Yesterday, once more! Is the world economy going the Japan way?

Vivek Kaul

High risk means high returns.
Or does it?
Not always.
When more risk does not mean more return
The ten year bond issued by the United States (US) government currently gives a return of around 1.8% per year. Bonds are financial securities issued by governments to finance their fiscal deficits i.e. the difference between what they earn and what they spend.
Returns on similar bonds issued by the government of United Kingdom (UK) are at1.9% per year.
Nearly five years back in July 2007 before the start of the financial crisis the return on the US bonds was at 5.1% per year. The return on British bonds was at 5.5% per year.
The return on German bonds back then was around 4.6% per year. Now it stands at 1.44% per year.
Since the start of the financial crisis governments all over the world have been running huge fiscal deficits in order to try and create some economic growth. They have been financing these deficits through increasing borrowing.
In 2007, the deficit of the US government stood at $160billon. This difference was met through borrowing. The accumulated debt of the US government at that point of time was $5.035trillion.
In 2012, the deficit of the US government is expected to be at $1.327trillion or around 8.3times more than the deficit in 2007. The accumulated debt of the US government is also around three times more now and has crossed $14trillion.
The situation in the United Kingdom is similar. In 2007 the fiscal deficit was at £9.7billion. The projected deficit for 2012 is around 9.3times more at £90billion. The government debt as a percentage of gross domestic product (GDP) has gone up from around 37% of GDP to around 67% of GDP.
The same trend seems to be happening throughout the countries of Western Europe as well. Hence we can conclude that it is more risky to lend to the governments of United States, United Kingdom and countries like Germany and France in Western Europe. Though to give Germany the due credit it doesn’t run fiscal deficits as large as US or UK for that matter. Its fiscal deficit in 2010 had stood at €100billion but was cut to around €25.8billion in 2011.
Even though the riskiness of lending to these countries has gone up, the investors have been demanding lower returns from the governments of these countries. Why is that?
The answer might very well lie in what happened in Japan in the late 1980s.
The Japan story
The Japanese central bank started running a low interest policy to help exports from the mid 1980s. This other than helping exports fuelled massive bubbles in both the stock market as well as the real estate market. The Nikkei 225, Japan’s premier stock market index, returned 237% from the start of 1985 to December 29,1989, the day it peaked at a level of 38,916 points. The real estate prices also shot through the roof. As Paul Krugman points out in The Return of Depression Economics “Land, never cheap in crowded Japan, had become incredibly expensive…the land underneath the square mile of Tokyo’s Imperial Palace was worth more than the entire state of California.”
This was the mother of all bubbles.
Yasushi Mieno took over as the 26th governor of the Bank of Japan, the Japanese central bank, on December 17, 1989. Eight days later on December 25, 1989, he shocked the market by raising the interest rate. And more than that, he publicly declared that he wanted the land prices to fall by 20%, which he later upped to 30%. Mieno didn’t stop and kept raising interest rates.
The stock market crashed. And by October 1990 it was down nearly 40%. Since then the stock market has largely been on its way down. And it currently quotes at 8,900 points down 77% from the peak.
The real estate prices also fell but not at the same fast rate as the stock market. As Ruchir Sharma writes in Breakout Nations – In Pursuit of the Next Economic Miracle “ “The greatest bubble in human history” burst in 1990 with no pain at all, like falling off Everest without breaking a bone. At its peak Japan accounted for 40 percent of the property value of the planet, but instead of collapsing, the price of real estate slowly declined at a 7% annual rate for two decades, ultimately falling by a total of about 80%. There was never a major round of foreclosures or bankruptcies, as the government kept bailing out debtors, ruining its own finances.”
The GDP growth rate collapsed from 3.32% in 1991 to -0.14% in 1999. In the next ten years i.e. between 2000 and 2009, the GDP growth rate never went beyond 2.74% and was at -5.37% in 2009.
The balance sheet depression
Japan has been in what economist Richard Koo calls a balance sheet recession. What this means in simple English is that after bubbles burst, specially real estate bubbles, the private sector companies as well as individuals and families who had speculated on the bubble end up with a lot of excessive debt and an asset (like land or stocks) which is losing value. The excessive debt has to repaid. Given this individuals and companies try to save, in order to repay the debt. But what is good for the individual is not always good for the overall economy.
The paradox of thrift
John Maynard Keynes unarguably the greatest economist of the twentieth century called this the paradox of thrift. What Keynes said was that when it comes to thrift or saving, the economics of an individual differs from the economics of the system as a whole.
If one person saves more then saving makes tremendous sense for him. But as more and more people start doing the same thing there is a problem. This is primarily because what is expenditure for one person is an income for someone else. Hence, when everybody spends less, businesses see a fall in revenue. This means lower aggregate demand and hence slower or even no growth for the overall economy.
The Japanese savings rate at the time when the bubble popped was around 0%. After this the Japanese started to save more and the savings rate of the Japanese private sector and households increased. It reached around 16% of the GDP in the year 2000.
All this money was being used to pay off the excess debt that had been accumulated. This meant slower growth for Japan. The government in turn tried to pump economic growth by spending more and more money. For this it took on more debt and now the Japanese government debt to GDP ratio is around 240%.
Ironically as the government debt went up the return on the government debt kept coming down. As Martin Wolf of Financial Times points out in a recent column “At the end of 1990, when its “bubble economy” went pop, the Japanese government’s 10-year bond was yielding 6.7 per cent…But yields on 10-year Japanese government bonds (JGBs) fell to close to 2 per cent in 1997 and then, with sizeable fluctuations, to troughs of 0.8 per cent in 1998, 0.4 per cent in 2003 and, recently, to 0.9 per cent. In short, the worse the Japanese government’s present and prospective debt position has become, the lower the interest rates on JGBs has also become.” (All returns per year)
The reason for this in retrospect is very straightforward. As the Japanese individuals and companies were saving more they did not want to risk their savings in either the stock market which had been continuously falling or the real estate market which was also falling, though at a slower rate. Hence a major part of the savings went into JGBs which they thought were safer. Given that there was great demand for JGBs the Japanese government could get away with offering lower returns on its bonds, even though over the years they became riskier.
The Japan Way
Richard Koo believes that what happened in Japan over the last twenty years is now happening in the US, UK and parts of Europe. Individuals in these countries are saving more to pay off their excess debts. An average American in the month of March 2012 saved 3.8% of his disposable income in March 2012. Before the crisis the American savings rate had become negative. . The same stands true for Great Britain where savings of household were -3% at the time the crisis struck. They have since gone up to 3% of GDP. The corporate sector was saving 3% of GDP is now saving 5% of GDP. Same stands true for Spain, Ireland and Portugal where savings were in negative territory (i.e. the people were borrowing and spending) before the crisis struck, and are now going up. In the case of Ireland the savings have gone up from -10% of GDP to around 5% of the GDP since the crisis struck.
Hence companies and individuals across countries are saving more to pay off the excess debt they had accumulated. This in turn has meant that they are spending lesser money than they used to. This has led to slower economic growth. A large part of these savings is going into government bonds keeping returns low. Retail investors have taken out nearly $260billion out of equity mutual funds in the United States since 2008, even though the stock market has doubled in the last three years. At the same time they have invested nearly $800billion in bond funds, which give very low returns.
ZIRP – Zero interest rate policy
The governments of these countries have cut interest rates to almost 0% levels and are also borrowing and spending more money. That as was the case in Japan has resulted in some economic growth, but nowhere as much as they had expected. Even though governments want their citizens and companies to borrow and spend money in order to revive economic growth, they are in no mood to do that.
The citizens would rather pay off their existing debt than take on new debt. And the companies need to feel that the economic opportunity is good enough to invest, which it clearly isn’t. That explains to a large level why US companies are sitting on more than $2trillion of cash.
The banks are also not willing to take on the risk of lending at such low interest rates, as was the case in Japan. What has also not helped is the case of continuously bailing out the financial sector like was the case in Japan. Hence real estate prices in countries like Spain still need to fall by 35% to come back at normal levels.
Slow growth
All in all most of the Western world is headed towards the Japan way, which means slow economic growth in the years to come. As Sharma writes “Over the next decade, growth in the United States, Europe and Japan is likely to slow…owing to the large debt overhang”. This will impact exports out of countries like China, South Korea, Japan, Taiwan, India etc. The Chinese exports for the month of April 2012 grew at 4.9% in comparison to 8.9% during the same period last year. This in turn has pushed down imports. Imports grew at a negligible 0.33% against the expected 11%.
A slowdown in Chinese imports immediately means lower prices for commodities. As Sharma puts it “It’s my conviction that the China-commodity connection will fall apart soon. China has been devouring raw materials at a rate way out of line with the size of its economy… Since 1990, China’s share of global demand for commodities ranging from aluminum to zinc has skyrockected from the low single digits to 40,50,60 % – even though China accounts for only 10% of total global output.” .
Over a longer term slower growth in the Western World will also means slower and lower stock markets. As the old Chinese curse goes “may you live in interesting times”. The interesting times are upon us.
(This post originally appeared on on May 17,2012.
(Vivek Kaul is a writer and can be reached at [email protected])

What the UPA government can learn from B.E.S.T

Vivek Kaul
Ek bandra station,” I told the conductor of the B.E.S.T (BrihanMumbai Electric Supply and Transport) bus number 83, handing over a ten rupee note.
Do rupiya aur,” he replied.
12 rupiya ka ticket hai?” I asked him.
Ji sir,” he replied.
I was travelling from Century Bazar in Worli to Bandra. The ticket till very recently used to cost eight rupees. It has now been increased to Rs 12, a rather steep 50% increase. The prices of tickets of lower denominations haven’t been increased so much. A four rupee ticket is now five rupees. But at the same time a ten rupee ticket now costs fifteen rupees and a twelve rupee ticket costs eighteen rupees.
This got me thinking. Why had the B.E.S.T increased prices? Well for the simple reason that they had to match their income with their expenditure, which is the most basic thing that needs to be done for successfully operating any institution. The fact that it is not allowed to raise prices as often as it probably wants to has led to this very high increase.
While the B.E.S.T believes in at least trying to ensure that its income meets its expenditure, the United Progressive AllianceUPA) which runs the government of India, doesn’t. And this is neither good for the UPA nor for you and me, the citizens of India.
In the year 2007-2008 (i.e. between April 1, 2007 and March 31,2008) the fiscal deficit of the government of India stood at Rs 1,26,912 crore. Fiscal deficit is the difference between what the government earns and what it spends. For the year 2011-2012 (i.e. between April 1, 2011 and March 31, 2012) the fiscal deficit is expected to be Rs 5,21,980 crore.
Hence the fiscal deficit has increased by a whopping 312% between 2007 and 2012. During the same period the income earned by the government has gone up by only 36% to Rs 7,96,740 crore.
Things cannot be quite right when your expenditure is expanding nine times as fast as your income. As Franklin Roosevelt, who was the President of America for a record four times, between 1933 and 1945 famously said “Any government, like any family, can, for a year, spend a little more than it earns. But you know and I know that a continuation of that habit means the poorhouse.”
So why is the UPA led Indian government headed to the poorhouse? For that we have to dig a little deep and look into this document known as the annual financial statement of the government of India. In this document the government gives out numbers for the amount it had assumed initially as the oil subsidy for the year, and the final oil subsidy it gave.
The data for the last three years has been very interesting. The subsidy assumed at the time of the finance minister presenting the budget has always been much lower than the final subsidy bill. Take the case for the year 2009-2010(i.e. between April 1, 2009 and March 31,2010) the oil subsidy assumed was Rs 3109 crore. The final bill came to Rs 25,257 crore (direct subsidies + oil bonds issued to the oil companies), around eight times more.
The next year (i.e. between April 1, 2010 and March 31, 2011) the oil subsidy assumed was Rs 3108 crore. The actual bill was nearly 20 times more at Rs 62,301 crore. For the year 2011-2012(i.e. between April 1,2011 and March 31,2012) the subsidy assumed was Rs 23,640 crore. The actual subsidy bill came to Rs 68,481 crore.
So in each of the last three years the oil subsidy bill has come out to be greater than what was assumed. For the current financial year (i.e. April 1, 2012 to March 31,2013) the oil subsidy bill has been assumed to be at Rs 43,580 crore. While this is greater than the assumption made over the last three years, it is highly likely that the oil subsidy bill will come to amount greater than this.
There are two reasons for the same. The first reason is that the rupee has been rapidly depreciating against the dollar and since oil is sold in dollars that means that the Indian companies are paying up more in rupees to buy the same volume of oil. Currently oil is priced at around $115 per barrel (around 159litres) of oil. This means that Indian companies pay around Rs 6141 per barrel of oil.
If the rupee falls further and one dollar equals Rs 60 (as has been written about on this website), the Indian companies will be paying Rs 6900 or 12.4% more per barrel of oil. In the normal scheme of things this cost would have been passed onto the customer and everybody would have lived happily ever after.
But that is not the case. Various products coming out of oil like kerosene, diesel etc, are heavily subsidized in India. Hence even with higher prices of oil internationally the Indian oil companies will have to keep selling their products at lower prices and suffer losses. These companies are then compensated for the losses they face by the government of India.
The second reason is that the price of oil is unlikely to go down in dollar terms as well. As governments and central banks around the world run close to zero interest rates and print more and more money (and are likely to continue to do so) in order to revive economic growth in their respective countries, oil has become a favourite commodity to buy among the speculators.
While central banks and governments can print all the money they want, they can’t dictate where it goes. As Ruchir Sharma writes in Breakout Nations – In Pursuit of the Next Economic Miracles “When money is loose, investors borrow to buy hard assets, which is why the prices of oil, copper, and other commodities have become disconnected from actual demand.”
This means that oil will either continue at its current price level or even go up for that matter. And with the rupee likely to depreciate further this means that India’s oil import bill is likely go up even further.
It is highly unlikely that this increase in price will be passed onto the end customer. This means that the government will have to bear the losses incurred by the oil companies, pushing up the oil subsidy, which has been assumed to be at Rs 43,580 crore.
A higher oil subsidy bill means the government expenditure going up and this in turn means a higher fiscal deficit. Typically, the government finances this deficit by borrowing money. With the government needing to borrow more money it would have to offer a higher rate of interest. At the same time a higher government borrowing will crowd out private borrowing, meaning that the private borrowers like banks and other finance companies will have to offer a higher rate of interest on their deposits because there would be lesser amount of money to borrow. A higher rate of interest on deposits would obviously mean charging a higher rate of interest on loans.
All this can be avoided if the government follows what B.E.S.T did recently i.e. allow oil companies to raise prices of its products. Why can’t a free market operate when it comes to oil products? If the price of oil products changes on a daily basis depending on its international price, like the price of vegetables, people will gradually get used to the idea of a changing price for products like diesel and kerosene.
And of course chances are that with the government borrowing coming down, interest rates might also fall. In 2007, when the government fiscal deficit was low, a 20 year home loan could be got at an interest rate of 8%. A loan of Rs 25 lakh would mean an EMI(equated monthly installment) of around Rs 25,093. A lot of banks are now charging their existing consumers around 13% on their home loans. This means an EMI of around Rs 35,147 or almost 40% more.
The huge subsidy on oil prices has had a role to play in this increasing EMI. Bad economics does not always mean good politics. Its time UPA woke up to that.
(The article was originally published on May 9, 2012,at Vivek Kaul is a writer and can be reached at [email protected])


Ruchir Sharma is the head of Emerging Market Equities and Global Macro at Morgan Stanley Investment Management. He generally spends one week per month in a developing country somewhere in the world. Also he has been a writer for as long as he has been an investor. Sharma has put his two areas of expertise that of having an extensive experience on emerging markets and being able to write about them, into a new book, Breakout Nations – In Pursuit of the Next Economic Miracle. In this interview he speaks to Vivek Kaul([email protected]).
Excerpts: `
How do you define a breakout nation?
Let me tell you where this idea came from. The last decade was a very exceptional decade for emerging markets in the sense that every developing economy did well. This is not consistent with the history of economic development. We have got two hundred countries in the world, and only 35 are developed, everything else is emerging. So the consistent history of economic growth is that you get bursts of growth and then it falters. Very few countries are able to sustain these bursts of growth and develop and become fully developed countries.
So why was the last decade different?
The 80s and 90s was a very bad period and this was a catch up happening because of that. Also there was a lot of easy money that started to flow out of the United States (US) from 2003 onwards. And there was a boom in the global consumer. It led to this myth at the end of the decade that if you were an emerging market it was all about a time as to when you would converge with the developed world. As I surveyed the world I figured out that’s not going to happen. That’s not the history of economic development and after a decade of economic success many countries were beginning to falter. Other thing that sort of stuck me was that people would ask me, listen even if India grows at 6%, no harm done, because the US is growing at 2-3%. There are two things that are wrong about that argument. One we saw last year, when the Indian equity market fell by 35% in dollar terms last year. So if you undershoot expectations it has a very negative fallout.
You are referring to the Indian GDP growth falling to less than 7%?
Exactly! One thing that people don’t take into account is expectations. Like in China today all expectations are of the country growing by 8-9% and if China grows below 8-9% it leads to instant panic in the markets, especially the commodity markets. So one of the definitions for a breakout nation is that the expectations have to be exceeded. If your expectations are already high and if you are just about meeting them, it’s not going to feel like bang for the buck for anyone.
You say one of the definitions….
The second is this per capita income argument, which is that if India grows at 4-5% that’s a real underachievement because we are only a $1500 per capita income country whereas if a country like Korea grows at 4% it’s a huge achievement because it’s a relatively rich country with a per capita income of more than $20,000. It is still classified as an emerging market but it is fairly rich. So there are three things behind which went into defining what a breakout nation is. One that not all emerging markets are going sort of emerge, so to speak, or become developed markets. Two that expectations are key in terms of how you define a breakout nation and three that you have to take into account per capita income levels. The lower the base the easier it is theoretically to grow and the more you should grow to get out of poverty.
You also say “very few nations achieve long term rapid growth”. Why is that?
This is because most countries or most emerging markets reform only when they have their back to the wall. They enjoy some success and then they stop reforming and begin to fritter away their gains. That’s what happened to Brazil. Brazil used to be the China of the 1960s. Its growth rate was nearly in double digits and then it completely lost its way. It started to fritter it away in terms of huge government spending, subsidies, and massive amount of wasteful expenditure which led to hyperinflation. If you look in the high growth list of the 1950s and 1960s, there were countries like Yemen, Iran and Iraq. The odds of long term success like it is with companies is very low. How many companies are there today which were there thirty years ago, or twenty years ago?
So which are the countries which have grown consistently over the long term?
There are only two countries which have grown over 5% for five decades in a row, South Korea and Taiwan. Only six countries were able at more than 5% for four decades in a row. The list included Hong Kong, Singapore, South Korea, Taiwan and I think there was Malta.
What is it that these countries did differently that other countries did not?
In countries like South Korea, China and Taiwan, they consistently had a plan which was about how do you keep reforming. How do you keep opening up the economy? How do you keep liberalizing the economy in terms of how you grow and how you make use of every crisis as an opportunity. Like Korea was really down in the dumps in 1997-98 crisis. They really had their back to the wall. But they capitalized on the crisis to clean up their balance sheet and to emerge again as an economic powerhouse. It is just about the fact you need to consistently keep reforming and understand that odds are against you. In India’s case what concerns me is the attitude. Listen we will grow by 7%, no matter what happens. That is a given. Now why it is a given, I don’t know. Earlier it was 8-9%. Many businessmen also like to parrot the line that 7% growth will happen, no matter what happens. To me I find that very disturbing. Maybe it is changing now, but till at least a year ago, the attitude was very clear.
You have set many doubts on China becoming a breakout nation. Why?
In fact I admire China’s success and of what they have done over the past thirty years but my point is that expectations on China have become too high. To me that is the big thing. Even though its per capita income has reached around $6000, IMF still thinks that for the next five years the growth will be 8% per annum. Every time the growth dips below 8%, it leads to panic.
Can you elaborate on this?
Surveys are carried out where fund managers are asked will China have a hard landing. I find two responses interesting. Only 10% say that China will have a hard landing. And how do they define a hard landing, a growth rate of 7% or less. The breakout nation concept is that you got to beat expectations. So what I am saying is that if China records a GDP growth rate of 6% next year, trust me it will lead to a lot of panic in many circles.
There are lots of negatives that you point out about China, which we do not tend to here in the normal scheme of things. Like you talk about salaries going up at a very fast pace i.e. wage driven inflation…
Chinese costs have been going up at the rate of 15% per year, and as I argue at the back of the book, the US in fact is now seeing some reshoring (i.e. factories are moving back to America), as we call it. After all the outsourcing and off-shoring the new trend in the US seems to be reshoring because the wage gap is narrowing. It is still there. But the wage gap is narrowing. An anecdote that I found very useful was when one of my portfolio managers went on the ground and the companies told him was that three years ago we could shout at the workers but today they can shout back at us. I think that’s natural. For the first time in China the urbanization ratio has gone to 50%. So a lot of the workers have moved from rural to urban areas, and the scope of workers left for companies to tap from is diminishing.
Why do you call the $2.5trillion foreign exchange reserves, an illusion?
If you look at the total debt of China as a share of their economy it comes to around 200% of their GDP. The Chinese know that. And therefore they are reluctant now to keep stimulating the economy with debt and they are trying their best to clean up the banking system by sort of being careful about off-balance sheet transactions. When you talk to the entire world, when it comes to debt statistics, they don’t look at the entire picture, they just look at the narrow picture that China’s central government’s debt to GDP is low. But a lot of the debt sits on the local government’s balance sheets or on company balance sheets which are owned by the government, which is all the same if you put it together.
You say that the Chinese consumer not doing well is a big myth…
This is because the Chinese consumer has been doing well. And this myth has got propagated because the Chinese consumption as a share of their GDP is low. But my entire point is that it is low not because consumption is doing badly but because investment and exports have done exceedingly well. My entire point is that the Chinese consumption growth cannot increase further. It can continue at this pace.
I was surprised when I read that the consumer spending in China has been growing in China by 9% every year over the last thirty years.
Yes. It is comparable to what Japan, China and Korea achieved.
So it’s been growing as fast as the Chinese economy…
No. Just a bit below. The Chinese economy has been growing at 10% and the consumption has been growing at 9%. Because the overall economy has grown at 10% and the consumption has grown at 9%, consumption as a share of Chinese GDP has come down, which leads many people to believe that the Chinese consumer is suppressed. Yeah, maybe suppressed relative to exports and investments but not in absolute terms.
Another thing I found quite fascinating in your book is the portion where you describe your experience of taking the maglev train in Shanghai. Can you take us through that?
It was like going to an amusement park. I had heard so much about this train which travels at 400 kilometres an hour. I never thought of taking it because typically someone is there to pick me up at the airport. In 2008, when I was driving from the airport back to my hotel, I heard this train zipping past me like zip. I was like what is this going on? It really feels like a bullet passing you by when you are going by the car. So I decided I have got to try this thing out. When we tried it out, it was a fascinating experience though you have to go out of the way to take the train. In the business class cabin there was nobody else there other than me and my colleague. And you have this fancy stewardess who comes and sort of buys the ticket for you. When you are on the train because it’s a levitation act you just feel zero friction. Outside the train zips past you, but inside you don’t feel as if anything is going on. It’s completely still.
But what is the broader point you were trying to make through this example?
The broader point is that no other country in the world will think of experimenting like this. But they have been investing at such a huge pace that they try out these experiments as well. When I asked why has this not been replicated in other parts of China, and I got all sorts of explanations. One was that now we get environmental protests because it goes through very close to some of the places. This is very new to China that you have got people who are protesting and saying we don’t what this to happen. The fact they are not extending this train to everywhere because it does not make logical sense from the economic point of view. This shows the Chinese thinking also that listen that how much can we keep spending on these things.
You call India and Brazil very high context societies. What is that?
This is a term that the anthropologist Edward Hall came up with. It would always strike me when I went to India and Brazil about the commonalities between the two countries. Someone says you come for dinner and the dinner won’t start till 9.30-10pm. And everyone sort of came late. I go to Brazil every year and in 2008 I heard about this serial called A Passage to India which was a huge hit in Brazil. People were talking about it in the party circles and I was like I want to see this serial. I figured out that it is a soap opera, and people are hooked to it at nine o clock at night. The whole thing is a love story set in Jodhpur and Agra, and the actors were all Brazilians in Indian garb, and they looked pretty much North Indian to me.
The latest item girl in Bollywood is a Brazilian…
Really? You can’t make out the difference very often. And that’s my entire point. There are many parallels. So all this was fun but what was the economic point coming out of it? I hope India does not go down the Brazil way with similar cultural habits of having a welfare state where you want to protect people. At that point of time the government spending in India was beginning to really take off and now it’s clearly sort of very high.
You even hint at India going the Brazilian way of hyperinflation…
This thing of having minimum wages and having them indexed to inflation, all these are traits through which a country like Brazil went down. The fact is that we have found inflation to be more sticky than it should be. This is happening because of all these welfare schemes being put into place. My whole thing is that you just can’t take this for granted. But just because it hasn’t mattered in the past does not mean that it won’t matter in the future.
What is your view on the S&P’s change in outlook on India?
It’s consistent with the fact that we need to obviously get these things under control before we begin to lose the plot.
You also say in the book that India has too many billionaires given its size. What is the point you are trying to make there?
Wealth needs to be celebrated. It is an integral part of a capitalistic society to have billionaires. But when I look at the number of billionaires we have in comparison to the rest of the world, it does seem a bit high. If we had new wealth being created and had new billionaires coming up, that would be a healthy sign. But if it is the same set of people holding onto their wealth, it is not a healthy sign. In the last five years the churn has gone down in comparison to what used to be. And you want high churn to take place because you know then new people are coming in. Also you want billionaires to come from industries which are celebrated because of the general entrepreneurial talent like technology, manufacturing etc, and not from places where the government is issuing licenses . If you look at other countries which have a high share of billionaires compared to the size of their economies they are all countries where cronyism is rampant. Like Russia and Malaysia. And if you look at the countries which have made economic success models in the past, the wealth of the billionaires as a share of their economy is relatively low. This is because to create up an environment conducive for the opening up of the economy, for reform and for wealth generation, you have to have this perception that it is being done in a fair manner.
Can India be a breakout nation?
I think so. I give India a 50:50 chance because expectations have now become lower to 6-7% GDP growth and that at least lowers the bar from growing at the rate of 8-9%, which is a very high bar. Most countries I have categorical stand which is I like I don’t think that Russia and Brazil are on my list of breakout nations. It is a clearly a negative take on them. There is relatively positive take on many of the South East Asian countries and Eastern European countries. But I think in India I am sort of caught in the middle. I see the positives taking place when I travel outside of Delhi, I go to the states. The whole India chapter in the book is about the fact that as the Southern States have dropped off in the growth statistics, but the Northern States which you never thought would do well, from Bihar to even Chattisgarh, are doing well.
I have lived in Bihar for almost 20 years. It is growing from a very very low base, and that’s why the high rate of growth.
Exactly. That is my point on India to you, which is that India’s biggest benefit for becoming a breakout nation is the fact that its base is so low. It is true of India. So what you say of Bihar in an Indian context is true of India in a global context, which is what gives India a 50:50 chance even though the policy makers keep messing it up at the top. As you know with Bihar the base has always been low. But obviously something has happened in the last seven years that the state has started to change.
In the last section of your book you talk about something called the What is that?
My whole point is that the world has developed for years and years and centuries and commodities have followed a very predictable pattern, which is that they go up for one decade and they go down for two decades because new technology, human ingenuity always come up triumph any demand burst that comes through. Yet at this stage all people think that commodities are in some sort of a super cycle that And one sort of stunning statistic that stood out for me is that in 2001 the world has twenty nine billionaires in the energy industry, seventy five in tech. By 2011, the situation had reversed, with thirty-six in tech and ninety one in energy, mostly in oil.
What is the point you are trying to make?
Why should you have so many billionaires out of commodities because all you are doing is digging dirt out of the ground? You are not doing something that is really smart and innovative. This is complete nonsense when you have so many billionaires coming out this sector. You can have a few. These are signs at the peak of any trend when it looks like that this trend is going to go on forever. But those lofty expectations have their own undoing. Along with all this comes my argument that China’s growth is about to graduate to a lower plane. And China is the 800 pound gorilla of the commodity market.
Why do you see the China-commodity connection falling apart soon?
Basically everyone says that China has to grow so it needs commodities. My point is again about expectations. If China’s growth falls to 6-7% as I think it may on a medium term basis, a lot of the investments, a lot of things will appear to be excessive. So China may grow but the demand for commodities could come of very significantly. So steel, copper etc could all face oversupply in the coming years.
One of the things you talk about in your book is that while central banks can print all the money they want, they can’t dictate where it goes…
Exactly. Even in India this whole sort of thing spread…and till date I get some of these questions that we have all this liquidity in the world, central banks are pumping it, you know it has to come here in search of opportunities where else is it going to go. And my point is that it can go into all sorts of wrong places like a lot of it has gone into oil, lot of it has gone into commodities, has gone into people buying fancy wine, luxury goods, gold etc Central banks have put all that money out there because they want growth to revive that the reason for doing it. But you can’t control it. You don’t know where it ends up.
(Vivek Kaul is a writer and can be reached at [email protected] A slightly different version of the interview appeared in the Daily News and Analysis, April 30, 2012)