China industrial policy - electric car battery edition

Forget Tesla, the disruption in battery market is more likely to come from Chinese companies like BYD and CATL. The FT has a nice article that highlights China's massive industrial policy push to promote battery makers for electric cards and dominate the global market estimated to reach $40 bn by 2025. The country is already the world's largest supplier of lithium-ion batteries.

Backed by aggressive government policies —ranging from subsidies for electric vehicles to restrictions on foreign rivals — China’s battery companies are beginning to dominate an industry which has been led for three decades by South Korean and Japanese manufacturers such as Panasonic, which makes the battery cells for Tesla cars. Beijing last week called for companies to double electric vehicle battery capacity by 2020 and encouraged them to invest in factories overseas... China’s approach has echoes of the one it took on solar power a decade ago. It dominated the industry by lowering costs and driving prices down by 70 per cent and could do the same for batteries...

Beijing released a list of companies allowed to supply batteries in the country. Not a single foreign company was included. Separately Beijing released draft guidelines at the end of last year that said car battery manufacturers would need to have at least 8 GWh of production capacity in China to qualify for subsidies — a target that only BYD and CATL can meet... China seeks to acquire world-class foreign battery technology while keeping overall Chinese ownership and control... It has been very careful to cultivate local battery champions while using licensing procedures to hold foreign companies at bay... Because the Chinese have artificial government protection they are able to grow scale that’s bigger than the Koreans..

And the scope of industrial policy goes far beyond the conventional use of such policies,

Even more than the subsidies or barriers to foreign operators, the greatest advantage for Chinese battery manufacturers over rivals such as Tesla is access to raw materials. Chinese companies have been making inroads over the past year into the lithium-ion supply chain, buying up mining assets from cobalt to lithium to help cut costs. This year Ganfeng Lithium, one of the country’s largest producers of the battery chemical, bought a 19.9 per cent stake in an Argentine lithium project. The deal followed on the heels of a purchase last year of a 2.1 per cent stake in Chile’s SQM, the world’s largest lithium producer, by Tianqi Lithium. Similarly in cobalt, China Molybdenum, a mining company partially owned by a Chinese local government, paid $2.65bn last year for the Tenke mine in the Democratic Republic of Congo. The mine contains one of the world’s largest concentrations of cobalt and offers “security of supply of a critical battery material for decades to come”.

When India pursues industrial policy, it would do well to look beyond the likes of Apple and Amazon and promote the likes of battery cars and artificial intelligence. 

The problem with first right of refusals

The Tata-owned Indian Hotels Co Ltd (IHCL), whose 33 year lease on New Delhi's Taj Mansingh Hotel expired in 2011, had moved the Supreme Court of India to stall the auction of the hotel property by its owners, the New Delhi Municipal Corporation (NDMC). IHCL demands the right of first refusal in the auction. The Supreme Court's verdict will be critical for the future of infrastructure concessions in India. 

It does appear that the original concession did not have a right of first refusal. The NDMC, dictated by the Government of India's policy to divest stakes in hotels, was therefore well within its right, to pursue this course of action. Even if available, a first right of refusal would have obviously deterred competition and benefited IHCL just as much as it would have caused loss to NDMC. Why would any serious bidder spend non-trivial amounts and significant time and effort to bid for a project where the bid structure heavily favours the incumbent whose stakes in winning the bid are, in most cases, likely to be far higher than that of any bidder? No structuring, including reimbursing costs for the highest bidder, will mitigate this incentive problem. It is apparent that while giving concessions, all sides underestimate the challenge of re-possession. 

Thousands of long-term concessions of assets ranging from land to utilities have been given to private providers through PPP contracts across India. The bulk of these concessions have been given in the last decade and half. Local government and parastatals have been the biggest participants. Many of them will be expiring over the coming decade. The Supreme Court's decision will strongly influence and set expectations in all these cases. 

This also raises questions about the appropriateness of the concept of first right of refusal. Most concessions, especially on land assets, accord first right of refusal to the concessionaire. But as we know, first right of refusal effectively kills competition and prevents fair price discovery. So why should there at all be the first right of refusal?

After all, governments do such concessions with the financial calculation that they will earn royalty or lease revenues and be able to repossess the property with a depreciated asset (typically a building in case of land or a utility network or facility). The concessionaire makes the bid with an assessment that it will recover the cost of investment and make an acceptable profit. The concession is a self-enclosed financial transaction, one which equilibrates the returns of both parties. 

In the circumstances, given its strong likelihood of deterring competitive price discovery, a first right of refusal distorts incentives and favours the concessionaire. 

The argument in favour of the first right of refusal is, assuming the continuation of the activity, that the incumbent is best positioned to do it most efficiently. But what if the government does not wish to continue the activity? Or what if there are equal or more competent alternatives? 

In any case, I struggle to find a compelling case for the first right of refusal in long-term concessions.

The return of bad loans resolution debate

Arguably the biggest obstacle to India's medium term economic growth prospects is the twin-balance sheet problem. It is therefore unfortunate that it has not received the sort of attention that it deserves. 

The new deputy governor of the Reserve Bank of India, Viral Acharya, has re-ignited the debate with a comprehensive proposal involving a two-track approach. He proposes the establishment of a Private Asset Management Company (PAMC) and a National Asset Management Company (NAMC) as private and quasi-government entities to resolve assets categorized based respectively on short-run and long-run economic value realisation. 

This broad contours syncs well with the proposal laid down by Ananth and me here. See also the blogposts here, here and here. The details of the proposal is here. The only differences being that instead of direct sales to ADCs or other buyers, he suggests a PAMC route to manage resolution and sales, and he also proposes the establishment of a new NAMC instead of leveraging an existing institution like the NIIF or IIFCL. In fact, this blog's proposal goes beyond what the Deputy Governor suggests and offers two more alternatives - sale of some assets to PSUs like NTPC, and bundled auctions of certain other types of assets like steel facilities. These two are potentially easier to tackle and can be the trigger points to catalyse the process. 

This blog feels that using existing institutions may be better than the creation of new institutions. For a start, new institutions will take time. For example, the NIIF, despite its creation more than a year back is yet to have a full-fledged team and the appointment of its CEO took more than six months. Creation of another PAMC will duplicate expertise currently available with IIFCL and NIIF, both of which are themselves sorely under-utilised. 

On the private side too, existing AMCs, ARCs, PE, and private infrastructure funds can be invited to  participate in the auctions and manage these assets. This is all the more relevant since the PAMC will also end up floating several funds or special purpose entities to resolve and revive the vast portfolio of such distressed assets. Further, establishing one or more PAMCs, as fully private entities, and allocating assets to them will raise its set of problems of price discovery etc. Finally, mobilisation of skilled resolution and revival professionals for these new AMCs may take inordinately long times.  

As with all such grand plans, the devil is in the details. Some of them will doubtless emerge as thorny issues - credibility of the credit ratings, stripping and removing existing management, co-ordination problem among banks, avoiding promoters sneaking back as buyers etc. Consider the following,

Haircuts taken by banks under a feasible plan would be required by government ruling as being acceptable by the vigilance authorities. Sustainable debt would be upgraded to standard status for all involved banks. The promoters, however, would have NO choice as to what restructuring plan is accepted, and may potentially get replaced and/or diluted, as per the preference of and depending on the price at which the new managing investors come in.

This is all fine to say. Government can always lay down the process and decision criteria. The vigilance findings will generally revolve around some process details. But it is not possible to cover all contingencies. Post-facto, with the benefit of hindsight, some omission, always likely, will get packaged as part of a criminal conspiracy. And even if the vigilance authorities are kept out, PILs and Courts cannot be. And about prohibiting promoter's choice, it is always likely that they will raise some interpretation of a procedural lapse, again difficult to avoid, and litigate.

In any case, what ever be the details of the process adopted, there will be two critical challenges. 

1. The biggest challenge to the whole process will have to be in figuring out the most (likely to be) acceptable mechanism for price discovery. After all, nothing about the process will be more scrutinised and more critical to the success of the proposal than the degree of haircuts. In such cases, there are no fair valuations, howsoever objective, since judgements on such valuations are always made on post-facto considerations. A haircut arrived at through a professional approach of evaluating alternative resolution plans is no guarantee against post-facto scrutiny. Procedural lapses and process vitiations are always round the corner. Given the size of the problem, as the process proceeds, auctions are likely to generate single bids or no bids, thereby necessitating revised bids, again only to generate single bids. Further, a handful of asset managers could corner the vast proportion of the best assets and make handsome gains down the line.   

Therefore, we may need to make prudent compromises. A Committee headed by a very credible retired judge of the Supreme Court (Justice Sri Krishna?) can be given the mandate to approve the haircuts. This will both ease the vigilance fear as well as possibly limit excessive judicial trespass. 

2. Then there is the issue of recapitalisation. There is only so much that can be raised for recapitalisation through equity dilution upto 51%. Even this will run into political difficulties. Dilution below 50% is a political taboo and may not be desirable too given the distressed valuations. Therefore, the vast majority of recapitalisation will have to come from the government. It will be a few times more than the proposed Rs 70,000 Cr over the 2014-19 period. And there is also the additional capital required to meet the Basel III norms. 

In the circumstances, the banks may need at least a 0.5% of GDP annual recapitalisation for the coming 4-5 years.

Finally, apart from the Deputy Governor's caution on cherry-picking parts of the proposal and ignoring others, it would be necessary to complement this proposal with the provision of real operational autonomy so as to increase valuations and set the stage for phased divestments. 

The US-Russia relationship is a hostage to Trump-bashing

Arguably one of the two most important international strategic relationship, between the US and Russia, has become a hostage to US domestic politics. 

Even liberals, who otherwise would have supported efforts to improve relations, are now blinded by their hostility to the President and are likely to see red in anything that is conciliatory and aimed at improving relations. Egged on by the media, all sides in the debate have boxed themselves into corners from where compromise looks very difficult. As President Trump has himself said, it is now virtually impossible for his administration to make any effort to improve relations. Or as Edward Luce writes, "Donald Trump is never likely to emerge from the Russian shadow". 

The debate has now degenerated into one where even the mere contact with designated Russian diplomats, a normal course of activity, has come to be viewed with extreme suspicion. The travails of Sergey I Kislyak, the Russian Ambassador in Washington, is symptomatic,

He has told associates that he will leave Washington soon, likely to be replaced by a hard-line general... For Mr. Kislyak, Washington is no longer the place it once was. It has become lonely, and he has told associates that he is surprised how people who once sought his company were now trying to stay away.

This is really unfortunate. It is difficult to not get the impression that Kislyak is a victim of his own success. He has done exceptionally well what every diplomat ought to be doing, expand your country's influence by cultivating important contacts in your host country. 

I am certain that Russia tried to influence the elections. But is there anything odd about that? Russia must have tried to influence every US election and vice-versa. It is no secret that US has supported the likes of Anatoly Chubais and Yegor Gaidar and theirs and other dissident political formations for years. Just recently, President Obama lent his weight behind the No campaigners in the Brexit vote in UK. The CIA has a very long history of trying to influence elections across the world from Philippines to Iran to Panama. Other countries do the same in countries with strategic interests. Real politik dictates that there is nothing unusual about this. 

Where the story can become poisonous is if the influence was used to campaign for their preferred candidate, the attempt succeeded, and the successful candidate is now willing to do Russia's bidding. In other words, Russia used its influence to instal their proxy in the White House. 

This means that despite candidate Trump's low electoral prospects, the Russians had enough conviction and backed him to pull it off. And that Trump is effectively a Russian stooge, at the least willing to compromise US interests in return for personal factors or succumb to blackmail. Even with Buzzfeed and other salacious stuff going around, I am not yet willing to buy this story.

I am inclined to believe that only a small proportion of people go this far, in suspecting their President of being a stooge. The vast majority feel indignant at Russian attempt to influence the elections. These two are qualitatively different positions, though lumped together and conflated by media characterisation. This is unfortunate since the latter, indignation, while understandable is ill-informed, and ought not to be a cause for holding the Russia-US relationship hostage.

Performance contracting in roads fact of the day

From an EBRD study of performance based contracting of maintenance in roads sector,

Every 1 euro/dollar of deferred maintenance today results in 3 euro/dollars needed in rehabilitation tomorrow.

This is evidence as clear as it gets. But governments, both in developed and developing countries, skimp on O&M despite knowing fully well that delayed maintenance or lack of preventive maintenance (say, for utility networks or motors) is only increasing the ultimate repair costs. 

The only solution to this is to outsource maintenance with a performance contract that lays down standards or service levels. In order to meet contractual obligations, the private contractors have to perforce do preventive and pre-emptive works. Another reason for outsourcing the maintenance of infrastructure assets. 

Academic research and development

Consider the big development challenges of our times. What can be to done to achieve learning outcomes or equip youth with skills development? How do we address the pervasive weaknesses of health care systems at all levels? What initiatives can enhance state capacity? How do we address two of the most debilitating sources of corruption and erosion of state capacity in all developing countries, public procurements and personnel deployments? How to improve urban governance? What can other developing countries learn from China's success? 

Unfortunately, none of these questions are amenable to neat field experiments and empirical analyses with focus on big micro-data. But focus of academic research and exploration in these areas have largely been confined to these approaches. In fact, most often, the enquiry does not even start with these problems, and instead focus on marginal dimensions and considerations. 

The occasional forays are confined to documenting best practice models. The large multi-lateral organisations, given the nature of their processes and incentives, are the only ones interested.

But unfortunately, a long history of bad experiences with the transplantation of best practice models has stigmatised even the mention of best practices. I would argue that an analysis of a best practice (or positive deviance) and its iteratively adapted implementation is far more valuable than the findings from realms of research that get generated every year as field experiments.

The demands of academic publication mean that ethnographic studies that examine systems and processes have become marginalised. Further, these approaches look unsexy without any math. The result has been a crowding out of academic effort away from such invaluable qualitative studies. This, I believe, has been a big (and most unfortunate) casualty of the obsession with evidence. 

It also draws attention to the excessive "economisation" of development, at the cost of insights from other disciplines. I have not come across any compelling argument that the theories and methodologies of economics should supersede those of sociology or political science and claim more wisdom in being able to address any of the aforementioned questions. It is of course a different matter that the purveyors of these other disciplines have largely stayed away from engaging with such real world challenges.

NIMBYism, community participation, market failures, and slum redevelopment

Conventional wisdom would have it that information asymmetry increases higher you move from the cutting edge. In economics, this translates into the belief that individuals know what is best for them and individual choices are reflected in the market mechanism. In case of governments, this underpins the case for decentralisation. 

Richard Florida highlights the challenge of NIMBYism in easing zoning regulations and expanding housing supply in cities. The prevailing institutional mechanisms give an effective veto to local residents in such land-use decisions. He points to a new paper by Paavo Makkonen that, among other things, has this to say

The paper joins a growing chorus of urban economists and urbanists who call for shifting land use decisions away from the local level and toward the metropolitan or even the state level. This would make it more possible to design a policy that encourages an increase in overall density—but would also require checks and balances to prevent abuses of less-advantaged neighborhoods.

This is clearly an example of a failure of excessive community empowerment. Local land owners privately appropriate most of the benefits of the city's development, for which their contribution is marginal or negligible. And they are sufficiently empowered to oppose any efforts to socialise even a share of these benefits. 

This reminds me of one of the less discussed problems of the current model of urbanisation, one this blog has raised on several occasions. As cities grow, the scarcity of buildable land intensifies driving up property prices, forcing redevelopment and gentrification of blighted and more affordable localities. In fact, the entire urban core becomes gentrified, with those who cannot afford housing being marginalised to the suburban doughnut. Even the affordable housing mandates in all these cities are only marginally useful since the rents are so high that such units are affordable to only the middle class. This is a serious market failure in the prevailing models of urbanisation in developed countries. 

Interestingly, the politics of urban areas in developing countries like India may have, unwittingly, become good antidotes to the wholesale gentrification of Indian cities. Slum-dwellers, collectively, form influential political constituencies. In other words, the frustrating failure to progress with slum-redevelopment on Public Private Partnerships (PPPs) in India may after all be a blessing in disguise. 

It is perfectly plausible, even most likely, that if these slums get redeveloped with a combination of good housing units for slum dwellers and commercial developments, then its gentrification is almost inevitable, only a matter of time. Even with all the regulatory restraints on resales,  it is impossible to fight the inexorable dynamics of market forces, dictated by rocketing prices in the city's central areas. The incumbents are most certain to sell off and be displaced further away from their livelihoods.