Are Government Auctions optimal?

The topic for this blog is very relevant today with most of the sectors where Government has resources to be given to private sector being done through auctions. Auctions have a peculiar character of giving the seller a good and easier way of attaining maximising the value of the asset being sold. Considering this shouldn't auctions been the right way for Government to auction public resources.But at the same does not hold true for the buyer, auctions have been known to loss making to many buyers, thus the word "winner's curse". Government's auctions are unique in the sense the seller is the populace and the ultimate end user is the populace.

Lets consider a simple example to illustrate the above point.

Case A: Take a person who owns a house. Note that the ownership of the house is held by a single person and he wishes to sell the house. The buyer of the house will have to rent out the house to recover his cost. There are many people who are willing to take the house on rent and the seller is not one among them.

Case B: There is a family which owns a house and the ownership of the house is divided among these people. The buyer as in Case A has to rent out the house to recover his cost. But in this case few of the members of the house have to stay in the house and are willing to rent it from the buyer.

In Case A, the seller is justified to go for an auction as he gets the maximum price and as he is not going to rent of the house, he is bothered with the fact that higher sale price translates to higher rental value. Whereas in Case B, the seller may not be justified to go for the auction. Here few of the sellers will have to bear a higher renting cost as the sale price is very high. Thus as long as the marginal gain in higher sale price is able to reduce the marginal costs in higher renting, the auction system works fine. But in case the transfer of high sale price does not happen to individual sellers properly then he is worse off than earlier.

Case B is what happens when Governments auction public resources. The Government achieves a higher sale price, but due to leakages in the systems the transfer of the higher sale price is not effective and the consumer ends up paying a higher price for using the resources. For instance, the recent 3G auctions, may have given the Government high price but most of the gains are going towards reducing the deficits run by the Government rather than any transfer of wealth to the people through increased infrastructure or better facilities. The high prices are only going to increase the eventual usage price of the 3G services. Thus the consumer may be better off by not having an auction itself.

The high price also raises the question of viability of the service itself. High price of usage may deter eventual consumers and the company which has one the auction may be forced to reduce prices thus incurring losses. This is also disadvantageous for the customer as eventually the company might stop providing the service.

In case of the public resources, I think one way to be followed by the Government is have an auction on both the highest price for the resource and lowest end user price for the eventual consumer. This would be able to generate higher price as well as restrict the consumer getting better services.

Urban Serfdom

Serfdom the once widely prevalent practice in rural populace, wherein the landless farmers would be enslaved to work in the fields of the landowners for perpetuity. With increasing economic growth the urban populace is also increasing the disposable incomes available with the populace. But is this increase in disposable income creating increasing wealth in the hands of the urban populace. Rather than wealth creation, consumption is taking a higher chunk of the disposable incomes in India. India has been a consumption driven economy over the last decade and the private consumption is a growth story. Easy access to credit is fuelling this growth of consumption. Credit purchases have increased and cover a wide variety of products starting from clothes. This every increasing dependence on consumption goods is only going to increase the dependence of the urban populace on credit and reduce financial independence which is very critical for wealth creation. We are looking at a situation wherein wealth is increasingly being concentrated in the hands of few and transfer of wealth taking place from a majority to the minority.
Let’s take an example of home ownership to understand this transfer of wealth. In a city like Mumbai, the cost of an average sized apartment is near to the seven figure mark. With easy access to credit, majority of the people would invariably take huge loan amount to acquire the apartment. The tenor would be for 10 to 15 year period. This leads to creation of a long term liability which the buyer has to service and this puts him dependent on his income to service the loan. The monthly payment would comprise a major chunk of the monthly earnings. Any negative impact on the buyer’s income earning capacity negatively impacts his ability to service the liability. Thus the person is highly dependent on his job. The situation of the buyer is similar to that of the landless farmer who has been caught in serfdom; the ownership of the apartment makes him more dependent on the vagaries of the economy and less financial independent. The entire consideration is being paid by the buyer to a developer who enjoys a high margin due to the faulty market and regulatory practices which have enabled them to form artificial monopolies.
Financial independence seems to be eluding the urban populace and in absence of a strong social security system in our country, the urban populace is very much dependent on continuing economic growth to be able to reduce the risks of high financial dependence. Innovations and entrepreneurship would flourish only when financial independence is achieved. Also on growth stalling, the risks of social unrest increase quite significantly. The twin risks of high consumption and high liabilities need to be resolved in order to overcome the scenario of urban serfdom.

Residential Bubble

(Source : Nomura Research)

(Source : www.livemint.com and RBI)

Over the last 1.5 years, Indian Real estate sector has seen a tumultuous journey. Starting with the fall in Q3 2008, real estate sector has seen recovery in some sectors while the other sectors have yet to see recovery. Commercial real estate (Office space) has seen increasing absorption across India. Q1 2010 absorption across India has been very positive compared to Q1 2009. However the vacancy levels are still quite high, and with additional space expected to come into the market, vacancy levels would remain high.Rentals have been stable over the last one year, BKC and Gurgaon are the two markets which have seen a slight increase in rentals. However, increase supply of space in these two markets would keep the rentals under check in these two markets. Retail space has also not seen any recovery yet.

Residential space has seen a strong recovery over the last one year. However this recovery has not been spread across India.Hyderabad, Chennai, Bangalore have not seen the high jumps that Mumbai and Gurgaon markets have seen. Prices in Mumbai have surged 31% Y-o-Y basis and prices have increased more than the 2008 levels. Affordability (EMI/monthly income) has increased to nearly 85% and is near 2007 levels.

The RBI report has also provided some interesting data on the transaction volumes and price movements. Over the last few quarters the transaction volumes have shot up in an unprecedented manner. The volumes which ranged over 15,000 to 25,000 units per quarter. The volumes have shot up to 45,000 units in a short time. This is far more intriguing than the price increase data. This volume upsurge is not sustainable and with increasing new product launches, there is going to be a definite oversupply situation in the residential space.

My personal belief is that these two markets are in a bubble zone. The main reasons for this belief area,

1.This increase in prices has been quite sharp and very localised. This localisation indicates that the broad based economic recovery has not been the only reason for this increase.

2. Increased liquidity and low barriers to availability of money.

3. Increasing stress towards high spec residential space.

4. Strong co-relation to the stock market movements.

5. Strong surge in transaction volumes in a short period.

Inflexion Point

(Source: RBI Q2 review)
The main risk factor which i had pointed out in my last blog is going to play a key role in the coming few days. Global economies are currently facing a key decision factor with regard to economies recovery. key countries which had implemented fiscal and other incetives to boost their economies during the period of 2008-09 are now being forced to think and act on removing these incentive schemes due to rising inflation. China has started the process, India is expected to raise interest rates in the coming quarterly policy review. The declines in global markets and strong performace of the dollar over the last one week are a reflection of the fears that market participants have, on the adverse impact due removal of these incentives. The declines indicate that the market feels that the recovery was due to these incentives rather than due to any demand recovery. So what does all this hold for India? The impact of the increasing risk aversion to emerging markets due to fears of a bubble or lower growth due to increasing monetary tightening is being felt and would continue for the next few weeks.

Let us analyse the performance of the Indian economy through the basic GDP formula, Y= C+I+G+NX.The growth of the Indian economy over the last few quarters has been helped to a great extent by the fiscal push by the government (G). The last quarter has seen the impact of the fiscal push through increased growth in the social and community services expenditure, which is funded by the government.With the government looking at reining in the fiscal deficit, the key growth factors for the Indian economy would be the recovery of the private consumption(C) and Investment(I). With the world economy still weak, growth in the exports would be lower, hence the need for C and I to grow. Growth in Private consumption fell to 1.6% in the first quarter of 2010 and but increased by 5.6 % in the Q2 2009-2010. The impact of the bad monsoon is expected to be felt in Q 3 2009-10 and this is expected to adversely impact the consumption in rural india. Investment growth has still not picked up. The Q 3 2009-10 could see a lower growth as compared to Q 2 2009-10 which had seen the main impact of increased government expenditure and private consumption.So is the government going to start the process of removal of incentives or has the Indian Economy recoverd and is ready to move forward with Government support? The policy review of RBI may give us some hint on these questions.

December Effect

It has been more than 3 months since my post on the dollar/gold movement post in 2009. It is a good time to recap and see if my bets had proven correct or went into a tailspin. Lets start with looking at gold prices (Source: www.goldprices.org), gold prices surged during the period from October 2009 till December 2009 and then the slide set in. December has seen a quite sharp fall in gold prices as compared in any other month in the previous 6 - 7 months. Lets now move onto the performance of the dollar (Source: http://www.marketwatch.com/). The dollar index also shows a reversal in fortunes with strong movement in December 2009. The dollar has shown its strongest performance in 2009 in December. What could be the reason behind this strong movements, did risk aversion started falling or did people think that a bubble had been formed?. Remember that in the last 6 months, dollar carry trade had increased a lot and with fed taking a posture of low interest rates for a long time it was only expected to increase. None of the conditions which resulted in the dollar carry trade and liquidity led rise in asset prices has changed. Interest rates in US are still low, governments have not started retracting stimulus packages, inflation concerns are still be sounded out. No major policy decisions were taken in December by any major economy.

One hypothesis which i have heard but did not have great belief is the "December Effect". With December being the last calender month and most of the traders having achieved there year end targets or not having the time to realise these targets for this year, would have shut shop and limit there risky positions. Also the holiday season of last 10 days of December when limited activity takes place, many people would be happy to reverse there risky trades and limit their exposure. Whether this a reason for the movements seen in December is very difficult to prove. Lets have a look at the equity market performance if there has been any December effect in these markets. The MSCI emerging markets ETF has not seen any major movement in December 2009 (Source: www.marketwatch.com).

Going forward, if December effect was the primary reason for the movements in December, then the reversal should be taking place. The projections I had made in October 2009 still hold good. One major concern on which i would touch upon next week in my next blog would be the performance of the China Property market.