Judicial delays fact of the day

In the context of the Chief Justice of Supreme Court's recent appeal to the government to help the courts expedite case disposals by filling up vacancies, Livemint shines light on more egregious internal delays like that between reserving for judgement and actually delivering the judgement. It examined 487 judgements delivered by the Supreme Court in 2015 for which information was available and found a disturbing trend. In more than 17% of cases, orders were not delivered within the three month benchmark suggested by the Supreme Court itself.

The article says,

The relatively large number of cases where the judgement is delivered more than 90 days after being reserved by the bench suggest the absence of a system to keep track of how long a case has been reserved for judgement. From the information available on the Supreme Court website, it is not possible to determine with any accuracy how many judgements have been reserved and for how long. A recent Right to Information application seeking details of cases that have been reserved for judgement was denied by the Supreme Court.

It is impossible to imagine any other agency of the government being able to deny such basic information and get away without a public admonition by a Court. As the article says, "it is high time perhaps that the apex court adopts a system to keep track of reserved judgements in the interests of transparency and accountability to the litigating public".

This again underscores the point that I have blogged many times that the country's highest court needs to urgently embrace the advise of Justice Louis Brandies and disinfect judicial performance with the sunlight of transparency on case disposal information. It is worth reiterating,

Even the most basic data on the performance of judicial officers is currently difficult to obtain. How many orders have been passed by each judge annually, individually and in a bench? What is their average time between the final hearing (reserving for orders) and passing of orders? How many orders of the judge have been appealed against? How many of the orders have been reversed in appeal? How many orders have been passed in favor of the petitioner and how many rejected? How many orders have been passed against the government and how many in favor? What is the average number of adjournments in a case for each judge?

For a part of the government whose accountability largely rests on self-regulation, and one which has mostly refused to play by the same rules of the game that it administers on all else, transparency may be the only check against degeneration.

US Presidential election quote of the day

From Edward Luce,

The presidential debates between Hillary Clinton and Donald Trump will shatter all audience records... Tens of millions will tune in to watch our age’s most trigger-happy insulter denigrate one of the world’s most famous women. In ancient Rome gladiators slaughtered barbarians to keep the people entertained. In this case however, the barbarian has a shot at becoming emperor. Whether or not he succeeds, US democracy will never be the same.

India banking sector update

With the Q4 2015-16 results declared, the admirable folks at Credit Suisse have their latest update on India's banking sector. The non-performing loans have exploded by nearly Rs 3 trillion over the last two quarters to about Rs 6 trillion or 8.1%. Worryingly, coupled with stressed assets, the total figure may well be above 17%!

Given the scale of losses, the budgeted capital infusion looks like small change. Instead, at the least an additional $40 bn or Rs 2.7 trillion capital infusion would be required. 

Currently, the bank credit is flowing mainly on the back of private banks, who though made only 25% of the total banking loan book had over half the profits, and contributed four out of the five banks which had double digit loan book expansion in 2015-16. The Credit Suisse report estimates that PSU banks would need five years of profits to provide for all the stressed loans. In fact, including the stressed loans (assuming 30% go bad), just four of the 22 PSU banks covered have positive net worth!

In this context, the drip-by-drip capital infusion is simply too little. As the report points out, the losses in 2015-16 more than wiped out the capital infusion done by the government. Whatever other reforms are undertaken, and there are many required, there cannot be any substitute for massive capital infusion for the public sector banks. And this will have to be in the form of allocating about 0.5% of the GDP for recapitalization for the next three years. It may even be alright to have the fiscal deficit targets of 3.5%. 3.25%, and 3% each for the next three years to meet this objective. 

Saving capitalism - Valeant edition

I had blogged earlier about Valeant Pharmaceuticals and its predatory capitalism. All too often there are such stock market darlings who claim to have discovered new approaches to making money. In case of Valeant, James Surowiecki describes its model,

For the past seven years or so, Valeant’s business model was to use cheap debt to buy pharmaceutical companies that it believed were undervalued, then to slash their costs, particularly in R. & D., and often to hike the prices of their drugs. In order to buy those companies, Valeant borrowed billions of dollars, promising investors that those companies, and the drugs they owned, would become far more valuable than before. Essentially, Michael Pearson sold those investors on the idea that Valeant’s core competencies were its superior approaches to capital allocation and drug pricing.

 James Surowiecki again writes,

Valeant became a serial acquirer, doing more than a hundred transactions between 2008 and 2015. It invested almost nothing in its core business; R. & D. spending fell to just three per cent of sales. It was ruthless about bringing down costs, sometimes laying off more than half the workforce of a company it acquired... A 2015 analysis looked at drugs whose price had risen between three hundred per cent and twelve hundred per cent in the previous two years; of the nineteen whose prices had risen fastest, half belonged to Valeant.

And their financial engineering borders on chicanery,

The company also pulled every trick in the financial-engineering handbook. In 2010, it merged with a Canadian company, in order to bring down its tax rate, and it sheltered its intellectual property in tax havens like Luxembourg. It used opaque accounting methods that made it hard for investors to judge how well acquired companies were doing. To ward off competition from generic drugs, Valeant entered into a complicated relationship with a mail-order pharmacy called Philidor. Meanwhile, it paid its executives exceedingly well, and tied their compensation to shareholder returns, thus encouraging a single-minded focus on stock price. Valeant embodied practically everything that people hate about business today. So it’s no surprise that much of Wall Street saw it as a profit-making machine.

This has been said before. Next time you come across a company with rising share price which is not grounded on any productive transformation but a new business model or financial engineering, it may be a good opportunity to short the stock and make good money. But it is more likely that people would still go long in the direction of the herd. 

Weekend reading links

1. Kishore Mahbubani has a nice article on Jakarta's popular Chinese Christian mayor, Basuki Tjahaja Purnama, popularly known as "Ahok". In 17 months, he has several achievements to show,

He has made some bold changes: closing down trendy but disruptive nightclubs, cleaning up red-light districts, evicting people from slums (while providing them with better housing) and dredging clogged-up canals. He has also demonstrated his willingness to make difficult policy choices, such as discontinuing a long-stalled monorail project in favour of a more cost-effective and efficient light rail system. Even more significantly, an underground railway, which had been held up by bureaucracy for more than 25 years, is going ahead. Mr Purnama also believes in transparency. The entire budget of the city of Jakarta is online. Citizens can scrutinise all spending. Even his mobile phone number is public, meaning that he receives a large number of text messages, many of which he responds to personally. The city’s inhabitants feel that their lives are improving.

2. On the same topic, FT points to the growing popularity of the municipal office among British politicians. It writes,

The modern world favours localism. Growing complexity and change, the clustering of the resources needed for innovation, and the diverse demands and expectations of modern citizens, all put a premium on getting decision-making closer to the people. Most national domestic policy fails. If this sounds like a sweeping statement, I offer in evidence decades of welfare reform, health reform, education reform, prison reform — and so on. Some local policy, in contrast, succeeds. Around the world, surveys show mayors to be more popular and effective than presidents and prime ministers. On the whole, local leaders are pragmatic dealmakers. Voters prefer politicians who are close to the action and keen to emphasise that geographical loyalty comes above political allegiance.

Where are India's city leaders?

3. The FT writes about China's creeping encirclement of India. And about its ambitious Central Asian interests.

This graphic captures all the investments planned in the region,

I agree with Samir Saran of Observer Research Foundation who says, "For every belt they create, and every road that we create, can we create a slip road that connects Indian opportunities to the larger global market rather than reject it outright? Can we . . . use their institutions to our own advantage?”

4. FT has an article on the woes facing the global steel market,

Over half of China’s major producers were loss-making in 2015, but rather than close or go bankrupt, these companies, the majority of which are state owned, continue to churn out more metal than the nation needs. Last year alone, China’s exports soared by a fifth to 112m tonnes — greater than the total output of Japan, the world’s second-biggest steel producing nation... In Europe, steel demand is 25 per cent lower than before the 2008 financial crisis. Despite painful closures and the loss of one in five steel jobs, some analysts say the continent still has excess capacity. When plants are underused, operators lose their ability to set prices and unit costs go up.

5. Fascinating Wilson Center report (pdf here) on production sharing and integration of supply chains between US and Mexico.

Mexico is the United States’ third-largest trading partner and second-leading destination for exports after Canada... A full 40% of the value of U.S. imports from Mexico is made of content produced in the United States... The number is 25 percent for Canada, which is part of many of the same supply chains, but is only 2 to 5 percent for the European Union, India, China and South Korea... Production sharing, also known as vertical specialization, occurs when two or more countries share in the manufacturing of a specific good... Since the United States is the supplier of such a large portion of the materials in imports from Mexico and Canada, an increase in regional imports actually increases U.S. exports, supporting local jobs and industry... The regional auto industry is a good example of the phenomenon of production sharing. The United States, Mexico and Canada each produce and assemble auto parts, sending them back and forth as they work together to build complete cars. Cars built in North America are said to have their parts cross the United States borders eight times as they are being produced, and between 80% and 90% of U.S. auto-industry trade with its North American partners is intra-industry, both of which signal an extremely high level of vertical specialization.

This highlights the impossibility of Trump's Presidential campaign rhetoric, one which is likely to remain just that even if he emerges the winner.

6. So Leander Paes has won his eighth Grand Slam mixed doubles title, becoming the second Indian after Mahesh Bhupati to win all the four Grand Slam titles in a career. In recent years, thanks to the likes of Paes, Bhupati, Sania Mirza, and even Rohan Bopanna, India has become a powerhouse in paired tennis events. But has this been necessarily a good thing?

As a celebration of global sporting success for a country with very few successes outside cricket, these victories are great. But as a celebration of tennis greatness, I am not sure. In fact, I am inclined to believe that their successes in paired events have had the result of crowding-out tennis talent from the "real" tennis of singles and engendering a resource misallocation problem. Given that none of the top singles players participate in these events and our own paired event superstars are unlikely to make the main draw of even non-Grand Slam events, these successes ring hollow.

7. More evidence that you need a much broader middle-class consumption base than what India currently has to support the high growth assumptions that underlie many sectors comes from e-commerce,

Online retail sales in India have been sluggish so far this year and start-ups across the board are struggling to make money from ads, content and sales of products and services, raising concerns whether Internet companies can attract enough new paying users to support the rosy projections of investors who have pumped billions of dollars into them. According to a report on Thursday by Kleiner Perkins Caufield Byers, a Silicon Valley venture capital firm, the number of Internet users in India grew by 40% in 2015 to 277 million. While the number of Internet users is growing rapidly, that of those transacting (or online shoppers) isn’t increasing at the same rate... The large Internet base in India looks attractive but making money from users is another matter altogether.

8. The Ministry of Power proposes to instal Supervisory Control and Data Acquisition (SCADA) systems on rural feeders to monitor in real time the power supply. I have blogged extensively about the difficulties associated with the use of technologies like SCADA and GIS in electricity distribution sector. Instead of unimplementable fancy solutions which are most unlikely to work in these environments, the sector needs rigorous feeder level energy audits, for which smart meters more than suffice. All that can be said is that this is a terrible idea.

9. FT has an excellent series on the future of cities. This is more evidence strengthening my firm belief that the biggest challenge facing the future of cities is gentrification and the crowding-out of affordable housing. This applies to cities in developing countries with even greater effect. The narrative is straight forward.

The scarce vacant lands available, coupled with restrictive zoning regulations and the practical difficulties associated with slum redevelopment makes housing within the city unaffordable for all but those at the very top of the income ladder. Housing costs take up an increasing share of household incomes for everyone. This leaves people with lower disposable income which hurts consumption and business investment. Worse still, businesses are forced to provide a wage premium, all of which in turn affect their competitiveness. Finally, with vertical growth constrained, cities spread out to accommodate the migrants. This, in turn, increases commute times, decreases productivity and lowers the quality of life. This is a very bad equilibrium with all round bad outcomes.

10. There is growing evidence that institutional investors like pension funds have been paring down their exposures to hedge funds, who are battling to deliver high returns in a low interest rate environment and face outrage at their exorbitant management fees even as their returns have declined. 

According to Chicago-based Hedge Fund Research, pension funds and other big institutions now account for only 43.1 per cent of hedge funds’ assets, from 47 per cent three years ago.

11. My favorite fish is being hit by a severe toxic algae bloom in Chile.

12. Finally, as the Government of India invites private participation in defence manufacturing, there may be a danger that this industry will take over from infrastructure as the preferred operating ground for crony capitalists. Is it any more a coincidence that one of the ten most indebted groups in the country, one without any experience in defence manufacturing and a history of not delivering on promises in its projects, but with deep expertise in deal making in opaque environments, is also at the forefront of the private sector engagement in the industry? Watch this space.

13. Praveen Chakravarthy and Ajit Ranade have an excellent article which chronicles the cascade of unintended distortionary policies engendered by the India-Mauritius Tax Treaty, an 'original sin', as they call it, 

India signed a tax treaty with Mauritius in 1983 that gave Mauritius the sole right to tax investment gains made by investing in India. Mauritius’ tax rate on such gains was zero. Needless to say, a large majority of investments into India chose this attractive route... Investments in publicly listed shares were granted exemption from long-term capital gains tax in 2004. The rationale for that decision was to provide a “level-playing field” to domestic investors vis-à-vis Mauritius’ investors. A new tax called the securities transaction tax was imposed on stock market transactions to offset any loss of revenues from the exemption of capital gains. This higher transaction tax on shares triggered a massive shift by investors to investing in risky derivatives vis-à-vis shares. The budget of 2016 increased transaction tax on derivatives to create a “level-playing field” with shares. 

Not to be left behind, investors in real estate through real estate investment trusts want a “level-playing field” with equity investments... In January 2016, a committee constituted by the Securities Board of India (SEBI) under the chairmanship of Narayana Murthy recommended exemption of long-term (more than a year) capital gains tax on investments made in shares of private (not listed on stock exchanges) companies. The rationale was the need for a “level-playing field” for such private equity investors on par with investors in shares of publicly listed companies...

This treaty has led to a long tail of arbitrages across various asset classes (private vs public shares), types of investors (Mauritius vs non-Mauritius), types of income (capital gains vs dividends) etc. This treaty has hampered India’s ability to garner enough tax resources through progressive direct taxes. While it is true that this treaty provided an opportunity for illegal round tripping of domestic money, the most damaging impact has been the cascading effect on India’s tax structure.

The original sin having been washed away, it is now time to roll back the entire cascade of policies that it engendered.

14. The week also saw the inauguration of the Gotthard Base Tunnel, at 57.1 km, the longest and deepest railway tunnel in the world. The twin rail tunnel has cost $12 bn and taken 17 years to build.

Start-ups and me-too e-commerce are not innovation

The Nobel laureate Robert Solow said in 1987, "We see the computer revolution everywhere, except in the productivity statistics". In the context of the excitement about India's IT startup companies, one could as well say, "People talk about Bangalore bubbling with young and smart entrepreneurs indulging in a vast array of innovations. While we can see bubbles of "me-too" startups everywhere, where are the innovations?"

Entrepreneurship demands creativity, risk appetite, diligence, and deferred gratification. I am not sure, whether any of these elements, in a reasonable magnitude, are at play in India's entrepreneurial eco-system. Consider the examples of the popular e-commerce and sharing economy firms. All of them borrow well-tested business models, work-flow processes, and technology platforms from developed markets. This naturally limits project risks, except commercial viability risks associated with any such ventures. Creativity and diligence is confined to finding ways to manoeuvre around the country's stifling and inhospitable bureaucracy. In line with modern shareholder capitalism, our entrepreneurs too prefer to pursue gratification which is instant than deferred. 

Unfortunately, despite the generic nature of the business models and processes, India's e-commerce story has not gone beyond the well-trodden paths of e-commerce, vehicle sharing, home stays, and e-payments. Where are the entrepreneurs who have taken the agricultural market place by storm with extension services or sharing of farm implements? Where are the tele-medicine and e-learning apps which have grown in scale and enabled access to high quality health care and school education for millions? Where are the killer apps that could have broken the stranglehold of middlemen by enabling farmers, fishermen, milkmen, and other producers of primary products to bridge information asymmetry by being able to access large enough markets? Where are the public grievance redressal or public systems monitoring apps that could have transformed governance delivery?

Given that each one of the above mentioned, if successful, could have transformed the global market itself, it is surprising that India has not had any homegrown global brands and market leader like the M-Pesa of Kenya. All these endeavors have the potential to constitute market opening innovations, and would actually demand significant doses of all the four aforementioned attributes. They would require patience and hard work, understanding the markets and iteratively designing appropriate business models. That would have been innovation. 

However, it may be unfair to blame the entrepreneurs alone for chasing low hanging profit opportunities, especially when there is plentiful investments chasing them. This takes us to the role of finance itself. It cannot be denied that venture capitalists like Kleiner Perkins, Sequoia and A12Z played the classic role of venture capital in catalyzing technology startups in the Silicon Valley. But, given that the Indian startups are merely replicating commercially validated models (and that too across several global markets), it is perhaps a fair point that this capital is more private equity than venture finance. This begs the question, where are the real venture capitalists in India? How do the venture capitalists see Indian market?

Worse still, none of the big domestic startups have been able to do at least the one thing that defines a successful startup, me-too or not - transition from customer acquisition to sustainability of commercial model. It is most likely that, given the dipping valuations and the contractual obligations like liquidation preferences, none of the Indian unicorns are much above the line for their original promoters. It is, therefore, not unlikely that ten years hence, the e-commerce and sharing economy landscape of India will be littered with Amazons, Ubers, Zillows, AirBnB's, Lending Clubs, Alipays, Expedias and so on with nary a sight of Flipkarts, Oyos, and Olas. 

As an ardent behaviouralist, I am one of those who subscribe to the view that you need to provoke in the extreme in the opposite direction to unsettle conventional wisdoms. It, therefore, follows that none of this is to overlook the significant achievements of start-ups in economic value addition and promotion of a culture of entrepreneurship. On the contrary, the objective is to initiate a debate on questioning the settled wisdom on our startups and innovation.

IMF questions neo-liberalism

John Maynard Keynes said, "When facts change, I change my views. What do you do sir?" The latest adherent to this appears to be the IMF. In the ferment that followed the sub-prime crisis and which continues till date, the IMF has been the undisputed thought leader in revisiting many fundamental tenets of conventional wisdom in economics.

It has initiated debates on a higher inflation target, bigger fiscal deficit, some form of capital controls to stem flows volatility, and expressed concern at the distributional consequences of competitive policies and free trade.

The latest salvo comes in the form of an article in the latest edition of its F&D magazine which can only be construed as the formal obituary of the neo-liberal order, popularly embodied in the Washington Consensus. The two central tenets of this were competition, achieved through extensive deregulation and globalization, and shrinking the role of the state, through large-scale privatization and fiscal consolidation. The article questions two of the important elements of this policy push - elimination of capital controls (financial openness) and fiscal consolidation. Its findings are three-fold,

One, the benefits in terms of increased growth seem fairly difficult to establish when looking at a broad group of countries.­ Two, the costs in terms of increased inequality are prominent. Such costs epitomize the trade-off between the growth and equity effects of some aspects of the neoliberal agenda.­ Three, increased inequality in turn hurts the level and sustainability of growth. Even if growth is the sole or main purpose of the neoliberal agenda, advocates of that agenda still need to pay attention to the distributional effects.­

The headline finding on unrestricted capital flows is,

Some capital inflows, such as foreign direct investment—which may include a transfer of technology or human capital—do seem to boost long-term growth. But the impact of other flows—such as portfolio investment and banking and especially hot, or speculative, debt inflows—seem neither to boost growth nor allow the country to better share risks with its trading partners... Although growth benefits are uncertain, costs in terms of increased economic volatility and crisis frequency seem more evident. Since 1980, there have been about 150 episodes of surges in capital inflows in more than 50 emerging market economies... about 20 percent of the time, these episodes end in a financial crisis, and many of these crises are associated with large output declines  

And on fiscal consolidation is,

The need for consolidation in some countries does not mean all countries... Markets generally attach very low probabilities of a debt crisis to countries that have a strong record of being fiscally responsible. Such a track record gives them latitude to decide not to raise taxes or cut productive spending when the debt level is high. And for countries with a strong track record, the benefit of debt reduction, in terms of insurance against a future fiscal crisis, turns out to be remarkably small, even at very high levels of debt to GDP... The costs of the tax increases or expenditure cuts required to bring down the debt may be much larger than the reduced crisis risk engendered by the lower debt... Faced with a choice between living with the higher debt—allowing the debt ratio to decline organically through growth—or deliberately running budgetary surpluses to reduce the debt, governments with ample fiscal space will do better by living with the debt.

Austerity policies not only generate substantial welfare costs due to supply-side channels, they also hurt demand—and thus worsen employment and unemployment... in practice, episodes of fiscal consolidation have been followed, on average, by drops rather than by expansions in output. On average, a consolidation of 1 percent of GDP increases the long-term unemployment rate by 0.6 percentage point and raises by 1.5 percent within five years the Gini measure of income inequality.

It is impressive that IMF has been willing to revisit such holy cows, for very long the central tenets of its own policies, and widely and aggressively prescribed by the institution.