A refreshing view: Financial Express 21st July 2013 (Book Review)

One outcome of the global financial crisis was the publication of a plethora of books on the subject, where the authors have delved into the ‘why’ of the crisis with specific focus on capitalist greed. It became fashionable to bash institutions and regulators who were supposedly responsible for this catastrophe. Against this background, the collection of 17 articles by authors from across the globe put together by RK Mishra and K Trivikram, The Global Financial Crisis: Challenges and Opportunities, is refreshing as it looks beyond the cliche. While some of the pieces do give a background on how the crisis transpired, the analysis is at a different level where the experiences of various countries have been narrated with the causes and remedies being embedded along the way.
The genesis of the crisis was straightforward as it started with a banking crisis, which became a real-sector crisis leading to diminution of growth in the affected countries. This was exacerbated by weak regulation where everything was left to the market, which was not quite able to deliver. Therefore, the diminished role of the state in an environment of globalisation of free trade hastened the contagion. While this is a view taken by Maurice Odle, there is a counter-view by Leo Goodstadt, who has argued in favour of minimum role of the state in such issues on the grounds that when there is more regulation, we automatically create a moral hazard where institutions know that they have to be rescued in case something goes wrong. An interesting analysis brought out is that almost all countries had to go in for a stimulus programme, which had gone to the extent of 24% of GDP for South Africa and 12% for China between 2009 and 2013. The focus was on providing this stimulus towards the unskilled workers, where the impact was more effective. This probably is a lesson to remember in future too, when such programmes have to be undertaken. The US had a cumulative bailout package of $8.1 trillion. India, in relative terms, came quite low at 1.3% of GDP. Who should we blame for the crisis? Here, there are differing views. Some say the regulators should take the flak. The Federal Reserve had pointed towards incompetent bank lending and defective regulation, while the Bank of England has averred that they had given early warning signals on CDS, which was not heeded by the systems. And the common target were the credit rating agencies, which worked in an environment of distinct conflict of interest. The gist was that one could have seen this coming and intervened to preempt the crisis, which was not done. An issue covered quite in detail is how the emerging markets got affected by the crisis and the impact on poverty. While their own financial systems did not have the same problems as those in the US, the slowdown in the West, as well as loss of faith between banks on account of the opacity in the systems affected the flow of funds—FII and FDI to the developing countries. Capital transfers came down as did official flows, which had a distinct impact on countries in the sub-Sahara region, which otherwise were doing well. Also, as most of these economies were exporting raw materials, they witnessed lower demand for their products. This was aggravated by diminishing commodity prices, which affected exporters the most and hence their own economies were also pushed back considerably. An article by Chen and Ravallion calculates that the number of poor had increased by 53 million across the world going by the $1.25-per-day criteria and by 64 million by the $2-a-day criteria. The impact on specific countries is also examined by different authors. China got affected as its surpluses flow to the US and is heavily dependent on trade flows, which are contingent on what happens in the developed world. While citizens cannot easily invest overseas, the government got exposed indirectly to the sub-prime crisis as their sovereign wealth funds were affected, though data is hard to come by. But China, too, had to go in for a stimulus to compensate for the loss of output. The French banks have shown relatively more resilience to the crisis more on account of diversification in activity. However, support had to come though recapitalisation of banks and refinancing of loans. The same held for German banks, though it was more a case of the larger banks being affected by the contagion. Curiously, countries like those in the Caribbean, which did not have too many foreign banks operating to spread the risk, were affected more on account of the low growth syndrome in the developed countries, which affected their exports. Also, their own investments in the US CDOs (collateralised debt obligations) and MBS (mortgage-backed securities) did have repercussions on these institutions. At a different level, there is also an analysis to show that within both the developed and emerging markets, the micro, small and medium enterprises (MSMEs) were at a disadvantage as they were affected by weak demand conditions. This went along with adverse financial market conditions for them, where credit conditions were tight for them and banks became cautious while lending. Therefore, this outcome was common across nations. The solution offered was a stimulus through taxation, procurement from government and enhanced trade. But all this led to a slowdown in investment. Related to this impact, Mckibbin and Stoeckel examine the potential impact of the global financial crisis in terms of risk and liquidity. The risk premium on inter-bank borrowing had increased to over 5%, which must be one of the largest in recent times. This also lowered the level of capex as big companies stopped borrowing. Sectors affected were automobiles as demand came down, both in countries as well as on the trade front on account of the recession in developed countries. All this was a result of what had been called financial protectionism in the affected countries. This book is a good collection of articles with some incisive analysis. By looking at various aspects of the crisis and its impact across different geographies, the focus is less on being judgmental and more on the way forward. This is a book that would add value to the shelf of any library.

Authors: RK Mishra and K Trivikram, The Global Financial Crisis: Challenges and Opportunities
 

Merely relaxing FDI limits will not mean FDI coming in a big way today: Madan Sabnavis: Business Standard Smart Investor 19th July 2013

In a bid to support staggering currency and revamp growth, Indian government announced slew of measures to attract foreign investments. Madan Sabnavis, chief economist, CARE Ratings tells Aastha Agnihotri that the recent moves will take time to materialize and its impact will be seen over a year or two.


India's growth concerns aggravated after a steep contraction in June's IIP data coupled with rise in both CPI and WPI inflation. What kind of trend do you expect in terms of recovery?
Growth in fiscal 2014 would tend to be muted and marginal, aided considerably by a low base effect. We have seen quite a few announcements made by the Government in the context of reviving growth, but these measures have to get translated into action for any impact to show on growth numbers. In the first two months it is clear that there has been virtually no movement in industry and the two sectors that would be the starting points, i.e. capital and consumer durable goods are in the negative growth rate territory. With the festival season being a few months away we cannot expect consumer demand to pick up and hence we could expect a similar picture till that point of time. It is expected that the good rains and resulting harvest along with the seasonal trend of consumer spending in the festival season will provide some fillip to growth.

Also there is still expectation that the infra projects that have gotten stalled for various reasons would be in motion soon, which will aid the gradual upward shift in the growth curve. Further there are expectations of a rate cut, which may be deferred against the backdrop of developments in the currency market and the measures taken by RBI recently to check liquidity and hence the exchange rate. There is hence a lot of uncertainty in the market and hence any recovery will be gradual and marginal.


The Reserve Bank of India's recent move to hike short-term rates did little to save rupee but slaughtered growth prospects further. Where do you see currency by the end of the year and have you revised your GDP target for the fiscal 2014?
I do not think that the RBI move has come in the way of growth prospects in a very significant manner even though it is tempting to come to such a conclusion. What the RBI has done is to tighten liquidity which will result in higher interest rates at the lower tenure spectrum. Long term interest rates will be guided, to my mind, more by what the RBI does to the repo rate. While base rates will increase for banks which are more dependent on short term funds, overall lending rates may not rise yet. Besides, we should remember that interest rate is just one factor that affects growth. Demand is the main problem that we have today. Consumers are not spending because of high inflation, government is not spending because of high fiscal deficit and investment is down because rates are high and there is still spare capacity. This entire cycle has to be reversed and interest rate is not a magic wand in the hands of the RBI.

We have lowered GDP growth prospects to 5.8% but that is not because of the RBI action but based on the underlying factors in the economy today. The rupee should range between 58-60 against US dollar based on fundamentals but there will be variations around this range depending on sentiment. We have seen that the variation is between 50-70 paise in both directions on account of the effect of any news.


Does the recent macro-economic data dampen any hope of a rate cut by the Reserve Bank of India in the medium-term?

The RBI would have gone slow on rate cuts for two reasons. First, the forex situation does put pressure on loosening rates today given the dependence on FII flow though assuredly given the rupee volatility, there may still not be inflows into the economy. Second, inflation though seemingly under control has shown an upward tendency by both the CPI and WPI for June. Though not significant, it does not take into account the impact of depreciation in core inflation as a lot of imported inflation will be translated through this factor. Therefore, a rate cut would not have been considered by the RBI in the forthcoming policy even in case the recent measures were not invoked. I should think that once stability comes in the forex market and a clear picture on inflation emerges, RBI will not be averse to a rate cut, which will be probably in the second half of the year.


Going forward, do you believe the recent reforms to be a key catalyst in India's out-performance in the Emerging Markets basket?

There are two points on reforms. First, they should be seen as a part of the overall approach to growth that the government has undertaken in steps and would bear results over a period of time. Merely relaxing FDI limits will not mean FDI coming in a big way today. The impact will be seen over a year or two. Second, reforms are only an enabler for growth and create an environment conducive for doing business. Growth has to come from within and here, I would like to reiterate that the clue is in demand, and all segments have to contribute to it (exports may not be able to do so even with the rupee depreciating as global prospects are weak).

Will new banks change things? Financial Express 11th JUly 2013

The receipt of 26 applications for a banking licence is interesting as it evidently shows the high level of interest on both sides—corporates who see scope for business and RBI who would like to have more banks to meet the capital requirements for future expansion.

The background of the applicants is also quite disparate. There are four public sector or semi-public sector entities that have put in their claim where the attraction is to have access to CASA deposits which constitute around 33% of total deposits. These are cheap funds that lower costs for them. Then there are three corporate bodies that are looking out for diversification which would probably also involve their financial outfits. The 14 NBFCs are evidently on the lookout for a change of image as their current line of business which includes gold loans has turned nasty. Converting to a bank will be easy for them and relatively seamless as they also have branches across the country that can be remodelled as bank offices. There are three other entities that do work in the finance field and would be relative new entrants that can add variety, while the idea of the P&T department to become a bank has turned serious now. This is unique as it is a government department that wants to turn into a bank with a strong infrastructure, though questionable mindset. And finally an MFI which could be better placed at the starting line to meet the RBI norms on business model.
The enthusiasm is palpable in this area which is one of the better regulated fields that has shown fairly smooth progression in the last five years that have been tumultuous in the West. New entrants without a baggage of NPAs would start on a clean slate but will have to create structures to keep the business ticking. Besides CASA deposits, there is access to the inter-day call market for banks as well as the repo market for shoring up funds. The risks in plain vanilla lending are lower than in other financial businesses and hence are enticing. Therefore, banking is a good area to explore. The fact that there are several safety valves installed by RBI to ensure governance of the highest order addresses any apprehension on this side.
RBI has put certain clauses like priority sector lending and having branches in unbanked areas which deserve some discussion. While priority sector lending cannot be avoided given that all banks have this commitment as per the national priorities, the insistence on branches is interesting. The quarterly data released by RBI has a story to narrate. The top 100 centres account for around 2/3 of deposits in the country and 77% of total credit. Further, the top 200 centres account for 73% and 81% of deposits and credit respectively. Also, while there were 101,567 offices in December 2012, 31% of them covered these business lines. In fact, around 50% of total offices have deposits of less than R20 crore and 75% of them have credit of less than R20 crore.
Quite clearly there is concentration of business in the major centres and the offices which generate it are a disproportionate number.
Given these facts, the new players would have to contend with opening branches in centres that are unbanked which raises an obvious question. Why have others shied away from them? In fact, banks have been allowed to close down non-viable branches in rural areas. If this is the case, then will the new centres really be financially viable? Also the fact that MFIs have made a mark in the un-bankable segment is because they cater to a section that banks would typically not lend to on account of the risk and absence of collateral. From this counterintuitive logic it appears that there will be a major challenge for the new players who will have to design these structures in a manner that meets regulatory requirements but may not really be able to generate business.
The other interesting issue relates to growth in business. When the first set of new banks came in, they did change the face of banking through technology. Is there anything new that the fresh set would be bringing to the table? Today banks are competing for a slice of the cake which though expanding at around 15-18% per annum has its own set of issues during a downturn in the form of NPAs, restructured debt, and slow growth in deposits. In such a situation would more banks mean more business or a division or substitution of the same?
In fact, curiously, in the two decades before reforms and the advent of new private banks, overall growth in credit averaged 17% per annum which has increased to around 19% in the subsequent two decades. In terms of deposits, it has come down from 19% to 17%. But broadly speaking, the business growth rates have been stable, with of course a major quantitative shift in the contours of banking in terms of quality, efficiency and experience. While new banks will mean more numbers that will help in providing for future growth, can the same be done with the existing banks by going in for recapitalisation? There is evidently no clear answer here.
While one is not sure of how many would finally qualify though there could be a strong case for at least a dozen of them, such a move will mean more banking facilities, expenditure on technology, more jobs, and hopefully more products. Given that there are companies with different backgrounds that are seeking to get into commercial banking, the questions which will seek answers are what happens to specialised segments such as say truck and gold finance, term lending, infra finance, home finance, etc, when such specialised institutions turn into banks and encourage others in their filed to contemplate such a switch at a later date. The advent of universal banking has not quite found suitable replacement structures for term finance given ALM issues and the absence of a vibrant debt market. Maybe commercial banking would have to reinvent itself to also address these demands in a proactive manner.

The true state of our nation: Book Review in Financial Express 7th July 2013

Fali S Nariman’s book is more than timely, giving a dispassionate view of the country and where we are headed

It is now accepted that a ‘rot’ has set in our country, not just in terms of governance issues at the political level, but also loss of integrity, with scams ranging from sector-specific issues to cricket. Nariman’s book, The State of the Nation, is more than timely and gives a dispassionate view of the country and where we are headed. The author, an eminent defender of the Constitution, starts from the beginning at the time of independence when we set up the Constituent Assembly, and meanders through various issues, most of them sticky, that have evolved, which, in turn, warrant remedial action.
How many of us are aware that the Constituent Assembly which was responsible for the Constitution did not derive the power from the people to frame it? The members were not elected but were sitting members of the existing legislative assemblies. He starts the book from this misapprehension and builds on the controversial issues that have emerged in our setting. He boldly discusses the issue of reservations in education and how the creamy layer of the backward castes has usurped the benefits. His view is that as there is no judicial criterion that has evolved for defining these classes, there is ample room for administrative manipulation, which has been leveraged by those in power. More fundamentally, he poses a conundrum: If one is defined as being a part of the backward class, can he or she forever be called one when it comes to benefits? If this holds, then does this not defeat the purpose of this clause in the Constitution which wanted advancement of these people through this route?
On the issue of Centre-state relations, he contends that the fact that states are dependent on the Centre for finances makes them subservient, which has come in the way of true functioning of federalism in the country. Some states have now started wooing foreign investment that is, in a way, pragmatic to become more independent in the financial sense.
Nariman’s main argument is that the legislature and executive have not quite lived up to what the Constitution envisaged and the result has been failure of systems as far as people are concerned. The judiciary has had to take a stance to reinforce the Constitution, but in the process, at times, has been criticised for overreach.
The corruption that has set in our systems is serious. But often nothing can be done as certain clauses are picked up from the Constitution that provide protection. Here, he has some interesting tales to narrate. In the infamous JMM case of 1993, where money was paid for votes, the clause that no MP can be liable for any court proceeding in respect of any vote given was used to escape censure. The CVC Bill of 2003 had come up in the Rajya Sabha after being passed by the Lok Sabha and the idea was to have a three-member commission with fixed tenure. The argument under contention was that only officials under the level of joint secretary could be considered as those above were protected as they were taking decisions and needed protection. Further, he cites the 1991 Jain Havala case where the big fish were in the net, but on appeal had a fresh bench in the same court acquitting them, thus making a mockery of justice. This, according to the author, is nothing new in India, where when one bench of the Supreme Court comes heavily on the rich and powerful, has the same case overruled by another bench when taken for review. The cases of allottments of petrol pumps and shops by various ministries are clear examples of such instances.
How about the judiciary? According to him, it is not above corruption and the fear of contempt of court has kept the media at bay in writing about its prevalence. He gives an anecdote of a Delhi-based publication carrying out a survey among lawyers to describe the quality of judges of the Delhi High Court in 2001. It became a big issue, with the publication being forced to apologise to have the case closed. Even the case of Arundhati Roy questioning a court verdict that allowed the wall of a dam to be raised, was treated as contempt, though she escaped with only a censure. And this is not just in India, but also in the US, where the courts have the final say, being the final ‘umpire’. It is not surprising that no publication will publish even a letter against the judicial system.
Therefore, there is a lot of opacity when it comes to the judiciary. How are judges appointed? Who recommends them? What are their shortcomings? How do we correct the systems? Why are judgments not delivered on time? Why do they get reversed? He talks of the creation of a kind of trade unionism among the judges. This ensures that the realm remains sacrosanct and everyone stands up for one another. Another anecdote of three judges being found in a shady joint outside Bangalore did not lead to action on the judges, but the media which exposed it faced the flak in the form of contempt proceedings.
His solution is to have the lawyers take up the cause and gives the case of Justice Dinakaran where his elevation to chief justice of Karnataka High Court and later to the Supreme Court had the lawyers taking the position not to appear before either him or those of the collegium who recommended his name. That worked. There was another instance where a judge had ruled against commercial activity being conducted from residential complexes when his own sons ran their business from his own house. How does one explain integrity in the system?
At a different level, he discusses the case of fundamental rights and gives the example of Kerala where children were expelled from school for not singing the national anthem as they were from the sect Jehovah’s Witness where religion forbade them to do so. The Supreme Court ruled in their favour, but yet they could not be readmitted as schools were reluctant to take them. Here, even the Congress party leaders had argued against the children.
At a broader level, Nariman points out that we have several issues on hand that have to be addressed. First, there are just too many people around. Second, the wall built by the British between the governed and the rulers has not been broken, but strengthened. Third, our leaders are corrupt, which comes in the way of development. Fourth, our constitutional functionaries have failed us, like in the case of the Emergency. Fifth, we are simply incompetent, and last, there are too many poor people. All of them have to be addressed with alacrity.
Nariman has a charming style of writing and makes this book very readable. By giving anecdotes, he is able to drive home his arguments not just convincingly, but also in an interesting manner. It should be a must-read book for any student of law while the old-timers would revel in these stories that have been out together at a time when there is a lot of disenchantment with all our systems. Kudos to Nariman for providing a hard-hitting exposition of the true state of our nation!

The State of our Nation: Fali Nariman

Let's not get hyper about the Food Security Bill: Financial Express: 5th July 2013

The Food Security Bill (FSB) has evoked a very negative response from everyone. The politicians feel that the government is scoring brownie points through this measure keeping the elections in mind. The haggling is over having a discussion in Parliament and using the ordinance route, which, in turn, has been interpreted as dodging the systems. This is an issue where arguments could be on both sides. Economists are crying hoarse that the fiscal numbers will slip up badly and that everything will go wrong right from procurement, pricing policy, subsidy, deficit and selection. Let us look at this issue dispassionately.
The Bill addresses two-thirds of the population, which would be around 830 million (two-thirds of 1.24 billion). Is the number too large? If we look at World Bank’s data on poverty that goes by the definition of $2 a day, then the number of poor is roughly this number (68.8% in 2010). Why use $2 instead of $1.25? The answer is that this converted number at R110-120 is even lower than the wage being paid under MGNREGA which is above R135 in the low-end states. This means that the number we are talking of is has some justification. What does the FSB do? It says that 5 kg of foodgrains will be provided to each one of this group at a price ranging from R1 for coarse cereals to R2 and R3 for wheat and rice, respectively. Let us look at the physical numbers first. This allotment means 60 kg per year per person which multiplied by 830 million amounts to 49,800 million kg or about 50 million tonnes per annum. Evidently, to supply this amount, we have to use the existing fair price shops which are part of the PDS. If this number has to come from outside the system, then we need to ask whether or not our PDS has the infrastructure to reach out to these people, or else they would be left out anyway. What goes on in the PDS? The Food Corporation of India (FCI) website provides information on the off take of foodgrains—basically rice and wheat—which are handled by the organisation. In FY13, under the TPDS (targeted PDS), the supply of wheat was 22 million tonnes and wheat was 30 million tonnes. This amounts to 52 million tonnes. Besides, another 7-8 million tonnes were offered through various schemes of the government, which presumably will also get included under this new FSB dispensation. There were also open market sale of wheat. Therefore, the numbers we are talking of—around 60 million tonnes at the upper limit—may not be that large even if we assume that the present PDS may be seeing drawls of over 5 kg per head. In fact, under the present system, the BPL families get 35 kg per month and APL families 15 kg per month. Assuming a size of 5 per family in most BPL cases, it could be that some part has to be bought in the open market, which, however, is another issue. Also, the given stocks of foodgrains in the central pool are 77 million tonnes as per June 2013. As the FSB will be PDS-based, on the face of it there should not be much of an issue with the quantity of grain to be dealt with. An argument raised is that with such demand for foodgrains and the tendency to increase MSPs, there will be less grain the private market. But, the fault, so as to call it, is with the procurement policy of the government and not FSB as the procurement policy with MSP is aimed at protecting the farmer. Farmers will distort cropping pattern and grow and sell more rice and wheat even if FSB was not there. So, we should not mix the two issues. The other issue relates to the pricing of grains and the emerging subsidy bill. One must remember that even today we have a food subsidy which is broadly the difference between economic cost and issue price. The economic cost is driven by MSP and other incidentals and is outside the FSB. The issue price has been fixed historically and is anyway being charged. What the FSB does is lower the issue price and hence we need to look at this difference, which is the incremental cost. The economic costs will remain the same in normal course of procurement policy. The issue price now changes. Assuming we look at wheat and rice, which will average R2.5 per kg, we can guess the additional burden for the government. Now, the present issue price for rice and wheat varies depending on the type of household we are looking at. If we have to average that for rice it would be in the range of R5.8 to R8.3 or mid value of R7. In case of wheat the range is between R4.15 to 6.1 or an average of R5.1. Again, as an approximation, the average for the two would be around R6 per kg. The difference between the new average and existing average is R3.5 per kg or R3,500 per tonne. Let us also assume that all government schemes are covered under FSB and a total of 60 million tonnes is involved. The additional subsidy is around R21,000 crore which could go up to R25-30,000 crore if the averages assumed in this exercise are on the lower side. All this proves the following. First, there is some basis for the 800 million number and it is not random. Second, the physical demand for meeting this end is manageable even in the ordinary course. Third, the additional price subsidy involved is around R25-30,000 crore, which is not really abnormally high to generate panic. Fourth, we should not mix up issues of procurement, leakages or adverse targeting, which, though very critical, are not caused by the FSB. While the political undertones do evoke some debate, that should not cloud our vision when evaluating such a policy. At any rate, there is no need to get hyper about the FSB. It helps the needy and releases money for other consumption, which will help to improve standards as well as demand in the economy, which is missing today.

How to create corporate debt for households: Economic Times 3rd JUly 2013

A solution for developing the corporate debt market can be found by weaving the fabric from the end of the household. Household financial savings are around 10% of GDP, and valued at about 10 lakh crore.

Of this, around 90% are concentrated in bank deposits, insurance and provident funds. If the corporate debt market is to appeal to this segment, which will be on the buy side, products have to be recreated that mimic the attributes of these products. This can be the clue to the growth of the debt market.
These three preferred products have characteristics of capital protection, return, liquidity and tax benefits, with insurance products also having added life protection. Bank deposits offer capital protection, fair taxable return, liquidity and very limited tax benefit for long tenures only.

Insurance offers relatively lower return, involves deferred payments; have restricted liquidity, but offer tax-free returns in general with initial investment also qualifying for tax deduction. Provident funds offer good returns, low liquidity, all encompassing tax benefits and full protection. If a corporate bond can address at least 3 of these 4 attributes, a beginning can be made.
So, what should be done? First, the returns need to be competitive to bring about migration of savings. Therefore, the interest rate offered should be between the base rate and the rate charged by banks from the company.
Second, for capital protection, credit rating becomes very important so that investors know how good their investment is. Further, a back-to-back credit default swap should be part of the process wherein insurance is provided by a third party.

This can be a bank or financial institution. By having such a link, we will not just provide protection to the investor, but also take steps in reviving the CDS market, which was introduced with much fanfare, but did not quite move ahead.
Third, to tackle liquidity, two routes have to be followed. First, companies should float paper with different tenures so that there is an array of corporate paper ranging from 1 month to 5 or 10 years so that we are able to replicate the nominal yield curve on bank deposits.

Here companies substitute bank borrowing with corporate debt which is offered to the public. Second, to make them liquid there should be institutions that will necessarily buy back the security, albeit, at a discount - just like how a bank cuts the interest rate for pre-maturity withdrawals.

Hence, there is need to have market makers, which can be any bank or financial institution, including primary dealers.Fourth, the government has to play an active part in providing tax benefits on these bonds. If public sector entities are able to raise tax free bonds, why not private sector companies?

To begin with, it could be provided for higher rated long-term bonds with maturity of 10 years or more. This will appeal to the person who is investing in provident funds and insurance.
In fact, if funds move over from small savings to the corporate debt market, the government would also be better off as presently the cost of market borrowings is lower than that of these small savings.

But governments have to pick up small savings which come in exogenously. The rationale for giving tax breaks is that if funds are long term and are being used for creating capital and not financing working capital requirements, then there must be parity with public sector bonds.

By bringing about these changes, which only require regulatory support, households can be enthused to enter this segment, which, in turn, will help to develop the secondary market gradually. The question then is whether companies are willing to go in for such issuances given the plethora of clearances involved.
Here the clue is to reduce these costs and provide blanket clearances at the beginning of the year for a target amount. To provide an icing to these bonds, the better-rated bonds should be given SLR status so that banks find them attractive to hold - there has to be a buy-in from the RBI, which has hitherto opposed this move.
By having the backup of a mandatory CDS, a credit enhancement would be provided to the instrument. This will be also be useful for mark to market (MTM) purpose for the market makers, where such bonds are marked to equivalent government yields.
Given that globally corporate debt markets are dominant, we need to make them attractive. Banks will still have their own issues of MTM (if treated differently from GSecs) and preference for cash and collateral backed credit, which the company is comfortable with.

But given that the households can provide interest for such debt, the system should make it easier for the company and attractive for the individual, which is possible by tweaking regulation. This can initiate a virtuous cycle.

Does India need another sovereign bond? Financial Express 2nd JUly 2013

It is necessary to ensure that this 'support' does not turn into a 'burden' going ahead
Every time there is a currency crisis, various ideas are suggested to tide over the same. The idea mooted this time is to get in big dollar flows through special bonds. This way we get in long-term funds that are locked for a predetermined period of time at a fixed cost. The questions that arise are: Do the conditions warrant such an attempt? What should be the quantity that can be raised and for what period? What should be the offer rate? What kind of concessions have to be given? Are there any underlying risks for such a scheme? The idea of getting in sovereign debt funds to invest is a novel idea which is being explored today but getting in investors, especially NRIs, to put their money in bonds is not new. We had two experiments that were fairly successful in the past that can be replicated today. The first was called Resurgent India Bonds that were raised in 1998 for five years at a dollar cost of 7.75%. The risk was borne by the State Bank of India (SBI) and there were tax benefits provided in the form of wealth tax, income tax, and a total of $4.23 billion was garnered through this scheme. The interest rate paid was higher than LIBOR by 225 bps. A similar scheme was launched in 2000 called India Millennium Bonds (IMD), which got in around $5 billion. The rate offered was 8.5% which was 175 bps above LIBOR for the same terms as the RIBs, with the difference being that the forex risk was shared between SBI and the government. Commissions too were paid to attract such deposits. The economic conditions during these time periods were similar. In 1998, at the time of RIBs, we had $24.8 billion of foreign currency assets which, based on FY98 imports, provided cover for around seven months. In 2000, when IMD was launched, the reserves stood at $32 billion and covered 7.7 months of imports based on FY2000 numbers. Today, with our currency reserves at around $260 billion and imports of $500 billion, the cover is 6.2 months. Clearly, there is a deficiency of dollars which merits such a consideration. How should the bond be priced for five years? LIBOR is at around 0.70% and pricing it at, say, 225 bps higher would mean 3%, which is not adequate given that US 10-year gilts provide a yield of 2.2%. More importantly, FCNR deposits of five-year tenure by Indian banks offer 4.2% and hence, to attract funds, the rate has to be above this mark. Besides, if one keeps aside the nationalist spirit, we would be competing with other emerging markets. Therefore, the rate has to be necessarily higher than 4.2% to attract investors. Further, with the expectations of higher interest rates in the western world, the benchmark rates would increase, which has to be factored in. The forex risk would be high and it has to be borne by the government—a cumulative depreciation of even 2% on an annual basis will push up the principal repayment amount by 10%. What should be the targeted amount? On the last two occasions the amount raised was around 15-20% of the existing foreign currency assets. The same today would be hard to collect and service as it would amount to around $40-65 billion. At the same time, the amount has to be significant to make a difference as a similar number of $5 billion will not make much difference. But a high number will add to our external debt, which is rising prodigiously. Therefore, an amount of around $20 billion looks more reasonable. What are the downsides? The first is that if the rates are very attractive, then NRIs could move out from FCNR deposits, which will lead to just a substitution and we may not really be better off at the end of the day. Second, any debt raised is analogous to ECBs being borrowed and adds to our external debt. We need to be sure what these dollars are going to be used for. If they are to be used only to strengthen reserves and improve sentiment, then the implicit cost is much higher. If they were to be used for productive purposes, then it may just be the same to increase ECB limits and get the private sector to get the dollars. Third, getting in such a sum at a point of time would also mean issues of monetisation as RBI will have to sterilise these flows at a time when inflation is a still a concern. If, however, the government stacks up these dollars, then this issue will be eschewed but finally would have to be released to balance the external account. Fourth, the exchange risk, which was taken on by SBI/government earlier, has to be hedged as the quantity we are dealing with will be much higher. Last, any amount raised would mean repayment on due date and hence will add to the pressure in the terminal year. To answer all the questions posed in the beginning. First, we certainly do need to shore up our foreign currency assets so that we are able to tackle the CAD which is losing support from FIIs. As QE will end some time for certain, capital flows are required to provide support. The present import cover is not too comfortable. Second, we should borrow around $20 billion for a long term of at least five years. A call/put option can be considered however. Third, the rate has to be higher than the FCNR rate given that LIBOR benchmarking will not be attractive. A thought, however, is to have a flexi rate linked to a benchmark, which could be challenging today. Fourth, tax concessions may have to be retained similar to what was offered earlier. The downsides remain and the government or any bank which takes on this onus should hedge effectively to cover the exchange risk. Careful structuring of the product would be necessary to ensure that this ‘support’ does not turn into a ‘burden’ going ahead.

Conquering the Chaos: The great Indian litmus test Book Review Financial Express 16th June 2013

India’s so-called growth story was more an infatuation, and the proclamation that we are as good, or nearly as good as China was a sheer case of hubris overriding reality. This is starting point of Ravi Venkatesan’s book, Conquering the Chaos. The Indian business environment is characterised by the acronym VUCCA—volatility, uncertainty, complexity, corruption and ambiguity. To succeed one has to get past all these barriers, which is not easy and this is why only some companies succeed, while others give up. These problems, though distinct in India, would also exist in varying degrees in other emerging markets. But in case one can win in India, you can anywhere else. Hence, operating in India is a litmus test for any MNC.
Some of the success stories are companies like Unilever, Deere, Vodafone etc, which actually were able to adapt, by changing their mindset and displaying commitment to the market. Blindly replicating business models in home territory does not work in India because of both the VUCCA effect, as well as the nature of the market. India has the advantages of talent, markets, strong economy but also the weaknesses of functioning anarchy characterised by corruption, governance, patronage, crony capitalism etc. The Vodafone case is used to show how policy changes can be daunting. Shell, HP and Nokia also went through similar harassment. The trick is to get around the negatives and leverage the positives. Venkatesan brings with the famous NCAER consumption pyramid to show what goes wrong for several MNCs. Business needs to straddle the entire pyramid of consumers that are to be targeted—there are 16 million affluent, 160 million middle class, 350 aspiring class and 684 million deprived people. Usually companies target the top, also called Australia, stagnate and then exit falling into the ‘midway trap’. The companies that succeed have moved down the pyramid and followed the policy of 70% of value at 30% price. Microsoft did it to address the issue of piracy. Deere did it for tractors, and Nokia, learning late, went in for lower price sets with dual SIMs. HLL did it with Pureit water filter. More importantly, MNCs should basically be serious about India in terms of long-term commitment and greater trust in local leadership, which is not always there. Curiously, according to the author, not more than 1% of income or profit for most global players comes from India. In terms of basic objectives, Venkatesan says companies should target one of the following—being leader in India, get 10-20% growth from India or use India to win markets elsewhere. Only then can they actually go about doing business with commitment. The book turns slightly monotonous when the author describes the qualities require din the leader and it reads like any book on leadership—ambition, passion, entrepreneurship with learning agility and people skills. He gets pedantic about how leaders should be groomed and espouses the HUL model here. He prefers a model where everyone reports to the country manager who is in touch with headquarters, which is committed to India and trusts the local leaders. Some of his thoughts are like 70% of management should be filled from within and the development of leaders should be from within. The book turns interesting when the author is candid in his views on the chaotic environment that can be caused by a Maoist attack or a bandh when an actor dies of natural causes, or deals with public sector coming to a halt on account of fear of corruption, uncertain tax laws and so on. Here he feels that local leadership is better able to tune to such uncertainty or ambiguity rather than home leaders who have a different mindset on how to deal with political and legal environment. There are, however, several challenges in this uncertain environment. One needs to distinguish between speed money and grease payments. How do we stop data theft or deal with piracy? Should we be using agents to cover up some of these operations given that a MNC operating in India has to abide by rules in their home country? How do you deal with extortion from bureaucrats or politicians? Some successful companies have actually stood their ground and established that they cannot be driven to use of such methods and hence have shown character. The author has his experiences with JVs in India, which become necessary given the regulatory hurdles in the country. Often they fail when there is absence of complementarities (Volvo-Eicher). At times the MNC is not willing to adapt to the Indian situation (Renault-Mahindra). Globally, 60% of JVs have failed in emerging economies and he does not have faith in acquisitions too. Problems that afflict such deals are absence of trust, payment of a high price with low value and poor governance. His mantra for success under VUCCA is to follow what he calls—glocalisation, which McDonald has done in a country where $1 means a lot. A company that was famous for being the largest dealer of beef and pork runs a successful business in India which uses neither, and sells at a low cost and yet is profitable. Cummins brought in the small DG set while Deere adapted with small tractors so that Indian farmers with small size farms had use for them. The path to be followed is to have a start-up culture, create a profitable model through experimentation and the right mindset by creating an aspiration brand. Also they should clearly have a no-exit policy. The real takeaway is that if one can win in India, you can win anywhere; and more importantly such companies are automatically viewed differently in the global arena as they become role models for others to emulate. How would one rate this book? It is largely interesting, especially when real life examples are provided. At times it meanders into clichés as there is overemphasis on change of mindsets, leadership traits and trust, which get repetitive. Since it is based on interviews with the companies concerned it would have been even more exciting if he gave examples of how these companies actually confronted the VUCCA situations and got past successfully—like how did they deal with a bribe or a threat, so that it would have given lessons to take home for several other companies that are still trying to find pragmatic solutions to these problems.