Month: September 2015 | Page 2

25 September, 2015

What business news channels have in common with Chacha Chaudhary

I normally don’t watch business news channels given that I find them quite flaky and get put off by their lack of depth. Nevertheless, these days with nothing better to do while having lunch, I sometimes do end up watching these channels discussing the vagaries and the volatility of the stock market.

And one of the things I have noticed is that the anchors as well as the stock market experts who offer their opinion on these channels speak with a lot of conviction and confidence. They appear to be in control of things. They appear to know what is happening, when the world around them is probably going crazy. We never hear them use words like probably, maybe or phrases like I don’t know. Further, they seem to have this uncanny ability to understand and explain something just as it has started to unravel. Their story telling abilities are simply terrific.

The uncanny ability of these anchors and experts to explain things at the speed of thought reminds me of a thought bubble in the Chacha Chaudhary comics, which used to say: “Chacha Chaudhary ka dimaag computer se bhi zyada tez chalta hai (Chacha Chaudhary’s mind works faster than a computer).” These anchors and experts are perhaps the Chacha Chaudharies of this day and age.

How is such speed possible? If the anchors and experts are so much in control and seem to have so much insight with such clarity, why are they not making money out of it? Why are they offering their advice for free on TV?

As the British economist John Kay writes in his new book Other People’s Money—Masters of the Universe or the Servants of the People?: “We deal with radical uncertainty through storytelling, by constructing narratives…The reality of market behaviour…relies on conviction narratives – stories that traders tell themselves, and reinforce in conversation with each other. Such narratives are the means by which we cope with radical uncertainty – the unknown unknowns that characterise… business and securities markets.”

The anchors and the experts appearing on business news television are in the business of telling us stories, which offer an explanation for why the market moved the way it did on a particular day. These days the most offered explanation is that economic jitters in China caused the stock market to fall. But this explanation is always offered after the stock market has fallen. No anchor or market expert ever says: “The stock market will fall today because there is economic trouble in China”.

As Kay writes: “The ‘explanations’ provided…by…market commentators…are little more than rationalisation of the noise generated by…market volatility.” And given this, it is worth asking that how useful is it for investors to listen to these explanations and make investment decisions after that.

Bob Swarup calls this phenomenon the illusion of explanation. He defines the term in his book Money Mania as: “Believing erroneously that your arguments…explain events.”

Further, how is it that the anchors and the market experts have an explanation for everything that happens in the stock market? And what is even more surprising is how they are able to come up with explanations so quickly. As John Allen Paulos writes in A Mathematician Plays the Stock Market: “Commentators…provide a neat post hoc explanation for every rally, every sell-off, and everything in between…Because so much information is available—business pages, companies’ annual reports, earnings expectations, alleged scandals, on-lines sites and commentary—something insightful can always be said.”

Over and above this there are many data releases which can also be used to come up with explanations. These data releases include inflation as measured by the consumer price index and the wholesale price index, index of industrial production, export and imports numbers, bank credit growth, and so on. And if all this does not fit into a convincing narrative you can always blame the Reserve Bank of India for not cutting interest rates.

Investing in specific stocks is not easy as it is made out to be by business news television. In fact, what anchors and market experts specialise in is making things simplistic rather than simple, given that they have limited time at disposal to say what they want to say. In this situation, where everything has to be said in thirty seconds to a minute, it is hardly surprising that things ultimately become simplistic. And this is clearly not good from an investor point of view.

What works for these anchors and experts is the fact that while coming up with explanations and predictions, their past record is not available for examination.

As Jason Zweig writes in Your Money and Your Brain: “Whenever some analyst brags on TV about making a good call, remember that pigs will fly before he will broadcast a full list of his past predictions, including the bloopers. Without that complete record of his market calls, there’s no way for you to tell whether he knows what he’s talking about.” This is a very important point that needs to be kept in mind when listening to anchors as well as experts on television.

Also, it is worth remembering here that which way a stock market will go is impossible to predict regularly on a day to day basis. Nassim Nicholas Taleb in his book The Black Swan—The Impact of the Highly Probable lists a certain category of experts who tend to be…not experts. In this list he includes economists, financial forecasters, finance professors and personal financial advisers.

As he writes: “Simply, things that move, and therefore require knowledge, do not usually have experts, while things that don’t move seem to have some experts. In others words, professions that deal with the future and base their studies on the nonrepeatable past have an expert problem…I am not saying that no one who deals with the future provides any valuable information…but rather that those who provide no tangible added value are generally dealing with the future.” Given this, the stock market experts clearly have an expert problem.

Hence, the next time you switch on your television to try and understand what is happening in the stock market, do remember all that has been pointed out above.

Happy investing!

The column originally appeared on The Daily Reckoning on September 25, 2015

24 September, 2015

Ratings shopping: Lessons from the Amtek Auto default

Amtek Auto was supposed to repay Rs 800 crore of its debt by Sunday (Sep 20, 2015). It has not been able to do so. Media reports suggest that the company has a total debt of Rs 18,000 crore, whereas the Amtek group has a debt of Rs 26,000 crore.

The interesting bit is that this debt that Amtek Auto has defaulted on will not be declared to be a bad loan immediately. As I have often written in the past in The Daily Reckoning, banks do not like to recognise bad loans immediately.

More often than not they kick the can down the road by restructuring the loan. When a loan is restructured a borrower is either allowed to repay the loan at a lower rate of interest or over a longer period of time or possibly both.

Deepak Shenoy makes this point on Capitalmind.in: “For a bank holding the bonds[on which Amtek Auto has defaulted on] this account is technically not an NPA [non-performing asset or a bad loan] until 90 days is over. So they can extend and pretend and hope that Amtek manages to salvage itself. Since the banking system has exposure to more than Rs 7,000 crore of loans to Amtek, you can bet your next salary that they will restructure the loan in some way and manage to not call it an NPA at all.”

And that is not the only disturbing bit. Amtek Auto is also a very clear case of rating agencies having been caught napping on their job. The agencies should have seen this default coming. But that did not turn out to be the case.

Care Ratings suspended the rating of the company on August 7, 2015. Before suspending the company Care had rated Amtek Auto at AA−. Care defines an AA rating as: “Instruments with this rating are considered to have high degree of safety regarding timely servicing of financial obligations. Such instruments carry very low credit risk.” Over and above the rating, Care also uses plus or minus for a certain level of ratings. These signs “reflect the comparative standing within the category.”

From a rating of AA−, Care stopped rating Amtek Auto. Another rating agency Brickwork Ratings downgraded the debt of the company from a level of A+ to C−. This was a downgrade of 12 levels in a single shot.

Brickwork defines an A rating as: “Instruments with this rating are considered to have adequate degree of safety regarding timely servicing of financial obligations. Such instruments carry low credit risk.” It defines a C rating as: “Instruments with this rating are considered to have very high risk of default regarding timely servicing of financial obligations.”

It is worth asking here that how did a company go from being categorised as having an “adequate degree of safety” to a “very high risk of default,” all at once. The only possible explanation here is that the rating agency was caught napping or just chose to look the other way.

In fact, Amtek Auto is not an isolated case. There have been other such instances as well. As a recent news-report in the Mint newspaper points out: “In the past one year, there have been other instances where ratings have been cut sharply by three notches or more in one revision. In July, CARE Ratings downgraded Jaiprakash Associates Ltd by six notches from a rating of BB to D-, a rating that reflects a default in the debt security. Non-convertible debentures of Bhushan Steel Ltd also saw their rating drop by six notches following a revision by CARE Ratings in December 2014. Punj Lloyd Ltd faced a similar drop in ratings in July.”

Monet Ispat and Energy Ltd, Bhushan Power and Steel Ltd, Shree Renuka Sugars and 20 Microns Ltd, are examples of other companies that the Mint news-report points out.

There is a basic problem with the way rating agencies operate. The company which they are rating is the one which pays them as well. In this scenario one rating agency can be played against another, and a company can indulge in ratings shopping.

In fact, ratings shopping was a major reason behind the financial crisis. Banks and other financial institutions looking to rate their subprime bonds and other mortgage backed securities played off one rating agency against the other. If they did not get the AAA rating (which is the best rating on a financial security), they threatened to take their business elsewhere.

There was a huge ratings inflation that happened as well. As George Akerlof and Robert Shiller write in their new book Phishing for Phools—The Economics of Manipulation and Deception: “One ratings agency alone, Moody’s, gave 45,000 mortgage-related securities a triple-A rating(for the period 2000 to 2007); that generosity for the mortgage-backed securities contrasts with only six US companies that were similarly rated AAA(in 2010).”

This possibly explains that the rating agencies were giving high ratings to subprime and mortgaged backed securities in order to continue to get business from investment bank issuing subprime bonds and other mortgage backed securities.

As Akerlof and Shiller point out: “The originator of the packages [i.e. subprime bonds and the mortgage backed securities], typically an investment bank, was rewarded by high ratings on its offerings. And the ratings agency, in turn, would be shunned if it did not give the investment bank what it wanted. It was in the interest of neither the investment banks nor the ratings agencies to go back and do that extremely difficult—and perhaps impossible—task of opening up the packages and carefully examining their innards [the emphasis is mine].”

This is precisely what has happened in the Indian context as well. In their zeal to get business, the rating agencies awarded these companies higher ratings than what they deserved in the first place. If they hadn’t done that the companies would have taken their business elsewhere. Pretty soon shit hit the ceiling and they had to cut ratings by several notches all at once.

To conclude, it is worth repeating here, something that a managing director of Moody’s told his employees: “Why didn’t we envision that credit would tighten after being loose, and housing prices would fall after rising, after all most economic events are cyclical and bubbles inevitably burst. Combined, these errors make us look either incompetent at credit analysis, or like we sold our soul to the devil for revenue, or a little bit of both [the emphasis is mine].”

The Indian rating agencies did something similar as well.

The column originally appeared on The Daily Reckoning on Sep 24, 2015

23 September, 2015

When it comes to reviving real estate, Jaitley needs to look beyond RBI

Arun Jaitley is at it again. On Sunday (September 20, 2015) the finance minister said in Hong Kong: “RBI historically has been a very responsible institution.
Now, as somebody who wants India’s economy to grow and who wants domestic demand to grow, I will want the rates to come down…Real estate, for example, can give a big push to India’s growth and this is a sector which is impacted by high policy rates. Therefore, if the policy rates come down over the next year or so, certainly this is one sector which has a huge potential to grow.”

This is not the first time Jaitley has said something like this. In December 2014 he had said: “Now time has come with moderate inflation to bring down the rates. If you bring down the rates, people will start borrowing from banks to pay for their flats and houses. The EMIs will go down.”

As I have often said in The Daily Reckoning in the past, homes are not selling because prices are high. It has got nothing to do with high EMIs. A fall in interest rates will not make such a huge difference in EMIs so as to get people all excited about buying homes to live in.

The finance minister has regularly talked about high interest rates and the fact that the Reserve Bank of India (RBI) needs to cut interest rates, so that people start buying homes again. Given that he talks to the media almost every week, why can’t the finance minister also talk about high real estate prices? Why doesn’t he talk about the real estate companies sitting on a huge amount of inventory and still not cutting prices?

Further, public sector banks can be encouraged to go after real estate companies which owe them money. Such real estate companies should be forced to liquidate the inventory of unsold homes they are sitting on. If this is happening, the finance minister needs to talk about it, instead of just asking the RBI to cut interest rates.

Real estate prices can also be brought down if the stamp duty charged by state governments on real estate sales is brought down. The Bhartiya Janata Party (BJP) is in power in many big states, and these governments can be encouraged to bring down the stamp duty. The chances are that as home prices fall, with a lower stamp duty, home sales will pick up, and the total amount of stamp duty collected by the government will go up or at least remain the same.

Media reports suggest that in a few states the market price of homes is lower than the circle rate. This has brought the transactions to a complete stand still. Why can’t this anomaly be corrected? I agree this is something that the state governments need to do, but the finance minister, given that he talks so much, can set the agenda by talking about this as well.

Along similar lines, why can’t the finance minister and other senior BJP leaders encourage the states where the BJP is in power, to have better and more transparent FSI laws? The way these laws are currently structured, they allow the nexus between the builders and the politicians to flourish. I am no expert on this, but what is stopping the central government from coming up with a model FSI law, which states can follow, with their own tweaks.

Further, Jaitley can also perhaps explain to us why is his government opposing the move to bring political parties under the ambit of the Right to Information (RTI) Act? In an affidavit submitted to the Supreme Court in August 2015, the government said: “If political parties are held to be public authorities under RTI Act, it would hamper their smooth internal working, which is not the objective of the RTI Act and was not envisaged by Parliament. Further, it is apprehended that political rivals might file RTI applications with malicious intentions, adversely affecting their political functioning.”

If the political parties are brought under the ambit of RTI they will have to function in a much more transparent way in comparison to what they do now. This would mean keeping proper records of where the funds to finance them are coming from. Real estate companies are major financiers of political parties, at least at the state level.

If the political parties are brought under the ambit of RTI, the nexus between politicians and builders will come under proper scrutiny. And this is something that no political party can afford. This, perhaps explains why the Narendra Modi government does not want political parties to be brought under the ambit of RTI.

Nevertheless, if this were to happen, it would go a long way in ensuring that real estate prices in India at any point of time are a reflection of the underlying demand and supply of homes.

Also, as any builder will tell you off the record, the construction cost is only a small part of getting a real estate project going. Fees to politicians and bureaucrats form a major cost of a project, and are passed on to the buyer. The finance minister Arun Jaitley cannot do much about this, but at least he can talk about it. The first step in tackling a problem is acknowledging that it exists.

Finally, Jaitley can also explain to us why the Real Estate (Regulation and Development) Bill, which promises to bring some regulation to what has been a totally unregulated sector, up until now, has more or less been put on the backburner?

The government has shown a lot of aggression when it came to bills pertaining to land acquisition and goods and services tax. The same aggression has been missing when it came to the Real Estate bill. The bill provides for penalties to be paid by the builder, if a project is not delivered within a time bound period. It also stops builders from making arbitrary changes to project plans without the consent of home-buyers. It also has a provision for state level real estate regulators.

Long story short – why doesn’t Jaitley talk about all these factors as well. What is the point in blaming the RBI over and over again for a slowdown in the real estate sector?

The column originally appeared in The Daily Reckoning on Sep 23, 2015

23 September, 2015

Of Nehru and India’s unemployable

For many years, the most widely used economics textbook all over the world was written by the American economist Paul Samuelson. Samuelson in different editions of his textbook maintained for a very long period of time that in the years to come the economy of the Soviet Union would grow bigger than that of the United States.

As Daniel Acemoglu and James A Robinson write in Why Nations Fail – The Origins of Power, Prosperity and Poverty: “The most widely used university textbook in economics, written by Nobel Prize-winner Paul Samuelson, repeatedly predicted the coming economic dominance of the Soviet Union. In the 1961 edition, Samuelson predicted that Soviet national income would overtake that of the United States possibly by 1984, but probably by 1997. In the 1980 edition there was little change in the analysis, though the two dates were delayed to 2002 and 2012.”

Of course nothing of this sort happened and the Soviet Union broke up in December 1991. But those were the days and the narrative of the success of the Soviet style of economics driven by five-year-plans was very popular. Samuelson was not the only one to be seduced by it. In fact, an entire generation was.

The trouble as Acemoglu and Robinson point out was: “In reality, what got implemented in Soviet Union had little to do with the five-year-plans, which were frequently revised and written or simply ignored. The development of industry took place on the basis of commands by Stalin and the Politburo, who changed their minds frequently and often completely revised their previous decisions.”

Closer to home, Jawaharlal Nehru was also a great fan of the Soviet style of economic development. So India had its own set of five-year-plans. The second five year plan (1956-1961) put into practice the idea of economic growth driven by public sector enterprises. Further, trained people were needed to run these public sector enterprises.

As PC Mahalanobis who was the Honorary Statistical Advisor to the government of India as well as the brain behind the second five year plan said in November 1954: “In dealing with the programme of industrial production one of the most important questions would be an adequate supply of trained personnel at all levels. This may indeed prove to be a serious bottleneck.”

In order to tackle this bottleneck the government moved its focus towards higher education. As Sanjeev Sanyal writes in The Indian Renaissance—India’s Rise After a Thousand Years of Decline: “Rather than invest in the general primary education, the country used up all its education budget to provide specialized personnel for grandiose public-sector-projects…The needs of the Mahalonobis model…meant that the country had invested heavily in tertiary education and built up a handful of world-class institutions.”

An impact of this, as Sanyal writes was that “the bulk of the country’s workforce was effectively not employable in anything other than subsistence agriculture.” And this is something which hasn’t really changed. Currently more than half of country’s population works in agriculture but contributes only around 18% of the gross domestic product (GDP).

This means there are many more people working in agriculture than there should be. If India needs to get its millions out of poverty, it is critical that other earning opportunities are created for these individuals. In fact, only 17% of the people who work on farms survive only on money they make from their farm. Everyone else does some extra work.

Hence, a bulk of these people need to be moved on to other jobs. The question is what kind of jobs they can really take on, given that many of them have very basic literacy skills or almost none at all. This pushes skilled or even semi-skilled jobs for that matter, out of the equation.

The point here being that the choice of a wrong economic model has had major consequences for India. And the sad part is that we still don’t seem to have learnt enough from the disaster of public sector driven development.

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

The column originally appeared in the Bangalore Mirror
on Sep 23, 2015

22 September, 2015

The robber barons of India

In his latest book Other People’s Money—Masters of the Universe or Servants of the People?, the British economist John Kay talks about the robber barons of the United States, who lived through the late nineteenth and the early twentieth century.

As Kay writes: “The late nineteenth century is described as ‘the gilded age’ of American capitalism. The dominant figures of that era – men such as Henry Clay Frick, Jay Gould, J.P. Morgan, John D. Rockefeller and Cornelius Vanderbilt – are often called the ‘robber barons.’”

These robber barons helped build the railroads, oil supply systems and steel mills of the United States. As Kay writes: “They were both industrialists and financers, in varying degrees…But their immense personal wealth was as much the product of financial manipulation as of productive activity.”
Now replace United States with India, and you can see the similarities. While the United States had robber barons in the nineteenth and the early twentieth century, India has had them in the twentieth and the twenty-first century.

The Reserve Bank of India governor explained the finance skills of Indian businessmen in great detail in a speech he made in November 2014. As Rajan said: “The reason so many projects are in trouble today is because they were structured up front with too little equity, sometimes borrowed by the promoter from elsewhere. And some promoters find ways to take out the equity as soon as the project gets going, so there really is no cushion when bad times hit.”

What Rajan was essentially saying here is that many Indian businessmen start a project with very little of their own money invested in it. Further, some of them even manage to tunnel out this small investment as soon as the project starts. This is typically done by over stating the cost of the project, borrowing against the higher number and then tunnelling out a portion of the debt that has been taken on to get the project going.

Also, in the last few years, many Indian businessmen have taken on more bank loans than they could have possibly repaid. They have subsequently defaulted on it or renegotiated the terms, leaving the banks in a lurch. Interestingly, even after defaulting on their loans, they have continued to be in positions of control.

As Rajan said during the course of his speech: “In much of the globe, when a large borrower defaults, he is contrite and desperate to show that the lender should continue to trust him with management of the enterprise. In India, too many large borrowers insist on their divine right to stay in control despite their unwillingness to put in new money. The firm and its many workers, as well as past bank loans, are the hostages in this game of chicken — the promoter threatens to run the enterprise into the ground unless the government, banks, and regulators make the concessions that are necessary to keep it alive.”

And if after all this, the business comes back to health, the businessmen tends to benefit the most. As Rajan said: “The promoter retains all the upside, forgetting the help he got from the government or the banks – after all, banks should be happy they got some of their money back! No wonder government ministers worry about a country where we have many sick companies but no “sick” promoters.”

These businessmen over the years have survived on essentially manipulating the system (or what we like to call jugaad) and surviving on multiple doles from the government. This is something that Rajan clearly pointed out in a recent speech, where he said: “India must resist special interest pleas for targeted stimulus, additional tax breaks and protections, directed credit, subventions and subsidies, all of which have historically rendered industry uncompetitive, government over-extended, and the country incapable of regaining its rightful position amongst nations.”

But this is easier said than done, given that India’s businessmen have always operated like this. The question is how can this change? Kay has a possible answer in his book Other People’s Money, where he suggests that the United States went from strength to strength after the links between finance and business were loosened.

As he writes: “While the ‘robber barons’ were both financers and businessmen, the leading industrialists of the first half of the twentieth century – men such as Alfred Sloan of General Motors and Harry McGowan of ICI – were primarily businessmen. Their skill was in developing the systems and cadre of professional managers needed to run a modern corporation.”

This is possible if banks go after corporates defaulting on loans with great zeal, which they currently lack. Further, a new class of capitalists needs to flourish.
The Prime Minister Narendra Modi in a recent meeting with India’s biggest businessmen asked them to increase their risk taking appetite. As the president of the Confederation of Indian Industry, a business lobby, told the media after the meeting with Modi: “Prime Minister has said that industry must take risk and increase investments…we must go out and invest.”

The trouble is India’s incumbent businessmen are not the risk taking type. As Dipankar Gupta wrote in a recent column in The Times of India: “Till the 1980s Indian businesses were shielded from foreign competition, and they returned this favour by not introducing a single innovation above street-corner jugaad…Even after liberalisation came to India in the 1990s, this risk aversion among Indian capitalists stayed firm and remained protected by a friendly state. This can best be seen in the advocacy and implementation of the current Public Private Partnership (PPP) model.”

Hence, expecting such businessmen to suddenly start taking risk is a tad absurd. That ain’t happening. So what is the way out? As I said earlier, India needs a new class of capitalists. And for that to happen, as Rajan said the other day, it is important “to improve regulation by focusing on what is absolutely necessary to create a sound business environment.”
The column originally appeared in The Daily Reckoning on Sep 22, 2015