Re-energising the India Post model: Business Line 22nd AUGUST 2018

The strengths of India Post must be leveraged to make it financially viable

In a world where communication has assumed different forms with the written word being transmitted on mobile phones and the proliferation of private courier services for printed matter or documents, the role of India Post needs to be redefined. The starting of the payments bank is pragmatic because the department may have just taken the right step at a time when postal services have become less relevant while financial services continue to be important given their under penetration in rural areas.

To get a better sense of how the postal business has traversed over time, we must look at the last 10 years ending 2016-17. Table 1 juxtaposes some broad numbers taken from the Statistical Handbook of India and Annual Report of the Postal Department.

Today, the viability of any organisation is determined by the break-even numbers. Here it is clear that the deficit or loss made has increased sharply over the last decade. The table also indicates that over the last 10 years the importance of the Postal Department has declined and the government is aware of this.

The fact that the number of post offices has come down as have the employees on the rolls appears to be in line with the declining volume of business, which has come down by around 7 per cent. The handling of the savings pie has on the other hand increased which consists of small savings that is contributed more by the middle and lower income groups with a strong rural bias.

 

However, here too the compound growth rate of around 6.8 per cent is much lower than bank deposits which have grown at almost double the rate. Hence this section remains niche.

Also the losses of the department have increased by over nine times. The department has been run as an essential service which is primarily used by the weaker sections especially in the rural areas. This can be seen by the domination of the rural sector in total post offices and was 1,39,067 in 2016-17.

Postage rates

As a result it becomes very difficult for the government to increase the postage rate given that it is uniform across the country. Consequently, while trying to address the communication needs of the lowest income group, the higher income groups too end up enjoying this benefit.

With this goal in mind the department has been subsidising the cost of operations to a very large extent as seen by the losses being incurred on virtually every activity.

The only service which gets in a positive net income or surplus is insurance. A thought here is that the government should reconsider some of the services in the light of their relevance. Can money orders be replaced by mobile transfers? If private couriers have replaced India Post for some of the services, can the same be truncated? Can the small savings activity be hived off to the Payments Bank?

Interestingly, the volume of business has fallen across all segments which the accompanying table shows. The losses have been mounting as several costs like administration, maintenance, salary, etc. move with inflation while transportation costs keep moving up more than proportionately. Therefore with the volume of each business coming down, these fixed costs increase the cost per unit of business.

It is generally believed that visits to the post office come down when there are alternatives available. However, when the communication is from or to government departments across the country there is a mandatory use of postal services. This holds for all job applications and submission of documents and hence in a way is a cross subsidy which will get reflected in some savings in other departments as the cost would be higher if private services were used.

Also given the reach of the Postal Department, it is not possible for private services to reach the rural areas and even in case they do, there are time issues of delivery. The Postal Department delivers the best. Notwithstanding these advantages, the fact that technology and private services are catching up in a big way the threat of loss of business to Whatsapp and courier services is real.

The government has been working hard to make various departments function in a more effective manner. It is only a matter of time before the India Post comes under active review. The creation of the India Post Payments Bank is a good step and though the progress of these banks has been slow, there is scope for this venture to succeed given its reach.

But there are reforms which can be implemented for the other services.

Revamp pricing

First, the pricing structure has to be revamped as such heavy losses cannot be sustained. Differential pricing based on location can be considered with the rural areas getting a subsidy. The other centres would have to be made to pay the full cost. Hence an inland letter can be priced at ₹4 if sent from a rural post office and ₹10 from others.

Second, post office spaces should be leveraged to earn rent. As financial inclusion includes also non-banking products, these can be sold in post offices by the mutual funds or their agents.

Third, the existing staff can be trained to sell financial products like insurance and mutual funds in rural areas and a commission earned by the department.

Fourth, the post offices can be integrated with the eNAM initiative where terminals can be kept in these offices for use by farmers. Further, dak sewakscan be used to also form a link with the agricultural markets (eNAM) as they have direct interface with farmers and can be given the responsibility of spreading awareness as well as be the link with the market prices.

There is considerable scope to leverage the present strengths of India Post to not just make it financially sustainable but also maximise the utilisation of the infrastructure to link it with other goals of the government to create a virtuous cycle.

Higher interest rates are here to stay: Business Line 2nd August 2018

RBI’s thrust on price control could mean policy rate hikes each time inflation threatens to cross the 5 per cent mark

With the credit policy of the RBI being announced six times a year, the expectations are that the action to be taken would be based on precedent. One tends to look back at the language of the earlier policy and then juxtapose the developments that have taken place on the revealed concerns of the central bank and then make conjectures on what the RBI would do.

The decision, however, is of the Monetary Policy Committee (MPC) and hence the majority view is supposed to be based on similar rationale. Based on what the RBI had projected in the earlier policy, one could have expected the committee to wait for more data points before taking a call. However, the majority decision was to hike rates.

How should we look at this rate hike? Inflation is the main factor that is being targeted by the MPC and logically the future path becomes important. In the statement, the RBI says clearly that it still expects inflation to be less than 5 per cent this year. It has been put at 4.6 per cent for Q2 and 4.8 per cent in H2-FY19.

With the last inflation point at 5 per cent, these numbers look to mean moderation going forward. Yet the decision is to increase rates means that the intent is to keep the inflation rate below 5 per cent mark at all times. As a corollary, it can be said that whenever the rate looks to cross 5 per cent, we can expect rate hikes.

Inflation triggers

Now let us look at the factors that are causing concern. The MSP (minimum support price), combined with the monsoon, is the leading factor. Now the MSP story may be overstated by economists because even though MSPs have been hiked in the past they have not lead to inflation.

In fact, for pulses and oilseeds, MSPs have increased by around 5 per cent in the last couple of years but prices have actually come down. The reason is that when there is no procurement, the MSP becomes less credible. Therefore, it can be reasoned that farm prices causing inflation would be more when the crop fails or where procurement is active like in the case of rice and cotton.

The other factors such as HRA and oil prices are known concerns, which will play out either statistically or by global actions.

For the latter, it looks like there would be stability till the next policy. The government has taken a major step in lowering the GST rates, which should help lower prices on the manufacturing side.

This component had contributed to the over 6 per cent core inflation in the last few months. While the action of the RBI is justified, it will be interesting to see whether or not inflation will remain below the 5 per cent mark.

The RBI has also mentioned a neutral stance with the rate hike. This should be taken to mean that it would ensure that liquidity is available to the market and should not be a limiting factor.

This should assuage the market as lack of liquidity can cause a spike in rates which, the tone suggests, will not happen. So one can expect more OMO (open market operation) purchases during the year when required.

Will interest rates go up? It has been seen in the past that when the RBI lowers rates, deposit rates move down but lending rates remain sticky. The reverse holds when the rates are increased, where MCLRs and the base rate will go up while deposit rates would trail.

As bank credit growth is expected to revive this year with industry showing signs of a pick-up, it may be expected that the cost of credit would increase.

Normally borrowers tend to look at both the loan and bond markets for the best terms of borrowing. In a rising interest rate scenario, corporate bonds and CPs (commercial papers) would react faster, which means bank credit may be preferred. This was already observed after the June policy, when borrowers switched back to banks. This would be good news for banks though cherry-picking the projects will become crucial.

More rate hikes?

Will there be more rate hikes? The answer looks to be almost certainly yes, if the inflation number crosses the 5 per cent mark and, hence, the outlook on the monsoon and kharif crop will hold the key to this decision.

The sowing pattern so far has been slightly disappointing for some crops like pulses and oilseeds.

Low prices in the last two years could have caused either a migration to other crops or lower sowing to keep prices at more reasonable levels.

This can be a potential pain point in the next few months, which will be monitored by the RBI closely.

How about growth? The RBI has not changed its growth forecast and this means that notwithstanding the rather good growth numbers seen in IIP and core sector in the first few months of the year, the growth path will remain at around 7.4 per cent. While this is assuring, it also means that the country has to wait for another year or so before crossing the 8 per cent threshold which was last witnessed in FY16.

The RBI action is hard to conjecture as the futuristic view taken can provoke a differentiated response on different occasions. But, for sure, it can be said that higher rates are here to stay.

This can be the message taken from the rate action with another one on the cards, though the timing will be uncertain.

The spotlight is back on the MPC: Business Line 25th july 2018

With rising global crude prices and MSP hikes, there is every chance of the RBI panel hiking policy rates

With the RBI credit policy round the corner, the focus is naturally on the decision on interest rates. The fact that inflation has touched the psychological mark of 5 per cent shows that it could move up further in the coming months. The views of the MPC members will be important.

The overemphasis on the CPI inflation number is interesting because it has become the fulcrum for policy making. But is this the right indicator? When the WPI was used, critics had argued that the CPI was more relevant as it affected our lives and use of WPI understated inflation. When the CPI became the anchor, critics were quick to point out that while it helps to determine real income, interest rate action through demand management cannot affect prices if the problem is on the cost side.

If CPI inflation is driven by higher prices of pulses, then increasing rates does not help the cause. If people demand less tur when prices reach ₹100 per kg, demand may come down as it becomes unaffordable to many. Yet, prices do not adjust until the next season. Therefore, there is no clear answer here. But the RBI has decided to target CPI inflation and 4 per cent being the so called ideal target with a band of 2 per cent on both sides.

 

Why did the committee choose 4 per cent? Evidently there were models which threw up this number and so this has become a benchmark. The MPC came into being from the October 2016 policy when it took charge of the process. At that point of time, if the Committee had looked at the CPI inflation number of the last 10 years based on the CPI index for industrial workers (the so called old CPI number which is still collated today), it would have found the inflation number always being above 5 per cent. The range was 5.6 per cent to 12.4 per cent. Going by the new CPI index, the inflation rate was 4.9 per cent in 2015-16 and at 5.8 per cent, 9.4 per cent and 10.1 per cent respectively in the preceding three years. Therefore, to start off targeting inflation rate of 4 per cent was always going to be interesting.

MPC’s record

Against this background how have the MPC members reacted? There have been 11 policies so far and two rate cuts of 25 bps each and one rate hike in June 2018. Further within the Committee, there was near consensus in the first four policies after which there has been one outlier in all other policies till the June 2018 one when there was again unanimity. The inflation given in the table would be the latest inflation rate that was available to the MPC when the decision was taken (the second month preceding the month in which the policy was announced). Further, the first policy under the MPC was announced when inflation had come down from 6.07 per cent in July 2016 to 5 per cent in August 2017.

Is it possible to draw a pattern here? The first rate cut took place when inflation came down to 5 per cent. Subsequently the rate remained unchanged in the next four policies even as inflation came down to 3 per cent in April 2017 when the policy was announced in June 2017. The rate was cut again when inflation touched 1.5 per cent which was 3.5 percentage points lower than the previous instance of rate cut. When the inflation rate remained below 4 per cent subsequently only one member voted for a rate cut, while the others favoured a neutral stance. When the rate of inflation crossed 5 per cent and remained above 4 per cent for the next two policies, the majority maintained an unchanged stance before pitching for a unanimous rate hike after the third data point.

The question is how will the MPC view the last inflation point of 5 per cent? Logically this should stir a debate of a further increase in rates as this will be the fourth time that inflation has strayed above the 4 per cent mark. As the policy has to be forward looking, the future trajectory will be the focus of discussion. So will rates go up further?

Based on the previous assessments of the RBI most of its concerns have already started playing out. First oil prices are rising and coupled with a weaker rupee landed cost is increasing as seen in the transport and fuel component. Second, the government has aggressively increased MSPs which can have a price-fuelling impact albeit at a progressively lower rate than the increase in prices.

Third, the HRA component of the States will now kick in causing the index to move up further. The RBI in its study on State finances has highlighted this point. Fourth, a fiscal slippage looks more real going by the constant shortfalls in the Centre’s revenue which has prompted several auctions of cash management bills as well as recourse to ways and means advances. This being a pre-election year, the possibility of fiscal slippage is high.

Inflation worries

Therefore, the possibility of inflation moving up further to the 5.5-6 per cent range cannot be ruled out unless food prices crash due to a good harvest. While a good harvest cannot be ruled out (though the present indications could be varied), the higher MSPs may provide support to prices and ensure that inflation does not fall. Therefore, unless non-food inflation eases, overall CPI would remain elevated. Under these conditions further rate hikes may be taken as being more or less given.

The timing of these rate hikes and the voting pattern in the Committee would be a matter of conjecture. Even if rates are not increased, this time there could be two members voting in its favour.

Challenges before India’s growth story: Financial Express 23rd August 2018

Manufacturing’s contribution to GDP needs to get improve, and capital formation in the economy and the savings situation must get better.

The growth path in the Indian economy has been hazy at best in the last six years or so, with a certain modicum of desperation on our part to prove that things are looking brighter. This is notwithstanding the recent controversy on the back-series on GDP based on the new methodology, a matter that has now acquired political overtones.

GDP growth in FY16 was 8.2% and came down to 7.1% in FY17 (partly due to demonetisation) and further to 6.7% in FY18 (partly due to GST). There is hope that things will get better this year, and estimates are in the range of 7-7.5%. For sure, these growth rates are much lower than the 8-9% growth that we had taken for granted in the past. The hubris of the past notwithstanding, today, aspirations are more modest and a gentle ascent is what is being conjectured. But, there are some pain points when one looks at some of the major edifices in the economy. It can also be said as a corollary that, if these issues are not addressed, the sustainability of growth may come under a cloud as the present structure is not appropriate.

The first pertains to the composition of the GVA from FY12 onwards. It springs some surprises. There was a decline in the shares of two sectors—industry and construction—and that is quite significant. The share of industry, which includes mining, manufacturing and electricity, came down continuously from 32.5% to 29.1% in FY18. This would not normally be expected as the largest quantities of investment get directed to minerals, power and manufacturing. Clearly, the controversies in awarding of contracts in infrastructure in the pre-2015 period, followed by the funding challenges for the banking system with the increase in NPAs, has contributed to the decline in investment. Further, excess capacity has come in the way of the growth of these sectors.

The share of construction in GVA has come down from 9.6% to 7.4%. This is significant because there have been several reports on the relentless thrust of the government on roads and housing that should have, ideally, got captured here. Evidently, the amounts involved are quite small relative to the size of the economy, which has resulted in a declining share.

The second pertains to capital formation, which is a reflection of gross investment taking place in the economy. This has come down continuously over the years from 39% in FY12 to 30.6% in FY18 and has to be reversed to build the base for future growth.

The decline in capital formation started in a big way from FY14 onwards, when there were several controversies regarding irregularities in various sectors like telecom, power, coal, iron ore, etc. This, in turn, led to an increase in stalled projects, estimated at `4-6 lakh crore over a period of time. Despite streamlining of processes for resource allocation and clearing of projects, the quantum of abandoned projects had increased and there was further a slowdown in new projects. This was also the period when the NPA story really started, leading to further deceleration in fresh capital formation that, in turn, has resulted in such low numbers.
The third area of concern is savings. Savings are important as they finance capital formation, and the trends over the six years ending FY17 suggest that a lot of comfort that we have received on the external account, of low current account deficit, is mainly due to investment rate declining in consonance with the savings rate. Theoretically, the savings-investment gap is the current account deficit as the investment that cannot be financed by domestic savings has to be supported form outside. But, it has been a case of investment equilibrating with savings that had presented a better picture on the external front. This should ideally not be the case as it means that decline in investment has led to lower demand for funds.

The accompanying graphic shows that the overall savings rate had declined continuously from FY13 till FY17. The household sector, which was the largest contributor to total savings with almost a two-thirds share, accounts for just under 55% in FY17. The share of the private corporate sector has increased during this time period. Quite clearly, household savings have been impacted by a lower ability at thrift in terms of both financial avenues and physical assets. One reason can be because of more money being spent on consumption. While we tend to look at current inflation and take solace in these numbers coming down, consumption gets affected by cumulative inflation, especially in food, which comes in the way of savings. People are spending more on necessities and not on durable goods which gets reflected in the decline in share of physical savings by over 6% of GDP.

Therefore, the overall profile of growth in the last seven years does instil a feeling of discomfort as it is being driven more by the service sector; though this may be good in the short run, it can’t be sustained in the long run unless physical production increases in importance. Services need to support agriculture and manufacturing, and what is seen in our case is that the higher share of services (which increased by 4% in this period) has been driven by the government sector in three out of the six years and by the financial, real estate and professional services segment in the other three. This is not a sustainable model given that the financial sector is in a stage of transformation and has to grow in conformity with the manufacturing sector to eschew issues like adverse selection which has resulted in the NPA issue today.

The call to ensure that the share of manufacturing goes up in GDP supported by strong investment has always been there. This has not happened, and low demand conditions and an unstable banking system are major concerns. Employment has to increase to push up consumption which will gradually feed into new investment as optimal capacity utilisation rates are achieved. Investment in infrastructure has to re-commence from the side of the private sector as the thrust provided by the central government is not enough and states have limited fiscal space for the same. Funding is a challenge and practically speaking the next two years will be transformative and we have to get the plot right to get growth back on trajectory.

Draft e-commerce Bill gets it wrong: Financial Express 15th August 2018

The e-commerce model serves the same function as the current efforts to bring farmers closer to the consumers by linking them digitally. Also, e-tail discounts bring down prices for consumers.

The draft e-commerce bill needs to be critically viewed, as it seeks to shift the stance, once again, away from the consumer to the intermediary. The ideological issue in all cases of pricing is that, in a free market, pricing should be determined by the players when interacting through the invisible hand. This will be more so when the products concerned are not essential commodities and come under the category of lifestyle. Distribution is always a challenge in India given weak logistics, which leads to cost escalation that widens the gap between the price at which the manufacturer produces and the consumer pays. The question really is whether or not the consumer should get the best price?

The e-commerce model works efficiently as it puts buyers and sellers on a platform and deals are struck based on the mutually-accepted price as well as the comparative offering that saves time and money. It should be a Pareto-optimal situation where both sides are better off in this marketplace. Or probably not, as such a transaction has created an externality that affected another constituency—the bricks-and-mortar shop. The choice to sell or buy lie with the two parties that take rational decisions when getting into a transaction, as there is no pressure to go through with the deal.

The problem has arisen as bricks-and-mortar outlets do not offer the same prices as the e-commerce sites as they have to cover their overhead costs that include staff and establishment. Also, given their financial condition, they would also have to work on their higher margins, which, though subsumed in the MRP, are still higher than what the competition offers. With an e-commerce company, these costs fall drastically. This is the best solution for the consumer, driving demand growth in future.

Is there anything wrong here? There exists a similar scenario if one looks at the agricultural markets. The mandi is the place where the farmer sells his produce, and when the product traverses through the entire value-chain and reaches the consumer, there could be various layers involved, and that ends up driving a wedge between the two prices—at the mandi and at the retail outlet. These costs are considered to be superfluous and efforts have been on to bring the farmer closer to the consumer so that the former gets more and the latter pays less than in the present situation. This idea can be translated to the market for retail products.

The e-commerce model does the same, since a seller—who could be a dealer or the producer—is selling directly to the customer on this platform, at a price that is lower than the retailer’s in a bricks-and-mortar shop. The model here is one that works on lower margins and on quick and high turnover, which ensures that capital is not stuck in inventory. There are added services, viz. returns, that are not normally allowed in the traditional outlet. It is a win-win situation for all and, hence, should be welcomed. But, we always like to take sides and play the game from one constituency, which, here, is the bricks-and-mortar shop.

Any transformational change in the country would mean asking existing players to reinvent themselves. So should the bricks-and-mortar outlets if they are to survive. It is worth recollecting that when domestic organised retail was proliferating, there were objections raised to this on the grounds of the kirana stores getting affected as prices offered by organised retail were lower because of ‘bulk purchase and quick turnover on lower margins on higher volumes’. Ironically, e-commerce has gotten the larger branded stores to be on the same side as the smaller physical shops as it disrupts their model.

If there is predatory discounting, where the seller is selling at a loss, it is a commercial decision being taken; there should be no interference here. Also, this is not sustainable, and, hence, can only be a periodic phenomenon. Merely taking up the cause of the bricks-and-mortar retailers because they are a big constituency is just not right. FDI is already not permitted in an inventory-based B2C model, and the marketplace structure operates. Goods being dealt on the platform are Indian and can also be procured from anywhere in the country. The bone of contention is the deeper discount that e-commerce offers where break-even takes time but deep pockets permit such patience.

Interestingly, even today, there tends to be cartelisation inadvertently, where all dealers sell, say, mobile phones at the same price—the MRP. There has been no objection when discounts are offered in the ‘chain establishments’ periodically where the larger ones can crowd out the smaller ones. Here, differential pricing is permitted. However, when the scale has increased to a new level where even the larger physical chains face competition from more efficient e-commerce platform, umbrage has been taken.

The government has always been looking at prices from the consumer’s side as inflation is a constant worry. There is always the concern that prices are being pushed up in certain segments and action is often taken to ensure fair play. The e-commerce story is unique because, here, the government seems to be against the idea of deep discounts. While the telecom episode is about getting the telecom companies to lower rates, the 20% discount being offered on, say, medicines through the e-commerce mode has not raised any objection even though the bricks-and-mortar chemists charge MRP, which, in a way, is ‘overcharging’. The entire edifice of GST was built to ensure that more efficient reckoning of taxes will lead to prices coming down. In fact, the latest grievance with the GST regime is that there is profiteering in several cases, and these are under investigation.

Therefore, it appears that the present grievance against e-commerce companies that have FDI backing is a result of lobby groups that are not able to compete in this setting. Teaser prices have been permitted in telecom and, hence, the analogy in the foreign trade canvas relating to ‘dumping’ where products are dumped at lower than cost is not valid. If the commerce system is to progress, the market should be the best judge and price intervention from above is certainly not desirable. More important, the products dealt with are in the comforts/luxury segment where competition means bringing down prices which helps to push up sales, production and, at the limit, GDP growth. Where is the problem then?

A new all-time low: Rupee at 70 a dollar now, but let us be reasonable: Business Standard 14th August 2018

The rupee has already plunged under 70 to a dollar. How much more? The question is very relevant, now that the rupee has breached that psychological mark. Just a week ago, one thought the rupee would settle in the range of 68-69 a dollar; but the currency suddenly gravitated towards and then under 70. Curiously, the Reserve Bank of India (RBI) had mentioned in its last credit policy that trade wars were a major concern. But the concept of trade wars has assumed another dimension now, going beyond the US and China.

The present problem has been caused ostensibly due to the imbroglio in the diplomatic issues involving Turkey vis-à-vis USA. The fact is that the USA is using the concept of higher tariffs or ban on imports as a way of controlling not just economic but also political concerns. Hence, sanctions on Iran or the present disenchantment with Turkey (an American pastor is imprisoned in Turkey) has been settled on the basis of sanctions and tariffs. The fallout is also that these issues can snowball into something more serious as there could be threats to other countries to desist from dealing with the targeted nation, which in this case can be Turkey or Iran earlier. It is for this reason that the tensions can be long lasting and it will be difficult to guess when the issue will get resolved.

The market behaviour tends to get volatile as a collateral effect of such a phenomenon which can be felt across the world. This is the major reason why the rupee has been going down. Therefore, volatility is here to stay, at least for a while, and it will be hard to say when the normalcy will return. It could be a couple of trading sessions or a longer period of time. The way the market works is that the yo-yo movements continue as long as the ‘noise’ factor is there, and then it reverts to normal once the final call is taken – in this case, once US President Donald Trump takes his final action.

At present, the external situation based on fundamentals is satisfactory – the foreign portfolio investment (FPI) flows have started turning positive of late. Trade deficit has been widening, but it is not a major concern, as oil prices have stabilised. The US Federal Reserve’s future action is known, and there could be few surprises here. Also, the domestic economy seems to be on the move in the right direction, and the forex reserves, though declining, are fairly robust to cushion such shocks. Therefore, there should be few reasons for concern, and the rupee should revert to the 69 level finally.

However, the interim period will be volatile and it is here that the right sounds are heard from the RBI. It is not so much action in terms of supplying dollars which will not help right now, but ‘talking the market’ which is important to ensure that the speculators do not try and cash in on this situation and drive the rupee downwards. It will hence be interesting times for the market, and the holidays in between should provide some cushion.

How Democracy Ends: Book Review: Financial Express August 5, 2018

In this rather engaging discourse, Runciman showcases how democracies ended in the earlier days, which is quite different from what happens today.

Donald Trump has probably become one of the most critiqued leaders in contemporary times. His election to the post of US President has been democratic, but the general opinion is that he can’t be controlled, and the majority does not seem to be with him on most of the decisions taken. Is this what democracy is all about? David Runciman, in this quite hard-hitting book titled How Democracy Ends, takes us through what goes on in this world and explains why leaders like Trump may not mean the end of democracy.

There are three threats to democracies according to the author. The first is coups, where governments are overthrown. The second is catastrophes, where the environment or nuclear warfare can spell the end of such systems. The third is technology, which enables those who have power of money to create opinion and then manipulate the people who elect them to power. Voters are often fooled into doing what the rulers want through the spread of misinformation. This has become more problematic today and is a danger for democracy.

In this rather engaging discourse, Runciman showcases how democracies ended in the earlier days, which is quite different from what happens today. Maybe some 50 years back, when there was dissatisfaction, there would be a coup to overthrow rulers who were misgoverning. This could be by the military or the opposition, which would invariably talk of restoring democracy after unseating the head. However, the truth would be that those taking over would use democracy to legitimise their own tenure. This happened in Greece when, in 1967, Andreas Papandreou was overthrown. However, when Greece went through tough times when the sovereign default took place and people took to the streets, we did not see a similar coup where the leader was displaced or thrown out.

For this, the author has an explanation. First, institutions now run in a different way and politics has changed, where debates and dissension take place in the Parliament or other official quarters and not on the roads. People do not wield daggers and guns, but slug it out with words in these confines in business suits. Therefore, there is civilised conversation and debate. Besides, most democracies in the western world are much better off today than they were in the past. The author goes through data to show that once the per capita income crosses $8,000 per annum, violent takeovers never happen. Also, the fact that the population has aged makes a difference. When there is a young population, there is a greater tendency to resort to more draconian means than when the population matures. This can also be deduced by looking at countries that have insurgencies, and which invariably always have low-income, high-unemployment and high-young population.

The current backlash against democracy is ironically happening in places that have firmly-placed democratic systems. People are disgruntled with situations that are ‘unresponsive’ not because they are ‘underdeveloped’. This is something which we in India would also identify with, as often we hear ourselves saying we need to change our system because democracy has not delivered. This can hold with the legislature, executive and judiciary, where things do not seem to be going by the commonly-held view on democracy. Political arguments from the opposition are normally in the areas of welfare state, constitution, economy, security or freedom. Each side wants to get back what it thinks it has lost, which creates what the author calls a ‘conspiracist’ mindset, where one starts blaming the other. In the US, it is put forward that the democrats stole constitutional freedom and the Republicans stole minority rights. In Europe, it is always the EU that stole British sovereignty. Such accusations are not uncommon these days.

There is a comparison between China and India, where the former runs the economy on market terms, where technocracy dominates. India is fully democratic, but has not achieved what China has since the process does not work as it should and the people’s will is not what comes from decisions taken at the top.

The author rightly points out that rising inequality is a pressing issue in democratic societies. In the Cold War days, such a system of distribution would be met with violence. But today, political systems can suppress such causes of violence without addressing the issue.

He argues that, invariably, we elect politicians who promise to shake up things because the show has come to mean nothing much, turning into a sterile performance. This does call for reflection, especially for rulers in democratic set-ups, as most countries that are not democratic do crave such freedom. However, once democracy sets in, the final picture always seems very different from what was expected, which leads to a certain modicum of disappointment. This is definitely a thought-provoking treatise on democracy, as is professed today across the world.

What RBI policy means for banks, markets, deposit holders: Key takeaways: Business Standard !st August 2018

The risks pointed out by the RBI still remains the same with the MSP, oil price, demand, HRA factors driving the decision to hike rates

The RBI policy decision does come as a surprise given that the overall inflation projections have not really changed significantly for the year being put at 4.6% in Q2 and 4.8% in H2. There is an adjunct of a neutral stance which probably may not read deeply as a similar stance in the past has not precluded a rate hike in subsequent policies. Yet the call to hike rates should sound good for the savers while industry would have to be prepared to pay more on loans. Moreover, the days of easy money are probably over.

The risks pointed out by the RBI still remains the same with the MSP, oil price, demand, HRA factors driving the decision to hike rates. The impact of GST changes on soothing inflation has been pointed out which should mitigate the pressures and ensure that inflation remains less than 5%. The call on MSP is however debatable because even though MSPs have increased sharply this time anecdotally it has been seen that the same does not get translated into higher inflation for all crops. It normally works only when there is procurement or else the price movement is driven more by supply conditions. Therefore, the key would be the kharif crop and its impact on prices eventually taking into consideration both the MSP hikes and the supply of commodities.

The RBI appears to be very keen to ensure that the inflation number should remain at less than 5% during the year and hence the rate hike can be viewed more as a preemptory measure to quell any demand-side forces which could emanate given that core inflation has been the main driver of this number in the last 6 months or so. Future action should be data-driven and hence the monthly numbers on CPI inflation-especially the core inflation number becomes even more important.

What would this mean for the markets? First, banks will have to revise their interest rates which will be more sluggish than the markets. Deposit holders should gain and it may be expected that the MCLRs also react in a similar manner. Second, the market rates should increase soon and hence bonds should get more expensive. Third, government security yields will move upwards which is going to be problematic for banks when they mark to market their portfolios. They are still facing the twin challenges of NPAs and marking to market their investment portfolio. Given that they have excess SLR of above 8% NDTL< the amount is significant.

Fourth, this should be good for the forex market as the FPI flows could now turn positive with two successive rate hikes and the rupee could get more stable. Fifth, an increasing rate scenario at this point of growth in the country would make investing more expensive and given that global rates are also higher would mean that much more strain on corporate P & L.

Last, the economy has to be prepared now for a higher range of interest rates and the years of cheap money are over.

Whose wealth is it anyway, has inequality increased in India? Financial Express July 30 2018

Both ownership of gross fixed assets created and share in market value of companies point to a lower share of wealth transferred to the ‘people’ as against family-owned or private business.

One good that emerged from Thomas Piketty’s Capital in the Twenty-first Century is the debate that got triggered on inequality. The diktats of capitalism had dominated economic thinking since the turn of the century, and the concept of economic Darwinism caught on. The 2008 financial crisis exposed the fissures in this landscape—greed was then no longer considered good, and it was felt that there needs to be better governance when it comes to compensation to corporates. Piketty’s tome is built on these tenets, and goes back through the ages to make the point that inequality had generally increased over the period.

It is, however, hard to quantify this concept when the economy in question is as complex as India’s. Data is available only for select areas, and the levels of accuracy are questionable given the dominance of the unorganised sector. But, within corporate India, it is possible to pose this question and see the trends based on data from annual reports. This can be one measure of inequality. Piketty has always distinguished between inherited wealth and that which was earned where the former had a distinct advantage. At another level, he does use data to show that even in the contemporary world, corporates were to blame for inequality where they paid themselves large sums of money in the name of management pay that came through both cash and stock options. As a result, even after the financial crisis exposed management wrong-doings at many companies, this set of people had already made their money and hence never quite lost—unlike shareholders whose wealth was wiped off.

Three aspects are looked at here, based on annual report data, to assess the level of inequality, the key metric being whether it has increased or not. The first is ownership of assets (measure of distribution of wealth), the second’s the market value of shareholders (share of market rewards) and the last is the share of salaries in overall income (share of labour in value added). Two points of time have been chosen—2007 and 2017—to assess whether inequality has gone up or not in the span of a decade.

A sample of 3,826 companies selected has been classified under four categories by ownership—private, MNC, public and family-owned. The limitation here is that the concept of public limited company is fuzzy, where a family-owned company will also be having non-family members as shareholders even as their own share in the company can be in the region of 25-30%. But the company is associated with the family name and operates under this franchise. The idea is to see if there has been any change in the pattern of wealth, measured as gross fixed assets and market capitalisation, across these segments. The accompanying graphic depicts the results.

The graphic shows that, in a decade’s time, the share of the family-owned companies increased by almost 10 percentage points, to 44.1%, while that of government-backed entities came down by around 12 percentage points. The shares of the MNCs and non-family private sector increased. Therefore, it does appear that, in terms of ownership of assets in the country—valued at `42 lakh crore—the largest share went to the family-owned companies.

Next, to the story on market capitalisation, which is the value of these companies (around `106 lakh crore). Here, too, family-owned business maintained its share in the cake. However, the value of wealth of PSUs came down. This means that the government companies had lower valuation in the market, which also means that all the disinvestment that had taken place in the market was unable to actually prop up the market cap as the perception of being ‘public-owned’ militates against higher valuation. This also means that the wealth to the general public, which is what PSUs represent, came down. In case of private companies and MNCs, the shares went up.

Both the indicators point to a lower share of wealth transferred to the ‘people’ as against family-owned or private business. The part on gross fixed assets supports the Piketty concept of inherited wealth increasing in terms of dominance. The third variable is the share of salaries in total profits, which is defined in terms of profit and loss account components of ebitda plus salaries and wages—the value added. A higher share of salaries would mean that labour is getting a higher share which is an income equaliser in the broader sense. Here, a sample of 2,350 companies for these two points shows that the share increased from 24.4% to 29.1%, indicating that there has been an improvement.

There is, however, a caveat here: The salary referred to includes also the payment to the top management on which one does not get details from annual reports. This is what Piketty had referred to when he spoke of managements of companies taking the larger share of the pie, pleading better performance—this is acceptable in a capitalist world. Annual reports are quite opaque on this front, and do not provide information on the shares of top brass in overall compensation bill for companies. A possible approach is to look at the revealed information on the board of directors published for, say, the Sensex companies to get an idea of what part of total bill is attributable to the top brass—only the working directors and not the independent ones who get sitting fees. While this number too would not be right as it is influenced by higher or lower denominator, it is still interesting. The accompanying graphic gives the frequency distribution of the shares of the board management in total compensation for 24 companies in the Sensex that are in the private sector.

The highest share of top board level management was 7.3% that, surprisingly, was in the private sector. The others with above 2% share were expectedly in the family owned companies. The banking sector had the lowest ratios with the software firms, where a high numerator was balanced by very large employee compensation outlays.

The conclusions that may be drawn have to be put in some perspective. There is a definite tendency of a good level of concentration of wealth with the ‘inherited wealth’ class that has evidently built on wealth with a lot of effort—and this is commendable. The fact that their share in market value is unchanged also reflects probably fair valuation. The fall in the share of the public sector is significant and reflects the diminishing value of this sector. Counter-intuitively, it can be said that, in the case that initiative was not taken by the private sector, wealth creation would have been slower.

However, the second part of the story is revealing as there has been some sings of top management taking a higher portion of the total salary payouts. Now, whether or not companies could have continued to create value without such handouts is a matter of conjecture.

New bond market framework: A big push for corporate borrowings: Financial Express 24th July 2018

While SEBI has done its bit, it is necessary to get in more investors and this is where other regulators need to build their framework. A one-year tenure bond would appeal to mutual funds, but probably not insurance companies or provident funds. There also has to be more paper and derivatives working in consonance for this market to develop in the desired manner.

The Securities and Exchange Board of India (SEBI) draft report on deepening the bond market is pragmatic, and when read along with the RBI regulations regarding large exposures, it seeks to change the face of corporate borrowing from April 2019 onwards. The premise is that companies should progressively access the bond market for meeting long-term requirements, and banks should ideally be lending for working capital purposes and not term lending.

There are two reasons for this. First, there is a definite asset liability mismatch where deposits are for a short duration while assets are for a long tenure. Second, it is these long-term assets that have been part of the sordid NPA story and hence should be addressed through the bond market, with the Insolvency and Bankruptcy Code (IBC) playing in the background.

A large exposure has been defined as a company with more than `100 crore of long-term borrowing of above one-year tenure, which excludes external commercial borrowings (ECBs) and inter-corporate borrowings. The one-year criteria probably needs to be revised upwards to more than three years, given that bank deposits would normally be for three years, and a one-year classification could be too conservative. It is clear that the reference is to `100 crore of aggregate long-term borrowing and not just from banks, which was the case with the RBI large exposure norms. The proposed rule says that all such companies that have a rating of AA and above will perforce have to borrow 25% of incremental requirement from the bond market. Therefore, if a company needs `100 crore more, it can get only `75 crore from other sources and `25 crore must come from the bond market. This move will give a fillip to the bond market.

By starting off with AA-rated companies, SEBI has ensured that there is no risk of default as data shows that the default rate for such paper is negligible. There is a sop thrown in, which says that there is no need to have a debenture redemption reserve created—which is the case today for non-financial companies or those that choose to go for public issues.

There would be two challenges for corporates. First, in case they were using banks for term lending earlier and now have to partly use the debt market, they would have to look at two sources and, to this extent, bear the additional expense. Second, which is more pertinent, is the cost of funding. It was observed that corporate bond yields are smarter to react to the interest rate environment. Hence, when the repo rate is increased, bank MCLR—the marginal cost of funds-based lending rate—moves sluggishly, while bond yields are quicker to respond. It was observed that when rates were moving down, the non-banking financial companies (NBFCs) in particular would move from banks to bonds. Similarly, ever since G-Sec (government securities) yields have increased post the credit policy, they have moved back to banks. Therefore, the cost of funding would increase in a rising rate scenario and come down in a falling interest rate environment. NBFCs in particular, which are large and continuous borrowers in this market, would be affected the most here. Interest rate risk management would become more important for these companies.

Banks will be relieved on the whole as they can run on more prudent lines. However, with the 25% rule coming in, they will have to strive that much harder for meeting their own top-line targets as the concept of term loan gave them the leeway to go in for big tickets, which served the purpose. But they will have to be more choosy when it comes to lending, as in case the AA-rated clients—which are the cream—partly move to the bond market, they would be left with the lower rated portfolio. To this extent, their capital requirements in terms of risk-weighted capital will need to be worked on.
On the whole, this move initiated by the government and conceptualised by SEBI is very good for the market as it brings in more order. Depending on how the IBC turns out, the same paradigm can be extended to lower-rated investment-grade paper. It will also take us to the global level where bond markets dominate and banks are investors in this market. A collateral benefit that can be seen here is the development of the credit default swap (CDS) market progressively as well as credit enhancement scheme. Both have not taken off due to status quo in the market. As companies with lower rating seek to raise funds, CDS would become more compelling and lead to its development. Maybe at some stage, the regulation could also insist on such a cover for lower-rated paper.

Credit enhancements have not quite taken off today. However, once the A-rated companies see value or advantage in borrowing from this market, they would perforce look for enhancements and hence would work towards getting a higher rating. This would be off-balance sheet exposure for banks and not fund-based. Therefore, a lot of change can be expected in this market.

The Indian financial system has evolved over the last two decades or so, which involved the conversion of development finance institutions (DFIs) into universals banks. The erroneous thinking at that time was that these banks would continue to do what DFIs did. Banks had the lure of CASA deposits (current account and savings account), and assumed that since these funds remained constant in proportion over the longer term, it actually provided the asset liability management (ALM) congruence. This led to higher exposures to infra projects and other heavy investment projects, which got associated with non-performing assets (NPAs).

In retrospect, the pertinent question is, whether or not banks have the ability to evaluate long-term projects when they converted to banks? Unfortunately, instead of building the debt market before letting DFIs become banks, we chose to jump the queue. The situation had to deteriorate to the extent it has today, before these drastic changes have been made. This move will certainly create the right structure for future borrowing and the financial system will emerge stronger than before.

While SEBI has done its bit, it would also be necessary to get in more investors and this is where the other regulators need to build their framework. A one-year tenure bond would appeal to mutual funds, but probably not insurance companies or provident funds. In addition, there needs to be more paper and derivatives working in consonance for this market to develop in the desired manner. Also, this agenda has to be taken up simultaneously.

Book Review: Linda Yueh’s The Great Economists: Financial Express 22nd July 2018

If you want to return to your economics classroom to get a refresher on macro-economic theory or want to know what all these theories are about, you should pick up Linda Yueh’s book The Great Economists.

If you want to return to your economics classroom to get a refresher on macro-economic theory or want to know what all these theories are about, you should pick up Linda Yueh’s book The Great Economists. It is true that almost all subjects today are explained with jargon, which makes the specialist and practitioner important, as only they can explain the finer aspects. But Yueh shows that you can do it yourself in this excellent book, where she takes us through the theories of 12 major economists. What makes this book special is that it is simple to read and understand. It follows a fixed pattern, where there is an introduction of the economist and a write-up on their early lives and how and why they became what they are now known for.

There was evidently inherent excellence in them that led to some remarkable achievements and breakthroughs in economic thinking. More importantly, all these theories are relevant today and one can actually match the present environment with their ideology. Next, she explains what their statements and theories were all about. Here, the reader gets to know what these economists stood for and the various debates they engendered along with the elements, which became the foundations of their theories. The third part is probably the most exciting, where the author takes you through how the current economic situation, starting from the financial crisis and other contemporary developments, can be understood based on their theories. Interestingly, these economists had answers to all the issues.

These three elements on various economists make this book a great one. It does not prolong the discourse and gives the reader enough to tell you how their lives and theories turned out, including some personal details. Most theories were formulated against the background of the environment in which they lived. You get to know that John Maynard Keynes and Joseph Schumpeter lost lots of money in the stock market at the time of the Depression in the 1930s. Most of them were well-off individuals who ventured into the subject of economics out of sheer passion and belief. Probably the least discussed economist today is Douglas North, who had a deep impact on a subject, which we talk of today, but never relate it with an economist—institutions.

North had spoken of the importance of institutions in bringing about growth and this is where one can relate to the concept of governance. Africa is a very good example—even though it has shown signs of growth in some pockets, it’s been an underperformer because of poor governance. This has meant that growth has been uneven across nations, where institutional development lags. If we look at India and the progress made in the last quarter-century following reforms, it becomes clear that strengthening them has made a difference. Robert Solow, who became famous for his theory on factor productivity as a means to growth, is relevant today, with the concept of technology catching on in a different way. Artificial intelligence is something that would have puzzled this economist.

The conflict is that when we bring in too much technology, which becomes labour-displacing and does not create jobs, can we say technology has brought about growth or has it only substituted labour? This is a question worth thinking over. Schumpeter became popular for his theory on creative destruction, besides his famous book on capitalism, socialism and democracy. His argument was that it is a natural order that countries go for an overhaul when existing structures are uprooted and replaced by new ones. The financial crisis was an example of how the financial system was changed completely, as institutions crumbled and the structure changed. David Ricardo and his free trade theory get questioned when we talk of the recent Brexit issue or the rather inward-looking policies followed by the US. Would this be something that Ricardo would have agreed to? Today, countries are all moving against the dictates of the WTO, while forging free trade agreements elsewhere. Therefore, countries are becoming closed and open at the same time based on political motivations.

Ricardo, on second thoughts, would still be right, as benefits of free trade are much larger than the loss of freedom. The great Adam Smith would never have agreed to services being the driver of the economy, which is the case in most countries today. For him, the manufacturing sector mattered, as this was where production took place along with innovation. Countries moved ahead because they produced goods. Therefore, can one say the financial crisis was inevitable when this sector was out of sync with the industrial sector’s progress? The fact that several countries decided to go back to manufacturing post the crisis, in the form of rebalancing their economies, would be a vindication of the Smith doctrine. Closer home, our government, too, is trying to get manufacturing back on the growth map.

Keynes, the ‘big boss’ of economics, always remains relevant, as pump priming is considered most proper globally. Joan Robinson’s theory on low wages can be linked with her stance on imperfect competition, where factors of production are not mobile nor is there perfect information, which is what most economic theories assume. Milton Friedman became more politically oriented for a large part of his later career, but he is relevant from the point of view of open markets and less government interference. Inflation is always a concern and when we see the RBIand the MPC always talking of these numbers, we realise that Friedman was spot on and is even today working in everyone’s mind. The Great Economists is extremely engaging and serves a grand five-star buffet meal with all the starters, main courses and desserts. Each chapter can be read independently and the sequencing of the three sub-courses, when writing on an economist, makes this book even more delectable.