Why Large Economies Are In a Technical Recession

Almost all large economies in the world, other than China, are in the midst of a technical recession, with their gross domestic product (GDP) having contracted for two or more quarters. On Friday, India became the latest large economy to enter this list. The spread of the covid pandemic and a big fear of a possible second wave, have led to consumers and businesses being very careful in the way they spend their money and saving for a possible rainy day.

What is a technical recession?

When the GDP of any economy contracts for two consecutive quarters, economists refer to the situation as a technical recession. GDP is a measure of economic activity and size of a country. Let’s take the case of the United States. The GDP contracted by 9% between April and June 2020 in comparison with the same period in 2019. It contracted again by 2.9% between July and September 2020. So, as of end September, the American economy was in a technical recession.

If we consider the United Kingdom, the economy has contracted in each of the periods between January to March, April to June and July to September, by 2.1%, 21.5% and 9.6%, respectively. Hence, the country has been in a technical recession since the end of June. The only exception to this has been China, which has grown by 3.2% and 4.9%, respectively, between April and June and July and September.

How is a technical recession different from a recession?

An economic scenario where the economy of a country has been contracting for a long period of time, is referred to as a recession. The trouble is there is no standard definition for how long is long. The National Bureau of Economic Research in the United States defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months”.

Hence, if the current decline in economic activity across countries continues in the months to come, then we can safely say that we are in the midst of a recession. The spread of covid has led to economic activity slowing down. Businesses in order to continue to exist have slashed salaries and/or fired people. Even those who haven’t been fired live with the fear of getting fired. All this has led to a slowdown in people and businesses spending money.

When was the last time the world was in a recession?

Lehman Brothers, the fourth biggest investment bank on Wall Street, went bust in mid-September 2008. Many other financial institutions came under huge financial stress and had to be rescued by the governments and the central banks of the United States and Europe. The trouble spilled from Wall Street to Main Street and a recession hit the Western economies.

The central banks in the Western world printed a huge amount of money to drive down interest rates, in the hope that people will borrow and spend, and businesses will borrow and expand. A lot of this money found its way into stock markets all across the world. The interesting thing is that even in 2020 the central banks are using the same formula. They have printed a lot of money to revive economies. The Federal Reserve of the United States has printed more than $3 trillion between end of February and now.

When did India enter a technical recession?

The Indian economy had contracted by 23.9% during the period April to July. This was the largest contraction among all large economies of the world. It contracted again by 7.5%, between July to September, thus entering a technical recession. Hence, as of end September the Indian economy has been in the midst of a technical recession.

Why has this happened? Private consumption, or the stuff that people buy, and which forms more than half of the Indian GDP, has completely collapsed. Between April and June, it contracted by 26.7%. It contracted by 11.3%, between July and September. As mentioned earlier, this is primarily because of people saving more for a rainy day. This can be gauged from the fact that deposits in the Indian banking system have gone up 6% or Rs 8.1 trillion between end of March, when covid first started to spread in the country, and now.

How can the world get out of this economic mess?

The British economist John Maynard Keynes had a term for a situation like this – the paradox of thrift. When a society as a whole saves substantially more, it hurts the economy, simply because one man’s spending is another man’s income. Hence, in recessionary times, when individuals and businesses are spending less money, the government needs to chip in and spend more money than it usually would have.

This spending puts more money in hands of people. And if they go out there and spend it, it helps in economic revival. The trouble is that thanks to a recessionary environment, tax collections have collapsed. Some governments have resorted to printing more money to finance extra expenditure and hoping to create growth. But not every country has this option because money printing can lead to higher prices or inflation, as a greater amount of money chases the same set of goods and services.

This piece originally appeared in the Khaleej Times on November 30, 2020.

What a Mumbai Real Estate Agent Can Tell You About Indian Economy Contracting

Koi yahan aaha naache naache,
Koi wahan aahe naache naache.

— Usha Uthup, Faruk Kaiser, Bappi Lahiri and Babbar Subhash (better known as B Subhash), in the Disco Dancer

The gross domestic product (GDP) figures for the period July to September 2020 were published yesterday. The GDP is a measure of the economic size of a country during a particular period. The Indian GDP or the economic size of the country during the period contracted by 7.54%  against the same period last year.

This looks very good in comparison to the contraction of 23.92% that the economy had seen during the period April to June 2020 and has led to the uncorking of the bubbly among a certain set of politicians, economists, analysts, journalists, stock market wallahs and Twitter warriors.

Of course, there is no denying that a contraction of 7.54% is a lot better than a contraction of 23.92%, one would be a fool to deny that. But has the time to uncork the bubbly come? Or, if you are not the drinking type, should we be high-fiving on this one?

Let’s take a look at this pointwise.

1) For much of the period between April to June, the economy was under a lockdown. Once the economy was opened up, things were bound to improve. Hence, a better performance in July to September should not come as a surprise. Second, the period benefitted because of a lot of pent up demand. People who could not buy the stuff they wanted to during April to June, ended up buying it between July to September. These points need to be kept in mind.

2) The economists were expecting a contraction of 8.5-9% during the quarter. Against that a contraction of 7.54% looks just about a little better. Having said that, India has a large unorganised sector. Measuring the value added by the unorganised sector is never easy. Hence, when releasing GDP data for a period of three months for the first time, the National Statistical Office (NSO) essentially proxies the value added by the informal sector using formal sector data. This is set right as data streams in over a period of time.

Over and above this, we are in midst of a pandemic and hence, collection of data isn’t easy. As the NSO points in its release: “Some other data sources such as GST, interactions with professional bodies etc. were also referred to for corroborative evidence and these were clearly limited.”

What this means is that the GDP data presents a picture which is rosier than the actual picture.

3) There is another important point that needs to be made here. India has been publishing quarterly GDP for close to 24 years now. This is only the second time in all these years that the GDP during a particular period of three months has contracted. Only twice in 94 quarters has the economy contracted. And given that GDP has contracted in two consecutive quarters, India is in a midst of what economists call a technical recession. If the economy continues to contract in the months to come, it will enter a recession. That’s the difference between a recession and a technical recession.

Source: Centre for Monitoring Indian Economy.

4) In the period April to June with a contraction of 23.92%, India was the worst performing economy among the major economies in the world. From the data that is currently available on the OECD website, India is no longer the worst performing economy in the world, nonetheless, it continues to be among the worst performing economies in the world.

Source:  https://stats.oecd.org/index.aspx?queryid=350

5) A major surprise in the GDP data has been the recovery of the manufacturing sector. The sector grew by 0.62%, after contracting (or degrowing as analysts like to say) by 39.30% between April to June. While this is good news, it goes against the fact that index of industrial production contracted by 6.09% during July to September. If the production has contracted how has the growth come about? The growth has come primarily from the fact that companies in the listed space have been able to increase their profit margins primarily because of controlling costs, this includes firing employees and slashing their salaries.
As economist Mahesh Vyas recently wrote in a column: “In the September 2020 quarter, while sales fell again by 9.7 per cent, profits sprang a surprise by scaling up by a handsome 17.8 per cent. Yet, wages declined by one per cent. Evidently, companies do not apportion resources to labour in any proportion of profits.”

6) Sectors like construction, mining as well as services continued to remain weak, though better than they were during April to June. These sectors are high employment sectors. This remains a worry given that what seems to be happening currently is a recovery which isn’t creating enough jobs. In fact, financial services, real estate and professional services (bundled together for some reason in the GDP data) contracted by 8.09% during July to September. It had contracted by 5.33% during April to June. And that can’t possibly be a good thing. This can also be seen under NREGA data where demand for jobs this year remains astonishingly higher than last year. It can also be seen in the labour participation rate contracting with people stopping to look for jobs because they are unable to find one, and hence, dropping out of the workforce.

It also needs to be said here if there is a second round of covid, as is being feared, the services sector will continue to remain weak, in particular services like restaurants, hotels, tourism, cinema halls, malls etc.

7) If we look at GDP from the expenditure side, the private consumption expenditure contracted by 11.32% against a contraction of 26.68% between April to June. Clearly, there has been improvement on this front. Nevertheless, private consumption expenditure forms more than half of the Indian economy, and as long as it continues to remain weak, the economy will continue to remain weak. Also, we need to remember that the contraction of 11.32% happened despite pent up demand and festivals in the Western and Southern part of the country. Further, the fact that private consumption has continued to contract, brings into question the growth in the manufacturing sector. Are actual sales happening at the consumer level or is this simply a case of a  build-up of inventory, as has been the case in the auto industry?

8) This is a slightly technical point but still needs to be made. On the expenditure side, the GDP is calculated as a sum of private consumption expenditure, investment, government expenditure and net exports. Net exports is exports minus imports. In the Indian case, this is a negative entry into the GDP figure, given that exports are usually less than imports. During July to September, net exports is a positive number, given that imports are lower than exports, having fallen by a much higher rate. This is primarily because of a collapse in consumer demand, which is not a good thing. When it comes to the goods part of imports, the non-oil non-gold non-silver part of imports collapsed by 23.82% during July to September. This helped push up the GDP number.

9) The GDP has contracted by 15.67% during the first six months of the year. If the economy contracts by 3-5% during the second half of the year, we still are looking at 9-10% contraction this year. This was largely the consensus forecast made for this year. Even if there is no contraction in the second half of the year, the economy will still contract 7.66%, which will make India one of the worst performing economies in 2020-21. Also, we need to remember that the GDP of 2019-20 is likely to be crossed now only in late 2021-22 or 2022-23. So this pushes the Indian economy back by at least two years. Of course a lot of it is because of covid, but let’s not forget, the Indian economy had been slowing down even before the pandemic struck.

10) Let me close this piece with a little story. Sometime in April 2006, I first started to look for a flat to rent, in Mumbai. Of course, one had to go through agents. Pretty soon, I realised that the agents were trying a psychological trick on me. They first showed me a flat which was in a very bad state. They would then show me something which was slightly better. Nevertheless, the difference in rent between the flat was much more than the difference in their quality, with the rent of the second flat being much more than the first one. I caught on to this because I had read this book called Freakonomics sometime in 2005. The book had an extended chapter on the contrast effect.

We all tend to compare things before making a decision. Given this, the attraction of an option can be increased significantly by comparing it to a similar, but worse alternative. This is known as the ‘contrast effect’.

How does this apply in the present context? It’s simple. The fact that the Indian economy contracted by a massive 23.92% during April to June, it makes a contraction of 7.54% during July to September, much better. But there are many nuances, as explained above, that need to be taken into account.

PS: My writing has been highly irregular over the last few weeks. I was busy with a project I had taken on. Now that I am done with it, will write more regularly.

Why Large Corporates/Industrial Houses Owning Banks is a Bad Idea

 

An internal working group (IWG) of the Reserve Bank of India (RBI) has suggested that large corporate/industrial houses may be allowed to promote banks. Does this huge leap of faith being made by the Indian central bank, given their current extremely cautious and conservative approach, make sense? Let’s try and understand.

Why should large corporates be allowed into banking?

The IWG feels that allowing large corporates to promote banks can be an important source of capital. In a capital starved country like India this makes sense. Further, these corporates can bring “experience, management expertise, and strategic direction to banking”.

The group also noted that internationally “there are very few jurisdictions which explicitly disallow large corporate houses”. All these reasons make sense, but there are major reasons as to why the RBI in the last five decades hasn’t let large corporates enter the banking sector in India. At the heart of all this is the conflict of interest it would create.

Why have large corporates not been allowed into banking?

The IWG spoke to experts on the issue: “All the experts except one [said] that large corporate/industrial houses should not be allowed to promote a bank.”  The corporate governance in Indian companies isn’t up to international standards and “it will be difficult to ring fence the non-financial activities of the promoters.”

There will be a risk of promoters giving loans to themselves. Before bank nationalisation in 1969, some of the private banks were owned by large corporates. As Professor Amol Agrawal of Ahmedabad University puts it: “Since the private banks were run by big industrialists, they gave loans to themselves.”

What does history have to say in this regard?

As Pai Panandikar, an Advisor in the Finance Ministry, wrote in August 1967, regarding these banks : “Internal procedures… vest large discretionary powers in the Boards of Directors who have often acted as sources of patronage in deciding credit matters.”

A survey showed that 188 individuals served as directors on boards of 20 leading banks and held 1452 directorships of other companies. These individuals had directorships in 1100 companies.

What did these large discretionary powers lead to?

In an October 1967 report commissioned by politician Chandrashekhar, then the Secretary of the Congress Party, it was found that of the total bank loans of Rs 2,432 crore in 1966, Rs 292 crores was the debt due from the bank directors and their companies.

In fact, if indirect loans and advances were included, the actual debt-linked to directors was Rs 600-700 crore. There is a danger of something similar happening even now given the weak corporate governance structures.

*As of March 31, 2018.
Source: Rajya Sabha Unstarred Question No: 1492, Answered on 18 July 2018.

What does this mean in the current scheme of things?

As of March 2018, the domestic bad loans of Indian banks peaked at Rs 9.62 lakh crore. Of this, around 73.2% or Rs 7.04 lakh crore, were defaults made by industry.

The corporates have been responsible for a bulk of the mess in the Indian banking sector. Given that, handing over banking licenses to them is not a sensible idea, especially when the ability of banks to recover bad loans is limited.

High Inflation In Times of Covid Will Hit Us Hard

In October 2020, inflation as measured by the consumer price index stood at 7.61%. This is the highest inflation experienced during the period Narendra Modi has been prime minister. The last time inflation or the rate of price rise, was higher than this, was in March 2014, when it had stood at 7.63%.

Let’s look at this issue pointwise.

1) A major reason for high inflation has been high food inflation which was at 11.07% in October. Food forms around 39% of the weight of the consumer price index. Within food, prices of egg, fish and meat, oils and fats, vegetables, pulses and spices, went up by more than 10%.

Interestingly, potato prices are 104.56% higher since last October. This is the highest inflation among all the items which are a part of the consumer price index. One reason offered for this has been a disruption in supply chains due to the spread of covid. But the economy has now more or less totally opened up, meaning disruption can’t continue to be a valid reason. Also, food inflation has been on the higher side since October last year, much before covid broke out.

2) The high inflation is not just because of high food inflation. If we look at core inflation, which leaves out food items and fuel and light items, the inflation is at 5.64%, the highest in thirty months. A major reason for this has been an increase in transport and communication costs which went up by 11.16% in October.

Fares of buses, taxies, auto-rickshaws and rickshaws, have gone up. This is because petrol and diesel are now more expensive than they were last year. The government has increased the excise duty on both the fuels, despite the fact oil prices have fallen internationally. The government’s dependence on fuel taxes has only gone up this year and which is now reflecting in a higher inflation as well. Petrol and diesel used for vehicles come under the transport and communication category of the consumer price index and not the fuel category.

3) Another reason for high core inflation is the higher inflation in the pan, intoxicants and tobacco segment. Interestingly, foreign liquor and beer cost 22.32% and 25.32% more this year than last year. This reflects the state governments increasing the tax on these products in order to shore up revenue.

Toddy prices have also risen 20.19%. Also, the personal care and effects segment saw an inflation of 12.07% in October. The cost of going to a barber/beautician went up by 7.04%. But the major increase here has been in the prices of gold, silver and other ornaments, which went up by 33.77%, 36.66% and 20.52%, respectively. For some reason, they are categorised under personal care and effects.

4) While inflation in the health category has been lower this year than the last year, in October it went up by 5.22%, the highest it has been this year.

5) Within the fuel category, the price of domestic cooking gas went up by 10.16% in October, while non-PDS kerosene was up 8.28%.

6) The high inflation is primarily in the areas of food, parts of fuel, communication and to some extent, health. These are areas which impact the common man. How do higher prices of gold, silver and other ornaments impact the common man? They play a very important role in Indian marriages.

All in all, high inflation has hit India at a time when the country has just gone through its first ever recession after independence. The Indian economy contracted by 23.9% during April to June. It is expected to contract between July and September as well. A recession is defined as a period when the economy contracts for two consecutive quarters.

In fact, as Nikhil Gupta and Yaswi Agarwal of the stock brokerage Motilal Oswal point out in a recent research note: “The rise in the core inflation in India is also the highest among the 21 major economies in the world.” Indeed, this is very worrying.

7) High inflation has hit us at a time when an economic contraction has led to a fall in incomes. Over and above this, people are also saving more to be ready for a rainy day. The total amount of bank savings have increased by Rs 6.32 lakh crore between March 27, around the time the country first started to realise how dangerous covid could be, and October 23. Last year, during a similar period, the deposits had gone up by Rs 3.29 lakh crore. The psychology of a recession is totally in place.

What does this mean?  A good segment of the population has been cutting down on their consumption, particularly non-essential consumption, thanks to lower incomes. A high rate of inflation, if it prevails, will only add to people cutting down on consumption further, making the job of the government and the Reserve Bank of India (RBI) to get the economy going even more difficult.

8) While deposits with banks have soared, the total amount of loans given by banks has actually contracted by a little over Rs 32,000 crore between March 27 and October 23. On the whole, banks haven’t given a single rupee of a new loan, since covid struck.

This has led to the RBI cutting the repo rate or the rate at which it lends to banks. Along with this, the central bank has printed and pumped a lot of money into the financial system, in the hope of driving down interest rates, in order to get both companies and individuals to borrow and spend more money.

That clearly hasn’t happened because of the lack of certainty of economic future. But all the money flooding around in the financial system has led to lower deposit rates making lives of senior citizens difficult, who have no other option but to cut down on their consumption. Even those who use fixed deposits to save for the future are caught in a jam.

To conclude, in this environment if inflation continues to remain stubbornly high, as it has through much of this year, the job of the government and the RBI to get consumption going will become even more difficult. It will also lead to the RBI finding it difficult to continue cutting the repo rate.

This column originally appeared in the Deccan Herald dated November 22, 2020.

The Real Story Behind India’s Two Wheeler Sales or Rather the Lack of It

Two wheeler sales are a widely used economic indicator. They give us a good indication of the prevailing spending capacity of the middle class. To put it in simpler words, is the middle class in the mood to borrow and spend money or simply spend money (given that everyone doesn’t take a loan to buy a two-wheeler).

In the last few months, several economists, analysts, journalists, politicians and many Twitter warriors, have cited robust domestic two wheeler sales data to tell us lesser mortals that the economy is well on its way to revival.
But is that really the case?

Two wheeler sales data are reported in two ways. The industry body Society of Indian Automobile Manufacturers (SIAM) publishes sales data every month. The Federation of Automobile Dealers Associations (FADA) also publishes this data every month.

The manufacturers produce the two wheelers and the dealers sell them to the end consumers.

Let’s take a look at the following graph which basically plots domestic sales of two wheelers as reported by SIAM and FADA, for this financial year.

What’s that GAP?

Source: SIAM and FADA.

As can be seen from the chart, there is a wide difference in sales as reported by SIAM and as reported by FADA (The blue bar is bigger than the orange bar throughout). Why is this the case? Let’s look at this pointwise.

1) The only month where SIAM and FADA reported same sales was in April, when the economy was under a lockdown, and the two wheeler sales reported by both the bodies was zero.

2) While both the bodies report sales, what they report are totally different numbers. SIAM reports the number of units of two-wheelers leaving the gates of manufacturers or factory gate shipments. In simpler words, these are units which have been sold by manufacturers to dealers across the country, who in turn will sell to the end consumers.

In turn, FADA reports the number of units of two wheelers registered at the Regional Transport Offices (RTOs) across the country after they have been sold to the end consumer. Hence, the sales number reported by FADA is a better representation of sales to end consumers.

3) As can be seen from the chart, in every month from May to October, two wheeler sales as reported by SIAM were more than that reported by FADA. As per SIAM a total of 8.04 million units of two-wheelers were sold during the period April to October 2020, or the first seven months of this financial year. This is around 29.8% lower than sales reported by SIAM during the same period last year. Clearly, year on year sales are down even as per SIAM data.

4) As per FADA, the two wheeler sales during the period April to October stood at 4.78 million units, which is 3.26 million units or 40.5% lower than the number reported by SIAM. Cleary, there is a huge difference between the two numbers. One reason for this lies in the fact that the FADA data still does not capture registrations made at RTOs all offices across the country. The states of Andhra Pradesh, Madhya Pradesh and Telangana, are not hooked on to the Vahan 4 system from which FADA draws its data.

This explains a part of the discrepancy but it’s still not good enough to explain the difference of 3.26 million units in the data  between SIAM and FADA.  The difference was more than a million units in October.

5) Why is the difference so huge? What SIAM is counting as sales is essentially inventory getting built up at their dealer level, something that the FADA data does not capture. This explains a bulk of the difference. A good proportion of the two wheeler units which have been sent from manufacturers to the dealers have not been sold to the end consumer.

Companies have been building up inventory with dealers across the country in the hope of good festival season sales. Also, the new Bharat Stage VI emission norms came into force from April 1. This meant that the inventory of two-wheelers at the dealer level had to be built all over again.

In fact, in its October press release, FADA pointed out that the inventory at the dealer level was at its highest in this financial year and it may impact the financial health of the dealers. In September, FADA had pointed out: “Inventory for two wheelers stands at 45-50 days”. It has only gone up since then.

6) Has this strategy of companies piling up inventory at dealer level in the hope of festive season sales worked? The answer to this question will become clearer once we get the November data from both SIAM and FADA, early next month.

Hero Motorcorp has put out a press release saying it has had a good festival season.  As the company points out:

“Despite the severe disruptions on account of the Covid-19 this year, the good retail off-take during the 32-day festival period – spread between the first day of Navratra and the concluding day after Bhai Duj – was 98% of the festive season volumes sold by the Company in the previous year (2019) and 103% compared to the same period in 2018.”

The question is does this apply to the sector as a whole or has Hero Motorcorp simply been gaining market share? The festival season this year was from around the middle of October to the middle of November. The October data as we have already seen hasn’t really been inspiring on the end consumer sales front with a gap of more than a million units in the sales data as reported by SIAM and FADA.

To conclude, two wheeler sales this year have been weak. As we have already seen, they are down 29.8% year on year, as per SIAM. As per FADA, they are down close to 40.3% year on year. This is the real picture of two-wheeler sales in the country and not the one several economists, analysts, journalists, politicians and many Twitter warriors, have been citing to us lesser mortals.

Of course, things may have improved a tad in November due to the Diwali festival. But will that be good enough to pull the industry out of the mess that it currently is in? I have my doubts about that. Also, in the months to come, the pent up demand will get exhausted. Further, one reason people are buying two wheelers these days is to avoid travelling by public transport. This is likely to have played out by the end of the year.

It will be interesting to see what happens next. Meanwhile, it is safe to say that a large part of the great Indian middle class isn’t really in the mood to spend currently like they did in the past.