larger civil damage claims) on how it worked to drive sales of Purdue Pharma's OxyContin painkiller. This drug has been documented as being at the centre of the opioid crisis in the US that has claimed more than 450,000 lives over the past two decades.
McKinsey’s extensive work with Purdue included advising it to focus on selling lucrative high-dose pills, the records show, even after the drugmaker pleaded guilty in 2007 to federal criminal charges that it had misled doctors and regulators about OxyContin’s risks. The firm also told Purdue that it could “band together” with other opioid makers to head off “strict treatment” by the Food and Drug Administration...
In 2009, the firm wrote a report for Purdue saying that new sales tactics would increase sales of OxyContin by as much as $400 million annually, and suggested “sales ‘drivers’ based on the idea that opioids reduce stress and make patients more optimistic and less isolated,” according to a lawsuit filed in 2018 by Massachusetts. McKinsey worked with Purdue executives in finding ways “to counter the emotional messages from mothers with teenagers that overdosed” on the drug. In 2013, the federal government reached a settlement with Walgreens, the pharmacy chain, to crack down on illegal opioid prescriptions. Sales to Walgreens began to fall. According to the Massachusetts lawsuit, McKinsey recommended that Purdue “lobby Walgreens’ leaders to loosen up.”
See also this, this, and this.

NYT has excerpts from a new book on McKinsey by two of its reporters, Walt Bogdanich and Michael Forsythe (this is a review of their book). The scale of engagement with the tobacco industry was extensive,
For decades, McKinsey has helped manufacturers boost sales of the most lethal consumer product in American history — cigarettes... McKinsey began counseling the tobacco industry in 1956, when researchers had already reported data suggesting that smoking appeared to cause cancer... In 1964, Surgeon General Luther L. Terry settled questions over the dangers of smoking when he announced to the nation that studies had confirmed the link between cigarettes and cancer... In addition to Philip Morris, the firm’s clients included R.J. Reynolds, Lorillard, Brown & Williamson, British American Tobacco and Japan Tobacco International... As late as 2019, McKinsey’s roster of tobacco clients included not just Altria but also Imperial Brands, British American Tobacco and Japan Tobacco International... From 2018 through early 2020, McKinsey made at least $45 million in fees from these four companies, including more than $30 million from Altria alone, according to McKinsey billing records.

McKinsey saw nothing wrong in advising to maximise sales,

McKinsey saw merit — and profits — in continuing to help companies sell more cigarettes. In a slide deck prepared for Altria, formerly Philip Morris, McKinsey offered ideas for how the tobacco company could keep customers and lure new smokers. It presented a mock-up of what a Marlboro smartphone app would look like, complete with a way for loyal smokers to win points redeemable for small prizes... McKinsey also advised Altria on marketing e-cigarettes, with the goal of making one of its products the “Nespresso of e-vapor”... It wasn’t until 2017 that the consultancy performed a pricing study for Juul’s vaping device. Afterward, McKinsey offered advice on branding, organization, retail, flavor evaluation, youth vaping prevention and regulatory issues... Flavored nicotine had become highly controversial because health care experts blamed Juul for using flavors that appealed to young people... McKinsey had surveyed teenagers as young as 13, asking them to rank flavor names in order of preference.

But the most corrosive aspect was the simultaneous engagement with the regulators of the industry,

McKinsey’s most important work for Juul involved responding to the F.D.A.’s crackdown on youth vaping. With the F.D.A. circling, demanding answers as to why teenagers were so attracted to Juul, the company asked McKinsey to help prepare a defense and respond to the agency’s inquiry. The nature of that work remains a secret, because for those services McKinsey was paid through Juul’s law firm, Sidley Austin, allowing Mr. Alfonso Pulido, a McKinsey partner, to claim lawyer-client privilege... After Congress gave the F.D.A. the authority to regulate tobacco products in 2009, the agency sought McKinsey’s wisdom on a variety of issues, though its leaders apparently were unaware that the firm had been guiding Big Tobacco’s development for decades. In subsequent years, the agency awarded the consultancy $11 million for advice on tobacco regulation and for organizing the F.D.A. office that includes tobacco regulation... McKinsey’s services are highly valued... For companies selling addictive products it also offered deep ties to the Food and Drug Administration, a regulatory agency vital to their survival. In four years under President Donald J. Trump, McKinsey took in $77 million in consulting contracts with the F.D.A.

McKinsey's role in advising addictive industry clients like opiod and tobacco manufacturers on increasing their sales while also consulting for FDA to regulate the drugs and tobacco industry should count as the Great Conceit of Consulting. It's the clearest signal of state capture that McKinsey was even considered eligible to bid for FDA's consulting contract to regulate tobacco and drugs industry even as it was advising the industry also on how to beat FDA regulations.  

There are so many problematic issues here. One, given the widely accepted and official view linking tobacco to cancer, was it appropriate for McKinsey to advise tobacco manufacturers? Even more so in advising the opioid manufacturers? Two, even in advising tobacco and opioid manufacturers, was it appropriate to advise them on maximising the sales of their harmful products? Three, how appropriate was it for McKinsey to bid for the FDA contract, given the clear conflicts of interest? Four, shouldn't their extensive engagement with the industry have automatically barred McKinsey from bidding for a FDA contract? How disingenuous is the claim that FDA did not know McKinsey was also advising the industry? Or this from the book extract,
How could McKinsey, with its booming health care practice, justify advising hospitals and government agencies on how to reduce health care costs and improve medical outcomes when for years its tobacco clients were filling hospital beds with the sick and dying at an enormous cost to society?
These in turn raise fundamental questions about the business model in the consulting industry. Shouldn't it be mandatory for consultants to disclose their clients? This would especially be so for public contracting tenders. Do the public costs of confidentiality on clients far outweigh its private benefits? Shouldn't consultants be barred from advising both sides on the same issue/subject? In practice, how robust and credible are the Chinese walls within the consulting industry? If not credible, shouldn't regulators dispense with this pretence which provides a convenient fig leaf (and legal cover) to perpetuate egregiously bad practices? Shouldn't clearly suspicious round-abouts like engagement by a law firm to prevent scrutiny be barred? If their clients indulge in business practices which are subsequently found legally questionable and hauled up for civil or criminal liabilities, then shouldn't the consultants who advised on those practices be also similarly held liable vicariously?

It also raises questions (in the context of the US) about the practice of off-court settlements which allow businesses (consultants, financial institutions etc) to escape with relatively small financial penalties. Besides, these penalties are borne by the firm, thereby doing little to impact individual incentives on such predatory and abusive practices. 

Sunday, October 2, 2022

Weekend reading links

1. Business Standard writes about how Edtech companies are rapidly entering physical tuition centre business. To paraphrase Peter Theil in another context - we were told that Edtech would disrupt education at scale, instead we're getting tuition centre chains!

2. Nice story on the emergence of Koothanapalli in Tamil Nadu's Krishnagiri district as an iPhone component manufacturing hub. Tata Electronics in a JV with Taiwanese Wistron is venturing into iPhone manufacturing as part of the PLI initiative. India needs several Koothanapallis.

3. From Matt Stoller. Amazon promotes Dayna Howard, a former analyst at a private prison company, to the head of training for warehouse workers.

Following Howard’s path is interesting for what it says about Amazon. She started her career at the private prison giant known as Corrections Corporation of America, which has since been renamed CoreCivic because it had such a toxic brand. (Some fun controversies involved letting private gangs run an Indiana prison to save costs, and stock manipulation.) At CCA, according to her LinkedIn page, Howard “re-vamped inmate admission process and revised all processing documentation. Resulted in a 20% reduction in inmate processing time and a reduced error rate.” Howard was apparently good at designing systems to herd prisoners. So naturally, she went to Amazon.

At Amazon, she came to head their global security group, and then their loss prevention team, which is to say, she ran their efforts to stop employees and contractors from stealing. All of this is reasonable if distasteful; theft in retail is a problem and having internal security is a clear need for a firm like Amazon. But what is surprising is that Howard was then promoted to run their learning and development team, which is Amazon’s internal training program for all warehouse workers. There’s nothing illegal about any of this, but Howard’s career path does give us some perspective on how Amazon execs understand those who did not attend college and what they are good for.

Says a lot about the motivations and work ethics.  

4. Will the Pound Sterling breach the 1 US dollar level? See this

And this
To put the scale of shock engendered by the Truss-Kwarteng tax cuts, which has been uniformly chastised among economists, the bond market response has been worse than anything in the past 35 years (including UK's ERM exit, Brexit, and Covid)
The fall of pound and rise in bond yields (UK now compares with Greece) reflects genuine concerns at UK's ability to repay its debts.

5. Elsewhere in Europe, German inflation rose at a 10.9% annual rate in September, the highest rate recorded since 1951. This comes on the back of nearly 44% rise in energy prices in the month. 
6. Akash Prakash points to a BofA report which highlights the top performance of Indian equity markets in dollar returns terms.
Since December 1992, (almost 30 years of data) Asia ex-Japan equities have delivered a dollar return of only 3.7 per cent per annum (excluding dividends). In contrast, the US has delivered 7.8 per cent returns per annum. Japan itself had a return stream of only 1.1 per cent and Europe was 4.1 per cent. EMs as an asset class delivered 3.9 per cent... China was the worst performer at (-) 1.4 per cent and India the best at 7.3 per cent dollar returns over a 30-year period. The next best markets in Asia were Korea and Taiwan, which delivered dollar returns of 4.5 per cent and 4.4 per cent, respectively, over this period. India thus outperformed its closest peer in Asia by almost 300 basis points per annum over a 30-year period... for a passive investor into China, (-) 1.4 per cent per annum is the return they would have achieved, had they been invested from the day China entered the MSCI benchmark... Within the EM universe, the next best country (of size) is Brazil, which has delivered dollar-based returns of 6.2 per cent over the last 30 years. However, Brazil has been a very difficult place to be, with returns over the past 10- and five-years at (-) 5.7 per cent and (-) 5.6 per cent, respectively. What stands out for India is the consistency of performance. It is the best-performing EM on a 30-year basis and is among the top two when you look at 20-year, 10-year and 5-year returns as well. It is also one of the two significant EM countries where the returns are positive and above 6.5 per cent in dollars, whether you look at 30-year/20-year/10-year or even five-year data... In fact, after the US, Sweden and Switzerland, it is the fourth best-performing equity market over the last 30 years (of substantial size and relevance).

The poor dollar performance of EM equities can be explained by the equity dilutions,

Asia has actually outperformed the US very significantly in terms of economic growth over this period. The US delivered nominal gross domestic product growth of 4.5 per cent compared to 9.5 per cent for the countries of Asia ex-Japan since 1992. This translated into revenue growth for the companies in Asia of 15 per cent, compared to 6.5 per cent for American companies. The strong revenue outperformance led to net profits growing at 12.6 per cent per annum for the Asian stocks compared to 10 per cent for US stocks. The problem, however, becomes obvious in the earnings per share (EPS) numbers. Despite delivering profit growth of 12.6 per cent, EPS growth for the Asian equities was only 4.4 per cent, compared to 8.2 per cent for the American companies. Dilution destroyed the returns ultimately delivered to investors... The excess dilution also reflects ultimately in the return on equity (RoE). Asian RoE’s were stuck at 11 per cent, compared to 15 per cent for the US. India has been able to match the US as dilution was far lower in India, than other Asian economies. The gap between index earnings at 13.7 per cent and EPS growth at 8.2 per cent was far narrower for India than the rest of Asia. Consequently, the RoE in India at 15-16 per cent was far higher, comparable to US levels. India never had easy access to capital, at least not in the early years and the discipline this lack of easy money brought is still visible.

7. Why do mutual funds avoid Adani Group stocks?

Adani Green Energy and Adani Total Gas trade at 12-month trailing price-to-earnings of more than 700-times. Adani Enterprises and Adani Transmission trade between price-to-earnings multiples of 400-450 -times on trailing basis.

8. The ongoing global economic turmoil should be a reminder to sceptics about the premature claims of dollar's demise. Since the beginning of the year, dollar has risen against all except Russian Rouble, Brazilian Real, and Mexican Peso, and the nominal effective exchange rate of dollar has appreciated 12%. 

The dollar remains the undisputed safe haven currency. And it's importance in other areas remains very high.
9. Fascinating studies on the impact of narcissism among CEOs as measured by the size of their signatures. Charles Ham et al find
Using the size of CEO signatures in SEC filings to measure individual narcissism, we find that CEO narcissism is associated with several negative firm outcomes. We first validate signature size as a measure of narcissism but not overconfidence... We then use CEO signatures to study the relation between CEO narcissism and the firm’s investment policies and performance. CEO narcissism is associated with overinvestment, particularly in R&D and M&A expenditures (but not in capital expenditures). Firms led by narcissistic CEOs experience lower financial productivity in the form of profitability and operating cash flows. Despite this negative performance, narcissistic CEOs enjoy higher absolute and relative compensation.

Evans Boamah writes

The paper examines how CEO narcissism affects a firm’s presence and intensity of a share repurchase announcement. Using the novel signature size measure of narcissism, we find that firms with narcissistic CEOs are more likely to make repurchase announcements and announce higher repurchase dollar amounts. However, narcissistic CEOs are unlikely to make actual repurchases. They repurchase a small dollar amount if they make an actual repurchase... Overall, the results presented in this study demonstrate that the unrealistic inflated views of narcissistic CEOs play a critical role in the presence and the intensity of share repurchase announcements.
10. Finally shrinkflation (from John Mauldin via Anas Alhaji)

Thursday, September 29, 2022

Spillovers in the global over-kill with inflation-fighting

I had blogged earlier expressing hope that the unmistakably clear and co-ordinated monetary tightening by central banks could have the effect of shaping inflation expectations downwards. 

But like with all such actions, there is also the possibility of over-shooting with the tightening. Excessive tightening and associated reshaping of expectations could have the effect of tipping the world economy over into a recession. This is what the World Bank worries in its latest report about the possibility of a global recession. 

But this is also a teachable moment in understanding macroeconomics in a financially integrated and globalised world economy. 

Adam Tooze points to some graphs from the latest World Bank report. On the monetary policy side, the report informs that we are now seeing the most widespread tightening of monetary policy since early 1970s.
On the fiscal policy side too, the share of countries tightening their fiscal spending is greater than ever.
And the fiscal tightening is universal
Tooze writes,
The level of real interest rates - nominal rates adjusted for inflation - remains low. But this is the most dramatic shift in the stance of policy we have witnessed since the 1980s. The risk is that it will be excessively contractionary and will trigger a worldwide recession.

But this global over-kill towards monetary (and fiscal) tightening can be traced to the US Federal Reserve's delayed reversal of its monetary accommodation. After falling behind the curve big time, the Fed has been catching up with some vengeance. Its collateral damage has been in the form of spillovers to developing countries, forcing those central banks to respond with their own tightening. The spillovers have not spared even those central banks who responded early enough to the inflationary trends and tightened. In fact, those countries, like Brazil, are now being forced to respond with further tightening, thereby adversely impacting domestic growth. Not to speak of the inflationary effects from depreciating currencies. 

There is nothing new in this script. The globalisation of the US monetary policy and its spillovers (especially on developing economies) was a central theme in The Rise of Finance. This is just one snippet,

BIS economists Peter Hordahl, Jhuvesh Sobrun and Philip Turner find that ‘central banks in small economies have only a very limited ability to influence the long-term interest rate in their own currencies’. In other words, taken together, the monetary policy autonomy of small open economies has been progressively declining. They not only have less ability to influence their own interest rates but their long-term interest rates are also vulnerable to shifts in US long-term yields. Another paper by Robin Koepke of the Institute of International Finance (IIF) examined the impact of changes in US monetary policy in 27 emerging economies, specifically in terms of currency and banking crises and sovereign defaults. The paper studied 154 such crises over the 1973–2014 period and claimed that ‘US monetary policy is often just as important as domestic factors in explaining the incidence of EM crises, if not more important’. In other words, US monetary policy is not just a trigger, but one of the underlying factors that amplify EM vulnerabilities. More specifically, it finds that the ‘probability of crises is substantially higher when the federal funds rate is above its natural level (stance), during Fed policy tightening cycles (direction), and when market participants are surprised by signals that the Fed will tighten policy faster than previously expected (surprise)’.

Claire Jones summed it up very nicely,

In March 2021, when the US Federal Reserve was still buying $120bn-worth of securities a month, Brazil’s central bankers raised their benchmark rate by 0.75 percentage points on the back of concerns that a surge in global commodity prices would trigger inflation. It took another year for the US central bank to catch on to the fact that price pressures would prove far from transitory and finally raise the federal funds target from near zero. By then, Brazil had increased borrowing costs to 11.75 per cent. Time has proven Brazil’s monetary guardians right. Yet the Fed’s tardiness in keeping inflation in check is unlikely to leave the South American country — or, indeed, anywhere — unscathed.

The Fed, which on Wednesday made its third 75 basis point increase in a row, is playing catch-up. While that may be the best course of action for the US economy, its aggression is triggering what Maurice Obstfeld, of the Peterson Institute for International Economics, labels “beggar-thy-neighbour” policies. The consequences of the Fed‘s mistakes are effectively exported from the US, burdening America‘s trade partners. Higher US rates have bolstered the dollar, exacerbating inflation elsewhere by raising the cost of commodities which are, more often than not, priced in the greenback. A “reverse currency war” is in full flow, with monetary authorities across the world now ditching their standard quarter-point increases in favour of 50, 75 and — in the case of Sweden and Canada — 100 basis point moves in order to stem dollar declines. Rate rises, while necessary to quell inflation, have become so aggressive the World Bank warned last week they risk sending the global economy into a devastating recession that would leave the world’s poorest countries at risk of collapse. The World Bank described the situation now as akin to the early 1980s, when the surge in global interest rates and slump in world trade sparked the Latin American debt crisis and a wave of defaults in sub-Saharan Africa.

Tooze points toADB's Chief Economist Shang-Jin Wei,

For the 66 smaller economies that peg their currencies to the US dollar – especially those without significant capital controls, like Hong Kong, Panama, and Saudi Arabia – local interest rates tend to rise automatically whenever the US raises its interest rate, even when higher rates are harmful to their economic prospects... an interest-rate hike by any major central bank has the effect of exporting inflation to other countries, forcing other central banks to raise interest rates more than they otherwise would have done... The result is an interest-rate spiral that is more damaging to world output and employment than these countries may wish to see collectively.
And this excellent graphic from Peterson Institute 
This is only the latest example of how the dominance of the US Fed and the Dollar has led to the demise of monetary policy autonomy of central banks elsewhere. The impossible trilemma has been replaced by the impossibility of monetary policy autonomy. This also means that exposure to vulnerabilities have to be reduced in the first place. Based on this reality, this was our conclusion in The Rise of Finance,
Given integrated capital markets and the unipolar importance of the US dollar to the international payment system, commodities and capital markets, spillovers from policies pursued in developed countries to developing countries is inevitable. Developing countries lack instruments and coercive power to dissuade advanced nations from pursuing domestic policies that have negative spillover effects for them. Since the world has no alternative to the US dollar presently, the only option left to avoid spillovers is to reverse integration of capital markets and free capital flows. In the absence of restrictions on capital flows, both the impossible trinity and the financial market trilemma have been reduced to the impossible duality and financial market dilemma, respectively. Therefore, capital controls cannot be the policy of last resort to be deployed in the event of financial instability. It is central to ensuring financial stability. Developing countries must be cautious in liberalizing external commercial borrowings for their domestic borrowers and in inviting foreigners to invest in domestic debt.

This episode is a cautionary note to policy makers in countries like India. Policy makers, entrusted with protection of national interests, should be cautious with the advice and wary of lobbying on capital account liberalisation from market intermediaries and ideological enthusiasts whose incentives are aligned differently. This is especially important since the pressure from foreign institutional investors and their domestic supporters to liberalise capital account in the guise of deepening bond markets will be the highest now, also because India appears to be the only big EM game in the town for now. Policy makers should resist this temptation. 

Update 1 (01.10.2022)

Central bank real rates are negative across most countries

Update 2 (03.10.2022)

FT reports that bond investors have pulled out over $70 bn from EM bond funds this year, the highest ever.
The investor flight underscores how emerging markets are facing mounting risks from surging interest rates in developed markets, which make the typically high yields on EM debt look less attractive... Rather than weighing the relative risks of currency exposure, investors are simply getting out. It marks a sharp turnround: flows were positive into both types of bond funds for each of the previous six years, at a combined average of more than $50bn a year.
No matter how strong the domestic economic fundamentals, sudden stops and capital flights from developing countries to the safe haven of dollar assets are inevitable in times of global economic crisis. This cannot be avoided. The only way to mitigate its adverse effects is to limit exposure to the global financial markets in the first place to only what's required to manage macroeconomic balance. This is a cautionary note on capital account liberalisation.

Monday, September 26, 2022

The stability premium of large economies

FT has a feature on the success of Indonesia under Joko Widodo,
At a time when the global economy is being battered by the war in Ukraine and the global energy, food and climate crises, Indonesia has emerged as an unlikely outlier, boasting both a booming economy and period of political stability. Gross domestic product expanded 5.4 per cent year on year in the second quarter, well above forecasts. The country’s inflation rate of 4.7 per cent in August, prior to a recent petrol subsidy cut, is one of the lowest globally. Its currency, the rupiah, is among the best performing in Asia this year and its stock market is hitting record highs. The resource-rich archipelago, south-east Asia’s largest country with 276mn people, is riding high on soaring commodity prices. Exports rose 30.2 per cent year on year to $27.9bn last month, the most on record. The world’s largest producer of nickel, a critical component in electric vehicle batteries, Indonesia is putting in place plans to benefit from the upcoming boom in EVs… 
With inflation relatively low, Indonesia’s central bank only raised interest rates for the first time in three years in August to 3.75 per cent. Banks are also still lending and exports are booming, not just from commodities. Widodo’s signature “omnibus law” that loosened employment regulations to help job creation has encouraged more foreign investment, as some producers diversify manufacturing away from China... One of Widodo’s principal achievements has been to expand infrastructure on an unprecedented scale for Indonesia, a vast country of more than 17,000 islands. His governments have constructed 2,042km of toll roads in eight years, he says, compared with about 780km in the prior 40 years, as well as 16 airports, 18 ports and 38 new dams.
And the main reason for this success has been the political stability under President Widodo,
Much of the credit for this boom has gone to President Joko Widodo, who has managed to maintain popularity with both ordinary Indonesians and investors alike after eight years in power. A poll released this week by research firm Indikator Politik Indonesia showed 62.6 per cent of Indonesians approved of the charismatic former furniture salesman’s performance... Support for Widodo, who is known as “Jokowi”, is so strong that at one point his supporters were pushing to change the constitution to allow him to stand for a third term in office.

Coupled with opportunistic policies, 

Yet by far the flagship industrial policy of Widodo’s second term has been his attempt to use Indonesia’s giant nickel reserves — which are tied with Australia as the world’s largest — to create a domestic electric vehicle industry. In 2020, the government banned outright the export of nickel ore, forcing foreign companies, many of them Chinese, to begin refining it onshore. While most of the end-product is going into the stainless steel industry, the aim is to begin extracting more higher grade material for use in batteries. Indonesia is expected to provide a significant part of the new nickel supply needed by the global EV industry but its reserves of laterite ore require more processing... Widodo credits the restrictions with lifting the value of nickel ore-related exports from $1.1bn annually five years ago to nearly $20.9bn last year. “After [this], we can export maybe more than 40 times or 60 times [more],” he says. “Indonesia has the largest nickel reserves in the world, around 21mn tons, [or] around 30 per cent of world reserves.” He adds that the next step could be to extend the policy to Indonesia’s large reserves of bauxite and copper. Demand for the materials, used for aluminium production and renewables, is also growing globally...
The plan to refine Indonesian ore into battery-grade material is still just starting, with one refining plant commissioned in May last year and seven more in the pipeline, all on the island of Sulawesi... Near Jakarta, South Korea’s LG Energy Solution and Hyundai Motor Group are building the country’s first electric vehicle battery cell plant while Hyundai is building an EV plant nearby. Indonesia says China’s CATL, the world’s biggest EV battery maker, has agreed to invest in an EV battery plant and Widodo says he was also wooing Tesla.

There are striking similarities with India. 

There is a strong case that political stability by itself contributes to economic growth. And if the government does not mess around with the macroeconomy and allows things to play out, even without any major reform there comes a growth premium with political stability. Further, if the country is a large enough market, the premium becomes substantial. 

For investors used to policy flippancy in developing countries, the familiarity of nearly a decade of the same government is an under-appreciated factor. Even without any Big Bang reforms, a government that does not rock the boat and provides reasonable policy predictability is a boon for investors. In fact, the stability premium explained a significant part of foreign investor interest in China in the last three decades. 

Into this mix, if governments can focus on the plumbing issues - human capital development, infrastructure provision, and enabling policies for economic growth - then the stage is set for sustainable growth. 

This is the main takeaway from my first book, Can India Grow. Forget the fetish with high growth rates and Big Bang reforms. Neither does the country have the foundations to sustain high growth rates for extended periods nor are there any such implementable Big Bang reforms. In the circumstances, the preferred strategy should be to target the baseline growth of 5-6% for the next three decades, while also opportunistically grabbing the occasional short high-growth episodes. This requires hunkered down execution to painstakingly expand the physical, human, and financial capital foundations.  

In so far as economic growth is the biggest poverty eradication strategy, India and Indonesia have lucked out with political stability, at least for now. They need to focus more on the plumbing to build sustainable and higher growth foundations. 

Saturday, September 24, 2022

Weekend reading links

1. Fascinating graphic which shows how the US and UK resemble societies where the poor are poorer than the developed country average, and the rich are richer.

While the top earners rank fifth, the average household ranks 12th and the poorest 5 per cent rank 15th. Far from simply losing touch with their western European peers, last year the lowest-earning bracket of British households had a standard of living that was 20 per cent weaker than their counterparts in Slovenia... In 2007, the average UK household was 8 per cent worse off than its peers in north-western Europe, but the deficit has since ballooned to a record 20 per cent... The rich in the US are exceptionally rich — the top 10 per cent have the highest top-decile disposable incomes in the world, 50 per cent above their British counterparts. But the bottom decile struggle by with a standard of living that is worse than the poorest in 14 European countries including Slovenia.

2. I have blogged here about the difficulties presented in evaluating the current episode of economic slowdown. As the graphics show, on most parameters of labour market health, the current situation is far better than in any recession over the last ten years. 

The picture is mixed on the consumption


... and production sides.

3. Indian cinema industry fact of the day
Affluent southern states often have more cinema screens than the Hindi-speaking heartlands. Tamil Nadu, with a population of less than 80mn, has 1,104 screens; Hindi-speaking northern Uttar Pradesh, India’s most populous state with nearly 230mn inhabitants, has just 539.

4. Local government financing vehicles (LGFV) in China have stepped in as buyers of last resort in the property market, thereby allowing cash strapped local governments raise money by selling lands and also backstopping the real estate market from crashing.

According to official data, land acquisitions by LGFVs rose to Rmb400bn ($57bn) in the first half of the year, up more than 70 per cent compared with the same period in 2021. This is despite overall land purchases, which have previously been dominated by private developers, falling by almost a third as Beijing cracks down on real estate speculation. The buying spree is intended to help cash-strapped local authorities, for whom selling land is an important source of income. But the LGFVs, which play a critical role in funding long-term infrastructure development, are being forced to borrow more from state banks and issue bonds to finance the deals... Most LGFVs, which typically have little experience in property development, are leaving their newly purchased plots idle. This, combined with the larger housing market meltdown, means the short-term relief that local authorities get from the financing vehicles’ land purchases ultimately risks bigger problems for China’s already faltering economy...

Official data show LGFVs accounted for almost a quarter of land sales in the first half of this year, compared with 9 per cent in the same period a year ago. The ratio exceeded 50 per cent in some less-developed small cities... To make up for the lack of bidders, many cities have raised the minimum price for land auctions. That has often forced LGFVs to pay a premium even as the market is weakening... Most LGFVs face cash flow constraints as they derive the bulk of their income from government-backed infrastructure projects with long-term horizons for returns. In the meantime, state lenders are willing to either issue loans to LGFVs against land as collateral or buy the latter’s bonds in the hope authorities will step in if a crisis occurs.

5. The global race to dominate semiconductor manufacturing

The article outlines what China is doing to achieve self-sufficiency in the cutting-edge technology sectors. It's packing its bureaucracy with technocrats instead of bureaucrats, and picking winners among emerging businesses and supporting them with fiscal concessions.
At a national meeting held this month in the eastern province of Jiangsu, China named 8,997 enterprises as “little giants”, putting them in line for tax breaks so they can help China compete with the US and other western powers... In the past few years, China has overseen the establishment of more than 1,800 so-called government guidance funds, which have raised more than Rmb6tn ($900bn) to invest largely in tech sectors that Beijing deems “strategic”. The funds’ salient feature is that they are mostly run by provincial and local governments or by state-owned enterprises... Companies had to be vetted by local governments in the first instance, opening up the potential for favouritism and corruption. At the same time, government officials can be poor assessors of a company’s prospects, especially when it involves technology that is hard to understand.
6. Tamal Bandopadhyay has some interesting snippets about government bond market in India,
Till the last week (September 16), the government has raised Rs 7.72 trillion without any hiccups. Net of redemptions, the net borrowing has been Rs 4.39 crore... In FY2019, it had borrowed Rs 5.71 trillion gross amount (net Rs 4.23 trillion). The next year, the gross borrowing was Rs 7.10 trillion (Rs 4.74 trillion). In the Covid-hit FY2021, the gross borrowing zoomed to Rs 13.7 trillion (Rs 11.43 trillion). Last year, it dropped to Rs 11.27 trillion (Rs 8,63 trillion) before rising to its historic high of Rs 14.31 trillion this year (Rs 11.61 trillion)... In FY2019, the gross SDL was to the tune of Rs 4.78 trillion (Rs 3.49 trillion); in FY2020, it rose to Rs 6.35 trillion (Rs 4.87 trillion) and further to Rs 7.99 trillion (Rs 6.52 trillion) in the next financial year. Last year, the states raised Rs 7.02 trillion (Rs 4.92 trillion). Till September 16 this year, the states have raised just Rs 2.44 trillion (net Rs 1.29 trillion) from the market, much less than the estimated Rs 4.01 trillion in the first half of the financial year.

The article also had an interesting factoid which underlines the problem of low investment appetite among corporates

Till June, the net corporate bond issuance has been negative. This means, redemptions of old bonds have been higher than fresh bond floats. Contrast this with Rs 4.04 trillion net issuance in FY2022 and Rs 3.59 trillion in FY2021.

7. Fascinating set of stats about Roger Federer, Novak Djokovic, and Rafael Nadal.

More on Roger Federer. Barney Ronay in The Guardian

And with Federer greatness was as much about style and form and texture. There was a sense in his talent of something that never quite reached its end point. Even at its most concentrated pitch one never felt one got to the limits of what Federer might do. There is probably still a bit in there, Rog, if you ever feel like giving it another go... His backhand was frankly ridiculous, overblown, hilariously good. This, one thought, watching that thing – the flex of the knee, the flourish of the wrist – is a kind of artefact, a European cultural treasure, like a Bach cantata or a complete acorn-fed Iberian ham, the kind of backhand a power-crazed Bond super villain might try to steal from its laser-guarded case and transport to the moon... It was not the styling, the deep, piercing (woof) eyes, the balletic grace in his movements. The real Federer hit was the way these things were combined with accuracy, power, shot selection, competitive will. Federer was never just getting the ball back or staying in the rally but challenging to live at this pitch, to exist in his sporting world.

8. In an interview with CBS News, President Joe Biden has clearly indicated that the US would defend Taiwan from a Chinese attack by sending US forces to defend Taiwan. 

Whether he intended it or not, there is a game being played out here. Hitherto there was a strategic ambiguity about the likely American response in case of a Chinese invasion. This and the three previous statements by President Biden should serve as sufficient enough indication to the Chinese that there may no longer be any ambiguity about US response. To this effect, it has atleast significantly reduced, if not removed, from the Chinese calculations the possibility of US staying out in case of an invasion. One can reason that this, coupled with the outcomes from the ongoing Ukraine crisis, would have significantly reduced, at least for now, any possibility of a Chinese invasion.  

9. From Martin Wolf, in the context of UK economy, the point about limited correlation between tax rates and economic prosperity.

And this about product and labour market regulation among western economies.
10. Business Standard reports that the RBI has cracked down on outsourcing of loan recovery operations by lending institutions. 
The Reserve Bank of India (RBI) on Thursday barred non-banking financial services company Mahindra & Mahindra Financial Services(MMFSL) from outsourcing recovery agents, days after a 22-year-old pregnant woman died in Jharkhand’s Hazaribagh while trying to block loan recovery agents from taking away her father’s tractor and was crushed under the vehicle. The loan was taken from M&M Financial. “The RBI has… in exercise of its powers under Section 45L(1)(b) of the Reserve Bank of IndiaAct, 1934, directed MMFSL, Mumbai, to immediately cease carrying out any recovery or repossession activity through outsourcing arrangements, till further orders,” the RBI said... This is probably the first time the regulator has cracked down on lenders on recovery by coercive methods, which is typically a hallmark of outsourced recovery agents.

As the report says, given the widespread use of this practice, it remains to be seen how the RBI will be able to enforce its circular. 

It has become an increasingly common practice among banks to outsource its two critical activities - credit-worthiness assessment and recovery operations. In the circumstances, the lender becomes a fund manager who takes deposits, manages it, and transacts through the third parties. If you add securitisation of the loan book, the lender has limited skin in the game. 

11. Following concerns raised by Amundi Asset Management's Chief Investment Officer Vincent Mortier a few weeks back, now Mikkel Svenstrup, the CIO at ATP, Denmark's largest pension fund has compared the private equity industry to a pyramid scheme

Mikkel Svenstrup... said he was concerned because last year more than 80 per cent of the sales of portfolio companies by the private equity funds that ATP has invested in were either to another buyout group or were “continuation fund” deals, where a private equity group passes it between two different funds that it controls. “We’re a big fund investor, we have hundreds of funds and thousands of portfolio companies,” he said. “This is not good business, right? This is the start of, potentially, I’m saying ‘potentially’, a pyramid scheme. Everybody’s selling to each other . . . Banks are lending against it. These are the concerns I’ve been sharing.” ATP is a major investor in private equity funds. It has $119bn under management and has committed money to 147 buyout funds, according to PitchBook data...Mortier said some parts of the private equity industry “look like a pyramid scheme in a way”. Svenstrup said the “exponential growth” of the private equity industry in recent years, as investors have poured cash into its funds, would stop “at some point”, adding that this was “just a question of time”.

These calls may be the canary in the coal mine with respect to the PE industry. 

12. In The Rise of Finance, we discussed the adverse effects of US monetary policy spillovers on developing countries. The ongoing rate hikes and consequent strengthening of dollar, and associated sudden stops and capital flows reversals and imported inflation into developing countries is only the latest instance

The Fed, which on Wednesday made its third 75 basis point increase in a row, is playing catch-up. While that may be the best course of action for the US economy, its aggression is triggering what Maurice Obstfeld, of the Peterson Institute for International Economics, labels “beggar-thy-neighbour” policies. The consequences of the Fed‘s mistakes are effectively exported from the US, burdening America‘s trade partners. Higher US rates have bolstered the dollar, exacerbating inflation elsewhere by raising the cost of commodities which are, more often than not, priced in the greenback. A “reverse currency war” is in full flow, with monetary authorities across the world now ditching their standard quarter-point increases in favour of 50, 75 and — in the case of Sweden and Canada — 100 basis point moves in order to stem dollar declines. Rate rises, while necessary to quell inflation, have become so aggressive the World Bank 
warned last week they risk sending the global economy into a devastating recession that would leave the world’s poorest countries at risk of collapse... Since the 2008 global financial crisis the Fed and other major market central banks have deployed wave after wave of stimulus. That left global interest rates at ultra-low levels for years on end. The result of that — plus the pandemic — is international debt levels are close to all-time highs. As financing costs rise, more and more of the world’s poorest countries are seeking support from the IMF and the World Bank.  

13. On gastronomy and air travel,

Business and first class account for about one-third of all airline seats but generate up to 70 per cent of revenue. The promise of a better meal is part of what motivates passengers to buy a premium ticket... At 35,000ft, the human tongue goes partially numb, causing you to lose about one-third of your taste buds. The microclimate of an aeroplane is drier than most deserts, which has an effect on the nose roughly equivalent to stuffing one nostril with toilet paper. Even the sound of the engine changes the way food tastes. Exposure to the background noise of an aeroplane, which can reach 80-85dB, dulls your sensitivity to salty and sugary flavours, while enhancing your perception of the proteinous fifth taste, umami. This explains the enduring love affair between air passengers and tomato juice, which is ordered as much as beer in flight. If you drink it in the sky, it will taste richer, more savoury, and less acidic.

14. Finally, Andy Mukherjee calls for greater scrutiny of the drivers of wealth creation of Gautam Adani.

Adani’s commodities, energy and transportation empire the $255 billion stock-market juggernaut it is today, even when the combined annual net income of its seven publicly traded firms is less than $2 billion... Elara India Opportunities Fund, which has amassed $4.2 billion — practically all of its assets under management — from three stocks: Adani Transmission Ltd., Adani Enterprises Ltd., and Adani Total Gas Ltd. APMS Investment Fund Ltd., whose $3.6 billion portfolio also includes Adani Power Ltd., has done it with four. There are three more of these Mauritius-based entities among major shareholders: Cresta Fund Ltd., LTS Investment Fund and Vespera Fund Ltd. A sixth, Albula Investment Fund Ltd., has exited Adani firms, with its portfolio shrinking to about $240 million from $1.6 billion in December, according to Bloomberg data. Between them, these publicity-shy investors own a combined $12 billion of Adani stock.

And the staggering reach of the conglomerate

The coal he mines, moves through his ports, and burns at his power stations provides electricity to Indians. Adani supplies families with piped gas when they’re sitting down to dinner, in which the cooking oil is also his, and the wheat probably stored at his warehouses. The new structures that will adorn the landscape of an underbuilt India over the next couple of decades will take construction materials from Adani, who just acquired 70 million tons of cement capacity and now wants to double it in five years. The businessman will collect toll on roads in the states of Gujarat and Andhra Pradesh, and host Indians’ data when they’re browsing the internet, waiting for a flight to take off from one of his airports. He’ll also help book the airplane tickets. And before you complain about the impact of coal, cement, palm oil and data centers on the environment, Adani says he’ll invest $70 billion into “cooling the planet down” with green hydrogen, wind turbines and solar panels. Throw in forays into media and money-lending to small businesses, and Adani may soon command a bigger share of an average Indian’s life than Amazon will ever garner from a typical American’s wallet.

Monday, September 19, 2022

A Note for funders of development impact evaluations

This post will provide a list of suggestions and checklist for funders of international development impact evaluations. 

First, the suggestions:

1. An important parameter for categorising impact evaluations should be whether they emerged from the primary policy maker’s side or not. Funders should make this an important point of diligence when they are funding impact evaluations. They should incentivise researchers to engage closely with policy makers, understand their real needs (as against hypothesising their perceived needs), and work together to design and present the evaluation proposal. Is the evaluation arising as a demand from a policy maker and whose outputs will feed into a program design or redesign? Or, is it primarily a proposal from a researcher, which also happens to have taken the consent of the policy maker? 

2. In the normal course, the highest priority impact evaluations should be those arising directly from policy makers about impact evaluation issues agitating them and whose evaluations can be done within their expected time frames. In this context, the highest value impact evaluations are of the quick but rigorous A/B testing kind which help with changing the design of an intervention to improve its operational efficacy or implementation fidelity. 

3. Also, in the normal course, concurrent evaluations which feed into program design or implementation should have greater preference than post-facto evaluations of headline efficacy. For example, an evaluation question which emerges from a deep-dive of an ongoing implementation and on a proximate cause of likely implementation effectiveness (say, the periodicity or the manner of a cash transfer; or converging an intervention in agriculture with another ongoing program; or a procedural change or small add-on to an ongoing program) should be considered high value and prioritised. Such evaluation proposals also reflects active engagement by the researchers with policy makers to surface an important factor which impacts the program effectiveness. 

4. Any impact evaluation of an intervention/idea in a context should necessarily be preceded by a deep-dive that also includes examination of the history of same or similar interventions/ideas in the particular local context (and not merely based on theory and evidence from other contexts). What are the examples of such interventions in that context in the last three decades? What have been their outcomes? Do the government and other local stakeholders know about them? How have they been received by the system?

5. Impact evaluation should always be associated with qualitative research (key informant interviews, focus group discussion etc), which should help in interpreting the quantitative study findings relating to design and implementation issues.

6. Encourage (or in certain cases mandate) enlisting a local researcher as Principal Investigator in impact evaluations. Despite all its possible flaws and distortions, this is perhaps the only way in which local researchers can become involved in a meaningful enough manner in impact evaluations in their own countries and develop evaluation expertise. 

7. On a similar note, philanthropic donors like BMGF should prioritise local researchers, and that too working in local institutions, in the impact evaluation projects they fund. 

8. Large scale and long-drawn research projects (eg. RISE, Young Lives etc) should necessarily enlist a local institution as the anchor/host institution in the country. Encouraging local researchers and institutional capacity building in developing countries should be an explicit primary objective of such funding. 

9. Large funders should also incorporate some features and parameters that capture capacity building and knowledge transfer when they approve impact evaluation proposals. For example, funders should insist that outsourced services like surveys should be given on open competitive bids to preferably local providers instead of being given on nomination to captive foreign partner institutions. Or a clear plan (with accountability) that explains how the government partner is actively engaged in the evaluation design, the conduct of the evaluation, and how the evaluation findings are used. 

10. Encourage and incentivize studies to explore and reference impact evaluations and studies of impact evaluations done by researchers, government agencies, and non-government institutions in developing countries (and not just those in foreign think-tanks and by foreign researchers). For example, the Directorate of Monitoring and Evaluation Office (DMEO) in India has a rich expertise on the challenges and issues with impact evaluations, and have very useful things to say about what type of evaluations could be used where and when. 

11. Multilateral and bilateral funders, who have the credibility of government backing, should make available model procurement documents and contracts for hiring evaluation agencies; and templates of evaluation designs, survey instruments etc which can be drawn by evaluation agencies of governments and local evaluation providers. There should be something similar to the World Bank’s PPIAF in case of impact evaluations. This will help atleast those interested government leaders who are committed to undertaking impact evaluations, thereby also creating a local supply-side for it. It’s important that this be housed in a bilateral or multilateral institution (and not in a philanthropic entity or think tank) to allow government leaders the freedom to draw and use. 

A checklist for diligence of proposals considered by funders of impact evaluations

1. Is the primary demand arising from policy makers, with a commitment to incorporate the results? What are its signatures and how credible are they?

2. Has there been extensive stakeholder engagement by the impact evaluators?

3. Is cost-effectiveness of the intervention a consideration in the evaluation?

d. Is bureaucratic feasibility (or state capacity consideration) a factor in the evaluation?

4. Is the evaluation to improve design/implementation or to assess headline efficacy?

5. Is it a concurrent or post-facto evaluation?

6. Does the evaluation team have a local PI based in the subject country?

7. Does the evaluation proposal have meaningful partnerships with local institutions?

8. Does the evaluation involve some signatures of capacity building or some form of knowledge transfer?

9. Does the evaluation involve procurement of services from local providers?

10. Does the report reference and document the work done by local researchers, government agencies, and non-government institutions?