Depression with a Difference?

At last, it seems to be dawning on the world that we may be staring at another Depression. The Greek PM was candid to admit that the country is in a version of Great Depression. But, unlike the other leaders, the Greek PM has an advantage of accepting the fact that they are staring at another economic depression. Greece, of course, will be mired in economic depression/stagnation or whatever name we give it for the next decade, if not two. Luckily for Greece, they are unlikely to be the only one there. The nature of global economy means that it would be very hard to find a textbook definition of depression as of now. So, technically, we can gloat that we are not even in a recession let alone depression. While it may be a long time  before policy makers give up in exasperation, all the indicators seem to indicate that the parts of the global economy will remain in varied forms of depression for a long time. The Japanese are probably the best to listen to in the present situation: they have after all been dancing round the liminal boundary between a recession and a depression for nearly two decades. They have warned that the Chinese slowdown will be far deeper than it was thought. 

Bond yields indicate that the poor state of the economy is likely to continue. Falling bond yields are no more a big event. It is now more profitable to invest in junk bonds rather than private equity. At last, investors have realised that in a financialised world, investing is basically shooting in the dark. It needed the biggest crisis in the history of the human race to understand the true character of finance. Low long-term bond yields are indicative of inability to deploy funds and high present indebtedness. Uncertainty of the future and possible unintended consequence of the future, including the likely bouts of fears about counter party risk, mean that the new long-term is six months. Moreover, we have not yet seen the worst to even think of a recovery. The problems may be starting all over again: this time they may be centered around the core regions of Europe and the Emerging markets - both of which have not been factored by markets other than the bond markets. Downgrade of the core (Germany) have only just started. The Credit Default Swaps of the indebted countries seem to be behaving in a similar pattern: panic leads to a sharp rise, central bank intervention follows, a semblance of normality - small drop and then they start their upward march, and the cycle goes on. The chart below of Spain's CDS reflects the movement of the other countries. (The Chart is sourced from Bloomberg)

More interesting is that the present crisis, if it turns out not to be a depression, will take years for an actual. And, when there is actually a recovery, the global economy will shrink to such an extent that it will still feel like a downtrend. The shrinking of the global economy has already started in some countries, like USA (leave Ireland, Spain and Greece) where companies have already started to attempt to deleverage themselves. Bank of America is one such case that has announced their decision: rest will invariably follow sooner. BoA is cutting the number of ATMs. Next will be branches and then subsidiaries (if they can sell them) and then will be bankruptcy - that is the life-cycle of any over-leveraged companies in Capitalism. 

Unemployment will continue to soar - unless the world adopts the US system where those unemployed for more than six months are deemed to be lazy and hence removed from the labour force statistics. A cursory glance at Spain, Ireland, Portugal, Greece and a long list indicates that instead of adding jobs, the economies are at best stagnant. But, no growth is not an option - especially when indebtedness is all pervading rather than an exception. And, when everybody attempts to deleverage all at once, it only compounds the problem rather than the other way round. 

Emerging markets are likely to be the next shoe to drop. Each emerging market is indeed unique: as are their problems. They seem to believe that low interest rates will solve the problem. The problem with emerging markets is that they never learn and hence over the past 100 years they have continue to attempt to emerge without much success. 

India is in a unenviable position: over the years, we have increased our dependence on commodity exports, software exports and exports to China. None of which seem to be the right place to be in at the present. The government seems to be groping in the dark, though they would not like to accept that their policy of encouraging exports to China was a good move in the first place. Industry has leveraged itself to the hilt, as have the central and the regional governments, individuals from the richest to the poorest are no different - after all they are not islands in society. 

There is however, one particular aspect that the government seems to have overlooked. The nature of social and economic change is such that, once the forces are unleashed, they cannot be controlled. The slowdown is slowly, but surely seems to have begun process of unleashing all the social and economic contradictions and problems that till date were papered over due to the recent economic boom. Boom time meant that various issues were relegated to the background. Now that this has ended the tinder box is being reopened. Look at the recent strike at Maruti plant. Never before have we witnessed striking workers killing senior managers in India. This has happened two times in the past six months: once in Pondichery and now at the Maruti plant. That should be sufficient reasons for policy makers to understand that this downtrend will unleash more violent process of change than the processes at work during 1989-1993 period. 

Disappearance of the 'Old Elite'

The past two decades have been quite momentous in a literal sense. Close observation of the socio-economic, cultural and political landscape invariably raises more questions than ever. And, most of these questions cannot be answered to our own satisfaction, let alone to the satisfaction of others. 

Over the past decade, one question has frequently come across my mind. I keeping asking this question but have never got any help. It is a question that nobody has been able to answer. The first time, the question came up was during research on the Culture of Finance Business in the Vijayawada Region of Andhra Pradesh. The interesting aspect of the Krishna district (and the neighbouring districts) is that the present day elite invariably consists of one that has climbed the social, economic and political ladder in their own life time. Most of them started their career as either handymen (cleaners) or drivers, clerks, small time commission agents or those doing odd jobs graduating into small time business men and subsequently growing. Coming from the lower rungs of the economic pyramid, they would invest all their surplus in land (agricultural land in rural areas or urban real estate). This investment in land may have also been due to their intention of making known their own success to their peers and kinsmen in their community. It had its own advantages: it increased their assets and also their creditability (they could now be lent money since they had some asset). Rising land values invariably increased their economic and social status.

The rise of the new elite is by itself not surprising. However, what is very surprising is that the 'Old Elite', especially those who dominated the economic and social landscape of the region a few decade back are conspicuous by their absence. Interestingly, none of their descendents are anywhere close to the top of the social and economic matrix. The only exception seem to be those who belonging to the Andhra Sugars Group. They seem to have simply faded into the background and from there into oblivion. It has become almost impossible to track them to even find out, even from an academic point of view. 

This seems to be happening in a number of other districts of Andhra Pradesh. The photos below are from Wanaparthy Town in Mahabubnagar district of Andhra Pradesh. The buildings that belonged to the former Raja now house the Polytechnic college. The Raja was magnanimous to donate it in 1954. The Raja's daughter's, like a number of other descendents of the elite have migrated to the USA and his adopted son is in Hyderabad, governing a school which became more famous for the supposed riches buried deep underneath rather than his activities beyond it. It is now the centre of the town. Despite its majestic appearance from the distance, the close we get the more it reflects the status of their former owners: either crumbling or in a state of fading into the oblivion. This particular structure it is a bad state and requires urgent repairs though not completely dilapidated.

The  occasional maintenance expenditure apparently was possible when some film producers decided to shoot Telugu films about Factions and related stories. Ironically, the Rayalaseema faction films were shot in Telengana region of Andhra Pradesh.

A View from the Balcony of the building

The picture below is a well in the college compound that was built first built in 1868 and then rebuilt in 1904.

Hopefully, we can find a way to protect our heritage, even if we were to remind our posterity of the existence of a different kind of socio-economic environment from the present.

Bailouts, Banks and Bankruptcies: Consequence of Asking the Wrong Quesitons

The immediate present seems to be so eerily similar to the very distant past to such an extent that sometimes (with cynicism) I feel that those who claim that history is useless may actually have a point. At the end of the day, there is absolutely nothing more blessed that being ignorant or even better dementia is in the present economic conditions quite a blessing, albeit in the short-term. The fact that we seem to be blissfully ignorant of the economic crisis speaks volumes of our ability to be selectively demential. Every sector of our economic life has innumerable examples of crisis or near crisis level situations that are very recent, leave alone those going back a couple of decades. The problems in India during the period 1995-2000 should have provided sufficient lessons to our businesses and policy makers. Obviously, they have not. We have not made any new mistakes, we have essentially made the same mistakes. Little wonder that Einstein (who lost heavily in the markets) defined insanity as 'doing the same thing over and over again and expecting different results'. That these mistakes have occurred when we have sufficient information is indicative of the fact that information is not the problem and, the problems lie elsewhere - in the changing social forms and connotations in the way we construe money and wealth. 

Almost every segment of economy and society is craving (or demanding) bailouts: Sovereigns are demanding one too - from other sovereigns. IMF, for once seems to have decided that their legitimacy is at stake and seem to have warned the world about the magnitude of the problems in each country (p.3 of their report). Though, they got it right, nobody seems to care because they are like the Indian police - always late to the scene and always state the obvious. 

The IMF report cited below provides a stark picture of our economy: 

Name of Country	Projected Fiscal Deficit (% of GDP)
	2012	2013
USA	8.1	6.3
Japan	10	8.7
UK	8	6.6
Italy	2.4	1.6
Spain	6.0	5.7
France	4.6	3.9
Germany	0.8	0.6
China	3.2	3.0
India	8.3	8.2

Source: http://www.imf.org/external/pubs/ft/fm/2012/01/pdf/fm1201.pdf

The irony of this deficit is that unlike, the other countries' India's economic position is precarious and hence cannot even think of fiscal austerity. But, rest assured over the years as Indian's we have mastered the art of creative accounting so in the next two years, the deficit will decline, not rise.
Considering the fact that this blog has served as some sort of 'canary in the coal mine' over the past three years, we will be right again. The reason for this confidence is the fact that we are still in a stage where we have to provide large scale bailouts: Power sector needs a bailout and the need for a bailout: they have a 40% gap between costs and revenues while debt has reached Rs.200,000 crores. Add the telecom, real estate, mining and every other industry and it becomes hard to count the zeroes. To this add: the debts of the Central and State Governments, we get the picture, or do we?

We have forgotten the banks, which will themselves need a bailout. Deja Vu all over again!

All the above is not very surprising, considering that we prefer selective long/short term memory loss when it is very convenient. But, how we come to such a situation? The short, albeit bitter answer, is that we have conditioned ourselves to ask the wrong questions. Over the past decades, we have not trained ourselves to ask one simple question: who is taking the other side of the bet or what is on the other side? This pervades through the public and the private sector. 

Take for example the government: a large number of our policy makers do not like being asked uncomfortable questions. In order to avoid this inconvenience, they take the easy way out: appoint cronies who are beautifully useless to positions where one can ask uncomfortable questions. That has created a situation where the army of clerks and beautifully useless cronies excel at exactly one thing: follow procedures. Just as anywhere else in the world, there are extremely smart and intelligent policy makers who well intentioned and attempt to get the system to work by granting greater independence. All their reforms end up creating new rent-seeking institutions. Following procedures means that more often then not, the beautifully useless end up in control. Independence and functional autonomy means more money through rent seeking behaviour. Apparently, this independence has reached an extent where a very elastic interpretation of the law has led to the courts to crack the whip. Ironically, we have reached a stage where a private consultancy has to be approached to tutor a regulator agency about how to function!!! Would it not have been better for SEBI (the more recent of the regulators) to simply imbibe a culture of asking uncomfortable, but right questions at the right time rather than the wrong questions at the wrong time with the wrong intentions? If only the government can come out of 'governmentality' we would not be in this place.

The private sector is even worse. Historically, they have never understood that trees do not grow to the sky. Their excessive dependence on the valuation model of wealth creation and their inability to understand the secular change in the global market place may be doing more harm. The past 18 years has seen capital appreciation as the primary vehicle for wealth creation. It is for this reason that we have mastered price rigging of commodity, equity and real estate prices as the best way to create wealth rather than dividends.

Pointless Interest Rates and Economic Recovery

Since the onset of the Global Financial Crisis in 2008, the hallmark of policy making has been the hope that lowering interest rates will lead to recovery in spending. The cuts in interest rates have been accompanied by other incremental measures. One reason for such insistence on interest rates is invariably their non-controversial nature. Ardent fiscal hawks prefer that to other forms of stimulus. But, the world economy has reached a point where we have doubt the utility of these rate cuts as an attempt to stoke recovery. 

Sometime back we had put up a third party chart that showed that the US bond yields were at their lowest in more than a 100 years. The fact that low interest rates have not helped is again reinforced by the US 30 year mortgage rates. It reached around 3% recently. The chart below points to the secular downtrend in the mortgage rates for the last more than 30 years. The fall since 2008 has been particular steep. A day may not be far when banks and governments plead (and pay) borrowers may not be far off. 

1996-1998 All over again?

Cicero once observed, 'everything has a history, therefore history is everything'. Alas, we are in a age when most of us tend to belittle history to such an extent that we are always condemned to repeat the same mistakes in different forms. It is probably for that reason that Hegel once noted that 'we learn from history that man can never learn anything from history'. Almost always we forget that the cost of forgetting history are immense.
 

The present state of the Indian economy is a typical example. The remarkable aspect of the present situation is that our collective memory does not seem to go beyond a few days, let alone 1996-1998.Of course, we did not have Google, though we had Netscape, we did not have digital papers - connecting to the net was still expensive. But not that these make any difference. After all, we have forgotten the consequences of the drought of 2002-04 as well. But, worrying about the rains is probably the last thing that we should worry about at this moment. Considering the fact that we are going to be effected by El-Nino, don't be surprised if there are floods in September.

There are a number of reasons why the present economic conditions reflect the problems that plagued the conditions that existed then. As in the present, Indian  corporate sector was working off the excess of the borrowing binge after the liberalization of the norms for raising money through ECBs/GDRs. Industries, that had built capacities far in excess of the requirement thinking that trees grow to the sky were shutting down due to lack of demand (sounds familiar - China). The United Front Government, ruled by regional satraps pulled in different directions, and the list goes on. 

The present seems eerily like the past: demand is slowing (but as Indian's we don't accept that there is a problem), bad loans were piling up: then it was Steel and other basic industries, now we have added to the list and now call them 'infrastructure'. Now, as in the past, we were in denial: we still insist 6% growth is possible, when it clear that the world and emerging markets are slowing and there are riots in Eurozone against austerity. At that time we were hopeful that exports would help India - it took the collapse of South East Asia, Russian Default, and collapse of Long-term Capital Management to realise that the world was different than what we had thought. After those events occurred there was an interesting change in the attitude of the banks: rather than lending, they started investing in Government bonds: it was called the phase of 'lazy banking'. Interest rates were high and it was safer to invest in Government securities than to lend it to crooks in the corporate sector. Ironically, this process is well under way in 2012.

Our politicians are a mirror image of our Equity markets: always hopeful and always wrong, especially when faced with reality. Again the present is illustrative: India a capital deficient country, and globally in the present context capital is a scare commodity, yet we are hopeful that our economy will withstand the present turbulence. Nobody elaborate how this is possible. What is odd is that despite the global bond markets factoring major slowdown in the economies, we refuse to learn from history. Our policy makers are still talking in terms of 6-7% economic growth when the world is talking about another bout of deflationary spiral, emanating from China. One has to wonder where India can hope to gain growth: We know for sure that the power sector is in trouble because our dependence on Hydel power and lack of capital. Exports are going to keep coming down in the next few years (not even months) due to problems everywhere. Oh yes, there is one way they can keep growing: slow return of all the illegal money stashed away in foreign banks. The likelihood of this happen is bright: banking sector in all the countries is in trouble plus interest rates are high in India. In deflationary time there is nothing better than steady income.

Indian corporate sector seems to completely unprepared for at least two important global consequences that plagued the Indian economy during 1996-98 and is likely to return in the next few quarters: dumping by Chinese and Russian companies. Chinese companies are likely to dump their goods for the simple reason that China in the throes of a deflation spiral and banking sector riddled with bad loans but a government with sufficient surplus would continue to subsidize their products. The result will be large scale dumping all over the world.

The other consequence that Indian corporate sector is completely unprepared is the consequence of the Union Government cutting its expenditure drastically. The last time this happened (1997-2000) there was a drastic slowdown. The rise in oil prices and the fall in the rupee only aggravate the problems. The expected rise in the diesel price may help avoid a ratings downgrade immediately but in the medium term it will not stop the inevitable (a ratings downgrade). India attracted foreign capital as due to its domestic consumption story. Since that is likely to end sooner rather than later, it remains to be seen how we can avoid the 'junk' status.

Dawn of Depression and the Era of Changing Goal Posts

The last week has seen a subtle shift among businesses and Central banks the world over,  India excluded. The shift, more akin to dipping their toes to test the waters, is indicative of a new trend in the making. Since the collapse of the hedge funds of BNP Paribas in August 2007, policy makers have been in denial that the crisis is likely to drag on for years and that the problems are a mirror image of those in 1929. However, due credit needs to be given to them since without the intervention of the Central Banks, the world would have been mired in a depression that would have made 1929 seem like a walk in the park. The Central Banks saved the day by postponing the crisis but they now seem to have realised that their efforts have more or less been wasted by the politicians and the ability of global capital to see to it that their short-term interests are not hurt beyond a scratch. Even as bond yields of the supposed safe havens reach record lows (below that of the Great Depression era), Central Banks seem to have realised that they will soon run out of bullets and hence have started one last attempt to salvage the economies of the world. One, change the goal posts so that they can postpone the inevitable to buy some more time and, two concurrently gradually prepare the masses for the inevitable: the Dawn of the first Depression of the 21st Century. Bankers seem to have joined the effort. First to release the balloon was the CEO of RBS warning that the crisis in Europe will take years. That was actually the best effort at being frank because, he knows very well that if he is too candid then he will lose his job. Next came Morgan Stanley warning that the world was short of US$2 trillion, then came the Chief of the Austrian Central Bank, who is so nervous about the situation in Europe that he blurted out what is  probably  being discussed in hushed tones by the central banks: compare the situation with the Great Depression.Clearly, the Central Banks know very well that the present situation is irretrievable unless they follow what we have long advocated: write off debts on a biblical scale so that everybody starts on a clean slate. Ultimately there will be such write offs because all the junk paper currency has been exchanged for junk bonds - in the form of bonds that banks are depositing with ECB and borrowing Euros which will anyway will collapse sooner than later.Even the Germans are scandalised by this!!!

It is indeed surprising that there is so much complacency that the economy is going to recover soon. Recovery at a time when there is such great austerity is either a joke or will require a complete overhaul of our understanding of every discipline as it has been taught since 1789. Take the case of Italy which will have to cut 3.2 percent of GDP due to tightening; US will have to cut nearly US$ 1 trillion over the next few years due to fiscal discipline related causes. Greece has to tighten nearly 4.5% of a shrunken GDP, France and a host of others will follow. Such a collapse will only make the ugly balance sheets look worse one year down the line.

The best option, writing off debts, is something that is not palatable at the present juncture. Governments would have the bondholders lose gradually than all at once. Sounds scandalous? Look at those who lent money to Greece over the past five years, and especially those remarkable finance whizkids who lent money over the past three years (since the first package): they have already lost 75% of their principal.

So what is to be done?

For Starters: in the next five years, be prepared for the biggest bull run in the history of the US Dollar Index. The Chart below shows the long-term charts of the US Dollar Index (since 1985) and all the technical patterns seem to indicate that the markets are preparing for the worst. Nothing that seems to be more safe than the US dollar in the era of fiat currencies. After all it is better to loaded up on lousy dollars than being loaded on a sinking currency in the form of Euro.

Two, learn from India: We can still function with active cartels, crony capitalism, an economist PM whose sole USP  can do nothing - like even winning a panchayat election for himself and yet has been the PM for so many years, a Finance Minister who is hoping to retire peacefully with a promotion though his skills never went beyond helping over leveraged promoters become directors of the Central bank,  and we have a central bank that has solved the problem of bad loans very easily - simply reschedule as many loans as possible. That postpones the problem for up to seven years and after that who really cares, there will always be a new theme. And worse may be in store: if the raingods forget us.

After all this is the era when ignorance is bliss and people will anyway forget that the present list of emerging markets have remained emerging for the last century and those like South Korea which are supposed to have 'developed' will be back to the list of emerging markets that tried to emerge but failed. Remarkable how beautifully useless the rating agencies are in practice: they upgrade an economy that is 95% dependent on exports at a time of the most important economies that consume are suffering from indigestion. 

Three, Avoid China - we have highlighted the problems of that country innumerable times and hence no need to repeat it again. 

But, all is not lost for Indian speculators. Indian charts seem to indicate that our speculators are all set to rig stock prices once again.

Is Government Welfare a Bull Market Story?

One cannot but marvel at how 'lucky' our generation is! We are witnessing events that normally occur a century or two apart in the span of a few months or years. When was the last time that history recorded tumult on such a large scale in the world? 1789, 1848-1870, 1914-1950 and the present. Unlike a few decades back, this time around technology will make sure that we will not be overawed beyond the first 48 hours with the events that are likely to overtake us in the near future. The speed of the collapse is however an important new trend. The collapse in wealth in ashort span has been aggravated by the fact that finance has become the  tail that wags dog. US is a classic example of the consequence of this: 18 years of economic advancement were wiped out in about three years - and we are probably only half way through the crisis.  However, what is remarkable is that following the economy over the past few weeks has been quite 'boring' except for speculation about the quantum and form of QE3. 

Then, what exactly is new? The answer may be the macro economic problems that may be round the corner for countries in such as India and the emerging markets. The attendant consequence is that it is clear that in countries such as India, welfare seems to be nothing more than a bull market story. Remember the decade from 1989 to 1999! It is pertinent to note that economic problems do not come on a stand alone basis: buy one, get two free (social and political problems/uncertainties) is almost a foregone conclusion that needs to be factored . In India, the problem is aggravated due to the fact that we have all forgotten what a severe economic downturn is like. Everybody has built their livelihood and/or business models around continuation of high commodity prices, easy liquidity and the India story continuing for another 20 years. However, the pendulum is swinging the other side in almost all the positives.

A cursory glance at government expenditure indicates that India is heading into a prefect storm. And, it seems to be riding into the biggest economic challenge it has faced when it is least prepared. Tax-GDP ratio has dropped from about 12% in 2007-08 to the present approximately 10.5%. Fiscal Deficit is rising. Revenues are bound to start falling (there is always the lag). The government response has been very typical: cut expenditure by restricting subsidies to less than 2% of GDP. That goal is plausible on paper, but practically it would be impossible to achieve considering that the GDP will keep falling, thereby making the target bigger than possible to achieve.

It would be interesting to see which segment suffers. Historically it has been the middle and lower classes. There is no reason to think that it would be any different this time. Government always claim that it will cut wasteful expenditure or even welfare, which at time is also termed as 'unproductive subsidy'. However, the question that we often forget to ask is, if it is wasteful expenditure, why was it allowed in the first place?

The interesting change that has occurred, largely unnoticed, in the immediate aftermath of the collapse of Lehman. The impact of the collapse of Lehman Bros was remarkable in India. Businesses stopped preaching that subsidies should be cut - instead they started blatantly demanding that they should get larger subsidies. That is always the best way to ask for more. The clock has turned a full cycle. Presently it is claimed that subsidies should be cut: invariably the corporate sector means that it should be cut for everybody else while they are exempt. Yes, they should be cut - but the steepest should be for those who have accessed them the past or those who have already benefited in too many ways - that would mean cutting them first for Ambanis, Birlas, Tatas, et al. There are a number of indications that clearly show that Welfare is going to be cut substantially. Till 2014 elections, it is likely to be small cuts but, once the elections are over we should be prepared for big cuts. The reason? Corporate sector and along with it the banking sector in India needs to be bailed out. And if that has to happen, some body has to pay, after all post-Lehman events have taught us that it is easy to socialise losses. Good thing for India is that Everybody is so fixated with Eurozone crisis that they seem to be overlooking our own home grown crisis.

India's banking sector and the government seem to be on the verge of a crisis that will unfold - if the truth was disclosed. The present crisis is such that we would probably be better off if the truth was never disclosed. If that sounds scandalous look at China!

A cursory glance at the monies owed to the banking sector by troubled sectors show us that the magnitude of the problem we have at hand. This problem is compounded because it has been under-estimated and remarkable complacency of policy makers. There are a number of sectors in India in the line for a bailout.

• Textile industry has debt of nearly Rs.1,55,000 crores (yes you read it right) and it wants to restructure Rs.35,000 crores of debt at present. But rest assured, by the time, the crisis is over it is likely to be at three times the present estimate - especially if the history of textile industry is an indicator.
• Real estate companies have to repay at least Rs.35,000 in the present quarter - that is the last sector that is likely to repay their loans. The banks can safely write off at least 75% of that. The total exposure of the banks to unlisted companies has been estimated at more than Rs.1,00, crores. 
• The power sector requires rescheduling of nearly Rs.1,00,000 crores. 
• Telecom sector? Could be in excess of Rs.1,00,000 crores (A.Raja will be the first to vote for a bailout of the sector). 
• Add another Rs.10,000 crores of loans already restructured for the MFI sector.

To the above list we may add the need for about Rs.3,00,000 crores needed annually for various direct subsidies like petroleum products (about Rs.1,81,000), fertiliser,etc.All this excludes the subsides that our political class gives itself - including the money carted out in the form of over/under-invoicing of trade, hawala, etc.

The list is actually never ending, yet in a recent report CRISIL claimed that it expects nearly Rs.2,00,000 crores of loans to be restructured in the next two years. I believe that figure will be at least three times that amount.

To answer the question we have raised, is government welfare a bull market story? The short answer in India is a resounding YES.

After all, ignorance is really bliss!!!

US Treasury Yields - Wake Up Call

The Chart below should serve as a wake up call for all those who believe that the World Economy is on the mend. For the past three years, we have been pointing out that the worst is yet to come.

Since 2008, some of us have fondly nurtured the hope that a sustainable recovery is just round the corner. Unfortunately, the world economy seems to be taking the wrong turn all the time. The bond markets think we are far from a sustainable recovery. The US Treasury Yields are lower than they were in 1900 and as low as they were during the depths of the Great Depression. The yields seem to indicate that despite various "pundits" calling bonds a bubble, they are not about to bottom out anytime soon. 

Probably, time the more rational individuals prepare for the worst. But, the good news is that the Central banks have a bit more ammunition left - in the form of QE3 and QE4. It is unlikely that we will see any improvement in the economy in the next three to four years (except for a semblance of recovery with another bout of QE3 and QE4, but they are likely to be temporary. Unless Greece exits the Euro in the next few weeks, we could see a semblance of recovery from early next year, which could last into the winter of 2013. The best thing to do: Conserve cash. 

Rural Indian Economy: Reflections from the Field

A visit into the rural regions of Andhra Pradesh leaves the impression of a society and economy that is in the throes of change. However, the pace of change seems to universally underestimated. Little wonder that, events that grab the headlines "suddenly" always seem to confound our middle class, liberal sensibilities.

Two interesting underlying  trends seem to be underway in Rural Andhra Pradesh: (a) Mechanisation of Agriculture is gathering momentum at a previously unheard of pace, and (b) Technological adoption has spread to even the remote villages. This technology adoption is quite widespread in all the small towns. 

The small towns, though are still quite enamoured with "computer", "hitech", etc. The picture below is that of a e-seva Kendra in Kandukur, Ranga Reddy District, which advertises, the computerised bus pass service as some sort of niche service that they offer.  

The growing emphasis on mechanisation of agriculture is even more interesting. The case of Mahabubnagar district and Kalwakurthy Mandal in the district is illustrative of this trend. The Mandal is considered to be "backward" by AP standards. There five different show rooms (of different companies) that sell tractors and other farm equipment. This year, till date, the business volumes have been far below expectations due to the drought conditions. Sales have been only 20% of the expected sales. The sale of harvesters, in the district, is quite brisk and if the monsoons are good (normal or above normal) they are likely to grow faster than the past few years because a number of farmers have embraced technology in order to reduce labour costs. None of the companies display harvesters, but will accept order for the same, which will be sourced from their showrooms in Mahabubnagar town. Each harvester costs about Rs.16 lakhs and the banks (or hire-purchase firms) finance at least Rs.10 lakhs. The maintenance costs for an harvester average about Rs.500 per acre. The cost charged for those who hire a harvester vary from Rs.1200 to Rs.1800 depending on the demand. An acre of land takes about one hour to be harvested. As a generalisation but subject to normal monsoons, the loan for an harvester is repaid in about 2 years, implying earnings to that extent from hiring the same to other landowners. Interestingly, the larger the landholding of the buyer, the less the initial cash down payment required. In the case of tractors, if the prospective buyer possesses less than four acres, they are expected to cough up 50%. Land ownership of more than 10 acres mean cash margin requirement at about 25-30%. 

This year, the demand for hiring harvester has slumped in the district and the neighbouring districts, hence the owners have sent to the coastal districts of AP, thereby reducing their margins. One dealer rued that in such times, the drivers demand up to Rs.15,000 plus the fact that there is no easy way to monitor how much the driver actually harvest. The downside of harvesting paddy with these machines is that the farmer often loses the hay as it becomes unfit for milch animal consumption. Thus, the growing adoption of this technology will invariably have an unintended consequences: shortage of hay will have an impact on milk production and with it the cost of milk in the next few year. Add to this growing population and it may be a good idea as to why the price of milk is not about to decline in a hurry.

 

An aspect of rural economy that cannot be missed is the widespread prevalence of pyramid schemes and shady investment companies - often registered as Agro Farms or Real Estate companies. These companies often masquerade as those involved in selling plots of land/houses or house sites in projects that are in various stages of completion. In reality, they are entities that collect deposits (always in contravention of RBI guidelines), mostly from shops or from those Below the Poverty line.

In a number of villages, Sahara India often markets its products as a "safe" alternative to deposits in the banking sector. It is present in almost all the towns which have a population of less than 10,000. One such office is in Kalwakurthy (picture below). Interestingly, their offices have a knack of being closed at any point of the day yet their agents collect lakhs in deposits every month. 

The Other side:

It would be a mistake to believe that merely because process of change is underway in earnest, the momentum will take it forward unhindered. What should be unsettling for the policymakers is that the risk of rural economy grinding to a halt is real and lurks just below the surface. Till date, the bull market in commodities has often been mistaken for brilliant policy making. The unprecedented phase of economic growth has been largely wasted. Instead of setting their balance sheets right, governments, corporations and individuals have used the boom to exponentially increase their leverage, often with the mistaken impression that trees grow to the sky. That unfortunately is about to change. Considering the fact that, India may either be headed for years of stagflation or into a phase that is eerily similar to 1996-1998 conditions increased leverage is an change that we are likely to regret for years to come. [Personally, I would bet on the latter than the former, but global factors could swing the scales. A deflationary spiral in Europe and China would send us into a 1996-98 type downward spiral, while stagflation will take hold if the World Economy were to chug along in the present manner].

What could upset the process of  rural change that is underway?

• Top of the list is the failure of monsoons - possible and we will not know till it is too late. Unfortunately, we cannot depend on the Met Department: their best guess-estimates of normal are always abnormal for the real world and are too vague to even think about depending on them other than to provide temporary solace.
• Rural house construction has come to a standstill in a number of regions. This seems to be for two reasons: the shortage of sand (due to High Court ban - see what happens when you follow the rules in India) and the lack of surplus cash. The banks have their own problems are not interested in lending - with or without Priority Sector Status. It has nothing to do with high interest rates in the rural areas, where the standard interest rate that people pay is at least 24% per month. Hence, 15% for a housing loan compared to 12% a few years back is not a major factor.
• Fall in agricultural commodity prices - a process that is underway
• Drying up of institutional credit - a process that is underway. 
• Water availability -  The present drought conditions are already having an effect.

NOTE: The above mentioned rural change is based on observations in parts of Rural Andhra Pradesh, especially Kurnool and Mahabubnagar districts.

Rural India: Are We Underestimating the Pace of Change?

In India, the Utopian image of an idyllic rural community untouched by change has occupied the centre stage of various discourses for a variety of reasons. A recent central thematic concern has been the problems that Indian  agriculture faces including its inability and lack of profitability. This lack of profitability has created numerous hurdles that dis-incentivise change - like investing in technology, etc. The reasons cited vary from (in order of precedence) small size/uneconomic size of holdings, lack of credit, rising cost of inputs (favourite whipping target: NREGA) and a host of complex issues (that often confuse any observer). Conventional wisdom is all encompassing and those who refuse to conform to the consensus do so at great risk. 

Historically, the consensus has been very often wrong in predicting the nature of economic (and the attendant social) change in Indian agriculture. This may be about to happen again. A remarkable feature of the rural landscape over the past two years is the increased visibility of machines in the fields. Interestingly, these machines dot the landscape of not only the more prosperous regions of the country but also the supposedly more ''backward'' regions. In Andhra Pradesh, a visit through the rural areas shows the increased presence of these machines. Ironically, the growing spread of the use of the machines seems to fly against another conventional claim that they can be profitable only when deployed in large sized holdings - implicitly a view that backs large scale "corporatisation of agriculture". While profitability is always a relative calculation, the fact that even small sized holdings in rural Andhra Pradesh prefer to deploy machines (as in the picture below) indicates that we may be underestimating the pace of change in rural India. 

The picture from Medipoor Village of Mahabubnagar District is illustrative. Harvesters are now used in small holdings (often to harvest paddy in less than 1 acre). The picture is significant of a trend for the simple reason that Mahabubnagar is considered to be one of the poorest regions of AP. The size of holdings where the harvester has been deployed is mostly less than 2 acres. 

What is often missed is that it not the uneconomic size of holdings that primarily hinders investing in agriculture or introduction of new practices. It is often the inability of the small and marginal producers to navigate volatility in a financialised, globalised electronic market place. Unfortunately, precious little is being done to help the small producers to navigate price volatility and information asymmetry that pervades through out rural India.

Probably, change may be closer to Rural Society and Economy than we would like to believe. 

Microfinance: A Fading Business Model?

An interesting aspect of the recent discussion about the nature of microfinance is the quick change in heart of even the most ardent advocates of microfinance about the limitations of their business model. This is in sharp contrast to the views over the past decade, where microfinance was seen as a panacea for the problems plaguing India’s attempt to fight poverty. Less than two years since the AP government’s forceful intervention on behalf of the borrowers, the proponents of Microfinance business seem to be coming to terms with the flaws in their business model, albeit grudgingly and painfully slowly. In a recent article by Suresh Gurumani, titled Ensuring Microfinance’s future prospects, the former CEO of SKS Microfinance, came rather close to accepting various contentions of the AP government. He accepts that "there has been a mission drift where the pioneers of the sector failed to manage the pressures of private equity providers who pushed MFIs to pursue unbridled growth to build their personal wealth disregarding the consequences of excessive growth". 

Microcredit business (as encouraged by the MFIs, especially in AP) is remarkable for the complete lack of vision displayed by the companies. The logic of a business expanding the supply of credit many times beyond the ability of customers to repay is astoundingly similar to a lack of understanding of the history of bubbles. The photo below of the loan sheets of one family in Chittoor district is the norm rather than the exception. 

(The photos in this posting were collected during the course of a larger study supported by the Society for the Elimination of Rural Poverty, Government of Andhra Pradesh, titled " An In-Depth Study of Issues and Challenges in Microfinance Sector in Andhra Pradesh" in 2011)

Most of the borrowers have assets that are not proprietary rights that are acceptable by the present market system. The security that these companies accepted are often like the houses in the picture below:

The owner of the house borrowed Rs 180,000 from different MFIs in Andhra Pradesh and committed suicide due to the harassment by employees of the companies. 

A consequence of this business model resulted in the present crisis in the microfinance sector. It is doubtful if the MFIs have actually changed their behaviour and strategy in different parts of the country.

Gurmani's article contains mostly old contentions but with a very interesting (new) suggestion. His suggestions include:

Among the suggestions that are a reiteration of the old ideas include:

• Allowing MFI NBFCs to offer thrift and savings products
• Increase presence in money transfer business (using the banks' network across the country) 

A new suggestion, albeit unworkable, includes:

• Banks taking ownership of MFI non-banking financial companies (NBFCs). Each of the major banks that hold major debt in these companies can convert that into equity and become majority owners. Alternatively, banks that have NBFC subsidiaries can launch microfinance operations, hiring trained staff from MFI NBFCs.

A very interesting suggestion enunciated by Gurmani is the need for banks to  "graduate seasoned borrowers with successful enterprises to more substantial products such as loans against property and home loans, etc".   

 

There seems to be no reason why the banks, should yet again subsidise the MFIs. The growth in the MFI business was due to the largess provided by the banks. The banks have paid dearly for this support. There is no reason why the banks should yet again support allow a socialisation of the losses. Moreover, there is little need for the banks to ride to the rescue with growing emphasis on financial inclusion by the Government of India and the Reserve Bank of India. Instead of expending money on attempting to revive a redundant model that has clearly failed, the banks will be better advised to invest money on rural branches, Business correspondents, single person rural branches, and business facilitators. Leveraging government promoted SHGs may provide a better safety net for the banks (when it comes to collecting their dues) rather than depending on the muscle power of MFI NBFCs.