At the margins

Formula for startup success in India

Thu, 16 May 2013 05:05:00 +0100

The second piece in the series on start-ups in India. This one looks at the kind of companies that could work.

For Indian companies, the path to global relevance is building technology products for businesses, not individuals. These products, also known as enterprise software, help companies run all aspects of their operations, from payroll to customer relationship management. As businesses grow and try to increase productivity with limited resources, they constantly need to upgrade their technology – so the demand for a good product is evergreen.

The full text is here.

Why Indian consumers aren't the path to start-up success

Wed, 15 May 2013 20:48:10 +0100

Entrepreneurs and investors rushed into e-commerce sites in India over the last few years. But returns from from online retail have been disappointing. This piece looks at the reasons for the false dawn of online shopping in India.

Indians haven’t taken to online shopping as widely as hoped. (Quick test – what percentage of your monthly spending is done online?).

People distrust using credit cards online, so retailers began offering a cash-on-delivery option. But this is an expensive proposition for the online retailer, who basically has to finance the sale till the order is delivered. Also, cash-on-delivery makes it easy for customers to reject products at the point of delivery. These manual interventions take away some of the efficiency gains of online selling.

The full text is here.

The democracy bottleneck

Fri, 08 Jun 2012 14:38:14 +0100

India’s economy has run out of steam. Years of dithering and inaction by India’s government has finally caught up. As I discuss in this piece, the policy paralysis won’t be cured anytime soon.

Unfortunately, the situation isn’t likely to improve anytime soon. In the parliament no single party has a clear mandate and the largest party, Congress, is beholden to smaller regional allies for majority. Welfare programmes and populist policies that appeal to their base guarantee the support of these parties. As the government is more concerned with short-term survival, any difficult decisions are put on the back burner.

That is a shame. Continued growth promises to lift millions of Indians out of poverty. But this requires the country’s leaders to take a long view and think beyond the next election cycle. Under the current electoral arithmetic, that seems unlikely.

The full text is here.

The limits of plug-and-play development

Fri, 04 May 2012 00:00:00 +0100

In which I evaluate the impact of technology-based development projects. Despite best intentions and smart engineering, the results aren’t encouraging. The problem, as it turns out, is that we are too focused on the technology and not enough on how people interact and integrate with technology.

There is also a big difference between well-controlled field trials and real world usage. As engineers and scientists, it is easy to fixate on the technology. It is a lot harder, however, to predict human behaviour and how that interacts with technology. With the clean stoves, Ms Hanna and her colleagues found that previous evaluations of the programme relied on trained fieldworkers to inspect and repair the stoves regularly. Not surprisingly, households readily switched to the newer stoves and the results were positive. But in cases where owners were responsible for the upkeep and proper use of the stoves, take-up of the programme was slow. What’s more, in households that did make the switch, use of new stoves declined over time, broken stoves weren’t repaired and households ultimately reverted to the polluting cooking fires.

A longish post, the full text of which can be found here.

From print: Taxes and the cash stash

Thu, 01 Mar 2012 08:00:00 +0000

Overcomplicated corporate tax policies in the US are distorting financing decisions

How much cash does one company need? According to Apple, $97 billion seems plenty. At the company’s shareholder meeting last week, Apple’s CEO Tim Cook conceded that the company had more cash than needed to run operations. But barring a large acquisition or an unexpected dividend payout, Apple will continue its upward cash trajectory. The company, which ended 2011 with $97.6 billion in cash, is on course to pass the $100 billion mark for cash holdings. In the previous two quarters, the company’s cash reserves grew by $21 billion.

Apple isn’t an isolated case. For the past few years, non-financial companies have been accumulating large piles of cash, driven by lack of good investment opportunities and fear of another recession. Leading this race for cash, by a wide margin, are technology firms. The top eight technology companies by market size, collectively hold around $320 billion in cash reserves. Microsoft has $51 billion in the bank, while both Cisco and Google have more than $45 billion squirreled away.

There are good reasons why companies in knowledge-based industries such as technology and life sciences, need large cash balances. The most valuable assets for the firms are intellectual capital such as people or algorithms. Valuing these intangible assets can be difficult. Knowledge-based firms also compete in a volatile environment, where a new smartphone or social-media platform can render the product obsolete. A comfortable cash cushion, allows these companies to weather market movements while focusing on innovation. Indeed, previous research has shown that knowledge-based industries lose up to 80% of their enterprise value in times of financial distress, while companies with more tangible assets such as energy, lose only 10% on average.

And yet, the numbers seem excessive. Consider Apple. The company has zero debt and its operating expenses last quarter were $3.6 billion. A $97.6 billion cash buffer is overly conservative. Google’s debt-to-equity ratio is a benign 7%. The reason for this stockpile isn’t financial prudence but tax avoidance. Apple has stashed $64 billion of its cash offshore. The top eight technology companies have around $210 billion or, 66%, of their cash overseas. Microsoft and Cisco have close to 90% of their cash outside the US.

These numbers are symptomatic of broken tax system. At 35%, America has one of the highest corporate tax rates in the world. But there is a large variance among businesses in the effective tax rate, due to countless loopholes and exceptions. For instance, transfer pricing - the mechanism by which multinational firms assign a price to the sale of goods and services among subsidiaries - can be manipulated to recognize profits in low-tax havens. By deferring overseas profits, firms can avoid paying any taxes. Most technology firms indefinitely defer the foreign income, preferring to reinvest overseas, rather than repatriate. Ironically, most of the overseas earnings are held in dollar denominated assets such as US Treasury bills.

Of course, one could argue that these companies are maximizing value by exploiting market distortions. But these tax dodging schemes can hurt shareholders. For one, cash rich managers have the temptation to make bad investment decisions. A strong justification for Microsoft’s $8.5 billion acquisition of Skype and HP’s $10.3 billion acquisition of Autonomy was that these deals were financed with overseas profits. While cheap cash may have made these companies attractive, did it trump other business factors?

Focusing on tax policies can also skew financing decisions. Most of the technology companies have large operating costs in the US. Domestic earnings do not fully cover these costs. But rather than use the overseas profits, companies prefer to issue debt to fund ongoing operations. Thus companies are levering up domestically even as they lobby for a repatriation tax holiday. While the large technology companies have room to grow their debt, it could impact their ability to react to business slowdown. It also isn’t clear if the strategy of investing overseas cash in low-yielding assets is the right one. Without many investment opportunities outside the US, shouldn’t the companies return the cash to shareholders and let them make investment decisions?

To be sure, America’s tax code needs reform. However any substantial changes to the US tax code appears unlikely until the presidential elections are over. Until then companies must recognise that building up cash mountains solely to avoid taxes may lead to inefficient financing and investment decisions. Returning the profits to shareholders through dividend payout may be the best use of the cash.

Cautious capitalism

Wed, 07 Dec 2011 14:10:00 +0000

The post crisis economy - tentative and risk-averse.

A firm’s aversion to capital markets can persist for decades after a recession. A recent paper by Antoinette Schoar and Luo Zuo, from MIT’s Sloan School of Management, concludes that managers who begin their career during a recession have a conservative management style when compared with their non-recession peers. The authors find that early career experiences are important and can influence firm-level decisions even decades later, when the “recession manager” becomes a CEO. The companies headed by these managers are reluctant to access public markets, have lower capital budgets and pay higher effective tax. If the pattern from previous downturns holds, then we can expect the next generation of business leaders to eschew capital markets in favour of self-sufficiency. Firms will invest less in capital-intensive projects and in research and development (R&D) to tightly control finances.

This strain of financial conservatism could also impact start-ups that seek to commercialise innovative technology. Typically, in the aftermath of a recession, the flow of money to early-stage companies is reduced. This may not be a bad thing. It is possible that during boom times, excess capital dents financial discipline, and leads investors to fund mediocre ventures. In contrast, during a recession, investors are more diligent about their investment. In fact, a study by the Kauffman Foundation found that more than half of the companies on the 2009 Fortune 500 list were launched during a recession or bear market.

My full post is here.

Still not open for business

Thu, 03 Mar 2011 17:56:00 +0000

The challenge with modernizing India’s retail sector.

Opening up the retail space to foreign investment would help in overhauling the country’s antiquated supply chain. Shortcomings in the distribution systems have created huge differences between wholesale and retail prices. Inefficiencies are common. The government estimates that 40% of the fruit and vegetable production in country is lost due to inadequate storage and transport infrastructure. Waste of this magnitude, troubling in the best of times, is appalling as the country battles double-digit inflation.

Yet, despite a consensus among policymakers that opening up of the retail sector to foreign investment has benefits both in the near and long term, the government shied away from reaching a decision. The reason behind the hesitation is the political clout of existing traders. An estimated 35m people or 7.3% of India’s workforce, are employed in the unorganised retail sector. The traders have been very vocal about their opposition to any form of organised retail and have regularly conducted mass protests and ransacked supermarkets to make their sentiments known. They fear that the arrival of big-box retailers will price the corner grocery stores out of business. There is some truth to this. As this article notes, the advent of an organised retailer can lead to reduced sales in the first year. But after a few years the stores are more or less back to where they started.

My full post is here.

High-speed traders set their sights on Asia and Latin...

Thu, 12 Aug 2010 00:00:00 +0100

High-speed traders set their sights on Asia and Latin America

Will robots take over exchanges in the emerging markets?

There are hurdles to the spread of HFT, however. Emerging-market governments are wary of encouraging short-term foreign investors. HFT firms which seek to exploit currency movements or arbitrage price differences between local-currency and foreign-currency bonds want to move funds in and out of a country with minimal friction. The presence of capital controls makes this hard. Brazil’s 2% tax on foreign equity and debt investments in 2009 did not deter existing HFT firms but did discourage new ones.

My piece in the magazine is here (subscription needed).

The breakfast club

Fri, 06 Aug 2010 15:34:00 +0100

What’s behind the recent round of food inflation?

A look at the reasons behind the price movements of each of the commodities suggests that the rally on some of the commodities may be overdone. First, unlike the food crisis two years ago, this time around inventories of rice, corn and other commodities are at healthy levels. The Food and Agriculture Organisation estimates that after two consecutive years of record crops, world wheat inventories have been replenished sufficiently to cover the production shortfall. Crude oil prices are also lower than in 2008, suppressing the demand for biofuels, which drove the rise in corn prices last time around. Finally, one only has to look at the divergence between the wheat futures and the physical cash market to understand that the futures surge is probably an overreaction to the drought.

My full post is here.

Building better models

Tue, 03 Aug 2010 16:20:00 +0100

Identifying and measuring systemic risk isn’t easy. But complexity of a problem shouldn’t be a barrier. Why can’t economists use advances in network theory and computational mathematics to refine their models?

A new NBER paper by Mila Getmansky, Andrew Lo and Loriana Pelizzon attempts to identify some early warning indicators that can be a useful for assessing future vulnerabilities. Instead of using financial information such as leverage and asset size, which may not be publicly available, the paper relies on econometric techniques to tease out systemic risk. The actual analysis is very mathematical, but essentially the authors first create a map of the connections among the four major groups of financial institutions. (The groups are hedge funds, banks, brokers and insurance companies.) Next, they identify the causal relationships among individual firms to create a web of statistical relations among individual firms.

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Such an analysis is long overdue. For too long macroeconomics has relied on simplistic models to explain an ever more complicated world. As the authors in the paper point out, the severity of a financial crisis depends on the correlation between assets of different financial institutions, the sensitivity of these assets to market conditions and linkages between the financial institutions and the rest of the economy. Current economic models cannot process so many variables. The ideas presented in this paper are a good start, as are discussions around agent-based models or econophysics.

My wonkish post here.

Financial reform whack-a-mole

Thu, 29 Jul 2010 12:41:00 +0100

A telling quote from Volker on his feelings about the Financial Reform bill - “[I]t doesn’t have the purity I was searching for”.

A short post here.

India looking to the rain gods

Tue, 27 Jul 2010 20:15:00 +0100

Trying to make sense of the RBI’s multiple targets for India’s economy.

Unlike central banks around the world, the RBI doesn’t have a clear inflation or unemployment mandate; instead it targets multiple indicators that are known only to officials within the bank. At any given point it is not clear whether the bank is monitoring inflation, exchange rates, financial stability or some other metric. This uncertainty has made guessing the RBI’s policy statements a favourite game amongst analysts.

The RBI’s rejection of inflation targeting is now increasingly at odds with the central government, which is finding its fiscal policy hampered by the RBI’s inability to get prices under control.

My full post is here.

Asia decoupling?

Fri, 23 Jul 2010 13:01:00 +0100

Can Asia ever decouple from the West?

There is some evidence to support this. The bank’s data show that the Asian recovery has been driven by the region’s own economic demand - there has been a rebound in intra-regional trade. The region is also less dependent on foreign capital than before. The impact of the European debt crisis has been minimal, with bond yields falling as capital continues to flow in.

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Yet the region is still vulnerable to shocks from the West. Despite an increase in domestic demand, Asia depends heavily on exports. Most countries in the region continue to undervalue their currencies, making it difficult to move away from developed-world demand and toward domestic consumption. Stimulus spending has driven much of Asia’s blistering growth this year, but if America and Europe continue to face sluggish growth, no amount of fiscal or monetary pump-priming can prevent a slowdown.

My full post is here.

From print: When the chips are down

Thu, 22 Jul 2010 00:00:00 +0100

The latest Big Mac index suggests the euro is still overvalued

Covering the annual movement in the Big Mac index has to be one of the most fun topics to write about. Where else can you “chomp” at over valued currencies, attract “yield-hungry investors” and ask readers to take your analyses with a “generous pinch of salt”?

Sample this:

Other currencies are dearer still. Investors looking for a safe place to put their money have sought refuge in the Swiss franc. Despite attempts by the Swiss central bank to stem the appreciation, the Swiss franc is overvalued by 68%. Those on the hunt for a value meal should also steer clear of Scandinavia. In Norway a Big Mac would set you back by 45 kroner or $7.20, nearly twice the cost in America.

Place an order for my full piece here (subscription needed).

More powerful than you think

Fri, 16 Jul 2010 13:44:00 +0100

Interesting research which shows that central banks are not helpless when short-term rates reach zero.

When the Fed announced its intention to buy large portions of long-term Treasuries, which are in limited supply (in theory), the price of the bonds increased and their yields decreased. If investors were able to substitute Treasuries with comparable bonds from other countries the effect should have ended there. But sovereign bonds are imperfect substitutes, and American yields fell more than those of other countries. The change in relative yields caused the dollar to depreciate immediately due to undershooting, but led to expectations of appreciation over a long horizon.

The full text of my post is here.

Out of the shadows

Tue, 13 Jul 2010 12:23:00 +0100

Exactly how big was the shadow banking system, in the run up to the crisis?

First, as the graph below shows (figures in trillions of dollars), the volume of credit intermediated by the shadow banking system is larger than that of the regular banks. Prior to the crisis, shadow banks had liabilities of $20 trillion compared with $11 trillion for regular banks. Today, the figures are $16 and $13 trillion, respectively.

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The subprime crisis may have started the fall, but the financial crisis was precipitated by a run on shadow banks. As this paper shows, there is an inherent weakness in the shadow banking system that makes it vulnerable to future bank runs.

In traditional banks, deposit insurance acts as an official put, limiting any losses suffered by retail investors. For shadow banks, the bulk of the deposits are provided by money market funds. These funds expect their deposits to be available on demand and at par. But the implicit put option, at par value, is not backed up by any capital or official enhancement whatsoever.

My full post is here.

Few big to fail

Fri, 09 Jul 2010 17:58:00 +0100

A short post on how a small set of banks soaked up most of the government bail out money.

Between 37 and 63 percent of the support extended under capital, guarantee and asset protection schemes has been absorbed by the largest three recipient institutions. For each individual measure, the three largest recipients account for 3 to 9 percent of total euro area banking assets.

The full post is here.

From print: Infra red

Thu, 08 Jul 2010 00:00:00 +0100

India’s ambitious development plans hinge on attracting private capital

Socialist-era infrastructure remains a bottleneck for India’s growing economy. Yet, despite a clear market need, raising capital is a challenge.

One reason for the gap is that private-sector participation has been lower than expected. All infrastructure projects have an element of risk, but in India structural impediments create additional dangers. The single largest factor in project delays is the difficulty in acquiring land. In most countries, land acquisition is completed before a project is bid for. In India the government often rushes to award projects with only a part of the land acquired. In the absence of any mechanism that ensures fair compensation for land, developments easily become embroiled in long legal disputes.

My piece in the magazine is here (subscription needed).

A new global reserve?

Fri, 02 Jul 2010 15:05:00 +0100

Moving away from the dollar as the global reserve currency will not be easy. A natural experiment from Hungary demonstrates just how difficult it is.

A reserve currency must have a deep and liquid market. This is where the dollar scores over other currencies. Even the euro, which was a viable alternative before the current crisis, has not been able to displace the dollar’s dominant position as an international medium of exchange. One explanation is obviously inertia. Banks are used to dealing with a set of bilateral exchange rates and will continue to do so. But these attitudes can change, particularly with a crisis. What is more difficult to get over is network externalities—if dollars can be exchanged easily against other foreign currencies, then any domestic currency can be exchanged against dollars.

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Beyond just a store of value, the currency must be at the centre of international banking and cross-border lending. Introducing a new currency into this network will be hard, even if it’s the right thing to do.

The full text of my post is here.

Gathering clouds

Wed, 30 Jun 2010 21:31:00 +0100

The coming Euro-zone storm.

As Buttonwood reports, the three-month dollar Libor rate is almost as high as the two-year bond yield. Banks are reluctant to lend to Spanish and Greek banks because they are deemed too risky. This chart from the FT shows that European banks deposited €305 billion with the ECB on Monday night, despite getting only 0.25%. Banks prefer to forgo excess rates from other banks in favour of safety. Compare this to the €196 billion that the euro-zone banks had deposited with the central bank during the height of the crisis to understand how nervous they are at the moment.

Next, Simon Derrick makes an interesting comparison between the behaviour of the euro now and during the crisis. He points out that since the Swiss National Bank stopped intervening in the market in June, the Swiss Franc, Yen and Pound have all done well against the Euro, while the Euro has gained against the Australian and Canadian dollar. Why is this important? Well, Simon notes that between September and December of 2008, the Euro collapsed against the Franc and Yen, while it gained on the Australian and Canadian dollars, which are commodity-linked.

The full post is here.