Month: May 2015 | Page 3

22 May, 2015

The Western growth model is broken and it ain’t getting fixed any time soon

There is nothing more deceptive than an obvious fact.
–Arthur Conan Doyle, “The Boscombe Valley Mystery”

It’s around 1.30 pm on Thursday afternoon and I have just finished reading a wonderful speech titled ‘Going bust for growth‘, made by the Reserve Bank of India governor Raghuram Rajan, to the Economic Club of New York on May 19, 2015. The speech which runs into 14 pages like all Rajan speeches is a very good read and gets to the heart of the issue and explains things very well.
No wonder the prime minister Narendra Modi is so impressed with Rajan. As Modi said about Rajan in April earlier this year: “I happen to meet Raghuram (Rajan) once every two months and he comes prepared with three or four slides. He makes me understand them so perfectly that I don’t need to question anything, I understand what he says.”
In his latest speech Rajan talks about the steps taken by developed countries in the aftermath of the financial crisis that broke out in September 2008, why they are not working and how they are creating problems for what the developed world likes to call emerging markets.
Consumer demand collapsed in the aftermath of the financial crisis. One of the things that governments of the developed world did was to borrow and increase spending. This money was supposed to be spent towards creating physical infrastructure.
Returns on investing in infrastructure are supposed to be high given that currently both interest rates as well as constructions costs are low. Nevertheless, it is not easy to spend on building infrastructure in a developed country. As Rajan points out: “However, high-return infrastructure investment is harder to identify and implement in developed countries where most obvious investments have already been made – political influence is as likely to create bridges to nowhere or unviable high speed train networks as needed infrastructure.”
Nevertheless, money can be spent on improving existing infrastructure. The trouble here is that decision making in this case needs to be a lot more decentralized in comparison to spending on mega projects. Given this, it “may be harder to initiate and finance from the centre”. Hence, spending money on infrastructure may not always be the best way going around in order to create economic growth in developed countries.
Also, money being spent always does not go to projects which are likely to generate the most returns. It may go to projects backed by politicians who have the most influence. It’s worth remembering here that even in well-functioning democracies some groups wield more influence than others. As Raghuram Rajan and Luigi Zingales write in Saving Capitalism from the Capitalists: “Policy making is often captured by powerful special interests that thrive because of the peculiarities of democratic governance… Governments may work in the interest of a privileged few rather than the larger public and dig the wrong channels.”
Other than increased spending, central banks of developed countries also printed and pumped money into the financial system. They did this by printing money to buy government and private bonds. By buying these bonds, the idea was to pump a lot of money into the financial system, keep interest rates low, with the hope of people borrowing and spending more at low interest rates.
But low interest rates make things difficult for investors. They need to invest in riskier assets and go searching for yield (return). Since the start of the financial crisis, there has been a huge flow of money from the developed markets into emerging markets, in search of a higher return.
As Rajan put it in his speech: “Indeed, the post-global crisis capital flows into emerging markets have been huge, despite the best efforts of emerging markets to push them back by accumulating reserves (net capital flows to emerging economies reached US$ 550 bn in 2013 compared to US$120 bn in 2006).”
So the money flowing into the emerging markets has increased many times over since the start of the financial crisis. And these flows create problems in emerging markets. When the money is coming in it leads to the appreciation of the local currency against the dollar (unless the central bank intervenes), creating problems for exporters. And when this money leaves in a hurry it leaves financial markets in a mess (Stock markets fall, yields on government bonds go up as foreign investors leave in a hurry) and the value of the local currency depreciates against the dollar., creating problems for importers. This makes things much more difficult for central banks in emerging markets.
Further, despite many years of increased government spending, money printing and low interest rates, economic growth is yet to recover in developed countries. What this tells us is that policies followed in the aftermath of the financial crisis haven’t really worked. And the reason for this the slow growth of consumer demand.
A major reason for the same is that Western economies have lost the ability to make things. As Rajan and Zingales point out: “For decades before the financial crisis in 2008, advanced economies were losing their ability to grow by making useful things. But they needed to somehow replace the jobs that had been lost to technology and foreign competition… So in an effort to pump up growth, governments spent more than they could afford and promoted easy credit to get households to do the same. The growth that these countries engineered, with its dependence on borrowing, proved unsustainable.”
With a manufacturing in developed countries being outsourced to emerging markets, a section of the population isn’t exactly employable any more. As Rajan said in his speech: “Because of changes in technology and the expansion of global competition, routine repetitive jobs, whether done by the skilled or the unskilled, have diminished greatly in industrial countries. Many of these jobs, ranging from assembly line worker to legal aides or insurance clerks, have either been automated or outsourced.”
And this is where the problem is. Good jobs now require skills. “The middle class recognizes that they need quality higher education and training to not slip into competing with the poor for low-skilled non-routine jobs such as security guard or gardener. But the poor quality early education they have received, as well as the prohibitive cost of quality higher education, puts many better livelihoods out of reach,” said Rajan.
This is a problem that cannot go away either by spending more money on physical infrastructure or by maintaining low interest rates by printing money. It needs to be tackled over the long-term. But how politicians understand that term?

The column originally appeared on The Daily Reckoning on May 22, 2015

22 May, 2015

One year later: A mixed bag of acche din for the aam aadmi

Most communication that works is essentially so simplistic that even a school going child can understand it. Narendra Modi’s pitch in the 2014 Lok Sabha elections: “acche din aane waale hain, hum Modi ji ko laane waale hain,” was one such example.
It was so good that one year later, people still remember it and given half an opportunity ask: “kahan hain acche din?(where are the happy days?)” That’s the thing with communication which is dumbed down to a level of a school child—it works, but it also leads to people asking questions in the days to come.
On May 26, 2015, the Narendra Modi government will complete one year and it is time to ask that proverbial question: “have the good days come?” In this column I will try answering that question from the point of view of the aam aadmi or the common man.
Inflation as measured by the consumer price index averaged a very high 10.2% between 2007 and 2013. In April 2014, before Narendra Modi was sworn in as the prime minister, the consumer price index inflation was at 8.59%. By April 2015, this number had fallen to 4.87%.
More often than not, the credit for this tends to go to the Reserve Bank of India. But what one needs to keep in mind is the fact that food products constitute nearly half of the consumer price index. And there is no way that the RBI can influence food prices.
Several steps taken by the Modi government helped on this front. One of the first decisions made by the government was to release 5 million tonnes of rice into the open market from the stocks maintained by the Food Corporation of India. News reports suggest that eventually only around 2 million tonnes was sold. But just the news that the government was selling was enough to contain inflation.
Active steps were taken by the government to contain rapidly rising onion prices as well. As Ashok Gulati, former Chairman of the Agricultural Costs and Prices, wrote in a recent column in The Financial Express: “A slew of measures were announced by the government to contain the damage from surging food inflation. It not only restricted exports of onions but also imported onions and dumped them in major onion markets at prices below import cost. It also used the stick and raided many onion traders/hoarders.” And that clearly helped.
Over and above this, the minimum support price(MSP) of rice was raised by only Rs 50 per quintal or 3.8% to Rs 1360. The MSP is the price at which the government buys rice from the farmers, through the Food Corporation of India(FCI) and other state government agencies. This increase of 3.8% was much lower than the average increase of 9% per year in the MSP of rice since 2007-2008.
These measures helped to control food inflation. Food inflation hurts the poor the most. Half of the expenditure of an average Indian family is on food. In case of the poor it is 60% (NSSO 2011).
Further, Rahul Gandhi said in a farmer’s rally recently that the Congress government had raised the MSP of rice and wheat, the Modi government hadn’t. What Rahul and the Congress party need to understand is that everyone associated with agriculture does not own land. As per the draft national land reforms policy which was released in July 2013, nearly 31% of all households in India were supposed to be landless. The NSSO defines landlessness as a situation where the area of the land owned is less than 0.002 hectares. Any price rise, particularly a rise in food prices which is what an increase in MSP leads to, hurts this section of the population the most.
Hence, on the food inflation front, the Modi government has been able to deliver acche din for the aam aadmi.
What are the other benefits that the aam aadmi has got over the last one year? In the two budgets that the finance minister Arun Jaitley has presented, the total deductions allowed under some of the most important sections of the Income Tax Act have been increased. The deduction under Section 80C has been increased from Rs 1 lakh to Rs 1.5 lakh. The deduction allowed on a home loan on a self-occupied property has been increased to Rs 2 lakh from Rs 1.5 lakh earlier. The deductions allowed for the payment of medical insurance premium has been increased from Rs 15,000 to Rs 25,000.
The Modi government has also been very aggressive on the financial inclusion front with the Jan Dhana Yojana. The government claims to have opened 15 crore bank accounts which allow account holders an overdraft of Rs 5000. This is a near saturation coverage. Nevertheless, 70% of these accounts remain dormant. What this tells us is that the communication around the Jan Dhana Yojana still remains weak.
While this is a good move at the individual level, the scheme clearly isn’t financially viable and the government hasn’t made it clear as to who will bear the cost of servicing all these accounts. As Diwakar Gupta, former Managing Director of the State Bank of India, told Sreenivasan Jain of NDTV, no-frills banking “will never be profitable for banks. SBI has opened 3.6 crore accounts and the balance in them is Rs1,400 crore. So, it’s an average of Rs 400 per account. The bank on Rs 400 a year will make Rs 12. The cost of just putting it (the account ) on the core banking system, answering few questions, depositing, withdrawing, paying, reconciling all are significantly higher.”
Further, interest rates and EMIs have fallen a little over the last one year, but not significantly enough to get people to borrow and spendi at the same rate as they were in the past. Also, affordable housing in cities and town continues to remain a dream. The Economic Survey estimates that the shortage of urban homes stands at 1.88 crore units.
There has been no improvement on this front in the last one year. While, no one expects the government to solve the housing problem in one year, no concrete plan has been put forward either. Also, while the government keeps talking about a crackdown on black money that has left the shores of the country, but there is no talk about a crackdown on the massive amount of black money that lies within the country and a massive amount that continues to be generated.
A large part of this money gets invested into real estate, thus driving up prices. A FICCI report on black money published in February 2015 points out: “The Real Estate sector in India constitutes for about 11 % of the GDP15 of Indian Economy, as these transactions involve high transaction value. In the year 2012-13, Real Estate sector has been considered as the highest parking space for black money.”
Only, once this nexus is broken down will affordable housing become the order of the day. Further, while corruption at the top-echelons of the government may have fallen, at lower-levels it is business as usual. Also, one of the main things promised in Modi’s campaign was the creation of jobs. Things are yet to move on that front.
Long story short—Narendra Modi has managed to deliver on some of the “acche din” hype that it had managed to build in the run up to the 2014 Lok Sabha elections. It has fallen short on many fronts as well. But given the hype was so simplistic that was inevitable.

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

The column originally appeared on Firstpost on May 21, 2015

22 May, 2015

There is no plan in sight for public sector banks

One of the points that I forgot to talk about in the recent Master Series chat (“Looking Behind The Modi Smokescreen with Vivek Kaul”) that I and Rahul had, was the bad state of public sector banks in India.
As S S Mundra, one of the Deputy Governors of the Reserve Bank of India pointed out in a recent speech: “asset quality [of banks] has seen sustained pressure due to continued economic slowdown.” The primary reason for this is the fact that banks have lent too much money to companies. And many companies right now are not in a position to repay the loans they had taken on.
The gross non-performing assets(or bad loans) of banks have been on their way up. As on March 31, 2014, they had stood at 3.9% of their total advances. By March 31, 2015, the number had shot up to 4.3% of the total advances. Crisil Research expects this number to touch 4.5% of the total advances of banks, during the course of this financial year.
What is worrying is that 40% of the loans restructured during 2011-2014 have become bad loans. A restructured loan is where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank) by increasing the tenure of the loan or lowering the interest rate. If 40% of restructured loans have gone bad, it is safe to say that the banks have been essentially restructuring loans in order to postpone recognizing them as bad loans.
Interestingly, bad loans are expected to go up during this course of the year primarily because more and more restructured loans will turn into bad loans. As Crisil Research points out in a recent research note titled Modified Expectations: “Reported gross non performing assets[bad loans] will still remain at elevated levels as some of the assets restructured in the previous 2-3 years, especially in the infrastructure, construction, and textiles sectors, degenerate into non-performing assets again.”
And this is clearly worrying. In fact, Mundra during the course of his speech went on to refer to the recent Global Financial Stability Report of the International Monetary Fund(IMF) and said: “Referring to the high levels of corporate leverage, the [IMF] report highlights that 36.9 per cent of India’s total debt is at risk, which is among the highest in the emerging economies while India’s banks have only 7.9 per cent loss absorbing buffer, which is among the lowest. While these numbers might need an independent validation, regardless of that, it underscores the relative riskiness of the asset portfolio of the Indian banks.” This statement coming from one of the top officials of the RBI needs to be taken seriously.
Mundra also pointed out that because of this inability of corporates to repay loans that they had taken on, the public sector banks are in a much bigger mess than other banks. He pointed out that the stressed assets ratio of banks in India as a whole stood at 10.9%.
The stressed asset ratio is the sum of gross non performing assets(or bad loans) plus restructured loans divided by the total assets held by the Indian banking system. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan by increasing the tenure of the loan or lowering the interest rate. Hence, a stressed assets ratio of 10.9% essentially means that for every Rs 100 given out as a loan, Rs 10.9 has either been defaulted on or has been restructured.
As Mundra pointed out: “The level of distress is not uniform across the bank groups and is more pronounced in respect of public sector banks…The stressed assets ratio[of public sector banks] stood at 13.2%, which is nearly 230 bps[one basis point is one hundredth of a percentage] more than that for the system.” The stressed assets ratio of public sector banks as on March 31, 2014, was at 11.7%. The overall stressed assets ratio of banks was at 9.8%.
This is indeed very worrying. Between March 31, 2014 and March 31, 2015, the stressed assets ratio of public sector banks has gone up a whopping 150 basis points. This has hit the capital that public sector banks carry on their balance sheets. As Mundra pointed out: “Our concerns are larger in respect of the public sector banks where the CRAR [Capital to Risk (Weighted) Assets Ratio also known as capital adequacy ratio] has declined further to 11.24% from 11.40% over the last year.”
The government seems to have made it more or less clear that it is unlikely to pump in any more money into the weaker public sector banks. Also, given the poor perception and stock price of these banks, they are unlikely to be able to raise capital from the stock market. In such a situation it is imperative they be very careful in handling the capital they have. “The need of the hour for all banks, and more specifically, in respect of the PSBs, is that capital must be conserved and utilized as efficiently as possible,” writes Mundra.
What Mundra means in simple English is that banks need to take almost no risk while lending. And this unwillingness of banks to lend has hit the infrastructure sector the most. As Crisil Research points out: “In the past, many private developers have bid aggressively for projects, especially in roads and power. However, most projects have seen execution delays due to issues such as fuel availability, land acquisition and environmental clearances; resulting in significant cost overruns….As a result, poor operational cash flows coupled with rising debt burden have led to a sharp deterioration in the debt-servicing ability of many companies. Banks, too, are wary of lending to the sector.”
The PJ Nayak committee report released in May 2014, estimated that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.” The report further points out that “assuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.50 lakh crores.” The budget for the year 2015-2016 provided Rs 11,200 crore towards this, which is not even peanuts given the kind of money that is required.
It is clear that the government does not have the kind of money that is needed to recapitalize the public sector banks. But the money is needed. What is surprising that even though one year has more or less elapsed since the Modi government came to power, no comprehensive plan has been put forward to solve the mess in the public sector banking space.

The column appeared on The Daily Reckoning on May 22, 2015

20 May, 2015

Now a govt red carpet for those who have black money hidden abroad

Last week the Parliament passed the Undisclosed Foreign Income and Assets (Imposition of New Tax) Bill, 2015. This Bill up until now was referred to as the foreign black money Bill. Now it has become an Act.
The Act allows the government to tax those who have undisclosed foreign income and assets at the rate of 30%. No exemptions or deductions as per the Income-Tax Act 1961 will be allowed. Over and above a tax of 30%, there will also be a penalty of three times the amount of tax.
However, the government plans to offer a compliance window. This window will allow those with undisclosed foreign assets and income to declare them, pay a tax of 30% and a penalty of 30% and not face any prosecution.
In fact, The Economic Times reported on May 18, 2015 that: “The income-tax department is likely to set up two centres, in Delhi and Mumbai, to process claims from those with dodgy overseas wealth to declare.”
The cells in Mumbai and Delhi will be manned by senior tax officials whose job will be to ensure that those who come out and declare their undisclosed foreign income and assets are not harassed. It is being suggested that individuals will be allowed a period of two months to declare their undisclosed foreign income and assets and up to a period of six months to pay the tax on it.
In simple English, what this means is that the government is essentially laying out a red carpet for those who haven’t paid income tax on the money that they have earned over the years, created black money and managed to divert that money out of the country.
The ministry of finance 2012 white paper on black money defines black money as: “any income on which the taxes imposed by government or public authorities have not been paid.”
The wealth that has been accumulated in this way “may consist of income generated from legitimate activities or activities which are illegitimate per se, like smuggling, illicit trade in banned substances, counterfeit currency, arms trafficking, terrorism, and corruption,” the white paper goes on to suggest.
Of course this wealth that has been accumulated through tax evasion has “neither been reported to the public authorities at the time of their generation nor disclosed at any point of time during their possession.”
And it is these people who will now be welcomed with open arms by the government. The justification offered will be that “but, we are fining them 30% over and above the 30% tax”. Yes, but how does this decision make look the minuscule portion of Indians who have been paying their income-tax honestly over the years.
The annual report of the ministry of finance points out that in a country with a population of more than 120 crore, the number of income tax assessees in the 2013-2014 stood at a mere 4.7 crore. And by laying out the red carpet for the tax cheats, what message is the government sending out to the 4.7 crore individuals who have been paying their taxes? This is not the best way to go about trying to increase the number of people who pay income tax. In fact, the annual report of the ministry of finance points out that between April and December 2014, just 24.35 lakh fresh assessees were added. The point being that the rate of growth of tax compliance is anyway very slow and on top of that if the government keeps welcoming those who have black money, what future does tax compliance really have in this country?
Instead of welcoming the tax cheats, the government should be naming and shaming them. Steve Levitt and Stephen Dubner make this suggestion in an American context in their new book When to Rob a Bank…And 131 More Warped Suggestions And Well Intended Rants: “Maybe it’s time…to launch a War on Tax Cheats. What if they could demonize the tax cheats so thoroughly, emphasizing that the “tax gap” (the difference between taxes owed and money collected) is about the size of the federal deficit…Maybe they could put pictures of tax cheats on milk cartons, on flyers at the post office, even on America’s Most Wanted.” Why can’t something along similar lines be tried in India, instead of bailing out the tax cheats?
Further, between April and November 2014, the income-tax department seized assets worth Rs 538.23 crore only. This is hardly anything given the huge amount of black money floating around in the country. And given this, the government should be concentrating its resources in unearthing black money in the country, instead of welcoming those who have accumulated black money over the years.

The column originally appeared on The Daily Reckoning on May 20, 2015

20 May, 2015

HDFC finds India’s real estate to be affordable. Here’s why it is wrong

The home loan lender HDFC in its latest investor presentation says that homes have seen an “improved affordability”. This goes against everything that one sees in the real estate sector these days, where prices have gone so high that most people wanting to buy a home to live in, can’t.
So how did HDFC manage to come to such a conclusion? Allow me to explain.
In a graph in the presentation, HDFC points out that homes are more affordable than they have been at any point of time in the last ten years. It defines affordability as property prices divided by annual income. This number for 2015 comes in at 4.4. In 2014 it was at 4.6. In 2013 it was at 4.7. The last time the affordability number was lower than 4.4 was in 2004, when the number was at 4.3. Hence, homes are now more affordable than they were in the last ten years.
So far so good. What does affordability of 4.4 really mean? It means that the property values in 2015 were 4.4 times the annual income. The average annual income considered by the company is around Rs 12 lakh. And the average property value considered by the company is around Rs 52 lakh. Hence, while the property prices have been going up, so have incomes – hence housing has become more affordable. QED.
Of course, something is not ‘quite’ right about this calculation. But before we get into that, let me recount a war story here. During the course of the Second World War, the British Royal Air Force (RAF) wanted to protect its planes from the German anti-aircraft guns and fighter planes. In order to do that it wanted to attach heavy plating to its airplanes.
The trouble was that the plates that were to be attached were heavy and hence, they had to be strategically attached at points where bullets from the Germans were most likely to hit. Historical data on where exactly the German bullets hit the RAF planes was available. As Jordan Ellenberg writes in How Not to Be Wrong: The Hidden Maths of Everyday Life: “The damage[of the bullets] wasn’t uniformly distributed across the aircraft. There were more bullet holes in the fuselage, not so many in the engines.”
If the data were to be interpreted in a straightforward manner, it would mean plating the area around the fuselage because that was what got hit the most. Nevertheless, the German bullets should also have been also hitting the engine because the engine “is a point of total vulnerability”.
A statistician named Abraham Wald realised this anomaly. As Ellenberg writes: ‘The armour, said Wald, doesn’t go where bullet holes are. It goes where bullet holes aren’t: on the engines. Wald’s insight was simply to ask: where are the missing holes? The ones that would have been all over the engine casing, if the damage had been spread equally all over the plane. The missing bullet holes were on the missing planes. The reason planes were coming back with fewer hits to the engine is that planes that got hit in the engine weren’t coming back.” They simply crashed.
Another example that can be considered here is of people in a recovery room in a hospital. There will be more people with bullet holes in legs in comparison to people with bullet holes in chests. This in no way means that people don’t get hit in chests. They sure do. It’s just that people who get hit in the chest don’t recover.
As Gary Smith writes in Standard Deviations: Flawed Assumptions Tortured Data and Other Ways to Lie With Statistics: ‘Wald…had the insight to recognize that these data suffered from survivor bias…Instead of reinforcing the locations with the most holes, they should reinforce the locations with no holes.’ Wald’s recommendations were implemented and ended up saving many planes which would have otherwise gone down.
But why are we discussing wars and hospitals, when we started of with HDFC. The data used by HDFC to arrive at the conclusion of “improved affordability” also suffers from survivor bias. Allow me to explain.
When HDFC considers an average home price of around Rs 52 lakh and an average income of around Rs 12 lakh, it is possibly referring to a set of people who have approached HDFC for a home loan and bought one. In short, it is referring to a sample that it has ready access to.
But the people approaching HDFC are possibly those who can still afford to buy a home. And they can do that primarily because their incomes have kept pace with the rise in home prices.
Nevertheless, what about all those people out there who want to a buy a home to live in, but can simply not afford it. Their incomes are simply not high enough and haven’t kept pace with rising home prices. These people possibly do not form a part of HDFC’s sample. And hence, the data suffers from a survivor bias. Given this, the conclusion of “improved affordability” is essentially wrong.
There are other points that can be made against the “improved affordability” argument. If the affordability has improved why are there so many unsold homes all over India? Reports put out by real estate consultants regularly point out to the huge number of unsold homes all over India. (You can read about it here and here).
Further, if the affordability has improved why is there such a huge shortage of homes in urban areas. As the latest Economic Survey points out: “The widening gap between demand and supply of housing units and affordable housing finance solutions is a major policy concern for India. At present urban housing shortage is 18.8 million units of which 95.6 per cent is in economically weaker sections (EWS) / low income group (LIG) segments and requires huge financial investment to overcome.” Obviously, HDFC does not cater to this group.
To conclude, it is worth remembering here what American writer Upton Sinclair once said: “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”
HDFC as a company has been doing well. In fact, in the last one year its loan book grew by 20%. Having said that, it is in the business of giving out home loans and it would like to think that “all is well,” with the real estate sector and homes are affordable, but that is really not the case.

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

The column originally appeared on Firstpost on May 19, 2015