Indian economy reading links

Indian economy reading links

1. More confirmation that India's middle class may be much smaller than originally thought comes from the latest Credit Suisse Global Wealth Databook 2015. It finds a middle class of just 24 million adults, less than a fourth of China. This is confirmed by findings of recent Pew survey, the Government of India's own socio-economic and caste census, and by the income tax assessee base.

The report also finds disturbing trends on wealth dispersion, with the richest 1% and 10% Indians respectively owning 53% and 76.3% of the country's wealth, far more unequal than the US where the top 1% own 37.3% of the total wealth.

Highlighting the rapid widening of inequality, even as the national wealth rose by $2.284 trillion in the 2000-15 period, the richest 1% and 10% respectively claimed 61% and 81% of the increment.

2. More dismal news from Credit Suisse through the latest version of its status report on the debt levels of India's ten most indebted infrastructure firms. Their cumulative debt has risen seven-fold over the past eight years to reach 12% of all bank loans and 27% of all corporate loans, with debt levels rising for all the ten groups. Their interest cover dropped to 0.8 in 2014-15 from 0.9 in 2013-14, despite a significant share of interest being capitalized, and debt/EBITDA rose to 7. 

While the loans are standard in the bank books, 35-65% of the debt of four groups have been downgraded to default by rating agencies. In fact, the report points to auditor findings that 48% of the total debt, or $53 bn, was in some form of default, with $37 bn for 0-90 days and $16 bn for more than 90 days. It also estimates that 20-90% of the loans for some groups, aggregating to $48 bn or equivalent to declared banking sector gross NPAs, may be under severe stress. Taking all these into the count, the report estimates that the total NPA of India's banking system could be close to 17%.

Some of the groups have sold away their better-performing assets to raise capital, leaving them with an even greater struggle to repair their balance sheets. Faced with such levels of balance sheet problems, these firms have cut back on capital expenditure by 20-70%. Most worryingly, many projects have 20-70% cost over-runs, thereby pushing capital costs beyond their pre-loss replacement costs and leaving the projects unviable. 

It is most certain that many of these projects will have to be restructured with large haircuts and/or further equity infusions, maybe even public support. The aggressive traffic forecasts and tariff estimates that formed the basis of financial closure in road and power projects respectively may be impossible to realize. This coupled with the accumulated interest during construction and construction cost escalation may have made many projects insolvent. Any simple rescheduling of loans may be merely kicking the can down the road. 

3. Rajan Govil joins those questioning the GDP growth numbers based on underlying indicators. He points out that nearly three-quarters of August's 6.4% annual IIP growth are explained by four items - gems and jewelry, insulated rubber cables, heavy commercial vehicles, and electricity - whose out-sized growth rates are simply unsustainable. He also points to the unabated trend of declining credit growth - non-food credit growth was 8.4%, and that to industry and services was 5-6%. 

4. A new report by Bain and Co estimates private equity (PE) investments in India to touch $22.3 bn in 2015, exceeding the previous record of $17.1 in 2007. With this, PE would make up more than half the FDI into India.  

While this is an encouraging trend, its details need to be carefully parsed. Investments in consumer technology (e-commerce, aggregators, and other sharing economy firms), real estate, and financial services collectively made up 65% of all inflows and those into manufacturing is marginal. By its very nature, PE investors generally take positions in existing firms. A few large deals make up a disproportionate share of all PE investments - the top 25 deals made up 49% of 2014 PE investments. Finally, as the graphic below shows, the potential inflows from such sources is very small.

In any case, as I have blogged earlier, all such sources are a rounding error when compared to the country's credit needs, the overwhelming majority of which is met by the banking sector.

my reading

1. Polio is the new cross-border threat for India from Pakistan,

Experts warn that neighboring India, which succeeded in shedding its label as a polio-endemic nation three years ago, could face serious cross-border infection.

As immunization efforts flounder in Taliban-controlled northwest regions, the number of Polio cases reported have been growing, thereby raising the specter of cross-border infection. Yet another reason why India needs a stable and developing Pakistan.

2. Livemint has a graphic on judicial vacancies and case loads.

3. Arguably one of the most important macroeconomic debates in recent years has been over the relative superiority of fiscal austerity or expansion in combating economic weakness in developed economies. Two contrasting tales from both sides of the Atlantic.

In Spain, the Conservative Popular Party has pursued a vigorous austerity policy, slashing public spending in the middle of a recession and pushing through a series of labor reforms to improve external competitiveness. It has achieved internal devaluation through wage compression - wages have fallen in nine of the last fourteen quarters since the PP government assumed power. These measures appear to have succeeded, with output estimated to grow by 3% this year, Spanish exports have grown fastest rising from a share of 17% of GDP in 2007 to 23% in 2014, the number of Spanish companies selling abroad has risen 50% in the same period, and unemployment though still high has been declining. In contrast, in Canada, the center-left Liberal Party of Justin Trudeau recently won elections on an avowedly Keynesian platform.

4. Times points to this paper that evaluated the impact of seven cash transfer programs in Mexico, Morocco, Honduras, Nicaragua, Philippines, and Indonesia and found "no systematic evidence that cash transfer programs discourage work" and thereby promote lazy behaviors.

5. Business Standard points to another price transmission problem in India, in piped natural gas (PNG) distribution in cities. An 18% recent reduction in the regulated (by indexation) upstream price of natural gas (from $4.66 mBtu to $3.82 mBtu due to fall in global oil prices) translated to a mere 3% cut in the PNG price for consumers. As of June 2015, India had 2.8 PNG consumers in 11 states. 

The Indian Supreme Court had in July 2015 ruled that the Petroleum and Natural Gas Regulatory Board (PNGRB) had no powers to regulate transmission through CGD network and could only determine tariff for gas transmission through common or contract carrier pipelines. It, therefore, rejected PNGRB's claim to fix retail city gas prices. City gas distribution (CGD) firms are, therefore, currently monopolies and enjoy freedom from price regulation. They have marketing exclusivity for the first five years of their operations. Subsequently, the CGD network would be on "open-access", available to third parties to supply gas as a "common carrier", thereby ushering competition in the closed market. Once they become "common carriers", the PNGRB would have the regulatory powers to fix tariffs. However, the challenge then would, in all likelihood, be to get the incumbent network owners to not sabotage the open access arrangement. 

6. The digital traces left by mobile phones have emerged as one of the most exciting areas of studying human behavior in real-time, with the potential to frame public policy accordingly. Here are a few applications. 

LogAnalysis software developed by Emilio Ferrara and Co of Indiana University analyzes social networks developed from telephone calls (chiefs of gangs makes a few calls to trusted lieutenants who in turn disseminate the same widely and repeatedly) and compares them with crime data to identify (and pre-empt) criminals and crime locations. Adeline Decuyper and Co in Belgium monitored food consumption patterns by superposing an FAO household survey data with mobile phone calls data from Rwanda and found that airtime top ups correlated with purchases of high-value food items. Kevin Kung and Co at MIT used data from Ivory Coast, Portugal, and Boston and found that humans spent an hour daily commuting, independent of distance or mode of transport or the country, thereby validating the old Marchetti's constant (they assumed people's homes as where they made calls in the night and office as the location of calls during working days). Vasyl Palchykov and Co use the duration and frequency of telephone calls from a database of nearly 2 billion calls (age and sex of the callers were available) to tease out the changing patterns of relationships between men and women at different ages. Jameson Toole and Co use mobile data to study the economic and social impact of mass lay-offs by analyzing the changes in people's social networks. 

7. Andres Velasco points to the findings of Tulane University's Commitment to Equity Institute, which examined the impact of various fiscal policy instruments (direct taxes, indirect taxes, direct transfers, indirect subsidies like food and energy prices, and in-kind transfers like education and health care services) on inequality and poverty for Brazil, Chile, Colombia, Indonesia, Mexico, Peru, and South Africa,

The largest income redistributive effect is in South Africa and the smallest in Indonesia. Success in fiscal redistribution is driven primarily by redistributive effort (share of social spending to GDP in each country) and the extent to which transfers/subsidies are targeted to the poor and direct taxes targeted to the rich. .. South Africa’s result can be attributed to the combination of a large redistributive effort with transfers targeted to the poor and direct taxes targeted to the rich... While fiscal policy always reduces inequality, this is not the case with poverty. Fiscal policy increases poverty in Brazil and Colombia (over and above market income poverty)... meaning that a significant number of the market income poor (nonpoor) are made poorer (poor) by taxes and transfers. This startling result is primarily the consequence of high consumption taxes on basic goods... 

The marginal contribution of direct taxes, direct transfers, and in-kind transfers is always equalizing. The marginal effect of net indirect taxes is un-equalizing in Brazil, Colombia, Indonesia and South Africa. Total spending on education is pro-poor except for Indonesia, where it is neutral in absolute terms. Health spending is pro-poor in Brazil, Chile, Colombia and South Africa, roughly neutral in absolute terms in Mexico, and not pro-poor in Indonesia and Peru.

They calculate the marginal contribution of a tax or transfer (as the difference in inequality gini with and without the intervention) and the total redistributive effect (difference between market income gini and disposable or post-fiscal (disposable income plus indirect subsidies minus indirect taxes) incomes gini). 

Several counter-intuitive findings stand out - regressive taxes in Chile and South Africa are equalizing or neutral; the marginal contribution of contributory social security old-age pensions is un-equalizing in Chile, Mexico and Peru. 

Given this heterogeneity, to the question of whether direct taxes or indirect taxes and direct transfers or in-kind transfers are more effective at lowering inequality or reducing poverty, one can only say that "it depends" on its interaction with the other fiscal policy instruments already in operation.

The one graphic about India's learning outcomes that you should see

The one graphic about India's learning outcomes that you should see

The conventional wisdom on learning outcomes is that the country's state government public schools and low-end private schools are where the problem lies and their troubles have to do with poverty and other social issues. And that the remaining part of the country's education system is in good shape and those students can compete with the best in the world. This belief gets entrenched by the excellent performance of Indian students in international Math and Science competitions as well as the dominance of graduates from IITs etc in various professional fields.     

So, it comes as a surprise (HT:Lant Pritchett) when we examine the relative performance of Indian students at the top end of the achievement spectrum in the 2009 PISA tests which assessed a representative sample of students from the two best performing Indian states, Himachal Pradesh and Tamil Nadu. As can be seen, less than a percent of students in both states were above Level 4 (out of six levels) in the PISA test. The contrast with those countries that we aspire to match or even claim equivalence, atleast for the best and brightest among Indians, is staggering.

The comfort that we are better off comes from a cognitive bias. The immediacy of these kids engenders an availability bias, which makes people feel as though the schools where their children are going are as good as anything in the world. Sure, there are outliers, and they are the top 0.1% (or maybe 1%) or so of the schools.

Even the worst ELSS outperformed PPF over 15 years

Investments in equity-linked savings schemes (ELSS) of a mutual fund’s would yield higher returns compared to other fixed income instruments like public provident funds and national savings certificates (NSCs) over the past 15 years, if invested systematically. However, in a point-to-point comparison over the past 15 years, LIC Nomura Tax Plan, the worst performing scheme, delivered a return of just 6.91% over the period from 1 March 2000 to 30 April 2015. A PPF earned an average interest rate of around 8.50% over the same period.

But when investing in an equity scheme, it is essential to invest regularly. Had you invested systematically in the LIC Nomura scheme, the yield (IRR-internal rate of return) works out to 13.49% compared to a yield of 8.31% for the PPF. Therefore, if an investor made a single one-time investment in the mutual fund scheme, he would have underperformed a PPF. Making regular investments each year would have improved his yield.

LIC Nomura Tax Plan was the worst scheme over the 15-year period. HDFC Taxsaver was the best performing scheme with a return of 16.09% on a point-to-point basis. The CNX Nifty index delivered a return of 10.86% over the period. The average return of the 12 schemes available over the period was 13.45%.

A few percentage point difference may seem small, however, over 15 years, the power of compounding and investing systematically can lead to a huge difference in the final value. Investing Rs1 lakh each year in HDFC TaxSaver would have led to a portfolio value of nearly Rs1.14 crore at the end of the period in March 2015, a yield of around 24%. Had you invested in the LIC Nomura scheme, your portfolio value would be less than half of this at Rs47.71 lakh.

Investing in schemes of Franklin Templeton, ICICI Prudential and SBI Magnum too would have led to a corpus of over Rs1 crore.

There is no doubt that PPF is among the best long-term fixed income product, but investing in equity is the key to long term wealth generation. However, when investing in equity mutual fund schemes, one not only needs choose the right scheme but also needs to invest regularly to benefit from the volatility in the market through rupee-cost averaging.

More on bond market distortions

FT points to a BIS paper by Valentina Bruno and Hyun Shin which draws attention to the spectacular growth of the now $1.7 trillion emerging market (EM) dollar bond market, which now outstrips even the more established US high-yield debt market. It claims the motivating factor for a significant share of these issuance as simply "carry trade" (borrow in cheap dollars and invest in higher interest rate securities at home) by EM non-financial firms. The authors examined firm-level balance sheet data for 3500 non-financial companies in 47 developed and emerging countries that issued dollar bonds in 2002-14,

The dataset combines bond issuance data with firm-level financial information. We find that firms with already high cash holdings are more likely to issue US dollar-denominated bonds, and that the proceeds of the bond issue add to cash holdings. The tendency to add cash is more pronounced during periods when the dollar carry trade is more favourable and is prevalent for emerging market firms. 

They find that the issuance is more likely when the local currency is gaining in value against US dollar. They also find that a large portion of this is raised by overseas subsidiaries of the EM firm. In fact, nearly half the international debt issuance by non-bank private corporates of EM countries in the 2009-13 period were by the firm's overseas subsidiary. In other words, these EM firms were pursuing a corporate version of "carry trade", as they seek to profit from financial arbitraging, rather than using the borrowings for investment purposes or for re-balancing their debt portfolio.

Their findings carry great relevance for policy makers in EM economies.

1. The scale and pace of such debt accumulation is staggering - it is estimated that the total outstanding USD-denominated debt of non-banks located outside the US stood at $9.2 trillion in end-September 2014, against $6 trillion at the beginning of 2010. In a matter of 2-3 years, fortunes can be reversed dramatically. It is one more, and increasingly large, channel of capital inflows into EM's when credit is plentiful, with all the attendant risks when sudden-stops ensue. The attendant risks are well documented.

2. A large part of the overseas issuance by subsidiaries come back to the firm headquarters as borrowings from the subsidiary. Such flows apart from increasing firm and country vulnerability to exogenous shocks, also raises a host of regulatory concerns. For a start, discriminating such flows from plain tax avoidance or even money laundering is very difficult. It creates a financial flows channel within each firm which facilitates transfer pricing and other similar policies aimed at avoiding taxes and evading various regulatory requirements.

3. The subsidiary which transfers money to the parent firm acts as a "shadow bank" or a "surrogate intermediary". Given that a significant share of these issuances were done by firms with strong balance sheets and deployed for financial investments, and held as cash, rather than capital investments, its effects on the domestic credit markets can be uncertain. The graphic below shows the increasing share of non-residential EM non-bank issuances.

4. The traditional measures of a firm's external indebtedness may no longer be a reliable estimation of the firm's true external debt exposure. It may be necessary to take into account, off-shore borrowings by subsidiaries, thought accurate information on this may not be very easy to get.

5. This is a powerful example of the distortions engendered by the extraordinary monetary accommodation in developed economies. As the authors show, it has distorted the incentives of yield-hungry fixed income investors in developed economies and non-financial corporates in EM countries, leaving both parties vulnerable when the tide turns. 

6. The carry trade by non-bank corporates in EMs is yet another reiteration of arguably the biggest failure of financial markets, its characteristic disciplining powers break down when credit is plentiful,

The size and maturity of issuance follow the pattern of risk-taking in financial markets, with periods of easy financing conditions being associated with larger issuance as well as longer maturities.

7. There exists wide heterogeneity among countries in issuances. India has among the lowest USD non-bank bond issuance of any large country.

However, this can change dramatically once the regulations are relaxed. Reversing the course or managing such issuances are virtually impossible. 

Where is India's middle class?

Where is India's middle class?

Livemint points to a Pew research work which highlights that while the global middle class (with per capita incomes more than $10 per day) has grown from 7% to 13% of total population in the 2001-11 period, nearly two-thirds continue to remain poor (less than $2 per day) or low-income. 

The income distribution barely shifted at the top half of the income ladder.

In India, while the share of poor declined from 35% to 20%, the middle income hardly changed, inching up from 1.4% to 2.6% in the same period. In fact, among all its major peers whose middle class share is more than 20% of the population, India is easily a disconcerting outlier in its middle-class share. 

This raises several disturbing questions about the country's long-term growth prospects. At 3%, those with middle class incomes and above constitute just 37 million, and is clearly not growing at a satisfactory enough rate to sustain very high economic growth rates. Simply put there aren't enough Indians around who can afford refrigerators and cars, shop at the malls, buy a house in a metropolis, send their children for management education or get treatment at Apollo hospitals, or take-off for annual vacations within the country. Further, since the stock of middle class is growing ever so slowly, the boost from the pent-up demand may be tapering off. Even doubling this estimate, assuming the Pew study is off the mark (which is unlikely given that the recently released Socio-Economic Survey of Indiapoints to similar trends), does little to minimize the concern.

Being smart with your fund picks

When making a buy or sell decision on a fund, it is essential to look beyond returns.

When it comes to fund managers and market strategists, this year's hero usually turns into next year's zero.

William Bernstien makes that statement in his book titled The Investor’s Manifesto. Bernstein is an American financial author, theorist and neurologist. His words are worth noting.

Irrespective of whether the decision is to invest or to liquidate, performance often becomes the sole deciding factor – an error that many investors commit unknowingly. While we vociferously advocate that returns remain an important indicator of how a fund has been able to deliver historically across varied market cycles, it is not the only factor. A more holistic approach is needed when evaluating a mutual fund from an investment perspective.

Top performing fund? Don’t live in the past!

Historical returns do provide an insight into what the fund has done in the past, but its predictive powers are definitely limited. A fund’s impressive performance is not guaranteed to be repeated in the future.

It is not without reason that the regulator, the Securities and Exchange Board of India, insists on the disclosure along the lines of: Past performance of the Sponsor/ Mutual Fund/ Investment Manager is not indicative of the future performance of the Scheme(s).

Why?

For one, performance could change if there is a change in the fund manager. It could change for better or for worse. Having said that, in most cases, it is not the issue of a fund manager change. It could simply be plain market dynamics; the stock bets that worked in the past may not work going forward. For instance, if the fund manager was stocking up on value stocks and the market favoured them, it would have worked to his benefit. If growth stocks were on a roll and value stocks were being punished, he would suffer. The stock bets that worked in the past need not work going forward.

Companies that were part of the portfolio and propelled the fund’s overall returns in the past may have either changed significantly in terms of their structure and/or their and ability to generate similar levels of return. In contrast, the constituents of the fund itself could have changed affecting the return profile of the fund.

Hence, while returns can be used as a starting or reference point, taking investment decision solely based on them could lead to financial disaster.

Top performing manager? But for whom?

Fund managers tend to have different styles, investment horizons and philosophies. Investors on the other hand tend to have varying investment goals and risk appetites. Since there is no concept of ‘assured returns’ or a ‘one size fits all’ solution in the mutual funds industry, evaluating a manager’s style and comparing the best ‘fit’ with individual investing preferences becomes essential.

A so-called top performing fund manager may be a disastrous fit for your portfolio. Let’s say he manages his fund in a volatile fashion, and while he delivers admirably, the highs and lows could churn your stomach. In that case, you should be avoiding his fund.

Understanding the styles and the differences across the investing patterns of different fund managers helps gauge the suitability of funds managed by them and prevents investors taking on additional unwarranted risks as part of their portfolio. It also encourages a higher level of investment discipline. Not all strategies are suitable for all investors. For example, large cap funds are typically considered as being lower risk as compared to a mid or small cap fund. You need to check whether the fund falls in the large-cap category, flexi-cap category, or mid-and-small cap category. You would also need to look at other parameters such as concentrated portfolios against highly diversified ones.

Investors need to first assess their requirement and then the fund’s suitability to meet their individual goals.

Don’t ignore costs.

Additional costs and increased fund expenses can eat into the income that an investor really makes. In John Bogle’s words, “The miracle of compounding returns is overwhelmed by the tyranny of compounding costs.” A higher expense ratio will tend to lower investment gains thus nullifying and/or lowering actual earnings. Bogle is an author and founder of the Vanguard Group.

Furthermore, the tax structure in India can have an impact on fixed income funds that are redeemed before the 3-year period, thus making the income from such funds taxable.

An exit load as defined by the fund documents is another factor to consider while redeeming investments. With all these different facets of costs come into play, it becomes important to take into account the actual income vs. the percentage returns that a fund is able to deliver.

In conclusion….

Investors often exit a fund due to its under performance just in time to see its returns take a 360 degree turn. While maintaining a long-term view is important, it is important to understand the reasons for short term aberrations and their possible impact over the long term.

Investment decisions should be based on a combination of fundamental strength backed by quantitative support. Look for consistency of returns and whether or not the fund manager’s style is in sync with the fund’s mandate. And don’t expect a blockbuster performance every year. William Bernstien’s words yet again: Mutual fund manager performance does not persist.

Source: Morningstar india  By Kavitha Krishnan |  02-09-15