Why is there is no lending in crisis?

On LinkedIn, Callum Thomas has shared a post detailing tightness in lending standards and gradual shifting to tight credit conditions.

Lending standards tighten at the exact wrong time in a crisis. Also in a crisis the ratings get downgraded en masse. When we want banks to lend, banks do not want to lend. When we want banks to stop lending, banks get busy making risky loans. This is one problem of banking regulation that has not received enough attention. 

Markets and particularly rating agencies need to appreciate the difference between Macro risk (where all aspects of the economy are impaired) v/s corporate risk (where particular company suffers impairment because of its own actions or inactions).

Credit cannot be pushed - it needs to be pulled. To achieve this, a better mechanism is interest subvention. It seems to be a much better tool when macros risks are prevalent.

An SPV which guarantees interest rate up to X% (ranging from 30-50% of lending rate - so for India it will guarantee 3% interest cost for US it could 0.75%) it should cause firms to pull credit and deploy it for productive uses.

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Rahul Prakash Deodhar, Advocate, Bombay High Court is also a private investor. He can be reached at rahuldeodhar@gmail.com, on twitter at @rahuldeodhar or at his website www.rahuldeodhar.com.

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COVID-19 Corona Virus - What we need to know.

I have uploaded my first video on Corona Virus what we need to know. Please watch and subscribe to the YouTube Channel. Also follow Right Views on Twitter (http://twitter.com/rtvws) and Instagram (https://www.instagram.com/rtvws/)




The video is accompanied by info pack that can be downloaded here.

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Rahul Prakash Deodhar, Advocate, Bombay High Court is also a private investor. He can be reached at rahuldeodhar@gmail.com, on twitter at @rahuldeodhar or at his website www.rahuldeodhar.com.

Buy my books "Subverting Capitalism & Democracy" and "Understanding Firms"

India Growth Model 03: Fix-Contest-Leapfrog-Prepare Growth Model for India

Indian growth model must have various components addressing local AND global demand. The window of opportunity is short, we need to develop faster. The growth needs to come from both public and private sector and must utilize the Indian human resources. I propose a four-way Fix-Contest-Leapfrog-Prepare model for growth.

Fix

For basic infrastructure and basic capacity building there is enough capital available globally and that capital is seeking low returns which is good.

We need to continue to fix basic infrastructure, from ports, roads, power, housing, etc. to law and legal systems, education, defense to modern infrastructure like telecom and digital infrastructure etc.

We need to continue the cleanup that began in 2014 which mean reformative laws need to be cleaned and reworked for example, Insolvency and Bankruptcy Code, GST Act, etc. needs to be shepherded through the legal institutions that are trying to muzzle it.

However, the most important part of this strategy is to create a proper social security framework. What demographic dividend we envisage, will turn into a demographic nightmare in about 40 years. The problems faced by pensions, medical insurance, health insurance etc. In the developed countries like US, Japan, Europe etc. Signal potential pitfalls for the Indian economy.

The Fix strategy focusses mostly on government action. While there is ample scope for Public-private participation or for divesting government created infrastructure to investment vehicles, the central focus of this strategy will be driven by government. It requires high quality last mile delivery. The strategy will depend on known and innovative models of government action.

Contest

The Contest strategy is relevant for industries operating currently. The catch-up will involve penetration, locally by global companies and globally by Indian companies, of known business models. It is spread of McDonalds and Sushi across the Indian hinterland. It is also the spread of Vada Pav and Fish curry across the remote corners of the world.

This strategy portends that we will liberalise and open the economy. At the time when trade wars are looming large, this will mean global corporates will focus on India intensifying the competition in the domestic space. This will be quick win for consumers and job creation but a difficult time for domestic industry. However, it is not all bad, things will improve for domestic industry also. Something similar to what we say between 1992-1994 and between 2002-2005 we can hope to achieve. This is domestic battle. Battle for Indian consumers by Indian and global companies.

However, we need to prevent the mistakes and learn from the experience of the world when we liberalise. Thus, we may want to regulate the propogation of Genetic modified foods, or hormonally treated meats etc.

The contest strategy focusses on private players and known business models. The role of government shall remain limited to regulation and monitoring. Coordinated export development strategy is required. This means industrial policy will be as important as Fiscal policy.

Leapfrog

Generating, lasting, fast paced private growth is quite difficult. Particularly at the time when trade wars are looming large where economies will try to protect their jobs and therefore their markets. It will come from those industries where we India can deliver susbtantive and impossible to replicate advantage that will remain exclusively tied to India. This will be the focus of the Leapfrog strategy.

The Leapfrog strategy will focus on IT/ITES, Food, Fashion, Jewellery, Movies, Music, Entertainment, Culture, medicine, among other sectors.

Leapfrog strategy will be driven by innovative private players. The role of government will be limited but innovative interventions. We also need champions for each of the industry clusters working in this area. Dewang Mehta is the name that immediately comes to mind.

Prepare

At the time we are developing this strategy, we need to keep an eye on emerging trends in distributed manufacturing, robotics, artificial intelligence, advances in biology, etc.

These opportunities are for the private sector. In this report we focus on what private sector can do to address these opportunities in the economy and market place and create value. This participation by the private sector will entail some innovative groundwork by the government. We highlight that in later section.

Model in summary

The Fix-Contest-Leapfrog-Prepare Model is meant to limit the role of the Government. It also recognizes that Government is also necessary and required to deliver certain services. Thus, the model is centrist in terms of economic leanings. It is meant to clarify the necessary reform that government needs to undertake and to underline its urgency.

It is also the aim of this model to enumerate some of the many opportunities open for private sector in India. It is the private sector that will create those jobs. The model is meant as a treasure map that hopes to inspire many private sector treasure hunters to go forth and seek this treasure of growth and prosperity for the economy.

It is also important for this model to highlight the nature and extent of coordination that will be required between government and private sector. Both these entities will be required to complement each other so that India can address these opportunities before us. Coordination is more important because, unlike between 2002-2007, the macro environment is volatile.

The Fix-Contest-Leapfrog-Prepare Model will be explained in detail in subsequent sections.

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India Growth Model 02: India needs a new Growth Model

India needs growth at a time when global growth is sluggish, globalization of trade and supply chains has plateaued and is likely to reverse. These headwinds are challenging for any economy. Therefore, the Indian model of growth has to be substantially different.

Proven business models are broken

Across times countries have deployed similar models for growth. They are based on trade to places that have demand for goods / skills available in your economy. This demand emanates from cost arbitrage or availability arbitrage. 

Early Europeans were seeking spices available only in the tropical Asia. At that point in history they did not have much to trade with Asia but Industrial Revolution changed all that. With use of force they were able to maintain demand side and supply side in control and make neat profits. This enrichment of Europe came at the expense of Asia and Africa. The armed control over markets and suppliers allowed Europeans to run a level of protectionism that is unparalleled and hopefully will never be repeated. Nevertheless it represents one model of growth.

In the pre-war era, America developed exporting to war torn Europe. Taking advantage of wage differential, higher risk tolerance thanks to innovative risk mitigation mechanisms, and a healthy domestic demand augmented by immigration, Americans were able to enrich themselves both at the expense of Europe in some cases and also in cooperation with Europe in others. American protectionism was more from the cost side. Using slave labor and forcibly usurping the land and other resources Americans were able to create value. The American growth model was thus based on military industrial complex.

The Post World War II development of Europe was entirely based on exploiting American demand augmented by domestic demand from rebuilding initiatives supported by low cost capital. This time, Europe was not able to run the kind of protectionism that had benefited them earlier. However, they benefited from twin protectionism. Europe enjoyed fortuitous financial protectionism based on low cost of capital thanks to Marshall Plan. It also engaged in currency management to help sustain the development. There were other factors allowing faster growth in Europe - lower population in all of West, new technologies from war for productivity enhancement and solid demand from rebuilding.

The Japanese growth which partly overlaps with European growth was also based on the same premise. Japanese fine-tuned this strategy by self-deprivation and focusing on exports to the West turning it into a protectionist advantage. Japan had another advantage, it did not need to spend on military and defense.

However, this dependency of Japan and Western Europe became unbearable for United States which was operating under the Gold Standard. It lead to abolishing of Gold Standard and start of modern finance driven development era. This is the time when John Connally made his two famous statements - “Dollar is our currency and your problem” and the ever prescient and my favourite “My philosophy is that all foreigners are out to screw us and it’s our job to screw them first.”

East Asian tigers and then China were the first to take advantage of the growth unleashed in this period. Using essentially the same model, these countries relied on pegged exchange rates and export demand to move out of poverty. By the time India joined the party in 1991, this model was quite well understood. The initial quirks were exposed during the South East Asian Crisis. The crisis led to refinement rather than correction of the model.

By 2002-03 this model became so well understood that most of the developing countries started using this model. Over-reliance on consumers from developed world and excessive constraints on domestic demand were norms of the day. This old model of development has finally broken or is in the process of breaking. In effect we will need a new model for growth.

Indian model of growth has to be substantially different. It has to withstand competitive forces right from the word go. India will not have any advantage of protectionism except what naturally accrues to it. Indian model must take advantage of the uniqueness of Indian demand in comparison with other countries. Given that Indian markets are not exactly uniform, India can become the hotbed for innovations that can be exported to the whole world.

The future is hypercompetitive

In the next phase of globalization, we are likely to encounter countries defending their domestic consumer. India has to withstand competitive forces right from the word go. India will face stiff competition winning in the markets outside India. India will not have any advantage of advantages except what naturally accrues to it.


Thus, India will have to fight for the global consumer,  some times on unfavorable terms, other times with entrenched players. India will face technological gridlock making innovation costly and product development long drawn. India will also have to face adverse tacit protectionism in the form of unreasonably demanding product/service quality or unreasonable punitive damages from product/service failure.

Within Indian markets too there will be intense competition. There is shortage of consumer demand globally. All the top companies will look to gain from addressing the Indian demand. This competition will be both - an opportunity and a threat. If this competition for domestic market creates jobless profitability then it is threat. If it creates vibrant ecosystem then it is an opportunity. Indian model must take advantage of the uniqueness of Indian demand in comparison with other countries. Given that Indian markets are not exactly uniform, India can become the hotbed for innovations that can be exported to the whole world. Thus, the ecosystem will create competency to win across the world.

In short, while other countries grew by looking outwards, India should grow looking inwards AND outwards. But, how will India grow? 

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India Growth Model 01: Introduction

Two forces help the arduous journey of a nation towards progress. The How force makes us confident to embark on the journey and reduces the risks associated with it through sheer details. The second force is the Where force. It is the lure of the dream of a new tomorrow. That dream makes us turn, it gives us energy, carries us through the tough times and gives our life meaning. A nation that knows its WHERE can bear with any HOW! (1)

I was a bit disappointed with the Niti Ayog released their report titled “Strategy for New India @75”. [Here is the the accompanying presentation.] It was a very detailed HOW. The WHERE is missing - not just from the report but even from discussions, research papers, media. It is as if our WHERE has not been conceived. And that is a problem as the “how” depends on WHERE you are and WHERE you want to go. Without the WHERE, everything seems important and when everything is important, nothing is.

Even now the Where is missing. What does this India of 2050 look like? What do people do in this developed India? Where do they work? Where do they live? What do they wear? What things do they buy? What is their relationship with their government? What is their relationship with other countries? What are they worried about? How are the cities? How is the countryside? We can imagine many questions and paint a picture of India at 2050. It is here we want to go. This is our WHERE.

When we know the WHERE, our entrepreneurs will start gearing up for the challenge. When we know the WHERE, we will know what to prioritise, what to speed up, where can we go easy.

In my mind, I have a WHERE and hence my HOW is a little different. So this effort is to paint a detailed picture of the WHERE and augment the picture of the HOW we have already seen.

This series of posts details my thoughts on vision of new India and how to get there. These thoughts I will compile into a report at the end. At present time, the thoughts come from a broad based thinking on the topic, the final report will differ from this but hopefully not by much.

Notes:

1. Alluding to the quote “Those who have a 'why' to live, can bear with almost any 'how'.” ― Viktor E. Frankl, Man's Search for Meaning

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Comments on Ray Dalio's post on Monetary Policy 3 and MMT

Ray Dalio's comments are always well researched and interesting. For starters, I think, Principles for navigating Big Debt Crises is must read. (Its free PDF). His recent post on his LinkedIn blog is about Monetary Policy 3.0 and MMT. 

Some fundamental comments about present crisis:

1. QE only creates a space for fiscal response: Central banks and governments alike misunderstood the role of monetary policy in the 2008 financial crisis. The crisis was different than others we have faced since Great Depression. Per my reading of Keynes (which seems to different than Keynesians and neo-Keynesians both), in such crises, the proper response has to be from fiscal side. The monetary policy merely creates space for the fiscal response or accommodates the fiscal response preventing untoward consequences. The response had to be holistic - a coordinated and sustained monetary and fiscal policy response.
2. Fiscal policy amplification mechanism is broken: Broken may be a harsh word, we may choose "has become messy" in its place. The point is, fiscal policy needs an amplification mechanism. When government starts infrastructure spending, it needs some real value-creating sector to take it from there and start driving the economic engine. At present we do not have such "real value-creating sector" that can boost employments and wages generally. In 1980s we had tech, in 2000s we had internet, now we need something. In absence of a big driver, we need many small ones. If such capability is difficult to create in one sector it is quite difficult to create in more than one sectors too. The solution is to let inherent advantages play out.
3. Inherent advantages are muzzled: Inherent advantages have stopped driving international trade since east asian crisis, and at a larger scale with China's entry to WTO. Instead, we have pegged exchange rates (soft/hard/overt/covert), manipulated tariff and non-tariff barriers, and, in general, non-transparent trade policy. Until that is fixed we cannot have trade based on pure competitive advantage.
4. Small business innovations are indefensible: When people talk of China usurping Intellectual property they usually talk about submarine plans etc. But I am talking of something very basic. Check out new funding projects on kickstarter - innovative shoes, innovative bags, innovative pens, anything that takes your fancy. Just search on alibaba or just wait for few months you will see some products like those (invented by kickstarter entrepreneurs) in the market on mass scale. These products are not sold by those companies who invented them on kickstarter or such platforms. This is IP theft that hurts the most. It removes new business competitiveness right at its infancy.
5. Trickle-up always works; trickle down some times: Monetary policy practitioners and academic economists in general prefer trickle down economics. But empirical evidence says reverse is true. Trickle-up works all the time. Thus, when there is a choice of bail out, we must lean to lower strata. (A) It is more fair and just, (B) better optics and (C) right incentives. But MAIN reason it works because it balances the bargaining power of both sides. Bail out the top and they lean on to regulation to prevent or constrict trickle down stifling the economy. Bail out the bottom and lo and behold all the incentives align beautifully.
6. Certainty of employment and wages is the one super-indicator: The best solution to any crisis is to get certainty of employment and wages going, rest follows from that. Today we have almost full employment but it is uncertain. Wage predictability is also uncertain. That's why the lack of demand is so persistent.
7. Interest Rates are like friction: Too much and too little friction are both bad. Sames goes for interest rates too much is bad, too little is ALSO bad.

Some comments about Monetary Policy 3:

1. Debt financed Fiscal spending financed by QE: I don't agree with Ray Dalio that this was pursued after 2008 financial crisis. The fiscal spending was essentially going to the same group who could access the QE funds. Yes, there was fiscal deficit and increased fiscal spending and yes there was QE to finance it. But this is exactly the wrong kind of stimulus as I have written since 2009 itself.
2. Giving $10,000 to one person Vs $100 to 100 persons Vs $1 to 10,000 people: Helicopter money is not easy to design. The behavioral response in each of three cases varies drastically.The range of outcomes possible is mind boggling.
3. Spending conditions interfere political rights: If I am tasked to spend $10,000 can I give it to someone from my family to pay down her loan? Does that amount to spending? Should I buy something? What thing? These questions are difficult to answer, monitor and control. 
4. A little inflation is necessary: People will spend when they can surely afford it (condition above - certainty of employment and wages) and it will get costlier tomorrow. Inflation is important, zero inflation may not be that great.

The examples of Monetary policy 3.0: 

The best part of the analysis is the historical perspective Ray Dalio gives. Sharp readers of this blog will immediately note that there are fundamental differences between the conditions in various situations described and those existing now. That is acceptable difference.

Particularly interesting is the Roosevelt response in 1930s. It still forms the basic template for solution today. However, we are at a slightly different position today than in 1930s. So we have to make more adjustments than Dalio may seem to suggest. [Dalio is NOT suggesting it - it appears simple but it is incredibly complex - politically, fiscally and economically]

In Sum

Do not understand these comments as put down of Ray Dalio (as if he cares what I think!). I admire the man because he is being honest and creating a framework to solve the crisis. Good intentions and honest efforts deserve praise - even if the guy making those efforts is one of the richest.

From my side, I solved this crisis puzzle back in 2009 itself.

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Socialism or capitalism - Big government is a consequence, Small government an objective

Look at what they do NOT what they say!

Socialism or Capitalism - it is one of the central discussion points these days. Socialist too form a broad spectrum - from Bernie Sanders to AOC to Elizabeth Warren. The capitalist are not yet vocal but many are simply dismissive of the left-leaning neo-politics. But are there really left-right differences? Not too much. And I say that as I look at what they do NOT what they say.

Governments get bigger

The basic aim of government at the formation of Amercian revolution was twofold - Army formed protection force protecting citizens from outsiders AND legislation, police, courts system formed Law and Order for resolving disputes among citizens.

Gradually government came to provide diverse services - education, healthcare, insurance, subsidies, legislation and regulation of various industries. Each of these activities has grown in scale over the past 100 years. 

When you want government to take up more responsibility then you will end up with a big government. 

Big government = MORE TAXES

First objective of taxes is to pay for the government. In some countries the salary expenditures of government account for more than 50% of the total expenditure of the government. This is not counting the maintenance cost and other regular expenses government has to incur just to exist. = MORE TAXES.

Then all these people employed by the government have to do something. Even if they do nothing and just make presentations they consume a lot of money. That requires even more budgets = MORE TAXES.

To make it worse usually they add to procedure and impose cost on society. They prevent innovation. They make it their responsibility to say NO. That stops entrepreneurs before they can create value. It means MORE HIDDEN TAXES.

It all eventually leads to more taxes.

 

Big Government attracts big responsibility

People have started viewing government as a provider. Governments have encouraged that view. In effect whatever we want to get done, we want government to do it. We would like universal health care, you ask government. You want insurance for all - you ask government.

When governments become bigger, governance becomes difficult. Hence laws turn into fine prints, every step of industry is managed by dozens of legal clauses. Compliance becomes a cost.

Big government is a consequence - Small government is an objective

We need to prune governments regularly. On one level that means improving productivity of government servants. But on other level we need to reinvent our systems to be designed for less government.  But remember, no matter what they say, they will increase the size of government AND they will increase taxes AND they will default towards socialism.

To prevent it we must actively reinvent the system to stay on the money. We shall discuss how in subsequent posts.

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World War 3 Watch 04: Indian Defense Equipment strategy

India needs to up its defense game. India is dealing with potential conflicts on two fronts. On both these fronts we have belligerent neighbors engaged in asymmetric multi-dimensional confrontation. Pakistan is more of warfare and China is more of competition. Yet, India must prepare for the potential conflict. And in this we need to improve our preparation substantially.

Airforce

Just cursory look at the Air force in the region will set us back. Pakistan Air Force generally known combat strength is about 500 aircraft. China is about 1600 aircraft. India is about 600. While the numbers are not exactly a way to differentiate - but considering the length of border and our defense requirement India should aim for 2000 combat plane air force.

This means HAL cannot produce 16 aircraft per year. It has to produce 16 aircraft per month. Using private participation we need to improve this number quickly. Second, it appears we need full Rafale deal AND a F16 manufacturing line at the same time.

IAF should also think of getting larger number of combat drones. These drones should be able to manage to fly with manned aircraft. This one manned aircraft (M) -coupled with around 10 drones (D) or more. Thus one mission unit with M-D combination. Then you can add mission units with xM-yD.

These mission units will need to collaborate and coordinate with share intel. That will require a robust ICT interface.

Airforce needs support from ground and space in the form of missiles and information. We should develop mechanism for coordinated launch of missiles controlled by the aircraft pilot herself. We can augment it with coordinator based ground support too.

Army

The future soldier will be an augmented information soldier. 

We need to up our game in terms of equipping the soldier with top-class equipment. AK-203 is a step in the right direction. But we need to lighten the soldier and get every soldier a robo-buddy. The buddies could be in multiple form - carrier mules, terrain mapping drones, communication bots and combat drones (sniper buddy). For this we need very intense development in robotics and again the ICT component will also play a role.

We should experiment with augmenting the soldiers with exoskeletons and other techniques to improve battleground performance.

Air-cover has been neglected part of the army. Apache helicopters in air support is essential. 

Navy

Future of navy is stealth platforms. As the US stealth ship Zumwalt goes for a maiden mission, China is developing aircraft carrier buster missiles. The Chinese missiles are hyper-sonic and thus almost impossible to intercept. In this context any above surface ship will find it difficult to beat the defenses. Hence reliance of submarine platforms should be increased.

Sub-marine drone tech is actually quite interesting. It can be used on sink-and-forget  wait mode. Thus we should be able to plant and move around many depth assets on wait and watch basis. Without humans on board this is (a) easier and (b) safer. It also improves the counter-strike and defense capability. These drones should be easy to manufacture in large numbers and low cost. These drones need not be large they can simply be attachments to ammunition that can help the ammunition to navigate and activate.

Deep sea surveillance and AGAIN ICT is also going to be critical.

So Navy must develop platforms but also develop choking -technologies for anti-ship systems.

Space wars

Space is important front for information wars. The satellites form critical part of the ICT infrastructure we need to deploy across the forces.

Satellites should be able to perform twin functions - jamming enemy satellites and keeping ICT infrastructure working for our forces.

The ability to quickly and rapidly restore downed satellites is very important. We should also explore possibility of smaller satellites that can last only for 5/6 months and then disintegrate. The smaller the satellite the costlier it is to destroy. Also because of size, you can build for redundancy. It is also possible to launch 100 satellites in one launch. These satellites are more relevant for theater coverage rather than country coverage.

Cyber war

Most of modern warfare is quite destructive and hence preventive techniques are more important than remedial measures.Cyber war allows for information and processing delays in enemy retaliation and gives us additional time and information to respond better.

Many times it is better for cyber initiatives to operate in bleeding mode than in crippling mode. Thus, it is better for cyber initiatives to delay the enemy communication rather than cripple it. Thus introducing delays and errors is better than crippling the infrastructure for short time. These cyber initiatives can also provide advanced information about enemy maneuvers. The aim is to destroy combat assets of the enemy.

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Indian Foreign Policy

Since last month's attack on Indian Security forces in Pulwama by the Jaish-e-Mohammad terrorist group, I have been thinking about the changes required in the national policy. Today we get the news that China once again blocked the proposal to declare Masood Azhar, the leader of JeM as a terrorist. In light of these developments here are some thoughts about Indian policy. 

Note: Many sound quite conflicting but that is the reality. I miss Narasimha Rao.

With Israel

India MUST announce a proper strategic deal with Israel including multi-faceted cooperation including defense, technology, agriculture, business, banking etc. 

We must improve integration with its defense network. A Multi-track developments must take precedence -

1. Designed in Israel, made in India, (avionics and defense info-tech subsystems)
2. Jointly designed and made by Israel and India,  (missile, interception & drone tech)
3. Designed in India and made for Israel - (aircraft and other equipment)
4. Joint Cyber warfare development cell.
5. We should have joint training - allowing Israeli forces to train in various conditions and set up training with them in Israel too.

We should aim for Agriculture and water management technology collaboration. We should explore policies that should allow Israel-India manufacturing companies to go global - compete across the world. We need to have 3 such companies be global brands like say ikea.


With Russia

India MUST announce a proper strategic defense deal with Russia as well. Russia is a long-term partner and we must improve the interaction with Russia. We must engage with Russians for heavy equipment - fighter aircraft, ships and submarine.  We should further the missile development cooperation and aim for joint technology development in defense space.

Economically, we have to help Russia ween itself from Chinese dependence. Russia should be able to stall and deny China without a huge economic cost.


With United States

That India and US are not friends is first the fault of India and then the fault of US. Unfortunately, today there a little bit of mistrust still left. 

India MUST have strategic partnership with US and must join the Quad.

1. This will include setting up bases
2. We must join the information sharing treaty with US
3. We must have/develop defense ICT that is interoperable one with US. 
4. We need cyber defense cooperation with Quad.
5. We need to step-up and take our responsibility in Indo-Pacific. 
6. We also need deeper collaboration and joint exercises between US and Indian defense forces.

With Japan

India must enhance partnership with Japan on following fronts:

1. Fighter aircraft development
2. Ship-building tech.
3. New Drone tech

 With Japan, India must set up ventures to develop infrastructure in the Indo-Pacific region. Japan has the capital and technology and India will need to give its man-power.


France
In general, it is not well-understood that France has been a long-standing defense ally of India since independence. More than Britain which somehow finds more sympathy than France. India and France need to improve the cooperation on defense as well as non-defense sectors.  We need to improve the status of France in the Indian economic and defense scheme.


South East Asia/ Asean / Asutralia New Zealand
We have to play very pro-active role in this region. We can work on the food side trying to reduce the cost of food and other goods in this part of the world.


About Pakistan
Pakistan will continue to remain an irritant unless we take proactive effort to eliminate the terrorist setup. It can be eliminated by imposing very high economic costs on the Pakistani Army. To this end, India needs to be part of Afghanistan solution. If US cedes Afghanistan to Taliban or to Pakistani Army backed group, we will soon have trouble on Indian soil.


Working in Middle East

India must UNDERSTAND and ACT on the fact that we are Hindu majority country AND we are the largest democracy of Muslim at once. India must use this to influence a lot of things in the Islamic sphere and give it a better direction. We must champion the reforms taken up by other middle eastern countries and overcome the regressive developments taking place. 

Africa

India should be able to collaborate with Africa much better than any other country. We should provide the institutional support and help African companies develop as suppliers to India. Japan and other countries will surely help us in this process. We have to showcase a credible alternative to Belt and Road but with good clean reformist credentials.

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Time Travel effect of Debt

Generally in Time Travel movies the actors go back in time to change some minor thing to alter the future dramatically. Debt does this in reverse.

Debt pulls value from future and alters the present in such a manner that more value is created in the future than estimated.

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One problem with Indian capital risk return matrix

One problem with Indian corporate and their regulation can be summed up in the chart below.

Ideally a simplistic capital risk return matrix looks like this (click picture for larger version). In the best of places it comes close to this. Note that this is a simplistic depiction.

Ideal Capital Risk-return matrix

In India, it looks like this:

Indian Capital Risk return matrix

This is law enforcement issue as well as information issue. There is lack of regulation on conflict of interest between promoters and investors (small and big), there are many issues related to corporate governance. There is paucity of information to ratings agencies and these days the rating rigour is under a cloud with intense competition.

The chart also tells us why India does not have a deep bond market. Since my days in CRISIL, we have been harping on the improving the depth of bond markets. But so long as the risk-return profile continues there are no incentives for it.

The dispute resolution mechanism is abysmal. It is particularly unwieldy, long winding, costly and infructuous in the end. This has hurt investment in the country. Once this is fixed India will have unprecedented growth in equity and bond investments.

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How Low interest rate can be bad for small business - 2

In a 2012 post with same title, How Low interest rate can be bad for small business, I had explained mechanics of how small businesses are denied capital BECAUSE of lower interest rates. This was summarized from my book Subverting Capitalism and Democracy. Over the years few readers have asked for further explanation. So here goes.

Demand for projects

Let us look at the following schematic.

Capital Quantum and return

The diagram shows the amount of capital demanded and its possible rate of return. The distribution is made from capital requirements of various businesses of various sizes. The financed part is the blue rectangle. The width of this rectangle and its location is determined by various factors.

Now our experience tells us following details - (1) smaller businesses have higher risk profile whereas larger businesses have lower risk profiles; (2) smaller businesses have smaller quantum requirement whereas larger businesses have diverse capital needs; (3) as a corollary projects with large quantum of capital requirement and low return are dominated by large corporations.

Therefore, let me quote what I said earlier:

How low interest rate leads to mal-investment
A bank takes risk by investing in a venture. Interest rate is also a reward bankers get, for taking the risk. Ideally, even in lower interest rate scenario, those projects with best risk-return trade-off should get financed.

However, in reality, lower yielding large borrowings backed by reputed corporates get access to financing more easily than new ventures. This means, irrational mega-projects or mal-investments of large corporates get financed at the cost of genuine investments of new ventures.

Typically, such irrational mega-projects consume a lot of credit requiring load syndication. This has twin benefits for bankers. First, there is a higher degree of comfort in being with the herd. Secondly, bankers do not have to go through credit appraisal of many small entities of questionable risk profile. This makes them assign a lower risk to these projects than appropriate. Intelligent investors will find that this contradicts with the "diversification as risk management" strategy. But being with herd has a stronger lure and is treated as risk mitigation (though wrongly).

Further, at lower interest rates, debt starts being used as an instrument to amplify equity returns. 

Thus the second blow to new ventures comes from crowding out. It implies that even in a low interest rate environment, small businesses and entrepreneurs may not have access to lower cost capital. Therefore this impacts the long-term strength of the economy.

The Mechanics

When interest rates are low this rectangle starts more towards the left. This is space where there are weak business models, those that are viable only in low return scenario. This space has irrational mega-projects of large businesses like debt financed share-buybacks etc. With the superior credit rating of large businesses these projects crowd out the smaller businesses.

As the interest rates rise the rectangle is pushed rightwards. In high interest rate scenario, the irrational mega-projects seem less promising. Hence, contrary to popular belief, it may be easier for smaller businesses to compete in high interest rate scenarios. 

Are few projects with consortium lending more risky?

The answer to this question is easy if you understand it from banks perspective and not from bank manager's perspective. From bank's perspective more the number of projects it finances the more the diversification possibility and thus lesser the risks.

But this has higher risks for bank manager who has to stick out her neck for each of these projects. From bank manager's perspective fewer the projects and more the number of borrowers approving the project as credit-worthy lesser the risk for bank managers. But this means more the risk for the bank (concentration risks).

In sum

The cumulative effect of all these is that at low interest rate the credit is denied to small borrowers at the expense of irrational mega-projects of large businesses. When the interest rates rise, as they always do, these projects turn bad and become a drag on the economy.

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About Australian banks and Australian property

John Hempton highlights something interesting today about resignation of top Australian Bankers.

Back in 2016 John Hempton and Jonathan Tepper of Variant Perception conducted research by personally meeting with the real estate brokers and seeking apartments to buy. In a sort of reply of scenes from the Big Short, they found banks wanting on the paperwork, mortgages being sold to those with questionable ability to repay. You can read some media reports about this here, here or here.

Today John Hempton wrote about recent firing in light of the final report of the Royal commission into banking and detailed allegation therein. John Hempton says:

Anyway come the Royal Commission Dr Henry talked to the Commission in a frank and open way about the problems. It was Dr Henry being Dr Henry: honest, competent, and realistic.

It came off badly. I remember the grilling he got from the Royal Commission and understood what was happening. It was clear that what was required from the Royal Commission was kowtow, rather than honest frank discussion. Dr Henry looked bad even though he was probably the single most reliable and honest witness the banks put up.

The Royal Commissioner made specific findings against Dr Henry and Andrew Thornburn. This surprised me because on my research National Australia Bank was the best of a bad lot, both in absolute level of moral decay and in direction.

The report quotes Dr. Henry and Thorburn in many places. The transcripts do not show Dr. Henry in good light. The transcript indicates that possibly Dr. Henry took this too lightly. He did not do any homework. A deposition once you are sworn in is a serious business. I do not sympathize with Dr. Henry.

The transcript of some others reveal that they kept repeating from jargon books and PR manuals. To that extent whatever their deep rooted ills did not come out. 

Implication for property market

There are two fundamental issues with the housing and mortgage markets. 

First the search for yields and the quantum of capital available makes real estate the best asset class to absorb the QE effects. It is doing precisely that. So some of the price appreciation is attributable to this. The macro policies have created this asset builders boom - create an asset and sell it to REIT type holders at ludicrous cap rates without any regard to final consumer.

Second, the problems in mortgages are of banks creation. As banks search for return in a tight market they have crossed the limits. The crisis in Australian banks is part of continuum that includes Wells Fargo opening accounts for customers to US sub-prime crisis. It may not be as acute but it is part of the same class.

Learnings for Commissions in India

The commission for banking has its website and documentation spot on. I urge Indian commissions to maintain such kind of records open for public scrutiny.

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Questionable Promoters' action

Deepak Shenoy from CapitalMind has an excellent blog and website. His post today titled Jubilant Backtracks From Paying Promoters For Brand They Don’t Really Use deals with some questionable actions by the Bhartias. Below are edited quotes from that article.

Jubilant Foodworks and Jubilant Life Sciences in a board meeting, they proposed a 0.25% royalty on consolidated sales for using the “Jubilant” name , to each of the companies.

To give you a perspective Jubilant Foodworks is franchisee operator for Dominos and Dunkin Donuts both well known US brands. Jubilant Life Sciences is a pharma company in generics and contract manufacturing.

The article further details various business groups doing this activity in some form or other. The two prominent ones that are missed in that discussion are the Aditya Birla Group and Kingfisher. Here are some from the article:

• Royalty from listed companies - 
• Colgate from Colgate India (4.8% of turnover) 
• Unilever from HUL (3.15%), 
• Dominoes from Jubilant Foodworks (~3%), 
• JSW Steel to Wife of Promoter (INR 1.25 billion)
• Tata from Tata companies using Tata name (0.25%) 
• Tata from Tata companies not using Tata names (0.15%)
• Muthoot group
• Shriram group
• Wadias (intending) from Britannia Industries
• Loans to promoters later written off
• Network 18
• DHFL (Alleged)
• Merging promoter companies with listed ones at unclear valuations
• Satyam
• JPAssociates
• LEEL
• Eon electric (attempted)
• Vedanta
•  
• Financing Promoter lifestyle
• Raymond - maintaining Raymond House

I do not like these kinds of "promoter earnings". You are either a promoter or an employee - don't be both. These should come within the purview of related party transactions irrespective of their materiality.

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Urban Development problem in India - the lack of proper Development Plan

Recently, I had the opportunity to examine the Draft Development Plan released by Maharashtra State Road Development Corporation (MSRDC). The plan is quite badly designed. Yet, what hurt me more was the fact that this plan was developed for Special Planning Area (SPA) which is not developed as much so the development is almost green-field urbanization. And yet, even when we are given a clean slate we make such primary mistakes in planning. I wrote about the shortcomings in an Article in Moneylife.in titled "How can smart cities be built on dumb development plans?"

I have looked at the population, water demand estimation, power demand estimation, waste estimation, transportation planning etc. On every parameter this plan falls short. Have a read and leave comments.

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Oil trade routes and India's geo-political advantage

Here is a picture about oil trade routesfrom Geopolitical futures:

You can see the Geo-political importance of India. India has access choke-points carrying about 40 million barrels per day - 4X flow at all other choke points put together. Guarded by a decent navy that can go against the best.

You will realise why China is interested in this area and interested in encircling India with string of pearls. More so if you have read Daniel Yergins The Prize. (If not read it now for understanding of oil industry).

For more details of balance of naval presence in the Indo-Pacific region look at the map below:

Naval Bases in Indo-Pacific - Rahul Deodhar (data from public sources)

These maps are important tools to understand Geo-politics and George Friedman of Geopolitical Futures has a great compilation. Head over there to check it out.

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Can only US markets go higher in the face of tariffs and other trade headwinds?

In one word - NO!

One the trade front, the US needs other countries (suppliers) as much  as other countries need US as a consumer No. 1. Yet, the consumption burden falls excessively on the US. That too is not sustainable. In the natural course of things this burden should gradually pare down. This natural process was impeded by interventions in currency and trade policy by (a) East Asian economies following 1997 crises and (b) Japan first then China. 

In the first case, the impact is benign as the comparative sizes of the economies in South East Asia and US/UK etc is too big. 

The second case turned out to be problematic, though bit less, in case of Japan. Absent the computer and technology revolution, US would be in same position as today as in post-Japanese growth phase. At the time when the US jobs were diminishing in the face of Japanese competition and trade, Tech was already cooking in the oven. The massive productivity boom unleashed by tech was supported by job growth in new sectors. These sectors pulled decent quantum of current workforce and modified the training profile of upcoming workforce.

Today, there seems to be no new sector that is vigorously attracting the current workforce into itself. There are two reasons for this. First, the speed of Chinese growth is dramatically higher than Japanese growth. What Japan achieved between 1945-1980, China achieved between 1980-2000. Second, Japan started at the time of man-power constraint. China started gaining traction when manpower was becoming surplus. Therefore, job "protection" in developed world has become important.

The trade fears can be allayed / calmed if there is another sector that can create as many jobs for the profile of workforce that exists today and about 20 years from now. Absent that, growth will require  fighting for a larger share in a diminishing pie - a potent trigger for conflict.  The war can be won by biggest bully if he is alone. But when there are a few contenders it takes time to settle the pecking order. Many skirmishes (I mean trade & currency conflicts) need to happen to settle that order. For strategy suggestions we can look at how pecking order is established in prisons. The strategies will be same the tools will be sophisticated. 

Thus, US cannot do trade wars alone. US needs its own "gang". That gang was NATO, NAFTA and these days the "Quad".  The Stock markets of one gang may rise if the gangs are tighter) and they may decouple from other gang. But only US markets rallying is not possible.

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My two favourite HR people!

I was listening to Masters in Business and discovered Patty McCord. Patty is former HR head of Netflix. She doesn't speak HR she speaks innovation. Listen to the MiB episode with Patty Mccord here. It is worth it. THIS is what HR should be.

My suggestion:

1. Ask your HR manager if he/she knows what is your job like day-to-day. ( analyse financial statement, work on new toothpaste launch, etc.) it has to be specific.
2. Does he/she know who are your clients? 
3. How do you make money for the firm? How much?

And the next one is of course EvilHRLady.

Jobs/Employment and Growth

Why are incomes not picking up even when the unemployment rate is at its lowest and profits are rising?

The first phase of automation focussed on improving productivity. So skill requirement of workers goes up and hence their pay goes up.

In present phase of automation, the skill requirement of worker operating the equipment is going down and hence their pay is going down.

Thus, if you replace the spade with earth moving equipment, you need to pay the worker more for the higher skill requirement. But when you replace an expert barista with a coffee-maker machine then you need to pay less to the operator of that machine. 

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Revenue Deficit vs Fiscal deficit and Fiscal responsibility

"Ballooning Revenue Deficit is far more worrisome than nominal slippage in fiscal deficit" said Mythili Bhusnurmath in ET. Her views are correct. But how to curb Revenue deficit. Let us understand the terms a bit more in detail.

Revenue deficit is amount by which Revenue expenditures exceed Revenues. 

What are revenues or Revenue receipts?

Revenues can be tax or non-tax. Tax component includes share of tax of Union Government in general taxes and "cess" or specialized taxes accruing to Union Government alone. [Refer Note 1]. Non-tax revenues includes interest on loans to various entities (state governments, etc.),  profits and dividends from enterprises, duties and fines received, grants from multilateral agencies or other governments etc.

What are revenue expenditures?

Revenue expenditures includes:

1. Salaries and pension paid to government employees
2. Subsidies
3. defense expenditure (relates to national security)
4. Government procurement from stationery to vehicles to arms and ammunition for police (internal security)
5.  Expense required for running government schemes and programs
6. Interest paid on borrowings - domestic and external.
   

Fiscal Deficit is more like capital account deficit.

Capital Account Receipts side includes recovery of loans to States etc., receipts from disinvestment or privatization and borrowing (external and domestic). Capital expenditures includes investments in Public sector companies, investments in public projects, etc.

Further, accounting 101 will tell you that revenue deficit accumulates in the Fiscal side and it has to be financed through borrowing which sits on the capital account. The servicing of this borrowing is done through revenue expenditures. These twin deficits thus, are quite interlinked. Mathematically, it is true that we can reduce Fiscal deficit (FD) while Revenue Deficit (RD) remains high. But it is true only for small values of RD. But a more ideal situation is when FD is higher (though less than the 3%) and RD is zero or lower. Then, one presumes, your excess FD would be mostly because of high quality capital expenditure. This capital expenditure will yield more Revenues and thus lower RD in the future. [Refer Note 2].

The Problem

For past decade or more, reverse is true. Most of borrowing is used for revenue expenditures - i.e. payment of salaries to bureaucrats. In return, bureaucrats and government employees have stifled any possible revenue growth for citizen or companies thereby reducing the revenues. This widens the revenue deficit and pushes the system into a negative spiral.

It is clear that the present malaise is largely self-inflicted. Imposing FRBM target without first having a RD at zero or lower is a recipe for disaster. At present, government appears to throw disinvestment money after revenue expenses and that is very bad idea. It erodes the structure of the economy.

How to kickstart the positive spiral?

The government is now required to first ensure that RD is reduced to zero but using revenue receipts. That requires expansion of tax base which is impossible without taxing agriculture. Thereafter, using asset sales i.e. disinvestment or privatization route, reduce the lower quality borrowing. Most of the borrowing by the government should be directed towards investments that yield revenues in the future and thus create structural zero- revenue deficits or revenue surpluses. This is the improvement in quality of budget is what prudent observers seek.

Notes:

1. Indian federal structure implies that both center and states have power to tax and they have share in the tax. Most of the taxes are shared and go into "consolidated fund of India" for central share and "consolidated fund of the state" for state taxes.
2. Ideally, the any borrowing or loan or debt should create more revenue than expenses required to service it. To do that, borrowing must be invested in revenue boosting ventures. Companies borrow to buy new machine that can increase production. Similarly nations should invest in those assets that will increase profits for citizens and companies and thus improve tax receipts.

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