Weekend reading links

1. Tamal Bandopadhyay points to various reports highlighting to Indian banks being in pink of health and ready to lend. But, as he writes, the real problem seems to be lack of demand, which is forcing banks into a competitive race to the bottom in their search for yield. He offers a cautionary note,

Corporate borrowers are merrily replacing or rolling over loans at cheaper rates. The banks have no choice but to participate in such a repricing game. Earlier, private banks were snatching customers from the public sector banks (PSBs), quoting lower rates. Now, the war-turf has broadened — it’s private banks vs PSBs and PSBs vs PSBs. Such cannibalisation was not seen earlier. The banks are being caught in their own narrative — credit growth. It’s the same old story. Soon, one may see bubbles in certain pockets.

What’s the net result of this euphoria? The savers are the losers since post-tax, they don’t earn enough from bank deposits to beat inflation. The banks, too, are losing as their interest margin is being compressed. Only the borrowers are getting the benefit, but when one gets cheap money, one’s risk-taking ability rises. They may end up investing in projects only to regret such investments later. Also, cheap money may encourage fund diversions. Are we celebrating too soon?

I am genuinely surprised at being proven wrong at my assessment of the post-Covid 19 health of India's banks. They seem to have weathered the pandemic with limited damage. 

2. The informal sector and SMEs were supposed to have been the worst impacted by the pandemic. The Business Standard reports that the SME's continue to struggle. It points to an important concern about their business, the increasing duration of their receivables cycles from their clients. 

The Report of the Expert Committee on MSMEs, submitted in June 2019... had observed that MSMEs faced delays in payments from private companies as well as state-run entities and government agencies — at both the Centre and the states — because of their low bargaining power... The data showed that the average number of debtor days for MSMEs had been consistently in excess of 90 days, and that the gross working-capital cycle (days) for these firms was always 300 days (“very high”, according to the report). “This led to a high inventory-turnover ratio; and the very small bandwidth available from the creditor made things worse,” the report observed. In effect, buyers “tend to use MSMEs as an alternative to banks”, have an incentive to raise objections, and point out errors in bills that had been submitted, in order to avoid payment. Also, strict legislative measures mandating payment within a specified number of days (and penalty in the form of interest) hardly had an effect, as MSMEs feared loss of business, if they were to complain.

The report points to the problems faced by the receivables factoring system, TReDS

What’s adding to MSMEs’ woes is that the Trade Receivables Discounting System (TReDS) platform — an electronic platform for facilitating the financing and discounting of trade receivables of MSMEs through multiple financiers — has also not delivered in the way it was meant to. “It’s been observed that MSMEs don’t publish their invoices on TReDS platforms despite having the registration, due to unsaid pressure from corporate buyers,” says Ketan Gaikwad, MD and CEO of the Receivables Exchange of India Ltd (RXIL). He’s brutally frank: “Buyers don’t approve the published invoices, which defeats the entire purpose of these platforms, as banks can’t fund such invoices.” The RBI’s guidelines on TReDS categorically state that an invoice has to be accepted by buyers before they can be financed by banks.

3. As the equity markets flag, US companies are announcing plans for record volumes of share buybacks. FT reports that a record $319 bn worth share buybacks have been cleared so far this year.

Clearly businesses flush with cash feel the decline in stock markets present an opportunity to buy their own shares back cheap. 

4. Rana Faroohar points to price gouging by fertiliser manufacturers amidst the supply squeeze due to the Ukraine invasion putting out Russia which supplies 10% of the global trade of fertilisers. 

A Farm Action report released in January noted that while many areas of American agriculture have a concentration ratio in which the market share of the top four companies exceeds 40 per cent (the level at which economists say that market abuses start to occur more frequently), fertiliser has experienced some of the highest levels of consolidation in the past 25 years. As the report puts it: “Between 1980 and the mid-2000s, low commodity prices and high input expenses led to a drop in demand. During this time period, we saw the number of fertiliser firms decline from 46 to 13. As the price of natural gas (from which nitrogen-based fertilisers are derived) dropped and demand increased, this pattern of consolidation continued.” Today, just two companies, Nutrien and the Mosaic Company, supply the entirety of North America with potash, a potassium-based fertiliser. Fertiliser expenses have increased far beyond the levels that agricultural simulation models would have predicted. Farmers say price gouging is part of the problem. Nutrien, for example, reported a 51 per cent increase in the cost of goods for nitrogen production (a key fertiliser input) in the third quarter of 2021, while gross manufacturing margins were up 680 per cent over the same period.

5. More clear signs of increased military spending,

US president Joe Biden has proposed increasing the country’s military funding by 9.8 per cent as part of a sweeping $5.8tn budget plan that includes measures to boost the Pentagon’s response to Russia’s invasion of Ukraine as well as a tax crackdown on the wealthiest Americans. In the proposal released on Monday, the White House said Biden would ask Congress to increase spending for the defence department by $69bn in the coming fiscal year, to a total of $773bn. Of this, $6.9bn would be specifically earmarked to support Ukraine and “enhance the capabilities and readiness” of the Nato alliance in the region. Additional funding would also be directed towards bolstering US “deterrence” in the Indo-Pacific region.

6. The government of India have opened the public contracting space to foreign competition by according national treatment to companies from UAE in public procurement contracts in the recently concluded Comprehensive Economic Partnership Agreement (CEPA). The decision to open up a market which makes up at least 20% of the GDP is bound to set precedents and generate calls for similar treatment by other companies. In June 2020, the government barred global tenders in public procurements below Rs 200 Cr and allowed itself the choice to impose similar restriction to those above Rs 200 too. 

In reality, public procurements is perhaps the last remaining big industrial policy lever that's still remaining with national governments in promoting local industry. It's important that we do no barter this away in the name of the questionable benefits of a few free trade agreements. 

7. The problem with investment recovery in Indian economy. This remains the biggest challenge for the economy.

8. Interesting graphic on the destinations of US LNG exports. 

It's clear that the US has been rapidly switching its LNG exports away from Asia towards Europe, as part of its "cargo diversion strategy". This raises an important concerns in other gas importing countries about the political economy of natural gas. If the US can today easily switch its private LNG exports, then it's a source of risk for LNG importers. 

Even with diversion, the best case scenario is for US to expand its supply from the current 22 bn cubic meters (2021) to 50 billion m3, and that too by 2030. However, the Russian gas exports to Europe was 155 bn m3. It remains to be seen how the Russian gas exports can be substituted. The more sustainable substitution would be fuel substitution. 

9. China hype and Cold War boosting is the staple of mainstream commentary. The west is on terminal decline even as China's rise continues unabated. China is pulling ahead on technological leadership and assuming global economic leadership. And so on. I've never bought into that narrative. 

Ruchir Sharma has a rare realistic assessment of China's economic prospects. He points to the real estate market as a likely trigger for a crisis now,

The spread between high-yield bonds in the overseas Chinese market and government bonds is now at a staggering 3,000 basis points, a level last seen during in the 2008 financial crisis. Property is critical to growth in China. About 25 per cent of gross domestic product and 40 per cent of bank assets in China are tied to the property market, where estimates of the effective default rate on high-yield bonds are close to 25 per cent, a record high.

He points to the dreaded demographic headwinds,

The fact that credit growth in China continues to be weak despite central bank efforts to stimulate the economy may be an early-stage sign of Japanification. With its rising debt, shrinking population and market turmoil, China looks increasingly like Japan did in the 1990s. That’s when Japan entered a deflationary trap, as lenders became reluctant to lend no matter how much liquidity the central bank pumped into the system. Total debt in China has tripled over the past three decades to nearly 300 per cent of GDP, the level hit by Japan around 1990, at the start of its so-called lost decades. China’s working age population started to contract in 2015, a step toward stagnation that Japan crossed in the mid-90s. Fewer workers mean slower growth. Looking at data from 200 countries going back six decades, my research found 38 cases of a country’s working-age population shrinking for a full decade. GDP growth in those countries averaged just 1.5 per cent and surpassed 6 per cent in only three cases. All three were small nations in special circumstances, such as recovering from a crisis. Strong economic growth is virtually unheard of when the working-age population is shrinking, which makes it highly unlikely Beijing can hit its growth target of close to 6 per cent, particularly when productivity is also declining.

China may well be the latest, but biggest, case of premature ageing - ageing before it reaches high income level. This is likely to be the contributor entrapping China in the middle-income trap. 

10. Currency remains the primary reserve asset of countries.

Of this, 59% of global foreign currency reserves were dollar denominated, with another 20% in Euros and less than 3% in renminbi. 

Foreign exchange reserves are important as insurance against financial market and economic turmoil. Countries have sought to build up these reserves since the late 1990s East Asian crisis.

The biggest obstacle to the emergence of renminbi as a foreign exchange reserve currency is the very nature of the Chinese engagement with the world. Given that countries build reserves as a crisis risk insurance, why would one want to build up the reserves of the riskiest trading partner?

11. The US labour market continues to remain tight. The labour market added 431,000 jobs in March, taking the unemployment rate down to a record 3.6% from 3.8% a month earlier. The economy has recovered 93% of the 22 million jobs lost at the peak of the pandemic in Spring of 2020. 

Wages have risen by 5.6% over the past year, much higher than the 2-3% increases for much of last decade. There are 1.8 job openings for every unemployed worker. In another measure of tightness, prime age participation in labour force is rising,

This has evoked contrasting responses. The Fed Chairman, Jerome Powell has described the labour market "extremely tight" and tight to "an unhealthy level". However, President Biden has expressed happiness,

“After decades of being mistreated and paid too little, more and more American workers have real power now to get better wages. Some people see this as a problem — we’ve had this discussion in the past. I don’t. I see it as long overdue.”

Meanwhile inflation in the 19 Euro area countries has risen 7.5%, with energy prices having rocketed nearly 45% in March from a year earlier. Consumer price increases - Lithuania (15.6 percent), Estonia (14.8 percent), Netherlands (11.9 percent). Germany (7.6 percent), Spain (9.8 percent).