Friday, August 28, 2015

India's courts need more "sunlight"

Livemint has a rare statistical peek at India's higher judiciary, with this article on a study documenting the time taken between court hearings for different categories of cases across High Courts in India. The graphic below documents the wide variance in hearings per judge and the time between hearings across High Courts. 
You cannot improve what you cannot measure. Given the near total absence of dynamic information about court work, performance monitoring of judiciary is a non-starter. In this context, the words of Justice Louis Brandeis who is reported to have said with reference to transparency that "sunlight is said to be the best of disinfectants", carries great relevance. Nowhere is it more necessary than our judiciary. And data and its analysis can shine light on the performance of India's judicial systems. 

Even the most basic data on the performance of judicial officers is currently difficult to obtain. How many orders have been passed by each judge annually, individually and in a bench? What is their average time between the final hearing (reserving for orders) and passing of orders? How many orders of the judge have been appealed against? How many of the orders have been reversed in appeal? How many orders have been passed in favor of the petitioner and how many rejected? How many orders have been passed against the government and how many in favor? What is the average number of adjournments in a case for each judge?

Admittedly the judges are over-burdened with case load. But much the same could be said about every public functionary from the ANM to the District Collector. Answers to each of these questions and more, and their comparative analysis across judges and courts, would undoubtedly be a massive step in ushering greater transparency to the functioning of India's judicial system. 

Wednesday, August 26, 2015

This time is no different - EM shocks spares none

The contrast in economic fundamentals with the May 2013 US Fed taper-tantrum days and today's China contagion could not have been more stark. At that time India was one of the most vulnerable, even among the 'Fragile Five'. Now the country has become so much of a positive outlier that it does not even figure in assessments of emerging market (EM) risks.

The two graphics from FT conveys the relative strength of the Indian economy. The first conveys how insulated the country is from the two biggest risks - exposure to Chinese market and foreign currency bond borrowings.
The country is among the only two EM economies not overly exposed to the trifecta of unwinding Chinese leverage, US QE, and domestic debt. 
Clearly, India is as insulated as markets can be from any triggering exogenous shock, with its accompanying portfolio re-balancing by foreign institutional investors. Further, its macroeconomic balance, both domestic and external, as well as inflation, are stable. But the events of Monday shows that very little of this is material, atleast in the immediate aftermath of the triggering exogenous shock. The battering of the equity markets and the rupee this week, especially given the relative strength of the Indian economy and the depth of weakness among almost all of its emerging market peers (a position that it has never been in), is the strongest possible reminder that such global shocks are largely divorced from fundamentals and spares none. As the RBI Governor found out, no central banker (or anyone) has a magic wand to ward-off or talk up the markets. 

The trajectory of the current bout of market volatility in India will be contingent on the trends across other emerging markets. If the markets adjust to the potential adverse consequences of a Chinese slowdown or the Chinese government is able to postpone the denouement to its bubble valuations, the Indian market too would be calmed. However, if the EM weakness persists, the volatility will continue to haunt the Indian markets. In that case, stability will return only when the broader EM sentiments stabilize (and not with country-specific events), as happened in August 2013. 

This should also serve to put in perspective the despair that followed similar trends in the aftermath of the May 2013 taper-tantrum and the subsequent uptick that was popularly attributed to the entry of the new central bank governor. 

Tuesday, August 25, 2015

Limits to growth with Chinese characteristics

Another carnage, and the China doomsday season accelerates. George Magnus writes the latest obituary. Michael Schuman joins the bandwagon questioning the infallibility of the Chinese technocrat. The collateral damage from China's travails are everywhere - equities are plungingcommodities are declining unabated, currencies are being battered, and the retreat from emerging market bonds may have been triggered. So are we near the end of capitalism with Chinese characteristics?

In very simple terms, the nearly thirty years of China's rapid economic growth was underpinned by a top-down (guiding hand of the communist party at all levels) and inputs-driven (infrastructure and manufacturing investments) structural transformation that capitalized on the country's vast supply of cheap and skilled labor, high savings rate, and a continental sized markets. An opportune moment in world history, coinciding with the high-noon of the latest round of globalization, boosted global trade and China was best positioned to capture its benefits. It is fair to assume that China is nearing the end of, or has already exited, this phase of its economic growth. 

Thanks to the benign leadership of the same technocrats, China seized the moment to achieve more than a quarter century of spectacular growth that has pulled hundreds of millions out of poverty. The externalities from the juggernaut were just as impressive - it sucked commodities spurring a boom in commodity prices and driving up the fortunes of the commodity exporters, its cheap exports contributed in no small measure to fueling the extended low-inflation period of Great Moderation, and its huge trade surpluses financed the credit appetites of countries like the US. In a just world, instead of celebrating its obituary, the world economy should have left the biggest "Thank You" note at the door-step of Beijing. 

Leave that aside. Moral-politik is rarely the nature of international relations. The more relevant issue for consideration is whether the next phase of China's growth is amenable to similar benign guidance. It would arguably involve transition into more knowledge and technology-intensive manufacturing, diversification and expansion of the services sector especially the creative knowledge-based activities, deregulation and external opening up of its financial markets, and domestic structural adjustment towards a normal and more consumption-based economy. And all this will have to be achieved without upsetting the socio-political balance that is essential to managing change and reforms with the least discordance. 

The challenge is whether the pacing and sequencing of this new phase can be managed in the same way as was possible with the manufacturing and infrastructure investment led current phase. More precisely, the challenge is whether such trends can be achieved in a socially-repressed and politically-controlled environment. Each of the aforementioned transitions contain too many moving parts and involve behavior and perception changes that are normally achieved through the dynamics of incentives and market mechanism, with adequate regulation, and may be beyond the powers of even the best of the Communist Party's technocrats. 

Will the communist party be willing to loosen its iron-grip on the country's society and polity? And more importantly, if that happens, will the disruption, which will inevitably follow, be acceptable enough for the mandarins in Beijing to allow the transition to progress? Or can the mandarins in Beijing manage a calibrated social and political deregulation, just as they did the economic deregulation? It is difficult to credibly prophesy all this except through backward-looking assessments, which may not be as relevant given China's uniqueness. 

I am not sure whether the Communist Party has the stomach, much less the enlightened self-interest, to bite the bullet. Encouragingly, in this context, China has precursors. Japan and a few North and South East Asian neighbors achieved similar long-periods of top-down, inputs and exports-driven growth which laid the foundations for a phased transition towards a more deregulated and liberal democratic environment. But then, these countries were smaller and far less authoritarian than China when they embarked on their similar growth phases. 

Monday, August 24, 2015

Another teachable moment in currency management

After spending $28 bn over two years propping up the tenge, late last week, Kazakhstan's central bank announced a regime shift from exchange rate targeting to inflation targeting. The decision, prompted by the Chinese and Russian devaluations and falling oil prices, resulted in a steep plunge in tenge's valuation by nearly a quarter in a single day. 

As the graphic shows, even by Kazakhstan's usual standards, with bouts of sharp devaluations, this one has been exceptionally steep.
Especially when compared to its oil exporting peers.

Oil dominates the country's export basket and contributes the lions share of the government's revenues, as seen from this 2013 export products graphic
For such countries, a floating exchange rate regime can be a useful automatic stabilizer. As commodity price falls and current account balance weakens, a gradually depreciating currency would serve to both keep exports competitive and squeeze imports, thereby restoring the external balance. Similar forces work in the reverse with rising commodity price and appreciating currency so as to moderate capital inflows during the commodity upturns. Further, this dynamic would also serve to promote manufacturing diversification and mitigate the "resource curse" effect during good times, which is characterized by a hollowing out of the non-commodity tradeables sector, especially manufacturing. Most importantly, it would leave the country with the monetary policy autonomy to combat the headwinds arising from external shocks. 

In this respect Kazakhstan is no different than many commodity exporting emerging market peers. In order to maximize revenues during good times, these countries play the foreign exchange markets to keep their currencies over-valued, thereby fueling asset price bubbles, only to be forced into depreciating sharply when the tide has turned and the central bank can no longer hold on. Such unpredictable reversals erode the country's macroeconomic policy credibility and markets punish it with violent swings. Inflation and economic stagnation, accompanied by banking crises, soon follow. Monetary policy discretion goes out of the window as the country is forced to hike rates to retain capital and rein in inflation. It is not devaluations per se that erode credibility and disrupts the markets, but sharp and unpredictable devaluations.

Nigeria, which has stubbornly kept its currency pegged to the US dollar, thereby suffering a steep drop in its oil revenues, looks most likely to soon burn out its reserves and be forced to let the over-valued naira depreciate steeply. 
An example of such macroeconomic prudence, with the attendant credibility and stability that anchors inflation expectations and limits cross-capital flows volatility, which enables countries to weather the storm, is Colombia, another country dependent on oil exports. The FT writes,
Under successive presidents, Colombia put together a framework that aimed for structural fiscal balance, instituted inflation targeting and achieved relatively broad-based growth... Over the past year, the economy’s exposure to the oil price (more than 50 per cent of exports) has resulted in the Colombian peso being one of the weakest freely-traded currencies in the world, by falling 36 per cent over the past 12 months. Like most EM currencies, it received another kick downwards from China’s renminbi devaluation last week. The rapid depreciation alongside falls in dollar-denominated oil prices means that in recent months, Colombia’s oil revenues in domestic currency terms have fallen relatively little, even compared with other oil economies. Economists at Barclays calculate that oil priced in Colombian pesos fell just 1.3 per cent from early May to late July, compared with falls of 6.2 per cent in Russian rouble terms and 14.4 per cent if priced in Nigerian naira...

(unlike its peers) the Colombian central bank has left monetary policy on hold since last August. Colombian consumer price inflation has recently risen to 4.5 per cent, just above the central bank’s 2-4 per cent target band, but inflationary expectations have remained well anchored... the IMF forecast that the economy would expand 3.4 per cent this year, below last year’s 4.6 per cent but far better than the recessions forecast in Russia and Brazil, and that inflation would drop back below target.
Kazakhstan may well have now embraced an inflation-targeting regime. But on the issue of which monetary policy regime best suits such countries, Jeffrey Frankel has written here about the possible superiority of NGDP targeting. Writing in the aftermath of a shift in the nominal anchor from US Dollar to a basket of currencies in September 2013, Prof Frankel had cautioned against any adoption of inflation targeting,
An example illustrates the point.  If a truly serious CPI target had been in place five years ago at the time of the global financial crisis, then Kazakhstan would have faced a difficult and unnecessary dilemma when it was hit by adverse shocks in oil prices, the housing sector, and the banking system. The country would have had either to forego the necessary February 2009 depreciation of the tenge or else to violate strongly the CPI target as the devaluation pushed up import prices.  The former choice would have been dangerous for the economy, while the latter choice would have largely defeated the purpose of having announced IT in the first place (that purpose being long-term monetary credibility).
Instead, he suggested an NGDP targeting nominal anchor for monetary policy as the best automatic stabilizer for oil exporters like Kazakhstan,
Kazakhstan is vulnerable to a variety of possible shocks, such as a fall in the world oil price, which would be better accommodated by a more flexible exchange rate regime... An alternative anchor for monetary policy, in place of either the dollar exchange rate or any version of the CPI, is nominal GDP... the innovation would in fact be better suited to middle-income commodity-exporting countries like Kazakhstan. The reason is that supply shocks and trade shocks are much larger in such countries. In the event of a fall in dollar oil prices, neither an exchange rate target nor a CPI target would let the tenge depreciate. An exchange rate target would not allow the depreciation by definition, while a CPI target would work against it because of the implications for import prices. In both cases sticking with the announced regime in the aftermath of an adverse trade shock would likely yield an excessively tight monetary policy. A nominal GDP target would allow accommodation of the adverse terms of trade shock: it would call for a monetary policy loose enough to depreciate the tenge against the dollar.

Saturday, August 22, 2015

Weekend Reading Links

1. Ambrose Evans-Pritchard hints at an OPEC obituary, arguing that the Saudi bet on driving out shale producers as oil price falls may not materialize, 
The North American rig-count has dropped to 664 from 1,608 in October but output still rose to a 43-year high of 9.6m b/d June... Gas prices have collapsed from $8 to $2.78 since 2009, and the number of gas rigs has dropped 1,200 to 209. Yet output has risen by 30pc over that period.

He argues that while the shale producers may be able to innovate and remain competitive despite the falling prices, the fiscal burden may be prohibitive for Saudi Arabia to weather, 
Tyler Durden though thinks that all the talk of increasing productivity and the dawn of era of low oil prices is kool-aid. Very difficult to predict such trends since there are too many other factors at play. Only time will tell.

2. Fantastic investigative essay in the Indian Express on the not-so-glamorous under-belly of India's e-commerce system, the parcel delivery boys (and yes, they appear to be mostly boys!). I am not surprised at all with this. Such practices will continue so long as the benefits (by way of cheap labour in plenty with limited alternative employment opportunities) out-strip the costs (of high attrition rates and resultant limited skill-set employees etc).

Interestingly, coming in the same week as this scathing indictment of Amazon's work practices, this essay on India's own Amazons appears to have hardly raised a flutter. Does it reflect poorly on the quality of public debates in India? As an aside, the real story with e-commerce would be one which shows how most of these firms are bleeding capital and it could be a very prescient curtain raiser on what looks certain to be India's first real dot-com bubble and bust. 

3. When Anat Admati and colleagues advocated capital reserve requirements upwards of 20 per cent, it elicited strong reaction from Wall Street. Now, Alan Greenspan, of all people, advocates higher capital reserves,
If average bank capital in 2008 had been, say, 20 or even 30 per cent of assets (instead of the recent levels of 10 to 11 per cent), serial debt default contagion would arguably never have been triggered. Had Bear Stearns and Lehman Brothers continued as capital-conscious partnerships, a paradigm under which both thrived, they would probably still be in business. The objection to a capital requirement of 20 per cent or more, even when phased in over a series of years, is that it will supress bank earnings and lending. History, however, suggests otherwise...
If history is any guide, a gradual rise in regulatory capital requirements as a percentage of assets (in the context of a continued stable rate of return on equity capital) will not suppress phased-in earnings since bank net income as a percentage of assets will be competitively pressed higher, as it has been in the past, just enough to offset the costs of higher equity requirements. Loan-to-deposit interest rate spreads will widen and/or non-interest earnings will increase. An important collateral pay-off for higher equity in the years ahead could be a significant reduction in bank supervision and regulation.
4. Livemint points to a report on ownership of equities in the Indian stock markets. Foreign participation has been rising in recent years, as reflected in the steadily rising share of foreign holdings on BSE 200 equities...
... and the declining and rising shares of Indian and foreign institutional investors respectively in BSE 200.
5. From FT, on the distortions induced by the extended period of ultra-low interest rates, which arises from the transformation of central bankers to creating demand (by low rates) from their original role as lenders of last resort,
By lowering interest rates we can weaken our exchange rate and take demand from our trading partners. We can also take demand from the future by inducing more borrowing against future income and also by a “wealth effect” when lowering interest rates makes future cash flows appear more valuable. So we can steal demand from foreigners, induce people to borrow more than they otherwise would, or make rich people appear richer. 
6. Nice article in Times which shows why the Federation of Quebec Maple Syrup Producers is the new OPEC,
Quebec's trees produce more than 70 percent of the world’s supply and fills the majority of the United States’ needs. The federation, in turn, has used that dominance to restrict supply and control prices of the pancake topping. It is effectively a cartel, approved by the provincial government and backed by the law. In 1990, the federation became the only wholesale seller of the province’s production, and in 2004, it gained the power to decide who gets to make maple syrup and how much... In 2003, a majority of federation members voted to make production quotas mandatory, meaning farmers could sell only a certain amount each year. Farmers are required to sell all of their syrup through the federation or its designated agents... When the federation suspects farmers are producing and selling outside the system, it posts guards on their properties. It seeks fines from producers and buyers who do not follow the rule. In the most extreme situations, it seizes production... 

It defends the system, saying it keeps prices high and stable... To keep prices high, the federation enforces strict quotas for the province’s 7,400 producers. Instead of flooding the market during years with bumper crops, all syrup produced beyond that amount is stored in the federation’s warehouse, which helps prop up prices by limiting supply. When seasons are lean, it releases the syrup, to maintain stable supply and pricing... Stacked in barrels nine high, the reserve currently holds about 60 million pounds of maple syrup. Prices are set by the federation, in negotiation with a buyers’ group. The federation holds most of the power, given that it controls a majority of the world’s production.
7. Share-holder friendly activities, share buy-backs and mergers and acquisitions, both driven largely by cheap borrowings and cash hordes of large corporates, have underpinned the equity boom in the US. FT points to this data from Dealogic,
Companies have raised $290bn of debt to buy competitors this year — almost triple the level in the same period in 2014. The number of issues, however, has risen only 46 per cent, so the average size has been much larger. In the first half of the year there were $987.7 bn of deals in the US... the highest since records began in 1980. 
8. Mexico is distributing 10 million 24 inch flat-screen television sets at a cost of $1.6 bn to the beneficiaries of two social welfare programs Prospera (campaign against hunger) and Liconsa (subsidized milk program) in what it calls the world's largest television distribution program. That moniker though may belong to the Indian state of Tamil Nadu, which in the 2006-11 period distributed 16.4 million 14 inch color TV sets.

The Mexican government hopes to promote internet penetration with these digital televisions which have USB and HDMI ports to access digital content. 

9. Business Standard has this story which highlights that housing is simply out of the reach of all but businessmen, self-employed, and a handful of top-flight executives. A Liases Foras study finds that housing is unaffordable within India's eight largest cities, but for double-income households. 
As I have blogged on numerous occasions, affordable housing may turn out to be the biggest brake on India's urban growth engine. 

Friday, August 21, 2015

Cross-subsidizing inefficiencies Vs direct subsidy transfers

Livemint reports that the Indian Railways is considering purchasing stressed power assets since they are an attractive opportunity to buy power assets at a cheap price. The argument for such purchases is that it would kill two birds with one stone - provide captive power assets for Railways at a cheap price and thereby de-stress the asset and help banks eliminate their non-performing loans. But does the cheap price alone make the asset attractive?

Consider this. The vast majority of power generation projects currently distressed are so because either their tariff is prohibitive or because they are unable to access assured fuel supplies. The former can happen because of high construction cost, high fuel price, or inordinate delay which cause cost over-run and accumulation of interest during construction. Since the contributory factors are not easily mitigated, if at all, the majority of these assets are most likely to remain high-cost generators. The lure of the cheap price would generally be more than off-set by the high life-cycle cost and sunk-cost effects (such projects generally require further large capital investments). After all, if the assets were really that cheap, wouldn't they be equally attractive to those with far bigger pockets, the infrastructure funds and other asset managers, leave aside other competing power generators. 

This brings us to the issue of efficiency and public policy. Governments are attracted by the prospect of such apparent free-lunches that typically ends up cross-subsidizing inefficient public entities. They are everywhere - mandating that government officials travel by Air India, forcing LIC to purchase shares during disinvestment, regulating that power generators can buy coal only from state-owned coal miners etc.

The Railways would surely have to incur higher transaction costs in running power stations and pay more (than if it were purchased from the market) to purchase that power, apart from suffering greater unionization and resultant politicization. The former would crowd-out resources available for its core activity, while the latter would exacerbate the bureaucratic inefficiencies of the organization. The cumulative costs (which are effectively another form of subsidy) of all these are most likely to be far more than the simple cross-subsidy (either as a tariff or investment subsidy) that would have enabled the project to begin generation. All this would force an otherwise efficient entity to now bear the cost of some one else's failures, with attendant knock-on effects on its operations.   

This raises the question whether governments should abjure from such stealth cross-subsidy to prop-up demand or keep running inefficient entities, with its numerous distortions, and instead directly finance them through its budget resources. Reinforcing the second welfare theorem, conditional on the political economy constraints that necessitate such choices, direct budgetary support is a cleaner and efficient approach. 

Wednesday, August 19, 2015

Mitigating last-mile gaps in irrigation

Mihir Shah has a nice reminder in the Indian Express where he advocates to "push irrigation not dams". Pointing to large numbers of dams constructed with disproportionately low irrigation coverage realized, he argues in favor of a participatory and multi-disciplinary approach to the development and management of irrigation structures. 

This is not dissimilar to last-mile gaps elsewhere - schools where no learning happens, hospitals which do not cure, toilets which are not used, no-frills bank accounts which are not transacted, and so on. At a fundamental level, it is also a reflection of how weak state capability comes in the way of achievement of transactional outcomes. 

In case of irrigation, the incentives associated with major irrigation projects and minor irrigation works are grossly mis-aligned. In fact, it strikes as disturbing that irrigation sector stands out with contracting which is divorced from outcomes. Irrigation structures like large and small dams and water harvesting units, by themselves contribute little to irrigation, unless complemented with canals and field channels. 

Contractors though are more interested in the former. They find the single-location, regular construction work associated with dams far more easier and attractive than the right-of-way acquisition problems and other transaction costs that characterize widely-spread canals and channels. In case of larger projects, the dam and canals are given as separate contracts, and it is common place to find the dams and other large engineering structures in place without the canals. 

Similar incentives drive government stakeholders. Irrigation departments, most often interested only in contracting out works, too push projects, making unrealistic irrigation coverage estimations. In cases of projects done with assistance from Government of India, state governments routinely make over-optimistic irrigation coverage claims to get project approvals. The tortuous process of acquiring right-of-way for canals and field channels, which involves engaging and negotiating with local land owners and resultant transactional challenges, is severely constrained by weak state capability. All this, coupled with the problems of siltation and maintenance for canals and channels, makes dams the primary objective and irrigation a distant and secondary objective. 

The physical salience of the dam or water harvesting structure being dominant and its relative ease of site acquisition, compared to the long-drawn process of getting right-of-way clearance for long-winding canals and channels, makes everyone more interested in the dam instead of the canals. It is therefore no surprise that dams have been built with vast difference between the promised and actually delivered coverage. In fact, an audit of the original estimate of the irrigation potential and the realized coverage from all major and minor irrigation contracts is most likely to reveal a scandal as big as anything we have seen. 

While there are no easy answers to the problem, one possible strategy would be to package construction contracts as irrigation contracts rather than dam construction contracts. Instead of constructing a dam, the terms of reference in the bid should be clearly redefined as "creation (or stabilization) of 5000 Acres", with levels of water access. This would require much closer engagement among the contractor, irrigation officials, and the beneficiary farmers, and far more rigorous project preparation work. The project reports for each structure would have to evolve bottom-up, capturing local requirements and practical considerations, so as to ensure that outcomes remain at the center of the project.

The risks associated with not getting the coverage estimations right can be mitigated by appropriate safeguards with respect to upstream water availability. I am not aware of any state which have procured even minor irrigation contracts through irrigated land coverage tenders.