After Detroit, other cities in line for bankruptcy - Straight from the Hip by J Mulraj
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Investing in India - Straight from the Hip by J Mulraj
After Detroit, other cities in line for bankruptcy A  A  A

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27 JULY 2013

As per a blog by Mike Shedlock several US cities, including Chicago, Philadelphia, Miami, Los Angeles, Houston and others are ready to follow Detroit and file for bankruptcy. Filing for bankruptcy gives the cities breathing space to negotiate its way out of trouble, without being pursued by creditors or claimants. More importantly, it allows the cities to raise taxes to be able to meet its obligations.

But the root of the problem goes all the way back to the 60s, when, in a bid to win support from labour, John F Kennedy struck a deal with the then largest trade union, AFL CIO, in which union members got defined pension benefits, linked to inflation. It has taken over 50 years for the chickens to come home to roost. The system worked well so long as there were more workers contributing to the pension fund than those taking money out of it. All this changed due to demographics, globalisation and of excess liquidity created by Central Bankers.

Thanks to excess liquidity and lower interest rates, pension funds do not earn a rate of return on their funds which are sufficient to meet their liabilities, which are both defined and, most often, inflation indexed. The State, or city, has to make up the shortfall. But it can't do so, because its tax revenues are falling.

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Ultimately, it is expected that some people will take haircuts. These could be bond holders of the city/county/state. These could be pensioners, who would be given reduced benefits and made to pay a share from their pockets. This has social and political ramifications, which is why the looming problem of insufficient pension funds has not been publicly tackled so far.

For countries like India, which have gone full speed ahead with welfare programmes, with the Food Security Bill being the latest, policy makers must learn that chickens always come home to roost, even for a country which is largely vegetarian!

The Planning Commission has come up with a survey which shows that the number of people living below the poverty line (BPL) as having fallen to 22%. If true, this is quite an achievement. The key words are 'if true'. It appears that the goalpost has been moved. The definition of poverty line seems to have been changed.

The UPA seems to be caught in its own petard! It would be interesting to hear their explanation that if only 22% of India's people are BPL, then why does the Food Security Act cover 70% of the population? One of the two figures must be true, right?

The obvious and unstated reason is that the FSA is a bribe, at taxpayer expense, by the UPA to get votes.

The solution is to pass a legislation that any welfare scheme ought to be paid in equal measure by the party that espouses it and by the Union Budget. If parties are made to pay a half share, as they should, they would be less eager to seek vote banks at the cost of the exchequer. There should be no free lunches.

Talking of lunches, the tragedy in Bihar, where several school children died after ingesting lunches, under the Mid Day Meal programme, which were mixed with insecticide, is a pointer to the fact that whilst the numbers show a success of such schemes (higher spend each year) the truth is that without proper administration, they are failures. Yet there is no accountability for implementation of the schemes.

Similarly, the Government's claim that its food procurement programme is a success, and has garnered huge stocks of foodgrains, is untrue. With a significant chunk of that foodgrain, stored in the open, being eaten by rats, or rotting, it is actually a failure. Without strict monitoring and proper implementation, these schemes do not serve their intended purpose, but act as a drain on the exchequer.

It is this drain that has caused the rupee to slide. It is this slide that has caused Moody's to threaten a downgrade of India's rating. It is this fear of downgrade that has prompted the RBI to take measures to stanch the slide, by squeezing out liquidity. It is this squeezing out of liquidity that has led rating agency CRISIL to caution that heavily leveraged companies would find it difficult to refinance the 1/3rd of their corporate debt, when the debt falls due, which will lead to their downgrade. The Chairman of SBI, India's largest bank, has been critical of RBI's move to throttle liquidity and says that raising interest rates is a better route.

This mess has come to pass because, again, of poor governance. There has been a slowdown of investment by both domestic and foreign investors, entirely due to poor governance. Domestic investment is stuck for a variety of reasons. Land acquisition is a problem. Getting permissions, especially environmental clearances, is a problem. The spate of corruption scandals, and the upbraiding of bureaucrats for their role in them, has made the bureaucrats overly cautious to clear pending files.

Foreign investors are outwardly welcomed but find that the devil is in the details. William Pesek, writing an article 'Why Buffett bailed on India' in Bloomberg, says "India has fallen into a self-destructive pattern of relenting on the big issues, then killing would-be investors with the details. Take the experience of furniture retailer Ikea of Sweden AB, which in January won approval to open outlets in India. Not content with the Swedish icon investing about $2 billion, the government played hardball. It tried to bar Ikea from selling food in its stores; Ikea stood its ground. But the damage was done."

Indian policy makers feel that the attractiveness of India, because of its huge market, overrides such nitpicky details. It doesn't.

A huge debate was fought over allowing FDI (foreign direct investment) in multi brand retail, over which TMC walked out of the UPA coalition. Yet there has been no FDI investment. In fact, Walmart, the biggest hope, is reviewing its options and is going slow. The reason is, again, in the details. Indian policy makers had asked retailers to source 30% of their requirements domestically. There is not enough reliable supply, feel the retailers, to be able to meet the condition. Walmart states it can't meet the 30% obligation, perhaps 20%.

Other than the devil in the details, foreign investors detest uncertainties created by changes in law. The most celebrated case is the retrospective change in law brought in by the Government, after it lost the case against Vodafone in the Supreme Court. The matter is now headed for arbitration. In a similar case relating to Sanofi's acquisition of Shanta Biotech, the Andhra Pradesh High Court recently held that tax treaties between countries override Vodafone amendments

It isn't that Indian policymakers have a monopoly on foolishness. The Spanish Government also competes! It has passed a law which puts stiff penalties on those trying to privately generate solar power, in a bid to protect its own power producers!

This is nothing short of insanity! The whole world is trying to encourage generation of energy from renewable resources, and Spain is seeking to tax the sun! Bizarre!

In corporate news of interest, there has been a brouhaha over the plan proposed by Holcim, which holds a majority stake in Ambuja Cements and in ACC. In a complex deal, Ambuja will buy the Holcim holding company which holds the ACC stake, making ACC its subsidiary. Holcim will raise its stake in Ambuja to 61.3%, but will get paid by Ambuja for the holding company. Net, net, Holcim will get an additional Rs 3,500 crores. Investors did not take kindly to the deal. In its defence Ambuja's Managing Director says that the ACC stake, held by the holding company, is being transferred at market value, without any control premium, and hence is a fair deal. SEBI is investigating the deal. It had investigated the Jet-Etihaad deal, and the deal has been restructured to incorporate changes suggested by SEBI. News that it was likely to be now cleared caused the stock to take off faster than its flight.

Last week the BSE-Sensex lost 401 points to end at 19,742 and the NSE-Nifty lost 143 to close at 5,886.

The market has been kept high because of the global liquidity and by a handful of performing stocks such as ITC (which declared an 18 % increase in net profits for the quarter ended Jun), Reliance, Infosys, TCS and HUL.

The US liquidity tap is running at $ 85 b. a month and may be slowed down to $ 65 b. a month perhaps from September. The squeezing of the liquidity tap would affect global markets negatively.

He who fights and runs away will live to fight another day, goes an old adage.

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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9 Responses to "After Detroit, other cities in line for bankruptcy"
R D Pyage
Jul 30, 2013
Interesting but depressing truth.. It is catch 22, someone has to pay for correction, nobody is willing. As has been said and believed majority is right, for India, to please major vote bank (poor/rural voters) schemes will stay, but economics thinks differently. who is the culprit..? politicians (any party)?, ever raising population? deteriorating and/or skewed education system? or educated/well to do/urban non voters?
At the end.. excellent article.. shall wait for the chickens to come to roost!!!
Like 
rj
Jul 29, 2013
Indian population must empower itself to overthrow the corrupt politicians with the help of the judicial system.

Surely the supreme court needs to be more active in effecting changes for the betterment of the country and its exploited people.

It is no use citing Detroit and other US cities. In the US it is the problem of governance by the affluent who have learned the tricks of sucking dry the middle class with seemingly legal means that no one can jail them for.

As Jamie Dimon famously said earlier this month " can you arrest a person for being stupid....?" Thereby excusing all the bad deeds by the bankers and their cohorts during 2007 2008 and on an on.
Like 
kpinto
Jul 29, 2013

In your article you referenced ..'Why Buffett bailed on India' in Bloomberg ... .. I would like to comment that he had set up an agency to sell non life insurance in India.
My guess is that having burnt his fingers with massive claims/payouts due to the nuclear disaster in Japan, now with the flash floods in India and with new nuclear facilities coming up, he may have found it to be too risky to sell insurance here, notwithstanding population and demographic dividend.
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subir kumar das
Jul 27, 2013
India is dominated by educated greedy and illiterate needy,no question of pure beautiful mind which helps to grow.Now economics is minus civics.Politics is minus policy plus tricks. What you are talking about that has no impact on them.They are motivated to their own goal.Only we have to blame ourselves - why we elect them if we are well aware about their words and work for the last so many years? Like (1)
LOVEPAREEK
Jul 27, 2013
THANKS MR MULRAJ FOR AN EXCELLENT WRITEUP AGAIN AFTER SO MANY MEDIOCRES. IT WAS PURE GOLD ALL THE WAY. YOUR FIRST PARA ABOUT U.S. MADE ME FEEL THAT THE STRUCTURE OF US PENSIONS FROM 60'S HAD AN UNCANNY RESEMBLANCE TO PONZI SCHEMES, AND THE COLLAPSE ALSO FOLLOWS THE SAME TRAIL. ONCE AGAIN, THANKS FOR ALL THAT WISDOM U IMPARTED - RGDS - LOVEPAREEK. Like (1)
surajit som
Jul 27, 2013
When the hell Kolkata, Mumbai,Chennai,Delhi etc are going to file for bankruptcy ? Like (1)
Prakash Basrur
Jul 27, 2013
Ultimately, everything boils down to the age old cultural habits of the people of various countries ! The economic principles we follow were evolved under the western cultural thoughts wherein there is no concept of " MaiBaap " government like in our culture ! Shifting of a large farm population to cities happened in the west gradually through their "free market" economy over a period of almost a hundred years of their civilsation and Manmohan Singh and his band of "modern economists" are attempting it to happen in next 10 to 20 years! That may perhaps yield good economic and political results in the short term but its long term effects of social upheaval will have lasting damging effects ! Like (1)
VS Gurumani
Jul 27, 2013
There is a simple way out of the subsidy trap: just freeze them at current levels. Announce the overall number, with the freedom to reconfigure the various components each year before the budget. If this were done for two years to begin with, the mood will be created to start tapering them off. Experience of many organizations show that a deliberately created adversity stimulates out of the box thinking and innovation. Such stretching following a jolt in the form of a budget freeze is absolutely essential to get the government machinery in India moving. Like (1)
parimal shah
Jul 27, 2013
In fact, all such welfare schemes are a guise for the ruling party to pocket money by those who are in power. Like (1)
  
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