PMI: Is it time to press the panic button? Financial Express: 11th January 2016

The PMI, which cannot really be taken as representative of the production scenario, is nevertheless useful, as it is forward-looking and indicates to an extent the future environment.

Should we be worried about the Purchasing Managers’ Index (PMI) number for manufacturing for December? The index has come at 49.1, which is an all-time low since March 2013, and has also turned negative for the first time since October 2013. A score of less than 50 indicates a decline in confidence, while any number above this is positive.

The PMI is a survey-based number where around 500 private sector companies are polled and asked specific questions on new output, employment, delivery, stocks of purchases and new orders. The respondent has a choice to say things are ‘better’, ‘worse’ or the ‘same’ for the month compared with the previous month, with different weights being assigned to these parameters. With scores of ‘1’, ‘0’ and ‘0.5’, respectively, intuitively it may be observed that if all say conditions are unchanged, the score would be 50, and if the majority pitches for a decline, then it goes below 50. As a corollary, if the number keeps moving upwards, it will indicate sustained improvement in confidence. As most of these parameters change quite gradually, the PMI, per se, cannot be seen to be moving sharply at any point of time and would be like a crawl-in-a-tunnel.

The issue with the PMI is that it is based on a survey of only private companies and excludes PSUs, which could be dominant in some sectors. Also, the SME segment gets included, which has a significant role in overall production. Further, it is based on a comparison with reference to the previous month and hence involves a more immediate outlook. That said, the PMI is an early indicator of the shape of things to come in the manufacturing sector and cannot be ignored. As it includes an impression on new orders, there is some element of being forward-looking, which is refreshing. In addition, views on stocks and deliveries give some idea of the state of business and cannot be ignored. But does it correlate well with production?

The answer is ‘no’, as the composition of the production index, the IIP, varies, as does the point of comparison. In case of the IIP, production is compared on a year-on-year basis, while the PMI looks at it month-on-month. Further, the PMI is based on an impression, while the IIP is based on physical numbers of production. Therefore, the two may not be expected to move together.

For instance, the PMI for December says that confidence level is low and has declined. The IIP growth number till October shows an increase of 5.1% as against 1% in the same period of last year. Therefore, the picture in terms of production still looks positive. Besides, for industrial production, it always makes sense to look at cumulative growth numbers, as production is a continuous process over a year and by looking at monthly numbers there are distortions in terms of base effects as well as spillover of reporting, which create spikes. Deliveries especially can spill over from the previous months and the same could be recorded differently. A smoothened number is the cumulative one, which is free from seasonal influences too, and going by this approach, manufacturing is not doing too badly and we can be confident of a growth of 4-5% this year—an improvement over the 2-3% that we witnessed in FY15.

The PMI number, though susceptible to change in perception over months, does give a fair picture of confidence levels, and hence is a barometer of the shape of things to come. However, for a meaningful interpretation, trends need to be observed rather than single numbers, which would be susceptible to distortions due to seasonal factors as well as specific incidents like, say, flooding in Chennai or additional holidays in a month.

Given that the PMI has been in the vicinity of 50 and not really moving upwards significantly, it is possible to conclude that conditions look fairly lacklustre. This is also supported by the fact that there is not much investment taking place in this sector and surplus capacities exist across industries to the extent of 30% or so. In addition, as December marks the end of the festival season—demand is typically satiated in the months of October-November when spending increases—the overall confidence level would tend to move downwards unless there is an upsurge in demand subsequently.

The major takeaway for us is that the manufacturing sector is still just about moving in a stable manner and the outlook is unchanged. It may be expected that this mood would continue to prevail till the end of the year, considering that a fundamental shift in production is not really expected. This would come as a disappointment, as it was expected that the industrial recovery would become pronounced in the second half of the year based on all the efforts that have been put on the policy front.

More importantly, there are growing concerns on government spending too, which was to be a prop this year on two counts. First, the income growth could be constrained by the pressure, with some concern being on the disinvestment programme that has yet not taken off. With the stock market gyrating downwards due to international developments, the timing too does not appear to be favourable.

Second, the disinflation in the economy has lowered the nominal GDP, which will upset the fiscal deficit ratio even if the absolute level is met. Growth of 11.5% was assumed in the budget, but with this number coming down to 9%, the fiscal deficit may have to be reduced by around R25,000 crore to meet the target of 3.9%, or else we have to settle for a revised figure of 4.1%. Adherence to the target would mean some cuts in capex that will impact demand and hence manufacturing output.

Therefore, the PMI—which cannot really be taken to be representative of the production scenario—is useful because it is forward-looking and indicates, to an extent, the future environment. Although a one-time slippage to less than 50 is not alarming, any conversion to a trend can send negative signals of future growth prospects in the manufacturing sector.

The golden rules: Financial Express 27th Dec 2015

As the title suggests, Strategy rules is another book for CEOs on strategy.

Strategy rules
David B Yoffie & Michael A Cusumano
Harper Business
Pp 254
Rs 399

As the title suggests, this is another book for CEOs on strategy. It has become big business today to provide a prescription on how to strategise; and Yoffie and Cusumano use the stories of Bill Gates, Andy Grove and Steve Jobs to build their template in this book. There are five lessons worked on here, which may not all sound new, especially as the reader would have come across them in any book on strategy.

The first part is what is termed as looking forward into the future and then reasoning back for taking action. This sounds clichéd, as all strategies need to start with a vision that is translated subsequently into action by the CEO.

Things like anticipating customer needs and restricting competition can alter the industry dynamics in one’s favour.

The authors argue that strategy involves anticipating competitors’ moves and building barriers to entry by locking in customers. A question that must be posed is what do we think the world will look like tomorrow, and, as a corollary, what will our own company look like in this environment? This will lead to the question of what should be the next killer product or idea that the company must produce.

The important thing is to identify inflection points in the industry and turn threats into opportunities. This was called ‘10X change’ by Grove. Jobs mastered the art of anticipating and shaping customer needs. He drove four 10X changes, starting from graphical user interface in PCs, to iPod and iTunes in digital music, iPhone, App Store revolution and iPad. IBM created a new operating system and Gates took it as an opportunity to control the platform for all PC software. He invested in an operating system, which would replace Windows in the Eighties itself.

The second suggestion is that while successful CEOs have to make big bets, one should not risk the company. This is insightful, as in any business one has to take risk, but at the same time has to cap the quantum so that the company does not go down if the chips are not in one’s favour. The authors argue that we cannot win by betting small and hence have to change industry norms and create new technology, as was the case with these three CEOs.

Gates had developed Windows to take on IBM, which was the powerhouse at that time. Grove in 1985 decided that Intel would change its licensing policies to become the sole source for the next generation microprocessor. Jobs risked the future of Mackintosh franchise when he replaced Mac’s Power PC chip with Intel technology. In all these cases, risk was taken, but the company was not compromised. Gates even postponed his break with IBM until Microsoft’s other lines of business were strong enough to keep it afloat.

The third part of the recipe is slightly offbeat and different. The authors say that besides products, we should build platforms and ecosystems. This makes a lot of sense, because for any industry the entire ecosystem has to grow and only then will everyone benefit, including the leader. We clearly need to influence the world beyond the firm. When IBM came to Microsoft for an operating system, Gates thought of ‘platform first and product next’. Jobs, in his first stint at Apple, thought of the product first, but later shifted to building the platform. Gates always believed in building network externalities.

The fourth bit of advice is to exploit leverage and power by playing ‘judo and sumo’. This is using size and playing strategically, which is sumo, and being alert and perspicuous, which is the judo part. All the three protagonists were master tacticians, often turning the opponent’s strengths to weaknesses and using resources to dominate competition. Three ideas are provided here.

If Gates had not embraced the Internet in 1995, Microsoft would have lost the browser war. If Grove had not invested in engineering and manufacturing in the 1990s to fill the holes in the microprocessor line, Intel would not have maintained its market share. If Jobs had not figured out the importance of looking unthreatening when he approached music executives in 2003 about selling through iTunes, the online store would not have taken off. If Jobs had not made peace with Gates in 1997, Apple might have disappeared. Hence, leaders should know when to stay within the radar, when to work with rivals and embrace competition and when to throw one’s weight around.

While talking of the use of strength and thwarting competition sounds real, an issue not covered is the prevalence of anti-trust laws and rules concerning unfair competition, which are prevalent in almost all countries and hence have to be given careful consideration.

The last episode is shaping the organisation around their personal anchor, which need not be elaborated, as all the three have become icons symbolising their respective companies.

The authors end on the note that the same approach is being used by what they term the new generation ‘rock stars’: Larry Page, Mark Zuckerberg, Jeff Bezos, etc. Surely, this looks like being the way forward.

Shakespearean pondering on 2016’s prospects: Financial Express 26th December 2015

“If you could look into the seeds of time, and say which grain will grow and which will not.”
—William Shakespeare (Macbeth)

This is the thought that will strike readers upon any conjecture on what will be in 2016. The year 2015 has not quite been eventful either ways, which is reassuring as there is no past baggage to carry forward into the new year. There are 10 questions that will be asked to economists and, quite expectedly, there will be several views. But frankly, it is hard to guess given that most conjectures have not quite worked out in 2015.

Will GDP growth be better? We normally assume that, since 2016 will be better than 2015, it has to be higher at 8%. But even in 2015, we started with 8+% and ended up weaker. It is just a case of adaptive expectations, where we are assuming that things get better. Various economists would hold a view that takes the number beyond the 2015 number of 7.5%. After all, everyone is doing their job as they are supposed to. ‘All the world’s a stage, and all the men and women are merely players.’ (As You Like It)

Will the investment cycle take off? In 2015, this has not quite happened. We have pinned our hopes on the government, which has been aggressive on roads and railways. But the numbers do not still show. After all, the government has a small part to play in this big game given the constraint on its resources, with several fiscal issues casting a shadow. But clearly, something has to be done, or else, we will continue to go down the cycle. ‘Delays have dangerous ends.’ (Henry VI)

What about the big projects that have been played up through the year? The Make-in-India, Digital India, Smart Cities, Swachh Bharat initiatives, etc, were all to be big game-changers, given the money involved. Do we have the money to back them up, as, ultimately, while creating an enabling environment is necessary, that by itself cannot turn things around. ‘Nothing will come of nothing.’ (King Lear)

What about the fiscal deficit for FY17? We had spoken of lowering it towards 3% in course of time from 3.8% targeted for FY16. But then things never go as planned and the best laid plans receive setbacks. Disinflation has pushed back growth in GDP, which makes it harder to achieve the 3.8% mark. Disinvestment remains a game for PSUs to play and while tax collections have been buoyant this year even though the base has not increased substantially, we cannot bank on being this lucky twice. It is hoped that we have a pragmatic budget which is realistic and formulated on such lines even if it means living with a higher fiscal deficit ratio. ‘This above all, to thine own self be true.’ (Hamlet)

Will the rupee be stable? This is anyone’s guess. Besides, do we want it to be strong or weak? A strong rupee impedes exports while a weak currency affects corporate profitability. Our fundamentals have been fairly robust but external conditions, like the expected Fed rate hike or the Yuan depreciation, have driven the rupee down. We like to take calls on the rupee and scale up when it falls and vice versa. ‘Confusion now hath made his masterpiece.’ (Macbeth)
How will the global environment be? The Fed action is no longer a surprise as the direction and quantum of change is known. It will not play a decisive role now. Nor will the ECB action as that has also been stated. The Bank of England or Japan will not matter, too. But the joker in the pack can be China which can keep devaluing its way out to keep exports ticking. This is something we will never know and, when it happens, there will be another round of turmoil. Somehow, the global community never has control over the dragon kingdom. ‘Fair is foul, and foul is fair.’ (Macbeth)

Will our interest rates come down? One hopes so but cannot be sure as it will depend on inflation. When rates go down, it is not that everyone is happy. Savers lose and borrowers gain. But when the latter happens, it does not necessarily lead to higher offtake and growth. So, frankly we do not know if it is good or bad. Therefore, we should not be carried away by the present trajectory of interest rates as all the pieces on the demand side must fall in place for these cuts to make sense. ‘All that glisters is not gold.’ (The Merchant of Venice)

Will the ghost of GST will keep haunting us? Everyone seems to be in agreement over it as all amendments have been made to placate interest groups. The rollout date has been getting rolled over every year, with political motivations stymieing discussion—a true manifestation of democracy. And everyone is pleading for it, but it all lies in the hands of the Opposition, which, despite its feeble strength, is big in stature now. ‘The fault, dear Brutus, is not in our stars, but in ourselves.’ (Julius Caesar)

What about agriculture? Well, that will be remembered when the monsoon fails. Till then, it is assumed that there is no problem. We normally never have two pulses shock and, hence, based on past experience, should not worry too much. True, no one speaks of this sector after the storm passes because, frankly, we do not care. It is not glamorous and attracts fewer people at seminars. ‘The miserable have no other medicine but only hope.’ (Measure for Measure)
Last, will our banking sector turn around? We have all been talking of lowering NPAs and increasing capital of PSBs. A lot of measures have been announced, like Indradhanush or the bankruptcy code. PSBs are waiting for these big changes to come through. But RBI data in the financial stability report, brought out just as the calendar year changes, is disturbing. What do we do about NPAs? The question will linger on in 2016. ‘Out damned spot, I say’ (Macbeth)

While there will be a plethora of models by various economists, analysts, banks, agencies, research houses on all these subjects, the last words would be—que sera, sera. Whatever will be, will be. The future’s not ours to see. Que sera, sera. Whatever will be, will be.

But we economists, as the ubiquitous stage players, will make our entries and exits with forecasts and expectations. So, better watch out.

Happy New Year!

The global reversal of fortunes: Financial Express Dec 23, 2015

The so-called South-South dialogue—which was in vogue for quite some time now—has not resulted in  emerging economies creating a decoupled environment in which they could grow on a sustained and symbiotic basis.

In the aftermath of the financial crisis, it was widely believed that emerging markets would take over the global stage, with developed countries taking a secondary position. This appeared logical, as these were the growing economies largely insulated from both the financial turmoil in the US or the sovereign debt crisis of Europe. In addition, with a low base level and surplus capacity—especially in infrastructure—there appeared to be tremendous scope to maintain high growth for a decade, if not more. The famous decoupling hypothesis was mooted, which argued that these economies were separated from the mainland countries and could push the world economy along on their own. Seven years on, however, the business cycles have changed and the tune being hummed is quite different.

First, the main growth impulses are coming from the developed countries, with the US now poised to witness higher interest rates as the unemployment rate has come down and the threat of inflation, though distant, is being talked about. The European Central Bank (ECB) has also been fairly gung-ho about growth by 2017, and most of the countries are on a growth path albeit at different paces. The Greek crisis has ebbed, and while the refugee problem remains, there is definitely no concern about the recession, with the ECB pledging to ease the monetary reins. In fact, the latest statement reaffirms its belief that the quantitative easing (QE) programme was responsible for this turnaround.

On the other hand, China has slowed down, as have Brazil and South Africa, which are all members of the BRICS group, and Russia remains in disarray. India appears to be the only engine running at a stable pace, which, however, does not matter much for the global economy, given the domestic orientation. Interestingly, most emerging market central banks are moving towards lowering interest rates to propel investment at a time when the US is going to increase them.

Curiously, the slowdown in global trade due to pressure on developed economies has impacted emerging economies, which did well on the back of exports. They have not been able to create their own trading circles and are still dependent on the US to keep their economies ticking.

Second, inflation has remained low in developed countries while the picture is disparate for emerging markets. While lower oil prices have helped across the globe, their impact has been greater for developed countries. Domestic factors have impacted inflation, especially on the supply side. Although some countries continue to have high inflation—such as Russia, Brazil and, to an extent, India—the rates are moderate in others, but still higher than those in developed countries.

Third, emerging markets had a flurry of foreign investment flowing in the last 5-6 years as interest rates remained low in these economies, while developed economies confronted low growth situations. Besides, with their prospects appearing to be better, valuations of equity markets tended to be overstated, with portfolio investors coming in relatively large numbers. But since July, there has been a tendency for these flows to get reversed and move back to the US. We have a potential situation where the US increases interest rates while central banks in emerging markets lower theirs. Add to this currency depreciation, and foreign investors would be in a withdrawal mode. The prospect of a US Federal Reserve rate hike has prompted these funds to turn around as well as present a greater business opportunity, given that the US economy has started its upward trajectory. This has caused distortions in the market as negative flows have upset the balance of payments of several emerging markets. Further, it appears the stock markets of developing economies are inexorably linked to the US stock indices.

Fourth, related to the foreign institutional investor (FII) flows, the currencies have become more volatile, with emerging markets bearing the brunt. The strengthening of the dollar due to stronger economy as well as lower outflows had collateral impact on their currencies. While all currencies have depreciated, volatility has increased. Brazil, Malaysia, Turkey and South Africa have witnessed significantly higher rates of depreciation. In addition, with most currencies depreciating by between 15% and 25%, the competitive advantage has diminished substantially and has only added imported inflation.

Fifth, the debt scene has changed dramatically. The leverage of companies has increased for emerging markets, thus pushing up the debt-to-GDP ratios, while the same has been coming down for advanced economies that have gone in for consolidation. Even though there is no imminent threat of a crisis, the possibility of non-performing assets (NPAs) increasing has gone up as they tend to increase when economies slow down. Anecdotally, it has been observed that when economies grow, they tend to get leveraged and the chasms do not show as long as this chain is kept in motion. However, when economies start to slow down, the problems emerge as companies are not able to service debt. A challenge today for these countries will be that, with their external debt increasing mainly due to companies’ borrowing from the euro markets where rates are very low, debt service would become expensive on account of currency depreciation that has taken place. Low GDP growth with higher interest rates and extended debt levels is a perfect recipe for a debt crisis.

Last, developed countries, especially in the eurozone, have been able to moderate their fiscal balances as part of the austerity measures that came along with the package (the UK and Japan remain exceptions). Emerging markets have not shown the same kind of discipline and hence may have to scale back in the coming years.

Hence, overall, it does appear that the scales have turned in favour of western economies as growth models of emerging markets were still centred on the US and European countries. A conclusion is that the so-called South-South dialogue that was in vogue for quite some time now has not resulted in these nations creating a decoupled environment in which they could grow on sustained and symbiotic basis.

Given the differing stages of development and core competencies, creating an alternative ecosystem is difficult. African nations, for instance, are rich in natural resources but are otherwise low growth centres. Latin America has distance issues as well as vulnerable economic indicators, while East Asia is export-driven, with the main consumer being developed countries. China, although very strong on its own, faced the barrier of limitations erected by a growth model driven by investment more than consumption.

Quite clearly, the invisible hand has not led to this decoupling and we continue to be in a flat world where all countries are interlinked.

Why there may be a need to tone down priority sector lending: Economic Times 16th December 2015

Jan-Dhan, small banks, payments banks, MUDRA Bank, new private banks are all efforts to enhance financial inclusion. The bifocal vision is on garnering deposits and enhancing lending to segments which come under ‘priority sector’. This is the social aspect of banking.

The other side to banking is the commercial motivation where banks strive to deliver higher returns to shareholders which can be the government for PSBs and various institutions and individuals for private banks. Curiously, while banks have to perforce ensure that 40 per cent of lending is to the priority sector, this segment has also been vulnerable to shocks leading to a build-up of NPAs.

The table below provides an overview of the spread of NPAs across four broad sectors for FY15 for 6 new private banks (ICICI, HDFC, Axis, Kotak, IndusInd and Yes Bank) and top 10 public sector banks in terms of the size of advances (SBI, BOB, PNB, Canara, Bank of India, IDBI, Syndicate, Central Bank, Indian Overseas Bank and Union).



The table shows that new private banks perform quite differently from PSBs. Their NPAs were 1.31 per cent in the priority segment while PSBs had a ratio of 6.38 per cent. Within this set, these banks had an even dispersion of priority sector advances to agriculture and industry which accounted for around 50 per cent while the balance was in services and personal loans where the incidence of NPAs was lower. For PSBs around 62 per cent of the priority sector advances portfolio was in agriculture and industry which had higher delinquency rates.

The higher delinquency rates for agriculture and industry within priority sector lending was due to their vulnerability to adversities. A slowdown in industry affects the small units the most of which face diminishing growth in sales, high cost of credit, receivables and inventories with NPAs being 8.95 per cent (10.64 per cent for PSBs) across all sectors. In case of agriculture, a poor monsoon implies higher NPAs which were 6.02 per cent for PSBs.

Within the non-priority classification, too, the PSBs had higher NPA ratios. The PSBs had 58 per cent of their exposure to industry, followed by 25 per cent to services and 17 per cent in personal loans.

In case of the new private banks the ratios were 40 per cent, 33 per cent and 27 per cent, respectively. Once again the PSBs have been saddled with more of their advances going into the industrial sector — infra and vulnerable sectors such as textiles, steel, mining, aviation and power.

Private banks have played smarter by diversifying into services and personal segments, where NPA propensity is lower. This has kept the overall NPA levels low at just about 2 per cent, while PSBs have had a ratio of 4.4 per cent in this segment.

What are the takeaways here? First, priority sector lending is not the ideal avenue for banks as it pops up higher NPAs given the vulnerability of the segments.

Second, if this is the possible outcome, new entrants into banking especially on the financial inclusion side, like the small and new private banks, have to examine and explore the issues relating to priority sector lending with dexterity to ensure that their books remain clean from the start.

Third, within the non-priority sector, the NPAs in industry reflect to a large extent the risks involved in lending to the infra sector where the private banks have limited their exposures.

Fourth, a large part of this funding requirement has to shift to the corporate debt market. Companies perforce should be asked to borrow a certain part of their requirements, say 20 per cent to begin with, from this market as the PSBs cannot bear the burden of supporting growth in infra and manufacturing where the risk is high.

Fifth, the PSBs would also need to probably pursue the strategies of the private banks in keeping NPAs lower and focus on services and personal loans segment.

The government on its part would also have to review the sanctity of the 40 per cent level. While the weaker sections have to be supported, banks may not be the ideal medium as it weakens the genetic design of the system. Curiously, in our context, we expect the government to prop up economic activity, which should be done by the private sector and also simultaneously want banks to do social good, which though laudable, weakens its structure.

Ironically after doing so, asset quality and capital issues relating to PSBs come back to haunt the government!

The Health Gap book review: All’s not well: Financial Express Dec 13, 2015

The Health Gap
Michael Marmot
Bloomsbury
Pp 387
Rs 499

WHEN WE speak of inequalities, the reference is usually to income or wealth, with the Gini coefficient used to depict it. However, health inequality is rarely analysed—probably because we take it for granted. Michael Marmot, in his amazing book, The Health Gap, delves deep into the world of health inequality to highlight how social gradient plays a very important role in determining not just access to health facilities, but also life expectancy. Interestingly, he shows how different parts of the same city can have different life expectancy rates because of dissimilar income levels of people.

Marmot’s research shows that culture makes a big difference to health quality. To prove this, he compares the general health conditions of the Japanese living in their own country and those who live outside. He finds that as they move out, the Japanese become distant from their families and are more likely to suffer health issues like hypertension and heart ailments compared with those still living in Japan. Staying in a big family eases living conditions, he says. Similarly, race makes a difference and Marmot explains why the US, despite being one of the largest spenders on healthcare, has lower life expectancy and more maternal deaths than, say, Italy. Also, the probability of an American boy aged 15 years living up to 60 years of age is lower than that of other developed countries—factors like large-scale immigration of people into the US and the low-quality living conditions of coloured people explain this difference.

The basic hypothesis is that once one is born in an underprivileged household, one will be discriminated against in terms of health, besides other cultural mores. Marmot argues that these initial conditions have a bearing on the future course of a person’s life and longevity as well.

The rich, the author argues, also face health issues despite having access to the best facilities, but this is due to their own doing, like eating the wrong food or getting addicted to alcohol, tobacco or drugs. Marmot’s analysis shows that in higher-income countries, obesity is related to lower incomes, but when it comes to low-income countries, it is the higher-income groups that fall prey to it. This is something we can see in India as well. A revelation in the book,
however, is that, in the UK, women with more education and of a high status drink more and hence endanger their health.

One of the solutions advanced by Marmot is education—even though that is also skewed—as an effective way to improve health. Here, the author provides data to show that educated people not only get better jobs and incomes, but also enjoy better health, as they become more conscious of their surroundings, eating habits, lifestyle, etc. Further, among males, education keeps them from trouble and hence improves their life. Marmot points out, quite rightly, that whenever there is a riot, it is always people from the lower-income groups who are involved. We, in India, can identify with this observation quite easily.

A factor that the author keeps harping on is his concern with outcome rather than expenditure. Again, we will find this relevant because we, too, in India spend money on education and health, but never pay attention to quality, which results in poor outcomes. Marmot links health and education while talking about the need for a more effective social system from the government. He is critical of conditional cash transfers for children in Brazil and Mexico, which have been showcased as progressive, as they get the children educated. However, Marmot questions the quality of this education and argues that we should also invest in institutions, so that children can become more able. This is worth thinking about because while in India children do go to school to get, say, a mid-day meal, the dropout rate is very high.

The book is full of such questions, which make the reader think. The author also espouses the role and quality of society, which have a huge bearing on the ‘health gap’. He gives examples of the earthquakes in Chile and Haiti, which happened almost at the same time and resulted in deaths of around a couple of hundreds in the former and over two lakh in the latter. This difference was due to the response of society, including the government, he says. This hypothesis also explains why infant mortality is the lowest in Kerala, as society there takes this issue very seriously.

In the same breath, Marmot argues that governments should not cut back on health-related expenditure, which, unfortunately, has become the norm in Europe after the financial crisis, where government austerity has been called for.

The book is refreshing and quite novel because it highlights issues we usually chose to ignore. By tracing all inequality to health and education, Marmot’s work appears to be an extension of Thomas Piketty’s—the flavour of the season. We talk of a market system, which is fair and open to all and where only the best succeed, but everybody doesn’t begin life with the same opportunities. As you peruse the pages of the book, you are likely to say, “Who doesn’t know this?”, but what we need is ask ourselves, “Why have I not thought of its significance?” and, as a corollary, “What should we be doing to reduce this social gradient?” to have a more equitable society. If you do this, as this reviewer did, the author would have accomplished a great deal.

The GDP growth signals: Financial Express 8th Dec 2015

he Q2FY16 GDP numbers have brought cheer to the market, as these came at a time when we needed assurance that the economy is on the upward path. Being the most comprehensive indicator of the health of the economy, the GDP numbers, notwithstanding the unresolved controversy on the methodology being used, are a reasonable leading indicator. The numbers for Q2 are interesting and one can draw at least 10 takeaways from the data.

First, a growth rate of 7.4% in the second quarter, which is also a relatively lean period, bodes well for the next two quarters—it means that an overall growth rate of 7.5% for the year cannot be ruled out given that the main season, once called the busy season, starts from the onset of Q3.

Second, the growth in nominal GDP at current prices comes in lower at 6%, with a cumulative growth of 7.4% against 13.5% last year. This is a conundrum for two reasons. The first is that while normally growth at current prices is higher than that in real terms, on account of negative inflation going by the GDP deflator or WPI, we have an anomalous situation where real growth numbers would always be better than those in nominal terms. This is on account of the price adjustment, which is negative. The other outcome is that all economic ratios that are monitored which are juxtaposed with GDP in nominal terms will tend to get skewed. For example, the fiscal deficit was to be 3.9% of GDP, assuming 11.5% growth in nominal GDP in FY16. If growth is lower at, say, 7.5%, then the fiscal deficit has to be pruned by Rs 25,000 crore to maintain this ratio.

Third, the relationship between industrial growth across sectors in IIP and value added in corresponding components in GDP is interesting. In case of manufacturing, growth of 4.6% in physical terms goes with 9.3% growth in value added, indicating a multiple of 2. In case of mining, 2.7% growth in IIP leads to 3.2% in GVA, a multiple of 1.2, while for electricity the multiple is unity with both the growth rates being 6.8%. The conclusion is that there is evidently more value addition coming from the manufacturing sector, and the other two conventional infra industries do generate this value addition even though they involve large investment.

Fourth, the first two quarters are free from the influence of the monsoon and its impact on farm output. As the kharif season starts from October onwards, the impact of lower output will come in Q3. Also, Q4 is critical as most of the rabi crop is harvested. Therefore, the negative impact of lower kharif agricultural output is to be felt in the second half of the year.

Fifth, the construction sector has grown by just 2.6%, which comes as a disappointment as there were expectations that there were big bang investments coming from the government in roads and railways. It has not happened so far, but there is hope that if these assignments are finalised, there could be heightened activity in subsequent quarters. This means the movement in previously stalled projects in the construction space has not been significant as issues beyond permissions have come in the way.

Sixth, the segment trade, transport and communications has shown a healthy growth rate of 10.6%, which has been attributed more to the trade sector where high growth in sales tax collections has contributed to the same. Here, given that the nominal growth was 6.1%, it has been more of a statistical calculation that has caused real GDP from this part growing at 11.1%. With low consumption growth of 8.3% in Q2 relative to 13.4% last year, collections growth in nominal terms has been sluggish.

Seventh, the financial sector including real estate and professional services has been buoyant with 9.7% growth being witnessed. With professional services growing by 15.6%, it is tempting to conclude that self-employed income generation has been vibrant, probably reflecting growth in entrepreneurial spirit. The banking sector has been lacklustre in terms of business numbers, though value addition could be high because of higher spreads and profit margins being maintained, as the concept of value added looks at gross profit which is before provisions are made.

Eighth, the growth in GDP from public administration etc has been tardy, at just 4.7%. This is a let-down as it has always been maintained that the government should be the first to spend to kick-start the economy. Quite evidently, this has not yet happened, as the government has been cautious. The problem is really that once the government has to adhere to the 3.9% fiscal deficit number and nominal GDP grows at a slower rate, it would perforce have to trim its expenses, which can slow the growth process.

Ninth, the share of consumption in GDP has come down from 56.2% to 55.9%, which. though not really significant. is still indicative that consumption has not picked up. It may be pointed out here that the economy is confronting a situation where spending is low from all sectors. Household consumption was to be one of the areas of comfort, which has not picked up so far. However, again, Q3 and Q4 would be the critical phases for consumption.

Lastly, the gross fixed capital formation rate continues to lower—from 30.3% to 30.1% in real terms and 28.9% to 28.3% in nominal terms. This is a reflection of the construction sector which showed less traction. Hence, we are still waiting for investment to turn around.

How then can the GDP numbers be summarised? Numerically we are on the right path and stronger numbers may be expected partly due to negative deflators. Spending is still down, as all the main potential engines have been less active in the first half of the year. Interestingly, the share of valuables has gone up from 1.4% to 1.9% of GDP. While agriculture will be a concern going ahead, a lot is expected from the government in terms of spending, which can be challenged statistically by the lower nominal GDP growth number. Therefore, Q3 and Q4—and especially the former—will hold the clue from all points of action, i.e. consumption, investment and government spending.

Corporate tax rate reduction: To retain or remove exemptions: Financial Express Dec 3, 2015

As we move towards GST, it appears the logical corollary is to do away with various privileges

The decision to lower the corporate tax rate to 25% from 30% over the next few years sounds alluring. The tax cut would also go along with rationalisation of a plethora of benefits provided to corporates on various grounds that help to lower the taxable income. This appears to be a transparent way of setting the house in order, where the taxable income is what one sees in the accounts that is subjected to lower tax rates. Logically, this can be extended also to the household level, which the Direct Taxes Code spoke of, where tax rates are lowered and exemptions dispensed with.

The Budget document for FY16 on revenue foregone by the government reveals some interesting numbers. For FY14, the average effective rate of taxation was 23.22% for a large set of 5,60,000 companies while the statutory rate averaged 33.22%. In fact, including the dividend distribution tax, the effective tax rate worked out to 25.47%. The effective tax rate is the actual tax rate paid by the companies on the reported profit before tax as in their accounts.

Against this perspective, the future rate of 25% seems to be broadly restating the currently prevailing numbers without all the exemptions. Prima facie, this appears to be a prudent thing to do as the system becomes transparent and predictable with less scope for any kind of evasion or camouflage.

The documents also talk of the ‘revenue foregone’ under various heads for corporate taxes, which for FY15 had a revenue impact of R98,000 crore (without adjusting for MAT). The major components were accelerated depreciation (~38%), deduction of export profit from SEZs (~19%), scientific research (~8%), power (~11%), etc. Clearly, we have been targeting specific areas to give a push which was in the form of deductions or exemptions to spur investment or activity in areas of high priority. The underlying assumption is that companies on their own may not be interested in going into these areas until such time there are incentives provided, given the risk-return matrix considering the gestation periods. In fact, even while depreciation can be called capital replacement, such allowances provided an incentive to spend on fixed assets which helped in capital formation.

While simplicity is a cornerstone of a tax system, there would always be a compulsion to balance the same with incentives. A tax system is not just about collecting money, which can be used to run the administration and bring about distributive justice, but also a means to spur the economy. It is not just a flow of funds from the productive sectors to the government, but also a means for incentivising entities.

For example, an investment allowance that is tax deductible is useful to channel funds for investment which otherwise could be disbursed to shareholders as dividend or reside in the books under the reserves and surplus category. At the individual level, giving exemptions on, say, interest on housing loans not just helps in creating purchasing power for households, but also provides a boost to housing industry. There is hence justification for incentives.

Doing away with incentives to get in simplicity and transparency would necessarily push back the motivations for certain acts. It is also true that often when incentives are provided there would be a tendency for companies to ‘cheat’ and take advantage of the clause while not really adding value to the objective, thus generating ‘perverse incentive’. It is not surprising that several companies have managed to become zero-tax ones by taking advantage of all these tax breaks, which inspired the concept of minimum alternate tax (MAT). If this was the reason to make the system less opaque, the solution would be more to provide the benefit only on fulfilment of the objective.

Hence, by going in for a simpler system that is transparent, the government may not be able to target specific objectives. Of late, the incentive provided for the backend support for agriculture, including logistics, was required to get in funds in an area which hitherto was underdeveloped mainly due to these ventures not being too profitable as standalone businesses. This may be lost in case of withdrawal of exemptions.

This is a tough call for the government to take as there are compelling arguments on both sides. One may recollect that several policies in the past involving incentives for investment in backward areas or even, for that matter, setting up SEZs have not quite yielded the intended results and may have also led to the destruction of resources. The new format of just simplifying affairs seems a logical outcome from this experience. The solution may be to rationalising these breaks where they did not work; or setting strong performance indicators to claim the same, which may not be easy. A tax holiday for, say, 5 years which ends with a stalled project cannot come under punitive measures even when the same is revealed as the enterprise will not be able to pay it.

An interesting outcome of such a decision by the government on the revenue side would also generate sufficient discussion on the expenditure side. The area under focus is cess which is imposed for different purposes by the government that is targeted at certain expenditure. Ideally, it should be removed when we have a single tax rate. There have been some questions about how the money that is raised via a cess is utilised since it does not fall in the purview of the Finance Commission’s ambit. Currently, the education cess in FY15 was around R31,000 crore. This concept should also be dispensed with.

As we move towards GST, which will be a single rate for state and central taxes, it does appear that the logical corollary is also to do away with various exemptions so that the system will work better. There will be a tradeoff with ‘initiative’ in case specific areas need special attention through incentives. Therefore, a fine balancing act is required to ensure that we do not lose this advantage, especially at a time when we are struggling to enhance the capital formation rate which has been ruling in the 27-28% range for the last few years. A question for which we still have to conjecture an answer is will the new format involving lower tax rates with few breaks work the Laffer way and encourage investment?

We expect positive growth from next quarter’ Buisness Line interview Nov 25, 2015

Though the growth of 3.6 per cent in the index of industrial production for September was disappointing, Madan Sabnavis, Chief Economist of Credit Analysis and Research, expects the same to be sustainable and be in the range of 4-5 per cent for FY16.

He is satisfied with the government’s performance and is confident that corporate results will not deteriorate from the December quarter.

What is your view on IIP growth going ahead?

The cumulative IIP growth for the first six months of this fiscal has been 4.4 per cent. This, I think, is reasonable given the base of 3 per cent in the same period last year and also for full year of FY15. More importantly, capital goods and consumer durable goods have shown positive movement upwards. I won’t say it is a great revival but definitely, it is a major improvement over last year. This also gives an indication that things are happening on the industrial front, which probably won’t get fully reflected in the current financial year. But hopefully, next financial year, we would see a more complete revival cycle taking place at a higher range and I see this being driven by both consumer and capital goods.

Is growth in consumer durables and capital goods sustainable?

 I am not too confident whether growth in consumer durables is sustainable as it depends also on how the rural incomes and spending behave, but the rise seen in capital goods is definitely sustainable as the government has been talking of spending a lot especially on roads and railways. I am focusing more on the government as the engine for this year as private capex will take time to pick up given the current capacity utilisation of 70 per cent as per data by the Reserve Bank of India. Normally, until the capacity utilisation reaches 80-85 per cent, private players don’t start investments in fresh capex.

Given the IIP growth in the first six months, do you feel confident about India’s improving growth prospects? 

Given the fact that for the last three years, we have seen very low industrial growth rate in the region of 2-3 per cent and lot of policy initiatives have been taken by the government, I am satisfied about what is happening presently though arguably, one would have been happy with a better growth rate.  But, there is may be less to cheer about as it is not a major turnaround. India has been used to growth rate in the region of 8-10 per cent (going by the new methodology juxtaposed on the earlier numbers). Today, it is in the region of 4-5 per cent, which is half of what the potential is. 

Are you happy with the government’s pace of work?

I think the NDA government has done spectacularly well in terms of doing what could be done. Expecting government to do more miracles is not possible at this stage given the fiscal constraints. Consumers are not spending because they do not have the purchasing power. The government is not spending because it has 3.9 per cent fiscal deficit target. And industry is not investing given the surplus capacity.

 There are no easy solutions to the economy and historically, economies take time to recover. It is always a U-shaped recovery and not V-shaped. 

Do you also see India Inc’s financial performance bottoming out from December quarter? 

Even if the September quarter witnessed a decline in sales for the fourth consecutive quarter, the ‘negative numbers’ have improved.  I am confident that things are not going to deteriorate from here in terms of pace of recovery. We could probably go in for positive growth from next quarter onwards.

The RBI policy meet is before the US Fed meet in December. What do you think it will do?

I think the RBI will opt for a status quo in the December policy since inflation has gone up and US Fed is definitely going to start increasing interest rates which will impact currency and foreign flows to India.  But by March, there could be a rate cut of 25 bps in a bid to spur growth. 

Cash Transfers: Look Before you leap: Financial Express Nov 24, 2015

he Indian economy is not yet prepared to replace physical delivery of state services with cash, given the large population being covered and low levels of income of those who are accessing the same.

The relentless focus on financial inclusion on the deposits side leads to a logical implication that these accounts can be used to transfer money from the government to the targeted recipient, making the action seamless and free from manual intervention. This is the basis of a direct benefit transfer where a wage or pension is transferred to the account without the individual going to the office asking for it. The corollary is the same can be used for other government programmes, ranging from food subsidy to conditional transfers like the mid-day meal programme for children. The examples of Brazil and Mexico have often been given to buttress this argument. How can we evaluate this option?

Cash transfer works well when we are dealing with ‘direct cash’ rather than cash in lieu of a physical product. The UID-linked bank account can be used to transfer MGNREGA wage or pensions of senior citizens to ensure no manual intervention. The subsidy provided on LPG also works fairly well, as the household pays the full cost of the cylinder and is subsequently compensated the balance through a cash transfer. But we may have to think harder in expanding the scope.

Translating the same concept for the delivery of other services raises some ticklish issues that need to be addressed. The usual argument provided against such transfers relates more to timing, when certain sections get excluded because of the difference in time between their having an account and the transfer actually taking place. But this is more of a logistics issue, which in on the administrative side and not ideological.

There are two major issues on cash transfers replacing current government programmes. The first relates to the role of the state. Once we move to cash transfers, the state frees itself from provision of services that are vital for lower income groups. While the quality of services provided by government-run hospitals or schools is abysmal, they are still the only points of contact for the poor, especially in far flung areas where access to private health or education facilities is remote. And where it is available, either the quality is worse or the cost prohibitive.

The larger issue is whether or not the government can withdraw from such services? Governments all over the world play a role in creating institutions for delivery of services. Once we move over to cash transfers, the individual is left to choose the mode of use and the state steps out of the picture. In a way, the government ceases to provide services which are required for maintaining social standards. Can we really think of around 375 million children below the age of 14 years getting education in private schools once a transfer is made to their parents? Or, for that matter, health access for around a billion people who still use public institutions. Therefore, the duty of the state is to provide social services, of which food also becomes a part of the package.

A lot has been written on replacing the PDS with cash, which sounds good, given the success of the LPG transfer. The complex issue here is one of pricing foodgrains where the price varies across regions. Based on latest government data on retail prices, the price for rice varies between R21 per kg and R38 per kg and that of wheat Rs 18-36 per kg across the country. How then do we price the cash transfer? Further, once the government steps back, consumers will have to buy grains from the market where the prices would also tend to increase. Here governments can tend to under-price and save on their own subsidies with pressure coming from the budgetary side. With increasing pressure to keep the deficit within the pre-stated norms for borrowing, subsidies could be a useful head to lower the allocations. Today, with the PDS system being the front-end and the procurement of the FCI being the back-end, the system is well set to ensure a singular price for everyone based on their categories. The system is inefficient, but the cash transfer replacement will be even less efficient as the basic purpose of the scheme would get lost.

Hence, while cash transfers are more efficient as a mode of delivery, it becomes more nebulous when we are dealing with larger numbers of beneficiaries and physical products. When taken to cover health and education, the state could subtly withdraw from its responsibilities, which may not be appropriate in a country like India where the number of underprivileged households is so big.

The second issue is the end-use of the transfer. While it is okay for the government to leave it as the prerogative of the beneficiary, it becomes self-defeating in case the money is used for other purposes. Different surveys carried out by economists/institutions show that the rural poor actually prefer foodgrains to cash.

Foodgrains provided by PDS have to be consumed and cannot be resold, given the quality and value. But a cash replacement will enable households to spend the money on other priorities. The same holds for the conditional transfer being spoken of to replace midday meal, which has largely been successful but which also suffers from leakages as it involves contracts being given to the providers of such meals. A cash transfer will stop the child from being sent to school, which will affect the future of the household.

Hence, it appears our economy is not yet prepared to replace physical delivery of state services with cash, given the large population being covered as well as the low levels of income of those who are accessing the same. The success attained in transferring cash with cash transfers should be judiciously extended to other services if we are to retain the core values of helping the underprivileged. We need to strengthen our institutions and not dilute them as once we do replace them, it would be hard to reconstruct them. Besides, from an economic standpoint, when services are being provided by state institutions, backward linkages are created in employment, physical structures, networks and value chains as natural by-products. Replacing the same with cash could weaken these links.