Friday, January 22, 2016

SC stays disinvestment in Hindustan Zinc

The Supreme Court has stayed the government's decision to disinvest its residual stake in Hindustan Zinc Limited by selling it to Vedanta which runs the company now. Vedanta had acquired control of HZL through the disinvestment that happened in 2002-03. The reason given by the SC should make people, especially in government, sit up- it raises serious questions as to whether disinvestment in several PSUs, especially profit-making ones, can happen at all.

Going by this news report in the TOI, the National Confederation of Officers' Associations of Central Public Sector Undertakings had challenged the residual stake sale.The reason given by the SC is interesting. I have not seen the judgement but, going by news reports, the SC had earlier given an order that, in selling stakes in PSUs, the government needs to amend the Act of parliament by which ownership in these PSUs came to be vested in government.

This was not done in the original disinvestment. The Attorney General argued that the company has ceased to be in the public sector, so the SC order, which came after the first disinvestment, was not applicable. As reported in Mint, the SC refused to buy this:
Referring to the earlier sale of 26% stake in the firm to Sterlite Ltd (now Vedanta Ltd) in 2002, the court told the government that the sale was a circumvention of the law.
“You’ve done it once and we can’t allow you to do it again,” it said.
The remark was in the context of the apex court-mandated probe by the Central Bureau of Investigation into the alleged irregularities in the 2002 sale.
“No divestment can happen in a public sector undertaking without Parliament amending the concerned statute,” the court said.

The SC has also raised the question of whether the government is at all justified in selling stakes in profit-making PSUs:
“If the company is making profits, then let the government also make some profit from the remaining stake. Why disinvest in that case,” the court remarked. 
Since the government can reasonably hope to make money only out of disinvestment in profit- making PSUs, one wonders whether taking credit for disinvestment proceeds in the budget document makes any sense at all until this issue is sorted out. 

Monday, January 11, 2016

Financial market jitters: real or imagined?

I made the point a couple of days ago that projected global economic growth is line with long-term trend growth of 3% despite the problems in China. Are the markets seeing ghosts? FT columnist Gavyn Davies appears to think so:
Market fears of a global recession this year seem to be rising, if we are to judge from the way in which asset prices have been behaving. But so far there is little sign of a recession starting, either in our “nowcasts”, or in hard data for industrial production and retail sales. The global activity growth rate is estimated at 3.1 per cent, which is slightly higher than the 2.6 per cent rate recorded when markets collapsed in August/September last year. Although this is not a significant difference, the direction of change is informative. If the Chinese and other emerging market economies were dragging the world into recession, it would surely be showing in a generalised weakening of activity data, rather than the opposite.
Larry Summers, however, thinks the markets are on to something:
Policymakers who dismiss market moves as reflecting mere speculation often make a serious mistake. Markets understood the gravity of the 2008 crisis well before the Federal Reserve. They grasped the unsustainability of fixed exchange rates in the UK, Mexico and Brazil while the authorities were still in denial, and saw slowdown or recession well before forecasters in countless downturns. While markets do sometimes send false alarms and should not be slavishly followed, the conventional wisdom essentially never recognises gathering storms....Because of China’s scale, its potential volatility and the limited room for conventional monetary manoeuvres, the global risk to domestic economic performance in the US, Europe and many emerging markets is as great as at any time I can remember. 
A Chinese collapse has been forecast for so many years now that we should not be surprised if Summers and his ilk are proved wrong. There is a Chinese slowdown but no collapse in sight as of now. What is happening, as I have argued earlier, is that investors cannot make sense of the events because heightened political tensions spell greater uncertainty.

So, yes, the markets are conveying something. But that something is not a sharp slowdown in global growth but a sharp rise in political tensions that render investment decisions more difficult than before.

Sunday, January 10, 2016

Falling oil prices: is greater supply or falling demand the problem?

Oil prices are heading towards $30. Is this good or bad?

Well, the answer depends on what the underlying cause is. If greater supply is the reason, then it's good. Input prices fall for a given level of demand. This makes consumers and producers richer, increases consumer spending, investment and exports and pushes up aggregate income. If, however, falling demand is the reason, a fall in oil prices is bad news. It's a sign that global growth is slowing down.

Stephen King of HSBC argues that it's the latter factor at the moment. It's not greater supply, whether shale production in the US or greater Saudi, Iran and Russian production, that's the cause. Why does he say that? Because, while there's some increase in consumer spending, investment and exports aren't growing months after the oil price decline set in. And much of the fall in demand is caused by China:
The cause of the inward shift in the demand curve is, more than anything else, the slowdown in Chinese economic growth. In every year since 2012, initial projections for Chinese growth have been too high. Part of the slowdown is self-administered, a reflection of Beijing’s attempt to deflate a property investment bubble. The rest reflects both weak demand elsewhere in the world and, until recently, a dramatic appreciation in the renminbi’s value on the world’s foreign exchanges: both have seriously limited China’s export performance. As the world’s second-largest economy, biggest infrastructure investor and dominant commodity consumer, China’s slowdown has had enormous global repercussions — from a Brazilian recession through to persistent deflation and incredibly low borrowing costs.
I would go along with that. Yes, falling global demand is the primary reason for falling oil prices. But that doesn't explain why the Saudis and others should not be cutting back on oil production. Why are they almost perversely pushing oil prices even lower? It's not plausible that the Saudis are doing this to hurt shale producers in the US: the Saudis dare not threaten US interests.

No, lower oil prices are intended to hurt Russia and Iran, to weaken them economically. So, falling oil prices are not entirely a demand-side issue today. As I have been saying in several posts, geo-politics is at work.

Friday, January 08, 2016

Global uncertainty, not slow growth, is the real challenge

Look out for another year of lacklustre growth for the world economy.

The World Bank has cut its forecasts for growth for the global economy for 2016 as well as its estimate for 2015. In 2015, the world economy grew at 2.4%, down from 2.6% in 2014 and lower than the forecast of 2.8% made in June.

In 2016, things won't get a lot better. The Bank pegs growth at 2.9% but this could go for a toss if the present turbulence in the financial markets continues.

One thing is crystal clear: the world economy has done a 180 degree turn since the early years of the financial crisis. Then, the developed countries sank but the emerging economies chugged along. There was much talk of "decoupling"- how the emerging markets' fortunes would be disconnected from those of the advanced world.

Now, things have changed. The advanced economies (as a group) have bounced back. It's the emerging markets that are sputtering. In Brics, all economics face major challenges except for India (relatively speaking). In 2010-14, the major advanced economies contributed 0.7 percentage points to world growth; in 2015-18, they are poised to contribute 0.9 percentage points.

Still, 2.9% growth does not constitute a crisis by itself- in 1993-2000, the world economy grew at 3.4%, so a drop of 0.5 percentage points should not cause panic. As I have been saying repeatedly, the problem we face today is not entirely economic. It's not China's slowing down or crashing stock markets there that pose the major problem.

Rather, the problem is that weak economic growth is happening at a time of worsening geo-politics. This can cause financial turbulence that is out of all proportion to fundamentals. We could have major funds simply dumping securities in emerging markets and fleeing. Then, a manageable problem becomes an unmanageable one.

Why do I say that? Well, FT columnist Gillian Tett reports that Nevsky Capital, an emerging markets specialist is closing shop. This is a fund that has produced annual average returns of 18% since inception! Why are they shutting down?
Martin Taylor, Nevsky’s co-founder, thinks the world economy is subject to so much political risk that “it is more difficult than ever before for us to accurately forecast macroeconomic and corporate variables”. .....Moreover, it is not alone in drawing in its horns: several high-profile funds, including BlueCrest, Seneca, LionEye and Lucidus Capital have recently done likewise. They have all presented their decision in slightly different ways but all point to a common theme: markets are becoming so unpredictable that tried and tested strategies are breaking down.A world shaped by irrational politics and capricious policies — in the west as well as in China and other emerging markets — is not something modern investors are equipped to deal with.

So, the real source of the problem, it would appear, is leaders in the west ratcheting up tensions with respect to Russia, China and the Middle East. They do so in the knowledge that the outcomes are relatively benign for themselves and bad for Russia, China and the Middle East. In other words, good for us (the west), bad for the rest. It's the political economy, stupid.

Wednesday, January 06, 2016

Risks to the world economy are mainly political

I had a post in August, following the crash in China, saying that I did not think the Chinese slowdown was not the primary reason for market jitters. I said the primary reason was worsening geo-politics, in particular, the resumption of the Cold War between Russia and the west and the heating up of the Middle East.

I was happy to see my position echoed by Martin Feldstein in a recent article. He sees the primary geo-political risks as emanating from four sources: Russia, China, West Asia and cyberspace. I agree with his analysis in respect of three of these sources. China's flexing its muscles as it grows in economic strength is certainly a problem. The Sunni-Shia conflict epitomised by the rivalry between Saudi Arabia and Iran is a source of tension. And the potentially crippling effects on infrastructure, physical and financial, of cyber attacks should not be under-estimated.

However, Feldstein's portraying Russia as a threat thanks a loose cannon called Putin is a travesty of the truth. Russia has demonstrated its willingness to be a disciplined member of a multilateral fraternity such as the UN. In the case of Syria, in particular, it has repeatedly asked for a UN-led coalition against ISIS. It is the West's ambitions in the Middle East, as much as those of Nato in relation to the Russia periphery, that has led to the estrangement between Russia and the West. This is what poses the biggest danger at the moment.

The West hopes that tightening sanctions and an economic collapse will bring about Putin's fall. This could turn out to be a serious miscalculation with grave consequences for the world order. It is hard to see the world economy -and world markets- return to an even keel as long as the rift between Russia and the west continues.

Friday, January 01, 2016

Quote of the day: Leadership and CEO pay

Lars Sorensen of Novo Nordisk, a Norwegian pharmaceutical company, has been ranked the no.1 CEO of the year by HBR. He ranks somewhere at the bottom when it comes to CEO pay.

Here is what he has to say about the subject:
My pay is a reflection of our company's desire to have internal cohesion. When we make decisions, the employees should be part of the journey and should know they're not just filling my pockets. And even though I'm one of the lowest-paid people in your (HBR) whole cohort, I still earn more in a year than a blue-collar worker makes in his lifetime.
Food for thought for greedy CEOs in India and elsewhere.

Central bank autonomy: a lively US debate

I realise that I return to my blog after an unusually long lay-off. I guess my New Year resolution ought to be that I will be more regular hereafter. Let's hope this doesn't go the way of most New Year resolutions.....

I'd like to focus on a lively debate in the US on the role and governance of the Fed. Bernie Sanders, a candidate for the Democratic nomination, kicked off the debate with a strongly worded article in the NYT. Sanders draws attention to the fact that the banking industry is heavily represented on the US Fed and this introduces serious conflicts of interest- monetary policy may be guided by the interests of the financial sector rather than those of the larger economy.

Secondly, he thinks the Fed has an excessive focus on inflation- he wants the Fed to focus on an unemployment rate of 4% as compared to the present 6-6.5%. Thirdly, Sanders would like the Fed to ensure greater lending to small businesses (our priority sector) and he signals that he wants tighter limits on bank exposure to investment banking. He wants the Fed to release full transcripts of meetings within six months and not after five years. Not least, he wants an independent audit of the Fed every year by the Government Accountability Office.

Larry Summers has a spirited response, agreeing with some of the proposals and disagreeing with others. Summers agrees that having bank representatives on the boards of the Fed system is a terrible idea:

Each of the 12 regional Feds has a board of directors that is made up of nine people— three banking representatives, three private sector non-banking representatives and three public interest representatives. The fact that a member of Goldman Sachs’ board at the time of the 2008 crisis was the “public interest” chairman of the New York Fed board is, to put it mildly, indefensible.
More generally, it is not clear why a government institution with vital policy responsibilities should have a role in governance for the private sector. Yes, advice on market conditions and the like is needed but this can be sought from advisory committees. Yes, the Dodd-Frank reforms did clean things up some by removing bankers from the selection process for regional bank presidents and orientating regulatory responsibility towards Washington. But it is hard to imagine an appropriate governance activity for business figures with respect to the Federal Reserve System. Nor is it clear why banks should in any sense be “shareholders” in that system.
This is where the RBI scores. It has strict rules that bar members of the RBI's board of directors from serving on the boards of any commercial bank. It does have industry representatives but these come from the non-financial sector. The RBI also scores in its much greater focus on financial inclusion (partly thanks to the political authority's own focus on this objective).

Summers seems to think that the Fed is already subject to audit. I do not know what form this takes and whether any GAO audit is made public. Here, I have been arguing that the RBI should be subject to management audit by the CAG. We need always to look at internal processes, including HR issues, and not just on outcomes (such as interest rates or licensing of new banks). Additionally, the RBI governor must have interactions with the Standing Committee of parliament attached to the ministry of finance. That would give him an opportunity to explain the rationale for various decisions to the law makers. Releasing full transcripts of meetings - we can decide what an appropriate time lag is- is also a good idea. It would help ensure that board members are not solely preoccupied with downing samosa and cashew nut.

The danger, in the Indian context, is that autonomous institutions (such as the RBI, IITs, IIMs,DRDO, BARC and others) exercise autonomy without due regard for accountability. The beauty of the parliamentary system is that there is, in the ultimate analysis, accountability to the people for outcomes. We need to formalise mechanisms of accountability for all autonomous institutions. Subjecting institutions to management audit- as distinct from audit of accounts - is a good starting point.