Easy Money

Why Facebook liked WhatsApp

 facebook-logoVivek Kaul 

The messaging company WhatsApp was recently bought by Facebook for a whopping $19 billion. The owners of the start-up will receive $4 billion in cash, $12 billion in Facebook stock and the remaining $ 3 billion in the form of restricted stock units, which will vest over the next four years.
In rupee terms, Facebook paid close to Rs 1,18,000 crore (assuming one dollar is worth Rs 62.2) for Whats-App, a company with just 45 employees. This amount is greater than the individual budgets of most ministries of the Indian government for the next financial year, except the defence and the finance ministries.
So what is it that made Facebook pay so much money for WhatsApp?
Lets compare this with Instagram, a company that Facebook acquired in 2012 for a billion dollars. Interestingly, Instagram had just 13 employees, when it was acquired. Why did Facebook a billion dollars for a company with just 13 employees and 19 times more for another company with just 45 employees?
Computer scientist and philosopher has an explanation for it in his book Who Owns the Future? As he writes “When it was sold to Facebook for a billion dollars in 2012, Instagram employed only thirteen people…Instagram isn’t worth a billion dollars just because those thirteen employees are extraordinary. Instead, its value comes from the millions of users who contribute to their network without being paid for it. Networks need a great number of people to participate in them to generate significant value. But when they do, only a small number of people get paid.”
In the above paragraph replace Instagram with WhatsApp and the logic stays the same. As of the end of 2013, WhatsApp had around 400 million users worldwide. So Facebook was essentially paying to acquire the number of people who used the messaging service rather than the knowledge and the technological prowess of the people who ran it.
But wouldn’t it be cheaper for Facebook to just build a similar application? In fact, it wouldn’t take much effort on the part of Facebook to develop a similar and even a better application than WhatsApp. So why pay so much money for it?
In fact, WhatsApp like Facebook and Twitter before it is a classical example of what economists like to call a network externality. This is a situation where demand for a product creates more demand for the product.
As economist Paul Oyer writes in his new book “A product has a network externality if one added user makes the product valuable to other users…The rise of the internet has made network externalities more apparent and more important in many ways…Perhaps the best example of the idea is Facebook. Essentially, the only reason anyone uses Facebook is because other people use Facebook. Each person who signs up for Facebook makes Facebook a little more valuable for everybody else. That is the entire secret of Facebook’s success—it has a lot of subscribers.”
Again, replace Facebook with WhatsApp in the above paragraph and the logic stays the same. What made WhatsApp very valuable is the fact that it has close to 400 million users. Hence, even though Facebook can create a similar application at a much lower price, it can’t get 400 million people to use it.
Take the case of Google, which launched Google+ a few years back to take on Facebook. The experts felt that Google+ was a better product and some of them even went ahead and predicted that people would now move on from Facebook to Google+. But that did not happen.
As Niraj Dawar writes in Tilt – Shifting Your Strategy from Products to Customers “For those who want to be a part of a social network, it makes sense to congregate where everybody else is hanging out. There is only one village square on the Internet, and it is run by Facebook. Being on a different square from everyone else doesn’t get you anywhere—you just miss the party.”
This was the main reason why people did not move from Facebook to Google+, even though it may have been the better product. “Google + may offer features such as greater privacy or group video chat,” writes Dawar, but it fails to “create the positive feedback loop, because it makes sense for everybody to be where everybody else already is.”
So even though Google+ was believed to be superior to Facebook, the users continued to stay put with Facebook. As Oyer puts it “Google+ has signed up many users, but it has not put any real dent in Facebook’s dominance. Nobody is going to switch to Google+ from Facebook unless most of her friends do, too, and it seems very unlikely that whole groups of friends will act in a coordinated fashion to move from one social network to another.”
Given this, even though Facebook could have launched a better version of an application on its own, there was no guarantee that people would start using it. Chances were that they would have continued to use WhatsApp. And that explains why Facebook paid a bomb for it.
Also, in a way Facebook was just buying out prospective competition. Many youngsters have their parents and family, as friends on Facebook. This obviously limits the frankness of the conversation that they can have with their “real” friends.
This has led to teenagers preferring to use messaging services like WhatsApp rather than Facebook. In fact, in a recent earnings call Facebook admitted that teens were spending lesser time on its service and were fleeing to messaging applications like WhatsApp WeChat etc. Mark Zuckerberg, the chairman of Facebook, believes that kids are fleeing the format because parents spam their walls with inspirational quotes and tagging them in photographs which they really do not want their friends to see.
Another explanation on why teenagers are fleeing Facebook was offered to me by a friend who has worked extensively in the technology industry in the United States. When it comes to technology, Facebook is not a light app, like the chat sights. There is a newsfeed comprising of various kinds of data and there is always a chance that things get lost to your intended audience under large piles of such data. Also, it might need more memory, something that the lowest priced smartphones, which the kids are likely to use ave may not have.
Due to all these reasons Facebook paid $19 billion for WhatsApp.

The article originally appeared in the Mutual Fund Insight magazine dated April 2014

 (Vivek Kaul is the author of Easy Money. He can be reached at [email protected]. He would like to thank Somnath Daripa for providing some excellent thoughts on the topic)

10 cr ‘new’ jobs: This number in Cong manifesto shows what’s wrong with India

 congress-party-symbol1

Vivek Kaul

A lot has been written panning the manifesto of the Congress party for the Lok Sabha elections scheduled over the next two months. Given this, I will just concentrate on one point that the party promises in the manifesto.
The grand old party of India has promised to create 10 crore jobs for the youth, if it forms the next government. A very noble idea indeed, at least on paper. Let’s go into this in a little detail.
In order to create 10 crore jobs (or a large number of jobs irrespective of a specific number) primarily four things are required—land, labour, money and electricity.
Let’s look at these factors one by one. If a large number of jobs are to be created, India needs labour intensive manufacturing to progress. But labour-intensive manufacturing in India has slowed down over the years. As Crisil analysts point out in a recent report titled Hire and Lower: Slowdown compounds India’s job-creation challenge “The decline in employment creation has been compounded by falling labour intensity in the economy…The capacity of labour intensive sectors such as manufacturing to absorb labour has diminished considerably in face of rising automation and complicated labour laws.”
Take the case of the apparel sector. A country like Bangladesh does better at it than us. Economist Arvind Panagariya in an open letter to Rahul Gandhi in November 2013 wrote that “India exported less apparel than much smaller Bangaldesh and less than one-tenth that by China.” Most Indian apparel firms start small and continue to remain small.
This leads to a situation where they cannot benefit from the economies of scale and hence, cannot compete in the export market. In their book India’s Tryst with Destiny, Jagdish Bhagwati and Panagariya point out that 92.4% of the workers in this sector work with small firms which have forty-nine or less workers. Now compare this to China where large and medium firms make up around 87.7% of the employment in the apparel sector.
Why is that the case? A surfeit of labour laws are a major reason why Indian apparel firms choose to remain small . Labour comes under the Concurrent list of the Indian constitution, meaning both the state government as well as the central government can formulate laws in this area. “The ministry of labour lists as many as fifty-two independent Central government Acts in the area of labour. According to Amit Mitra (the finance minister of West Bengal and a former business lobbyist), there exist another 150 state-level laws in India. This count places the total number of labour laws in India at approximately 200. Compounding the confusion created by this multitude of laws is the fact that they are not entirely consistent with one another, leading a wit to remark that you cannot implement Indian labour laws 100 per cent without violating 20 per cent of them,” write Bhagwati and Panagariya.
This leads to a situation where the cost of following these laws is very high. Labour costs account for close to 80 per cent of the total costs in the apparel sector. As Bhagwati and Panagariya write “As the firm size rises from six regular workers towards 100, at no point between these two thresholds is the saving in manufacturing costs sufficiently large to pay for the extra cost of satisfying the laws”.
The authors recount an interesting story told to them by economist Ajay Shah. Shah, asked a leading Indian industrialist about why he did not enter the apparel sector, given that he was already backward integrated and made yarn and cloth. “The industrialist replied that with the low profit margins in apparel, this would be worth while only if he operated on the scale of 100,000 workers. But this would not be practical in view of India’s restrictive labour laws.”
Given this, it is not surprising that the Crisil analysts expect the number of fresh jobs being created to fall over the next few years. As they write “Employment generation in the non-agriculture sector will slow down sharply in the coming years as the economy treads a lower-growth path. CRISIL estimates that employment outside agriculture will increase by only 38 million between 2011-12 and 2018-19 compared with 52 million between 2004-05 and 2011-12.”
The Congress party hopes to create 10 crore or 100 million jobs in a considerably lesser period of time. In fact, the Crisil estimate suggests that more people will join the agriculture workforce over the next few years. “Due to insufficient employment creation in industry and services sectors, more workers will become locked in the least productive and low-wage agricultural sector. We estimate that 12 million people will join the agriculture workforce by 2018-19, compared with a decline of 37 million in agriculture employment between 2004-05 and 2011-12,” the Crisil analysts write.
Now let’s take the case of electricity. Every new manufacturing set up requires electricity. India currently has the power plants but it does not have the coal required to feed into those power plants to produce electricity. As Neelkanth Mishra and Ravi Shankar of Credit Suisse write in a report titled Elections: Much Ado about Nothing dated March 19, 2014 “True utilisation in thermal power generation is below 60%, near 20-year lows (reported plant load factor is 65%).”
India does not produce enough coal to feed its power plants despite having the third largest coal reserves in the world. A major reason for the same is that it takes more than 10 years and many permissions to get a coal mine going. In fact, even if coal mines are auctioned to private sector it will take a while to get these mines going. “From the time the blocks are auctioned to the time coal can start to get mined could be another 3-5 years at least,” write Mishra and Shankar. Hence, by the time, the term of the next Lok Sabha will be more or less over.
Now let’s consider the land factor. Over the years, land has been taken over from farmers by the government at rock bottom rates and been handed over to industrialists and real estate builders, who have profited majorly from this. The Congress led UPA government (along with most of the opposition parties) passed the Land Acquisition Act in 2013. This Act goes to the other extreme in comparison to what was happening till this point of time.
As TN Ninan wrote in a recent column in the Business Standard “The land law stipulates that forcibly acquired land must be paid for at two to four times…market prices, in addition to other relief and rehabilitation costs. So the new law will make land acquisition next to impossible, or unaffordably expensive (which becomes the same thing) in most states.”
Ninan also points out that “land prices “ in significant parts of rural India “are higher than those in any rural area of the United States, and in almost all of Europe barring countries like Holland.”
So, for anyone looking to set up a new business enterprise, land will be a huge cost. And this may make the entire idea of setting up a new enterprise unviable.
Finally, let’s consider the money factor. The interest rates charged by banks on loans have been at high levels over the last few years. This is because the fiscal deficit of the government (or the difference between what it earns and what it spends) has exploded. To finance the deficit the government has had to borrow more and hence, crowding out other borrowers. This has led to high interest rates. If interest rates are to come down, the fiscal deficit of the government needs to come down dramatically.
One final factor that needs to be considered here is the ease with which a new business can be started in India.In a ranking of 189 countries carried out by the World Bank, when it comes to the ease with which a new business can be set up, India stands 179th. Hence, anyone looking to start a new business enterprise in this country, needs to be slightly wrong in the head. And it is ultimately, new enterprises that create many jobs.
If all these factors are taken into account, the promise by the Congress party to create 10 crore jobs, is a big joke played on the people of this country.
The article originally appeared on www.FirstBiz.com on March 27, 2014

(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Beware the debt binge: China may just be the next big bubble to pop

Vivek Kaul

In a previous piece I had highlighted the economic dangers that the next government is likely to face. All the factors highlighted in the piece were local in nature. But in the world that we live in today, international factors also play a huge role.
An international factor that needs to be taken into account is China. The Chinese yuan has been depreciating against the dollar since the middle of January 2014. This, after it had been appreciating against the dollar since the middle of 2010.
In the middle of 2010, one dollar was worth around 6.81-6.82 yuan. Since then, the yuan appreciated against the dollar, at a slow and steady pace. And by January 15, 2014, one dollar was around 6.03 yuan. But since January, the yuan has started to depreciate against the dolllar again. As I write this one dollar is worth 6.18 yuan.
So what is happening here? Why has the yuan suddenly changed course? One explanation is that the Chinese economy is slowing down, but that is not visible in the official data that comes out of China. The famed investor Mark Faberexplained this in a recent interview to Bloomberg Television, where he said China is more likely to see 4% economic growth this year than the 7.5% that the Chinese government is targeting.
As Faber said “if you look at the figures of China, exports are still growing. If you look at the trade figures China exports to Taiwan, so China records exports of so and so much. The Taiwan report imports from China at a much lower level. So which figures are more reliable? I think the figures of the trading partners of China are more reliable. And they would suggest that growth has slown down considerably.”
With exports slowing down, it is in the interest of the Chinese central bank to let the yuan to depreciate against the dollar, to ensure that Chinese exporters stay competitive. With the yuan depreciating against the dollar, the Chinese exporters will earn more yuan for every dollar they get paid for their exports. This will ensure that the Chinese exporters stay more competitive in the global market, where several other countries like Japan are rapidly depreciating their currencies against the dollar to get their exports going.
What makes the situation even worse is the fact that China has seen a major credit binge, where Chinese companies have borrowed more and more over the years. As economist Worth Wray of Mauldin Economics writes in a recent report “China’s total debt-to-GDP (including estimates for shadow banks) grew by roughly 20% per year, from just under 150% in 2008 to nearly than 210% at the end of 2012 … and continued rising in 2013. Even more ominous, corporate debt has soared from 92% in 2008 to 150% today against the expectation that China’s government would always backstop defaults. That makes Chinese corporates the most highly levered in the world and more than twice as levered as US corporates.”
Another interesting data point clearly shows how much debt China has managed to take on in the last few years. “By another measure, China has accounted for more than $15 trillion of the $30 trillion in worldwide credit growth over the last five years, bringing Chinese bank assets to roughly $24 trillion,” writes Wray. So China has accounted to close to 50% of the loans made over the last five years.
What has made the debt particularly addictive is the fact that the new debt is less productive. As Wray puts it “China’s incremental capital/output ratio rose from 2.5x in 2007 to almost 5.5x in 2012. That means it takes more than twice as much debt to generate a given improvement in growth as it did before the debt binge began.”
The Chinese central bank, the People’s Bank of China, did try to rein in this debt binge in 2012, but that immediately led to an economic slowdown. The government stepped in and in July 2013, it ordered the central bank to go easy on things. As George Soros wrote in a January 2014 column “Aware of the dangers, the People’s Bank of China took steps starting in 2012 to curb the growth of debt; but when the slowdown started to cause real distress in the economy, the Party asserted its supremacy. In July 2013, the leadership ordered the steel industry to restart the furnaces and the PBOC to ease credit. The economy turned around on a dime.”
But that seems to be changing now. One reason is the fact that the government and the central bank are looking to rein in the shadow banking sector, which has been a huge source of loans for the Chinese property companies. China is in the midst of a huge property bubble, which has been on for a while. As The Economist reports in a recent article “Prices are still rising in 69 of the 70 cities tracked by the official statistics (Wenzhou in Zhejiang province is the exception).”
The Chinese banks have been staying away from lending to the Chinese property sector. But the property companies have managed to continue raising money through the “cash for copper” scheme. I had explained this in a previous piece, but let me recount it here in brief.
The way this works is as follows. A Chinese speculator manages to raise money in dollars. These dollars he then uses to buy copper. He then sells the copper and gets Chinese yuan in return. He then invests the Chinese yuan in wealth management products, which promise huge returns. The money invested in wealth management products is typically lent to borrowers like property developers to whom the banks are reluctant to lend.
And this has kept the property prices high and property bubble going. The cash for copper scheme works as long as the the Chinese yuan remains stable against the dollar or appreciates. A depreciating yuan makes the cash for copper scheme unviable simply because the speculators need more yuan in order to repay their dollar loan. Also, what has not helped is the fact that the price of copper has been falling.
This is another reason why the Chinese government and the central bank have allowed the yuan to depreciate against the dollar. They want to squeeze out the shadow banking sector. A country like China could easily do with more houses for its huge population. But the trouble, as it is in India, the homes that are being for speculators instead of the masses who need homes to live in. As The Economist writes “One fear is that China’s developers are building houses for the wrong people (speculators) in the wrong places (backwaters). Instead of accommodating China’s overcrowded urban masses, too many houses stand empty, serving as stores of value for people dissatisfied with bank deposits and distrustful of the stockmarket.”
This is something that the Chinese government needs to set right, if they want to continue to stay relevant in the eyes of people. Ultimately, it is worth remembering that China is a capitalistic economy being run by a communist party (which is also the government).
Experts believe that the current government is moving in the direction of popping the domestic debt bubble in China. As Wray writes “China’s ruling elite doesn’t appear to be in denial about its debt problem, as we have come to expect from the United States and the Japan of old. In fact, it seems the new government under President Xi Jinping is intent on popping the domestic debt bubble and allowing widespread defaults rather than continuing to leverage the system into an unmanageable crisis or a Japanese-style stagnation.”
As and when this were to happen (given that predicting when a bubble will pop is next to impossible) it will mean huge problems all over the world, particularly emerging economies. As Faber put it in the Bloomberg TV interview “investors are not sufficiently aware that the Chinese economy is far more important for other emerging economies than the United States because China is a large importer of resources. In other words, iron ore, copper, zinc. And at the same time, they are a huge exporter to commodity producers of their own manufactured goods.”
And this formula won’t work any more. “So if the Chinese economy slows down, commodity prices – industrial commodity prices are likely to remain under pressure. They already come down a lot. They remain under pressure and the resource producers have less money. In other words,…Brazil goes into recession. The Middle East does not grow as much as before. Central Asia, Africa and so forth all contract, and then they buy less from China and you have a vicious cycle on the downside.”
What this also means is that Indian exports will take a huge hit and that in turn will have some impact on economic growth. Also, if China grows at 4%, as predicted by Faber, then what is the Indian economic growth likely to be?

The article originally appeared on www.FirstBiz.com on March 25, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)

When it comes to faith in Modinomics are we becoming victims of the Karan-Arjun syndrome?

karan arjun Vivek Kaul  
Rakesh Roshan made a fairly trashy but super successful movie called Karan Arjun, which was released in 1995. It was a rare occasion when the Khan superstars, Salman and Shah Rukh, shared screen space (They were also seen together in Karan Johar’s Kuch Kuch Hota Hai and K C Bokadia’s Hum Tumhare Hain Sanam).
So, Karan Arjun was a story of reincarnation, where the two heroes(played by Shah Rukh and Salman) are killed by the villain. They are reborn and come back to their original village and take revenge. But before they are reborn, their mother(played by Raakhee) keeps telling everyone, “Mere bete aayenge, mere Karan Arjun aayenge … zameen ki chaati phad ke aayenge, aasman ka seena cheer ke aayenge.”
Despite the ridiculousness of the idea, the sons are reborn and they come back and take revenge. Such confidence in something happening is rarely seen in reel or real life for that matter. A similar confidence seems to have taken over stock market investors in India right now. They firmly believe that Narendra Modi will become the next Prime Minister of the country and clear up all the economic ills that have held back economic growth for a while.
Stuck projects will be cleared. Investment will pick up. Consumption will be back. And happy days will be here again. Or so the logic goes.
The BSE Sensex has been rallying on this possibility and between September 2013 and March 20, 2014, it has rallied by 14.4%. The foreign investors seem to be more taken in by the possibility of Narendra Modi coming in as the knight in the shining armour and rescuing the Indian economy.
Goldman Sachs said in a recent report that “the upcoming parliamentary elections could have an important bearing on policy choices and the progress of structural reforms. Adoption of more decisive and/or pro-growth policies could help boost investment activity and provide impetus to the overall growth cycle, in our view.”
The bank had been a little more direct in a November 2013 report where it had said that “Domestic equity investors tend to view the BJP as business-friendly, and the party’s prime ministerial candidate Narendra Modi (the current chief minister of Gujarat) as an agent of change. BJP and Mr. Modi, in particular, have been focussed on infrastructure and capital spending in the past and a BJP-led government may be beneficial for the investment demand pick up, in our view.”
The foreign institutional investors have bet big time on this possibility. Between September 2013 and March 20, 2014, they have invested Rs 62,271.54 crore into the stock market. During the same period the domestic institutional investors have sold out stocks worth Rs 45,034 crore.
And this investment by the foreign investors is clearly because of the Modi factor. As Geoff Lewis, Global Markets Strategist, JPMorgan AMC told The Economic Times recently “Well, Modi is obviously a very big influence on the stock markets.”
But even Narendra Modi, despite his best intentions, may not be able to do much, if and when he does take over as the Prime Minister of India. And there are several reasons for the same. Let us look at them one by one.
A big hope from a Modi led government is that he will restart the investment cycle. As Neelkanth Mishra and Ravi Shankar of Credit Suisse write in a report titled Elections: Much Ado about Nothing dated March 19, 2014 “Hopes are high among investors that elections can re-start the investment cycle. Even if the electoral verdict is favourable, such misplaced optimism ignores the realities of the business cycle, and overestimates the powers of the central government. Only a fourth of investment projects under implementation are stuck with the central government; the rest are constrained by overcapacity, balance sheets, or state governments.”
They further point out that “two-thirds of the projects awaiting central approval are in Power and Steel sectors, both wracked with massive overcapacity, obviating new investments. True utilisation in thermal power generation is below 60%, near 20-year lows (reported plant load factor is 65%). Of the litany of problems in the sector, two are crucial: SEB[state electricity boards] reforms, and coal availability.”
The reforms for state electricity boards need to happen at the state level. As far as solving the problem of coal availability is concerned that is something that cannot be solved overnight. As Swaminathan S Anklesaria Aiyar pointed out in a recent column in The Economic Times “our systems are now clogged with so many laws and regulations at the central and state level that Cabinet clearance is just the first step in a long obstacle race. It takes 10-12 years and over 100 permits to open a coal mine. India, with the world’s third-largest coal reserves, has become a coal importer.”
What about accelerating private coal production in the country? That also is not likely to happen any time soon. As Mishra and Shankar of Credit Suisse point out “Given the controversy around coal block allocations, auctions are the only way forward. These are unlikely till the data on reserves in these mines are updated. The government has been planning to conduct coal block auctions for close to three years now (see link), but despite repeated pronouncements of it being a few weeks/months away, there has been little progress. In our view, the challenge is inadequate prospecting—the ministry may be apprehensive of the winning private bidder in an auction managing to increase reserves estimates within a short time frame. Such a development would create negative press and possibly trigger anti-corruption investigations.”
Hence, coal blocks most likely won’t be auctioned till the reserves have been updated. “Blocks are unlikely to be auctioned till reserves have been updated. This is a time-consuming process, and in our view is unlikely to be completed in less than 1-2 years. From the time the blocks are auctioned to the time coal can start to get mined could be another 3-5 years at least,” write Mishra and Shankar.
What about other infrastructure projects? There are many challenges on this front as well. “Challenges abound elsewhere too: legal challenges are likely to stall the National Highways projects, and matter less for India’s road network; Railways lacks financial muscle, and Private Partnership schemes are yet to take off,” write the Credit Suisse analysts.
What does not help is the fact that the banking sector seems to be headed towards difficult times in the days to come. The stressed asset ratio of the Indian banking sector currently stands at 10.2%. This means that for every Rs 100 of loans given by Indian banks Rs 10.2 worth of loans have either not been repaid or been restructured in some way, where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank) by increasing the tenure of the loan or lowering the interest rate on it. Also, nearly 85% of the restructured loans have been restructured over the last two years.
What makes the situation even more dangerous is the fact that the non performing assets are likely to increase in the years to come. The Credit Suisse analysts point out that their banking team has been highlighting that “that there is Rs 8.6 trillion of loans with the top 200 companies with interest cover less than one. Only about 23% or Rs2 trillion has become NPA yet.”
Interest cover is earnings before interest and taxes divided by the total interest expenses of s company. If the interest cover of a company is less than one what it means is that the interest expenses of the company are more than its earnings before interest and taxes. Hence, the company is not in a position to fully repay the interest on the loans that it has taken on. In this situation it has no other option but to default or get the loan restructured. Either ways it means problems for the banking system. Or as John Maynard Keynes once famously said “If you owe your bank a hundred pounds, you have a problem. But if you owe a million, it has.”
If the problems in the banking system erupt that would mean that there would be lesser money to lend. Also, the government will have to come to the rescue of the public sector banks, and that would mean greater expenditure for the government, something it can ill-afford to do at this point of time.
And if all this wasn’t enough, the ability of the next government (irrespective of who leads it) to spend its way through trouble is fairly limited. As I had estimated in this piece, nearly Rs 2,00,000 crore of the government expenditure hasn’t been accounted for in the next financial year’s budget.
As Mishra and Shankar point out “The apparent reduction seen in the last three years has been achieved mostly by pushing expenditure into subsequent years: while earlier the month of March used to see 16% of the full-year expenditure, in the last three years, it has come down to 11-12%.”
Obviously, this trick of pushing expenditure into the next year cannot continue forever and needs to stop at some point of time.
To conclude, Modi will have to work in a coalition, which will severely limit his ability to make decisions as quickly as he is used to. Given these reasons, the foreign investors and everyone else who feels that Narendra Modi will turnaround the Indian economy in a jiffy, need to understand that they might be becoming victims of what I would like to call the Karan-Arjun syndrome. Reel life and real life do not always go together.
The article originally appeared on www.FirstBiz.com on March 21, 2014 with a different headline
 (Vivek Kaul is a writer. He tweets @kaul_vivek) 

Where is global economy headed? Copper prices will tell you

dr copperVivek Kaul 
Copper prices have fallen by a little over 12.1%(in dollar terms) since the beginning of this year. Interestingly, a substantial portion of this fall has come since the beginning of this month. Analysts often refer to copper as Dr Copper, given that the demand for copper is often a reliable indicator of economic health.
How is that? Copper is widely used across different sectors of the economy. It has uses in sectors as varied as electronics, homes, factories and even power generation and transmission. Given this, demand for copper is often a very good lead indicator of the economic health of the global economy. This demand is reflected in the market price of copper.
Hence, rising copper prices indicate strong demand for copper, which in turn indicates a growing global economy. Vice versa, falling copper prices indicate low demand for the metal and hence, an imminent economic slowdown.
As Albert Edwards of Societe Generale writes in a note dated March 13, 2014, titled We are repeating 2008- just backwards? Ignore copper meltdown at your peril “Copper and iron ore prices have slumped almost 10% over the last week. Interpreting this move may prove crucial for global investors who traditionally have looked to Dr Copper specifically, and industrial commodity prices in general, to give an early warning to any changing direction of the global economy.”
In fact, there has been a lot of talk in the recent past about a worldwide economic recovery. But that doesn’t seem to be reflected in the price of copper, or other industrial metals for that matter. As a recent column in The Economist points out “It is not just copper this time; the aluminium price is down 10% over the last 12 months, nickel 7.9% and lead 6.3%. Compared with a year ago, metals prices are down 10.2 per cent. With the important exception of oil, commodity prices in general have been weak over the past year.”
What this tells us is that all the talk about a global economic recovery should not to be taken very seriously. In fact, other data suggests the same. The core personal consumption expenditure deflator, a measure of inflation closely tracked by the Federal Reserve of United States, the American central bank, rose by just 1.1% in January 2014. This is well below the Federal Reserve’s benchmark of 2%.
In fact, if housing is excluded from this index, the inflation comes in at 0.7%. Housing prices in the United States have been rising at a fast pace because of the low interest rates maintained by the Federal Reserve.
What this tells us is that consumer demand is rising at a very slow pace in the United States. And there can be no economic recovery without an up-tick in consumer demand. And how are things in Europe? The inflation in the Euro Zone (18 countries which use euro as their currency) fell to the lowest level of 0.7% in February 2014. It was at 0.8% in January 2014.
What these numbers clearly tell us is that most of the Western world is close to deflation. Deflation is the opposite of inflation and is a scenario where prices are falling. In a scenario where prices are falling (or even in a prospective scenario where people start to believe that prices will fall) people tend to postpone consumption in the hope of getting a better deal. And this lack of consumer demand essentially ends up killing the possibility of economic growth.
In fact, the inflation numbers in China are not looking good either. As Edwards writes “Indeed the widely ignored RPI (retail price index)…is rising by only 0.8% year on year, confirming that China is closer to outright deflation than widely appreciated.”
What is interesting is that falling copper prices also tell us clearly that the demand for the base metal is falling in China. Estimates suggest that Chinese demand comprises 40% of the world’s demand for copper. Nevertheless, the thing is that all the demand for copper in China is not genuine industrial demand.
A lot of copper demand is due to a practice known as “cash for copper”. The way this works is as follows. A Chinese speculator manages to raise money in dollars. These dollars he then uses to buy copper. He then sells the copper and gets Chinese yuan in return. He then invests the Chinese yuan in wealth management products, which promise huge returns. The money invested in wealth management products is typically lent to borrowers like property developers to whom the banks are reluctant to lend.
As Lucy Hornby and Paul J Davies point out in The Financial Times “The trick works best for copper because of the red metal’s liquidity and easy storage. Importers have also tried zinc, rubber, plastics and – least successfully – palm oil, which turned out to be bulky, difficult to store and perishable.”
The cash for copper scheme works as long as the the Chinese yuan remains stable against the dollar or appreciates. As on March 19, 2013, one dollar was worth around 6.21 Chinese yuan. Since then the yuan has gradually appreciated against the dollar and by January 13, 2014, one dollar was worth 6.04 yuan.
But since January 13, 2014, the yuan has started depreciating against the dollar, and one dollar is now worth around 6.15 Chinese yuan. A depreciating yuan makes the cash for copper scheme unviable simply because the speculators need more yuan in order to repay their dollar loan. Given this, as things stand currently, the cash for copper scheme doesn’t really work.
What this means is that a huge section of the Chinese economy which was borrowing through this route has effectively been cut off. As Horny and Davies write “Import financing is one of the few sources of cash flow left for companies that are already cut off from loans by state banks at official interest rates. Many have already exhausted their ability to fund themselves through high interest rate trust products.”
Also, an important part of this trick is that borrowers to whom yuan loans are given return the money. In the second week of March the solar equipment producer Chaori Solar missed a $14.7 million interest payment. This was first case of a Chinese company defaulting on a bond payment. What is interesting here is whether China will allow the yuan to continue to depreciate against the dollar. If it does that then the cash for copper scheme will automatically get killed. Also, it will be a recognition of the fact that the government is taking the deflationary fears in China seriously.
By allowing the yuan to depreciate it will make Chinese exporters more competitive internationally. A Chinese exporter will make much more money when one dollar is worth 6.5 yuan vis a vis when one dollar is worth 6.15 yuan, as it currently is. If this were to happen, Chinese exporters will get more competitive internationally and cut the prices of their products. In order to stay competitive manufacturers from other countries will also have to cut their prices (or source their products from China) and in the process, China can effectively end up exporting deflation to large parts of the world.
The article originally appeared on www.FirstBiz.com on March 20, 2014
 (Vivek Kaul is a writer. He tweets @kaul_vivek)