Thursday, October 20, 2011

Is China a currency manipulator?

Once upon a time, there were two countries, one named the US of A and the other named China. US of A bought Chinese goods cheaply for several years, by simply printing more of their money. China scrounged and worked hard, to be able to provide acceptable quality at very, very cheap dollar prices. US of A benefited hugely from a low priced yuan - it gave them more goods and value per dollar of spending. In the meanwhile, China saved, and saved, and saved. In US of A's dollars. So the US of A was the grasshopper that danced all summer, and China was the ant that saved up for the winter, from Aesop's fable.
China's thriftiness allowed the US of A to spend in excess of their incomes, and not bear the consequences, because, by buying up US of A's treasury bonds, China in effect sequestered the extra dollars printed in the US of A that could have led to inflation at home.
Now, US of A finds that they have reached the limit of deficit financing, and its cupboards are as empty as Old Mother Hubbard's was. They have suddenly realised that they have to repay all the Treasury Bonds that China has accumulated. They want to pay back the debts after China has appreciated the yuan, so that they will pay less dollars to pay off their debts. So they decide that China has to allow the yuan to appreciate against the dollar.
But China now has new-found confidence - the confidence of the rich ant, with a granary replete and bulging on all sides with dollar debts issued by the US of A. So it looks the US of A in the eye and says, "Please manage your own currency, we will manage ours." When pressed, the Chinese will point out that they have never lectured the US of A on what to do with their currency even when they were buying Chinese manufactured goods at a small fraction of what it would cost them to manufacture and sell, so why should China listen to lectures now?
So now, the US of A is doing the equivalent of the grasshopper in W Somerset Maugham's version - marry a rich widow and escape the consequences of past profligacy, by alleging that China is a currency manipulator, and forcing China to value its currency upwards. If China gives in, then they have been hit twice - once by being forced to sell goods cheaply with an undervalued currency; and once again when it is time for them to reap the benefits of investing their savings in US of A's Treasury bonds.  
Which version of "The Ant and the Grasshopper" will triumph - Aesop's, or Maugham's? The jury is out. I certainly hope that Maugham's cynical and dishonest grasshopper does not triumph. In this case, currently, it is worse: China's currency has risen, and yet they are being branded currency manipulators. 

Monday, October 10, 2011

Lessons in integrity from Bharat Ratna Sir M Visvesvaraya

Please read on till the end! 
Bharat Ratna Sir M. Visvesvaraya (15 Sep 1860- 14 April, 1962) was one of India's finest sons. The breadth of his achievements mark him out as the Leonardo Da Vinci of India.
He was a Civil Engineer par excellence. He devised innovative techniques that were well ahead of his time. Among them,
  • The Block System of Irrigation – to optimize, control and evenly distribute water supply to agricultural lands over many villages. The supply was rotated within “blocks” in each village to curtail misuse and water-logging. This system, devised in 1899, is still used in Deccan Canals.
  • The "collector well” in Sukkur in Sindh province (Pakistan). The area was hot and arid, and they had to pump water from River Sndhu to a hill nearby, filter it and supply water to the town through pipes.They did not have enough money for filters. Visveswaraya solved this ingeniously by digging wells in the river bed itself close to the river bank to obtain spring water through percolation. Thus filtering was achieved without installing filters. To increase supply of water, a tunnel was driven from the bottom of the well under the flowing river. This is now standard civil engineering textbook content under the Heading, “Collector Wells”.
  • He designed and patented Automated Floodgates, which permit flood water to enter a reservoir without water level exceeding full reservoir level, thereby reducing risk of submerging surrounding land. The gates are automatic because they open and close at the rise and fall of water in the reservoir for flood control. He designed water supply schemes for many towns in Bombay Presidency, Hyderabad and later as Chief Engineer of Mysore State.
As Dewan of Mysore State, he established many rural industries and set up basic education for small shop owners in the fields of book-keeping and commerce. Agricultural schools were opened to help with modern agricultural practices that reduced farmers’ overdependence on rain and good luck. Many industrial workshops and training institutes were set up. Public libraries were established. The Kannada Sahitya Parishat was formed. Many books on science were published in Kannada. The University College of Engineering (now known as University Visvesvaraya College of Engineering) and Maharani’s College for Women came into being. He established the Mysore University, as until then, all colleges in Mysore State were under Madras University. He established the Bhadravati Iron and Steel Works, The Mysore Sandal Oil Factory, the Mysore Sandal Soap Factory, the Metals Factory, and the Chrome Tanning Factory. He started the Bank of Mysore (now State Bank of Mysore) and The Mysore Chamber of Commerce. The Institution of Engineers (India) celebrates his birthday, 15th September every year, as Engineers Day.
He differed with Mahatma Gandhi whose view essentially was “Industrialize and Perish”, while Sir MV's motto was the opposite, “Industrialize or Perish”, but great men that they both were, both respected each others' views and capabilities.
Sir MV led a very simple life. He was known for his honesty and integrity. In 1912, Maharaja of Mysore appointed Visvesvaraya as his Dewan.
Before accepting the position of Dewan of Mysore, he invited all his relatives for dinner. He told them very clearly that he would accept the prestigious office on the condition that none of them would approach him for favours.
When on tour on official business, Sir MV carried a set of candles bought with his personal money, and used them for personal work like reading etc in the night after he was finished with official work.
Just think – this man lived a life of total personal integrity that we cannot even imagine today. It has taken another simple person like Anna Hazare to raise our collective anger against corruption. Across the political spectrum are ranged small minds who do not want to see corruption rooted out of this great country. They do not realise that because of their selfish interests, India is held back from fulfilling its rightful role in the world by the “hand-brake” called corruption. It is time to release the hand-brake and surge forward..

Friday, October 07, 2011

Dexia Bank Collapse: What it means for Europe, Belgium and the World

Dexia Bank is among the Top 50 financial institutions in the world. It is not just some small, unknown bank. It is different from other banks because it, and with it, Belgium, are caught in an uncomfortable spot. How? Let me attempt an explanation.
  1. Belgium has external debt to GDP ratio of close to 100% already. The Government thus does not have room for manouevre to fund losses of Dexia. That's already been done once - in 2008, the Belgian Government took control of Dexia. Various arms of Belgian and French Government now hold over 50% in Dexia. This closes off one source of succour. Worse, there is a political standoff in Belgium because of which there is no functioning Government at all at present in Belgium! Worst time for such problems to hit.
  2. Dexia's leverage at present is estimated to be almost 60:1 – double that of Lehman Brothers when its collapse was triggered. So Dexia is not in pretty shape at all. Worse, of its over €500Bn of assets, €20Bn are debts of Portugal, Italy and Greece, all of whom are in need of bailouts.
  3. After the 2008 takeover by the Government, instead of getting better, things got worse, because Dexia was a source of funds for the various parts of Belgium's Government. When they took it over, instead of stopping loans to Government which were the major part of its NPAs, they stepped up lending to Government, which enabled the Government to reduce its fiscal deficit somewhat. Now, if the Government were to bear even a small part of the losses of Dexia, its external debt to GDP ratio will shoot up to almost the level that Italy is at currently (which is 134%). So PIIGS will no longer be a sufficiently comprehensive acronym of European states in deep fiscal trouble. We have to find some way of adding a “B” to it. Just for comparison, US, Australia and India are at 99%, 94% and 22% respectively. France, one of the co-owners of Dexia, is at 208%.
  4. The only time-tested solution for banks or financial institutions in such a mess as Dexia finds itself in is to break up the institution into a “good bank” and a “bad bank” - like India did for Unit Trust of India a decade or so ago. Usually, the bad bank sells the 'bad” assets for anything they can get for it – which could be single digit percentages of the book value. In Dexia's case, this is apparently not feasible because (a) Belgium's Government does not have the money and the political will (there is no functioning government now!) to bail out Dexia because it would mean choking its own source of funding; and (b) “Good bank” assets have not takers almost anywhere in the world today. So the good bank-bad bank solution will not work very well for Dexia. But that is the only solution – so you can expect sell-offs of any saleable assets.

    Already, Reuters reports Qatar as being interesting in buying out Dexia's Luxembourg business. So the dismembering of the Bank has officially begun. The vultures are circling, but then, there aren't too many vultures, this time. Trading has been suspended in Dexia's shares, and S&P has downgraded Dexia's group companies steeply. In its downgrade press release, it notes that there is negative revaluation reserve in respect of available-for-sale securities of almost €6.9 Bn. Moody's has followed S&P in steeply downgrading (by 3 levels) the sovereign rating of Italy, and also some Italian banks in the last 2 days. Besides, 12 UK banks and 9 Portuguese banks have also been downgraded. Sovereign ratings of Spain, Ireland, Greece, Portugal and Cyprus have been cut as well. From the US, Ben Bernanke has said that the US economy is close to faltering. Deutsche Bank has warned that it will miss its profit target.

    One must remember that failing banks are not just like manufacturing or services companies that fail. Banks, as they fail, tear asunder the transaction enablement capability of its citizens. Thus, slitting the banking system's throat is akin to slitting the underbelly of a crocodile – however strong the economy may otherwise be, the banking system is its weakest link. This, all the above news in just a few days is bad news indeed, for the entire world. When banks collapse, other businesses will follow, and depositors will panic, causing a financial logjam in not just those countries, but in all countries where businesses have business ties with enterprises in countries whose banking systems are collapsing.
    In India, our very own SBI has suffered a downgrade because of its low Tier-I capital level that would require it to raise money and/or ask for Government help/ support. So where is the good news? If at all, it is in India where the Government has both, the wherewithal (with some difficulty) and the will and inclination, to support its banks.
    PostScript: This is the text of an email I received. Makes for interesting reading.
    Uncertainty has now hit Japan. In the last seven days, Origami bank has folded, Sumo Bank has gone belly up and Bonsai Bank has announced plans to cut some of its branches. Yesterday, it was also announced that Karaoke Bank will go up for sale and will likely go for a song, while shares in Kamikaze Bank were suspended today after they nose-dived. While Samurai Bank is soldiering on after sharp cutbacks, 500 staff at Karate Bank got the chop and analysts report that there is something fishy going on at Sushi Bank, where it is feared that staff may get a raw deal.

Thursday, October 06, 2011

Re-visiting Modern Accounting Standards

Should acquisition cost of an asset depend on how it is financed?
To my mind, and to most non-accountants, the simple answer seems to be No. But that is not how modern accountants see it. Costs incurred (including interest) till the time an asset is ready for use is treated as part of the cost of the asset. Whatever compulsions may have been behind adoption of such a treatment as standard, it tends to militate against simplicity, and creates needless (in my view) complexity.
Can a company have Net Profit After Tax equal to double its turnover for a quarter?
Common sense tells us that this is impossible. How can profits exceed turnover, that too profits after tax? However, modern accounting is not all common sense. Or maybe, it is such highly developed common sense that it takes truly uncommon levels of sense to understand why this can happen. As it happens, there are several reasons why this can happen. Deferred Taxation Accounting (DTA) is one of the reasons. DTA is one more area where accounting has been made dreadfully complex. So much so that it creates situations occasionally as the one described in the question above, where quarterly Net Profits After Tax of some companies exceed even quarterly revenues! How can accountants explain to laymen this paradox – where, say, the quarterly turnover of a manufacturing company is Rs.50 crores and its NPAT is Rs.90+ crores? Most accountants trying to explain this situation will end up tying themselves and their listeners in knots. This happens in the relatively rare instance when a company has just turned the corner after several years of losses. One argument in favour of the currently favoured treatment of deferred taxes is that it makes clear the differences in expected tax provision on reported profits, and the actual tax provision. However, we lose sight of the fact that the net result of the income statement becomes almost impossible to understand, even to reasonably financially literate individuals. Surely, this could not have been the intent of introducing such accounting treatment!
Is it a bad thing to allow retired employees medical treatment for life in hospitals run by the company?
Certainly, one cannot fault managers in Tata Steel if they begin to think like this. Accounting for Employee Benefits is another area where accounting complexity has reached ridiculous levels (in my view). Tata Steel used to routinely allow their retired employees and their families to be treated in the wonderful hospital they have built in Jamshedpur; and absorb and meet the net losses or cash shortfalls of that hospital quite routinely, as part of its employee-friendly initiatives. Let us say their costs were Rs.30 crores per annum, give or take a few crores. When AS 15 was made mandatory, suddenly they realized that because they allowed their retired employees and their families to enjoy these facilities for life, they suddenly had to recognize the present value of all the costs they expected to incur over the next several years, as a cost in a single year. This resulted in a hit to their Income Statement to the tune of hundreds of crores in the year in which the new Standard was made mandatory (if I remember it right, it was over Rs.250 crores). Why? Could not well enough be left alone? Now, it has accountants and managers thinking closely about the impact of such facilities to its past employees on its current profits, way beyond the actual cash expenses of offering such facilities. Simplicity flies out of the door, to be replaced by dreadful complexity. What I wonder is, what purpose is served by such complexity?
Why did Warren Buffett call derivatives "weapons of financial mass destruction'?
Buffett should have included "securitised, structured products" which are a class of "innovative" derivatives, by the same appellation. We know now that derivatives and securitisation have made financial life, and accounting for the new-fangled "innovations" they spawned infinitely more complex. Banks in the developed world are still facing the consequences of the complex accounting legacy of the millions of securitised structured note transactions it entered into almost without thinking in better times. They are now realising the impact of all that complex accounting – it only passed the parcel of risk onto others. It did not eliminate risk. Ultimately, every bank in the developed world was left holding such risk parcels to varying degrees. But they did not simply pass on risk to others. Some structured products passed on risks to a distant tomorrow.
We have yet to see the complete impact of such contracts that, in addition to passing the risk around to different people, also passed the risk to a future date. There are several apparently innocuous deals and assets sitting on the books of several companies (not just banks) which represent accounting legerdemain of pushing losses off to a point of time in the distant future, so that the current management came out smelling like roses though their results should have had the faecal matter hitting the overhead rotating cooling device. They are the financial equivalent of mines in modern warfare. They will go off and claim the lives of innocents at any time in future, without warning. This is because several best-selling "structured products" designed by mathematical geniueses sitting at investment banks the world over, were designed to hide losses from shareholders, future management and regulators alike. We have yet to see the full impact of such deals. Liabilities under such contracts will crawl out of nowhere, as it were, and trouble future managers and bankers alike. This is the long-term legacy of allowing untramelled financial innovation. AS 30, 31 and 32 (collectively dealing with accounting and reporting of derivatives) is something that almost 90% of practising Chartered Accountants – those charged with implementing them and checking their implementation incompanies, will privately admit to not being comfortable with. I think these Accounting Standards is a gigantic case of GroupThink – the management phenomenon where even a unanimous decision taken by a Group is completely at variance with what almost all of those participating in taking the decision privately think and opine. We need the small boy who points out shrilly that the Empe3ror is not really wearing clothes!
Why should we bother about all these complexities?
Almost all the modern accounting standards that have contributed their bit to making accounting more complex and less understandable have behind them the objective of making a company's Balance Sheet more "realistic". What they have actually succeeded in doing is to make the Income Statement almost impossible to understand or predict. Why should one prefer Balance Sheet accuracy to Income Statement accuracy? I think that the Balance Sheet showing assets at unrealistic low values based on historical cost is a form of desirable conservatism in accounting. We have succeeded in making the Income Statement, which is a good indicator of how well a company is being run, almost too volatile to be of any use – whether to compare results with past years, or to compare results with those of peers. Therefore, what I make above is a case for a complete re-thinking of the basis of modern, fair-value based accounting, and slowly going back to the traditional historical cost based accounting.

Steve Jobs, RiP

He was a technical AND marketing genius. I do not remember a single person who has had such deep impact over such a sustained period, as Steve Jobs has had, on the state-of-the-art in multiple consumer-facing industries. Personal computing, animation films, portable music players, music and entertainment marketing, smartphones, and hand-held tablet computers – all these are markets which he created, and in which he led his company to success at a level that can only be dreamed of by other companies. He did not make products – he made objects of desire. He changed the ways of working of every industry that he touched.
He built the first commercially successful personal computer in 1982 – the Apple II, after first developing the prototype in a garage, along with another technical genius, Steve Wozniak, whose autobiography is titled iWoz. This was the first commercial computer to have a mouse and an OS with graphical user interface. For several years – maybe 10 years, no machine came out on the market with comparable graphical OS. This probably represents the longest period of a technical monopoly ever.
He then went on to build the successors, called Macintosh computers, or Mac for short, which has been through several avatars. They became the gold standard for ease of use and stylish looks. Like every product that Jobs introduced, they were objects of desire, that sold even though they were usually far more expensive than the competition.
The famous story of how he got thrown out of the company he had founded is too well-known to recount, but genius that he was, he continued to develop cutting edge technology, in a company appropriately called NeXT. While the company never did come out with a commercial launch, several technologies developed there were incorporated into later versions of the Mac OS and other products. During that phase when he had nothing to do with Apple, he also bought and spent time on building a young startup company called Pixar Animation, where he learnt and taught the world how to to create full-length ultra-realistic 3D animation feature films using cutting edge computing technologies that his company used, as well as nifty software that it developed for internal use. The only other company that had successfully made animation films before, Disney, had made 2D films. Toy Story, Pixar's first film, was a blockbuster hit heralded a new genre in personal entertainment. It was inevitable that Disney and Pixar would merge, especially after Apple Inc reclaimed Jobs as its own. However, the success of Pixar and the deal with Disney made Jobs wealthy independent of Apple – an important factor that allowed him to dictate his own terms when he came back. Apple had become a basket case in the nearly 10 years that it ran without Jobs – to the extent that Jobs got arch rivals Microsoft into the company to continue to make Office for the Mac, and also a significant stake in Apple. This horrified Apple loyalists, and people felt that Microsoft had bought into Apple at a throwaway price, that allowed Apple to raise some much needed money and to stay alive, something that Microsoft also needed to defend themselves against charges of monopolistic behaviour. The reality was that Microsoft needed Apple to be alive, not kicking. But he had not contended with Jobs' steely determination to reinvent Apple.
Jobs' speech at Stanford's commencement, Stay Hungry, Stay Foolish, is an all-time classic with advice for anyone who aspires to be a creative success. It is a story of persistence and resilience, along with curiosity and willingness to question the weight of collective wisdom. It is something that every young person on the threshold of a career would be well advised to read and internalise.
Jobs' second innings with Apple has been even more exciting than the first, by almost any measure. He revived a moribund company to become the most valuable company on Earth by market capitalisation and profits. Jobs has left behind a company that has more liquid cash resources than the US Government. It sits on the largest cash pile in the world of any manufacturing company. It may be surpassed probably only by Berkshire Hathaway, which is mainly an investment company.
Jobs' second innings at Apple began with the i-Mac – with transparent plastic-encased monitors, computers and peripherals, not much functional difference, but great looks that evoked gasps at first sight made it the first hit product that gave Apple its second wind. Thereafter, there has been no looking back. i-Pods,i-Tunes, i-Stores, i-Phones, i-Pads, and the yet unheralded i-Cloud have all followed in monotonous succession; each redefining rules of the marketplace, and creating new standards to such an extent that Apple blazes the trail, and the entire world simply plays catch-up. It seemed as if Apple was unstoppable – till, cruelly, cancer took hold of Jobs. He battled on for a few years, but all the medical knowledge of humankind could not extend the life of this great man.
I don't envy Tim Cook – while he has been Jobs' close aide and confidante for several years, and been the de facto day-to-day head at Apple for a long time,  stepping into Jobs' shoes won't be comfortable – he will feel like a pygmy wearing three-league boots. The world will keep comparing him with Jobs. Like the i-Phone's latest version (4S) released a couple of days back, even though it has almost all-new innards, looks no different from the earlier version. Early reports suggest that Apple loyalists seem to be disappointed – quite possibly because it was the first product in more than a decade to be launched without Jobs' involvement, either at the launch or in its making.
Steve Jobs, RiP.

Saturday, October 01, 2011

Is Consumption of Rs.32 per day a realistic poverty line?

Simply stated, Yes. 

It is higher than it has ever been. The number of people  defined as poor by this yardstick are higher than they have ever been.

That is reason number 1 - we haven't objected in the past, so why the outcry now? 

This is a consumption figure, remember. And a per capita figure. Not the gross revenue of any itinerant businessman on a single day. Thus, your domestic servant's family, with 4 earning members earning an average of Rs.3,000 per month (translating to a family income of Rs.12,000 per month) are possibly under the new poverty line as drawn. How many of us are comfortable with paying a full-time bai more than Rs.3,000 per month, though she sets at least one of you free to earn not less than 10 times that sum? 

If your bai  has an unemployed husband, she is most definitely under the line. But how many of us are willing to bear the burden of maintaining a husband on a salary of (say) Rs.3,000 per month? 

We  are a poor country - we have lifted as many people as the entire population of Australia out of absolute poverty in the last 15 years alone. But we still have just as many queueing up! Poverty is a BIG issue in India, and will remain so for the next 15-20 years, make no mistake. We can look forward to abolishing absolute poverty levels and setting relative ones, linked to quality of life, that they have today in richer nations. I saw that in the UK, the homeless bring out their own monthly magazine with ads, to generate revenue. I really hope that in my lifetime, I will buy or advertise in such a magazine in India.

One possible accelerating factor is if we realize anywhere near the fullest potential of the UID Scheme, and convert all welfare and subsidies into direct  cash transfers through the banking system straight into the accounts of beneficiaries identified by a combination of 10 fingerprints and 2 iris scans. When, and to the extent that happens, it will prove to be a welfare accelerator that will make the India of today seem like driving with a hand-brake fully engaged. Today, it is estimated (no, there is no way of finding out the actual figure) that nearly 85% of the welfare spending, running into lakhs of crores of rupees per year, does not reach the intended beneficiaries. That is why I am rooting for Nandan Nilekani's UID Scheme completely.  If we can extract 7-8 times more welfare for every buck the Government spends on welfare, our GDP growth rate will surely soar, with the increased demand from people who have more money than ever to spend. Giving a fillip to all local businesses. It will be the tide that raises  all boats. 

Of course, so many of our babus and businesses will then have that much less black money  money to throw around. But few will shed a tear for them.  And I am sure that Ratan Tata and Adi Godrej and Savitri Jindal won't mind if they pay Rs.1,000+ for the gas cylinders in their home kitchens. Why should they be subsidized? Better to remit Rs.600 per cylinder purchased direct to the accounts of those who are below the poverty line automatically, minutes after they have paid for their own cylinder at full prices. This is a dream that I hope comes true. All power to Nandan Nilekani and his gang. 

Hope this does not seem idealistic in retrospect!