When talking about the Indian economy, are we missing the big picture ?

Posted on September 24, 2017. Filed under: Uncategorized | Tags: , , , , , , , , , , , |

So the new government got into the office on the back of a pitch that was based on a lot of hope and promises, and while I have been personally quite supportive of the need for change. I have never been in any doubt that, the changes will require time and government will have to let down people. In a country like or anywhere else for that matter, a government gets elected mostly on perception built around the hype. Average people are simply unable to breakthrough each policies and make sense of it. A country like India needs a complete overhaul of its existing economic and financial infrastructure , and that requires a lot of re-wiring and also redesigning of the entire system. Any good reforms takes time, and a prudent policy is always, to not overload the system with Big Bang reforms, one after the other, the changes have to be incremental, but constant. A system overhaul takes time, and you can’t expect the system to start firing on all cylinders right away especially when you are creating more capacity in the old system.

But economic policies alone can’t re-wire the system, it also requires better execution. And if we are talking about creating growth then, there should be a realisation that, without the ability of funding, government policies on their own aren’t the magic fix. So I don’t care what economic policies the government can come up with, driving growth in a country like India , where almost 80- 90% financing is sourced from banks simply isn’t going to work, unless and until the banks are back in shape. The fact is, the bad loans problem hasn’t been fixed, and the lenders have been too slow to offload the garbage sitting in their living room, yes there are legislative policy changes and reforms to help the banks, but banks haven’t been proactive enough. And a lot has to do with the existing training as well as mindset of the executives within the current banking system. For example, based on my own experience, I have realised that a sizeable percentage of the senior bank executives in India aren’t willing to make tough decisions, because for them, as I understood it, it’s all about a peaceful retirement and self preservation. And the investigative agencies haven’t helped decision making process either. Also some of the rule changes don’t really help the banks clean up their balance sheet. The asset reconstruction companies or ARC as they are known in India are, like a time bomb waiting to explode . On practicality basis, there is almost zero value in the ARC structure.

Without recycling the rubbish, you can’t get rid of the stinky garbage, and monetise it. Many quality ideas are simply not getting funded in India, and young entrepreneurs who could drive growth are more or less shut out from funding. And the other real issue is that, like European banks, the Indian banks are also now scared to lend. The ex RBI governor did good talking and provided public opinion on almost everything, but failed to provide real solutions, and now he is busy promoting a book.

I would prefer a wholesale reform of the financial infrastructure of the Indian economy, where capital market becomes the largest source of capital and not the banks. The regulators also need to support the government by unburdening the system from socialistic era policies. Also the government needs to do more work and talk less, there is too much distraction. A lot of announcement, but not much is getting done. Media channels have an endless lineup of experts, who probably wake up everyday, ready to provide new round of expert opinion. And the quality of journalism is rubbish, where is a decent discussion on, what reforms need to be brought in, to help the nation grow? The issue is everyone is drinking from the same source, whether you are the federal or state government, central or state government owned companies, or the private sector. And unless there is new liquidity going into the banks, it’s going to be tough to fund growth.

Various state governments across India are struggling with a very bloated fiscal situation, and they also own companies that have not made money for a long period of time, so it doesn’t make any good business sense for these states, to continue to own unprofitable companies. And in most cases, these companies are competing with other unprofitable or distressed state owned companies across India. These companies were set up in various states across the country, to provide services to the citizens, and by design they were probably never pushed to make a profit. But the time has come for states across the country to find an exit, by either privatising the companies or merging them together with similar companies in other states, and then exiting it. This will also reduce the debt burden on the states.

Also to fund growth, I will encourage the government of India to put in $ 3 billion in equity and then raise additional $ 7 billion from local banks as well as international investors/ banks, to create a growth and investment fund. This fund could also be made tax exempt from withholding taxes for foreign investors, and let this fund buy new loans from the banks, the fund could then repackage the loans in an asset backed security ( ABS) as a way to refinance itself. The fund could also provide working capital loan indirectly to the SMEs through the banks, and let the originator banks hold just 10% of the new loan on their books. RBI could also buy some of these securities from the secondary market to improve the liquidity and pricing. Also Emerging market focused fixed income investors could buy into these securities, and will be exempt from any withholding taxes. I am not a great fan of using pure debt to finance infrastructure, I would rather first raise equity to fund the infrastructure, and then give equity investors an exit by issuing the debt. If you look at it from pure risk perspective, the equity investors are in fact protected from the completion of the underlying asset, and that’s why you need a strong construction company to provide completion and construction risk coverage. So once the asset is built, equity investors will have their value protected, and the return will come from issuing the debt at a premium. There is a natural cycle, and any insurance cover to protect your investment in infrastructure asset will not work, if you simply buy a credit protection. I prefer a equity – debt- equity – exit cycle , which is based on water cycle of cloud – liquid water- ice – water – cloud. That’s the best value preservation model.

The idea that you can protect your asset for its entire life cycle carrying just debt is completely absurd, and it simply doesn’t work, any debt, if not managed well tends to have the natural tendency to end up spiralling into an unsustainable burden. And, if there was no refinancing then, most debt will not be repaid. You can repay debt from cash flow, but refinancing still remains the most frequently used tool. So we need to link the cycle especially for infrastructure assets. The issue with an infrastructure asset also is the permanent loss of value, and this is when the asset becomes redundant for a number of reasons, but if as an investor, you haven’t recovered money during the cash flow generation lifespan or lifecycle of the asset then, you are looking at a permanent loss of capital.

 

 

 

 

 

 

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The statistical data and the design of the modern economy

Posted on July 6, 2014. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , , , , , , , , |

Our modern economic system is overload with all sorts of statistical data, all aimed at helping us better understand and interpret, the overall health and condition of the economy. And one of the top leading economic indicator to measure the health of an economy is the Gross Domestic Product (GDP), used by central bankers around the world to adjust their monetary policies, by the governments to create economic policies and by the markets to make economic assessment in order to make investment decisions.

So how is our world doing ? well, based on the international comparison program ( ICP ) data for the year ending 2011, the PPP- based world GDP is over US$ 90 trillion. And around 32.4% of this GDP comes from the six Middle income countries including of China, India, Brazil, Indonesia and Mexico, while the six high income countries including of US, Japan, Germany, France, UK and Italy make up around 32.9% of this PPP-based world GDP. The average per capita income of Qatar, Macau, Luxembourg, Kuwait and Brunei of around US$ 100,000 is much higher than the six high income countries, and the US being the cheapest in terms of living cost among the high income countries. And EGYPT, Pakistan, Myanmar, Ethiopia and Lao rank among the cheapest economies in the world.

In terms of investment expenditure, China now has the largest share of the world’s expenditure for investment in other words gross fixed capital formation, and roughly 80% of Asia’s ( including the pacific region ) investment expenditure comes from China and India while Brazil makes up 61% of South America ‘s overall investment expenditure.

But for many, all this is might not only be quite boring statistical data but also somewhat irrelevant as they may not be able to relate to it or interpret it. On the other hand, many would find and consider these vital statistical data extremely important as it confirms ( their interpretation ) that our world is getting a bit richer than it was over a decade ago but then some may disagree especially those who are still struggling to keep their head above water after the financial crisis of 07/08, and would rightly argue that rich are getting richer and the income gap is expanding.

Whatever may be the case, these statistical data are nothing but a rough estimate prone to error. So far we have not managed to design an efficient economic reporting system that is able to account for all (100% ) of the economic activities of the world.

So whichever way, we decide to measure or calculate, how rich our nations economy or the world is getting, there will always be an element of misrepresentation of the actual fact. And I believe Simon Kuznets, who developed the idea of using GDP matrix to measure the size of a country’s economy knew about its limitation. This is why Kuznets extensively wrote about its use and abuse. And one of his statement in 1962 more or less sums up the issue. He said,  ” Distinctions must be kept in mind between quantity and quality of growth, between costs and returns, and between the short and long run. Goals for more growth should specify more growth of what and for what “

Antarctica has trillions of dollars worth of natural resources but zero GDP because it is the people and their economic activities that is what a GDP calculation is tying to measure. So it is the people who make the economy as well as the GDP number, and without people, there is no economy so quite clearly, a economy should be built around people and not the other way round.

The economic literacy of the world population is extremely low, and people on the street today couldn’t be more connected to the financial world than ever before, as evident from the immediate after of the financial crisis. And increasingly more people are starting to talk and pay attention to economic issues that has already affected them directly or indirectly or may affect them going forward as consumers, investors, citizens and what not.

So the design of the modern economy should also incorporate providing basic and essential economic literacy to all the participants and users of the system. A higher rate of basic and essential economic literacy will help people around the world better understand the complex economic system. Economics and overall health of an economy affects people in different ways, and its influence on people’s life is ever increasing so there is strong case for the system to be upgraded, and designed around people, to make it work better.

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The SMEs Bank project – An Idea that could energize the SME sector in a gloomy outlook

Posted on September 22, 2011. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , , , , , , , , , , |

In the past few weeks the markets have come to a realization that the developed world is struggling to generate growth and going forward the global growth projections put out by multilateral institutions including of the International Monetary Fund ( IMF ) and the World Bank paints gloomy picture. The growth outlook has been downgraded to a lower level from previous estimates. To counter the downturn in the economy the policy makers and the central bankers have been trying out various ideas to keep the economy growing. One of the widely used though unconventional monetary policy tool to stimulate growth has been to print more money through quantitative easing (QE) program by the central bankers. Although through their quantitative easing (QE) program the central bankers were able to provide critical support to the market it has had a limited affect on generating growth so far. And one could also argue that monetary policy tools on their own are not going to be enough to create growth.

Going forward the policy makers in the government will have to take the baton from the tiring hands of the monetary policy makers and have the courage to take bold decisions that goes beyond party politics and is right for the economy.  The people on the streets especially those in the U.S. and Europe as well as the markets are increasingly losing faith in their political leaders’ ability to fix the CRISIS.  And it is probably the right time for the politicians to stand up and deliver. In a recent speech delivered by the president of United States to joint session of the congress Mr. Obama proposed tax credit to the SMEs under Obama’s American Jobs act plan as one of his own initiatives to encourage SMEs to hire more and create jobs. He also proposed common sense based regulations to remove the regulatory burden on the SMEs. Although these are steps in the right direction but the tax credits and the removal of unnecessary regulatory burden on the companies won’t do much on their own to create the level of jobs growth that US economy needs. Besides the tax credits and regulatory reforms the SMEs also need to have an easy access to capital at very reasonable and flexible terms. The government will also need to energise the supply and demand side. Consumers’ confidence is going to be one of the key factors in turning the economy around and the government will need to work closely and tirelessly with all the parties to bring the confidence and positivity back in the system.

It is important to point out that a CRISIS born in a globalised world will need a global effort to fully overcome it. Although it is unwise to expect the developing world especially the BRIC nations to bailout European states it is in the best interest of both the developing and the developed world to work together closely on finding a long term sustainable solution.

In the aftermath of the CRISIS high street banks especially those in Europe and the United States have so far failed to support the SMEs and in fact most banks have reduced their lending to the sector significantly while increasing the cost of capital at which they will lend to the SME sector companies. Banks as one of the beneficiary of the quantitative easing program have not passed on the cash to the real economy and they are still struggling with their risk management strategy so to expect them to do more to support the economy and the SMEs sector is probably unrealistic at least for now.

The small and medium size enterprises ( SMEs ) are an important integral part  and the supporting pillar of any economy. Generally the sector tends to lead a country’s new and fast growing industries.  Some of the success stories of developing world today including of Korea, Taiwan among others has been built on the dynamism of the SME sector. Also due to its inherent structure the labour intensity is generally higher in the SME sector companies hence the sector is usually the largest employer in a country. For example over the last two decades the SMEs sector has accounted for around 65% of new jobs created in the U.S. and overall it accounts for about half of non-farm U.S. employment and within Europe the SMEs sector employs around 68 million people which in percentage terms translate to around 72% of the workforce in the non-primary private sector.

Even though the SMEs are seen as an important part of an economy and play a very crucial role in jobs creation in general the sector is not serviced well by banks today. The banks who mostly play the role of an underwriter of loans or suppliers of credit to an enterprise are limited in their abilities to offer a flexible funding solution to the sector and provide the right support  to the SMEs due to a number of reasons, including banks being very cautious in their lending approach, uncertainty about the future and the changing market conditions, a changing mandate from their shareholders and the board, lack of commitment to the sector as well as the lack of the supporting secondary market infrastructure that will encourage and allow the banks to make good PRIMARY loans to the SME sector and be able to refinance in the secondary market if and when required. Financing SMEs do pose real challenges for the banks especially in the current environment where they are continuously feeling the pressure on their balance sheet and struggling to keep their heads above water. Also it is important to point out that while there is an immediate need to address the lack of capital availability to the SMEs it is important that the solution is sustainable and will add value in the long term.

The idea behind the new SME bank or the SME financing vehicle will be to work closely and directly with the sector as well as other banks, credit guarantee agencies, regional development agencies, usiness associations among others to provide direct and right funding solutions to the SMEs and also help in developing the secondary market infrastructure that will allow existing banks and lenders extending loans to SME sector companies to refinance their loan books.

Most Small and Medium Size enterprises require a flexible funding solution that is right for their business and will support them fully and won’t be called back or withdrawn living their business in limbo like an overdraft facility or credit line due to changes in the market conditions or a change in the strategy of the bank. SMEs like any other sector of the economy will prefer certainty and also a ring fencing of their funding commitments from the banks so they can make business decisions.

The inception & operational strategy of the proposed SME Bank

  • The Central banks and the governments could create a SME Bank or SME Financing Vehicle in partnership with financial institutions including of development banks, private investors and other investors with focus on SMEs or similar investment asset class.
  • The investment strategy and the role to be played by the SME Bank should be multifaceted and flexible to allow it to meet a range of capital requirements coming out of the SMEs. A single funding solution or investment strategy may not provide the right support to the sector.
  • The SME bank should also be able to work with traditional and nontraditional lenders to SMEs including of high street banks.
  • The SME bank should also provide a third party service to others and help other banks manage and monitor their existing SME loan books better and get paid a fee for its services.
  • Buy off the existing loans from the balance sheet of the banks enabling them to refinance their loan book and use the new money to extend more loans.
  • Also act as a guarantor to the SME sector companies that are looking to secure funding or provide performance bonds to their counterparties/clients if and when required.
  • Be able to securitise SME loans under special tax free investment provisions for a limited period to attract investors into the asset class.
  •  Provide advisory and consultancy services to SMEs and work intimately with the sector.

 Proposed Shareholders/Participants of the SME Bank (or the SME financing Vehicle) 

The government or the central banks, development agencies, multilateral institutions, local banks, credit guarantee agencies, private investors and financial institutions among others

Proposed Capitalisation and Guarantees

A part of the capital commitment to the SMEs bank could come from the Central banks using the government bonds purchased through their QE program and the remaining from its prospective shareholders. The capitalization of the bank should be based on the real funding requirement of the sector and should be sufficient to service good SMEs.

Benefits of the SMEs Bank

The SMEs bank will play a very important role with huge benefits to the SMEs sector companies, high street banks, lenders focused on SMEs, credit guarantee agencies as well as development banks and other market players. It will also act as an additional pillar supporting the market in the long run and will be a good value ADD going forward.

The local banks, credit guarantee agencies and other lenders or service providers to the SMEs by working closely with the SMEs Bank will be able to take a preemptive action on any loans or services extended to the SMEs that has a possibility of becoming a non performing loan. Also banks could easily offload good and performing loans to the SMEs Bank (or the SME financing Vehicle). While the SME Bank will do direct primary loans and investments to the SMEs sector companies it also will also help develop the secondary market for SMEs loans underwritten by the local banks and other lenders. It could also play the role of the credit guarantee agency to the SMEs sector.

Exit strategy for the shareholders

The shareholders could EXIT if and when required through an IPO in few years time when the markets are going to be much calmer.

The SMEs bank will energize the sector by providing a critical support to the SMEs with a range of financing solutions and will also add significant value to the existing system on a long term basis. It is an idea that needs to be seriously explored by the policy makers.

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