Month: May 2016 | Vivek Kaul

30 May, 2016

Flipkart, Air India and the Crony Socialism of Narendra Modi

News-reports published in several newspapers last week revealed that the ecommerce company, Flipkart, had postponed the joining date of fresh MBAs it had recruited from the various IIMs, to December, later this year. The MBAs were supposed to join the company in June 2016. In order, to compensate them for the late joining Flipkart will pay the MBAs an extra joining bonus of Rs 1.5 lakh each.

These are clear signs of trouble at the company. In fact, one of the first things the information technology companies had done after the dotocom and telecom crash of 2000-2001, was to postpone the joining date of the fresh engineers it had recruited. The joining dates kept getting postponed and in several cases went beyond one year.

A friend of mine got so fed up waiting to join that he ended up joining the Indian Navy.

The news-reports on Flipkart further suggested that the company is facing funding issues and has had to cut costs to keep itself going. The question is why are Flipkart and many other Indian ecommerce companies, having funding issues?

In late January, earlier this year, I had written a column (not on Equitymaster), in which I had called Indian ecommerce a Ponzi scheme. After the post was published, I got solidly trolled on the social media. People said, I did not understand technology. Honestly, I don’t understand technology, even though I am a BSc in Maths and Computer Science, and have an MBA in Information Systems. But that part of my education I have more or less forgotten.

I don’t understand technology, but I do understand a very basic point—in order to survive, businesses need to make money. And almost all of the Indian ecommerce companies don’t make any money. If you look at their financial results (currently available only as on March 31, 2015), their losses have grown at a faster rate than their revenue. What sort of a business model is that?

Take the case of Zomato, a company which basically delivers food at your doorstep. The latest numbers of this company are available because 47% of it is owned by Info Edge, a stock market listed firm.

For the financial year ending March 31, 2016, the losses of Zomato shot up by 262% to Rs 492.3 crore. It had reported a loss of Rs 136 crore for the year ending March 31, 2015. The revenue of the company went by around 91.3% to Rs 184.97 crore. The revenue for the year ending March 31, 2015, was at Rs 96.7 crore.

So, the losses of Zomato went up by 262%, when its revenue went up 91.3%. What sort of business model is this, where the losses of the company go up at a much faster rate than its revenue? Of course, I don’t understand information technology.

The Indian ecommerce companies have adopted a discount model in order to lure customers. This means selling products at a loss in order to build a customer base. And this has made their operating structure very similar to that of a Ponzi scheme.

A Ponzi scheme is essentially a financial fraud in which investment is solicited by offering very high returns. The investment of the first lot of investors is redeemed by using the money brought in by the second lot. The investment of the second lot of investors is redeemed by using the money brought in by the third lot and so on.

The scheme continues up until the money being brought in by the new investors is greater than the money being redeemed to the old investors. The moment the money that needs to be redeemed becomes greater than the fresh money coming in, the scheme collapses.

How does this apply in case of Indian ecommerce companies? Up until now the ecommerce companies have managed to survive because of private equity, venture capitalists and hedge fund investors, bringing in fresh money into the company at regular intervals. This fresh money being brought in essentially funds the huge losses that these companies make, in order to drive up their revenues.

This money seems to have dried up or is coming in more slowly than it was in the past. And this has put many Indian ecommerce companies in trouble. Some of them have had to cut down their operations. And some others like Flipkart have had to postpone joining dates of MBAs they have recruited, in order to control costs.
And this brings us back to the oldest business lesson—businesses need to make money, in order to survive. Businesses which don’t make money for an extended period of time, don’t survive. They shutdown. That is how it is.

Of course, there is a corollary to this rule. There are businesses which can keep running, even if they don’t make money. They can keep making losses. This is only possible if they happen to be owned by the government of India.

Take the case of the government operated airline Air India (Okay, I know I am sounding like a broken record here, if you know what that means, in the MP3 era). The airline has made losses of Rs 34,689.7 crore between 2010-2011 and 2015-2016, and is still running.

Or take the case of Hindustan Photo Films, the fourth largest loss making public sector enterprise. The company has accumulated losses of Rs 7,794.51 crore between 2010-2011 and 2014-2015. As the table shows, the losses of the company have been going up over the years.

Hindustan Photo Films Manufacturing Company
Year	Losses(in Rs crore)
2010-2011	1156.65
2011-2012	1352.32
2012-2013	1560.59
2013-2014	1560.59
2014-2015	2164.36
Total losses	7794.51
Source: Public Sector Enterprises Surveys

This is sheer waste of money. The money can be better spent on many other things like primary education, health, roads, railways, ports, and so on. There isn’t exactly a shortage of things that the government of India needs to spend on. And it isn’t exactly going around loaded with money. In this scenario, it needs to be careful with where and on what it spends its money on. Hence, the last thing it should be doing is subsidising losses of public sector enterprises which have been perpetually losing money.

The prime minister Narendra Modi in a recent interview to the Wall Street Journal said: “You can’t suddenly get rid of the public sector, nor should you.” Well, that doesn’t mean that the government continues to run loss making companies like Air India and Hindustan Photo Films. Further, Modi has been governing for more than two years now, and if he still continues to run companies like Air India and Hindustan Photo Films, it clearly tells us that he has no intention of shutting them down.

The Congress led United Progressive Alliance practiced crony capitalism (the mess at public sector banks is a clear evidence of that) as well as crony socialism (by continuing to fund loss making public sector enterprises). While Modi, to his credit, has gotten rid of crony capitalism, he continues with crony socialism.

While, we may be able to have a Congress mukt Bharat in politics, it seems difficult to have that scenario when it comes to economics. Indeed, that is a big tragedy.

The column originally appeared in the Vivek Kaul Diary on May 30, 2016

25 May, 2016

Why the big fat Indian wedding has become fatter

Over the last three decades of attending weddings I can safely say that the big fat Indian wedding has become fatter. In an ideal world, I wish I had numbers to back this claim up. But I don’t and hence, I will have to go with what I have seen and felt.

The question is why do people spend so much on weddings? Why would anyone in their right minds, spend a substantial part of their savings accumulated over a lifetime of working, over the course of few days, that any Indian wedding lasts? I am asking this question more in the context of the Indian middle class than others.

The funny thing is that most people attending the wedding are still not happy about it. I see some of my relatives still analysing and criticising weddings that they had attended years ago. So what gives?

Indian weddings have gotten bigger and complicated over the decades. A basic reason for this perhaps lies in the fact that people are now making more money than perhaps their parents did. And hence, it is but natural for them to spend more.

But I guess there is more to it than just that. Robert H Frank has a very interesting example in a slightly different context in The Darwin Economy—Liberty, Competition and the Common Good, about how the size of the average of American home has grown bigger over the decades.

As he writes: “Top earners build mansions simply because they have more money. The middle class show little evidence of being offended by that…But the larger mansions of the rich shift the frame of reference that defines acceptable housing for the near-rich, who travel in the same social circles…So the near-rich build bigger, too, and that shifts the framework for others just below them, and so on, all the way down the income scale.”

Hence, the society as a whole end up with bigger homes, primarily because those at the top decide to build bigger homes. And this trend gets copied across the income scale.

The dynamic of the big fat Indian wedding has also worked along similar lines. As the weddings of the rich have become bigger and more opulent, over the years, the frame of reference for the near-rich changed. This meant that the weddings of the near-rich also became bigger. This shifted the frame of reference for the middle class and as a result the middle class weddings have also become bigger. And so the trickle-down effect of the big fat Indian wedding has worked its way through.

What has helped is the extensive coverage in the media of celebrity weddings. Further, big weddings have become an important part of Bollywood story-telling as well. Given this, is it isn’t surprising that what people wear at weddings these days, almost always appears to be as tacky as of what actors wear while attending weddings in a Karan Johar movie.

The trouble is that the weddings keep becoming bigger. As Frank writes in the context of homes: “Once mansions pass a certain size, the demand for additional space is driven almost exclusively by social forces having nothing to do with intrinsic utility of the extra space itself.”

So people build a bigger home because someone they know has built a big home. A similar dynamic is at work in case of Indian weddings. Hence, it is safe to say that weddings keep getting bigger and fatter, because they keep getting bigger and fatter. The trouble is that bigger weddings, like bigger homes, come with their own share of challenges and they don’t necessarily add to any extra happiness.

To conclude, if the biggest homes or the biggest weddings were a little smaller, then everyone would end up being happier than before. But that, like many such things in life, is easier said than done.

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

The column originally appeared in the Bangalore Mirror on May 25, 2016

20 May, 2016

Why is Arvind Panagariya Cherry Picking Data to Show Modi Govt in Good Light?

220px-Arvind_Panagariya

The Narendra Modi government will be completing two years next week. Given this, currently there is a lot of propaganda on. The finance minister Arun Jaitley has been giving interviews highlighting the good performance of the government.

The Vice Chairman of NITI Aayog, economist Arvind Panagariya, has also been writing columns in newspapers talking about the good show of the Modi government. There is nothing wrong with this. It is the right of every government to highlight what it thinks is the good work that it has done, in the best possible way.

And as long as governments don’t place full page advertisements in newspapers, highlighting their achievements by wasting taxpayer’s money, I have nothing against the entire idea of the government talking about its good work. Please talk about it as much as you want to, but don’t waste my taxes in the process.

One of the points that Panagariya made in a column in the Business Standard was about village electrification. The general impression is that the government has done good work on this front.

As he wrote: “In power, the government has already electrified 6,816 villages in the last two years compared with 5,189 villages in the three years before that.”

Take a look at the following table. It gives the number of villages electrified every year, over the last decade.

Years	Villages electrified
2005-2006	9819
2006-2007	28706
2007-2008	9301
2008-2009	12056
2009-2010	18374
2010-2011	18306
2011-2012	7934
2012-2013	2587
2013-2014	1197
2014-2015	1405
2015-2016	7128*
Source: Annual Report Rural Electrification Corporation 2014-2015
* Press release put out by Press Information Bureau dated April 4, 2016

Let’s run the numbers for what Panagariya said. In the last two years 8,533 villages (7128 villages in 2015-2016 and 1405 villages in 2014-2015) have been electrified. Panagariya says 6,866 villages. In the three years before that 11,718 villages were electrified (1197 in 2013-2014, 2587 in 2012-2013 and 7934 in 2011-2012) which is more than the villages electrified in the last two years and not less as Pangariya suggests.

So where did Panagariya get his numbers from? I think he has gotten the years mixed up while making the calculation. In the years 2012-2013, 2013-2014 and 2014-2015, a total of 5,189 villages were electrified. This is the same as Panagariya’s number. But Panagariya has essentially suggested years 2011-2012, 2012-2013 and 2013-2014. This is incorrect.

I guess basically what he wanted to compare was the performance of the government on the village electrification front in 2015-2016, with that of previous three years, i.e. 2012-2013, 2013-2014 and 2014-2015. In 2015-2016, the government electrified 7128 villages, which is close to the 6,816 number that Panagariya offers, for the last two years. This difference could be primarily because end of the year data keeps getting updated I guess.

The Modi government has put up a decent show as far village electrification in 2015-2016 is concerned. More villages were electrified in 2015-2016, than were electrified in the three years before that. This is what Panagariya I guess wanted to say. But he got the years mixed up.

Nevertheless, let’s look at the performance on the village electrification front between 2005-2006 and 2011-2012. In each of the years more villages were electrified than in 2015-2016. In 2005-2006, 28,706 villages were electrified, which is four times the number last year. Hence, Panagariya is essentially cherry-picked data in order to show the Modi government and the power minister Piyush Goyal in good light.

Also, as I have mentioned in the past, if we keep comparing the economic performance of the Modi government to the second half of the second term of the Manmohan Singh government, things are definitely going to look better. Nevertheless, that is too low a benchmark to set. Anything will look better in comparison to those years.

Further, during the year 2014-2015, the Modi government governed for to ten months. During the course of the year only 1,405 villages were electrified. This can’t be totally held against the government because every government needs time to start operating. Also, given the fact that the number of villages electrified in 2012-2013 and 2013-2014 were very low, some time would have been needed to get the system going again.

It needs to be mentioned here that as the number of villages to be electrified comes down, it becomes more and more difficult to electrify the villages and the same pace cannot be maintained. If one takes this factor into account, electrifying more than 7,000 villages in a single year, is not a bad performance.

But trying to pass it off as something extraordinary is really not done.

Discslosure: The basic idea for this column came after reading Amitabh Dubey’s column Arvind Panagariya Spins an Infrastructure Tale on Chunauti.org

The column was originally published in the Vivek Kaul Diary on Equitymaster.com

19 May, 2016

Okay, Let’s Get Subramanian Swamy’s Nonsense on Raghuram Rajan Out of the Way

ARTS RAJAN

Subramanian Swamy has gone after the Gandhi family over the last few years and been fairly successful at it. Now he seems to have moved on to a new target—the Reserve Bank of India(RBI) governor, Raghuram Rajan.

Swamy, who recently became a Rajya Sabha member, wrote a letter to the prime minister Narendra Modi, asking him to terminate the services of the RBI governor immediately or when his term ends in September, later this year.

As Swamy writes in the letter: “The reason why I recommend this is that I am shocked by the wilful and apparently deliberate attempt by Dr Rajan to wreck the Indian economy. For example the concept of containing inflation by rising interest rates is disastrous.”

Let’s take the point of Rajan raising interest rates turning out to be disastrous. When Rajan took over as the RBI governor, inflation was close to 10%. Interest rates offered on bank fixed deposits were lower than that. Hence, people were losing money once inflation was taken into account.

Due to this, money had moved into real estate as well as gold, as people looked for a “real” rate of return. In fact, when Rajan took over as RBI governor,
rupee was rapidly losing value against the dollar. One of the reasons was that there was a huge demand for dollars because Indians were buying gold to hedge against inflation. Rajan cracked down on this, and managed to stabilise the value of the rupee.

The stabilisation of the rupee was important because India imports 80% of the oil that it consumes. And when the rupee depreciates oil becomes expensive in rupee terms. This isn’t good for the government nor the overall economy.

Also, over the years high inflation has essentially ensured that the household financial savings as a proportion of the gross domestic product have been falling. Between 2005-2006 and 2007-2008, the average rate of household financial savings stood at 11.6% of the GDP. In 2009-2010, it rose to 12% of GDP. By 2011-2012, it had fallen to 7% of the GDP. The household financial savings in 2014-2015 stood at 7.5% of GDP.

Household financial savings is essentially a term used to refer to the money invested by individuals in fixed deposits, small savings schemes of India Post, mutual funds, shares, insurance, provident and pension funds, etc. A major part of household financial savings in India is held in the form of bank fixed deposits and post office small savings schemes.
In order to ensure that household financial savings go up, basically two things are needed—lower inflation as well as a real rate of return on financial savings that people make, in particular fixed deposits. Fixed deposits offer a real rate of return when the interest rate on the fixed deposit is higher than the inflation.

Since the beginning of 2015, after a very long time, the interest rates on fixed deposits have been in real territory. And this is a very important achievement for Rajan. The interest rates need to stay in real territory, if household financial savings need to go up, in the years to come.

In fact, it needs to be said here that Rajan recognises the fact that interest rates are not just about borrowers. They are also about savers as well. The savers include the young trying to save for the future of their children and the old trying to live a decent life in retirement. And savers need to be paid a reasonable rate of return on their savings as well. This is something that Rajan set right.

Swamy further said: “When the Wholesale Price Index (WPI) started to decline due to induced recession in the small and medium industry, he shifted the target from WPI to the Consumer Price Index (CPI) which has not however declined because of retail prices. On the contrary it has risen. Had Dr. Raghuram Rajan stuck to WPI interest rates would have been much lower today, and given huge relief to small and medium industries. Instead they are squeezed further and consequent increasing unemployment.”

It is important to understand here why the Rajan led RBI moved from following inflation as measured by the wholesale price index to inflation as measured by the consumer price index. When the RBI tracked inflation as measured by the wholesale price index, it took a very long time to raise interest rates, and by the time the high consumer price inflation had well and truly set in.

The high inflation then caused problems, as I have explained above. Let’s take the point about high interest rates hurting small and medium industries. Recent data shows that this is not true at all. Data for 2.37 lakh unlisted private firms was recently released by the RBI. This primarily includes small and medium enterprises, which Swamy feels are having a tough time.

This data clearly shows that these firms are doing much better than the big listed firms, over the last three years. Aarati Krishnan writing in The Hindu Business Line points out: “Unlisted firms managed far better sales growth in the last three years. They went from 13.3 per cent sales growth in FY13 to 8.7 per cent in FY14 before bouncing back to a healthy 12 per cent in 2014-15. In contrast, listed companies saw their sales growth dwindling from 9.1 per cent in FY13, to 4.7 per cent in FY14 and further to an abysmal 1.4 per cent by FY15.”

The same trend was seen when it comes to net profit as well. As Krishnan points out: “Their profits grew at 16 per cent, 23.6 per cent and 12.3 per cent in the last three years. Listed companies struggled with shrinking profits, their net profits falling by 2 per cent, 5.1 per cent and 0.7 per cent in the same three years.”

So what is Swamy really talking about here? And why is he misleading the prime minister Modi in particular and the nation in general?

Swamy further says: “Thus, in the last two years estimated NPA in public sector banks has doubled to Rs. 3-1/2 lakhs crores.”

What Swamy is basically saying is that the high interest rate regime initiated by the RBI led to small and medium enterprises defaulting on their loans and bad loans of public sector banks doubling. The first point that needs to be made here is that before Rajan took over as the governor of RBI, banks were not recognising their bad loans. He has pushed them to recognise their bad loans. Hence, the jump in bad loans has been primarily because of that.

What this means is that even before Rajan led RBI started raising interest rates, many corporates were not in a position to repay their loans. The banks were pretending all was well, when that wasn’t really the case. Rajan forced them to start recognising bad loans. All these huge losses that banks have suddenly started to report can’t have been created overnight. They are a result of banks not recognising these bad loans for a substantially long period of time. Hence, Swamy’s charge doesn’t hold true.

Also, defaults by mid and large corporates are a very important reason for public sector banks being in the mess that they are in. Crony capitalists close to the previous UPA regime are primarily responsible for this.

The last that I checked the RBI was a regulator of banks and did not give out any loans. So how can the RBI governor be held responsible for what are basically bad lending decisions by banks? How can the RBI governor be held responsible for banks not insisting on enough collateral for the loans that they gave out? And how can the RBI governor be held responsible for politicians forcing public sector banks to give loans to crony capitalists?

Swamy further said: “These actions of Dr. Rajan lead me to believe that he is acting more as a disrupter of the Indian economy [italics are mine] than the person who wants the Indian economy to improve.” I agree with the part of the statement which says that Rajan is acting as a disrupter of the Indian economy.

In fact, on many fronts, the Indian economy did need a disrupter. Rajan has forced banks to start recognising their bad loans instead of extending and pretending, as they were doing earlier. This has brought out the real situation that public sector banks are in.

Further, he has also empowered banks to go after defaulters. A few Indian promoters have started selling their assets in order to repay banks. This is something that hasn’t happened before.

Rajan has also initiated the formation of a monetary policy committee where monetary policy will be made by a committee. As of now, only the governor is responsible for it. A central bank operating through a monetary policy committee is the norm the world over. And by doing this, the governor is essentially diluting his powers.

Further, he has given small banks licenses and payment bank licenses as well, with the idea of expanding financial inclusion across the country. So, yes Rajan is a disrupter, who wants the Indian economy to improve.

Swamy also accused Rajan of being mentally not fully Indian. As he said: “Moreover he is in this country on a Green Card provided by the U.S. Government and therefore mentally not fully Indian. Otherwise why would he renew his Green Card as RBI Governor by making the mandatory annual visit to the U.S. to keep the Green Card current?”

Rajan still has an Indian passport. This after having lived in the United States for more than 25 years. How many Indians who have lived in the United States for 25 years still have an Indian passport?

And if Rajan wants to keep his green card active, what is wrong with that? He is a professional in his early 50s and still has his career to think about. He needs to think about his career beyond the RBI and if that means visiting the US once every year, then so be it.

Swamy finally asked for the termination of Rajan’s appointment as RBI governor. As he said: “I cannot see why someone appointed by the UPA Government who is apparently working against Indian economic interests should be kept in this post when we have so many nationalist minded experts available in this country for the RBI Governorship. I therefore urge you to terminate the appointment of Dr. Raghuram Rajan in the national interest.”

This is a very silly argument. Appointing Rajan as the RBI governor was one of the few correct things that the UPA government did in the second half of its second term. Why undo that?

And as far as Swamy is concerned, there are better ways of showing interest in the RBI governor’s job than this.

The column was originally published in Vivek Kaul’s Diary on May 19, 2016.

18 May, 2016

Why Public Sector Banks Should Not Be Merged

Over the last few months there has been talk of the government merging public sector banks. The finance minister Arun Jaitley said so in his budget speech in February: “a roadmap for consolidation of Public Sector Banks will be spelt out.”

In an interview to the Business Standard newspaper published on May 15, 2016, Jaitley said, “wait for a few days,” when he was asked for a timeline on consolidation of public sector banks. Between February and May, there have been other occasions on which Jaitley has said that the merger of public sector banks is on the cards.

What is the logic behind the idea of consolidating or merging public sector banks? The government currently owns twenty-seven public sector banks, which is way too many. The idea is to merge some of these banks so that they can also compete globally. The size of these banks varies a lot. The State Bank of India is the biggest public sector banks and its balance sheet is seventeen times larger than the smallest public sector bank.

As Jaitley told Business Standard: “Our public sector banks(PSBs) also must be global players and therefore the idea of consolidating some of them.”

While this is a noble idea, it does not solve the problem of bad loans from which all public sector banks are currently dealing with. This is something that first needs to be solved. It doesn’t help anyone if a weak bank is merged with what looks like a relatively strong bank. And the problem of bad loans of public sector banks still hasn’t gone away. It’s alive and kicking.

As R Gandhi, deputy governor of the Reserve Bank of India, the banking regulator, said in a recent speech: “Merger of a weak bank with a strong bank may make combined entity weak if the merger process is not handled properly. The problems of capital shortages and higher non-performing assets (or bad loans) may get transmitted to stronger bank due to unduly haste or a mechanical merger process.”

Gandhi also pointed out that there was very little past precedent to go on. As he said: “Recent merger of State Bank of Saurashtra and State Bank of Indore into State Bank of India may be seen as basically merger among group companies. The only example of merger of two PSBs is merger of New Bank of India with Punjab National Bank in 1993. However, this was not a voluntary merger.”

Research evidence suggests that mergers tend to work when they lead to firing of employees. When two similar organisations merge, it leads to many sets of people having the same kind of expertise and skillsets. Hence, one set is gotten rid of.

For two banks merging this could mean, shutting down one of the two branches operating in the same area and then firing the employees of the branch which has been shut-down. This will bring down employee cost as well as operational costs. This is a good example of synergy that often gets talked about in case of mergers.

Having said that, nothing of that sort will be possible in India. Even a hint on this front can lead to labour unions going on a rampage. Jaitley made this clear in his interview where he said that consolidation shall be looked at “without adversely affecting labour employment considerations”.

And without fewer employees after the merger of public sector banks, there is very little synergy that will be created.

Also, merging banks will not solve the most basic problem that the government owned public sector banks face—crony capitalism. A large part of bad loans that public sector banks are currently dealing with has been because of lending to crony capitalists. Till the public sector banks continue to be government owned, some set of crony capitalists will thrive.

If the government really wants to deal with this problem, then best way is to start privatising public sector banks. As far as fulfilling its social sector obligations is concerned, the government does not need to own 27 banks for that. Around five to six banks should be good enough.

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

The column was originally published in the Bangalore Mirror on May 18, 2016