Zoo Station

I was invited by Matthew Bishop, the U.S. editor of The Economist and author of Philanthrocapitalism, to contribute a piece to an issue of Alliance Magazine that he's guest editing. The focus is on "discontinuous thinking for a crisis." Here is my piece on catalytic philanthropy in full.

With free markets in retreat, economic development risks losing one of its foremost drivers. People forget that economic growth in India and China alone, fostered by open markets, has lifted hundreds of millions out of absolute poverty over the past 15 years. A crisis is a terrible thing to waste, so this is a good time for capitalism's greatest beneficiaries to bring its sheen back. Philanthropy can play a pivotal role in catalysing markets and market-based solutions that promote inclusive economic growth in developing countries.

Developing countries are plagued by instances of mispriced risk, where the perception of risk is often far greater than the reality, which drives up the cost of capital. Though market clearance – in which supply is equal to demand so the market 'clears' – is a central tenet of free markets, a nudge is often required to kick-start markets. Philanthropic capital with a longer horizon can very effectively provide this stimulus, demonstrating a market opportunity into which commercial capital then flows.

Small and medium enterprises (SMEs) are traditionally an economy's largest job creator, so any developing country aiming for rapid and inclusive growth requires a robust SME sector. Contrary to popular opinion in venture capital circles, real investment opportunities may well lie in ‘bread and butter’ industries with a high or exponential correlation to GDP growth and huge social impact (waste management, for instance, or logistics and warehousing). The first true exit for a venture capital firm in India is likely to come next year in a business with a high social impact: microfinance. The bottom line in these businesses is that social and financial returns are not mutually exclusive.

There are several factors that retard the growth of SMEs, including lack of policy, limited knowledge networks and poor management skills, but availability of finance is key. Realizing this, the Soros Economic Development Fund, Omidyar Network and Google.org have set up the SONG[1] Fund at the Indian School of Business to invest in early-stage companies that will generate financial and social returns without compromising on either. There is enormous scope for long-term 'patient' capital to be deployed effectively. For instance, with 80 per cent of India's healthcare system in the private sector, our research reveals an opportunity to help build an asset management business around low-cost healthcare services.

Low-income housing is typically ignored in developing countries, and slums and shanties are a poor substitute. Market surveys in India have shown that there is a shortfall of 25 to 35 million houses in the $4,000 to $30,000 price segment. Our research shows that it is possible to generate internal rates of return of 40–60 per cent by building for the lowest end of the market. We have set up a for-profit housing company that will build houses for between $4,000 and $6,000, targeted at the working poor.

In doing so, we have identified several opportunities for catalytic philanthropic capital to play a role, besides the obvious as investors. There is a serious inability to access project finance, so anyone who can provide a first-loss guarantee can effectively catalyse the market and bring even smaller developers to the table. Similarly, end customers in the developing world can incur severe penalties for defaults and late payments arising from cyclical cashflow problems such as illness or unemployment. A payment protection insurance plan funded initially by philanthropists could offer incentives to mortgage providers and banks to offer loans.

The CARE Protected Note, developed by Derilab SA of Switzerland, offers investors the option to support a large low-income Pakistani school system that is based on a public-private partnership, and to participate in a structured product with capital protection at maturity. A yearly coupon will be paid to the CARE Foundation only if the school system grade average is greater than the regional average; if not, the coupon is returned to the investor. The CARE Protected Note offers the investor a tradable and liquid financial product, where investments in a liquid underlying asset generate positive returns. This mechanism not only provides incentives for all parties, and protection and returns to the investor, but also sources capital for charitable projects that is more sustainable than donations.

These three examples of innovations clearly show that the 'base of the pyramid' market segment needs more financial ingenuity, not less. Many more exist. Most just need a nudge from smart philanthropic capital to see the light of day.

Dr Reuben Abraham is a professor and executive director of the Centre for Emerging Markets Solutions at the Indian School of Business, Hyderabad.
1. SONG is an acronym for Soros, Omidyar Network and Google.

Laura Galloway just sent me this preview video for TED India. Enjoy.

My friend Asieh (who is Persian) sent me this story from the Fars News Agency. Apparently, my colleague from Soros/Open Society (and fellow Ph.D. from Columbia), Kian Tajbaksh, has been forced to confess after identifying him as an agent of the Soros network trying to "cause a velvet revolution" in Iran. According to Asieh, Kian is being used as a pawn to get to Khatami, to prove that he is in bed with mysterious foreign powers.

Ahmadinejad's government is getting nuttier by the day. In the meanwhile, I hope better sense will prevail and Kian will be released soon, especially since he was released from Evin prison just two years back after another brief spell of incarceration.

In between my crazed travel schedule, I forgot to link to this WSJ story which extensively quotes me. The story had originally appeared in Knowledge @ Wharton and was reprinted in the Journal. The story is titled "The Poor as Stakeholders: Can Inclusive Capitalism Thrive in India?" Here are the portions that quote me, though the entire story is worth a read.

Reuben Abraham, assistant professor and director of the Emerging Market Solutions Initiative [Ed Note: It should read Exec Director and Centre for Emerging Markets Solutions now] at the Hyderabad-based Indian School of Business (ISB), points out that business success must come first. "At its core, Fabindia is a sourcing business," he says. "Everything else that they do -- making weavers [into] shareholders, etc. -- is peripheral to their main activity."

"Capitalism at its core is basically agnostic," says Abraham of ISB. "It does not try to be inclusive or exclusive. Capitalism is about optimal allocation of resources. The more it is allowed to thrive, the higher the number of people who will be impacted positively by [its] growth. So, in that sense, being inclusive is perhaps a natural process. But for this to happen, what is really needed is more liberalization and fundamental reforms. For instance, until 1995 the fruits of telecom were not available to 95% of the country. Because of the reforms in this sector, [they are] now available to 50% of the country.... In this sector, capitalism has become a force for good. We could have the same thing happen over and over again in different sectors."

Corporations naturally go for high-margin customers in the beginning, Abraham notes, but given that there is a very small number of high-margin customers in India, they will have no option but to look at other segments of the population. "These are natural consequences of a well-regulated market at work. The problem really is: What is the optimal amount of regulation in a sector and who decides that? In my opinion, it is an iterative process. This is a journey that needs to be figured out by trial and error."

If regulatory reforms don't take place, "corporations will be forced to do inclusive capitalism [Ed Note: Not sure what this means]. Otherwise, there will be social unrest. The issue then will be about the level of commitment of the corporates given that they always have to walk the thin line between their responsibilities toward the shareholders and the society at large."

Reforms are the key, Abraham says. As an example, he notes that various studies show that urban slum dwellers are willing to spend as much as 30% of their household income on educating their children in private schools. "This means that demand clearly exists. The reason that supply does not exist to meet this demand is because of regulations that don't allow profit-making in education."

(Via Marginal Revolution) Since I am all about Paul Romer these days, I figured I need to link to Professor Romer's five favourite live rock recordings as well. Some interesting tips in there, including the Dead, Hendrix etc.

And while we're on the topic of lists, here are the top 20 movies made since 1992, according to Quentin Tarantino. Fabulous bunch of movies.

I am doing some research into the installed power generation capacity in India. As of May 2009, these are the numbers, with another 80,000 MW expected to come online in the next 18 months. What better way to share than with a chart?



As you can see, the share of coal is dropping and of renewables on the rise. The real increase, however, will be in nuclear as the nuclear agreement kicks in. For those of you who are curious, here are the all the numbers (rounded off).

Total installed capacity: 149,392 MW

Thermal -- 95,152 MW
Hydro -- 36,877 MW
Nuclear -- 4,120 MW
Renewables -- 13,242

I have argued on this blog against romanticizing micro-finance, especially the notion that MFI's create vast armies of entrepreneurs etc. If it wasn't bad enough that do-gooders cannot get enough of the hype, in recent times capital flows into the sector have led to a bubble building in the market. Sure, Sequoia will make a major exit next year via SKS, but I am not so sure about all the late-comers and insane valuations. The bubble has led to large-scale rollovers, higher levels of indebtedness and so on. I have meant to write about this (time has become an enemy), when I came across two pieces, one in the WSJ and the other in the Economist about the hype machine and the disconnected reality. First, the WSJ has an anecdotal piece from India about a credit bubble.

Today in India, some poor neighborhoods are being "carpet-bombed" with loans, says Rajalaxmi Kamath, a researcher at the Indian Institute of Management Bangalore who studies the issue. In India, microloans outstanding grew 72% in the year ended March 31, 2008, totaling $1.24 billion, according to Sa-Dhan, an industry association in New Delhi. "We fear a bubble," says Jacques Grivel of the Luxembourg-based Finethic, a $100 million investment fund that focuses on Latin America, Eastern Europe and Asia, though it has no exposure to India. "Too much money is chasing too few good candidates."

Here in Ramanagaram, a silk-making city in southern India, Zahreen Taj noticed the change. Suddenly, in the shantytown where she lives, lots of people wanted to loan her money. She borrowed $125 to invest in her husband's vegetable cart. Then she borrowed more. "I took from one bank to pay the previous one. And I did it again," says Ms. Taj, 46 years old. In four years, she took a total of four loans from two microlenders in progressively larger amounts -- two for $209, another for $293, and then $356.

At the height of her borrowing binge, she says, she bought a television set. The arrival of microfinance "increased our desires for things we didn't have," Ms. Taj says. "We all have dreams." Today her house is bare except for a floor mat and a pile of kitchen utensils. By selling her TV, appliances and jewelry, she cut her debt to $94. That's equal to about a fourth of her annual income.
[...]
Many of the problems in Indian microlending might sound familiar to students of the U.S. mortgage crisis, which was worsened by so-called "no-documentation" loans and by commission-paid brokers. Similarly in India, microlenders' field officers are often paid on commission, giving them financial incentive to issue more loans, according to Ms. Kamath. Lenders are aware that applicants often lie on their paperwork, says Ujjivan's founder, Samit Ghosh. In fact, he says, Ujjivan's field staffers often know the real story. But his organization maintained a policy of "relying on the information from the customer, rather than our own market intelligence."
[...]
It's tough to monitor how borrowers spend their money. Ujjivan used to perform regular "loan utilization checks," but stopped because it was so costly. Now it only checks in with people borrowing more than $310, Mr. Ghosh says.

The Economist piece is not anecdotal and busts a few myths about the "miraculous curing powers" of microfinance. Some background first.

Despite growing interest from private investors, 53% of the $11.7 billion that was committed to the microfinance industry in 2008 still came at below-market rates from aid agencies, multilateral banks and other donors. Given that there are other things that aid money could be spent on, and that the rationale for subsidising microcredit is its effectiveness as an anti-poverty tool, it is important for donors to know whether it has the advertised effects.
[..]
Two new papers* apply this idea to measure the effect of access to microcredit. Researchers from the Poverty Action Lab at the Massachusetts Institute of Technology (MIT) worked with an Indian microfinance firm to ensure that 52 randomly chosen slums in the city of Hyderabad were given access to microfinance, while 52 other slums, which were equally suitable and where the lender was also keen to expand, were denied it. This allowed the researchers to see clearly the effect of microcredit on an entire community. Dean Karlan of Yale University and Jonathan Zinman of Dartmouth College carried out a similar exercise in the Philippines, this time at the level of the individual borrower. They tweaked the credit-scoring software of a microfinance firm so that only a random subset of people with marginal credit histories were accepted as clients. These clients could then be compared with those who sought credit but were denied it.

Broadly speaking, neither study found that microcredit reduced poverty. There was no effect on average household consumption, at least within a year to 18 months of the experiment. The study in the Philippines also measured the probability of being under the poverty line and the quality of food that people ate, and again found no effects. Microcredit may not even be the most useful financial service for the majority of poor people. Only one in five loans in the Hyderabad study actually led to the creation of a new business. Providing people with safe places to store their (small) savings may help them more in the long run.

So, the next time you hear someone mouth off about how micro-finance is going to eradicate poverty, hit that pause button. If something sounds too good to be true, it probably is.

The Big Picture links to an excellent piece by Andy Xie on China's recovery building up to a Ponzi scheme. He first sets the scene with the dollar.

Like in the 1970s the Fed is denying the inflation risk due to its loose monetary policy. The longer the Fed waits, the higher the inflation will peak. When inflation starts to accelerate, it would cause panic in financial markets. To calm the markets, the Fed has to tighten aggressively, probably excessively, which would lead to a massive dollar rally. This would be the worst possible situation: a strong dollar and a weak US economy. China’s asset markets and the economy would almost surely go into a hard landing.

He then looks at the Chinese market today.

Chinese stock and property markets have bubbled up again. It was fueled by bank lending and inflation fear. I think that Chinese stocks and properties are 50-100% overvalued. The odds are that both will adjust in the fourth quarter. However, both might flare up again sometime next year. Fluctuating within a long bubble could be the dominant trend for the foreseeable future. The bursting will happen when the US dollar becomes strong again. The catalyst could be serious inflation that forces the Fed to raise interest rate.

Chinese asset markets have become a giant Ponzi scheme. The prices are supported by appreciation expectation. As more people and liquidity are sucked in, the resulting surging prices validate the expectation, which prompts more people to join the party. This sort of bubble ends when there isn’t enough liquidity to feed the beast.

Add demographics to this mix.

The most serious damage that a property bubble inflicts is in changing demographics. High property prices bring down birth rates. When property prices decline after a bubble bursts, the low birth rate culture cannot be changed. Hong Kong, Japan, Korea, and Taiwan all went through property bubbles during their development. Their birth rates dropped during the bubbles and didn’t recover afterwards despite government providing incentives. China’s one-child policy alone will lead to a demographic catastrophe in two decades. The property bubble makes the trend irreversible: when the government abandons the one-child policy, there wouldn’t be meaningful impact on birth rate.

The trouble is I see something very similar happening in India vis-a-vis asset bubbles. I think the current *recovery* in the equity markets and real estate is more likely to be linked to the weaker dollar rather than any fundamental change; corporate earnings, for example remain weak.

Those of you on my Facebook feed know I was at TED Global in Oxford this year. As always, TED blew my mind and I am going to embed a few of my favourite talks on here. While I wait for Henry Markram's talk on the Blue Brain project to go online, here is the other talk that really grabbed my attention: Paul Romer on Charter Cities.




If you want to know more, go here.