Don't blame Modigliani-Miller for overleveraging in the corporate world

 An article  in the FT suggests that the Modigliani-Miller Theorem is responsible for over-leveraged companies and the wrecks they have left behind:

Franco Modigliani and Merton Miller both later won the Nobel Prize in economics, partly thanks to their groundbreaking work on what became known as the “M & M theorem”. Until then most companies had assumed that too much debt would affect the value of the firm, so their paper was a counterintuitive bombshell. Their initial findings only held in a world without “frictions” — such as taxes, imperfect information and inefficient markets. But a later revisitation that incorporated the tax-deductibility enjoyed by interest payments showed that the value of an indebted company is actually higher than that of an unleveraged one. It eventually helped lay the intellectual groundwork for a dramatic erosion of corporate creditworthines

I'm afraid the article gets it quite wrong. When they wrote that capital structure is irrelevant to the value of the firm, MM meant there is no particular gain in introducing debt into the capital strucure. Debt increased the return to equity; at the same time the expected return to equity also went up, that is, shareholders expected higher returns of a company exposed to the risk of debt. So, the higher return produced by debt was, in some sense, deceptive. 

The introduction of tax does enhance firm value through the tax shield provided by debt. But this is beneficial only up to a modest level. Beyond that level, the probability of bankruptcy erodes firm value. In other words, firms face a trade-off between the tax shield that debt provides and the increased probability of bankruptcy that it creates. 

In the real world, the most highly valued firms- Apple, Google, Micrososft, Infosys, TCS- are all debt free. They don't think it necessary to enhance shareholder value by injecting debt. There is so much value created through the intelligent deployment and utilisation of assets that tinkering with the liability side is rather redundant. The best managers would adhere to M-M and not resort to debt, certainly not to excessive debt.

In the world of banking, the downside to debt has come to be internalised after the global financial crisis, so banks have raced to give themselves capital far higher than what the regulators have mandated. HDFC Bank has a capital adequacy ratio of 17-18 per cent when the regulatory requirement is under 12 per cent. That is because the markets have come to reward well capitalised banks. It may well be that the valuation of non-financial firms in the markets does not yet reflect the risks entailed by debt. But you can't blame M-M for that.

Of M-M, it could well be said that they came to bury debt, not to praise it.

More on the IMF's recanting austerity

In a recent post, I wrote about the IMF discarding its austerity mantra in its latest World Economic Outlook Report. The FT has a detailed article on the about-turn. The author writes:

Carmen Reinhart, the eminent economic historian who is now chief economist at the World Bank, recommended countries should borrow heavily during the pandemic. “While the disease is raging, what else are you going to do?” she asks. “First you worry about fighting the war, then you figure out how to pay for it.” Ms Reinhart was a leading advocate of austerity a decade ago after publishing a research paper which concluded that at a similar stage in the 2008-09 financial crisis — to where we are now — high levels of public debt undermined economic performance. It concluded that, “traditional debt management issues should be at the forefront of public policy concerns”.

The author mentions three reasons for the change in the IMF stance. One, the experience post the global financial crisis when fiscal policies  remained relatively restrained while monetary policy was assigned the task of restoring normalcy. It didn't quite work. Now, central bankers urge that monetary policy must work in tandem with fiscal stimulus.

Two, interest rates have fallen steeply over the years and this makes a higher level of borrowing feasible. One wonders whether the fiscal deficit target of 3 per cent  of GDP under the Maastricht Treaty and the notion that debt to GDP in the advanced economies should be under 90 per cent hold water any more. We need to consider alternative indicators: say, the interest to GDP ratio or the ratio of interest to total government income. Better still we have to take a view on (r-g), the differential between the interest rate and  the GDP growth rate. If the interest rate has fallen more than the GDP rate of, say, two decades ago, then the old rules for fiscal policy no longer apply. There is, of course, the interesting question of why interest rates have fallen in the advanced world despite rising public debt and a huge expansion in liquidity- on that, more in a future post.

Three, there is little public appetite for austerity now after the havoc visited on jobs post the global financial crisis. The article notes that even conservative Germany takes pride in the fiscal stimulus it provided post the pandemic.

Carmen Reinhart's prescription, however, may not enthuse Kenneth Rogoff, Reinhart's co-author of the famous book on debt crises, This time is different. In an article in the Guardian written last December, Rogoff gives three reasons, not all of them persuasive. why one must be wary of assuming higher debt given low interest rates.

First, governments may be able to service higher market debt but they may be jeopardising their obligations under social security systems. Well, I guess the measurement issue can be addressed by including contingent liabilities, such as pensions, in government's debt obligations. Let’s monitor the total, public debt plus pension liabilities.

Secondly, the next crisis may be very different in character, say, global climate change or a cyber war, with unpredictable implications for growth and interest rates. This strikes one as something of a bogey. One is not saying the interest burden on government should rise. Let the interest burden in normal times remain the same as before after adjusting for lower interest rates. That means we are at the same level of risk as before in confronting unpredictable crises of the sort Rogoff talks about. Again, the debt level is the wrong indicator to target.

Thirdly, Rogoff argues that "aggressive experimentation with much higher debt might cause a corresponding shift in market sentiment – an example of the Nobel laureate economist Robert Lucas’s critique that big shifts in policy can backfire owing to big shifts in expectations." Well, such a shift has not happened  for well over a decade post the crisis. Markets are not factoring in higher inflation and interest rates consequent to the shift in policy. If it does, policy makers have room to adjust. 

IMF report vindicates India's approach to tackling pandemic

Was the government right in enforcing a stringent lockdown in response to the pandemic? Or was there overkill on its part ?

The questions have been hotly debated over the past several months. A common criticism is that, in trying to kill the pandemic, the  government ended  up killing the economy. We flattened the wrong curve, as Rajiv Bajaj said. meaning we flattened the GDP curve, not the pandemic curve. Prioritising lives over livelihoods was the wrong thing to do.

Well, this is not a debate that will end soon. But it's interesting to see the observations and conclusions contained in Chapter 2 of the IMF's latest World Economic Outlook. Let me highlight the important ones:

i. The more stringent the lockdown, the greater the impact on the economy

By looking at the effect on  GDP of the stringency of lockdown in a sample of economies (which does not include India), the report concludes:

...more stringent lockdowns are associated with lower consumption, investment, industrial production, retail sales, purchasing managers’ indices for the manufacturing and service sectors, and higher unemployment rates.4 These correlations persist with and without controlling for the strength of each country’s epidemic based on the total number of confirmed COVID-19 cases scaled by population. 

 ii. Easing the lockdown may not necessarily lead to a sharp revival in economic activity.

As long as the fear of getting infection persists, people will observe voluntary lockdown even if the government lifts its own.

However, lockdowns are not the only contributing factor to the decline in mobility. During a pandemic, people also voluntarily reduce exposure to one another as infections increase and they fear becoming sick.....Both lockdowns and voluntary social distancing had a large impact on mobility, playing a roughly sim-ilar role in emerging markets. The contribution of voluntary social distancing was smaller in low-income countries and larger in advanced economies.

Just think of the large number of proprietary establishments. Are the owners going to be in a hurry to re-open when cases are rising? Most unlikely. It's not clear, therefore, that an early lifting of the lockdown would have let to a spurt in economic activity in India.

iii. The more stringent the lockdown, the greater the chance of reducing the rate of spread of the infection.

Lockdowns engender sizable short-term economic costs, but they are also an investment in public health to protect susceptible populations from the highly transmissible virus.... Countries that imposed lockdowns faster experienced better epidemiological outcomes. The differences are even more striking if countries are divided with respect to the number of COVID-19 cases at the time of lockdowns.... Countries that adopted lockdowns when COVID-19 cases were still low witnessed considerably fewer infec-tions during the first three months of the epidemic compared with countries that introduced lockdowns when cases were already high.

Based on the above, the IMF comes to the following conclusion:

The observation that lockdowns can reduce infections but involve short-term economic costs is often used to argue that lockdowns involve a trade-off between saving lives and protecting livelihoods. This narrative should be reconsidered in light of the earlier findings showing that rising infections can also have severe detrimental effects on economic activity. By bringing infections under control, lockdowns may thus pave the way to a faster economic recovery as people feel more comfortable about resuming normal activities.

It's hard to argue that what India did was anything different from what has been outlined above. You could argue that despite having a stringent lockdown, we did not experience a quick reduction in the incidence of cases. It may be that the norms for social distancing, wearning of masks etc were not taken seriously, so we did not experience the expected benefits. But it's also true that we have no means of knowing the counter-factual: what the incidence of cases might have been sans a lockdown.

My guess is that the mass movement of migrant labour may have resulted in sub-optimal outcomes in India. Maybe we failed in providing the support that would have kept migrants where they were. Maybe the fear psychosis over the spread of the virus and the contention that migrants were hugely at risk resulted in a panic reaction.

We were also in the difficult position of not having the healthcare infrastructure in place, so we could not afford an explosion in cases at the very start. Six million cases over six months can be handled; not so, six million cases in the first couple of months.

While on the subject, the recurrence of cases in Europe points to the hazards of relaxing restrictions too soon, even in places where social awareness and discipline is said to be higher than in our country. Germany, France, the UK,  the Netherlands and others are re-imposing restrictions in varying degrees.

Health systems around the continent are switching to crisis mode as hospital wards begin to fill up with Covid-19 patients. Fears are growing that medical facilities could soon be inundated and that the swelling volume of new cases could overwhelm track-and-trace teams tasked with interrupting the virus’ chains of transmission.

....Virus cases started to tick upwards after European governments eased lockdowns over the summer to kickstart economies that had been hit hard by the restrictions. But public health experts say Europeans let down their guard, holidaying abroad in large numbers, ignoring social-distancing rules and gathering in groups to eat, drink and socialise.

In the week to October 11, Europe registered its highest weekly number of Covid-19 infections since the pandemic began, with almost 700,000 new cases, according to WHO statistics.

No, we don't need austerity, says IMF!

 The IMF does not prescribe austerity any more- at least not for the advanced economies.

The advanced economies have resorted to a large fiscal stimulus in response to the pandemic. The IMF World Economic Outlook, October 2020, estimates that discretionary stimulus amounts to 9 per cent of GDP in advanced economies (compared to 3.5 per cent of GDP in emerging economies). 

Public debt in advanced economies is poised to rise by a full 20 percentage points to 125 per cent of GDP by the end of 2021 (in emerging economies, the figure will be 65 per cent of GDP). Yet, the IMF thinks the rise in debt will not be a big deal for the advanced economies.

Why? Because interest rates have fallen to close to zero in the advanced world, so more debt does not translate into an unsustainable interest burden. There's more debt but it's cheaper now. As a result, by 2025, overall deficits will be back to pre-pandemic levels without any cuts in public spending, according to a report in the FT:

Most advanced economies that can borrow freely will not need to plan for austerity to restore the health of their public finances after the coronavirus pandemic, the IMF has said in a reversal of its advice a decade ago. Countries that have the choice to keep borrowing are likely to be able to stabilise their public debt by the middle of the decade, Vitor Gaspar, head of fiscal policy at the fund, told the Financial Times. That would mean they would not have to raise taxes or cut public spending plans.

As the report notes, this is a change in the IMF's position with respect to what it had advocated after the global financial crisis.

The IMF is now urging advanced economies to spend their way out of trouble. Growth will take care of debt sustainability because the growth factor 'g' will outweigh the interest rate factor 'r'. 

But the point is that this - the positive gap between growth and interest rate- is not happening by accident. It is happening because central banks are intervening in the debt markets to make it happen. Central banks first allowed the policy rate to drop to close to zero at the lower end of the yield curve. Then, they resorted to Quantitative Easing which is the purchase of a defined amount of government bonds from investors. They have followed this up with Yield Curve Control, which is defining the interest rate they want to see at the higher end of the yield curve.

If central banks elsewhere can make it easier for governments to borrow, why is it a problem if the RBI does the same here? Why is the management of interest rates to facilitate more government borrowing and spending such an issue here? Why the criticism that fiscal dominance dictates monetary policy?

There is merit in what the proponents of Modern Monetary Theory are saying. They say that it's not true that government borrowing drives up interest rates because there is a limited pool of savings to finance it. When the government spends, the interest rate falls, it does not rise. There is an accretion to bank reserves at the central bank. This causes the inter-bank rate, which is the anchor rate in advanced economies, to fall, thereby facilitating more government borrowing and spending.

There is only one constraint in central banks allowing interest rates to fall: the fall in interest rates must not spell higher inflation. This is a constraint in India at the moment, given that inflation has been at over 6 per cent in recent months, that is, beyond the upper bound of the the inflation target framework. However, once the inflation rate falls, there is nothing that stands in the way of a cut in the policy rate. And until then, managing yields at the higher end of the curve is par for the course.

Central bank independence: Response to a reader's comment

In response to my post on central bank independence, a reader comments:

Aren't you using the pandemic-induced exceptional circumstance to rubbish Acharya's thesis? Granted that exceptional situations require a less doctrinaire approach but that apart i think there is merit in the view that a restructured standard asset is an oxymoron. I am one with you on accountability though. Take the issue of bank supervision. Musn't the RBI be held accountable for sleeping at the wheel and waking up too late to the crisis, the more so given its nominees were on the Boards of PSU banks? There cannot be independence without accountability.  

First, my basic problem is with Viral Acharya's thesis that fiscal dominance is the root cause of our banking woes. If that were so, how does one explain recurrent banking crises in economies where there has been no fiscal dominance? 

Adair Turner, former Chairman of UK's Financial Services Authority, explains in his book, Between Debt and the Devil, that money creation happens either by government or through the banking system. He argues that both can be equally irresponsible in the creation of money. The financial crisis was the result, not of fiat money created by government, but excess loan creation by private bankers. So, the idea that if government practises fiscal prudence, banking crises will somehow disappear seems rather misplaced.

Secondly, about loan restructuring or 'kicking the can down the road'. At the risk of sounding heretical, I make bold to say that without some kicking of the can down the road, it's impossible to practise banking. The question is one of proportion. If, say, 5 per cent of loans are restructured, it is not an issue; if the proportion of 25 per cent, there is certainly an issue. Next, restructuring must be based on sound financial considerations, it should not happen for mala fide reasons. Subject to these to two caveats, one should not have an issue with loan restructuring. 

Especially in the case of infrastructure projects and SMEs, where cash flows can be uncertain for reasons beyond the control of firm management, one cannot rigidly apply NPA norms and despatch the firm to IBC. Bankers need to exercise their judgement in handling such cases. That they refuse to in today's fraught environment is a different matter.

Thirdly, about the accountability of RBI. Not all of the bad loan problem is the result of irresponsible lending. The Economic Survey of 2016 argued persuasively that much of the NPA problem was the result of factors extraneous to management: 

Without doubt, there are cases where debt repayment problems have been caused by diversion of funds. But the vast bulk of the problem has been caused by unexpected changes in the economic environment: timetables, exchange rates, and growth rate assumptions going wrong.

   

So the idea that there was a colossal management failure at PSBs to which the RBI nominees were party is suspect, to say the least.

 

Where the RBI, perhaps, went wrong was in its over-zealous approach to NPA recognition under the Asset Quality Review. In one year, 2016, the ratio of gross NPAs to advances jumped to 7.48 per cent from 4.27 per cent in 2015. This led to a severe capital crunch, which affected credit growth, which affected borrowers and led on to more NPAs.

 

One could argue that it was not lack of central bank independence but the assertion of independence through an extremely stringent AQR that led on to major problems for the banking sector and the economy at large. The issue was not so much lack of supervision as the RBI's response to the NPA issue when it surfaced. This also was the reason for the tensions that emerged between the RBI and the government. 

Next round of fiscal stimulus: Question is when and how to do it

The Indian government has received much stick for the weak stimulus it has given so far, amounting to about 2 per cent of gdp. 

Following the onset of the pandemic, other economies vied with each in doling out large stimuli, covering support for both individuals and firms across the board. The government here chose to be far more cautious  and relied instead on monetary policy and the banking channel to ride out the lockdown.

Six months on, it does appear that the government called correctly. The economic outcomes from large fiscal stimulii elsewhere have been pretty modest. Even after sticking to borrowing limit of Rs 12 crore, which is the limit set for now, India's combined fiscal deficit for the centre and the states will be around 12 per cent of gdp. Any further stimulus will cause the fiscal deficit and  public debt to rise to a level where  a rating downgrade becomes inevitable, followed by an exodus of foreign capital.

More importantly, we have seen that large fiscal stimulii have not been effecting during the lockdown. Massive cash transfers and payroll support for businesses has not prevented a contraction in GDP. The stimulii have been wasted, so to speak, and the advanced economies have seen their debt to gdp ratios rise to well above 100 per cent.

Now that the lockdown is well under way, is it time for another dose of fiscal stimulus? Yes, except that inflation is now trending at above the inflation target limit of 6 per cent. We may opt for another round of fiscal stimulus once inflation falls below 6 per cent- and, I would argued, it should happen through direct monetisation of the deficit. Then, fiscal deficit does not rise. Inflation would have fallen below 6 per cent. More government spending can happen without inviting a rating downgrade.

More in my BS column, Now is not the time for stimulus

Is Trump authoritarian?

US President Donald Trump is portrayed as part of the current set of authoritarian leaders that includes Russia's Putin, Turkey's Erdogan and Brazil's Bolsanaro.

An article in the FT makes the interesting point is that Trump's instincts are libertarian rather than authoritarian. He simply doesn't match the profile of the classic authoritarian leader  who favours greater use of executive power. The author argues that Trump wants to roll back the state, not advance its frontiers:

If the president’s illness has shown anything, it is that he differs from classic strongmen in a very US way. His populism tends more to the libertarian than the repressive. The mask-spurning, the cavalier gatherings, the call to not let the virus “dominate”: it is personal freedom to which the president has shown a heedless attachment. A conventional despot would use the pandemic as a pretext to hoard and exploit executive power. Mr Trump has used it to define himself against a meddling state. His line of attack against Joe Biden, the Democrat candidate, is that he would smother America’s economic bounceback with fussy curbs on everyday life. 

In other ways too, Trump's instincts go counter to those of the classic autocrat. He is wary of the military, he doesn't favour too much of a fiscal stimulus and he doesn't want the state intruding into the life of the ordinary person. 

Trump may brush aside rules, his utterances may be jingoistic, he may be impatient with criticism but  he is not your classic dictator who uses the state to repress citizens. Liberals are wont to call somebody they think is unpleasant 'authoritarian' but that doesn't make the characterisation accurate.

 

Inflation targeting in India: RBI's mandate must be modified

Barry Eichengreen, the well known economist, thinks inflation targeting is working in India and that it's good to stick to it. His views come at a time when the regime is seen to be coming in the way of cranking up growth just when the economy is suffering a huge contraction.

Eichengreen cites a co-authored paper of his which shows that the inflation targeting regime is "functioning well" in India. The RBI uses both price stability and growth to determine its policy rate. Policy has not become more hawkish after the regime was put in place. It has made for better anchoring of inflation expectations. Even when the inflation rate moves up, inflation expectations don't go up because people believe the RBI is capable of reining it in. In other words, the credibility of RBI has gone up consequent to inflation targeting.

Eichengreen, however, sees room for improvement especially in RBI's management of expectations of inflation. The data shows that while the RBI is able to manage expectations of professionals well, it hasn't done a great job of managing the expectations of ordinary people. He urges the RBI to reach out and better communicate to ordinary people.

All this is fine but the inflation targeting regime may still need modification. The problem thus far has not been with the inflation regime so much as how the RBI has interpreted it until recently. Although the upper limit for inflation in our regime is 6 per cent, the RBI chose to focus on a target of 4 per cent in practice. As the lower limit of 2 per cent is not particularly relevant now, why not make the mandate more specific by asking the RBI to limit inflation to 6 per cent instead of setting a band of 2-6 per cent?

Perhaps this can be done once the current spurt in inflation subsides and inflation falls below 6 per cent. The time to modify the regime is when the going is good, not when the going is bad. If the government moves to modify the inflation target at a time when the fiscal deficit of the centre and the states is poised to be rise to around 12 per cent of gdp and inflation is running above the limit of 6 per cent, it is unlikely to sit well with rating agencies and investors. At least one of the two closely watched indicators must look good before any change is attempted. 

Inflation must be kept under control. But inflation cannot be allowed to control macro-policy.

America's pandemic bailout is more for corporates than for ordinary folk

America was quick to announce one of the largest fiscal stimuli in the world following the onset of the corona pandemic. Mariana Mazzucato, writing in Foreign Affairs, contends that the government bailout was more for corporates than for ordinary workers.

She writes:

Rather than put in place effective payroll supports, as most other advanced countries did, the United States offered enhanced temporary unemployment benefits. This choice led to over 30 million workers being laid off, causing the United States to have one of the highest rates of pandemic-related unemployment in the developed world. Because the government offered trillions of dollars in both direct and indirect support to large corporations without meaningful conditions, many companies were free to take actions that could spread the virus, such as denying paid sick days to their employees and operating unsafe workplaces.

The CARES Act also established the Paycheck Protection Program, under which businesses received loans that would be forgiven if employees were kept on the payroll. But the PPP ended up serving more as a massive cash grant to corporate treasuries than as an effective method of saving jobs. Any small business, not just those in need, could receive a loan, and Congress quickly loosened the rules regarding how much a firm needed to spend on payroll to have the loan forgiven. As a result, the program put a pitifully small dent in unemployment. An MIT team concluded that the PPP handed out $500 billion in loans yet saved only 2.3 million jobs over roughly six months. Assuming that most of the loans are ultimately forgiven, the annualized cost of the program comes out to roughly $500,000 per job.  

Bailouts that benefit corporates are part of a larger problem in the US. The relationship between government and the private sector is flawed. The government supports basic research that benefits private corporates but the success of those corporates does not translate into any flow of income for the government or any larger public benefit:

The California-based company Gilead developed its COVID-19 drug, remdesivir, with $70.5 million in support from the federal government. In June, the company announced the price it would charge Americans for a treatment course: $3,120. It was a typical move for Big Pharma. One study looked at the 210 drugs approved by the U.S. Food and Drug Administration from 2010 to 2016 and found that “NIH funding contributed to every one.” Even so, U.S. drug prices are the highest in the world.

It is the same story with Silicon Valley companies:

The U.S. Navy did the same for the GPS technology that Uber depends on. And the Defense Advanced Research Projects Agency, part of the Pentagon, backed the development of the Internet, touchscreen technology, Siri, and every other key component in the iPhone. Taxpayers took risks when they invested in these technologies, yet most of the technology companies that have benefited fail to pay their fair share of taxes.

 Mazzucato argues that the relationship between government and the private sector must be set right: socialisation of risk and privatisation of profit is untenable. If the government funds pharma research, this must be reflected in the funding of pharma products. If the government provides financial support to start-ups with guaranteed loans and the like, it must benefit from the upside to these companies.

She moots the idea of a citizen's dividend, as  distinct from a universal basic income. Wherever the state supports private initiative, it must be entitled to the benefits that flow from the initiative. The state can then the share the wealth that accrues to it with all citizens. 

This is a terrific idea. Much of private wealth creation rests on a support system created by the state, whether through land given at a concessional price, tax benefits, public investment in research, guaranteed loans, etc. Wherever there is a subsidy built into wealth creation, the state must get a share of the proceeds. The same goes for companies that are bailed out by public funds.This is not to be confused with taxes that are applicable even where no special dispensation is given by the state.

Do you see any of these ideas in the debate between Trump and Biden?

 

India must fight Vodafone arbitration award

 There is jubilation in many circles over the award at the Permanent Court of Arbitration at the Hague going against India in the matter of the retrospective tax demand of Rs 22,100 crore made by India on Vodafone.

We asked for it, many seem to be saying.  Amending the law retrospectively to deal with the Supreme Court judgement, as the UPA government did, was wrong. Retrospective amendment of laws gave a jolt to foreign investors and is bad in principle.The Modi government must now accept the arbitration award: that would send the right signals to international investors.

Rubbish! As senior lawyer Biswajit Bhattacharya argues in BS today, the SC judgement was wrong, the retrospective amendment was right and India's tax demand on Vodafone is appropriate. 

The issue is capital gains on assets located in India. If the assets are transferred between parties located outside, are capital gains on such assets taxable or not? Bhattacharya points out that if the SC judgement were to be accepted, any two individuals could avoid tax by transferring assets located in India between themselves simply by acquiring non-resident status!

Bhattacharya also raises an important question about how Vodafone approached the matter of acquiring the telecom assets:   

The SC’s ruling that India’s tax authorities had no territorial jurisdiction over this transaction leaves several questions unanswered, given that Vodafone approached the FIPB in India before the transaction. Why did Vodafone await FIPB’s approval before remitting funds from Cayman Islands to Hong Kong if India had no territorial jurisdiction? The Central Board of Direct Taxes (CBDT) is also located in the same North Block where the FIPB office was. How could CBDT, and through CBDT the tax authorities, then not exercise territorial jurisdiction, if the FIPB could?

Bhattacharya also dismisses the contention that retrospective amendment of laws is an evil that governments must avoid:

Critical comments about retrospective amendment are misplaced. It is a settled law that Parliament can legislate prospectively as well as retrospectively, even in fiscal statutes. Many such amendments have been carried out before. Retrospective amendment to FCRA (Foreign Contribution Regulation Act) was carried out by Parliament only to bail out the Bharatiya Janata Party and the Congress, to nullify a judgment of Delhi High Court, which held both political parties guilty of violating the FCRA norms. Why this hue and cry only for Vodafone?

The so-called impact on foreign investor sentiment is bunkum. In the decade since the initial High Court judgement favouring the government, FDI and FII flows have kept rising. It's not as if the retrospective amendment has had foreign investors running away from India.

Bhattacharya seems to suggest that the government was wrong to accept international arbitration. One option appears to be to go on appeal in Singapore. It's for legal experts to suggest other options.

However, we need to be clear that if we are to retain respect as a sovereign nation, the retrospective amendment to the law done by Parliament must be upheld. It's worth recalling that the late Justice JS Verma  had said of the Vodafone judgement that it is one of three judgements "which are best forgotten or allowed to pass" (the other two being the Habeas Corpus case judgement during the emergency and the judgement in the JMM bribery case).  

See also the hard-hitting interview with academic Surajit Mazumdar. 

My latest book, Rebels with a Cause, is out

Happy to share that my latest book, Rebels With A Cause: Famous Dissenters And Why They Are Not Being Heard, is out. It's published by PenguinRandomHouse.

 

I reproduce the blurb:

Democratic societies take pride in freedom of expression. Indeed, the right to dissent and tolerance of diverse viewpoints distinguish a democratic society from a dictatorship. In his new book, Prof. TT Ram Mohan profiles well-known dissenters Arundhati Roy, Oliver Stone, Kancha Ilaiah, David Irving, Yanis Varoufakis, U.G. Krishnamurti and John Pilger to illustrate how, in practice,  dissent tends to be severely circumscribed.  It is only the celebrity status of these dissenters that has kept them from being actively harmed. Through an exploration of the lives and ideas of these personalities , the author argues that, while one may not agree with their positions on various issues, their views merit discussion and debate. Engaging with them and responding to their analyses holds out the prospect for substantive reform within the system. Yet, the dominant elites prefer not to do so, instead marginalizing and even ostracizing dissenters precisely because they find change of any sort threatening.

 Rebels with a Cause is book that asks hard questions to challenge the way we view, and live in, the world—an important book for anyone who refuses to lamely accept the status quo.

 

 

The university after the pandemic

 Is the residential university soon going to be a thing of the past? Will online learning displace it in  a big way? Will young people opt not to go the universities?

No, no, no, going by article in the FT on the future of the university. 

The pandemic has forced a lot of experimentation and improvisation. Blended learning- a combination of online and classroom learning- is pretty much the norm. Alternatives to the 2-3 hour exam are being explored. Online exams through special proctoring mechanisms have come into vogue.

At the end of the day, however, the university will not go away and the residential university will remain dominant. As everybody knows, there is more to the university than classroom learning- the social interactions on campus and group learning have their place. And online learning, many students seem think, is not the real thing.

The most striking fact in the article is that the flow of UK students this year is undiminished, with some universities, such as Cambridge, even seeing a small rise. (Although the experience in the US and Australia seems to be different). That's again because students do not see online as an alternative to the residential university.

What is more likely is that online education will supplement, not supplant, the residential university. It will be an useful aid to classroom learning. And universities will use their learning from the online model to offer it to those who can't make it to university. That will boost revenues at universities- and it will also result in greater inclusion.

Standoff with China: India's options limited

 The government's critics accuse it of meekness in the face of China's land grab in Ladakh. The fact of the matter, as many security experts have testified, is that China has appropriated chunks of Indian territory. What is not stated as explicitly is that India's military and diplomatic options in responding to Chinese belligerence are limited, as an article in The Wire makes clear, citing a recent paper by two US analysts.

There are three options. One, take on the Chinese and throw them out before they consolidate. This is a huge challenge in the Himalayan heights given that defenders have an enormous advantage. Two, seize Chinese territory that can then be exchanged for ours. We haven't quite attempted this: the territory we have moved into at Pangong is our own. The third is to accept the fait accompli. This would mean more Chinese aggression down the road.

It does appear that, faced with a superior economic and military power, our options are limited. Some hawks says we should make it costly for China to embark on such adventures by mobilising in a big way along the border. But this raises costs for us too- and China can outlast us, given the strength of their economy.

Any suggestions, anybody?

(Thanks to SM Deshpande for the pointer to the Wire article)

Depsang is a headache for India

 The present standoff with China in Ladakh has had one positive: the large number of insightful military analyses it has spawned.

India has been on the defensive in Ladakh ever since China upped its belligerence a few months ago. There is an impression that our moves in the southern part of Pangong lake have changed the scenario and China is seriously rattled.

It may be that the Pangong thrust has moved things to our advantage in that area. But the real problem for us is Depsang where, as military analyst Sushant Singh points out, China blocks access to 900 sq kms of our territory. That blockage is a real headache because it could limit India's access to Siachen Glacier and give Pakistan a chance to mount an attack on it. As Singh points out, it is not that the PLA and the Pakistani army can link up. However, acting in collusion, they can pose a serious threat to our positions. Singh notes that the defence minister was conspicuously silent on Depsang in his recent speech to Parliament.

RBI's loan restructuring scheme has a good chance of success

The RBI's loan restructuring scheme is now on. It is only for corporates. For SMEs, there is a separate scheme that was unveiled in 2019. 

Restructuring will become imperative with the ending of the six month interest moratorium on August 31, 2020. Unfortunately, it is not ended as yet because a petition on chargeability of interest in the moratorium period is pending before the Supreme Court. 

There is an issue of whether interest can be charged at all; there is a further issue of whether interest on interest can be charged, that is, whether the interest during the moratorium period can be capitalised and added to the outstanding loan as on August 31. 

The Supreme Court will hear the matter again on September 28 after  the government submits an affidavit outlining its position on the petition before the SC. A three member committee under former CAG, Rajiv Mehrishi, has been set up to define the government's position.

About the restructuring scheme, there are doubters. Many see the scheme as yet another attempt to kick the can down the road. Precisely because the market is sceptical, the scheme has a better chance of success. Banks will want to keep the proportion of restructured loans down to the minimum if they don't want their valuations driven down. 

Secondly, provision coverage ratios at banks are higher than in the past, so they don't have to worry about recognising bad loans as much as before. 

Thirdly, the RBI and the KV Kamath committee have laid down fairly stringent norms for restructuring. The tenure of a loan can't be extended by more than two years, for instance, and for 26 sectors, thresholds in respect of key financial parameters have to be observed.

So there's reason to believe that this restructuring exercise won't go the way of earlier ones.

The practical problem for banks is how to decide the extent of restructuring given the uncertainties about the growth outlook. I believe it makes sense to wait for a month or two and gauge the strength of the recovery before rushing into restructuring plans (except where default is imminent). They must also put in provisions for an upside to repayments that is linked to cash flows.

A good bit of non-restructured loans will have to be provided for. There will also be slippages in respect of loans that meet the requirement that no default should have occurred more than 30 days prior to March 31, 2020 (which requirement is laid down to ensure that the restructuring covers only covid 19-induced stress). Banks, especially public sector banks, will need capital. Unless adequate capital is forthcoming, the objective in cleaning up bank balance sheets, which is to ensure higher credit flows down the road, will not be met.

More in article in BS, Loan restructuring: this time is different

How not to reform the IAS

Today's TOI carries an article by two ISB profs on reforming the IAS. Frankly, I find the proposals impracticable.

The authors propose that at the end of seven years, IAS officers be given the following options;

Continuation in the service at a prestigious senior position for which the officer may have to compete with other experts from outside the service who could be inducted laterally (something that Prime Minister Narendra Modi has espoused).

A fully paid scholarship to any PhD, MBA, or other top professional programmes in the world (eg Harvard MBA, Princeton Masters in Public Policy, or a PhD at the University of Chicago) into which the officer can get admission based on his or her merit.

  A Rs 1 crore seed capital from a capital fund run by professional venture capitalists to begin an entrepreneurial startup venture

 

Those who can compete with. Others will try to upgrade themselves with higher studies. Those who want out can be turn entrepreneurs.

 

Well, it's not clear that the alternative to being in the IAS is becoming an entrepreneur. But even if some want to take the plunge, the government cannot, by any stretch of imagination, lavish Rs 1 crore on anybody who wants it. How do you ensure accountability of the money spent?

As for the second option, it is already being exercised.  Many go for higher studies, a few quit thereafter.

It is also not possible to get IAS officers to compete with outside experts for all positions. This can happen only for a few positions that require technical expertise.For the vast majority of generalist positions, outsiders can't fit in- the IAS training and background are indispensable.

The authors also propose that the government recruit from professional courses even at the entry level. That would completely undermine the IAS exam. Today, IITians and IIM students appear for the IAS exam. The authors are saying they- and others from professional courses- could be hired from campuses, as  happens with corporates. This overlooks the fact that the IAS written exams plus interviews look for qualities other than mere technical competence. That is what gives the IAS exam its cachet and ensures high quality of recruits.

 

 By and large, the IAS at the centre remains meritocratic above the joint secretary level. And the pressure to perform is pretty intense. The problem is at the states. That has to do, not just with the motivation and incentives of IAS officers, it has to do with the way politicians run the system. That calls for reform of a different character from what the IBS profs propose.

RBI, financial stability and central bank independence

 Viral Acharya, the distinguished academic who served as Deputy Governor of RBI from December 2016 to June 2019,  has been vocal on the subject of financial stability over the past several weeks.  

In several interviews and webinars following the publication of his book, Quest for financial stability in India, Acharya has said that lack of concern for financial stability on the part of successive governments has led to recurring problems in the banking system. This, in turn, has resulted to growth getting stalled time and again. 

The book is a collection of speeches Acharya made as Deputy Governor. The highlight is a lengthy introduction that Acharya has written in which he expatiates on the importance of financial stability. Acharya says that during Urjit Patel's tenure as Governor, the RBI made a valiant attempt to defend financial stability but, ultimately, could not stem pressures in favour of faster credit growth at the expense of stability. He suggests that both Patel and he had to quit as they could not reconcile their stand on financial stability with that of the government.

Acharya contends that the root cause of financial stability is what he calls 'fiscal dominance', that is, the imperative of governments having to spend in order to boost growth, no matter what the implications for the fiscal deficit. After a point this becomes untenable.Governments then lean on the central bank to facilitate faster growth through credit expansion. 

This invariably involves sacrificing financial stability in a number of ways- by not recognising bad loans and the associated losses, not recapitalising public sector banks as required, manipulating the yield curve to keep interest rates low so that governments can borrow cheaply, etc. Compromises on financial stability result in banking crises and weak growth down the road. 

The answer, Acharya suggests, is first to ensure that fiscal discipline is practised. Secondly, to ensure that the RBI enjoys greater independence, preferably conferred by law, so that it can resist pressures to compromise financial stability.

There are problems with the thesis. First, it is not true that credit booms and financial crises result exclusively or mainly from fiscal dominance. The global financial crisis of 2007 as well as multiple bank crises in numerous economies in the past several decades did not flow from fiscal dominance.

Secondly, financial stability can result from excessive concern with financial stability at the expense of growth. If you are too focused on inflation and allow growth to weaken, that itself can cause financial stability. If you are not willing to relax regulations in unusual times, such as the pandemic, and insist that defaults should automatically result in loans being categorised as non-performing assets, you are going to create a major banking crisis here and now- in the cause of financial stability. Find me one banker who thinks that the loan restructuring scheme announced recently by RBI is not desirable and that we should accept Urjit Patel's contention that a restructured standard asset is an oxymoron.

Thirdly, conferring independence on the RBI by law is a bad idea. Matters of monetary policy and regulation cannot be decided by technocrats alone. It is the elected government that is accountable to the people for its decisions that must have the final say. This is because monetary policy and regulation involve choices about trade-offs between growth and stability and they have distributional implications. These choices cannot be made by technocrats sitting in Mint Street. If central bankers are not to accountable to the government, how will make them accountable? We need a vibrant media, swift judicial redress and a culture of peer pressure that will ensure accountability once central banks are given independence by law. Those conditions are not satisfied in India today.

Fourthly, it's extremely naive to think that governments make "political" choices while technocrats are utterly apolitical or detached in their approach to questions of public policy. All public policy choices are overtly or implicitly political in nature and central bankers are political animals in their own ways. We know central bankers are not unworldly in their outlook: many have the happy gift on landing juicy positions with private banks after they have demitted office. 

We have to accept that those elected to office have the right to decide matters of public policy. If they make mistakes, the electorate has the choice of voting them out the next time. Pitting the saintly technocrat against the diabolical politician can only undermine democracy and pave the way for the technocracy known as dictatorship. 

More in my column in BS, Technocrats versus politicians