For a Telecom Revival

Positive steps on telecom and broadband need to be bolstered with more for a resurgence

Shyam Ponappa   |  December 5, 2013

The government announced momentous decisions subject to Cabinet approval on telecom policy on December 3*. There are some major pluses: increased spectrum made available, and higher market shares allowed through acquisitions. Less constructive for the sector are decisions like acquirers having to pay for spectrum above a floor (4.4 MHz for GSM and 2.5 MHz for CDMA) at market rates unless the spectrum was won through auctions. While there are positive decisions, more are needed for true resurgence in this sector.

Perhaps there's also a need to curb the inappropriate application of direct-democracy to complex issues. This refers to choices influenced by uninformed but vociferous public opinion, whereas the requirement is for logical conclusions based on knowledge and understanding of the facts, domain expertise, and skill in problem formulation, solution design and implementation. The underlying constructs may include factors like technology; economics and its dissimilar sibling, finance; society's organisation, capacity and inclinations; and the law. This is especially true for infrastructure, a recognised weakness in our economy. The issue is that misdirected policies can result from the indiscriminate application of old frames of reference, customary practices, or just following the herd.

Consider the state of telecom and broadband: how bad our services are, and how badly the sector is doing, despite the enormous potential. Decisions on spectrum have profound effects on how these services affect productivity and living standards, with inappropriate policies resulting in impediments and misdirection. This is especially important in developing economies because the opportunity losses are unaffordable, and recovery is difficult in the absence of robust institutions and processes. Negative examples like the drive to refarm 900 MHz spectrum and maximising short-term government revenues from spectrum make a mockery of government-for-the-people. "Refarming" refers to mobile operators having to give up most of their 900 MHz band holdings for redeployment of newer technology, primarily because more developed economies did so. Existing operators would lose much of this spectrum, unless they win it back through auctions or acquisitions. This is like taking away captive mines from established steel manufacturers to create a "level playing field".

There are differences, of course, between spectrum and mineral resources. Unlike minerals, spectrum is not depleted by usage, the time taken to develop a new mine is usually more than to deploy a new network, and so on. But refarming will entail significant costs for new networks with many more base stations. This will take years, requiring interim arrangements to avoid service disruption to existing users. It seems like an enormous burden, in effect cross-subsidising newer technology for the high-end user segment. 

How bad is the situation for the industry? Take indicators like profitability, debt, and spectrum costs. Chart 1 shows Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA) as a percentage of revenue for mobile network operators in India, Indonesia, Malaysia, China, Thailand and Singapore, with India being lowest at 20 per cent.

Chart 1: Mobile Network Operators’ Profitability - APAC

Source - GSMA + BCG: http://www.gsmamobileeconomyindia.com/GSMA_Mobile_Economy_India_Report_2013.pdf

Regarding indebtedness, two Indian operators have Debt/EBITDA ratios at 4 and 6, well above acceptable levels. Others, whose debt is in line with Asian operators, are less able to service it because of lower revenues. While some urge that leveraged companies in difficulties be allowed to fail, the magnitude is such that there is a serious risk of destabilising the economy.

Spectrum reserve prices in India are much higher than in other countries (Chart 2), despite the average revenue per user (ARPU) being much lower in terms of purchasing-power parity (PPP), rendering investments unattractive.

                                            Chart 2

Source - GSMA + BCG: http://www.gsmamobileeconomyindia.com/GSMA_Mobile_Economy_India_Report_2013.pdf

It is because of this stressed situation that the authorities, the industry, and the public need to reconsider their basic approach to spectrum needs. One reason for the forced refarming is supposedly that 900 mHz spectrum is needed for more efficient technologies. Another is that some operators with no 900 mHz spectrum are at a genuine disadvantage in terms of in-building coverage. Of course, the most compelling reason may be simply the government's need for revenues to cover its deficit, despite the enormous negative consequences to the long-term public interest. The question is whether there have been adequate efforts to explore less disruptive alternatives to achieve the objectives of reliable, inexpensive communication services.

Spectrum Bands & Ecosystems

As of May 2013, the prevalent frequencies in LTE networks in Asia were as shown in Chart 3.


Chart 3: Spectrum Bands in LTE Networks (Asia) May 2013

Source: Wireless Intelligence
http://www.mobileworldlive.com/asias-apt700-band-plan-leads-the-way-to-large-scale-4g-lte-growth

The most common were 1800 MHz and 2.6 GHz networks. The 2.3 GHz band used in India (and China) is not very widespread, while 900 MHz is barely there. Bands that are not widely used are unlikely to benefit from scale economies. From this perspective, it is more logical to refarm 1800 mHz for LTE rather than 900 MHz, and the now widely adopted 700 MHz band.

The adoption of the APT700 band across Asia (including India), Latin America and Europe opens up the possibility of evolving into the largest LTE ecosystem with significant scale economies. As Verizon's established 700 MHz band in America differs from the APT700 band, the availability of devices may be a concern.

However, the fact that many countries have adopted the APT700 band improves the chances of quick development of equipment, starting with Telstra's planned trials in December 2013/January 2014.

For the resurgence of telecom and widespread access to broadband, the current positive moves to cut reserve prices somewhat, allow spectrum trading and consider uniform spectrum usage charges are not enough. Public opinion tends to view these steps as favouring telecom operators, or as sops to one operator or group. However, policies need to be formulated from considerations of the public interest, including that of users, the industry, and the government. Regarding auctions, there needs to be rethinking on the lines of the Swedish approach of bids for network investment and rollout, perhaps with incentives for faster delivery.


shyam [no space] ponappa at gmail dot com

* http://www.business-standard.com/article/economy-policy/m-a-rules-for-telecom-cleared-113120400012_1.html

Predictability in Infrastructure

Systematic planning and execution can reduce the need for crisis management in infrastructure and manufacturing

Shyam Ponappa  |   November 7, 2013 

Problems related to projects in infrastructure and manufacturing are either predictable or unpredictable. For the type of problem that is more predictable, the "known known", we need to apply ourselves to facilitate productivity across sectors. An example of the unpredictable variety is in the developments dogging the erstwhile Dabhol project.

Until we plan and build infrastructure systematically, our current account deficit will continue to overshadow our economic prospects, including our ability to increase exports. The United States' easy-money policy is no more than a stopgap thumb-in-the-dyke. While unpredictable infrastructure problems require crisis management, no amount of clever short-term measures can substitute for timely, co-ordinated actions that are within the controllable domain. Whether it's power generation and distribution, telecommunications and broadband, the railways, or air travel, any form of infrastructure - apart from exceptions such as the Delhi Metro - suffers from our inability or unwillingness to plan and execute systematically. 

The Unpredictable: Dabhol


Consider the continuing, unforeseen problems with the Dabhol project. This power plant with a separate liquefied natural gas (LNG) terminal nearby is going through yet another crisis. The owner and operator is Ratnagiri Gas and Power Private Limited, owned by public sector units, the state and banks. This joint venture - between the National Thermal Power Corporation (NTPC), Gas Authority of India Ltd (GAIL), the Maharashtra State Electricity Board, and some banks - was constituted to pick up the pieces after Enron. Yet, the Maharashtra State Electricity Distribution Company Ltd (called MahaVitaran), after taking most of the plant's output, is significantly behind on payments. Second, after the drop in gas production by the supplier, Reliance Industries' KG D-6, gas supplies have been reduced and are now cut off. The plant has been running well below capacity because of limited gas supply since 2012. Imported gas prices are so high that the Maharashtra State Electricity Distribution Company Ltd refuses to buy power at prices nearly double that of domestic gas, so the plant may have to be shut down.

There we have it: a potentially valuable asset providing a critical resource, electricity, with a substantial, untidy set of problems that have dragged on for a decade. It's ironic that desperately needed energy assets were shut down because the output was deemed too expensive at first and then restarted without the "rapacious" private sector - only to run short of fuel, with state payments in arrears, and now close to another shutdown. This kind of problem needs hard decisions like getting state entities to pay on time, and the capacity to devise creative solutions and co-ordinated execution to tide over the crisis in the long-term public interest. Unless we muster the resolve to deal with such unforeseen, unstructured problems through hard decisions, Dabhol will continue to sap national resources.

Yet, when Chandrababu Naidu as chief minister in Andhra Pradesh dared to attempt rational tariff increases in 2004, the electorate swept him aside for the populists, who gleefully reverted to unsustainable free electricity and other handouts. More recently, the Aam Aadmi Party's plank in Delhi's state elections included lower-priced electricity, triggering another unsustainable race to the bottom. But there is a public outcry against accepting hard decisions in governance - and a consequent political unwillingness to deal with them, or to display the leadership to create public awareness. Raucous public opinion is not a substitute for knowledgeable and informed inputs and judgement. Until we break out of this self-abasing, illogical spiral of seeking instant gratification or short-term gains over balanced, reasoned, deferred gratification, the race to the bottom will continue.

Predictable Infrastructure: Telecom, Power, Railways, Airlines…

There's the other kind of problem, the one that is amenable to forward-planning, but doesn't seem to get it. The kind that it is impossible to put in place without comprehensive, integrated planning and execution. The classic cases from the 1990s have been telecom and power. 

In telecom, the recent emergence of three national operators with smaller, localised successes reaffirms the oligopolistic structure of this sector. Three operators account for 67 per cent of the market in India, 82 per cent in Brazil, 90 per cent in the US, and 98 per cent in the UK; in China, two operators have 99 per cent. If policymakers accept this principle regarding market structure, the refrain that more competition is always better can be jettisoned in favour of delivery and results, with the objectives of quality services at reasonable prices. Once the focus is on these objectives, the primacy of delivering services over collecting government revenues becomes apparent, except from narrow "fiscal deficit" considerations. The point is that planning and project management have to be done upfront to be effective, and are much less powerful when retrofitted to problematic situations, as in stranded power generation or telecom services.

However, even with the best of intentions and skills, there can be mistakes requiring course correction in predictable processes. A good example is South Korea's adoption of WiMAX and the attempted creation of their own standard, WiBro. While successful initially, it turned out to be inferior to a newer technology, LTE. What South Korea has done after evaluating its alternatives is to abandon WiBro in favour of LTE. This is the approach and capacity that we must strive to cultivate. To be unafraid to commit - but equally, unafraid to retract and change tack if and when a choice proves inappropriate. 

By recommending reduced reserve prices in auctions, the Telecom Regulatory Authority of India has indicated for the first time that delivery and price may be acceptable as concomitant goals alongside government revenues. Meanwhile, the department of telecommunications is reportedly considering lower levies on operators, although insisting on higher reserve prices, perhaps because of the finance ministry and/or public opinion. What is unclear is how public opinion will react to the focus on delivery and price. Contrarily, it favours auctions of inputs like coal mines and spectrum, but lower tariffs for power and telecom/broadband; auctions will have the opposite effect. Populists are more likely to go with public opinion, instead of analysing and resolving logical contradictions.

Every situation need not result in a crisis and firefighting. Systematically addressing end-to-end processes beforehand with those involved and experts can help in the resolution of a large set of predictable processes in areas like infrastructure and manufacturing.

---

shyam (no space) ponappa at gmail dot com

Bullet-Proofing the Balance Sheet - Interest Rates 4

          A strong balance sheet needs reasonable profits and, therefore, reasonable interest rates.


Shyam Ponappa  |  New Delhi  

October 3, 2013

Several analysts lauded the Reserve Bank of India (RBI) governor's announcements on interest rates on September 20. Others rued the lost opportunity to capitalise on sentiment, especially after his dramatic entry statement stopped the collapsing rupee and markets in their tracks with what seemed like a magical swish of his cape.

Is sentiment all that important? And are these merely differences in subjective perceptions, or are there objective reasons that explain these differences? Analysing this quote on easy money tapering may provide some answers: "We must use this time to create a bullet-proof national balance sheet and growth agenda...."

Reasonable profits are a prerequisite


How are balance sheets strengthened? Barring external events like third-party equity investments, strengthening happens through building assets of good quality, or reducing liabilities and debts. To do this, profits are essential from activities in the "P&L", or statement of profit and loss; these give rise to the flow through the balance sheet to the cash-flow statement. Only profits (up to a reasonable level) in the ordinary course can make the balance sheet strong - although there can be productivity gains from other means, such as speeding up receivables or reducing inventory/debt. Extraordinary gains from selling assets or intangibles could also help.

Our excess of imports over exports also makes us vulnerable. This is aggravated by events like the mining crisis, which lowered power generation and exports, while increasing coal imports. This is why the timing of cash movement is critical. When foreign investments slow, excess imports become unfunded, and the rupee weakens. Other off-balance sheet actions also strengthen or weaken our balance sheet position - for example, the currency swap with Japan expanded from $15 billion to $50 billion. Conversely, investments in unproductive assets that immobilise capital, like gold, worsen it.

The essential fact is that India is short of capital, and has to rely on foreign investment. This is why higher price-earnings (PE) multiples and investments by foreign institutional investors (FIIs) are preferable to a more conservative approach, and why we need more locally manufactured high-quality products.

The growth agenda


It is the central and state governments that have a great deal to do to remove obstacles to investing and functioning here, as spelt out by the Damodaran Committee recently (http://www.mca.gov.in/Ministry/annual_reports/DamodaranCommitteeReport.pdf). It will take much more than governments, however, because a major reason for our inability to act in concert is our fractious, adversarial approach that extends to corporate interests as much as to our politics.

There is one important aspect to which the RBI can make a real difference: perceptions and sentiment. It can lift sentiment and facilitate performance. Better returns are required for higher domestic investment. According to an RBI report, returns also have a positive influence on foreign institutional investment ("QE-II and FII inflows into India - Is there a Connection?", Anand Shankar: http://rbi.org.in/scripts/PublicationsView.aspx?id=13973).

In our circumstances, functioning below capacity with high interest rates (State Bank of India's prime lending rate is 14.55 per cent), lower interest rates can help close the output gap in the short term, although major structural changes have to be addressed for the medium and long term. Some opine that high inflation prevents this; others cite India's supposedly negative real rates. Consider these facts before reaching your conclusion:

• According to the RBI, real lending rates were positive over the last two decades, as shown in the graph.
   

• The RBI apparently didn't reduce the repo rate because the inflation based on the wholesale price index (WPI) rose to over six per cent in August. This happened because onion prices rose 244.6 per cent. Higher rates have not reduced food inflation so far, as the problems, mostly in vegetables, are supply-related. It couldn't possibly bring down onion prices or overall food inflation, but it destroyed positive sentiment. Instead, it would help if the RBI could be persuaded to act on inflation when it is appropriate, as in the case of interest-rate-fuelled asset bubbles. It could institute policy-driven, real-time sectoral dampers to deflate funds diversion and excessive speculation, and leave supply problems, as in the case of vegetables, to the government.
   
• After the rate increase, sectors like banking, real estate and automobiles fell sharply because of anticipated lower earnings. Bank securities holdings fell immediately, marked to market at lower prices.
   
• Some think that higher rates make bonds attractive to FIIs. Typically, if there's high uncertainty, FIIs don't look to emerging market bonds for returns, whereas they may consider this if they perceive less risk. In the last 12 months, FII bond holdings went down by Rs 18,000 crore, while holdings in equities increased by about Rs 1.48 lakh crore. There will be far higher investment in stocks if profits improve.

The opportunity: Our markets


India's economy is near a chasm because of a convergence. This convergence gave India a rising economic tide, and feeds the aspirations of an increasingly larger number of people. Together with this, demographics over the next decade will create the largest proportion of working-age population in India's history. To the extent that they can be educated, trained, absorbed and productively employed, India is likely to flourish. The alternative - if their potential is squandered through actions leading to economic stagnation and societal disorder - is simply unthinkable. We face an enormous threat which, if we get across successfully, will turn into a tremendous opportunity. Yet, large sections of the political leadership including of the ruling party, and of the press and media, seem oblivious of how close we are to real danger.

Our markets are also our greatest attraction, ranging from being large but potentially weak, if we do badly, to large and strong, if we do well. This is why investors put up with our obstacles; why Japan Inc, for instance, is struggling to replicate the success of Maruti-Suzuki. This is a strength that we can use to achieve more of our potential, with a judicious combination of governance, positive sentiment and monetary policy, instead of being bypassed as we are now.

shyam ponappa at gmail dot com

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Regrouping for Growth - Interest Rates - III

Aside from muddling along, the choices are to try to grow and retain capital to staunch the gap temporarily, or to settle for low growth and capital flight.

Shyam Ponappa  September 5, 2013

What are possible ameliorative steps for India's economy? Taking stock, are we overreacting to our economic woes? Second, do our problems have global origins? To the extent they are home-grown, what were the missteps? How can they be corrected?

The answers to the first and third (overreaction, policy errors) depend on whether one takes a "static" or "dynamic" view. Static views compare measures at points in time to arrive at an assessment of better or worse. Dynamic views, by contrast, emphasise system-wide flows and consequences, as in financial simulation models, with the focus on outcomes. The real question is whether we can grow sufficiently so that foreign and domestic funds cover imports and build manufacturing, or shrink and risk a deluge.

Risk assessment

From a static perspective, the present situation is nowhere near the dangers of 1991. Flows, however, highlight the potential for danger of slow growth: a demographic bulge with high aspirations and low opportunities; and a large, low-skilled population. What's worse is that foreign investment-fuelled growth rode a wave of imports without sufficient development in direct manufacturing. This imbalance is heightened by the stoppage of iron ore exports and the slump in coal production because of mining scandals, aggravated by high coal and gold imports. The problems - in telecom, mining, aggressive environmentalism, retrograde tax impositions, inadequate manufacturing - are all self-generated except for oil prices and the Syrian crisis. They stem from abdication of governance, overreach, or greed, compounded by judicial and citizen backlash. Only the triggers are external - from capital flowing in to the signal of a cutback.

Policy missteps 1: Interest and profits

The left side of the chart below shows interest expenses and profits for several thousand listed companies over the last four quarters. In terms of flows, higher interest rates curtailed demand as intended, so lower revenues and higher costs reduced profits - all while supply-constrained inflation continued.

Some experts maintain that rate cuts won't affect growth, citing the lack of a clear correlation; or the insignificant share of interest in total costs (reportedly three per cent); or that rates drive savings or consumption, but not investment. Clear correlations are unavailable because credible research must cover all major variables and interrelationships; simplifying them can distort conclusions. The research must also include how the effects of changes vary for rising or falling, large or small economies at different stages of development. The other reasons appear to ignore aspects of flows like momentum and turbulence - or even the data. And aggregates and averages can be misleading, as detailed below.

• Interest costs in 850 non-financial companies went up by 40 per cent as a share of earnings before interest, taxes, depreciation and amortisation over three years. While Ebitda roughly doubled, interest costs nearly tripled(http://articles.economictimes.indiatimes.com/2012-10-25/news/34729789_1_inflation-control-potential-growth-rate-capital-formation).
   
• Interest costs in 2,242 companies reportedly doubled from 2.3 per cent to 4.2 per cent of revenues over two years. Costs two years earlier were 16 per cent of Ebitda, whereas in the quarter ending December 2012, costs were 34 per cent of Ebitda. Analysts attributed this to low demand, and expect worse in 2013-14 unless demand improves (http://articles.economictimes.indiatimes.com/2013-02-18/news/37160258_1_interest-outgo-rise-in-interest-expenses-interest-cost).
   
• In July 2013, earnings of 85 out of 600 listed non-financial companies did not cover interest payments, up from 61 the year before; another 43 were at risk compared with 36 a year earlier, and non-performing loans were increasing (http://www.thehindubusinessline.com/companies/debt-traps-india-inc-as-profits-fail-to-cover-interest-outgo/article4889184.ece).
   
• Aggregate costs and averages sometimes conceal problems. Credit Suisse reports that the aggregate interest cover for 10 large, overleveraged industrial groups has dropped from 1.6 last year (borderline) to 1.4 (inadequate). For four of these groups, interest costs exceed profits. Rejoicing in the woes of "profligates" is inadvisable, however, because a collapse affects everyone.

Policy missteps 2: Sustainable profits and stability


Profits are essential for savings, investment, stability and order. This is why sustained profitability is of paramount importance for India. Provided industrial relations are harmonious and demand is resilient, that is, momentum is positive, lower interest costs within reason can sustain positive sentiment, resulting in higher profits up to a point (see chart - right). This has been a matter of incomprehension or denial for government (central and states), the Reserve Bank of India, the judiciary, and many citizens.

Instead, we have populist handouts to capture treasuries, and irresponsibility in replenishing them. What started with cheap rice in the 1980s has degenerated into a free-for-all, promising a distribution from the treasury contingent on capturing it for aspirants, or recapturing it for incumbents: vote us in, and you'll get these spoils.

Plausible remedies

• Lower rates: A number of experts in India and abroad recommend a reversal of monetary tightening and reduced interest rates. Some aver that the biggest risk is stifling growth by raising rates, eg, Paul Krugman and Ryan Avent (http://krugman.blogs.nytimes.com/2013/08/22/generation-b-for-bubble/). Others, unfortunately, suggest confusing strategies, including raising rates to contain inflation, despite this not having worked and been shown to be detrimental.
   
• Fiscal responsibility: A second requirement is fiscal responsibility in trade-offs for resources, betrayed by all parties in the impractical Bills on food security and land acquisition. This is a crucial requirement from both the government and the Opposition. For example, an effective step would be to raise diesel prices by Rs 5 a month for three months (which the government could evaluate using simulations).
   
• Manufacturing: Another requirement is action supporting manufacturing. A National Manufacturing Plan has been mentioned for years, but only coherent action will change the perception of yet another plan on the shelf. For instance, the government has resiled on the preferential marketing access for telecom equipment, which will increase imports.
   
• Stalled projects: There have been future-oriented announcements, eg, on fuel supply for power projects, but no demonstrable actions and results.

In sum, a rate cut combined with consistent actions on fiscal responsibility, disentangling projects, manufacturing, and stop-gap measures like swap facilities for oil companies and "stretching" imported coal may provide a breather. These could have a stabilising effect on the rupee, improve sentiment, and re-establish India's growth potential.

---

shyamponappa@gmail.com

Comments

Anand Tandon

1. Interest costs did not go up because of "high rates". Over FY07-13, interest costs for approx 750 companies with a market cap of >$1bn increased at 30% CAGR, while net debt increased at 31% CAGR. Comparing with revenues mis-states the problem. Yes, there is an economic slowdown, but it is NOT caused by interest rates. In fact, over this entire period, real interest rates have been NEGATIVE. 2. Krugman et al are operating in an environment where interest rates are zero, and there is little inflation. There the attempt is to INCREASE inflation, so that the economy can be given a stimulus through a negative interest rate ! India suffers from extremely HIGH inflation, and out of control revenue expenditure of the government - an entirely different problem 3. The weak rupee, in part caused by a low real interest rate and high consumption demand,has already led to a tightening in the near end of the interest rate curve. This could have been avoided if as Dr Subbarao mentioned in his outgoing speech, the RBI has been faster in the tightening cycle.

SP Replies

“…over this entire period [FY07-13?], real interest rates have been negative.”

Data for Real Lending Rates according to (a) the RBI and (b) the World Bank (from TadingEconomics.com)

Real Lending Rate – RBI  1992-93 to 2009-10

Measures of Nominal and Real Effective Lending Rates of Banks in India

Deepak Mohanty, A.B. Chakraborty and S. Gangadaran

May 2012

http://www.rbi.org.in/scripts/PublicationsView.aspx?id=14236

a) RBI - Real Lending Rates & Growth

Real Lending Rates - 1992-93 - 2009-10

Real Lending Rates & GDP Growth

b) The World Bank

http://www.tradingeconomics.com/india/real-interest-rate-percent-wb-data.html

REAL INTEREST RATE (%) IN INDIA

The Real interest rate (%) in India was last reported at 2.01 in 2011, according to a World Bank report published in 2012. Real interest rate is the lending interest rate adjusted for inflation as measured by the GDP deflator.This page includes a historical data chart, news and forecasts for Real interest rate (%) in India.

“2. Krugman et al…  India suffers from extremely HIGH inflation, and out of control revenue expenditure of the government - an entirely different problem.”

Reply

They are writing about India (http://krugman.blogs.nytimes.com/2013/08/22/generation-b-for-bubble/).

"The emerging-market squeeze, short version"

Ryan Avent   Aug 21st 2013

http://www.economist.com/blogs/freeexchange/2013/08/global-economy-0

"My conclusion was that the big risk is a policy overreaction in affected economies. Governments or central bankers worried about depreciation or its effect on inflation will be tempted to move monetary policy in an inappropriately tight direction."

Srinivasan

Shyam Ponappa has exceeded himself in this columns. Brilliant stuff. "Rejoicing in the woes of "profligates" is inadvisable, however, because a collapse affects everyone." Nobody could have given a better argument to silence the liberals who have been crying hoarse about 'Moral Hazard'. I think this eliminates Moral Hazard as a category worthy of consideration because losers should not lose in capitalism as it will bring everyone down. Effectively, those who are on top should not be tested. Even if they lose they should be reinstalled back through subsidies for the Rich. And there goes Schumpter and his Creative Destruction. If we are going to have to pay the price of Destruction, we dont need Creativity itself. It is nothing short of revolutionary stuff for Ponappa to keep insisting on stopping all this Churn business. Society really does not need new innovaters to be well rewarded, continuation with old failures is the way to go. That will The basic framework of economic policy should save the well-entrenched and keep out the troublesome unsettling new aspirants. That will keep society stable as well. Everybody will know their place and learn to stay put. Along similar lines, he has also excelled in returning to his pet topic of lowering Interest Rates as the preeminent route to save the corporates which are failing. The 850 or 2000 corporates which are failing need to be subsidised through the lower interest rate mechanism, no matter what price the rest of the Economy has to pay for it. Head of PM's Council of Eco Advisers has said on 3 Sep that the country was suffering from very high inflation for an extended period and so the rupee adjustment was only to be expected. Does he mean to say that the inflation targeting should have been done through higher interest rates. The rupee drop has no link to prior inflation and low inflation rates. Isnt it so Ponappa? Ponappa based on this clear simplemindedness has been crying oarse in his columns for a 300bps drop for interest rates even before DV Subbaro raised it by 300bps. To drop them to around 200bps! Brilliant assumption - There is no price to pay for economic policy failures. 

SP Replies

The Real Effective Exchange rates, according to the Reserve Bank of India (RBI):

http://rbidocs.rbi.org.in/rdocs/Bulletin/PDFs/36T_CB080813.pdf

The statement that reduced interest costs will increase profits if other factors are constant is a truism.  It would be true if any cost is reduced with other factors unchanged. 

Should this be done?  Or should the “850 or 2000 corporates which are failing” (Srinivasan) [be allowed to fail].

As written, I think the choice is to tide over the difficult situation we are in by retaining foreign and domestic capital, or risk a serious, prolonged downturn with capital flight.  Whether this is justifiable or not depends on the facts of our economic situation and what our objectives are. 

In my opinion, we are at a juncture where employment opportunities must be improved somehow.  I think the way to do so is to improve the profitability of sound enterprises, and not consign all overleveraged companies to mass bankruptcy, because it will be too disruptive to our political economy.  A mass bankruptcy would destabilize our banking system and jeopardize what is most important for employment and for the future, the development of infrastructure.

There are distinct areas in which decisions have to be made: exchange rates, interest rates, and economic policies in areas other than exchange and interest.  I am suggesting that action on interest rates and on other economic aspects can strengthen the economy, so that the currency becomes more stable.

Srinivasan

Srinivasan replies - Choice 1 is To try to maximise working within an illiberal non-market-based system which i) rewards crony Big Business without any reason through interest rates (but that is a model which can be followed only for so many years before currency has to be devalued) and ii) helps them out when they take wrong decisions, and iii) when the above disastrous decisions stretch the system beyond the limit, and systemic risks emerge, they are addressed by spreading the pain to all sectors of the economy. Choice 2 - have a market based system which rewards innovation and energy and efficiency. Those who fail, no matter how much their clout - they Fail. Those who do well the market rewards them amply. These basic incentive mechanisms are not tampered with. The full potential of the People gets unleashed. As Ruchir Sharma of Morgan Stanley point out since UPA-I the Churn within the Top Twenty-Hundred-Thousand has stopped. Most of those who were in the Top Twenty in 1991, had dropped out and been replaced by fresh entrants by 2001. But in the next 10 years there has been hardly any change in the Top Twenty. These new entrants have grabbed control over the policy structure in Delhi to close the door to any further new entrants. The choice - Choice 1 or Choice 2 - is up to us. Think short-term and save and exalt a corrupt Big Business system in which SMEs and common people languish in the absence of right incentives. Or, Think long-term and over-haul it to empower people to excel and outperform. Brilliant assumption by SP - There is no price to pay for economic policy failures. There will be two mega-benefits. No penalty to Big corporates for their erroneous decisions, and no penalty to the Nation for erroneous policies.

05-09-2013