Trump’s Plan to Make America Great Again Will Fail Because of Dollar

In the early 16th century the Spaniards captured large parts of what is now known as South America. The area had large deposits of silver and gold. As I write in my book Easy Money: Evolution of Money from Robinson Crusoe to the First World War: “The precious metals were melted and made into ingots so that they could be easily transported to Spain. Between 1500 and 1540, nearly 1,500 kg of gold came to Spain every year on an average from the New World.” i

Gold wasn’t the only precious metal coming in. A lot of silver came in as well. As I write in Easy Money: “One of the biggest silver mines was found in Potosi, which is now in Bolivia, in 1545. Potosi is one of the highest cities in the world and is situated at a height of 4,090 m. Given the height it sits on, it took Spaniards sometime to get there. Here a mountain of silver of six miles around its base was discovered.ii The mountain or the rich hill, as it came to be called, generated nearly 45,000 tonnes of silver between 1556 and 1783. iii

Most of this new found silver was shipped to Seville in Spain where the mint was. In the best years some 300 tonnes of silver came in from silver mines in various parts of South America.iv

Once the gold and silver started to land on their shores, the Spaniards became proficient at spending it rather than engaging themselves in productive activities. Easy money had spoiled them and they produced very little of their own. Once this happened everything had to be imported. Weapons came from the Dutch, woolens from the British, glassware from the Italians, and so on.v It also led to Spaniards buying goods like bangles, cheap glassware, and playing cards from foreigners for the sheer pleasure of buying them.

As Thomas Sowell writes in Wealth, Poverty and Politics: “The vast wealth pouring into Spain [in the form of gold and silver from South America]… allowed the Spanish elite to live in luxury and leisure, enjoying the products of other countries, purchased with the windfall gain of gold and silver. At one point, Spain’s imports were nearly twice as large as its exports, with the difference being covered by payments in gold and silver… It was a source of pride, however, that “all the world” served Spain, while Spain “serves nobody”.”

Dear Reader, you must be wondering, why have I chosen to point out all this history so many centuries later. The point I am trying to make is that there is an equivalent to what happened in Spain in the 16th century in this day and age. It is the United States of America.

Like Spain, the total amount of good and services that the United States imports is much more than what it exports. The ratio of the imports of the United States to its exports was around 1.23 in 2016. The difference between the imports and the exports stood at $503 billion. In fact, if we look at the imports and the exports of goods, the ratio comes to around 1.51.

The point being that like Spain, the United States imports much more than it exports. Spain had an unlimited access to money in the form of gold and silver mines of South America. This gold and silver over a period of time was mined and shipped to Spain and in turn used by Spaniards to buy stuff from other parts of the world.

What is the equivalent in case of the United States of America? The dollar. The US dollar is the international reserve currency. It is also the international trading currency. As George Gilder writes in The Scandal of Money-Why Wall Street Recovers But the Economy Never Does: “Today it [i.e. the dollar] handles more than 60 percent of world trade, denominates more than half the market capitalization of world stocks, and partakes in 87 percent of global currency trades.”

Spain had almost unlimited access to the gold and silver from South America. Along similar lines, the United States has unlimited access to the dollar. Other countries need to earn these dollars by exporting goods and services. The United States needs to simply print the dollars (or digitally create them these days) and hand it over for whatever it needs to pay for.

While the unlimited access to gold and silver was Spain’s easy money, the dollar is United States’ easy money. And given this, it isn’t surprising that like Spain, the United States imports much more than it exports. This basically means that the country consumes much more than it produces. Also, while the Spaniards had to face the risk of gold and silver ultimately running out, the United States does not face a similar risk because dollar is a fiat currency unlike gold, and can be created in unlimited amounts. As long as dollar remains the global reserve currency and trading currency, the United States can keep creating it out of thin air. Of course, the role of the United States in global politics will be to ensure that the dollar continues to remain the reserve and trading currency. Having the biggest defence budget and military in the world, will help.

The supply of silver in Spain peaked around 1600 and started to fall after that. But the spending habits of people did not change immediately, leading to Spain getting into debt to the foreigners. The government defaulted on its loans in 1557, 1575, 1607, 1627, and 1647.vi

One impact of access to the easy money in the form of gold and silver, was a huge drop in human capital in Spain. As Sowell writes: “What this meant economically was that other countries developed the human capital that produced what Spain consumed, without Spain’s having to develop its human capital… Even the maritime trade that brought products from other parts of Europe to Spain was largely in the hands of foreigners and European businessmen flocked to Spain to carry out economic functions there. The historical social consequence was that the Spanish culture’s disdain for commerce, industry and skilled labour would be a lasting economic handicap bequeathed to its descendants, not only in Spain itself but also in Latin America.”

So, what is human capital? Economist Gary Becker writes: “Economists regard expenditures on education, training, medical care, and so on as investments in human capital. They are called human capital because people cannot be separated from their knowledge, skills, health, or values in the way they can be separated from their financial and physical assets.”

What is happening on this front, in case of the United States? As Michael S Christian writes in a research paper titled Net Investment and Stocks of Human Capital in the United States, 1975-2013, published in January 2016: “The stock of human capital rose at an annual rate of 1.0 percent between 1977 and 2013, with population growth as the primary driver of human capital growth. Per capita human capital remained much the same over this period.”

So, over a period of more than 35 years, the per capita American human capital has remained the same. And this is clearly not a good sign.

Further, unlike Spain which ultimately ran out of gold and silver, given that there was only so much of it going around in South America, the United States does not face any such risks given that dollar is a fiat currency and can be printed or simply created digitally.

But like Spain, the access to this easy money will ensure that in the years to come, the United States will continue to import more than it exports. This will go against the new President Donald Trump’s plan to make America great again. His basic plan envisages increasing American exports and bringing down its imports. But as long as America has access to easy money in the form of the dollar, the chances of that happening are pretty low because it will always be easier to import stuff by paying in dollars that can be created from thin air, than manufacture it locally.

The column was originally published on Equitymaster on March 14, 2017

Advertisements

Indian Economic Growth Data Has Gone the Chinese Way—It’s Not Believable

narendra_modi
The Central Statistics Office (CSO) has declared the economic growth, as measured by the growth in gross domestic product (GDP), for the period October to December 2015. During the period India grew by 7.3%.

The economic growth for the period July to September 2015 has also been revised to 7.7%, against the earlier 7.4%. The economic growth for the period April to June 2015 was also revised to 7.6%, against the earlier 7%.

The CSO also said that the “growth in GDP during 2015-16 is estimated at 7.6 per cent as compared to the growth rate of 7.2 per cent in 2014-15”.

The question to ask here is that why doesn’t it feel like India is growing at greater than 7%? Before I answer this question let me reproduce a paragraph from author and economic commentator Satyajit Das’ new book The Age of Stagnation: “In a 2007 conversation disclosed by WikiLeaks, Chinese premier Li Keqiang told the US ambassador that GDP statistics were ‘for reference only’. Li preferred to focus on electricity consumption, the volume of rail cargo, and the amount of loans disbursed.”

This was promptly dubbed as the Li Keqiang index, by the China watchers.

Over the years, lot of doubts have been raised about the official Chinese economic growth data. And many analysts now like to look at high speed economic indicators to figure out the ‘actual’ state of the Chinese economy.

The Indian GDP data also seems to have reached a stage where it is ‘for reference only’. And we probably now need our own version of the Li Keqiang index, to figure out how different the actual economic growth is from the official number.

It is worth understanding here that GDP ultimately is a theoretical construct. One look at the high speed economic indicators clearly tells us that India cannot be growing at greater than 7%.

Let’s first take a look at the data points that constitute the Li Keqiang index. The electricity requirement for the period April to December 2015 has gone up by only 2.5% to 8,37,958 million Kwh, in comparison to the period between April to December 2014.

How does the earlier electricity requirement data look? The electricity requirement between April to December 2014 had gone up by 8.3% to 8,16,848 Kwh, in comparison to the period April to December 2013. What this clearly tells us is that the demand for electricity has gone up by a very low 2.6% during the course of this financial year, in comparison to 8.3% a year earlier. This is a clear indicator of lack of growth in industrial demand. As industrial demand picks up, demand for electricity also has to pick up.

And how about railway freight? Between April to December 2015, revenue earning railway freight grew by 1% to 8,16,710 thousand tonnes, in comparison to April to December 2014. Between April to December 2014, revenue earning railway freight had grown by 5% to 8,08,570 thousand tonnes, in comparison to April to December 2013.

The railways transports coal, pig iron and finished steel, iron ore, cement, petroleum etc. A slow growth in railway freight is another great indicator of lack of industrial demand.

This brings us to the third economic indicator in the Li Keqiang index, which is the amount of bank loans disbursed, an indicator of both consumer as well as industrial demand. The bank loan growth for the period December 2014 to December 2015 stood at 9.2%. Between December 2013 to December 2014 the loan growth had stood at a more or less similar 9.5%. Bank loan growth has been in single digits for quite some time now. In fact, growth in loans given to industries stood at 5.3% between December 2014 and December 2015.

And what is worrying is that bad loans of banks have jumped up. Bad loans of banks stood at 5.1% of total advances as on September 30, 2015, having jumped from 4.6% as on March 31, 2015. The stressed loans of public sector banks as on September 30, 2015, stood at 14.2% of the total loans.

Hence, for every Rs 100 of loans given by public sector banks, Rs 14.2 has either been declared to be a bad loan or has been restructured. In March 2015, the stressed assets were at 13.15%.

Estimates suggest that over the last few years nearly 40% of restructured loans have gone bad. This clearly means that banks have been using this route to kick the bad loan can down the road. It also means that many restructured loans will go bad in the time to come.

Hence, the Indian economic growth story is looking ‘really’ weak when we look at the economic indicators in the Li Keqiang index. There are other high frequency economic indicators which tell us clearly that economic growth continues to be weak.

Exports have been falling for 13 months in a row. Between April and December 2015, exports fell by 18% to $196.6 billion. Non petroleum exports between April and December 2015 were down by 9.4% to $173.3 billion. The bigger point is that is how can the economy grow at greater than 7%, when the exports have fallen by 18%? In 2011-2012, exports grew by 21% to $303.7 billion. The GDP growth for that year was 6.5%. How does one explain this dichotomy?

Between April and December 2015, two wheeler sales went up by 1.05% to 1.42 crore, in comparison to a year earlier. Two-wheeler sales are an excellent indicator of consumer demand throughout the country. And given that the growth has been just 1.05%, it is a very clear indicator of overall consumer demand remaining weak.

In fact, the rural urban disconnect is clearly visible here. Motorcycle sales are down by 2.3% to 97.61 lakhs. Scooter sales are up 11.5% to 39 lakhs. Scooters are more of an urban product than a rural one. This is a clear indicator of weak consumer economic demand in rural and semi-urban parts of the country. Tractor sales fell by 13.1% between April to December 2015 to 4.12 lakh. This is another  indicator of the bad state of rural consumer demand.

One data point which has looked robust is the new car sales data. New car sales during the period April to December 2015, grew by 7.9% to 19.22 lakhs, in comparison to a year earlier. Between April to December 2014, new car sales had grown by 3.6% to 17.82 lakhs. The pickup in new car sales is a good indicator of robust consumer demand in urban areas.

Over and above this, not surprisingly, corporate earnings continue to remain dismal. If all the data that I have pointed up until now was positive, corporate earnings would have also been good.

The larger point is that if so many high frequency economic indicators are not in a good state, how is the economy growing at greater than 7% and how is it expected to grow by 7.6% during the course of this year. What is creating economic growth?

It is worth pointing out here that sometime early last year, the CSO moved to a new method of calculating the GDP. Since then robust economic growth numbers have been coming out, though the performance of high frequency economic indicators continues to remain bad. In fact, some economists have measured the economic growth rate between April and September 2015, as per the old method, and come to the conclusion that the growth is in the range of 5-5.2%, which sounds a little more believable.

To conclude, there is no way the Indian economy can possibly be growing at greater than 7%. Honestly, Indian economic growth data now seems to have gone the Chinese way—it’s totally unbelievable. And since we like to compete with the Chinese, at least on one count we are getting closer to them.

And there is more to come on this front in the time to come.

Stay tuned!

The column was originally published on the Vivek Kaul Diary on February 9, 2016

Why exports have fallen 12 months in a row

deflation

This is something I should have written last week but with all the focus on the Federal Reserve of the United States, the analysis of India’s export numbers had to take a backseat.

Merchandise exports (goods exports) for the month of November 2015 were down by 24.4% to $20 billion. Take a look at the following table. What it tells us is that the performance on the exports front has been much worse during the second half of 2015. During the first six months of the year the total exports fell by 16.4% in comparison to the same period in 2014. Between July and November 2015, exports have fallen by 19.7%, in comparison to July and November 2014.

Month Exports (in $ billion) in 2015

Exports (in $ billion) in 2014

% fall
January 23.9 26.9 11.15%
February 21.5 25.4 15.35%
March 23.9 30.3 21.12%
April 22.1 25.6 13.67%
May 22.3 28 20.36%
June 22.3 26.5 15.85%
July 23.1 25.8 10.47%
August 21.3 26.8 20.52%
September 21.8 28.9 24.57%
October 21.3 25.9 17.76%
November 20 26.5 24.53%

Why have the exports fallen so dramatically? A major reason for the same lies in the fact that oil prices have been falling for a while now. At the beginning November 2014, the price of Indian basket of crude oil was at around $81 per barrel. Since then price of oil has fallen to $34 per barrel, a fall of around 58%.

But how does that impact Indian exports? India imports 80% of the oil that it consumes. Given this, any fall in the price of oil is usually welcome. The oil marketing companies need to spend fewer dollars in order to buy oil. At least that is the way one looks at things in the conventional sort of way. What most people don’t know is that in October 2014, petroleum products were India’s number one export at $5.7 billion. Several Indian companies run oil refineries which refine crude oil and then export petroleum products.

In November 2014, petroleum products were India’s second largest export at $ 4.7 billion. In November 2015, the export of petroleum products was down by 53.9% to $2.2 billion, in comparison to a year earlier. Also, petroleum is now India’s third largest exports behind engineering goods and gems and jewellery. This is a clear impact of the fall in price of oil price.

How do things look if we were to take a look just at exports of non-petroleum products? Exports of non-petroleum products in November 2015 was down by 18.3% to $17.8 billion. This doesn’t look as bad as fall of 24.4% of the overall exports, but is bad nonetheless.

How are India’s other major exports doing? Engineering goods are currently India’s number one export. In the last one year they have fallen 28.6% to $4.7 billion. Gems and jewellery are India’s number two export. In the last one year they have fallen 21.5% to $2.9 billion.

A simple explanation here is that the global economy as a whole has not been doing well and that is bound to have an impact on Indian exports as well.  When other countries are not doing well, they import less and this has had an impact on Indian exports.

As Dharmakirti Joshi and Adhish Verma economists at Crisil Research write in a research note titled Exports, Hex, Vex: “Global growth recovery has been slow and uneven. In its latest world economic outlook released in October, the International Monetary Fund (IMF) downgraded its global growth forecast for 2015 to 3.1% from 3.3% earlier. The World Trade Organisation has predicted stagnant trade growth at 2.8% in 2015, which implies annual trade growth would be below 3% for the fourth consecutive year compared to over 7% in the pre-financial crisis period…This suggests global trade has fallen more than world growth, implying trade intensity of world GDP has declined – a worrying phenomenon for export-dependent economies.

But have Indian exports just because global growth and in the process global trade have slowed down? As Joshi and Verma write: “For instance, while world real GDP growth improved from 3.2% in 2009-2011 to 3.4% in 2012-2014, India’s real growth of exports came down from 11.1% to 4.1%. This suggests the decline isn’t merely cyclical; there are structural elements at play as well. The cyclical component of exports will move up when cyclical factors (world GDP growth, prices) turn favourable, but structural factors, if not addressed, will continue to act as a drag on India’s export performance. Falling competitiveness is one of the structural factors restricting export growth. For key export items such as gems & jewellery and textiles, revealed comparative advantage has come down over the years.”

So Indian exports have come down also because their competitiveness vis a vis goods from other nations has gone down over the years. It’s not just about slowing global economic growth.

How are things looking on the imports front? Imports in the month of November 2015 fell by 30.3% to $29.8 billion. This is primarily on account of a huge fall in oil imports due to plummeting oil prices. Oil imports during November 2015 fell by a whopping 45% to $6.4 billion.

If we ignore oil imports from the total imports number, how do things look? Total imports ignoring oil were down by 24.5% to 23.4 billion in November 2015 in comparison to a year earlier. In fact, if we look at non-oil non-gold imports things get interesting. Non-oil non-gold imports for the month of November 2015 have fallen by 22.1% to $19.8 billion. This number is a very good reflection of how consumer demand as well industrial demand is holding up and still hasn’t recovered. And things clearly aren’t looking good on this front.

The column originally appeared on The Daily Reckoning on Dec 21, 2015

What the media did not tell you about the economy this month

newspaperAn old adage in journalism goes: “if it bleeds, it leads”. But this doesn’t seem to apply to bad economic news. Allow me to elaborate. Let’s start with new car sales. New car sales are a reliable economic indicator which tell you whether the economy is starting to pick up.

People buy a car only when they feel certain about their job prospects. Further, once car sales pick up, sale of steel, tyres, auto-components, glass etc., also starts to pick up. New car sales have a multiplier effect and hence, are a good indicator of economic growth. At least that’s how one would look at things theoretically.

The jump in the new car sales numbers was on the front page of the Mumbai edition of the leading pink paper where it was reported that sales saw a double digit growth in November 2015. Car sales in November 2015 went by 11.4% to 2,36,664 units, in comparison to November 2014. That is indeed a good jump and does indicate at some level that the consumer sentiment is improving.

But we need to take into account the fact that Diwali this time was in November and that always pushes up car sales. The December 2015 new car sales number will be a proper indicator of whether car sales have actually recovered or not.

Now contrast this with merchandise exports (goods exports) which fell by 24.4% to $20 billion in November 2015, in comparison to the same period last year.

Over and above this, the exports have been falling for the last twelve months. This piece of news was buried in the inside pages of the Mumbai edition of the leading pink paper. Exports are a very important economic indicator. Countries which have driven their masses out of poverty have done so by having a vibrant export sector.

Getting back to car sales. It is important to ask how important car sales are in the Indian context.  As per the 2011 Census, 4.7% of the households owned cars in India. At the same time 21% of households owned two-wheelers (scooters, motorcycles and mopeds (yes, they still get made and sold).

This tells us very clearly that two-wheeler sales are a better economic indicator in the Indian context than car sales. Many more people own two-wheelers than cars. Further, many more people are likely to buy two wheelers than cars given the fact that two-wheelers are more affordable.

And how are two-wheeler sales doing? Not too well. Two wheeler sales in the month of November 2015 went up just 1.47% to 13,20,561 units, in comparison to November 2014. The motorcycle sales went up by 1.57% to 8,66,705 units. Scooter sales went up by 2.45% to 3,96,024 units. And moped sales fell by 6.16% to 57,832 units.

In fact, the increase in two-wheeler sales in November 2015 in comparison to November 2014 stood at just 19,130 units. Whereas the increase in car sales was at 24,226 units. The increase in car sales was greater than two wheeler sales. And this is indeed very surprising, given that total two wheeler sales in November 2015, were 5.6 times the car sales.

You won’t find this very important point having been made in the pink papers. What does this tell us? It tells us that a large part of India is still not comfortable making what is for them an expensive purchase. It also tells us that the consumer demand at the level of the upper middle class (for the lack of a better term), which can afford to buy a car, is much better than it is for others.

The question is why is did the business media miss out on this? A possible explanation is that most of the business media these days is run out of Delhi. And in Delhi everyone owns a car, at least that’s the impression you are likely to get if you work in the media in Delhi. So car sales are important, two wheeler sales are not. But that is really not the case even in Delhi.

As TN Ninan writes in The Turn of the Tortoise—The Challenge and Promise of India’s Future: “In Delhi, according to data collected for the 2011 Census, 20.7 per cent owned cars and 38.9 per cent owned two-wheelers…In a conscious middle-class entity like Gurgaon, neighbouring Delhi…the credit rating agency CRISIL assessed that 30 per cent of households owned cars [and] 38.9 per cent owned two-wheelers.”

Long story short—two wheeler sales are a better economic indicator than car sales. What this also tells us is that any piece of positive news will be played up and highlighted on the front page whereas any piece of negative news will be buried in the inside pages. Why does this happen? Why did the media almost bury the news of very low growth in two-wheeler sales?

Satyajit Das has an explanation for this in his terrific new book The Age of Stagnation—Why Perpetual Growth is Unattainable and the Global Economy is in Peril: “Bad news is bad for business. The media and commentariat, for the most part, accentuate the positive. Facts, they argue, are too depressing. The priority is to maintain the appearance of normality, to engender confidence.”

Also, given that a business newspaper (or for that matter any newspaper) makes money from advertisements and not the price the buyers pay to buy a newspaper, this isn’t surprising.

Of course, you dear reader, need not worry, as long as you keep reading The Daily Reckoning.

The column originally appeared on The Daily Reckoning on December 17, 2015

11 reasons why India growing at 7.4% is simply not believable

rupee

Data released by the ministry of statistics and programme implementation shows that India’s gross domestic product (GDP), a measure of the size of the economy, grew by 7.4% during the period between July to September 2015. These are fantastic numbers in a world where real economic growth is slowing down. Even China is finding it tough to grow at rates that it did in the past.

So what is driving India’s economy? Manufacturing grew by a 9.3%. Trade, hotel, transport, communication & services related to broadcasting grew by 10.6%.

And financial, insurance, real estate and professional services grew by 9.7%. These three segments which formed 62.6% of the total economy between July to September 2014, helped the economy grow by 7.4%. Agricultural, forestry and fishing grew by just 2.2%.

The question is how believable is this growth of 7.4%? The short answer is—not very. It is worth mentioning here that GDP is ultimately a theoretical construct.

Most real economic numbers suggest otherwise.

Let’s take a look at them one by one.

1) Exports have been falling eleven months in a row. In fact, between April and October 2015, exports have fallen by 17.6% to $154.29 billion, in comparison to the same period last year. Between April and October 2014, the exports had stood at $187.29 billion. A greater than 7% economic growth rate with falling exports is a little difficult to believe.

2) Corporate profitability continues to remain subdued. As a recent news-report in the Business Standard points out regarding the profitability for the period July to September 2015: “It was another muted quarter for India Inc, with aggregate profit growth at both the operating and net level growing at only under one per cent over a year-ago period. The sample is of 2,300 companies…The numbers are worse for the benchmark indices such as the Nifty, where operating and net profit are down between three-five per cent over the year-ago quarter, with aggregate numbers below expectations.”

3) Passenger vehicles sales, another good measure of economic recovery, have been subdued through most of this financial year, though there has been some recovery in October 2015, which doesn’t come under the July to September 2015 period, for which the economic growth number has been reported. Between September 2015 and September 2014, passenger vehicles sales went up by only 3.85%.

4) Motorcycle sales, a very good economic indicator in the Indian context, have fallen for most of the financial year, only to have recovered a little in October due to festival season sales. It remains to be seen whether the sales can be sustained for November 2015. Data from the Society of Indian Automobile Manufacturers (Siam) points out that motorcycle sales during the first six months of the year (April to September 2015) were down by 4.06% to 5.36 million units, in comparison to the same period last year.

5) Tractor sales have been falling for thirteen months in a row. Data from the Tractor Manufacturers Association shows that sales have fallen by 20% during the first six months of this financial year (i.e. April to September 2015). This is a clear example of weak agricultural growth.

6) The loan growth of banks continues to remain subdued. The sectoral deployment of credit data released by the Reserve Bank of India (RBI) shows that bank loans grew by 8.4% between September 2014 and September 2015. In fact, they grew by an even slower 8.1% between October 2014 and October 2015.

7) Along with this, the bad loans of banks continue to pile up. As a recent report in The Indian Express points out: “Already burdened by bad loans, 37 banks, led by public sector ones, have reported a 26.8 per cent rise in non-performing assets (NPAs) over the 12-month period ending September this year.”
The overall non-performing assets of banks as of September 2015 stood at Rs 3,36,685 crore. This was an increase of Rs 71,000 crore, according to numbers put together by credit rating firm CARE.

8) The number of stalled industrial projects went up during the period July to September 2015. As a recent research note by Morgan Stanley points out: “The stock of stalled projects climbed in the September quarter, while existing capacity is being underutilized. This has, not surprisingly, lowered interest in greenfield investments, with industrial credit loan growth stagnating in single-digits.” The bulk of the stalled projects belong to the manufacturing and infrastructure sectors. Further, there is a good anecdotal evidence to suggest that small and medium enterprises, a major source of job growth, continue to struggle.

9) The Reserve Bank of India governor Raghuram Rajan recently pointed out that factories were running 30% below capacity as of now. A research report by DBS points out that the capacity utilisation rate was at 80% in 2011-2012. This suggests a significant slack in the economy. How is manufacturing then growing by 9%, as suggested by the data released by the ministry of statistics and programme implementation?

10) The real estate sector, a major employer of people, continues to be in the doldrums, with new launches coming down and the number of unsold homes going up.

11) Further, for two years in a row India has had a deficient monsoon. In its end of season report, the India Meteorological Department (IMD), the nation’s weather forecaster, stated that rainfall over the country as a whole was 86% of its long period average (LPA). Thus years 2014 & 2015 was the fourth case of two consecutive all India deficient monsoon years during the last 115 years.”

IMD uses rainfall data for the last 50 years to come up with the long period average. If the rainfall is between 96% and 104% of the 50 year average, then it is categorised as normal. If it is between 90% and 96% of the 50 year average is categorised as below-normal. And anything below 90% is categorised as deficient.

If something has happened only four times in 115 years, there is clearly reason to worry, given that nearly half of India’s population is dependent on agriculture. Also, this has clearly slowed down consumer demand in much of rural India.

On the positive side a lot has been written on the 36% jump in indirect tax collections. This has been offered as an example of a revival in economic activity.

Nevertheless, much of this huge jump has come from the government increasing the excise duty on petrol and diesel and capturing much of the fall in oil prices. Excise duty collections have jumped by 68.6% during the course of this financial year.

In fact as a recent ministry of finance press release points out: “These collections reflect in part increase due to additional measures taken by the Government from time to time, including the excise increases on diesel and petrol, the increase in clean energy cess, the withdrawal of exemptions for motor vehicles, capital goods and consumer durables, and from June 2015, the increase in Service Tax rates from 12.36% to 14%. However, stripped of all these additional measures, indirect tax collections increased by 11.6% during April-October 2015 as compared to April-October 2014.”

As the Chief Economic Adviser Arvind Subramanian recently said in an interview: “Even if you take away all the new things, new taxes have been added, that number[indirect taxes number] is growing at a robust about 11.5 -12% and if that number is right, that means that the underlined economy is recovering.”

There are few other data points on the positive side. The commercial vehicle sales have been robust during the first six months of the financial year. At the same time consumption of petroleum products has also gone up by 8.5% between April and Septmber 2015.

While the underlying economy might be recovering, it is very difficult to believe that it is growing at 7.4%. In fact, Subramanian and Rajan suggested the same in a very roundabout sort of way in a recent joint interview to a television channel.

To conclude, once you take all the factors I have listed above into account, the economic growth (or GDP growth) number of 7.4%, doesn’t look believable at all.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

(The column was originally published on Firstpost on December 1, 2015)

Busted: The ‘biggest’ myth about Indian exports

3D chrome Dollar symbolOne of the economic theories (I don’t know what else to call it) that often gets bandied around by almost anyone who has anything to say on the Indian economy, is that India’s economy is not as dependent on exports as the Chinese economy is. Honestly, given that China and the word “exports” are almost used interchangeably these days, it sounds true as well. Nevertheless, that is clearly not the case. While this may have been true in the 1990s, the most recent data does not bear this out.

Let’s look at exports of goods and services as a proportion of the gross domestic product (GDP, a measure of the size of the economy) of both these countries. In 1995, the Chinese exports to GDP ratio had stood at 20.4% of the GDP. The Indian exports to GDP ratio was around half of that of China at 10.7% of the GDP.

In 2014, the Chinese exports to GDP ratio had stood at 22.6% of the GDP. On the other hand, the Indian exports to GDP ratio was at 23.6% of the GDP. Hence, as a proportion of the size of the economy, Indian as well as Chinese exports are at a similar level. And that is indeed very surprising. It is not something that one expects.

As Rahul Anand, Kalpana Kochhar, and Saurabh Mishra write in an IMF Working Paper titled Make in India: Which Exports Can Drive the Next Wave of Growth?: “India’s exports have been increasing since the early-1990s – both as a share of GDP and as a share of world exports. Total exports as a share of GDP have risen to almost 25 percent in 2013 from around 10 percent in 1995. Likewise, Indian goods exports as a share of world goods exports have risen, with the share almost tripling to 1.7 percent during 1995-2013. A similar trend is visible in India’s services export – the share tripling to over 3 percent of world service exports during 2000-2013.” Computer services form around 70% of India’s services exports, which forms around one third of India’s total exports.

What these data points clearly show us is that the theory that India is not dependent on strong exports for a robust economic growth, is basically wrong, as exports now amount to nearly one-fourth the size of the Indian economy.

The Indian exports have been falling for the last nine months. In August 2015, the exports were down by 20.7% to $21.3 billion. Twenty three out of 30 sectors  monitored by the ministry of commerce saw a drop in exports in August 2015, in comparison to August 2014. Exports for the period of April and August 2015 stood at $111 billion and were down by 16.2% in comparison to the same period last year. Hence, there has been a huge slowdown in exports during the course of this financial year as well.

A major reason for the same has been a fall in commodity exports. As Chetan Ahya and Upasana Chachra of Morgan Stanley write in a recent research note titled What is Driving the Sharp Fall in India’s Exports?: “Persistent downward pressure from commodity prices has undoubtedly put pressure on commodity export growth (in value terms). Indeed, commodity exports (including oil), which account for 33% of India’s total exports, have been declining since Jul-14.”

Commodity prices have been falling because of a slowdown in the Chinese economic growth. China consumes a bulk of the world’s commodities.
Not many people would know that refined petroleum oil, much of which is exported out of the state of Gujarat, forms around one fifth of India’s exports.

Hence, while India benefits immensely due to a fall in the price of oil, given that we import 80% of what we consume, there is a flip-side to it as well.
Further, in India’s case, export of services, in particular computer services, has played a major role in driving up the exports over the years. The same cannot be said about India’s manufacturing exports. As Anand, Kochar and Mishra point out: “[India’s] services exports, as a share of total exports and in terms of sophistication, are comparable to high income countries, the share of manufacturing exports and their level of overall value content are still low compared to its peers, especially in Asia.”

The reasons for this are well discussed. They include an unpredictable tax regime (which the government keeps promising to correct), complicated labour laws and land acquisition policies, inspector-raj and a shaky physical infrastructure.

And this best explains why unlike China, India’s manufacturing exports are not a major part of its goods exports. As Anand, Kochar and Mishra point out: “For example, in 2013, manufacturing exports accounted for 90 percent of total exports in China, almost double the share during 1980-85. Indian exports have also undergone transformation during the decade of high growth, though to a lesser extent compared to peer emerging markets. The share of manufacturing in total merchandise exports has increased to 57 percent in 2013 from 41 percent in 1980.”

Also, given the problems an entrepreneur faces in India, in getting a manufacturing unit going, India’s share in global goods exports may have plateaued as far back as 2012. Data from Morgan Stanley suggests that India’s good exports as a proportion world goods exports has plateaued at around 1.7%.

As Ahya and Chachra of Morgan Stanley point out: “India’s market share in exports of goods for which we have monthly data has declined marginally over the last 12 months but has remained largely flat since 2012…The structural bottlenecks in the form of inadequate infrastructure, outmoded labour laws, a cumbersome taxation structure and systems, and poor ranking in terms of overall ease of doing business are probably making it harder to make gains in market share at a time when external demand has been weak and excess capacities in competitor economies have rise.”

And this is something that cannot be set right overnight.

The column originally appeared on The Daily Reckoning on Sep 28, 2015

In theory, Rupee at 72 to dollar is the solution to CAD


Gary Dugan 4

Gary Dugan is the CIO – Asia and Middle East, RBS Wealth Division. In this freewheeling interview with Vivek Kaul he talks about the recent currency crash in Asia, where the rupee is headed to in the days to come and why you would be lucky, if you are able to find a three BHK apartment, anywhere in one of the major cities of the world, for less than $100,000.

What are your views on the current currency crash that is on in Asia?
People are trying to characterise it as something like what has happened in the past. I think it is very different. It is different in the sense that we know that emerging markets in general have improved. Their financial systems are more stronger. The government policy has been more prudent and their exposure to overseas investors in general has been well controlled. I don’t think we are going to see a 12 month or a two year problem here. However, countries such as India and Indonesia have been caught out and the money flows have brought their currencies under pressure. So, it’s a problem but not a crisis.
One school of thought coming out seems to suggest that we are going to see some version of the Asian financial crisis that happened in 1998, over the next 18 to 20 months…
I totally disagree with that. The rating agencies have looked at the Indonesian banks and they have said that these banks are well-abled to weather the problems. If you look at India, the banking system is well-abled to weather the problems. It is not as if that there is a whole set of banks about to announce significant write down of assets or lending. The only thing could go wrong is what is happening in Syria. If the oil price goes to $150 per barrel then the whole world has got a problem. The emerging market countries would have an inflation problem and that would only create an exaggeration of what we are seeing at the moment.
Where do you see the rupee going in the days to come?
There is still going to be downward pressure. I said right at the beginning of the year, and I was a little bit tongue in cheek when I said that in theory the rupee could fall to 72. At 72 to a dollar, in theory, clears the current account deficit. I never expected it to get anywhere near that, certainly in a short period of time. But some good comes out of the very substantial adjustments, because pressure on the current account starts to disappear. Already the data is reflecting that. Where the rupee should be in the longer term is a very difficult question to answer.
Lets say by the end of year…
(Laughs) I challenged our foreign exchange market experts on this and asked them what is the fair value for the rupee? I ran some numbers on the hotel prices in Mumbai, relative to other big cities, and not just New York and London, but places like Istanbul as well. India, is the cheapest place among these cities. Like the Economist’s McDonald Index, I did a hotel index, and on that you could argue that the rupee should be 20-30% higher. But, if you look at the price that you have got to pay to sort out your economic problems, it is probably that the currency is going to be closer to 70 than 60 for the balance of this year.
One argument that is often made, at least by the government officials is that because the rupee is falling our exports will start to go up. But that doesn’t seem to have happened…
It takes a while. I was actually talking to a client in Hong Kong last week and he said that warehouses in India have been emptied of flat screen TVs, and they have all been sent to Dubai because they are 20% cheaper now. It is a simple story of how the market reacts to a falling currency.
But it’s not as simple as that…
Of course. A part of the problem that India has is that the economic model has more been based on the service sector rather than manufacturing. The amount of manufactured products that become cheaper immediately and everyone says that I need more Indian products rather than Chinese products or Vietnamese products, is probably insufficient in number to give a sharp rebound immediately. Where you may see a change, even though some of the call centre managers are a little sceptical about it, is that call centres which had lost their competitive edge because of very substantial wage growth in India, will immediately get a good kicker again. It would certainly be helpful, but I would say that it normally takes three to six months to see the maximum benefit of the currency adjustment.
What are the views on the stock market?
I am just a bit sceptical that you are going to see much performance before the elections. I always say it is a relative game rather than absolute one. If all markets are doing well, then India with its adjustment will do fine. Within the BRIC countries, India falls at the bottom of the pack, in terms of relative attractiveness, just because there is a more dynamic story for some of the other countries at the moment.
One of the major negatives for the stock market in India is the fact that the private companies in India have a huge amount of dollar debt…
It is definitely a reason to worry. It’s not something I have looked at in detail. But as you were asking the question, I was just thinking that people are dragging all sorts of bad stories out. When there were bad stories before, people were just finding their way through it. And India has a wonderful way of working its way through its problems and has been doing that for many many years. Remember that these problems come to the head only if the banks call them to account. I think there will be a re-negotiation. It is not as if a very substantial part of Indian history is about to go under because someone is going to pull the plug on them.
Most of the countries that have gone from being developing countries to becoming developed countries have gone through a manufacturing revolution, which is something that is something that has been missing in India…
It is. You look at the stories from the past five years, and the waning strength of the service sector in India, in th international markets, comes out. A good example is that of call centres that have gone back to the middle of the United States from India. A part of that came through currency adjustment. You can say that maybe the rupee was overvalued at the time when this crisis hit. But it is true, in a sense, that India has got to back-fill a stronger manufacturing industry and it has got to reinforce its competitive edge in the service sector.
What is holding back the Indian service sector?
A number of structural things. I talked to some service sector companies at the beginning of the year. And one of things I was told was that I have got all my workers sitting here in this call centre, but now they cannot afford to live within two hours of commuting distance. Why did that happen? That is not about service sector. It is about the broad infrastructure and putting people at home, close to where they work. There are lot of problems to be solved.
There has been talk about the Federal Reserve going slow on money printing(or tapering as it is called) in the days to come. How do you see that going?
Everyone has got to understand that the principle of quantitative easing is to generate growth. So, if there is enough growth around they will keep tapering, even if they get it wrong by starting to taper too early. They will stop tapering if growth is slow. Secondly, number of Federal Reserve governors are worried about imprudent actions of consumers and industrialists, in terms of taking cheap money and spending it on things that they typically do not need to spend on. A good example is speculation in the housing market, something which created the problem in the first place. So they want to choke such bad behaviours. They will probably start tapering in September in a small way. The only thing that may stop it from happening is if the middle Eastern situation blows up. The US didn’t think it was going to get involved a few weeks ago. Now it is.
Isn’t this kind of ironical, that the solution to the problem of propping up the property market again, is something that caused the problem in the first place…
That’s been very typical of the United States for the last 100 years. Evertime there is a problem you ask people to use their credit cards. Or use some form of credit. And when there is an economic slowdown because of the problems of non performing loans, then you get the credit card out again. So, yeah unfortunately that is the way it is.
Why is there this tendency to go back to the same thing that causes the problem, over and over again?
It is the quickest fix. And you hope that you are going to bring about structural changes during the course of a better economic cycle. So people don’t bring the heavyweight policies in place until they have got the economy going again and sadly the only way you can get the economy going again is to just to make credit cheap and encourage people to borrow.
Inflation targeting by central banks has come in for criticism lately. The point is that because a central bank works with a certain inflation target in mind, it ends up encouraging bubbles by keeping interest rates too low for too long. What is your view on that?
These concepts were brought in when central banks thought they could control inflation. If you look at one country that dominates the world at the moment in terms of product prices and in terms of the inflation rate, it is China. Your monetary policy isn’t going to change the behaviours of China. And some of the flairs up in inflation have been as a consequence of China and therefore monetary policies have no impact. Secondly, the idea of controlling inflation, the concept worked for the 20 years of the bull market. Then we got inflation which was too low. So we have changed it all around to actually try to create inflation rather than to dampen inflation. I don’t think they know what tools they should be using. The central banks are using the same tools they used to dampen inflation, in a reverse way, in order to create it.
And that’s where the problem lies…
For nearly two to three hundred years, the world had no inflation, yet the world was kind of an alright place. We had an industrial revolution and we still had negative price increases, but that did not stop people from getting wealthy.
Many people have been shouting from the rooftops that because of all the money that has been printed and is being printed, the world is going to see a huge amount of inflation, so please go and buy gold. But that scenario hasn’t played out…
Chapter one of the economic text book is that if you create a lot of money, you have got a problem. Chapter two is that there is actually another dimension to this and that is the velocity of money. If you have lots of money and if it happens to go around the world very very slowly it doesn’t have any impact. And that has been the point. The amount of money has gone up considerably but the velocity of money has come down. To date, again in the western world, there is little sign of the velocity improving. We are seeing this in the lending numbers. Even if banks have the appetite for lending money, nobody wants to borrow. Someone’s aged 55, and the job prospects are no wage growth, and the pension is tiny, I am not sure that even if you have gave him ten credit cards, he’ll go and use any of one of them. And that is the kind of thing that is happening in Europe and to some extent in the United States.
Yes that’s true…
The only money going into housing at the moment is the money coming from the institutional market, as they speculate. If you look at students coming out of college in the United States, they have come out way down with debt. There is again no way that they are going to go and take more loans from the bank because they have already done that in order to fund their education. So I do not seeturnover of money in the Western world.
There may be no inflation in everyday life but if you look at asset inflation, it has been huge.. That’s right. People just find stores of value. Gold went up as much as it did, in its last wave. If you look at Sotheby’s and Christie’s, in the art market, they are doing extremely well. The same is true about the property market. Places which are in the middle of a jungle in Africa, there prices have gone up to $100,000 an acre. Why? There is no communication. No power lines. It is just because people have money and are seeking out assets to save that money. Also, there has been cash.If you go to Dubai, 80% of the house purchases there, are in cash. So you don’t need the banks.
Can you tell us a little more on the Africa point you just made?
I did laugh when Rwanda came to Singapore to raise money for its first ever bond issue and people were just discovering these new bond markets to invest purely because they did not know what to do with their money. So someone said that I am building, you know in a Rwanda or a Nigeria, and people just ran with their cash, buying properties and buying up land wherever the policies of the government allowed. Sri Lanka again just closed the door on foreign investors because you start to get social problems as the local community cannot afford properties to live in. It was amazing how commercial many of these property markets became, even though in the past they were totally undiscovered. And as we have seen with many of them, you take considerable risk with the legal system. The world has got repriced. I always say that if you can find a three bedroom house below a $100,000-$150,000 in a major city, you are doing well anywhere in the world today.
In Mumbai you won’t find it even for that price..
Yes, though five years ago it was true. It is impossible now.

(The interview appeared in the Forbes India magazine edition dated Oct 4, 2013)