Wednesday, September 27, 2017

India's post-demonetisation policy agenda

My latest work with V Ananthanageswaran examines the policy agenda for the Government in the aftermath of the demonetisation and the efforts to clamp down on black money and shrink the informal economy. Please read the abstract here and the full report here

Monday, September 25, 2017

Bringing in specialisation into the IAS

I have an oped in the Indian Express with Dr D Subbarao which argues for specialisation within the Indian Administrative Service (IAS) and suggests a possible strategy for its implementation. 

Saturday, September 23, 2017

Weekend reading links

1. From Scroll, on the dire straits of health care and school education in Bihar,
Seventy years after Independence, the state’s healthcare infrastructure continues to be grossly inadequate. Seventeen of the 38 districts in the state have no more than three government doctors for every 100,000 people. One district, Siwan, has just one doctor for 100,000 people. The highest, Sheikhpura, has eight doctors per 100,000 – or one for every 12,500 people. To put that in perspective, the WHO-prescribed level is 1:1,000. In the same way, while the Right To Education law mandates student-teacher ratios at 30:1 in primary schools and 35:1 in upper primary, the ratio in Bihar districts hovers between 43:1 and 96:1.
This is a nice exploration of why Bihar has remained so grossly under-developed.

2. Job losses from trade, off-shoring, technological changes or automation assume grave proportions when they are concentrated. Sample this from David Author and Co's study on the China effect on the US economy,
When China joined the World Trade Organization in 2001, there were fewer than 400,000 people working in American textile mills. As a proportion of the 150m-strong workforce, they were a tiny sliver. But in 57 counties in the south east of the country, they accounted for more than 15 per cent of all jobs. The impact of Chinese competition in these places, says Prof Autor, was “like a mini economic bomb going off over downtown”. His research found the people who lost their jobs went on to suffer more job churn and lower lifetime incomes. Poverty rose. More men started to die from drugs and alcohol. The economic ripples from the loss of manufacturing jobs hit other local businesses.
3.  Is Switzerland the best health care system in the world? Read this very informative Upshot analysis. The description of Swiss system,
Like every country here except the U.S., Switzerland has a universal health care system, requiring all to buy insurance. The plans resemble those in the United States under the Affordable Care Act: offered by private insurance companies, community rated and guaranteed-issue, with prices varying by things like breadth of network, size of deductible and ease of seeing a specialist. Almost 30 percent of people get subsidies offsetting the cost of premiums, on a sliding scale pegged to income. Although these plans are offered on a nonprofit basis, insurers can also offer coverage on a for-profit basis, providing additional services and more choice in hospitals. For these voluntary plans, insurance companies may vary benefits and premiums; they also can deny coverage to people with chronic conditions. Most doctors work on a national fee-for-service scale, and patients have considerable choice of doctors, unless they've selected a managed-care plan.
Noah Smith thinks Japan offers the highest quality at the lowest cost, despite having the burden of the the oldest population. He describes the Japanese system,
The government pays 70 percent of the cost of all health procedures, unless you’re a low-income elderly resident, in which case it pays as much as 90 percent. The remaining 30 percent is covered by private health insurance -- either employer-sponsored or privately purchased -- which citizens are required by law to have. Spending on private health insurance to cover the 30 percent co-pay is partially tax-deductible. Benefits are the same for everyone, and -- unlike many U.S. health plans -- include dental and mental-health care. For catastrophic care, poor people, and people with disabilities or certain chronic conditions, the government pays more... In Japan, fees for health services are capped by a government committee.
4. Robert Shiller tweets this graphic capturing the exuberant valuations in US equity markets,
On the valuations, as reflected in the ten-year lagged cyclically adjusted price to earnings ratio (CAPE), he writes,
The C.A.P.E. ratio is above 30 today, compared with an average of 16.8 since 1881. It has been above 30 in only two other periods: in 1929, when it reached 33, and between 1997 and 2002, when it soared as high as 44. The current number is troubling. After the ratio’s peak in 1929, real inflation-corrected stock prices in the United States lost four-fifths of their value by 1932, the biggest crash in the market’s history. And from 2000 to 2003, they lost half of their real value.
But he acknowledges that unlike those two past episodes, investors and financial market opinion makers appear remarkably calm now despite the inflated valuations.

5. From a nice article by Kshitij Batra and Ohan Shridhar sounding a cautionary note on the effects of the Real Estate Regulation Authority in India,
Currently, constructing residential housing in Indian cities requires a costly array of clearances from different government authorities at the central, state and local levels. These approvals can take between 12-18 months, in other cases longer, where a single department or official could block a file and stall an entire project. Under these circumstances, developers in many cases are unable to meet the timelines agreed to with the buyers not as a result of their malfeasance, but due to a failure of efficient government coordination. Moreover, the uncertainty about the time schedule for approvals also raises the risk-adjusted costs of capital for project financing. Rera in its present format imposes mandatory obligations on builders to abide by a previously agreed to time schedule, without enforcing these same obligations on governmental agencies responsible for project clearances. The costs of penalties, refunds and interest payments thus borne through hamstrung state capacity by developers will then ultimately be paid by consumers in the form of higher prices, without fundamentally increasing housing supply.
I have blogged earlier and am in agreement with the concern. But an alternative narrative could be that reforms like RERA (and the legal obligations that come with it) provides the political cover for well-meaning government bureaucracies in at least a few states to streamline and crackdown on the inefficiencies and weaknesses in local government buildings approval processes. 

6. Good article by Sujatha Rao on the controversy surrounding the standardised National Eligibility Entrance Test (NEET) for medical college admissions. For several reasons, I have reservations on a nationwide entrance examination for India and would prefer more flexibility to states, even with all its ill-effects. The concerns of good colleges like CMC Vellore are well-founded,
Like in the UK, over the years, they have “perfected” the admission policy to look beyond marks and assess students’ commitment and value systems through a process-based interview — a system that government should adopt as well, including for recruiting IAS officers. The NEET is clearly a regressive policy in so far as such colleges are concerned.
The solution, as also suggested by Sujatha Rao, is to have a stricter licensing examination,
Given our commitment to cooperative federalism, allow states to have their own admission policies but make an All India Licence Examination for registration with the MCI mandatory for those wanting to study or practise in other states or go abroad (on the logic that states have an obligation to fulfill the minimum criteria that is acceptable to all if their doctors seek to treat patients of other states), alongside instituting the National Exit Examination.
After they complete their coursework, let students be allowed the freedom to either take the All India Examination or the respective state government examination.

7. The graphic below captures how oil price lottery that the government has enjoyed, which has singularly been responsible for the government meeting the fiscal deficit target.
As the report says, the central government has raised the excise duty on petrol and diesel nine times since November 2014, boosting tax revenues from petrol and diesel from 0.44% of GDP in 2013-14 to 1.44% of GDP in 2016-17. In the same period, fiscal deficit fell from 4.5% to 3.5% of GDP!

8. Interesting point that India has been a relative laggard in lowering poverty, in terms of GDP growth elasticity of poverty reduction, compared to even countries like Brazil and Mexico,
India extricated 120 million people from extreme poverty between 1990 and 2013. However, this process was relatively slow. Over the same period, China reduced the number of people living in extreme poverty from 756 million to 25 million. If we factor in economic growth, between 1995 and 2012, the growth elasticity of poverty reduction for India is just over 0.12. By contrast, countries such as Brazil, Mexico, Ecuador, and Thailand — that witnessed relatively low economic growth rates — emerge as positive outliers, exhibiting higher growth elasticities of poverty reduction than many high-growth countries, including India. While the growth elasticity of poverty reduction for China is a little over 0.28, the numbers for Mexico and Brazil are 3.28 and 1.14 respectively.

Thursday, September 21, 2017

Gaming the rules - the case of India's Bankruptcy Code

I had blogged earlier about the challenges associated with the effective implementation of the Insolvency and Bankruptcy Code (IBC). In particular, I had alluded to the likelihood of capture of the valuation agency, Insolvency Resolution Personnel (IRP), Insolvency Professional Agency (IPA), and the Insolvency and Bankruptcy Board of India (IBBI) and the round-tripping of assets back to promoters. 

Well, on the face of it, both concerns appear to have materialised in the very first case settled through the process! 

The resolution of Synergy Doorays is nicely described by Debashis Basu here. The modus operandi is simple. Get proxies (of the promoter) to submit Resolution Applications (RAs). Get another proxy as the majority debt holder in the Committee of Creditors (CoC), by either cutting a deal with the majority creditor or transferring the major share of loans to that creditor. Then force down massive haircuts. And if you can capture the IRP, an easy picking on most occasions, then everything becomes all the more easy. There will be small sub-plots that vary with cases, but the script would more or less remain the same. Welcome to the real world of implementing IBC!

I am not one bit surprised and and will not be surprised if such subversion becomes the norm. In fact, I would surprised if it does not become so, especially if we stretch the system with too many cases to start with. After the first blush of cases occupy the handful of good IRPs and resolution agents and the limited market size in stressed assets buyers starts to bind, gaming will become easier still. 

Why shouldn't it be the case? Consider the ingredients. Very high stakes. Resolution institutions populated by existing market participants, many of whose reputations were never covered in any glory. Weak institutional capacity. Government agents prone to being captured. Promoters desperate to retain control.   

In this milieu, it is very difficult to expect institutional integrity, of both private and public participants, to remain unscathed. 

Though I have not examined the procedures in detail, it does appear that there were no clear technical and financial qualification norms for the RAs or norms that govern creditors and transfers among them. Let's face it, these playbooks are pretty well known and at least some of these egregious violations could have been avoided.

But a more effective approach to ensuring effective implementation of such regulations is to have the approach explained here and here. Get the best possible version of regulations out, and then keep  resources and personnel ready to respond swiftly and credibly to emergent problems. A few iterations and with good luck, you could potentially have settled on a good and practical set of regulations. Easy to do? Yes, in theory. But requires leadership and professional competence of a very high order. Unfortunately, both very scarce resources.

This is also a teachable moment in making regulations. There is no point in having state-of-art regulation if the real world in which it has to function cannot be expected to bear them. What is the use of grafting an elaborate insolvency architecture if its implementors are most certain to be seriously compromised? Wouldn't second-best options have been better? Or maybe, we should just graft state-of-art regulations and then hope that things mature and fall into place in a couple of decades? Or, and I really hope so, I am being very pessimistic!

Sunday, September 17, 2017

Weekend graphics

1. There is limited correlation between exchange rate movements at the margins and export competitiveness. That India has a problem with its exports is undoubted. Buoyed by green shoots in US and Europe, as well as rebound in China, emerging market exports have been growing at their fastest pace in volume terms in six years. Emerging Asia has been at the forefront of the rebound in global trade. 

While rising commodity prices have given many predominantly commodity exporters a leg up, it has been only one driving factor, and in value terms for the year to July 2017, among exporters, India competes with Turkey for the wooden spoon!
But it is incorrect to blame exchange rate appreciation for that. For one, emerging market currencies have strengthened against the dollar. 
And, till end-March this year, far from strengthening, compared to its EM peers, the rupee has actually been among the weakest performers. And those which have appreciated significantly like Russia, S Korea, Mexico and Taiwan have done far better than India, despite its far smaller appreciation.
In fact, till now, compared to its EM peers, the rupee has been very stable against the dollar. On REER too, India comes middle of the pack over the past 12 months. 
And it is not as if India's currency problems have cropped up in the last one year. From the Bruegel database, the REER of India's main EM peers weighted against 138 trading partners since end-2007 shows that rupee has appreciated more than all others except Vietnamese Dong, Bangladeshi Taka, and Chinese Yuan. The appreciation has been continuous since the taper-tantrum in mid-2013,
But for the same period, from WDI database, while India clearly has suffered a vertiginous drop in exports, especially since 2010, others with stronger or similarly moving currencies like Bangladesh, Vietnam, China, Indonesia, and Philippines have done better with their exports,

Clearly, there is more at play here than exchange rates. In any case, even assuming we need to weaken rupee, do we have the instruments at hand to manage it. Apart from sterilisation costs as well as the opportunity cost of holding low yielding dollar assets, open market operations come with risks of being marked out as a currency manipulator. 

2. From John Mauldin's latest newsletter, this stunning graphic shows the impact of search for yields. Euro junk-bond yields have converged with US Treasuries!
The Euro high-yield bonds is only representative. The spread between US Corporate Bonds and Treasuries are inching towards their pre-crisis lows.  

As a measure of the search for yields, the total assets managed by the 100 largest alternative investment managers rose by 3% to $3.6 trillion in 2016. Pension funds and insurers, squeezed by low yields in traditional fixed-income assets and the need to invest for long-term, have been forced into moving their portfolio allocation towards alternative investments which sit at the riskier end of the spectrum. 

In this context, the risks from a slowdown, and its attendant adverse impact on these high-yield issuers and asset categories, are enormous. They have the potential to freeze up the financial markets immediately more than in earlier times with far lower exposures. 

3. Alternative investors are not the only ones to have increased the demand for fixed-income corporate assets. FT has a nice story on the emergence of large corporates, with their massive and growing surpluses, as important buyers in the $8.6 trillion US corporate debt market. Thirty US companies have amassed cash, securities and investments worth $1.2 trillion, with some of the corporates rivalling even the larger asset managers. Roughly $840 mn of the $1.2 trillion were held in investments outside the US. As FT writes,
These companies, each with more than $10bn of cash, equivalents and other financial investments, own roughly $423bn of corporate debt and commercial paper securities, $369bn of government and agency debt and disclose holdings of more than $40bn of asset and mortgage-backed securities.
These investors' risks arise from the steep falls in bond prices with any likely increases in interest rates.

Ironically this situation of massive cash surpluses and their investments in corporate bonds, sits alongside a reality of large borrowings by the same corporates,
Apple, Microsoft and others have borrowed to fund activities that are easily financed with cash, like distributions to shareholders and share repurchases. The iPhone maker has raised more than $28bn through debt markets this year to fund, in part, shareholder returns, according to Dealogic. It is cheaper for those companies to borrow than it is to pay tax on repatriated cash.
4. Staying with the same theme, and reminding us about the risks associated with such search for yields, the FT has a nice graphic that maps asset yields against their respective ten year volatility.
Clearly higher yields come with higher volatility. And underlining the dangers of cross-border capital flows, EM local currency corporate bonds have the highest volatility. Another reminder about the risks of capital floods followed by sudden-stops and crises.

5. Finally, Warren Buffet appears to have all but won his famous 2007 bet that passive investing would outperform active fund managers, excluding their high fees, over a ten year period. An update shows that S&P 500 has outperformed hedge funds in nine out of the ten years.
One more reminder about the fallacy of picking stocks!

Thursday, September 14, 2017

Piketty, price markups, and Houston floods

There are two ways to critique something which questions strongly held conventional wisdom. The honourable way is to question the core of the argument, and a less honourable way is to detract attention from the core issue by picking holes on incidentals. 

Consider three examples - Thomas Piketty's book highlighting the issue of rising incomes at the top of the ladder and widening inequality, a recent paper on rising markups in US businesses, and the Houston floods and the debate on zoning regulations in urban areas.

Take Piketty. Never mind that the primary takeaway from the book was the fact that inequality is  increasing alarmingly across the world, the right-wing critique of the book was focused on picking holes at Piketty's argument that the returns to capital was higher than economic growth, thereby increasing the incomes of the rich and widening inequality. No, they argued, capital, especially the modern information technology based ones, depreciates fast enough to offset any high returns. Or, that among all returns to capital, it is increases in property prices that forms the vast majority of wealth creation.

Sure, there are some policy implications based on what are drivers of widening inequality, but is it a necessity for taking action on the first order issue that incomes at the top of the ladder are rocketing up even as those of the overwhelming majority are stagnating or declining?

As to the debate about whether r > g, the recent work of Alan Taylor, Oscar Jorda, and Co, on the returns to property, equity, bond, and government bills for 16 countries for the 1870-2015 period is only a confirmation of Piketty's argument. I have not seen too many blogposts in Marginal Revolution on this or their extended work! 

Or the just released work of Jan De Loecker and Jan Eckhout who find out,
In 1980, average markups start to rise from 18% above marginal cost to 67% now. There is no strong pattern across industries, though markups tend to be higher, across all sectors of the economy, in smaller firms and most of the increase is due to an increase within industry. We do see a notable change in the distribution of markups with the increase exclusively due to a sharp increase in high markup firms.
Tyler Cowen highlights his main takeaway - "In 1980, average markups start to rise from 18% above marginal cost to 67% now". And his response is grudging,
That sounds like big news, and probably it is.
He then goes on to conflate the fundamental issue of rising markups, and whether it is leading to rising profits and is the result of business concentration. He detracts attention from a first order problem by quibbling at flaws in data sources, arguing about monopolistic competition, and so on. What is the meaning of being disingenuous? Heck, monopoly profits or not, markups are markups, and they are happening! 

As Noah Smith nicely summarises the growing pile of evidence - business concentration has been increasing, is correlated with declining labour's share in national income, executive salaries have gone up with deregulation, profits have risen substantially, there has been a slackening of anti-trust enforcement, prices go up while productivity does not after mergers, business investment declines has been associated with market power, and so on. Isn't all this adequate to connect the dots? Do we need to get exact evidence? In any case, is real world policy-making so exact a science that it requires information on causal channels with great precision? 

Finally, consider the case of the recent floods in Houston and the loss of lives and damage caused, especially among those living in areas vulnerable to flooding. The city has long been the poster child for deregulated zoning regulations, reflected in its affordable housing, and contrasted with the zoning intensive San Francisco's exorbitant housing prices. 

Forget Houston and zoning laws. Take any large Indian (or developing country) city beside a river. Encroachments on river banks and liberal building permissions in areas vulnerable to floods are commonplace. Flooding is an annual feature, with some deaths, houses washed away, and huge damages. In fact, large parts of Indian cities, with either poor or no enforcement, are the closest anywhere in the world to free market in housing development. 

Instead of confining the debate to the issue of regulating construction on areas prone to flooding, the ideologues have been waging war on whether construction is responsible for flooding or not. While the left have blamed climate change and deregulation, the right has used the opportunity to blame everything from historical reality of Houston's flood pronenesss to subsidies on flood insurance. Since the ideological fort is under attack, the defenders have to mount their defence. In the din, the real issue of regulating (and it is not incentives that work here) housing on flood plains and, more importantly, promoting vertical development in the remaining areas has been lost. An opportunity to promote zoning regulations that work in this direction may have been lost.

In all the three cases, attention from the central issues - widening inequality, markups and business concentration, and unfettered construction in flood plains - have been scattered by splitting hairs on important, but secondary concerns. 

In all these cases the narrative, as I see it, is this. Central tenets of ideological beliefs that have shaped both your life and career for atleast over 30 years are now being threatened. So you push back aggressively, even if it means stretching the boundaries of everything we call truth and decency. Everyone faces it once in a while, but ideologically prone individuals are the most vulnerable and possibly the worst offenders. It is as much true of the right as it is true of the left!

Tuesday, September 12, 2017

Housing and financial market instability

Is real estate trends the biggest force for macroeconomic distortion? I have blogged earlier about the work of Mathew Rognlie which highlights the central contribution of housing prices to widening inequality. 

Now, following on from the work of Atif Man and Amir Sufi, √íscar Jord√°, Moritz Schularick, and Alan Taylor construct historic housing price data for the 1870-2012 period for 17 countries and find,
First, we discuss long-run trends in mortgage lending, home ownership, and house prices and show that the 20th century has indeed been an era of increasing “bets on the house.” The strong rise in aggregate private debt over GDP that can be observed in many Western economies in the second half of the 20th century has been mainly driven by a sharp increase in mortgage debt. Mortgage credit has risen dramatically as a share of banks’ balance sheets from about one third at the beginning of the 20th century to about two thirds today. As a result, the intermediation of savings into the mortgage market has become the primary business of banking, eclipsing the stylized textbook view of banks financing the capital formation of businesses.

Second, turning to the cyclical fluctuations of lending and house prices we... show that throughout history loose monetary conditions were closely associated with an upsurge in real estate lending and house prices... Broadly speaking, when countries peg to some base currency they effectively import the base economy’s monetary policy, even if it is at odds with home economic conditions. Exchange rate pegs therefore provide a source of exogenous variation in monetary conditions. By conditioning on a rich set of domestic macroeconomic controls, we are able to isolate exogenous fluctuations in the short-term interest rate imported via the peg and trace the effect of these fluctuations over time on other variables. Third, we also expose a close link between mortgage credit and house price booms on the one hand, and financial crises on the other. Over the past 140 years of modern macroeconomic history, mortgage booms and house price bubbles have been closely associated with a higher likelihood of a financial crisis. This association is more noticeable in the post-WW2 era, which was marked by the democratization of leverage through housing finance.
Their data construction allows them to identify causal pathways and converge on two important findings, 
Loose monetary conditions are causal for mortgage and house price booms, and this effect has become much more dramatic since WW2... Mortgage and house price booms are predictive of future financial crises, and this effect has also become much more dramatic since WW2.
The case study of how in the aftermath of EMU when countries lost their monetary policy autonomy, monetary accommodation increased mortgage lending, and engendered housing bubble in Spain and Ireland is fascinating. 
As can be seen, for the 1999-2007 period, coinciding with the first years of the monetary union, the optimal monetary policy rates for Ireland and Spain should have been much higher than the ECB policy rates, given the rapid growth rates experienced by them during that period. The loose policy boosted mortgage lending which doubled in eight years, and in turn inflated housing prices by 65-75%. This contrasts with Germany, with its moderate growth and resultant tighter monetary conditions, stable mortgage lending, and declining property prices. 

Its implications are clear. One, policy actions, like macroprudential tools, have relevance in the regulation of the market failures arising from the inevitable excess of mortgage lending. Two, central banks should be cognisant of the fact that the side effects of monetary accommodation can destabilise financial markets, with housing being a major channel of instability. Three, it may be time to re-examine the dominant role of dollar and the attendant effect of its pegging other currencies, which creates the channel for importing financial instability. In simple terms, the dominance of dollar effectively invalidates the Mundell-Fleming trilemma and makes monetary policy always significantly dependent on the US Fed's policy actions.