Month: October 2015

For Make in India to succeed, India needs to be a part of global supply chains

make in india
Indian exports have been falling for a while now. For September 2015, the merchandise exports (or goods exports) fell by around 24.6% to $21.8 billion, in comparison to September 2014.

In fact, the merchandise exports between April and September 2015, the first six months of this financial year, have gone down by 17.6% to around $133 billion.

This isn’t surprising in an environment where global growth is slowing down. The International Monetary Fund (IMF) projects the global growth for 2015 to be at 3.1%. This is 0.3% lower than in 2014. Further, it is also 0.2% lower than the forecast IMF made in July 2015.

As the IMF points out: “Prospects across the main countries and regions remain uneven. Relative to last year, the recovery in advanced economies is expected to pick up slightly, while activity in emerging market and developing economies is projected to slow for the fifth year in a row, primarily reflecting weaker prospects for some large emerging market economies and oil-exporting countries.”

It further points out that: “In an environment of declining commodity prices, reduced capital flows to emerging markets and pressure on their currencies, and increasing financial market volatility, downside risks to the outlook have risen, particularly for emerging market and developing economies.”

What this means is that the global economic growth this year and possibly the next, will remain worse than it was in the past. Hence, this will impact Indian exports. Exports for one country are essentially consumer and industrial demand in another.

Having said that Indian exports have fallen much more than other Asian countries. Take the case of China. The Chinese exports in September 2015 fell by 3.7% in comparison to India’s 24.6%. And this is clearly a reason to worry.

So what can India to do step up its exports? It is important to understand here that there are no quick fixes to this problem. An important thing for any country looking to drive up its exports in this day and age is to be a part of global supply chains.

As the World Trade Report for 2013 points out: “A central feature of this second age of globalization is the rise of multinational corporations and the explosion of foreign direct investment (FDI)…By 2009, it was estimated that there were 82,000 multinationals in operation, controlling more than 810,000 subsidiaries worldwide. Upwards of two-thirds of world trade now takes place within multinational companies or their suppliers – underlining the growing importance of global supply chains.”

This is an important factor that Indian policymakers need to understand because this is something that the country is clearly missing out on.

As TN Ninan writes in The Turn of the Tortoise—The Challenge and Promise of India’s Future: “India has not allowed large retail networks to set up base in India. The sourcing requirements of global retail chains would have encouraged scale manufacture that would have led in turn to export success. With the exclusion of the big firms and big supply chains, the country has found itself relatively excluded from global supply networks—and this has stunted export growth.”

One way of correcting this was by allowing foreign direct investment in big retail. The Modi government and the ruling Bhartiya Janata Party (BJP) have been against this. A possible explanation for this is the opposition of the trading community to big retail. The trading community remains a big supporter of the BJP.

In fact, India becoming a part of global supply chains is very important for the Make in India programme to succeed. As of now, it continues to remain a fancy slogan.

As Ninan writes: “In everyday terms, therefore, India does not have the equivalent of an Infosys or a Tata Consultancy Services when it comes to merchandise trade. Nor has it made it easy for Wal-Mart or IKEA to set up store chains in India, the way that IBM and Accenture have set up back offices for BPO. Some of this can still be done, though the political reluctance to allow a free run to large retail trade chains is a constraint.”

One school of thought often espoused these days is based that India will end up capturing the low-end export market being vacated by China. This logic is based on the Chinese labour costs going up. The per capita income of China in 2004 was $1498.2 (current US$, World Bank Data). This had jumped nearly five times to $7,593.9 in 2014. Hence, Chinese labour costs have shot up.

A May 2015 news-report in The Economist points out: “The China price is under pressure, though. Since 2001, hourly manufacturing wages in China have risen by an average of 12% a year…Some believe this means that China’s days as a manufacturing powerhouse are numbered.”

In 2013, Asia as a whole accounted for 46.5% of global manufacturing output. China accounted for half of Asia’s output.
With increasing labour costs the low end manufacturing may no longer be viable. As an example, The Economist points out: “Garments are a natural first step in the spread of production out of China: they are low-skill, low-cost and highly transportable.”

Is India in a position to capture this low-end manufacturing market which is likely to move out of China? In theory, yes. The per capita income in India in 2014 was at $1595.7, which is close to 79% lower than that of China at $7,593.9.

Hence, as far as labour costs are concerned India is cheaper than China. But there are cheaper options like Bangladesh and Myanmar, which are available to manufacturers. The per capita income of both these countries in 2014 was at $1092.7 and $1203.8 respectively.

Also, the labour cost is just one of the things that manufacturers look at. As Ninan summarises the issue: “China has the enabling factor of a very efficient infrastructure, which will not be replicated in the foreseeable future. Indeed, most producers looking for alternatives to China are not looking at India. Its rigid labour laws remain a handicap, its workers are not always productive, the infrastructure is deficient and dealing with the authorities is a nightmare. Almost all countries in East Asia offer easier working environments.”
The column originally appeared on The Daily Reckoning on Oct 24, 2015

What bankrupt Indian business groups can learn from Genghis Khan

genghis khan
Over the last few years, Credit Suisse has brought out an interesting series of reports titled the “House of Debt”. The latest version of the report was released last week.

The report tracks the total debt of 10 Indian business groups which have taken on around 12% of total loans of the Indian banking system. These groups are Adani Group, Essar Group, GVK Group, GMR Group, Lanco Group, Vedanta Group, Reliance ADAG Group, JSW Group, Videocon Group and Jaypee Group.
Analysts Ashish Gupta, Kush Shah and Prashant Kumar make several important points in this report. Here are a few of them:

a) The loans given to these business groups amount to 12% of total bank loans. Further, they amount to 27% of the corporate loans made by banks. In the last eight years the loans of these 10 business groups have gone up seven times. This pace of rise has slowed down in the last couple of years and in 2014-2015, the increase was 5%.

b) The interest coverage ratio of these business groups was at 0.8 in 2014-2015, down from 0.9 in 2013-2014. The interest coverage ratio essentially points to the ability of a company to keep servicing its debt by paying interest on it. The ratio is calculated by dividing a company’s earnings before interest and taxes (or operating profit) during a given period by the total interest it has to pay on its outstanding debt, during the same period.

Typically, companies need to have an interest coverage ratio of at least 1.5, to be considered in healthy financial territory. In this case the ratio is just 0.8. An interest coverage ratio of less than one means that the company is not earning enough to keep paying interest on its outstanding debt. Hence, on the whole, these groups are not earning enough to pay the interest on their debt.

The trouble with any average number is that it does not give us the complete picture. The interest coverage ratios of several groups are well below the average.

The GMR group is at 0.2. The GVK group is at 0. The Lanco Group is at 0.2. The Videocon group is at minus 0.3. And the Jaypee Group is at 0.6.

These business groups are in a very bad situation when it comes to the ability to keep servicing their debt.

c) The interest coverage ratio is at abysmal levels despite a large amount of interest being capitalised, as can be seen from the accompanying table.

As the Credit Suisse analysts point out: “while interest coverage is less than 1, a large amount of interest (15-170% of P&L interest) is being capitalised.”
The Accounting Standard 16 states that “borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset should be capitalised as part of the cost of that asset.” It further defines a qualifying asset as “an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.”

What this tells us is that the real interest coverage ratios of these business groups are worse than they seem.

d) Given that the interest coverage ratios of these firms are in such a mess, it is not surprising that they are already defaulting on their debts. As the Credit Suisse analysts point out: “Rating agencies have now assigned the default “D” rating to ~5-65% of debt for these groups. For Jaypee Group, almost two-thirds of the group debt is now in the default category including standalone parent company debt. Other groups have also seen multiple defaults at the SPV level for power and road projects.” (As can be seen from the accompanying table)

In fact, the auditors have also highlighted these defaults in the annual reports of these companies. As the Credit Suisse analysts point out: “According to their auditors report, eight of the ten ‘House of Debt’ groups were in default last year. Total debt with these companies in default was at US$53 bn (~48% of total debt with the groups) of which US$37 bn were reported to be in default for 0-90 days by the auditors.” These are not small numbers by any stretch of imagination.

e) Over the last few years, the business groups have tried to repair their balance sheets by selling assets in order to repay their debts. This hasn’t helped much given that in certain cases, the assets that they have had to sell, essentially brought in the money.

Take the case of Jaypee Group. The group has sold assets and these sales are expected to   bring in Rs 22,000 crore. The trouble is that these assets contributed 59% of its operating profit (earnings before interest and taxes) during 2014-2015.

Further, “a large number of projects especially from power and road sectors have seen delays in completion which has led to cost overruns. Some of the projects now have reported cost overruns of 20-70%.”

What makes the situation trickier is the fact that “some of the companies have 5-50% of long-term debt (~US$15 bn) maturing within the next year and would need refinancing. Also, 5-37% of their debt is short term (~US$20 bn) that needs to be rolled over.”

What this tells us very clearly that all this talk about general corporate revival needs to be taken with a pinch of salt. A major section of the corporates the infrastructure sector continues to battle the high debt that they had taken on during the go-go years between 2004 and 2011 and are now not in a position to even pay interest on this debt.

Also, it is worth mentioning here that owners of a bankrupt company have no real incentive in acting in the best interests of the company. This is a point that Nobel Prize winning economists George Akerlof and Robert Shiller make in their book Phishing for Phools – The Economics of Manipulation and Deception.

As they write: “If the owners of a solvent firm pay themselves a dollar out of the firm, they diminish the amount they can distribute to themselves tomorrow by that dollar plus its earnings.” Hence, owners of a solvent firm have some incentive to not take out money from it. But that is not the case with the owners of an insolvent or a bankrupt firm.

As the economists write: “In contrast, if the owners of a bankrupt firm take an extra dollar out of their firm, they will sacrifice literally nothing tomorrow.”

And why is that? “Because the bankrupt firm is already exhausting all of its assets, paying all those Peters and Pauls [read banks in the Indian case]. Since there will be nothing left over for the owners, they have the same economic incentives as Genghis Khan’s army, as it marched across Asia: what they do not take today, they will never see tomorrow. Their incentive is to loot.”

Look at what happened to the banks in case of Vijay Mallya and all the money he had borrowed. This also explains why many Indian firms become sick but no Indian industrialist ever becomes bankrupt.

Long story short – banks will continue to have a tough time ahead.

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

Some new old lessons on black money

rupee
Credit Suisse released the Global Wealth Report earlier this month. The report had some very interesting data points in the Indian context.
As the report points out: “Measured in domestic terms, wealth has grown rapidly in India since 2000 except during the global financial crisis. Annual growth of wealth per adult in rupees has averaged 8% over 2000–2015.” This is a clear reflection of the strong economic growth India has experienced since the turn of the century.

There are some other interesting data points in the report as well. “As in many other developing countries, personal wealth in India is dominated by property and other real assets, which make up 86% of estimated household assets,” the report points out.

It further points out “a very small proportion of the population (just 0.3%) has a net worth over USD 100,000. However, due to India’s large population, this translates into 2.4 million people. India has 254,000 members of the top 1% of global wealth holders, which equates to a 0.5% share.”

Let’s look at the second point first. So India has 254,000 members in the top 1% of the global wealth holders. It is worth remembering here that in his February 2013 budget speech, the then finance minister P Chidambaram had estimated that India had only 42,800 people with a taxable income of Rs 1 crore or more.

Between 2013 and 2015, the number of people with a taxable income of Rs 1 crore or more must have gone up a bit. No new data is available and given that we can assume that the number is perhaps around 50,000.

So, India officially has 50,000 individuals with a taxable income of Rs 1 crore per year. At the same time there are 254,000 members in the top 1% of global wealth holders. There is a huge dichotomy here. The total global wealth as per the Credit Suisse report stands at $250.1 trillion.

Income on which tax has to be paid and accumulated wealth, are two different things. Nevertheless, wealth cannot be built unless an income is earned. And if an income is being earned, some tax needs to be paid on it.

What this tells us is that many Indians are earning incomes, building wealth, but not paying any income tax. A bulk of the “black money” on which tax has not been paid is parked in real estate. And that explains the fact that 86% of personal wealth in India is in real estate and other real assets. In fact, if we look at the 2010 report, the number was at 90%.

This is not surprising given that real estate remains the best parking space for black money. As a FICCI study on black money released in February 2015 points out: “About a third of India’s black money transactions are believed to be in real estate…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.”

The Modi government up until now has been concentrating on chasing black money that has left the shores of the country. After a huge failure on that front, now they have been talking about domestic black money. The finance minister Arun Jaitley wrote on his Facebook page sometime back that “the bulk of black money is still within India”. That should have been obvious from the day the government decided to focus on black money, given that the bulk of black money gets invested in real estate.

Justice (retired) Arijit Pasayat, the vice-chairman of special investigation team (SIT) on black money said something along similar lines recently: “The volume of black money stashed in India is much more than it is now in the foreign countries. If the generation of black money is stopped, its flow to the foreign countries will be substantially reduced.”

The surprising thing is that it took the Modi government nearly 17 months since being elected to power in May 2014 to figure out where the bulk of the black money was inside India and not outside it, something that should have been obvious from day one.

Another interesting thing the report points out is the distribution of wealth among Indians. The top 1% owns nearly 53% of India’s wealth. The top 5% owns 68.6%. And the top 10% owns 76.3%. So what this clearly tells us is that 90% of the country’s population owns less than 25% of its wealth.

Black money has helped increase this inequality. Those who have black money have invested it in real estate and seen their wealth grow at a fast rate. French economist Thomas Piketty calls this the “principle of infinite accumulation” in his book Capital in the Twenty First Century.

Piketty defines the principle of infinite accumulation as the “inexorable tendency for capital to accumulate and become concentrated in fewer hands, with no natural limit to the process.”

This has also led to a situation where all the black money floating around in real estate has led to very high prices of homes, making them unaffordable for those who want to buy homes to live in.

The column originally appeared on The Daily Reckoning on October 21, 2015

Why Chitrahaar was fun and music channels are not

DDMore than two decades back in 1992, Bruce Springsteen wrote and sang a song called 57 Channels (And Nothin’ On). Ironically, 1992 was also around the time when cable TV first started to spread across India. It was in 1992 that I first heard the Springsteen song on MTV and wondered what did he really mean by it?

How could more TV channels be a bad thing? But then we were coming out of an India which just had one television channel. And we thought that more TV channels would be better than just one. It was an era when the choice of TV watching was limited to a single channel, Doordarshan. Okay, there was DD Metro as well, but only in the bigger cities.

But now 23 years later I can safely say that I am bored with too much TV.

Monopoly was when Delhi Doordarshan used to broadcast Chitrahaar twice a week at 8pm on Wednesdays and Fridays. For the uninitiated Chitrahaar was a 30 minute programme on Doordarshan that played Hindi film songs. I used to look forward to it and have great fun even if “nanha munha raahi desh ka sipahi hoon,” from the movie Son of India, was played for the umpteenth time.

Perfect competition is when there are so many music channels broadcasting a Chitrahaar every minute and I really cannot watch any of these channels for more than two minutes.

Perfect competition is essentially the opposite of a monopoly. In this scenario there are many players selling a product or a service and none of them is big enough to dominate the market.

And given this, the consumer has choice, like he has while watching music on TV these days. There many music channels playing music all through the day. But why isn’t it as enjoyable as it used to be?

The answer perhaps lies in “more” choice. As Sheena Iyengar writes in The Art of Choosing: “When the options are few, we can be happy with what we choose since we are confident that it is the best possible choice for us.” So, when Doordarshan was the only channel available it was a no-brainer to watch Chitrahaar playing at 8pm twice a week than watch Krishi Darshan which played an hour earlier on weekdays.

Now with so many music channels there is choice. And that makes things difficult. As Iyengar writes: “When the options are practically infinite, though, we believe that the perfect choice for us must be out there somewhere and that it’s our responsibility to find it. Choosing can then become a lose-lose situation.”

And this leads to a situation where despite so many TV channels people keep switching channels in the hope of finding something better to watch. As Iyengar writes: “If we make a choice quickly without fully exploring the available options, we’ll regret potentially missing out on something better; if we do exhaustively consider all the options, we’ll expend more effort(which won’t necessarily improve the quality of our final choice), and if we discover good options, we may regret we can’t choose them all.”

It would be simplistic to say here that more choice is bad. But beyond a certain point choice does start to hurt. As Barry Schwartz writes in The Paradox of Choice: “Part of the downside of abundant choice is that each new option adds to the list of trade-offs, and trade-offs have psychological consequences. The necessity of making trade-offs alters how we feel about the decisions we face: more important, it affects the level of satisfaction we experience from decisions we ultimately make.”

These days I seem to be spending more time changing TV channels in the hope of being able to listen to a better song. Time I moved to YouTube and heard just the songs I want to, instead of changing channels all the time. As Iyengar puts it: “The more specific one’s preferences, the easier the choosing task becomes.”

Guess, there is a lesson in it.

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

The column originally appeared in the Bangalore Mirror on October 21, 2015

 

The shift from agriculture to manufacturing will not be easy

make in india
One of the points that I have often made in The Daily Reckoning is about close to 50% of Indians being engaged in agriculture generating around 18% of the Indian gross domestic product (GDP). What this clearly tells us is that agriculture is a low-income earning activity.  It also tells us is that there are many more Indians employed in agriculture than there should be. And this can be made out from the fact that only 17% of Indians employed in agriculture, survive on money they make from it. The rest, have to do some other work along with working on the farm, in order to add to their meager income.

Hence, it’s a no-brainer to suggest that people need to be moved out from agriculture into other higher paying areas like industry and services. As TN Ninan writes in his new book The Turn of the Tortoise—The Challenge and the Promise of India’s Future: “Both productivity and incomes will go up substantially if more people can be moved from low-paying agriculture to higher-paying industry and services—a key transition the country has barely begun.”

The Make in India initiative of the Narendra Modi government should be seen in light of this. The programme envisages “an increase in the share of manufacturing in the country’s Gross Domestic Product from 16% to 25% by 2022” and “to create 100 million additional jobs by 2022 in manufacturing sector”.

One reason why this target at best remains a pipedream is because of the lack of education among Indians. The rate of literacy as per the 2011 Census stood at 74.04%. As this website points out: “Compared to the adult literacy rate here the youth literacy rate is about 9% higher. Though this seems like a very great accomplishment, it is still a matter of concern that still so many people in India cannot even read and write.”

The trouble with this literacy number is that it does not give you the whole picture. As per the Human Development Report 2014, the average Indian male has around 5.6 years of schooling and an average Indian female has around 3.2 years of schooling. Both Bangladesh and Pakistan are ahead of us. For Bangladesh, the numbers being 5.6 years and 4.6 years, respectively. For Pakistan, the numbers stand at 6.1 years and 3.3 years, respectively.

And this is where the plan to move people from agriculture to industry or services for that matter, starts to go haywire. As Ninan writes: “Acquiring job-related skills without the benefit of a basic education is a challenge—it is hard to be a fitter or an electrician at a construction site if you don’t know basic arithmetic and can’t read simple instructions on a product pack.”

What this means is that the Make in India plan cannot take-off beyond a point unless our primary education system starts to improve. Individuals need to spend more time in school receiving better quality education. As things stand currently not much is being learnt in schools.

In fact, surveys have pointed out that most children cannot read basic text. The Annual Status of Education Report facilitated by Pratham points out that only 48.1% of children enrolled in Class V could read standard II level text. This means more than half of children enrolled in standard V cannot read standard II level text. In fact, more than one-fourth of children enrolled in standard VIII could not read standard II level text. The report further points out: “The gap in reading levels between children enrolled in government schools and private schools seems to be growing over time.”

And this is a worrying factor. Further, moving people away from agriculture into other more productive domains is a time taking process. As Ninan writes: “Thailand, one of the most successful manufacturing countries, has those in agriculture continuing to account for 40 per cent of its workforce. China, despite its considerable success in building a factory sector, has 35 per cent of its workforce still engaged in agriculture, generating about 10 per cent of its GDP.”

The point being that “whether one likes it or not, the transition away from agriculture as the primary source of employment is going to be slow”.

So what is the way out? Ninan suggests that one way out is to increase productivity of Indian agriculture. “Paddy output per hectare [in India] at about 3.7 tonnes, is 20 per cent short of the global average and barely half of China’s. One reason is that Indian farmers are not using the latest strains of high-yield varieties (growing them is also more employment-intensive) or adopting new methods of cultivation that require less water. It’s the same with maize,” writes Ninan. If these numbers were increased India’s agricultural output would go up in the days to come, and so would the income of people dependent on agriculture for their living.

The problem here is that the size of farms over the decades has grown smaller. Take a look at the accompanying table from the annual report of Department of Agriculture and Cooperation 2013-2014.

What does the table tell us? It shows very clearly that most farms are small in size and less than two hectares in area. 85% of the farms are less than two hectares in size and 67% of the farms are less than one hectare in size. And this doesn’t help the productivity cause at all.

As Mihir Sharma writes in Restart—The Last Chance for the Indian Economy: “Indian farms are tiny. Over 80 per cent of them are smaller than 2 hectares…And they are getting even smaller. They are just over half as big today, on average, as they were in 1970. Everywhere else in the world, farms have gotten bigger in the same period…Many people have been convinced that if there was just some way to increase agriculture’s share of output, some way in which all of agriculture received ‘support’, things would be better.”

Only if it was as simple as that.

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