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Unravelling the spaghetti: India and its future - Part 1 (Book review)

29/4/2013

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Many times, I have felt that India is like a bowl of spaghetti. In such a diverse country with so many things going on at any time, it is difficult to sort out the issues and make sense of what needs to be done.

In the book, “Imagining India”, Nandan Nilekani (co-founder and ex-CEO of Infosys and the current head of the national identity card project) tries to view the country in terms of the ideas that define it. He sorts them into four categories: ideas that have been accepted in the society; those that are under progress; those about which there is still considerable debate and disagreement; and those that will be relevant for the future, but are not receiving the attention they deserve.

As I kept reading the book, I found myself arguing with the author. While I had my  preconceptions, I also found myself learning many new facts about India. Nilekani's understanding of the country is impressive, and his arguments are supported by well-researched data and statistics. As a co-founder of Infosys and one of the corporate leaders of India, he has had tremendous access to other leaders: finance ministers, Nobel Prize winners, economists, social workers, historians, and even a foreign country's prime minister.

This book is a "must-read" for anyone interested in understanding today's India and its future. It is the most balanced of the three books that I read recently about India, the other two being "India: The Emerging Giant" by Arvind Panagariya and "The Indian Renaissance: India's Rise after a Thousand Years of Decline" by Sanjeev Sanyal. Panagariya's book is packed with facts and figures, but much of it historical; Sanyal's book is good, good but does not address the challenges deeply. Nilekani's book not only discusses the issues deeply, but provides enough facts to support the arguments.

Accepted Ideas

Nilekani starts the first section with the argument that India has finally started viewing its people as assets rather than liabilities. He cites the now-famous concept of demographic dividend as the foundation of India's future. Of course, having led Infosys for many years, Nilekani cites the IT and BPO sectors as evidence of the positive role that a well-educated population could play. But as I read the chapter, I kept wondering if his views were not tainted by his IT  experience. For instance, he does mention the fact that the southern states have  crossed their peak period of demographic dividend, while the population of the lower-developed BIMARU (Bihar, Madhya Pradesh, Rajasthan and Uttar Pradesh) states are still growing and getting younger. But he does not discuss the implications of this split fully. Unless the BIMARU states manage to develop, and that too at a rapid pace, the population profile of those states may become a curse, and the current regional imbalances may intensify and lead to social problems.

Besides, how can one conclude that the human population of India has become its asset, when over 60% of the population still depends on agriculture for a living, and even in that sector, the labor productivity is very poor? Whether India's young demographic profile may turn into a blessing or a curse depends on how well other areas of the economy are reformed to produce the growth and jobs necessary to satisfy the people. And that is where Nilekani's other ideas become relevant.

Nilekani next discusses the acceptance of entrepreneurs in the society. He traces the dominating influence of Nehru's socialist policies on India's early economic path as an independent country, and their failure to produce sustainable growth. He then goes on to discuss the Bombay Plan devised by the industrialists as a compromise to the fiercely socialist government, and describes the eventual rise of the entrepreneur after Manmohan Singh's 1991 liberalization. As I read the chapter, I could not but feel angry and disappointed at the missed economic opportunities, thanks to the failed Nehruvian policies. I also remembered the futile rules that curtailed production of various products, even as demand was booming. (My father wanted to buy a Bajaj scooter in 1987 and found that he had to place a deposit and wait for three years for his turn to buy one; so he  eventually bought one in the black market by paying a premium of about 25% of the actual cost, and had to run the scooter in someone else's name for a year before it could be transferred to his name!).

The overall thrust of the argument that private enterprise is now encouraged is fine, but it is difficult to agree with Nilekani when he says that the ineffectual economic policies are what bought the Congress down finally and led to the rise of multi-party democracy. In fact, in many other parts of the book, he does a masterly job of describing the rise of multiple identities that led to a regional and multi-party political system.

The other problem with this chapter, and indeed the whole book, is that Nilekani scarcely mentions the role of corruption in holding down India's development. There is no doubt that the nexus between the politicians, bureaucrats and businessmen twisted the system to their benefit rather than that of the common people. This omission also made me think about Dhirubhai Ambani, who had brilliant ideas about business (in particular, his conviction to build world-scale capacities and his use of capital markets), but who nevertheless manipulated the system to his unashamed advantage, including blatant scandals such as smuggling and duplicate share certificates. But now, there is even a book on “Ambanism” as if it is a legitimate economic philosophy!

The next accepted idea that Nilekani talks about is the growing use of English across the country and its almost universal acceptance by politicians. No disputes on this point, happily! It reminded me of a discussion in my business school about what unites India. After considering different ideas, we settled upon commerce and business that keeps India united. English is, of course, the glue that links Indians and keeps the commerce flowing.

Next to come is IT, Nilekani's home subject. His description of how Rajiv Chawla, a cunning bureaucrat, slipped computerization quietly into the land records system of Karnataka is hilarious. The government workers had not realized what was going on, and by the time they woke up, it had been done! It is indeed heartening to see IT being used in many key private sectors, such as banking, railways and insurance, and it is seeping into core government services.

When Nilekani talks about globalization as an accepted idea, he again falls back on IT as the main example. While that is indisputable, there is much work to be done to reap the benefits of globalization in the manufacturing, agriculture and financial sectors. There are good examples of some Indian manufacturing companies benefiting from access to global markets, but what has been achieved falls far short of the overall potential of the country. I am also not sure how Indian agriculture would react to globalization in terms of input and output pricing, as well as product choice. For instance, what kind of crops might be produced if all input and output are priced at international levels? Or, what kind of agricultural imports and exports might take place? Will Indian agriculture benefit from globalization without first eliminating the structural inefficiencies such as small farm holdings and land ceiling legislations? These are complex questions, but Nilekani does not carry the argument about agricultural globalization to its logical end. While he has covered so many important aspects in the book, I wish he had discussed the agricultural sector more thoroughly, instead of just mentioning it in passing in different contexts.

Nilekani's final accepted idea is democracy, and it is also one which I found most difficult to digest. For all its positives and ills, democracy is an idea that has finally been accepted in India as the political system of choice. Nilekani has provided a good description of the rise of regional parties and factions, but it is not clear what his judgment is about the phenomenon: is he just describing, bemoaning or celebrating? He argues that the caste, language and regional identities grew in prominence due to the failure of the state to provide  broad-based growth. The question is not whether India has accepted democracy, but whether the current form of democracy is not turning into kleptocracy.

He believes that the new identities are coalescing into an Indian identity, but in my view, he is treading on thin ice when he says that. On the other hand, I feel that the multi-identity democracy is serving to hinder progress rather than enable it; and whatever progress is achieved is in spite of it rather than due to it. After all, how many regional parties have an overarching view of Indian progress and society? How many of them function on the basis of any principle, except that of taking care of their own supporters and constituents? At the extreme instances, when I think about the unprincipled bargaining between different parties, I only get the image of hyenas tearing at the prey from different directions, getting their fill of the meat. Finally, even Nilekani is forced to acknowledge the inescapable, but he still gives it a positive spin when he says, “this period of stonewalling, backtracking and accommodation is essential ... it is the only way we can frame policies that are truly sustainable.” It is a shame that even after 60 years of independence, a discerning writer like Nilekani has to call India's democracy young in trying to justify what is happening.

... Click here to read Part 2.
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Private bank incentives in Asian bond market

23/4/2013

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Today's Bloomberg article draws attention to the practice in the Asian USD bond market of paying incentives to private banks to distribute new bond issues to their clients.

Over the years, private banks have subscribed to a rising share of new USD bonds from Asia. Before GFC, when equities used to be hot, private banks' share of subscriptions to new bonds used to be 3%-8%. After GFC, the figure has risen substantially to reach 16% for 2012 and 18% for 2013 so far. Undoubtedly, private wealth has discovered a new love for bonds. We must view the importance of the private banking subscriptions to new issues in this context.

Private banks have become key buyers for all bonds, but more so in case of high-yield bonds. They took 29% of high-yield issues this year, but only 11% of investment-grade issues, up from 25% for high-yield and 12% for investment-grade issues last year.

In some issues, particularly unrated or high-yield bonds, allocations to private banks are so large that one wonders if the issues would have managed to get out the door without them. Consider these, for example: Private banks took 24% of First Pacific's 10 year bond, 37% of Bank of Ceylon's 5-year issue, 39% of Suzlon Energy's 5-year issue, 37% of Shun Tak Holdings' 7-year issue, 55% of Guangzhou R&F's 7-year issue, and 42% of Lai Sun's 5-year bond. (These are only some examples from this year, not a complete list of bonds with high  private bank participation!)

In most of the perpetual bond issues, private banking clients have contributed a large chunk of demand: 48% of Beijing Capital Land, 76% of Agile Properties, 60% of Cheung Kong Holdings, 53% of Reliance Industries, 76% of Petron - all examples from this year alone. (It is another matter than many of these are trading below issue price - see my article about the risks in perpetual bonds.)

The level of private banking incentives has also changed with the market. In a "hot" market, where new issues are flying off the door and recently issued bonds are trading above the issue price, the incentive could be 25 cents; but last year, in times of market stress, the incentive is known to have gone up to 75 cents or even a dollar in some cases.

Given the the rising clout of private banks, it is no surprise that issuers and bankers are willing to pay them an incentive to distribute their bonds, and consider such incentives to be a cost of raising funds. I see little scope for this practice to change any time soon. Private banks will continue to play a significant role in Asian bond markets for a while yet. Issuers will have to just grin and bear it.
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Asian bond issues cross $50bn this year

21/4/2013

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We have reached a milestone in Asia – Asian USD bonds issues have crossed USD50bn this year – see this chart from Reuters.

I remember the pre-crisis years of 2004 to 2007, when the average issue size used to be USD30bn per year. Then came the GFC and the volumes fell to USD16bn in 2008. Since then, not only have the volumes sprung back with a vengeance, but have smashed all previous records. The new issue volumes shifted to around USD60bn for three years, 2009 to 2011,
and then more-than-doubled to USD130bn in 2012.

It so far looks like this year has started even stronger. At this rate, we can look forward to breaking the 2012 record this year.

When I look back, two trends stand out in Asian bond markets. One is the rise of China. Before GFC, China used to account for 10-15% of bond issues; just after GFC, the share rose to about 25%; and this year so far, it is 38%. Two factors are behind this phenomenon. One is the growth of the Chinese high-yield market, particularly the property sector. But equally, there
have been chunky large issues from Chinese state-owned investment-grade companies that are expanding their business overseas. A large share of these companies are in oil, gas, coal and other natural resources, and are raising funds for overseas acquisitions.

The other major trend in Asian issuances is the rise of high-yield bonds, which have gone from a pre-GFC share of about one-third to 43% this year. This increase is, of course, linked to the issuance of bonds by Chinese property companies.

While the rise of China is welcome in creating a large and viable asset class, it presents a challenge to investors as it reduces their ability to diversity, to which I alluded in the earlier
blog post
.
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Asia's century!

16/4/2013

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I recently came across two charts that tell an eloquent story.

The first is one that we have put together using data from the USDA. The chart shows the share of global GDP over the last 40-odd years. Asia has risen to rival USA and Europe in terms of GDP share: each of them contributes roughly a quarter of global GDP now. (The other stunning thing in the chart is the decline of Europe.)
Picture
The second one is even more striking. It comes from the excellent “Asia 2050” report published by the Asian Development Bank. Looking at a longer period in history, the chart shows the turnaround in Asia’s contribution to global GDP starting in mid-20th century. It looks about 40 years ahead and plots an increase to over 50% share of global GDP for Asia by 2050.
Picture
As the report puts it, Asia’s rise is not preordained. There are many challenges ahead. But if any one region has the potential to develop and grow, it is Asia!
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Junk bonds in Asia taking off

14/4/2013

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Today's Financial Times article shines the spotlight on the growth of Asian high-yield bonds this year. It says that Asia ex-Japan high-yield bonds have contributed 30% of new supply this year, significantly higher than the 12% reached at the same point last year. In fact, according to our proprietary database, the share of corporate high-yield issues in USD has reached a much higher level of 44% so far this year.

While this may sound like excessive exuberance, reflecting the thirst for yield around the world, Asian high-yield is an established asset class and not just a passing fancy. In the previous five years, the share of high-yield issuance in Asian USD bonds has ranged from a low of 27% in 2012 to 53% in 2010. Traditionally, these figures have included bonds from Philippines and Indonesian sovereigns, as both used to be rated below investment-grade. But what is new is that the high-yield market share in Asia is rising even after these countries have been upgraded to investment grade.

Certainly, some of the development around the fringes of the Asian high-yield market is fueled by the global wave of liquidity. We have recently seen more issues of perpetual bonds, many of which have disappointed investors. We have also seen "CCC" rated issuers being able to issue new bonds this year - a first for the Asian bond market. More innovative (and riskier) structures have also managed to go through. But not all of Asian high-yield market growth is froth. There are many solid businesses and repeat issues that are accessing the market.

The challenge in the Asian high-yield segment is how to balance the weight of China, particularly the Chinese property sector. After the spate of corporate governance scandals in the equity and bond markets involving Chinese non-property industrial companies, the market had grown wary of these issues, but is beginning to open up to them again. This year, China has issued 52% of all the high-yield bonds. While the FT article talks about non-Chinese issuers emerging slowly, diversification still remains a challenge for Asian high-yield portfolios. Indonesian high-yield is picking up again, after the market had been smothered for a long time by impractical rules that required the issuers to take the approval of shareholders for the bond issue, including the proposed yield!

While there are challenges to the growth of Asian high-yield, it is a product here to stay and grow.
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Low yields from high yield bonds: What an oxymoron!

9/4/2013

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Another day, another article about how low the yields in high-yield bonds have reached. This time in FT, which cites the recent 5-year bond issue by Case New Holland (CNH) at a yield of 3.625%. The article discusses the disproportionate interest for somewhat better-rated high-yield bonds; in this case, the CNH bonds are rated “BB” by S&P and “Ba2” by Moody’s – pretty solid ratings for a high-yield company.

Looking at this from an Asian perspective, we see the same phenomenon here of investors’ chasing better-rated, “BB” category high-yield bonds. But the yields are still higher in Asia. For example, a 2018 bond from Country Garden, an established Chinese property name in Asian credit, rated one notch lower, is trading at over 7%. Citic Pacific 2018, rated one notch higher, gives you over 5%. Zoomlion 2017, also rated a notch higher than CNH, gives just over 5% yield. Adaro 2019, an Indonesian coal company with a lot of coal under the ground, also rated one notch higher than CNH, gives nearly 5.75%. In general, it is possible to easily find 5-year bonds in Asiafor “BB” rated companies with over 5% yield.

Then the question arises: is there any other reason for Asian bonds to provide higher yields? One possible answer is liquidity. The other is unforeseen risks of corporate governance in Asia, which have proved to be the bane of investors in some Asian companies such as the notorious Sinoforest. 

But with careful picking of names, it is possible to choose companies with solid history, state backing or good assets. It is also possible for experienced Asian market professionals to identify those bonds with better liquidity. 

Make no mistake: Asian yields, for both investment-grade and high-yield bonds, have also tightened a lot. But they still provide valuable pick-up over US bonds.
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    Dilip Parameswaran
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