Over the course of 2013, many factors might have been expected to lead to a slowdown in Asian dollar bond issuance. First of all, interest rates have risen from their lows in 2012, with the yields on 10-year Treasuries higher by over 100bp. While everyone knew that interest rates had to normalize at some point, the rise in yields brought that fear to the front and center of everyone’s thinking. Then, in May, Bernanke raised the possibility of slowly withdrawing the monetary accommodation with his discussion of “tapering.” Third, for the last three weeks, we have tried to grapple with the possibility that the U.S. government may have to cut back on paying for its commitments and expenses if the debt ceiling is not raised by October 17.

In the midst of all this, Asian bond markets have had a great year in terms of new issues. So far this year, by our count, over USD 110bn worth of dollar-denominated bonds have been issued by Asian issuers. Month after month, in terms of issue volumes, 2013 has outpaced 2012 (which itself was a record year).

It must be noted that this year’s record volumes are despite the lean period in June to August, when only USD 7bn was issued in the full three months. Although this period is usually a low season, this year’s volume was much below the USD 18bn issued during the same three months last year. 

What accounts for the robust state of this market? Are investors blithely indifferent to the ructions around them?

The first thing to recognize is that much of the new issues are simply replacement for maturing bonds. This becomes clear if we consider the increase in the net market value outstanding at the end of the last few years (see chart below). This year, the market value has risen by USD 30bn – not a bad number, but still a slower pace of growth.

The figures nevertheless show that net new money has been available for bond issues, despite the repeated challenges. From the issuers’ point of view, the cost of funding is still attractive. Yields of 2.6% on 10-year Treasuries are still near the multi-decade lows, and the bond spreads are also reasonable although higher than the pre-crisis levels. From the investors’ point of view, Asian dollar bonds still offer a pick-up over comparable US domestic issues, even among investment-grade bonds. 

At this stage, it is fair to say that Asian dollar bonds have become a legitimate, large asset class with a diversified pool of issuers and sufficient liquidity for investors. Asian dollar bonds represent roughly 40% of all emerging market dollar bonds. Even as interest rates continue their upward journey in the medium term, we believe that institutional money would still be actively engaged in this market.

This is a reproduction of an article in Reuters published on September 11, 2013.

Ever since reports emerged that the United States might taper off its bond-buying program, emerging markets have whipsawed: falling currencies, rising rates and fleeing funds. India and Indonesia have been two of the most affected countries in Asia.

The Asian dollar bond markets have also been affected by the fear of tapering. On the one side, longer-term bonds have lost substantial value as U.S. interest rates have picked up. Additionally, investors have discriminated between bonds from vulnerable countries and those from stronger countries.

In India’s case, state-linked entities such as banks and oil companies have issued most of the bonds. Since May 22, when the word “tapering” burst into financial markets, the Indian rupee has plunged by 23 percent. At the same time, spreads for Indian dollar bonds widened by as much as 130 basis points, even for five-year bonds. The spreads on the benchmark 2018 bond from State Bank of India widened by 120 basis points from end-May until end-August.

There were many underlying fears that led to this. One was a potential downgrade of India’s rating, currently at its lowest investment-grade level. Standard & Poor’s, in particular, has a negative outlook on its rating, and has remarked that there is a one-third chance of a downgrade in the next one to two years, which may well be accelerated if things do not improve. The other fears are rising inflation, a slowdown in growth and the consequent deterioration of business fundamentals.

For Indonesia, the currency depreciation during the same period was 16 percent; but the 2018 and 2023 Indonesian sovereign dollar bond spreads widened by 140-150 basis points. This is despite the fact that Indonesia took some strong steps to control the situation, including raising petrol prices by 44 percent and diesel prices by 22 percent in June, and raising interest rates by 125 basis points.

During the same period, the spreads on dollar bonds issued from stronger countries have hardly widened. For instance, from Hong Kong, Hutchison’s 2019 bond spreads are up by only 10 basis points; from Singapore, Temasek’s 2023 bond’s spreads have not changed; from Korea, the 2019 sovereign bond’s spreads have risen by only 5 basis points.

Chinese dollar bonds present a different story. Their performance has been driven more by evolving views on Chinese growth, rather than U.S. Fed tapering fears. While bonds from cyclical sectors, such as Cement and Steel, have widened by 50-150 basis points, those from property companies have held well (for instance, the benchmark Country Garden 2018 bond has actually compressed by 40 basis points in terms of spreads).

The overall picture in the Asian dollar bond market, then, is one of rising discrimination between bonds from weaker and stronger economies. Similarly, even within the same country, bonds that are more vulnerable to economic slowdown have underperformed. For instance, in India, bonds issued by private-sector banks and companies have outperformed those from state-linked banks and companies.

In a way, this is a testament to the market’s ability to distinguish specific kinds of credit in terms of their strengths and weaknesses, rather than lumping all of them into an “emerging market” bucket.

As we look ahead, one key question is whether potential tapering has been fully priced in to the Asian bond markets. While U.S. 10-year rates have gone up by more than 120 basis points, many emerging-market currencies and equities have slid, and bond spreads have risen, there is still likely to be a residual effect which will kick in once the tapering plans are confirmed and the actual tapering begins. When that happens, the discrimination between credits in Asia will only strengthen.

In that sense, India and Indonesia cannot rest easy yet. Their struggles with currency, inflation and their balance of payments are likely to spill over into their dollar bonds too, taking their spreads higher as and when tapering begins in  earnest.

At some point, though, some investors will find value in these bonds. There is some evidence that Indian spreads reflect about 60 to 70 percent of the impact of a rating downgrade. If that number inches towards 80 to 90 percent, that would be a good time to buy those bonds.

"It is exceedingly difficult to make predictions, particularly about the future." – Neils Bohr
 
I was remembering my history with forecasts and predictions as I read Nate Silver’s book, “The Signal and The Noise.” I started my career in the Indian financial markets as a credit rating analyst. When we had to make financial forecasts for determining the ratings, we used to make them “conservative” and it was the accepted thing to do. A couple of years later, I switched to being an equity analyst, and I had to make forecasts for a power company. When I made my first recommendation to my boss, he asked me the basis for my forecasts. I told him I was being conservative. I still remember the way he barked at me: “You are not paid to be conservative; you are paid to be correct.”

Over the years, I have made hundreds of corporate financial forecasts, but I always remember that the objective of forecasting is to be as correct as possible. If you are too conservative, you might miss out on good opportunities; but if you are too optimistic, you might get stuck with dud investments.

But I do not understand the false precision in the forecasts of many financial-market analysts. Instead of acknowledging that they can forecast the EPS only within a range, they still provide forecasts to the second decimal place. In predicting macro-economic numbers too, most economists still provide single-point number, rather than a range.

Silver’s book opens with a discussion on the failure of rating agencies to forecast default rates on the U.S. mortgage-backed securities. He runs through some of the familiar ground, including the home speculators’ failure to see that prices could fall, the rating agencies’ failure to see that the quality of the underlying mortgage pool was changing, and the policymakers’ failure to  understand that the housing crisis could have implications spread across the economy.

In another chapter dealing with the failure of economic forecasts, Silver cites studies to show that actual GDP growth fall outside the 90% confidence interval almost half the time. That is a terrible track record, indeed. It is no wonder that the Queen of England asked the economists in the London School of Economics why nobody had noticed the  financial crisis coming. Silver acknowledges that economies are complex  systems, but argues that part of the failure of economic forecasting has to do  with overfitting the data. In other words, there are simply so many economic  variables being measured that you can fit the data to reach any conclusion you want.

He also points out that, even if you manage to choose the right variables to predict the path of the economy, it is  still difficult to separate correlation from causation; economic policymakers observe the same variables and start influencing them through their policies, changing their subsequent behavior. Even more fundamentally, economic data is noisy and subject to many revisions as better estimates become available. And finally, there is the incentive problem: even if an economist is not sure, it benefits him in the long run to issue forecasts as if he is sure!

In contrast to the failure that economic forecasting has been, Silver’s book also provides a fascinating explanation  about another, more successful, area of forecasting complex systems: the  weather. Although the number of variables in the weather system is very large  and the interaction between variables complex, weather forecasting has steadily improved in terms of forecasting accuracy over time. For example, predictions of hurricane paths, temperatures, rainfall and other components of weather have steadily improved as meteorologists have repeatedly used the actual weather to improve their models.

Silver also discusses sports forecasting and political forecasting, the two areas that have won him fame. While it is true that he is generally dismissive of “punditry,” he still finds value in adding judgment to a probabilistic forecast derived from numerical analysis. For me, two of the most fascinating chapters were the one on the probabilities behind poker and the one discussing heuristic models in playing chess. He also discusses the problems with making long-range forecasts, such as global warming models, or forecasting with inadequate feedback, such as with large earthquakes.

While this is not a “how to” manual, the book discusses a lot of relevant concepts such as overfitting, calibration of models, the Bayesean model, and probabilistic thinking. Perhaps the biggest takeaway from the book is to think in terms of probabilities and not single-point forecasts. Among the people in the financial markets, traders are more adept in thinking probabilistically, trying to make a profit in the aggregate, rather than from every single trade.

As a practitioner of forecasting of company financials, I think there are two kinds of forecasts, one based on mass of statistical data (such as sports or weather), and the other based on judgmental systems (such as the financial results of a specific company). In the first, good forecasts depend on the quality of the data and the forecasting models, both of which can be refined over time. In the latter, the challenges are greater because you are trying to predict the behavior of a single firm based on economic, sectoral, technological and regulatory trends. Even if your underlying predictions of business trends are correct, the company’s management may still surprise you by its actions, say, an acquisition or entry into a new business. I believe it is important not to shy away from making forecasts of the big trends and their impacts, but one should not get too focused on single numbers of single years. 

Besides getting the overall trend and turning points correct, one also has to get the magnitude and timing correct in order to make money in the markets. Otherwise, one can keep issuing bearish forecasts in the hope of being eventually correct (a la Nouriel Roubini!)

Nate Silver’s book is an important and entertaining read for anyone in the prediction business. 

Asian fixed-income markets have undergone a sea change in the last five years. The market value of outstanding USD bonds from Asia ex-Japan issuers has soared from USD160bn in 2008 to USD420bn currently.

This dramatic growth is the result of the confluence of many factors. Investors were happy to absorb increasing volumes of bonds as their portfolio values kept rising because of falling interest rates as well as tightening spreads driven by the search for yield. Particularly in Asia, private-wealth investors piled into debt investments, raising their participation in new issues from 1%-4% during 2004 to 2008 to a high of 16% in 2012. Issuers were happy to supply the market, as they benefited from lower cost of funds from falling interest rates and tightening spreads, and as they sought to replace bank loans with bond issues.

But now, there is fear in the fixed-income land. As the Fed began to talk of “tapering” its QE3 purchases of government securities, 10-year Treasury rates have flared up by 100bp in a short period of eight weeks. Not only that, but people have begun to realize that interest rates are due for a continual rise in the 12-24 month horizon. In Asia, new bond issues have slowed to a trickle; the frequent flow of new issues stopped on May 22, followed by just two issues in the last seven weeks.
 
If indeed interest rates are set to rise continually, and the best days of fixed-income investing are past, then what does the future hold for Asian fixed income?
 
First of all, Asian investors will need to start appreciating the different roles that fixed income can play in their portfolios. One is capital preservation. While Asian investors have got used to capital appreciation from their fixed-income portfolios, they will need to start viewing them as instruments for capital preservation.

The other role of fixed income is to provide stability; in other words, bonds have a lower beta than equity and are less volatile. If equity markets correct by 20%-40%, bonds will not be completely immune, but would drop by a lower percentage (unless they are highly speculative bonds issued by companies on the verge of default).

Another role of fixed income is to produce stable income. Although it is possible to invest in high-dividend equity, the exit value from the investment is still uncertain; but in case of bonds, investors know the income and the maturity value of the investment (barring default).

The coming period of 2-3 years will be the most challenging for fixed-income: as interest rates rise in response to the improving economic picture in the US, existing bond portfolios are bound to show a mark-to-market loss. But once interest rates reach a higher level with some stability, fixed-income investments will be available at higher yields, making them attractive to Asian investors once again, not for capital appreciation, but as instruments for capital preservation and income generation.

India’s economic growth has slid inexorably from a height of 9.4% in the Jan-Mar 2010 quarter to a low of 4.8% in the latest quarter. Although India’s prime minister fervently argues that it is just a cyclical slowdown and will reverse soon, there are many structural factors too behind the fading of growth.

I was surprised to read the recent article by Raghuram Rajan on India’s slowing. In his piece, he identifies two reasons: one, he says India’s economic institutions were not ready to support a high growth, and two, he points to global financial crisis. But in both cases, he argues that the political system stepped in to save the poor and the weak against institutional failures and against unbridled development; and the political reaction led to the fall deceleration.

It is indeed a strange take on the recent issues in India. The first question to ask is this: if indeed the economic institutions failed the people, who created those economic institutions? It is the politicians! The political class has been far from being the saviors of the poor, weak, oppressed, swindled and the trampled masses; indeed, it is the political class that has been doing the oppressing, the trampling and the swindling of the people.

I am not sure why Rajan argues this way, but I hope that he has not become a part of the “system” after serving as the chief economic advisor to the government. I also hope the possibility of his nomination as the next governor of the Reserve Bank of India has nothing to do with this line of argument.

Unsustainable structure

Why, then, did Indian growth decline back to the disappointing “Hindu rate of growth”? There are many structural imbalances in the economy that have impeded India’s potential to achieve high growth rates. To start with is the persistent fiscal deficit (4.9% of GDP for 2012-13), which can be traced not only to the traditional food, fuel and fertilizer subsidies, but also to the newer employment guarantee programs started by the current Congress government. 

The high fiscal deficit also leaves little money for infrastructure investment or development expenditure. India’s power sector, for example, has perpetually run at a deficit of 7-10% and suffered a power blackout in July 2012 that left 620 million people or half of the country’s population without power! In the southern state of Tamil Nadu, for example, my mother still suffers from power cuts of 2 hours when she is in the state capital of Chennai, and 10 hours when she travels to the other cities in the state.

India’s current-account deficit has soared in the last five years from 1% to 4% of GDP,  thanks to global oil prices and Indians’ insatiable lust for buying gold. (In fact, the deficit hit 6.7% of GDP for the Oct-Dec 2012 quarter.) At the same time, exports have faced headwinds from the economic slackening in the U.S. and Europe. Besides, barring a few companies, Indian manufacturers have not risen to the challenge of building themselves into sustainable exporters in terms of scale, technology and cost-competitiveness. 

India’s balance of payments has always been dependent on foreign capital inflows (except for a couple of years in the mid-2000s when the current account moved close to break-even), but the recent widening of the current account has made the task of attracting foreign capital  even more critical. 

Confidence

Investment, both domestic and foreign, depends ultimately on confidence. After all, investors are trusting that their money would come back to them with a reasonable return. Indian politicians have singularly failed to create and sustain confidence in the economy.

For many years, the Congress-led coalition has governed the country without instituting any meaningful structural reforms. Even the few initiatives that it tried to advance, such as the nuclear agreement with the U.S. and opening up of the multi-brand retail sector, faced considerable headwinds in the political system. Congress’s allies also put up a price for their support on every single issue. Although now postponed to 2016, India’s attempt to change the taxation principles for foreign investors investing though third countries such as Mauritiusalso produced considerable uncertainty for investors.

Corruption has played a big role in turning off investors. Instead of positive reforms, corruption
scandals emerged with regularity. Who would want to invest in the telecom sector if they faced the prospect of the licenses being cancelled? Coalgate (as the coal-sector scandal is popularly called) managed to slow investments in the coal sector. Before that, the 2G telecom licensing scandal led to the mass cancellation of licenses, leading to the withdrawal of some international telecom companies.

It is clear that India is fighting the fire with some measures to control the fiscal deficit, retain the investment-grade credit ratings, ease the flow of investments into infrastructure, and revive the economic growth. It is the long-established pattern again: India will act only after facing the crisis.

Who is responsible for this mess? Rajan may feel that the political process is the necessary corrective factor against unbridled market forces. In reality, it is the political class that has brought the country down.

Originally published on May 24, 2013

I was the moderator of the opening multi-asset panel last week in the Family Office Leadership Summit in Singapore. The panel derived its strength from the fact that my fellow-panelists came from different  backgrounds, including a hedge-fund manager, a private-wealth manager
from India, an Asian family-office manager, and an advisor to European clients on Asian  funds.

The panel started with a discussion on investing in these times of low interest rates and high liquidity. The panelists spotted the search for investment opportunities extending into a range of asset-backed securities, alternative assets (including Australian forestry), real assets (Asian property), high-dividend equity and private equity. Given their disappointing performance in the recent years, hedge funds were not in favor. 

When it comes to investing, private-wealth investors enjoy a few advantages: they can afford to have a longer-term outlook, accept a reasonably high level of illiquidity, and ignore the volatility in the meantime. That approach gives them the freedom to look at a wider range of investment options. One panelist pointed out that family offices have the opportunity to play in an intermediate size range: between USD 50m and USD 150m - too big for individual investors, but too small for public deals.

On selecting managers, the panel pointed to the team and strategy as the key areas to consider. But communication between the family offices and the fund managers was highlighted as a potential problem area. Not only are managers unable to explain their strategies in simple terms, but family office investors also do not have adequate inhouse professional talent to understand what the managers are trying to do.

The extent of home bias among private-wealth investors seemed to vary. European investors are actively seeking to diversify outside their home territory. On the other hand, Indian investors seem to find greater value in their home market, diversifying into properties in India, US, London and Singaporeas the next choice, but limited in their investments in global financial markets.

Overall, private-wealth investors are navigating the current investment realities well, thanks to their superior ability to diversify across asset classes.

Ideas under progress

The next section in the book, "Imagining India", contains the ideas that are being debated, shaped and molded in the Indian society today. Nilekani starts this section with state of school education. There is much that is wrong with India’s primary education, despite the excellent mage of Indian education in the eyes of the outsiders – after all, they only meet the highly educated finance, IT and engineering professionals from India. Nilekani discusses several of the challenges in Indian education, including the limited attention paid to primary education, the increasing politicization of even excellent institutions like the Indian Institutes of Technology (IITs) and Indian Institutes of Management (IIMs), lack of accountability by the teachers, the overall failure of the state education system which has forced the society to seek private education at considerable cost, and the use of reservation policies as bargaining tools by politicians.

Another idea in progress is the role of urban centers, and the love/hate relationship that politicians have with them. The Gandhian heritage (“India lives in its villages”) makes it difficult to acknowledge that much of the growth in the future is going to be based on cities. The sooner India takes up the urban problems in a no-nonsense way, the better it would be able to
manage the impact of growth on the rural and urban areas. Nilekani speaks hopefully of government programs such as Jawaharlal Nehru National Urban Renewal Mission as one of the catalysts for reform.

Speaking about infrastructure, Nilekani makes the usual points about the lack of different types of infrastructure, but believes that it has now become a key political point such that politicians can no longer ignore it. He then discusses the efforts to build a common market and credits the Vajpayee government for most of the progress that has been made. Much of the momentum has, however, been lost in the last five years under Manmohan Singh. 

Ideas being debated

Then, Nilekani moves on to a third set of ideas, those about which there is fierce disagreement in the society. He starts this section with economic reforms. Nilekani feels that politicians have not openly embraced reforms as an idea and they are falling back into populism. He writes about a few aspects of reforms that no politician has been bold enough to handle, in particular the caste-based reservations and the role of subsidies. However, he feels that reforms have begun to succeed as a political argument. A case in point is Narendra Modi, who is feted for the economic dynamism of Gujarat, despite the reservations about the role of his administration in the 2002 massacre of Muslims. But then, the Congress government has resorted to populist programs such as the Rural Employment Guarantee Scheme.

One of the key points that investors have always made about India is that the country is firmly set on a path of economic reforms, and no party will be able to reverse the process. But that argument addresses only one half of the issue: the point really is not about the direction, but the pace of reforms. If Indian reforms stop after doing the easy bits and there is not enough political or social will to handle the difficult ones, then the biggest opportunity in the history of the country may be lost. I only wish it does not turn out to be the case. Everyone knows the next set of reforms needed is more challenging, most of them related to the various subsidies and price distortions. It is not knowledge, but political will and implementation that are required. Unfortunately, the current government under Manmohan Singh has done precious little to push reforms forward in the last five years.

Nilekani’s next topic is jobs and labor. He traces well the cornering of privileges and resources by the workers in the organized sector, leaving little for the rest. He also points to the fact that organized workers end up setting the political agenda, simply because they are more organized. I was staggered to read that 14 million people are entering the job market every year. Nilekani also mentions that the IT and BPO sectors have created 1.6 million jobs so far. Contrast these two figures and the problem becomes apparent. There is therefore no surprise when Nilekani says, “A population of India’s size, and with its upcoming demographic surge, cannot rely on the services sector to create the mass of jobs it needs, and a large mass of unemployed and seasonal workers is a recipe for instability.”

As the next idea that is being hotly debated, Nilekani discusses the state of higher education. There is little that is unknown in the chapter. People from foreign businesses, who are used to dealing with highly educated Indians, may find it surprising that most of India’s higher education is failing to produce people with good skills. Politicians, again, stand in the way of improvement. It is saddening to read Nilekani’s description of how he and the Gujarat government successively offered to finance new facilities in IIT Bombay and how the then Education Minister, Arjun Singh, obstructed it. But Arjun Singh was not alone; BJP’s Murli Manohar Joshi too did his best in trying to interfere with IITs and IIMs. I was also shocked to read that St Stephen’s College in Delhi, one of India’s most reputed educational institutions, announced that it would reserve 50% of its seats for Christians. Why?! The whole aspect of reservations remains a mess that is dragging India down (although I must confess I do not have data about how well the Supreme Court’s decision of excluding the creamy layer from the “Other Backward Castes” reservation is being implemented).

Ideas for the future

The fourth section in the book comprises ideas which are not being considered in the society, but which will nevertheless prove important in the future. The first of these is the power of IT. Nilekani argues for introducing a national identity card for citizens (and for using it to target subsidies directly to the citizens by way of a bank transfer for them to spend as they please). Now that Nilekani has become the chairman of the ID card authority, he is trying furiously to implement it. Perhaps direct cash transfer of subsidies will gain political acceptance if it is seen as a way to obtain votes. Nilekani also discusses the various other areas where IT can make a difference, such as land records and government services.

Health and social security for the aged are two topics that are not being discussed actively, according to Nilekani. As a result, he believes that lifestyle diseases are likely to explode – something that India is ill prepared to face. It is perhaps true, but even I found it difficult to place it in the same order of importance as several other economic issues. Nilekani also argues in favor of creating a sustainable social security system while the demographic dividend lasts. Environment, says Nilekani, is another topic that gets scant attention. The basic warning here is that unless India manages to achieve environmentally friendly growth, growth may not be sustainable. Perhaps true, but the chapter did not convince me – I still think there are more important, and more accessible, reforms that need to be carried out first.

Nilekani classifies India’s energy needs and solutions as another idea that is not being debated
well. I am not so sure; most citizens face power cuts everyday, and when oil prices touched USD 150 per barrel, there was even some fuel rationing in some cities. However, it is not the solutions but the political will to implement them that is missing. India still relies too much on coal – Nilekani says that India is likely to import a staggering 95% of its coal needs by 2030. There is little resolve to carry out reforms in the usage of power. I read some years ago that all the states had agreed to charge at least half-a-rupee per kilowatt-hour for the power used in agriculture. But then, it looks like many parties are winning elections by promising free power to farmers. Nearly a quarter of total power generated was lost in transit (genuine losses or theft) in 2011. In the southern Indian state of Tamil Nadu, I regularly hear from my friends of power cuts of 9-12 hours a day! It is important to use the available sources well even as new sources are being sought. So far, China has shown great foresight in securing its energy and mineral needs by entering into deals around the globe, and India will need to catch up fast. I think Manmohan Singh has done India a great service by firmly sticking to his bargain with the USA, so that India can generate more nuclear power, potentially the only solution to the country’s future power needs.

Finally, in his concluding remarks, putting all this together, Nilekani passionately argues that “after a long and convoluted path, after many a stumble and wrong turn, a different kind of moment seems to be upon us. For the first time, there is a sense of hope across the country, which I believe is universal. There is a momentum for change.”

Just do it

Nilekani has done India a great service by putting a comprehensive and thought-provoking book together. After all, how many entrepreneur-industrialists have the intellectual ability and rigor to compile such a commendable treatise on India?

One point that keeps recurring through his discussions is the futility of the Nehruvian socialist model and the irrelevance of Gandhi’s economic ideas. India has paid dearly by holding on to both and the sooner the country gets rid of them, the better it would be. The other aspect that
surprised me was Nilekani’s assertion in many places that the Indian government finances had become much more comfortable. He quotes several programs that the government has taken up, all of which need massive financial investment, but he says repeatedly that the government has enough money. India’s investment-grade credit ratings from Moody’s, S&P and Fitch hang in balance, thanks to the struggles of containing the fiscal deficit. India must get back to controlling the deficit, rather than expand the list of spending programs.

One thing that shines through in the book is his love for the country and his dreams for its future. Sometimes, I had the feeling that this passion had colored his vision and made him see the glass as ‘half full’ all the time. Earlier, I had read another book on India, “In spite of the Gods” by Edward Luce, who was the correspondent in India for Financial Times. In that book, Edward had done a great job of describing many of the social pressures and changes, but had left the conclusion much more open by listing out the areas on which India needs to work if it is to progress. Luce’s book had much less economic analysis than Nilekani’s. But, as the Economist magazine opined, both are indispensable introductions for anyone wishing to understand contemporary India.

As both the books make it clear, the trouble is not in identifying what needs to be done, but in actually getting it done!

Many times, I have felt that India is like a bowl of spaghetti. In such a diverse country with so many things going on at any time, it is difficult to sort out the issues and make sense of what needs to be done. 

In the book, “Imagining India”, Nandan Nilekani (co-founder and ex-CEO of Infosys and the current head of the national identity card project) tries to view the country in terms of the ideas that define it. He sorts them into four categories: ideas that have been accepted in the society; those that are under progress; those about which there is still considerable debate and disagreement; and those that will be relevant for the future, but are not receiving the attention they deserve.

As I kept reading the book, I found myself arguing with the author. While I had my  preconceptions, I also found myself learning many new facts about India. Nilekani's understanding of the country is impressive, and his arguments are supported by well-researched data and statistics. As a co-founder of Infosys and one of the corporate leaders of India, he has had tremendous access to other leaders: finance ministers, Nobel Prize winners, economists, social workers, historians, and even a foreign country's prime minister.

This book is a "must-read" for anyone interested in understanding today's India and its future. It is the most balanced of the three books that I read recently about India, the other two being "India: The Emerging Giant" by Arvind Panagariya and "The Indian Renaissance: India's Rise after a Thousand Years of Decline" by Sanjeev Sanyal. Panagariya's book is packed with facts and figures, but much of it historical; Sanyal's book is good, good but does not address the challenges deeply. Nilekani's book not only discusses the issues deeply, but provides enough facts to support the arguments.

Accepted Ideas

Nilekani starts the first section with the argument that India has finally started viewing its people as assets rather than liabilities. He cites the now-famous concept of demographic dividend as the foundation of India's future. Of course, having led Infosys for many years, Nilekani cites the IT and BPO sectors as evidence of the positive role that a well-educated population could play. But as I read the chapter, I kept wondering if his views were not tainted by his IT  experience. For instance, he does mention the fact that the southern states have  crossed their peak period of demographic dividend, while the population of the lower-developed BIMARU (Bihar, Madhya Pradesh, Rajasthan and Uttar Pradesh) states are still growing and getting younger. But he does not discuss the implications of this split fully. Unless the BIMARU states manage to develop, and that too at a rapid pace, the population profile of those states may become a curse, and the current regional imbalances may intensify and lead to social problems.

Besides, how can one conclude that the human population of India has become its asset, when over 60% of the population still depends on agriculture for a living, and even in that sector, the labor productivity is very poor? Whether India's young demographic profile may turn into a blessing or a curse depends on how well other areas of the economy are reformed to produce the growth and jobs necessary to satisfy the people. And that is where Nilekani's other ideas become relevant.

Nilekani next discusses the acceptance of entrepreneurs in the society. He traces the dominating influence of Nehru's socialist policies on India's early economic path as an independent country, and their failure to produce  sustainable growth. He then goes on to discuss the Bombay Plan devised by the industrialists as a compromise to the fiercely socialist government, and describes the eventual rise of the entrepreneur after Manmohan Singh's 1991
liberalization. As I read the chapter, I could not but feel angry and disappointed at the missed economic opportunities, thanks to the failed Nehruvian policies. I also remembered the futile rules that curtailed production of various products, even as demand was booming. (My father wanted to buy a Bajaj scooter in 1987 and found that he had to place a deposit and wait for three years for his turn to buy one; so he  eventually bought one in the black market by paying a premium of about 25% of the actual cost, and had to run the scooter in someone else's name for a year before it could be transferred to his name!).

The overall thrust of the argument that private enterprise is now encouraged is fine, but it is difficult to agree with Nilekani when he says that the ineffectual economic policies are what bought the Congress down finally and led to the rise of multi-party democracy. In fact, in many other parts of the book, he does a masterly job of describing the rise of multiple identities that led to a regional and multi-party political system.

The other problem with this chapter, and indeed the whole book, is that Nilekani scarcely mentions the role of corruption in holding down India's development. There is no doubt that the nexus between the politicians, bureaucrats and businessmen twisted the system to their benefit rather than that of the common people. This omission also made me think about Dhirubhai Ambani, who had brilliant ideas about business (in particular, his conviction to build world-scale capacities and his use of capital markets), but who nevertheless manipulated the system to his unashamed advantage, including blatant scandals such as smuggling and duplicate share certificates. But now, there is even a book on “Ambanism” as if it is a legitimate economic philosophy!

The next accepted idea that Nilekani talks about is the growing use of English across the country and its almost universal acceptance by politicians. No disputes on this point, happily! It reminded me of a discussion in my business school about what unites India. After considering different ideas, we settled upon commerce and business that keeps India united. English is, of course, the glue that links Indians and keeps the commerce flowing.

Next to come is IT, Nilekani's home subject. His description of how Rajiv Chawla, a cunning bureaucrat, slipped computerization quietly into the land records system of Karnataka is hilarious. The government workers had not realized what was going on, and by the time they woke up, it had been done! It is indeed heartening to see IT being used in many key private sectors, such as banking, railways and insurance, and it is seeping into core government services.

When Nilekani talks about globalization as an accepted idea, he again falls back on IT as the main example. While that is indisputable, there is much work to be done to reap the benefits of globalization in the manufacturing, agriculture and financial sectors. There are good examples of some Indian manufacturing companies benefiting from access to global markets, but what has been achieved falls far short of the overall potential of the country. I am also not sure how Indian agriculture would react to globalization in terms of input and output pricing, as well as product choice. For instance, what kind of crops might be produced if all input and output are priced at international levels? Or, what kind of agricultural imports and exports might take place? Will Indian agriculture benefit from globalization without first eliminating the structural inefficiencies such as small farm holdings and land ceiling legislations? These are complex questions, but Nilekani does not carry the argument about agricultural globalization to its logical end. While he has covered so many important aspects in the book, I wish he had discussed the agricultural sector more thoroughly, instead of just mentioning it in passing in different contexts.

Nilekani's final accepted idea is democracy, and it is also one which I found most difficult to digest. For all its positives and ills, democracy is an idea that has finally been accepted in India as the political system of choice. Nilekani has provided a good description of the rise of regional parties and factions, but it is not clear what his judgment is about the phenomenon: is he just describing, bemoaning or celebrating? He argues that the caste, language and regional identities grew in prominence due to the failure of the state to provide  broad-based growth. The question is not whether India has accepted democracy, but whether the current form of democracy is not turning into kleptocracy.

He believes that the new identities are coalescing into an Indian identity, but in my view, he is treading on thin ice when he says that. On the other hand, I feel that the multi-identity democracy is serving to hinder progress rather than enable it; and whatever progress is achieved is in spite of it rather than due to it. After all, how many regional parties have an overarching view of Indian progress and society? How many of them function on the basis of any principle, except that of taking care of their own supporters and constituents? At the extreme instances, when I think about the unprincipled bargaining between different parties, I only get the image of hyenas tearing at the prey from different directions, getting their fill of the meat. Finally, even Nilekani is forced to acknowledge the inescapable, but he still gives it a positive spin when he says, “this period of stonewalling, backtracking and accommodation is essential ... it is the only way we can frame policies that are truly sustainable.” It is a shame that even after 60 years of independence, a discerning writer like Nilekani has to call India's democracy young in trying to justify what is happening.

Originally published on April 23, 2013

Today's Bloomberg article draws attention to the practice in the Asian USD bond market of paying incentives to private banks to distribute new bond issues to their clients.

Over the years, private banks have subscribed to a rising share of new USD bonds from Asia. Before GFC, when equities used to be hot, private banks' share of subscriptions to new bonds used to be 3%-8%. After GFC, the figure has risen substantially to reach 16% for 2012 and 18% for 2013 so far. Undoubtedly, private wealth has discovered a new love for bonds. We must view the importance of the private banking subscriptions to new issues in this context.

Private banks have become key buyers for all bonds, but more so in case of high-yield bonds. They took 29% of high-yield issues this year, but only 11% of investment-grade issues, up from 25% for high-yield and 12% for investment-grade issues last year.

In some issues, particularly unrated or high-yield bonds, allocations to private banks are so large that one wonders if the issues would have managed to get out the door without them. Consider these, for example: Private banks took 24% of First Pacific's 10 year bond, 37% of Bank of Ceylon's 5-year issue, 39% of Suzlon Energy's 5-year issue, 37% of Shun Tak Holdings' 7-year issue, 55% of Guangzhou R&F's 7-year issue, and 42% of Lai Sun's 5-year bond. (These are only some examples from this year, not a complete list of bonds with high  private bank participation!)

In most of the perpetual bond issues, private banking clients have contributed a large chunk of demand: 48% of Beijing Capital Land, 76% of Agile Properties, 60% of Cheung Kong Holdings, 53% of Reliance Industries, 76% of Petron - all examples from this year alone. (It is another matter than many of these are trading below issue price - see my article about the risks in perpetual bonds.)

The level of private banking incentives has also changed with the market. In a "hot" market, where new issues are flying off the door and recently issued bonds are trading above the issue price, the incentive could be 25 cents; but last year, in times of market stress, the incentive is known to have gone up to 75 cents or even a dollar in some cases.

Given the the rising clout of private banks, it is no surprise that issuers and bankers are willing to pay them an incentive to distribute their bonds, and consider such incentives to be a cost of raising funds. I see little scope for this practice to change any time soon. Private banks will continue to play a significant role in Asian bond markets for a while yet. Issuers will have to just grin and bear it.