Cash is Back: Ill-Effects of Demonetisation are Finally Going Away

We had written about this issue, earlier this month.

At that point of time, the currency in circulation was approaching its pre-demonetisation level.

As of March 9, 2018, the currency in circulation crossed its pre-demonetisation level, for the first time. This is a significant event, which has largely gone unreported in the mainstream media. We wonder why? Dear Reader, guess you know the answer to this one.

Take a look at Figure 1.

Figure 1:The currency in circulation as on November 4, 2016, four days before demonetisation was announced, had stood at Rs 17.98 lakh crore. After that the currency in circulation fell, as people deposited Rs 500 and Rs 1,000 notes in their bank accounts. It fell to low of Rs 8.98 lakh crore as on January 6, 2017, and has had largely had an upward trend since then.

Of course, it is not fair to look at currency in circulation, just in isolation. Then there would be no difference between what passes of as analysis on the social media and us.

The currency in circulation is also a function of the size of the economy. Between November 2016, when demonetisation happened and now, the economy has also increased in size. Hence, we need to adjust for this, and the right metric to look at is the currency in circulation to the Gross Domestic Product (GDP) ratio.

In order to come up with this ratio for the end of this financial year, we will have to project the currency in circulation. A projection for the GDP is available.

We basically look at the weekly growth rate of currency in circulation over the last one year (i.e. from March 10, 2017 to March 9, 2018). We ignore the rate of increase in currency in circulation from January 6, 2017 and March 2, 2017, because it was growing at a very fast rate at that point of time.

Using the weekly rate of increase of currency in circulation from January 6, 2017, onwards, is likely to lead to a higher currency in circulation at the end of this financial year and we like to be slightly conservative in our calculations.

Using the rate of weekly increase in currency in circulation between March 10, 2017 and March 9, 2018, the currency in circulation at the end of March 2018, is likely to be around 18.53 lakh crore. As of March 9, 2018, it was at 18.14 lakh crore.

The GDP at the end of the year is projected to be at Rs 167.51 lakh crore. This means a currency to GDP ratio of 11.1%. Take a look at Figure 2, which basically plots, the currency to GDP ratio of the Indian economy, over the years.

Figure 2:The currency in circulation as of March 31, 2017, had stood at 8.8% of the GDP. By March 31, 2018, it is expected to be at 11.1% of GDP, a jump of 230 basis points. One basis point is one hundredth of a percentage. While, this has still not crossed the pre-demonetisation level, it is a tremendous recovery from the March 2017 low.

There are multiple interpretations that can be made from this. Firstly, it tells us very clearly that Indians have gone back to cash as a medium of exchange. It also tells us very clearly that fundamental habits cannot be changed overnight, a point we have been hammering away at for a while now. An economy which used cash for close to 98% of its transactions (in volume terms), cannot be suddenly expected to use substantially less cash.

The increasing currency in circulation as a proportion of the GDP, is a sign of people carrying out more economic transactions with each other than they were in the past. Only when economic transactions happen do people need cash or currency to pay for stuff. If economic transactions are not happening, the currency can continue to stay in the bank account. Only, when transactions start to happen, money is withdrawn from banks and currency in circulation goes up.

Of course, many transactions are carried out in cash. Informal economy forms a huge part of India’s total economy. It also employs a major part of the workforce.

Depending on which estimate you want to believe the informal economy forms around 40-45% of India’s economy and employs anywhere between two-thirds to 92% of its workforce. The currency in circulation going up is clearly good news for the informal sector.

It shows that life seems to be gradually getting back to normal, for this sector, which was badly hit in the aftermath of demonetisation. This should gradually translate into good news for the formal sector as well. If the informal sector does well and people working in it earn money and spend it, the firms operating in the formal sector are bound to benefit, as well.

Of course, the propaganda these days is that everybody who operates in the informal sector is bad, because they don’t pay tax. But that is incorrect. As we have written in the past, a bulk of the individuals working in the sector do not come under the tax bracket and hence, they don’t pay tax. Hence, painting everyone with the same brush is neither fair nor required.

Having said that, there are people and firms operating in the informal sector not paying their fair share of taxes. This means the income tax department needs more efficient targeting, instead of painting everyone with the same brush, as the government has been doing since November 2016. But that is easier said than done.

Propaganda is way easier than doing the right things.

The column originally appeared on Equitymaster on March 22,2018.

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Corporates Responsible for More Than 80% of Bad Loans of Public Sector Banks

One of the points that we have been making regularly in our columns and Letters is that public sector banks should not be lending to corporates. And now we have found more data to back it.

In a written answer to a question raised in the Lok Sabha, the government provided data regarding the accumulated bad loans across different areas of lending. Bad loans are basically loans on which repayment has been due for 90 days or more.

Take a look at Table 1.

Table 1:

As on March 31, 2017 Industry Agriculture and
Allied Activities
Services Retail Loans Other loans
Total NPAs 4,70,084 57,021 84,686 23,795 5,470

Source: Unstarred Question No: 4614, March 23, 2018 

It is clear from the above table that lending to industry forms a bulk of the bad loans of public sector banks. The total bad loans of public sector banks as on March 31, 2017, had stood at Rs 6,41,057 crore.

This basically means that lending to industry forms 73.3% of the total bad loans of public sector banks. Or to put it a little differently, lending to industry forms nearly three-fourths of the bad loans of public sector banks. Take a look at Table 2, which basically lists out the proportion of bad loans that have accumulated for public sector banks, from different forms of lending.

Table 2:

Sector (As on March 31, 2018) Proportion of bad loans in each sector
Industry 73.33%
Agriculture and Allied Activities 8.89%
Services 13.21%
Retail Loans 3.71%

Source: Author calculations on data taken from Unstarred Question No: 4614, March 23, 2018 and Centre for Monitoring Indian Economy 

Table 2 tells us very clearly that the industry and services sector are together responsible for 86.5% of the accumulated bad loans of public sector banks. This basically means that Indian corporates (because while lending to the services sector also, banks are lending to corporates) are responsible for more than 80% of the bad loans of public sector banks.

Of course, one can’t just look at bad loans in isolation of the total loans given out by public sector banks in each of the different areas. Take a look at Table 3, which lists the proportion of the overall loans, given to each sector.

Table 3:

Sector (As on March 31, 2017) Proportion of loans
Industry 37.78%
Agriculture and Allied Activities 13.99%
Services 25.40%
Retail Loans 22.83%

Source: Centre for Monitoring Indian Economy. 

Table 3 makes for a very interesting reading. The total lending to industry by public sector banks forms around 37.8% of the total lending. On the other hand, as we can see from Table 2, the lending to industry is responsible for 73.3% of bad loans. This clearly tells us where the problem with Indian banking is.

Now, let’s take a look at Table 4, which basically lists the bad loans of different sectors as a proportion of total lending carried out to that sector.

Table 4:

Sector Total Bad loans
(in Rs crore)
Total loans Bad loans
(in %)
Industry 4,70,084 26,80,025.00 17.54%
Agriculture and Allied Activities 57,021 9,92,387.00 5.75%
Services 84,686 18,02,243.00 4.70%
Retail Loans 23,795 16,20,034.00 1.47%

Source: Author calculations on data taken from Unstarred Question No: 4614, March 23, 2018 and Centre for Monitoring Indian Economy 

What does Table 4 tell us? For every Rs 100 that Indian public sector banks have lent to industry, Rs 17.5 has not been repaid. For retail loans, the bad loans rate is 1.47%. This shows the difference between lending to industry and lending to individuals.

Finally, let’s take a look at Table 5, which lists the retail NPAs and the industry NPAs of different banks as on December 31, 2017.

Table 5:

Name of the bank Retail NPA in% Industry NPA in %
State Bank of India 1.3 21.9
Bank of India 2.6 27.6
Syndicate Bank 4 16
Bank of Baroda 3.4 16
IDBI Bank 1.4 39.4
Central Bank of India 4.6 23.5
Bank of Maharashtra 4.4 15.3
Andhra Bank 1.8 29.1

Source: Investor/Analyst presentations of banks. 

One look at Table 5 makes it clear that public sector banks do a fairly decent job of lending to the retail sector. The retail bad loans are all less than 5% in every case, whereas the corporate NPAs are higher than 15%.

There are multiple reasons for this. There is no pressure from politicians to lend to crony capitalists when it comes to retail lending. The managers can carry out proper due diligence while giving the loan.

There is very little incentive for the manager to crack a deal on the side, with a retail borrower (unlike is the case with a loan given to industry) and give a loan, where he shouldn’t be giving one. This is primarily because the average loan amount is much smaller in case of a retail loan than a loan to industry, and any dishonesty while giving a retail loan is really not worth the risk.

In case of default, the legal system can be unleashed on to the retail borrower, unlike a loan given to industry, which has access to the best lawyers. A retail defaulter is unlikely to leave the country, like has been the case with several corporate defaulters, in the recent past. The asset against which the loan has been given to a retail borrower can be easily repossessed in case of default, unlike is the case with a loan given to industry.

In case of a home loan, which forms a little over 50% of all the retail loans given out by banks, the value of the home against which the loan has been given tends to much more than the outstanding loan at any point of time. This is primarily because banks don’t fund 100% of the value of the home, getting the borrower to put in at least 20% as a down payment. Over and above this, most homes in India when they are bought also involve the payment of a black component and this adds to the margin of safety of the bank.

In comparison, many loans given to industry are gold plated where the borrower essentially fudges the cost of the project, takes a higher loan than he should and then tunnels money out from the project, thus having very little of his equity in the project. In some cases, the value of the asset against which the loan has been taken tends to be lower than the value of the loan.

Narrow banking is the solution. Most of the public sector banks in India, should not be lending to corporates.

It will ensure that Indian public sector banks do not end up in the mess that they currently are in, anytime in the near future. The trouble is the politicians aren’t going to like it because it is the crony capitalists who fund their elections at the end of the day. And where do crony capitalists get their money from?

The other problem is that if banks do not lend for long term projects, what is the alternative arrangement? The corporate bond market in India barely exists. Pension funds, provident funds and insurance companies, prefer to invest in government bonds, and do not really have the expertise to invest in long term corporate projects. The project finance institutions of yore do not exist, having turned themselves into retail banks.

Having said that, the first and the foremost function of a bank is to ensure the safety of the money of the depositors.

To conclude, all these factors leave the public sector banks in India, in an extremely vulnerable space. As far as the government (or should I say governments) is concerned, all it has done is to throw money at the problem, which is never enough to solve any problem.

Some thinking is necessary as well.

The column originally appeared on Equitymaster on March 26, 2018.

What Donald Trump Can Learn From Adam Smith

The American President Donald Trump wants to make America great again. At the heart of his plan to make America great again lies the idea of encouraging American manufacturers, Trump wants to implement tariffs on imports into America from other countries. He has already implemented tariffs on steel and aluminium.

This method of trying to make America great again by forcing Americans to buy stuff made in America, goes against basic principles of economics.

One of the most quoted paragraphs in economics was written by Adam Smith in a book called The Wealth of Nations. Steve Pinker writes about this in Enlightenment Now—The Case for Reason, Science, Humanism and Progress: “Smith explained that economic activity was a form of mutually beneficial cooperation: each gets back something that is more valuable to him than what he gives up.”

As Smith put it: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest.”

Hence, exchange is at the heart of any market. Trump is basically trying to clamp down on this exchange, which ultimately makes things cheaper for Americans.

The reason why the United States lost its manufacturing prowess over the years, is simply because other countries produced similar or better goods at a cheaper price. Take the case of China. In 2017, the United States ran a trade deficit of $375 billion (or more than a billion dollars a day) with the country.

Why did the situation come to this? The answer lies in the fact that China produced stuff  that American consumers wanted to buy, at a much more competitive price than the American manufacturers did.

Of course, the American consumer benefited from this because he had to pay a lower price than if he had bought the same thing from an American manufacturer. As Smith had said, “through voluntary exchange, people benefit others by benefitting themselves”.
Americans benefited because of competitive pricing of Chinese goods and the Chinese benefited because they got dollars in return for what they sold. Of course, it needs to be said here that Americans paid paper dollars for tangible goods from China.

These dollars earned by China helped pull many millions  of Chinese out of poverty in a period of around four decades starting in 1978. At the same time, it helped America maintain a lower rate of inflation, though many American jobs were lost due to lack of competitiveness of American firms.

The Chinese companies earned dollars while selling stuff in the United States. But they couldn’t spend these dollars in China because the Chinese currency happens to be the renminbi (also known as the Yuan). They exchanged these dollars with the Chinese central bank, the People’s Bank of China, which gave them renminbi to spend. The Chinese central bank then invested a good portion of these dollars in financial securities issued by the American government and other American institutions.

This flood of dollars from China and other big exporters earning dollars, helped keep interest rates low in America.

Donald Trump is now looking to break this arrangement that has been in place for the past few decades. As economist Ludwig von Mises put it a few centuries after Adam Smith: “If the tailor goes to war against the baker, he must henceforth bake his own bread.”

By imposing tariffs, Trump will force American consumers to buy expensive American goods. And this will not create any jobs. Take the example of steel. Buying American steel will make things more expensive for American car manufacturers.

They will either pass on this increase in cost to the American consumer, who will then have to cut down on expenditure somewhere else. If they don’t do that and decide to maintain the cost, they will have to fire a few employees that they currently employ.
All in all, there are no short-cuts to make America great again. The only way is to be competitive. The sooner Trump understands this, things will be much better.

The column originally appeared in the Bangalore Mirror on March 22, 2018.

If Home Loans Are Growing, what is the Problem with Real Estate?

India-Real-Estate-Market

The government shared some data earlier this month in the Lok Sabha, which has led to this column. Take a look at Table 1. It gives us the total home loans given by public sector banks and housing finance companies over the last few years.

It was further pointed out as a part of an answer: “As per the data compiled by National Housing Bank, the growth in housing loans of public sector banks and housing finance companies during the six month period from 1st July, 2017 to 31stDecember, 2017, has been about 34% as against 12% during the corresponding previous half year.”

Table 1: Total amount of home loans given by public sector banks and housing finance companies.It would have been great if the government had shared the total amount of home loans given out between July 1, 2017 and December 31, 2017, instead of just sharing percentages.

Also, on a slightly different note, the National Housing Bank needs to share home loan lending data (both banks and housing finance companies) on a regular basis, which it currently doesn’t. While, the Reserve Bank of India shares the total amount of home loans given out by banks, no such data is regularly available for housing finance companies.

Anyway, getting back to the point. Between July 2015 and June 2016, the home loan disbursement grew by around 25%. Between July 2016 and June 2017, it grew by around 13%.

Since then, growth rate has improved considerably, which tells us that the ill-effects of demonetisation which plagued the sector, are on their way out to some extent.

Now contrast this to data recently released by property consultant JLL. As of December 2017, a total of 4.4 lakh housing units remained unsold in seven major cities. Delhi along with the National Capital Region came on the top with 1.5 lakh unsold homes. Mumbai, Delhi-NCR, Chennai, Hyderabad, Pune, Bengaluru, Kolkata were the seven cities covered in this survey.

How does one contrast the JLL data with the increase in home loans being disbursed, is a question worth asking. There are several explanations. One is that homebuyers are no longer buying under-construction properties. Take the case of the JLL data, only 34,700 units are ready-to-move-in flats. Hence, people are not interested in buying properties which aren’t totally ready. Why?

The answer for this is very simple. Many builders in the last decade have taken money from prospective buyers and not delivered homes. And the prospective buyers have seen what has happened to the earlier set of buyers, and does not want to make the same mistake again. Nobody wants to get into a situation where the biggest investment of their life gets stuck and doesn’t go anywhere.

Given that many people bought real estate as an investment over the years, and kept those homes locked, my guess is, it is that inventory which is now being cleared, to some extent.

This loss of trust between the real estate companies and the prospective buyers, is the basic problem at the heart of India’s real estate crisis. And the data suggests, the lack of trust continues to prevail.

Further, the growth in home loans is basically coming in the affordable housing segment. As the Affordable Housing Report released by the Reserve Bank of India (RBI) in January 2018, points out: “Affordable housing is currently driving home loan growth in India… Housing loans up to Rs 10 lakh recorded robust growth in 2016-17, primarily driven by the public sector banks.. While the number of beneficiaries for loan amounts up to Rs 10 lakhs has increased sharply in 2016-17, the number of beneficiaries for higher value loans of above Rs 25 lakhs has, in fact, declined marginally during the year.”While the bulk of the lending still happens in the greater than Rs 25 lakh category, the growth actually is coming from the sub Rs 10 lakh segment, which is where the real market for homes in India is. Of course, much of this growth is being pushed by the government (which is why the government loves public sector banks) and is not happening in the top seven cities that JLL covers.

What this again tells us is that if home ownership in large cities has to pick up, the prices need to still fall from where they are. Also, buyers are not interested in buying under-construction property and that is something that the real estate companies need to realise and do something about. But that would mean a substantial change from their current way of operating. It hits at the heart of their current business model. And all change is a slow process.

This appeared on Equitymaster on March 22, 2018

Let’s Move Beyond Nirav Modi, Bad Loans Are Bleeding India

Nirav_Modi
Nirav Modi, Nirav Modi, where have you been?” is a question that the bankers at the Punjab National Bank (PNB), must be asking themselves these days.

Media reports suggest that Nirav Modi is in New York, and has no plans of coming back to India. His operational fraud is expected to cost PNB Rs 12,646 crore. PNB is the second largest public sector bank in the country and as of December 31, 2017, had accumulated bad loans of Rs 57,519 crore. A bad loan is a loan which hasn’t been repaid for a period of 90 days or more.

The one good thing that has happened since Nirav Modi’s fraud came to light is the relentless focus of the mainstream media on the operations of India’s government owned public sector banks.

The total bad loans of the public sector banks as of December 31, 2017, stood at Rs 7,77,280 crore. This forms 86.4% of the total bad loans of scheduled commercial banks (i.e. public sector banks + private sector banks + foreign banks).  This basically means that the total bad loans of scheduled commercial banks as of December 31, 2017, would be around Rs 9,00,000 crore.

Hence, Nirav Modi’s fraud of Rs 12,646 crore is just a drop in this ocean of bad loans. But his fraud has put a face to the sad state of affairs that prevails at public sector banks and has thus elicited interest from the mainstream media and the common public.

Before Nirav Modi came long, the bad loans of public sector banks was just an issue which with the business press was concerned about. Now even the TV channels in different languages are having discussions around the issue.

Nevertheless, the fundamental issue at the heart of the bad loans of India’s public sector banks continues to remain unaddressed. Who is responsible for this mess and what should be done about it?

The government released some interesting data earlier this month in an answer to a question raised in the Lok Sabha. As per data from the Reserve Bank of India (RBI), the total bad loans from the “industry-large” category of loans, as of December 31, 2017, stood at Rs 5,27,876 crore. This was for scheduled commercial banks as a whole. The RBI defines a large borrower as a borrower with whom the bank has an exposure of Rs 5 crore or more.

Such borrowers are essentially responsible for a bulk of the bad loans of the banks in India. They are responsible for around 59% of the bad loans (Rs 5,27,876 crore expressed as a percentage of Rs 9,00,000 crore) of scheduled commercial banks. Bank loans to large industrial borrowers formed 59% of the bad loans, even though the total lending by banks to such borrowers formed only around 30 per cent of the total loans given by banks.

Public sector banks accounted for Rs 4,64,253 crore or 88% of bad loans in this.
In fact, the much criticised public sector banks do a pretty decent job of lending to the retail sector. Take a look at Table 1, which basically compares proportion of retail loans which turn bad with proportion of loans to corporates which turn bad, for a few public sector banks.
Table 1:

Name of the bank Retail bad loans
( in %)
Corporate bad loans
(in %)
State Bank of India 1.3 21.9
Bank of India 2.6 27.6
Syndicate Bank 4 16
Bank of Baroda 3.4 16
IDBI Bank 1.4 39.4
Central Bank of India 4.6 23.5
Bank of Maharashtra 4.4 15.3
Andhra Bank 1.8 29.1
Source: Investor/Analyst presentations of banks.    

Table 1 clearly shows that corporate bad loans are much higher than retail bad loans. The question is why? The answer perhaps lies in what economists call regulatory capture. As Noble Prize winning French economist Jean Tirole writes in his book Economics for the Common Good: “The state often fails. There are many reasons for these failures. Regulatory capture is one of them. We are well aware of the friendships and mutual support that create complicity between a public body and those who are supposed to be regulating it.”

How does one interpret this in the Indian case? While it would be totally unfair to suggest that the RBI, which regulates banks in India, is pally with corporates, but it would be totally fair to say that Indian politicians are very pally with Indian corporates. This is where the problem for public sector banks in India lies.

While giving out retail loans, the managers running public sector banks, can make right lending decisions, the same cannot be said when they carry out corporate lending, given the political pressure that prevails on many occasions.

In this scenario, it is worth asking whether all the 21 public sector banks in India should actually carry out corporate lending and put public deposits at risk, over and over again? This is a discussion that we should now be having as a nation and the mainstream media is where this discussion should be happening.

The column originally appeared on The Quint on March 22, 2018

India’s Demographic Dividend is Collapsing

indian flag

Sometimes we get accused of being a stuck like a broken record. But then how else does one follow an issue of utmost importance to a nation, without saying the same things over and over again.

A few days back, The Economic Times reported that the Indian Railways had received a record 1.5 crore applications for 90,000 vacancies. This is the highest number of applications that the Railways has ever received. These are vacancies in Group C and Group D categories, with salaries ranging from Rs 18,000 to Rs 60,000.

Of the 90,000 jobs, around 63,000 jobs are in the Group D category, which includes the job of a gangman. Around 26,500 jobs are in the Group C category, which includes jobs of loco pilots and assistant loco pilots.

The last day of the application is March 31, 2018.  “The number could cross even two crore as there’s still a lot of time to file application,” a senior railway ministry official not willing to be identified told The Economic Times.

Around 167 individuals are competing for one job. If the number of applicants goes up to 2 crore, then 222 individuals will compete for one job in the Indian Railways.

This is India’s demographic dividend, competing for a government job, when barely any are going around. Nearly two million people cross the age of 14 every month in India. Potentially, all of them can join the labour force to look for a job. But all of them don’t. Some people continue to study. A bulk of the women do not look for a job. After adjusting for this, and folks leaving the workforce through retirement, nearly a million Indians join the workforce every month i.e. 1.2 crore a year, which is around half the population of Australia and two and a half times, the population of New Zealand.
A recent estimate made by the Centre for Monitoring Indian Economy suggests that in 2017, two million jobs were created for 11.5 million Indians who joined the labour force during the year.

Of course, the Indian Railways example cited earlier is just one example which shows the lack of jobs for the Indian youth entering the workforce every year. A random Google search will tell you that this is not an isolated example. A late January 2018 newsreport in The Times of India points out that, engineers, law graduates and MBAs were among the 2.81 lakh people who applied for 738 peon posts in Madhya Pradesh.

Another newsreport which appeared in The Indian Express in early January 2018 pointed out that at least “129 engineers, 23 lawyers, a chartered accountant and 393 postgraduates in arts were among 12,453 people interviewed for 18 Class IV posts — in this case, for jobs as peons — in the Rajasthan Assembly secretariat.”

Imagine, if 12,453 individuals were interviewed for 18 posts of peon, how many people would have applied in the first place?

Another newsreport in The Telegraph points out that 1,000 people turned up for three data entry posts that the Odisha University of Agriculture and Technology (OUAT) had advertised for. As the newsreport points out: “While the required qualification for the post was graduation with mandatory knowledge of computer, candidates with BTech, MCA and law degrees turned up for the job interview.”

These are not isolated news stories. Such stories have appeared in the media regularly over the last few years. They are the best example of the fact that there aren’t enough jobs going around for India’s youth, the country’s demographic dividend.

As the Fifth Report on Employment and Unemployment points out: “The Unemployment Rate for the persons aged 18-29 years and holding a degree in graduation and above was found to be maximum with 18.4 per cent based on the Usual Principal Status Approach at the All India level.” Also, the Usual Principal Status Approach considers anyone working for a period of 183 days or more during the course of the year, as employed. Hence, a person could be unemployed for 182 days, and still considered to be employed.

In fact, in a recent answer to a question raised in the Lok Sabha, the government basically pointed out that the more educated an individual is in rural India, the more difficult it is to find a job, in India. Take a look at Table 1.

Table 1:

Educational classification Unemployed
Not literate 2.3%
Primary 3.3%
Middle/Secondary/ Higher Secondary 3.7%
Graduate & above 23.8%

Source: http://164.100.47.190/loksabhaquestions/annex/14/AU1385.pdf
As the 12th Five Year Plan (2012-2017) document pointed out: “One hundred and eighty-three million additional income seekers are expected to join the workforce over the next 15 years.” This essentially means that a little over 12 million individuals will keep joining the workforce every year, in the years to come. This works out to around one million a month. And at this rate, the Indian workforce is expected to be larger than that of China by 2030.

And this is India’s demographic dividend. As these individuals enter the workforce, find work, earn money and spend it, the Indian economy is expected to do well. This will put India on the path to faster economic growth, which will eventually pull millions of Indians out of poverty.

The demographic dividend is a period of a few decades in the lifecycle of nation where the working population expands at a faster pace than the overall population. As the working population gets into the workforce, finds a job, starts earning and spends money, all this creates rapid economic growth, which pulls millions of people out of poverty. At least that is how it is supposed to work in theory. In India’s case it isn’t.

How have things been with other countries been in the past? Have countries which were expected to benefit from the demographic dividend benefitted from it?

As Ruchir Sharma writes in his new book The Rise and Fall of Nations—Ten Rules of Change in the Post-Crisis World: “The trick is to avoid falling for the fallacy of the “demographic dividend,” the idea that population growth pays off automatically in rapid economic growth. It pays off only if political leaders create the economic conditions necessary to attract investment and generate jobs.” This has clearly not happened in India, with the investment to GDP ratio constantly falling over the last decade.

Sharma then talks about the Arab world which despite being poised to, did not benefit from a demographic dividend. As Sharma writes: “The Arab world provides a cautionary tale. There between 1985 and 2005 the working age population grew by an average annual rate of more than 3 percent, or nearly twice as face as the rest of the world. But no economic dividend resulted. In the early 2010s many Arab countries suffered from cripplingly high youth unemployment rates; more than 40 percent in Iraq and more than 30 percent in Saudi Arabia, Egypt, and Tunisia, where the violence and chaos of the Arab Spring began.”

So, what is the way out for India? The answer as we have said over and over again in our previous columns, is the export of low-end manufacturing goods. This is something that India has missed out on. As Sharma said in a recent conference: “If you look at the success stories across the world, their key to success was all the same thing which is they all exported their way to prosperity. They exported their way to prosperity by producing low end manufacturing goods. It is low end manufacturing goods where you end up getting a huge amount of employment growth as well.”

Given that India has missed the manufacturing bus, jobs are hard to come by. As Nobel Prize winning economist said in a recent conference: “India’s lack in the manufacturing sector could work against it, as it doesn’t have the jobs essential to sustain the projected growth in demography. You have to find jobs for people.”

All this leaves us with the question, what does the future have for India? Pakodas we guess.

This column originally appeared in Equitymaster on March 19, 2018.

There’s a Basic Disconnect in Trump’s Plan to Make America Great Again

donald trumpThis is the third and the final column in the series, where I explain that Donald Trump’s idea of making America great again, by imposing tariffs, is not going to work.

Dear Reader, before you start reading this column, it perhaps makes sense to read the two columns published before this, in order to get a complete perspective on the topic. (You can read the columns here and here).

In today’s column we will take a look at how Trump’s entire idea of driving up exports while driving down imports, is contradictory to say the least. Let’s start by looking at Figure 1, which basically plots the trade deficit of the United States over the years.

Figure 1: US trade deficit (in $ million) 

Trade deficit is a situation where the imports of a country are more than its exports. We can see that the United States has run a trade deficit with the rest of the world over the last four decades. The trade deficit peaked between 2004 and 2008, fell for a few years after that, and started going up again.

The American trade deficit came down in the years 2009 and 2010, and these were years when the American economy and the global economy, were both not doing well. Now let’s take a look at Figure 2, which basically plots the exports and imports of the United States over the last four decades.

Figure 2: 

Figure 2 makes for a very interesting reading. The exports and the imports curves of the United States, move more or less in the same way. This basically means that when imports go up, exports also go up and vice versa. Why is that the case? The reason for this is very straightforward. The United States is the largest market in the world. When it imports stuff, it pays dollars to other countries, which are exporting stuff to the United States. These countries can then use these dollars to pay for American exports.

Hence, if Trump keeps going ahead with imposing more tariffs on imports into the US, as he has suggested for a while, he will deny other countries an opportunity to earn “enough” dollars through which they can pay for their imports from the US, which are basically the exports for the US. The larger point being that it is not possible to increase American exports and decrease American imports at the same time. This is the simplistic plan that Trump has to make America great again and there is a basic disconnect at the heart of it. Also, any such plan will have a negative international impact.

Now let’s take a look at Figure 3, which basically plots the American trade deficit with one country, and that is China.

Figure 3: 

Figure 3 clearly shows that the American trade deficit with China has gone up dramatically over the years. The Chinese imports help keep inflation low in the United States. They also help keep interest rates low, as the dollars earned by the Chinese, have over the years found their way back into the United States and are invested in American treasury securities and other debt securities. This foreign demand for American financial securities has helped keep interest rates low in the US. Over and above this, there is another major point that arises here. Take a look Figure 4. It plots the overall trade deficit of the United States, along with the trade deficit that the country runs with China.

Figure 4: 

Figure 4 tells us very clearly that over the years, the trade deficit with China has formed a greater proportion of the overall trade deficit run by the United States. In 2017, the trade deficit with China formed nearly 66% of the overall trade deficit.

Much has been said about the fact that Trump is basically not thinking about the long-term, but is trying to beat down American trading partners into giving American companies better terms. The trouble is that the bulk of the American trade deficit is with China and unless Trump takes on China, the gains of his so called policy are going to be very low.

Of course, it is not easy to bully China, given that other than helping maintain a low inflation and low interest rates in the US, the Chinese also own more than a trillion dollars of American government treasury securities and if push comes to the shove, it can use these treasury securities, as a bargaining tool.

Also, the current Chinese regime is turning more and more authoritarian and is unlikely to take to any bullying by the US, lightly. The only way America can become great again on the industrial front is, if it is able to compete with the products being produced internationally, both on the price as well as the quality front.

The column originally appeared on Equitymaster on March 16, 2018.