Vijay Kumar Gaba

Friday, May 22, 2020

Farm sector economics in India

Continuing from yesterday (see here)

Before planning for any reform in the India's form sector, it is critical to understand the key characteristics of the India's farm sector. To be successful, any strategy, plan, policies and programs must be in congruence with such characteristics. Unfortunately, most of the policy initiatives and programs implemented in past couple of decades have not been congruent with the characteristics of the farm sector.

The following are some of the typical characteristics of the India's farm sector which have been hindering the growth and profitability of the sector and large proportion of population associated with the farming and allied activities.

Farm sector of India

As per the 6th Economic Census (2014) and Agriculture Census of India (2017), and NSSO (2013) data the following are the broad contours of the farm sector of India:

Non-farm activities

1. There are about 3.5cr rural commercial (non-farm) establishments in India. Out of these only 1.3cr are engaged in agriculture related activities (excluding crop production and plantation).

A visit to 10 typical Indian villages will tell you that these establishments primarily include small shops, auto and farm equipment dealerships, services (tailor, auto repair, salon, telecom, medical, coaching, financing, etc.) and petty artisans like potters etc. Livestock constitutes 87% of economic activity in the farm sector

What is important to note is that over 60% non-farm commercial establishments are directly impacted by farm sector, even though farm sector contributes about 15% to GDP.

About two third of all rural households have farming as their principle source of income.

2. About two third of these establishments are run without any hired worker (Own Account Establishments or OAE). Meaning the households manage the business themselves, mostly from home (36%) or without any fixed structure outside home (18%), e.g., from a cart, vehicle or on pavement. This segment is characterized by huge under-employment, disguised unemployment, low productivity and negative side effects like child labor, pollution, non-compliance with civic rules etc.

3. The period between 2005-13 saw a massive jump of 56% in OAEs. This was incidentally the period of highest growth for Indian economy. Labor intensive construction in particular recorded very high growth during this period. MNREGA also started during this period. I believe this trend continues after 2013 also.

In my view, most of these OAEs added during 2005-13 were not voluntary. These were direct outcome of diminishing employment elasticity of growth, acquisition of large tracts of agriculture land for infra projects thus rendering a large number of farm labor jobless, at a time when number of people joining workforce is accelerated.

4. Fewer than 2mn establishment are engaged in handicraft/handloom sector employing about 4mn people. About 80% of these establishments are OAEs.

If we browse through the headlines since 2013, the governments have made significant efforts to damage these sectors, e.g., through encouraging large retail formats and impeding beef trade etc. There is no evidence of any incentive or promotion for Mobile telephony related retail trade activities which have inarguably been the largest provider of incremental employment in past one decade.

Farming activities

The farming sector in India is characterized by (a) small holdings; (b) low productivity and (c) landless farmers.

1. During FY11 and FY17, the total operated farm area has decreased from 160million hectare to 157.872million hectare; number of holdings have increased from 138.35 million to 146.45 million and the average holding size has decreased from 1.15 hectare to 1.08 hectare. For the context, the average farm size was 2.4hectare in 1971.

2. The number of small and marginal farmers is rising consistently. UP, Bihar, Maharashtra and MP account for 45% of operational holdings. Bihar has the highest percentage of marginal and small holdings, followed by UP.

3. 14 out of 36 states & UTs account for 91% of the total number of holdings and 88.19% of the operated area. A large majority of states are thus relatively less relevant insofar as the policies and programs relating to farm sector are concerned.

4. The marginal and small holdings (0 to 2 hectare) account for 86% of total holdings, covering about 47% of the operated area. Medium (2 to 10 hectare) holdings are 13.3% covering 44% of the operated area. Large holdings (above 10 hectare) are merely 0.57% covering 9% of the operated area.

5. The more important and worrying statistics however is that there are over 100mn Marginal Farmers, with average holding of 0.38 hectare (0.9 acre) accounting for almost 68% of the total farmers. These farmers mostly do sustenance farming, and under no circumstances can earn decent two square meals from farming activity alone. 100mn farm holdings means about 400mn population, assuming an average family of 4. Marginal farmers with average land holding of 1.4 hectare are another 18% or 25mn.

About 47% of the total operated area is covered by these small and marginal farmers. The uneconomical size of holdings, which are getting further divided with the death of each farmer, ensures low productivity, poor financial conditions, no investment capacity and perennial debt in many cases.

6. There is huge variation in land holding pattern amongst states. For example, AP and TN have largest proportion of landless farmers (more than 50%): Bihar and West Bengal have largest number of marginal farmers (close to 60%), where Rajasthan has the largest share of large farmers. Same agri policy for all these states is bound to fail.

7. The average monthly rural household income in India is about Rs6426 and average Monthly rural household expenses are about Rs6223. About 85% of households earn less than their expenses. About half of this income comes from cultivation and rest from other activities like labour (including MNREGA) and animal husbandry.

8. Rural household spend about half their income to buy food.

9. As per the last available NSSO data, the average per student annual expense for education in rural areas was Rs6788 in 2014. It had risen more than 2.5x since 2008 when it was recorded at Rs2461.

10. The average hospitalization expense in rural areas is close to Rs17000 per case of hospitalization as per the last available NSSO data

11. Doubling the farmers' income by 2x in 8years (2014-2022) means a nominal growth rate of 9% CAGR. There is little change in real rural wages over past five years. Rural wages are an important component of rural income and a key determinant of minimum support price for farm produce, the government might need to review its strategy.

...to continue on Wednesday, 27 May 2020

Thursday, May 21, 2020

Farm Sector - Govt may need to do much more

The much publicized and even more widely criticized Rs20trn Self Reliant India economic recovery package has laid significant emphasis on the farm sector reforms. The following 10 key promises have been made as part of the package.

1. Essential Commodities Act to be amended to enable better price realization for farmers by attracting investments and making agriculture sector competitive.

2. A central law to be enacted to provide for inter-state trade and framework for e trading of agriculture produce.

3. The government to facilitate appropriate legal framework for an enforceable standard mechanism for predictable prices of crops at the time of sowing (some sort of contract farming or forward pricing mechanism).

4. Financing facility of Rs.1Lakh Cr to be provided for funding Agriculture Infrastructure Projects at farm gate & aggregation points (Primary Agricultural Cooperative Societies, Farmers Producer Organizations, entrepreneurs, Start ups, etc.)

5. Rs 10,000 Cr. scheme to be launched for Formalization of Micro Food Enterprise (MFE). through Cluster based approach (e g Mango in UP, Kesar in J&K, Bamboo shoots in North East, Chilli in Andhra Pradesh, Tapioca in Tamil Nadu etc

6. Rs20,000 cr support to be provided under the Pradhan Mantri Matsya Sampada Yojana (PMMSY) for integrated sustainable, inclusive development of marine and inland fisheries. Rs11,000 cr to be provided for activities in Marine, Inland fisheries and Aquaculture and Rs9,000 cr for infrastructure including Fishing Harbours Cold chain, Markets etc. Provisions of ban period support to fishermen (during the period fishing is not permitted) and personal & boat insurance.

7. Rs 13343cr to be provided for starting National Animal Disease Control Programme for foot and mouth disease and brucellosis.

8. Animal Husbandry Infrastructure Development Fund to be launched with total outlay of Rs15,000 cr.

9. Rs4,000 cr support for promotion of herbal cultivation covering 10lakh hectare. Rs500 cr scheme infrastructure development related to integrated beekeeping development centres, collection, marketing and storage centres, post harvest & value addition facilities etc.

10. Operation Green proposed to be extended from tomatoes, onion and potatoes (TOP) to all fruits and vegetables i.e., (TOTAL)

Indubitably, these measures are important and desirable. It is totally redundant to debate whether these are new measures or part of the work in progress as part of the plan to double farmers' income within the stipulated period. The important point is that if the current crisis is leading the government to accelerate these long pending initiatives, we must welcome this.

However, the second question, which in my view may be more pertinent, is "whether these measures sufficient or we would need much more to attain the twin objectives of self reliant India and sustainably higher economic growth?"

I believe that these measures are important and required. But these will deliver the desired outcome, only if implemented with the many more structural reforms in the farm sector. I have shared my views on this issue before also. I would like to discuss these again in light of the recent developments, over next couple of days.

Wednesday, May 20, 2020

ABCD of workers' migration

A popular saying is that "the true character of a person is often revealed in the times of crisis". The crisis tests intellect, common sense, resolve, grit, emotions, beliefs, etc. of people, besides highlighting their strengths, weaknesses and vulnerabilities. This applies mutatis mutandis to various organizations and systems also.

The present crisis, for example, has highlighted the strong character of the common people of India who are usually financially insecure (poor), less educated (or illiterate), religious (and superstitious), and oppressed. Often derided by the elite as dirty and non-compliant, these people have shown amazing resilience and grit. They have bore the brunt of economic consequences of the disease; faced cruel apathy of the administration & state (and in some cases employers also); have been most vulnerable to fatalities due to COVID-19 infections; and still managed to stay peaceful and non-violent.

Thousands of them received animal like treatment from administration and law enforcement agencies. Millions of them have walked hundreds of miles on highways and rail tracks, in scorching heat with infants, old, infirm and sick family members, sometimes going without food for hours. Some accidents causing death of many migrant workers have been reported on the media. However, many deaths due to heat, starvation, fatigue, infirmities and other curable diseases may go unreported.

The heart rending pictures of their painful journey back home have been widely shared and mourned in media. The rhetoric on TV channels and social media did spur the politicians into action, but unfortunately the action on the ground has been abysmally inadequate and apathetic.

Our team traveled to some highways and towns of UP, one of the largest destination of the migrant workers returning back, to assess the extent of the problems and its socio-economic impacts. I would like to share some key takeaways as follows:

1. It is estimated that more than 10 million migrants may eventually return home to the states like UP, Bihar, Jharkhand, Chhattisgarh, MP, Odisha, West Bengal and Rajasthan. These workers are returning from relatively developed states of Maharashtra, Gujarat, Tamil Nadu, Andhra Pradesh, Karnataka, Punjab, Delhi and Haryana.

It is expected that once the lockdown is lifted fully, significantly larger number of migrant workers may seek to return home. Most of these workers are unskilled or semi skilled; though it may include sizable number of skilled workers also.

2. The central and state governments appear to have completely ignored these workers in their planning for the lockdown. No thought was spared for their survival and sustenance in a prolonged lockdown scenario. This adequately highlights the pseudo feudal structure of our governance system (a key weakness) and absolute mediocrity of our administrative machinery (a key vulnerability). The Chief Minister of UP has emerged as most popular politicians insofar as handling of migrant workers is concerned. Even though he started a little late and is not supported ably by the administration and bureaucracy, he still has managed to convey the message that he cares.

3. The innocent, helpless, scared, hungry and tired migrant workers have been treated worse than animals. Many states have treated them as if they were illegal intruders from some foreign country. This highlights that our economic and governance model may still be colonial in nature.

4. A significant number of migrants on roads we spoke to confided in us that they were planning to return home since past few years, but were not able to muster enough courage. They believe that with so many government schemes operative, two square meals with dignity & freedom is not a problem in villages. They find it better than living in urban slums like insects.

5. After speaking with over 900 migrant workers on road, we can say with some confidence that:

(i) A large number of migrant workers returning home may not easily go back to their previous place of work. Many of them may in fact never leave their homes for work. There could be at least the following five consequences of this trend:

(a) Businesses, especially construction and textile, may be forced to invest more in technology and automation. Household relying on domestic worker may also be forced to invest in home automation for household chores.

(b) Many labor intensive businesses like textile may have to either relocate their manufacturing units in the areas where adequate number of local labor is available.

(c) The pressure on civic infrastructure in large cities and railways may ease. The multibillion rupees remittance industry may be a key loser.

(d) The home states of these workers may be incentivized/forced to invest in industrial infrastructure and seek private investments to create ample employment opportunities close to home. This may be a big fillip to the "self reliant" India mission. Agro processing is one industry that may see exponential investment and growth.

(e) The regional imbalances in India may gradually bridge, if the home states seize this opportunity and develop a good industrial infrastructure.

(ii) The Agony, sense of Betrayal, Confusion and Disillusionment (ABCD) is ideally a fertile ground for emergence of communist movements. Given the democratic communist parties in India are totally marginalized, the fear is that the violent Naxal movement may spread out of the forests of central India. A strong strategic initiative to prevent such eventuality must be taken immediately. The forthcoming election in Bihar may display some reflections of this fear. Watch out for that closely.

(iii) The expectation from, and reliance on, the government's cash, food and fuel provisions shall rise materially, especially in the rural and semi urban areas. The fiscal pressures may remain elevated for many years to come.

(iv) The pressure on civic and social infrastructure of villages and semi rural (or semi urban) areas shall rise significantly. Administration need to gear up for this well in advance, otherwise we may have garbage, filth, and disease everywhere.

(v) The migrant workers returning home after spending many years in large cities are carrying an entirely different culture with them. On the positive side we may see improvement in religious and superstitious practices. However, on the other side, we may see many indulgences creeping in the simple village life style.

Tuesday, May 19, 2020

New 3Ds - disappointment, dismay and disillusion

Post budget presentation of Union Budget for FY21 on 01 February 2020, I had cautioned the investors to avoid becoming victim of their own expectations (Mr. Market victim of his own expectations). From the reactions over the mega Rs20.97trn stimulus package, coming from the various market participants, it appears that perhaps no one has heeded to my suggestions. The market participants in particular, and the public in general, appear disappointed, dismayed and disillusioned by the policy measures announced by the finance minister in five tranches last week.

The set of policy measures has been analyzed threadbare by numerous experts, commentators, and various stakeholders, using zillions of gigabytes of data. Had the newspaper being published regularly, millions of reams of paper would have also been used by now in analysis and criticism of the set of policy measures announced. I shall therefore refrain from further analyzing the series of announcements made by the finance minister.

(The readers may have noticed that I am deliberately avoiding the term of "stimulus" to describe the set of policy measures announced. In my view, "stimulus" would be a misnomer to describe these measures. In fact, it would not be totally wrong to say that the term "stimulus" must be used only in medical context. Using it in economic, financial, social and personal contexts may be subject to frequent misinterpretations. It is an established principle of human psychology that different people may not respond similarly to the same stimulant. For example, in the principles of management it is recognized that some employees respond to monetary stimulus while the others get stimulated by the challenging tasks.)

However, since many readers have asked for my views, I must state as follows:

(a) The policy measures announced by the finance minister are all good and well intended. There are some serious administrative improvements like allowing private participation in mining sector; rationalization of interstate trade of farm produce, marginalization of the role of APMCs, hike in FDI limit in defense production, consolidation of PSUs, etc. There are some significant liquidity support measures for the beleaguered NBFCs and MSMEs. Some compliance deadlines have been pushed back.

Admittedly, none of the measure announced represents any out of box thinking. Most of these were either in the pipeline (APMC marginalization, defense production, PSU consolidation, accelerated payment of dues to MSME, settlement of Discom dues, interest subvention, MNREGA, Fisheries, Bee Keeping and Social Forestry missions, Contract farming); had already been announced by the RBI is past three months; or are merely extension of the steps already by the government or RBI.

I am sure, only a few could find fault with the policy measures announced per se. These measures are growth supportive and desired.

(b) Packaging the growth supportive measures that were going to be announced anyways over next few months, as emergency stimulus package to counter the socio-economic impact of COVID-19 induced lockdown is a avoidable mistake. This unnecessarily inflated the expectations of people and led to serious disappointment, dismay and disillusionment. With this, the process of diminishing confidence in government's policy making machinery and abilities that started with demonetization shall accelerate further.

(c) The timing of announcing this set of policy measure is questionable. You imagine a young man who has met with a serious accident and is struggling for his life in ICU of a hospital lying on life support system, and his father shows him picture of a suitable girl that he has found for him. The girl shall marry the boy, if (i) he survives; (ii) is fit enough to marry; and (iii) gets his job back. The boy obviously is not interested in the proposal. He is definitely more interested in standing at his own feet first.

Similar is the situation with the entrepreneurs & farmers staring at huge losses and uncertainties, laborers, daily wage workers, middle class workers facing the prospects of job losses and salary cuts, students and professionals entering the job markets this year, etc.

I however do not concur with the popular rhetoric of cash distribution to stimulate demand; removal of tax on Long Term Capital Gains (LTCG) and Securities Transaction Tax (STT) on equities, and reduction in rates of GST, etc. I am not sure if these measures would help significantly enough to lead the economic revival.

The things like LTCG, STT etc are relevant for a tiny proportion of the economically relevant population. Moreover the amounts involved are insignificant in the broader economic context.

In my view, the government should the following five things simultaneously too help the economy revive and get back on the sustainable growth path:

1. Prepare the ground for accelerated growth in future. This will involve laying the foundation stone for top class infrastructure and supportive policy framework for development of industrial base to widen and deepen the participation of India in global supply chain.

2. Make India self reliant in technology, food and energy.

3. Anticipate the new post COVID-19 world and identify the businesses and methods that shall survive and grow in that world. Support those businesses in their transition. Identify the businesses that might be redundant in the new world order. Arrange for peaceful and orderly demise of such businesses and rehabilitation of the businessmen and workers in the new order.

4. Help the citizens to (a) survive this period of crisis by ensuring adequate supply of all essentials (food, shelter, healthcare, education, clothes etc.) at affordable prices; (ii) retain their dignity in life and death; (iii) acquire new skills that may be needed in the new world order; and (iv) maintain peace and harmony.

5. Ensure the stability, liquidity and vibrancy of the financial system to support the growth and sustenance efforts of the people and businesses.

In my view the lower incomes, job uncertainty, and higher effective taxation shall mean that discretionary demand may not normalize for next three years at least. There is no point in wasting scarce resources in stimulating such demand.

The demand for insurance, healthcare, and skill development needs may become non-discretionary. The government must support people in meeting these demands by enhancing the initiatives like Ayushman Bharat, Skill India etc.

Our team visited Agra and Aligarh divisions of UP over past 5 days. I shall share some key observations made during this visit tomorrow.

Thursday, May 14, 2020

Fear dominates hopes

In past 50 days of lockdown, I had a chance of interacting with numerous professionals, investors and businesspersons. The general environment is that of anxiety, fear and pessimism. The promise of a meaningful economic stimulus by the prime minister seems to have rekindled some hopes. Though greed usually accompanies hopes, as of this morning, the fear still continues to be the dominating factor in influencing the investment decisions.

In my view, the following three are the primary sources of rising hopes:

(a) The prospects of total collapse in economic growth and consequent high stress in the financial system is prompting RBI for an aggressive monetary easing. Easing inflation and government’s resolve to bring back the economy on growth path is also helping the sentiments.

(b) There is abundant liquidity in the financial system. As of 6 May 2020, banks had deposited over Rs8.6trn in RBI's reverse repo window @3.75%. The banks have been reluctant to lend for quite some time now. People are hoping that the government may assure banks on credit losses through some sort of guarantee and motivate them to restart the lending.

(c) The impact of COVID-19 is receding as the most developed countries are reporting flattening of curve. There are reports of an accelerated approval for vaccine to treat the infection.

However, unlike August 2019, when the corporate tax rate restructuring was announced, there appears no urgency amongst investors and businesspersons to catch the first flight, as the fear still is continues to be the dominating sentiment.

The fear is stemming primarily from the structural weaknesses in the economy, anxiety about the future course of socio-economic life, health concerns and likely redundancies of businesses and people in post lockdown world.

From stock market perspective, it is pertinent to note that FY21 earnings estimates have been drastically cut to almost 0% growth from 24-28% growth projected a few months earlier.

The downgrade to upgrade ratio of credit rating of Indian corporates has touched its nadir in the current quarter, highlighting the deteriorating solvency and liquidity profiles of Indian businesses.

The stimulus package, the details of which would be known fully only by Friday evening, notwithstanding its size and shape, is likely to support businesses and economic over a period of time. Many MSME or even larger businesses may not survive till that time.

Under these circumstances, I continue to remain hopeful that we shall get a better entry point in Indian equities during summer of 2020. Till then I shall savor the cash and watch the markets carefully.

I shall keep reminding myself the most inspiring tag line I saw behind a truck: Jinhe jaldi thi woh chale gaye(Those who were in hurry, have passed away.)

Wednesday, May 13, 2020

Financial assets have two clear manifestation. Which one you see?

Continuing from yesterday (see here)

Many readers have asked a very pertinent question, viz., "why the stock prices are not reflecting the economic reality?" It is a common knowledge that the outbreak of COVID-19 pandemic and consequent socio-economic shutdown has caused extensive damage to

After pondering over this question for many days, I have reached the following conclusions:

All financial assets (Bonds, Equity, MF Units, Derivatives etc.) have two clear manifestations - (i) Interest in some underlying business(es) or loan to some underlying business with or without a charge on the assets; and (ii) independent commodity without any regard to the any underlying business or asset.

When someone buys equity shares of a company with the intent of acquiring an interest in the underlying business of that company, he is considered an investor in that underlying business. He may use the services of stock broker or may buy directly from the company or some other shareholder. Such a person is mindful of the price he is paying for acquiring the interest in the business. He usually would not like to pay much more than what he believes is the fair value of that business, based on various parameters like future cash flows, replacement cost of assets, market leadership (product, technology, brand, accessibility etc.), competitive advantages etc.

This person would be usually concerned with the performance of the company as reflected by the profitability, cash flows, solvency margins, and sustainability etc. The price at which the stock is trading on the stock exchanges would be least of his concern.

Similarly, when a person lends money to a business with the intent of earning a regular fixed income over the predefined term of loan, he is concerned with the liquidity, solvency and viability of such a business during the term of the loan. How the yields on benchmark government security or other corporate securities move on day to day basis would be least of his concern.

When a person buys a security which is regularly traded on some platform like stock exchange, or buys units of a mutual fund in which the underlying asset is the security regularly traded on some platform, with the intent of selling these securities at a higher price at some point in future, he is a trader, dealing in securities as commodities. He is concerned with the day to day market price of the security.

The interest in business of an investor is mostly linked to the real economy. Good businesses will usually do well in a growing economy; and these will do relatively better in a declining economy. Nonetheless, during the down cycles of the economy growth of most of the businesses will slow down.

However, when we consider financial assets as commodities, the dynamics completely changes. The day to day price of the stocks or bonds is determined purely by the forces of demand and supply on that particular day. The factors like storage capacity (margin money or loss bearing capacity) and carrying cost (interest rates, forward premiums etc) significantly influence the demand and supply. Temporary demand or supply disruptions (ban on short selling, hike in margins, market shut down, credit freeze etc.) significantly impact the market prices. The day to day prices usually have little or no connection with real economy.

In past three months, global central banks have added significant liquidity to the global financial system. This additional liquidity is available at near zero cost. Naturally, the demand for "securities as commodity" is higher due to higher holding capacity and lower carrying costs.

Similarly, when someone buys units of a mutual fund, he has no control over the asset or securities underlying those units. It is the discretion (or decision) of the fund manager (or index manager in case of ETF) that would decide what would be the asset underlying those mutual fund units. I wonder how could someone be termed as an investor or lender if I have absolutely no control over the security or asset I am buying or the entity I am lending to?

Also, consider if a fund manager tells you that I will interest in these five businesses and hold it for next 20years regardless of the market price of their stock, and charge you 2% every year for holding stock on your behalf. How many investors would agree to this proposition?

Obviously, when you buy units of a mutual fund, you entrust your money to an expert who has a track record of dealing in "securities as commodity". Your bet is on the jokey (fund manager) and not the horse (underlying securities); because you have no clue about or control over the horse.

Therefore, basically buying mutual units is also trading in "securities as commodity". The gains and losses from this trade are closely linked to the day to day demand and supply equilibrium without any regard to the strength of ultimate underlying business.

The occurrences in the debt mutual funds in past 12-15 months aptly illustrate this point. A debt mutual fund receives a large redemption request (excess supply) on a day when the liquidity in the market is tight. To meet the redemption obligation, the fund manager sells bonds below fair value causing loss to the unit holder. The company who had issued this bond is working perfectly fine and is fully solvent. This phenomenon can only be explained if we treat MF units as commodity, which realized less money because supply was more than demand on that particular day.

If the market participants assimilate these two manifestations of the financial assets, it would be much easier to navigate through market cycles and business (economic) cycles.

Tuesday, May 12, 2020

Nothing looks outside of the realm of possibilities

Thirty years ago, the period between May 1990 and December 1990, was a watershed in global social, political and economic order. In the 7 months, the world changed the most in the post WWII era. For India, in particular that was a defining period in post independence history.

In global context, some of the key events that took place in those seven months included the following:

(a) Apartheid ended in South Africa, marking the end of one of the darkest chapter in world history.

(b) The process of USSR dissolution begins. The Supreme Soviet of the Soviet Union grants Gorbachev special powers to secure the Soviet Union's transition to a market economy.

(c) Soviet Union collapse marked the end of a bipolar world that had divided the world in two camps in post WWII era. In the subsequent two decades, USA would reign over the world as the only super power.

(d) End of cold war between USA and USSR with treaty to destroy chemical weapons and most of the nuclear arsenal.

(e) Iraqi forces invaded Kuwait. This was followed by the invasion of Iraq by 34 nations in a joint operation, first of its kind in post WWII era. This was followed by a long bloody war between the super power USA & its allies on the one side and radical Islamic forces on the other side. The war on terror thus started still continues, but many key supporters like Saddam Hussain, Muammar al-Gaddafi, Osama Bin Laden etc have been eliminated.

(f) Reunification of Germany, ending more than four decades of separation of German people, healing the post war wounds.

(g) LTTE guerillas massacred 600 unarmed Lankan policemen intensifying the long violent conflict in Sri Lanka.

(h) WHO removed Homosexuality from its list of diseases, erasing the centuries old stigma attached to the practice.

(i) The era of Iron Lady Margret Thatcher ends in UK.

In the Indian context also many significant events took place, which changed the course of Indian politics, economics and social milieu forever.

(i) Massacre & exodus of Kashmiri Pundits in January 1990 was followed by firing by CRPF on funeral procession of Mirwaiz Moulana Muhammad Farooq in May 1990. These events triggered a long intense terror war in the valley, nearly destroying the heaven on earth.

(ii) Mandal Commission report was implemented in India, reserving 49% of government jobs for SC/ST and OBC in India. This changed the politics of India forever, marginalizing the Congress Party and strengthening the regional parties who contested elections on social justice slogan not the poverty elimination.

(iii) BJP President L. K. Advani undertakes a road trip (Rath Yatra) to mobilize support for a Ram Temple in Ayodhya. The V. P. Singh Govt falls, after Advani is arrested in Bihar. The BJP rises as the primary challenger in India's national politics. 6 year later Atal Bihari Vajpayee would make the first BJP led coalition government in India that lasted 13 days.

(iv) Chandrasekhar, a socialist leader becomes prime minister and initiates the transition of Indian economy from a controlled economy to free market economy. The job would be carried forward by the Congress government formed in 1991 under leadership of P. V. Narasimha Rao.

This was also the period, when the stock markets globally, including India, did rather well disregarding all the turmoil, uncertainty and concerns.

Three decade later, the circumstances are almost similar to the summer of 1990. The outbreak of novel coronavirus COVID-19 has completely shaken the global economics, politics, geopolitics and social framework. The things look set to change dramatically.

Nothing looks outside of the realm of possibilities. The ways people work, travel, socialize, live, eat, and communicate are all set for major changes. The global strategic and trade relations face the prospects of dramatic paradigm shift.

India will also be a participant in these changes. Marking "anything", yes I repeat "anything", as unlikely or impossible may not be appropriate at this juncture. The more uncertainty we face, more certain we must believe in the change.

The resilience of stock markets in light of this uncertainty has perplexed many market participants. Many readers have asked about my views on the divergence in the stock indices and real economy.

I will share my thoughts on this in next couple of days.

Friday, May 8, 2020

Gold is not the end game

Continuing from Wednesday (see here)

Not long back in the global history, aluminum was thought to be more precious than gold. Most powerful kings were served food in aluminum utensils while the lesser knights had to do with gold flatware. The sudden change in the value of aluminum took place when much cheaper means of refining the ore became available. Suddenly, it was disposable – as in aluminum foil or cola cans. In no time it transformed from most expensive thing in the world to garbage. Similarly, in African continent for long common salt remained a more prominent store of value and medium of exchange than gold. For past two centuries though gold has been globally preferred as a store of value over another commodity, primarily for its limited supply and physical traits that make it indestructible. However, in past four decades, the demand of gold for storage of value, vanity, social & financial security, and religiously important object shall has diminished. In my view, there is no reason to believe that this trend will reverse in foreseeable future.

Gold phasing out of cultures

I strongly believe that when economics fails in providing solution to the problem of livelihood and sustainability, philosophy provides the answer. It is a natural instinct of human being to look up to the skies for guidance when all our efforts fail. (Some even do so without making any effort at all!) Religion has therefore been an inextricable part of human life since beginning of the civilization and has grown with the growth and expansion of the global trade and commerce.

Most ancient cultures, China, Egypt, Mesopotamia, Indus Valley etc. have believed in continuation of life after death. Gold being an indestructible (and therefore sacred) object had always been an important part of their religion, culture, traditions and beliefs.

However, the factors like popularity and spread of technology in common man’s life; rising fascist and communist tendencies due to worsening socio-economic disparities; rise in electronic transactions (personal, social and commercial) thus lower risk (less travel, less physical transactions & deliveries); emergence of new articles of luxury to serve the vanity needs of the affluent; stronger and deeper social security programs; demise of monarchy; spread of spiritualism; dissipation of church & temples, etc., have resulted in diminution of traditional demand and pre-eminence of gold.

In the modern context, technologically challenging things, e.g., Crypto Currencies, have more potential to attract peoples’ fancy as compared to gold, I feel.

The spread of radical Islamic forces is the only factor that somewhat weakens my conviction in decline of gold. But the way, the global war on radicals is progressing I am sure that in next decade or so we shall see this concern easing materially and then gold may decline rather precipitously in value.

Gold relevant today...

However, the demand of gold as store of value is a deeply complex matter. In past gold had been a preferred asset to store value both during economic as well as political (including geo-political) crises.

Gold has served as reserve currency whenever the paper currencies have lost faith of people due to a variety of reason, particularly high inflation and/or fiscal profligacy. It has also been used as such during transition periods in global strategic power equilibrium.

However since end of Breton Wood agreement in 1971, gold has not been used as reserve currency. In post Berlin Wall (1989) era the strategic supremacy of USA, and consequently USD, has remained mostly unchallenged.

In past five decades post Breton Wood, there have been two instances of global financial crisis. In 1970s the world faced serious stagflation as the demand generated by post WWII reconstruction activities faded and Iranian revolution created a worldwide energy crisis. Gold jumped 10x in real terms during the decade of 1970-1980), to give back most of the gains in the following two decades. Again in the decade of 2000s, as the dotcom bubble hit the global economy, interest rates crashed leading to sub-prime crisis that culminated in a major global financial crisis. The gold jumped 5x in real terms during this decade (2001-2011).

Gold is still down about 10% from its 2011 high. But given the negative rates in large economies like EU & Japan and near zero in US; persistent deflationary pressures despite unprecedented and obscene amount of money printed by Central Bankers; poor economic growth outlook; and war like situation in global currency markets – the gold is reemerging as a favorite asset to store value.

...but not the endgame

The socio-economic disparities are rising in the developed world at a pace unprecedented in the economic history. The situation in my view is likely to materially worsen in coming years. Inarguably, the so-called unconventional monetary policies followed by the central bankers own the primary responsibility for this phenomenon. With an overwhelming US$15-17trillion worth of bonds, many of which are 10-30year maturity, are yielding negative return at this point in time. Many more promise to return no income to the holders. Poor savers and pensioners who mainly rely on their savings for their livelihood are stressed like never before.

Large economies like Japan and EU have mostly failed in their vigorous efforts raising inflationary expectations in their respective economies. There is therefore little incentive to invest in these economies. The employment opportunities are therefore are not likely to rise in any sustainable manner. We have already seen the unsustainability of one decade of job gains in US. All jobs created in 2009-2019 have evaporated in just one month of lockdown.

There is no dearth of experts who have written about the endgame of the current monetary policy practices. Most of them suffer from historical hindsight and extrapolation of current trends. Being no expert of global economics and monetary system, I can afford to conveniently break from the empirical experience and think freely. I believe the endgame will mark a watershed in global economic history - among other things, many systems will become redundant; many currencies will cease to exist; and monstrous debts will be written off the books. It is difficult to fathom that this task can be achieved under the current democratic system. Communism will therefore make a grand entry sometime in next one decade, may be in a new format.

A large number of analysts have forecasted that gold will be a preferred currency of the world amidst all this chaos. I beg to disagree. In my view, presently the interest in gold appears to be more intuitive rather than analytical. It is being presumed that the end game of the non-conventional monetary policies currently in practice will be prolonged stagflation, complete disintegration (or euphemistically restructuring) of the present monetary systems where USD may longer be the sole reserve currency and near complete erosion of savers’ financial wealth.

I find most of the current analysis suffering from some degree of cognitive dissonance. It is trying to dress a trading opportunity into a secular trend. I do not see any reason why gold should ever touch its 1980 high in real terms and why not go below its 1971 lows (in real terms).

Thursday, May 7, 2020

Caught in a quagmire

The jokes & memes on coronavirus are now getting stale. The opening of liquor shops and hike in duty on transportation fuel has provided some new fodder to the meme and joke writers. But the new jokes are more ironical than funny. This clearly indicates that the people are now tired & frustrated to the extent that they are now willing to risk their life to get back to their pre lockdown status.

The government however appears to be caught in a quagmire. It is finding it extremely challenging to strike a balance between (a) the urgent need to augment resources to compensate for the poor revenue collection in past 5 weeks; (b) to provide meaningful stimulus to the businesses facing unprecedented liquidity, solvency and viability crisis; (c) support consumers who have lost income; (d) make concessions for the businesses to attract new investment; (e) restore confidence of people who psyche has been damaged; and (f) continue pursuing its agenda of nationalistic and cultural renaissance.

Three recent events are noteworthy in this context. These events amply highlight the predicament of the government and materially dampen the confidence of investors and entrepreneurs.

(a) A group of senior Indian Revenue Service (IRS) Officers released a report suggesting ways and means to augment resources to compensate for the revenue shortfall and stimulus needs. The government not only contemptuously rejected the suggestions but also initiated punitive action on the concerned IRS officers. However, within a week, the government has decided to steeply hike duties on transportation fuel denying the consumers the benefit of fall in global crude prices. BJP led Haryana government has also raised fees, duties and taxes sale of liquor, petroleum products, and fruits and vegetables.

It is clear that the government is in favor of higher taxation, but is afraid of antagonizing big businesses by imposing higher direct taxes. They have chosen the easier route of indirect taxation, which incidentally will hurt the poor most.

(b) As per some media reports, the government has apparently identified a land pool of 461,589 hectares across the country in a bid to attract Multi-national Companies (MNCs) that will be looking for new sites once they shift their operations out of China. Almost everyone relevant in the central government as well as the governments of BJP ruled states has gone to media, claiming this to be a massive opportunity which the government is determined to seize.

Attracting new investments, aiming for deeper and wider integration into the global supply chain, accelerating industrialization of Indian economy are all noble intentions.

However, it would have been more comforting and believable, if before counting the chickens, the government had clearly specified the learnings from the POSCO, Niyamgiri (Odisha), Hasdeo-Arand (Chhattisgarh), Amravati (Andhra Pradesh), Tata Nano (West Bengal), Bhatta Parsol and Dadri (UP), Mumbai Coastal Road (Maharashtra), Tuticorin (Tamil Nadu), Sardar Sarovar (Gujarat), Tehri (Uttrakhand), Giri Barrage & Spiti Solar project (Himachal Pradesh), several SEZs approved and de-notified since 2000 etc.

People would also like to know how (and if) the government plans to address sustainability concerns before allowing any new major industrial activity. Remember, at this point in time there is absolutely zero margin for error. Any mistake will prove extremely costly, as India will not only miss the massive opportunity, but also lose credibility for future investments.

(c) The decision to allow the states to open of liquor shops to ease the fiscal pressures, despite poor experience of handling the issue of migrant laborers' return to their native place, and consequent chaos at liquor shops across the country, highlights two things: (a) there is little coordination and/or willingness to cooperate between the center and non BJP ruled state governments.

Besides, the management of lockdown is popularly believed to be lacking. Besides economists, many scientists and medical experts have raised question marks on the necessity and desirability of total lockdown in Indian context.

The unpredictability of the current regime, as demonstrated by decisions like Demonetization, strikes on Pakistan, and total lockdown, has perturbed the both the investors and the entrepreneurs.

(I will continue with Investment Strategy series tomorrow)

Wednesday, May 6, 2020

Investment Strategy - 2

Continuing from yesterday (see here)

Before I share my thoughts on USD and Gold, I would like to make it clear that I am a simpleton who:

(a) does not understand the economics beyond its first lesson which says all economic decisions involve a trade off and price of things having economic value is determined by their demand and supply at that given point in time;

(b) does not know how to play with data on Microsoft Excel Sheet;

(d) seriously believes that numbers invariably follow the good story.

In my view, the currency of any country is nothing but an “unsecured zero interest bond” issued by the respective central bankers. This bond usually loses its value with the passage of time due to inflation.

Since 2008 global financial crisis, central bankers in the developed world, especially US Federal Reserve (Fed), European Central Bank (ECB), Bank of Japan (BoJ) and Bank of England (BoE), have created enormous amount of virtual currency (not physical) under various QE programs.

In the second step of QE, the central bankers have exchanged this virtual currency with interest bearing sovereign and corporate bonds. This way while the banks are saddled with the virtual currency that cannot be put in the ATM machines for the savers to withdraw and spend; the central bankers are able to earn additional income by way of interest on the bonds bought by them from the banks and fearful savers. This additional income has helped the governments in extending a variety of stimulus payments to the citizens. Moreover, this enormous buying of securities by the central bankers has also created an artificial scarcity in the debt market and hence allowing the governments to borrow at significantly lower cost. It may be pertinent to note that over US$17trn worth of bonds are now trading at negative yield.

In the third step of QE, the central bankers of developed countries have tried their best to create an acceptable level of inflation in their respective economies so that they can also make some capital gains as the “virtual currency” rotting in the bank accounts depreciates in its value.

While this is the usual mechanism of monetary policy since 2008-09, the case of USD has another manifestation. Besides being the medium of exchange and "unsecured zero interest bond" for the US citizens, the USD is also used as a medium of exchange for a large part of the bilateral global trade. Accepting USD status as an unchallenged global currency, many countries have pegged the exchange rate of their local currencies to the exchange rate of USD. So, even if an Indian trader agrees to sell some goods to a buyer in Dubai and accept payment in AED (UAE currency), in effect his transaction value is measured in USD terms as AED exchange rate is pegged to USD.

The exchange rate of USD in relation to other world currencies is influenced by the physical USD in circulation. The enormous amount of virtual USD created by Fed has helped reducing the supply of physical USD to the world and hence increasing the relative value of USD. For example, the US asset prices (especially equity and bonds) have seen material rise in prices thus attracting investments from world over; and the large fiscal stimulus enabled by QE has made businesses in US relatively more profitable thus reversing the current account deficit trends (large US CAD traditionally has been a major source of physical USD supply to the world).

So far so good for US as it's all win-win for businesses, government and common people. But unfortunately all good things must come to an end.

Taking advantage of low interest rate on USD funds and plenty of liquidity, many global borrowers had borrowed money in USD. As per some estimates, about US$13trn of this debt will come up for repayment in next few years.

As institutional market research at Global Macro Investor, succinctly puts it—

"the $13tn short dollar positions (foreign dollar debt held mainly by foreign corporation and investment vehicles) is the largest position ever taken in the history of global financial markets. It can only mean a massive, uncontrolled dollar rally.

QE will not fix this. Swap lines will not fix this. A debt jubilee would fix this or multiple trillions of dollars in write-downs and defaults.

It is the dollar strength that brings to world to its nadir (just like the 1930s). It is the dollar system that is the really big problem.

This eventually breaks the dollar after a super-spike as global central banks are forced to find alternatives. They are already working on digital currencies for exactly this.

The biggest event of all of our lifetimes has now begun to come clear. We are still only in the first phase – the panic. It will most likely play out in three acts over several years:

First, the panic, which is the liquidity phase.
Then the hope, which is the correction phase.
And finally, the insolvency, the brutal phase that changes everything, including the system itself."

In my view, these phases will play out in much shorter span of period (may be 5-6years).

The strength of USD itself will divert the global trade away from USD, as the commodity producers may not be able to manage their local economies with their produce priced in expensive USD. We shall see more bilateral trade and multiple smaller trade blocks. The first signs of this trend shall emerge from rise in volumes of oil traded in CNY; de pegging of Arab currencies; more jurisdictions granting legal tender status to cryptos, etc.

US government defaulting on its debt obligations to China, as reported by a section of media (see here), may further expedite the process of USD cessation as global reserve currency.

...to continue tomorrow

Tuesday, May 5, 2020

Investment Strategy - 1

Last week, I had shared latest update relating to my investment strategy. I had highlighted that we may be standing at the threshold of a new economic and market cycle. The global economics, politics and markets may change rather dramatically in next couple of years, in the aftermath of the current crisis. I have therefore decided to reorient my investment portfolio to suit what I believe could be the shape of the new world. (see here)

Many readers have expressed surprise on my decision to (a) raise the weight of equities in my asset allocation; especially at this point in time when almost everything appears uncertain and future is shrouded in thick black clouds; and (b) prefer Neutral currencies like Cryptos over USD and Gold. I would like to address the inquisitions of the readers as follows.

It is pertinent to note that I have been expecting a paradigm shift in the global markets for past 5 years now (for example see here). Especially in past 5 years there have been many indications pointing to the shift taking place, though at a subtle pace.

Sino-US tariff conflict; virtual dismantling of SAARC, launch of ambitious Chinese projects like Chine Pakistan Economic Corridor (CPCE) and One Belt One Road (OBOR), Exit of United Kingdom from common European Market (EU); negotiations over new economic blocks like Regional Comprehensive Economic Partnership (RCEP) & Trans-Pacific Partnership (TPP) agreement, US-EU trade renegotiations; US-Japan trade conflict; Indo-US trade conflicts; Indo-Arab realignment; enhanced Indo-Japan trade relationship; decision of US to completely exit Afghanistan; fissure in the cartel of large oil producers (OPEC+), and strong reemergence of socialism in the developed world are some of the indicators pointing towards the shifting paradigm.

When I say that the paradigm is shifting in global markets, I am certainly not suggesting "it is different this time". What I am essentially saying is that "it is the same as always".

I have also written this couple of times before (see here), the global market paradigms have shifted every few decades. The shifts have been caused by a variety of factors. Sometimes it has been led by shift in strategic and geo-political power (spread of European empires in 17-18th centuries and strength of US post WWII). Sometimes technology innovation (industrial revolution in Europe and US, post-war Japanese manufacturing renaissance and then internet revolution in US) caused the shift. Rise of oil economies post 1970's in middle east Asia and Chinese and Korean manufacturing revolutions have also caused material shift in global markets. Nature has also played vital role in causing tectonic shifts in global power equations and market balances. Decline of great Roman empire is case for study.

In most of these market transition phases, currencies have played a key role. Therefore it is pertinent to evaluate the current transition in global market paradigm from this angle also. In most earlier instances the emerging currency (including gold and silver in earlier instances) has changed its relative global value during the course of the shift. Sometimes strength in the currency or gold & silver stock played a critical role, as in case of British and Portuguese dominance in earlier centuries. In some cases weakness in currency supported the shift, as in case of the rise of Korean and Chinese manufacturers causing decline of Japanese dominance.

The present case appears no different - Chinese are trying to establish their supremacy in global technology, economic and political affairs by becoming a primary challenger to the US hegemony; Japanese are trying to regain their lost market share in global manufactured goods market by depreciating their currency; Germans are struggling to retain their market share by forcing the Euro down; and EMs like India are trying to establish a foothold in the global markets.

US have so far been successful in reigning its currency without compromising the supremacy of dollar. But this situation may not last longer. ....to continue tomorrow