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Aftermath of Venezuelan Socialism

Venezuela is on the brink of a complete economic and political collapse, which has been building up since the early days of Bolivarian Socialism.

How does one know that things are going bad in Venezuela? – By the fact that there are no reliable ways of knowing it. Good economic data about Venezuela is conspicuous by its absence. It seems that President Maduro has made it State policy to not publish data. The last time that the Venezuelan central bank published inflation data was in January 2015 and it was 63% at that time, already the highest in the world. By the end of 2015, it was estimated by the IMF that inflation rates would have reached 275%

The Venezuelan economy and the government is in complete shambles and the only question is, as a Washington Post article points out, is which one will collapse first. A combination of bad policies and global situation has put Venezuela on the edge of the precipice.

The Venezuelan economy is driven by oil. In fact, it has the world’s largest oil reserves and like many oil-exporting countries today, is suffering due to low global crude oil prices. However, this is just the proximate cause. The seeds of destruction were sown with the extreme socialist measures taken by the late populist President Hugo Chavez. When oil prices soared in 2000s, it offered Chavez the funds to pursue a hyper-populist and socialist reforms in the economy. The Chávez government pursued a series of “Bolivarian Missions” aimed at providing public services (such as food, healthcare, and education) to improve economic, cultural, and social conditions. Very soon, fiscal spending ballooned in a view to retain loyal political support. Two cent gasoline, free housing, highly subsidized food from government controlled supermarkets and a whole range of such populist policies were practiced.

The first part of his inequality reduction was to conduct land reforms. Many productive agricultural lands were seized with the belief that land belongs to the state and not private individuals. With this move, a sizeable area of productive land previously owned by individuals were now sitting idle under government control, which led to reduction in food supply.

Further, the Chavez government set price controls on about 400 food items in 2003, in an effort to “protect the poor”. In March 2009, the government set minimum production quotas for 12 basic foods that were subject to price controls, including white rice, cooking oil, coffee, sugar, powdered milk, cheese, and tomato sauce. As it has been throughout history, price controls lead to massive shortages and to the creation of underground economies. In January 2008, Chavez ordered the military to seize 750 tons of food that sellers were illegally trying to smuggle across the border to sell for higher prices than what was legal in Venezuela.

As many socialist countries in the past will bear witness, one set of distortions introduced by the government will lead to many more and an attempt to correct those leads to further distortions. Price controls led to supply shortages. A few of the supermarkets that could manage to get its hand on essential supplies charged a price higher than what was stipulated. The government seized all of these supermarkets and the shelves have been empty ever since. This was a pattern that was found across all industries. A few examples:

  • Price controls caused shortages in the cement industry and led to a downturn in construction activities. The government nationalized the cement industry, including hostile take over of multi-national companies, which completely eroded business confidence in Venezuela, and led to a marked decrease in cement production.
  • The largest electricity producer in Venezuela was a private US firm, which was later nationalized. In 2013, 70% of the country plunged into darkness with 14 of 23 states of Venezuela stating they did not have electricity for most of the day
  • Similar cause and consequences were seen throughout Venezuela. Cable and telephone companies were nationalized – led to government censorship; Steel companies were nationalized – led to drop in production and capacity underutilization; Food plants – shortage of processed food; bank nationalization – a banking crisis in 2009-10, etc.

The biggest development that has led to present crisis is the complete take over off their biggest oil company. Even though the Petroleos de Venezuela was State-owned previously, it was at least run professionally before Chavez took over. People who knew what they were doing were replaced with people who were loyal to the regime, and profits came out but new investment didn’t go in. Accusations of nepotism were ripe. The result was that the company did not receive any new investments, which made the much-required technical upgradation impossible. Consequently, oil production in Venezuela declined by as much as 25% between 1999-2013.

The current economic crisis is a direct result of economic mismanagement in the past decade. Price controls led to reduction in supply and export bans led to shortage of foreign exchange needed for imports. The result is empty shelves on most retail outlets and a severe shortage of food supplies and being on the route to galloping inflation rates. Two to three hour-long lines in front of government owned supermarkets are not an uncommon sight. The government even deployed security personnel to kick out shoppers from the lines and introduced a two day per week limit for buying groceries.

People line up to buy food at a supermarket in San Cristobal, Venezuela. Source: Gateway Pundit

People line up to buy food at a supermarket in San Cristobal, Venezuela. Source: Gateway Pundit


Excessive government spending has led to deep fiscal imbalance and huge external debts. Many analysts are betting on a Venezuelan default by the end of the year, which will cripple the economy’s ability to rebound from the current crisis.

When faced with huge debt with no ability to raise revenues and limited borrowing opportunities, countries inevitably resort to one thing: printing notes and Venezuela has been doing it relentlessly. This has caused the Bolivar to drop 95% in the last two years, from 64/$ to 959/$ in the beginning of 2016. Given this, the IMF estimates inflation rate to touch 720% in 2016, which will no doubt intensify civilian protests in the country.

The Bolivar has dropped 93% in the past two years. Source: Washington Post

The Bolivar has dropped 93% in the past two years. Source: Washington Post

The need of the hour is economic reforms in order to dull the pain of an intensifying crisis. However, even if Maduro is prepared to bring in some much-needed reforms (which he probably is not), the opposition will not allow him. The opposition has just won the Congressional elections, which has given it a veto-proof majority, and they are determined to stall any plans that the ruling government may have.

The possibility of the opposition blocking Maduro’s reforms is a moot point. Maduro has far too much conviction in his socialist ideals and doesn’t look like he is too eager to change his policies. In fact, he passed a law, which has made it impossible to remove the Central Bank Governor that he has chosen and surely, he has chosen a remarkable candidate. He has chosen a central bank governor who doesn’t believe in the concept of inflation. As the Washington Post quotes the governor:

“When a person goes to a shop and finds that prices have gone up, they are not in the presence of ‘inflation,’ but rather parasitic businesses that are trying to push up profits as much as possible. Let me be clear, printing too much money never causes inflation. And so Venezuela will continue to do so”.

Please Mr Maduro, ask any Zimbabwean how this went down. Many economies have been on a similar path in the past and it is not pleasant. Venezuela will keep printing money until it runs out of money to buy printing paper. Hyperinflation (with inflation rates in millions) will ensue, before a complete economic and societal collapse, which will include asset stripping, rent seeking, and resource capture and hoarding by those who have power. In the end, generations in the future will suffer.

Anupam Manur is a Policy Analyst at the Takshashila Institution and tweets @anupammanur

Read about Brazilian economic crisis here and the Chinese debt burden here.

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Changes in FDI Regulation in 2015

An overview of the significant changes in FDI regulations in 2015. 

2016 saw the highest FDI inflows into India. Amount in USD million. Data source: RBI, chart by author

2015 saw the highest FDI inflows into India. Amount in USD million. Data source: RBI, chart by author

The financial year 2015 has been an exemplary one for foreign investments. Both FDI and FII have peaked in 2015. Net FDI inflows into India were a staggering $35billion, a 62 per cent jump from the previous fiscal year, which saw $21.6 billion. A report by the Japanese brokerage firm Nomura calculated that FDI forms 1.7 per cent of GDP, up from 1.1 per cent in the previous year.

  • The report attributes the higher net FDI to two factors: growing investor confidence in the country and lower outbound FDI following weak balance-sheet of domestic companies coupled with a weak global growth outlook. “We expect FDI inflows to pick up further in FY 2016, driven by an improving domestic growth outlook, recent liberalisation of FDI limits and government efforts to improve the ease of doing business,” the report says.
  • A sector wise breakup of the FDI inflows reveals interesting information. FDI into manufacturing, which the government has been trying to promote, has been modest. The auto industry has been an exception. Telecom, pharma and financial and business services were the largest recipients over the first three months of this fiscal year. The report speculated that some of the inflow was due to fund-raising in the e-commerce sector.
  • The government’s ‘Make in India’ campaign and higher FDI in the defence, insurance and other sectors are likely to see a further fillip in the net inflows.
  • The government’s move to put most of the sectors onto the automatic route and out of the RBI purview, as part of the grander plan for FDI liberalisation, has helped immensely. Further, increased caps on many sectors such as defence and insurance have helped.
  • FDI limits have been hiked in teleports (uplinking hubs), DTH (direct-to-home) and cable networks to 100 per cent with government approval required beyond 49 per cent. Further, news and current affairs TV channels and FM radio companies can now bring in up to 49 per cent FDI under the government route compared with 26 per cent earlier. For non-news and down-linking of TV channels, 100 per cent FDI has been permitted under the automatic route.

Apart from increasing the ceiling, the government has undertaken other steps towards FDI liberalisation. Some of them are:

  • Companies need not approach the Foreign Investment Promotion Board (FIPB), which is the nodal agency for attracting foreign investment, for M&As in sectors where FDI is allowed under the automatic route.
  • The circular also said the government permission will not be required for issuing ESOPS (employees’ stock option scheme) in sectors under the automatic route.
  • Allowed the Foreign Investment Promotion Board (FIPB) to clear proposals up to Rs 5,000 crore from Rs 3,000 crore earlier.
  • In construction industry, where India has traditionally fared poorly, area restriction (20,000 sq m) and minimum capitalisation requirement of $5 million to be brought in within six months of commencement of business have been removed. Further, foreign investors can exit and repatriate investments before a project is completed, but with a lock-in of three years.
  • In banking, the government has introduced full fungibility, meaning FIIs/ FPIs/ QFIs can now invest up to the sectoral limit of 74 per cent subject to the condition that there is no change in control and management of the private bank.
  • Manufacturers have been allowed to sell their products through e-commerce without government approval.
  • Another major booster for companies such as IKEA, a single-brand retail company with 100 per cent FDI, has come in the form of dilution in sourcing norms. Earlier, such companies had to ensure sourcing to the extent of 30 per cent of the value of goods from the date of FDI receipt. Now, it has been changed to opening of the first store.
  • In case of “state-of-the-art” and “cutting-edge technology” ventures under the single-brand route, sourcing norms have been relaxed. Further, single-brand retail companies can also undertake e-commerce business, not allowed at present.

Anupam Manur is a Policy Analyst at the Takshashila Institution and tweets @anupammanur

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The Flavoursome Financial Instrument

Masala, or rupee denominated, bonds are an exciting new financial instrument that transfers the currency risks from the issuer to the investors. Its success will depend on the investors’ confidence in the Indian growth story.

Prime Minister Modi, on his visit to the UK, announced that the Indian Railways would issue bonds in the London stock exchange and raise funds. Though an Indian company raising funds in foreign markets is not new, this time it was slightly different. Traditionally overseas issuance of bonds has been in foreign currencies: pounds and dollars. However, this time, the bond issued by the Indian Railways will be denominated in rupees.

Rupee denominated bonds were first issued by the International Finance Corporation, the private corporate lending arm of the World Bank group, in 2013 and were given the innovative name of ‘Masala Bonds’. It was only in 2015 that an Indian entity, the railways, issued a rupee denominated bond in overseas market. Since then, HDFC issued the first corporate masala bond in London to raise about $750 million. Many others have followed suit: IIFCL, a state-backed funder of infrastructure projects, Power Finance Corporation Ltd, which arranges finance for the electrical power sector, power producer NTPC, etc.

The concept of Masala bonds is not entirely new. The Chinese have been issuing bonds denominated in their local currencies in overseas markets called Dim sum bonds. There are also the Japanese Samurai bonds, US Yankee bonds and the British Bulldog bonds.

Masala Bonds are rupee denominated bonds issued in foreign markets.

Masala Bonds are rupee denominated bonds issued in foreign markets.

The advantage with the Masala bonds is that the risk of currency fluctuations is solely with the investors and not the issuer. Usually, in a bond denominated in a foreign currency, the issuer bears the risk of currency fluctuations – if the rupee were to depreciate significantly during the period, the issuer loses out. To counter this, the issuer will have to hedge against this risk, which adds to the borrowing costs. With the Masala bonds, the risk has been transferred to the investor, who is taking a bet on the Indian story.

Further, the issuer gets access to the larger and more liquid overseas markets. The cost of borrowing is also significantly lower in the foreign markets, roughly by about 200 basis points, than in India. An Indian company usually pays about about half a percentage point higher than the government bonds, which translates into roughly 8.25 for a five year bond and 8.2% for the 10 year bond. In the UK, the issuer will be willing to pay upto 7.5 or even 7.8% for the bond. This is a good alternative for companies who struggle to raise funds in India as Indian commercial banks are reluctant to lend to sectors with heavy debt and facing weak demand.

Investors are exempt from many taxes for investing in the Masala bonds. The Finance Ministry has cut the withholding tax (a tax deducted at source on residents outside the country) on interest income of such bonds to 5 per cent from 20 per cent, making it attractive for investors. Also, capital gains from rupee appreciation are exempted from tax. The masala bonds will offer an opportunity to those foreign investors who are not registered in India to take exposure to Indian debt. It will diversify the investor base for Indian corporations and, most importantly, its success will internationalise Indian currency.

Though this is an exciting new venture, it is unlikely to see immediate big results. There are still concerns in the overseas markets about the liquidity for offshore bonds raised by Indian companies. In a report by Standard Chartered, ―analysts cited investor worries over pricing and a lack of liquidity in offshore rupee paper as factors likely to limit the market‘s growth in the short term. The bank said the global Masala market was likely to be worth between $3bn and $5bn over the financial year ending in March 2017.

Anupam Manur is a Policy Analyst at the Takshashila Institution and tweets @anupammanur 

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Potential Areas for Reforms

With most parliamentary sessions in 2015 being washed out due to noncooperation by the opposition, there is a lot left to done by the Modi government. Depending on the success of Modi’s talks with the opposition, here’s a few things that can be achieved in 2016.

The February session promises to be action packed with a few interesting bills lined up:

GST: The goods and services tax, once approved, will simplify India’s tax regime by integrating the central excise tax, service tax, and state value-added tax. India currently has as many as 14 state level taxes, each of which differ from state to state in levels and implementation. The simplification and unification of these taxes is, according to some estimates, poised to add 2% to India’s GDP. The GST, which has been adopted in several other countries with good results, is expected to boost export volumes, create employment opportunities, encourage competition between states, and increase the tax collection for the government.

Pushing the GST through the parliament has not been easy though. Despite a clear majority in the lower house, the BJP has not been able to pass the bill in three consecutive parliamentary sessions, due to opposition from the Congress party. The latest winter session was again washed out without any major reform going through. Since then, however, PM Modi has had several political talks with the opposition leaders with GST as the specific agenda and the Finance Minister Arun Jaitley commented on January 3, 2016 that he was reasonable confident of passing the GST in the February session. Mr. Modi will have to spend a great deal of capital to pass the GST in the upcoming session, and even then, the bill that gets passed might be a slightly diluted form of the ideal bill.

Bankruptcy Reforms: The average time taken for insolvency proceedings in India is a staggering 4.3 years, whereas the comparable figure in the US is 1.5 years and 1 year in the UK. Having a clearly defined bankruptcy law is essential for providing a favourable investment climate in any country. Exit norms are as important as easy of entry. The new bankruptcy law is expected to not only reform domestic bankruptcy law but also set the framework for developing an effective system for addressing cross-border insolvencies in India. The Insolvency and Bankruptcy Code Bill, which was introduced in the 2015 winter parliamentary session, is currently stalled in a joint committee between the two Indian houses of parliament. However, because bankruptcy reform is a priority area for the Modi government, we expect to see movement on this important matter in the next parliamentary session.

Banking Reforms: The Indian banking sector is dominated by the public sector banks, which are starved for capital and have huge Non-Performing Assets. The pace of stressed asset creation has also been high, which had prompted Moody’s to keep a ‘negative’ outlook for Indian banking sector. However, the Modi led government has been talking of reforming the banking sector with the Finance Minister introducing a 7 point programme to revitalize the public sector banks. The revitalization plan includes creation of a Bank Board Bureau, improving governance standards, and additional capital infusions. Though privatization of the banking industry is the need of the hour, which is unlikely to happen any time soon, this is the first step in the right direction. 2016 should see some significant improvements in the banking industry. Moody’s has already changed its outlook to ‘stable’, following the reduced pace of stressed assets addition.

Legal reforms: Opening up the legal sector in India, i.e., allowing foreign firms to practice and set up offices in India will be crucial to improving the ease of doing business. Inflow of FDI is hampered by concerns over legal cover and arbitration. Companies investing in India want the assurance that they can rely on sound legal advice, judges, and courts.  In 2015, the government began discussions surrounding a gradual opening of the legal services sector to foreign attorneys. The Prime Minister strongly supports legal reform in India and though India is adopting a cautious approach, it has taken the first steps by informing the World Trade Organisation in August 2015 that it would open its legal sector to foreign lawyers and law firms, but would do so only after consultations with all stakeholders, including the Bar Council of India (BCI). As the first step, the benefits of an open legal sector would only be provided to those countries that offer similar treatment to Indian lawyers and firms.

The proposal being considered by the CoS recommends that international arbitration and mediation services and only advisory or non-litigious services in home country law of the foreign lawyer, third country law and international law may be allowed. It proposes that foreign lawyers could be permitted to practise in India in conjunction with Indian lawyers, as a joint venture, with a cap on foreign participation.

Increased Ceiling for FDI: The Modi government has increased the ceiling for FDI in India in many sectors since 2014. It has also cleared many sectors to be considered under the automatic route and has allowed up to 100% FDI, without prior approval of the RBI. The long-standing 10 percent limit on single institutional investors still exists and continues to inhibit growth. Furthermore, even in sectors where the investment limit has been increased to 49 percent, barriers still exist. For example, in the insurance sector, even though the government raised the FDI cap to 49 percent, no foreign company has been able to increase its investment due to India’s restrictive interpretation of management control.

There are some exciting times ahead. If the Modi government can push through some of these long pending reforms, India can look forward to the next wave of growth.

Anupam Manur is a Policy Analyst at the Takshashila Institution and blogs @anupammanur


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Taking Advantage of Lower Commodity Prices

By focusing on those industries that rely on oil as a producion import, India can take maximum advantage of falling global commodity and oil prices. 

The biggest headlines in the economic world over the past year has been news of slowdown in the Chinese economy and the resultant fall in commodity prices. The slowdown in China, which has been the engine of growth in the past decade, has had significant impact on most other economies. China has been the biggest consumer of commodities and oil and thus, a slowing Chinese economy will import lesser amounts and this reduced demand leads to a fall in prices. Commodity prices have fallen by over 40% since their peak in the early part of this decade. Apart from oil, copper, iron ore, zinc, and many metal prices have been declining consistently. Price of energy related commodities, such as coal, has also significantly dropped. The reduced prices have hit many commodity and oil exporting countries. Brazil, Russia, South Africa and many other emerging markets have had severe declines in their exports and consequently in their GDP growth.

Commodity prices have fallen by 40% since their peak.

Commodity prices have fallen by 40% since their peak.

How is India poised? Is it going to be hurt by the Chinese slowdown or can it be a tailwind to increase growth?

First, the negatives: Indian apparel and yarn exports have declined considerably. China has been a big importer of Indian textile products and its decreased pace of income generation has meant lesser demand for Indian exports. Further, with China devaluing its currency considerably as a means to improve their trade, Indian competitiveness has been further eroded. India’s exports have fallen in every single month from April to November 2015 in comparison with the same month a year ago.

However, with India being a net importer of oil and commodities, it should really focus on taking advantage of the lower global commodity prices and falling oil prices. Here’s a few things that India can focus on:

1. With oil prices set to decline further in the first half of 2016, this is the time for India to seriously consider building a large enough strategic oil reserve.

2. India should get its current account balance in line. The rupee has also been declining significantly and if India can increase its exports, and with a reduced import bill, the current account deficit can be corrected to an extent.

3. Lower oil prices will imply smaller oil, petroleum and fuel based subsidies. This should be a golden opportunity for the government to get its fiscal accounts in check.

4. A lower import bill will also have positive effects on inflation and inflation expectations. This should give more room for a more accommodative monetary policy.

5. Most importantly, the government should focus on those industries that uses imported material, commodities and oil, as raw materials for production. The Indian auto industry should get a considerable fillip due to lower input prices. If policy can be more accommodative, the auto industry can soar. Other industries that rely on oil, such as, plastic industries including pipes, chemicals and resins selectively, paints, footwear manufacturers etc can really benefit from oil prices and the government should focus on creating a friendly climate for these industries. Apart from oil, reduced price of iron-ore, copper and even coal should help a large number of Indian industries by lowering input costs.

6. Finally, since India’s nearest peers – Brazil, China, South Africa, and many other EMs – not faring well in terms of economic opportunities, it is poised to receive a lot more of global funds, both FII and FDIs. The next round of liberalising reforms cannot come soon enough to attract global capital into India.

After the stagflationary episode in 2010-12, India is finally getting back to the higher growth track and global conditions seem to be favouring India. It should do all that it can to take advantage of these conditions and accentuate the positives.

Anupam Manur is an economics Policy Analyst at the Takshashila Institution. Connect with him on Twitter @anupammanur


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Choosing channels à la carte

Would you be better off paying only for those channels that you watch?

The advent of digital set-top boxes and satellite televisions in India was extremely exciting at first. The ability to choose and pay for only those channels that individuals preferred was an appetising offer and held the promise of decreased cable bills for families. Many were under the impression that one could pick and choose exactly those channels that one regularly watches. However, the satellite television companies such as Dish TV and Tata Sky took the established American route and bundled the channels into certain packages. This actually resulted in increased costs for families for different reasons. The most obvious reason is that there is enough heterogeneity in preferences in a family and thus, multiple packages had to be selected. While, hypothetically speaking, one member would want a regional package (kannada movies+news package, for example), another member would want to have a sports package, while a third preferred English entertainment. This diversity leads to most families choosing all channels package, which would cost significantly higher.

The more prominent reason for increased costs, however, lies in economics. Providing such packages is called bundling, which is prevalent in imperfectly competitive markets. Bundling refers to the offering of several products for sale as one product. The reason for doing this is to capture all of the consumer surplus.

Take a hypothetical example: There are two customers and two channels. Amit prefers to pay Rs.75 for the Zee TV, but Rs.50 for Star World. Manjunath, however, prefers the opposite: Rs.50 for Zee TV and Rs.75 for Star World. If the cable company offered the channels individually, it can charge only Rs.50 for each channel and will receive Rs.200 as total revenues. If it charges anything more than Rs.50 per channel, say Rs.75, one of the customers will not buy it – Amit will not subscribe to Star World, while Manjunath will not subscribe to Zee TV. The cable company ends up loosing revenue (Rs.75*2 = Rs.150). So, by charging at Rs.50 per channel, the cable company maximises profits and total consumer surplus is Rs.50 (Each customer gets the channel at Rs.50 when they were willing to pay Rs.75 for one of the channel and thus, enjoys a consumer surplus of Rs.25)

Imagine now that the cable company offers a package for Rs.125, a pure bundling strategy, where individuals cannot choose the channels separately. Now, both consumers pay exactly according to their willingness to pay (thus, eroding their consumer surplus) and the cable provider increases its profits to Rs.250. This extraction of consumer surplus by the cable company is known as price discrimination.

Bundling channels into packages might not be as harmful to the consumer as economic theory suggests.

Bundling channels into packages might not be as harmful to the consumer as economic theory suggests.

Given this scenario, it would be tempting to clamour for a regulation where cable companies should provide à la carte option to the consumer where he gets to choose only the channels that he prefers. While economic theory suggests that the consumer would be better off doing so, it is not evidently clear that this might be the case in practice.Content providers, like Star and Zee, also have high degree of market power and would then renegotiate the price with cable companies. Imagine that, under the bundling offer, Star and Zee, received Rs.120 each as revenue from the cable company (who retains Rs.10 profit). Now, if the cable company offers each channel individually, chances are that Star and Zee will increase the rates of their respective channels to Rs.75 to capture all of the consumer surplus, since they are loosing one of the customers. Thus, both Amit and Manjunath will end up paying a price equal to their maximum willingness to pay for one of the channels and they might be worse off as they are loosing the choice of the other channel. Microeconomic Insights has some interesting research on this and found that “consumers bought and watched fewer channels, and their average spending was estimated to rise by 2.2%.”

Anupam Manur is a Policy Analyst at Takshashila Institution and tweets @anupammanur


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The Chinese Debt Burden

By Anupam Manur

There is a bond market bubble brewing in China as investors seek a safe haven. 

The global financial markets did not enjoy a particularly happy new year. Most markets across the world tumbled on news of Chinese economic slowdown. The Chinese stock market led the way, experiencing 11.6 percent slump in the first week of 2016. It had two emergency stoppages, i.e., trading was halted as the circuit breaker was activated. This spread across the world with Dow, Nasdaq, and even the Sensex having bad days.

There is another interesting thing happening in parallel. Chinese investors are spooked and are retreating from the equity market. They are looking for safer investment options and usually, in times of stress, the flow of funds is usually directed towards the bond markets, especially government bonds. After a prolonged stock market bubble in China in the past few years, there is bond market bubble brewing and it may be headed for a major correction and this is not particularly good news. The Chinese bond market is worth RMB 47 trillion ($7.3 trillion), more than 50% of Chinese GDP.

It is not just China that is experiencing increasing debt. Asian debt has increased exponentially since the global financial crisis: from around 110 percent of GDP in Mar-2009 to 160 percent in Mar-2015. The non-financial private debt in Singapore and Hong Kong is as much as 200 percent of GDP. Normally, It is not uncommon in today’s financial world to see such high debt levels. However, the worrying aspect is that all of these Asian economies are also slowing down considerably, which implies that the ability to repay the debt is considerably reduced.

China debt

Back to China, two major reports in the past week have highlighted the bond market bubble and the slight possibility of a correction – by UBS and Macquarie. Total Chinese debt – government + non-financial corporate + financial institutions + households – account for as high as 282 percent of GDP. In 2001, it was 121 percent of GDP and  158 percent in 2007. Again, the debt problem is compounded by the fact that the Chinese economy is slowing down. Another important aspect is the reduction in Chinese foreign exchange reserves. As the Fed raised interest rates in December, there has been an outflow of foreign currency reserves from China to the tune of $500 billion. A large part of the new bond issuance is coming from Chinese local governments. There has been an explosion in municipal borrowing in 2015 and much of it has been to refinance the previous debt burden.

Local (municipal) government debt in China has increased exponentially

Local (municipal) government debt in China has increased exponentially.

China’s debt numbers are not anywhere close to Japan or Greece or even the US. It is not an alarming figure yet. Growing debt is usually ignored in fast growing economies. However, now that China is slowing down, analysts have just begun to get the Chinese debt on their radar.

Anupam Manur is a Policy Analyst and macroeconomics enthusiast at the Takshashila Institution and tweets @anupammanur

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Brazilian Economy in the Doldrums

By Anupam Manur

Brazil is staring at a lost decade of economic output, with political upheavals, domestic economic crisis of falling output, debt and inflation and a stagnant external sector due to falling commodity prices internationally.

While the world is gripped with stories of Chinese slowdown, another economy is staring down the barrel of deep economic and political crisis and faces the possibility of a lost decade for economic growth. Brazil has had another contraction in the previous quarter and according to The Economist, by the end of 2016, the Brazilian economy may be 8% smaller than it was in the first quarter of 2014. The Economist’s GDP forecast for 2016 is particularly dire for Brazil, the largest economy in the downside projections, with over 2% contraction in real GDP.

The last time that the Brazilian economy saw positive growth was in the first quarter of 2014. So, Brazil is officially in a recession in 2015, going by the NBER definition of recession as contraction of output for two consecutive quarters.


Brazil's GDP growth rate has been negative for the past 7 quarters and is expected to fall further in 2016.

Brazil’s GDP growth rate has been negative for the past 7 quarters and is expected to fall further in 2016.

Amidst the economic downturn, Brazil is also facing a political upheaval. Dilma Rousseff  and many of her party members, who are part of parliament, face very serious corruption charges against them and are presently being investigated. They are alleged to have accepted billions of dollars in bribes in exchange for bloated contracts with Petrobras, the State controlled oil and gas company. Also, Joaquim Levy, the Finance Minister who was known to bat for greater fiscal austerity and structural reforms resigned last week. When the need of the hour is urgent economic reforms and a plan to kickstart the economy, the Parliament Is obsessed with the impeachment of President Rousseff. This implies that Rousseff does not enjoy the political capital to initiate any reform agenda, assuming she has one, to get the economy back on track.

Falling commodity prices have a big part to play in Brazil’s misfortunes. Brazil’s commodity exports, and with it, its GDP, had a spectacular rise along with China’s growth story. However, with China slowing down, demand for commodities has fallen and so have its prices. Oil, iron ore and soy beans account for more than half of the Brazil’s export basket and their prices have been depressed for quite some time now. Brazilian commodities index has slumped 41% since 2011, according to Credit Suisse. The average price that Brazil used to receive for a ton of iron ore has slumped from about $125 in 2011 at its peak to about $40 currently. Among the big commodities exporters of the world, Brazil has been hit the hardest.

While it may be convenient for Brazilian administration to blame global conditions for their weak economic performance, a closer look will establish Brazil’s home grown problems as the chief culprit. Australia is a bigger commodity exported and relies heavily on Chinese manufacturing industry for its GDP growth. The share of exports in Brazil’s GDP is 11.5 per cent while Australia’s is much higher at 21 per cent. Despite this, Australia is slated to grow at a 2 percent this year. Other major commodity exporters in Latin America such as Chile and Peru are also affected by the declining prices, but are yet slated to grow at 2-3 percent this year.

The reason for this is Brazil’s structural problems. While Australia handled the global 2008 recession with caution, Brazil followed an excessively loose monetary policy and uninhibited fiscal expansion. Brazil has been spending indiscriminately: the estimate of budgetary deficit for 2015 was 10 percent of GDP. The debt to GDP ratio in July 2015 was already 65 percent and was set to touch 70 percent by end 2015. Further, the government is running a primary deficit of $13.9 billion or roughly equivalent to 2.5 percent of GDP. Primary deficit is defined as the difference between current government spending on goods and services and total current revenue from all types of taxes net of transfer payments, and excludes interest payments. This implies that Brazil is adding to the total debt at a far greater rate than it can afford to do. Rating agencies such as S&P and Fitch have already downgraded Brazil’s debt instruments to junk bond status, which will translate into even higher costs of borrowing.

Corporate debt has been on the rise as well for the past decade. It is presently as much as 63 percent of GDP. It does not help the government that much of this is from either state owned companies such as Petrobras or other companies who have the implicit backing of the Brazilian government.

Quite unfortunately for Brazil, the usual routes for recovery from a recession are unavailable to them. As aforementioned, public debt is far too high to accommodate a fiscal push to the economy. The need of the hour is, in fact austerity, but that is bound to depress the economy further.

Monetary policy does not have too much wiggle room either and the central bank is in a real fix. The SELIC rate, Brazil’s policy interest rate is at 15%. With 150,000 jobs being shed in the formal sector every month, there is a real clamour for reducing the rates. However, this might fuel inflationary pressures, which are already quite high and high inflation will drive away the investors further. The consumer price inflation is hovering around 10 percent and the real has been steadily depreciating.

Raising taxes is also going to be extremely difficult, as Mr Levy  found out. Part of the reason for him quitting the cabinet as Finance Minister was the political opposition both from the opposition and within his own party to raising taxes, cutting federal spending and general fiscal adjustment.

The only way out is unlikely to be popular. Ms. Rousseff needs to come out with a credible new plan for restructuring the economy. This will involve painful cuts to pensions and other social security measures along with slight increases in the tax rates. Finally, Brazil also has to look at improving its business environment. It is currently placed at 120th out of 189 countries in the Ease of Doing Business Report by the World Bank. Though it is definitely going to be a tough period for Brazil in the next few years, it must aim to reduce the duration and severity of the problem by following sound economic policies.

Anupam Manur is a Policy Analyst at the Takshashila Institution and tweets @anupammanur

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Ministry of Risk Management

By Anupam Manur

An expert committee to forecast risks in the short and long run and suggest measures to manage it.

Delhi’s alarming pollution levels and the ensuing chaos in attempting to mitigate the problem has lessons for all the other big cities in India. That Delhi waited for this long and for the problem to gain such magnitude before attempting a solution is by itself a telling sign of the ineptitude of our state government machinery.

Going by the present growth trajectory, it is not hard to forecast that Mumbai, Bangalore and few other cities will face the same problems that Delhi is presently facing in a few years time. Bangalore is about 5-8 years behind Delhi on all the negative signs: the rate of vehicular growth, population growth, reduction in green spaces, bad urban planning, etc.

Further, urban planning in Bangalore is known to have a terrible record with regard to the ability to foresee problems in the future and taking evasive actions. Officials in Bangalore have typically waited for the problem to be deep set before deciding that something must be done, after which it takes a few years to come up with a viable solution. The extremely slow pace of implementation of the solution implies that the problem would have compounded many times over by the time the solution is in place. The Bangalore Metro is a classic example of this. It is now slated to be completed only by 2032, by which time Bangalore’s population and traffic woes would have increased to such an extent that the Metro will be completely inadequate in addressing the issue. Though the problems of garbage disposal and water management has already reached a critical point, the administrators are just beginning to become cognizant of the problem. Many other issues are already imploding, which still hasn’t appeared on the administrators’ radar.

Can we predict the state of Bangalore traffic in the next 10 years? Can we address that issue now?

Can we predict the state of Bangalore traffic in the next 10 years? Can we address that issue now?

The solution to this is to set up an independent set of experts in risk management. Either the central government or the state government should appoint a ministry of risk management, whose task it would be to foresee possible threats and risk to the quality of life in Indian cities and suggest immediate mitigating and evasive actions. The exact scope and structure can be ironed out later, but the main idea is to attempt being ahead of the problem.

The scope for such a committee/ministry could be huge. It can cover issues such as environment (pollution, disappearance of lakes, green cover, etc), water shortage, contingency plans for natural and man-made disasters, etc in the long run and in the short run it could focus on the immediate issues that threatens the quality of life, such as power shortage, traffic problems, housing, garbage clearance, etc.

Corporations succeed when they are able to manage their potential risks and convert them into opportunities. It is time that Indian cities invested in risk managements as well.

Anupam Manur is a Policy Analyst at Takshashila Institution and tweets @anupammanur


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Karnataka’s confounding solar policy

BESCOM’s inability to purchase power has led to a bizarre solar policy which discourages and limits solar power generation.

The officials at the Karnataka Electricity Regulatory Commission (KERC) recently announced that it would reduce the amount paid to individual producers of electricity using solar panels, which will create disincentives for people from becoming self-sufficient for their energy needs. This has come at a time when Karnataka has been facing an acute power shortage, as was demonstrated by the interminable power cuts in Bangalore over the past few months.

The Union and State government has been trying to encourage citizens to install roof top solar panels and produce electricity for their household consumption. Further, any excess electricity generated can be sold back to the grid at a predetermined rate. This also ties in with Prime Minister Modi’s new thrust on solar energy.

Paying the right price is the only way to encourage households to install solar panels

Paying the right price is the only way to encourage households to install solar panels

The response initially has been lukewarm. Since 2014, when KERC released its Karnataka Solar Policy that envisaged achieving a minimum of 400 MW of grid-connected solar rooftop plants and 1,600 MW of grid-connected utility scale solar projects in the State by 2018. The target for 2014–15 and 2015–16 was 100 MW each. However, only 144 customers have come on board in Karnataka and together, they generate 2.4 MW of power, which is grossly inadequate.

It is in this context that the downward revision of tariff paid to solar power generators seems bizarre. Initially producers were paid Rs.10.5 per unit produced, which was reduced to around Rs.9.51 and is now slated to decrease to Rs.6.50 per unit. The stated reason is that capital costs for installing of the solar panels have reduced. Another absolutely confounding proposal by KERC is to set a cap on power generation per customer. The discussion paper actually states that consumers generating electricity “far in excess of the sanctioned load should not be encouraged”. Imagine a state starved for power and experiencing power cuts up to 8 hours a day in its capital city complaining about excess power generation.

The real reason however, is quite straight forward. BESCOM does not have the money to pay Rs.9.51 per unit generated. Consider the current cost of electricity: a normal urban consumer pays Rs.2.70 per unit up to 30 units, Rs 4 per unit for consumption between 31 and 100 units, Rs 5.25 per unit for consumption between 101 and 200 units and Rs 6.25 per unit beyond 200 units per month. Even for high tension commercial users, the maximum rate applicable is Rs. 7.65 per unit for consumption beyond 200,000 units. Given this scenario, how can BESCOM possibly buy power generated by individual users at Rs. 9.50? It is then no surprise that it wants to reduce the price paid per unit of electricity generated and that it actually fears a situation where there is excess production and distribution of electricity.

The solution is not to reduce the amount paid to people who incur considerable costs in installing solar power. The reduced amount will inevitable further reduce the incentives for consumers to use solar energy. Leaving aside an infinitesimal set of consumers who might want to opt for solar energy out of environmental consciousness, most people will react to financial incentives, even if it manages only to cover the cost of installation over a long period.

The answer lies in BESCOM employing marginal cost pricing for the electricity it produces. The price of electricity in Bangalore (and most of India) is below the market price and thus, electricity supply companies (ESCOMs) have heavy losses in their balance sheets. This hampers the ESCOMs ability to purchase power, whether from private generators of solar power or distribution companies, and supply it to the end user. Raising electricity prices will ensure the supply companies have enough income to purchase electricity and provide uninterrupted power supply. Given the high costs associated with power outages (as this article points out), it is imperative to ensure continuous power supply.

Finally, it is high time that KERC introduced contestability and competition in the power sector. Allow private players into the market who can provide uninterrupted power to all at the market determined prices. Mumbai, for example rarely experiences power outages. This is because there are three suppliers of power: TATA, Reliance and BEST. Competition among private electricity suppliers along with the state electricity board will ensure that prices are market based and there are no interruptions in power supply to domestic, commercial and industrial units.

Anupam Manur is a Policy Analyst at the Takshashila Institution. He tweets@anupammanur


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