Weekend reading links

1.  Ruchir Sharma points to the attractions of investing in China.

China now has more than 250 companies with a market cap of over $1bn and a free cash-flow yield of more than 10 per cent; the US has fewer than 150. Of those 250-odd China stocks, all but about 20 are in sectors other than tech, led by industrial and consumer discretionary businesses, so the opportunities are not just in the internet and AI... But by some measures, capitalism with Chinese characteristics is more competitive than its US rival. Large caps account for a smaller share of listed companies in China, leaving more room for newcomers. Among the 11 leading sectors, seven are less concentrated in China than in the US, meaning the top five businesses constitute a smaller share of each sector’s market cap. China’s tech sector is much less concentrated, which means a private upstart such as DeepSeek could rise in an environment less dominated by giants.

2. Interesting that amidst all talks of green transition in the US under Biden, the country continued to increase oil and gas extraction at an increased pace since 2016.

3. Good description of the bear and bull case for US equity markets with associated numbers.

4. Microsoft announces a breakthrough in quantum computing by unveiling Majorana 1, the world's first quantum chip powered by a topological core architecture. 

Microsoft’s ability to exploit a new kind of matter to create a new type of qubit (or quantum bit) promises to accelerate the development of reliable large-scale quantum computing... It’s kind of a generational technology like moving from vacuum tubes to a semiconductor. The advantages of Microsoft’s topological qubits are that they are fast and digitally controlled. That should enable them to scale more reliably to the 1mn qubit threshold that researchers consider necessary for sophisticated quantum computation. But it will still take years of experimental engineering before the company can deploy its quantum processing units (QPUs) in data centres alongside the classical graphics processing units (GPUs) that are currently powering the AI revolution. Nevertheless, the company still hopes to build a utility-scale quantum computer by the end of the decade configured to tackle a set of problems that no classical computer can address. By exploiting the special properties of a quantum computer, Zander reckons researchers will be able to develop new catalysts to break down microplastics, enhance the fertility of soils or develop new forms of self-healing concrete, for example.

A summary of the latest on quantum computing chip development - Google's Willow, IBM's Heron, Microsoft's Majorana 1, Amazon's Ocelot, and others. It's estimated that we are 15-30 years from any commercial chip deployment. 

5. In a paradigm breaking shift from its more than two decades of fiscal conservatism, Germany looks set to amend its 'debt brake'

Chancellor-in-waiting Friedrich Merz late on Tuesday agreed with the rival Social Democrats (SPD) to exempt defence spending above 1 per cent of GDP from Germany’s strict constitutional borrowing limit, set up a €500bn off-balance sheet vehicle for debt-funded infrastructure investment and loosen debt rules for states. Deutsche Bank economists described the deal as “one of the most historic paradigm shifts in German postwar history”, adding that both the “speed at which this is happening and the magnitude of the prospective fiscal expansion is reminiscent of German reunification”.

The plan is expected to open €1tn of additional borrowing over the next decade, more than a fifth of the country's GDP, for defence and infrastructure spending. Given its far lower debt to GDP ratio of 63%, Germany fortunately has enough fiscal space to accommodate such spending which is expected to rise to 84% over the decade. It has precedents in so far as similar spending spike happened in the aftermath of the reunification and boosted economic growth in the nineties. 

At the core of the problem has been a “debt brake”, written into Germany’s constitution in 2009 at the peak of the global financial crisis, that limited the government’s capacity to take on new debt to 0.35 per cent of GDP — one of the most stringent anti-borrowing laws in history. Much of the fiscal space that did exist was spent on the welfare state and social benefits. Merz’s plans bypass the debt brake by enabling the exclusion of everything over 1 per cent of GDP spent on defence. Goldman Sachs anticipates that the plan will drive German defence spending to as much as 3.5 per cent of GDP by 2027 — up from 2.1 per cent in 2024 and a mere 1.5 per cent in earlier years... Even with a debt-to-GDP ratio of around 84 per cent, German public leverage would be “still pretty favourable” compared with most peers, said Cyrus de la Rubia, chief economist at Hamburg Commercial Bank, pointing to ratios of 115 per cent in France and 124 per cent in the US.

The markets reacted in all the positive ways to the announcement.

Markets are applauding. As a Kiel Institute policy brief notes, the increase in German borrowing costs after the announcement was accompanied by rising stock prices, an appreciating euro, a steeper yield curve and stable default insurance — all pointing to improved growth expectations.

6. It's a measure of the unprecedented global power wielded by Donald Trump that his tirade against Chinese ownership of Panama Canal has led to the Hong Kong based CK Hutchison has decided to sell its ownership of two ports at either end of the Panama Canal to BlackRock. The deal involves the takeover of 43 ports, including the two, by a consortium headed by BlackRock and includes Global Infrastructure Partners (the private infrastructure investment company purchased by BlackRock last year), port operator Terminal Investment Ltd (TIL), and the world's biggest container shipping line, Mediterranean Shipping Company (MSC).

7. Good primer on the effects of tariff increases. Interesting that it confines to short-term costs and does not talk about the gains and the long-term impacts.

8. Efficiency maximisation, Amazon edition.

Amazon’s fulfilment centre in Shreveport, Louisiana — its most technologically advanced warehouse — has demonstrated the type of savings it can achieve with automation. The 3mn sq ft facility, which opened in September, uses robots at every stage of fulfilment and has achieved a 25 per cent cut in costs, according to Amazon, following a tenfold increase in robotics compared with its previous generation of warehouses... Shreveport features a range of mobile drive units, which are used to carry items across the warehouse, and advanced robotic arms that pick and sort items, cutting down on the number of human workers in the warehouse. The tech giant is also investing in robotics talent as part of a wider push to deploy AI large language models in its warehouse robots... 

While its retail business continues to be profitable, Amazon has forecast more modest growth across the group in the first quarter of this year, with a strong dollar knocking revenues. The US ecommerce group is pushing to lower delivery times, particularly for users of its Prime subscription service. This includes separating its logistics network into specific regions to ensure inventory is in place for same day deliveries... The group has deployed more than 750,000 mobile drive units since it acquired robotic start-up Kiva Systems in 2012. In recent years it has introduced Proteus, a fully autonomous lift vehicle that navigates sites independently using a set of sensors having been trained using AI. The company has also partnered with chipmaker Nvidia to develop “digital twins” of its warehouses to enable it to run thousands of simulated situations before deploying an autonomous robot.

9. Bjorn Lomborg interview in FT. He appears to have 12 hanging fruits, drawn from deep research evidence, that would cost $35 bn to add $1.1 trillion to developing world output and save 4.2 million lives a year. 

His favoured educational reform, for example, is to improve outcomes in countries such as Malawi by teaching children according to their level, not their age. Many children, crammed into massive classes, fall hopelessly behind. Lomborg’s solution is to teach for one hour a day using tablets with adaptive software, giving children the benefit of a good curriculum delivered at their own pace. Implementing it, according to his think-tank, would cost $9.8bn and deliver a $604bn boost to income through better-educated children. “This is spinach for the world. I want people to know about it.”

Ahem!

10. Donald Trump, Elon Musk, neo-colonialism, and corruption.

Foreign companies operating in South Africa have to navigate Broad-Based Black Economic Empowerment (B-BBEE) regulations set by the Department of Trade, Industry and Competition, and in the case of certain multinationals, such as auto manufacturers, where ownership quotas can’t be applied, “equity-equivalent” programs require investments that drive Black participation in supply chains to meet empowerment targets. This doesn’t apply in the case of communications companies, though, which need to be 30% owned by “previously disadvantaged” people to qualify for a license.

Musk wants to launch his Starlink satellite-communications service in South Africa, but that requires him finding an equity partner for a South African operation to qualify for a license. “Change the laws,” Musk is said to have repeatedly told Ramaphosa during a Feb. 3 meeting. On Feb. 5, Musk’s SpaceX (representing Starlink) withdrew from the Independent Communications Authority of South Africa’s hearings into a proposed licensing framework for satellite services. Trump’s executive order blasting South Africa came two days later... Donald Trump’s Feb. 7 executive order decried the “egregious actions of the Republic of South Africa,” claiming its 2024 Expropriation Act, which allows the state to seize land without compensation in certain scenarios, has been used to dispossess White people of their property.

11. The best illustration that America is now a country of rule by law, where law is that decided by the President and his cronies, comes from the decision to cull USAID programs. 

In Afghanistan, women’s education programmes shut down. Health services were suspended for refugees from Myanmar taking shelter in camps in Thailand. In Colombia, anti-narcotrafficking helicopters were suddenly idle. But African countries were hit particularly hard. In Uganda, medical trials were halted. Life-saving medicines are gathering dust in warehouses in Malawi, where more than half of healthcare spending is dependent on US and foreign aid. Perhaps greatest of all has been the impact on the decades-long battle to end the Aids pandemic... The President’s Emergency Plan for Aids Relief, known as Pepfar, screeched to a halt. Launched by George W Bush in 2003, a year in which Aids killed more than three million people, the multibillion-dollar health initiative is based on a simple premise that everybody deserves access to antiretrovirals that suppress the spread of HIV... The initiative changed the trajectory of the Aids pandemic. To date, Pepfar has saved more than 26 million lives and prevented roughly 1,000 babies a day from being born with the HIV virus. Pregnant women can avoid passing on the virus to their babies by taking medications that either suppress their own viral load to undetectable levels, or pass through the placenta to the baby’s body... 

Mitchell Warren, the executive director of the Aids Vaccine Advocacy Coalition (Avac), a New York-based campaigning group, called Pepfar “inarguably the best investment ever in global health and development”. “We took 20 years to build up what has taken less than four weeks to dismantle,” he said, reflecting on the chaos caused by Trump’s move... Within days, the 340,000 global healthcare workers whose salaries depend on the Pepfar programme — doctors, nurses, lab assistants and community outreach workers — received “stop-work orders”. More than 20 million HIV-positive people like Samkelo no longer knew when their next dose of antiretrovirals would come. Already, since January 24, at least 15,000 premature deaths have occurred because of the funding gap, according to a Pepfar tracker set up to monitor the impact.

The surest sign of the phasing out of Rule of Law and phasing in of Rule by Law comes when one hears news like this.

Congressional Republicans, egged on by Elon Musk and other top allies of President Trump, are escalating calls to remove federal judges who stand in the way of administration efforts to overhaul the government. The outcry is threatening yet another assault on the constitutional guardrails that constrain the executive branch... “The only way to restore rule of the people in America is to impeach judges,” Mr. Musk wrote this week on X, his social media platform, in one of multiple posts demanding that uncooperative federal judges be ousted from their lifetime seats on the bench.

12. Two maps that convey the striking reversal of global trade leadership between the US and China.

13. Xiaomi does what Apple could not.

After nearly a decade of trying, Apple finally gave up its effort to produce an electric car last year, canceling a project that soaked up $10 billion. But last year in China, the electronics maker Xiaomi launched its first electric car after just three years of development and delivered 135,000 vehicles. It has vowed to double that number in 2025. Xiaomi’s ability to succeed where Apple could not shows how thoroughly China has come to dominate the supply chain for electric vehicles. Chinese companies have mastered electric vehicle manufacturing. By tapping that infrastructure, Xiaomi was able to get components quickly and cheaply. More Chinese electric vehicle companies — including Leapmotor, Li Auto and Seres Group — are starting to turn a profit after burning cash for years in their intense competition for the world’s largest auto market... The telecommunications giant Huawei, which the U.S. government has targeted with sanctions and legal action for years, is making autonomous driving software. Huawei has teamed up with multiple Chinese automakers, including Seres Group and the state-owned firms SAIC Motor, BAIC and Chery.

14. Two striking graphics about the masculinisation of the US society. First on gender roles.

The second on society becoming too feminine.

15. Javier Blas introduces a dose of realism to the debate on the critical minerals squeeze due to Chinese restrictions.

Beijing has targeted five metals: tungsten, tellurium, bismuth, molybdenum and indium. China is the biggest producer of all of them...My calculations suggest the US spends about $300 million importing tungsten; roughly $30 million on bismuth; about $90 million on indium; and less than $1 million on tellurium. The total annual cost for all four comes to less than $500 million... it’s the same trend as the one observed in the much-hyped rare earth elements sector. Fears abound, but the cost of importing the 17 metals that form that category is tiny. The US Geological Survey calculated rare earth imports at less than $200 million in 2023... 

The import bill of minor metals could increase by five, 10, 20, even 50 times, and not amount to more than a rounding error for the US economy. Prices, however, are lower today than they were a decade ago. Did you notice when they were high? Nope; for a reason. Indium, for example, traded as high as $800 per kilogram in 2011; it’s now at $345. The cost of the most common compound of tungsten, one of the much-hyped critical minerals, is trading 25% below its 2011 peak. Even if prices rise because of Chinese restrictions, recycling will increase, American engineers will work to reduce their use and alternatives will be found. High prices cure high prices.

This is a good primer on rare earth minerals and their refining (where, in particular, China has a 30 year headstart advantage). 

16. Some facts on employment increase in the Government of India, which rose 4% from 3.17 mn to 3.3 mn from March 2022 to March 2024. 

But what contributed to the rise in the civilian staff strength in the last three years? Note that over 86 per cent of the total civilian staff is accounted for by just four heads — Indian Railways, posts, central police forces, and tax departments... And even as the overall civilian staff strength has risen by over 489,000 in the last three years, the Indian Railways has seen a small increase during the same periods—about 3,000 employees. Of the four heads, the postal department and the police saw the largest increase by over 179,000 and 143,000, respectively, in the last three years. The two tax departments (overseeing direct and indirect taxes) have seen an increase in their staff strength by over 71,000, bringing their total strength to over 172,000.

17. As defence spending rises globally, it may be end of the peace dividend.

Weekend reading links

1. Jared Bernstein, Chair of the White House Council of Economic Advisors, makes an important point while justifying the Biden administration's large fiscal stimulus.

Twenty-twenty hindsight is an analytical luxury — certainly one we didn’t have in January of 2021. Back then, we had millions of unemployed people. We had Covid deaths peaking. The economy was improving, but it was far from reopened. And vaccinations hadn’t been anywhere near adequately distributed. So the extent of uncertainty regarding the impact of Covid on the economy warranted a very strong rescue plan. And I don’t regret the plan. We certainly got more heat than I envisioned at the time, no question, but we also got a lot more growth, less child poverty, fewer evictions, more business survivals, and a much quicker return to full employment and very little economic scarring... I used to say, back then, “The risk of doing too little was greater than the risk of doing too much.”

2. NYT on the China risk that Elon Musk is riding on. In every industry Musk is in, his main competitors are the Chinese - EV, batteries, solar panels, boring machines, and satellite launches. Tesla is still awaiting permission in China for full-self driving, something which domestic competitors have already secured. 

As an illustration, during President Xi's latest visit, SpaceSail, the state-backed Chinese satellite launch company, signed a deal with the Brazilian government to launch satellites for Brazil. 

In terms of corporate risk, brand Elon Musk stands completely at the mercy of two forces he cannot control at all - Donald Trump and China. Worsening matters, the two conflict with each other at several points, making it tails he loses and heads the other side wins!

3. DHL and NYU have a Global Connectedness Tracker which gives a wealth of information.

4. EV car manufacturing in China

The business of car-making in China is far more promiscuous. Huawei has Seres-style alliances with three other major local manufacturers and presents itself as a provider of smart software, hardware and retail expertise that more traditional automakers can put on four wheels. It’s also joined forces with Anhui Jianghuai Auto Group Corp., or JAC, which manufactures cars for US-listed EV-maker Nio Inc., on a soon-to-be-released luxury people mover. Xiaomi is now making its SU7 in-house, but even there it initially tied up with BAIC Motor Corp. in developing it.

5. The problems with Trump's threat to tax Canadian imports.

“How do you compete with China if you price Quebec aluminum, Ontario cars, Saskatchewan uranium and Alberta oil prohibitively?” Flavio Volpe, the president of the Automotive Parts Manufacturers’ Association, a Canadian industry group said, citing some top Canadian exports to the United States. “Half of the cars made in Canada are made by American companies, and half of the parts that go into all the cars made in Canada come from U.S. suppliers, and more than half of the raw materials are from U.S. sources,” Mr. Volpe added. “We are beyond partners. We are almost as inseparable as family.”

6. China EV market facts 

BYD, Tesla’s biggest rival in China, has demanded its suppliers slash prices by 10 per cent, as the world’s largest auto market braces for a fresh salvo in a cut-throat price war. The carmaker urged its suppliers to send over their quotes by December 15 and officially mark down prices starting next year, executive vice-president He Zhiqi wrote in an email circulated on social media on Wednesday. “In 2025, the EV market . . . will go into a grand final battle and a knockout tournament,” he said. “To enhance BYD cars’ competitiveness . . . you and your team must take it seriously and effectively exploit space for cost reduction”... “The rise of China’s auto industry cannot come at the expense of the livelihood of domestic workers and suppliers,” one supplier responded. “We are unable to accept your company’s request and unwilling to take part in this type of co-operation that violates business ethics and human nature.” In the first nine months of 2024, the average time BYD took to clear its bills payable, most of which were attributed to suppliers, was 144 days, longer than the 124 days a year earlier, according to company filings.

7. Claudia Sheinbaum is pushing ahead with radical reforms as the new President of Mexico.

During her first weeks in office, she has thrown her weight behind a package of López Obrador’s most controversial ideas, branded “Plan C”. Her first year in office will be spent implementing elections for judges, dismantling regulators and cementing the dominance of state companies in the energy sector... Mexico will be by far the biggest country to elect all its judges via popular vote, in a process Sheinbaum backed enthusiastically throughout the campaign, arguing that it would reduce corruption and make the distrusted judiciary more accountable... Together we are going to transform the judiciary, truly from the bottom, from the people of Mexico,” she said at a recent rally in Zacatecas. “What is democracy? The power of the people by the people and for the people.” Despite warnings from the US government, business leaders and lawyers that it would damage judicial independence and democracy, Sheinbaum pressed ahead.

But she has to preside in the long shadow of her predecessor and mentor Andres Manuel Lopez Obrador (AMLO) 

Much of Morena’s leadership — in the party and congress — is seen as more loyal to its founder than to her, a profound risk as she faces a recall referendum three years into her six-year term.

8. As President designate Trump threatens a full-scale tariff war, here's a graphic pointing to who will likely be hurt the most.

There are many worthy academic studies of the Trump tariffs from 2018. While not the most riveting reads, they give a reasonably clear account of the evidence... The evidence suggests: US importers bore the vast majority of the cost of tariffs. Overall, for a 20 per cent tariff, the importer paid 18.9 per cent higher prices with the ex-tariff price reducing just 1.1 per cent. Tariffs were passed on to US importers much more than US exchange rate depreciations, where contracts tend to be fixed for a period in dollars... While US importers paid, these costs were not always passed on directly to US consumers. Washing machines were a bit of an exception where prices rose. In other areas, prices barely increased. It is less certain whether retailers spread the tariff effect over multiple goods, margins were squeezed or products were bought ahead of tariffs being imposed... The incidence of US tariffs clearly appears to fall on the US corporate sector, with it then passed on to households in a combination of lower profits, higher prices and lower wages.

9. We are not yet at peak fossil fuel emissions.

And this on off-shore oil drilling

10. The souring of China market ambitions of Western financial institutions.

In spring 2009, Beijing’s state council, the country’s top decision-making body, set an ambitious target: Shanghai would become an international financial centre by 2020... More than 15 years after China pledged to turn Shanghai into an international financial centre, the port city has failed to live up to its early promise... American law firms, once participants in huge cross-border financial flows, have left the city as foreign investment plummets. No western bank has participated in a single IPO on Shanghai’s stock market this year, and, in a domestically-focused market, the need for foreign staff is increasingly unclear. Asset management firms that flocked to the city in the hope of a loosening of China’s capital controls must reckon with the prospect that Beijing will tighten them instead.

11. Important point about Tamil Nadu's manufacturing base

Tamil Nadu has been pursuing a policy of creating multiple electronics manufacturing clusters across the state rather than locating them in one area. Apart from Sriperumbudur, it is creating a cluster near Tiruchirappalli where Jabel Inc, an American electronics major, will set up a production facility. Coimbatore, the minister said, will focus on electronics and semiconductor design. Madurai, meanwhile, is being prepped to house large global capability centres.

12. For all punditry around what to expect from the Trump White House, Alan Beattie has, in my opinion, the best assessment.

If you enjoy watching narratives disintegrate and re-form like crystals in a supersaturated solution, you’ll have loved the last few days in Washington... The value of palace politics in analysing the Trump administration will be strictly limited. The economic and trade team will be a gaggle of vying courtiers under an erratic president motivated by instinct and prejudice. This was, after all, exactly what we got during Trump’s first term. This time, his compulsion to listen to voices outside that circle urging him to deport foreign-born workers or pursue security goals even if they damage the US economy will be even stronger. It’s more productive to look at what powers the administration has and what it can get done if it tries... As in Hollywood, nobody knows anything. The one pretty safe bet is that Trump will use tariffs over the next four years. But it is very unclear how they might be employed, or for what end, or what other economic and financial tools might also be deployed, or whom he will be listening to at any given time. This week is a warning to anyone who thinks they have the Trump administration all figured out. They do not.

Weekend reading links

1. The Economist on whether India can outcompete Bangladesh in textile exports 

Since building its first export-orientated apparel factory in 1978, a joint venture with a South Korean firm, Bangladesh has turned its economy into a clothes-exporting powerhouse. The sector employs some 4m people, mostly women, and contributes 10% of the country’s GDP. Last year Bangladesh shipped $54bn-worth of garments, second only to China... India does not have the capacity to compete with Bangladesh at this stage, according to one industry insider. Too much policy attention is directed towards boosting capital-intensive sectors, such as electronics, instead of labour-intensive textiles, he says. Between 2016 and 2023 the value of Indian apparel exports fell by 15%, whereas Bangladesh’s increased by 63%. A recent World Bank report points to India’s protectionist policies as the culprit. Average import tariffs on textiles and apparel, including on intermediate inputs used by local manufacturers, have increased by 13 percentage points since 2017, raising prices for producers.

2. Some data on India's services-led growth

Over the last decade, India has added close to $1.7 trillion to its nominal GDP, 52% of which came from the services sector, compared to 11% from manufacturing. Services are far less capital intensive, as they do not require heavy machinery and large factories . Thus, the capital intensity of Indian growth has fallen in tandem... A booming services sector also leads to a concentration of the economic surplus. The backward linkages of this sector happen to be relatively weak. For each additional dollar worth of output by it, only 30 cents reflects the inputs it absorbs from other sectors in the economy. For the manufacturing sector, in contrast, this proportion is much higher at 73 cents... Industrial production data shows sectors (mostly low-tech) that account for 15% of manufacturing output have still not reclaimed their pre-pandemic output. In some of these, such as leather and apparel, production is still down by more a fifth from their pre-pandemic levels.

3. Some important findings from the Annual Survey of Unincorporated Sector Enterprises (ASUSE) of 2021-22 and 2022-23.

Presently, there are 14.6 million active taxpayers, of which nearly 10.4 million have come in the post-GST regime and are therefore new registrations. They represent a formalization of the economy... Over the two surveys, from 2021 till 2023, the number of enterprises rose from 59.7 to 65.4 million, and the corresponding employment from 97.9 million to 109.6 million. The employment numbers include single person-owned enterprises and are lower than in the 2016 survey... Of the 65.4 million enterprises, 82.6% have an annual turnover of less than ₹5 lakh. Almost 99% of the unincorporated enterprises have turnover of less than ₹50 lakhs, and merely 0.3% have more than ₹1 crore. More tellingly, only 2% are registered for GST. Two-thirds of all unincorporated enterprises are not registered under any act or authority. Note, a lot of the benefits to small businesses are linked to their registration on UDYAM. These include collateral free loans under schemes like the Credit Guarantee Fund Trust for Micro and Small Enterprises... A large section of informal small businesses involves sales of products and services directly to the end customer at wafer thin margins. These could be, for instance, selling vegetables or carrying out shoe repair, and often are single-person enterprises. For them, entering the GST net has a disincentive, even if they grow above the exemption threshold, since they do not derive any input tax credit, nor can they pass on the burden to their customer due to a competitive market.

4. Official data has shown that the net financial assets of Indian households declined precipitously from 11.5% of GDP in 2020-21 to 5.1% of GDP in 2022-23, a five-decade low and a fall of over Rs 9 trillion. 

The article says that the decline cannot be explained by the rise in physical assets. 

This trend has been accompanied by a trend of growing non-housing loan share.

The report informs that while the share of vehicle loans has remained stable at aroubg 9-10% since 2018-19, the other loans to finance consumption (medical loans, credit card loans, consumer durable loans etc.) has risen sharply from 14% to 19%. India's non-housing debt is around 30% of GDP, easily higher than peers and in fact higher than those even in advanced countries. The housing debt stands at a low 10-11% of GDP. 

5. The declining venture capital in India.

A longer series is below.

6. China's National People's Congress, the rubberstamp Parliament, has finally announced its long-awaited fiscal stimulus plan. But in a disappointment to investors, the plan avoided targeting the flagging household consumption and was aimed at bailing out local governments. 

As part of the bailout, Beijing would authorise local governments to issue bonds over three to five years to restructure most of an estimated Rmb14tn in “hidden” or “implicit” debts, finance minister Lan Fo’an said in a rare press briefing at the Great Hall of the People in Beijing. These debts are mostly held by thousands of off-balance sheet finance vehicles that local governments used to invest in infrastructure and property-related sectors. Many of these bets went sour when China’s real estate market entered a deep slowdown three years ago, sinking local government finances and undermining the broader economy... Lan said Beijing would authorise local governments to issue Rmb6tn in new bonds over three years for the debt restructuring and would reallocate a further Rmb4tn in previously planned bonds over five years for the same purpose... Local governments would be able to swap these bonds for those of their finance vehicles, bringing the debts on to their own balance sheets. This would lead to lower financing costs, saving Rmb600bn in total, Lan said. Lan estimated that “hidden debts” would be reduced to Rmb2.3tn once the swaps and another debt programme related to slum redevelopment were in place. This would free up resources previously “constrained” by the debt problems and allow local governments to refocus spending on “development and public welfare improvement”, he said. On additional stimulus measures, Lan said officials were “studying” extra steps to recapitalise big banks, buy unfinished properties and strengthen consumption.

This massive fiscal stimulus essentially allows local governments to issue bonds to take on their balance sheets a large proportion of the off-balance sheet debts. It's hard to say this is fiscal stimulus. It's more like monetary stimulus.

This is a longer article. Fundamentally, the debt restructuring of Rmb 10 trillion will allow local governments to convert off-balance sheet loans of LGFVs to longer-maturity, lower-interest liabilities, thereby saving Rmb 600 bn in interest payments over five years and reduce such debt to about Rmb 2 trillion by 2028. However, independent estimates put the LGFV hidden debt at Rmb 60 trillion and not Rmb 14 trillion as claimed by the government. 

7. Veterinary care has become the latest in the sectors dominated by independent businesses to fall to private equity investments. 

Private equity groups Silver Lake and Shore Capital Partners have struck a deal to create one of the biggest US veterinary care groups valued at $8.6bn, with ambitions to further consolidate a sector historically dominated by independently-owned businesses, said people briefed on the matter. The merger between Southern Veterinary Partners and Mission Veterinary Partners, both of which were part-owned by Shore, will create a network of vet hospitals and clinics spanning more than 750 locations and generating $580mn in yearly earnings before interest, taxes, depreciation and amortisation. The veterinary sector is benefiting from a surge in demand as people seek care for their animals following a pandemic boom in ownership... As part of the deal, Silver Lake and Shore Capital will make a $4bn fresh equity investment split evenly between them. The newly combined company has raised roughly $3bn of debt, said people briefed on the matter. Southern and Mission’s founders and employees will have shareholdings worth almost $1.5bn rolled over, and a syndicate of large co-investors will fund a few hundred million dollars of extra equity. The new company will carry less leverage than prior to the recapitalisation... People briefed on it said the combined company is likely to pursue more deals to roll up vet clinics and hospitals, as private equity groups play an increasingly dominant role in consolidation sweeping the petcare industry... Bloomberg previously reported that the two private equity groups were in talks over a deal to combine Southern and Mission. Rival company IVC Evidensia is owned by Sweden-based buyout group EQT, while PetVet is owned by KKR. Among the other biggest petcare clinic networks are AEA-backed AmeriVet Veterinary Partners and the veterinary health division of family-owned consumer group Mars, which operates more than 3,000 clinics worldwide. Southern, in which Shore has been an investor since 2014, operates more than 420 locations across the US, while Mission, which Shore helped to found in 2017, operates more than 330 vet hospitals nationwide.

8. Livemint writes on single or super-specialty hospitals becoming an attractive takeover option for PE firms.

Many private investors have been increasingly showing a preference for single-speciality hospitals, especially since 2022, with deals and fundraising taking place at a brisk pace... This year, in one of the bigger deals so far, Quadria Capital acquired a minority stake in dialysis chain NephroPlus in May for $102 million. In 2022, the healthcare-focused private equity (PE) firm had invested $159 million in eye-care hospital Maxvision... Last year, funding deals worth $5.5 billion were inked by hospitals in India, of which 20% went to single-speciality facilities, according to consulting firm Bain. Among the most prominent deals were Asia Healthcare Holding (AHH)s’ acquisition of Asian Institute of Nephrology and Urology for ₹600 crore ($75 million) and PE firm EQT buying a majority stake in Indira IVF, India’s largest fertility chain, reportedly at a ₹9,000 crore valuation...

Nothing matters more to a PE firm or a similarly aggressive buyer than scaling up a business quickly. Compared to elephantine multispeciality hospitals, single-speciality chains offer a more attractive turnaround time. A multispeciality hospital opening with more than 300 beds in a location can take up to five years to break even... With relatively fewer beds (or none in some cases), these individual hospitals tend to be smaller, making it easier to open many of them in dense urban centres in a short period of time. Smaller spaces also mean a hospital has plenty of existing hospitals and clinics to choose from for a brownfield acquisition... Investors find the single-speciality model attractive because it needs less investment, less space, can be expanded into a chain faster, and tends to have higher prices... That helps the single-speciality-chain model, whose strength is in offering higher-priced, higher-margin procedures at lower fixed costs than those in a multispeciality model... Globally, single speciality hospitals trade at a premium to multispeciality hospitals for several reasons, including higher ROEs... This is because single-speciality chains don’t need to store expensive machinery for multiple diseases, and can use their machinery more than a multispeciality hospital can, leading to a higher asset utilisation and higher margins.

9.  Telecommunications sector comes full-cycle.

The details of how telecom was liberalised in India are much more complicated, and frankly, some of it has repercussions to this day. In 2001, one of the things that the Indian telecommunication did to ease things was that it allowed players who had a “basic service licence” to offer limited mobility services. I don’t want to get too deep into this, but essentially, this allowed players who offered something called WLL (wireless local loop technology) to expand and offer mobile services to Indians... Existing telecom players complained that this was tantamount to a “backdoor entry”, because it let WLL players become mobile telecom players without having to pay the higher fees that they were paying for spectrum, entry, or revenue share. This made existing Indian telecom companies—Bharti, Hutch, Idea, BPL, and a few others—quite upset... In January, 2001 when the government approved the use of CDMA (Code Division Multiple Access) based Wireless in Local Loop (will) platforms by basic telephony companies to provide ‘limited mobile’ services (within a single Short Distance Charging Area, approximately 250 square km), Reliance made its move. It bid for, and won 17 new licences, to go with the one for Gujarat that it had acquired in 1997...

This specific ruling was the basis on which Reliance stormed into telecom, and changed India forever. Mukesh Ambani, who had just taken over as the head of Reliance Infocomm, countered all claims by saying, “If anyone thinks this is a backdoor entry (into cellular telephony), well, it is a backdoor that was open to all”. In just a couple of years, Reliance launched the now famous ‘Monsoon Hungama’ offer, giving away handsets for free to consumers, offering rock-bottom prices, and driving up adoption of mobile services across the length and breadth of the country. Competitors were forced to respond in kind, and well, the rest is history. And it all began with India’s telecom regulator letting the wireless loop players use their technology to disrupt existing telecom players.

Starlink now threatens to reprise the scenario!

10. On America's envious economy, The Economist writes.

In 1990 America accounted for about two-fifths of the overall gdp of the G7 group of advanced countries; today it is up to about half (see chart). On a per-person basis, American economic output is now about 40% higher than in western Europe and Canada, and 60% higher than in Japan—roughly twice as large as the gaps between them in 1990. Average wages in America’s poorest state, Mississippi, are higher than the averages in Britain, Canada and Germany... Since the start of 2020, just before the covid-19 pandemic, America’s real growth has been 10%, three times the average for the rest of the g7 countries. Among the g20 group, which includes large emerging markets, America is the only one whose output and employment are above pre-pandemic expectations, according to the International Monetary Fund... A decade ago many analysts thought that China would, by now, have overtaken America as the world’s biggest economy at current exchange rates. Instead its gdp has been slipping of late, from about 75% of America’s in 2021 to 65% now.

On productivity

This year the average American worker will generate about $171,000 in economic output, compared with (on purchasing-parity terms) $120,000 in the euro area, $118,000 in Britain and $96,000 in Japan. That represents a 70% increase in labour productivity in America since 1990, well ahead of the increases elsewhere: 29% in Europe, 46% in Britain and 25% in Japan... when assessed on a per-hour basis the gap remains sizeable: 73% productivity growth for American workers since 1990 versus 39% in the euro area, 55% in Britain and 55% in Japan.

The churn rate among US companies is 20% (half being new businesses created and other half being those that stop operating), compared to 15% in Europe. Similarly, over any three-month period, about 5% of American workers change jobs, whereas in Italy it takes a year to get the same level of labour turnover.

11. India derivative markets fact of the day.

Four-fifths of equity futures and options trades in the world now take place in India.

On the positive side, India’s capital markets should be counted as perhaps the most impressive economic policy successes of the country. 

India generates only 3% of the world’s GDP, but has been home to nearly a third of all public listings so far this year, which accounts for a tenth of the capital raised in ipos globally. Unusually among emerging economies, India has successfully translated economic growth into shareholder returns, letting ordinary investors benefit. Stocks there have roared since 2019, even as those in China have fallen by 15%. Analysts at Franklin Templeton, an asset manager, reckon that the correlation between Indian company earnings and gdp growth is closer than in any other emerging market. 

The Economist has another article that hails the introduction of the new Rs 250 monthly contribution Mutual Fund.

One in five households today holds shares, up from one in 14 just five years ago. The number is set to rise further... In dollar terms, Indian stocks have risen in price by 80% over the past five years, compared with a 6% rise across emerging markets as a whole... As investment habits have shifted, the share of household assets held in bank deposits has fallen below half...

In August the number of mutual-fund accounts reached 205m, up from 73m in 2021. Most are small: the average holding is under $4,000. The growth is facilitated by a wave of new electronic brokers... Much of the growth has been driven by products available to humbler investors. The number of Systematic Investment Plans (SIPs), a way to invest in mutual funds, has risen from 10m to 99m in the past eight years, with contributions increasing to $24bn in 2023. The funds take monthly instalments from investors. In August they received $2.8bn, continuing a run of record monthly inflows that has, with only rare interruptions, extended back to 2016.

There has also been an explosion in “demat” accounts, short for the dematerialised form in which shares are held. In August their number reached 171m, up by 54% from January last year. But the most extreme aspect of the investment boom is in derivatives trading: India now accounts for 80% of global turnover, and retail investors count for 40% of Indian trading, up from 2% in 2018... In the first three quarters of this year, India’s 258 IPOs accounted for 30% of the global total by number and 12% by the amount of money raised, in an economy that makes up just over 3% of global GDP.  

12. Robert Lighthizer makes a very important point

Economists’ free trade prescriptions fail because they do not reflect modern reality... what we have seen in recent decades is countries adopting industrial policies that are designed not to raise their standard of living but to increase exports — in order both to accumulate assets abroad and to establish their advantage in leading edge industries. These are not the market forces of Smith and Ricardo. These are the beggar-thy-neighbour policies that were condemned early in the last century. Countries that run consistently large surpluses are the protectionists in the global economy. Others, like the US, that run perennial huge trade deficits are the victims. They end up trading their assets and the future income from those assets for current consumption. Many economists will say this is all the fault of the victim, and that the US has too low a savings rate. Of course the trade deficit is equal to the difference between a country’s investment and its savings, but the causation runs the other way. Foreign industrial policy creates the deficits and with investment being set by demand for domestic investment, savings must go down. The problem is not the concomitant savings rate. It is the predatory industrial policies.

13. Rana Faroohar writes on the Trump victory

... the market reaction that greeted Trump’s victory, when stocks and risky assets rose while bond prices fell. This is a man who has promised across-the-board import tariffs and support for the US manufacturing sector. That would argue for lower US share prices and a weaker dollar, to make exports more competitive; investors are betting on just the opposite... America Inc under our brand new CEO Trump feels less like a blue-chip and more like a private equity firm: it’s a highly leveraged, short-term play with an average hold time of around four years. Like Trump, private equity is able to strip assets for immediate profit — no matter how important... If Trump is our CEO, is America now a distressed asset? One has to wonder.

14. Is Mumbai's economic growth choking?

Despite being the country’s financial and entertainment hub, Mumbai, accounting for about 20 per cent of the state’s economy, failed to lead the growth charge. Maximum City real GDP grew at 5.9 per cent between 1994 and 2020, significantly slower than the state, with financial services growing at a paltry 3.6 per cent (2005-20). Mumbai suffers mainly from two main challenges — expensive housing and weak transport. The price-to-income ratio (the median price of a 90 square metre apartment relative to median familial disposable income) in Mumbai is around 40, making it one of the most expensive real estate centres in the world. Likewise, road density in the poshest part of Mumbai, the Island City, is around 7 km per square km as against 10 km for Delhi. Furthermore, Mumbai started developing its metro network relatively late. While Delhi has around 400 km of metro network operational, it is close to 50 km in Mumbai, with about 150 km under construction.

15. In one stroke President elect Trump may have neturalised Elon Musk and Vivek Ramaswamy! Both have been tied-up together (it's very unlikely that they will be able to work together and come up with something coherent). It'll "provide advice and guidance from outside the government", thereby ensuring that its role will be purely advisory with little or no teeth in actual implementation. Finally, by giving it time only till July 4, 2026, there's a sunset for this experiment.  

16. KP Krishnan has a very good oped on how the structure of Statutory Regulatory Authorities in India, with their delegated power to make and amend laws, detract from federalism.

Urban local bodies (ULBs) require the approval of their respective state governments for borrowing money. With the growth of bond markets, increasingly municipal bonds are replacing institutional borrowings as the mechanism for providing debt to ULBs. Sebi’s regulation of municipal bonds implies that the regulatory arm of the Union Ministry of Finance is exercising control over a subject in the state list. So, the deficit is also material in its impact.

The drivers of inflation in the US

One of the big macroeconomic debates after the pandemic has been on the trajectory of inflation. The team persistent, led by Larry Summers and Co., worried that the persistence of the extraordinary monetary and fiscal policies, long after the pandemic subsided, may have unleased inflationary forces that cannot be brought down without a recession. The team transitory, led by Joseph Stiglitz and Co., argued that the inflationary episode was due to negative supply shocks from the pandemic and the Ukraine war and would recede once the shocks subside. 

As with everything in economics, it’s difficult to establish who’s turned out right conclusively. There are arguments in favour of both. The Economist has a good summary here that also points to a study by researchers at Allianz.

They conclude that the Fed played a vital role. About 20% of the disinflation, in their analysis, can be chalked up to the power of monetary tightening in restraining demand. They attribute another 25% to anchored inflation expectations, or the belief that the Fed would not let inflation spiral out of control—a belief crucially reinforced by its tough tightening. The final 55%, they find, owes to the healing of supply chains.

I’m inclined to agree with the Allianz conclusion. Even if the surge in inflation was completely driven by supply shocks, given the massive accompanying fiscal and monetary stimuluses, I don’t think inflation would have subsided on its own. In fact, it can be argued that inflation could have been lower if the monetary authorities acted earlier than they did. 

The latest World Economic Outlook has some useful pointers about the sources of inflation across advanced countries in the 2020-24 period. Martin Wolf has the same graphics that disaggregate the drivers of inflation in the US and the Eurozone.

This disaggregates inflation drivers in the UK.

It’s clear that at least from early 2021 till about the end of 2022, all the advanced countries were deeply impacted by the supply shocks and the pass-through effects. These effects were more pronounced in Europe given its direct dependence on Russia for its energy needs. But the one standout feature is the rapid recession of the supply shocks and pass-through effects once the episodes themselves (the pandemic and the war) subsided. The difference though is that in the US a labour market tightness emerged to sustain inflation. The WEO writes,

The rapid fading of pass-through from past relative price movements––in particular from energy price shocks––has played a larger role in the euro area and the United Kingdom than in the United States in reducing core inflation. In the United States, labor market tightness and, more broadly, strong macroeconomic conditions, which partly reflect the effects of earlier fiscal stimulus as well as strong private consumption, are the main source of remaining upward pressure on underlying inflation. In the United Kingdom, labor market tightness predating the pandemic may partly explain why inflation has been higher than in the US or euro area following the onset of the pandemic. 

The WEO also points to the normalisation/depletion of the excess savings accumulated during the pandemic. 

As the WEO writes, the massive fiscal stimulus especially by way of direct transfers coupled with the booming stock markets, and associated strong private consumption has been an important factor in keeping the labour market tight and inflation elevated in the US. While the supply shocks have long receded, the lagged effects of this stimulus still linger. 

But there have been two additional factors stimulating the economy and consumption in the US - the strong equity and housing markets and associated wealth effects, and the investment boom (including government stimulus) in green technologies, semiconductor chip manufacturing, and AI. The investment boom is in its early phase and will play out over at least this decade, if not longer. There will be associated productivity improvements. 

All this means that it’s unlikely that the US inflation will fall back to 2% anytime soon. In fact, as I have blogged earlier, the return to normalcy in inflation might not mean a return to the pre-pandemic 2% rate but a slightly higher band, perhaps 2.5%-3.5%. There has been a regime shift in inflation. If this is true, the US economy is far closer to its new normal inflation regime than the Fed imagines.

Some thoughts on government interventions to prevent recessions

Ruchir Sharma points to a very important point about government interventions to prevent or mitigate recessions and its moral hazard and cushioning effect,

Faith in government as a saviour in recessions has been worming its way into people’s minds for most of their lifetimes. Since 1980, the US economy has spent only 10 per cent of the time in a recession, compared with nearly 20 per cent between the end of the second world war in 1945 and 1980, and more than 40 per cent between 1870 and 1945. One increasingly important reason is government rescues. Combined stimulus in the US, the EU, Japan and the UK, including government spending and central bank asset purchases, rose from 1 per cent of gross domestic product in the recessions of 1980 and 1990 to 3 per cent in 2001, 12 per cent in 2008 and a staggering 35 per cent in 2020. Though the 2020 recession was sharp, it was the shortest since records begin, lasting just two months. Government bailouts in the pandemic came so fast and large that it felt to many people, particularly white-collar employees working from home, as if the recession never happened. Their incomes and credit scores went up. Their wealth exploded with rising stock and bond markets. Now this experience of recession as a non-event seems baked into the professional psyche.

The article also points to the likelihood of a period of higher inflation,

The most lasting legacy of Covid may be its impact on work and wage inflation. One in eight people say they plan “no return” to pre-pandemic activities, including work... In conversations I hear chief executives saying that they have “pricing power” for the first time in decades... Meanwhile, the world is changing in fundamentally inflationary ways: birth rates have been falling for years but are now rapidly shrinking working-age populations. Countries are retreating inward, offshoring to the nearest and most friendly nations rather than to the least costly. The pressure from demographics and deglobalisation will push the new normal for inflation higher, closer to 4 than to 2 per cent.

Some observations

1. On the point about government interventions over the years leading to the build up of excesses, I am reminded of a Howard Marks newsletter (which I blogged here),

In the forestry business, if there's a small fire they let it occur and sometimes they even cause some small fires to burn up the fuel that lies on the forest floor. And if you don't permit any small forest fires, when you finally have one that you can't put out right away, you're going to have a doozy because of all the accumulated fuel on the forest floor.

I believe that if they prevent every recession, that will give rise to such excesses on the high side, it will be, as I say, unsustainable and will cause a recession and that's going to be a doozy. So it just seems to me that if I were running Fed, which I'm absolutely unqualified to do, I would opt for leaving it alone most of the time, the economy, and having it do what it does naturally...We're all in the investment business because we believe in the efficacy of the free market as an allocator of resources. So if you do, then shouldn't you leave the economy and the capital market alone as much as you can so that it can freely allocate resources?

Excessive interventions invariably come in the way of the self-correcting mechanisms of the market, of which recessions are one. However, no matter the logical arguments against such interventions, the political economy of the times cannot help avoid such interventions. In the circumstances, there is little to be done except to endure and face up to the reality. 

2. The normalisation of the resolve (and public acceptance) to undertake such massive interventions by governments also means that they could in theory pull some more cards out to backstop and cushion the next recession, even as more excesses (in the form of debts, zombie companies, financial market distortions etc) build up. Further, the powers and instruments available with governments today (combined with the willingness to use them) to mitigate recessions are more than ever. It may require the later recession to bring the house down. The can could be kicked down the road. 

3. The forces pulling in the direction of higher inflation will have to be seen against those pulling in the other direction. I had blogged here about how the period of low interest rates may continue for long into the foreseeable future. 

4. Besides, I think a steady state inflation of 4% should not be seen as the arrival of a period of higher inflation. Instead it should be seen as a return to more normal times. Instead, the last two decades and more of 2% and below inflation have been an aberration.

Update 1 (28.03.2023)

Ruchir Sharma has more on the culture of reflexive bailouts

In stark contrast to the minimalist state of the pre-1929 era, America now leads a rescue culture that keeps growing to new maximalist extremes... A restrained government was a key feature of the industrial revolution, marked by painful downturns and robust recoveries, resulting in strong productivity and higher per capita income growth. Right into the 1960s and 1970s, resistance to state rescues still ran deep, whether the supplicant was a major bank, a major corporation or New York City. Though the early 1980s is seen as a pivotal moment of broader government retreat, in fact this era was marked by the rise of rescue culture when Continental Illinois became the first US bank deemed too big to fail. In a move that was radical then, reflexive now, the Federal Deposit Insurance Corporation extended unlimited protection to Continental depositors — just as it has done for SVB depositors... In each crisis, rescues held down the corporate default rate to levels that were unexpectedly low, compared with past patterns. They are doing the same now even as rates rise and bank runs begin... The rescues have led to a massive misallocation of capital and a surge in the number of zombie firms, which contribute mightily to weakening business dynamism and productivity. In the US, total factor productivity growth fell to just 0.5 per cent after 2008, down from about 2 per cent between 1870 and the early 1970s. Instead of re-energising the economy, the maximalist rescue culture is bloating and thereby destabilising the global financial system. As fragility grows, each new rescue hardens the case for the next one... constant rescues undermine capitalism. Government intervention eases the pain of crises but over time lowers productivity, economic growth and living standards.