Why Rajan should not jump into bed with Jaitley

There have been a spate of media articles recently about how all is not well between the finance ministry (i.e. Arun Jaitley) and the Reserve Bank of India(i.e. Raghuram Rajan). In fact, so loud has been the noise around the “supposed differences,” that the finance minister
Arun Jaitley had to recently clarify that: “There has always been and shall continue to be regular and continuous interaction between the central bank and the government. We have completely free and frank discussions and therefore there is no issue of a disconnect [the emphasis is mine]. I have routinely clarified that.”
It is important to note that Jaitley used the word disconnect. He did not say that there were no differences between the RBI and the finance ministry. Jaitley was talking in the specific context of the setting up of the monetary policy committee.
One of the things that he had
announced in the budget speech was: “To ensure that our victory over inflation is institutionalized and hence continues, we have concluded a Monetary Policy Framework Agreement with the RBI…This Framework clearly states the objective of keeping inflation below 6%. We will move to amend the RBI Act this year, to provide for a Monetary Policy Committee.”
World over the monetary policy of a central bank is essentially decided by its monetary policy committee. In India setting the interest rate is the personal responsibility of the RBI governor.
A report in The Hindu points out that the finance ministry wants the monetary policy committee to have eight members with a government nominee who wouldn’t have any voting rights.
The RBI on the other hand wants a five member committee where the majority would determine monetary policy decisions (for example whether or not to increase the repo rate). The governor would act only as a tiebreaker if a member is not present during the course of a meeting. The RBI also wants two outside experts in the committee which it would pick. And there is no space for a government nominee in RBI plans.
Jaitley was essentially referring to this issue when he said: “there is no disconnect”. Interestingly, Rajan clarified that: “overtime, as the Finance Minister said, we will figure out the details of the committee.”
Nevertheless, there is a much larger point that comes out of this. As I said earlier Jaitley (who is a lawyer and chooses his words very carefully) used the word “disconnect” and not “differences”. If he had said that there are no differences between the finance ministry and the RBI, that would have had me worried.
There has to be some friction in the relationship between a regulator and the government for the regulator to be effective.
Alan Greenspan, the former chairman of the Federal Reserve of the United States, recounts in his book The Map and the Territory that in his more than 18 years as the Chairman of the Federal Reserve of the United States, he did not receive a single request from the US Congress urging the Fed to tighten money supply, increase interest rates and thus not run an easy money policy.
In simple English, what Greenspan means is that the American politicians always wanted low interest rates. India is no different on that front. Arun Jaitley has made enough noises since taking over as the finance minister asking the RBI to cut the repo rate. Repo rate is the interest at which RBI lends to banks and acts as a benchmark to the loans that banks make.
If there would have been no differences between the RBI and the finance ministry, the central bank would have cut interest rates every time Jaitley asked it to. And given the number of times Jaitley has asked for lower interest rates, the repo rate would have been close to 0% by now. But would that have led to lower interest rates in general? And would that have been the best for the Indian economy? The obvious answer to both the questions is no.
At times when politicians ask for low interest rates they are essentially batting for industrialists.
As Rajan had said in a speech in February 2014: “what about industrialists who tell us to cut rates? I have yet to meet an industrialist who does not want lower rates, whatever the level of rates.”
He further went on to elaborate that: “Will a lower policy interest rate today give him more incentive to invest? We at the RBI think not. First, we don’t believe the primary factor holding back investment today is high interest rates. Second, even if we cut rates, we don’t believe banks, which are paying higher deposit rates, will cut their lending rates.”
Rajan was making a very important point here. The politicians and the industrialists just think about one side of the interest rate i.e. the borrowing side. At lower interest rates, borrowers are likely to borrow and spend more (at least theoretically, though I don’t buy this theory in totality). This would mean better prospects for business and faster economic growth.
At lower interest rates businesses also will end up paying lower interest on the debt that they have managed to accumulate, leading to higher profits, if everything else stays the same.
But what about the people who invest their hard earned money in fixed deposits? The politicians and the industrialists are not bothered about them. These people also need to be paid a certain rate of interest on their bank fixed deposits. Between 2008 and 2013, the fixed deposit interest rate was lower than the prevailing rate of inflation.
This led to a lot of money going into gold and land, where people thought the returns would be better. Many of them were also lured into investing into Ponzi schemes.
Long story short—the RBI has to look at all sides of the equation while making a decision to change the interest rates. That is not the case with politicians and industrialists. Given this, it is vital that there are some differences between the RBI governor and the finance minister. Hence, it is important that the RBI governor should not jump into bed with the finance minister.

The column originally appeared on The Daily Reckoning on Mar 26, 2015

Don’t confuse a great company with a great stock

indian rupees

Vivek Kaul

“Buy great companies,” is a cliché one often hears from people who make a living out of peddling stock market tips. But what they don’t bother to tell us is “how do you identify a great company?” And even if one has done that, does a great company always make for a great stock? Or is the timing of buying the stock equally important?
Gary Smith, answers a part of this question in his book Standard Deviations—Flawed Assumptions, Tortured Data and Other Ways to Lie With Statistics. He takes the example of an American company called Sears. It was dropped on November 1, 1999, from the Dow Jones Industrial Average (Dow), which is one of America’s premier stock market indices. Stocks which are a part of the Dow are supposed to be “substantial companies—renowned for the quality and wide acceptance of their products or services—with strong histories of successful growth.”
Sears was one of America’s biggest success stories. It sold everything from watches to toys and even ready to assemble houses. It had been a part of the Dow for 75 years before it was dropped. It was replaced by Home Depot.
So why was Sears dropped and replaced with Home Depot? “Sears…was struggling to compete with discount retailers like Walmart, Target and yes, Home Depot. Revenues and profits were falling, and Sears’ stock price had dropped nearly 50 percent in 6 months. Home Depot on the other hand, was booming..and was opening a new store every 56 hours,” writes Smith.
The question is if a stock is dropped from an index and replaced by another stock, which stock gives better returns in the days to come? The stock which is added to the index? Or the one which is dropped?
Common sense tells us that the stock which is added to the index is the one that should give us better returns. But that is not what happened in this case. Sears gave a return of 103% over the next five and a half years, before it was bought out by Kmart. On the other hand Home Depot lost 22%.
Interestingly, in 1999, four substitutions were made to the Dow—Home Depot, Microsoft, Intel and SBC. These stocks became a part of the Dow at the cost of Sears, Goodyear Tire, Union Carbide and Chevron. All the four stocks that became a part of the Dow were great companies. Nevertheless, they performed poorly over the next ten years.
An investment of $ 2,500 each in the four stocks that were added to the Dow would have been worth $6,604 ten years later. An investment of $2,500 each in the four stocks that were deleted from the Dow would have been worth $16,367 ten years later.
The basic point that comes out of this example is inherently simple. As Smith points out: “No matter how good the company, we need to know the stock’s price before deciding whether it’s an attractive investment.”
Another great company that Smith talks about in his book is IBM. In 1978, the earnings of IBM had been growing at about 16 % per year (adjusted for inflation) for more than 50 years. A saying that was popular at that point of time was: “No purchasing manager ever got fired for buying IBM computers, and no portfolio manager ever got fired for buying IBM stock.”
Given this, many portfolio managers recommended IBM stock in 1978 and predicted that its price would triple over the next ten years. Based on the earnings that the company made during the period 1968-1978, it was predicted that by 1988, the earning per share of IBM would be $18.50. The company achieved only half of that.
What went wrong? The analysts were simply projecting that IBM will continue to grow at the same rate as it had in the past, without realizing that it was simply not possible. As Smith points out: “If IBM kept growing at 16 percent annually and the overall US economy continued to grow at its long-run 3 percent, by 2003 half of US output would be IBM products and in 2008 everything would have been made by IBM.”
This example also tells us that IBM may have been a great company in 1978, but it was no longer a great stock—at least not something on which you could earn fantastic returns. Log story short—the point of time at which an investor buys a stock is extremely important.
An excellent example in the Indian case is Infosys in the late 1990s. As Parag Parikh points out in his book Stocks to Riches: “The stock price [of Infosys] shot up from around Rs 2,000 (Rs 10 paid- up) in January 1999 to around Rs 12,000 (Rs 5 paid-up) in March 2000. Nothing spectacular had happened to the company to justify such a steep increase. But by the end of September 2000, the stock was down to Rs 7,000. Nothing had gone drastically wrong with the company either since March when it was quoted around Rs 12,000.”
The analysts justified this increase by saying that Infosys was growing at the rate of 100%. What they did not tell the investors was that Infosys couldn’t keep growing at such a rapid rate. As Parekh points out : “In the financial year 2000, Infosys reported revenues of Rs 882 crore. If we were to compound this figure at 85% annually for 10 years (as some people believed the growth would continue), then in 2010, Infosys would report revenues of a staggering Rs 4,14,176 crore. At that time, assuming a market capitalisation of 100 times revenues (similar to what Infosys was quoting at its peak), it would put Infosys’ value at $9.2 trillion. The GDP of the US was around the same figure!” So, Infosys in 2000 was a great company. But it was clearly a bad investment.
The moral of the story at the end of the day being—
don’t confuse a great company with a great stock. 

The column originally appeared on The Daily Reckoning on Mar 27, 2015  

Janet Yellen will keep driving up the Sensex

yellen_janet_040512_8x10Vivek Kaul

The Bombay Stock Exchange (BSE) Sensex, India’s premier stock market index, rose by 517.22 points or 1.88% to close at 27,975.86 points yesterday (i.e. March 30, 2015). On March 27, 2015 (i.e. Friday), Janet Yellen, the Chairperson of the Federal Reserve of the United States, gave a speech (after the stock market in India had closed). In this speech she said: “If conditions do evolve in the manner that most of my FOMC colleagues and I anticipate, I would expect the level of the federal funds rate to be normalized only gradually, reflecting the gradual diminution of headwinds from the financial crisis.” The federal funds rate is the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank on an overnight basis. It acts as a sort of a benchmark for the interest rates that banks charge on their short and medium term loans. What Yellen was basically saying is that even if the Federal Reserve starts raising interest rates, it will do so at a very slow pace. In the aftermath of the financial crisis that started in mid September 2008, when the investment bank Lehman Brothers went bust, central banks in the developing countries have maintained very low rates of interest. The Federal Reserve of the United States, the American central bank , has been leading the way, by maintaining the federal funds rate in the range of 0-0.25%. The hope was that at low interest rates people would borrow and spend more than they were doing at that point of time. This would help businesses grow and in turn help the moribund economies of the developing countries. While people did borrow and spend to some extent, a lot of money was borrowed at low interest rates in the United States and other developed countries where central banks had cut rates, and it found its way into stock markets and other financial markets all over the world. This led to a massive rallies in prices of financial assets. For the rallies in financial markets all over the world to continue, the era of “easy money” initiated by the Federal Reserve needs to continue. And this is precisely what Yellen indicated in her speech yesterday. She said that even if the Fed starts to raise interest rates it would do so at a very slow pace, in order to ensure that it does not end up jeopardizing the expected economic recovery. Yellen went on to add in her speech on Friday that: “Nothing about the course of the Committee’s actions is predetermined except the Committee’s commitment to promote our dual mandate of maximum employment and price stability.” This is where things get interesting. The rate of unemployment in the United States in February 2015 was at 5.5%. This was a significant improvement over February 2014, when the rate of unemployment was at 6.7%. But even with this big fall, the Federal Reserve is unlikely to raise interest rates. Typically, as unemployment falls, wages go up, as employers compete for employees. But that hasn’t happened in the United States. The wage growth has been more or less flat over the last one year (it’s up by 0.1%). The major reason for the same is that more and more jobs are being created at the lower end. As economist John Mauldin writes in his newsletter: “66,000 of the 295,000 new jobs[that were created in February 2015) were in leisure and hospitality, with 58,000 of those being in bars and restaurants…Transportation and warehousing rose by 19,000, but 12,000 of those were messengers, again not exactly high-paying jobs.” Further, in the last few years the energy industry in the United States has seen a big boom on the back of the discovery of shale oil. But with oil prices crashing, the energy industry has started to shed jobs. In January 2015, the energy industry fired 20, 193 individuals. This was 42% higher than the total number of people who were sacked in 2014. As analyst Toni Sangami pointed out in a recent post: “These oil jobs are among some of the highest-paying blue-collar jobs in the country, so losing one oil job is like losing five or eight or ten hospitality-industry jobs.” The labour force participation ratio, which is a measure of the proportion of the working age population in the labour force, in February 2015 was at 62.8%. It has more or less stayed constant from December 2013, when it was at 62.8%. This is the lowest it has been since March 1978. The number was at 66% in December 2007. What this means is that the rate of unemployment has been falling also because of people opting out of the workforce because they haven’t been able to find jobs and, hence, were no longer being counted as unemployed. So, things are nowhere as fine as broader numbers make them appear to be. The overall inflation also remains much lower than the Federal Reserve’s target of 2%. The Federal Reserve’s preferred measure of inflation is personal consumption expenditures(PCE) deflator, ex food and energy. For the month of February 2015, this number was at 1.4% much below the Fed’s target of 2%. The Fed’s forecast for inflation for 2015 is between 0.6% to 0.8%. At such low inflation levels, the interest rates cannot be raised. Yellen summarized the entire situation beautifully when she told the Senate Banking Committee earlier this month that: “Too many Americans remain unemployed or underemployed, wage growth is still sluggish, and inflation remains well below our longer-run objective.” What does not help is the weak durables data that has been coming in. Orders for durable goods or long-lasting manufactured goods from automobiles to aircrafts to machinery, fell by 1.4% in February 2015. The durables data have declined in three out of the last four months. Given this scenario, it is highly unlikely that the Yellen led Federal Reserve will start raising the federal funds rate any time soon. Further, as and when it does start raising rates, it will do so at a very slow pace. What this means is that the era of easy money will continue in the time to come. And given this, more acche din are about to come for the Sensex. Having said that, any escalation of conflict in the Middle East can briefly spoil this party. The article originally appeared on The Daily Reckoning on Mar 31, 2015

Benevolent autocracy: India is drawing the wrong lesson from Lee Kuan Yew


One of the favourite arguments offered by middle class Indian men (especially when all other arguments fail) is that “India needs a benevolent autocrat,” if the economy has to grow at a fast pace. The word “autocrat” is often used interchangeably with the world “dictator”.
This argument is often made by the corporate types who have made their money in life and are now looking for some intellectual stimulation through what they consider as philosophical musings.
The argument has gained a new life with the death of Lee Kuan Yew (or LKY as he was commonly known as) who was the prime minister of the city-state of Singapore from 1959 to 1990. Between 1990 and 2011, he was the senior minister as well as minister mentor of Singapore. LKY died on March 23, 2015.
Data from the World Bank shows that the per capita income of Singapore in 2013 was $55,182.5. When LKY took over as the prime minister in 1959, the per capita income was $400. What this clearly tells us is that LKY turned around Singapore from a poor country to a developed country in about one generation. When he became the prime minister, Singapore was basically swamp with almost no natural resources. He turned it around into a global financial centre first and now an entertainment destination as well.
His achievements not withstanding, LKY was an autocrat who was honest enough to admit it. As he said in an interview to The Straits Times in April 1987: “
I am often accused of interfering in the private lives of citizens. Yes, if I did not, had I not done that, we wouldn’t be here today. And I say without the slightest remorse, that we wouldn’t be here, we would not have made economic progress, if we had not intervened on very personal matters – who your neighbor is, how you live, the noise you make, how you spit, or what language you use. We decide what is right. Never mind what the people think.”
But as I have said above LKY’s autocratic style of working paid huge dividends for Singapore. It was transformed from a swamp to a developed country in around 50 years. And that was a huge achievement.
This high growth that Singapore achieved has led people to suggest that India also needs a benevolent autocrat to grow at a fast pace. LKY and Singapore are not the only example that is given to buttress this point. There are other examples as well—Chile under Augusto Pinochet. Or countries like Hong Kong, Singapore, South Korea and Taiwan, which grew at a very fast rate under autocratic regimes. They moved to a democratic form of government only after having grown fast for a significant period of time.
Then there is the example of China. The country is ruled by one party, the Chinese Communist Party (CCP).  It has had a generation of fast economic growth without any democracy. All this has led many people to believe that if a country has to grow fast it needs to be under an autocratic regime. Hence, India needs a “benevolent autocrat,” is the argument offered. QED.
But are things as simple as that? Or are people becoming victims of what behavioural economists term as the “availability heuristic”? As John Allen Paulos writes in
A Mathematician Reads the Newspaper: “First described by psychologists Amos Tversky and Daniel Kahneman, it is nothing more than strong disposition to make judgements or evaluations in light of the first thing that comes to mind (or is “available” to the mind).”
So, Lee Kuan Yew was an autocrat. Under him Singapore grew at a very rapid rate. Hence, India needs a benevolent autocrat as well, if it has to grow at a very fast rate. That’s how it works for those who feel that India needs a “benevolent autocrat”.
Economist William Easterly has done some interesting research in this area, which he summarises in a research paper titled
Benevolent Autocrats. As he writes: “The probability that you are an autocrat IF you are a growth success is 90 percent. This probability seems to influence the discussion in favour of autocrats.”
But that is the wrong question to ask. The question that needs to be asked should be exactly opposite—if a country is governed by an autocrat what are the chances that it will be a growth success? “T
he relevant probability is whether you are a growth success IF you are an autocrat, which is only 10 percent,” writes Easterly. To put it simply—most fast growing nations are ruled by autocrats. Nevertheless, most autocracies do not grow fast.
The thing is that one never knows whether an autocrat will turn out to be benevolent or will he turn out to be an out an out dictator, once he starts to rule. That depends on the luck of the draw. Most autocrats usually end up screwing up the economies they rule. This is a simple point that middle class Indian men who want a “benevolent autocrat” to rule this country, need to understand.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on Mar 30, 2015

Relentless cricket and the fleeting sense of loss

dhoni and sharma

It was March 1996. India had just lost to Sri Lanka in the cricket World Cup semi-finals. And I remember roaming around listlessly in the colony I grew up in, trying to make sense of what had just happened.
It was not supposed to end like this. India was supposed to win the World Cup. For many months to come, me and my friends kept talking about the loss. And even after we had discussed the issue threadbare, we still kept coming up with new reasons for the loss. Such was the pain or our inability to accept what had happened. Those were the days.
This is how things were back then. Losses to England in the 1987 World Cup semi-final and Pakistan at Sharjah in 1986, when Javed Miandad hit a last ball six of Chetan Sharma’s bowling, were events that were discussed for years to come.
Cut to now—India lost to Australia in the World Cup semi-final on March 26. Television channels tried to create a lot of outrage. Some showed footage of people burning their televisions protesting against the loss. They did not bother to tell us how many televisions were burnt? Or how many such incidents happened all across the country?
Given the pressures of TRP, what were possibly a few isolated incidents made it to prime time television news. And then other television channels blamed the loss on a girl friend of a star cricketer. Her fault being that she was at the Sydney Cricket Ground watching the match. Since when did such idiocy start to become news?
A few others said the selection was all wrong. Yuvraj Singh should have been in the team. The question is, if the selection was wrong, how did the team win seven matches at a trot before they lost to Australia. And then there came the proverbial reason—it was fixed!
When it comes to the inability of the Indian cricket fan to accept a loss, not much has changed. But what has changed is the fact that the losses don’t linger in the minds of people like they used to. By the time the next week starts people would have moved on and there would be other issues to rant about.
What has led to this change over the last two decades? First and foremost is the fact that in the 80s and through much of the 90s there was only one state owned television channel. So, whatever it broadcast(from Ramayan and Mahabharat to cricket) was fodder for discussion for days at end. There was no social media, no cable television and even no FM radio channels, around. Hence, the chances that the attention of people could be diverted once they had caught on to an issue was rare. These days there are too many things seeking the attention of the Indian cricket fan.
Further, as far as cricket is concerned, back then, there weren’t as many matches as are played now. The ICC till very recently used to organize three major events—the Champions trophy(which it has now disbanded), a T20 World Cup every two years(which it has now changed to every four years) and a 50 over World Cup every four years.
Back in the 80s and the 90s, there was just one 50 over World Cup (starting from 1987 onwards, before that it was 60 overs). And even other one day internationals played between two countries were few and far between. That isn’t the case now. Also, there was no T-20 cricket. Within ten days of the cricket World Cup ending the Indian Premier League (IPL) starts on April 8, 2015.
Given this, the gap between matches has come down dramatically. And there isn’t much time to linger over a loss. In a way this is a good thing. It gives the Indian cricket fan an opportunity to move on quickly, until the next big disappointment comes along.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column originally appeared in the Daily News and Analysis on Mar 28, 2015