Weekend reading links

1. Tim Harford points to "zero-sum thinking", or the frame where we think in terms of winners and losers, us and them. This contrasts with the frame where the pie is expanded and everyone wins, or the rising tide lifts all the boats. 

If one person is to get richer, someone else must get poorer. If China is doing well, then the US must logically be doing badly. Jobs go either to the native born, or to foreigners... a zero-sum thinker tends to be in favour of more redistribution and in favour of affirmative action — traditionally leftwing policies — but also in favour of strict immigration rules. Rightwing populists also think affirmative action is important, they just think it’s important and wrong... Stantcheva’s work strongly suggests that zero-sum thinking isn’t some sort of senseless blind spot. When people see the world in dog-eat-dog terms, they usually have a reason. Young people in the US tend to see the world as zero sum, reflecting the fact that they have grown up in a slower-growth economy than those born in the 1940s and 1950s. A similar pattern emerges across countries: the higher the level of economic growth a person grew up with, the less likely they are to see the world in zero-sum terms. People whose ancestors were enslaved, forced on to reservations or sent to concentration camps are more likely to see the world in zero-sum terms.

2. Early takeaways from the UK-US trade deal. The main theme is the UK's commitment to ensure that Chinese manufactured goods don't enter the US through the UK. The text of the agreement is here. 

The tariff reductions on UK exports will depend on the findings of the US Section 232 investigations (to determine whether and how specific imports affect US national security). It argues that the the United Kingdom will work to promptly meet U.S. requirements on the security of the supply chains of steel and aluminum products intended for export to the United States and on the nature of ownership of relevant production facilities.

3. China's weaponsisation of its manufacturing dominance should be seen as part of a long-drawn-out conscious strategy. Sample this from Xi Jinping (the speech here).

Chinese leaders must “tighten international production chains’ dependence on our country, forming a powerful capacity to counter and deter foreign parties from artificially disrupting supplies” to China, Mr. Xi said in his speech to the Central Financial and Economic Affairs Commission in 2020.

The Chinese language original version of the speech appeared to have a more threatening tone.

"We should increase the dependence of international supply chains on China and establish powerful retaliatory and menacing capabilities against foreign powers that would try to cut supplies."

4. Interesting long read on the late French philosopher, Rene Girard, who has emerged as an ideologue for those currently ruling the US. His central contribution is the idea of "mimetic desire".

Girard is best known for his theory of “mimetic desire”, the idea that humans don’t desire things in and of themselves, but out of a wish to imitate and compete with others. On the back of this insight, the writer built a distinctive anthropology, borrowing from and contest-ing the theories of Nietzsche and Freud... Girard’s first book, Deceit, Desire and the Novel (published in French in 1961), which describes how Don Quixote, Madame Bovary and characters from Stendhal, Proust and Dostoyevsky come to desire things because others already want them. “Man is the creature who does not know what to desire, and he turns to others in order to make up his mind,” he wrote. The fact that desires are borrowed means they are necessarily competitive. If you desire your neighbour’s husband, you have to contend with your neighbour in order to get what you want — or what you think you want. Mimetic desire leads to fruitless competition, unhappiness and even violence... Over the past half-century, mimetic desire has been Girard’s chief legacy, not only in humanities departments but also, increasingly, among Silicon Valley entrepreneurs and east London brand managers. Inducting Girard into the Académie Française in 2005, the philosopher Michel Serres called him “the Darwin of the human sciences”.

He also came up with a set of ideas on scapegoating and how it impacts politics. 

His second book, Violence and the Sacred, published in 1972 and perhaps the most influential of all his work, describes how human societies enter into periods of crisis in which competition becomes unbearable. The solution, Girard claimed, is a violent act of scapegoating. The scapegoat has certain recurrent features: they are a foreigner, someone with a disability or a person in a position of authority. Such acts are then commemorated in the founding myths of cultures, myths in which the scapegoat becomes deified... Girard rarely used contemporary case studies, preferring to find his evidence in ancient literature, scripture and anthropology, but his view on lynchings ancient and modern was unambiguous: they were unconscionable. The insistence that the scapegoat was innocent would become a justification of Girard’s faith as well as the basis for a darkly pessimistic vision of politics later taken up by both Vance and Thiel. Girard’s next book, Things Hidden Since the Foundation of the World, published in 1978, argues that Christianity had revealed the hidden truth of the scapegoat mechanism. By insisting on their saviour’s innocence, Christians had deconstructed the “primitive” belief in the scapegoat’s guilt. It is for this defence of Christianity that Girard has been called a modern Church Father.

5. After scorning and abhorring arms manufacturing for decades, buoyed by a punishing industrial slowdown and the commitment to much higher defence spending due to the growing unreliability of the US defence umbrella, the German Mittelstand are taking to the defence industry with some vengeance. Thanks to the legacy of industrial co-operation with the Nazis, arms making had become taboo in Germany. 

6. Indians are the largest content consumers in the digital world, but does not rank among the top 7 content creators. 

In addition to its software industry stuck at the lower end of the value chain, the lack of world-class brands and mass market companies, lack of companies and startups who have gone on to become global companies, its startup ecosystem with little to show at the frontier, we now also have its massive entertainment industry which does not figure among the top content creators globally despite being the largest consumption market by volume and digital traffic. 

The FT article points to how Japanese content makers have since the pandemic conquered the world with their anime genre of cartoons, and their manga comic books from which these anime characters and stories are derived. 

The Japanese content industry — including gaming, publishing, movies TV and animation — saw overseas sales triple during the past decade, to an estimated ¥5.8tn in 2023. “The export value of the content industry is bigger than the steel, petrochemicals and semiconductor sectors,” says Minoru Kiuchi, the country’s economic security minister and the man now in charge of its anime and manga strategy. The government now wants to push even harder, Kiuchi says, increasing overseas content sales to ¥20tn by 2033. Yet previous efforts to reap the proceeds domestically have struggled. In 2013, the government launched an initiative called Cool Japan, which funded an ill-fated anime streaming platform called Daisuki that aimed to rival the likes of Netflix. Cool Japan has been relaunched multiple times — most recently last year, with greater emphasis on subsidising better working conditions, combating piracy and promoting overseas expansion.

This is a tantalising possibility

If Japan succeeds in boosting the economic clout of its entertainment industry, then anime, manga and other sources of valuable IP could help offset the effects of the country’s declining population and vulnerable industrial base.

The article is a good short history of the emergence of manga comics and anime cartoons, and how since the pandemic it has gone global. 

Begs the question why India's Jataka Tales or Hitopadesha or Panchatantra in the form of the Tinkle comics did not spread beyond the country's borders.

7. The Supreme Court's ruling overturning the NCLAT order on the sale of Bhushan Steel to JSW, more than four years after its consummation, opens several questions for discussion - the competence and integrity of the Resolution Professionals, the rigour and fidelity of the IBC processes, the competence of the NCLT and NCLAT, and finally, the Supreme Court's decision-making delays and its decision principles. 

This is a good summary of the issues. This is another good article. Finally, this raises some important issues about its impact on investor confidence.

It is a case study in institutional compromise. The Resolution Professional acted more as a passive bystander than a statutory officer. The CoC, far from being a sentinel of creditor interests, capitulated to a flawed plan and later defended it in Court with shifting arguments. The NCLT and NCLAT, expected to be guardians of due process, failed to check even the most basic procedural violations, including eligibility criteria, payment timelines, and the resolution applicant’s bona fides... The Supreme Court invoked Article 142 to direct BPSL’s liquidation. While this may be legally tenable, one is compelled to ask: could this power have been better used to restore legality without derailing an otherwise successful business revival?

Substantively, JSW has already paid substantial sums to creditors, restarted operations, and brought BPSL back into the industrial fold. Was it not possible to preserve this progress by correcting procedural anomalies, imposing penalties, or directing compliance retrospectively? Couldn’t the Court have modified the Plan to align with the IBC instead of nullifying it entirely? This verdict may inadvertently send a chilling message to global investors that in India, even resolution plans implemented over 7- 8 years may be overturned due to procedural infirmities, regardless of real-world success. With the world watching India’s insolvency ecosystem as a key plank in its “ease of doing business” pitch, the implications are serious.

In this context, MS Sahoo makes an important point. 

If irregularities are discovered post-facto, those responsible must face swift and stringent civil, regulatory, or criminal consequences. However, the underlying transaction must remain undisturbed. This principle of punishing the wrongdoer without unsettling the transaction is firmly embedded in securities jurisprudence. Trades executed on stock exchanges are never reversed, nor are public issues unwound, even if grave irregularities are discovered post-facto... It is time the law, policy, and institutions recognised the finality of commercial transactions, which should form the bedrock of all economic regulatory frameworks. The legal architecture should enable rigorous oversight to prevent and deter misconduct and hold wrongdoers accountable. However, such oversight must be disentangled from the validity of commercial transactions once they have been lawfully approved or deemed approved.

 This is the balance sheet of the IBC itself since its formation.

8. Shifting market expectations on tariffs

There is an emerging view that Trump’s tariff climbdown will ultimately bring US duty rates closer into line with his campaign plans; 10 to 20 per cent for most countries, and 60 per cent for China. Given all the tariff twists and turns over the past few weeks, markets might be forgiven for thinking that’s a good outcome. But prior to the president’s inauguration, that was most analysts’ worst-case scenario.

9. Trump tariffs and their impact on the US Dollar is helping indebted developing countries.

In practice, and purely by accident, Trump’s tariff wars have created a surprisingly benign environment for emerging markets. Although no one could claim with a straight face that he is judiciously managing the exchange rate lower as part of some fantastical “Mar-a-Lago Accord”, the dollar has weakened, benefiting EMs that borrow in the US currency. The traditional perverse effect whereby risk aversion arising from eccentric US policymaking actually causes a flight to safety and strengthens the dollar has so far been absent. The net effect of a shambolic trade strategy and weakening growth has also been to reduce US Treasury yields, similarly supporting capital flows to higher-yield markets elsewhere. The spread of EM bond prices over US bonds, which typically rises at times of financial market stress and uncertainty, has remained well contained.

10. UK minimum wages now match those of some white collar entry level workers.

11. Ajai Srivastava of GTRI feels that India's FTA with UK has crossed several red lines.

For the first time in any free trade agreement (FTA), India has agreed to slash car import duties, open up its vast government procurement market to a foreign country, and weaken its patent regime under external pressure... India’s decision to slash car import duties from 100 per cent to 10 per cent — even with quotas — is a first in any trade deal. The cuts also cover electric and hybrid cars where Indian industry is just beginning to grow. India will soon receive requests from the European Union, the United States, Japan, and South Korea, demanding equal or deeper tariff cuts...

Around 40,000 high-value Indian government contracts will now be open to UK companies, covering transport, green energy, and infrastructure sectors. One of the most problematic provisions is that UK firms will be treated as “Class 2” local suppliers if just 20 per cent of their product value originates in the UK. This grants UK firms the same procurement preference previously reserved for Indian suppliers with 20–50 per cent domestic content. It allows them to use up to 80 per cent Chinese or European inputs while still benefiting from local supplier status in India. UK companies will also have access to India’s central e-procurement portal, making tracking and winning public contracts easier... India has, for the first time in any FTA, agreed to rules that go beyond its obligations under the WTO’s Agreement on Trade-Related Aspects of Intellectual Property Rights. This threatens not only access to affordable medicines within India but also its global leadership as a supplier of generic drugs to developing countries. This move hands over a big win to global pharma giants.

12. It's the uncertainty that kills. John Coates writes,

What happens if you go up and over that cortisol curve? Then you start to change. In our studies we found that prolonged volatility elevated cortisol chronically and caused traders to become dramatically more risk-averse. The masters of the universe turned timid (potential pushovers in bonus — or tariff — negotiations). Here again we can see a biological mechanism driving macro events: during a bear market, the higher volatility increases risk aversion, which causes more selling and even more volatility and risk aversion, in a runaway chain reaction that ends in a crash. Uncertainty has this power. Uncertainty over whether something nasty might happen can be more stressful than the nasty thing itself. Experiments have shown this. Imagine you are exposed to something mildly unpleasant, like brief blasts of white noise; but the blasts come at predictable time intervals, say once every two minutes. Between blasts you have downtime and need not brace yourself against the noise. In this timing regime, your stress hormones would probably be only slightly elevated. But now imagine the intervals fluctuate, making it more difficult to predict when to brace yourself, so you brace for longer periods of time. Now your stress hormones begin to rise. As the intervals become random and cannot be predicted, cortisol levels reach a maximum. Under each timing regime, you have been subjected to an identical amount of noise. But your cortisol levels increased with the uncertainty of the timing. 

My colleagues and I observed this effect in traders: their cortisol did not track their profits and losses but rather the variance of their returns. This effect was also observed during the second world war. German soldiers on the front lines during the Battle of Stalingrad faced constant attack, while soldiers manning supply lines faced danger less frequently but more unpredictably, and it was here, behind the front lines, that they suffered a higher incidence of gastric ulcers. So uncertainty over when something nasty is going to happen to you, such as losing money, or a bandage being ripped off, can be more stressful than the actual event. It is the not-knowing when it will happen that keeps us on edge, keeps us revving our engine. In fact, we hate being kept in a state of uncertainty. Some macabre experiments conducted in the 1970s found that animals — and humans too, presumably — will accept four times more aversive stimuli if they are delivered predictably rather than unpredictably.

This has relevance to policy making

This stress biology could be harnessed by policymakers. Central banks, for example, could use uncertainty, as does Ref #2, to control the financial markets, and to deflate bubbles by increasing risk aversion. Paul Volcker, chair of the Federal Reserve from 1979-87, understood this power, and possessed the knack to scare the pants off the financial markets. Part of that fear stemmed from his tendency to move interest rates enormously, in the early 1980s raising the Fed funds rate to 20 per cent. But he also kept the market guessing as to when he would act, and by how much. Street wisdom says do not fight the Fed, and no one did with Volcker lurking in the hood. Today, the Fed could veil its activities with a similar uncertainty as a means of calming market exuberance, even cooling an inflationary economy, and all without raising rates. In fact, a deft application of uncertainty could well drive investors into Treasury bonds, thereby lowering long-term interest rates and reducing the debt burden. Since Volcker’s time, however, central banks everywhere have relinquished uncertainty, one of their most potent weapons, in favour of a policy called forward guidance, which involves communicating clearly their intentions, in other words reducing uncertainty. Not surprisingly, this namby-pamby policy has failed utterly in taming the wild beast that is irrational exuberance. To control the market you need to corral its animal spirits, and uncertainty has more than enough power to do so.

This is important since for all his unpredictability, it's emerging that there's one big predictability with Trump policies - they'll not cross a threshold laid down by the markets. In other words, there's an emerging Trump put to the downside risk with US equity markets. It's no surprise that the markets have responded to the temporary truce with China by rebounding in a manner that makes one feel that the whole issue is now settled. The market reaction was stunning. Wall Street had the biggest one-day gain in five years.

In fact, markets are now behaving as though Liberation Day not only did not happen but the underlying issues have been fully resolved.

The great middle class squeeze

I had been thinking of posting on this for some time. There’s now enough evidence to suggest that the middle class globally is feeling squeezed. 

Tej Parikh has an excellent graphics-filled article on the problems being faced by the middle class in developed countries. Middle-class incomes have stagnated, their numbers have reduced, and inflation has worsened matters.

While real incomes at the top have risen, those at the middle and lower ends have stagnated since the financial crisis.

The result is that the middle class has shrunk in many countries. 

Inflation has been a major contributor. Here’s from the UK on how wage growth has lagged behind inflation.

And below from the US, points out that while lower prices of tradeable products have held back inflation, rising costs of non-tradeable essential services have more than offset them. 

And all this is translating to a middle-class pessimism.

The trend of middle class woes goes beyond developed countries. Another article pointed to the case of Indonesia where middle class (monthly income of $122-605) fell from 47.9 m in March 2024 from 60 m in 2018, down from 23% of the population to 17%. 

See also this on Indonesia’s stock market which fell sharply early this week on the back of fears weakening purchasing power, consumer confidence, and economic growth.

The middle-class squeeze is being felt in India too. India’s fundamental economic problem of a narrow consumption baseis compounded by an economy which is not creating the number of good jobs required to quickly expand the middle-class base to support sustained high growth rates. As I blogged here, the vast majority of job creation is in gig work and the likes of construction, security guards, and housemaids, all of which generate monthly incomes in the range of Rs 15000-20000 and have limited productivity improvement opportunities and occupational mobility. 

See this about the shrinkage of the Indian middle class during the pandemic and this about the small size of its middle class. The problem is amplified by the acutely deficient dynamism in India’s corporate sector, the low level of R&D investments, and rising business concentration. 

A matter of great concern at the good jobs creation side is the growing share of non-regular workers. The ASI data tells us that in the 2001-02 to 2022-23 period, while the number of workers in formal manufacturing more than doubled from 5.96 m to 14.61 m, the share of contract workers rose from 21.8% to 40.7%. In Bihar, 68.6% of the industrial workforce is contractual, compared to 23.8% in Kerala. Capital-intensive industries have had a greater increase in the share of contractual workers. The Quarterly Employment Survey data tells us that the share of contract employees in nine major non-farm sectors doubled from 7.8% of total workers in April 2021 to 18.44% in July 2022. Even accounting for the cyclicality in certain industries which necessitate the hiring of contract labour, this level of increase is striking. 

Marcellus Investment Managers provide data that points to stagnant middle-class incomes for more than a decade. 

A striking fact presented by them is that the average annual income of the 53% of the taxpayers (2023-24) who filed non-negative tax returns and earns between Rs 5 lakh to Rs 1 Cr per annum have seen their incomes stagnate - average annual income barely moving from Rs 10.23 lakh in 2012-13 to Rs 10.69 lakh in 2023-24!

They also point to how inflation has eroded middle class incomes…

… leading to India having the highest level of household indebtedness if we exclude mortgages. 

This is also reflected in the steep decline in the net household financial savings to 5.1% of GDP in 2022-23, the lowest level since 1976, even as gross household savings hold steady at 10-11% of GDP. 

The middle-class squeeze is likely to be amplified in the days ahead as automation and AI take hold. One of the most disturbing possibilities is that AI models will virtually eliminate the basic coding jobs that have been an important source of middle-class entry for the Indian workforce. In this context, the new version of Agentic AI has the potential to be even more disruptive. 

AI agents, often referred to as ‘Agentic AI’ systems, are models capable of making decisions and taking actions to achieve specific goals without human intervention, making them truly autonomous. Think of a driverless car that adapts to traffic conditions, a smart home assistant that learns your habits, or an AI-driven financial bot that analyses market trends and makes stock trades. Other examples include AI-powered automation in finance and healthcare, policy claims processing, and software development. The distinction between a non-agentic and an agentic system lies in the level of autonomy and decision-making capabilities. For instance, a non-agentic workflow will respond only to specific inputs or commands, follow pre-defined rules and procedures, and need constant human intervention for most decision-making. 

A basic chatbot, for instance, will only respond with pre-programmed, scripted answers to specific questions. An agentic workflow, on the other hand, can initiate actions and take its own decisions… AI agents also learn continuously, refining responses and actions over time, as seen with Uniphore, which improves customer service by analysing call interactions. Unlike large language model-based chatbots, agentic AI integrates with business software such as customer relationship management (CRM) and enterprise resource planning (ERP) systems and handles multi-step workflows such as processing insurance claims or automating supply chains… This means that AI agentic systems go beyond chatbots by autonomously making decisions and executing tasks.

The trends in advanced economies, Indonesia, and India point to the same three aspects of middle-class discontent - scarcity in the creation of good jobs, stagnant wage growth, and erosion of purchasing power. 

Globally, good jobs are being displaced by automation and lower-paying temporary jobs. In the US, David Autor and others have pointed to the role of automation and cheap imports from China contributing to job losses and a hollowing out of middle-class jobs. I have argued here that cheap Chinese imports should be a bigger source of concern for developing countries (than developed ones) in so far as China is their direct competitor at the lower and middle ends of the manufacturing sector. As Artificial Intelligence (AI) emerges as the general purpose technology (GPT) of our times, another trend unfolding is that of automation and job losses. In their search for efficiency and maximisation of profits, businesses will increasingly adopt AI solutions.

Second, greater returns to capital coupled with weaker bargaining power has led to stagnant labour incomes. High and rising business concentration and financialisation raise the returns to capital at the cost of labour. This, coupled with incentives facing them - stock market expectations, a never-ending cycle of rising executive compensation, and weak labour bargaining power - means that businesses are loath to share profits. 

Finally, inflation is eroding incomes. Across the world, globalisation, trade liberalisation, and immigration integrated markets and lowered prices in the tradeable goods and non-tradeable services sectors. But the trend of rising protectionism and anti-immigration are strong headwinds that will start to bind with increasing intensity in future and raise prices. An additional inflationary factor is the compressed timelines on climate change policies. See the latest from Australia on a “cost of living crisis”.

There’s nothing on the horizon that’s likely to counteract these trends. Middle-class discontent will only grow. Any meaningful response must necessarily involve some (or all) of the following

1. In advanced economies, minimum wages must rise to levels that allow for some basic level of dignified life. Notwithstanding inflationary risks, such regulatory wage minimums can have knock-on upward pressures on wages. 

2. In both developed and developing countries, the sharing of returns between capital and labour should become more equitable. This will require that labour’s bargaining power be increased through institutional (unions, workplace management councils, etc.) and regulatory measures. At some time in future, broad caps on the salary and compensation ratios across levels becoming a norm cannot be ruled out. 

Measures in this regard are most effective when they emerge from internal deliberations and form part of an industry consensus. This requires serious debates in industry forums on this issue that both sensitise all stakeholders on its importance and lead to the emergence of constructive solutions to address it. As an example, benchmarks could be agreed upon, and businesses could be ranked on the equity of their recruitment modes and compensation structures. 

3. Gig work is rapidly emerging as the major source of formal sector job creation. It is estimated that there are over 12 million workers employed in the gig economy, and this number is rising rapidly. It poses economy-wide risks to allow such a large workforce to remain without access to basic social safety protections. Since the sector is now de-risked and mature, there’s a case for closing the regulatory arbitrage opportunities essential for its emergence and early growth. 

Further, such services cater to the top end of the income ladder, whose demand is unlikely to diminish significantly even with higher costs of service arising from closing the regulatory arbitrage opportunities. It also helps that these services are non-tradeable in nature. 

4. The practice of increasing contractual and other non-regular modes of recruitment too should be discouraged. As with wages, it’s most appropriate if there’s an industry consensus on these that creates the right industry-wide incentives to ensure balance on the modes of recruitment. To start with, it might be useful to have some light-touch regulation that provides non-binding guidance on the share of non-regular employment. This information for each company should become public and salient. This could be supplemented with mild incentives to encourage firms. 

In the East Asian economies, there are cultural and normative restraints that moderate the undesirable trends on issues like the sharing of profits, executive compensation structures, recruitment modes etc. There’s a danger that corporate India, with its weaker cultural restraints and closer affinities to the US capitalism, could end up imbibing practices arising from the single-minded pursuit of profit and efficiency maximisation. They must be consciously addressed. India could become a global leader in creating consensual industry benchmarks in these areas. 

5. Finally, governments must proactively engage with policies that guide the direction of technology adoption and associated changes. Industrial policy should prioritise incentives linked to employment over capital expenditure and production. Labour-intensive sectors should become the focus of industrial policy. Scarce resources should not be wasted on low-labour-intensity sectors like semiconductor fabrication or data centres. The only exception should be as a strategic requirement.

A strategy would be to double down on employment-linked incentives in various forms - internships, apprentices, reduction in EPF and other costs, wage support for new entrants, industrial policy support through employment generation-linked incentives, etc. The PM Internship Program is a good start. The learnings from the apprenticeship scheme should be used to improve its effectiveness and uptake. Existing schemes like reimbursement of EPF contributions should be simplified to facilitate ease of uptake and continue for an extended period. 

The implementation of all these is challenging, and its quality is critical, though the difficulties with eliminating leakages should not become an excuse for not doing these. After all, efficiency and effectiveness concerns have not deterred us from pursuing highly questionable schemes and projects with massive capital subsidies. 

All these will be effective only if they are complemented with policies that strive to improve human resource quality, lower the cost of capital, and reduce regulatory burdens. A highly ambitious objective for the government would be to discuss, debate, negotiate and arrive at a consensus on a grand compact with the corporate sector on these issues. 

As a final note, while bad choices by the government are certain to attract the ire of opinion makers and the electorate, allowing the market to create bad equilibriums in trade, immigration, inequality, and automation does not generate anywhere close to the same level of opprobrium. And counterfactuals of scenarios avoided by government intervention hardly get a mention.

Weekend reading links

1. Debashis Basu draws attention to this,

One of the most egregious recent cases of misconduct is the behaviour of credit-rating agencies. YES Bank AT1 Bonds, DFHL, and IL&FS all sported AAA or AA+ ratings just months before they went bust. A fortnight before IL&FS went bust in September 2018, the rating-agencies India Ratings, ICRA, and CARE had all given its debt papers AAA/AA+ ratings, even when its subsidiary, IL&FS Transport Networks, had defaulted in June the same year. Investors looking for safe investment have lost billions of rupees due to the ratings. And yet, the Securities Appellate Tribunal (SAT) seems to think this is simple carelessness.

Last week, SAT reduced the penalty imposed by the Securities and Exchange Board of India (Sebi) on CARE Ratings from Rs 1 crore to Rs 10 lakh in a case related to lapses in assigning a credit rating to non-convertible debentures of Reliance Communications (RCom). SAT felt this was a case of “lack of due diligence for not having acted in a timely manner … the maximum penalty of Rs 1 crore is highly excessive, harsh and arbitrary and (is) not commensurate with the violation”. After all, it is not that the ratings were not downgraded, pointed out SAT, “but not in a timely manner. There could be a case of carelessness or sluggishness or laxity … but it is not a case of oversight”.

When you have orders like this, it's no surprise that financial market regulation remains weak. This is also yet another example from India's disappointing experience with appellate tribunals. It's a reminder to market enthusiasts like those who formulated the Indian Financial Code that theory and practice often diverge to the detriment of the system. 

In this context, I had blogged here outlining the case against having appellate tribunals to adjudicate on regulatory decisions by financial market regulators like RBI, SEBI, or IRDA. 

2. Ashok Gulati writes about the unsustainability of rice and sugar exports by India, pointing to their very high water consumption. 

It is well known that a kg of sugar has a virtual water intake of about 2,000 litres. In 2020-21, India exported 7.5 million tonnes of sugar, implying that at least 15 billion cubic metres of water was exported through sugar alone. Another water guzzler, rice, needs around 3,000 to 5,000 litres of water for irrigating a kg, depending upon topography. Taking an average of about 4,000 litres of water per kg of rice, and assuming that half of this gets recycled back to groundwater, exporting 17.7 million tonnes of rice means that India has virtually exported 35.4 billion cubic metres of water just through rice.

3. India is not alone in its import dependence on China. But given the border issues, India's dependence assumes even greater significance. Sample this,

Two categories topped Chinese imports during 2019-20 (the latest disaggregated data): “electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, and parts" ($19.1 billion), and “nuclear reactors, boilers, machinery and mechanical appliances; parts thereof" ($13.32 billion), amounting to almost 50% of the total Chinese imports that year. China has already supplied a significant chunk of India’s installed turbine-boiler-generator capacity, sweetening the deal with dirt-cheap financing. The critical question here is: Can the private sector in the West finance Indian infrastructure at comparably low rates?

This raises some questions. One, notwithstanding all the blame that will reflexively get laid at the doorstep of the government, the electrical and electronics imports are clearly an indictment of India's private sector. They've had three decades since the liberalisation to get this right, but due to lack of entrepreneurship, risk appetite, and ambition, they have instead allowed the sector to be dominated by foreign competitors (especially Chinese). It's stunning that the landscape of even consumer durables in India, including the new category of mobile phones, is dominated by foreign brands. For a large country, it surely cannot be that the government is to blame for this. 

Second, the infrastructure equipment story raises a conundrum. Given the lower cost of Chinese equipment, is there a case that the lower cost imports are alright since it would also lower the life-cycle cost of the infrastructure service? Or do the risks outweigh the benefits from lower life-cycle cost? And in cases like solar, it's an indictment that, despite the presence of the likes of Adani Group, Indian module/cell manufacturing has been so poor.

4. When Abiy Ahmed took over as Ethiopia's Prime Minister, he was hailed as the next great African hope, and even won a Nobel Prize. Just two years later, the fall from grace is near complete.

5. Livemint writes about the rise of start-ups and their financing in tier 2 and 3 cities of India,

According to data from Tracxn, a business intelligence platform, nearly 3,700 startups were launched from tier-2 and tier-3 cities in 2020, which cumulatively raised as much as $3 billion from investors. In the current year until May, a total of 120 startups have been founded in such towns. Cumulatively, these startups have raised as much as $2.25 billion, showing that the per-deal average has increased in 2021. Among sectors, the consumer technology vertical saw the highest number of new ventures in the last couple of years. It was followed by fintech, food/agriculture and travel/hospitality.

Even if majority of the financing is aimed at services and little towards manufacturing, it's a good thing that formal financing is finding its way into funding risk endeavours in smaller cities and towns of India. This is an important outlet for mobilisation of risk capital that would otherwise have gone into speculative activities like real estate. Sample this

In Maharashtra’s Amravati, chartered accountant Mayur Zanwar, 40... decided to put money in other startups. Till date, he has invested in nearly 20 ventures. He liquidated all of his real estate holdings last year to increase his bets on the startup segment and aims to invest in as many as 30 early-stage ventures by the end of 2021.

6. The deal involving the majority ownership takeover of PNB Housing by Carlyle Group through allotment of preferential shares worth Rs 4000 Cr has generated controversy. Following an advisory firm's report, SEBI stepped in and directed that the deal be done only after a valuation by an independent entity.

PNB Housing is a public sector undertaking (PSU) because it is promoted by PNB, a public sector bank. PSUs command considerably low valuation in the stock market compared to their private sector peers because of a variety of reasons, such as the style of functioning and government interference. Since the control will change after the deal, an independent valuation of the firm was critical. The PNB Housing board kept the allotment price in tune with the Sebi rules, but rather strangely did not factor in any premium for the control it was ceding. In fact, the share price nearly doubled after the deal announcement, though it has corrected recently because of the uncertainty over the deal. The stock market has re-rated the stock to account for a change in control... Even if the board was convinced that there was no case for such a premium, it should have followed good governance practices and got the deal vetted by an independent valuer instead of its own auditor. This would have not only made the deal more transparent and acceptable but would have also absolved some of the directors of the accusation that it was influenced by their links with Carlyle Group in the past.

7. Questions are being raised and evidence to the contrary is building up about the efficacy of the Chinese vaccines,

In the Seychelles, Chile, Bahrain and Mongolia, 50 to 68 percent of the populations have been fully inoculated, outpacing the United States, according to Our World in Data, a data tracking project. All four ranked among the top 10 countries with the worst Covid outbreaks as recently as last week, according to data from The New York Times. And all four are mostly using shots made by two Chinese vaccine makers, Sinopharm and Sinovac Biotech... In the United States, about 45 percent of the population is fully vaccinated, mostly with doses made by Pfizer-BioNTech and Moderna. Cases have dropped 94 percent over six months. Israel provided shots from Pfizer and has the second-highest vaccination rate in the world, after the Seychelles. The number of new daily confirmed Covid-19 cases per million in Israel is now around 4.95. In the Seychelles, which relied mostly on Sinopharm, that number is more than 716 cases per million...

China, as well as the more than 90 nations that have received the Chinese shots, may end up... contending with rolling lockdowns, testing and limits on day-to-day life for months or years to come. Economies could remain held back. And as more citizens question the efficacy of Chinese doses, persuading unvaccinated people to line up for shots may also become more difficult... Mongolia has now vaccinated 52 percent of its population. But on Sunday, it recorded 2,400 new infections, a quadrupling from a month before... a Sinovac study out of Chile showed that the vaccine was less effective than those from Pfizer-BioNTech and Moderna at preventing infection among vaccinated individuals.

The much hyped vaccine diplomacy of China, far from furthering the country's soft power, may have only reinforced the stereotypes about Chinese products being of inferior quality.

This is an important episode in so far as it highlights the possibility that the much hyped Chinese catch-up in technology frontiers may be less than factual. 

8. Labour markets in the US have been flashing signatures of increasing wages. Sample this from an article which points to Amazon's massive hirings and that too at $15 an hour having an upward effect on wages,

Non-supervisory roles have seen strong wage gains in recent months, while New York Federal Reserve surveys show that the average lowest wage that workers with no college degree say they will accept for a new job has jumped by 19 per cent since before the pandemic hit — the sharpest such increase since at least 2014.

It remains to be seen how persistent would be this trend. It's too early to argue that this marks a reversal of a long period of labour wage compression relative to capital income. 

9. Latest unicorns update (HT: Marginal Revolution).

10. Interesting announcement by Reliance Industries on its entry into renewables industry with a Rs 75000 Cr investment plan over the next three years,

Under the plan, RIL will set up a Dhirubhai Ambani Green Energy Giga Complex, spanning 5,000 acres, in Jamnagar, Gujarat, at Rs 60,000 crore while another Rs 15,000 crore will be invested in value chains, partnerships, and future technologies, including upstream and downstream industries. RIL will create a capacity of producing solar power of 100 Gw in 10 years. The ambition is stunning as India’s installed capacity of solar power is now 40 Gw (including ground mounted and rooftop)... RIL will set up four giga factories for integrated solar photovoltaic modules, advanced energy storage, an electrolyser factory for green hydrogen, and a fuel cell factory for converting hydrogen into motive and stationary power. For solar manufacturing, RIL will have integrated manufacturing starting from raw silica and poly silicon to ingot, wafers to finished products cells and modules. This will be a major addition to India’s solar manufacturing plans though the company did not reveal the capacity it would be putting up... RIL will focus in a major way on rooftop solar and decentralised solar installations in villages. The second part of the plan entails creating a value chain for the giga factories. It will be part of the Jamnagar complex of the company. RIL’s renewable energy project management and construction division will provide end-to-end solutions for large renewable plants across the world.

To put this in perspective,

India imports close to 90 per cent of its solar cells and module requirements. Eighty per cent of this is from China. According to the industry data, India has 3,100 Mw of cell manufacturing capacity and 9,000 Mw of module manufacturing.

And this pits the two richest men in India in direct competition,

The move will bring RIL into direct competition with the Adani group. Adani Solar has 3.5 Gw of annual solar photovoltaic production capacity while Adani Green Energy has a portfolio of 25 Gw of commissioned and under construction projects.

Whatever finally happens, it says something about Adani Group, that this completely new greenfield announcement by Reliance is more likely to materialise than the Adani Group's plans on green energy. 

11. On a related note, Reliance's financials don't appear too healthy,

The company’s RoCE on consolidated basis declined to 7.8 per cent in financial year 2020-21 (FY21) — the lowest in at least three decades. Similarly, the company’s RoNW declined to a low of 8.4 per cent last fiscal, according to data from Capitaline database. In other words, the company’s returns from its large asset base – the biggest in India Inc – is just a notch above the yield on top-rated corporate bonds. In comparison, Nifty 50 companies reported RoNW of around 14.9 per cent on average in FY21... RIL is also one of the lowest dividend payers among top companies, proportionate to its revenues and balance sheet size. The company paid a total equity dividend of Rs 4,512 crore in FY21. In comparison, Tata Consultancy Services... distributed nearly Rs 30,000 crore among its shareholders by way of dividend and share buybacks last fiscal... The stock is trading at trailing price to earnings multiple of 31X, against Nifty 50 earnings multiple of 29.2X.

12. Pratik Datta has a very educative article which highlights the experience of China with its bad banks. 

In the aftermath of the Asian financial crisis, China set up dedicated bad banks for each of its big four state-owned commercial banks. These bad banks were meant to acquire non-performing loans (NPLs) from those banks and resolve them within 10 years. In 2009, their tenure was extended indefinitely. In 2012, China permitted the establishment of one local bad bank per province. In 2016, two local bad banks were allowed per province. By the end of 2019, the country had 59 local bad banks. Chinese banks can currently transfer NPLs only to the national or local bad banks. Recent research by Ben Charoenwong at the National University of Singapore and others highlights that Chinese bad banks effectively help conceal NPLs. The banks finance over 90 per cent of NPL transactions through direct loans to bad banks or indirect financing vehicles. The bad banks resell over 70 per cent of the NPLs at inflated prices to third parties, who happen to be borrowers of the same banks. The researchers conclude that in the presence of binding financial regulations (for example, on provisioning) and opaque market structures, the bad bank model could create perverse incentives to hide bad loans instead of resolving them.

He also points to the US and Swedish experiences,

The US had set up a bad bank in 1989 — the Resolution Trust Corporation. It had a sunset clause of December 1996. The date was subsequently advanced to December 1995. Similarly, Sweden established Securum in 1993 with an estimated lifespan of 10-15 years. In 1995, Securum’s board proposed that the company be wound up by mid-1997. The parliament finally dissolved Securum in 1997. At the time of its closure, Securum had disposed of 98 per cent of its assets.

He argues for four requirements for India's new bad bank, National Asset Reconstruction Company Limited (NARCL) - finite tenure with a clear sunset; specific narrow mandate with a clear strategy for resolution of bad assets and not mere transfer of those assets; reduce the original banks' exposures to the bad loans (through security receipts) once they are transferred to NARCL; resolution should happen through market mechanism, and arbitrage between ARCs and bad banks should be discouraged. 

13. From an article about how private equity has managed to evade paying taxes. This on how they turned ordinary income into capital gains, twice,

The I.R.S. has long allowed the industry to treat the money it makes from carried interests as capital gains, rather than as ordinary income. For private equity, it is a lucrative distinction. The federal long-term capital gains tax rate is currently 20 percent. The top federal income tax rate is 37 percent... Private equity firms already enjoyed bargain-basement tax rates on their carried interest. Now... they had devised a way to get the same low rate applied to their 2 percent management fees... In a nutshell, private equity firms and other partnerships could waive a portion of their 2 percent management fees and instead receive a greater share of future investment profits. It was a bit of paper shuffling that radically lowered their tax bills without reducing their income. The technique had a name: “fee waiver.” Soon, the biggest private equity firms, including Kohlberg Kravis Roberts, Apollo Global Management and TPG Capital, were embedding fee-waiver arrangements into their partnership agreements... Say a private equity manager was set to receive a $1 million management fee, which would be taxed as ordinary income, now at a 37 percent rate. Under the fee waiver, the manager would instead agree to collect $1 million as a share of future profits, which he would claim was a capital gain subject to the 20 percent tax. He’d still receive the same amount of money, but he’d save $170,000 in taxes...

The whole idea behind the managers’ compensation being taxed at the capital gains rate was that they involved significant risk; these involved almost none. Many of the arrangements even permitted partners to receive their waived fees if their private equity fund lost money. That was the case at Bain Capital, whose tactics a whistle-blower brought to the attention of the I.R.S. in 2012. That year, Bain’s former head Mitt Romney was the Republican nominee for president. Another whistle-blower’s claim described fee waivers used at Apollo — one of the world’s largest buyout firms, with $89 billion in private equity assets — as being “abusive” and a “thinly disguised way of paying the management company its quarterly paycheck.”

And this about how IRS audits of private equity partners and firms have become very rare,

While intensive examinations of large multinational companies are common, the I.R.S. rarely conducts detailed audits of private equity firms, according to current and former agency officials... One reason they rarely face audits is that private equity firms have deployed vast webs of partnerships to collect their profits. Partnerships do not owe income taxes. Instead, they pass those obligations on to their partners, who can number in the thousands at a large private equity firm. That makes the structures notoriously complicated for auditors to untangle. Increasingly, the agency doesn’t bother. People earning less than $25,000 are at least three times more likely to be audited than partnerships, whose income flows overwhelmingly to the richest 1 percent of Americans.

14. It's well known that during the sub-prime crisis, the then Treasury Secretary Hank Paulson was in constant touch with his Goldman successor Lloyd Blankfein and other Wall Street executives. It raised serious concerns about conflicts of interest and ethics. 

Now comes evidence that Steve Mnuchin and Jerome Powell were in constant touch with Larry Fink, the Chief Executive of BlackRock, in the days when the Fed announced several emergency rescue schemes after the pandemic broke out. 

Mr. Mnuchin held 60 recorded calls over the frantic Saturday and Sunday leading up to the Fed’s unveiling on Monday, March 23, of a policy package that included its first-ever program to buy corporate bonds, which were becoming nearly impossible to sell as investors sprinted to convert their holdings to cash. Mr. Mnuchin spoke to Mr. Fink five times that weekend, more than anyone other than the Fed chair, whom he spoke with nine times. Mr. Fink joined Mr. Mnuchin, Mr. Powell and Larry Kudlow, who was the White House National Economic Council director, for a brief call at 7:25 the evening before the Fed’s big announcement, based on Mr. Mnuchin’s calendars... On March 24, 2020, the New York Fed announced that it had again hired BlackRock’s advisory arm, which operates separately from the company’s asset-management business but which Mr. Fink oversees, this time to carry out the Fed’s purchases of commercial mortgage-backed securities and corporate bonds.

The capture of US Treasury by Wall Street is near total. It does not change with administration. As an illustration, now that a Biden administration is in charge, it is fair to imagine it revoking the carried interest loop hole and cracking down on the fee waiver strategies of private equity discussed above. But it's unlikely to happen, even if corporate tax rates go up.