The Indian Economy Blog

March 9, 2007

The Unknown Education Revolution in India

Filed under: Business, Education — Naveen @ 5:35 am

This is an op-ed piece of mine that appeared in the March 8th issue of Mint.

Unknown Education Revolution
There is a silent and telling revolt against the poor performance of government schools

Naveen Mandava

Walking around the hot summer streets of Sangam Vihar—Delhi’s largest slum colony sprawled over 150 acres and home to 4 lakh people—in 2005, Aditi Bhargava noticed that almost every street had a school.

These schools were often just holes in the wall or a room with a few benches populated by eager children. They were not government funded or subsidized, nor did they have world-class facilities.

These were low-budget schools, where poor parents paid small amounts extracted from their meagre wages in the hope that their children would get a good education, a promise too rarely delivered at the “free” government schools. View photographs at The photo-state of schools in an urban slum in Delhi.

Aditi’s discovery piqued my interest in this phenomenon. I realized that Sangam Vihar was not a path-breaking exception but part of a mainstream, silent and telling revolt against the poor performance of government schools.

Independent research[1] continues to report strides both in the quality and quantity across all private schools in urban and rural areas. Most people in urban areas and at least 28% of the rural population already have access to private schools. [2]

The surprise is not in the absolute number of schools, but their proliferation rate. Nearly 50% of the rural private schools accounted for in the study [3] conducted by Harvard economists Michael Kremer and Karthik Muralidharan were established after 2000, and nearly 40% of private school enrolment is in these schools.

This massive expansion of private primary schooling across India is a harbinger of the Unknown Indian Education Revolution. The survey found that more than 80% of government-school teachers send their own children to a private school. [4] When government teachers don’t trust government schools with their own children, it’s time to sit up and take notice.

So what is fuelling this extraordinary surge and what is the quality of education being imparted? The key to understanding this surge lies in the low entry barriers.

Schools need a “recognition” status so that they can issue valid “transfer certificates” to students leaving the school. But what the recognition status primarily ensures is that teachers are paid according to relatively high government salary scales.

In reality, a primary school doesn’t strictly need “recognition” from the state to start business. Also, rural schools don’t read too much into the transfer certificate. So the rural market for primary education is comparatively unregulated vis-à-vis to secondary education. This is similar to the software industry in India. The government’s light regulation of the sector helped it become an engine of growth.

It is not just the rural rich who are moving to private schools. Studies have found that a large mass of parents are shifting because of the low quality of government education, and concern for their children’s future.

Regulatory gaps and dissatisfaction with government schools are the key factors driving the demand for private schooling. There is already evidence of such a surge in Punjab [5], Haryana [6], Uttar Pradesh [7], Andhra Pradesh [8], West Bengal, Karnataka, Meghalaya and Delhi. In seven districts of Punjab, 86% of the private schools are unrecognized. [9]

A majority of these private unrecognized schools are operating outside the scope of policymakers’ radars. It is a “don’t ask, don’t tell” situation. Officials think of it as a fringe phenomenon. Consequently, these schools do not make it into any of the education statistics compiled by education departments.

Private schools benefit from being “unrecognized” because they save on labour costs. Teacher costs are the largest expense in the schooling sector. State governments easily spend 90% of their total budget on teachers. In contrast, private-school teachers are paid one-fifth to one-tenth of government salary levels and have more flexibility to innovate and improve learning outcomes. [10]

Studies carried out in India all share the common conclusion that private-school students outperform their government-school counterparts. For example, in a 2005 Delhi study [11], James Tooley found that children in low-budget unrecognized private schools did 246% better than government school children on a standardized English test, with around 80% higher average marks in mathematics and Hindi.

There are important lessons here for education policymakers in India. Education entrepreneurs need to be encouraged by removing rules that hinder the establishment and operation of schools in the primary, secondary and higher secondary areas of education. Competing schools will create choices for parents, improving access and quality for all. The government can then focus its limited education budget on the neediest sections of society.

Inadequate education in India is not only a funding problem but also a result of over-regulation of the school market. The burgeoning market of low-budget private schools has enormous potential to do public good.

Naveen Mandava is a doctoral fellow in Public Policy Analysis at the Pardee RAND Graduate School in the US. The school is part of the RAND Corporation, a non-profit research organization.

Other related and interesting studies are the following:

The regulation of private schools serving low income families in Hyderabad, India: An Austrian economic perspective
An overview of primary education in an unauthorised colony of Govindpuri, Delhi
Teacher absence in India: A snapshot


[1],[2],[3],[4],[10] : Public and private schools in rural India
[5],[9]: Elementary education in unrecognised schools in India: A study of Punjab
[6]: A study of unrecognised schools in Haryana
[7]: Private and public schooling: The Indian experience
[8]: Private schools for the poor: A case study from India
[11]: Private schools serving the poor: A study from Delhi, India

February 28, 2007

Budget 2007: The Moment Of Truth

Filed under: Business — Nandan Desai @ 9:06 am

(Click here for a live webcast of the FM’s Budget presentation - starting 11AM IST)

(Click here for live intraday SENSEX values)

Here at IEB, you (our faithful readers) can always trust us to get excited about something like the FM’s budget presentation. CNBC’s got the pretty women covering the reactions on the trading floor, old Indian Marxists are dusting off their loafers for that appearance on NDTV, and here at IEB, we libertarians are simply smirking and waiting for the bloodbath.

The circumstances couldn’t be more propitious: markets globally have crashed. China’s down 9%, Bovespa’s down 7%, the NASDAQ is down 4%. Our precious SENSEX - ever resilient to logic - had touched highs in the 14,000s, and has already come down a bit. Today, however, is a new day, and we’re about to see some fireworks.

In the next few hours, the Finance Minister will deliver the budget for the coming fiscal year. India has already been testing new (economic) limits, as we have documented on this blog - and, the FM’s address will come at a time when confidence in the committment to reforms is waning, and onion prices are starting to make people worry. Just for good measure, the Goddess Laxmi has thrown in three more obstacles: crashing global stockmarkets, a recession warning from Alan Greenspan, and sustantial electoral losses for the Congress Party in the state assemblies.

So the burning question is: will he make it worse, or help us (investors) out?

People worldwide already have the selling impulse coursing through their veins, so it would be unfair to lay blame for the market bloodbath which is sure to come, squarely at the FM’s feet. Nevertheless, one must ask: is he aware?

Does he realize that India has to keep reforming in order to open up supply-side constraints? And that the need for reform has increased, not dimished?

Does he acknowledge the need for the independence of the Central Bank? Because short term constraints have to be addressed through adept demand-management?

Most of all: does he realize how much is riding on this? This is not just about the markets and the billions of wealth which is likely to be wiped off (and probably, just as speedily, recreated). It is about reforming a broken system.

India’s population, its private sector, and its civil society have emerged; but the government has thus far lagged behind -thereby constraining the others. The moment today is about understanding how the aspirations of Indians have changed and the bar could not be set higher.

Remarkably, about 16 years ago, another man stood at a similar precipice of [economic] history and chose to follow his dreams and what he knew to be right, rather than what he thought was most expedient.

Will this Finance Minister follow in those footsteps? Will this be the “Dream Budget”?

If he doesn’t or if it isn’t, trust me: Sell.

(Click on the embedded links above for good Budget Day reads)

February 23, 2007

What Is It About Bandwidth in India?

Filed under: Business, Infrastructure — Reuben Abraham @ 11:17 pm

There is no shortage of hype about India’s superpowerdom in IT and Telecom. However, the truth seems to be far from it. Why is it that there is not a single provider out there who is capable of providing decent broadband access, for instance? The prevalent logic seems to be that the only thing that matters is price, seemingly oblivious to the fact that some consumers may be price-insensitive when it comes to fast and reliable broadband access. The U.S. is not the model to follow, but even so, you could get 3-4 MBps thoroughput at any given time for $40 a month (Rs 1800 approx). I bet there’s at least a million households in India that are willing to pay Rs 2000 a month to get decent access. I certainly would be willing to pay that much.

Instead, all you have are providers who claim to provide you high bandwidth, but then place download limits. What do you need 1 MBps for, if you can only download 1 GB worth? A single album from Itunes is about 700 MB, so what’s the point? Surely, you don’t need high bandwidth to check emails? If they give you unlimited download, they restrict your speed to 256 KBps maximum. So, what the hell are these guys thinking? Or is there some problem with the bandwidth available to each of these ISP’s? It seems to make no sense otherwise, when there is an obvious business model in price discrimination, right?

I know the available bandwidth in India today exceeds 20 TB. The question is how much of this is lit. Does anyone know? Secondly, are there any ISP’s out there that are actually providing high bandwidth residential access with unlimited downloads? I am sure lots of IEB readers would like to know, besides me.

The Multipliers. At Last.

Filed under: Business, Science and Technology, Basic Questions — Reuben Abraham @ 9:00 pm

It always intrigued me that noone, especially in academia, had bothered to do robust research on the downstream multiplier effects of the IT-ITES industry. Anyone who has looked at the industry in any seriousness knows there have to be serious multipliers involved. All of those cab drivers, construction workers, caterers etc are the multiplier at work, after all. Given the subsidies the industry enjoys, it would seem that the multipliers are probably the best public policy justification one could come up with.

Everyone has speculated about the multiplier effect, including me. This week, however, NASSCOM released the results of the first ever comprehensive study that I know of on the multipliers associated with the IT industry in India. The research itself was conducted by CRISIL and the main highlights are:

* For 1 job created in IT-ITES, 4 jobs are created in rest of the economy
* In 2005-06, maximum additional employment generated through consumption spending (2.49 million) followed by Operating expenses (2.1 million) and Capital expenditure(0.63 million)
* Re 1 spent on OPEX generates additional output of Rs 0.9 (Multiplier 1.9x). Re 1 spent on CAPEX generated additional output Re 1 (Multiplier 2x)
* Re 1 spent by IT-ITES professionals generates additional output of Rs 1.1 (Multiplier 2.1x)
* In terms of potential impact on the economy by 2010, total economic output could be as high as $120 billion, while jobs created (direct+indirect) could cross 115 million

I had a look at the methodology and it looks fairly robust as well. It includes a combination of I-O, surveys and financial statement analyses. The study, however, does not look at forward linkages (use of IT as input by others), but only backward linkages, so that leaves space for more research on multipliers.

In the meanwhile, comments?

A Brand New Model?

Filed under: Growth, Economic History — Reuben Abraham @ 7:18 pm

A lot of bandwidth has been used up to discuss what model of development India should adopt: the Chinese model, the American model, the French model etc. I myself have sucked up quite a bit of bandwidth on this issue. However, I was reading an Indian business magazine (I apologize, I cannot remember which one) recently that made an altogether different and valid point. India is, in fact, following a model that has never been tested before. According to the magazine, not once in world history has a large-sized country gone into rapid industrialization mode, while also guaranteeing universal franchise or a vote for all of its citizens. When you think about it, this claim is probably true. Forget China, think about the U.S., Soviet Union, the U.K., France, Germany etc. Not one of those countries actually industrialized while everyone had the vote. In fact, in a country like Switzerland, all cantons gave women the right to vote as late as 1991. Effectively, this means India is following an untested model and the risks associated with such a model are what stand in the way of quicker growth (the stuff we tear our hair over, on this blog).

I have never seen this observation made anyplace else, and I figured I should share it with you. What do you think? Can you think of any prominent countries that industrialized while also being a full democracy?

PS: If any of you have read the piece I am talking about, please post a link so I can make a proper attribution.

Kyrgyzstan & Zimbabwe Offer Higher ICT Opportunities Than India: ITU

Filed under: Outsourcing, Infrastructure, Miscellaneous, Science and Technology — Nitin @ 8:50 am

Wonk nirvana

The 2007 ICT Opportunity Index, the ITU explains, “has benefited from the expertise of several international and research organizations, (and) is based on a carefully selected list of indicators and methodology. It is an important tool to track the digital divide by measuring the relative difference in ICT Opportunity levels among economies and over time.”

It’s the result of some clever analytical effort:

The 2007 ICT-OI, which is the result of the merger of the ITU’s Digital Access Index (DAI) and Orbicom’s Monitoring the Digital Divide/Infostate conceptual framework has been modified since it was last published in 2005. It is an excellent example for successful international cooperation and partnership work and follows the explicit recommendation of the WSIS Plan of Action, paragraph 28, to “…develop and launch a composite ICT Development (Digital Opportunity) Index” to combine statistical indicators with analytical work on policies and their implementation. [ITU]

It does all this and comes to the conclusion that Zimbabwe, Namibia and Kyrgyzstan, among others, offer higher ICT opportunities than India. (via LIRNE Asia)

Let’s say that this conclusion is methodologically sound. What’s it good for?

February 21, 2007

On Corporate Political Resposibility

Filed under: Politics, Business, Outsourcing, Growth, Infrastructure, Media & Economics — Nitin @ 2:50 pm

Yes, the IT industry has to do more for India. But not what Amartya Sen says it should

Amartya Sen made a JFK-esque speech asking the IT industry what it had done for India. His point was not that the IT industry isn’t doing anything for the economy at large—he concedes that it is—but that it should do ‘much more’. Indeed, Sen argues, given that it has benefited from the country’s contributions to its development, the industry should have a ’sense of obligation’ to do much more.

Sen has a point. But it’s not the one he intended to make. The IT industry’s primary obligation is to its shareholders and customers. It will be doing its bit for the country as long as it does this with efficiency and excellence. This ’sense of obligation’ may not even apply to state-owned enterprises and public sector undertakings who can best serve the country by sticking to their charter than by attempting to champion various good causes. Of course, corporations, like citizens may want to do good for the society they are a part of. But they have no moral or legal obligation to do so. In a country where a communal socialist government is not only unwilling to do the needful to unshackle restrict labour laws that hurt both employers and employees but is also attempting to impose community-based quotas on private companies, the use of the word obligation must be treated with extraordinary care.

What is true is that Indian industry in general has chronically under-invested in improving the quality of governance. Industry associations like FICCI, CII, ASSOCHAM and NASSCOM have seen themselves solely as a voice of their members. In India’s political economy they are an ‘interested party’ on various issues. Furthermore, their ability to shape government policy has been limited to the extent their most influential individual members have been able to create and exploit specific loopholes that only benefit a small number of companies. Thanks in part to the license-permit raj and its legacy, large corporate houses have found it more worthwhile to invest in ‘fixers’ who could work on the concerned ministry rather than in broader initiatives that benefit the industry as a whole. Contrary to what Sen argues, NASSCOM has perhaps been more inclined to pursue a progressive industry-wide agenda than its ‘old economy’ counterparts. Furthermore, there are private commercial ventures, like those that Rajesh Jain and Atanu Dey are working on, for instance, that seek to both address a social need and turn a profit at the same time.

But where are the think-tanks, the public policy schools, the social science research endowments and sponsored professorships? To its credit, corporate India has foundations working on setting up village schools or improving rural infrastructure. While these are commendable, they are no substitutes for the industry applying sustained pressure on government to do its job well. Running village schools and improving rural infrastructure, after all, is the government’s job. The Acorn has argued in the past that the IT industry has to find its political feet. Not because it has an obligation. But because it is necessary for its own growth and development. The externalities from doing so can far more profoundly benefit the nation than from any ‘obligations’.

Cross-posted from The Acorn, where you can join the discussion on this post

February 14, 2007

Indian Politicians: Are They The Problem Or The Solution?

Filed under: Business — Nandan Desai @ 1:58 am

I had the chance to attend a lunch meeting earlier today with a handful of MPs from India who were in New York as part of the Indo-US Parliamentary Forum. The audience was a largely receptive business-minded one with questions like “what do you think about the future of real estate in India?”

All of the politicians displayed an admirable understanding of what India needs today (except for the gentleman from Jharkand, who spoke somewhat incomprehesibly). For the most part, the storylines were well-rehearsed: India is booming, the world is finally seeing India for what it is, democracy makes things move slow, etc. Throw in a joke or two, and that was enough to elicit the applause from the smallish audience. Two of the MPs however stood out in their characterizations of India, and their aspirations for what she can do and become.

The first was Robert Karshiing, MP from Meghalaya. His hope for an  ”India which understands humility” was refreshing. It reminded the others that all the glory of being received by businessmen in the Harvard Club in New York City will not change the fact that a large part of our population remains in poverty, or that health and education are nowhere near adequate. India may have ‘arrived’ for the rest of the world, but she has yet to do so for many of her citizens.

The last one to speak was Congress MP Sachin Pilot (elected to parliament in 2004 at the age of 26). He was intelligent and self-effacing. He understood that his strong belief in helping farmers may strike the audience as populism - and clearly explained why it was not. Towards the end of the meeting, an audience member asked a touchy question: “To what extent is bad governance retarding growth and poverty reduction? and what specific steps do you think Parliament can take to change that over the coming years?”

The others didn’t seem to want to take on the question. The man from Jharkhand looked genuinely perplexed. Pilot asked for the mic, and clearly iterated that he understood precisely what the concern was, and said that, even as a newcomer, he had seen a significant change in the last couple of years - with politicians gradually realizing the importance of finding common ground with regard to how to reduce poverty, and stimulate growth.

“Ultimately,” he said, “We are part of the problem… and hopefully, we can be part of the solution.”

Time will tell.

February 10, 2007

The Indian Elephant

Filed under: Business — Atanu Dey @ 5:24 pm

The Indian economy must be an elephant. At least that’s what it feels like when you read the stuff that observers are saying about it. Blind people describing what they perceive the elephant to be through their sense of touch comes closest to characterizing the quite varied descriptions of the Indian economy. Here’s Cait Murphy of Fortune advising us “India the Superpower? Think Again” (Feb 9th, 2007) and there’s Stephen Roach of Morgan Stanley telling us that “India [is] on the Move” (Feb 9th, 2007), while Niranjan Rajadhyaksha of Mint holds forth in his new book on “The Rise of India.

To get a better understanding of an elephant we have to walk around the elephant, of course, and integrate the various localized partial descriptions in our mind’s eye. Murphy is right of course that the myopic hubris which declares India to be an economic superpower is a load of nonsense. Surely, an economy that cannot even feed half its below-five children or one where around 20 percent of the people are chronically hungry is a pretty dismal one, never mind all the hot air about 8 percent GDP growth rates. He points to the 2006 Human Development Report’s ranking of countries according to health and human welfare measures, where India ranks 126th out of 177 countries. “India was only a few places ahead of rival Pakistan (134th) and hapless Cambodia (129) and behind such not-about-to-be-superpowers as Equatorial Guinea (120), and Tajikistan (122).” India failed according to that report card at least.

But that is not in fundamental conflict with Roach’s position that India is making progress. One can be quite sick and still be on the road to recovery. It’s the positive trend that should give some hope. Roach’s vantage point is the Indian corporate sector, which of late has been hitting the headlines. He says of his recent visit to India: “What blew me away were the corporate and entrepreneurial stories. For all the buzz over China, one of the great paradoxes of the world’s greatest development story is that it only has a handful of truly world-class companies. By contrast, India has a much deeper and broader stable of very powerful businesses. Moreover, it’s not just IT services - it’s also telecom, pharmaceuticals, energy, steel, and auto components.” You can not expect the chief economist of an investment bank and a global financial services company to not be a cheerleader in the game of international takeovers.

India is sick but on the road to recovery, seems to be a reasonable position. In the excerpt (linked above) of Rajadhyaksha’s book, I read that, “India will have to deal with myriad challenges in the years ahead if it is to ensure that it remains on its current growth trajectory and also if it is to help more and more of its citizens become active participants in the global economy. Five issues stand out: poverty trends, income inequality, energy, employment, and infrastructure.”

Poverty trends are positive, he notes, but he is worried about rising income inequality. It is somewhat puzzling that within a discussion of growing income inequality he cites irrelevant[1] figures on how many Indians are US dollar millionaires (~70,000) and billionaires (23). Be that as it may, he does note that more than income inequality, changes in consumption patterns matter.

I intend to read Rajadhyaksha’s book at the earliest opportunity and until then I will reserve my comments on his position. But I am disappointed that he did not include education in the list of the main challenges that India faces. Sure, both Murphy and Rajadhyaksha note the lack of adequate physical infrastructure. But Murphy mentions education also.

Like everyone else, I too have my biases. Whenever I read an analysis of India’s economy, I keep a keen eye out for the word “employment.” It is red flag to me and I feel like screaming “It’s not employment, stupid, it’s production that matters.” I can argue (and will do so at length one of these days, be warned) that it’s precisely that obsession with employment at the detriment of production that has been the primary cause of India’s dismal economy. Production is king, and the rest of the bunch of concerns including employment are at best minor functionaries.

On that note as we continue to walk around the elephant, I will conclude with the immortal words of Inspector Clouseau, “Until we meet again, and the case is sol-ved.”

Notes: [1] It would appear that the wealth of these 70,000 US dollar millionaires and 23 billionaires (lower bound around US$ 100 billion) is being implicitly compared with India’s annual GDP (around US$700 billion.) That is like comparing apples to horses. The wealth of these super-rich 70,000-odd people has to be compared (if at all) not with the income of 1 billion Indians, but rather with the wealth of 1 billion which I guess will be around US$ 20 trillion.

February 8, 2007

Why Japan Matters To India

Filed under: Business — Edward @ 8:35 pm

Well Nanubhai has certainly stirred up a storm with his overheating post. So now that the intial burst of energy has started to die-down, and the dust has begun to settle, it may be well worth sifting through the various pieces that constitute this whole debate, to try and see what exactly is at issue here, why the issues are important, and what can be learnt from the episode.

Amongst the many topics of not inconsiderable interest would be to think about what can be learnt about the whole development process from studying the Indian case, and this topic is by no means an incidental one, as there are still plenty of countries stuck back-there in the mire of poverty, and if they can learn anything from the Indian example about how economic break-out works, then apart from getting the benefits from its own growth process India can also help others to see how they too might move forward.

So this will be the first of a series of posts to try work through the issues raised, which have, of course, been accumulating fast, indeed such issues seem to be mushrooming far faster than our capacity to assimilate them has.

Today I am going to start the process off with an India-Japan comparison, in part since the India-China one so often generates more heat than light, but also in part since I want to argue that you cannot make any sense of the current ‘capacity growth’ debate in India unless you take into account what is happening in Japan, and the impact of Japanese deflation on the global liquidity situation.

I want to hammer-home here two points concrening what is new and different in the post turn of the century Indian situation, and underline the fact that the presence of these changes make all that talk about growth rates in the 1980s and the 1990s rather dated to say the least.

Firstly India now increasingly forms part of a global economy, so global factors need to be thought about much more than they were say ten years ago. The most obvious example of this is to be found in the rapid acceleration of high value services, and the migration of a lot of ICT related activity to India, a phenomenon which can’t be understood, IMHO, outside of the 1995-2000 internet boom-bust cycle in the USA.

Now the impact of these high value services has been, as many would note, rather more strategic than decisive, since they still account for only a very small share of overall GDP. Thus we could say they have been something of a catalyst to a process rather than the process itself. By the same token, it is now impossible to look at Reserve Bank of India monetary policy outside of the general global liquidity context, things just aren’t decided locally any more.

All this is only going to become even more important as India gradually incorporates in the global economy, and as the share of external trade in GDP only climbs and climbs.

So what is needed insofar as the economic debate in India is concerned is something of a change of mindset. There is a rather dated feel about many of the arguments which are being marshalled around the capacity issue, they seem to have been prepared and honed in the context of yesterday’s problems, and and as a consequence they are often found to be woefully lacking when fielded to confront the problems of today, problems which are in many ways very different from those to be found back in the decade of the 90s. Indeed I think this is precisely why the Economist article is causing so much fuss, since it may quite simply be the last gasp of a view of the world which no longer holds, a view whose closest adherents find it ever so difficult to let go of.

The second point I would want to underline in the appparent high degree of interconnectedness of so many things we are seeing here. Things have suddenly become more complex, and what appears to be a small and isolated phenomenon in one country or region may in fact turn out to have important and significant consequences elsewhere. I could cite the way in which China’s need for soy beans has fuelled a significant national grwoth spurt in Argentina or Brazil, or the way in which climatic change may be accelerated by growth and yet subsequently turn round and have a secondary unexpected impact on growth itself, but today I simply want to think about what is happening to interest rate policy in Japan, and why this is important even (or especially) for people in India.

In order to to this I would refer back to a comment by Andiron in Nanubhai’s post:

“Liquidity has reduced the deficit as payments are lesser, but the risk premium will go up dramatically. As foreign economies cool, remittances to india will dry up leading to more current account problem..(>5%)..A large portion of $ 180 bil reserves is a mouse click away from disappearing.. Lots of palapappans forget, that last 4 yrs were unusual in liquidity.. It is time to pay higher risk premia..”

Now despite the peculiar way in which this is expressed the comment does go straight to the heart of the matter. Have the last four years been unusual in liquidity terms, or can we expect more of the same? This is the issue. In fairness to them I suspect that the writers at the Economist are sort of making the same assumption that Andiron is, whilst I am certainly assuming the contrary, and this is precisely one of the big reasons I imagine that trend growth may well accelerate in India, since cheap finance will be available to make it possible. Is this in iteslf a good thing or a bad thing? Well people can argue afaiac ad infinitum on this, the problem is that it is a very probable reality, and what we need to focus on in this debate is the world we are likely to see, not the one we would like to see.

(Incidentally, I should point out that the liquidity issue is only part of the reason I go with Nanubhai, there are other reasons which I will try and explain in other posts, but the liquidity environment is one part of the picture, and an important one).

Now, OK, why is Japan important?

Japan is important due to the existence of something called the “carry trade”. So just what is the carry trade? Well simply put the carry trade is a phenomenon which is based on the existence of substantial interest rate differentials between countries (with a secondary driver being the anticipated direction of future currency movements). Japan has become an important focus in this trade due to the existence over long periods of time of zero or near-zero interest rates. So if you want to borrow money in a country like India with interest rates significantly above zero, and if you anticipate that over the appropriate time horizon the value of the rupee is going to rise relative to the value of the yen (which given the large anticipated economic growth differential between these two economies seems a reasonable enough assumption) then it makes a lot of economic sense to borrow in Japan and spend in India. The net result of this is that development in India becomes cheaper than it would have been, since the cost of capital - or the so-called risk element - goes down.

Now applying normal Econ 101 type market reasoning to this situation you might imagine that the result of this process would be that interest rates in India would go down and those in Japan would go up, based on the increased availabilty-of and demand-for funds. Well if you thought this you would be half right and half wrong. Long term rates in India will of course be pulled down by this process, and this will give a lot of headaches to people over at the RBI in implementing monetary policy since their ability to control both rates and the money supply will be affected. But interest rates in Japan will not necessarily be affected at all, since Japan has long been caught in a rather strange and unique situation known as a liquidity trap. Now the easiest way of describing the problem is to say that the Bank of Japan has created a kind of monetary black hole (via a policy known as quantitative easing) and what this means effectively is that the more quickly the bank throws money into the economy the more quickly it disappears, without - and this is the key point - having any noteable impact on the country’s inflation rate (Japan has been struggling since the early 90s with a phenomenon know as deflation). As a consequence interest rates in Japan do not move up, so the two country mini-market model (Japan-India) process descibed above simply does not equilibrate, and Japan acts as a kind of negative attractor (deliberately using a term from chaos theory) for interest rates, gradually sucking in the rest.

Well, it isn’t all quite as simple as this, but I imagine you may be getting the picture.

So just how important is the yen carry trade?

Well as the ever excellent Brad Setser points out (citing the FTs Gillian Tett) no-one really knows, but the number might be anything up to a trillion dollars. This number is almost certainly rather on the high side, but that being said, there is a very, very large quantity of money going the rounds here. As Gillian Tett says:

Just how large the carry trade is, nobody really knows … But whatever the precise number, what is clear is that carry trades have been fuelling the dash into risky assets in the past couple of years.

After all, with Japanese interest rates at rock bottom and the yen on a downward path, it has been frighteningly easy for any hedge fund to borrow in yen, invest in something yielding, say, 5 per cent a year, apply a bit of leverage and – hey presto – produce returns of 20 per cent, or more. Conversely, if an investment bank wants to create a collateralised debt obligation but cannot sell the riskiest debt tranche, it can put this on its own books – funded by ultra cheap yen. The yen has thus been tantamount to the ATM of the global credit world – spewing out (almost) free cash.

Given this you can understand just how much the leaders of the G7 would like the Bank of Japan to start raising rates, and how much this is going to be talked about this weekend in Essen. And much as I hate to have to disagree with Anantha Nageswaran, I take the view that the world’s central bankers haven’t stopped trying to intervene in market processes over the last twelve months, by forcing up interest rates to what they call normalised rates. In the case of the EUs ECB they have only met with moderate results in their crusade (and with potentially worrying consequences as we may be about to see in Germany), and in the case of Japan the most that they have been able to extract is one quarter point raise. And according to Bank of Japan policy board member Hidehiko Haru, gioven that internal consumption in Japan is congenitally weak and that there’s no imminent threat that rising prices will cripple economic growth (indeed there’s every danger of falling back into deflation) then there’s no hurry to start raising rates again any time soon.

Also, of course, it isn’t only from Japan itself that the carry trade is at work. Andy Mukherjee in an interesting Bloomberg column recently drew attention to the possibility that people might like to borrow in yuan to buy rupees. The rationale for this may seem strange, but Andy explains it like this:

According to the ABN Amro economists, the appreciation in the Chinese currency is already in the price: Forward traders expect the yuan to rise about 5 percent against the U.S. dollar in one year. The risk of a sudden, large revaluation, from its current level of about 7.78 to the dollar, is low.Even if you agree with this assessment, how do you borrow yuan to buy rupees, beating capital controls in both China and India? The offshore forward markets may offer a solution.”

“The implied interest rate on borrowing yuan for one year, according to my Bloomberg, is just 0.15 percent in the non- deliverable, offshore forward market where trades are settled in U.S. dollars. That compares with an inter-bank rate of 0.63 percent on borrowing Japanese yen.
One-year non-deliverable forward contracts on the Indian rupee currently offer implied interest rates of 7.93 percent. There is, thus, a neat 7.8 percent interest-rate differential — or “positive carry'’ — to be pocketed from selling yuan forward (against the dollar) and buying rupees forward (against the dollar).

But back to our main topic: just why is it that Japan is finding it so difficult to raise rates and bring an end to the yen carry trade? Well here’s the rub, at least if you are a writer at the Economist it is, since the underlying issue is a demographic one, but not this time the demographic dividend which India is just begining to benefit from at this point, and which they seem to want to attempt to trivialise so much, but rather the demographic penalty of an ageing society which is busying diverting resources away from consumption and towards saving. And what do you think our dear friends at the Economist have to say about all of this? That Japan is underheating? Not at all: Japan’s recovery is going from strength to strength. Talk about the world turned upside down.

Footnote: some good background explanation into the real ongoing difficulties Japan has in raising domestic consumption and interest rates can be found in these two posts (and here) from Claus Vistesen.

February 6, 2007

To Market, To Market

Some interesting commentary in the papers this week:

Anantha Nageswaran’s opening salvo, in the newly launched Mint:

Central bankers in most of the developed world have taken that to heart in dealing with financial markets. Financial markets, in theory, have more participants than those engaged in the economic marketplace. Hence, the outcomes of their buying and selling decisions—as reflected in asset prices— should be more superior to the judgement of a few men sitting around the table in an austere government building, deciding whether financial markets are in a bubble or not…

To reiterate, the reason central bankers hesitate to intervene when asset prices keep climbing is that they find it unreasonable that a few men could overrule the judgement of hundreds and thousands of market participants. Perhaps, the real reason is that it is also politically unpopular to throw sands under the wheels of asset markets. In any case, it is hard to say whether asset prices were in a bubble or were discounting rational optimism (an oxymoron?) until after the fact. Precisely such a debate is under way in India right now. The all-important question is whether the Sensex, at over 14,000 points, is a product of global liquidity or is a rational reflection of the current and prospective high-economic growth in the country.[Mint]

And an editorial in the Business Standard arguing against the call for a ban on futures trading on some agricultural commodities (via Ajay Shah):

The deeper reason why futures trading is extremely important lies in a strategic sense of Indian agriculture. Where is India going on the terrible distortions of the agricultural sector? Is India ever going to move away from the knee-jerk responses of hurting milk farmers one day by banning milk export, and then trying to set up a minimum support price for milk because milk farmers are unhappy? If India is going to make progress towards a well-functioning agricultural sector, then there is no question that futures trading belongs in it. Futures trading is as much a part of modern agriculture as fertilisers, drip irrigation and bio-technology. [Business Standard]

February 2, 2007

An Overheated Debate About India Overheating

Filed under: Business — Nandan Desai @ 9:33 am

Economist Cover.jpg

I didn’t know whether to laugh or cry when I saw the cover of the new issue of the Economist. The tiger’s face is hilariously confused, his tail is on fire; the Indian economy is overheated. Game, Set, Match.

Regular IEB readers have seen Edward, myself, and others question the premise of these judgments, and we have had some lively discussions. Clearly, there is opinion on all sides here, and it is based on sound observation and analysis. On the one hand, inflation and credit have accelerated way too fast, and reforms have seemingly slowed. On the other hand, productivity has accelerated, there is finally a glimmer of hope that some half-decent infrastructure may be built, and the ambitions of the Indian private sector are rapidly expanding. Economic opinion has split into two general camps: “the raging bulls and the raging bears.”

In its lead article, the Economist challenges two big notions that have been raised on IEB: one is the idea of the demographic dividend, and the other is the idea that Indian productivity has seen a step-function increase in the early part of this decade. “Many Indian economic commentators say that further structural reforms, though desirable, are not essential to keep the economy growing at 8% or more because of the “demographic dividend”.” Even our own Edward Hugh, perhaps the biggest proponent of India’s demographic dividend that I have come across, probably would not sign on to this. As I have repeatedly stressed here, the Economist is making a political judgment: ‘reforms are essential; and the government (and the, ahem, optimistic economic commentators) don’t realize this.’

“Yes, the economic reforms of the early 1990s spurred competition, forced firms to become more productive and boosted India’s trend—or sustainable—rate of growth. But the problem is that this new speed limit is almost certainly lower than the government’s one. Historic data would suggest a figure not much above 7%—well below China’s 9-10%.”

The comparison with China seems apt - inflation is low, their growth and productivity is higher, and their leadership knows what needs to be done. Not so for India. It is compelling narrative, but it misses the point. In fact, the defining feature of India’s growth over the last 15 years, and the last 4 years in particular, has been the wholesale move away from the command-and-control economy. The Chinese economy, by contrast, still functions at the behest of the Communist Party leadership - if they want to stop migration to the cities, they can; if they want to stop real estate construction, they can; if they want to build a dam…

India, meanwhile, has mostly been powered by individual initiative. Embedded in the Economist’s forecast for trend growth is a 30%-40% deceleration in total factor productivity - from a rate of 5%pa over the last 4 years, to about 3%-3.5% in the next five. Unlike the analysts at Goldman Sachs, they believe that the recent acceleration has been cyclical and not a structural up-shift. The Government of India is on the other end, believing that the recent acceleration can be sustained. Part of me is sympathetic to the Economist’s hand-wringing - no one wants our bloated government to get complacent. But it is disingenuous to extrapolate that a hard landing is imminent - because of this lack of confidence. (The Economist’s in-house data bank, the Economist Intelligence Unit, has made estimates of TFPG which are far more optimistic. Click here to see them in Google Spreadsheets)

“India’s demographic structure is indeed starting to look more like that in East Asia when its growth took off. But this mechanistic view of growth assumes that demography is destiny and that economic policies do not matter.” 

Demographics is not destiny - the economy has to be able to accomodate the increased workforce if the benefits of the DD are ever to be realized. But basic economics still hasn’t changed that much. Unlike in China, the domestic private sector is a very powerful force in India. They are hiring fast, and others are investing in private schools, colleges and training institutes. India’s civil society in the yin to the private sector’s yang - the NGOs, the social entrepreneurs, and the public-private types are probably more vibrant and active in India than anywhere else on the planet. In China, these people are mostly in prison. It is also worth repeating that, because we are a democracy, the voice of these masses actually has the potential to echo in the halls of government.

One example of this is the case of our beloved Railways Minister (now the subject of an upcoming Harvard Business School case study), who made Indian Railways the only profitable government rail system in the world - with an operating profit around $2 billion. And other examples abound. Hampered by the communists, reforms have been rather stealthy of late, but nevertheless substantial. The privatization of the airports was no small task, nor was the freeing up of civil aviation and the resultant boom. Tariffs are inching down, freeing up high-end exporting industries. A damn big highway system is being built, Delhi has a shiny new subway system, and Mumbai is set to get its own. Other big, ambitious infrastructure projects have been greenlighted - and, contrary to the Economist’s claims, private investors are starting to snap up these opportunities, now that the easy money (resulting from falling interest rates) has already been made - capex is the in thing.

With tacit approval from the government, the private sector has also brought us to the cusp of a revolution in the retail industry. Distribution, logistical, and back-end infrastructure is barely there in India - and thanks to massive investments on the part of the Wal-Mart’s and pretty much every big corporate house in India - this picture might change within the near future. (It is worth mentioning that, in most large countries, the retail industry is the largest employer).

Other, more ambitious structural reforms (like the loosening of labor laws) await - and once our leadership is endowed with the political capital to make them happen, they will. The budget presentation at the end of this month will be a defining moment, and time will tell how the “Dream Team” will seize the opportunity. Over the horizon, another such moment awaits. In 2009 (or perhaps earlier), Indian voters will render a verdict on high growth - decide whether or not they want it to continue, and empower those they think can best get them there. It sounds a bit idealistic, I know - but stranger things have happened. Amidst massive economic change, the politics of the day have to change as well. The MLAs and the MPs may drag their feet, but my guess is that the private sector, the NGOs, and masses who want to get out of poverty will gradually show them the way, as they did with Lalu.

I don’t normally consider myself an economic nationalist - but there is something in the Economist’s words which hearkens back to how Wall Street viewed East Asia before the crisis, or how the IMF prodded Argentina in the early part of this decade. Fortunately, unlike those two cases, the Economist (as far as I know) does not have the resources to carry out a run on the country’s equity market and currency. There is a part of me which can’t resist believing that this is another case of West misunderstanding East - but, until recently, the Economist has not always been prone to such error. It is not often that the magazine issues such a categorical denunciation of a country’s stated economic aspirations and prospects without so much as acknowledging the (fairly prominent and obvious) long-term trends.

Still, I must say, the cartoon tiger is hilarious.

January 31, 2007

India Still Overheating?

Filed under: Business — Edward @ 4:33 pm

The Financial Times has an article today which draws attention to the preoccupations they have over at the Reserve Bank of India that the Indian economy might be overheating:

The Reserve Bank of India raised the repo rate by 25 basis points to 7.5 per cent and doubled bank provisioning requirements for loans for real estate, credit cards, stock market purchases and personal expenditures to 2.0 per cent. It said: “Demand pressures appear to have intensified, reflected in rising inflation, high money and credit growth, elevated asset prices, strains on capacity utilisation, some indications of wage pressures and widening of the trade deficit.”

Now what follows here represents something more like working notes than a regular post, since the issue is so complex, and even those of us who are economists are pretty perplexed at this point, so please don’t expect any kind of authoritative assessment right now from anyone. The first step to knowledge, however, is recognizing that there is something which you don’t know, so here goes.

I think there are two necessary points of departure here:

1/ The Indian phenomenon is a huge one. India will quite simply become the biggest developed economy ever (the only real debate is about when), and since India is the planet’s most populace country, and global population sometime later this century will start to turn south, India will become a unique phenomenon, there will never be the like of this again. This is of course what leads to all those China comparisons, and Nanubhai is currently working something up on this angle.

2/ The global context. Quite simply it is impossible to look at what is happening in India at simply the country level. In particular getting hold of trends in global liquidity is going to be vital for understanding what happens next in India, and what is sustainable and what is not. With this in mind (here comes the plug) some of us have recently started a global economics blog (Global Economy Matters) and in some ways this offers a complementary perspective to the one we have here on IEB, since the focus of the new blog is the contextualisation of local economic phenomena in terms of global trends. Another good reason to bookmark the blog might be that four of the contributors are Indian (Nanubhai, Artim, Arjun and Venkat) and beyond the issue of the blog I feel this representation is only a realistic reflection of the vast economics talent which there is knocking around in India. This may seem a detail, but arguably good economists are a scarce commodity, and evidently India is comparatively rich in this scarce commodity, so my feeling is that the rest of the world had better watch out :)

Incidentally, it is strange how people sometimes note data points like this, but seem unable to join up the dots sufficiently to be able to think clearly about what the implications of this might be - IT engineers, writers, economists……

So returning to the main topic to hand, I had a brief post on GEM yesterday where I took a quick look at the arguments which Deepak Parekh has been advancing across various media outlets of late. He seems to think that there is a significant danger of an imminent correction coming in India, and I tend to doubt this, but one of the reasons I doubt it is a strange one, since I tend to doubt the imminence of any generalized correction in India for the simple reason that Japan is unable to raise interest rates. Now why should this matter? Well it matters due to the existence of what is known as the ‘carry trade’, where people borrow money in countries with ultra-low interest rates like Japan or Switzerland, and then invest the funds borrowed in financial instruments which pay a higher rate of return, like US treasuries or emerging market debt. So the big news from Japan this month has been that the carry trade show is set to go on and on, and this means that funds will be available to India more cheaply and in greater volume than might have been previously expected. The G7 central bankers are of course seething about this, since they would like to ‘normalize’ interest rates, and eliminate the carry trade. Some indication of the problems all this is causing has been observed recently in Thailand, and Eddie Lee has a go at putting this in some sort of perspective here.

So the debate really is, how fast can India grow without precipitating excess inflation? Well, as I am saying, the funding is going to be there, and the labour is certainly there, maybe the big constraint is the resource one, namely the pressure that India’s (and China’s etc) rapid growth puts on oil and other commodity prices.

Of course there are other elements, like the bottleneck in highly skilled, highly educated workers for the high value services sector. But this may not be the bind it seems to be, if India now moves - as I feel sure it must - away from a middle class consumption driven model, and towards and investment driven export-oriented one (how else do you imagine the trade deficit is ever going to correct?). The difficulty here lies in India’s poor urban infrastructure which is surely going to do more than simply creak at the edges if this whole process opens up the internal migration floodgates. But that topic, like so many other touched on here, will simply have to await a subsequent post, as will the Economist’s somewhat dubious use of the productivity data, which either Nanubhai or I will explicitly address in the very imminent future.

January 23, 2007

A Brief Introduction To RISC — Rural Infrastructure & Services Commons

Filed under: Infrastructure — Atanu Dey @ 5:44 pm

I had been pondering about India’s rural development for a while before I signed up as a Reuters Fellow at Stanford University in Sept 2001. Later, Vinod Khosla and I co-authored the concept paper. This is a short version introducing the why, what, how of RISC. There is a distinct possibility that RISC may be piloted some time soon somewhere in south India.


India’s economic growth and development is predicated to a large extent upon the development of its 700-million strong rural population. Currently, the majority of India’s population lives in about 600,000 small villages and are engaged primarily in agriculture and related activities. Since a very large labor force in agriculture necessarily implies very low per capita incomes, a substantial portion of India’s current agricultural labour force has to move to non-agriculture sectors for incomes in all sectors to go up. The challenge is to manage the transition of a large segment – perhaps even 80 percent – of the rural population from a village-centric agricultural-based economy to a city-centric non-agricultural economy, and do so in a reasonable period.

January 18, 2007

Hutch-Essar: The Coming-Of-Age Of Private Equity In India

Filed under: Business — Nandan Desai @ 10:56 am

Sometime in the next month or so, the battle for control of India’s fourth largest mobile phone operator (third largest privately-owned), Hutchison-Essar, will truly begin - with the opening bids coming in. At this stage, the details are a bit murky to say the least. What we do know is that the company will be valued around $18 billion (double of what it was in June 2006 when the Hindujas sold their 5% stake). We also know that the battle will involve a fascinating cast of characters competing against and co-opting each other. They include:

  • Li Ka-shing: a Hong Kong tycoon who owns 67% of the company – he has indicated that he wants to sell his stake
  • Anil Ambani: owner of Reliance Communications, India’s second largest mobile operator – a successful bid would allow him to topple Sunil Mittal as the market leader
  • Arun Sarin: CEO of Vodafone, the world’s largest mobile operator (by revenues) – he needs Hutch to satisfy shareholders who want to see a strategy for growth
  • The Ruia family: owners of the steel and oil-refining Essar Group and the remaining 33% of Hutch – they have not decided whether to exit along with Li, hold, or try to buy out Li’s stake. They (claim they) have the right to refuse another investor from buying Li’s Hutch-Essar stake.
  • Orascom: Egyptian telecom company which owns ~20% of Li’s Hutch Telecom (not Hutch-Essar). If Reliance, Vodafone, and/or the PE firms encounter resistance from the Ruia’s and decide to buy in to the parent company, Orascom (claims it) has right of refusal.
  • The Hinduja family: definitely the long-shot here – they may try to make a play for Li’s stake
  • Palaniappan Chidambaram: If Essar decides to sell its stake along with Li, then any foreign player will need a local partner – foreign ownership in telecoms is capped at 74%

Increasingly, it looks like this will turn into a battle with Vodafone on one side, and Reliance on the other. Orascom, the Ruia’s, and possibly the Hindujas will try to play the spoilers. Vodafone’s Sarin was in India this past week for a round of meetings with the finance minister and the various executives involved in the deal. Not to be outdone, Ambani made his own trip to North Block, no doubt urging Chidambaram to (wink, wink) help keep the company primarily in Indian hands. Of course, neither Reliance nor Essar have the financial muscle to make a bid that large on their own – so they, in turn, are wooing cash-rich and deal-hungry private equity players including Blackstone, KKR, The Carlyle Group, and others to come on board as partners. Whether or not one or more of these players are eventually involved, this deal will represent a significant turning point in Indian finance – for the private equity industry; and more importantly, in the market for corporate control.

(Click to see coverage of deal)

Unlike retail and institutional investors; hedge funds and mutual funds; and other asset managers – private equity firms are known primarily for being active investors. In most cases, these firms buy a large enough chunk of a company to be able to influence management and long-term strategy decisions – usually through directorships. In some cases, the firms seek outright majority control in order to give them the power to replace the management team altogether. Due to the large size of the deals, the investment decisions are usually predicated on an agreed-upon strategy for aggressive growth. Historically, large and established private equity firms have been able to consistently beat market returns – often by large margins – primarily because of this activist investment philosophy (as well as their ability to mobilize large amounts of cheap debt financing).

Private equity firms first came on the Indian radar screen in the mid 1990s. In the ensuing years, some got carried away in tech mania, others made bets on the promise of regulatory change, and some others simply tried to get their footing. With some notable exceptions, the deals were relatively small and foreign interest was minimal. That was, of course, until a US investor sold their $300 million stake in Sunil Mittal’s Bharti-Airtel for an amazing $1.9 billion. Though the returns were certainly a magnificent advertisement for investment in India, another more subtle fact aroused the fancy of the other foreign private equity majors. A majority of the sale was done through three large half-billion dollar block trades – which were almost perfectly absorbed by the capital markets. Finally, they had an ‘exit-strategy’!

A host of big spenders like Blackstone, Carlyle, TPG, and others committed to India in no uncertain terms – poaching away talent, and opening their own big, shiny offices at Nariman Point, Mumbai. The next stage, still ongoing, is the vigorous hunt for good investments. In looking for deals which can satisfy their hunger for returns, western private equity players have found their traditional investment model challenged by three central facts about the current Indian corporate world:

  1. A hunger for financing so that they can take advantage of the massive growth in opportunities – both in India and abroad.
  2. An equal revulsion toward ceding any corporate control to the investor – either because the company is family owned, or simply because the owner is worried about the prospect of challenges to his power
  3. A comparative lack of debt financing in most Indian companies. (This should be a plus because it means that the large companies can absorb a good deal of debt – thus bolstering the investor’s returns.)

In the countries where the industry is most vibrant, private equity serves a critical economic function: it acts as a powerful force that aligns management’s interests with those of shareholders. It challenges the notion of the almighty CEO or chairman by acting as a check on their power, and benchmarking their performance. Ideally, corporate governance improves, profits grow faster, and operations are more efficient [see comment 1]. This is contingent on the ability of these firms to buy a large enough stake to gain control and be able to influence management in the first place.

Foreign PE firms in India have not quite gotten to this stage yet. Till date, with few exceptions, private equity deals have been financed mostly with equity; and rarely is the investor given anything close to majority control [see comment 2]. Indian CEOs want these firms as ‘partners’ – though not the type that can tell them how best to run their business. However, as the industry matures, and the honchos of the Indian business world move on to these PE firms, this reality is slowly changing and the market for control of India’s most-promising businesses is rapidly expanding. This is most clearly represented by the potential Hutch deal – where a 67% stake is up for grabs.

An expanding market for control is in the best interests of the shareholders of these Indian companies. More importantly, it is in the best interests of the broader economy. As private equity (both domestic and foreign) expands, there will be an increasing premium attached to good management. Growth will be generously rewarded by the market; and disappointing performance will be punished.

Despite this seemingly cold calculus towards management, private equity and venture capital firms are a lot more patient than most other classes of investors. This is because when big-ticket asset managers (like pension funds, oil sheikhs, and university endowments) plow their money into private equity funds, they essentially lock-it in at the sole discretion of the fund’s managers. This gives the manager the flexibility to negotiate long-term strategy with the management teams on potential investee companies, and it gives management the confidence that the investor will not pull out at the hint of trouble; or simply to create liquidity.

Over the coming months, it will be interesting to see what happens with the Hutch-Essar deal. It will represent a significant turning point in the evolution of private equity in India which began about a decade ago.

Will the Ruia’s – who have plainly admitted that their existing business (steel and oil refining) has no overlap with Hutch’s – relent in the face of Reliance Communications and Vodafone (and possibly Orascom), who both have more domain knowledge, financial muscle, and are hungrier (my guess) for market share in the world’s fastest growing mobile market?

What will the entrance of cash-rich private equity firms mean: will they use their international connections to out-maneuver, or will they pay a hefty price to buyout the assorted ‘Rights of First Refusal’?

Or, will babudom prevail – neatly condemning the fate of the deal to the courts?

January 6, 2007

Introducing Commodity Futures Markets In India

Filed under: Politics, Regulatory reforms, Growth, Agriculture — Nitin @ 4:46 pm

Setting up a commodity futures market is the first attempt to reform agriculture

Why have reforms not improved the lot of the Indian farmer as much as it has improved, say, the lot of an educated city dweller? One blogger (can’t remember exactly who) made the point very succinctly. Well, because there has been no ‘reform’ in agriculture.

There’s one waiting though. According to PRS Legislative Research, a bill to allow futures trading in commodities, introduced in March 2006, is in parliament. The Acorn has advocated futures markets as a means by which farmers can mitigate some of their risks. Ila Patnaik’s op-ed in the Indian Express suggests that the trading families that have traditionally dominated rural spot markets are attempting to throw a spanner in the works.

In some ways, there is nothing more innocent than futures trading. In a spot market, the buyer and seller agree to do trade at a certain price, and the settlement is done on the spot. In the futures market, the price is agreed upon, but the settlement takes place at a prespecified future date. The classic application involves a farmer who is planting in June and wants certainty about the price at which his goods will be sold at Dussehra. Nobody forces a farmer to use the commodity futures market, but a farmer who chooses to use the futures market in this fashion is happier because of greater certainty.

Normally traders in a region surrounding a town would be the major players in purchase of the product of this region. This trade would typically be dominated by 10 or 20 families. These families would often determine purchase prices. Farmers would have little choice vis a vis the price at which they can sell; indeed farmers might not even know prices elsewhere in the country.

The futures market is a powerful tool for breaking the market power of these families. Futures trading — taking place on a transparent, electronic exchange with nationwide access — brings in a host of new players. Indeed, there are hundreds of people in India who are watching world markets, processing information, and putting trades onto overseas commodity futures markets. Physical proximity to the market becomes a non-issue once an electronic exchange is in operation. Someone in Orissa can be trading guar seed, even though he may have never been to Bikaner which is the traditional trading centre for guar. [IE]

There are umpteen parties and politicians who profess to champion the cause of farmers. The passage of this bill will be a test to their claims.

India’s New Year Resolution: Move Beyond Left And Right

Filed under: Politics — Nandan Desai @ 12:25 pm

India is a land full of ideologues – which according to my definition, describes someone who is so committed to their principles that they treat facts which challenge their ideology with utter contempt. Ideologues, of course, come in all shapes and sizes: we have our commies and our market fundamentalists; liberals and conservatives; Hindu nationalists and Naxalites; the right wing hawks and the left wing doves; the libertarians and the bureaucratic babus; the localists, the nationalists, and the globalists; and a bunch of others who defy definition and convention. In fact, there are probably few Indians (including myself and the others at IEB) who could credibly argue that they are not ideologues. As Amartya Sen so astutely observed, arguing about our beliefs (sometimes blindly) is basically part of our blood.

The only problem is that our discordant national discourse is not genetic – it is a direct function of our collective desire for a better India. It is also a reflection of the freedoms we enjoy and jealously guard. It has been argued by some that there is nothing which unites India aside from territory and cricket. And as political scientists like to remind us, democracy only works when there are some set of fundamentally shared beliefs and aspirations.

In India, ideologues dominate the political landscape (notwithstanding our current PM), and the endless bickering between the extremes has the perverse effect of creating a seeming absence of any sense of shared values. Indeed, for democracy to be able to move a society forward, there has to be a basic direction that all sides agree on – and the argument ought to be about the best way to get there.

Shared values and aspirations are of course closely tied to the relative size of the middle class. A growing middle class shifts the balance of politics – because leaders are then compelled to work in the interests of a larger share of constituents – mostly in order to keep their jobs. The direction of economic policy becomes easier to sustain as more and more people’s fortunes get intertwined with it.

Therein lies the challenge for both India’s economic ‘left’ and ‘right’. For those who believe in the virtue of the free market and the necessity of further structural reform, the challenge lies in ensuring that the gains go to the middle and the bottom, and not just the top – it is both a moral and a practical imperative. Similarly for the left, the challenge is to articulate an economic direction for the Republic. Is the goal simply to remain reactionaries – trying endlessly to dampen the excesses of the market? Or is it more practical – to use the market as a means to end poverty and want?

Unless these two seemingly irreconcilable views can coalesce, we may be destined for perpetual political gridlock. We will be resigned to the unfortunate position of being a nation of ideologues, without any ideology.

January 2, 2007

What Happened To Government Reform?

Filed under: Politics, Regulatory reforms, Infrastructure — Nitin @ 3:35 pm

TCA Srinivasa-Raghavan puts Prime Minister Manmohan Singh in the dock:

It is also useful to dwell on the imperatives that have been at work. Basically, the public and private thing, for instance in infrastructure, is the result of bad governance. The governments transfer the little money they collect from the cities to the countryside because the votes are there. The cities suffer. The government doesn’t have the money to improve things, so they turn to the private sector, which makes the investments and hopes to earn a profit.

In a sense, then, the surplus that should have accrued to the government goes to the private sector. In due course, this means the government will have even less to transfer from the cities to the countryside. Not just that either, because even the little that is transferred out will end up in the pockets of politicians and bureaucrats.

This is what has been happening till now and that is why we need good government. This is what makes Dr Singh’s strategy so vexing, especially when he talks of the need for government reform, if only to deliver public services better. [Business Standard]

December 20, 2006

Upcoming IIT Hoopla In Mumbai

Filed under: Education — Atanu Dey @ 6:15 pm

The American Heritage dictionary defines “hoopla” as

1. Boisterous, jovial commotion or excitement.
2. Extravagant publicity: The new sedan was introduced to the public with much hoopla.
3. Talk intended to mislead or confuse.

Reading about the PanIIT 2006 brought that word to mind.

There will be much posturing and congratulatory mutual back-slapping in Mumbai for three days starting Dec 23rd at the Bandra-Kurla Complex. I will be there to witness the spectacle and for which I have paid my Rs 2,500.

Ram Kelkar, a Chicago-based investment professional and a Director of the IIT Bombay Heritage Fund, wrote a pretty balanced piece called “IITians, Do something for Indian Education.” His assessment is not rosy:

The state of the IITs and higher education in India in general is dismal. One has to remember that by selecting youngsters from the top 3,000 to 4,000 rank holders in a nation of a billion, it is inevitable that IITians will do well, regardless of whether the IITs add any value or not. But has the quality of research, the quantity of publications, and the depth of the faculty reached anywhere close to the calibre of the MITs and Stanfords of the world? Without taking anything away from the many wonderful and dedicated professors and faculty members at the IITs, I am afraid the answer is that the IITs are not even close.

He concludes with

Indians and IITians should shun hubris which contrasts with the sharp focus of China, South Korea and other nations, who are spending less time on self-congratulation and focusing on building truly world-class universities.

While it is wonderful to have events like the upcoming PanIIT 2006 in Mumbai, the focus at these events should be less on rah-rah backslapping and more on identifying the shortcomings of the IITs and the Indian educational system. IITians should be pressuring the Indian government, industry and alumni to provide the funding and resources needed to make the IITs into genuine peers of the MITs and Stanfords of the world.

Even more importantly, India needs to support and fund excellence in many more Indian universities, and not all of them need to be renamed as IITs. CalTech and Stanford did not become well-known by calling themselves the MITs of the West Coast.

Rather than hype the IIT brand ad nauseam, India should build BITS, the NITs, Pune University’s CoE, Delhi Engineering College and dozens of other Indian universities into centers of excellence in research and teaching.

With some luck, there will come a day when the IITs will become truly world-class. And they will no longer be the only globally branded university from India. Until then, Deng Xiao Ping’s advice to Tao guang yang hui is worth remembering.

Ping’s advice? “Hide brightness, nourish obscurity.” Yeah, that will be the day!

December 19, 2006

The Indian Productivity Miracle

Filed under: Fiscal policy, Capital markets, Labour market, Business, Growth, Economic History — Nandan Desai @ 2:00 pm

Back in the late 1990s, economists were trying to figure out what it was that led to the secular acceleration of economic growth in the United States: the longest and largest peace-time economic expansion in the 20th century (see footnotes). How was it that a country could grow so much and for so long without causing inflation and overcapacity? Was the business cycle dead?

Clearly not: the financial crash that followed was swift and brutal – making investment bankers’ Christmases depressing for all of two years. Indeed, the accompanying recession was the shortest and shallowest in US history (click to see on the chart below).

us gdp.bmp 

During the boom, the US economy benefited from an unprecedented acceleration in productivity growth. This was driven primarily by the efficiencies created by technological and financial deepening – particularly in the retail, wholesale, electronics, semiconductors, and financial services industries. While the dot-com’s and Stanford techies in pastel suits got the glory, the economy itself was being powered by the Wal-Marts, Intels, and GEs – who were innovating rapidly – and implementing that innovation in long-term strategies to enhance their bottom line.

Now before I get to how this compares to India today, a brief economics refresher. According to neoclassical theory, at the most basic level, a country’s output is powered by structural and cyclical forces. Structural or long term growth is driven by three factors inherent to the economy: the number of workers, their productivity, and how much long-term capital is available to them. Cyclical growth is powered by the various short-term influences on the economy: wealth effects from the asset markets, monetary and fiscal policies, etc. In theory, an economy should grow at its structural (or ‘trend’) growth rate plus or minus the cyclical component. To simplify, a country trend level of annual real GDP growth should equal:

Y% = (% change in labor force) + (% change in productivity)

This is the rate at which an economy can (and should) grow without causing excess inflation. The current capacity debate (discussed here, here, and here), in essence, is about what this number is today. Ajay Shah, the Economist, and various investment banks (including Morgan Stanley and HSBC) have repeatedly said that India is overheated – evidenced most clearly by the run-up in inflation, and also by ‘bubble-like’ real estate and equity prices. Skittishness about the policy direction of the current governing coalition supports the prevaling belief that a crash (or, for the less brave, a “cooling down”) is imminent. According to them, economic growth and/or asset prices are both set to decrease in the near-medium term.

They may well be right. Nevertheless, it is worth taking a look at the numbers and seeing exactly what has been powering economic growth in India over the last couple of decades. If we want to figure out where the Indian economy is headed over the next 4-5 years (as opposed to say, the next 4-5 quarters), surely this is better than looking only at the short-term indicators.

Our potential workforce (defined as people aged 15-64) has been increasing at about 2% a year – and is projected to continue at that rate at least till 2020. However, labor force participation rates vary substantially from state to state, between the sexes, and between rural and urban areas – as do unemployment and underemployment. Given that labor force growth (potential workforce x overall participation rate) has been averaging about 2% over the past 10 years, in the absence of better statistics, it is a safe assumption that overall employment is growing in the range of 1-2% and gradually accelerating.

The rest of real GDP growth has to come from growth in the productivity of those workers. In this framework, there is one fixed determinant of productivity growth: the capital-to-labor ratio. When capital is substituted for labor, then up to a point, this increases the productivity of labor. The rest of productivity growth is lumped up into a residual which economists call total factor productivity growth, or TFPG. While there is considerable debate on this, there is strong evidence at the national and industry level that TFPG is correlated strongly with measures of competition, deregulation, technology and innovation (much more on this in a later post). For the purposes of this analysis, we can simply say that TFPG is the component of growth which captures the extent of the structural change in an economy.

By running the calculations over the 1980-2005 period using real GDP, capital stock, and the labor force as the variables, we can see a relatively clear trend in India. Labor force growth has been fairly steady around 2%, and capital deepening has been a fairly small contributor to growth (on average 1.5%). Predictably, the acceleration in GDP growth since 1991 (and through much of the 1980s) has been almost entirely because of an increased pace of TFPG.

india tfpg.ppt (Updated chart)

The 5-year averages in the chart hide an even bigger change: if you look at the breakdown from 2004-2006, TFPG has been almost 5%. This acceleration has been partially due to changes in government policy, but my guess is that a larger portion of it is driven by the impact of the natural forces of globalization. The internet and the opening up of global financial markets has allowed a boom in IT enabled and financial services, and the loosening of trade barriers has boosted industry. Furthermore, there have been massive changes in the way Indian companies do business: ranging from increased transparency in order to tap the capital markets, aggressive cost-cutting and outsourcing of non-core functions, and an increased pace of technology transfers – both from abroad, and within industries. All of this impacts the productivity of labor (and TFPG) at all levels of the economy – and in another sense, is the very definition of ‘structural change’.

While there is an eventual limit to how much all these factors can influence productivity, it is my contention that we are a long way away from that point. When our leaders remind us that the reform process is “irreversible”, it is not just a diplomatic nicety to appease investors; it is in fact the truth. The forces of competition unleashed over the last 15 years cannot proverbially be brought back into the box – they will continue until they run their course; until all those who want to and can take advantage of the benefits of a more-open economy, have done so. Further policy changes have the ability to increase or decrease the magnitude and the speed of this change – but they cannot alter its direction.

If this were the extent of the change, it might alone be enough to help India out of chronic underdevelopment. Fortunately, the extent is even bigger. Along with the acceleration of TFPG, we will most likely soon see an acceleration in capital deepening as well, and soon thereafter in the growth of the labor force. The investment to GDP ratio has risen by about 5% from 1991 to now. Most economists are expecting a further increase once the numbers for the current fiscal are released – the prevailing estimates are that it will be about 29-30% of GDP. Surjit Bhalla of Oxus is even more optimistic, saying that it will increase to over 35%. As long as this investment boom lasts – and there are some reasons to believe that a lot of this is long-term capital, not just short-term ‘hot money’ – the capital deepening portion will continue to accelerate. And, as I mentioned earlier, sometime between 2009 and 2015, labor force growth will peak around 3.5% - 4%. This alone would constitute a 2% acceleration from the current trend level of GDP growth.

Now the real heart of the capacity debate centers around this question: what is India’s trend rate of growth now and what will it be for the next few years? (This is the red italicized number in the previous chart) If you add up the numbers, it seems to me that at a minimum, trend growth is at 8% with the capacity to reach 10% in the coming years. The 6.5% baseline level of growth that the Economist and others use to form their assessments of the Indian economy is fundamentally flawed. Any judicious accounting of the productivity trend over the last 25 years, when combined with stable and high labor force growth, should reveal that, over the long-term, the ‘supply-side’ of the economy is advancing at an accelerating rate.

Now, all this is not to say that ‘India-bears’ don’t have legitimate concerns: accelerating inflation, rapidly increasing asset prices, and a lack of sufficient policy direction are all worrying signs. But one must clearly distinguish between short-term fluctuations, and the long-term trend. On the fiscal front, the government is clearly too profligate: spending by the centre as a percent of GDP has increased by 2% over the past three years. The RBI (on account of persistent goading from North Block) has not increased short-term interest rates enough, with real rates continuing to decline. And, as our recent discussion about the real estate “bubble” highlighted, asset values are quite clearly borrowed against future growth.

However, all this does not necessarily add up to unmitigated disaster. High productivity growth is the closest thing to a panacea that central bankers can find these days – it tends to keep long-term inflation expectations down. The recent run-up in prices can be explained by short-term capacity constraints (particularly in agriculture), and an increase in oil prices in the first half of the year. Similarly, on the fiscal front, we are extremely unlikely to see a fiscal stimulus of the type introduced over the last three years (in particular the employment guarantee scheme). Moreover, high growth and structural change have allowed the tax base (% of workers that pay taxes and tax/GDP) to expand rapidly. This has allowed for a gradual change in the nature of government spending, with direct subsidies growing slower and direct investment growing faster. (Having said all that, I will admit that state finances are a complete bloody mess).

As for the asset markets – even after the run-up of the SENSEX, India’s market-cap to GDP ratio is still around 95%, which is lower than countries like South Korea (100%) and South Africa (240%), as well as developed capital markets (which range from 120% - 400%). Similarly, to summarize our earlier discussion, real estate has exhibited some disturbing trends in some regions, but on the whole, the jury’s still out on whether this means that it’s a nationwide price bubble.

To conclude, India faces some real risks in the short-term. If I had to give my top three, they would be:

  1. Supply bottlenecks (particularly in agriculture and industry)
  2. External environment (particularly turns in the global growth and liquidity cycles)
  3. Frothy asset values (particularly those which are borrowed against unreasonable future growth)

Nevertheless, any sober analysis will reveal that in the midst of unprecedented structural change, it will take a lot more to knock India off its long-term growth trajectory. Of course, we should expect to see fluctuations – sometimes big ones. However even the most pessimistic observer must see that the fluctuations are happening around a steadily increasing mean. Amidst this rapid transformation, India’s progress and prospects cannot be best judged month-to-month or quarter-to-quarter – but rather year-to-year, and in some instances, even decade-to-decade.

In India, we must see this as a golden opportunity to get our house in order: start cleaning up governance and the budget; build infrastructure; and balance growth between the regions. All these things will be much harder to achieve when (and if) the going gets tough.

In other words: don’t worry too much, but don’t get complacent either.

(If you want to check out my numbers and projections in detail, keep checking back at I will be posting a link to my spreadsheet in the next few days, once I clean it up a bit)


[1] 107 consecutive months
[2] added $1.7 trillion in inflation-adjusted dollars to GDP between 1995 and 2000
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