Some New Lessons on Jobs from an Old Economist

hyman minsky
Many economists do not write in a language which is easily understandable. While John Maynard Keynes was a terrific writer (he is possibly the only economist who actually came up with one-liners), his magnum opus The General Theory of Money, Interest and Employment, which was published in 1936, isn’t such an easy read.

Believe you me! I have tried reading it several times over the years.

Just because the book isn’t an uneasy read, doesn’t mean that the points it is trying to make are not important. As Paul Samuelson, the first American economist to win a Nobel Prize, wrote about Keynes’ book, in a research paper titled Lord Keynes and the General Theory. As he wrote: “It is a badly written book, poorly organized; any layman who, beguiled by the author’s previous reputation, bought the book was cheated of his five shillings…It is arrogant, bad tempered, polemical and not overly generous in its acknowledgements. It abounds in mares’ nests and confusions…In short, it is a work of genius.”

Another economist whose work is not easy to read is the American economist Hyman Minsky, who died in 1996. The world discovered Minsky and his work in the aftermath of the financial crisis that started in September 2008 and so did I.

I tried reading Minsky’s magnum opus Stabilizing an Unstable Economy but could only read it half way through. I have been lucky to have since discovered other authors and economists who have tried to explain Minsky’s work in a language that I have been able to understand.

Over the last few days I have been reading L Randall Wray’s Why Minsky Matters—An Introduction to the Work of a Maverick Economist. Other than discussing Minsky’s views on banking and the financial system in great detail, Wray also discusses what Minsky thought of unemployment. Minsky’s interest in unemployment primarily came from the fact that he was brought up during The Great Depression, when the United States saw never before seen levels of unemployment and a huge contraction of the economy.

And what did Minsky think of the unemployment problem? As Wray writes: “His argument [i.e. Minsky’s] was that simply increasing the “employability” of the poor by providing training without increasing the supply of jobs would just redistribute unemployment and poverty. For every better trained worker who got a job, a worker with less training would become unemployed. Minsky was not arguing against better education and training—he was arguing that to reduce unemployment and poverty we need more jobs, too.”

Minsky also argued against the idea that “if the economy grows at a sufficiently robust pace, the jobs will automatically appear.” As Wray writes: “The notion that economic growth together with supply-side policies to upgrade workers and provide proper work incentives would be enough to eliminate poverty was recognized by Minsky at the time to be fallacious. Indeed, evidence suggests that economic growth mildly favours the “haves” over the “have-nots”—increasing inequality—and that jobs do not simply trickle down.”
How do things stack up in the Indian context? First and foremost, let’s look at the youth literacy number and how it has changed over the years. As per the Human Development Report, in 1990, the youth literacy rate (i.e. individuals in the age 15 and 24) was at 64.3% in 1990. This improved to 76.4% in 2003. In 2013, the youth literacy rate for men was at 88.4% and for women at 74.4%.

What these data points tell us clearly is that the education level of India’s youth has improved over the years. But has this led to more jobs? Answering this question is a little tricky given how bad Indian data on jobs is.

Nevertheless, as the Economic Survey released in February 2015 points out: “Regardless of which data source is used, it seems clear that employment growth is lagging behind growth in the labour force. For example, according to the Census, between 2001 and 2011, labour force growth was 2.23 percent (male and female combined). This is lower than most estimates of employment growth in this decade of closer to 1.4 percent.”

Hence, even though the youth education has improved over the years, this hasn’t led to an adequate number of jobs. This is clearly visible in all the engineers and MBAs that we produce without having the right jobs for them.

As Akhilesh Tilotia writes in The Making of India: “An analysis of the demand-supply scenario in the higher education industry shows significant capacity addition over the last few years: 2.4 million higher education seats in 2012 from 1.1 million in 2008.” In 2016, India will produce 1.5 million engineers. This is more than the United States (0.1 million) and China (1.1 million) put together.
The number of MBAs between 2012 and 2008 has also jumped to 4 lakh from the earlier 1 lakh. As Tilotia writes: “India faces a unique situation where some institutes (IITs,IIMs, etc.) are intensely contested while a large number of the recently-opened institutes struggle to fill seats…With most of the 3 million people wanting to pursue higher education now having an opportunity to do so, the big question that should…be asked…are all these trained personnel required? Our analysis seems to suggest that India may be over-educating its people relative to the current and at least the medium-term forecast requirement of the economy.”

This explains why many engineers and MBAs cannot find the right kind of jobs and have to settle for other jobs.

A major reason for the lack of enough jobs is the fact that Indian firms start small and continue to remain small. As Economist Pranab Bardhan writes in Globalisation, Democracy and Corruption: “Take the highly labour-intensive garments industry, for example. A combined dataset [of both the formal and informal sectors] shows that about 92 per cent of garment firms in India have fewer than eight employees.”

It’s only when small firms start to become bigger, will jobs be created. As the Economic Survey points out: “A major impediment to the pace of quality employment generation in India is the small share of manufacturing in total employment…This is significant given that the National Manufacturing Policy 2011 has set a target of creating 100 million jobs by 2022. Promoting growth of micro, small, and medium enterprises (MSME) is critical from the perspective of job creation which has been recognized as a prime mover of the development agenda in India.”

And this, as I keep saying, is easier said than done.

The column originally appeared on the Vivek Kaul Diary on January 20, 2016

 

Why banks love lending to you and me, but hate lending to corporates

RBI-Logo_8
Regular readers of this column would know that I regularly refer to the sectoral deployment of credit data usually released by the Reserve Bank of India(RBI) at the end of every month. This data throws up interesting points which helps in looking beyond the obvious.
On December 31, 2015, the RBI released the latest set of sectoral deployment of credit data. And as usual the data throws up some interesting points.

What the banks refer to as retail lending, the RBI calls personal loans. This categorisation includes loans for buying consumer durables, home loans, loans against fixed deposits, shares, bonds, etc., education loans, vehicle loans, credit card outstanding and what everyone else other than RBI refer to as personal loans.

Banks have been extremely gung ho in giving out retail loans over the last one year. Between November 2014 and November 2015, scheduled commercial banks lent a total of Rs 5,04,213 crore (non-food credit). Of this amount the banks lent, 39.4% or Rs 1,98,727 crore were retail loans. Hence, retail loans formed closed to two-fifths of the total amount of lending carried out by banks in the last one year.

How was the scene between November 2013 and November 2014? Of the total lending of Rs 5,45,280 crore carried out by banks, around 27.7% or Rs 1,50,843 crore was retail lending. Hence, there has been a clear jump in retail lending as a proportion of total lending over the last one year.

In fact, if we look at the breakdown of retail lending (or what RBI refers to as personal loans) more interesting points come out.

Outstanding as on: (In Rs crore)Nov.28, 2014Nov.27, 2015Increase(in Rs crore)Increase in %
Personal Loans1105910130463719872717.97%
Consumer Durables1466016545188512.86%
Housing (Including Priority Sector Housing)59460370523511063218.61%
Advances against Fixed Deposits553396045851199.25%
Advances to Individuals against share, bonds, etc.38616886302578.35%
Credit Card Outstanding2948637646816027.67%
Education627216768249617.91%
Vehicle Loans1194101378871847715.47%
Other Personal Loans2258302722974646720.58%

 

The overall increase in retail loans has been around 18% over the last one year. This is significantly better than 8.8% increase in overall lending by banks (non-food credit i.e.). Within retail loans, vehicle loans and consumer durables have grown slower than the overall growth in retail loans. How did things stand between November 2013 and November 2014?

Outstanding as on (in Rs crore)November 29, 2013November 28,2014Increase in Rs croreIncrease in %
Personal Loans955067110591015084315.79%
Consumer Durables998714660467346.79%
Housing (Including Priority Sector Housing)5101715946038443216.55%
Advances against Fixed Deposits5603255339-693-1.24%
Advances to Individuals against share, bonds, etc.28323861102936.33%
Credit Card Outstanding2414729486533922.11%
Education589536272137686.39%
Vehicle Loans979141194102149621.95%
Other Personal Loans1950282258303080215.79%

The retail loans between November 2013 and November 2014 had grown by 15.8%. In comparison, the growth between November 2014 and November 2015 was at 18%. This increase can be attributed to the 125 basis points repo rate cut carried out by the Reserve Bank of India during the course of this year. One basis point is one hundredth of a percentage. Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark to the interest rates that banks pay for their deposits and in turn charge on their loans.

But despite a rapid and massive cut in the repo rate, the jump in retail loan growth hasn’t been dramatic. In fact, loans for the purchase of consumer durables grew by 12.9% between November 2014 and November 2015. They had grown by 46.8% between November 2013 and November 2014, when interest rates were higher. Vehicle loans grew by 15.5% in the last one year. They had grown by 22% between November 2013 and November 2014. This despite a fall in interest rates. Home loans had grown by 16.6% between November 2013 and November 2014. They grew by 18.6% between November 2014 and November 2015. There has been some improvement on this front. Hence, lower interest rates have had some impact on retail borrowing, but not as much as the experts and economists who appear on television and write in the media, make it out to be.

What does this tell us? As L Randall Wray writes in Why Minsky Matters: An Introduction to the Work of a Maverick Economist, quoting economist Hyman Minsky: “According to Minsky, bank lending would…be determined….by the willingness of banks to lend, and of their customers to borrow.”

So why are banks more than happy to lend to give out retail loans? As I had pointed out in yesterday’s column, lending to the retail sector continues to be the best form of lending for banks. The stressed loans ratio (i.e. bad loans plus restructured loans) in this case is only 2%. This means that for every Rs 100 lent by banks to the retail sector only Rs 2 worth of loans is stressed.

The same cannot be said about the loans that banks have been giving to corporates. The lending carried out by banks to industry as well as services in the last one year formed around 43.4% of the overall lending carried out by banks. Between November 2013 and November 2014, the lending carried out by banks to industry as well as services had stood at 50% of overall lending.

What explains this? Lending to large corporates has led to 21% stressed loans. The same is true for medium corporates where stressed loans form 21% of overall loans. And this best explains why banks have been happy to lend to you and me, but not to corporates.

The column originally appeared on Vivek Kaul’s Diary on January 6, 2016

Did RBI just hint that Indian corporates have reached Ponzi stage of finance?

ARTS RAJAN
The Reserve Bank of India(RBI) releases the Financial Stability Report twice a year. The second report for this year was released yesterday (i.e. December 23, 2015). Buried in this report is a very interesting box titled In Search of Some Old Wisdom. In this box, the RBI has resurrected the economist Hyman Minsky. Minsky has been rediscovered by the financial world in the years that have followed the financial crisis which started with the investment bank Lehman Brothers going bust in September 2008.

So what does the RBI say in this box? “When current wisdom does not offer solutions to extant problems, old wisdom can sometimes be helpful. For instance, the global financial crisis compelled us to take a look at the Minsky’s financial stability hypothesis which posited the debt accumulation by non-government sector as the key to economic crisis.”

And what is Minsky’s financial stability hypothesis? Actually Minsky put forward the financial instability hypothesis and not the financial stability hypothesis as the RBI points out. I know I am nit-picking here but one expects the country’s central bank to get the name of an economic theory right. I guess given that the name of the report is the Financial Stability Report, someone mixed the words “stability” and “instability”.

The basic premise of this hypothesis is that when times are good, there is a greater appe­tite for risk and banks are willing to extend riskier loans than usual. Businessmen and entrepreneurs want to expand their businesses, which leads to increased investment and corporate profits.

Initially, banks only lend to businesses that are expected to gen­erate enough cash to repay their loans. But as time progresses, the competition between lenders increases and caution is thrown to winds. Money is doled out left, right, and centre and normally it doesn’t end well.

This is the basic premise of the financial instability hypothesis. In this column I will explain that the Indian corporates have reached what Minsky called the Ponzi stage of finance.  Minsky essentially theorised that there are three stages of borrowings. The RBI’s box in the Financial Stability Report explains these three stages. Nevertheless, a better explanation can be found in L Randall Wray’s new book, Why Minsky Matters—An Introduction to the Work of a Maverick Economist.

As Wray writes: “Minsky developed a famous classification for fragility of financing positions. The safest is called “hedge” finance (note that this term is not related to so-called hedge funds). In a hedge position, expected income is sufficient to make all payments as they come due, including both interest and principal.” Hence, in the hedge position the company taking on loans is making enough money to pay interest on the debt as well as repay it.

What is the second stage? As Wray writes: “A “speculative” position is one in which expected income is sufficient to make interest payments, but principal must be rolled over. It is “speculative” in the sense that income must increase, continued access to refinancing must be expected, or an asset must be sold to cover principal payments.”

Hence, in a speculative position, a company is making enough money to keep paying interest on the loan that it has taken on, but it has no money to repay the principal amount of the loan. In order to repay the principal, the income of the company has to go up. Or banks need to agree to refinance the loan i.e. give a fresh loan so that the current loan can be repaid. The third option is for the company to start selling its assets in order to repay the principal amount of the loan.

And what is the third stage? As Wray writes: “Finally, a “Ponzi” position (named after a famous fraudster, Charles Ponzi, who ran a pyramid scheme—much like Bernie Madoff’s more recent fraud”) is one in which even interest payments cannot be met, so that the debtor must borrow to pay interest (the outstanding loan balance grows by the interest due).”

Hence, in the Ponzi position, the company is not making enough money to be able to pay the interest that is due on its loans. In order to pay the interest, it has to take on more loans. This is why Minsky called it a Ponzi position.

Charles Ponzi was a fraudster who ran a financial scheme in Boston, United States, in 1919. He promised to double the investors’ money in 90 days. This was later shortened to 45 days. There was no business model in place to generate returns. All Ponzi did was to take money from new investors and handed it over to old investors whose investments had to be redeemed. His game got over once the money leaving the scheme became higher than the money being invested in it.

Along similar lines once companies are not in a position to pay interest on their loans they need to borrow more. This new money coming in helps them repay the loans as well as pay interest on it. And until they can keep borrowing more they can keep paying interest and repaying their loans. Hence, the entire situation is akin to a Ponzi scheme.

By now, dear reader, you must be wondering, why have I been rambling on about a single box in the RBI’s Financial Stability Report and an economist called Hyman Minsky.

In RBI’s Financial Stability Report the box stands on its own. But is the RBI dropping hints here? Of course, you don’t expect the central bank of a country to directly say that a large section of its corporates have reached the Ponzi stage of finance. And there are many others operating in the speculative stage of finance. Even without the RBI saying it directly, there is enough evidence to establish the same.

In the report RBI points out that as on September 30, 2015, the bad loans (gross non-performing advances) of banks were at 5.1% of total advances of scheduled commercial banks operating in India. The number was at 4.6% as on March 31, 2015. This is a huge jump of 50 basis points in a period of just six months.

The restructured loans of banks fell to 6.2% of total advances from 6.4% in March 2015.  A restructured loan is a loan on which the interest rate charged by the bank to the borrower has been lowered. Or the borrower has been given more time to repay the loan i.e. the tenure of the loan has been increased. In both cases the bank has to bear a loss.

The stressed loans of banks, obtained by adding the bad loans and the restructured loans, came in at 11.3% of total advances. They were at 11.1% in March 2015.
The numbers for the government owned public sector banks were much worse. The stressed loans of public sector banks stood at 14.1%. In March 2015, this number was at 13.2%. This is a significant jump in a period of just six months. The stressed loans of private sector banks stood at a very low 4.6% of total advances.

Let’s look at the stressed loans of public sector banks over a period of time. In March 2011, the number was at 6.6% of total advances. By March 2012, it had jumped to 8.8% of total advances. Now it is at 14.1%.

What is happening here? Banks are clearly kicking the can down the road by restructuring more loans, because many corporates are clearly not in a position to repay their bank loans. Why do I say that? As the Mid-Year Economic Review published by the Ministry of Finance last week points out: “Corporate balance sheets remain highly stressed. According to analysis done by Credit Suisse, for non – financial corporate sector (based on ~ 11000 companies in the CMIE database as of FY2014 and projections done for FY2015 based on a sample of 3700 companies), the number of companies whose interest cover is less than 1 has not declined significantly (this number was 1003 in September 2014 and is 994 in September 2015 quarter).”

Interest coverage ratio is essentially obtained by dividing the earnings before interest and taxes(operating profit) of a company during a given period, by the interest that it needs to pay on the loans that it has taken on.

In the Indian case, a significant section of the corporates have an interest coverage ratio of less than 1. This means that they are not earning enough to even pay the interest on their outstanding loans.

Further, the weighted average interest coverage ratio of all companies in the sample as on September 2015 was at 2.3. It was at 2.5 in September 2014. As the Mid-Year Economic Review points out: “Research indicates that an interest cover of below 2.5 for larger companies and below 4 for smaller companies is considered below investment grade.”

What this means that many corporates now are not in a position to even pay interest on their loans. They need newer loans to repay interest on their loans. They have reached the Ponzi stage of finance, as Minsky had decreed. Still others are in the speculative stage.

The RBI Financial Stability Report again hints at this without stating it directly. As the report points out: “Bank credit to the industrial sector accounts for a major share of their overall credit portfolio as well as stressed loans. This aspect of asset quality is related to the issue of increasing leverage of Indian corporates. While capital expenditure (capex) in the private sector is a desirable proposition for a fast growing economy like India, it is observed that the capex which had gone up sharply has been coming down despite rising debt. During this period, profitability and as a consequence, the debt-servicing capacity of companies has, seen a decline. These trends may be indicative of halted projects, rising debt levels per unit of capex, overall rise in debt burden with poor recoveries on resources employed.”

What the central bank does not say is that rising debt without a rising capital expenditure may also be indicative of the fact that newer loans are being taken on in order to pay off older loans as well as pay interest on the outstanding loans. The public sector banks are issuing newer loans because if they don’t corporates will start defaulting and the total amount of bad loans will go up even further.

In such a scenario, the public sector banks have also been helping corporates by restructuring more and more loans. By doing this they are essentially postponing the problem. A restructured loan is not a bad loan. Further, around 40% of restructured loans between 2011 and 2014 have turned into bad loans.

All this hints towards a large section of Indian corporates operating in what Minsky referred to as a Ponzi stage of finance. Many corporates are also in the speculative stage. And given that, it’s not going to end well.

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

The column originally appeared on SwarajyaMag on December 24, 2015