Month: September 2015

Overconfidence of the ‘Bengaluru’ entrepreneur

flipkartThe last time I was in Bengaluru in late January and early February, almost everybody I met either wanted to be an entrepreneur or had already become one. I know I am stretching the truth here, nevertheless, the enthusiasm for entrepreneurship that I saw in Bengaluru is clearly missing in Mumbai, where I live, and Delhi, the city where my extended clan does.

A major factor that is needed for an individual to become an entrepreneur is “overconfidence”. As Gary Belsky and Thomas Gilovich write in Why Smart People Make Money Mistakes and How to Correct Them: “If people were not overconfident…significantly fewer people would ever start a new business…That their optimism is misplaced—that they are overconfident—is evidenced by the fact that more than two-thirds of the small businesses fail within four years of inception.”

It is worth clarifying here that overconfidence here does not mean arrogance. So what does it mean? As Belsky and Gilovich write: “What research psychologists have discovered about overconfidence is that most people—those with healthy egos and those in the basement of self-esteem—consistently overrate their abilities, knowledge, and skill, at whatever level they might place them.”

The entrepreneurs work along similar lines. In fact, research shows that even when entrepreneurs are told that their chances of survival are small, they don’t believe in it. As Nobel Prize winning psychologist Daniel Kahneman writes in Thinking, Fast and Slow: “The chances that a small business will survive for five years in the United States is about 35%. But the individuals who open such businesses do not believe that statistics apply to them. A survey found that

American entrepreneurs tend to believe that they are in a promising line of business…Fully 81% of the entrepreneurs put their personal odds of success at 7 out of 10 or higher, and 33% said their chance of failing was zero.”

Given that a whole host of Bengaluru denizens have worked in the United States or know someone who has, it is hardly surprising that the American way of doing things, has caught on, in the city as well. Nevertheless, this overconfidence works in several sways. It encourages people to become an entrepreneur in the first place. Further, it helps them to keep running the business in the face of all odds.

As Kahneman writes: “One of the benefits of an optimistic temperament is that it encourages persistence in the face of obstacles…[The] confidence [of the entrepreneurs] in their future success sustains a positive mood that helps them obtain resources from others, raise the morale of their employees, and enhance their prospects of prevailing. When action is needed, optimism, even of the mildly delusional variety, may be a good thing.”

On the flip side overconfidence also leads many entrepreneurs to launch businesses without any business model in place. Take the case of the Indian ecommerce companies, many of which are headquartered in Bengaluru. A significant number of these companies are operating without any business model, backed by an unending amount of private equity and venture capital money that has been pouring in.

The money that keeps pouring into these companies shows the ability of the entrepreneurs to keep raising money from investors in the hope of their companies making money someday. And this couldn’t have happened without them being overconfident.

As Kahneman explains: “Inadequate appreciation of the uncertainty of the environment leads economic agents to take risks they should avoid. However, optimism is highly valued, socially and in the market; people and firms reward the providers of dangerously misleading information more than they reward truth tellers.”

Given this, at this point of time, ecommerce is the flavour of the season, and anyone raising points about the viability of the entire sector, is usually shouted down upon. Nevertheless, as Warren Buffett said during the course of the dotcom bubble which burst in 2000, “but a pin lies in wait for every bubble.” And that is something worth remembering here as well.

The column originally appeared in the Bangalore Mirror on Sep 30, 2015

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

The RBI rate cut won’t revive the real estate sector; lower home prices will

ARTS RAJAN
I don’t know what you want to call me, Santa Claus or hawk. My name is Raghuram Rajan and I do what I do – Raghuram Rajan, governor of the Reserve Bank of India, yesterday in a press conference

During the course of the last few weeks, anyone who had any opinion on the Indian economy was saying just one thing: “Raghuram Rajan should cut interest rates.” Given this, there was tremendous pressure on Rajan to cut the repo rate, or the rate at which the Reserve Bank of India (RBI) lends to banks.
The expectation was that Rajan would cut the repo rate by 25 basis points. One basis point is one hundredth of a percentage. He surprised everyone by cutting the repo rate by 50 basis points to 6.75%.

Or as a Facebook friend put it quoting Akshay Kumar from the movie Rowdy Rathore: “Main jo bolta hoon woh main karta hoon. Aur jo main nahin bolta hoon, woh main definitely karta hoon (I do what I say. And what I don’t say I definitely do that).”

One of the first reactions that came in on the rate cut was from Rajeev Talwar, co-CEO of DLF, India’s largest listed real estate company. Talwar said that a 50 basis points rate cut was a “pleasant surprise” from the RBI governor. He also suggested that now that the governor had “bitten the bullet”, it is time he allowed “teaser home loans…at least for a period of two years” and that would “give a huge boost to new buyers”.

The insinuation here is that high interest rates had kept people away from buying homes. Nevertheless, is that really true? Let’s take a look at what the numbers suggest. The RBI publishes the sectoral deployment of credit data every month. As per this data, the overall lending by banks grew by 8.2% between July 25, 2014 and July 24, 2015. During the same period the total amount of home loans given by banks grew by 17.8%.

How was the scene in July 2014? Between July 26, 2013 and July 25, 2014, the overall lending by banks had grown at a much faster 12.6%. During the same period home loans grew by 17.4%.

What do these data points tell us? While the overall lending growth of banks has come down, the home loans have grown at a faster rate, despite high interest rates. Further, during the last one year, 21.6% of overall lending by banks was in the form of home loans. This number had stood at 13.2% between July 2013 and July 2014.

Hence, Talwar insinuating that the real estate sector has been down in the dumps because of high interest rates, is basically all bunkum. Take the case of the State Bank of India, the largest bank in the country. Between June 30, 2014 and June 30, 2015, home loans formed around 36% of all the domestic lending carried out by the bank. And this is a huge number.

If builders had their way, they would happily turn all Indian banks into home finance companies. But the fact of the matter is that banks are already giving out a substantial portion of their overall lending as home loans.

If real estate companies are still not managing to sell enough homes and have managed to accumulate a huge amount of inventory of unsold homes, high interest rates are not responsible for it in anyway. The home loan lending by banks hasn’t slowed down one bit and continues to grow at a good pace.

The only way to revive the real estate is to cut prices. But that is something that the builders don’t want to do, having gotten used to easy money in the form of high prices over the years. Hence, they keep blaming everyone but themselves.

As Navin Raheja, chairman and managing director of Raheja Developers recently said: “I don’t think there is any further possibility of developers to reduce the price further because there is no way they can reduce the prices…If you look at it, last 10 years, there have been so many new developers which came without knowing the dynamics of the sector and later on they went into distress selling.” I sincerely wonder where this so called “distress selling” is happening, a few projects here and there notwithstanding.

The larger point here is that this sort of attitude will only hurt real estate developers in the time to come. They want to sell stuff at a price at which most people can’t afford to buy. A recent study by real estate consultant JLL points out that 69% of the unsold homes in Mumbai are priced more than Rs 1 crore. This when the weighted average price of a home in the city is around Rs 1.3 crore.

The real estate developers have refused to look at this basic fact and continue to price homes at high rates. Data from JLL shows that of the new launches that happened in Mumbai between April and June 2015, only 3.2% of the homes being built were priced between Rs 31-65 lakh. There were none under Rs 30 lakh.

As I have often pointed, the impact that falling interest rates have on EMIs isn’t huge. A  home loan of Rs 50 lakh, at an interest rate of 10% and a tenure of 20 years, leads to an EMI of Rs 48,251. At 9.5%, assuming the fifty basis point repo rate cut is passed on to the borrower, the EMI works out to around Rs 46,607, which is around Rs 1,650 lower.

No one is going to go buy a house with a loan of Rs 50 lakh, because the EMI is now Rs 1,650 lower. Also, in order to get a home loan of Rs 50 lakh, the individual interested in buying a home would need to arrange Rs 12.5 lakh for a down-payment (assuming an optimistic ratio of 80:20). Over and above this, some portion of the payment will have to be made in black as well.

What all this clearly tells us that most of what is being built by real estate developers will continue to remain unsold. The real estate developers have priced themselves out of the market. The sooner they come around to this reality, the better it will be for all of us.

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

The column originally appeared on Firstpost on Sep 30, 2015

EMIs down by Rs 20 per lakh, we will all buy cars now

 

car
The Nobel Prize winning physicist Albert Einstein once said: “It can scarcely be denied that the supreme goal of all theory is to make the irreducible basic elements as simple and as few as possible without having to surrender the adequate representation of a single datum of experience.”

This line is believed to be the source of another quote that often gets attributed to Einstein: “Everything should be made as simple as possible, but no simpler.” Irrespective of whether Einstein said this or not, it remains a very powerful quote.

It is typically applicable in scenarios where we are trying to explain things to people. And in our zeal to explain things we end up making things much simpler than they actually are. Now take the case of the Reserve Bank of India’s decision to cut the repo rate by 50 basis points (one basis point is one hundredth of a percentage) to 6.75%, yesterday. Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark to the interest rates that banks pay for their deposits and in turn charge on their loans.

This immediately led many analysts and experts who appear on television to conclude that EMIs will now fall and hence, people will borrow more and buy cars, bikes, homes, and so on. This simplistic sort of analysis you would have read by now in your daily newspaper as well.

Only if it was as simple as that.

The banks borrow deposits at a certain rate of interest. They lend these deposits as loans at a higher rate of interest. Hence, for banks to cut the interest rates at which they lend, they first need to cut interest rates at which they borrow.

Further, even if banks cut deposit rates, after a cut in the repo rate, they may not cut lending rates or they may not cut lending rates to the same extent as the deposit rates. As the RBI said in a statement released yesterday: “The median base lending rates of banks have fallen by only about 30 basis points despite extremely easy liquidity conditions. This is a fraction of the 75 basis points of the policy rate reduction during January-June, even after a passage of eight months since the first rate action by the Reserve Bank. Bank deposit rates have, however, been reduced significantly, suggesting that further transmission is possible.”

Before yesterday’s 50 basis points cut in the repo rate, the RBI had cut the repo rate by 75 basis points between January and June 2015. In response to this banks had cut their lending rates by around 30 basis points on an average. They had cut their deposit rates more.

Why was this the case? In some cases, banks were simply trying to make more money. In other cases, particularly in case of public sector banks, the banks also had to deal with a huge amount of bad loans that had been piling up. Basically banks had lent money to corporates, who were no longer returning it. In this scenario, in order to maintain their profit levels, banks decided to cut their deposit rates more than their lending rates.

Further, banks also need to compete with small savings schemes offered by India Post. Hence, they cannot cut interest rates on their deposits beyond a point, unless the interest rates offered on the small savings schemes are cut as well.

The larger point being the “transmission” as experts like to call it from a repo rate cut to falling interest rates on banks loans, is not so straightforward, as it is often made out to be.

In the press conference that happened soon after the RBI rate cut, the economic affairs secretary Shaktikanta Das said that the government would review the interest rate offered on small savings schemes like the Public Provident Fund (PPF) and post office deposits.

Soon after this, the State Bank of India cut its base rate by 40 basis points to 9.3%. The cut will be effective from October 5, 2015. Base rate is the minimum interest rate a bank charges its customers. This cut by the country’s largest bank is expected to force the big private sector banks to act as well and cut their base rates. Andhra Bank also cut its base rate by 25 basis points to 9.7%.

Hence, this time the transmission of lower interest rates after a repo rate cut is likely to be faster than in the past. Nevertheless, does that mean consumption will pick up because interest rates are now slightly lower?

Let’s do some basic maths to understand this. SBI currently offers a car loan at 10.05% to men, 35 basis points above its base rate of 9.7%. For women, the rate of interest charged is 10%.

A car loan of five years of Rs 5 lakh at 10.05% would mean paying an EMI of Rs 10,636 in order to repay the loan. With the base rate being cut by 40 basis points, a new car loan would be offered at an interest of 9.65%. This would mean an EMI of Rs 10,538 or around Rs 100 lower. Hence, for every Rs 1 lakh of loan, the EMI will come down by around Rs 20 (Rs 100 divided by 5).

So, does that mean people will now buy cars because the car loan EMI will be down Rs 20 per lakh? Does that also mean that people were earlier not buying cars because the car loan EMI was Rs 20 per lakh higher?

If the car industry is to be believed that seems to be the case. Rakesh Srivastava of Hyundai Motors told the news-agency PTI that the rate cut was a “festival gift” from the RBI. R S Kalsi of Maruti Suzuki said: “On the whole, it gives a good signal to customers. The market so far has been moving very slowly but with this (rate cut) sentiments will improve. It gives the much-needed boost to the market in the pre-festive season.”

In fact, Pawan Munjal of Hero Honda also joined the rate-cut kirtan and said: “It has come at an opportune time as it will help in raising customer sentiment during the festival season.”

Hero Honda as you would know is in the business of selling two-wheelers, motorcycles in particular. SBI currently charges 12.85% on its Superbike loan. The EMI on a Rs 50,000, three year loan, would work out to Rs 1681.1. With a 40 basis points cut, the new interest rate will be 12.45%. The EMI on this will be around Rs 1671.5, or around Rs 10 lower.

So people will go and buy bikes because the EMI is Rs 10 lower now? And they were not buying bikes earlier because the EMI was Rs 10 too high?

This sort of simplistic logic on part of corporates and analysis on part of the media, really beats me.

People will consume and buy things when they feel confident about their economic future. This will happen when they see job security and steady increments on the way. Steady increments will come when corporate profits start growing, which isn’t the case currently. Corporate profits will start growing when the corporates are able to clean up the excessive debt that they have on their balance sheets now, among other things. And all this is easier said than done.

At the end of the day, monetary policy can only do so much.

Postscript: I would also suggest that you read an excellent piece by Tanushree Banerjee, Co-Head of Research at Equitymaster, on yesterday’s rate cut. You can read the piece here

The column originally appeared on The Daily Reckoning on Sep 30, 2015

What we can learn about the financial crisis from Arab Spring & First World War

Mohamed_Bouazizi
I don’t know how many of you have heard of this man called Mohammed Bouazizi. Honestly, even I hadn’t heard about him until a few days back.
On December 17, 2010, this 26 year old set himself on fire and died. And why did he do that?

His story is recounted by Philip Tetlock and Dan Gardner in their new book Superforecasting—The Art and Science of Prediction. Bouazizi was a Tunisian who sold fruits and vegetables on a handcart. On December 17, 2010, the police approached him and took away his weighing scales on the pretext that he had broken some regulation. Bouazizi knew that this was a lie and the police basically wanted money.

He went to the town office to complain. He was told that the official he wanted to meet was busy. Bouazizi left on being told this, feeling humiliated and powerless. He went and got some fuel, poured it over himself and set himself on fire.

This sparked protests in Tunisia and the police as expected responded with brutality. Bouazizi died on January 4, 2011. After this, the unrest in Tunisia grew. As Tetlock and Gardner write: “On January 14, 2011, [President Zine El Abidine] Ben Ali fled to a cushy exile in Saudi Arabia ending his twenty-three year kleptocracy.”

Protests soon spread to Egypt, Syria, Jordan, Kuwait and Bahrain. The Egyptian dictator Hosni Mubarak was also forced to leave office. “This was the Arab Spring—and it started with one poor man, no different from countless others, being harassed by police, as so many have been, before and since, with no apparent ripple effects,” write Tetlock and Gardner.

An event like this couldn’t have been predicted. Nevertheless, in the days to come the Middle East experts came up with their own explanations for the Arab Spring. They talked about high-unemployment and poverty. They talked about corruption and repression and how all these factors led to the Arab Spring.

However, all these factors did not appear overnight and had been around for a while. As Tetlock and Gardner write: “An observer could have drawn exactly the same conclusion the year before. And the year before that. Indeed, you could have said that about Tunisia, Egypt and several other countries for decades. They may have been powder kegs but they never blew—until December 17, 2015, when the police pushed that one poor man too far.”

Something similar happened in June 1914 as well, more than 100 years back. Mark Buchanan recounts this story in Ubiquity—The Physics of Complex Systems.

At around 11 AM on June 28, 1914, a driver of an automo­bile carrying two passengers in Sarajevo made a wrong turn. The car wasn’t supposed to make this turn and leave the main street. But due to the mistake of the driver it ended up in a narrow lane and stopped right in front of a Gavrilo Princip, a 19-year-old student.

But that wasn’t Princip’s only identity. He was also a member of the Serbian terrorist organization Black Hand. Princip couldn’t believe his luck. He drew out his pis­tol and fired twice killing the two passengers in the car. Prin­cip had recognized them and gone ahead and pulled the trigger. They were Archduke Franz Ferdinand and his wife Sophie of the Austro-Hungarian Empire.

The assassination led to a series of events in a politically fragile Europe and started what was first known as the Great War and later came to be known as the First World War.

Very soon Austria used the assassination as a reason to invade Serbia. Russia guaranteed protection to the Serbs. Soon Germa­ny got involved and offered to be on Austria’s side if the Russians supported the Serbs. France and Britain also got involved. And a few years later the United States also entered the war. A chauf­feur’s mistake triggered a series of events which led to one of the biggest armed confrontations that mankind had ever seen.

More than 100 years later, historians are still writing books on what started the First World War. History is replete with many such examples.
The start of the Arab Spring as well as the First World are excellent examples of the butterfly-effect. The term was coined by the American meteorologist Edward Lorenzo in 1972. As Dan Gardner writes in Future Babble—Why Expert Predictions Fail and Why We Believe Them Anyway: “Lorenzo…came up with a slightly more down-to-earth image to capture the idea of minuscule changes making a big difference in outcomes: The flutter of a butterfly’s wings in Brazil, he said, could ultimately cause a tornado in Texas. The label “Butterfly Effect” has stuck ever since.”

How does the Butterfly effect fit into the context of the Arab spring? As Tetlock and Gardner write: “If that particular butterfly hadn’t flapped its wings at that moment, the unfathomably complex network of atmospheric actions and reactions would have behaved differently, and the tornado might never have formed—just as the Arab Spring might never have happened, at least not when and as it did, if the police had just let Mohammed Bouazizi sell his fruits and vegetables that morning in 2010.”

The same can be said about the First World War. If Princip hadn’t carried out the assassination, the First World War would might never happened, at least not “when and as it did”.

So what can we learn from these examples? The current financial crisis is also an excellent example of the butterfly effect. The investment bank, Lehman Brothers, went bust on September 15, 2008. Lehman Brothers was the fourth largest investment bank on Wall Street. Individually, it looked like a big event, but it turned out to be very small in comparison to what followed.

The very next day, AIG, the biggest insurance company, had to be nationalized by the American government. This was followed by a spate of financial institutions across the United States as well as Europe getting into trouble. This led to the central banks as well as the governments coming to the rescue of these financial institutions.

While, many economists had predicted the crisis (and some had been predicting for a very long time), almost no one got the timing right. And any prediction without a time-frame is essentially useless, even if it eventually turns out to be right.

The collapse of Lehman Brothers led to the start of the financial crisis. Now more than seven years later, the underlying problems that led to the start of the financial crisis still remain the same. The banks are too big. And they continue to be heavily financialized. As John Kay writes in Other People’s Money:

“Lending to firms and individuals engaged in the production of goods and services – which most people would imagine was the principal business of a bank – amounts to about 3 per cent of…total.”

What this means that trading in financial securities continues to be the principal business of banks. And this was one of the major reasons behind the financial crisis.

This leads me to believe that the current financial crisis hasn’t come to an end. I can also say with great confidence that the next round of the financial crisis will also be a very good example of the butterfly effect, where one small event will start the financial fire all over again. This will force the governments and the central banks to become firefighters all over again.

The only thing I don’t know is, when the next round of the financial crisis will start. Neither does anyone else. And if they do claim to know, they are lying.

The column originally appeared on The Daily Reckoning on Sep 29, 2015

Busted: The ‘biggest’ myth about Indian exports

3D chrome Dollar symbolOne of the economic theories (I don’t know what else to call it) that often gets bandied around by almost anyone who has anything to say on the Indian economy, is that India’s economy is not as dependent on exports as the Chinese economy is. Honestly, given that China and the word “exports” are almost used interchangeably these days, it sounds true as well. Nevertheless, that is clearly not the case. While this may have been true in the 1990s, the most recent data does not bear this out.

Let’s look at exports of goods and services as a proportion of the gross domestic product (GDP, a measure of the size of the economy) of both these countries. In 1995, the Chinese exports to GDP ratio had stood at 20.4% of the GDP. The Indian exports to GDP ratio was around half of that of China at 10.7% of the GDP.

In 2014, the Chinese exports to GDP ratio had stood at 22.6% of the GDP. On the other hand, the Indian exports to GDP ratio was at 23.6% of the GDP. Hence, as a proportion of the size of the economy, Indian as well as Chinese exports are at a similar level. And that is indeed very surprising. It is not something that one expects.

As Rahul Anand, Kalpana Kochhar, and Saurabh Mishra write in an IMF Working Paper titled Make in India: Which Exports Can Drive the Next Wave of Growth?: “India’s exports have been increasing since the early-1990s – both as a share of GDP and as a share of world exports. Total exports as a share of GDP have risen to almost 25 percent in 2013 from around 10 percent in 1995. Likewise, Indian goods exports as a share of world goods exports have risen, with the share almost tripling to 1.7 percent during 1995-2013. A similar trend is visible in India’s services export – the share tripling to over 3 percent of world service exports during 2000-2013.” Computer services form around 70% of India’s services exports, which forms around one third of India’s total exports.

What these data points clearly show us is that the theory that India is not dependent on strong exports for a robust economic growth, is basically wrong, as exports now amount to nearly one-fourth the size of the Indian economy.

The Indian exports have been falling for the last nine months. In August 2015, the exports were down by 20.7% to $21.3 billion. Twenty three out of 30 sectors  monitored by the ministry of commerce saw a drop in exports in August 2015, in comparison to August 2014. Exports for the period of April and August 2015 stood at $111 billion and were down by 16.2% in comparison to the same period last year. Hence, there has been a huge slowdown in exports during the course of this financial year as well.

A major reason for the same has been a fall in commodity exports. As Chetan Ahya and Upasana Chachra of Morgan Stanley write in a recent research note titled What is Driving the Sharp Fall in India’s Exports?: “Persistent downward pressure from commodity prices has undoubtedly put pressure on commodity export growth (in value terms). Indeed, commodity exports (including oil), which account for 33% of India’s total exports, have been declining since Jul-14.”

Commodity prices have been falling because of a slowdown in the Chinese economic growth. China consumes a bulk of the world’s commodities.
Not many people would know that refined petroleum oil, much of which is exported out of the state of Gujarat, forms around one fifth of India’s exports.

Hence, while India benefits immensely due to a fall in the price of oil, given that we import 80% of what we consume, there is a flip-side to it as well.
Further, in India’s case, export of services, in particular computer services, has played a major role in driving up the exports over the years. The same cannot be said about India’s manufacturing exports. As Anand, Kochar and Mishra point out: “[India’s] services exports, as a share of total exports and in terms of sophistication, are comparable to high income countries, the share of manufacturing exports and their level of overall value content are still low compared to its peers, especially in Asia.”

The reasons for this are well discussed. They include an unpredictable tax regime (which the government keeps promising to correct), complicated labour laws and land acquisition policies, inspector-raj and a shaky physical infrastructure.

And this best explains why unlike China, India’s manufacturing exports are not a major part of its goods exports. As Anand, Kochar and Mishra point out: “For example, in 2013, manufacturing exports accounted for 90 percent of total exports in China, almost double the share during 1980-85. Indian exports have also undergone transformation during the decade of high growth, though to a lesser extent compared to peer emerging markets. The share of manufacturing in total merchandise exports has increased to 57 percent in 2013 from 41 percent in 1980.”

Also, given the problems an entrepreneur faces in India, in getting a manufacturing unit going, India’s share in global goods exports may have plateaued as far back as 2012. Data from Morgan Stanley suggests that India’s good exports as a proportion world goods exports has plateaued at around 1.7%.

As Ahya and Chachra of Morgan Stanley point out: “India’s market share in exports of goods for which we have monthly data has declined marginally over the last 12 months but has remained largely flat since 2012…The structural bottlenecks in the form of inadequate infrastructure, outmoded labour laws, a cumbersome taxation structure and systems, and poor ranking in terms of overall ease of doing business are probably making it harder to make gains in market share at a time when external demand has been weak and excess capacities in competitor economies have rise.”

And this is something that cannot be set right overnight.

The column originally appeared on The Daily Reckoning on Sep 28, 2015