What I read this week: Money trail & TN’s ticking time bomb.
It's a strange world we are living in! A surge in currency in circulation since October 2015 is baffling investors and economists, Bernanke is nudging BoJ to go for helicopter money and in our own Tamil Nadu a bomb is ticking with debt bondage is expanding at a rapid pace.
All of this and more for this week! Have a great weekend ahead.
Money, money, money!
One thing that has been baffling investors and economists alike is the surge in currency in circulation (CiC) since October 2015. During this period, CiC growth has averaged 15-16 per cent YoY, which is a five-year high. In absolute terms, CiC rose by Rs 2.6 lakh crore in the 12 months since August 2015. Besides having implications for monetary transmission via the banking system and higher liquidity, CiC also has implications for tax base and collections, financial inclusion and efforts by the government to squeeze the parallel cash-based economy.
The situation was nicely articulated in a report, titled 'Currency in circulation - an unsolved puzzle' by Prasanna A and Abhishek Upadhyay of ICICI Securities Primary Dealership.
Currency demand is an interplay of three broad factors - inflation, interest rates and growth. But neither of the three have been able to provide ample insights or explanations for this sudden surge in CiC.
Election-related spending led to a temporal surge in CiC, but it is unlikely to trigger this kind of sustained surge. However, a continued increase in service tax over the past few years could have led to tax avoidance by small business owners and consumers, leading to more cash transactions.
Add to this the crackdown by the government on accounted transactions, which may be leading to greater hoarding of cash to avoid service tax with higher reliance on cash transactions and avoiding any paper trail.
Admittedly both these explanations are not backed by data and remain conjectures. Coincidentally, outward remittances under the liberalised remittance scheme (LRS) have also surged since the middle of 2015. Interestingly, the LRS limit per resident was doubled to $250,000 in May 2015. While this flow is a combination of current and capital transactions and the magnitude involved is but a fraction of CiC, the co-movement between remittances and CiC should provide food for thought to policymakers.
Why Unilever did it really?
Unilever recently agreed to buy the Dollar Shave Club, an online men's razor for $1 billion. It paid about five times the dollar shave club's expected revenues this year. Much of that premium stems from the value Unilever placed on the razor seller's brand and customer-relationship skills. The key to Dollar Shave Club's appeal is not so much its online prowess, but the fact that it built a powerful brand in four years.
Dollar Shave Club developed relationships with men, many itching to find an alternative to the high-price blades sold by Gillette and Schick. It upended the industry's traditional business model by offering a subscription service that sells blades for as little as $3 all-inclusive per month. The company learns about its audience and curates messages specifically meant to keep them engaged.
Dollar Shave Club began running television commercials, an expensive tactic tried by very few startups. One made sport of the cumbersome process men go through to buy big-brand razors at a local drugstore. The pricey blades are locked away behind plastic doors that set off a siren when opened without the help of a salesperson. In the commercial, the customer vainly asks for help and tries to grab razors without assistance. He's quickly subdued with a tranquilizer dart. Then Dubin touts Dollar Shave Club as a much better alternative.
As per Unilever, the company reached $150 million-plus in sales in 2015. That despite the fact that the blades lack many of Gillette's high-tech enhancements. Few other e-commerce startups can claim to have built a brand so quickly. Unilever and P&G are masters at traditional marketing, mostly offline, but they struggle with the direct-to-consumer brand-building at which upstarts like Dollar Shave Club excel.
Debt bondage in Tamil Nadu
Over the last 15 years, G Venkatasubramanian and his fellow researchers at Pondicherry's French Institute have been studying debt bondage among families in 20 villages in Tamil Nadu. While the average income for the sample study has risen 8 times, debt has increased 25 times. The families were slipping deeper into a debt spiral.
Other parts of Tamil Nadu are also seeing large changes in how people lend and borrow. And this is seen across income classes. In Trichy, bank officials talk about businessmen with Rs 10 lakh, taking a Rs 30 lakh loan, using Rs 20 lakh in their businesses and lending the remaining Rs 20 lakh to others and at very high interest rates - as high as an effective interest rate of 300 per cent. In the fishing village of Pichavaram fishermen are borrowing more. These loans are expensive - going as high as 5-6 per cent a month. The parties they borrow from have changed - government employees are among the new moneylenders here.
Why are farmers borrowing in Tamil Nadu? The first part of the story is simple enough to understand. Neither traditional livelihoods (like farming or fishing) nor their modern alternatives (industrial labour, construction or trading) generate enough income to support families. And drastic change in weather patterns and weak monsoons have not helped either, leading farmers to sell livestock. When agriculture fails, livestock also fails.
The problem lies in expenses outstripping income - a common trend across the state and even those outside agriculture are turning to debt. Families have begun borrowing more - for education, daily needs, medical expenses, repaying old loans and housing. The debt problem is so acute that in some families, more than 50 per cent of expenditure is based on borrowed money - and at very steep interest rates - quoted in monthly terms and not annual.
A major source of credit in the past was from the state government's self help group programme, which faded out in 2011 with the new government coming into power. With the demand remaining intact, the void was filled by both formal and informal credit including microfinance companies which lent aggressively and without apparently properly assessing the end use of the loan. Do remember that these loans are intended to be disbursed only for livelihood generation, and not for consumption. The lending boom fanned a spike in consumption. Signs of distress are already visible.
As per an expert in rural finance, we could be headed for a local politician driven sensationalism with the poor struggling to pay loans at exorbitant rates. Then there could be mass defaults and lenders could lose a lot of money.
Lessons from Japan's experiment
From the economic dynamism of the 80s, Japan is now drawing attention largely for its economic stagnation. After years of falling prices and fitful growth, Japan's nominal GDP was roughly the same in 2015 as it was 20 years earlier when its developed peers marched on.
Compared with its promises, Abenomics has indeed been a disappointment. The lesson many are quick to draw from Abenomics is that the weapons deployed by the Bank of Japan (BoJ)—and, by extension, other central banks—since the financial crisis do not work.
The BoJ has more than doubled the size of its balance-sheet since April 2013 and imposed a sub-zero interest rate in February; still more easing may be on the way. Yet its 2 per cent inflation target remains a distant dream. The BoJ has buoyed financial assets, but it has failed to drum up a similar eagerness on the part of consumers or companies to buy real assets or consumer goods. Japanese firms are reluctant to spend on capex or increase base salaries leading them to hoarding a mountain of cash. A lesson here: monetary policy is less powerful when corporate governance is lax and competition muted.
If companies are determined to spend far less than they earn, some other part of the economy will be forced to do the opposite (read the government). Mr Abe set out intending to rein in the public finances and ran budget deficits for 20 years. But after a rise in a consumption tax in 2014 tipped Japan into recession, he has backed away from raising the tax again.
Abenomics has not only demonstrated how self-defeating fiscal austerity can be, particularly when it comes in the form of a tax on all consumers. It has also shown that, in Japanese conditions, sustained fiscal expansion is affordable.
Without any private borrowers to crowd out, even a government as indebted as Japan's will find it cheap to borrow. Japan's net interest payments, as a share of GDP, are still the lowest in the G7. Politicians in Europe make fiscal rectitude a priority. Abenomics shows that public thrift and private austerity do not mix.
Abenomics could succeed only if enough people believed it would. This is a final lesson that Japan's economic experiment can impart to the rest of the world. Aim high.
LINK TO THE ECONOMIST ARTICLE
Lastly, Charts That Matter
I publish a monthly Charts That Matter (CTM) series, which carries the most interesting charts in the financial world that I come across during that month. We just published the August edition.
Recently, I have been getting a lot of queries from anxious investors about helicopter money, and understandably so. Does it entail that the government will literally throw bundles of cash from helicopters into the hands of the public? Well, not exactly. So I decided to start this edition with a chart to de-mystify some questions on helicopter money. This time I have included a very interesting chart that shows a strong correlation between spike in outward remittances and CIC. Causality or mere correlation? I don't really know.
There is a chart on the divergence between bank credit to retail and corporate sectors. This divergence is a mirror image of the current recovery, which is largely consumption-driven while industry (investment) demand remains weak. There is this one chart on how under-penetrated India is when it comes to health insurance even when compared with its EM peers. A huge opportunity for health insurers.
In what could be a possible risk-on resurgence, ETF flow to emerging markets has been on the rise recently. In June we saw the highest single-day ETF inflows in 27 months. Now, we very well know how finicky ETF money is. It can flee as fast as it flows in.
A very interesting chart on how the current rally in the S&P is driven largely by equity risk premium compression than earnings growth or multiple expansion. Markets are putting too much faith on the ability of the central banks to drive up the markets even as quality of earnings deteriorates (-9 per cent earnings growth in this 2012-2016 rally). It's a strange world we are living in!
(Ritesh Jain is the CIO of Tata Asset Management. Views expressed in this weekly column are personal in nature and do not represent those of Tata AMC or ETMarkets.com. It should not be construed as an investment advice. Any action taken by the reader or recipient on the basis of the information contained herein is reader's/recipient's responsibility alone.)