Why PMI and IIP can’t be compared: Business Line 8th Jan 2018

The former assesses industry confidence levels while the latter focuses on output. IIP is a more reliable, representative index

The PMI for December has come in at an all-time high of 54.7 which has brought significant cheer to the economy. This comes on the back of smart growth witnessed in the core sector, of 6.8 per cent in November, which augurs well for a higher IIP growth rate. In these rather less than bright times, there is a tendency to pick up any such signal and extrapolate the same to the macro level to indicate that a turnaround, albeit a sharp one, has taken place. But what exactly does this PMI connote?

ELEMENTS IN PMI

Purchasing Managers’ Index is calculated on the basis of information received from companies on various factors that represent demand conditions. It is very different from industrial production which is indicative of actual production.

The PMI takes in responses from a company on a monthly basis on whether there has been improvement, deterioration or no change for a set of parameters relative to the previous month. Five questions have to be scored in this manner: new orders (weight of 30 per cent), output (25 per cent), employment (20 per cent), supplier’s delivery (15 per cent) and stock of purchases (10 per cent). This questionnaire is administered to 500 private sector companies and the comprehensive score is arrived at. The public sector is left out.

Intuitively, it can be seen that the purpose of the PMI is to indicate some degree of confidence level in manufacturing based on this representative sample of companies. While the reference is to the previous month, the methodology involves adjusting for seasonal influences. The answers are tabulated in terms of the proportion of respondents who say yes, no and no-change with weights of 1, 0 and 0.5 being attached to the three responses.

This is done for all the five parameters and a weighted average is taken to arrive at the score. Hence if all say no change then the score would be 50; and if all said yes, the score 100. If everybody says there is deterioration, then the score would be zero. Typically a score of above 50 is looked at positively while anything less than 50 would be a marked deterioration.

The IIP is measured as comprehensive production across the industrial sector and is a comparison over the previous year; hence in a way it takes care of seasonal factors. While the December PMI number of 54.7 can be interpreted as a case of the sample companies feeling they were better off than in November, the IIP growth rate for December would be reckoned over the same month in 2016.

Therefore, a comparison between the two is really not appropriate as the basis for comparison is different. However, as the PMI is released on the first of every month and the IIP is known on the 12th, the PMI score is assumed to be a precursor to the IIP. But, is there a strong relation between the two variables?

POOR CORRELATION WITH IIP

The coefficient of correlation between changes in PMI (month-on-month) and industrial growth rate (y-o-y) for the last five years was 0.25. The coefficient for the same when reckoned on m-o-m basis with growth in IIP was 0.15. (The coefficient of correlation states whether or not there is a strong association between two variables i.e. if PMI changes by a certain amount will IIP also move commensurately in the same direction).

Hence the relationship between the two variables is quite low and insignificant. If the same is calculated for the absolute value of PMI and IIP growth on either ‘y-o-y’ or ‘m-o-m’ basis, the results are less satisfactory at 0.18 and 0.06 respectively. Hence, statistically a high or low PMI number does not tell us anything about the IIP growth number, however compelling it may seem.

The reasons for this are the following. First, a sample of 500 companies is too small to be representative of what is happening at the aggregate level. Also as these companies would tend to be the bigger ones, the SMEs would be left out. The IIP is more comprehensive in coverage. Second, the responses are of an ‘either or’ variety and hence is not graded to any number. If the increase is of say 20 per cent, it would be given the same weightage as 2 per cent growth as the answer is only in the affirmative of the parameter being better. Therefore, there would be an inherent bias in the final numbers that are tabulated.

PMI NOT RELIABLE

Third, even if one were to force a comparison between the two indices, the PMI has only one component, output, which can be related with IIP and has a weight of just 25 per cent. Therefore, at the aggregate level the PMI could be scoring well on orders, stocks, employment or suppliers’ delivery but scoring low on output.

Fourth, even with the PMI new orders increasing, it would not necessarily mean that output would increase in a subsequent period. Fifth, the exclusion of the public sector is significant as there is a very high contribution by this segment, especially in capital goods and infra areas.

Last, since July when GST has been introduced, there have been significant disruptions in the production cycles of companies. As there was some ambiguity in the input tax treatment, companies had gone in for de-stocking prior to the introduction of GST. Subsequently there was the emergence of festival demand which pushed up production. Presently companies are getting back to their normal stock levels and are hence increasing their output. This has causes some degree of volatility in the production cycles.

To conclude it may be said that the PMI is not a leading indicator of the state of industry which is better represented by IIP growth. While the IIP growth calculation has its challenges, the fact is that this number is also used for calculating GDP when reckoning the contribution from the unorganised sector. The sample used by the PMI is not known, but a guess would be that it includes the larger companies, which are also the ones likely to report their conjectures on a monthly basis and could be biased. But nonetheless, th

7 reasons why FY18 GDP growth forecast should be viewed with caution: Business Standard: 5th Jan 2018

The first advance estimates for FY18 GDP growth should be viewed with caution. This is because the estimates have been compiled by extrapolating numbers available for 6-8 months on different variables against the full year. Hence, it is more of a statistical exercise and does not take into account any new information.

This said, the fact that growth will be 6.5% is significant as it is even lower than the Economic Survey assumption of 6.75-7.5% for the year. Hence, it is not expected to be higher than the base mark which means that it would be lowest in the past three years. The effects of demonetisation and GST have played some role here.

Second, capital formation continues to fall to a new low of 26.4% from 29.3% in FY16 and 27.1% in FY17. This means that the private sector investment is not expected to pick up this year and will be showing a declining trend, as there is evidence to show the government spending is on track, given the fiscal numbers.

Third, the difference between gross value added (GVA) growth and gross domestic growth (GDP) growth is 40 basis points, which is again significant as it means that there is an assumption that net indirect taxes would be increasing. That means that GST impact would be positive for revenue collections and could signal reversal of the present trend witnessed in the market.

Fourth, the government sector is again the leader in terms of growth at 9.4% on top of 11.3% last year. Clearly the overdependence on the government cannot be missed and this also means that until private sector investment picks up or household consumption increases, fiscal deficits have to be made flexible to keep growth ticking. This could mean the government is not targeting 3% mark for FY19 but taking on a number between 3% and 3.5% depending on the final outcome for this year.

Fifth, the manufacturing sector is the major disappointment with 4.6% growth, which should ideally be in the 8-9% range. This also reflects that the Central Statistics Office (CSO) does not expect corporate profit-and-loss accounts to look any better in the last two quarters, as the value-added numbers are based on their statements. Also, the Index of Industrial Production (IIP) growth for the entire year would not really pick up steam.

Sixth, despite a normal monsoon, the overall growth of the primary sector covering agriculture and allied activities would be lower than last year. Implicit is that the lower rabi sowing would not give a robust harvest this time.

Seventh, the reforms in real estate could have been a deterrent for this sector, which has kept construction growth at a lower level.

Assuming this growth number holds, two things can be said. First, the fiscal deficit number for the year, other things being constant, would go up as it was based on higher nominal GDP growth number. Second, we will have to wait for one more year to cross the 7% mark, which should be possible in the absence of any disruptive reform – that is definitely not expected.

Recalling 2017: GST was a victory for Modi government: Financial Express 26th Dec 2017

The highlights of the year, in terms of impact on the economy, would have to be GST, the IBC process and inflation

Every year has its economic stories to recollect, and 2017 has been no different. When one looks back on the year, one is remind of that phrase from Macbeth: “full of sound and fury, signifying nothing”. That was the sense that one would get when one tries to make out something from the clutter. We are great in ‘doing business’, ‘fastest growing economy’, ‘introducing plethora of reforms’, ‘Bharatmala, UDAY, UDAN, INDRADHANUSH, UJALA’, etc. But at the end of the day there are few jobs being created and investment is not taking place. Just what is happening? Stock markets across the world went crazy and berserk, and all the greedy and gullible investors have switched over to stocks. Or is it Bitcoin now? The world economy is still wobbly, but who cares as long as the indices are singing a different song. Just look at the stock analysts talking about highest-ever level of indices, and everyone is doing great notwithstanding stagnant investment, mess in the banking sector, low consumption and precarious fiscal balances at home. This will be is number 9 in the countdown. The bard would have said, Lord, what fools these mortals be! (A Midsummer Night’s Dream).
The rupee is eighth in the countdown. It has beaten logic, and remains strong. Looking at the fundamentals, the rupee should be down with the trade-deficit widening and FPI flows just about being there. But the rupee continues to be one of the best-performing currencies, though we are losing our export advantage. This melody continues to play as the dollar remains fragile even though it is the only economy which continues to do better which has prompted the Fed to increase rates thrice this year. There is nothing either good or bad, but thinking makes it so (Hamlet). Next, in the reverse pecking order, is the wonderful interpretation of statistics. The CSO continues to startle everyone to the extent that one ceases to be affected when nice numbers are churned out. Interpretations change as, for the first time, we had economists and politicians saying that GDP growth in Q2 was better than Q1. From when has one does such a comparison? Normally, logic dictates that we compare Q2 over Q2, but then when it comes to statistics, nothing is wrong because we are dealing with numbers. The number-7 spot in the countdown clearly belongs to the way we look at numbers—it can always be made convenient. Talking isn’t doing. It is a kind of good deed to say well; and yet words are not deeds (King Henry VIII).
Demonetisation would be number 6 in the countdown. The fascinating thing about demonetisation is that everyone claims to be a winner. More tax-payers have come into the tax-net, but why, then, are collections not increasing? People are using more digital currency, but why are cash levels back to 90-92%? The moral fabric has improved, but why are we still paying bribes along the way or demanding cash payment? The economy was resilient to the act, but why did GDP growth come down in FY17 when all seemed right? The truth is we will never know. The wheel is come full circle: I am here (King Lear). GST, which came on the back of demonetisation, was again a victory for the government, though the small enterprises took a second hit. Multiple rates and chaos brought about by compliance requirements—so typical of the Indian spirit of jugaad—typify this new scheme. Remember the number of notifications on demonetisation being issued almost every day for two months? One advantage of this new regime is we have all forgotten demonetisation and are focused on dealing with the new tax system. Creating a new challenge is a sure way to ensure we forget the past travails. The SMEs continue to wail, but then this is all good for the larger cause—GST takes the 5th slot. The miserable have no other medicine, but only hope (Measure for Measure).
At number 4, is inflation. Everyone is obsessed with the CPI inflation number, which means that tomatoes and onions are not humble vegetables but main drivers of the economy. Add to this the joker in the pack called the HRA allowance, which scales up inflation. The enigma here is that no one can explain why the same number and direction of movements can mean different things in different months for the central bank. Our doubts are traitors (Measure for Measure). At number three is the fiscal deficit of the government. A simple number like fiscal deficit as a ratio of GDP can involve a lot of diabolic thinking and action, as it is now held as being sacred, to the point of being an obsession. Several debates have been held on whether one should be flexible or not. Seriously, there is much ado about nothing considering that we can get PSUs to pay more dividends or simply cut back on capex to balance the budget. This above all: to thine own self be true (Hamlet).
At the number 2 spot is the Great War against defaulters. The IBC has taken shape and RBI has taken the onus of identifying the bad guys, referring them to NCLT. Not surprisingly, when the assets are to be put on sale, the critics of the defaulters have become sympathetic and want them to be allowed to buy back their assets. This is the irony of the situation. Borrower A and Bank B cannot reach a settlement, and RBI now refers it to the NCLT. But A now wants to buy back its asset a lower price which it was not willing to settle earlier. Come what come may, time and the hour runs through the roughest day (Macbeth).
The top slot goes to the new class of experts who could also be economists who have formed what is called the Shouting Brigade. Their job is to lambast anyone who says that growth is not taking place, and ridicule those who are critical of any reform. The crescendo was attained in haranguing RBI to lower the interest rates one month before the policy, and one month after the policy—which makes it an round-the-year phenomenon! At times, the brigade missed the point that RBI does not decide on rates, but the MPC does. But that was not important as the MPC could have been bluffing! You cannot argue on this and more. All the world’s a stage, And all the men and women merely players. They have their exits and their entrances; And one man in his time plays many parts (As you like it).
Happy New Year!

Book review: Economics of India – How to Fool all people for all times by Madan Sabnavis: Review of book in FE Dec 24, 2017

Is ‘Make in India’ faulty? Could bank NPAs be better managed? Are voters being misled? A book that answers questions like these and more.

Running a government involves tough decisions. More importantly, it involves difficult choices. For example, lower interest rates are good because they bring down the cost of capital and trigger investment. However, we all know how a period of easy money didn’t help the US economy. Nor did it help India in 2012-13 when the RBI lowered rates by one percentage point. Also, what happens to savers? And retired people, who often have no source of income other than deposits? The decision, it may be hard to believe, mostly depends on the central bank, even if it may or may not be convinced about how the government is looking at the economy and what constituents it is looking to please. There is no universal truth in economics, nor a perfectly right thing to do. More so in a democracy like India, argues economist Madan Sabnavis in his latest book, Economics of India, written around a collection of his media articles on various contentious socio-economic issues. The book makes for interesting reading because Sabnavis promises to offer an ‘alt’ view to the prevailing wisdom. Though not always a contrarian, he is more of a careful assessor of both sides of the debate. He doesn’t believe in laying all problems at the government’s door and maintains that turning over the economy to the private sector also won’t work. The truth, in his case, often falls between two stools. Sabnavis sets the tone in the very first chapter by asserting that the Indian government, with its various competing interests to look after and a very small role in the economy (government expenditure has only 12% share in GDP at current prices), is hardly an engine of growth, but a necessary condition at best.

However, the opposite isn’t necessarily true. Indeed, governments in India have been the biggest generators of bureaucratic red tape and policies that “have nothing to do with common sense”, to quote Sir Humphrey Appleby. Yet, when one looks at the risks and rewards, one sees the stark gap between the private and public sectors—just compare the salaries of the heads of public-sector banks/mutual funds and private ones, and their performances. The gap in the former is much larger than the gap in the latter!

The truth is similarly hidden in the case of subsidies, which everyone wants the government to do away with. Subsidies actually are not a waste of money at all; even developed countries have them. It’s their delivery that’s a problem, so there’s an argument in favour of plugging leaks and targeting them. Sabnavis also counters the argument against fuel subsidy by saying that the middle class, which is a major contributor to tax revenues, deserves it. Indeed, subsidies are everywhere; “special lounges and elevators for CEOs of private enterprises is also a subsidy provided for by public money, though it is called shareholder money”. Perhaps his strongest argument is in favour of the MGNREGA and he proves through data that it is effective in providing employment to the poorest. He dismisses the controversy over inflated wages, and asserts that if anything, the programme should be enhanced and perhaps government departments could coordinate to get all relevant schemes covered under the MGNREGA. Indeed, his proclivity for expansionary theories is evident in the chapter on fiscal policy, where he argues that in the years of the downturn, especially 2012-14, adherence to the FRBM limits (for deficits) made global agencies happy, but hurt our own economic growth. His research also doesn’t find any strong links between fiscal deficits and inflation over the years, so he contends that the argument that the budget is crowding out private investment or putting pressure on prices should be taken with a large pinch of salt. In fact, high interest rates, too, can’t bring down inflation, which is more reflective of supply-side dynamics. However, when inflation is high, it does become necessary for the RBI to keep interest rates high.

Not all that the government does is good though. Indeed, the accumulation of negative assets in the banking system has been a direct effect of protection of inefficiencies in the corporate sector, be it private or public, and the priority sector, including agriculture. Of course, the real world outcomes in these two cases are very different; while farmers kill themselves, corporate debt—crores of it—is restructured. Whatever be the political exigency, Sabnavis rightly argues that all rescue efforts or debt waivers should be from the budget, and sourced in a transparent manner, so that banks don’t have to carry the bad debt and put their own balance sheets under pressure. This is also applicable to newer schemes such as Jan Dhan Yojana floated by the current government. However, it is also true that in India, banking is good business and bank stocks enjoy a premium in the market. The proposed Financial Resolution and Deposit Insurance Bill, which intends to set up a corporation to replace the DICGC, is aimed at more effectively addressing bankruptcy of banks and insurance companies. Will it be another regulatory body to work as a stable door when the horse could have bolted due to poor government decisions? It is the same conundrum in manufacturing—can we have ‘Make in India’ without economies of scale and cost-effectiveness, factors essential to turning things around in manufacturing? Sabnavis contends that the government is not serious about manufacturing, and he is right. What we probably need is a government hands-off policy in manufacturing.

Interestingly, governments seldom have to answer to their shareholders, that is, voters. They are rarely pulled up for their performances. It used to be so at election time earlier. Today, elections are fought on social media, by whipping up emotions at rallies, misleading on economic issues such as demonetisation, and even vote capture. Books such as this one would help in revealing the real stories behind the cacophony of political sloganeering, and must be read for improving our voting decisions. A few minor quibbles. Two consecutive “concluding remarks” sections at the end of some chapters might confuse the average reader. Also, tighter editing and proof-reading would have really lifted reader experience. Notwithstanding these small issues, this book is a welcome addition to our economic literature, especially for its clarity in understanding and, in turn, explaining the controversial economic issues simply and elegantly.

Paromita Shastri is a freelance writer

India’s high inequality is hurting growth: Business Line 21st Dec 2017

Income concentration seems to have curbed the growth of broadbased demand, while the rich approach satiation levels

Inequality is one issue which Indians always shy away from; we do not want to accept that it is there, and that economic reforms have actually widened the wedge. While poverty definitions are fairly amorphous given the absence of a singular measure, inequality is even more nebulous on account of the absence of data, and hence it is hard to calculate the Gini coefficient.

While practical observations do reveal that billionaires living in mansions are surrounded by the destitute with little hope, the official argument is that even the poor have mobile phones which show that there is progress, and hence inequality has fallen.

The World Inequality Report 2018 has provided data on inequality across various countries which makes interesting reading. Besides picking up easy measures on inequality, benchmarks can be viewed across various nations to understand where India stands. A striking observation is inequality as a rule exists everywhere in the world where the rich have become proportionately richer than the other groups in the last three decades or so. India would look a bit more skewed in this respect.

For example, the share of the top 10 per cent in total national income in 2016 in India was 55 per cent. It was 47 per cent for the US, 37 per cent for Europe and 41 per cent for China. In our country, the top 1 per cent held 22 per cent of total income which was only below 28 per cent for Brazil. In case of China, it was 14 per cent and 13 per cent for Europe. This should give an indication of the concentration of income in certain pockets.

WRONG GROWTH

There are two other interesting parameters which are spoken about here in the report. The first is cumulative growth per adult between 1980 and 2014. Given the low base, growth was 223 per cent for this period in case of India. For the bottom 50 per cent it was 107 per cent and 112 per cent for the middle 40 per cent, while for the top 10 per cent it was 469 per cent.

More alarming is the income growth for the top 1 per cent where it was 857 per cent. This is probably a sharper measure of inequality as it speaks of growth in income over various groups where the richest has witnessed the highest increase over higher base numbers compared with the other categories.

The second metric is the share of income growth of various classes for the period 1980-2016. The bottom 50 per cent had a share of just 11 per cent, which is not really out of place with other geographies except the US where it is 2 per cent. The middle 40 per cent had 23 per cent, one of the lowest across regions like the World, the US, Europe, and China. The top 10 per cent had share of 66 per cent (same as in the US but much lower than in Europe with 48 per cent and China 43 per cent) and top 1 per cent, 28 per cent. This talks of which groups have gained the most on account of cumulative growth.

PRIVATE PUSH

Two conclusions can be drawn from this data. First, the level of inequality is very high in the country and cannot be disputed. Second, as a corollary, the benefits of growth have been extremely skewed towards the rich. How did this happen?

The growth model followed since reforms was tilted towards the productive sectors and liberalisation meant less of government and more of private enterprise. This was the chosen route to growth and hence it was felt that if the private sector was given space for expansion, the benefits would percolate downwards through employment opportunities as well as higher living standards.

This has not happened according to script and the benefits have largely flowed to the upper echelons. In fact, this limited growth syndrome acts as a useful social buffer as it gives the illusion of upward mobility even though the pace is much slower than that of the higher echelons. Therefore, it is not surprising that 90 per cent of the population accounted for just a third of the growth taking place during the period 1980-2016.

Reforms were focused on de-nationalisation. Privatisation meant that even public companies would be owned by private players, which began the process of heightened inequality. Governments have dithered on subsidies and the elite are anti-subsidy. The result has been that even government activity has tended to move towards projects generation in roads and city development. This is ironic, as we wanted the government to be out of productive activity when we went in for privatisation. This has actually meant that when a road is created the contracts go to private parties, which increases income of the relatively richer echelons.

Curiously, the NREGA has been rebuked by many as being a dole which has pushed up wages beyond productivity levels and affected corporate profits! This is so as NREGA wage has become a benchmark for all wages in industry. There is hence relentless pressure from the corporate world on the government to lower these allocations on grounds of its distorting the wage structure.

Further, the growth of crony capitalism has meant that the nexus between the government and some corporates has exacerbated the income distribution pattern. Privatisation programmes are normally for better performing companies — which is natural or else they would not be of interest to the private sector. Loss-making companies continue to be held by the Government. This is another reason which has fostered the inequality syndrome in the country and has been spoken about by Thomas Piketty in Capitalism in the 21st Century. Does this matter? While electorates seldom change governments on account of inequality or poverty, but rather on issues like caste and religion, permitting such a phenomenon is not good from an economic standpoint.

DEMAND SATURATION, AND MORE

Higher inequality comes in the way of demand creation. Economic growth is sustainable provided the poor are also able to rise in the hierarchy and spend on goods and services. If these incomes do not rise, the demand cycle is interrupted.

Therefore, it is essential to keep their income increasing at a reasonable rate. The problem we have today of absence of demand is because of inequality. The rich run into a cliff of ‘demand-saturation’ where motor vehicles cannot be changed every year or houses bought periodically. The other income groups too have to spend. If they do not have this wherewithal, as is the case in the last three years, the tendency would be to spend more on essentials than consumer goods which impact growth.

India does revel in having an increasing number of millionaires irrespective of whether they are self-made or ancestral. Also, as pointed out by Piketty, some sections of the corporate world have also tended to add to the money cycle with exaggerated pay, which includes huge stock options that carry no commensurate responsibility.

Tackling inequality and reducing the gap between citizens is ironically a necessity to keep the economy ticking. In the West, high levels of prosperity across the citizens was one reason for expanding markets overseas. We do have a large populace that needs to move up the ladder or else will continue witnessing growth in waves rather than in a linear manner.

FRDI Bill: In its current form it will throw up challenges for every banking segment: Financial Express Dec 19, 2017

The deposit-holders are already at the receiving end in the new mantra of banking. First, the return on deposits is very low. Second, it gets taxed unlike equity or some social funding schemes.

The Financial Resolution and Deposit Insurance (FRDI) Bill raises some very interesting issues for discussion. Banks are very unique entities. In case of non-bank corporates, the equity-holders own and take the risk of the enterprise while the managers run the show on leverage. i.e., money borrowed from institutions. When the enterprise fails, the owners take the hit to the extent of their equity stake while their private property remains unattached. The problem is now on the lenders which the NPA story is all about while managers continue with their business. This is the classic principal-agent conundrum. Now, in case of banks, the government or shareholders own the company, get managers to run the entity, but play around with the depositors’ money. It is not surprising that today, in the midst of heightened emotions, the complaint is that banks have made a mockery of deposit money, as this is the essential raw material. At present, losses lead to erosion of net worth and the owners—for PSBs, its the government—have to infuse capital.

Losses accumulated due to high NPA provisioning, for example, can wipe out the equity value of the owners. So far, it sounds okay. But the FRDI Bill speaks of the deposit-holders, too, being made a part of the bail-in process; this implies that they will have to also bear with the losses if the issue has to be resolved. This means that if the bank is a PSB, the government can clearly say that it will not infuse funds but simply let deposit-holders take the hit. The equity capital is any way low for banks which run on deposits and, hence, would not matter even if it is eroded. In a way, the loss is being shared with the deposit-holders (who are the equivalent of lenders for non-banks). The deposit-holders are already at the receiving end in the new mantra of banking. First, the return on deposits is very low. Second, it gets taxed unlike equity or some social funding schemes. Third, the insurance given today is only for up to Rs 1 lakh. Fourth, the deposit-holder is hammered for every service that is rendered by the bank. While entry into the branch is penalised, access to ATMs meets the same treatment. NEFT transactions get charged and, hence, almost all services that were free earlier have now been on the price-list. Banks state that if you want service, pay for it or else go elsewhere. Since most banks act as oligopolies, the same cost trickles in unless the account is a privilege account.

The last straw will be when the account-holder is told that any mismanagement in the operation of banks will be a cost imposed on them. Now, the situation reads like this. The government or the shareholders of private banks will reap the dividend when profits increase. They will also appoint their personnel to the management who, in turn, will decide on the remuneration and bonuses. However, when things go wrong, the burden will fall on the deposit-holder. This may be the most extreme situation conceivable, but cannot be ruled out. Even today, the issue of recapitalisation bonds points to this hilarious anomaly. Banks have excess funds which they are not able to deploy because demonetisation brought in a barrage of deposits. As these deposits reside in reverse repos, the banks will be glad to invest the same in these recap bonds issued by the government which in turn will be invested as equity (equity or bonds) in the banks. In the situation outlined earlier, a bank failure could just mean that the deposit is extinguished and the equity remains (as the resolution mechanism dictates). Quite clearly, subjecting deposit-holders to such risk is not acceptable. In fact, it will bizarre on the part of the government to do this. Several schemes are being floated for senior citizens who also have locked up savings in bank deposits. The more affluent or market-savvy customers prefer mutual funds and equity, and may be able to get out of this rut. Also, given the resolution committee under the IBC can decide which deposits have to be forfeited, there could once again be discrimination as banks would prefer to protect HNI clients against small deposit-holders, quite like it happens with using bank facilities—the former and corporate clients continue getting free services while the ordinary depositor is charged for everything.

Another aspect to ponder over is if the FRDI Bill were to be implemented in its present form, how would deposit-holders behave. At present, households are agnostic to the name of the bank as it is assumed that money is very safe, even if it is not owned by the government. There is some implicit understanding that money will not be lost and, even when bank failures have occurred in India, these have never meant loss of depositors’ money. But, once such a dispensation comes in, there will be a tendency to get all deposits rated as everyone would prefer to go to banks which are doing well and, hence, management quality will matter. This action would mean that as banks start sliding, there will automatically be a tendency for deposits to become mobile and gravitate to the better banks, which will result in further panic with a bank run being the the worst-case scenario. This can be very destabilising for the banking system, but cannot be ruled out. RBI, on its part, has to be more on-guard and make sure that banks are always transparent as deposit-holders now would need to know how these banks are performing.

Such a system would also means that people would progressively start exploring other avenues of savings, which can benefit the mutual funds industry in particular which has tended to deliver marginally better returns (debt schemes) if not higher (equity schemes). Are we prepared for such a scenario where the savings are over-invested in the market-oriented instruments? Also, the government would tend to lose out as the SLR becomes harder to maintain as banks will have to cut down on lending to meet such statutory commitments. Therefore, there will be challenges for every segment of the ecosystem if the Bill is passed in its existing form. There is need to go slow here

When statistics obfuscate meaning: Business Line Dec 12, 2017

It is important to read between the numbers to understand the real picture, whether it is GDP growth or inflation

The GDP numbers that were released for Q2 of the year were quite significant because of the interpretation. For the first time we have had comparisons made between Q2 and Q1 which showed that the economy had improved. In fact the explanation was carried forward to vindicate the view that neither demonetisation nor GST have actually affected the economy and that things were up and about. And as this news came on the back of a Moody’s upgrade and a pat for reforms from S&P besides the improved Doing Business rank of the World Bank, the impression gathered was that the country is out of the docks.

But will this mean that we are back to the 8 per cent growth path? Here everyone is hedging between 6.5 per cent and 7 per cent, and few are going beyond. The issue is actually one of interpretation of data which can lead to considerable obfuscation depending on how it is read.

GAUGING PERFORMANCE

Normally performance in Q2- FY18 should be juxtaposed against Q2- FY17 because the seasonal impact is removed as the periods are similar. The economy traverses various seasonal factors which by their nature make it difficult to compare with other quarters. Q1 for instance has the rabi crop while it is also the pre-monsoon time when infra projects are sped up. Industrial production slows down as this is the slack season when there is only residual spending from the rabi harvest, and marriage expenses in April-May.

In Q2, typically there is no major crop harvest except horticulture and animal husbandry which are a year-round phenomenon. Construction comes to a standstill due to the rains, while companies step up output to prepare for the festival season towards September. Q3 and Q4 are vibrant quarters as momentum picks up during harvest as well as festival time combined with accelerated production towards the end of the year.

The 6.3 per cent growth number in GDP in Q2-FY18 was well below the 7.5 per cent number of Q2-FY17 and 8 per cent in Q2-FY16 (16 per cent lower in terms of change in growth rate). A critic would say that the downslide continues and there are few signs of a recovery. However, the 6.3 per cent growth rate has been interpreted differently this time by juxtaposing the same with 5.7 per cent growth in Q1-FY18 (which is 11 per cent higher in terms of change in growth rate), which was also sensationalised to be the lowest growth rate in the preceding 12 quarters. With hype being built on the all-time low number, the 6.3 per cent growth rate gives the impression of a grand turnaround.

Hence even if one goes beyond the cynicism maintained when viewing new methodologies when economic variables are calculated where things look different, interpreting numbers could be made convenient depending on the outcome that has to be projected. In fact, the figure of 6.3 per cent growth would also be the lowest ever Q2 growth rate witnessed in the new base year methodology being followed with 7.3 per cent being the lowest in September 2013.

One can further dampen the mood by looking at gross fixed capital formation which came in at a low of 26.3 per cent in Q2-FY18 which marks a continuous decline in the second quarter for all the preceding years from a high of 34.4 per cent in 2012. Now the GDP growth number does not look as impressive when this trend is also juxtaposed.

CLEARER PERCEPTION

It is, therefore, necessary to be discreet when interpreting statistical data. A similar conundrum emerges when one looks at the core sector data numbers. There has been much ado about how the infra industries have really turned around with the October growth number of 4.7 per cent being extrapolated as a measure of sustainability for the rest of the year. But all production in the economy is cumulative in nature. Monthly data are susceptible to accounting issues when the date of reporting becomes important. Often at the end of the month large orders especially for capital goods could cause a spike which gets corrected subsequently leading to alternating phases of low and high growth rates. Cumulative numbers even out this anomaly.

A better way is to see overall performance is hence in cumulative terms. For the current year, growth has been 3.5 per cent compared with 5.6 per cent last year, which does not give the same sense of satisfaction as growth is still low. In fact a comparison with earlier years show an alternating picture of high and low growth rates with no discernible trend. Even in October, growth was lower than 7.1 per cent last year. This is where the ‘base year’ effect comes in when a higher number for the last year leads to lower number this year. This is a clumsy but valid explanation as statistically it is low. A similar picture is observed when we look at the IIP growth rates where it should be reckoned on a cumulative basis as monthly numbers would be misleading.

CONFUSING INTERPRETATION

When it comes to inflation, the interpretation of numbers seems more confusing. Households have a problem as prices of tomatoes and onions could blur the overall picture as spending on clothes and footwear happens only periodically. They are moved more by month on month changes because any comparison with what it was a year back would be less relevant as the shopping basket is compared with the immediate past. But this is never highlighted.

The RBI looks at the trend in growth rate in the last few months and then takes a call on interest rates. Since June 2017 the figure has been moving upwards from 1.46 per cent and would look at it as inflationary pressures building up notwithstanding some deviations in the period under consideration. But on an average basis for the year, the inflation rate for the first seven months till October was just 2.7 per cent while the last number remembered would be 3.58 per cent. But this may not matter as policies are coming in every two months and the monthly numbers matter more as interest rates are subject to fine-tuning.

Indian statistical data has several challenges including the presence of a dominant informal sector where data is not easily available. Further, given that even organised sector data is not free-flowing, several imputations are used for calculating numbers. This is one reason why often one cannot relate these numbers to the ground level situation. The 7 per cent growth in manufacturing GDP is hard to reconcile with corporate performance which shows a struggle, and low IIP growth for the period.

Further, the judgment used to interpret such data can result in differential interpretation. This is why we must read between the numbers.

Insolvency guidelines: In collateral damage, a few good promoters will get hurt : Financial Express 11th December 2017

The advantage of being a commentator is that one can be critical about everything without taking any responsibility. This holds for cricket, where the commentator may have never held the bat or could have been a very unsatisfactory one-day batsman, but may still talk eloquently and critically on the toss, let alone the game.This holds for cricket, where the commentator may have never held the bat or could have been a very unsatisfactory one-day batsman, but may still talk eloquently and critically on the toss, let alone the game.The advantage of being a commentator is that one can be critical about everything without taking any responsibility. This holds for cricket, where the commentator may have never held the bat or could have been a very unsatisfactory one-day batsman, but may still talk eloquently and critically on the toss, let alone the game. A similar principle holds for the Insolvency and Bankruptcy Code 2016 (IBC) resolution process where critics are quick to find fault in any measure taken, but also get worked up when nothing is done. Almost certainly, they provide no solution. The recent ordinance bars certain kind of promoters from bidding for their own assets which are being auctioned, though it allows them to join the fray if the dues are paid. It is not surprising that many have taken substantial volume of umbrage. Let us go back to the start.

Resolution of NPAs has always been difficult. After the asset quality review (AQR) was put in place, the NPA levels soared and reached almost 11-13% of impaired assets. This reflects poorly on our economic performance as there is an awkward feeling that, somewhere, we may have just inflated the economy by reckless lending, reminiscent of what China did when its the government supported an investment-led growth paradigm. The question is whether or not we swept the muck under the carpet, and have now gotten busy kicking the can to provide the camouflage that all is well.

The fact is that some large companies are not servicing their bank loans. Many an opportunity has been given for a solution—the Sarfaesi Act, corporate debt restructuring, the Scheme for Sustainable Structuring of Stressed Assets, strategic debt restructuring, etc, were all attempts to resolve the issue. But the tyranny of status quo prevailed. The public kept pointing out that these ruthless promoters were getting away at the expense of the taxpayers and deserved the strictest punishment. Bankers did not want to take a decision because there was a fear that any future investigation may conclude that the haircut taken was incorrect and a decision taken in vested interest. This would have the 3Cs (CBI, CVC and CAG) haunting them. The companies naturally wanted the maximum haircut, and hence, there was limited movement on NPA resolution. The final solution came in the form of the IBC which has set timelines for resolution and final sale of assets. The recent ordinance makes the system tighter by excluding defaulters from the game. This is when the story has developed a twist. A promoter who has not been paying his dues now decides to buy back the asset. Is it right? The public limited company is quite unique in structure as the promoter can control the company with limited stake and yet not be personally responsible for the NPAs. It is not surprising that these promoters often legitimately continue to live a life of luxury even when the enterprise cannot service its debt. In such a situation, should they be allowed to buy back their asset at a discounted price?

Such a point has been reached because no solution could be arrived at by the borrower and lender. But, it is only when the trigger—the exclusion clause—is being pulled that some promoters have taken offence. The law has now classified some categories of defaulters including wilful defaulters, NPAs for over one year, etc, that are to be excluded from the bidding process. Those who do not agree with this rule say that several such cases are due to extraneous factors that led to the normal course of business collapsing, and that if such action is taken, then risk-appetite will fall and investment will slide further down as investment hunger thins. There is some merit in this, but then no one had taken this stance when banks revealed that the NPA ratio was above 10%. Banks were accused of cronyism, pandering and incompetence.

Every major reform has some collateral damage. Demonetisation hit the household class quite perceptibly and the small and medium enterprises segment is still recovering from the backlash. GDP growth may have declined by at least 1% on this score. RERA has hit small real estate dealers hard—but they have to be clean now. GST has caused immense trouble for smaller players. IBC, if implemented in its current form over a wider spectrum of borrowers and loans, will also have such an impact.But such a cost would be worth it for cleaning the system. Further, as we have been crying hoarse for strict action, this ordinance provides a solution, albeit a moderately harsh one. In fact, when solutions were being suggested, there was support for naming and shaming defaulters as well as excluding them from further borrowing. The present dispensation only prohibits them from bidding for a mess created by them and, hence, is still quite moderate!

To make this exercise successful, some thoughts can be considered. First, while the law allows all NPAs to come under this umbrella, the committee of creditors (CoC) can be selective in taking decisions in conjunction with the Insolvency and Bankruptcy Board of India. Linkages could be built with the size and tenure of the NPA.

Second, valuation will always be a problem because a bidding process can lead to a sub-optimal price, leading to more controversy and even litigation. Strategic games played by bidders could push the price down. On the other hand, by allowing the promoter to bid, the system could be gamed with a higher bid being put in to reclaim the asset at a low price. So, we could have a ridiculous situation where a loan for, say, `100 is taken and not serviced. When the NCLT talks of selling the asset, the same promoter pays `40 and buys back the company or asset. The loss is, hence, still on the bank and the borrower has the last laugh. A minimum reserve price and auction should be the way out.

Third, the credit-default swaps (CDS) should now be used by borrowers and lenders for bank loans as well, as this will serve as an insurance cover. In fact, when a bond has to be issued in the market, a very good rating is required for investors to evince any interest. For bank loans, however, this is not the case. By insisting on a CDS, an enhancement can be made on the internal rating assigned.

There can be no debate that this is the right way out. Making it retrospective is a trifle harsh but sets a firm example that one cannot get away. Ideally, it should have been prospective, but doing so sends out the wrong signal, that the administration is weak. This creates a moral hazard—if the quantum of NPA is really high, then the system can never get harsh.

There will be genuine cases of companies affected by economic cycles. This is a cost to be borne, which will also get reflected in less risk-taking. We should be prepared for this. Also, one must remember that the industry is always against waiver of farm-loans where crises erupt mainly due to unfavourable weather. If this sounds reasonable, then the same should hold even for insolvency caused by external factors.