Five years after Lehman: Financial Express 12th September 2013

Indiscriminate household borrowing supported by banks (through sub-prime lending), with repackaging from Wall Street (to spread the risk across institutions) after getting a nod from credit rating agencies in an unregulated environment with tacit political support (as it led to economic booms), was what constituted the Lehman crisis in 2008. Five years on as the financial world looks back on September 15, which was more catastrophic than 9/11, are we in a better state today?
There are ten pictures that meet the eye in the periscope as one looks back on how things have turned out and how we have moved. First, the concept of investment banking has changed and it is no longer sexy to be an investment bank as it is now associated with all kinds of negatives. Several of them have turned into commercial banks with better regulatory oversight. In fact, a recent estimate drawn on the market value to book value for two top banks—Goldman Sachs and Morgan Stanley show that this ratio came down from 1.8 times to 1.11 times and 1.4 times to 1.02 times respectively between the onset of the Lehman crisis and the first week of September 2013. The 12- month forward EPS delivered a P-E multiple of less than 12 for both of them. Such has been the moderation. Second, the world of financial derivatives which came as part of the financial engineering revolution has been looked at with circumspection. The ABS, MBS, CDO, CDS, etc markets have all become less prominent than they were at that time when home loans were multiplied through securitisation. Regulators are putting structures in place before going for them in a big way. Third, the regulatory world has moved ahead with Dodd Frank talking of single regulators and the Volcker rule distinguishing client trading from proprietary positions. This, combined with the Basel III version where focus is more on liquidity than capital, has meant that the financial world is more cautious than before. The benefit of the crisis has been that we have started putting systems in place before the markets. Fourth, the credit rating agencies did come in for some criticism, and there has been a fresh set of regulations in place to eschew conflict of interest in their operations. This has been hastened with the sovereign debt crisis where similar questions have been raised. But more importantly, the door appears to have been opened up for more rating agencies to join the fray as it has been felt that oligopolistic structures may not be the best fit in such an industry. Fifth, the three big names that have been associated with the crisis, who worked towards saving and then reviving the system have or will move on—European Central Bank's (ECB) Jean-Claude Trichet was succeeded by Mario Draghi, Bank of England's Mervyn King by Mark Carney and Fed's Ben S Bernanke is likely to be succeeded by either Janet Yellen or Larry Summers. These were the wise men that could not help the Lehman collapse but worked towards getting others like AIG, Morgan Stanley, Fannie Mae, etc back on their feet. They will be known more for their innovative minds and unflinching resolve to ensure that the crisis did not go out of hand.Sixth, the fiscal stimulus, which was the solution to the crisis, was pursued everywhere in the world with mixed success. The USA ran into trouble with the debt levels reaching unsatisfactory levels which required presidential intervention and came off with a downgrade by a rating agency. Some of the euro nations which had been inflating their budgets ran into a crisis of confidence which led to ECB and IMF action as they came close to default status. India had also inflated its way out of trouble; but now it is believed that we have lost our way somewhere and whatever was done was just too artificial and at the cost of high inflation which we are not able to get out of.Seventh, banks have become much stronger today with a lot of capital being infused across the world. One estimate says that banks have raised as much as 60% risk-weighted capital in the last 5 years to ensure that they are back on the prudential path. Clearly, banks have gotten their bearing right this time. They have also written off a large proportion of their impaired assets. Curiously, the market estimates that 6 of the largest US banks have become even bigger today in the last 5 years and the old dilemma of ‘too big to fail’ continues to haunt us. Eight, banks have become more conscious of risk which has had unintended consequences. They are shy to lend if they are not sure of the quality of assets which has put global growth in jeopardy. Therefore, while liquidity has not been an issue, lending is. Central banks have lowered interest rates across the world to ensure that lending takes place freely. But banks have been more worried about their assets—on and off the balance sheets.Nine, following from the earlier point on risk aversion, banks had stopped trusting one another after the crisis as no one was aware of how rabid the other’s portfolio was. This compelled the use of non-conventional measures called quantitative easing which went under different names such as QE, LTRO, and Abenomics, etc. This was probably the most significant fallout for the rest of the world because buyback of bonds by the central banks meant more liquidity that was not put to full use in these countries but invested in the emerging markets in a big way which helped to spur the economies of the latter. Just while the analysts discussed the decoupling hypothesis where global growth was largely due to the emerging markets, there has been a reversal of fortunes with all these countries now under pressure from the fear of a withdrawal of these programmes. Last, while the US economic supremacy was questioned in 2007, and capitalism chided for wanton greed, the cycle seems to have returned to the start with the US economy still calling the shots. As much as central bankers have argued that domestic monetary policy is based on local conditions and is not determined by the Fed, any action here has a deep-rooted impact on such policy framework. Quite clearly, the world financial order has moved on learning lessons, where the core is on better regulation and stronger institutions. The easing programmes have had a lot of collateral effects—both positive and negative—and would probably be the last of the vestiges of the sordid episode as we go ahead. Schumpeter’s creative destruction may have just struck the right cord here.

Lead Review:Collaborate Or Perish: Book Review Business World 23rd September 2013

Nestlé Waters North America (NWNA) makes bottled water. The company has been in the news recently for a unique campaign, “I Want to be Recycled”, promoting plastic bottle recycling. As of now, in the US, only 30 per cent of such bottles are recycled, while in Finland it is 98 per cent. NWNA has lobbied with state governments to bring in a bottle bill. It has worked with several stakeholders to raise the level of recycled plastics to 60 per cent by 2018. The company worked in collaboration with legislators, NGOs, commodity associations, retailers and even rivals to make this happen. It has built a recycling plant that also takes in plastics of its rivals companies.

According to Eric Lowitt, author of The Collaboration Economy, Nestlé’s efforts reflect an idea that is germinating progressively in the world of business. That is, the way forward for is through collaboration; while competition is desirable, it is not by itself sustainable. The book discusses Lowitt’s pet concept of collaboration between the trinity of business, government and the civil society. The goal is, hence, not just profit maximisation but also sustainability in the long run, as we work towards meeting the requirements of society in the form of food, water and energy while keeping an eye on the environment — a challenge for everyone.

Madan Sabnavis

Like NWNA, Unilever, too, has taken a collaborative approach in better food management. By linking procurement of its raw materials to sustainability, it ensures that the products it buys from vendors follow specifications such as nutrients, pesticides, water, etc. This way, the value chains are also brought into the picture. Unilever has a set of 11 such indicators. It trains suppliers in growing food in an environment-neutral way.

Lowitt talks about an interesting concept called lease society that enhances sustainability. Here, the product belongs to the producer who is responsible for it until it becomes unusable. The consumer only collaborates with the producer by agreeing to use the service and not own the product. This way, the responsibility of disposal of the product lies with the producer. This is a novel way of conducting business in our society where consumers constantly want to move to the latest products (mobile handsets, for example), making existing models obsolete.

When this cycle sets in, Lowitt says, the economy is typified by higher recycling rates, more efficient transport systems and preservation of natural resources, growth in infrastructure, improvement in health and better human productivity. For this collaborative model to work, we need to have a different mindset. We have to focus on what works, develop relationships across the troika, organise the coalition, have a commitment to our goals and execute through our coalitions. Lowitt knows it’s not an easy job, but he feels it is the right job — and the inevitable one.

 

Baby steps to revival? Debate in Asian Age 12th September 2013

Raghuram Rajan, who recently took over as governor of the Reserve Bank of India, has been eloquent on financial reforms in his inaugural speech. This is to be distinguished from monetary policy action, which will be revealed on September 20. The head of the country’s central bank has spoken on monetary policy, financial markets, inclusive banking, internationalisation of the rupee, debt recovery, and financial infrastructure, among other things. The impact of this has improved sentiment, in terms of the rupee becoming stronger and bond yields moving down. But to really witness positive effects, monetary policy holds the key. The ideas referred to publicly affect the periphery. This is needed as sentiments drive markets to a large extent. But we need to go beyond.
So far, the critical factor that has come in the way of growth has been interest rate preferences of the RBI. The finance minister, too, has been urging the RBI to get bi-focal and look at growth, not just inflation. This is what has to be done aggressively to spur investment as the rate of fixed capital formation has been coming down in the last few quarters. This is due to low demand conditions as well as high interest rates. Dr Rajan’s caution on the generation of new non-performing assets (NPAs) can make banks more risk-averse. This can clog the transmission mechanism.
The market is currently wondering about two issues.
The first is: will the governor reverse the measures taken earlier to protect the falling rupee? The steps on the liquidity side have to be rolled back to provide a fillip to banks in particular, especially since the imposition of curbs on the liquidity adjustment facility (LAF), maintenance of cash reserve ratio (CRR), and marginal standing facility (MSF) rate did not quite help. In fact, it raised the cost of funds for banks that were borrowing more in the short-term market. The partial rollback of some of the measures on outward FDI and remittances, on the day that
Dr Rajan took over, has been interpreted as his idea. This should be logically followed up with other measures.
The second is whether the governor would live with higher inflation but work on propelling growth, which is the need of the hour. This would be the strong signal that would be expected to be sent by him which can turn things around. Any such measure will coincide with the upcoming festival period, and there is therefore a hope that there would be a demand- led recovery.
The governor has spoken a lot about creating “confidence”. It is the interpretation of this concept that would steer future discussion.
The market has taken the view that the RBI is obsessed with inflation and would not be averse to sacrificing growth. This view has to change internally. This means that a lot more has to be done by the RBI to move beyond sentiment, which certainly looks much better now but by itself cannot steer the ship. Clearly, the market expects some positive action on September 20, going beyond words.

 

Corporate lessons lost in transition: Book Review in Financial Express: 8th September 2013

The veryY first line in the introduction of the book by Subroto Bagchi is quite eye-catching. It says, ‘In 2006, my book, “The High Performance Entrepreneur” broke new ground as a must-read for would-be entrepreneurs’. It smells of hubris and shows that the author lacks modesty. Normally, if the same is true, we should hear it from someone else. But this is significant not because it says much about the author, but because this is one of the reasons why companies fall in the trap of stagnation. So while Bagchi talks a lot about how companies need to build scale as they move along, they do tend to hit a glass ceiling at some point of time. One reason why this happens is the absence of humility and the onset of hubris, which stops leaders from accepting that something is amiss.
The book, The Elephant Catchers, may be a misnomer, as it goes into building scale for a company, and the concept of ‘catching an elephant’ is only one part of the story. Let us see how Bagchi builds his narrative. There are six aspects of scale that companies have to look forward to when moving to a new level. Start-up companies are enthusiastic and grow fast, but after a point of time, there would be a loss of momentum, which is the time to introspect and look at creating scale. The concept of scale and how it can be managed is captured by Bagchi when we talk of strategy for the future in companies. Often we have several PowerPoint presentations that explain what we will do the next year. But we need to think long. Hence a plan is different from a strategy and he uses the example of Infosys to show how this was done. Structures and approaches have to be different when we approach it this way. He gives the example, which is now quoted in almost all leadership books, of how Unilever added zing to its strategy when the management talked not just of future numbers, but linked them to other goals such as reducing carbon imprints, conditions for suppliers and so on. This is part of emotive thinking.The mindset is hence important and he distinguishes between a ‘rabbit’ and an ‘elephant’ catcher, where the former has a role to play in the immediate run. But to grow, we need ‘elephant catchers’, which requires not just a different approach, but skills and temperament. So companies should be thinking of deals, funding, capacity creation, training and development, brand-building and so on as they move to a different level. The second aspect of scale is using it to build business. Here, the author gets autobiographical and gives his own company’s example of how they did deals and moved over to getting AIG as a customer in insurance and also inroads into banking. The third aspect of scale relates to intellect. Here, he provides some interesting insights on the board of directors, who should have domain knowledge, especially if the industry is technical in nature, or else, they could be taken for a ride by unscrupulous managements. He assigns a role of spending 70% of time looking into the future and only 30% into the past, which is rarely followed by most boards. The fourth aspect of scale is reputation. To scale this up, we need to continuously rebrand the image of the company, which goes beyond just the logo or the tagline. Here, he draws heavily on Mindtree’s story. While dealing with a professional agency, there should be involvement from within and the right people have to be chosen. They, for example, had changed their own image from ‘nice, humble and introspective’ to ‘collaborative spirit, unrelenting dedication and expert thinking’. On media management, he is quite emphatic that while one needs to be trained to face the media, one should be careful that one does not get misinterpreted. Also, the leader has to build an image of being an authority to be respected by the media, and a PR firm is essential for such an exercise.The fifth dimension of scale is people and it is important that we select the right staff. His own approach has been one of the white board approach, where the potential candidate has to draw up an entire plan and outlook on the board, so that both sides are clear about what can be expected and delivered. Leaders should spend quality time with the colleagues and this brings in some modicum of buoyancy in the organisation. And last, we have to scale up to face adversity and, for this, we should not get overwhelmed. Failure is inevitable along the road for any organisation and facing it bravely is the only solution, especially as a lot of it can come from the blue. It is assumed that if we have scaled right in the other five ways, this would follow. Bagchi is easy to read, though the book at times resembles a publicity brochure of Mindtree. With a large number of books telling companies how to move ahead with tips on leadership and sailing through adversity, the novelty factor is missing. However, his views on boards, consultants and media can be quite engaging. Maybe it is time for authors to think differently to bring in some fresh air—to avoid falling into the trap of what happened after the financial crisis, which has had tomes written with little differentiation.

Finding the correlation between currency, bonds and stocks: Economic Times 4th September 2013

The present exchange rate puzzle has created a new 'trilemma' which involves the forex, bond and stock markets. The impressionistic feeling we get is that when the rupee falls and the RBI intervenes, the bond market goes into a tizzy and rates increase.
In sympathy, this prompts the stock market to move down as these signals are interpreted perversely. Quiet clearly there is a basis for this theory which needs to be explored further.

The turning point in the rupee was May 20, when the rate crossed 55 a dollar. From then on till now, which is just a little over 3 months, there has been a lot of measures taken by authorities, some of which have worked more than others.
The objective here is to examine two sets of issues. The first relates to the linkage between the exchange rate, 10-year Gsec and stock market movements as denoted by the sensex. The other is a theoretical exercise which involves the notional cost that has been involved.
RUPEE & SENSEX
For the record, on a point-to-point basis up to August 22, the rupee (RBI reference rate) has fallen by 17.5%, the 10-year yield has gone up by around 90 bps and the Sensex has declined 9.5%. In terms of the linkage between the two, a rudimentary statistical exercise shows that the coefficient of correlation between the rupee and sensex at absolute levels was -0.58 which is quite high with an inverse sign, indicating that the market does not like a declining rupee. At the incremental level, i.e. daily changes in both of them, the coefficient was -0.37.
In case of the rupee and the 10-year bond, it was as high as 0.70 at the absolute level and -0.07 at the incremental level. This shows that high rupee rates go hand-inhand with high bond yields. However, the exact changes in levels are not correlated. Last, higher bond yields are negatively correlated with sensex at 0.29 (for absolute levels) and 0.35 (for changes). At the second level, a causal relation could also be examined between these three sets of variables.
While such correlations do have somewhere an inbuilt assumption of causation, the causality tests do not support such a relation between any of these variables. This probably makes sense as bond yields are also driven mainly by liquidity conditions and regulatory conditions. The sensex reacts also to political actions and global developments.
Therefore, while there is a tendency to move in a pre-determined direction — the stock market does not quite like a weak rupee or high interest rates, which sounds logical, a weak rupee should go along with higher interest rates.

COST OF RUPEE DEPRECIATION
The second exercise can be in the direction of guessing as to what has been the cost of the rupee depreciation as there has been a sequential drop in the stock market and an increase in bond yields. The cost is notional as these numbers are at specific points of time and while the changes that have been mentioned earlier are in the same direction for this 3-month period, they exclude the peaks.
At the FY13 level of trade deficit of $190 billion, rupee depreciation means an additional cost of Rs 1.83 lakh crore.Interestingly, the FII withdrawal at this time means that not only were they moving out when the stock market went down but also the rupee depreciated. FIIs leaving today with May 20 as benchmark would have taken a loss of above 25% as the combined effect of rupee depreciation and stock market decline. Quite clearly, the perceived rewards from going back home on account of the US recovery are more attractive for these players.
In the bond market, the 10-year yield has moved up by close to 100 bps, though the increase has been higher at the lower end of the maturity spectrum. The government will be affected under ceteris paribus conditions. So far, it has completed Rs 2.6 lakh crore of the Rs4.84 lakh crore of borrowing. Therefore, the balance Rs 2.25 lakh crore could be at around 100 bps higher, which means an interest ofRs 2,250 crore.
The dealers in the secondary market will be affected adversely with the MTM losses and there are varying estimates of this being between Rs30-50,000 crore. Lending costs have gone up and 25 bps increase in base rates could mean an additional cost of Rs1,200 cr for the borrowing community assuming 14% growth in credit for the year and a balance of Rs4.8 lakh crore of borrowing to be undertaken during the rest of the year. Deposit holders could gain a little less than this as there is general stickiness in changing deposit rates.
Therefore, a slight increase in NII could be expected on this count. As everything appears to affect everything, we could alter Thomas Friedman's phraseology, and say that markets are flat. The external debt at $390 billion in March means that in future we will have to pay another Rs 3.76 lakh crore. At the same time the fall in the stock market can be captured by the movement in market capitalisation. During this period, there has been a fall of Rs 2.5 lakh crore — which may not at all be because of the exInterestingly, the FII withdrawal at this time means that not only were they moving out when the stock market went down but also the rupee depreciated. FIIs leaving today with May 20 as benchmark would have taken a loss of above 25% as the combined effect of rupee depreciation and stock market decline. Quite clearly, the perceived rewards from going back home on account of the US recovery are more attractive for these players.
In the bond market, the 10-year yield has moved up by close to 100 bps, though the increase has been higher at the lower end of the maturity spectrum. The government will be affected under ceteris paribus conditions. So far, it has completed Rs 2.6 lakh crore of the Rs4.84 lakh crore of borrowing. Therefore, the balance Rs 2.25 lakh crore could be at around 100 bps higher, which means an interest ofRs 2,250 crore.
The dealers in the secondary market will be affected adversely with the MTM losses and there are varying estimates of this being between Rs30-50,000 crore. Lending costs have gone up and 25 bps increase in base rates could mean an additional cost of Rs1,200 cr for the borrowing community assuming 14% growth in credit for the year and a balance of Rs4.8 lakh crore of borrowing to be undertaken during the rest of the year. Deposit holders could gain a little less than this as there is general stickiness in changing deposit rates.
Therefore, a slight increase in NII could be expected on this count. As everything appears to affect everything, we could alter Thomas Friedman's phraseology, and say that markets are flat.change rate.


 

From baby steps to a trot? Financial Express 5th September 2013

Raghuram Rajan’s opening speech has been fairly open and bold where he has laid down the path to be followed in the next few weeks or months. More importantly, he has spoken of the need for us to adapt to change as there will always be risks involved with change. He has kept the monetary policy options open by not revealing his preference, and the fact that he has deferred the policy to September 20 makes it evident that Ben Bernanke’s call will have a bearing on his decision. He has stuck to financial sector reforms which are partly under his domain and worked on the assumption that there would be a buy-in from other regulators where required. He has consciously not given any hints on any possible action on the exchange rate front—leaving it open-ended for the time being.
But what are the risks that he is talking about? A lot of what has been said finds mention in his now famous 100 small steps report of 2008. It looks like that he is also aware of the fact that these steps may also not work but should be implemented anyway.First, he talks of getting away from lazy banking, which indicates that SLR would be reduced. There are two issues here. One, banks are willingly holding on to excess SLR, which makes lazy banking voluntary (the investment deposit ratio is over 30%). Two, lowering it creates an ideological battle with the government, which will necessarily have to control its deficit and ensure that the borrowing programme is under control. It will take a lot of character to drastically reduce this component. In fact, it will be revolutionary if RBI mandates an upper limit for SLR securities, which has not been spoken of.Second, he talks of inclusive banking and free opening of branches. The question is whether this is an issue? Banks are withdrawing from non-viable branches and while RBI may like to have more rural branches, banks’ P&L may come in the way. Also, it has been observed that typically NPAs tend to be higher in the priority sector lending. If this were so, then allowing banks to open more branches may not quite deliver the result. In fact, RBI could think of ensuring that the priority sector norms are adhered to and that non-compliance should not have access to the RIFD window.Third, deepening the financial markets is a good idea and should be done. However, given the experiences of the West, we would have to tread carefully here and not open up the trading limits for institutions especially those which are dealing with other people’s money. RBI will still have to put in enough safeguards so that the overall risk involved while widening the market does not grow proportionately. Counter-intuitively speaking, if there were no issues involved, it should have been done. Clearly, Dr Rajan is going to reverse this line of thinking.Fourth, RBI will once again be working on getting in the 10-year interest rate futures contract. This has been experimented with earlier and has not worked out. It would be necessary to study as to why this has not worked before reintroducing the product. The present state of limited liquidity across the maturity spectrum has come in the way of the development of the yield curve and hence an interest rate futures market. This will have to be examined in detail so that the final product is successful.Fifth, internationalisation of the rupee is an interesting concept, and the entire design has to be drawn up neatly to make it work. Today the demand is for hard currencies, which are the dollar and the euro. To say that ‘as our trade expands, we will push for more settlement in rupees’ is bold because it means that we do expect other nations to accept these terms of trade. He also admits that this will mean opening up our financial markets for those who receive rupees to invest it back in. There has to be a buy-in from other financial regulators which will have its own challenges considering that we do have limits to foreign participation in most market segments.Last, he has touched upon the tricky issue of NPAs and has rightly said that the promoters should not be allowed to get away with bad debts. This will be a hard nut to crack given the long processes that exist today where a defaulter tends to have an upper hand when dealing with the banking system. There is no indication of what can be done, as this has been a nagging issue which has often forced banks to shy away from lending and prefer lazy banking as it was safer.Most of what Dr Rajan has stated are, as he has already said, points that have had acquiescence from within RBI, and what he would be doing is really putting them into action as soon as possible. This really shows that we can expect continuous action to begin with, which should enthuse the market, though admittedly the latter still keeps looking for guidance on the exchange rate and the interest rate and his preference between currency, growth and inflation. More so now that he has raised expectations that he is going to be different. To know more on this, we will have to wait till September 20. Till then the markets will continue to be choppy.