Musings of a Banker on Macro Economic variables and few other things

Events in macroeconomy impact a banker’s life more than we realise. This quick reference guide revisits these first principles and hope will help evaluate the importance and impact of policy actions of regulators and governments. Focus in on perspectives and not on definitions. Some of these may have my own biases, limited by my learnings and I encourage you to apply your own experience there. Any linkages you draw may be coincidental.

I. GDP

  1. GDP is a good measure to see economic progress but increasing number doesn’t mean everyone is getting rich. Width in centers of production (eg. increase in the number of businesses, more no. of businesses with growth higher than GDP growth, increasing geographical spread…) indicates if the impact of GDP growth is deep enough.
  2. We look at Real GDP growth rate (GDP rate adjusted for inflation). However, absolute GDP number (nominal GDP) is still an indicator of economic heft and bigger size also brings strategic leverage.
  3. Per capita income along with purchasing power parity (PPP), give a good view on relative prosperity. Eg. A bread loaf of ₹50 in India vs  $2 (~₹173) in US indicates its cheaper to live in India. In PPP terms it means that even with lower per capita in India (~$2.2K) people will be able to afford more goods and services. However higher per capita of US (~$81K) indicates that most people in US would still be able to easily afford more expensive bread, thereby indicating higher relative prosperity. However, if you what to assess the depth of economic prosperity (how many people are well off?) then income distribution also needs to be looked at.
  4. GDP is an aggregate number and therefore to better interpret the drivers of GDP growth, the evaluation has to be done at sectoral level- which sectors are growing and which sectors are stagnant. For eg. even when the GDP is growing at say at 5%, it is possible that manufacturing is growing only at 3% while services are growing at 7%.

II. Inflation

  1. The difference between CPI and WPI rates broadly indicates demand and supply side challenges. Higher is the gap between the two, higher the impact on margins for business. For example, price of Portland cement is increasing at slow pace (WPI) while the cost of housing is increasing at higher pace (CPI). This is a margin positive for real estate companies.
  2. It is important to separate food and non-food inflation. If the inflation is driven by Food, then the issue needs to be addressed through supply side initiatives eg. farm productivity, storage, crop diversification, better distribution. If food inflation is controlled by demand side measures (example higher interest rates to curb consumption), the economic growth will slow down without solving the key issues.
  3. Inflation is an aggregate number with pre-defined weights. It can therefore attenuate the real effect of some significant impact items. For eg. education cost has increased in multiples but the overall inflation of 5-6% still looks benign.

III. Debt

  1. More debt is bad but bigger question is where the borrowings are used.
  2. Government borrows to bridge Fiscal Deficit. But more than the important is to understand the breakup of revenue and capital expenditure. Debt taken for creating productive assets with good IRR, is an effective way to fuel economic growth. Debt taken to cover revenue expenditure is recipe for economic disaster.
  3. Private debt in the economy is also a good measure and mostly indicates increasing capex. Although in some situations this may also indicate industry stress or banker-industrialist nexus.
  4. If total debt in the economy is primarily driven by government borrowing, it means government is crowding out access of credit to business. For high growth, a mix of Govt and Private debt is crucial

IV. Tax

  1. In any economy, tax broadly fuels three things- a. Asset creation for eg infra, defence, research b. Social welfare for eg Senior citizens, calamity support etc c. Government admin expenses
  2. As long as the balance is significantly skewed in favour of Assets, the economy would grow. Targeted Social welfare measures can help increase productivity too if it helps people without skills get trained or come above the survival level of income. However, high skew towards social welfare like cash doles, loan waivers, freebies, especially to younger population encourages unproductive demography and a creates a vicious cycle. Social welfare schemes once initiated are difficult to rescind. Instead they tend to have snowball effect with more and more groups seeking benefits.
  3. A reasonable amount of government admin expense is necessary to get right people in governance, but this should be bridled with statutory constraints. Else it’s like lion protecting the sheep (tax collection) within its den. Lion will be tempted to eat it all. Getting the right government is so crucial, therefore!
  4. Increasing Tax brings the revenue but also comes at some cost of economic development. Firstly, more tax means less savings and less money for consumption and secondly, for businesses it also translates to lower returns from business and lesser money for expansion. More tax-> Lower retained earnings->lesser capital expenditure. Low tax regime encourages investment as it improves ROI.
  5.  Higher Tax is a disincentive for cleaner books. In such cases governments may invariably resort to ‘snooping’ in some way to plug the leak!. Capital migrates from high tax to low tax.
  6. Indirect Tax system needs to define the base level of lifestyle a household should have and necessary items to maintain this level should be at minimal or low tax. Good and services above the base-level have higher tax. For eg. utilities are essentials, bike becomes essential for commute if public transport is weak, air conditioning becomes essential if the weather conditions are hot and humid. Their will be some subjectivity in defining this base level and it evolves as economy grows (aspiration changes)
  7. A direct tax system not aligned to inflation makes households poorer.

V. Savings and Consumption

  1. Savings provide the economy resources to build long term assets with lesser debt. More savings->lesser external debt. But more savings also means lesser consumption. So, a balance is needed. Higher saving are good for an emerging economy trying to build its infrastructure.
  2. Savings or consumption can be channeled to preferred asset classes by giving or taking away tax incentives. But Savings can increase only when a. income growth is higher than inflation and b. income level is higher than aspiration adjusted base-level.
  3. Both are also a function of consumer behaviour. Stable economy encourages more consumption while negative sentiments may encourage savings. Nouveau riche effect is real especially if people acquire capital easily, eg. selling ancestral land at high rates. Younger demographics will have higher consumption and lesser savings. There is also a vicinity affect in basket of consumption (if neighbour has a SUV, you want it too!)

VI. Asset creation and ease of living

  1. Government uses tax to build different types of assets. Some assets give financial return (productive assets) while some assets are strategic. Strategic assets give leverage or security for eg. border roads. As long as the skew is in favour of return-giving productive assets eg. ports, airports, intercity toll roads, the economy will grow.
  2. Private sector investment is the most efficient way for building productive assets, while government is best at strategic assets. An economy driven only by government trying to build all kind of assets will eventually face slowing growth. An economy driven only by private sector even in strategic segments will encourage strong lobbies, interference and nexus.
  3. Even when the government owned non-strategic assets are profitable, they would remain sub-optimal compared to when owned by private sector.
  4. There are another kind of important productive assets that are critical for day to day ease of living eg. utilities, intra-city road, transportation, drainage, water supply and footpath. These assets are mostly developed or dependent on local government at municipal level. If the municipal governments are inefficient or unaccountable, these assets tend to concentrate in elite areas while larger part of population struggle with broken infrastructure, waterlogging and no place to walk. Countries that want to attract or retain talent, focus on it.
  5. Assets once created also demand maintenance. Maintenance elongates asset life but may take a significant part of budget, without bringing in incremental revenue (marginal revenue). IRR of a project should factor in long term maintenance costs.
  6. Public Infrastructure Platform is another kind of strategic asset that a government can build to catalyse specific developments. We know of DPI (eg. UPI) but there could be many more For eg. an open source AI model, high end labs open to small industry for experimenting.  Data is an asset but can be exploited both by governments and private sector. Inherent checks become necessary.

VII. Interest rates, Finance and Banking

  1. Finance is fuel for business. Easy access and reasonable rates are boosters for the economy.
  2. If borrowing cost is high say 12-15%, only those businesses that make at least that much return on capital will borrow and invest (ROCE). However, emerging economies have small-scale low value-add or trading business, where margins are low (ROCE <15%) and hence the benefits of asset creation from borrowing comes with much delay. This slows down the virtuous cycle of private investment. Borrow at high cost to create asset->Use all earnings to repay -> Retained earnings start only once the asset is free from encumbrance.
  3. Bigger businesses have advantages of scale, distribution and negotiation power and therefore have access to lower interest rates. All these factors contribute to their higher ROCE. They crowd-out the available capital since Financiers prefer to lend to them.
  4. Govt guaranteed schemes for small-scale asset creation eg Vishwakarma, Svanidhi, are good balancers but may come at the cost of making bankers lethargic in credit risk assessment. Priority sector lending (stipulation to lend to weaker segments) is another tool but encouraging competition in financing is more efficient.
  5. Central Banks control liquidity. A low liquidity environment catalyses credit flow away from SMEs to Corporates.
  6. Structural weakness in debt recovery process hampers access to credit. For eg. cumbersome legal process.
  7. An economy that relies highly on property as collateral tends to slow the access to credit as collaterals cannot grow with the same speed as business. For working capital, unsecured Cash flow based short-term lending (eg. SCF) is much better than long term collateral-based lending (eg. Cash Credit or OD).

VIII. Startups, Innovation and Risk

  1. Any new entity can be called a startup, but the real benefit of startup ecosystem accrues when these entities engage in out-of-box, tech driven, cutting edge solutions.
  2. Startups in intermediation of goods or aggregation add some value but their success is mostly dependent on gaps in current infra. They themselves contribute very little to innovation or overall production. Eg. Online grocery gains coz traffic and parking are real issues. This is basically a margin transfer from local grocery store to quick comm. On the positive side, such startups have better ability to attract FDI.
  3. In a resource constraint economy, the cost of failure is higher. A first generation failed entrepreneur generally has little back up hence the tendency is to look at business that starts showing some revenue from day 1 to attract investors. Thus, the focus on say intermediation (trading) businesses.
  4. Encouraging cutting-edge research or business requires high-risk capital. Emerging economies need structural support from government since alternative financial channels like bonds, private equity or share markets are less mature. As more of these first-generation, simpler businesses succeed, they should be incentivised to invest in high risk, high impact areas.
  5. Lastly, innovation also needs initiative and skills. Ability to earn a living is an outcome of having skills. However, if the system discounts skills or makes it difficult to acquire them, it encourages the work force to get a job instead of getting the skill. Eg. Science graduate prefers a Bank PO job to pursuing research. (more on this in point IX)

IX. Human capital, Education and Jobs

  1. Job creation is crucial, but type of job is more important in the long run! A 10th pass resource in food delivery job may solve the employment issue in short run but adds little value to the economy in the long run. An 8th pass trained mechanic, plumber, electrician, carpenter or factory worker make the country better.
  2. Bias of the education system needs to be towards technical skills. Why? Because bulk of workforce cannot be made up of language experts or economists or lawyers. However, humanities provide a crucial foundation for administration and policy.
  3. If humanities do not have opportunities and respect, it discourages good talent to join in. Similarly if acquiring a technical skill comes at a premium, it tends to become elitist or create consumer debt burden without ROI. Example medical education.
  4. Higher women participation in workforce brings not only economic but also social benefits.

X. Taxpayer’s satisfaction

  1. A reasonable Taxpayer does not expect one-to-one return on Tax paid. However, there is a vicinity affect. Unless some part of the tax improves day to day life of taxpayers (vicinity assets), the satisfaction will be low and slowly make them disgruntled. Ease of living assets fall in this category (refer point VI). A disgruntled taxpayer feels shortchanged by the system and in the long run will find avenues to escape this frustration (eg. emigration, investment in foreign assets).
  2. Simpler Tax rules are always better than complex, open to interpretation rules. Sometimes complexity may be deliberate (remember the Lion!) but a tax system that’s always chasing the taxpayer is a waste of productive resources.

XI. Legal and judicial system

  1. A quick legal recourse and ability to enforce contracts, without the punishment of process, are major economy catalysts.
  2. Greed, anger and lust are inbuilt human defects. Swift legal system keeps these in check to ensure an environment of safety.
  3. A good measure of depth of legal system is road rage frequency and intensity. If most people fight on roads for minor scratches, it means they have little faith in the legal system’s ability or process to recognise this as significant. What is trivial for one may be important for other.

 Glossary:
CPI: Consumer Price Index | WPI: Wholesale Price Index | ROCE: Return on Capital Employed | IRR: Internal Rate of Return | DPI: Digital Public Infrastructure | FDI: Foreign Direct Investment

Disclaimer: The opinions expressed here are those of the author and do not reflect the views of FrankBanker.com

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