Earthly approach: Making Growth Happen in India: Financial Express 7th Dcember 2014: Book Review

Making Growth Happen in India: A Roadmap for Policy Success
V Kumaraswamy
Sage
R650
Pp 272
THE INDIA story since the 1990s has been presented in different ways, with the proclivity being to eulogise the process of reforms. In fact, reforms have always been taken to be the panacea for all our economic problems and the only solution to any issue that has come up is to have more such reforms. This has been followed by disenchantment with the pace of policy changes in recent years. More importantly, we have argued against several government schemes meant for the less privileged. Also, the recommendations are invariably in the direction of what more should be done to move forward.
V Kumaraswamy has, however, chosen a different route in his quite remarkable book, Making Growth Happen in India. Instead of reiterating the obvious, he focuses more on the ‘design’ of various such programmes and their ‘delivery’. He does recognise that the concerns of the poor have to be addressed, but we have to ensure that there is an effective impact of measures taken in this regard.
At first sight, this makes more sense, as we appear to be slipping on both these scores through the myriad programmes we have been implementing over the years. Few would refute the view that while setting lofty goals is necessary, the important part is how we design our structures and deliver. In fact, we do comment on the failure of implementation, but we seldom go back to the design of the programmes to analyse whether they were faulty to begin with.
In the course of his exposition, he is critical of various programmes of the government, such as the  Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA), minimum support price (MSP), cash transfers, etc, and discusses issues of land acquisition, foreign direct investment (FDI) in retail, goods and services tax (GST), etc, with an open mind. The basic point made by the author is that there are several places where there are weak links between policies and strategies at the broad level, plan designs and their implementation, and action plans and their follow-ups. Further, faulty design has made programmes less effective. Quite clearly, we need to address these issues.
One may not agree with the author when he argues that monetary policy can be ineffective when battling food inflation and hence should be delinked from it, but his arguments are cogent and well-articulated. Similarly, he does point out that higher productivity and output in agriculture, while benefiting consumers, can affect the incomes of those producing the crop and hence there could be an inherent conflict for policymakers.
His arguments are at times provocative, which is interesting, especially when he discusses the issue of petroleum product prices, as the poor do not really have access to these products, which we are protecting in their name. This probably is not relevant now, with prices of diesel and petroleum being marked to market. But he takes the argument to a different level when he puts forward a critique on why low freight rates on goods, such as ores or manufactured goods, do not quite deserve protection. The logic is that if refrigerators are being ferried by railways and freight is being subsidised, then it does not make sense, as the product is not consumed by the poor, but by those who can afford the full cost of transportation.
These arguments are surely compelling, though the reason for not raising freight rates or railway fares is more in the area of inflation rather than the protection of specific users. Going by this logic, we need to revisit the entire pricing structure of all goods that are affected by public policy at a broader level. This is necessary, as all governments subsidise various public goods and services to different extents. The author could have added realism to his theory by actually bringing to the fore case studies where governments have marked all prices to market and maintained zero or minimal subsidies.
One must remember that the ethos of all public expenditure is to bring about some redistributive justice and subsidise the public. How does one then strike a balance? In fact, by extending Kumaraswamy’s logic, one can say constructing highways for transport of goods not used by the poor should not be done by the government. And if the government does so, there should be differential charges for goods carrying different goods.
Kumaraswamy’s book turns a bit controversial when he discusses alternative growth paths, which are based on skill development and employment. His take is that the Indian Railways, the largest employer in the country, should actually be widening its employment base. This will definitely find few takers, as there has been a call for removing staff rather than adding to the existing numbers. His examples of low service quality in railway services is due to reasons like having fewer ticket checkers on trains, among others, which lead to other problems such as ticketless travel, as well as less rigorous monitoring of empty seats that can otherwise be sold to earn more revenue. He also talks of saving less and making capital more productive, which in effect means improving the incremental capital output ratio (ICOR).
While the focus is on skill development and employment, the author picks up three future growth sectors, which will partly click with the present government: creating new cities, extracting value from urban wastes and tourism. He is positive on moving towards a growth rate of 12% per annum, which today does look more than challenging, given that we still need to be in the stable 8% range. Looking at the suggestions made, with focus on employment generation-led growth, this number may appear to be out of sync.
Written by a non-economist by profession, but a management graduate with a strong analytical mindset and abundant experience across the world, Kumaraswamy does provide a refreshing framework for policymakers. His views come from a practitioner and not an economist, who would normally have definite leanings to specific ideologies. Several of these issues have been discussed spatially, but by putting all these views in one place, one gets to read a different perspective, which is erudite and compelling, though arguable. That’s what will make this book find space on your bookshelf.

Cheap oil: Arab Sheikhs’ gift to Modi : Deccan Chronicle and Asian Age: 7th Dember 2014

Lower crude oil led to a cut in CAD, slashed subsidies, narrowed fiscal deficit, lowered inflation
The fall in crude oil prices by over 30 per cent in the last few months has been extremely beneficial for the economy. On an average, we import around 190-200 million tonnes of crude oil which works out to roughly 1,300-1,400 million barrels per annum. Intuitively, on an annualised basis, we will be saving $1.3 billion for every drop in the price of oil by a dollar. A decline of $30 would mean savings of close to $40 billion, which is only the beginning which will get reflected in the trade deficit and current account deficit (CAD).
Our CAD has been under pressure due to high gold imports and crude oil prices. Both have come down, thus leading to a bounty on the external account. Crude oil imports at around $165 billion accounted for a little over 35 per cent of our imports and hence any saving here would prop up the external account. The strengthening of the rupee has been driven mainly by this factor which has also countered the sentiment regarding lower capital flows on account of the possible Fed interest rate hike next year.
The secondary effect comes on the budget in two ways. The first is that the subsidy burden gets tempered automatically as the price comes down with kerosene and LPG subsidy levels declining with unchanged prices of these products. The subsidy was targeted at `64,000 crore for FY15 and given that there was a rollover of subsidy of last year into this year’s budget, the present cooling of prices would provide a lot of support to the subsidy bill and there are few chances of a spillover this year.
The other benefit has been on the overall budget numbers. Lower crude oil prices can be transmitted to lower final product prices of products like diesel and petroleum. However, the government has chosen to retain the price at a predetermined level and has hiked the excise duties to ensure that they do not come down. This way the indirect tax collections have increased which is a major benefit considering that by October, 90 per cent of the fiscal deficit has been exhausted.
The other positive impact for the Modi government has been in inflation. With fuel products having a weightage of around 15 per cent in the Wholesale Price Index, lower prices have directly brought down the inflation rate. The fuel inflation along with food prices were chiefly responsible for high inflation in the last two years or so. With prices coming down the inflation numbers have gotten tempered automatically.
However, the tertiary effect is on monetary policy where the RBI is now more comfortable with the inflationary trends and can really think of lowering interest rates now. In fact an assumption made all through is that crude oil price will continue to remain benign and that after February a rate cut can be seriously considered once the food inflation numbers become clear.
Hence, the decline in crude oil prices has been very fortuitous for the government on all fronts and while there is reason to believe that this trend will be reversed, expectation is that they will remain low at least until the end of our financial year. This makes it easy for the government to do a lot of housekeeping and get the books in order which would not have been the case had prices remained where they are. To the credit of the government, they are not just using this opportunity but also following prudence in other areas to fully leverage this benefit

Banking on rural deposits: Financial Express, December 4, 2014

Payments banks and small banks must learn from the Jan Dhan Yojana experience and concentrate on rural depositors

The Jan Dhan Scheme has by far been the quickest and most expansive financial inclusion drive launched in the country. It was launched with a set target for the existing banks. The results are quite amazing and actually provide some guidance to the new players entering the market as ‘payments’ or ‘small’ banks.
So far, 81.2 million accounts have been opened of which 60% are in rural areas. Banks, primarily public sector banks (PSBs), have issued 51.1 million RuPay cards for these accounts. Deposits in these accounts were R6,355 crore as of November 26. Interestingly, there were 60.7 million zero-balance accounts, which implies an average of R3,100 in the non-zero accounts. This scheme has been aggressively implemented and the focus was more on opening accounts with minimum KYC norms to expedite the process. The idea is laudable as it is a quick way of accomplishing a task. But the high zero-balance accounts, as well as low balances on an average, actually signal that these households typically do not have the money to keep as deposits or are sceptical of the same. Alternatively, they may not really be interested in such deposits, notwithstanding the add-ons of a debit card as well as possible future credit and insurance going forward.
Therefore, RBI’s decision to start issuing licences to payments banks that will take savings bank deposits and invest only in government securities for a 1-year duration or less and, to a certain extent, in other bank deposits, will pose a challenge to the licensees as they will have to create a superstructure to keep their business going. All options are open and telecom companies and other card-based companies can tie their businesses with bank accounts and probably be more successful than banks as there is already an existing business relationship with the customer. The question is will these households actually keep the deposits with these banks or not?
Post offices qualify for such a licence and are well poised to leverage this market. They would only have to scale up and not really have to start afresh like the supermarkets or telecom companies. Their deployment of funds too would change—passing it on to the Centre and states; they will have to deploy all in short-term paper. Their operations too have to be altered unless a new Post Office savings bank is opened in the same premises, as there are other products being offered which can no longer be done—postage, fixed and recurring deposits, and small savings (including the Kisan Vikas Patra). Regulation does not permit the same and, hence, a new bank may be created for this purpose. However, for an completely new entrant, the establishment costs would be considerable.
The model, for any entrepreneur, makes a lot of sense as the bank will get deposits at 4% or free (current accounts) and can earn a good 7-8% return. Operational costs will be low at 1-2%, and hence a return of 1-2% can be maintained without any encumbrance of NPAs or capital as these variables will become irrelevant given the business model. However, if fresh infrastructure is to be created then there would be high overheads.
The small bank concept is, of course, more challenging as 75% of the funds have to go to priority sector lending, to the farm sector and the SMEs, with a cap of R25 lakh for 50% of the loans. This will be on top of the CRR and SLR requirements. Intuitively, it can be seen that the cost of servicing these small-sized loans would be high for these banks which will also have to open up brick-and-mortar branches, unlike the payments banks.
Additionally, both these segments are vulnerable. When the monsoon fails, the farm loans go bad and the cycle of monsoon failures has been moving with shorter amplitudes. Further, the economic cycle too has become more unpredictable and, often, a sustained industrial slowdown results in higher NPAs being generated as they get affected almost immediately when the economy slows down. This being the case, the pressure on quality would be high. This will also pressurise their capital and hence will be onerous, unlike it is for commercial banks where the portfolio is well spread across all sectors, smoothening the risks .
MFIs and NBFCs can apply here and it will be interesting to see if they are attractive to these players. This will hold for MFIs who would get access to deposits in a formal manner and can lend to these segments where there is a modicum of familiarity. NBFCs, too, may be inclined to consider this option given that the regulatory structure has become a little more intense for them in their normal line of business.
The crux of these banks working well would depend on their ability to garner deposits in the rural areas in particular. The Jan Dhan Yojana warns that it may be difficult to get the deposits, though opening accounts would be easy. It will require a lot of awareness. Counter-intuitively, if the Jan Dhan programme that offers the promise of credit and insurance has not caught on, would a plain vanilla deposit be convincing to the household. This is where the payments bank should work and linking one’s own product to the deposit could be a good way of making a start.

‘Powers of Two': Double impact: Financial Express November 30, 2014

Book- ‘Powers of Two: Finding the Essence of Innovation in Creative Pairs’
Joshua Wolf Shenk
Hachette
R499
Pp 339

In Powers of Two, the author, on the basis of intensive research on hundreds of pairs that have worked well together, draws patterns of what is required for such combinations to take place, survive, succeed and probably also break up

WE HEAR several stories of self-made men and women. But do we ever give a thought to the kind of power two people can bring in while working on the same project? In such a scenario, ‘one and one’ may add up to more than two—maybe 10 or even infinity. This is the thought pursued by Joshua Shenk in his quite remarkable book called Powers of Two. After intensive research on hundreds of pairs that have worked well together, the author draws patterns of what is required for such combinations to take place, survive, succeed and probably also break up.
Shenk’s examples cover various fields, though he has a lot to say on the Paul McCartney and John Lennon combo. The pairs that feature prominently are Marie and Pierre Curie, Steve Jobs and Steve Wozniak, Tiger Woods and Steve Williams, and David Crosby and Graham Nash of the famous Crosby Stills and Nash fame. The commonality between these pairs is that they worked well together, even though they may have been contrasting characters with different attitudes. For pairs, we normally tend to say one of them is an ‘ideal foil’ for the other and any inadequacy in one is made up for by the other, making them complementary subjects.
In his book, Shenk surprisingly does not talk about sportspersons who play doubles, even though we have seen several successful combinations around the world and in India too.
The research done by Shenk for his book shows that pairs typically go through six stages. The first stage is ‘meeting’, the natural starting point. The two could meet due to a variety of reasons. Somebody gets them to meet and things just click. Alternatively, they meet at a place of common interest, for instance, a museum, and from here the partnership takes off. Or it could be a chance encounter, which leads to the recognition of common areas of interest.
The second stage is called ‘confluence’ and, as the word suggests, this is where the two gel and bond. This metamorphosis leads to what can be called a joint identity, which supersedes individual egos. McCartney and Lennon had a common identity—that of the Beatles—which kept them moving alongside in the world of music. We can extrapolate this kind of bond to any music band that has lasted for long—often we are not familiar with the individual members of a band, as it is the band which has the identity. To reach this stage, one must have confidence and trust in each other so that this joint identity is maintained. When the concept is of ‘we’, and not ‘I’, it becomes a kind of marriage, where the two can maintain their own identities (distinct), absorb the other (asymmetrical) or work equally (overt). Again, these are more or less stylised facts based on research on successful pairs.
Stage three is called ‘dialectics’, where each one has a role, which gets automatically assigned—like how architects need contractors and singers need bands. There is always a star and a director—for example, Mark Zuckerberg and Sheryl Sandberg of Facebook.
Interestingly, Shenk points out that even poet William Wordsworth owed a lot to his sister Dorothy, though she always remained in the background. Therefore, in a pair, there are two positions, the spotlight and the shadow, with one person remaining in the shadow quite inadvertently. Shenk draws analogies to a liquid and its container, where both are required for a drink to work. All such partnerships have different personalities, as one is a doer, the other a dreamer. Both are required for an enterprise to flourish.
The fourth stage is about ‘distance’. In this, the two could be at different places, communicating with one another or living and working together. This is interesting because most of the earlier cases of great partnership were in an age where communication channels were rudimentary. However, today, collaboration is possible due to the advancement in communications. But often, being apart enhances creativity and engenders friction, something that is necessary to keep such duos ticking.
The next stage involves the ‘infinite game’, where there is room for conflict. While the two may have started with a feeling of cooperation, there will be stages when there is conflict between them due to a feeling of competition, an inescapable event. The same forces that goaded and brought them together can cause this friction, which leads to strain.
The final stage is of ‘interruption’, where there is a split  between the two and the bond gets severed. Here, the author goes into the details of the McCartney and Lennon split. The extent of competition was too sharp to keep them together and it was inevitable that they part ways. It was not just a case of competing in music, but in their personal lives too. Here, Shenk talks of their love lives coming in the way, with each one trying to outcompete the other. The author feels that though all such combos break up, it is more difficult for them to reconcile.
Powers of Two is an interesting book, as it draws patterns, which can be applied to various groups. The IT industry in India, in fact, can throw up several examples of such pairs, as can rock bands, which split and come back together only to split again. Often, there is a clash once success is attained, with recognition going to one of the two. During the course of moving along this path of success, one does not mind being in the shadow, but finally, everyone wants the limelight.

The beginning of bank mergers: Financial Express 26th November 2014

The merger of ING Vysya with Kotak Bank is interesting as it could be the first in a string of mergers in this segment. Today it is accepted that banks need to consolidate to grow given the pressures of enhancing capital. It is also within the ambit of the medium-term approach of creating large global banks that can scale up and become globally competitive. What are the issues thrown up by bank mergers?
First, RBI should be watchful of such mergers. The reason is simple. On one hand there is demand for more bank licences which has led to the creation of new banks with more to follow. While RBI is to soon start allowing smaller varieties like payments banks, there were over 20 applicants when the window was opened last year which has led to two of them being given permission. The broader issue is it should not be that someone creates a bank only to sell off later at an attractive valuation as our banking paradigm is based on both creating new banks and consolidation. Therefore, we need to have some checks to ensure that those entering the filed have a long-term commitment. When licences are issued for payments banks, this consideration should be kept in mind.
Second, curiously with ING Vysya being bought up, there is a coincidence of the tendency of more ‘new private banks’ being up for sale. It started with Times Bank, followed by the collapse and subsequent takeover of Global Trust Bank. Centurion Bank and Bank of Punjab too were sold out, which means that besides the institutional led new private banks, Indus Ind (owned by an industrial group), Yes Bank and Kotak Bank would be the players in this set of banks. DCB would be the other player in this field that got converted to a new private bank.
Third, any bank merger would ultimately mean loss of jobs, especially at the senior level where there is an overlap in portfolios. While other staff can be redistributed, the senior positions would be in jeopardy as there cannot be two heads of any business, and while a second level can be created, there has anecdotally been a migration of staff away from the acquired entity. Also, invariably the acquiring bank tends to keep the jobs unless there are specific segments where the acquired bank has a dominant presence. But, in this case, given that we are looking at the entry of more banks into this space, this could be good news as experienced banking professionals could move across laterally.
Fourth, the cost of a merger is also quite high and complex. Besides realigning designations and salaries of staff across two banks, there would be a need to reconsider the duplicity of branches, and ATMs, which is the physical infrastructure, would have to be realigned. Also, interest rates need to be aligned on deposits and depending on the current level of variation, the cost would vary.
Fifth, cultural integration is a major challenge for any merger as even two private banks will have different cultures. This starts from how one addresses one another to the work culture which can swing between late hours to a more organised professional approach. This is beyond other factors in the realm of technology which would definitely have been addressed given that all banks are now on the core banking solution that allows seamless flow of transactions across banks and the clearing system. But training would be another area to look for as the level of expertise has to be harmonised across the two entities. If such integration is not brought about, there would be a tendency again for the attrition levels to increase.
Sixth, such a merger would set the tone for further such action as the niche banks would become potential participants as they do have strong presence in their geographies and hence become the ideal fit for the larger banks looking for inorganic expansion. To give an example, when Bank of Madura was taken over by ICICI Bank, it increased the latter’s presence in the southern region. A strong bank looking for this mass can look at such niche banks, which are well run, as possible takeover ideas. Even in case of the Kotak-ING Vysya, there is a strong southern territory as well as SME base which has been acquired by the acquiring bank. At another level, some of the niche banks could introspect and review their prospects in the future given these changing equations. In fact, several of them with a strong priority sector lending portfolio would be attractive for potential buyers.
Seventh, the same holds for public sector banks too. There has been a lot of discussion on the merger of such banks. Here, of course, the motivation is different as the ownership remains the same. But there has been a strong voice for merger of smaller banks with bigger ones, with the SBI associates being high on the agenda. While such mergers will take time given the complexity of the issue, as unlike for private banks where commercial and shareholder interests supersede those of employees, the same does not hold for PSBs as closure of branches and redeployment of staff in large numbers would be a logistical issue that will have a lot of opposition. With the current merger giving Kotak Bank a considerable size, the idea of mergers could be opened up for serious discussion among these banks now.
Therefore, bank mergers, which will dominate the banking canvas in the times to come, will help the system leverage the advantages that go with size and synergies. At the periphery, there will be some pain given that the status quo is shaken in any such arrangement. With several challenges of size, capital, coverage, inclusion, competition, global presence, viability, etc, bank mergers appear to be the new order.

Best to keep monetary policy stance flexible: Financial Express, 21st November 2014

RBI has a flair for introducing new terms in our economics lexicon. The concept of ‘protein inflation’ was quite novel as was the concept of ‘calibrated movements’ in interest rates. The latest is the ‘glide path’ of inflation as per the new approach of inflation-targeting. Now that we are almost there with CPI inflation being less than 6%, which was the terminal point of the glide path stated for January 2016, there is prima facie a strong case for a rate cut. The only impediment is that it could rise again after December when the high base effect weans. But yet, it will definitely not come close to the 8% path set for January 2015, and will hence; still justify a rate-cut action.
The question really is that once we attain an inflation target and then lower interest rates—which can still be some distance away if we go by the technical paper which talks of an inflation rate of 4% with a band of 2% either ways—then how does one calibrate policy? Today, the market believes that as long as inflation is within these pre-set ranges, the path is known. But once attained, how would RBI react to ensure that these targets are still relevant?
The curious thing about monetary policy is that it should be unpredictable to be effective. If everyone expects rates to come down, then the market swallows this information and the result will be neutral. Hence, the Rational Expectations School led by Thomas Sargent and Neil Wallace argued that if policy rates are fixed and followed, then it would not affect growth as everyone adjusts to this scenario. By fixing these inflation-targets and linking action with these goal posts, investors would broadly know when interest rates would increase or decrease. As a corollary, the only way policy could work is in case the monetary authority stated its stance to begin with but then changed direction based on other considerations.
Otherwise, much like the famous efficient-market hypothesis, the interest rate would always be in equilibrium with information symmetry. The former says that if the market is efficient and all the information is available to all market players, then the market price would reflect the collective wisdom and be the right one. Right now, the GSec rates are moving down as it is expected that RBI will cut interest rates either in December or February as inflation has come down. Therefore, if RBI actually cuts rates now, the impact could be limited as the market has already absorbed this move.
But suppose, inflation increases after the series of interest rate cuts start, will RBI necessarily increase rates? It could use the concept of inflationary expectations to tarry for some time but rates have to be increased once we are committed to inflation-targeting. Not doing so would mean a serious deviation from the stated path. Hence, the element of surprise will never be there once we target inflation with specific goal posts. Growth, too, will not be affected as ‘rational’ agents know what to expect in advance. Policy would hence be targeting inflation which would be the monetarist stance.
At present, the revealed approach has been to target the inflation rate and stay there till there is conviction in the ‘glide path’ of inflation. Curiously, RBI had actually brought in an element of surprise when the Governor took over by doing the unexpected by raising interest rates. Or rather, the market was surprised when Raghuram Rajan took over as it quite irrationally expected a rate cut given that this was the time when there was a perceived difference of opinion between the finance ministry and RBI on interest rates when the change of guard took place. This gave an indication that RBI would follow the Rational Expectations approach but after the expert committee recommended inflation-targeting, which has been accepted, the logical corollary has been to remove the element of surprise.
The advantage of having an inflation-led monetary policy is that it allows agents to take decisions in advance. Presently there is expectation of a rate cut, but assuming inflation goes up at some time, then it would be logical to expect an increase in rates once these benchmarks are attained. Accordingly, decisions like long-term investment can be taken or slowed down based on these paths.
However, it must be realised that while policy targets retail inflation the measures per se may not have a bearing on the direction of this inflation. Food items, housing, transport, fuel, have a share of around 90% in CPI, which is normally not leveraged. Clothing, footwear and, probably education, with a weight of 10% could be financed through credit at the margin. Hence, when RBI follows the path of inflation-targeting, it could end up being a passive follower of inflation with policy changes being more a reaction to prices and not quite a controller of the same.
This scenario could be a valid outcome of the ‘glide path’ where interest rate policy waltzes with the inflation number without quite affecting it. Growth must then look for other policy impulses. Also, at the ideological level an issue that can be debated is that if we follow inflation-targeting, should we be having monetary policies or reviews periodically or go back to the two-policy per annum approach with announcements coming in when these inflation numbers are attained.

Reality check: Financial Express November 16, 2014

India Public Policy Report 2014: Tackling Poverty, Hunger and Malnutrition
Rajeev Malhotra
Oxford
R745
Pp 249

AN ISSUE often debated is the effectiveness of various state governments in bringing about growth and development in their respective territories. It is but natural that every state tries to show that it has achieved more than the others, with statistics normally used to support these claims. Almost every government official will vouch for the state’s resolve to bring about rapid social and economic development. So how do we know where each state stands? It is here that Rajeev Malhotra addresses the issue in a very balanced manner and creates a Policy Effectiveness Index (PEI) to show how states have progressed and performed over a period of almost three decades: 1981, 1991, 2001 and 2011.
The author uses four parameters in this index. The first is livelihood opportunity index, which encompasses employment and its quality. The second is social opportunity index, which takes in education, health and standard of living. The rule of law index is the third component, which looks at crime, law and enforcement. The last, physical infrastructure development index, looks at civic amenities, connectivity and housing environment. This approach is extremely pragmatic because it actually looks at what people like you and I expect from any regime in terms of governance. At the end of the day, it poses a question as to whether or not individuals are better off and hence looks more at the micro than macro issues.
Malhotra’s conclusions are both interesting and disturbing. There appears to be a very gradual change in the PEI over the years at the national level. The index is down due to limited traction in the livelihood and rule of law indices, while we do better in terms of social and physical infrastructure. Further, the best-performing states are the smaller ones like Sikkim, Mizoram and Goa. Among the bigger ones, Punjab and Himachal Pradesh do better. The traditionally weaker states like Bihar, Madhya Pradesh and Odisha continue to fare low down the order with high poverty, weak laws and low social opportunities. In a way, these conclusions rebut a lot of claims made about
the turnaround in some of these states.
The problem with employment is that the non-agri sector is not able to keep pace with the creation of jobs, and hence migration is taking place from rural areas. The only sector that is absorbing such labour is the construction industry. Here, the north-eastern states also perform low, as they do not have the bandwidth to provide such jobs.
The author is more positive when it comes to improvement in social opportunities with the National Rural Health Mission being singled out for playing an important role here. This has helped in the relatively backward states like Bihar, Assam, Rajasthan and Uttar Pradesh.
These results should hopefully be looked at closely by all state governments, so that they can work towards improvement in areas where they fall short. Very often, any ranking of states is based on very macro features, which look good, but do not really reflect the quality of life. Given that most government expenditure is directed towards improving this quality, a proper audit needs to be performed against these results.
This report is a must-read for all state government officials, as well as economists who believe in the trickle-down process. Often, we look at reforms and their impact on the life of the top percentile of the population and ignore the rest. That is the problem with economic statistics where the macros do not reflect the micros. Malhotra, a government official who has worked with the earlier finance minister, as well as in the Planning Commission, has provided brilliant insights and probably a different and more relevant way of evaluating policy in his report. He does point out at the beginning that a lot has been achieved and we should not let the issues of corruption or policy inaction blur the image. In that respect, he is sanguine of the future. But surely, we also need to look at the quality at the micro level. This is pertinent, as even the new government is talking a lot on inclusive growth and social progress. We need to go beyond just words.

Handling the Berlin Wall collapse: Financial Express 14th November 2014

The EMEs have broken a metaphorical wall to edge closer to the advanced economies in the last couple of decades

The collapse of the Berlin Wall on November 9, 1989, was more than a symbolic destruction of a political ideology. While it did herald the collapse of communism, with only a handful of countries embracing this dictum today, the economic transformation brought along by the
assimilation of capitalism in several economies has made the global economy look a better place. However, this transformation has tended to help the emerging market economies (EMEs) more, which took the new route with greater ease, than the developed nations which have
had to deal with the fallout of the Schumpeterian concept of creative destruction more often.
In India, the use of the market mechanism to solve problems, coincidentally, also occurred just after a similar ,though metaphorical, wall crumbled here, though for different reasons. The tenets of globalisation have caught on, but there has been a sea change in the shift of economic power. The overall growth in the world economy this quarter century had averaged a compounded growth rate of 5.5%. Yet, the shift has been more towards the EMEs and while they were buffeted more by the Asian crisis in 1997-98, the seismic zone, as far as growth is concerned, has been located the developed nations, starting with the US, where the derivative bomb exploded, and then the sovereign debt crisis in the EU, cutting through physical boundaries in the eurozone.
The EMEs (taken broadly to include all non-developed nations, as per the classical IMF/World Bank definition) have grown by an average of 9% per annum as against 4.2% for the advanced economies (AEs). While a lower base—with consolidated GDP being just $3.3 billion in 1989 as against $16 billion for the AEs—has helped their cause, their share has increased from 17% to 39% by 2013. Quite clearly, the centre of gravity has moved towards the EMEs, as also evidenced by the power exercised in global forums such as the WTO, where successive rounds of talks have been stymied by these voices arguing for greater equality. The BRICS grouping has become a natural corollary of such power, which appears closer to fruition given the creation of a new development bank.
Hence, globalisation and market-economy, while making the world a flatter place, have directed the winds of interest towards the EMEs, as investors are looking for spare capacity to leverage, and while the AEs are still dominant, opportunity has shifted to these regions. Let us look at FDI for instance. There has been an increase in the share of FDI flows to the EMEs from 16% of total in 1989 to 61% in 2013 of a total of $1,452 billion, with China being the clear leader.
Also, in terms of outward FDI, the EMEs have, quite uncharacteristically, taken over by increasing their share form 8% to 39%. They have also become the holders of a larger share of global forex reserves, from $285 million (out of $840 billion) in 1989 to $8,573 billion in 2012 (out of a total of $11,480 billion). Remittances of migrants have also been in the EMEs’ favour, with their share  being 71% in 2010 as against 53% in 1989. Therefore, both capital and labour have moved in favour of the EMEs.
Partly, this can be attributed to the inherent limitation in the AEs and, going by Rostov’s theory of growth, most of these nations are already in the stage of high mass consumption, with ageing populations. Attention has to shift to the EMEs which are taking-off or  approaching maturity. Amongst AEs, Germany posted a growth comparable to that of the US, at 4.4%, and has borne the brunt of the adjustment process in resuscitating the euro area.
The AEs have witnessed two serious setbacks and are still trying to recover from the twin crises that came in succession since 2007-08. Also, the euro experiment has not quite worked the way in which it was prophesised, leading to introspection on the concept of the unification of 17 currencies of countries that were not looking in the same direction. Along the way, the EMEs have continued on their path—though not consciously coordinated by the disparate nations—to create the ‘de-coupled economy’ which can grow independently fostered by strong domestic impulses and trade ties.
The energy of the US has turned more political in the aftermath of the collapse of the Twin Towers in 2001 and has gotten channelled increasingly into fighting terrorism and maintaining peace (along with UK, which has played a more secondary role) in Iraq, Afghanistan, Iran, Syria, etc. Therefore, the US market—though still a major one for all growing economies, given that China depends heavily on the success of the former—is less likely to distort the growth plans of EMEs.
At the institutional level, the UN has become relatively less relevant with the US taking on the onus of peacekeeper. The IMF which was established to correct fundamental disequilibrium in balance of payments has to reinvent itself as global capital flows do help to correct such imbalances, especially for EMEs. The IMF has been criticised for endangering these countries, where conditional packages have been detrimental to the interests of the latter (Stiglitz). The formation of institutions such as the new BRICS bank pose challenges for the World Bank and its affiliates, as such a bank would be free of the perceived AE biases.
While the world economy appears definitely to be stronger, is it a more equal society? One is not sure about the inequality across nations. Economist Thomas Piketty has argued about rising inequalities since the 1980s. Statistics show that while Britain was five times more prosperous than the poorest nation in the 1820s, today the US is 25 times richer than the poorest nation. The Gini coefficient between countries is now 0.55, which is quite high.
On the whole, it has been a good experience for most nations and forced integration under the pressure of markets has brought about a different kind of unification, which is commendable, coming as it does under the inevitable Smithsonian invisible hand.

Good times for commodity futures? Financial Express 4th November 2014

The Financial Stability and Development Council of RBI has reopened the issue of commodity markets by bringing to the discussion table the case for allowing financial institutions and FIIs to participate in futures trading. This is a positive move that, hopefully, will materialise and take the derivatives market to a new level.
The issue of allowing these institutions is not new and has been on the sidelines for a long time. The commodity futures market has come of age, having been in existence for over a decade, and has been through several upheavals with the misguided notion that such trading affects inflation. It is accepted that futures trading has little links with inflation and instead foretells the same which can prompt corrective action.
There is also a strong case for the restoration of banned futures contracts in products such as tur and urad which gave correct signals in the paston the NCDEX platform. It is time these contracts are restored so that the bouquet of products offered is wide and more meaningful.
Now, let us look at banks getting into these markets. Today, RBI is venting its ire on companies that have forex exposure but do not hedge because, in case the rupee swings widely in either direction, the losses could be large. The same holds for banks when dealing with lending because all farm loans as well as those to manufacturing—which are based on commodities—carry a high price risk, especially with inflation averaging of 8-10% in the last 2-3 years. It is less palpable for manufacturing where inflation has been more moderate at around 3-4%. Intuitively, one can see that the possibility of a loan going bad and turning into an NPA is higher with swings in commodity prices. There could be some natural hedge in manufacturing if producers pass on the cost to the consumer but this does not hold for farmers in case there is a crop failure. Hence, there is a case for intervention by banks.
Banks need to insist on corporates hedging their commodity price risk just as they have to for forex, as directed by RBI. While enforcing the same would be a challenge, the absence of such hedging should mean a higher lending rate with a charge for the same entering the base rate calculation. RBI also needs to work out if we can have an NPA reserve created by banks which is funded by an additional interest cost levied on companies when commodity risk is not hedged.
How about farmers? This is trickier as banks cannot insist on the same, as the lending rate is fixed at 7%. Here, banks have to be allowed to play the role of an aggregator (this was suggested by RBI in its 2005 report on warehouse receipt financing) where the local branch manager has to only pool the product that is kept in the warehouse and inform the banks’ treasury which does the hedging. The local bank branch manager need not have any knowledge of futures trading and only has to pass on the amount to the central office to enable this transaction. Since there is a hedge cost involved, the government could consider providing an incentive by covering it for farm loans which already carry a subvention on interest. But it would still be in the bank’s interest to hedge its exposures to the farm sector given their propensity to turn NPAs.
But there would be a problem in case the price at the time of maturity is higher than contracted—which is a notional loss. A futures contract provides protection against a lower price but does not allow one to take advantage of a higher price. Ideally, options should be permitted and this is where the FCRA needs to be changed simultaneously so as to make this proposition work.
Going forward, one also can think of banks trading in commodity futures as a part of their business with a certain part of deposits or credit being permitted for such trading with the requisite safeguards just as banks trade in forex or manage their investment portfolio.
FII trading in commodities is also a good idea as experiences in the stock market have been satisfying. They have added depth to the market and the same can be expected in the commodity market. While the FMC supported their participation in non-agro commodities as early as in FY06, it did not work out due to regulatory issues because while FMC was under the ministry of consumer affairs, FIIs were guided by Sebi, which was under the ministry of finance. Today, with the FMC being under the finance ministry, this should be easier.
Mutual funds, too, are not permitted to deal with commodities and permitting them will open another avenue for investors. Bullion can give returns between 15-20% while agro commodities like guar, soybean, mustard, pepper and jeera could go anywhere between 10-30% depending on market conditions. As the commodity futures market is trying to get in retail, players who on their own would not be in a position to trade given delivery issues and understanding of fundamentals of commodities which is very different from stocks and mutual funds through commodity schemes, could provide such access.
Are there any safeguards needed? First, the issue of delivery has to be tackled. None of these players would be interested in delivery and, hence, their terms of operations should exclusively preclude delivery where they have to close out on their contracts. Exchanges could consider non-deliverable contracts in parallel. In fact, taking delivery by FIIs can lead to foreign trade issues in case they would, in an unlikely scenario, like to ship them out. Second, to ensure that the markets are not pulled in a particular direction, the position limits should be set for these entities with deep pockets. As they are dealing with non-deliverable contracts, there would be a tendency to take higher positions. Last, regulation has to be firm and surveillance systems of exchanges robust to ensure that the system works well.
Going by the virtually smooth growth of this market in terms of regulation by FMC and conduct of commodity futures exchanges, one can be sanguine that bringing in these institutions will add depth and buoyancy which will lead to better price discovery. Therefore, this should be taken up with urgency and implemented with the regulatory structures in place.

View from the top: Book Review in Financial Express 26th Ocotber 2014

The Hard Thing About Hard Things
Ben Horowitz Harper Business Rs 699 Pp 289 THE HARD Thing About Hard Things is a book by Ben Horowitz in which he expresses his views on basic HR issues based on his experience in leadership positions in various organisations he founded and worked with. The book is not short on the use of profanities, which will strike the reader as odd. But then, the author explains that profanities are a part of the culture of IT-based companies and have to be accepted, provided their use does not go overboard and gets interpreted as personal assault. He, however, does not explain how one should draw a line on this. The Hard Thing About Hard Things meanders along several issues related to human resource management, providing solutions based on Horowitz’s judgment, and not on any theory or general practices in the industry. Let us sample some of his covenants. As a CEO, he believes one should not take too much on oneself or take things personally and that the entire business is like playing a game of chess. In times of stress, he says, it is better that there are more people working and this is where it becomes important to trust others. If things go wrong, one should spread the news openly, as adverse news travels fast, leading to speculation. Horowitz has his own theory on firing employees and devotes several pages on what should be done. Layoffs are necessary when a company does not do well and one should not delay this process, trying to cloak it by linking it with performance. One should, in fact, train managers to do this. More importantly, it should not be done stealthily, but openly. As a CEO, Horowitz says, one should address employees rather than equivocating personally with those being given the pink slip. Horowitz treads a different territory when he talks about colleagues who are also friends. What do you do when you have to demote a friend? How do you tell them that there are better people to do their job? Here, he believes in straight play rather than creating new roles, which mean nothing for the person. Surprisingly, Horowitz believes that it may not be right to hire employees from a friend’s organisation. He suggests that in such cases, one should get an NoC from the CEO of the other organisation. This may not find favour with several companies in a free market for employees. Horowitz also highlights that training is very important for an organisation and this is often ignored, as companies want to save time and money. But this is a fallacy because training helps raise productivity levels and the final quality of whichever product one is dealing with, be it manufacturing or service. Further, he argues that the entire system of performance management breaks down in case one does not train employees. How else can one actually judge anyone at the end of the day if one has not invested in such training? This is a useful message for several Indian companies that pay little attention to training, assuming that one learns on the job. The author is against people from big organisations working in smaller companies, especially start-up ventures. Besides inter-personal problems that come up given the difference in pay scales, it requires adjusting to the role and rhythm, which may not work well. Therefore, he posits that one should find out why the person wants to join and he should be grilled on this score. He believes that anyone who wants to further his CV is not the right candidate. Here again, the reader will disagree because ultimately everyone works for self-enhancement along with the company’s progress. Hence the two cannot be separated, as no one works for altruistic reasons. Expecting it to be otherwise may not be rational. Horowitz also suggests keeping politics to the minimum—but is that really possible, considering there are bound to be favourites? He also has a chapter on titles and designations, and blows hot and cold on their usefulness. While giving titles is a good way to keep employees happy, as very often one does not have to give more money for such titles and designations, there is a question of what happens when one reaches the level of competency, which goes with the designation, but can go no further? That’s when promotions become difficult. The author warns of smart employees turning slack when they start believing that they are bigger than the organisation and start badmouthing the firm. The reader may disagree here, as this outcome is largely a result of how organisations treat their employees—a relatively fair employer will never run this risk. Probably, Horowitz should re-examine this theory based on why the smart people he dealt with turned hostile. The Hard Thing About Hard Things is a collection of several small chapters on the different aspects of dealing with employees. It is not a template or a suggestive platform, but a collection of random thoughts of a CEO who has a view on the various aspects of HR based ostensibly on his own experiences. If one does not mind the bawdy language used at times and is willing to listen to suggestions that are personal and not universal, this book could be interesting to peruse.

Getting a grip on the tapering handle: Financial Express: 25th October 2014

Between the acting of a dreadful thing, And the first motion, all the interim is, Like a phantasma or a hideous dream’
– Brutus, in Shakespeare’s Julius Caesar The unwinding of the US Fed’s QE has been as sensational as the invoking of the same. The Fed had begun this programme in late-2008 and the reason was simple: Low interest rates, on their own, could not restart the economy which had low liquidity as banks were reluctant to lend to one another. By buying back paper from the market, liquidity was induced. There were several misgivings on QE. But inflation remained subdued and did not rise, contrary to expectations. The impact on growth was not too clear, as the GDP did recover to grow by an average of 2.2% in the 4 years following negative growth of 0.3% and 2.8% in 2008 and 2009 respectively. However, one unintended consequence was the explosion in the flow of funds to emerging markets. It was a clear case of ‘carry trade’ where funds could be borrowed at a low cost and then invested in emerging markets which were de-coupled and booming. We all loved it. The shock came in May 2013 when the Fed hinted at unwinding the programme and the emerging markets took fright as funds did an about-turn and distorted the external accounts of countries like Brazil, India, Indonesia, Turkey, and South Africa. The actual tapering began from December when the $85 billion per month buyback of MBS and treasuries was sequentially reduced to $15 billion as of October 2014. Surprisingly, the markets fared better when the tapering actually commenced. Currencies have stabilised and it is back to business as usual. There is just another $15 billion of bonds to be bought up on a monthly basis, after which the Fed would have reached equilibrium. After this point, the economic indicators will decide the Fed’s course of action. The consensus is that near-zero Fed funds rate will continue for some more time and there would be an increase in rates in mid-2015 if inflation becomes an issue and growth stabilises. The unemployment rate too would be critical which in August was 6.1% and 5.9% in September. The removal of QE can be looked at from the point of view of USA and India. In the US, the bond yields movements have been idiosyncratic. Typically, lower QE and the prospect of higher interest rates at some point of time should put pressure on the bond yields. But the yields have responded in a varied manner. The 10-years yield increased from 2.53% in May 2013 to 3.03% in December 2013 and then came down to 2.52% in June and to 2.09% in October 2014, even going below the 2% mark during intraday trade. Clearly, the markets are not expecting the rates to increase any time soon. Also, the movement of funds into bonds has pushed up demand and prices and hence lowered yields. Movement of such funds is also a result of weakening of global commodity prices, especially of crude and gold, hence diverting investments. Crude oil has been down from a little over $100 in May 2013 to the early-80s in October 2014. With the dollar strengthening from 1.36-38 to the euro in June to 1.26-28 in the last month on account of the recovery in the USA—though IMF indicates that growth will be stable at 2.2% in 2014 too, as in 2013—funds are moving back to US treasuries. With fewer treasuries available as the Fed has stocks of about $4 trillion so far, the prices have increased. From now on the approach of the Fed will be important. Will it start raising interest rates? Will it start selling treasuries in the market to mop of funds and hence cure the price rise? The answers are not known and the inflation and employment numbers hold the clue. Till then volatility can be expected in the market. How about our own economy? How vulnerable are we? The Indian economy hit back quite well after the initial slip with action being taken by RBI to shore up forex reserves. The important variable to look at would be the FII investments in debt. This is more likely to be affected than equity as the latter is guided by a different set of factors as the character of investment is different for the two, though there can be substitution at the margin. The trends in such investment in debt are interesting. Following the tapering announcement in May, there were 5 months of net outflows of $13 billion till November 2013. Subsequently, when the tapering actually took place following the December 18 announcement, the FIIs turned buyers for the next 4 months to $6.6 billion. April 2014 witnessed an outflow of $1.5 billion, but after that for the next 5 months there have been continuous inflows of $15.4 billion. These numbers are heartening as the debt market has been attractive to the investors notwithstanding the tapering of the amount. The interest rate differential is important. With our GSec yields being high, at above 8%, and a stable exchange rate, the returns are attractive. This raises some questions. First, should we be increasing the limit for FII investment in the GSec segment? The limits in the corporate debt and infra segments are underutilised as they do not evince much interest. Second, RBI has to take a call on the inclusion of this factor when formulating monetary policy once inflation moves down—which will hopefully happen by January or so. Third, RBI has to keep a close watch on the currency because the inflows of FII into debt from December was also associated with a relatively stable rupee. Last, just in case there are large outflows, how well are we prepared for it—RBI has managed this very well so far but will have to recreate a contingency plan for this extreme eventuality.

Jan Dhan is a cross for state-run banks to carry: Economic Times: 22nd October 2014

A bank is different from a company. While a company is answerable to the shareholders, a bank is to the deposit holders who have entrusted it with their funds. So when assets go bad or banks fail, we say the deposit holders have been wronged. The unfairness to customers has been questioned of late in India where deposit holders, on whose money banks make money, have become troublesome and banks want to dissuade them from using services by charging them for everything. It is only ironic that the new design — Jan Dhan — has turned the chairs.

The recent announcement of the financial inclusion policy that provides access to deposits, credit and insurance to everyone brings in a feeling of déjà vu. For those who lived through the seventies and eighties when we had the infamous loan melas, this raises a question on whether or not our mindset has changed after assiduously pursuing Narasimham I and Narasimham II. The present task set out to public sector banks to attain certain targets of opening deposits, though laudable, raises several questions. The government as an owner of public sector banks has a right to dictate terms to these banks, but given that they have all other kinds of problems, the timing of this is odd.

First, banks have been trying to close down non-viable branches where there is little business in terms of the deposit accounts being maintained or used. Having millions of additional accounts (75 million being targeted) will push up the cost of holding these deposits and pressurise their margins. Banks are already in the mood of punishing small deposit holders who do not maintain minimum balances with various hidden charges. Now for these deposit holders who probably will not be active, the costs will be high. The cost of opening a deposit ranges from Rs 80-100 with an addition of Rs 100 for the debit card, which is to be waived.

Second, to maintain these deposits, there will be costs of opening branches and staffing given the numbers. While the argument given is that technology will work, given the low level of internet penetration and the absence of electricity in most villages during the day time, will this work? Banks have already been told to start charging for excess ATM usage in metro cities. RBI data shows that on an average in a month, an ATM card rolls over just 1.4-1.5 times, which means that the usage is very low and there are several machines in non-metro cities that are hardly used (If the RBI is opening up charges for more than three ‘other bank’ ATM transactions, evidently the consumption is very high in these centres). Therefore, banks have to operate branches to be meaningful here.

Third, banks have been asked to lend Rs 5,000 as overdrafts to these customers. How does one guarantee that the amount will be repaid? Bank lending is collateral-based, and when there is no collateral, MFIs come in. Banks have eschewed this class given the risk. Now being forced to lend to such customers, there will be further jeopardy to their NPAs given the higher tendency for priority sector lending to turn into sour assets.

Fourth, while opening 15 million accounts in a day is good news, the question is, are the Know Your Customer (KYC) norms being followed? By diluting these norms to open accounts, we are actually degrading our systems. Generally to open a bank account one needs to go to a branch at least twice with a whole series of documents. Short cutting these processes will compromise on quality just like banks ran into a problem while meeting targets for credit cards by approaching every person outside an airport to subscribe to the same.

The justification given is that this will help to enable the direct cash transfer scheme. The major problem with the current system of distribution is the identification issue. With sloppy methods being used under KYC here, it is but natural that there will be replication of the same in this case too.

The challenge for banks is that out of every Rs 100 they receive, Rs 26 has to be kept aside as preemption and 40 per cent of the balance goes as priority sector lending leaving aside just Rs 44 for lending. For public sector banks, there are further pressures to be aggressive on inclusive banking and few bankers admit it is a strain as it is held to be sacrosanct. By counterintuitive logic if banks find this remunerative they should be lending more here, but they often fall short of the target. Now with this additional task being put forth, there will be several compromises that have to be made.

The fundamental problem is that conventional thinking has been turned around. While the government is supposed to be addressing social issues, we expect it to drive growth through spending on infra projects. Banks, which are commercial entities and answerable to deposit holders, have per force been compelled to carry out these social objectives, which has resulted in various issues. Also such grandiose schemes appear to be part of Indian psyche where we like to create new systems and never bother about maintenance. So we talk of smart cities, but the existing ones continue to decay. Hopefully, this grand design will not debilitate our banking system.

Payment banks - Spot the Difference: Business Standard 21st October 2014

With post office deposits and Jan Dhan already in place, is there really place for yet another
institution for banking inclusion?

The introduction of the concept of payments banks is an interesting proposition, but given that we already have similar systems, should we be duplicating them?

The idea of the payment banks is to provide access to banking for people, especially in rural areas. The bank's operations are rudimentary: funds will be invested exclusively in government securities or treasury bills with maturity of less than a year, eschewing issues such as non-performing assets and capital adequacy.

However, two competing entities already perform similar functions on a fairly large scale. First, India Post has around 1,40,000 post offices in rural areas, which have outstanding deposits of around Rs 3,70,000 crore (as on March 2013) with an annual flow of Rs 1,70,000 crore. This excludes certificates and Public Provident Fund accounts. Therefore, we do have strong structures in place that collect deposits from the public in the regular course of activity.

The business models are also almost the same. The money collected is devolved to the state and Central governments based on a formula and, since post offices are not commercial entities, they do not lend the money. The funds go towards balancing the budget, which is analogous to government securities and treasury bills.

The second area of competition for payment banks comes from the Jan Dhan scheme. This project is being executed within the existing structure of commercial banking where the public sector banks are to take the lead and open 75 million no-frills accounts by the year end. These accounts have two advantages - they have an embedded insurance product and, at a future date, could be entitled to an overdraft.

The Jan Dhan directly supersedes the payments bank objective because it has managed to include 55 million households (according to market reports) in an aggressive manner. Therefore, payment banks may not have many takers since they will be competing with post offices and the commercial banks' Jan Dhan, which goes beyond what the payments bank offers.

Prima facie, the payment bank model looks attractive - cost of deposits at four per cent, intermediation costs at 1.75 per cent and returns of seven to eight per cent, giving a net yield of 1.25 to 2.25 per cent. But there are nagging problems as revealed by the Jan Dhan experience.

The cost of opening an account is Rs 250, which includes a debit card. But 80 to 90 per cent of such accounts stay dormant forever. The numbers available from media reports on Jan Dhan indicate that for the 55 million accounts opened, the total amount mobilised was Rs 4,000 crore, which translates to roughly Rs 725 per account. The cost incurred by banks would have been Rs 1,375 crore, thus eroding a part of the deposits mobilised, hardly good economics for the payments banks.

There are other, practical issues. For instance, payment banks will entail building brick-and-mortar branches. There is a lot of talk about leveraging technology but given that most villages have limited access to power supply and knowledge of internet, physical access will be required. New ATMs have to be installed, since only 15 per cent of them are in rural areas right now.

It is generally believed that if financial inclusion is to be achieved we need an aggressive approach. In that sense, having multiple schemes to achieve the objective can really do little harm, so hence payments banks can coexist with post office savings bank and Jan Dhan. But it will be worthwhile to do an efficiency audit of the existing structures and put in place performance parameters for the new banks, so that we do not end up with a model that ends up eroding value.

Finally, we do have a proclivity for creating new institutions - the Mahila Bank is an example. This bank was set up with fanfare, even though the same objective could have been achieved by designating public sector branches exclusively for women. We have not heard much about this bank since. Is it possible that the payments banks could also reach this state?

Interpreting Tirole in the Indian context: Financial Express 14th October 2014

It appears to be quite timely and appropriate that the Nobel Prize in Economics has gone to Jean Tirole, whose major contribution has been in the area of market domination by a small set of firms and the regulatory action to be taken in this context. This has become a controversial issue in our country given the approaches taken to deal with critical resources such as mining or spectrum.

In the aftermath of the various crises in capitalism, the issue of crony capitalism has always been at the forefront where it has been argued that there are close connections between industry and the government, be it in East Asia or the USA, which indirectly encourage such market domination. Even in India, RBI has been blunt on hinting at this phenomenon.

Tirole has argued that in segments where there are monopolies or oligopolistic structures, companies tend to dominate the market and guide the prices in a desired direction given their strength. It can be through higher price or lower output, though the latter becomes difficult when there is free-trade and the product can be procured from outside. While price controls have often been spoken of, the issue is one of fixing the same and ensuring that profits are kept under check. However, with the advent of technology firms can minimise their costs and yet reap the benefits of higher profit through the fixed price. As there is no way to check the exact cost involved, monitoring the same becomes difficult.

We have seen this kind of structure in several industries like telecom, refining, banking, media, etc, where there are entry barriers in terms of costs and regulation, where market domination through alliances becomes common. Often industry associations work in this direction to ensure that this pricing power is exercised. While governments try to control cooperation between players, at times it could turn out to be counterproductive when it comes to sharing technology or patents.

There are several issues that need to be addressed. The first is to identify cases of market capture. This is important because it gets strengthened in four ways, especially when there is crony capitalism. First, markets, when dominated by a few firms, are driven by the structures of these companies and the consumer ends up paying a higher price all through. In India, we have seen how prices first come down when market share is to be increased and competition tackled and then prices start increasing once domination is reached. This has been witnessed in the electronics sector where this reverse curve has emerged.

Second, policies in the area are framed under pressure from these interest groups, which again works in maintaining this equilibrium for these firms. Often, one hears of how policies have been geared towards favoring specific companies. The issue becomes tricky, as Tirole's solution is to have in place such a framework which ensures more competition. But if this framework can be influenced by this oligopoly, then a solution will not be easily forthcoming.

Third, such domination also helps them secure a larger share of credit from the banking system. However, in our case, RBI's company and group exposure norms, which are more on the basis of prudence rather than 'credit capture', work well.

Lastly, the regulators are often pressurised to cooperate with the dominant group. Here, the political links could play a role in furthering these linkages. To ensure that such regulatory capture is not there, we need to have more transparency in the regulatory structures.

It is here that Tirole says that we need to have more regulation to control these firms. The use of competition laws comes to mind where countries need to design them to ensure that there is no misuse of the majority position. While one cannot increase the number of players by statute, there need to be adequate and empowered regulators to check the practices being pursued and ensure that there is fair play. There are however, some issues which come up here.

First, there can be several measures used to corner the market. Distribution of freebies is a way to push up sales. How does one stop this? Undercutting prices under the garb of introductory or promotional offers distorts the market place. The recent case of discounts being given in large amounts by e-commerce sites did raise a controversy as it, in a way, out-competes the other players. Clearly, there need to be rules in place to control such activity.

Second, how does one deal with patents. Here, the pharma industry would be in the frame as a lot goes into research when a patent is procured. Is it unfair play or a reward for superior knowledge?

Third, how does one deal with mergers as the raison d'etre of any takeover or buyout is to increase market share. Can we ensure that such deals do not end up giving disproportionate market power to these firms?

Fourth, what about public monopolies? Often, contracts are given by these monopolies based on the lowest-bid criteria. The bidder, who is a significant player on the buy-side, then cuts costs and quality to complete the contract. This happens often in road projects where there is an oligopolistic structure of bidders and often, they work in a manner such that they distribute the contracts between themselves. There needs to be regulation here, too, to ensure that the bidding process is transparent and that the contract is honored in true spirit.

Based on Tirole's theory, the key to having a more competitive structure is to ensure that we have regulation that cannot be influenced by industry. There is a call for transparency and fair play. Probably, in our structure the checks created by CAG in a way keeps watch on our policy approach. But this has to be done dexterously so as not to go back to the inhibitive license raj and MRTP days where enterprise was dissuaded.

10 commandments: Book review of Optimist's Diary: Financial express: 12th October 2014

An Optimist’s Diary: A Philosophical Economist Observes

Our World

Guy Sorman

Full Circle

R595

Pp 592

Madan Sabnavis

AN OPTIMIST’S Diary will certainly make champions of ‘the market’ happy. In today’s world, where we have tended to get suspicious of markets and their ability to deliver fair results, Guy Sorman offers a strong defence for capitalism. In fact, it is not so much a defence as it is a series of observations in this diary.

The basic observation is that there has been manifold increase in the standard of living of people where countries have tilted towards capitalism in various degrees. The cut-off point is the fall of the Berlin Wall, after which things have only improved. This is visible across countries in Africa, Latin America and Asia. Further, the countries that still seem to be struggling are those that have stuck to the communist or socialist dogma.

Sorman does admit that free markets failed when the financial crisis set in. The solution is not to reject it, but repair, which is being done today. He is hence critical to the point of being peevish when commenting on Joseph Stiglitz, who has launched a tirade against anything that capitalism stands for, as well as Paul Krugman, who has been critical of it too. He refers to Stiglitz’s views as ‘pop economics’. Here, he lambasts them, saying they are short-sighted and fail to offer any solutions or alternatives.

Sorman argues that capitalism runs on the Schumpeterian theory of creative destruction, where we are learning all the time. He also criticises Keynes and Marx for their philosophies, which he considers outdated. This probably is a problem with economists who are rigid in their stance and are unwilling to accept views that do not fall in line with their own. Hence, Friedman gets applause and Keynes his scorn.

In his diary, which goes chronologically from 2007 to 2012, he attacks the China story, which is thought-provoking. While lot of us like to revel in the way in which China has progressed, he shows that the double-digit growth has helped only the top 200 million while the rest of the one billion or more people live in penury. His travels and interviews reveal that a dictatorial regime that does not value human life and runs after growth numbers has literally squeezed the one billion by denying them basic facilities like health, education, water, electricity, etc, and has favoured growth of a very corrupt class. In fact, he goes on to highlight that China has nothing to say for its own production and most of what sells are foreign investment and foreign brands, which use these sweat shops to produce goods. China is more of a sub-contractor than innovator.

China on its own should be scorned for validating human rights and depriving its people of a humane living standard. He writes about how those who speak out disappear and even today, those killed during the Tiananmen massacre are unknown. Further, AIDS has spread widely in the interiors and the government is least concerned about the deaths. If what he says is true, then all those who talk of the China model should review their arguments, as no fair-minded country or government would like to do what China did to reach where it is today.

He puts forward 10 propositions for a more prosperous world. First, a market economy is the best. Even mathematical models used by economists like Gerard Debreu reinforce the claim made by Frederich Hayek in the mid-20th century that a market economy works the best. Second, free trade helps economic development. Third, good institutions are necessary for success, as there is a lot of Akerlof’s asymmetric information, which has to be corrected. Fourth, the best measure of an economy is growth and we should not try and camouflage this with abstract concepts like ‘happiness’. His stance is that even if environment has to be compromised, so be it. Fifth, creative destruction is essential, as it is the only way that innovation comes in and new enterprise emerges.

Sixth, momentary stability is essential for growth, as inflation comes in the way. Seventh, unemployment among unskilled workers is determined by the cost of labour. If we put too many restrictions like what France does for separation, then firms will employ less labour. Eight, the author believes that a welfare state does no good and once people are dependent on doles, the rot sets in. This has been argued in India too, where we have subsidy and employment programmes under which money is given out to people as part of welfare activities. This only makes people more dependent, wastes resources and leads to lower productivity. Ninth, complex financial markets have brought about economic progress. While the financial crisis was about the failure of some of them, he feels that the benefits have surpassed the cost of crisis. Derivatives have brought cheap capital everywhere around the world. Last, competition is largely desirable.

He is gung-ho about the US, which remains the leader in today’s world with a combination of private entrepreneurship and academic excellence. The dollar still remains the main anchor currency. And if one feels it is unpredictable today, the others are even more chaotic. Further, its military is the only one that can keep the global order ticking. More importantly, it is an exporter of values of democracy, individualism, gender equality and religious diversity. On this count, there will be little argument, as we have seen these values transcend all the revolutions we have witnessed in Algeria, Tunisia or Egypt. He also gives an example of how the US, its media and judicial system tackled the Dominique Kahn incident by providing justice to the coloured lady, which never happened in France where Kahn’s indiscretions were known, but protection of the elite was more important for the media.

There is also a chapter on Mahatma Gandhi, which Indians may not like. Besides Gandhi’s sexual preferences, which, he says, were a personal issue, he highlights the ambivalence in his approach to progress. Gandhi was for swaraj and asked people to burn anything foreign, yet he travelled in trains built by the British and not in an ox-cart. He also had a British surgeon when he needed an appendectomy. Sorman refers to him as the first 20th-century media-savvy political actor, as he walked briskly for the famous Dandi march when a film crew covered his steps and shifted to a leisurely pace when the cameras were turned off. But Sorman does praise him for bringing in values of hard work and honesty.

An Optimist’s Diary is a good book to read and is refreshing in this age, where we tend to be overly critical of the markets. That we have reverted to the markets after disdainful talks for five years shows that there is no alternative. It does get a bit distasteful when he attacks Stiglitz and Krugman, as it gets personal and goes beyond ideology. His revelations on China do make one think hard on whether this is the right way to go about it and if this kind of model is sustainable. A social uprising cannot be ruled out if pushed to the corner. And its economic model does not sound as alluring once we digest what goes on inside.