#234 Perfect is the Enemy of Good
Credit and Consumption Convolutions, Regulations on Substances of Human Origin, a Book Announcement, and Techno-evangelism
India Policy Watch #1: A Splash Of Cold Water
Reflections on current policy issues
— RSJ
One of the underreported stories of the Indian economy post-Covid is the strong consumption demand, which is somewhat at odds with slow capital formation, moderately high inflation, and an increasing interest rate cycle during this period. One possible answer to this is the strong retail credit offtake, which has been driven by a plethora of shadow banks (NBFCs in Indian parlance) and fintechs that have made the process of securing a small ticket (less than ₹50,000) unsecured loan extremely convenient. This segment has been growing at about 25 per cent, almost twice the rate of the remaining ‘less risky’ segments where the loans are secured by collateral like a house, car or gold for over a year. Now, this is somewhat unusual. More so, when you consider the data that of the total borrowers who have availed loans below ₹50,000, about half have four such loans. Now, unsecured personal loans are largely consumption-driven, where the end use of the funds is somewhat opaque to the lenders.
Simply put, this data tells us that many customers are either living beyond their means or using these short-term loans to fund their long-term secured loans (like home or car loans) because they don’t want to default on them. One way to look at this is to consider the share of unsecured loans to the total loan portfolio of the banking system at just below 10 per cent and not be too concerned about a short-term growth spurt in this segment. After all, this easy availability of credit is one of the contributing factors to the moderately strong GDP growth numbers. Or the other way to view this is to ask why are people willing to take unsecured loans at significantly higher interest rates in the current environment? Is there a bubble building up here?
I mean, the easiest thing in the world is to lend money to people without collateral. All the risk is upon you. The real business of unsecured lending isn’t disbursing loans at lightning-quick speed (which many a fintech think is a virtue) but to make sure you collect the money when the EMIs are due. The easier you make the process of availing a loan (all those ads of personal loans in less than 30 seconds), the more you attract customers who shouldn’t be getting these loans in the first place. There’s a moral hazard built in there.
The RBI has been flagging the risks of the rapid growth in unsecured loans over the past couple of quarters. These have been quite explicit and specific. The RBI governor made this point in his October monetary policy review speech. Though it was done in the usual anodyne style of a regulator:
“Certain components of personal loans are, however, recording very high growth. These are being closely monitored by the Reserve Bank for any signs of incipient stress. Banks and NBFCs would be well advised to strengthen their internal surveillance mechanisms, address the build-up of risks, if any, and institute suitable safeguards in their own interest. The need of the hour is robust risk management and stronger underwriting standards.”
There were good reasons for this note of caution. Transunion CIBIL, the largest credit bureau in India that tracks credit data across banks, had this to say in their latest report for Q2, FY 23-24:
“The report indicates that the delinquency rate for consumers with at least one small-ticket personal loan increased by 120 basis points year-on-year to 5.4%. The report highlights that small-ticket personal loans of less than ₹50,000 account for only 0.3% of the total retail loan book size at an industry level. However, these loans have seen a significant increase in disbursals since January 2022, representing about 25% of total origination volumes. This rise in small-ticket personal loans has had a marginal impact on the overall retail loan portfolio, which includes home loans, auto loans, credit cards, personal loans, and consumption loan products.
In addition to the rise in small-ticket personal loans, early vintage delinquency trends also saw an increase in Q3 FY23 on consumption loan products compared to Q3 FY20. Lenders have flagged these rising delinquencies on small-ticket unsecured retail loans following a caution from the Reserve Bank of India.”
On Friday this week, the RBI acted by raising the risk weight of Banks and shadow banks on exposure to unsecured credit, credit card receivables and other shadow banks by about 25 per cent. This would mean lenders will have to set aside ₹25 more capital than before for every ₹100 they lend in these segments than in the past. Therefore, their risk-adjusted Return on Capital will fall, and they will either live with lower margins than before, or they will make these loans more expensive to the borrowers to maintain margin parity. It is almost certain lenders will choose to make the loans dearer for customers than take a hit on their margins, which in turn should mean a slowdown in the credit offtake in these segments. This is a typical countercyclical measure that the central bank is imposing on the system to rein in the fairly strong growth in the unsecured segment, and its impact will be felt almost immediately. According to estimates, the banking system will require an additional capital of about ₹85,000 crores, which will mean an immediate increase in rates at which such loans are sold to customers. Also, it is a double whammy for NBFCs for whom the cost of raising funds from banks goes up because risk weightage for exposure to them at banks is up, and their own capital requirement for these segments goes up. Expect a significant deceleration of growth among them and fintechs who used the capital from NBFCs to peddle frictionless unsecured loans on their apps.
There are a few interesting macro takeaways that one can read from this action of the central bank.
First, it has not sprung this on the sector without reading the tea leaves and then cautioning the players for a period of time. The rate of growth in this segment and the gradual buildup of stress have been on its radar for a while now, and it has privately told a few players to temper their growth. As the growth continued unabated, it followed up with the most potent tool in its hands of raising the risk weights. This might slow economic growth, but the central bank is more concerned about macro-financial stability. To take this call in an election year suggests a fair degree of independence and maturity in doing what’s right rather than falling to the expediency of politics of the moment. To appreciate this, look at the contrasting actions of the central bank in China, which has yo-yo’ed from letting an asset bubble build up in real estate over the years while looking the other way and now taking knee-jerk actions because it favours the political will of the moment.
Second, the risk that the central bank sees is an overleveraged borrower with multiple small loans and no collateral who finds it difficult to repay the loans in a rising interest scenario. Some of this scenario is coming to a pass now when one looks at the Transunion CIBIL delinquency table, but this is also a way to derisk more indebtedness among borrowers going forward. This suggests the central bank is keeping its mind open for further rate hikes if the inflation doesn’t come down to 4 per cent. So, it is worried how much the system can sustain more rate hikes and increase in the EMI burden. The best course now is to not add further to this unsecured loan bubble by making it dearer for the banks. This is, therefore, a subtle message that the interest rate hike cycle is only paused for now, and it can’t be said that the direction of the pause has changed towards a lower rate cycle.
Lastly, this also supports a point we have made a few times in recent editions. Consumption-driven or total factor productivity-driven GDP growth can only get us so far. Beyond a point, pushing those levers without significant additional cost or risk is difficult. We have had meaningfully slow capital formation for almost a decade now. It must immediately kick off for India to average a 7 per cent or more annual GDP growth rate for the next decade.
India Policy Watch #2: Regulating SoHO
Reflections on current policy issues
— Pranay Kotasthane
Earlier this week, I came across two disparate news reports on regulations related to the exchange of substances of human origin (SoHO)—a technical term encompassing blood, tissues, cells and organs.
Newsflash 1: The European Commission plans to ban financial incentives for donors by limiting compensation to cover the actual costs incurred during the donation process.
The proposal wants to make SoHO exchanges voluntary and altruistic. EU wants to do today what India has already done yesterday.
Newsflash 2: A study analysing organ donations in India in 2019 showed that 80 per cent of the living organ donors are women, mainly the wife or the mother, while 80 per cent of the recipients are men.
All reports on this news item blamed socio-economic pressure without even considering that government policies might have a role to play.
So, how should we think about policies restricting SoHO exchanges?
When I think about this topic, my mind wanders to the movie Avtaar. Not the science fiction Avatar; I’m talking about the 1980s tear-jerker featuring actor overactor Rajesh Khanna. At one point in the movie, the protagonist and his wife are thrown out of their homes by naalaayak sons abetted by their ‘modern’ wives. To rescue them from the clutches of poverty, their loyal house help (Sachin Pilgaonkar, cast unimaginatively as Sevak) takes the matter into his hands. Soon enough, he is caught at a blood bank trying to earn money by donating blood on multiple occasions.
These concerns about people exchanging SoHO for money made the Supreme Court use its favourite instrument. It banned the exchange of money for blood and shifted to the voluntary and altruistic model in 1996 that the EU wants to adopt now. Similarly, organ donations in India are regulated by the Transplantation of Human Organs Act (1994), which makes organ donation by a non-relative conditional on the permission of an Authorization Committee of the State government set up to prevent ‘comercial dealings in organ transplantation’.
Can you anticipate the unintended? Of course, these regulations have led to a shortage of SoHO exchanges in India. Contrary to the portrayal in Avtaar, which makes you believe that a large number of Indians are ready to exchange blood for money, the reality today is that India faces massive blood shortages. This Hindustan Times article tells us that nearly 12000 people in India die every single day due to the unavailability of blood products.
Moreover, the well-intentioned ban has predictably not achieved its aim—a well-oiled “professional blood donor” market thrives nationwide. You can search for this term and find seasonal news about such scams. (One particular BBC article from 2015 innocently asks, “Selling blood and paying donors in India is illegal, but across the country, a vast "red market" proliferates.” The writer doesn’t consider that the underground market proliferates precisely because payments are illegal, not despite the ban.)
For a country prone to dengue infections which require platelet transfusion, survivors often depend on this illicit market of blood products. Who do we blame then — the tout who saves lives by arranging for blood products illegally or the State that prevents such exchanges because it stops people from monetising SoHO?
Going back to the European Commission’s policyWTF, this CEPR article by Axel Ockenfels and Alvin Roth is educative. (Al Roth is a Nobel Prize winner for his work on market design. I like him because of his great blog). They write:
“There is a severe and growing global shortage of blood plasma. While many countries are unwilling to pay donors at home, they are willing to pay for blood plasma obtained from donors abroad. The US, which allows payment to plasma donors, is responsible for 70% of the world’s plasma supply and is also a major supplier to the EU, which must import about 40% of its total plasma needs….
In the 1970s, it may have been reasonable to worry that encouraging paid donation would lead to a flow of blood plasma from poor nations to rich ones. That is not what we are in fact seeing. Instead, plasma supplies from the US and Europe save lives around the world.” [Consequences of unpaid blood plasma donations, CEPR]
Fascinating.
Switching contexts to the second news flash, I found it amusing, though not entirely surprising, that none of the news reports explores if regulations are to be blamed for the skewed sex ratio of organ donors. There’s no doubt that India’s socioeconomic structure contributes to causing more women to donate organs to their male family members. But it’s highly likely that many men are donating organs too, but are doing so in the “underground” market. Since what’s illegal is, by definition, not counted in official statistics, the donors sex ratio appears even more skewed than it might have been.
Should India reverse its policy? Perhaps. The crucial point here is that with changing technology and income levels, the concerns that led to the restrictions in the 1990s are far less relevant today. Well-planned payment systems can keep exchanges ethical and ensure enough supply. New medical and tech advances can keep the donation process safe, even if donors get paid. Here again, Ockenfels and Roth have a point:
“In our view, the dangers of undersupply of critical medical substances, of inequitable compensation (particularly for financially disadvantaged donors), and of circumvention of regulation by sourcing these substances from other countries (where the EU has no influence on the rules for monitoring compensation to protect donors from harm) are at least as significant as those arising from overpayment. Carefully designed transactional mechanisms may also help to respect ethical boundaries while ensuring adequate supply. Advances in medical and communication technologies, such as viral detection tests, can effectively monitor blood quality and ensure the safety and integrity of the entire donation process – including the deferral of high-risk donors and those for whom donating is a risk to their health – without prohibiting payment to donors. Even if it is ultimately decided that payments should be banned, there are innovations in the rules governing blood donation that have been proposed, implemented, and tested that would improve the balance between blood supply and demand within the constraints of volunteerism; non-price signals, for instance, can work within current social and ethical constraints.” [Consequences of unpaid blood plasma donations, CEPR]
Realistically, we are far away from a policy change on this issue. The Overton Window has shifted far away. But the shocking statistics of deaths due to SoHO shortages in India should probably make us rethink the bans. As for the European Commission, their planned policy move will only increase SoHO imports from outside Europe. As has often happened, the EU will solve problems by externalising the solutions.
The New Book Is Out!
— Pranay Kotasthane
A well-meaning reader pointed out that the newsletter has lately focused too much on semiconductors. That’s partly because my co-author, Abhiram Manchi, and I have been working on a book over the last couple of years. That work has come to fruition now. The book titled When the Chips are Down: A Deep Dive into a Global Crisis is now available in bookstores and on Amazon starting yesterday.
So what’s the book about?
As two IC design engineers interested in geopolitics, we felt a shortage of Indian perspectives in this domain, even though India is a crucial node of this supply chain. For instance, the otherwise excellent Chip War mentions India just twice, rather offhandedly.
I also cringed after attending conferences and discussions where Indians were asking foreigners questions such as “Should India build a chip fab?”.
Now, it’s terrific to keep yourself open to ideas from experts regardless of their nationalities. We should learn from the experiences and views of other countries. But surely, the question of whether India should or shouldn’t go down the path of semiconductor manufacturing can and must be answered only by Indians.
This book is one such attempt.
Here’s the blurb with more details.
The contest for the world’s most critical industry
To the world at large, technology was synonymous with software. But in 2019, such conversations changed dramatically. Today, the hardware that runs all software — semiconductors or chips — has become a subject of WhatsApp groups and international politics.
The chip shortage during COVID-19 made governments take notice of this complex supply chain. The US began denying advanced semiconductors toChinese companies. Worsening China-Taiwan relations further intensifiedthe debate. By 2022, China, the US, India, the EU and Japan hadreleased plans worth billions of dollars for setting up new semiconductor facilities.
This book is a comprehensive overview of this ‘meta-critical’ technology. How are semiconductors important from a geopolitical perspective? Why did the US and Taiwan become powerhouses in this domain while Russia and India fell behind? Is China’s semiconductor sector a threat to the world? What are the future trends to watch out for?
These are the questions that this book answers.
Truth be told, I am nervous about how the book will be received. I hope you will enjoy reading it and will recommend it to others. If you like it, consider dropping a review on Amazon. Or send brickbats if you prefer. Regardless, order it now.
Global Policy Watch: Beware Of Tech Evangelists Bearing Gifts
Global policy issues relevant to India
— RSJ
Listen, I’m as much a techno-optimist and free marketer as anyone else. But this Techno-Optimist manifesto of Marc Andreesen is a bit much for even me. This is largely self-serving, late-stage ‘capitalism on steroids’ that breeds fevered dreams like finding another planet for humans to colonise and live on rather than making this planet better.
Anyway, here’s a sample of the manifesto in case you missed it (you didn’t miss much, really). This is Andreesen identifying the ‘enemies’.
Quite illuminating stuff:
“We have enemies.
Our enemies are not bad people – but rather bad ideas.
Our present society has been subjected to a mass demoralization campaign for six decades – against technology and against life – under varying names like “existential risk”, “sustainability”, “ESG”, “Sustainable Development Goals”, “social responsibility”, “stakeholder capitalism”, “Precautionary Principle”, “trust and safety”, “tech ethics”, “risk management”, “de-growth”, “the limits of growth”.
This demoralization campaign is based on bad ideas of the past – zombie ideas, many derived from Communism, disastrous then and now – that have refused to die.
Our enemy is stagnation.
Our enemy is anti-merit, anti-ambition, anti-striving, anti-achievement, anti-greatness.
Our enemy is statism, authoritarianism, collectivism, central planning, socialism.
Our enemy is bureaucracy, vetocracy, gerontocracy, blind deference to tradition.
Our enemy is corruption, regulatory capture, monopolies, cartels.
Our enemy is institutions that in their youth were vital and energetic and truth-seeking, but are now compromised and corroded and collapsing – blocking progress in increasingly desperate bids for continued relevance, frantically trying to justify their ongoing funding despite spiraling dysfunction and escalating ineptness.
Our enemy is the ivory tower, the know-it-all credentialed expert worldview, indulging in abstract theories, luxury beliefs, social engineering, disconnected from the real world, delusional, unelected, and unaccountable – playing God with everyone else’s lives, with total insulation from the consequences.
Our enemy is speech control and thought control – the increasing use, in plain sight, of George Orwell’s “1984” as an instruction manual.
Our enemy is Thomas Sowell’s Unconstrained Vision, Alexander Kojeve’s Universal and Homogeneous State, Thomas More’s Utopia.
Our enemy is the Precautionary Principle, which would have prevented virtually all progress since man first harnessed fire. The Precautionary Principle was invented to prevent the large-scale deployment of civilian nuclear power, perhaps the most catastrophic mistake in Western society in my lifetime. The Precautionary Principle continues to inflict enormous unnecessary suffering on our world today. It is deeply immoral, and we must jettison it with extreme prejudice.
Our enemy is deceleration, de-growth, depopulation – the nihilistic wish, so trendy among our elites, for fewer people, less energy, and more suffering and death.”
Well, empirical evidence suggests elevating anything to a near-mythical god-like status is a bad idea. Further, identifying enemies of that god is worse.
But I don’t think Andreesen has too much time to read history.
Or, indeed, learn from it.
HomeWork
Reading and listening recommendations on public policy matters
[Podcast] A Puliyabaazi on the history of India-Israel and India-Palestine relations.
[Paper] This paper on the morality of public shaming has a useful framework—more on this in a subsequent edition.
Did you know that only 30 per cent of schools in Kerala are run by governments? The national average is 69 per cent. A large chunk of Kerala’s schools (44 per cent) is financed by governments through aid but run by private administrations. The national average for aided schools is 5 per cent. How often do we consider this when discussing Kerala’s education success?
"...the more you attract customers who shouldn’t be getting these loans in the first place. There’s a moral hazard built in there."
That's adverse selection :)
Nice stuff as always gents. I had missed the piece by a16z. It feels like it was written in early 2021 but published last month. Couldn't quite get through it.