Give some, take some: Financial Express: 23rd March 2014 (Book Review)

WE KNOW that if we want to download music, we can do it for free from the Internet. But a question that often arises is: if all of us download music for free, how does an artist benefit? Hard as it may be to believe, often, singers release their music for free on YouTube and still make a lot of money. Lady Gaga, for instance, earned $130 million in 2011 and just 24% of this came from record sales. The rest came from endorsements, sponsorships, touring and merchandise. This is the theme that author Nicholas Lovell develops in his book, The Curve.
With the Internet becoming almost a household appliance, says Lovell, one has to give away a lot of things free of cost to stay on top. This is not just an option, but an inevitable compulsion. The only way forward is to change track and get on to the ‘curve’. A pop star who keeps a listener hooked on to his music can draw him to his live show, making him pay a high price for the ticket. Also, once the listener is committed to his music, he will pay multiple times the cost of a music CD if it comes with special incentives like a personal signature or a unique pack. Thus, by giving free stuff, one can start building a relationship with a potential customer or audience. Interestingly, Lovell points out that the era of mass market has come to an end and the tyranny of the physical is eroding. Therefore, while the idea of giving anything free of cost could terrorise a company, it needs to think beyond it. In fact, Lovell points out that the concept of mass market was driven not by the desires of customers, but by those created by advertising and marketing processes, which worked on cost-efficiency. This, however, is changing. There are three aspects to the curve: first, people value products at different price points and the theoretical concept of a single price doesn’t work any more. Today, if we look at differential pricing in various industries in India, like airlines or hotels, this makes a lot of sense. Second, value is complex and is driven by the utility it gives. This is divorced from the cost and is often linked with concepts such as status or self-expression—the Veblen effect, where we prefer high-value items only because they make us look good. The last aspect is that there is no point in fighting against ‘free’ and firms need to focus on customers who will pay for the product or service when they see value in it. The theme all through Lovell’s narrative is about harnessing the power of ‘free’ to make money through viable business models. It does not involve the requirement to be ‘free forever’, but says one should build upwards from whatever base we have by finding and satisfying customers who love what we do and make them spend money. By making them pay from the beginning, a barrier is created automatically. This is what happens in case of the many coffee shops that we see opening in India. At the start, they offer discounts and freebies, but once people get used to the concept, they go back to the regular menu. In fact, we can also take the example of McDonald’s in India, which has some products that are cheap and are retained at the entry level, while prices for other products scale up subsequently. To put his theory into practice, Lovell shows how to be on the ‘curve’ in various fields. When it comes to music, giving free is necessary to create customer relationships, so that people come for shows, etc. Lovell gives several examples of singers who have not released a single album or video, and yet are rages when they perform live on stage. Here, he links human response to scarcity. Just as people over-react to threats and danger, they do to the risk of diminishing supplies. For instance, we don’t want to miss a show, thinking it may not come back to town anytime soon. Therefore, we end up buying that expensive ticket. Lovell also talks about self-publishing, which is replacing the process of going to a publisher and working out a deal. In the world of the Internet, there are unlimited possibilities. For fiction, self-publishing is a way out; one can get rid of the gatekeeper and an e-book can become a physical book once the idea catches on. For children’s books, one should let out one book free, so that when parents get bored of reading the same book to their child, they will go and buy the new ones. Even in the legal profession, the ‘curve’ argues that standard wills, employment contracts and non-disclosure agreements can be offered free or at minimum cost, which is done by many firms. But once a person is hooked on to the firm and needs advice, then the money meter can move. The same holds for accountancy firms. Movies are tricky. You can get a pirated version or have what he calls a middling price, which is the ticket price or legal rental. Movies typically start from movie theatres and then move to DVDs, TV and free-to-air. They also exploit ancillary rights like books, merchandise, etc, which is how money can be made. Lovell’s suggestion is also one of crowdfunding, where the producer can sell other options such as getting to be in the film or be invited to attend the premiere, etc. Hence the revenue model goes beyond the conventional theatre ticket or DVD. In case of sports, one has the choice to watch a match live or on TV. Being on the curve means that you have paid for the rights and to get the money, the ancillaries matter, as well as the sponsors. The customer may not finally pay much individually, but the ‘curve’ is already at work, as the sponsor gets your attention. Suppliers of services use YouTube videos to get customers into their shops. A flour producer could offer free recipes to get customers to buy his product. By offering free information and intent, one can target customers and turn those just ‘passing by’ into people who engage with your brand. In case of newspapers, it is a challenge. Having a hard pay wall will deter a customer when it comes to an online publication. The curve aims to have an audience, which loves what you do to pay more. So you give a fixed set of stories free for a pre-specified period after which a customer starts paying. Restaurants can have events, which create interest; artists could connect through the Web, essays and other products to get one to buy art. Low-cost airlines have defined the curve in the aviation industry already. The author is convinced that with the growth of the Internet, a lot of things will be available free to the public. The new business models should not sit back and lament, but frame strategies that become pro-active with the changes taking place, so that they can get people to spend more than they would otherwise on the product. It happens in all fields and, therefore, we should keep the scepticism aside and join the bandwagon.

Keep the markets guessing: Financial Express 22nd March 2014

The scope of a monetary policy statement has changed over the years. From the conventional slack and busy season policies, we have moved to multiple policy reviews, 8 times a year under former RBI Governor D Subbarao and now 6 times, under Governor Raghuram Rajan. In the earlier versions, the policy was comprehensive and covered all aspects of the financial sector including debt markets, credit delivery, urban banks, and prudential regulation and so on. Even when we had more frequent reviews, the quarterly reviews were all-encompassing.

RBI, however, retained the prerogative to intervene between two scheduled policy reviews if it was warranted, quite like in 2013 when the LAF facility was modified and the MSF rate was hiked. While the idea of having multiple reviews more frequently was to lower the ‘noise factor’, it may have made policy that much less effective as the market appeared to be ahead of the policy change. This is a conundrum which still needs to be resolved. Surprises can cause an upheaval in the bond market and affect the valuation of over R65 lakh crore of government securities. On the other hand, anticipated changes tend to silently pass by the impervious market once it has already been buffered.
Further, by having separate committees look at various aspects of the markets, we have actually spliced the policy and differentiated between monetary policy action and regulatory and systemic issues. Each of these subjects have been dealt with separately thus making monetary policy a pure ‘monetary affair’. Therefore, monetary policy will be about interest rates and nothing else. This becomes similar to what central banks do globally where only interest rates are spoken of in the context of growth, employment, and inflation.
To put the policy stance in perspective, a backdrop of the global forces and the state of the domestic economy becomes relevant so that one can understand the rationale behind the central bank’s moves. This, sort of, prefaces the policy while explaining the proposed action. Invariably, there is a call taken on how the economy would be behaving and what the price situation is likely to be going ahead.
If one were to put a theory to the current wave of thinking on Mint Street, then there appears to be a movement towards a pattern of surprise. The number of policy reviews has been reduced to 6 from 8. Also, since September, there has been no pattern in policy action though broadly we are aware that CPI-inflation matters more. This appears again with the line of thinking in countries that monetary policy should target inflation first and growth becomes secondary. In the past there was some vacillation between headline WPI-inflation and CPI-inflation and food inflation and core inflation. But now, it appears to be certain that we would be moving towards the global trend of targeting CPI-inflation. There is acceptance of the Urjit Patel Committee Report, which means that the CPI will matter more.
The accompanying table provides the signals that were available to RBI when a policy decision was taken based on the releases on CPI and WPI.
The table shows that it is hard to discern a pattern based on past action, as RBI has kept the market guessing all the time. Implicitly, RBI has taken into account the concept of inflationary expectations while deciding on its policy stance. Also, given that interest rates do not affect the components of the CPI, monetary policy will be reactionary to inflation, meaning that as long as retail inflation is high, so will interest rates. Therefore, one can surmise that we are looking somewhere at real interest rates. The concern is palpable on the retardation in financial savings in recent times.
What then can we expect RBI to do this time? Logically, if inflation was the cause and has come down, then there is definitely no case for increasing rates further as was done last time. But as CPI-inflation is still above 8% which was what RBI appears to have targeted for January 2015, it could mean that the time has not yet come to lower interest rates. Besides, one is not sure of the crop damage on account of the recent unseasonal rains, which could put some upward pressure on prices.
Add to this the talk of a possible El Niño effect which can upset the monsoon movements and eventually food prices, there is a strong argument for status quo. In fact, any change in monetary stance should ideally be consistent with the final borrowing programme of the government which will be known only when a new government is in place and a Budget is drawn up.
But, given the predilection so far for surprising the markets—which is also what the Rational Expectations story book, a la Thomas Sargent and Neil Wallace, advocates—lowering rates at this time would be a pleasant surprise. More so because it is not being expected given the market interpretation of RBI's thought process based on past monetary policy statements. On the flip side, it could just be interpreted as a prelude to the elections if rates are lowered.

Breaking (s)even: Financial Express 16th March 2014 (Book Review)

THE VISIONARY Leaders for Manufacturing (VLFM) Programme, which was spearheaded by Shoji Shiba of Japan International Cooperation Agency (JICA), has worked around helping Indian entrepreneurs to understand their business requirements better. Shiba in his book, 7 Dreams to Reality, shares the narratives of seven such enterprises, which brought about a change in the way manufacturing is done in India. While these examples were clearly witnessed in the manufacturing sector, they could be paradigms that can be used by any company in the country.
The case studies chosen here are real examples of entrepreneurs who enlisted for this programme. The VLFM programme starts with the thought that the term ‘to teach’ sounds arrogant and what is better is ‘a learning environment’. Further, Shiba argues that the fishbowl experience is necessary for all. The thought here is that unless you get into the middle of the action, you do not know what transpires inside. This analogy can be carried to the shop floor, where one needs to get their hands dirty to really experience what it is like inside. Often, there is a disconnection between what happens at the corporate office and the reality in the factory. This can be bridged only by getting into the fishbowl. He differentiates between the small ‘m’ mindset, where we refer to just manufacturing, and the big ‘M’. Manufacturing has several other aspects like design, research, sales, supply chain, etc, which is affected by technology, societal and environmental change. Expanding one’s own vision from small ‘m’ to big ‘M’ is the transformation that is required. A unique idea introduced here by the author when transforming a business is to develop the three eyes of Buddha. The third eye in Buddhism is associated with enlightenment. In management, the three eyes indicate three possible directions of problem-solving, each using a scientific approach. The first eye is about ‘control’, which involves maintaining standards and having complete perception of the current situation. The second is about incremental improvement by making small changes every day. The third is one of ‘breakthrough’, where something dramatic is done to counter a drastic change in the business environment. The VLFM programme focuses on this third eye, as this can be the game-changer. A package that can be taken from the book for better functioning of a concern reads like this: there are seven ingredients which should go into the transformation process. First, it is necessary to formulate goals for change. Second, one must provide an organisational setting to realise these goals. Third, it is necessary to stress on training and education. Fourth, change must be propagated within the company. Fifth, success stories need to be spread across the breadth of the company to provide initiative. Sixth, incentives and awards have to be provided to get this change in. Finally, the implementation of change needs to be monitored and modified when necessary. As a leader or entrepreneur, one needs to introspect and answer these questions. While there are seven cases provided, including the stories of innovation in Godrej and Boyce and Sona Koyo, the focus is even on smaller companies, which require such guidance. He states, at the end, that what has been written is a new way forward and it is really up to the people to get on to these locomotives and move forward. There should be effort to bring about this change continuously within. Shiba argues that there are two kinds of management—Type A and B. The former refers to growth, which is measured by profit. The latter focuses on sustainability and harmony and the measure of success is intangible, which is happiness. This is definitely worth thinking about.

Why 'Post Bank of India' is not a workable idea: Business Standard 11th March 2014

The idea is good in theory but a raft of regulatory and logistic issues need to be solved before the postal department can become a bank

The idea of converting India Post into Post Bank of India is quite tempting when we look at the basic structure of the postal system in India. There are around 155,000 post offices against around 98,000 bank branches. There is one post office for every 21.21 square kilometres of area and 7,817 people. These offices have 287 million accounts (2012); in contrast, the entire banking system has 903 million (2013) accounts. They have 116 million depositors with deposits of Rs 3.96 lakh crore (the number for banks is not available). If certificates are added, the amount would be Rs 6 lakh crore. The postal department has 474,000 employees - or an average of three people for every branch. Banks, on the other hand, employ 1.096 million people, with an average of 11 for every branch. Prima facie, we can think of the business correspondent model taking off.

Add to this the fact that postal services are progressively becoming less relevant today as a result of the proliferation of mobile telecom services and private couriers. The postal material carried fell from 91.63 million in FY 2003 to 63.71 million in FY 2013 - only speed post and packets showed an increase. Moreover, the number of postcards, unregistered letters and parcels has fallen dramatically. Therefore, there is a demand for this department to reinvent itself, since it is a matter of time before most of these services become anachronistic. Thus, the prospect of India Post turning into a bank sounds like a capital idea, especially since we are talking about inclusive banking and around 90 per cent of the country's post offices are located in rural areas. There are also moves to computerise around 25,000 of these post offices, which adds weight to this thought process.

This is where the good story ends. If one looks at the practical side of this conversion, several questions arise that do not have easy answers. On the technical side, if India Post becomes a bank, who will carry out postal services? Banking regulation does not allow banks to provide these services and one will have to meander through this regulation. If this bank is allowed to offer postal services, can other banks also offer courier services?

Second, the deposits held by these post offices are of a different type, ones that are used by the governments (Centre and state). Do we stop these deposits - and if we do, what happens to the existing deposits with the government? Post offices are merely pass-through vehicles for such money, which has made the rather deprecating term of "being a post office" legendary in corporate jargon.

Third, are we now thinking of creating another public sector bank afresh, considering that it will be new from the start? Our entire thinking is focused on bringing in more private players and investment in this segment. The idea of having a new public sector bank sounds out of place and contradictory to the new line of thinking.

On the operational side, there are even more interesting puzzles. First, the 474,000-strong workforce consists of 263,000 dak sevaks, and another 203,000 gazetted Group C staff. The so-called office cadre would not be more than 7,000. Most of the others would be barely literate and could classify and stamp documents but may not be expected to go beyond that. In fact, they would more likely be conversant with only the regional language. Can they actually pick up banking and go through the normal training courses and exams that bankers are expected to undertake?

Second, none of the staff members would know how to garner and use deposits. At present, customers come and deposit money and the postal official really does not care if it happens. The quality of service is quite mediocre in a monopoly-cum-government set-up that lacks incentive to perform and where the "baksheesh" culture dominates for many transactions. A metamorphosis is needed as far as mindsets and culture are concerned - it is a challenge and costs money. If we replace the entire staff with trained bankers, what will happen to the existing ones?

Third, specialised functions, such as treasury, lending, investment and balance sheet management, require skill sets that even the existing gazetted officials do not possess. This will mean wholesale recruitment where the logistics will be mind-boggling. The only way out is if it becomes a payments bank a la the recommendation in the Reserve Bank of India's (RBI's) report on inclusion. But then, it is already performing this function and need not be converted into a new bank.

Fourth, most of these post offices in rural India are too small, probably just a little room where stamps and letters are dispensed and letters picked up and distributed. They may not be stand-alone branches for a bank.

Fifth, starting the business will be complex, considering that the balance sheet has a size of Rs 6 lakh crore on the liabilities side, with no assets as such, with these funds being provided to the government. Based on just the deposits, the size of this department would be as large as that of Bank of India or Canara Bank. How does one reckon capital adequacy when there are only liabilities and no assets? At Rs 6 lakh crore and with a capital adequacy ratio of 10 per cent, the government will have to put in Rs 60,000 crore. Where will this money come from?

Once we put all these considerations together, it seems an India Post Bank will probably not work. Several regulatory and logistic issues have to be surmounted. One line of thought is that if the infrastructure is the premise on which post offices can become banks, then these post offices should ideally be leased wherever possible to banks on rent - which will help the department cut its losses. Moreover, this will get us out of our predilection to create new structures instead of integrating the existing ones with the present system. In FY 2012, India Post reported a loss of Rs 5,805 crore. In fact, the new banks, which are expected to allocate at least 25 per cent of their new branches in unbanked rural areas, could leverage these structures so that it becomes a win-win situation for banks, the RBI and post offices.

Sweetheart deals: Financial Express 9th March 2014 (Book Review)

ONLINE DATING is quite in vogue today. It is more pertinent when a person is not able to find a partner during college days or at the workplace. Or, as in Paul Oyer’s case, who was on the lookout for a partner through online dating sites after separation from his wife. In the course of his attempt to work out a compatible arrangement, he realised that a lot of economic principles can be better explained through the unwritten rules and practices that govern dating encounters. Unlike eBay or Monster.com, where products are traded, there is no commodity as such in online dating and hence no substitute. Also, no money actually changes hands, but it is a search for the best fit, which is what happens in a market economy. Date searching, in a way, is similar to job hunting, where the two parties have to like each other. But it is unlike, say, seeking a house, where the house need not like you and it is you who decides whether you like the house or not based on whatever criteria you have set. The author takes readers through concepts that work in our economic life too. Oyer’s approach in Everything I Ever Needed to Know About Economics I Learned from Online Dating is more in the genre of books written by Tim Harford, Steven Lewitt and Stephen Dubner or, for that matter, Tyler Cowen. It is a case of observing closely what goes on around you and then tracing the economic principles guiding us. Let us sample some of the analogies drawn by him in this fascinating book. First, the author talks of the existence of ‘network externalities’ in dating just like in the marketplace, where demand creates demand. If more people visit a matching site, more would join it, as everyone wants to have more options. An example is Facebook, where everyone who wants to get connected gets on to the site, which, in turn, gets more people to join. This is different from, say, eBay, which people don’t visit just because more people are there. It is a case of who gives a better deal. This is contrary from, say, using a highway, where there is a ‘negative network externality’ once we realise that everyone is using the track. We would prefer a less used route. Here, demand lowers demand on an incremental basis. Second, on a dating site, how does one ensure the parties are genuine? This may be asked about used cars too. Everyone says nice things about himself or herself and professes his or her love to get a date. This, according to Oyer, is ‘cheap talk’ and everyone knows it. A Korean dating site found a solution just like the way American economist Michael Spence spoke of the second-hand cars market—lemons and the use of signalling. The signalling solution in dating was where the Korean site offered, as part of the package, two free e-roses that a person could send. This limited the ability to indulge in cheap talk. In case of the employment market, too, education or qualification is a signalling tool, where the employer knows if what you are saying about yourself is genuine or not. In fact, often, while taking a general examination, you are asked to mention two universities you would like your score to be sent to. This ensures that you apply to colleges you really want. Also, the receiving college knows that it is not one of the many institutions you have sent your application to. Hence, colleges know you are really keen on getting admission there. In case of dating, women prefer that men travel to see them and they can gauge the man by the restaurant he chooses, the clothes he wears and also the watch on his wrist. Third, the principle of ‘statistical discrimination’ works in dating and business. Some offices prefer men to women, or even discriminate on race for that matter, which is based on a perception that, statistically, the job is better suited for the defined class. In dating, too, the exercise gets subjected to this principle, especially if the searchers have been through matrimony earlier. Some of the questions that may come to mind are: is the person genuine about the relationship or will he go back to their former spouse as time goes by? Or even more worrisome is whether a person is dating more out of anger against his or her last spouse and may not be committed to a new relationship. Also, if one is separated or divorced, there could be stigma attached to it, as in, if the first marriage did not work, is there any chance that this one would also not? Fourth, related to this discrimination is the possibility of adverse selection. One thought is that only losers join these dating sites and, therefore, there is a good chance of adverse selection. In the field of insurance, the risk is similar. Older people are more likely to need insurance as they have higher probability of falling ill. Companies are more likely to receive claims from them. Younger people normally do not take insurance as they are less likely to fall ill. Therefore, the premium has to be differential based on age. Buffet meals face the same risk, but cannot really distinguish on age, though they could charge lower rates for children. Dating, too, hence runs the risk of adverse selection, just like in insurance. Fifth, the author talks of the concept of ‘assortative mating’ that holds in the employment market and dating. The highest-paying companies normally go to the best schools for recruitment. When it comes to dating, too, something similar happens. When one is selecting a date, one looks at attributes like race, income, education, work, etc, or similar grounds for making a start, which also implies that there are pre-conceived notions. But at times in offices, it is realised that negative assortative mating works when less efficient people are teamed up with good workers, and this is when the demonstration effect sets in and helps the overall efficiency improve. Sixth, the author also talks of how the dating market relates to ‘thick and thin’ markets. This is just like shopping, where we prefer to go to a mall where we get everything in one place with a lot of choices thrown in. This is preferable to shopping in a town or an area, where there are just a few shops. In dating, too, one prefers thick markets and if one closes in on geography or habits, be it sports or, say, diet preferences, the market can thin down. If one is looking for, say, a vegetarian partner in and around a specific city who also plays tennis, then the market becomes thin. This holds in our lives too when we prefer to visit a place where more options exist. Some interesting observations added along the way are that looks and money matter everywhere. It is a positive even when searching for a job. Surprisingly, under ceteris paribus conditions, weight does not matter in dating. Looks work for athletes, as it means greater possibility of getting endorsements. Also, education does not matter in dating under ceteris paribus conditions. All these conclusions make the book quite enjoyable and, in the end, the reader is convinced that online dating and economics do have similar goals driving them.

Why are GSec yields high? Financial Express March 6 2014

Markets, as a rule, are filled with ‘noise’ which keeps analysts in business. Normally, we tend to say that the stock markets are whimsical and cannot be predicted. Otherwise one cannot explain how the Sensex has shown remarkable buoyancy during the year notwithstanding the relentless flow of negative news. The bond market also has assumed a rather unpredictable course with reasons being often ascribed post facto while conventional tools for analysis have not been able to deliver tenable a priori explanations.
The GSec market is probably one of the few active ones on the debt side and the 10-year paper is taken to be a proxy here. Typically, the yield should be reflective of liquidity conditions. The 10-year yield has been in the region of 8.8%, and while it was expected to come down with the rupee stabilising and liquidity conditions improving, things have not quite turned out that way. Last year at this time, the yield was around 7.8%, i.e., 100 bps lower. Liquidity conditions prima facie look stable presently. Growth in deposits has been higher than that of bank investments and credit in incremental terms. The inflow of deposits through the FCNR route has made this possible. In fact, this was not the case last year, where supply of funds through deposits was lower than the outflow through credit and investments thus necessitating affirmative action from RBI through the repo window. This time round, RBI continues to support through the repo, term repo and MSF routes. In fact, the overall outstanding amount through these combined routes would be about R70,000 crore, almost the same amount supplied last year directly through the repo window. This time round, RBI has channelled more funds through the term repo window which is understandable, given that the recommendations in the Urjit Patel Committee report, which speaks of the migration to the term repo as the signalling tool, are likely to be adopted. Based on relatively stable liquidity conditions, compared to last year's, the GSec yields should have been moving downwards. The exchange rate too has been stable, unlike it was in the period May-September 2013 when high levels of volatility had prompted the market to panic. Also inflation has been coming down, which normally should have gotten buffered in the downward direction of interest rates. Last, despite all the pessimism expressed on the fiscal front, the government has stuck to the fiscal deficit target (in fact, it has been bettered) and the government has ended up borrowing less than what was targeted. Even while the fiscal deficit for the first 10 months has come in higher than 100% of the target, the tax collections in March along with the spectrum sales flows would help to bring down the deficit. Therefore, this also should not really be a concern. Why then are the yields sticky in the upward direction? A clue can be had from the profile of the entire spectrum of rates where the short-term yields have, at times, been higher than the long-term ones. This, theoretically, is reflective of a recession. But given that the GSec market is not really reflective of what happens in the corporate debt market—which is not active anyway—it may not hold even though there is a slowdown in the economy. But, the CP rates have also been high with the one year rate being above 10%. This situation of short-terms rates being higher provides an answer here. First, RBI has indicated in its last policy that it would continue to target CPI inflation. While CPI inflation has started moving down, the fact that RBI has spoken of 8% target for January 2015 gives the impression that RBI does not expect the current downward movement to continue for long. Therefore, the market is not expecting RBI to lower interest rates any time soon, which has put pressure on yields. Second, global uncertainty still remains. While the Fed tapering has begun, which has not quite had a very perverse effect on inflows so far, the market is still waiting and watching whether there will be outflows once the tapering size become cumulatively larger, i.e., say, in five months, the funds will be shrunk by $50 billion. Third, the market is presently also following the normal end-of-the-year pattern where the month of March sees tax outflows: advance tax of corporates, excise and service tax flows. This would put pressure on the banks as there are withdrawals by corporates. In fact, the banks would also be typically upping their bulk deposit rates for short tenures to meet this contingency. Simultaneously, there would also be pressure on banks on account of mutual funds, where there tends to be higher amount of redemption for meeting year-end targets. This is one reason for banks to also access the term repo window regularly. Last, the spectrum sale would mean that companies would have to pay at least a third of the amount this financial year. While part of this could be met from internals, the rest would come from loans by banks. This would also put pressure on bank liquidity as credit increases. One can hence expect rates to inch upwards till the end of March, and come down only when the money flows back into the system. Therefore, the movement in GSec yields can, in a way, be said to be forward-looking where expectations of the future state of liquidity would get absorbed in the yield rates in advance, which is what we are witnessing today. A lot will depend next on what RBI has to say in April as it will also guide investment decisions. RBI may prefer to wait and watch on inflationary developments and expectations as well as the Budget to be announced once the new government is in place.

Getting a grip on NPAs: Financial Express 28th February 2014

The issue of accelerating non-performing assets (NPAs) of banks is quite worrisome as it comes when the economy is not doing well and casts a shadow on the recovery story we are trying to narrate. Further, just at the time when we have reined in our CAD and fiscal deficit, the banking sector appears to be weighed down with lower quality of assets. This actually puts them under pressure, considering that there are other challenges that are being confronted such as Basel III, recapitalisation of banks and new goals on inclusive banking in an environment which is open to more competition. How serious is the issue?
The accompanying chart shows how gross NPAs of banks have grown over the last 10 years or so. There are broadly three phases here. The first is from FY05 to FY08 when NPAs declined and the ratio too came down from a high of 5.2% to 2.3% in FY08. This was also the period when the economy performed very well with growth averaging 8.9% per annum. The second phase was one of relative stability with the NPA ratio crawling to 2.5% by FY11. In absolute terms, NPAs increased by an average of around R14,000 crore per annum. This was also a period of high economic growth with an annual average rate of 8.1%. Quite clearly, a good economic performance had corporates servicing their debt on time. The third phase has been quite a disaster as the NPA ratio has started climbing upwards to 3.1% in FY12 and further to 3.4% in FY13, and is expected to go closer to 4.2% by FY14. In fact, the number of R2.43 lakh crore in the chart is for 40 banks as of December 2013, which accounted for around 98% of NPAs in FY13 (R1.80 lakh crore in FY13). Therefore, this number for the entire system will be higher than R2.43 lakh crore in FY14 depending on the accumulation of such assets in Q4FY14. This period has been characterised by one of the lowest growth periods with GDP averaging 5.4% (assuming 4.9% for FY14). Quite evidently, NPAs have been related with growth conditions. Also, while growth in credit in the last phase was modest, it had been high in the earlier two phases, averaging 27% and 18%, respectively. Loans of long-term nature in the infra space sanctioned in the earlier years when the economy did well would have particularly been affected in the third phase on account of the economic slowdown. While lending judgements have also been on the weaker side, the inaction in the policy area as well as cut-back of spending by the government has had repercussions through backward linkages on companies whose projects have been held up, resulting in debt overhang and low service quality. Are these numbers ominous? The falling quality of assets is a concern across the world and the accompanying table provides information on the NPA ratios for some important countries based on IMF data for Q3 of 2013. India’s NPA profile has to be judged in relative terms with other countries as most nations are going through hard times. India’s NPA ratio, at above 4% currently, is on the higher side for sure, which has resulted in the Reserve Bank of India (RBI) also do some tough talking with banks. In fact, more than the NPA ratio, the incremental NPA ratio is even scarier (see chart). It had crossed 6% in FY12 and FY13 and looks likely to near 15% this year. The number provided for FY14 in the chart looks at an increase in NPAs for 40 banks of R63,369 crore and juxtaposes the same with the overall growth in credit for the system in these nine months. The concept of NPAs is actually quite narrow as it covers assets that are declared non-performing. RBI has pointed at the restructured assets in its Financial Stability Report, which are around 6% of total advances. If these are also looked at in incremental terms, the overall banking system would definitely seem more vulnerable. How do we go about mitigating the creation of these assets? Three checks can be thought of here. First, banks have to be more efficient in their evaluation and have to be responsible for the quality of assets. Often, chasing targets of market share make them aggressive in lending, which can have negative consequences when the economy goes downwards. The broader question is how commercial should banks be, given that they are a part of a financial infrastructure that can rock the system. There are no clear answers here because with talks of privatisation and shareholder value, drawing such lines becomes tougher. While pinning responsibility to the management or board looks tempting, it could still be difficult to isolate bank-specific lapses and those caused due to the environment turning adverse. Second, as a central bank, RBI can link payout of dividend by banks or access to the LAF market with NPAs and put pressure from outside to perform. As banks are custodians of deposit holder’s funds, the shareholders should logically bear a part of the NPA burden through lower dividends. This can put check on banks to improve their recovery record. Also, the tenets of narrow banking can be reintroduced once certain threshold limits of NPAs are breached. At the third stage, RBI’s announcements on dynamic provisioning, provisions for restructured assets and greater caution on the part of the system would help to cushion the impact on the system. While the economy will recover and the colour of the clouds will change, one must remember that business cycles are bound to recur, which will make the NPA problem resurface again. Addressing the three steps outlined here would help to buffer the system in the future.

Chaos theory: Financial Express 23rd February 2014 (Book Review)

The Downfall of Money
Frederick Taylor Bloomsbury Rs 599 Pp 320 GERMANY TODAY is a very strong economic power and, to use a cliche, has been holding the fort for the entire European region. It is known for its prudence and has, in a way, been criticised for being too finicky about what the other euro nations are doing. The euro crisis has been overcome mainly due to the leadership position taken by Germany. However, this has not always been the case, and Frederick Taylor, in his book, The Downfall of Money, shows what happened in this geography from the time of World War I till around five years after the war ended. Germany was a nation in a mess, with economic chaos pervading every sphere. Germany, which had free convertibility of marks into gold, had to move away at the time of the war mainly due to the metal disappearing from the system. The war had a crippling effect on the economy, especially after Germany lost. The double whammy came from the Treaty of Versailles, which heavily penalised the nation for the war and, contrary to what is taught in history books, America was particular that Germany should bleed, and pay for all the losses of the Allies. The threat was that if Germany did not pay up, the war would restart and the consequences would be severe. There was, therefore, no option for the country, which had to work hard to repay the money. Internally, there was a lot of dissatisfaction over the outcome of the war and while civil unrest was common, the government tried to inflate its way by increasing wages. The pension bill for the government staff, as well as monetary support to the maimed—which numbered 1.5 million—added a lot of purchasing power in the system. The profile of the government was to remain big and it had to pay higher wages to placate the masses. The working day was shortened and productivity declined sharply. The welfare system worked even as taxes were not collected, which meant that the government was in the throes of a large deficit. The result on both scores was high inflation. The rise of inflation was severe and there was a time when a load of bread was selling at a peak of 140 bn marks. Workers then demanded higher wages, but the government simply had no money to pay, thus driving prices up a spiral. This was the time when the mark depreciated like crazy. From an exchange rate of 4.2 marks per dollar at the time of the war, it moved up steadily to 7.4 when it concluded. But after that, hyperinflation set in and, by December 1923, the exchange rate had reached 4.2 trillion marks for a dollar. This was the stage when a new currency, called rentenmark, was introduced to make people used to thinking of small numbers again and the rate was fixed at 1 trillion marks for 1 rentenmark. This also led to the withdrawal of the paper marks. Along the way, Taylor has some interesting tales to narrate, especially about the hyperinflation in Germany. The best hotel in Germany cost around 15 Canadian cents and the only cheap product was public transport, fares of which were not raised by the government during those inflationary times. Economist John Maynard Keynes was always against the Treaty of Versailles and felt, at the onset, that the economic consequences of peace were going to be more damaging than could be conceived. In hindsight, he was proved right, as the brokering of peace did well for the victors, but impoverished the vanquished—America, Britain, France and Belgium were keen to make Germany pay for the war, and this had dire consequences. However, curiously, a number of investors thought that it made sense to invest in Germany just after the war concluded, on the premise that the economy would have to recover and they could make money by selling off at that point of time. But what happened finally? By 1924, with the new currency coming in, inflation came down and sanity was restored. While the reparation threat was there, no one got all the money and Germany used US money to repay France and Britain. Once the Depression set in in 1929, all three defaulted to the US and the story faded quietly. While the book is on the downfall of money, Taylor concentrates more on the historical context and traces the fall of the mark to the political situation in Germany, which went through turbulent times. Taylor refers to the opponents of Germany as ‘enemies’, which is refreshing, considering that conventional textbooks in history always refer to Germany as the enemy in both the wars. In fact, the author also traces the rise of Adolf Hitler, who took a dislike to Jews mainly on account of their involvement with trade and looked upon this community as being responsible for the problems of the nation. Taylor does not quite venture into World War II, but does draw a comparison with World War I in terms of the consequences on Germany. While the first war led to the pauperisation of the nation, the second one had a focus on restoration. The allied forces worked towards rehabilitation with the main motivation being that the country did not drift to communism, which was viewed as a possible unsavoury outcome. Therefore, the Marshall Plan was worked out to enable this development. This later led to a collaboration between France and Italy to include Germany to create the European Economic Community to be followed by what was called the EU. Most of the debt was repaid by Germany at the time of reunification in 1990, while the last tranche was settled as late as 2010. The author also draws parallels between Germany in the 1920s and other euro nations today. The single currency means that the euro nations cannot inflate their way out, as Germany had done and have hence been forced to reform. But both the stories are still Germany-centric. The narrative here is very interesting for anyone inclined towards history, but could prove difficult for those not familiar with Germany’s past. As the period covered is just around 10 years in a voluminous book, it is not easy reading. The fall of the mark, though, is interesting. However, as it is narrated in the context of historical developments, it could be difficult to assimilate in one go.

A dualistic economic road:Asian Age 22nd February 2014

The economic achievements over the last 20 years have been quite on the lines of the dualism spoken of in Hindu philosophy. Nothing quite has been absolute and there have been qualifications along the way, which really indicate that a lot more has to be done.
1 the country has witnessed various forms of governments with different coalition parties working together. The positive thing is that howsoever the ideologies have differed the country has never gone back on reforms. However, on the converse side, as economies have been reaped on reforms, it is becoming progressively more difficult to push through reforms which are critical today as often political goals have superseded economic conviction.
2irrespective of the way in which one calculates poverty, the poverty ratio has come down. This works also with absolute numbers. A lot has been achieved through the trickle-down route of growth with more employment opportunities being created. However, again on the flip side, we still have extreme poverty in villages which do not have access to basic social services such as health, education, drinking water, etc. We still have starvation deaths taking place and often farmers are driven to suicide when the crop fails. While there is improvement at the periphery, the core remains untouched by development notwithstanding all the schemes introduced by the government.
3there has been a significant change in the quality of living in these two decades. All branded products are available and one need not import them. The middle-class boom is visible across the country and pure capitalist tendencies have also made India Inc. reach out through innovative marketing tools to the bottom of the pyramid. This has been accompanied by significant advances in technology to deliver products with online transactions taking centrestage and eschewing human intervention. However, India continues to rank quite low in terms of competitiveness, governance or doing business which is an unfortunate reflection of the intransigency in mindsets that have not changed to improve the level of efficiency.
4growth per se has been quite impressive across differing political regimes which speaks well of the inherent resilience of the Indian economy. The fact that we are scraping through a growth rate of 4.5- per cent in the worst of situations is commendable. But on the converse side, unlike China which has retained a high close-to-double-digit growth rate continuously for two decades, India has witnessed considerable volatility in growth which indicates that we have still not got a firm, established base, especially in industry which provides the necessary impetus.
5inflation is more serious a concern today and the government, along with the RBI, works hard to ensure that the number is under control. Therefore, India is more price-conscious than it was earlier with steps being taken to counter an oil price hike through tariff cuts or crop failure through imports. Also monetary policy has been proactive with demand pull inflation forces. But, again, when inflation is on the supply side, such as what we have witnessed this year and also earlier in 2007 and 2009, we have not quite got our back-end structures in place.
6RBI and monetary policy have been metaphors for transparency and efficiency in these two decades. RBI has evolved to become one of the best Central banks in the world and being very transparent in every possible action. The pro-responsive approach of the RBI has been iced with forward-looking stances, which is what the textbook would say. However, given the structure of the economy, monetary policy by itself has become less effective with the transmission process becoming sticky and, unlike the US where the Fed’s policy drives all economic actions, the same does not hold in India.
7the government is more cognisant of the fiscal numbers and the FRBM ensures that we work towards being range-bound. The states are almost in consonance with the guidelines, though the Centre has shown commitment but not resolution. On the other side, the quality of the fiscal balances has got upset with a rather helpless stance taken towards fixed commitments such as interest, subsidies and defence which wipe out around 50 per cent of the total Budget.
8the growth of the capital market has been quite remarkable with India becoming one of the major emerging markets, especially for foreign investors. Around $175 billion has flown into the market which is mainly in the equity segment. However, our dependence on these flows and the inability to garner other flows, such as FDI, in similar quantities has made our forex position vulnerable to these flows, as witnessed last year when the tapering announcement was first made.
9while we have opened up virtually all sectors to FDI and have got in significant numbers (around $ 210 billion), we have not been able to get through the last mile with severe roadblocks when it comes to retail, insurance or pensions.
10India is self-sufficient in food grains and has scaled new peaks in production levels across almost all crops. However, our policies have never worked much on enhancing output levels; the only attempt has been through price support, which has distorted the cropping pattern. We still look up to the skies for a good performance and often this sector has bailed out the economy. Clearly, there is need for us to bring back the Green Revolution and ensure that this sector is robust as it supports between 55-60 per cent of the work force. That will be a true achievement that touches the lives of the lowest levels of income, where progress could still be elusive.

Some myths about India’s fiscal numbers : Financial express 20th February 2014

Whenever we speak of budgets, the focus is always on taxes on the income side and various components of government expenditure. Add to this the level of government spending, and the debt issue comes to the forefront.

While all of us want to pay less tax and feel that the tax rates in the country are very high, we also tend to get critical of the government for a lot of expenditure where we like to pass value judgements. There are also the accompanying conclusions drawn of government expenditure being intrusive and drawing away resources from the private sector. Are there any such benchmarks as to what should be the ideal rates or levels of expenditure?
In this context, it is interesting to view how India stacks up in the global context in these fiscal aspects. The accompanying table provides data on tax rates, tax burden, government expenditure and public debt for a set of 15 countries covering both the developed economies as well as emerging markets. The results are quite revealing.
First, the tax burden appears to be one of the lowest for India which means that, as a nation, we actually pay far less tax than other nations. This may be attributed to the predominance of a very large unorganised sector which is not quite captured in the tax net due to issues of identification. Also, large volume of consumer transactions are not based on cash memos and hence do not get billed along the way. Add to this the quantum of black money which goes into various transactions especially in the real estate sector and the government actually loses out on a lot of revenue due to this identification problem.
Second, the customs tariff rate calculated on an average basis is one of the highest with only Brazil and South Korea having more aggressive rates. This is an issue which comes up regularly in the WTO summits where the arguments on protection through tariffs are often the crux of discussions. The Indian case is different as we also are pressurised on the CAD front where lower import duty can lead to an increase in imports and exacerbate the deficit. The recent episode of import of gold and the corrective action of raising tariffs is an example of why India has to be discreet when lowering these rates. And given that customs account for around 15% of total tax revenue, lower tariffs and absence of elasticity in imports would mean lower revenue for the government.
Third, the highest marginal income tax slab is again on the lower side, with only Brazil and Hong Kong having rates of less than 30%. Arguably, various countries have their own system of providing exemptions and inclusions for the purpose of reckoning taxable income but this one is the highest tax rate. Quite clearly, India’s income tax rate is well within the global level. Interestingly, the developed countries have their peak marginal tax rate at close to 50%.
Fourth, in case of corporate taxation, the rates are quite varied. Germany and Hong Kong have rates lower than 20%, while the UK, Thailand, Korea, Japan, China and South Africa have attractive rates of less than 30%. This does help to provide an impetus to industry to produce more, and most of these nations are also well industrialised, which means that lower rates do have a strong relation with output. Here it appears that India Inc would have a genuine cause to argue for lower tax rates especially in difficult times. Currently, the government is less willing to relent as this is an assured source of income due to the audit trail which exists. But there could be the counter argument that the number of exemptions and deductions permitted for calculating taxable income is more liberal than that in other countries which is compensated for by a relatively higher tax rate.
On the expenditure side, a generalised observation is that governments in developing countries are relatively less intrusive in terms of claims on GDP. The ratio is less than 30% in the Asian economies but higher in Latin America. For all the five developed economies, the ratio is much higher in the range of 40-50%. This does come as a surprise as it would appear that governments have to play a more active role in the development process in emerging markets where poverty levels are higher. Also, the developed economies which are capitalist should typically have less of government.
As a corollary to the levels of government expenditure being high in the developed countries, the public debt-to-GDP ratio is also higher relative to the developing countries. This also gels with the sovereign debt crisis in Europe and the perennial debt overhang in Japan and the more recent controversy on debt ceiling and shutdown in the US. The developing nations actually fare better here.
Putting all these thoughts together, the impression one gets is that we are not quite a heavily taxed nation and the tax rates are not really inhibitive. On the expenditure side, the government does not claim a large part of the GDP which is driven more by private enterprise and, hence, even the public debt level is not really misaligned with global trends.

Growth revival is the question: Business Standard February 18, 2014

Three things stand out in the interim Budget. The first is that the government can rein in the deficit at a pre-determined level, notwithstanding the challenging economic conditions. Tax revenue was lower by Rs 77,000 in FY14 from the budgeted amount. Therefore, a 4.1 per cent deficit looks achievable in FY15.

Second, the quality of this achievement provokes comment as lowering the fiscal deficit ratio to 4.6 per cent from 4.8 per cent at a time when revenues slipped could have been attained only through rigorous expenditure cuts. Non-Plan capital expenditure was lowered by Rs 30,000 crore from the budgeted amount for FY14, while Plan capital expenditure was lowered by around Rs 9,000 crore. Therefore, this cut of Rs 40,000 crore actually compensated for the Rs 48,000 crore of tax revenue loss for the central government (the balance Rs 30,000 crore would be borne by states).

Third, social expenditure continues to be a priority of the government. While there can be a debate on its merits, the position taken is that the government would keep playing the role of a welfare state.

Such a Budget raises the issue of whether the government can actually be expected to contribute to the growth revival process this year. Such an approach runs the risk of discretionary expenditure being trimmed to balance the fiscal.

A slowdown in industry affects corporate, customs and excise collections and the final picture emerges only towards the end of the year. For FY15, the initiative to bring about growth has to rest with the private sector, which will depend on consumer spending as well as investment. For the former to work, inflation should come under control, while for the latter to fructify, interest rates have to come down. In fact, the entire thrust attempted to be given in a limited way by the Budget to industry through excise and customs  cuts work on the premise that interest rates move down to help spending on automobiles. Otherwise, the Budget is more tuned to getting the arithmetic right without compromising on committed expenditure — National Rural Employment Guarantee Scheme.

Almost unfree: Financial Express 18th January 2014

There have been discussions among economists, business leaders and other critics on the absence of an enabling environment in the country from the point of view of doing business. The World Bank has also rated us quite low on its scale of ease of doing business. Now, the Heritage Foundation has brought out its annual Index of Economic Freedom, which ranks India at 120 among 178 countries. Within the five broad categories of ‘free’ (score of 80-plus), ‘mostly free’ (70-80), ‘moderately free’ (60-70), ‘mostly unfree’ (50-60) and ‘repressed’ (less than 50), we fall in the ‘mostly unfree’ category, which is disturbing.
The Economic Freedom Index (EFI) works on the presumption that the best situation is where every individual has the freedom to work, invest, spend, move, own property, produce, etc, with few impediments. Governments need to create an environment that allows all this to happen by not just helping individuals but also keeping out of the way. The EFI looks at four broad factors covering 10 attributes which are evaluated to arrive at the final score. India’s score is 55.7 in 2014, and the silver lining is that it has increased from 45.1 in 1995. The earlier ranks do not quite matter as the number of countries in the set kept changing depending on the availability of data. Hong Kong leads with a score of 90. The four broad areas are ‘rule of law’, ‘limited government’, ‘regulatory efficiency’ and ‘open markets’. Out of the 10 parameters that have been evaluated, India was mostly free in 3 attributes, moderately free in 2, mostly unfree in 1 and repressed in 4. Generally speaking, this is not a good showing at all. In the ‘rule of law’ category, the EFI looks at property rights and corruption. We are at the borderline of property rights with a score of 50, which has not changed for the last 20 years or so. The issue that has been pointed out is that the protection provided to preservation of such rights is weak as the judicial system, though independent, is susceptible to prolonged processes which are expensive and also subject to political pressure. On corruption, we have always scored low and the best was 35 in 2009, against a present score of 31.5. One can hope that with this issue of governance coming up strongly in our polity, improvement could be expected in the next few years. The second area relates to ‘limited government’ where both government spending and taxation (fiscal freedom) are considered. The scores are 77.8 and 79.4, respectively, which is not bad on a relative scale too. However, government spending had scored a high of 90.6 in 1999. Quite clearly, a progressively higher deficit run by the government through spending has militated against the space to individuals. The ‘regulatory efficiency’ category is interesting, which covers business, labour and monetary freedom. The low score in business freedom (37.7) follows the World Bank Doing Business view given the challenges any entrepreneur faces. We do not do too badly when it comes to labour freedom with a score of 74 which comes under the ‘mostly free’ classification. Conditions are easier and there are exit options open for labour. But monetary freedom is low at 65.5 and has come down from a high of 77.2 in 2007. The high persistence of inflation comes in the way of efficient use of monetary tools by the central bank and this has been the case in India where an inflationary environment has made things tough for RBI. The fourth category, ‘open markets’, is where trade, investment and financial freedoms are evaluated. In terms of trade, we do not do too badly, scoring 65.6. In fact, compared to a decade back, when the score was 23.6, there has been more than doubling of the effort here. Investment freedom remains low and here the EFI looks more closely at the FDI rules, where India is not considered to be too open. For domestic investment too, the environment is not hospitable and overlaps with the business freedom index. The investment freedom score was 50.8 in 2006 and it has been downhill since then. FDI has been increasing in the country; but this index would say that if we were more open to such investment, the flows would have been larger which would have benefited growth. Last, India is again low on financial freedom, and this is more a regulatory and policy issue. With the government controlling the larger part of the financial system and having several pre-emptions under the umbrella of affirmative lending, the flexibility to operate and become more efficient is hindered considerably. The EFI is, most certainly, a wake-up call for the government to look at the faultlines and address them. These indicators comprise the economic and business environment, which has to be tuned to the requirements of accelerated growth. Almost all these indicators are within the confines of our legislative bodies and there is a pressing need to bring in the right policy framework to revive investment. Today’s economic plight is symbolic of our shortcomings in all these aspects. When we talk of policy inaction and impediments to do business, which also involves corruption, it is a grievance of almost the whole of India Inc. The limited fiscal space we have is due to high deficits and, given that we talk a lot on inflation but do little about addressing the problems, the monetary freedom level too is low. RBI’s latest group report on inclusive banking, which talks of more priority sector lending combined with the criteria of forcing banks to open branches in unbaked areas for new bank licenses, would actually bring down the level of financial freedom further. Since it is agreed by almost everybody that opening up the reforms and reducing controls helped the country to move out of the stagnant equilibrium path, it is evident that we need to do it all over again to move away from this state of ‘almost unfree’ as per the Heritage Foundation. Doing so, by addressing these five issues where we are sub-optimal, is the way ahead.