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Vol. 006 28 th Nov 2016
Vol. 006
28th
Nov 2016
WHAT WE ARE READING
Trump Inflection Point 3-7
India’s Demonetization Impact 8-12
Fortune Predictions For Year 2017 13-26
League Of Nationalists 27-35
Opinion Is The Lowest Form Of Knowledge 36-38
Analyzing The Trade Deficit 39-47
Sustainable Sources Of Competitive Advantage 48-49
When Borders Close 50-51 Demand Curve To Take A Downward Slope 52-61
How Tughlaqs Changed Currency & Lost Plots In 14th Century 62-65
Christopher Wood [email protected] +852 2600 8516
Friday, 11 November 2016 Page 1
Trump inflection point? New York In the end it was the sheer enthusiasm that counted. Those who have argued that the crowds consistently attending The Donald’s rallies during this presidential campaign belied the negative message sent by opinion polls have been proved absolutely right. Still it is remarkable just how wrong the vast majority of opinion polls have been, with the honourable expectation of the USC Dornsife/LA Times Daybreak tracking poll which has consistently shown The Donald leading. For example, the poll showed prior to the election Trump leading Clinton by 3.2ppts (46.8% vs 43.6%) and by an average 1.9ppts since the poll began in July (see Figure 1). Interestingly, this poll also called the last presidential election right. Indeed the poll was one of the most accurate of that election year. It predicted that Obama would be re-elected with a margin of victory of 3.32ppts, while he eventually won by 3.85ppts. Other highly paid political commentators and “pollsters” have clearly failed miserably.
Figure 1 USC Dornsife / LA Times Presidential Election Daybreak Poll
Source: University of Southern California (USC)
Moving on to the consequences of this truly historic result, with the election of what the New York Times front page headline on Wednesday called an “outsider mogul”, the answer is that the consequences could be momentous in the sense that Donald Trump has every intention of pursuing an aggressively pro-growth policy while, with the Republican Party retaining control of Congress, there is every chance that such policies can be implemented. It is also the case that the Republican Party owes more to Trump than he owes to them since they retained the Congress in part on the Trump wave which saw working class voters in the Northern Industrial Rust Belt turning Republican. This is the equivalent of Labour working class in the north of England supporters voting for Brexit.
The focus on growth is why the market reaction on Wednesday US time makes sense, namely falling bonds and rising stock prices (see Figure 2). Still it needs to be noted that this is the opposite of the market action that was happening in Asian time Wednesday when it first became clear that, contrary to all predictions, The Donald was on course to win. Then stocks sold off sharply and bonds rallied in classic “risk off” market action. The US dollar also sold off in line with traditional “risk off” mode, though in America it rallied on Wednesday may be because Treasury bond yields make the dollar look more attractive (see Figure 3).
GREED & fear must admit to surprise at the dollar’s strength since the base case here would have been that a Trump victory would lead to a weaker dollar. Still the critical issue right now is
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Christopher Wood [email protected] +852 2600 8516
Friday, 11 November 2016 Page 2
the Treasury bond action. This is because a Trump triggered “bond riot” has the potential to feed on itself in the run up to the inauguration on 20 January. First, there is the issue of the amount of money in America allocated to so-called “risk parity” strategies. GREED & fear discussed this issue in some detail last year (see GREED & fear – Panic attack, 9 July 2016). They key point is that such strategies involve owning bonds on leverage on assumed market correlations which may now break down.
Figure 2 S&P500 and 10-year US Treasury bond yield
Source: CLSA, Bloomberg
Figure 3 US Dollar Index
Source: Bloomberg
The second risk posed by a bond riot would be renewed turmoil in the credit markets where there remains a major technical problem in terms of the collapse in inventories held by brokers and dealers relative to the huge increase in mutual funds and ETFs holdings of corporate bonds. The ratio of US mutual funds and ETFs’ holdings of corporate bonds over brokers and dealers’ holdings has soared from 1.7x in 2Q07 to a peak of 32.4x in 1Q16 and was 28.7x in 2Q16 (see Figure 4). On this point, GREED & fear heard this week that flows into debts ETFs in America are almost equal to flows into equity ETFs so far this year. To be precise, inflows into global equity ETF products totalled US$120bn so far this year, compared with US$109bn into global fixed income products. While in America fixed income ETFs took in US$76bn and equity ETFs US$77bn year-to-date.
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Christopher Wood [email protected] +852 2600 8516
Friday, 11 November 2016 Page 3
Figure 4 Ratio of US mutual funds & ETFs’ holdings of corporate bonds over brokers & dealers’ holdings
Note: Not including money market mutual funds. Source: CLSA, Federal Reserve – Flow of Funds Accounts
The third issue raised by a bond sell-off is whether, as discussed here previously (see GREED & fear – History forming, 3 November 2016), it creates a stress test of the Bank of Japan’s recent commitment to fix the 10-year JGB yield at 0%. So far the 10-year JGB has barely moved relative to the significant decline in the price of the 10-year Treasury bonds. The 10-year US Treasury bond yield rose by 20bp on Wednesday to 2.06% and is now 2.05%, while the 10-year JGB yield rose by 3bps today to a negative 0.04% after falling 1bp yesterday (see Figure 5). But the more Treasury bonds sell off the bigger the risk that such a test occurs. In this sense a move in the 10-year Treasury bond yield through 2.25%, say, is the kind of market move that could trigger such a stress test. That in turn would mean the BoJ being seemingly committed to unlimited JGB purchases which would be yen bearish and Japanese equity bullish.
Figure 5 10-year JGB yield and US Treasury bond yield
Source: CLSA
If these are some of the risks and opportunities raised by a pending Trump presidency, the other point is that Trump now has ten weeks prior to his inauguration to calm markets ahead of his presidency. In this sense the American situation is very different from the situation, say, in Britain where the change in power after an election is immediate. This is important given it will be much easier for Trump to implement his pro-growth agenda if comparative bond market calm can be maintained. In this respect, his undoubted likely focus on getting the US$2.5tn of cash held offshore by corporate America back into the US could work out two ways. It could be interpreted as either very bond bullish or bond negative depending on how all that cash is deployed. It is also a potential issue for the funding of the European banking sector since
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Christopher Wood [email protected] +852 2600 8516
Friday, 11 November 2016 Page 4
US$2.5tn is equivalent to 20% of Eurozone bank private deposits. Another issue is, if Trump offers this tax break, will he demand in return a quid pro quo from corporate America in terms of how they deploy their cash.
The other point about the interim period is that Trump now has ten weeks to convince the world that he is not the cartoon character depicted by the mostly biased media, be it American or foreign, in recent months. This is why it is interesting to note that the rally in stocks commenced when Trump made his acceptance speech which was, to those who have bought into the media caricatures of The Donald, surprisingly gracious. The point here is that it has so far not paid to underestimate The Donald. He has made a success of whatever he has chosen to focus on as an adult, be it property development or perhaps more accurately property branding, reality TV and now politics. He has also pulled off a feat which GREED & fear never would have predicted in a politically correct age. That is that he has been elected as president while refusing to submit a tax return. That is real hutzpah to coin an expression loved by New Yorkers.
Being in New York this week it is also worth asking whether a Trump victory and a continuing Republican controlled Congress spells some sort of relief from the excruciating regulatory overkill which has been suffocating the American financial services industry. That is certainly a possibility to consider. The hope will be material changes if not repeal of the 2,300-page Dodd-Frank legislation. Such hope, along with rising bond yields, is why US bank stocks have rallied on the election. Another hope would be the repeal of the Department of Labour’s Fiduciary Rule which poses the latest threat to the active fund management industry as discussed here recently (see GREED & fear - The stampede into passive, 20 October 2016).
What about the protectionist theme? GREED & fear’s hope on this is that the Trump focus will be more focused on renegotiating trade deals rather than overt protectionism. The first target is likely to be Mexico not China. Meanwhile, the other hope must be that one of his more informed supporters will be able to convince The Donald that China ceased to be a currency manipulator many years ago.
Finally on the US, a rate hike now seems “baked in the cake” in December following last Friday’s data with average hourly earnings growth accelerating to 2.8%YoY in October, the highest level since June 2009 (see Figure 6). Still the Trump victory, combined with a continuation of a strong dollar and rising bond yields, would imply a tightening of monetary conditions which will not be welcomed by the Fed. But the base case now must be for a Fed rate hike in December unless equities sell off sharply in the interim.
Figure 6 US average hourly earnings growth
Source: US Bureau of Labour Statistics
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Christopher Wood [email protected] +852 2600 8516
Friday, 11 November 2016 Page 9
Figure 14 CLSA Korea universe’s dividend payout ratio
Note: Based on CLSA’s Korea universe of 101 stocks under coverage. Source: CLSA evaluator
Finally in Asia anyone who thinks Indian Prime Minister Narendra Modi is not serious about making bold changes should pay attention to the Indian Government’s surprise move on Tuesday night to scrap the legal tender status of Rs500 and Rs1,000 currency notes. This is a big deal since, as noted by CLSA Indian strategist Mahesh Nandurkar this week (see CLSA research India Strategy – Huge anti-corruption reform, 9 November 2016), India has one of the highest levels of currencies in circulation at 12% of GDP while cash on hand is an estimated 3.2% of household assets at the end of March. Of this cash, 87% is in the form of Rs500/1,000 notes.
Figure 15 India currency in circulation as % of GDP
Note: Fiscal years ending 31 March. Source: CLSA, RBI, CEIC Data
GREED & fear agrees with Mahesh’s conclusion that this will be short-term pain for long-term gain. Part of that pain will be reflected in renewed weakness in the property sector where use of “black money” is endemic, as reflected in the 10% decline in the India property index on the day following the announcement (see Figure 16). But this is all part of Modi’s ongoing effort to promote the use of digital money, a process enabled by the fact that 1.08bn Indians now have electronic ID cards.
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Disclosures & Disclaimer This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it.
Issuer of report: HSBC Securities and Capital Markets (India) Private Limited
View HSBC Global Research at: https://www.research.hsbc.com
In the short run, India’s drive to withdraw and replace high-denomination currency notes will bring some benefits, some losses
Inflation and banking sector liquidity will benefit, while ‘effective’ money supply and growth will get hit; an immediate fiscal bounty does not look likely
Longer-term gains will depend on follow-up reforms that authorities undertake
Well begun is half done… …though it’s the other half that can make or break. The government’s decision to abolish pre-existing stock of high denomination currency notes (demonetization) and issue new notes (remonetization) can have a mixed impact on the macro economy over a year. Long-term gains will be realised if this bold move is followed up by other reforms (like incentivizing digital adoption and tackling other shelters for unaccounted money).
Using the cash elasticity of GDP, we estimate that over a year, economic growth can fall by 0.7-1.0ppt, with the maximum impact in the immediate two quarters, which will see a large contraction in ‘effective’ money supply. Alternate estimates based on consumer behaviour also point to a similar ballpark. Our estimation of the Phillips curve points to a ~20bp fall in CPI inflation. Expectations of lower growth and inflation solidify our 25bp rate cut call for the current fiscal year.
As the old INR500/1,000 notes make their way to the banking sector, deposits are likely to swell and lending and deposit rates could fall by year-end. Government bonds have already seen an impressive rally. The RBI will need to suck out the large increase in liquidity, lest it leads to risky lending; we expect it to use of a variety of instruments (reverse repo and MSS issuances for temporary liquidity; OMO sales for permanent liquidity). There is much talk of a large one-time fiscal bounty for the government. However, neither its timing nor its quantum can be taken for granted. As long as the RBI is open to exchanging old notes for new ones, it cannot extinguish the liability and transfer funds to the government. Given the legal status of currency notes, it comes as no surprise that so far, the RBI has not officially signed up for an end date for the scheme.
While we expect imports of consumer goods to fall, we find that this could be easily offset by higher gold demand. Our FX strategists see the rupee weakening versus the USD to 68.0 by end-2016 and 69.5 by end-2017. All told, the short run is indeed a mixed bag. Longer-term gains depend on follow-up reforms.
Flashnote 16 November 2016
Pranjul BhandariChief India Economist HSBC Securities and Capital Markets (India) Private Limited [email protected] +91 22 2268 1841
Dhiraj Nim Economics Associate Bangalore
India’s demonetization impact ECONOMICS INDIA
A macro mixed bag
Inflation and banking sector liquidity will benefit, while ‘effective’ money supply and growth will get hit; an immediate fiscal bounty does not look likely
Longer-term gains will depend on follow-up reforms thatauthorities undertake
Well begun is half done……though it’s the other half that can make or break. T
Long-term gains will be realised if this bold move is followed up by other reforms (likeincentivizing digital adoption and tackling other shelters for unaccounted money).
Using the cash elasticity of GDP, we estimate that over a year, economic growth can fall by 0.7-1.0ppt, with the maximum impact in the immediate two quarters, which will see a large contraction in ‘effective’ money supply.
Our estimation of the Phillips curve points to a ~20bp fall in CPI inflation. Expectations of lower growth and inflation solidify our 25bp rate cut call for the current fiscal year.
Government bonds have already seen an impressive rally. The RBI will need to suck out the large increase in liquidity, lest it leads to risky lending
There is much talk of a large one-time fiscal bounty for the government. However, neither its timing nor its quantum can be taken for granted. As long as the RBI is open to exchanging old notes for new ones, it cannot extinguish the liability and transfer funds to the government. Given the legal status of currency notes, it comes as no surprisethat so far, the RBI has not officially signed up for an end date for the scheme.
While we expect imports of consumer goods to fall, we find that this could be easily offset by higher gold demand. Our FX strategists see the rupee weakening versus the USD to 68.0 by end-2016 and 69.5 by end-2017. All told, the short run is indeed a mixed bag.
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ECONOMICS INDIA 16 November 2016
2
The government’s decision to withdraw the pre-existing stock of high denomination currency notes from circulation (demonetization) and issue new currency notes (remonetization), in a bid to combat black money and counterfeit notes, has been a huge source of debate and discussion (see India Economics & FX Comment Shock and awe: Government cracks down on black money, 9 November 2016, for details of the scheme). In this note, we tease out its short-term macro implications.
Economic growth: 0.7-1ppt lower over a year In the short run, the move can be disruptive for growth via (1) negative wealth effect for those losing net worth (the ‘store of value’ function of money) and (2) transactional inconvenience for consumers and producers (the ‘ease of payment’ function of money). Cash-intensive sectors are likely to hurt most.
We quantify the disruption using two methods. Both methods suggest that GDP growth could fall by about 0.7-1.0ppt over a year. The current and next quarters are likely to be disrupted most as they will experience the maximum contraction in ‘effective’ money supply (this is discussed in more detail in the next section). This is a pity really, because these quarters were likely to benefit most from an improving rural economy. Growth rates could improve gradually thereafter, especially if RBI makes necessary currency available in a timely fashion.
Method 1: Cash is used for a large proportion of transactions in India, across both the informal (45% of the economy) and formal sectors. We calculate the cash elasticity of GDP growth and find it to be high and fairly stable over time. During the next few weeks, when remonetization is still incomplete and there are restrictions on the withdrawal of money, there will be a sizeable contraction in effective money supply, likely hurting economic growth.
Some of this disruption could get repaired when new notes become adequately available and limits on withdrawals are relaxed. But some disruption may not get repaired in a hurry. To the extent a proportion of outstanding INR500/1,000 notes never return to the banking system (or are not switched for new notes), money supply would be reduced for much longer, lowering economic activity and growth. The elasticities suggest that if the proportion of INR500/1,000 notes not returning lie in the 15-20% range, GDP growth over the year will be 0.7-1.0ppt lower.
Method 2: We look through the consumption basket and find that about 60-80% of it is cash-intensive by varying degrees (examples include food, transport, real estate and restaurants). We assume that growth for these components halve on the back of the monetary shock. As an alternative, we assume that growth in these sectors falls to its lowest quartile over its long history. Both scenarios suggest a fall in GDP growth of about 1.0ppt over a year.
Money supply: An ‘effective’ contraction
It is important to distinguish between ‘official’ and ‘effective’ money supply. Official money supply is what we find printed in the RBI’s press releases. Effective money supply is the amount available for carrying out everyday transactions in the real economy. It is possible for official money supply to remain unchanged but effective money supply to fall if, for example, there are restrictions on withdrawing money from banks.
Until the final deadline for depositing the old INR 500/1,000 notes (or exchanging them with new ones), official money supply (both base and broad money), could either remain unchanged (if all else remains unchanged1) or fall (if RBI resorts to liquidity-absorbing measures such as open market sales, reverse repo transactions, etc).
1 In the current context, the mix of money supply has changed from currency in circulation to deposits. It is possible for the mix to change and overall money supply to remain constant.
Economic growth is likely to fall by 0.7-1ppt over one year, with maximum disruption in the first two quarters
‘Effective’ money supply, which is needed to carry out day-to-day transactions, has contracted sharply
In the short run, the move can be disruptive for growth via (1) negative wealth effect for those losing net worth (the ‘store of value’ function of money) and (2) transactional inconvenience for consumers and producers (the ‘ease of payment’ function of money). Cash-intensive sectors are likely to hurt most.
The current and next quarters are likely to be disruptedmost as they will experience the maximum contraction in ‘effective’ money supply (this is discussed in more detail in the next section). This is a pity really, because these quarters were likely to benefit most from an improving rural economy. Growth rates could improve gradually thereafter, especially if RBI makes necessary currency available in a timely fashion.
During the next few weeks, when remonetization is still incomplete and there are restrictions on the withdrawal of money, there will be a sizeablecontraction in effective money supply, likely hurting economic growth.
We look through the consumption basket and find that about 60-80% of it is cash-intensive by varying degrees (examples include food, transport, real estate and restaurants).We assume that growth for these components halve on the back of the monetary shock.
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ECONOMICS INDIA 16 November 2016
Beyond the deadline date, the official stock of money will fall by the amount of currency that never returns.
On the other hand, effective money would have contracted right from the day the demonetization scheme was announced (8 November); unavailability of notes and restrictions on withdrawals have made it difficult to carry out transactions, even for those who have legitimate wealth in liquid bank accounts.
Over the medium term, as the current disruption eases, the RBI will go back to supplying (official and effective) money to the extent demanded and compatible with its inflation-targeting objective.
Inflation: Around 20bp lower over a year
The fall in aggregate demand is likely to put a downward pressure on prices. Our estimate of the Phillips curve (which describes the relationship between output gap and inflation) suggests that with lower growth (of about 0.7-1.0ppt) and a wider output gap (of about 0.4-0.5% of GDP), inflation can, on average, be 20bp lower over a year.
The lower inflation impact may not show up immediately because of supply disruptions. Anecdotal evidence suggests that agriculture food procurement, which largely runs on cash, has been hit in recent days. As remonetization gathers pace, some of the supply-side disruptions could be repaired.
Lower growth and lower inflation over the next year are supportive of our 25bp repo rate cut call for the remainder of the fiscal year.
Banking sector liquidity: Big bounty supportive of faster transmission
In the short run, the demonetization drive will see a change in the mix of money stock from currency in circulation towards deposits. If, for instance, about 80% of the outstanding stock of INR500/1,000 notes is deposited into banks, the deposit base could rise by INR11.3trn (USD170bn, about 7.5% of GDP) by December. This would be unequivocally supportive of lower deposit and lending rates. The interbank call money rate is already trading well below the repo rate. Expectations that some of these deposits will be parked in government bonds have also fuelled a G-sec rally.
While we remain constructive on monetary transmission into lower deposit and lending rates, it is important to get a sense of the limits. It is not clear how much of the liquidity bounty will remain in the banking system over time, and how much will go back into the cash economy once the restrictions are lifted. If banks fear that deposits will soon switch back into currency in circulation, they will not be in a hurry to lower deposit and lending rates by too much. After all, estimates suggest that if just 5% of active account holders withdraw INR24,000 per week (the current upper limit), the entire INR11trn demonetization bounty could leave the banking system in two quarters.
In the medium term, if the government is able to expand and incentivize the use of digital payments, banking sector liquidity could improve permanently. But until some important steps are taken, that cannot be taken for granted.
Inflation is likely to fall by about 20bp over a year, although it may not show up immediately due to several temporary supply side disruptions
Banks will be flush with liquidity, which will support transmission into a variety of rates – lending rate, deposit rate, and government bond yields
Over the medium term, as the current disruption eases, the RBI will go back to supplying (officialand effective) money to the extent demanded and compatible with its inflation-targeting objective.
The fall in aggregate demand is likely to put a downward pressure on prices. Our estimate of the Phillips curve (which describes the relationship between output gap and inflation) suggests that with lower growth (of about 0.7-1.0ppt) and a wider output gap (of about 0.4-0.5% of GDP),inflation can, on average, be 20bp lower over a year.
The lower inflation impact may not show up immediately because of supply disruptions.
Lower growth and lower inflation over the next year are supportive of our 25bp repo rate cut callfor the remainder of the fiscal year.
the deposit base could rise by INR11.3trn(USD170bn, about 7.5% of GDP) by December. This would be unequivocally supportive of lower deposit and lending rates. T
it is important to get a sense of the limits. It is not clear how much of the liquidity bounty will remain in the banking system over time, and how much will go back into the cash economy once the restrictions are lifted. If
In the medium term, if the government is able to expand and incentivize the use of digitalpayments, banking sector liquidity could improve permanently.
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ECONOMICS INDIA 16 November 2016
4
RBI’s liquidity management: Sucking out excesses using myriad tools
Even if about 80% of the deposits leave the banks over the next few months, the remaining 20% (worth 1.5% of GDP) is sizeable. Given that genuine demand for credit is weak, one can argue that this excess liquidity may not be inflationary. But inflation is not the only concern regarding excess liquidity. Over time, it can also lead to risky lending behavior. As such, the RBI is likely to feel compelled to absorb a part of it.
The RBI can suck out the part of excess liquidity it finds temporary by using temporary tools such as reverse repo transactions and issuance of short-term MSS bonds. For the part RBI finds more permanent in nature, it can use permanent tools such as OMO sales.
It will be difficult to tell exactly how much is temporary and how much is permanent in the short run. But rough estimates can be drawn.
Fiscal bounty: Still up in the air
As discussed above, it is likely that some proportion of the INR500/1,000 notes will never return into the banking system. In a similar drive in 1978, 15% of the currency never returned. Many are expecting that this amount may be transferred as a fiscal bounty to the government.
It could work as follows: if, say, 20% of the outstanding notes are not returned, the RBI’s liability will fall by that amount. An equal amount of assets could then be sold and the proceeds transferred to the government as a one-time fiscal bounty. By our hypothetical example, this amount could be a sizeable INR2.8trn (USD41.3bn, 1.9% of GDP). Many of those expecting this transfer of funds also believe that as the government starts spending this bounty, the growth drag could be largely offset. In our view, while an attractive thought, things may not work out as seamlessly.
First, only once RBI sets a final date beyond which it will not accept or exchange old notes, will it be in any position to write off the corresponding liability. Until then, the exact amount will not be known, and RBI will have to hold onto it on the liability side of its balance sheet (in case someone turns up to exchange it with new notes). Following some indication in one of the speeches, many believe that this deadline is 31 March 2017.
However, a closer look reveals that so far the RBI has not confirmed this date. It has left it open ended, and rightfully so, in our view. The RBI circular clearly mentions that “… any person who is unable to exchange or deposit the specified banknotes in their bank accounts on or before December 30, 2016 shall be given an opportunity to do so at specified offices of the Reserve Bank or such other facility until a later date as may be specified by the Reserve Bank”. All of this implies that these funds may not be up for grabs as early as some are expecting.
Second, even if this amount becomes available, the RBI traditionally does not share these kinds of gains (which are akin to capital gains) with the government. Rather, it tends to only share income on investment with the government. For making an exception, an appropriate procedure would have to be drawn out, with which both the government and the RBI need to be comfortable.
While the possibility of a fiscal bounty exists, neither its quantum nor its timing can be taken for granted.
The RBI is expected to use both temporary and permanent tools to suck out excess liquidity
A one-time large fiscal bounty from the RBI to the government may not work out quickly
Even if about 80% of the deposits leave the banks over the next few months, the remaining 20% (worth 1.5% of GDP) is sizeable. Given that genuine demand for credit is weak, one can argue that this excess liquidity may not be inflationary. But inflation is not the only concern regarding excess liquidity. Over time, it can also lead to risky lending behavior.
. Manyare expecting that this amount may be transferred as a fiscal bounty to the government.
. Many of those expecting this transfer of funds also believe that as the government starts spending this bounty, the growth drag could be largely offset. In our view, while an attractive thought, things may not work out as seamlessly.
First, only once RBI sets a final date beyond which it will not accept or exchange old notes, willit be in any position to write off the corresponding liability. Until then, the exact amount will notbe known, a
Second, even if this amount becomes available, the RBI traditionally does not share these kinds of gains (which are akin to capital gains) with the government.
For making an exception, an appropriate procedure would have to be drawn out, with which both the government and the RBI need to be comfortable.
While the possibility of a fiscal bounty exists, neither its quantum nor its timing can be taken for granted.
abc
5
ECONOMICS INDIA 16 November 2016
Balance of payment: Can worsen if gold demand rises
We assume that consumer goods imports that roughly comprise about 30% of overall imports will fall (in line with GDP growth impact estimated above). But the resulting 0.2% of GDP improvement can quickly be offset by a higher gold import bill and increased demand for foreign assets as they become more attractive as a store of value (and medium of exchange).
Our FX strategists see the rupee weakening versus the USD to 68.0 by end-2016 and 69.5 by end-2017 (see Currency outlook: Special edition, 15 November 2016).
Conclusion
We are currently staring at a mixed bag. While demonetization followed by remonetization could be positive for inflation and banking sector liquidity in the short run, effective money supply and growth will take the bullet. The balance of payments could worsen and the positive short-term impact on fiscal accounts (in the way of a one-time bounty) cannot be taken for granted. While monetary transmission will speed up, it may not be as fast as some expect, given the uncertainty around the deposits that will stay back in the banking system.
In this note, we have stuck to discussing the macro impact in the short run (about a year). What happens thereafter, in our view, will depend on follow-up reforms. For instance, if the government wants to lower the stock of black money substantially, it will have to attack other assets (real estate, gold, foreign currencies) where unaccounted money is stored. One easy action could be to bring real estate under the GST web.
If the government wants to use this as an opportunity to increase digital payments adoption, it needs to incentivize the move and remove bottlenecks along the way. Fast-tracking the Universal Payments Interface (UPI) network and incentivizing micro-ATMs are examples of some easy wins.
If the government follows up with a spate of reforms, gains can be immense, as the parallel economy moves towards official. As the saying goes, ‘well begun is half done’. But the other half needs work.
If gold demand rises, it could offset the benefits from lower consumer goods imports
The short term is a mixed bag; long-term gains depend on follow-up reforms
While demonetization followed by remonetization couldbe positive for inflation and banking sector liquidity in the short run, effective money supply andgrowth will take the bullet. T
we have stuck to discussing the macro impact in the short run (about a year). Whathappens thereafter, in our view, will depend on follow-up reforms. , if the government wants to lower the stock of black money substantially, it will have to attack other assets (real estate, gold, foreign currencies) where unaccounted money is stored.
If the government follows up with a spate of reforms, gains can be immense, as the parallel economy moves towards official. As the saying goes, ‘well begun is half done’. But the other half needs work.
The 2017 Fortune Crystal Ball The Fortune staff’s well-informed predictions about the people, products, and
trends that will matter in 2017.
The election of Donald Trump to the presidency represents a seismic shift in American politics, an event with implications nearly impossible to predict. One casualty of the election, indeed, may be the science of prediction itself: For all their algorithmic gymnastics, pollsters and betting markets were utterly confounded by Trump’s win. Which is why it’s essential to have a prediction tool that relies as much on art (and whimsy) as it does on science. And this year, for some extra insight, we’ve even teamed up with artificial-intelligence powerhouse IBM Watson, which mined tens of millions of sources to help us spot hidden trends. Here, we offer our well-informed, intuitive take on the stories that will shape business—and much else—in the coming year.
Techno-Futurism
Next year, on-demand delivery, better virtual reality, and Internet-connected everything will keep making life easier—and riskier.
Illustration by Wren McDonald for Fortune
The IPO Market Is Coming Back
This year, the market for technology company initial public offerings has been weak at best. Just four small deals were completed in the first half of 2016. But since August, 10 companies hit the market, raising almost $2 billion. And it could be just the beginning. Many of the top names in startups—from big-data analyzer Palantir to ride-sharing titan Uber—have been hinting that they’ll soon be ready to go public. Plus, Snapchat has
reportedly already filed for an IPO confidentially. For many VCs awaiting a payday, the tech IPO revival of 2017 should come just in time.
Watson Says: Even Your Grandma Will Use Grubhub
Amazon and Facebook have jumped into online food ordering and delivery, making a crowded field even more so. But GrubHub should remain an industry leader. Its active user total rose 19% over the past 12 months, to 7.7 million, and an unusually high volume of social media mentions (revealed by an IBM Watson analysis) suggests it’s poised for more rapid growth. Bonus: It’s already profitable.
The Internet Will Get Shut Down Many More Times
It is a great irony that a system designed to withstand nuclear war falls so easily victim to a stampede of beeping baby monitors and webcams. We’re talking about the Internet, of course. In October a number of top websites—Twitter TWTR -0.88% , Amazon AMZN 0.03% , Spotify, and more—were knocked off-line when a sprawling botnet attacked a New Hampshire firm that serves as an Internet switchboard. An army of hijacked “Internet of things” devices swarmed this choke point with overwhelming traffic. Now, far from being fixed, the problem compounds as more unsecured devices—including surveillance cameras, toasters, and other home appliances—roll off the production line with weak default passwords. Fortune tends to agree with Jeremiah Grossman of security firm SentinelOne, who said after the recent strike that it “could easily be just a canary in the coal mine.”
Virtual Reality Glitches
Gaming and entertainment firms are pouring serious money into virtual reality, betting that it’s destined to be the next big thing. There’s just one problem: Early adopters aside, consumers don’t agree.
As of November, shoppers can buy any of the big three “first-generation” headsets: Oculus VR’s Rift, HTC’s Vive, and Sony’s PlayStation VR. But there’s no sign of a mass frenzy to scoop them up: Most are finding that mere novelty can’t justify the high price tag.
To be sure, there are signs of growth in VR. Research by Deloitte expects 2016 to be the industry’s first billion-dollar year. But it’s looking likely that the rocket ship will stall in 2017, unless software makers can come up with a true raison d’être—and soon.
AOL Will Get Cool Again
Don’t look now, but the “You’ve Got Mail” progenitor is getting its groove back. With the help of a series of ad-tech acquisitions—like Millennial Media, Vidible, and Convertro—the Verizon VZ 0.88% unit is building out a powerful new advertising platform, called
ONE by AOL. It may never make it into another romantic comedy, but among tech-savvy marketers, AOL is looking downright hip.
The iPhone Will Get a Radical Upgrade
The rumor mill is already cranking with leaks about the iPhone 8, due in 2017. Marking the 10th anniversary of Steve Jobs’ original iPhone, the new model is expected to include radical changes like a super-high-resolution OLED screen that stretches from edge to edge of the device, and a home button transformed into a virtual on-screen button. Other rumored features include wireless charging capability. After the mildly disappointing iPhone 7, the next update should be a more radical hit.
Drones Will Deliver Pizza (but Not Toilet Paper)
In the past year, we’ve seen drones deliver pizza, burritos, fried chicken sandwiches, and Slurpees. Expect to see more one-off junk-food flights as companies like Chipotle CMG -0.03% and Domino’s DPZ 1.00% use them as marketing stunts. But anyone thinking drones will usurp delivery drivers or postal workers in 2017 will be disappointed. New FAA rules have made it a bit easier, but companies still can’t legally fly drones at night or outside the line of sight of their operators without a special exemption. A NASA national air-traffic management system is in early stages—don’t expect regular drone shipments of toilet paper or toothbrushes until it’s done.
Marissa Mayer Will Become an Investor and Startup Advisor
No more corner office for Marissa Mayer—at least not as a CEO. Expect the embattled Yahoo chief executive to step down after Verizon’s acquisition of Yahoo is complete, pocketing a reported $55 million in the process. But it’s unlikely she will run another company post-Yahoo. Why not? Not only did Mayer’s reputation decline along with the once-powerful search company’s stock, but the job market for former female CEOs is unfortunately particularly tenuous. Case in point: Since 2004, not a single female Fortune 500 CEO who was fired from her job ever got another CEO position. (Yes, Yahoo was once in the Fortune 500.) And only two women have held more than one Fortune 500 CEO gig during the same time period. Mayer’s sizable exit package should be a good start to an investing career, though.
A Tesla Will Drive Itself Across the Country (With Help)
Electric car company Tesla, led by billionaire industrialist Elon Musk, will enable one of its cars to drive itself across the country from California to New York in 2017. While the trip might make big headlines, and show off Tesla’s aggressive self-driving car tech, the Tesla venture will only be a test and likely filled with Tesla engineers ready to grab the wheel at a moment’s notice. The electric computerized road trip also won’t be the first one. That honor goes to auto supplier Delphi, which built an autonomous car that made the classic Americana trip in 2015.
Watson Says: Uber and Airbnb Will Conquer the Sunbelt
The new economy’s ride-sharing and home-sharing giants are most popular today in dense coastal cities—think New York, Boston, or San Francisco. But IBM Watson research suggests Uber and Airbnb will make more inroads in the Southwest next year: It found significant spikes in news and social media mentions of the phrase “sharing economy” in cities including Phoenix, Denver, and Dallas.
Politics
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A Trump White House may defy predictability, but with Congress under GOP control, expect these early moves.
Illustration by Wren McDonald for Fortune
The U.S. Gets a Giant New Infrastructure Bill
President-elect Trump will make this a high priority because it will give him a speedy bipartisan win. Members of both parties love spending money on roads, bridges, airports and other infrastructure. As a former Capitol Hill staffer memorably put it, “The smell of hot tar is an aphrodisiac to legislators.”
Last year, Congress passed a five-year, $305 billion highway bill, which President Obama signed into law, but legislators will vote for more because Democrats view it as a
jobs measure and Republicans crave the corporate tax reform that’s likely to accompany it.
Climate Change Rules Are Rolled Back
Trump will launch his first attack on Obama’s climate-change legacy by moving to dismantle the Clean Power Plan, the current administration’s ambitious attempt to dramatically cut carbon emissions via pollution regulations. It would probably take Trump’s team a year to unwind the rule, which was finalized in 2015 and for now remains tied up in a court challenge. But shots are likely to be fired early.
There Will Finally Be (Partial) Tax Reform
Congress will change the corporate tax code to encourage (or compel) companies to repatriate trillions in overseas cash at a low tax rate. The revenue generated by that deal will give Congress cover to pass some of the deficit-swelling income tax cuts that Trump and the GOP have backed.
The Pendulum Swings Against Immigrants
Trump won’t be able to assemble his promised “deportation force” to boot undocumented immigrants from the country. But he will rescind Obama’s executive order allowing about 800,000 immigrants who came here as children to stay on two-year work permits.
Economy
2,073: Where the S&P 500 Will Finish in 2017
Yes, stock markets rose sharply after Trump’s win. But uncertainty about his impact on growth and trade will unnerve investors who are already anxious about interest rates and overvalued U.S. stocks. Expect the S&P 500 to finish 2017 about 3% below where it closed on Election Day.
1.25%: The Federal Funds Rate at the End of 2017
The Federal Reserve spent much of 2016 hinting that it wanted to raise rates. Now, Janet Yellen and Co. have a president-elect whose economic agenda may prove to be inflationary. The economy won’t justify huge rate hikes, but we can expect three quarter-point increases between now and next Thanksgiving.
U.S. GDP Growth Will Break 2%
International agencies are signaling an upbeat message for U.S. GDP growth in 2017, with the OECD, the IMF, and the Economist Intelligence Unit all forecasting 2.2%
growth or more—up from a projected 1.6% in 2016. Some banks have taken a more dour tone about the forecast, but with wages rising and unemployment low, there’s reason for a little optimism.
Oil Will Cost $50 a Barrel Next Year
The Energy Information Administration says the price of oil will tick upward in 2017, to $50 a barrel from the current $45. Others expect a bigger jump—Merrill Lynch, for example, projects the price will hit $69 by summer. We think OPEC will opt to keep production high, and thus prices lower. But either way, gas will get a little more dear.
Homebuilders Will Rise From the Dead
Home prices have risen relentlessly of late—the S&P/Case-Shiller index is up 37% since 2012—but homebuilders have not kept pace with demand, as inventory for sale has fallen 9% over that time. With wages rising and unemployment low, 2017 will be the year builders finally start building in earnest again.
The World
Nationalism, political uncertainty, and stunted trade will create new headaches in 2017. But global prosperity will keep increasing.
China Keeps Booming
Make no mistake, when President Xi Jinping last year called for GDP growth of at least 6.5% for the coming five years, China was signaling it would prop up growth in any way necessary. The domestic debt-to-GDP ratio rose by an astonishing 28% in the 12 months through June, according to Emerging Advisors Group. The result: Real estate prices are
up, consumers are spending, and GDP growth is hitting targets (though actual growth will be at least a full percentage point below the government’s official releases).
Putin Picks New Targets
The Baltic states are fairly well defended, but Russia may see a target in the Balkans. Moscow will continue to bulk up its cyber offensive too. Bad news for establishment politicians throughout the West.
Alain Juppé Will Be France’s Next President
Veteran conservative Alain Juppé will be elected President of France in May, beating Nicolas Sarkozy to the center-right UMP party’s nomination and seeing off the Front National’s Marine Le Pen in the runoff. Bonus prediction: German Chancellor Angela Merkel wins reelection, despite rising fringe groups.
Brexit Will Start, and the Euro Will Pass the Pound
U.K. Prime Minister Theresa May will trigger Article 50, formally starting the thorny process known as Brexit and further fueling concerns about the economy (scaring off capital). Meanwhile, inflation will curb ECB quantitative easing, driving the euro higher.
We’ll Get Some Good Geopolitical News in 2017
There will be much media attention on China’s disputes with its neighbors in the East and South China Seas. But words are unlikely to force truly destabilizing deeds because China’s reform process demands that China avoid trouble and because the neighbors know they can’t count on Washington to rescue them if they stumble into conflict. In addition, Colombia’s peace deal took a tumble a few weeks ago, but it will still happen because both sides want it. Finally, despite political dysfunction in both Greece and Turkey, we can expect a deal to reunify divided Cyprus. In all three cases, pragmatism prevails. —Ian Bremmer, president, Eurasia Group
Watson Says: It’s The Philippines’ Year
President Rodrigo Duterte’s penchant for vigilantism and anti-Americanism is worrying. But he has taken over an economy that’s hitting its stride: Economists expect Philippine GDP to grow 6.2% next year. One clue to a looming boom: An analysis by IBM Watson of some 700,000 global news sources found a high concentration of mentions of infrastructure investment linked to the country.
Trendsetters
Next year’s crazes will include Star Wars (expect the new one to win at the box office), athleisure (comfort is king), and novelty fast food (sorry, calorie counters).
A Fortune 100 Company Will Go Office-Free
The first to go was the personal office. Then the cubicle bit the dust. Now even the open office is at risk, with the rise of “hot desks” that belong to everyone and no one. In 2017 the slow dissolution of the workplace will reach its natural conclusion: The first Fortune 100 company will jettison the office altogether. After all, why foot a hefty real estate bill
when telecommuting is an option? A backlash may be brewing, though, as mentoring drops off, laptop-bound workers report ergonomic issues, and employees burn out when they find themselves literally living at the office.
High Heels Go Out of Style
If we’re to take Victoria Beckham’s word as gospel (as we should), women will pitch their sky-high stilettos once and for all. The style legend famously ditched her Christian Louboutins this year for comfy sneakers, and women will follow in her newly cushioned footsteps. Increasingly health-conscious consumers now see high heels—once the epitome of elegance—as an unnecessary bodily risk.
Old Havana Beats Out Old San Juan (for Now)
Cuba’s tourism ministry expects a record number of visitors this year: 3.8 million, up 19% from the previous year’s high. If the momentum holds in 2017, the number of foreign visitors to Cuba will surpass those to Puerto Rico and the U.S. Virgin Islands combined. But the surge may be short-lived: Once American visitors realize that those 50-year-old classic cars belch noxious fumes, tourism will drop off.
Star Wars VIII Will Be the Year’s Biggest Release
Star Wars VIII will be the biggest film of next year, yes, but that’s not all. Expect it to blow past last year’s installment—which was the third highest grossing film globally of all time, according to Box Office Mojo. Last year, Disney likely breathed a sigh of relief when critics and diehard fans alike loved The Force Awakens. Despite three underwhelming prequels, the movie sold tickets faster than the Millennium Falcon jumping into hyperspace—collecting more than $2 billion in global sales. So, how can the 2017 follow-up possibly top those huge numbers? Well, along with pleasing existing fans, The Force Awakens also inspired a new generation of Star Wars devotees in the U.S. and overseas (the original trilogy didn’t even screen in China until 2015). Those new fans will have been waiting eagerly for two years by Dec. 2017, and they’ll all be lined up at theaters around the world.
Watson Says: Ross Will Go On A Retail Rampage
Ross Stores is on a roll: Analysts expect the discount retailer’s sales to rise 7% next year, to $13.6 billion—surpassing department-store giant J.C. Penney. Revenue has soared under CEO Barbara Rentler, who is reclusive but well liked. In an IBM Watson analysis of mentions of CEOs in news articles and social media, Rentler scored some of the highest positive “sentiment scores.”
These Are the Next Food Mashup Stunts
This year Burger King tried to take a bite of Chipotle’s lunch with its Whopperrito, and McDonald’s took a pass at Starbucks’ seasonal magic with pumpkin-spiced fries. Here, the weird ways food giants will (or, okay, might) try to knock each other off in 2017.
– DQ takes a page from Taco Bell with the Black Bean Blizzard Supreme. – KFC 12-piece Bucket of Cheeseburgers. – Applebee’s Tuña Colada: rich in omega-3s and rum. Look out, Long John Silver’s.
More Companies Tie the Knot
Helped along by low interest rates, the merger boom of 2016’s last quarter will keep rolling.
Comcast Will Buy T-Mobile
T-Mobile has been by far the fastest-growing U.S. wireless carrier since John Legere took over as CEO in late 2012, and has more than doubled its subscriber base, to 69 million. Sprint made a run at the company in 2014, but antitrust regulators waved it off. That likely wouldn’t be an issue for a buyer like Comcast CMCSA 0.29% , which has said it plans to offer a wireless service in 2017.
Private Equity Will Nab Hewlett Packard Enterprise
Now that it has sold off most of its software and enterprise services units to focus on high-end servers, storage, and data-center tech, the trimmer version of the once-mighty company will tempt buyers. Rumors are already circulating that private equity firms like what they see.
Simon Property Will Acquire Sears
Simon Property Group SPG 0.30% , the largest U.S. mall developer, formed a joint venture with Sears SHLD -2.26% last year to hive off some of its best locations and charge other retailers a premium. It follows that Simon could go one step further and buy the chain outright, then sell off or carve up the remaining space for other stores.
Amazon Will Make a Play for Barnes & Noble
After years of competing with physical bookstores, Amazon is building them. The tech titan has opened or announced four locations so far but is rumored to be planning more. Conveniently, Barnes & Noble BKS 0.00% has 638 stores and a market cap of $760 million—a pittance for its deep–pocketed rival. The risk? Antitrust regulators will close the book on it.
Slack Will Sell Out
Slack, the business-oriented chat product, has tons of traction if not profit. It would make a nice pickup for a company that wants to acquire potential customers and perhaps bask in Slack’s reflected glow. Any Slack acquisition—by IBM? by Cisco? by Oracle? by Salesforce?—would follow in the footsteps of Microsoft’s 2012 buyout of chat platform Yammer.
A Major Player Will Buy Netflix
There have been plenty of rumored suitors for Netflix, including Apple, Google and even Disney. Any company in the entertainment space drools at the company’s millions of subscribers and its growing stable of movies and TV shows. It would be an expensive mouthful, to be sure, with a market value of $50 billion. Plus Netflix CEO Reed Hastings has said he doesn’t want to sell. But he may not have much of a choice if the company’s spending on content keeps ramping up—it will hit $6 billion next year and it’s still growing. While it would take a suitor with very deep pockets, Netflix may have to go courting if its stock price starts to flag.
Under Armour Will Merge With Lululemon
Stretchy pants, meet basketball shoes. Under Armour’s UA -0.36% success outfitting the male gym-goer is matched only by Lululemon’s LULU 0.14% strength with yoga-loving women. A partnership could look good on both.
Where Fortune Is Placing Its Bets
A Streaming Service Finally Wins an Oscar
Netflix’s 13th, by Selma director Ava DuVernay, is a strong contender in the doc genre, and Amazon’s devastating drama Manchester by the Sea is getting buzz.
Disney Will Name Its Next CEO
The departure of Disney’s COO and heir apparent in April left CEO Bob Iger without a clear successor. Iger’s contract ends in 2018, and if it’s not renewed, Disney DIS 0.57% may have to nab an outsider as there’s not much time to groom an internal candidate. (Paging Sheryl Sandberg?)
We’ll Add More Solar Capacity Than Any Other Type of Power
As coal continues its decline, and wind and natural-gas growth slows, solar power just keeps getting cheaper. In 2017 more power companies looking to expand will turn skyward. Expect big new solar farms in remote areas.
Super Bowl Viewership Will Slip
NFL ratings are lagging this season. That’s partly because of the election, but also because of concussion concerns and domestic violence scandals. Our bet: This game gets 110 million viewers, down a bit from last year. Our other bet? It’s Cowboys vs. Patriots.
Ecuador Kicks Out Julian Assange
With its oil-exporting economy in recession and in need of investment, Ecuador may boot the WikiLeaks mastermind from its U.K. embassy as an olive branch to Europe and the U.S.
Barack Obama Will Get a $20 Million Book Deal
The post-presidential book deal is a time-honored moneymaker for past Presidents. But Obama, already the author of a writerly bestseller and a historic figure as the first African-American president, will command a higher premium than most.
There Will Be a Climate-Change-Driven Refugee Crisis
Hotter days, rising oceans, and extreme weather—already contributors to migration—will displace more people in 2017, particularly in low-sea-level areas.
Gourmet Burgers Get Hot (Cow Optional)
Pricey grass-fed beef sales grew 25% in the past year, while plant-based protein surged 35%. That combo only seems odd: Credit both rising trends to health and climate concerns.
Watson Says: The Next Big Drug Breakthrough—Beating Drug Resistance
A bit of sobering news on the threat of growing antibiotic-resistance: An IBM Watson study of news sources and medical journals found a surge in mentions of late-stage trials
related to CABP, a pneumonia associated with drug-resistant infections. Luckily U.S. drugmaker Cempra and Austria’s Nabriva each have drugs that are close to formal approval.
How We Did in 2016
On Target
We predicted correctly that slow growth and caution about the political climate would mean the Fed would raise rates only once in the past 12 months. We called an ongoing real estate boom (some would say bubble) in China. We predicted that new endorsement deals would put Serena Williams atop the female athlete earnings list. And we read the political tea leaves to predict that Sen. Tim Kaine would become Hillary Clinton’s running mate.
In the Ballpark
We warned that an email hack linked to foreign intelligence agencies would make news. (Hello, John Podesta.) And we predicted that hoverboards would be a hot item—roughly 3 million have been sold in the U.S.—but we missed that many would be so hot they’d catch fire.
Off the Mark
Ask us about the “Rubio/Haley 2016” T-shirts gathering dust in our garage. Like most of the media, we didn’t see Trumpism coming. We were also overoptimistic about tech, predicting a 22% surge for Apple AAPL 0.50% shares (instead they fell) and a breakthrough in nuclear fusion. (Still a Star Wars–only technology, alas.)
Contributors: Christina Austin, Kristen Bellstrom, Scott Cendrowski, Geoff Colvin, Barb Darrow, Katie Fehrenbacher, Alex Fitzpatrick, Erika Fry, Robert Hackett, Matt Heimer, Tom Huddleston Jr., Mathew Ingram, John Kell, Linda Kinstler, Beth Kowitt, Michal Lev-Ram, Polina Marinova, Chris Matthews, Tory Newmyer, Burcu Noyan, Roger Parloff, Aaron Pressman, Jeff John Roberts, Geoffrey Smith, Anne VanderMey, Jonathan Vanian, Phil Wahba, Valentina Zarya, and Claire Zillman
A version of this article appears in the December 1, 2016 issue of Fortune. This story was updated at 7:30 a.m. Nov. 16 to eliminate a discrepancy between the online and print versions.
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http://www.economist.com/node/21710276/print 1/9
Global politics
League of nationalistsAll around the world, nationalists are gaining ground. Why?
Nov 19th 2016 | BEIJING, BUDAPEST, CAIRO, DELHI, ISTANBUL, MARGATE AND PARIS
AFTER the sans culottes rose up against Louis
XVI in 1789 they drew up a declaration of the
universal rights of man and of the citizen.
Napoleon’s Grande Armée marched not just for
the glory of France but for liberty, equality and
fraternity. By contrast, the nationalism born with
the unification of Germany decades later harked
back to Blut und Boden—blood and soil—a
romantic and exclusive belief in race and tradition as the wellspring of national belonging. The
German legions were fighting for their Volk and against the world.
All societies draw on nationalism of one sort or another to define relations between the state, the
citizen and the outside world. Craig Calhoun, an American sociologist, argues that
cosmopolitan elites, who sometimes yearn for a postnationalist order, underestimate “how
central nationalist categories are to political and social theory—and to practical reasoning about
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democracy, political legitimacy and the nature of society itself.”
It is
troubling, then, how many countries are shifting from the universal, civic nationalism towards
the bloodandsoil, ethnic sort. As positive patriotism warps into negative nationalism, solidarity
is mutating into distrust of minorities, who are present in growing numbers (see chart 1). A
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benign love of one’s country—the spirit that impels Americans to salute the Stars and Stripes,
Nigerians to cheer the Super Eagles and Britons to buy Duchess of Cambridge teacups—is being
replaced by an urge to look on the world with mistrust.
Some perspective is in order. Comparisons with the 1930s are fatuous. Totalitarian nationalism
is extinct except in North Korea, where the ruling family preaches a weird mixture of Marxism
and racial purity, enforced with slavelabour camps for dissidents. And perhaps you could add
Eritrea, a hideous but tiny dictatorship. Nonetheless, it is clear that an exclusive, often ethnically
based, form of nationalism is on the march. In rich democracies, it is a potent votewinner. In
autocracies, rulers espouse it to distract people from their lack of freedom and, sometimes, food.
The question is: where is it surging, and why?
The most recent example is Donald Trump, who persuaded 61m Americans to vote for him by
promising to build a wall on the Mexican border, deport illegal immigrants and “make America
great again”. Noxious appeals to ethnic or racial solidarity are hardly new in American politics,
or restricted to one party. Joe Biden, the vicepresident, once told a black audience that Mitt
Romney, a decent if dull Republican, was “gonna put y’all back in chains”. But no modern
American president has matched Mr Trump’s displays of chauvinism. That no one knows how
much of it he believes is barely reassuring.
His victory will embolden likeminded leaders around the world. Nigel Farage of the UK
Independence Party (UKIP), the politician most responsible for Brexit, has already visited Mr
Trump, greeting him with a grin wide enough to see off the Cheshire cat. Viktor Orban,
Hungary’s immigrantbashing prime minister, rejoiced: “We can return to real democracy...
what a wonderful world.”
The consequences for the European Union could be disastrous. In France pollsters no longer
dismiss the possibility that Marine Le Pen, the charismatic leader of the National Front (FN),
could be elected president next year. Compared with other Europeans, French voters are
strikingly opposed to globalisation and international trade, and few think immigrants have had
a positive effect on their country (see chart 2). Ms Le Pen promises that she would pull France
out of the euro and hold a “Frexit” referendum on membership of the EU. The single currency
might not survive a French withdrawal. And if French voters were to back Frexit, the EU would
surely fall apart.
The rush for the exit
European elites once assumed that national identities would eventually blend into a continental
bouillabaisse. But the momentum is now with parties like the FN, including Hungary’s Fidesz,
Poland’s Law and Justice party and Austria’s Freedom Party (one of whose leaders, Norbert
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Hofer, could win Austria’s largely ceremonial
presidency next month). Ms Le Pen’s language is
typical. She caters to nostalgia, anxiety and
antipathy to the liberal international order. (“No
to Brussels, yes to France”, goes one slogan.) She
laments the decline of a proud people and vows
to make France great again.
Unlike Mr Trump, Ms Le Pen has never called for a ban on Muslims entering the country;
rather, she talks about curbing the “gigantic wave” of immigration. A lawyer by training, she
defends her arguments with reference to France’s rules on keeping religion out of public life. Yet
her voters are left in little doubt as to which sorts of immigrants she disapproves of, and whom
she counts as French. An FN campaign poster for regional elections in 2015 showed two female
faces: one with flowing hair and the French tricolour flag painted on her cheeks, the other
wearing a burqa. “Choose your neighbourhood: vote for the Front”, ran the text.
Ms Le Pen’s popularity has dragged other politicians onto similar territory. Nicolas Sarkozy, a
centreright former president, wants the job again. As soon as you become French, he declared
at a recent campaign rally, “your ancestors are Gauls.” At another, Mr Sarkozy said that
children who did not want to eat pork at school should “take a second helping of chips”—in
other words, that it was up to nonChristians whose religions impose dietary restrictions to
make do with the food on offer, not up to schools to accommodate them. France is witnessing a
“defensive nationalism”, says Dominique Moïsi of the Institut Montaigne, a thinktank, “based
on a lack of confidence and a negative jingoism: the idea that I have to defend myself against
the threat of others.”
Something similar is on the rise elsewhere in Europe, too. In 2010 the Sweden Democrats (SD),
a nationalist party, put out a television ad that captured the popular fear that Sweden’s
generous welfare system might not survive a big influx of poor, fertile Muslim asylumseekers.
An elderly white woman with a Zimmer frame hobbles down a dark corridor towards her
pension pot, but is overtaken by a crowd of burqaclad women with prams, who beat her to the
money. At least one channel refused to air it, but it spread online. Polls suggest the SD is now
one of Sweden’s most popular parties.
In the Netherlands Geert Wilders, the leader of the antiMuslim, antiimmigrant Party for
Freedom, is on trial for “hate speech” for goading his audience to chant that it wanted “fewer
Moroccans” in the country. Polls put his party in first or second place in the runup to the
national election in March; its popularity has risen since the start of the trial.
Britain’s vote in June to leave the EU was also the result of a nationalist turn. Campaign posters
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for “Brexit” depicted hordes of Middle Eastern migrants clamouring to come in. Activists railed
against bankers, migrants and rootless experts; one of their slogans was “We want our country
back”. After the vote David Cameron, a cosmopolitan prime minister, resigned and was replaced
by Theresa May, who says: “If you believe you’re a citizen of the world, you’re a citizen of
nowhere. You don’t understand what the very word ‘citizenship’ means.”
Even before Britain has left the EU, the mere prospect has made the country poorer: the
currency is down 16% against the dollar. Still, few Brexiteers have regrets. In Margate, a seaside
town full of pensioners, it is hard to find anyone who voted to remain. Tom Morrison, who runs
a bookshop, says: “[We] should be allowed to make our own laws…At least our mistakes will be
our own mistakes.”
Clive, a taxi driver, is more trenchant. “All the Europeans do is leech off us. They can’t even win
their own wars,” he says. He is glad that Mrs May has promised to reduce immigration: “We just
physically haven’t enough room for them…The schools are overfilled with foreigners.” He adds
that some of them are hard workers, but “in Cliftonville [next to Margate], you might as well be
in Romania. A lot of them are gypsies.” Asked if being British is important to him, he declares a
narrower identity: “It’s being English. English.”
Vladimir Putin, Russia’s president, is not sure what to make of Mr Trump. Though he doubtless
welcomes Mr Trump’s promise to reset relations with Russia, if America ceases to be the enemy,
he will need another one. Mr Putin’s core belief is in a strong state led by himself, but since he
first took power in 2000 he has harnessed ethnic nationalism to that end. In 2011 he faced huge
protests from an urban middle class angry about both corruption and uncontrolled immigration
by nonSlavic people. He responded by whipping up imperial fervour. When Ukraine sought to
move closer to the West, he then annexed Crimea and invaded Eastern Ukraine. State media
portrayed him as saving ethnic Russians from (historical) “Ukrainian fascists”.
With oil prices low, and after a long spell in the economic doldrums, nationalism is Mr Putin’s
way of remaining popular. His version involves rejecting the universal, liberal values that the
West has long promoted. That is why he so eagerly supports illiberal nationalist parties in
Western Europe, such as Ms Le Pen’s FN. “We see how many EuroAtlantic countries are in
effect turning away from their roots, including their Christian values,” he said in 2013. He
contrasted this with an ethnically defined version of Russia as “a state civilisation held together
by the Russian people, the Russian language, Russian culture and the Russian Orthodox
Church”.
In China a similarly ethnic, nonuniversalist nationalism is being pressed into service by the
Communist Party (see Briefing (http://www.economist.com/news/briefing/21710264worlds
risingsuperpowerhasparticularvisionethnicityandnationhoodhas) ). The party seeks to
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blur the distinction between itself and the nation, and to prop up its legitimacy now that
economic growth, long the main basis of its claim to power, has slowed. Soon after becoming
president in 2012, Xi Jinping launched the “Chinese Dream” as a slogan to promote the
country’s “great revival”. A “patriotic education” campaign extends from primary school all the
way up to doctoral students.
The government often blames “hostile foreign forces” for things it does not like, including
protests in Hong Kong or Xinjiang, a farwestern province where Uighurs chafe against Han
rule. State television tries to make other countries look stupid, dangerous or irrelevant. Anti
Western rhetoric has been stepped up. In 2015 China’s education minister called for a ban on
“textbooks promoting Western values” in higher education.
China’s glorious victory over Japan has become central to history lessons (though in fact it was
the communists’ rivals, the Kuomintang, who did most of the fighting). In 2014 three new
national holidays were introduced: a memorial day for the Nanjing massacre, commemorating
the 300,000 or so people killed by the Japanese there in 1937; a “Victory Day” to mark Japan’s
surrender at the end of the second world war; and “Martyrs’ Day” dedicated to those who died
fighting Japan.
My enemy’s enemy
Perhaps unsurprisingly, given the jingoism, many Chinese now see international affairs as a
zerosum game, believing that for China to rise, others must fall. A recent poll by Pew found
that more than half of those asked reckoned that America is trying to prevent China from
becoming an equal power; some 45% see American power and influence as the greatest
international threat facing the country. Chinese antipathy towards the Japanese has also
increased considerably.
The propaganda has been so effective that the government is no longer sure that it can control
the passions it has stoked. In 2012 protests erupted across China against Japan’s claims to
islands in the East China Sea: shops were looted, Japanese cars destroyed and riot police
deployed to protect the Japanese embassy in Beijing. The government now censors the angriest
online posts about nationalist topics.
AbdelFattah alSisi, Egypt’s authoritarian president, uses all the resources of the state to
promote the idea that he is the father of his country. His regime blames Islamists for everything:
when heavy rains caused flooding in Alexandria last year, the interior ministry blamed the
Muslim Brotherhood, a banned Islamist group, for blocking the drains. Last summer, after
splurging $8bn on expanding the Suez Canal, he declared a public holiday and sailed up the
waterway in full military regalia, as warplanes flew overhead. State television broadcast shots of
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the new canal to the bombastic theme tune of
“Game of Thrones”, a television show.
A similar story is playing out in Turkey, a country
that only a few years ago appeared firmly on
course to join the EU. Now its president, Recep
Tayyip Erdogan, vows to build a “New Turkey”,
bravely standing up to coupplotters and their
imaginary Western enablers. He recently attended a mass rally celebrating the conquest of
Constantinople in 1453. He accuses Turkey’s duplicitous Western allies of trying to “pick up the
slack of crusaders”. Such rhetoric is intended to justify the arrests of 36,000 people since a coup
attempt in July.
In India ethnic nationalism, never far beneath the surface, is worryingly resurgent. Since 2014
the country has been ruled by Narendra Modi of the Hindunationalist Bharatiya Janata Party
(BJP). The party seeks to distance itself from radical Hindutva (Hindu nationalist) groups,
which criticise it as “soft” on Pakistan, Muslims and those who harm cows (which are sacred to
Hindus). And Mr Modi is urbane, probusiness and friendly towards the West. But he is also a
lifelong member of the RSS (National Volunteer Organisation), a 5mstrong Hindu group
founded in 1925 and modelled loosely on the Boy Scouts.
Members of the RSS parade in khaki uniforms, do physical jerks in the morning, help old ladies
cross the street, pick up litter—and are occasional recruits for extremist groups that beat up left
wing students. And last year Mr Modi’s minister of culture, Mahesh Sharma, said that a former
president was a patriot “despite being a Muslim”. The minister remains in his job.
Hindutva purports to represent all Hindus, who are fourfifths of India’s population. It
promises a national rebirth, a return to an idealised past and the retrieval of an “authentic”
native identity. Its adherents see themselves as honest folk fighting corrupt cosmopolitans. They
have changed India’s political language, deriding “political correctness”, and calling critical
journalists “presstitutes” and political opponents “antinational”. The RSS also exerts huge sway
over education and the media. Some states and schools have adopted textbooks written by RSS
scholars that play up the role of Hindutva leaders and marginalise more secular ones.
The BJP has made a big push to control the judiciary by changing rules for appointments, but
has met strong resistance. It does not control most states in the east and south. Many of the
educated elite despise it. And banging on too much about Hinduism and not enough about the
economy is thought to have cost it a state election in Bihar last year.
So India will not slide easily into Turkishstyle autocracy—but plenty of secular, liberal Indians
11/25/2016 League of nationalists | The Economist
http://www.economist.com/node/21710276/print 8/9
are nervous. The police, especially, are thought to favour the ruling party. A reporter nabbed by
cops for the “crime” of filming angry crowds outside a bank in Delhi this week says they
threatened him with a beating and said: “Who gave you permission to film? Our government
has changed; you can’t just take pictures anywhere you like any more.”
Nations once again
Inquiring after the roots of nationalism is like asking what makes people love their families or
fear strangers. Scholars have suggested that nations are built around language, history, culture,
territory and politics without being able to settle on any single cause. A better question is: what
turns civic nationalism into the exclusive sort? There are several theories.
In rich countries, pessimism plays a role. As chart 3 shows, slower growth lowers support for
globalisation. Inequality hurts, too. Educated people may be doing just fine, but bluecollar
workers are often struggling. Mr Trump did remarkably well among bluecollar white voters.
One of the best predictors of support for Brexit or Ms Le Pen is a belief that things were better in
the past.
In developing countries, growth is often faster and support for globalisation higher. But people
still have woes, from rapacious officials to filthy air. For the newnationalist strongmen such as
Mr Sisi and Mr Putin, nationalism is a cheap and easy way to generate enthusiasm for the state,
and to deflect blame for what is wrong.
The new nationalism owes a lot to cultural factors, too. Many Westerners, particularly older
ones, liked their countries as they were and never asked for the immigration that turned Europe
more Muslim and America less white and Protestant. They object to their discomfort being
dismissed as racism.
Elite liberals stress two sources of identity: being a good global citizen (who cares about climate
change and sweatshops in Bangladesh) and belonging to an identity group that has nothing to
do with the nation (Hispanic, gay, Buddhist, etc). Membership of certain identity groups can
carry material as well as psychological benefits. Affirmative action of the sort practised in
America gives even the richer members of the racial groups it favours advantages that are
unavailable to the poorer members of unfavoured groups.
Nationalists dislike the balkanisation of their countries into identity groups, particularly when
those groups are defined as virtuous only to the extent that they disagree with the nation’s
previously dominant history. White Americans are starting to act as if they were themselves a
minority pressure group.
Lastly, communication tools have accelerated the spread of the new nationalism. Facebook and
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http://www.economist.com/node/21710276/print 9/9
Twitter allow people to bypass the mainstream
media’s cosmopolitan filter to talk to each other,
swap news, meet and organise rallies. Mr Trump’s
tweets reached millions. His chief strategist, Steve
Bannon, made his name running a white
nationalist website.
For Mrs May’s “citizens of nowhere”, all this is
deeply worrying. But they should not despair. Liberals can use social media, too. Demagogues
fall from favour when their policies fail to bring prosperity. And demographic trends favour
pluralism.
In many countries the universityeducated population—typically cosmopolitan in instinct—is
rising. In the postwar period about 5% of British adults had gone to university; today more
than 40% of schoolleavers are universitybound. In Germany 2m citizens were in tertiary
education in 2005; a decade later that number had risen to 2.8m. The share of 18 to 24year
old Americans in that category rose from 26% in 1970 to 40% in 2014.
And immigration, which has done much to fuel
ethnic nationalism, could, as generations are born
into diverse societies, start to counter that
nationalism. The foreignborn population of
America rose by almost 10m, to 40m in the
decade to 2010. In Britain it rose by 2.9m, to
7.5m, in the decade to 2011. Western voters aged
60 and over—the most nationalist cohort—have
lived through a faster cultural and economic overhaul than any previous generation, and seem
to have had enough. Few supporters of UKIP and the FN are young; the same is true for
Alternative for Germany, another antiimmigrant party (see chart 4).
But youngsters seem to find these changes less frightening. Although just 37% of French people
believe that “globalisation is a force for good”, 77% of 18 to 24yearolds do. The new
nationalists are riding high on promises to close borders and restore societies to a past
homogeneity. But if the next generation holds out, the future may once more be cosmopolitan.
This article appeared in the International section of the print edition
Opinion is the lowest form of knowledge
If this passes muster, all I have on offer is an argument on why I have no opinion about the demonetization issue Charles Assisi
I found myself on sticky ground last week. Soon after the Narendra Modi-led government announced that 86% of all Indian currency (by value) will be illegal tender, I was invited to be part of a panel discussion. I was asked to opine on what I thought of the decision. The problem was—and continues to be—is that I do not have one. I am too far removed from the powers that be and am unqualified to offer any opinion on what can only be described as a black swan event—unprecedented in contemporary Indian history. The world is looking at how things will unfold with much interest. The outcomes will be subject to much scrutiny in the months and years to come. Much water has passed under the bridge since the day it was announced. I don’t know what lies ahead. But this much every Indian will concede. We now know what “demonetization” means. Had it not been for this, the all of us would have been swamped by news of Donald Trump taking over as president of the US, the most powerful office in the world—again a black swan event. The foremost political pundits in the world hadn’t imagined a day when Trump would come to occupy White House. But allow me to keep Trump outside the scope of this dispatch. There are more pressing matters at home. Like a cash crunch every place. ATMs have run dry and pretty much everybody is operating on IOU notes. And if reports are to be believed, more pain is on the anvil. Then there are conspiracy theories of all kinds doing the rounds. That is why it is with much consternation and amusement that I am listening in to all quarters—the right wing, the left wing, the centre, right of centre, left of centre and every place else. Because, as it turns out, everybody has an opinion. And in no place are these opinions more amplified than on social media. While there is a no denying a lot of good that has emerged out of social media, I have in the past vocalized why I think what I think about social media. The sum and substance of my arguments about social media platforms have veered on the extreme. I have tempered down since then. I no longer argue that everyone get off Facebook. In fact, I have gotten back to it. But I refuse to post anything personal on it. Not for anything else, but because I am still uncomfortable with its privacy policies. Originally intended to be a benign platform for friends and family to stay connected on, it has morphed into an entity that shapes public opinions, is a threat to established media, and commands valuations in multiples of billions of dollars. I intend to watch what shape and form this beast takes. I have ranted as well about the degeneration of Twitter and the intrusiveness of WhatsApp. But this much I continue to stand by—most social media conversations resemble echo chambers where biases are reinforced. Minus the diversity and sanity an editor brings to the table, it is easy to find voices that reinforce what we believe in. Why? By way of example, consider demonetization and the nature of the current discourse. I don’t want to be a part of it. Like I have articulated upfront, I do not have an opinion. The issue is complex. That is why I want to hear voices of people who have been vetted and put through the wringer by tough editors. Whether or not I agree with them or not is another matter altogether. The editor’s job is to ensure I have access to plurality and diversity. On social media platforms, though, no editors exist. Everybody has an opinion. Some of which are certainly interesting to listen in to. That said, the larger narrative on these platforms sound eerie: “You are either with us, or against us.” This is a narrative that has existed since Biblical times—but got into popular lexicon when George W. Bush, the president of the US made
this dramatic statement after the terror attacks on the Twin Towers in New York in September 2001. It left the rest of the world with no alternative, but to take sides. Extrapolated into contemporary discourse, it compels you to subscribe to one of two schools of thought: 1. Demonetization is for the greater common good and everybody ought to accept some temporary pain. 2. Demonetization is a disaster because it was not thought through and the worst-hit is the common man. But both arguments are thought-terminating clichés. In other words, these are pliant answers to a complex question that discourages any meaningful dialogue and are designed to create a rift—much like patriotism. If seen as questioning the actions of our military forces, you are labelled a “traitor”. But what if your only motive is to seek answers to questions on whether the outcomes of a certain action are in the larger and longer-term interests? What if you haven’t made your mind up? What if you only want to listen in to all sides? What if you do not have an opinion? What could possibly be wrong with that? My experience over the past few weeks suggests it puts people in a tight spot. In an earlier dispatch, I had alluded to a course I enrolled for. Called Theory U, it insists we discard all existing methodologies of learning. This is because all of what we learn is anchored in the past. What, instead, if we were to let go and begin by connecting with the moment we are in? In letting go of our past, we let go of all biases and prejudices. Engagement begins by listening deeply to all of what is going on around us. It then frees us up to imagine what possibilities can exist in the future. When looked at from a philosophical prism, it is both Buddhist and Socratic. Buddhist because you live in the moment and let go of all else. Socratic because you question and test every assumption. On paper, the course sounds easy. In practice, it is incredibly tough for various reasons. 1. I figured we aren’t used to listening—or at least I am not, particularly when the person I am listening to has something to say I don’t agree with. My instinct is to butt in and argue. But Theory U insists I shut up and listen. If I don’t, how am I to understand that there exists a world that is different from the one I live in? And that there are people unlike me who live there? If I don’t listen to their voices, I will once again be part of the echo chamber that now exemplifies all that is wrong with the social media. 2. Often, when listening in to people I agree with, they expect me to commiserate—much like I expect of them. But is it necessarily the right thing to do? Because the world I haven’t seen and disagree with may contain some grains of truth that I am yet to come to terms with. 3. Then, there is a practical problem implicit to deep listening. People are used to me being a certain way. I am perceived as a problem solver. But, Theory U insists, how am I to provide a cohesive answer until I have heard all sides? So, you turn your default mode to first listen, before you engage. When no response is forthcoming from somebody who has always been a solution provider, you stand the risk of coming across as someone who is either not listening or somebody who has disengaged. It leaves the speaker unnerved and feeling distanced. I haven’t wrapped my head around how to get around that. I’m hoping my course mates will see me through that. That said—and on the issue of demonetization, certainly—I would love to know what is it the prime minister has in mind. For all his bravado, there is no taking away from that the voices against him are getting louder. For instance, that the move was hasty; that it was unplanned; that the economy is unprepared; that this was aimed at crippling opposition parties in the forthcoming assembly elections; that it has alienated his traditional voter base; and so on and so forth. On the other hand, it is difficult to imagine that one of the savviest politicians India has witnessed in recent times may not have foreseen this. And that resentment will come not just from rivals, but from within as well. Just for the heck of it, I posted a 24-hour long poll on my personal Twitter handle to gauge public sentiment. With 192 responses, the answer was skewed against the government. 106 people voted against the move and 86 in favour. But then, my question was designed to skew people’s minds. I manipulated public opinion.
Does the government have the moral right to take away what is mine even if it be for a few days #DeMonetisation #DeMonetisationResponse
— Charles Assisi (@c_assisi) November 13, 2016
I could have manipulated opinion in any which way I chose to. What if I had framed it differently? What, for instance, if I had asked: “If our armymen can spend years in the harshest of terrains like Siachen protecting our borders, can’t we gulp a few weeks of pain?” I am pretty damn sure the final answer would have been dramatically different by an overwhelming margin. To that extent, it is easy to manipulate our minds and opinions. Allow me, therefore, to end this dispatch by quoting ad verbatim, from a commencement speech by William (Bill) Bullard, a former English teacher and photographer of considerable repute. Legend has it, the speech did not go down well with the authorities because he spoke bluntly to them on what he thought of opinions and what they ought to unlearn from school. I could not independently verify the assertion that it did not go down well with the school or find the full text online. What I could manage to extract is reproduced below. On the importance of opinion: Opinion is the lowest form of human knowledge; it requires no accountability, no understanding. The highest form of knowledge, according to George Eliot, is empathy, for it requires us to suspend our egos and live in another’s world. It requires profound, purpose-larger-than-the-self kind of understanding... On the importance of solving given problems: Schools teach us to be clever, great problem solvers, but not to include ourselves in the problem that’s being solved. This is a great delusion. It makes us arrogant and complacent and teaches us to look at the world as a problem outside of us. As in Oedipus, public problems—the plague on Thebes or our own pestilences, war or global warming—are private problems. The plague is only lifted when each person sees his responsibility not in analysing the problem, not in solving the riddle, but in changing our actions to address a public need. Oedipus destroyed the two things that had deceived him—his eyes and his power—and in so doing saved his city. On the importance of earning the approval of others: Schools teach students to seek the approval of their teachers. Indeed, for all of our differences, this is one area that parents and teachers share; we are wired or we are hired to believe in you, to approve you, to prevent or mitigate the experiences of disappointment… Try to correct this in two ways. First, seek people, work for people who don’t have to like you, people who can easily disapprove of you, people that you can’t easily please. Their scepticism or indifference will define you. Second, if you don’t do so already, begin working for yourself, and let the teachers be damned. But they won’t be—they will just be all the more approving because that kind of integrity can only command respect. After all, most of the work we devise is devised for students who are not working for themselves, so those that do surpass our expectations and teach us things that we have never thought of. Charles Assisi is co-founder of Founding Fuel Publishing. His Twitter handle is @c_assisi Comments are welcome at [email protected]
Antique Stock Broking Limited 2
Stratosphere - India in charts 02 November, 2016
Analysing the trade deficit
In the Feb edition of Stratopshere, we had investigated the likely reasons for the fall in exports alongwith a detailed analysis on the various components which were a drag on the overallexports. We found that India's export basket is possibly not that hedged, especially in the light of increasing domestic consumption of petroleum products. POL exports which was themainstay of export growth between FY10-13 had begun to decline on account of increased capacities in Middle East. Thus the assumption that a simple recovery in oil prices would leadto a better metric on the trade deficit is not necessarily true. In the current edition of the Stratosphere, we look to revalidate those assumptions while drawing out a hypothetical calculationas to what the trade balance will look like once normalisation happens (oil prices go up, engg imports increase, etc). Some of the challenges which we had the highlighted have begunto soften if not dissipate. For instance, POL exports have recovered slightly, not to say that the momentum will continue and even more difficult to say if it will be sustainable but still thereis some reversal at the margin. Similarly, volumewise there is an incrementally positive change which is being seen in commodity led exports. But China still continues to inflict a bigdifference and the trade deficit with China continues to widen (USD 46bn for latest trailing 12m vs USD 44bn for comparable period in the previous year). One key item is the export ofgems and jewelry to Hong Kong which is still off from its previous peaks. The disaggregation of imports suggest that while oil & gold have been the big contributors to the decline,components such as engg imports have also played their part. Engg imports (ex metal products) bear a very strong correlation with the GFCF cycle. We have also looked at the externalsector and find that while the dynamics are very favourable, trajectory of invisibles due to the slowdown in Gulf is already beginning to have a detrimental impact. Whether this trend willreverse depends on the pace of bounceback and sustainability of crude oil prices. We also believe that the current levels of trade deficit between USD 7-8 bn is likely to normalise andbelieve that a trade deficit of USD 12-12.5bn is more likely on a sustainable basis once there is normalisation of crude oil prices (we have assumed a what if scenario with crude oil pricesat USD 65/bbl) and engg imports too rise in line with increase in growth. Net-net on the external sector while some of the concerns which we highlighted seem to be softening there areareas which need monitoring such as remittances and the rising trade deficit with China + HK. The issue with remittances as highlighted in a World Bank/IMF study is that remittances fromGulf are not as closely related to oil prices as let us say, remittances from Russia is. But the problem is that if lower oil prices persist and the reserves of GCC countries begin to contract,remittances are likely to slowdown further. On the other hand, trade deficit with China + HK combined accounts for almost 50% of India's total trade deficit and more structural measuresare required to improve India's competitiveness.
Overall from a market perspective, India is an outperformer over the last 6 months but despite the near 30% midyear rally, equities are still underperforming both gold as well as bonds.There are multiple events leading upto the year end and as history also suggests November is generally a choppy month for equities. YTD, factors are pointing to a value rally with lowP/E, high RoE and high earnings growth stocks generally outperforming. To re-iterate global factors will play a role but what will be the main concern from a domestic perspective is howearnings trajectory shapes up. 2Q results have thrown up both hits and misses but the key point to highlight is that ex of PSU banks and TATA, the rest of the components need to grow byjust 8% to achieve the required 14% earnings growth for FY17. Pace of downgrades too have reduced considerably and the trigger will be the topline growth which could result inearnings surprises given the high implied DOL in the system. Valuations on a standalone basis are neutral but on some other market parameters such as implied growth, Shiller's PE thereseems to be some room for a rally. From a sectoral perspective, we remain positive on consumer discretionary and high quality plays on the investment recovery theme.
volumewise there is an incrementally positive change which is being seen in commodity led exports. But China still continues to inflict a bigdifference and the trade deficit with China continues to widen (USD 46bn for latest trailing 12m vs USD 44bn for comparable period in the previous year). One key item is the export ofgems and jewelry to Hong Kong which is still off from its previous peaks.
the current levels of trade deficit between USD 7-8 bn is likely to normalise andbelieve that a trade deficit of USD 12-12.5bn is more likely on a sustainable basis once there is normalisation of crude oil prices (we have assumed a what if scenario with crude oil pricesat USD 65/bbl) and engg imports too rise in line with increase in growth.
On the other hand, trade deficit with China + HK combined accounts for almost 50% of India's total trade deficit and more structural measuresare required to improve India's competitiveness.
Antique Stock Broking Limited 3
Stratosphere - India in charts 02 November, 2016
Composition of export basket to China
Source: Bloomberg, CMIE, Data for equity funds
China contributes to a staggering 50% of total trade deficit
Source: Bloomberg, CMIE
Composition of Chinese import basket
Source: Bloomberg, CMIE
Remittances from Gulf at risk of decline
Source: World Bank
Focus charts
0
10
20
30
40
50
60
Sep-
12
Dec
-12
Mar
-13
Jun-
13
Sep-
13
Dec
-13
Mar
-14
Jun-
14
Sep-
14
Dec
-14
Mar
-15
Jun-
15
Sep-
15
Dec
-15
Mar
-16
Jun-
16
Sep-
16
Trad
e de
ficit
with
Chi
na a
s %
of t
otal
trad
e de
ficit
0.3 12.7
24.2
6.4
16.8
39.7
POL
Chemicals
Engg goods
Electronic goods
Gold/precious stones
Others
Importbasket(China+HK),%2.0 2.8 6.74.1
3.8
63.9
16.7
POL
Agri
Ores & minerals
Chemicals
Textiles
Gems & jew ellery
Others
Exportbasket(toChina+HK,%)
China contributes to a staggering 50% of total trade deficitgg g
Composition of export basket to Chinap p Composition of Chinese import basketp p
Antique Stock Broking Limited 3 0
Stratosphere - India in charts 02 November, 2016
Excise collection ex-petroleum still shows double digit growth
Source: Bloomberg, CMIE
Sequentially, prices of essential food items has started to decline
Source: Bloomberg, CMIE
Budget in a fine balance
Source: Bloomberg, CMIE
CPI to come off significantly in 3QFY17
Source: Bloomberg, CMIE
Macro trends: a few positives and risks
Budget math % of GDP, FY17 Comments
Likely slippages
Telecom 0.19
Disinvestment 0.07 Assuming INR 350bn
Slippage due to 7th Pay commission 0.08 From RBI annual report
Total 0.35
Likely upsides from
Additional money from IDS 0.10
Excess indirect tax collection 0.28 Growth so far has been 25% vs budgeted target of11%, we have assumed 17% full year growth
Total 0.38
Net off set 0.04
-10-505
1015202530354045
Sep-
13
Nov
-13
Jan-
14
Mar
-14
May
-14
Jul-1
4
Sep-
14
Nov
-14
Jan-
15
Mar
-15
May
-15
Jul-1
5
Sep-
15
Nov
-15
Jan-
16
Mar
-16
May
-16
Jul-1
6
Sep-
16
Exci
se c
olle
ctio
n (e
x di
esel
), tra
iling
12m
sum
, %, Y
oY
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
Jan-
16
Feb-
16
Mar
-16
Apr-
16
May
-16
Jun-
16
Jul-1
6
Aug-
16
Sep-
16
Oct
-16
Nov
-16
Dec
-16
Con
tribu
tion
to Y
oY c
hang
e in
in
flatio
n ra
te, %
3.0
3.5
4.0
4.5
5.0
5.5
6.0
(%, Y
oY)
Ex tomatoes, potatoes, pulses TomatoesPotatoes PulsesCPI Inflation (RHS)
-40.0-30.0-20.0-10.0
0.010.020.030.040.050.060.0
Sep
15
Oct
15
Nov
15
Dec
15
Jan
16
Feb
16
Mar
16
Apr 1
6
May
16
Jun
16
Jul 1
6
Aug
16
Sep
16
Oct
16
(%, M
oM, c
hang
e, e
ssen
tial f
ood
pric
es)
Arhar Potato Tomato
Excise collection ex-petroleum still shows double digit growthp g g
CPI to come off significantly in 3QFY17g y
Antique Stock Broking Limited 3 2
Stratosphere - India in charts 02 November, 2016
Exports: which have been the big contributors to the decline?
POL(53.1%)
EXPORTS
Agriculture(11.6%)
Rice(5.8%)
Non-POL(46.9%)
Ores & Minerals(+ve)
Manufactured Goods(36.0%)
Guar Gum(2.2%)
Oilmeals(2.5%)
Meat(1.7%)
Oil seeds(1.2%)
Cotton(+ve)
Leather(1.9%)
Chemicals(+ve)
Eng.Goods(32.7%)
Electronic Goods(+ve)
Textiles/RMG(5.4%)
Others(+ve)
Iron & Steel(6.6%)
Ferrous &Non-ferrous
(13.4%)
Machinery &Instruments
(1.1%)
TransportEquipment(12.9%)
Gems & Jewellery(1.7%)
Plastics(+ve)
Aircraft& Parts(9.5%)
Ships &Boats
(3.8%)
AutoComponents
(0.1%)
MotorVehicles
(+ve)
Source: CMIE Note: Contribution to decline on a latest trailing 12m as compared to corresponding period in previous year
Antique Stock Broking Limited 3 3
Stratosphere - India in charts 02 November, 2016
No concern in value add segment
Source: Bloomberg, CMIE
Region wise, Gulf and China have been the biggest contributors
Source: Bloomberg, CMIE
Commodities is a big contributor to overall fall
Source: Bloomberg, CMIE
12 reasons to explain for 45% of the fall in exports
Source: Bloomberg, CMIE
Exports countries and commodities
-6.0 -5.0 -4.0 -3.0 -2.0 -1.0 0.0
Pet exports to SaudiPet exports to BrazilAgri to neighbouring countriesAircraft parts to UAEPet exports to SGPet exports to KenyaMetal exports to ChinaAircraft parts to Sri LankaPet exports to UAEPet exports to NetherlandsTextiles to ChinaAgri to USA
(% contribution to fall in exports)
-40.0
-30.0
-20.0
-10.0
0.0
10.0
20.0
30.0
40.0
Jun-
12
Sep-
12
Dec
-12
Mar
-13
Jun-
13
Sep-
13
Dec
-13
Mar
-14
Jun-
14
Sep-
14
Dec
-14
Mar
-15
Jun-
15
Sep-
15
Dec
-15
Mar
-16
Jun-
16
Sep-
16
(%, Y
oY)
Commodity Value-add Traditional
100.0 53.1
13.49.5
6.65.8 5.4 3.8 2.4
0102030405060708090
100
FY17
/FY1
612
m tr
ailin
gex
ports
fall
Petro
leum
prod Met
als
Airc
rafts
/par
ts
Iron
& st
eel
Ric
e
Text
iles
(exc
lR
MG
)
Ship
s &
boat
s
Res
t
% C
ontri
butio
n to
the
fall i
n ex
ports
, 12m
tra
iling
betw
een
now
and
pre
viou
s 1
2m
100.0
10.810.2
7.9
7.27.0
5.24.1
4.14.1 3.0
2.8 2.42.3
12m
end
ing
Aug'
16
Chi
na +
HK
Saud
iAr
abia
Sri L
anka
Mal
aysi
a
Braz
il
UAE
Sout
hAf
rica
Japa
n
Iran
Keny
a
Moz
ambi
que
Bang
lade
sh
USA
Res
t
% C
ontri
butio
n to
the
fall i
n ex
ports
, 12m
tra
iling
betw
een
now
and
pre
viou
s 1
2m
Commodities is a big contributor to overall fallg
Region wise, Gulf and China have been the biggest contributorsg gg 12 reasons to explain for 45% of the fall in exportsp p
Antique Stock Broking Limited 3 4
Stratosphere - India in charts 02 November, 2016
POL exports were lagging, now picking up
Source: Bloomberg, CMIE
Volume-wise trend seems to be improving
Source: Bloomberg, CMIE
Net imports slowdown as domestic consumption declines
Source: Bloomberg, CMIE
China trade deficit: Still a woring factor
Source: Bloomberg, CMIE * indicates a reduction in surplus
Exports: What were our concerns and how it is played out
-80-60-40-20
020406080
100
Jun-
11
Sep-
11
Dec
-11
Mar
-12
Jun-
12
Sep-
12
Dec
-12
Mar
-13
Jun-
13
Sep-
13
Dec
-13
Mar
-14
Jun-
14
Sep-
14
Dec
-14
Mar
-15
Jun-
15
Sep-
15
Dec
-15
Mar
-16
Jun-
16
Sep-
16
(PO
L, %
, Yoy
)
Exports Imports
-10.0
-5.0
0.0
5.0
10.0
15.0
20.0
25.0
30.0
Jun-
11
Sep-
11
Dec
-11
Mar
-12
Jun-
12
Sep-
12
Dec
-12
Mar
-13
Jun-
13
Sep-
13
Dec
-13
Mar
-14
Jun-
14
Sep-
14
Dec
-14
Mar
-15
Jun-
15
Sep-
15
Dec
-15
Mar
-16
Jun-
16
Sep-
16
(%, Y
oY, 3
MM
A)
Domestic consumption Net imports (volume)
6065707580859095
100105
Jul-1
4
Sep-
14
Nov
-14
Jan-
15
Mar
-15
May
-15
Jul-1
5
Sep-
15
Nov
-15
Jan-
16
Mar
-16
May
-16
Jul-1
6
Sep-
16Inde
xed
to 1
00 a
t pea
k of
exp
ort
volu
me
(trai
ling
12 m
ma)
Iron & steel POL Rice
Deficit (USD mn) 12 m ending Sep'16 12 m ending Sep'15 Change
Total 45,405 43,963 1,442
Iron & steel (759)
Ferrous & non ferrous 727
Machinery 443
Textiles* 865
Gems/jewelery/gold* 1,044
Others (878)
China trade deficit: Still a woring factorgVolume-wise trend seems to be improvingp g
Antique Stock Broking Limited 3 5
Stratosphere - India in charts 02 November, 2016
Imports: Countries and Commodities
Countries: Gold & Oil
Source: Bloomberg, CMIE
Lower GFCF growth contributing to lower engineering imports
Source: Bloomberg, CMIE
Commodities: Contribution to decline in imports
Source: Bloomberg, CMIE
Trade deficit: Gold and oil again, China still a pain point
Source: Bloomberg, CMIE
37.6
100.0 12.27.9
7.06.7
6.1 5.7 5.7 4.63.3 3.3
0102030405060708090
100
Trai
ling
12m
chan
ge
Switz
erla
nd
Saud
iAr
abia
UAE
Kuw
ait
Nig
eria
Qat
ar
Vene
zuel
a
Indo
nesi
a
Iraq
USA
Oth
ers
% C
ontri
butio
n to
the
fall i
n im
ports
, 12m
trai
ling
betw
een
now
and
pre
viou
s 1
2m
-30.0
-20.0
-10.0
0.010.0
20.0
30.0
40.0
50.0
Dec
-02
Jun-
03D
ec-0
3Ju
n-04
Dec
-04
Jun-
05D
ec-0
5Ju
n-06
Dec
-06
Jun-
07D
ec-0
7Ju
n-08
Dec
-08
Jun-
09D
ec-0
9Ju
n-10
Dec
-10
Jun-
11D
ec-1
1Ju
n-12
Dec
-12
Jun-
13D
ec-1
3Ju
n-14
Dec
-14
Jun-
15D
ec-1
5Ju
n-16
(% Y
oY)
GFCF Core engg imports
100.0
17.9
10.1 8.98.3
5.9 6.47.4
4.3
-4.0 -7.0
-6.6
0102030405060708090
100
Switz
erla
nd
Kuw
ait
Nig
eria
Qat
ar
Saud
iAr
abia
Indo
nesi
a
UAE Ira
q
Sri L
anka
Chi
na +
HK
Oth
ers
Tota
l
% C
ontri
butio
n to
the
delta
in tr
ade
def,
12m
tra
iling
betw
een
now
and
pre
viou
s 1
2m
The oil benefit!
4.4
100.0 51.0
21.96.2
6.25.6 4.7
0102030405060708090
100
Trai
ling
12m
chan
ge
POL
Gol
d
Che
mic
als
Coa
l
Engg
impo
rts
Iron
&St
eel
Oth
ers
% C
ontri
butio
n to
the
fall i
n im
ports
, 12m
tra
iling
betw
een
now
and
pre
viou
s 1
2m
Commodities: Contribution to decline in importsp
Lower GFCF growth contributing to lower engineering importsg g g g p Trade deficit: Gold and oil again, China still a pain pointg p p
Antique Stock Broking Limited 3 6
Stratosphere - India in charts 02 November, 2016
How was the imbalance corrected
Source: Bloomberg, CMIE
REER and NEER
Source: Bloomberg, CMIE
Watch out for invisibles as slowdown in Gulf begins to pinch
Source: Bloomberg, CMIE
FDI flows continue healthy momentum
Source: Bloomberg, CMIE
Evolution of external sector
30.0
40.0
50.0
60.0
70.0
80.0
90.0
Dec
-07
Jun-
08
Dec
-08
Jun-
09
Dec
-09
Jun-
10
Dec
-10
Jun-
11
Dec
-11
Jun-
12
Dec
-12
Jun-
13
Dec
-13
Jun-
14
Dec
-14
Jun-
15
Dec
-15
Jun-
16
Exce
ss o
f inv
isbl
es s
urpl
us o
ver t
rade
def
icit,
U
SD b
n
6.50.5
0.5 0 -7.3
0.1
-0.1
0
1
2
3
4
5
6
7
8
3QFY
13
Rem
ittan
ces
Invi
sibl
es(O
ther
s)
Inve
stm
ent
inco
me
&ot
hers
Invi
sibl
es(s
oftw
are)
Trad
e
1QFY
17
Cha
nge
in C
AD a
s %
of G
DP
60.0
70.0
80.0
90.0
100.0
110.0
120.0
Apr-
04
Dec
-04
Aug-
05
Apr-
06
Dec
-06
Aug-
07
Apr-
08
Dec
-08
Aug-
09
Apr-
10
Dec
-10
Aug-
11
Apr-
12
Dec
-12
Aug-
13
Apr-
14
Dec
-14
Aug-
15
Apr-
16
Inde
x
REER NEER
-5.0
0.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
Aug-
13
Nov
-13
Feb-
14
May
-14
Aug-
14
Nov
-14
Feb-
15
May
-15
Aug-
15
Nov
-15
Feb-
16
May
-16
Aug-
16
(FD
I, 12
mm
a, %
, YoY
)
How was the imbalance corrected
Antique Stock Broking Limited 3 7
Stratosphere - India in charts 02 November, 2016
Trade balance
Trade balance: How will the normalisation happen12-m ending March 2013 12-m ending August 2016 Normalisation
(Segment) Volume Realisation Comments Value Volume Realisation Comments Value Volume Realisation Comments Value (USD mn)
(per unit) (USD mn) (per unit) (USD mn)
Petroleum imports 213.0 769.0 Vol in mn tonnes; 163,796.3 257.9 285.5 Vol in mn tonnes; Value is 73,632.6 283.7 468.0 10% increase in 132,766.9Value is USD 769/ton USD 286/ton which is volumes, realisationwhich is roughly equal to roughly equal to USD 40/bbl at USD 65/bblUSD 108/bbl
Petroleum exports 70.0 867.9 Vol in mn tonnes; Value is 60,751.2 72.7 377.8 Vol in mn tonnes; Value is 27,486.5 76.4 505.0 5% increase in volumes 38,573.5USD 870/bbl which is roughly USD 286/bbl which isequal to USD 120/bbl roughly equal to USD 53/bbl
Gold imports 0.9 59,615.6 Vol in mn kg 53,654.0 0.5 44,744.0 Vol in mn kg 22,372.0 Similar levels as of now 22,372.0
Jewellery exports 43,372.3 40,674.9 Similar levels as of now 40,674.9
Agri exports 40,907.5 31,984.9 Rises by 5% 33,584.1
Agri imports 18,924.1 22,202.8 Rises by 10% 24,423.1
Textile/leather/garment exports 32,227.4 38,425.0 Similar levels as of now 38,425.0
Coal imports 147.0 115.6 Vol in mn tonnes 16,995.1 199.2 61.2 Vol in mn tonnes 12,189.9 209.2 67.3 5% increase in vol, 14,079.310% increase in prices
Iron ore exports 18.1 91.1 Vol in mn tonnes 1,650.1 11.9 41.5 Vol in mn tonnes 495.4 12.5 45.7 5% increase in vol, 572.210% increase in prices
Iron & steel imports 9,782.7 9,982.4 5% increase 10,481.5
Iron & steel exports 8,093.8 5,513.5 10% increase 6,064.9
Ferrous exports 14,252.5 11,997.4 13,125.0
Ferrous imports 10,534.8 13,548.3 13,548.3
Pharma exports 14,659.9 16,655.9 Assumng 10% rise 18,321.5
Fertiliser imports 8,764.4 6,563.4 6,563.4
Engg imports 66,532.7 47,263.7 Assuming 15% rise 54,353.3
Engg exports 34,536.9 39,038.0 Assuming 10% rise 42,941.8
Consumer goods imports 31,402.2 42,967.6 Assuming 10% rise 47,264.4
Other imports 109,817.9 101,290.5 Increase by 5% 106,355.0
Other exports 49,698.8 45,917.6 Increase by 10% 50,509.4
Total imports 490,204.2 352,013.2 432,207.2
Total exports 300,150.4 258,189.1 282,792.2
Monthly avg trade balance 15,837.8 7,818.7 12,451.3
Source:
Trade balance: How will the normalisation happenpp
Sustainable Sources of Competitive Advantage Nov 16, 2016 by Morgan Housel
David Paul Gregg invented the CD, which is amazing and changed history. But you’ve probably never heard of him because CDs aren’t difficult to make, and lost relevance over time. Most things work this way. As soon as a smart product or business idea becomes popular, the urge to copy it and commoditize it is the strongest force economics can unleash. Jeff Bezos summed this up when he said “Your margin is my opportunity.”
The key to business and investing success isn’t finding an advantage. It’s having a sustainable advantage. Something that others either can’t or aren’t willing to copy once your idea is exposed and patents expire. Finding something others can’t do is nearly impossible. Intelligence is not a sustainable source of competitive advantage because the world is full of smart people, and a lot of what used to count as intelligence is now automated. That leaves doing something others aren’t willing to do as the top source of sustainable competitive advantage.
Here are five big ones.
The ability to learn faster than your competition
Someone with a 110 IQ but the ability to recognize when the world changes will always beat the person with a 140 IQ and rigid beliefs. The world is filled with smart people who get nowhere because their intelligence was acquired 20 or 30 years ago in a vastly different world than we live in today. And since intelligence has a lot of sunk costs – college is expensive and hard, for example – people tend to cling to what they learn, even while the world around them constantly changes. So the ability to realize when you’re wrong and when things changed can be more effective than an ability to solve problems that are no longer relevant. This seems obvious until you watch, say, Kodak or Sears trying to solve 1980’s problems in the 2000s.
Marc Andreessen promotes the idea of “strong beliefs, weakly held,” which I love. Few things are more powerful than strongly believing in an idea (focus) but being willing to let go of it when it’s proven wrong or outdated (humility).
The ability to empathize with customers more than your competition
Forty-seven percent of mutual fund managers do not personally own any of their own funds, according to Morningstar. That’s shocking. But I suspect something similar happens across most businesses.
What percentage of McDonald’s executives frequent their own restaurant as a legitimate customer interested in the chain’s food, rather than a fact-finding mission? Few, I imagine. How many times has the CEO of Delta Airlines been bumped from a flight, or had his bags lost by the airline? Never, I assume.
The inability to understand how your customers’ experience your product almost guarantees an eventual drift between the problems a business tries to solve and the problems customers need solved. Here again, a person with a lower IQ who can empathize with customers will almost always beat someone with a higher IQ who can’t put themselves in customers’ shoes. This was apparent in the recent election, when understanding the electorate’s mood far exceeded the power of traditional campaign strategies.
It’s also why the best writers are voracious readers. They know exactly what readers want and don’t want because they themselves are customers of content.
The ability to communicate more effectively than your competition
Business success doesn’t necessarily go to those with the best product. It goes to whoever is the most persuasive. George Soros may be one of the brightest minds in finance, but he would fail miserably as a financial advisor. Not one person in ten who reads his books understands what the hell he’s talking about.
Most business edges are found at the intersection of trust and simplicity. Both rely on the ability to tell customers what and why you’re doing something before losing their attention.
This is one of the crazy things that gets harder to do the smarter you are. There’s a bias called “the curse of knowledge,” which is the inability to realize that other people with less experience than you have don’t see the world through the same lens you do. I saw this firsthand when a financial advisor told an utter novice grandmother that a higher bond allocation (which she wanted) didn’t make sense “because of the slope of the yield curve.” She had no idea what this meant, and told me experiences like this eroded trust since she couldn’t distinguish her confusion from his obfuscation.
The willingness to fail more than your competition
Having no appetite for being wrong means you’ll only attempt things with high odds of working. And those things tend to be only slight variations on what you’re already doing, which themselves are things that, in a changing world, may soon be obsolete.
Here’s Bezos again: “If you double the number of experiments you do per year, you’re going to double your inventiveness.”
The key is creating a culture that allows you to fail often without ruin. This means not docking employees for trying things that don’t work, and not betting so much on a single idea that its failure could cripple the company.
Amazon and Google, I’m convinced, are successful because they’re better and more willing to fail than any other company. Accepting lots of small failures is the only way they’re able to eventually find a few things that take off.
The willingness to wait longer than your competition
Rewards sit on a spectrum: Small, unpredictable ones in the short run, big, higher-odd ones if you wait longer.
It’s amazing how much of a competitive advantage can be found by simply having the disposition to wait longer than your competitors.
Waiting longer gives you time to learn from, and correct, early mistakes. It reduces randomness and pushes you closer to measurable outcomes. It lets you focus on the parts of a problem that matter, rather than the chaos and nonsense that comes in the short run from people’s unpredictable emotions.
If you can wait five years when your competitors are only willing to wait two, you have an advantage that is both powerful and uncorrelated to intelligence or skill.
Which is about as close to a free lunch as it gets in business.
When Borders Close By RUCHIR SHARMA NOV. 12, 2016
The age of globalization generated great prosperity. As the flow of goods, money and people across borders surged, millions benefited. But the elite gained the most. And as inequality rose, it stirred pockets of fierce resentment among those left behind. When the great shock came, the discontented turned to nationalist firebrands, who promised to impose controls on free trade, global banks and immigrants. Globalization stalled. A new age of deglobalization hit full stride.
That great shock came in 1914, with the outbreak of World War I, and it ended an extraordinary four-decade period of rising migration and trade. But that era provides clear parallels to the globalization boom that gained momentum in the 1980s and stalled during the financial crisis of 2008. Today globalization is once again in retreat. Populists are on the march, as evidenced by Donald J. Trump’s stunning victory last week. They have already won control of the government in Britain and gained momentum in Italy, France and Germany.
It is not clear how Mr. Trump, who has called for protectionist measures and tighter borders, will govern. But it is clear that the open world order is breaking apart. The new age of deglobalization is on, and it is likely to last.
National economies move from boom to bust in cycles that last a few years, but globalization is different. At least since Genghis Khan secured travel along the Silk Road, the flow of goods, money and people across borders has advanced and retreated in decades-long waves. The retreat that began in 1914 continued for three decades, weakening the world economy and feeding the resentments that erupted into World War II. The retreat that began in 2008 is still gaining strength, and it is time to recognize the likely fallout, which is slower growth, higher inflation and rising conflict.
The parallels between the two booms are striking. The recent advance of globalization was driven by changing technology — including container ships and the internet — and new rules that opened the world’s most populous country, China, to commerce. Before 1914, steamships and the “Victorian internet,” the telegraph, as well as novel rules that opened the 19th century’s largest economy, Britain, to imports, drove globalization. By the eve of World War I, the world was in some ways as connected as now. Measured as a share of the population, immigration to the United States was three times greater in 1914 than at any time since.
The social tensions generated by rapid globalization in the early 20th century also ring familiar. The share of income going to the richest 1 percent of Americans rose steadily from 1870 to a peak of nearly 20 percent in the late 1920s, as global commerce created a “gilded age” plutocracy. Popular resentment spread, and politicians began working to seal the borders, particularly after 1929, when the economy crashed into the Great Depression.
America turned inward. Congress passed the sweeping Smoot-Hawley Tariff Act in 1930, prompting a global trade war. Measured as a share of the world economy, trade peaked at 30 percent in 1914, and fell to a low of 10 percent in 1933. That year, Congress passed the Glass-Steagall Act, which barred big banks from the investment business. The movement of money from country to country slowed to a trickle in the 1930s and 1940s.
The United States also virtually shut down immigration in the early 1930s, when the influx of people declined to a few tens of thousands, down from more than a million annually before 1914. As many as one million Mexicans went home in this period, with 80,000 deported by the federal authorities and many more scared off.
Closing the borders reduced competition and commerce, prolonging the Depression. In the United States, populists were fringe figures promising to “share the wealth” and chanting, “America First.” But in Europe and Asia, they took power as the militarist autocracies that started World War II.
After the Axis powers were defeated and the victorious democracies began rebuilding an open world order, it took decades for the flow of trade, money and people to regain momentum. Global trade did not recover to its 1914 peak until the 1970s, and capital mobility — the scale and ease of money flows — did not recover until the 1990s. Once these flows gained speed, however, they thundered along right up to the financial crisis.
Today, 2008 looks to be as clear a turning point as 1914. With global demand weak, and many nations erecting import barriers, trade is slumping. Measured as a share of global gross domestic product, trade doubled from 30 percent in 1973 to a high of 60 percent in 2008. But it faltered during the crisis and has since dropped to 55 percent.
The flow of capital — mainly bank loans — is retreating even faster. Frozen by the financial crisis and squeezed afterward by new regulations, capital flows have since slumped to just under 2 percent of G.D.P. from a peak of 16 percent in 2007.
The flow of people is slowing, too. Despite the flood of refugees into Europe, net migration from poor to rich countries decreased to 12 million between 2011 and 2015, down by four million from the previous five years. Between 2009 and 2014, the number of Mexicans leaving the United States outnumbered new arrivals by 140,000, and that was before Mr. Trump’s first anti-Mexican tirades.
In an echo of the 1930s, the slowing of trade, global investment and migration are further weakening the global economy. There are many reasons to expect that this new age of deglobalization will last, as the postwar order is under assault from both popular autocrats in emerging powers like Russia and China, and populist candidates in Western democracies.
The recent trade boom was fueled by relatively simple deals that cut import tariffs. But trade deals have become more complex, and now take much longer to complete. At the same time, the world’s major economies have imposed hundreds of protectionist measures since 2008, led by India, Russia, China and the United States. And once such protectionist walls spring up around one industry, they tend to grow and spread to other industries.
Changes in China’s economy will further slow trade. When China opened up in the 1980s, its vast population turbocharged global trade almost overnight. Nations all over the world prospered by supplying raw materials and parts to plants in China, and later in countries like Poland and Mexico. Before 2008, much of the global trade boom involved intermediate goods traveling within these supply chains. But this trend has reversed. Supply chains are contracting, particularly as China moves to make its economy less dependent on trade, and its factories learn to make more parts at home.
Recently, the International Monetary Fund and other institutional bulwarks of the postwar order have mounted a defense of globalization. They point to research blaming automation and other forces unrelated to globalization for middle-class job losses. But the technocrats are missing the political reality: The tide has turned against immigrants and trade. It is time to recognize the implications of deglobalization.
During and between the two world wars, the anti-global agenda reduced competition and worsened weak economic growth with rising inflation. Today, populists are again calling for protecting domestic industry and sharing wealth, which could have the same impact.
Redistributing wealth within nations could have the salutary effect of narrowing the income gap between individuals. But more protection could widen the wealth gap between nations. Since World War II, few nations have escaped poverty without a huge lift from exports, and rising trade barriers will make it harder for developing countries to do that. The economic advantage is shifting from export-driven economies, such as South Korea and Taiwan, to those that rely on large domestic markets, such as India and Indonesia.
More worrisome is the geopolitical fallout from closing borders. As the open global order has faltered since 2008, the number of democracies has stagnated. More than 100 of the countries tracked by Freedom House have shown a decline in freedom since then (some 60 saw gains), as democracies have grown more xenophobic and autocracies more repressive. At a time when approval ratings are plunging for political leaders worldwide, a combative few are maintaining their popularity by playing the nationalism card, including in Russia and China.
These governments are increasingly willing to close borders and to project military power. Though hardly global threats on a par with the Axis powers before World War II, they pose challenges on three main fronts, with China pushing into the South China Sea, Russia testing Europe’s borders and Iran’s proxies spreading across the “Shiite crescent” in the Middle East. Regions facing these newly adventurous powers are racked with tension, made worse by perceptions that the United States has been in retreat since 2008. While global military spending was flat worldwide for much of the last decade, it is up 75 percent in East Asia, 90 percent in Eastern Europe and 97 percent in Saudi Arabia.
World War I shattered the hope that an increasingly interconnected world would render armed conflict between nations obsolete. Similar hopes surfaced in recent decades. But the connections are fraying, tensions are spreading and my-nation-first populism is gaining, including in the United States. During the campaign, Mr. Trump called for toughening border security, renegotiating or blocking major trade deals, and cutting support for allies the United States has backed since 1945.
Mr. Trump may not follow through on all these proposals, but his direction is clear. The global movement of goods, money and people is likely to continue slowing. The lesson of the past is that just as night follows day, deglobalization follows globalization — and can last just as long.
STRATEGY NOTE
India | Equity Strategy
India 9 November 2016
India Equity StrategyImpact of Demonetization - Demand Curveto Take a Downward Slope
EQU
ITY STRATEG
Y IND
IA
Govindarajan Chellappa *Equity Analyst
+91 22 4224 6111 [email protected] Jasani §
Equity Analyst+65 6551 3962 [email protected]
Nilanjan Karfa *Equity Analyst
+91 22 4224 6118 [email protected] Singh, CFA *
Equity Associate+91 22 4224 6183 [email protected]
Arya Sen *Equity Analyst
+91 22 4224 6122 [email protected] Mathur *
Equity Analyst+91 22 4224 6115 [email protected]
Bhaskar Basu, CFA *Equity Analyst
+91 22 4224 6130 [email protected] Dhasmana *
Equity Analyst+91 22 4224 6126 [email protected]
Ankit Fitkariwala *Equity Analyst
+91 22 4224 6125 [email protected] Nahar *
Equity Analyst+91 22 4224 6113 [email protected]
Anurag Mantry *Equity Associate
+91 22 4224 6129 [email protected] Jaiswal *
Equity Associate+91 22 4224 6114 [email protected]
Poornaa Venkatesan *Equity Associate
+91 22 4224 6123 [email protected]
* Jefferies India Private Limited § Jefferies Singapore Limited
MCI (P) 047/07/2016
^Prior trading day's closing price unlessotherwise noted.
Key Takeaway
Beyond the next 3-7 days of logistical nightmare to replenish cash supply,demonetization of 86% of currency in circulation (CIC) will have significantshort-term shock on most sectors. Demand curve is expected to remain weakmedium term. Private investment should weaken further; a deflationaryenvironment will require more monetary and fiscal intervention. Rate cuts maybe on the way, but that can’t help change risk aversion in the short term.
Need for demonetization. As of 9 Sept 2016, currency notes of denominations Rs500and Rs1000 has ceased to be a legal tender, approx. 25% by volume and 86% by valueof currency in circulation. The stated objective of the Govt. is to curb black money,curtailing prevalence of fake currency, and countering terrorism financing. The RBI will issuenew currency notes of denominations Rs500 and Rs2,000, which will be made availablefor exchange starting 10 Nov until 31 Dec 2016. Electronic model of transfers have norestrictions. Restriction on cash withdrawals will slowly be eased over the next fortnight.
Transitory impact is huge. In the near-term, this move will hurt economic activitywith pronounced slowdown across sectors irrespective of the extent of usage of cash. Riskaversion is likely to inch up manifold. Over the next 1-3 months, we think all sectors barringIT & Pharma will face growth challenges, and in particular hurt discretionary spends, goldand real estate purchases. We are particularly worried about businesses that still need tooperate in cash with little access to valid legal tender. We think banks will benefit from highersavings account accretion.
Medium term (4-6 months) implication will still be negative. While the black-economy will certainly shrink, the second-derivative impact of the wealth-destruction onthe real-economy will still be meaningful, in our view. Financial sector could face higherstress levels in the small & mid-corporate segment which currently is challenged by anextended working capital cycle. Collections on mortgages/LAP will face scrutiny. Car/2W,CV & Rural demand would continue to be weak. A slow growth environment coupled withhigher banking system liquidity would possibly open up more rate-cut opportunities andtreasury yields could fall further. However, we don’t think this will be sufficient to change therisk aversion. Even where cash is accounted for, we expect risk-aversion will remain high forconspicuous consumption items e.g. expensive watches, jewellery, upper end of alcoholicbeverages, higher end cars etc.
Long term (12 months) looks positive for few sectors. The biggest benefit will beon the fiscal & monetary side. Assuming 25% of CIC amounting to US$ 53bn (83% ofnet market borrowing) remain untraced (possibly the unaccounted money) and does notget exchanged could have a dual impact of lowering market borrowings or increased fiscalspending. This should alleviate the slowdown in private investments. Moreover, a sustainedimprovement in banking system balances will negate the need for OMOs to achieve neutralliquidity position. We believe Private sector banks along with Payment and Small FinanceBanks will benefit from the increased transparency and from a shift of cash transactions toonline channels. We expect Staples sector to recover from the slower demand conditions.From an overall perspective, we remain neutral on discretionary consumption, Car/2W, CV,Cement and EPC/construction. We remain negative on gold and real estate.
An eye on election funding. Demonetization is also likely to impact upcoming stateelections in India, with elections in UP, the largest state accounting for nearly 15% ofLok Sabha seats, expected in February, 2017. A significant part of election financing andspending in India is believed to happen in cash and would to be impacted by the move.As per data available with the Election Commission, 63% of even the declared funding forpolitical parties ahead of assembly elections over the last decade was in cash.
Please see analyst certifications, important disclosure information, and information regarding the status of non-US analysts on pages 11 to 15 of this report.
As of 9 Sept 2016, currency notes of denominations Rs500and Rs1000 has ceased to be a legal tender, approx. 25% by volume and 86% by valueof currency in circulation.
Financial sector could face higherstress levels in the small & mid-corporate segment which currently is challenged by anextended working capital cycle. Collections on mortgages/LAP will face scrutiny. Car/2W,CV & Rural demand would continue to be weak. A slow growth environment coupled withhigher banking system liquidity would possibly open up more rate-cut opportunities andtreasury yields could fall further.
The biggest benefit will beon the fiscal & monetary side. Assuming 25% of CIC amounting to US$ 53bn (83% ofnet market borrowing) remain untraced (possibly the unaccounted money) and does notget exchanged could have a dual impact of lowering market borrowings or increased fiscalspending. This should alleviate the slowdown in private investments. Moreover, a sustainedimprovement in banking system balances will negate the need for OMOs to achieve neutralliquidity position.
Exhibit 1: Short term (1-3 months) impact across sectors/sub-segments Neutral Negative Bearish
IT 2W/Car CV Pharma Banks Discretionary spend
Cement EPC/Construction FMCG Gold Metals & Mining Real estate Non-Banks Oil & Gas Staples E-tailer Tractor
Source: Jefferies
Exhibit 2: Long term (12 months) impact across sectors/sub-segments Positive Neutral Negative
EPC/Construction 2W/Car/CV Gold Non-Banks Cement Real estate
Private Banks Oil & Gas Staples E-tailer
Discretionary spend / FMCG Metals & Mining SOE Banks
Source: Jefferies
Exhibit 3: Specific impact on auto-sector Segment Impact on supplier Impact on ultimate demand Impact on intermediaries
2-wheelers No Impact
Largely cash purchases and no requirement of PAN card implies that some purchases are done by black economy beneficiaries. This should come down.
Should remain largely unimpacted. Preparedness for cashless transaction would be helpful.
Cars No Impact
Some impact as some purchases were by black economy beneficiaries. Larger negative impact from risk aversion of individuals from wealth deterioration Largely unimpacted
Trucks No impact
Economy slowdown will impact demand. Second hand truck sales are largely in parallel economy. This might see lower transactions and thus lower resale value. Therefore very negative for demand and financiers Largely unimpacted
Tractors No impact Demand will be impacted as it is partly driven by black economy participants
Dealer trade practices are questionable with high over-invoicing relative to other auto products. This will change.
Parts makers
Will benefit from lower competition from illegal spare parts manufacturers
Source: Jefferies
Equity Strategy
India
9 November 2016
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Please see important disclosure information on pages 11 - 15 of this report.
Short term (1-3 months) impact across sectors/sub-segments
Long term (12 months) impact across sectors/sub-segments
Specific impact on auto-sector
Exhibit 4: Specific impact on sectors - contd Sector Impact on suppliers/expense Impact on intermediaries Impact on demand/revenue Impact on Cement, EPC and Toll Roads EPC contractors No significant impact on large EPC players,
since almost all suppliers of bitumen, cement, steel, etc are large corporates and hence all expenses are in bank transactions. Even employee cost is mostly via bank to sub-contractors who in turn pays the blue collar workers, hence no cash involvement. For small contractor, due to cash crunch there will be some disruption in medium term. Also profitability will take a hit, since contractors would want to channelise funds through the tax system
Not many intermediaries exist for a large EPC player. However for smaller players, most transaction occur through distributors in cash and hence impact will be there in terms of their profitability and demand from small contractors
No significant impact on large players since almost all revenue is from larger corporate houses and government authorities, which do bank transaction. Even for small contractors, most income is cash-based and hence they will face issues in getting contracts
Toll roads Large component of expenses is payment to NHAI and hence it is bank transaction.
No significant intermediaries for the sector 98-99% of transactions/income is in cash. There was lots of confusion on toll collection and hence revenue loss in the initial 2-3 days but as per NHAI circular, toll operators have been allowed to collect 500 and 1000 rupee notes till 11.11.2016. Post a small blip due to disruption in the operations of freight operators (who operate to a large extent on cash), traffic should normalise over the medium term. There may be improvement in toll reporting, since some leakage may be plugged due to crackdown on black money and hence may be report tolls correctly
Cement No significant impact Intermediaries will be impacted due to lower demand in short-term, which will normalise in medium term. However, on the profitability side, there may a longer term impact if higher proportion of sales get chanelised through tax system
Disruption in demand in short term due to cash crunch impacting rural sales and real estate sectors. However in medium term, the demand will normalise.
Impact on Oil & Gas companies Crude products Listed Cos: BPCL, HPCL, IOCL
No impact No impact 80%+ of sales of HSD, MS, LPG and kerosene. Possible negative impact on MS, HSD demand. MS demand in particular could be negatively impacted as it is almost entirely used in personal transportation with very high proportion of cash transactions
City gas Listed Cos: IGL, MAHGL
No impact No impact ~60% cash sales. Possible negative impact on CNG demand where cash transactions are high ex of sales to state transport corporations; less impact on PNG
Impact on E-tailers E-tailing Listed Cos: n/a
Negative impact on SMEs selling through e-tailing sites
n/a ~60-70% cash sales. Neutral - Negative impact on consumption could be offset by acceleration in shift to online transactions
Impact on Consumer companies Staples No impact. Market share gain opportunity
exists as regional competition gets squeezed out.
Retailers with no access to formal banking channel would get impacted
Given the need based demand and small purchase tickets, the impact on demand would be muted.
Cigarettes No impact. Tax-evaded tobacco products (like bidis, chewing tobacco and illegal cigarettes) currently constitute over 89% of total tobacco consumption, offering a potential of market share gain by cigarettes.
All Retailers (Paan stores) gets hit with the cash crunch.
c.70% of cigarette volumes are from loose sticks (i.e. very low ticket item); hence we expect the demand impact to be muted.
Alcoholic Beverages No impact. Limited market share gain opportunity as country liquor consumers are unlikely to trade up to IMFL, given the price differential between the two categories.
Retailer cash purchases take a hit, while the market dynamics (in terms of working capital intensity with state governments) remain high.
Indian Made Foreign Liquor (IMFL) consumers are higher ticket purchases, and we expect the demand to get hit.
Source: Jefferies
Equity Strategy
India
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Please see important disclosure information on pages 11 - 15 of this report.
Specific impact on sectors - contd
Consumer Sector – a level playing field with regional competition is a positive in the long term Last mile in distribution is cash exposed Modern Trade contributes c.8% of the fast moving consumer goods (FMCG) sales while the rest of the sale is realized through the traditional Distributor-Retail model. The payments relationship between the Company and the Distributor is entirely electronic in nature. Given that ticket sizes of purchases are small; consumer payment is mostly done in cash to the Retailer, who in turn settles the amount either in cash or electronically with the Distributors.
Exhibit 5: Last mile in distribution is cash exposed
Source: Jefferies estimates, company data Channel check suggest stress at the Retailer level While we see little risk to the Company-Distributor relationship, our channel checks suggest that small Retailers are at a risk of faltering on payments, through formal channel. This, in turn, could lead to inventory de-stocking at the Distributor level in the near term. Not all categories would be hit simultaneously A few categories (like tooth paste, soaps, Household Insecticides, etc) might not see any major impact in the medium term because of need based demand. Impact on discretionary (like Gold, alcoholic beverages et al) is going to be higher than staples as cash crunch hits consumption. We expect impact on Indian Made Foreign Liquor (IMFL) to be high as cash purchases take a hit, while the market dynamics (in terms of working capital intensity with state governments) remain high. There’s a silver lining The silver lining to the sector is going to come from the stress in the illicit channel. India is the 4th largest illegal cigarette market in the world; tax-evaded tobacco products (like bidis, chewing tobacco and illegal cigarettes) currently constitute over 89% of total tobacco consumption. Similarly, counterfeit products have been a menace to the FMCG companies and the cash crunch in the economy might serve as a blessing in disguise to the sector in our view.
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Equity Strategy
India
9 November 2016
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Please see important disclosure information on pages 11 - 15 of this report.
Modern Trade contributes c.8% of the fast moving consumer goods (FMCG) sales whilethe rest of the sale is realized through the traditional Distributor-Retail model.
While we see little risk to the Company-Distributor relationship, our channel checks suggest that small Retailers are at a risk of faltering on payments, through formal channel. This, in turn, could lead to inventory de-stocking at the Distributor level in the near term.
The silver lining to the sector is going to come from the stress in the illicit channel. India is ththe 4t largest illegal cigarette market in the world; tax-evaded tobacco products (like
bidis, chewing tobacco and illegal cigarettes) currently constitute over 89% of total tobacco consumption. Similarly, counterfeit products have been a menace to the FMCG companies and the cash crunch in the economy might serve as a blessing in disguise to the sector in our view.
Financials – Neutral at best in medium term, Positive in the long term We think the Street would be mistaken if it perceives banks will be ultimate beneficiary of the demonetization plan and black money curb in the medium term. True, savings account balances will spike over the next few weeks and “accounted” cash gets deposited, but this will get back in to equilibrium as cash supply eases from the bank branches and ATMs. In the long term, assuming the shock to cash economy translates to a shift of transactions to online channels, we should see better float level in account balances (better CASA ratio) as well as higher fee income linked to para-banking activities.
Exposure to SME/LAP could come under stress In the medium term, banks and non-banks will still need to negotiate the slowdown impact on retail consumption while the stress in small & medium corporates could increase with broken payment chain that relied on accounted source of money. Portfolio exposure to LAP/SME segment will likely see heightened stress levels. A large proportion of transactions/ income generation in these segments are cash based. Also, business models of many SMEs are dependent on tax arbitrage (facilitated by cash transactions).
Most NBFCs and housing finance companies have aggressively given loans to SME, loan against property segments in the last few years. The total estimated outstanding portfolio of LAP loans is currently ~Rs2.5tn (~20% of the total core home loan portfolio).
Exhibit 6: NBFC: AUM Mix BAF SHTF MMFS CAPF LICHF Consumer ex housing loans 31% 0% 0% 21% 0% Housing loans 4% 0% 0% 0% 88% Vehicle 9% 97% 100% 0% 0% SME 39% 0% 0% 67% 0% - Loan against property 27% 0% 0% 51% 10% - Business Loans 12% 0% 0% 15% 0% Infra/ equipment 0% 2% 0% 0% 0% Rural 4% 0% 0% 0% 0% Others 14% 1% 0% 13% 3% Total 100% 100% 100% 100% 100% Source: Jefferies, company data
Exhibit 7: Loan against Property – AUM of major players
Source: Jefferies, company data
Developer loanBanks/NBFCs AuM (Rs bn) Avg. Ticket size (Rs m) AuM (Rs bn)ICICI Bank 236.3 40.3Axis Bank 134.4 47.7Union Bank 96.9PNB 72.0 38.0IndusInd Bank 58.7 8.0 23.8DCB Bank 43.5 4.5 2.9Indiabulls Housing 160.0 7.5 66.0LIC Housing 127.2 1.2 36.7Dewan Housing 137.7 86.5PNB Housing 49.1Can Fin Home 7.3 0.2Reliance Capital 110.4 5.0 26.7Capital First 81.0 9.6Cholamandalam 72.4Shriram City Union 119.3Bajaj Finance 139.14 12.5
LAP
Equity Strategy
India
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In the long term, assuming the shock to cash economy translates to ashift of transactions to online channels, we should see better float level in account balances (better CASA ratio) as well as higher fee income linked to para-banking activities.
Most NBFCs and housing finance companies have aggressively given loans to SME, loanagainst property segments in the last few years. The total estimated outstanding portfolioof LAP loans is currently ~Rs2.5tn (~20% of the total core home loan portfolio).
Exhibit 8: Real estate price growth moderates in most of the cities
Source: Jefferies, RBI
Vehicle financing and rural sector to be affected adversely Small truck operators, especially in the used CV segment transact on a cash basis. NBFC’s like Mahindra Finance, mainly target the rural customers, who primarily deploy vehicles financed thru loan for commercial purposes. If economic activity slows due to the government move, loan demand for CVs could be affected. Also, used CV purchases, which are largely, cash based, could decelerate in the near term.
Approximately 60-65% of collections by Shriram Transport and Mahindra Finance are based on cash. We see near term disruptions/ delay in payments as standard borrowers would have to convert existing currency for making repayments. Payment receipts by borrowers could be affected due to the government move. This may lead to increase in delinquencies. A large proportion of savings in the unorganised/ rural sector is stored in the form of cash (could be partly unaccounted) which would have to be converted. This could hurt transaction volumes/demand in the near term.
Impact on consumer durable financing could be lower Destruction of wealth due to demonetization could hurt consumer durable purchases. However, customers using cash stocks for purchases would generally be different from customers taking loans to finance purchases. Thus, impact on disbursal growth could be lower. From repayment standpoint impact should be lower given that ticket sizes are small. Also, our interaction with consumer durable financing companies suggest that repayments are mainly thru electronic route/ post-dated cheques. However in case of delinquencies, collections could be partly thru cash route.
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Real estate price growth moderates in most of the cities
If economic activity slows due to thegovernment move, loan demand for CVs could be affected. Also, used CV purchases, which are largely, cash based, could decelerate in the near term.
However, customers using cash stocks for purchases would generally be different fromcustomers taking loans to finance purchases. Thus, impact on disbursal growth could be lower. From repayment standpoint impact should be lower given that ticket sizes aresmall.
Impact on upcoming state elections The demonetization measure is also likely to impact the upcoming state elections in India with elections in UP, the largest state accounting for nearly 15% of Lok Sabha seats, expected in February 2017. We note that UP election is expected to be a three cornered fight between BJP, SP and BSP. A significant part of election financing and spending in India is believed to happen in cash and would to be impacted by the government’s move. As per data available with the Election Commission, 63% of even the declared funding for political parties ahead of assembly elections over the last decade was in cash. Punjab is the other major state which is going into election over the next few months.
Exhibit 9: Upcoming election calendar State Likely date Key political parties
Uttar Pradesh Feb-17 SP, BSP, BJP Punjab Feb-17 Shiromani Akali Dal (SAD), Congress Manipur Feb-17 Congress, Trinamool congress Goa Feb-17 BJP, Congress Uttarakhand Feb-17 BJP, Congress Himachal Pradesh Nov-17 Congress, BJP Gujarat Dec-17 BJP, Congress
Source: Jefferies estimates, company data
Exhibit 10: UP past election results suggest a three cornered fight 2014 general elections 2012 state elections
Party Vote share (%) Seats Vote share (%) Seats BJP/NDA 43 73 15 47 SP 22 5 29 224 BSP 20 - 26 80 Congress/UPA 8 2 12 28 Others 7 - 18 24 Total 100 80 100 403
Source: Jefferies estimates, company data
Exhibit 11: Large amounts of cash and liquor are distributed ahead of major elections in India Date Source News
May-16 Times of India Total cash seized in Tamil Nadu since model code came into effect crosses Rs1bn Oct-15 NDTV Massive amount of liquor, cash and gold seized in Bihar election season May-14 Rediff Over Rs3bn of cash seized by Election Commission since announcement of general election
with Andhra Pradesh accounting for Rs1.5bn May-13 Election Commission Over Rs300mn of cash and liquor seized in run up to Karnataka state elections Mar-12 Economic Times UP tops in cash seizures, Punjab in drugs and liquor in state elections
Source: Jefferies estimates, News reports
Exhibit 12: Funds collected by political parties in Assembly elections, 2004-15
Source: Association for Democratic Reforms
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As per data available with the Election Commission, 63% of even the declared funding for political parties ahead of assembly elections over the last decade was in cash. Punjab is the other major state which is going into election over the next few months.
Funds collected by political parties in Assembly elections, 2004-15
Currency circulation & Management Infrastructure Replacing the old currency notes: gigantic logistics challenge The entire announcement to phase out Rs500 and Rs1,000 took everyone by surprise. The tight timeline to completely phase out the notes and immediate stoppage of these notes for regular transactions have created a task of unprecedented level of logistical challenge. The size of this country, population, and infrastructural limitations make this task even more complicated.
As per the initial comments from RBI and banks, the new notes and lower denomination notes will be available from 10th November at bank branches and from 11th November ATM services will be back. About 150 thousand of post offices along with 137 thousand bank branches will be executing the entire exercise of exchange and deposit of old notes over the next six weeks, until 31 December 2016. Many banks have already announced extended working hours, additional cash counters, and working over the weekends to facilitate the huge demand.
Stock of currency notes and coins in Indian economy At end FY16, the value of banknotes in circulation was Rs16.4tr showing an increase of 14.9% as against 11.4% in FY15. The volume of banknotes increased by 8.0% versus 8.1% in FY15. In value terms, Rs500 and Rs1,000 banknotes together accounted for 86.4% of the total value of banknotes in circulation; by volume, Rs10 and Rs100 banknotes accounted 53.0% of the total banknotes in circulation. The total value of coins in circulation increased by 12.4% in FY16 as against 12.1% in FY15. In volume terms, the increase was 8.2% which was marginally higher than that in the previous year (8.0% in FY15). In terms of volume, coins of Re1 and Rs2 together constituted almost 70% of the total coins in circulation. In terms of value, coins of Rs2 and Rs5 together were 59%.
Exhibit 13: Currency notes in Circulation
Source: Jefferies, RBI
Exhibit 14: Coins in circulation
Source: Jefferies, RBI
Demand estimation and supply of currency notes and coins The RBI places indent for banknotes with printing presses on the basis of an econometric model factoring in inter alia, real GDP growth prospects, rate of inflation and denomination-wise disposal rate of soiled notes. The total number of banknotes supplied was lower at 21.2 billion pieces in 2015-16 as compared to 23.6 billion pieces in 2014-15 – against an indent of 23.9 billion pieces for 2015-16 and 24.2 billion pieces for 2014.
Denomination Mar-14 Mar-15 Mar-16 Mar-14 Mar-15 Mar-16 Mar-14 Mar-15 Mar-16 Mar-14 Mar-15 Mar-162 and 5 11,698 11,672 11,626 15.1 13.9 12.9 46 46 45 0.4 0.3 0.3
10 26,648 30,304 32,015 34.5 36.3 35.5 266 303 320 2.1 2.1 1.920 4,285 4,350 4,924 5.5 5.2 5.4 86 87 98 0.7 0.6 0.650 3,448 3,487 3,890 4.5 4.2 4.3 172 174 194 1.3 1.2 1.2
100 14,765 15,026 15,778 19.1 18.0 17.5 1,476 1,503 1,578 11.5 10.5 9.6500 11,405 13,128 15,707 14.7 15.7 17.4 5,702 6,564 7,854 44.4 46.0 47.8
1,000 5,081 5,612 6,326 6.6 6.7 7.0 5,081 5,612 6,326 39.6 39.3 38.6Total 77,330 83,579 90,266 100 100 100 12,829 14,289 16,415 100 100 100
Volume (million pieces) Value (Rs. Bn)Volume share (%) Value share (%)
Denomination Mar-14 Mar-15 Mar-16 Mar-14 Mar-15 Mar-16 Mar-14 Mar-15 Mar-16 Mar-14 Mar-15 Mar-16Small coins 14,788 14,788 14,788 16.1 14.9 13.8 7 7 7 4.1 3.6 3.2
1 38,424 41,627 44,876 41.9 42.1 41.9 38 42 45 21.9 21.7 20.62 24,823 27,038 29,632 27.1 27.3 27.7 50 54 59 28.9 27.8 27.15 11,577 12,761 14,089 12.7 12.9 13.2 58 64 70 33.5 33.0 32.1
10 2,017 2,750 3,703 2.2 2.8 3.4 20 27 37 11.6 13.9 17.0Total 91,629 98,964 107,088 100.0 100.0 100.0 173 194 218 100.0 100.0 100.0
Volume (million pieces) Volume share (%) Value (Rs. Bn) Value share (%)
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page 8 of 15 , Equity Analyst, +91 22 4224 6111, [email protected] Chellappa
Please see important disclosure information on pages 11 - 15 of this report.
At end FY16, the value of banknotes in circulation was Rs16.4tr showing an increase of 14.9% as against 11.4% in FY15. The volume of banknotes increased by 8.0% versus 8.1% in FY15. In value terms, Rs500 and Rs1,000 banknotes together accounted for 86.4% of the total value of banknotes in circulation; by volume, Rs10 and Rs100 banknotesaccounted 53.0% of the total banknotes in circulation.
The total number of banknotes supplied was lower at 21.2 billion pieces in 2015-16 as compared to 23.6 billion pieces in 2014-15– against an indent of 23.9 billion pieces for 2015-16 and 24.2 billion pieces for 2014.
The Indian Statistical Institute (ISI) Kolkata was entrusted with a study to refine the demand estimation model being employed at present.
Exhibit 15: Indent and Supply of currency notes
Source: Jefferies, RBI
Exhibit 16: Indent and Supply of coins
Source: Jefferies, RBI
Printing of currency notes There are four currency printing presses - two owned by the government, at Nashik in Maharashtra and Dewas in Madhya Pradesh, and two owned by the RBI, in Mysore and Salboni in West Bengal. The notes printed at these four presses are distributed across the country through about two dozen offices of the RBI.
The two currency printing presses, located at Nashik in Maharashtra and Dewas in Madhya Pradesh, owned by government of India through the wholly owned company Security Printing and Minting Corporation of India Limited (SPMCIL), prints about 40% of currency notes circulated in India. Nashik facility was the oldest one, coming in operation in 1928. The Dewas facility was established in 1975.
The two currency printing press, located at Mysore in Karnataka and Salboni in West Bengal, owned by Reserve Bank of India through its wholly owned subsidiary Bhartiya Reserve Bank Note Mudran Private Ltd. (BRBNMPL), prints ~60% of the currency notes circulated in India. There are seven lines of production in Mysore press, while Salboni has 8 lines of production. Mysore facility came in production in 1999 and Salboni followed in 2000. During 2015-16, BRBNMPL produced 14,714 million pieces of banknotes of different denominations as against its annual target of 15,700 million pieces. The Bank Note Paper Mill India Private Limited (BNPMIPL) in Mysuru which is a joint Venture between BRBNMPL and SPMCIL, with a production capacity of 12,000 million tonnes has commenced commercial production. This is a significant step towards the indigenisation of production of new banknotes.
Denomination Mar-14 Mar-15 Mar-16 Mar-17 Mar-14 Mar-15 Mar-165 0 0 0 0 0 0 0
10 12,164 6,000 4,000 3,000 9,467 9,417 5,85720 1,203 4,000 5,000 6,000 935 1,086 3,25250 994 2,100 2,050 2,125 1,174 1,615 1,908
100 5,187 5,200 5,350 5,500 5,131 5,464 4,910500 4,839 5,400 5,600 5,725 3,393 5,018 4,291
1,000 975 1,500 1,900 2,200 818 1,052 977Total 25,362 24,200 23,900 24,550 20,918 23,652 21,195
Indent (million pieces) Supply (million pieces)
Denomination Mar-14 Mar-15 Mar-16 Mar-17 Mar-14 Mar-15 Mar-1650 Paise 50 40 40 30 40 20 30
Re1 5,418 6,000 6,100 6,300 3,092 3,247 3,753Rs2 3,546 4,000 4,000 4,200 2,424 2,367 2,899Rs5 1,819 2,000 2,100 2,270 1,393 1,091 1,492
Rs10 1,200 1,800 2,000 2,200 728 1,187 1,084Total 12,033 13,840 14,240 15,000 7,677 7,912 9,258
Indent (million pieces) Supply (million pieces)
Equity Strategy
India
9 November 2016
page 9 of 15 , Equity Analyst, +91 22 4224 6111, [email protected] Chellappa
Please see important disclosure information on pages 11 - 15 of this report.
The two currency printing presses, located at Nashik in Maharashtra and Dewas inMadhya Pradesh, owned by government of India through the wholly owned company Security Printing and Minting Corporation of India Limited (SPMCIL), prints about 40% of currency notes circulated in India. Nashik facility was the oldest one, coming in operation in 1928. The Dewas facility was established in 1975.
The Bank Note Paper Mill India Private Limited (BNPMIPL) in Mysuru which is a joint Venturebetween BRBNMPL and SPMCIL, with a production capacity of 12,000 million tonnes has commenced commercial production. This is a significant step towards the indigenisationof production of new banknotes.
Currency Management Architecture (CMA) CMA comprises 19 issue offices, 4,075 currency chests (including sub-treasury offices and a currency chest of the Reserve Bank in Kochi) and 3,746 small coin depots at commercial, cooperative and regional rural banks, across India. To strengthen the distribution of currency by leveraging technology, the Reserve Bank is considering a hub and spoke model of mega-currency chests (MCCs), which will meet the currency needs of a designated area (as a district). MCCs will receive fresh notes directly from the banknote printing press for distribution to bank branches and will be equipped with state of the art facilities for processing of notes.
Exhibit 17: Currency Chests and Small Coin Depots as at end-March 2016
Source: Jefferies, RBI
The cost of printing the notes Reserve Bank, in its annual report, has been reporting the cost of printing of currency notes in the past, but it has stopped providing this number since 2014-15 annual report. In 2013-14 annual report, RBI had disclosed printing cost of Rs32.1bn. In a response to an RTI, RBI has also disclosed printing cost of each note of different denomination. The table below presents the printing cost as disclosed by RBI and using that cost the replacement cost of entire Rs500 and Rs1,000 notes in circulation comes ~Rs50bn. However, the actual cost of entire exercise could be materially different, given that the new notes have additional security features (means higher cost versus existing notes) and the amount of notes that will come back through deposit/exchange is also uncertain.
Exhibit 18: Printing cost of currency notes
Source: Jefferies estimates, RBI
CategoryNo. of Currency Chest
No. of Small Coin Depot
State Bank of India (SBI) 1,965 1,859SBI Associate Banks 757 725Nationalised Banks 1,173 993Private Sector Banks 160 156Co-operative Banks 3 3Foreign Banks 4 4Regional Rural Banks 5 5State Treasury Offices (STO 7 0RBI 1 1Total 4,075 3,746
Denomination Printing cost per note (Rs) %age of note value Notes (mn pieces in circulation) Replacement cost (Rs mn)5 0.48 9.6% 11,626
10 0.96 9.6% 32,01520 1.5 7.5% 4,92450 1.81 3.6% 3,890
100 1.79 1.8% 15,778500 2.5 0.5% 15,707 39,268
1000 3.17 0.3% 6,326 10,027
Equity Strategy
India
9 November 2016
page 10 of 15 , Equity Analyst, +91 22 4224 6111, [email protected] Chellappa
Please see important disclosure information on pages 11 - 15 of this report.
To strengthen the distribution of currency by leveraging technology, the Reserve Bank is considering a hub and spokemodel of mega-currency chests (MCCs), which will meet the currency needs of adesignated area (as a district). MCCs will receive fresh notes directly from the banknoteprinting press for distribution to bank branches and will be equipped with state of the art facilities for processing of notes.
In 2013-14 annual report, RBI had disclosed printing cost of Rs32.1bn.
However, the actualcost of entire exercise could be materially different, given that the new notes have additional security features (means higher cost versus existing notes) and the amount of notes that will come back through deposit/exchange is also uncertain.
note demonetisation
History revisited: How Tughlaq’s currency change led to chaos in 14th century India The major gamble the Delhi sultan took with the currency in his kingdom led to the
weakening of his sultanate.
by Shoaib Daniyal
Published Nov 15, 2016 · 08:00 am. Updated Nov 15, 2016 · 08:39 am.
Nov 15, 2016 · 08:00 am Updated Nov 15, 2016 · 08:39 am
Since November 8, a crowd in rural Madhya Pradesh has looted a ration shop, people
in long lines at banks and Automated Teller Machines in Delhi and elsewhere have
broken into fisticuffs, parents do not have enough money to feed their children,
patients cannot pay for their treatment, and farmers are unable to buy inputs to sow
the next crop. These are just a few examples of the fallout of last Tuesday’s move by
the Narendra Modi government to suddenly withdraw high-denomination notes.
Several have referred to the decision as Tughlaqian in ambition.
The one decision for which Muhammad bin Tughlaq, the 14th century sultan of Delhi,
is most remembered, is the disastrous shifting of his capital from Delhi to Daulatabad
in the Deccan, in present-day Maharashtra. The hardship this sudden move caused to
the people led to his name becoming an idiomatic expression in Hindi-Urdu denoting
an unhinged dictator. But this wasn’t the only one of Tughlaq’s decisions that ended
in disaster.
Like Modi, Tughlaq took a major gamble with the currency in his kingdom.
Unfortunately for the ruler, that move was a disaster, leading to a weakening of his
sultanate.
Fragile monetary system
If anything, the chaos in India following the announcement of the demonetisation
policy points to just how incredibly fragile the modern monetary system is. What was
wealth at one moment, became, through the decision of a single man, worthless pieces
of paper.
The move starkly shows that paper money in itself has no value. Modern paper or
plastic currency, called fiat money, has worth only because a sovereign government
says so. If this system seems odd, you would not be wrong to think so given how new
it is.
Once humans moved beyond the barter system, people mostly used coins, usually
made of precious metals like gold and silver, as currency. This system is known as
commodity money.
Since the metal in the coin itself had value, it was a rather stable system. However, it
was stymied by shortages of precious metals.
At some point in the seventh century, the Chinese invented modern-style paper money
based on a system of conversion that allowed paper notes to be exchanged for gold,
silver or silk. Called representative money, the system was so radical it took Europe
another 1,000 years to use it.
However, Tughlaq was the one sovereign who managed to implement this Chinese
idea before the West.
As the Sultan of Delhi, he ruled over northern parts of the Indian subcontinent and the
Deccan. After he moved his capital to Daulatabad, in 1329, Tughlaq introduced
representative or token money. These were coins of copper and brass that could be
exchanged for fixed amounts of gold and silver from the Delhi Sultanate.
Called a tanka – a name that would later give rise to the Bengali word for currency,
taakaa – the new coins were aimed at financing the sultanate’s war operations, which
stretched dangerously across the subcontinent.
Shoddy implementation
Today, the system of representative money has ended for much of the modern world.
But till 1971, people could convert $35 for one ounce (28 grams) of gold – this is how
representative currency worked.
But when Tughlaq introduced representative money in his kingdom, it was a
drastically unfamiliar idea. Only one sovereign outside of China had done it – the 13th
century Persian king Gaykhatu. That experiment caused so much chaos that he had to
withdraw it within eight days, and he was even assassinated soon after.
While Tughlaq’s move was good in theory, he failed in implementation.
Representative currency is a sound idea but it has one weak spot: forgery. Since
representative money is worth very little intrinsically and can actually be exchanged
for valuable commodities like gold or silver, there is a lot of value in making
forgeries. Tughlaq’s tanka, made of brass or copper, could be traded in for valuable
gold or silver from the government – a lucrative deal for good forgers.
Forging chaos
Modern governments protect their paper currency against forgers by adding security
features such as watermarks to make it difficult for people to counterfeit the notes. In
fact, this was one of the reasons initially trotted out by the Union government to
justify its demonetisation plan. However, as it turned out, due to poor planning by the
government, there was no time to add any new security features.
While this is unfortunate, the Modi government could take solace in the fact that this
is not the first time that a government in the Indian subcontinent has badly planned
new currency.
Tughlaq’s new tanka was not crafted carefully enough to prevent forgers from
replicating it. As word got around, counterfeit tankas started to flood the market. A
contemporary historian reported that every house “became a mint”. Soon, there were
so many forgeries floating around that it led to hyperinflation, and the tankas became
worthless.
To stem the economic chaos, the Tughlaq administration rolled back the tanka and
promised to compensate genuine tanka holders with gold and silver. However, the
number of fakes were so large that for a number of years, mounds of worthless copper
tankas, rejected by the government, remained piled outside the Daulatabad fort.
As could be imagined, the economic chaos was not good for Mohammad Bin
Tughlaq, and it was one of the reasons for the dismemberment of his kingdom. By the
time Tughlaq died in 1351, key parts of his empire such as Bengal and the Deccan had
liberated themselves, and the sultanate was confined to a small area around Delhi and
the western parts of current day-Uttar Pradesh.
