Thursday, November 30, 2017

New Insolvency Law - the govt is right, market is wrong

This was published in the DNA Opinion page on 29th of Nov, 2017

The recent changes to the Insolvency and Bankruptcy Code (IBC) through an Ordinance has brought into stark relief an enduring cliché — “good politics is not good economics”. Or at least, that is the dominant narrative of the market and the financial nomenklatura (let’s call it the finklatura) that cheerleads the market. Prima facie, the rationale of the finklatura is unexceptionable. 
The amended IBC essentially bars controlling shareholders (or promoters) of companies from bidding for their bankrupt companies that are being auctioned off via the NCLT (National Company Law Tribunal)-overseen process. In its original avatar, only those promoters deemed as “willful defaulters” were proscribed from bidding. Before this amendment came through, bidders in many of these cases before the NCLT included promoters (eg, Ruias for Essar Steel).
The politics of this is ostensibly simple — harsh measures against big business make for good optics and good messaging.
Economically, the finklatura asserts, it’s the other way round. Currently, there are 12 identified bankrupt companies that are before the NCLT for auctions that try to minimise the haircuts creditors (primarily banks) will need to take on the loans outstanding. In the short run, with promoters out of the process, bids are likely to turn less aggressive. There are multiple reasons for that. Most of the 12 companies are in steel, power and infrastructure sectors. To start with, all of these are industries where an enormous amount of local operating domain knowledge is critical to successful operations. Second, all 12 are large, complex enterprises — typically insiders have a lot better handle on the complexities of effective management. Put both factors together, and it is clear why existing promoters would have greater confidence in running these companies, and therefore bid more aggressively, compared to any other third-party bidder. The cherry on the cake —– structurally, all three are what economists call oligopolistic markets, i.e, industries with few operating players. In other words, in the best of times, there are relatively few viable bidders, and removing the promoter from the fray takes away a large chunk of active interest in the auction. 
Less aggressive bids, naturally, would cause the banks to accept a price that demands a higher haircut on their loans (initial market estimates range from 10-20 per cent higher haircuts in bids). This, in turn, would mean banks requiring more capital to clean up their balance sheets. Given that the recently announced bank recapitalisation plan is fully taxpayer-funded, this would check all the wrong boxes — higher public debt, higher interest rates, potentially even an expansion of the recapitalisation required, and all their downstream adverse consequences. The economic impact, therefore, is clear, that we have (yet again) sacrificed economic gains at the altar of politics. Or is it?
Let us examine the economics of it. There has recently been a great deal of excitement around Richard Thaler’s Nudge Theory (primarily driven by, as is usual for arcane subjects, by the Economics Nobel Prize awarded to Professor Thaler). 
Simply put, a Nudge is an act (or influence) that alters behaviour, while not precluding any options for the user. Now, a law is somewhat more than simply a nudge, it is perhaps more akin to a shove. From a signalling standpoint though, this shove makes for interesting potential outcomes. Fundamentally, a strong, almost unforgiving insolvency law sends a strong message to promoters across the board. The message fundamentally seeks to alter promoter behaviour. It does not preclude the option of promoters taking loans in their enterprises but puts the fear of God on ensuring prudence, analytical rigour and above all, integrity, in the utilization of loans. 
India’s promoters don’t fall sick, only their companies do — has been an oft-quoted, and sadly, accurate description of Indian capitalism. The spectre of promoters of distressed companies remaining in a saddle, infusing no additional equity, even as banks take large haircuts on loans — militate against a very fundamental definitional tenet of the market economy. Under that tenet, creditors are senior to equity shareholders over assets of a company.
In other words, creditors need to be repaid in full before equity-holders can own any assets of a company that has defaulted on servicing its loans. Seldom has this been honoured in its letter and spirit in India. The new law and the ongoing resolution process should, hopefully, establish the seniority of the creditor in the capital structure, for perhaps the first time in India.
All policymaking is political. In this case, the good politics of the law makes for good economic principles too. Ben Graham, the legendary investor, described markets as being a voting machine in the short term (tallying up stocks that are popular and unpopular) and weighing machine in the long term (assessing the substance). In the case of the new Insolvency law, the nomenklatura representing the markets is seemingly in its voting phase. Ironically, the vote-driven government seems to have “weighed” it in a lot better!     

Sunday, November 26, 2017

Interest Rates: Stars Are Aligning, Not In The Direction Markets Hope!

This article was published by the Business World Magazine on the 26th of Nov, 2017

Interest rates are always in the news, but decibel levels on India's rates have gone up manifold since the last quarterly GDP growth print (of 5.7%) came out. The general refrain has been that India's rates, especially real interest rates (ie, net of inflation) are too high, and are adversely affecting growth and other macro outcomes like jobs. At the receiving end of most criticism has been the Reserve Bank of India (RBI), for not cutting policy rates aggressively. 

Unfortunately, like it is most of the times, the noise is likely to remain just that. Macro variables have not only vindicated RBI's stance on keeping rates steady, but also point towards marginal hardening of market yields.

To start with, the global monetary cycle, after years of easy money, is turning. Of the three major Central Banks (in US, Europe, Japan), two have embarked on a major unwinding of the Quantitative Easing (QE) that started after the global financial crisis in 2008, and injected trillions of dollars of liquidity in the global markets. At the same time, the global economy has started showing a coordinated upturn - IMF has recently upgraded its global growth forecasts to their best levels in five years. Global growth is expected to be 3.6% in 2017 (compared to 3.2% in 2016), driven by both developed markets (22% in 2017, compared to 1.7% in 2016) and developing markets (4.6% versus 4.3%). For well over a year, we have seen the goldilocks period in global growth since 2008 - with jobs, industrial production and global trade all moving up in tandem in a secular trend across the world. Both these factors, ie, unwinding of QE and strong global growth, together have meant that global interest rates are on their way up, limiting the headroom for Indian interest rates to decline from current levels.

India's macro variables on the other hand have started worsening at the margin. The key ballast for the economy in the last couple of years has been stable twin balance sheets (fiscal and trade) and low inflation, even as the economy settled to a low(er) growth equilibrium. The twin deficits have worsened. One, trade deficit is trending higher (averaging $12.6 billion in FY2018 compared to USD8 billion in the previous year). Two, fiscal situation of both state and central government have worsened, with farm loan waivers, state pay commission payouts, and now, the big bank recapitalisaiton plan (more of that later). To make things a little more interesting, inflation too seemed to have bottomed out, with more upside risks as global oil prices approach the USD60 level. In a nutshell, there is more at risk today for RBI to cut interest rates than many would have us believe.

The last piece in the interest rate jigsaw is the mega bank recapitalisation plan, funded substantially via a 1.3 lac crore Recap bond issuance. Ostensibly, this shouldn't expand the fiscal deficit - as many in the government, led by the Chief Economic Advisor have been at pains to explain. While "below the line" is the fashionable imprimatur of the Recap bonds, the impact of such definitions are optical rather than real. Effectively, the government (or some government institution) will issue bonds. While there might be adequate liquidity in the system to subscribe to these bonds, it expands the supply of bonds in the economy. In other words, it takes up the debt-GDP ratio, and skews the demand/supply dynamics for the bond market, adversely at the margin. At the end of the day, all bond (and equity) supply has to be financed by the same pool of financial (largely household) savings in the economy. Ergo, a large addition to the existing stock of bonds makes additional demands on the same pool, irrespective of the accounting treatment.

At the end, the real question is, does it matter? Will a reduction in interest rates by (say) 100 basis points kickstart the private investment cycle? When capacity utilisation in industry is running at mid-70% levels, the answer is almost obvious. In the last three year, the Indian economy has been marked by remarkable macro-stability in an increasingly uncertain world. By lowering rates today, is the marginal gain, in terms of higher potential growth, worth the risks of deteriorating macro? Historically, there has been very little correlation between interest rates and growth in India. Our growth challenges are elsewhere, in inadequate demand. Lower interest rates don't make for a good enough solution in the toolkit - the rates doves are barking up the wrong tree!

Friday, November 24, 2017

Moody's upgrade is a milestone in India's development journey

This was published in the Economic Times dated 20th Nov, 2017

In India’s argumentative ideas space, no news is good news. Therefore, the kerfuffle over the upgrade of India’s sovereign ratings by Moody’s (to Baa2, from Baa3) is entirely expected. For the partisan, it is a definitive validation of the government’s economic management. To naysayers, it is at best empty optics at a time when the economy is slowing down, at worst highly suspect on timing and credibility. Curiously, both miss essential woods for trivial plants.

First, the basic point – credit ratings, like most ratings, are predominantly an evaluation of the past, even though the objective is to provide guidance for the future. An upgrade is typically rare, especially so after the global financial crisis in 2008. It takes years of evaluation of policies (primarily related to macro-stability – debt-levels, sustainability of public finances, stability etc) before rating upgrades are done. In this case, the upgrade is especially creditable as it comes barely four years since India was classified as one of the “fragile five” economies, struggling with high twin deficits in fiscal and current accounts. To that extent, the current government deserves a lot of credit – it has privileged macro-stability over growth from its first day. It started with its first Budget, when the Finance Minister stuck with the deficit target set by his predecessor, a number that was received with much scepticism when it was presented by P Chidambaram. Since then, government has been a dogged “fiscal fundamentalist”, refusing any slippages even as growth plunged in the recent quarters. On the external account, a combination of luck (declining oil prices) and pluck (RBI ignoring shrill calls for massive reduction in interest rates), has kept the situation on an even keel.

Second, in many ways, this upgrade is merely a partial correction of a historical anomaly. Baa3, the toe-end of investment grade, clubs India with a bunch of countries with far worse macro-indicators. It’s a point that has been made repeatedly by Indian policymakers, most notably by Chief Economic Advisor Arvind Subramaniam in a section in the last Economic Survey. India’s structural strengths, eg, public debt entirely funded via rupee loans, all but a small part via local savings – were seemingly ignored while benchmarking on headline numbers.

Third, and most important point, is one of future signaling. What does it mean for India’s economic prospects going forward?
To start with, the sovereign rating is an estimation of the sovereign’s ability to repay its loans. An upgrade, technically, lowers the cost of borrowing for the sovereign. This is of limited practical utility to India, as the Indian government does not fund its deficits via offshore commercial bond markets. The entire public debt of India is funded via the domestic Rupee (INR) bond market, and foreign investor participation there is very small, and tightly regulated through quotas.   

Sovereign rating also serves as a benchmark for corporate entities domiciled in that country, as corporate ratings are (barring very exceptional cases) capped at the sovereign rating of the home-country of the corporate. Soon after the sovereign upgrade, Moody’s upgraded a bunch of Indian corporate entities (largely public sector companies). Over time, this has an impact on corporate ratings down the chain as well. While not automatic with a sovereign upgrade, a higher sovereign rating opens up fresh space for corporate upgrades too. This would result in reduction in cost of borrowing for Indian companies looking to raise financing from offshore bond markets.

Most important though is the optical macroeconomic signal. A ratings upgrade gives out a positive narrative on policy and builds incremental confidence in foreign investors. There are material benefits of the same, eg, in terms of incremental foreign investment pools from global Pension and Life Insurance firms that have minimum ratings criteria for investing. Typically, such incremental flows would tend to bid up Indian bond prices (both onshore and offshore) – we have already seen the first signs of the same in the form of dropping yields on government bonds. Higher bond prices, or lower yields, would tend to lower cost of funds – marginal for the government, but significant for corporate sector. Incrementally higher foreign flows tend to bid up INR too, making investments in a host of other Indian financial assets – equities, Real Estate – incrementally more attractive to foreign investors. It is especially propitious time for Public Sector Banks (PSB), that would find it easier to raise capital as part of the recapitalization plan announced earlier this month (PSB are expected to tap public markets to raise nearly 60,000 crores as a part of this plan). Lastly, as a net importer, a higher INR flows through as lower inflation into the economy, as imported goods become cheaper.
This isn’t an unmixed blessing. High levels of foreign flows resulting in rapid currency appreciation can result in loss of export competitiveness, with adverse consequences. South Korea’s meltdown in 1997-98 was at least partially due to a similar situation, barely a couple of years after it received a sovereign ratings upgrade.

In a nutshell, a ratings upgrade isn’t a major climax, nor is it much ado about nothing. It is a positive milestone, and quibbling about the size of the same is essentially narcissism of minor differences. But it is merely one milestone in India’s development journey, where there are miles to go before we can even think of dozing off!

Tuesday, October 31, 2017

Bank Reforms - preparing for the next crisis?

The Public Sector Bank (PSB) recapitalisation plan announced by the government has sparked off renewed debates on the shape and future of Indian banking. The big policy and philosophical question is — what should the Indian banking system look like in the future? Unfortunately, we are saddled with seriously flawed assumptions on what constitutes “reform” in India — some of them borrowed wisdom from the West, yet some more are ideological postures. Let us look at some of the key postulates.
One, the idea of having fewer, (much) larger banks. It’s an old idea, but embedded firmly across the political divide, and was first mooted by P Chidambaram as Finance Minister. Chief Economic Advisor (CEA) Arvind Subramanian reiterated its salience a few days ago. Ironically enough, this is one idea where India is bucking the global trend. Since the global financial crisis in 2008, regulators globally have become extremely wary of banks that are too large. The reason for that is intuitive.
First, larger the bank, larger is its footprint, and hence greater the damage to the wider economy should it fail. Second, Risk Management 101 dictates diversification is a key mitigant of risk, while concentration is a contributor to it. Ergo, smaller, more numerous banks are preferred to larger, fewer ones, from a systemic risk management perspective. Globally Systematically Important Banks, or GSIB — a list of essentially Too-Big-To-Fail (TBTF) institutions — have been identified, and they are required to have more stringent control around capital and risk. In this context, the idea of having larger Indian banks is bizarre, because its stated aim would be to merge small banks into fewer TBTF ones, thereby increasing risks to the system!
Two, assumption of public ownership of PSB to taxpayer-funded “bailout” through recapitalisation. It has been established many times over the years — banking obligations, when banks are under stress, automatically devolve to the taxpayer, irrespective of ownership. Whether Korean banks post the 1997-98 Asian Crisis, US/European banks post the 2008 global financial crisis, or Indian banks many times over (remember Global Trust Bank, Bank of Rajasthan?) — in a crisis, banks need to be bailed out by the government, irrespective of whether they are owned privately or publicly. Banks aren’t ordinary corporate enterprises — failure of a bank has large social impact. Further, increasing complexity of the financial system means there are snowballing effects of a bank failure that are difficult to assess. Therefore, the taxpayer liability isn’t an issue of ownership, but the quality of regulation to ensure risks are appropriately managed.
Three, privatisation as a panacea for all ills. This is an ideological position — based primarily on faith rather than reason. The assumption is the issues afflicting PSB are on account of its state-ownership, which somehow make them structurally vulnerable to taking poor-quality decisions, sometimes compromised with integrity issues. From Leendert Neufville in Holland in the 18th century to a range of Asian banks in the 20th century to American and European banks in 2008 — history is replete with privately-owned banks collapsing on the weight of poor decision-making. Regulatory investigations in the last few years in private sector banks have shown up numerous cases of moral turpitude too. Even in India, large private-sector banks have been found out making poor-quality decisions on transparency, risk-management and governance. In other words, there is too much data disproving the hypothesis of superior governance of a privately-owned banking system.
The question then is, what should policy-makers focus on? The focus should be at the core of the issue, i.e., risk. Banks are fundamentally risky enterprises, allowed a level of leverage in their capital structures and a level of interconnectedness with large parts of the economy that no other commercial enterprise (barring perhaps insurance) is allowed. The example of Lehman Brothers is illustrative. It was a mid-sized bank with no retail deposits — and its collapse engendered a crisis to the global financial architecture. No wonder, banks have a social compact of “backstop” from the taxpayer.
That is where the real issue lies — not in ownership, not in size. Regulators should be concentrating on mitigating that risk on society. Fundamentally, it means converting banks into utilities — essential institutions, but ones that don’t take risks that can put society at risk (similar to, though not the same as, a telephone company). Solutions lie in the domain of smaller (not larger) banks, higher capital requirements, lesser risk-taking, greater state oversight (and not lesser via privatisation) and higher governance. In other words, make banks (and banking) a boring affair. Unfortunately, most of the oft-discussed, clichéd solutions today are taking the other direction — taken to their conclusions, they will increase the risks to the system, and make it even more vulnerable to future taxpayer bailouts.
Through history and literature, bankers have rarely been boring. From the usurious Shylock in Merchant of Venice to the murderous Patrick Bateman in American Psycho to the philandering Humphry Wellwood in The Children’s Book — bankers are usually flamboyant, somewhat unscrupulous characters. The real objective for regulators would be around converting bankers (and banks) into Mr Banks, the benign, boring Bank of England official in the Mary Poppins books. That, and not ideological positions around size and ownership, is what will shape for a safer, better banking architecture for India in the future.

Tuesday, October 24, 2017

Credit Growth - the real issue is demand, not supply

This was published in the Op-Ed pages of Mint newspaper on 19th Oct, 2017

A constant lament around the state of the economy today is on “low credit growth”. Generally, the twin balance sheet issues are the identified villains. As fresh data on non-performing assets (NPA) keep coming in with numbers worse off at the margin, the noise levels keep getting institutionalized.
The narrative is simple enough—banks are not lending because they don’t have balance sheet capacity to lend (most banks, especially public sector ones, do not have enough capital to write off NPAs and write fresh loans). As a result, credit supply to the larger economy is being crimped, thereby constraining growth. Anaemic growth in non-food bank credit growth (9% in financial year 2016-17, or FY17, in negative territory this fiscal year) is held up as empirical basis of the hypothesis. Weaker-than-expected quarterly gross domestic product (GDP) growth (at 5.7%) provides the ostensibly clinching evidence that weak credit growth is pushing down growth.
Like many popular hypotheses though, this too has a case of missing some really large woods for the trees. First, the popular narrative conflates one source of supply of credit (bank loans) with the overall demand for credit. However, one of the remarkable changes in the Indian financial sector over the last three-four years has been the steady erosion in the importance of banks as financial intermediaries. A host of other credit suppliers—mutual funds, insurance companies, non-banking financial companies (NBFCs)—have taken market share away from traditional banks. These new suppliers of credit are also experimenting heavily with alternative credit instruments (away from loans), like corporate bonds and structured financing instruments. These are often more flexible and cheaper than vanilla bank loans.
Consolidated credit growth (bank loans, corporate bonds, NBFC loans) has been 13% in FY17, while bank loans alone grew only by 9%. The former represents a more representative estimate of real credit growth in the economy, than bank loans alone. The popular press (and even some of the more informed commentary) tends to focus only on bank credit, missing the real big story on disintermediation of credit. The real growth in credit demand is quite in line with nominal GDP growth and the 70% capacity utilization levels in Indian industry.
Second, the base effect of the Ujwal Discom Assurance Yojana (Uday) bonds. Since March 2016, the adoption of the Uday programme by state governments has transferred a large chunk of bank credit from state electricity distribution companies (discoms) to state government-issued Uday bonds. As the latter don’t get counted as “non-food credit”, growth numbers are automatically depressed going forward. Adjusted for Uday bonds issuance of Rs1.7 trillion in FY17, total credit growth in the year would have been about 11.4%, higher than the headline number of 9% and partially higher than the FY16 number of 11%.
Third, even for bank loans, the issue doesn’t seem to be so much about supply (or the willingness of banks to lend) as it is about finding bankable borrowers to lend to. In the recently released Reserve Bank of India (RBI) data on sectoral deployment of bank credit, banks have registered healthy growth in loans to the personal segment, trade, NBFCs. On the other hand, large swathes of manufacturing industries show barely any growth in bank credit.
There are multiple factors at play here. Highly rated (AAA) borrowers are increasingly finding the corporate bond market a cheaper source for fund-raising, compared to traditional banking channels. On the other side of the spectrum, in the riskier (and stressed) segments of borrowers, bank funding has shrunk—partly on regulatory diktat, and partly on account of the diminishing risk appetite of banks. These borrowers have tapped alternative sources of funding—via structured finance instruments—from NBFCs, private equity and alternative investment funds (AIFs).
Fourth, and somewhat non-linearly related, is the dramatic increase in equity raising by Indian industry over the past two years. Total equity raised via public (and rights) issues has risen by 200% over the last three years. At least part of the fresh equity raised has gone towards replacing debt in the capital structure.
We have a fundamental demand issue today in the economy. Total credit flows into the economy mirror the aggregate demand, and as we have seen above, are not a constraint. We looked at commitments raised by AIFs, a key emerging source of “risk-funding” today. As of FY17, only around 40% of the total funds raised by AIFs (in excess of Rs80,000 crore) have been deployed—thereby illustrating a paucity of deployment opportunities even for risk capital.
Unfortunately, most policy actions are concentrating on supply-side fixes (bank consolidation, NPA resolution, etc.). While these are important and necessary, they won’t help kick-start growth. As seen above, there is enough capital available to fund any amount of bankable projects coming on stream. The real issue is elsewhere—it is around lack of demand (both domestic and exports) for Indian industry. This is resulting in capacity utilization picking up painfully slowly, and constraining fresh investments by industry. Paraphrasing Cassius in Julius Caesar, the fault lies within (the industry), not in our stars (of the banking system).

Tuesday, October 3, 2017

A blueprint for job growth - Urban Employment Guarantee, an idea whose time has come

This article appeared in the DNA opinion page on 29th of September, 2017

The decibel levels have suddenly shot up. The lament of jobless growth is a long-debated one. The last quarterly GDP growth print (at 5.7 per cent) has now seemingly thrown up risks of significant economic slowdown too. To be sure, quarterly GDP numbers are estimates that are prone to massive revisions in the best of times, and we have a still-stabilising method of national income accounting. The issue is even starker for jobs, where almost no standardised, empirically robust data is available on a high frequency basis to make sure determinations.
However, policymaking cannot wait for perfect data. What is certainly verifiable are some indicators that point towards enduring weakness the economy. Capacity utilisation of Indian industry has hovered around the early 70 per cent range for many quarters now (RBI Capacity Utilisation Survey shows a slight decline in Mar 2017 from Mar 2016, at 74.1 per cent). Aggregate credit growth, while much higher than the oft-quoted bank credit growth, is in high single digit levels, and at the margin lower than previous year. Topline sales (and profit) growth numbers of listed firms display the same trend — and are generally undershooting beginning-of-the-year forecasts. On jobs, with the general collapse of private investment (especially Real Estate, the biggest jobs-creating sector), and struggles in the big employment-intensive services (IT and Financial Services) — it is safe to assume that we have a problem.
What should the policymaking response be? While there is never a dearth of ideas in India, is there something that can boost growth and generate additional employment at the same time, and quickly? Often, lessons are closer home than we realise. The National Rural Employment Guarantee Programme (NREGA) provides an interesting template. NREGA by design is an employment generating programme, and by many accounts was a big factor in India quickly bouncing back from the effects of the Global Financial Crisis in 2008.
There is, therefore, merit in considering a National Urban Employment Programme (NUEP) on similar lines. A well-funded NUEP will provide a soak for the urban and semi-urban unemployed, and provide an immediate Keynesian consumption boost to the economy. In principle, the consumption boost should enhance capacity utilisation levels, and hasten a revival of private investment, which is really the big driver of growth and employment. There are three big questions to be addressed though.
First, why a cash transfer programme (which is what employment programmes are), and not enhanced infrastructure expenditure? A couple of reasons. First, NUEP-type programmes are quicker on execution than large infrastructure projects, and hence would tend to have more immediate macro impact. And second, this provides for an immediate employment safety net to the most vulnerable, again something that would come only with a time lag in an infrastructure investment programme. Above all, some of the traditional assumptions around employment-intensity of infrastructure spending have been revisited in the last few years — it takes far fewer people to build a 100 km of highways than used to be the case a decade back.
Second, what would be the sort of jobs created under this programme? NREGA is designed around basic earthworks projects in rural areas, targeting employment for primarily untrained, barely literate farm labour. The workforce available in urban areas is likely to be better educated, and equipped to be trained for more.
They can, therefore, be deployed in auxiliary units for a range of urban services — municipals, schools, traffic control, even elements of basic policing – with a certain amount of training. India suffers from very large capacity gaps in all these areas.
For example, there is one police officer for every 720 Indians. The UN-prescribed standard is one for every 454. While a semi-permanent workforce with rudimentary training cannot be used for cutting-edge frontline policing duties, they could certainly be used for basic administrative and support services to enhance capacity.
Third, and perhaps most important, what should be the size of this programme? Targeting to create how many jobs? As a benchmark, the allocation to NREGA in the current year is Rs 48,000 crore. Let us assume that NUEP has a similar outlay. At an average wage of Rs 1.2 lakh/job (the approximate level at which a single wage-earner can ensure a family of 4 is above the urban poverty level), and assuming a 20 per cent support cost (ie, part of the outlay not accruing to wages, NREGA average is 30-35 per cent), this would create around 32 lakh jobs. India has around 1 crore new entrants into the jobs market every year. 32 lakh vacancies-on-demand will create a material tightness in the labour market to make a dent in wages and opportunities.
The last point would be, is it affordable? The amount in question would represent around 0.3-0.4 per cent of GDP. In a scenario where the banking system is flush with post-Demonetisation liquidity, that amount of excess government borrowing can be easily funded. It will have an electrifying message politically, while giving an instant consumption boost to the economy, with all-round multiplier effects. It is an idea whose time has come!

Thursday, September 21, 2017

Managing Wealth in times of Constant change

This was published in the DNA newspaper, dated 15th of Sep, 2017

“This time it’s different”, is an oft-ridiculed cliché used in the financial markets, mostly to debunk the idea that a particular phase of the market (usually bullish) has stronger legs than similar phases in the past. Markets are never one sided though, and excesses always tend to be shed through corrections later. This has been the case for centuries of trading history.
What has been truly “different” in the last few years though, especially in the new millennium, is the pace of structural changes presenting themselves to investors. Some are planned (like GST), some related to Moore’s Law effects (like technology), and some are simply Black Swans (like the global financial crisis). Consequently, money management has become tougher. Managing wealth, with its separate, often counter-intuitive and variable sets of objectives, has become tougher still. A few closely-held beliefs need to be junked / modified in order for investors to ensure their money keeps working hard (to use yet another old cliché!).
One, asset allocation is important, but “buy, hold, forget and see it five years later” is an incredibly stupid strategy. Traditional measures of risk, eg volatility, are not by themselves able to capture the impact of severe draw-downs on portfolios due to sudden market or regulatory events. When asset allocations start getting skewed due to sharp upward movements in a particular asset class (say equities), the vulnerability of the portfolio to Black Swan shocks go up exponentially. Investors and their advisors need to be a lot more on top of their portfolios, constantly optimising the same in line with their objectives and risk tolerances.
Two, liquidity management is as important an activity as identifying the next best investment opportunity is. This is especially true of Indian investors, given their heavy exposure to real estate, an asset class most prone to liquidity issues. As it is, even ostensibly liquid instruments have been affected by liquidity issues in the recent past (the JP Morgan Liquid Fund a couple of years back). On top of that, liquidity is often completely ignored in a chase for yields and/or the next exciting investment idea. There is a time and space for illiquid investments, but it is important to define sharply both the time and the space before making such investments.
Three, indexation is a two-way street. Investors judging their portfolios against index performance when broader markets are doing well should do the same when they are doing badly. This is a key difference between managing wealth (for individuals) and managing money (for institutions). At the heart of the difference is the fact that institutions are perpetual going concern entities, while individuals have finite lifespan with (often) non-discretionary objectives. Ergo, relative performance vis-à-vis an index for an individual is an academic, rather than practical construct. In other words, managing personal wealth, more often than not, is an absolute return approach by default. By definition, absolute return approaches do not sit well with benchmarks.
Four, volatility is not an enemy of investors, it can be a very useful friend, if used wisely. The conventional wisdom is for investors to avoid volatile markets, but it is often volatile markets that present the best opportunities. Looking back, in the current millennium, some of the best entry-point opportunities in equity markets presented themselves when markets were at their most volatile – think 2004, or 2008, or even 2013! Rule of thumb is to remain calm and behave with as much dispassionate emotion as possible when volatilities spike up.
Five, and perhaps most importantly, when an individual is looking to “manage wealth”, it is important to concentrate heavily on that, and not on fund managers managing various products in the underlying portfolio. Wealth management is a far more complex, multi-faceted and involved process than only managing a pool of money (which is what fund managers do). It involves elements of tax, estate, succession and other objectives that are non-linear in nature. They require far more attention and diligence than obsessing over an incremental 1% in portfolio returns. Ignoring the former could result in much larger impact. Unfortunately, too many individuals (and their advisors) spend almost their entire attention and time-spans on evaluating product performance, and too little time on what is really critical to successfully managing wealth.
As the Chinese say, the best benediction is “to live in interesting times”. We are fortunate to live in very interesting times. It also means we need to have newer, and sometimes less “interesting” approaches to managing wealth optimally.