Don’t expect low rates to spur growth: Financial express September 26, 2014

In the past few years, capital formation and growth showed a negative relation with policy rates, no matter which way the rates moved

There is a clarion call for the reduction in interest rates. The decibel level has increased ever since the latest IIP growth and CPI numbers were released. Growth continues to be low and inflation is sort of under control. RBI has indicated it would wait and watch how inflation pans out before taking a call on rates. The counter-view is that if high interest rates have not helped in reducing inflation, why not just start lowering interest rates. The question is, if high interest rates have not brought down inflation, will lower interest rates necessarily kick-start the economy?

The view here is that inflation has eroded purchasing power, which has affected demand for industrial products. In particular, consumer goods demand has been lacklustre and this has had negative backward linkages with other sectors. With capacity utilisation (based on RBI data) being 75% on an average, there is no need to invest more when demand is slack. Thus, investment can come only from infrastructure, where uncertainty has held back activity because, notwithstanding clearances and easing of administrative processes, there has been little traction here. If this is the case, then lowering interest rates will just not work in the desired manner.
To check how far this theory is true, we can look at the past decade and examine how these variables have moved. There have been five interest rate regimes in the last decade. The first was a long period between FY04 and FY08, when the repo rate was increased continuously by RBI. The next phase of two years, which coincided with the post-financial crisis regime, was when interest rates were lowered sharply. The third phase comprises FY11 and FY12, when rates were increased, while the next two phases were of single years each, when RBI lowered rates in FY13 and then increased in FY14.
The accompanying table juxtaposes interest rate movements with other growth rates such as GDP growth, capital formation rate, industrial growth, growth in consumer durable goods and in capital goods, and growth in credit.
The table shows that the first phase was a boom time when GDP growth was up with industrial growth also being in the double-digits. Hence, even though interest rates were increased, investment, as depicted by capital formation and growth in capital goods, rose at a high rate. Growth in credit averaged over 26% for this period, questioning the link between interest rates and credit growth. Importantly, consumer spending was high, which kept the machines rolling, and CPI inflation (industrial workers) averaged 5% per annum.
In the second phase, which coincides with the post-Lehman crisis years, when the government went for the stimulus programme, the picture was distorted as consumption was high due to the stimulus with fiscal spending adding a new dimension. However, low interest rates did not spur investment, and capital formation came down as production of capital goods slowed down sharply from an average of 14% to a little over 6%. Growth in credit also slowed down as uncertainty led to lower demand for credit. There was a negative relation between growth in interest rates and growth, as industrial growth slowed down. During this period, inflation doubled to 10.8% per annum.
In the third phase, we went back on the stimulus and increased interest rates, yet, with steady growth in consumer demand, there was an uptick in capital formation, industrial and GDP growth. There was a pick up in credit growth too, which averaged a little over 19%. Once again, a negative relation was witnessed between direction of interest rates and capital formation and growth. Inflation was high and averaged 9.4%.
The next two years have been typified by low growth in consumer demand and, hence, notwithstanding either higher or lower interest rates, capital formation was down, as was growth. Growth in capital goods was negative during this period and growth in credit slowed down to 14% in both the years—the lowest in this period. Inflation continued to be high, at 10.4% and 9.7% per annum.
While the textbook says that lowering interest rates leads to higher growth in credit and in overall economic growth, it is a simplistic theory, based on ceteris paribus. One needs to look at overall economic conditions and assess whether there is demand. Typically, no entrepreneur will invest at a time when surplus capacity coexists with higher interest rates. However, when demand is buoyant, interest rates will not be a limiting factor.
The other big-ticket driver of the economy is infrastructure investment. Here the situation is tenuous, since the government has shown its commitment to fiscal austerity and is not willing to go beyond to provide support for such investments. The stated direction is the PPP route, but this would take time to work out as investors would not like to lock into a high interest rate and would prefer to wait for interest rates to come down.
So, the recovery process will be gradual and by merely lowering interest rates not much can be achieved. The quantum of lowering of rates and expectations of the same will matter more for any entrepreneur who is looking to invest in the infra space. The move by RBI to allow banks to raise preemption-free resources for infra purposes will help them charge a lower rate, but then the borrower has to be convinced and would generally wait for the economy to turnaround first.
A lesson learned is that post-crisis, a ‘V-shaped’ recovery is not sustainable and that a ‘U-shaped’ recovery is more likely which will be relatively stable. Pressurising RBI to lower rates under these circumstances may not work. In FY13, RBI lowered rates by 100 bps, but growth continued to be anaemic.



 

Low-growth phase seems over: Business Standard 30th August 2014

The GDP growth estimate for the first quarter (Q1) has come higher than expectation at 5.7 per cent. Evidently, the economy has come out of the low growth phase in the past two years and it does appear the economy will continue to remain in the plus-five per cent range. The only negative factor is the sub-normal monsoon, which will affect farm output.

The government has taken several steps to revive investment, through better clearances and removal of administrative roadblocks. Hopefully, this should translate to higher investment. The Q1 number indicates capital formation has increased only marginally or has been unchanged, depending on whether we look at it in constant terms or market prices. Evidently, the second and third quarters will hold the clue to sustenance of growth in these areas, as the spending season starts from August and lasts till December. In the past two years, consumer demand has been low, affecting industrial growth.

However, this optimism should be bordered with caution. First, the government has played an important role in spending this time, with the fiscal deficit also being very high in the first four months of the financial year (April-July). However, given the commitment to the number of 4.1 per cent of GDP for the fiscal deficit, there is little room for substantial contribution from this end.

Second, low farm income growth can upset the consumer demand story, as the meteorological department has almost called this a drought year. So, farm spending could be constrained. Third, inflation continues to be a problem, especially on the food side. This means the Reserve Bank will not be lowering rates any time soon. Therefore, while growth has been robust this quarter, sustaining it at this level will be a challenge.

Also, remember a part of this growth has been due to the low base effect, with only agriculture and the finance sector maintaining momentum over last year. Construction growth has been positive, indicating infrastructure work is on, though it is to be seen whether this is maintained — typically, construction work slows in the monsoon. As the low base effect will persist in the next two quarters, there is room for optimism this year.

The government, it should be remembered, has made it clear that its own intervention through progressive Keynesian spending will not be there but it will be an active enabler. For this to work, things need to change fast but both higher demand and lower inflation will take time to happen. The second quarter (Q2, July to September) will not be quite exciting, as it is the monsoon time, when things are subdued. Q3 and Q4 would be the key quarters to watch.

Global Competitiveness Report 2014-15 - We can improve if we want to: Business Standard: 15th September 2014

Instead of slipping into denial over our poor score, let's look at what we can do better

It is but natural that we have taken umbrage at the World Bank Doing Business concept as some of the numbers reported are incorrect. But from a progressive view, one needs to keep an open mind and introspect when such numbers are put up and look at ways of improving the "parameters" on which we did not score well. The World Economic Forum has brought out its Global Competitiveness Report for 2014-15 that ranks us 71 in a set of 144 countries. Further, it states that our position has slipped continuously in the last six years and in terms of rank is lower than the other BRIC (Brazil, Russia, India and China) nations. The Confederation of Indian Industry is an affiliate organisation and a lot is based on replies to a questionnaire sent out. Therefore, one should treat these numbers as having some value. There will, of course, tend to be biases since industry responses will tend to be more demanding of the system.

The report looks at 12 pillars classified under three headings of basic requirements (four pillars within), efficiency enhancers (six pillars) and innovation and sophistication (two pillars). We do not rank well under the basic requirements with a rank of 92, within which we hit the middle with a rank of 70 for institutions, 87 for infrastructure, 101 for macros and 98 for health and primary education. We do better with efficiency enhancers with a rank of 61, within which we gain a lot in terms of market size with the third rank and 51 for financial markets developments. For the others it is quite abysmally low for higher education (93), goods market efficiency (95), labour market efficiency (112), and technology (121). The overall rank has been propped by the third criteria of innovation and sophistication, which have ranks of 59 and 57 respectively.

The report looks at both absolute data and perceptions through surveys since this is what finally counts when one has to analyse, in a relative sense, how countries fare. There are 114 parameters within these 12 pillars that have elicited views. In general, it was found that 40 per cent of the respondents found access to finance, taxes paid, financial regulation, and infrastructure and tax regulation to be the main stumbling blocks. Another 15.6 per cent found corruption and government red tape as being irksome, while 17.7 per cent found labour regulation, changes in government and its policy as being barriers to business. Uneducated workforce and low work ethic accounted for another 11 per cent of the problems for industry.

The table (Pillars of performance) has highlighted the score that India gets for 40 of the 114 parameters and juxtaposes them with the average for the world. The scale runs from 1-7 with 7 being the best and 1 the lowest.

What are the key takeaways from this table? First, we need to appreciate that India has done better than average on several scores, especially in the area of sophistication and innovation.

Second, contrary to perception, the government has not been quite an inhibiting factor relative to the average in the world even though this does come high in the list of grievances. Therefore, economic reforms have brought about substantial changes in the way in which we function.

Third, infrastructure is a major lacuna in our growth story and clearly, the emphasis has to be on bringing about rapid development to sustain growth. Surprisingly, the railways, a public sector venture, has done us well on the global map.

Fourth, corporations also need to do something about governance standards, both in the way they operate as well as the conduct of their boards. Fifth, there is still a lot to be done on the social front (not provided in this table since the elements have absolute numbers and not scores). Health and primary education needs improvement and the government should continue to channel efforts here. There have been some moves made on financial inclusion, but this needs to be expanded to ensure equitable growth. This can be related to the fact that our reforms process has been largely driven by focusing on the productive sectors i.e. industry and services, to the neglect of these sectors.

At a broader level, a rank of 71 calls for some serious effort to be put in since we need to leverage the high economic growth that we have attained to become more competitive or else we will lose out to other nations when it comes to attracting investment. We should refrain from getting into a denial mode and bring about improvements. In fact, on the positive side, we can take pride in remaining attractive notwithstanding these failings. Clearly, bringing about these improvements will take India to another level. The current government has it in its veins to do so, and one does hope to see this rank improve substantially in the next three to four years.

Retirement age disparity: Why can't public sector banks have 70-year-old CEOs when private banks can: Economic Times 13th September 2014

The Reserve Bank of India (RBI) has stirred the proverbial hornet's nest through what appears to be a fairly innocuous statement: private bank CEOs can continue till the age of 70. This, at a time when the government is antagonistic towards its own seniors. The age factor has always been an issue for discussion. Often, CEOs are reluctant to leave and the boards are pleased with the status quo. Technically, there is nothing amiss as this is permitted by Companies Law.


The question that comes up is that if the RBI is happy to have CEOs continue until 70 for private banks, why should the same not be permitted for public sector banks (PSBs)? A bank, after all, is a bank, and all the arguments that support the former should hold for the latter. But we appear to be fairly strict when it comes to PSBs, and there are absurd cases of heads getting only a couple of years once the age factor kicks in.
Globally, there is no rule, as the decision is taken by the organisation. If one looks at names like Jamie Dimon, James Gorman and Michael Corbat, they would all be less than 60 years. However, at the central bank level, the ages can really go up. America Federal Reserve chief Janet Yellen is 68 while European Central Bank president Mario Draghi is a year younger. Alan Greenspan went on as Fed chairperson till 80 and Mervyn King was in his mid-60s as governor, Bank of England. So, when you are heading a central bank, it doesn't really matter.
The RBI has made an announcement, but it is left to the boards to decide. What are the arguments for extending the term of a bank CEO? First, the stability factor is important for banks that are considered to be staid organisations. This is unlike investment banks that need to have more dynamism and it is felt that with age, one's risk appetite decreases. Just like how treasury dealers become 'old' once they touch 30, investment banks need youth. But for commercial banks, having someone who has been around for a long time gives the comfort of continuity and stability.
Second, experience matters. As the CEO gets older, the experience gained adds up over the years. The last 20 years have been phenomenal, for instance, for Indian banking where there have been myriad changes. Such an experience helps someone to guide the bank better.
There are compelling arguments on the other side too. First, extending the tenure smacks of the absence of imagination and a reflection of the conservative nature of the board. Second, doing so creates resentment down the line as the so-called second line also loses interest, which can lead to stagnancy.
  Third, keeping the same person for alonger period would mean less innovation as there are limits to what any individual can create. They may not really be prepared to bring about the 'big deltas' in vision. Fourth, retaining or extending the tenure also helps to cement the cliques that tend to build within the organisation, with the same people being favoured all the time. This invariably leads to the senior and middle management sending their CVs outside.
At an ideological level, a disparity between the retirement ages for CEOs and that of employees is odd because if one is supposed to retire because one is not fit for the task, then there's an inbuilt CEO-employee contradiction. This becomes stark as the RBI has a different rule for PSBs. While it is true that the RBI is going by the book, the inconsistencies in our rules that guide appointment for government positions and private offices need to be repaired.
At the end of the day, it would be the board's decision. But we need to ask whether this anomaly should continue. In fact, often, even government officials who retire from service get to run other institutions on a contract basis with their experience used as the clinching argument.
Some of our esteemed public institutions have had experts older than 70 being in charge. But we need to draw the line somewhere, given that positions are limited and it should not end up being the old boys' club forever sipping on their cocktails.
 

Learning from the Lehman crisis: Financial express September 12, 2014

September 15, 2008, has become as legendary as all other dates associated with catastrophesthis was the day when Lehman Brothers collapsed officially and become synonymous with everything that spells financial disaster. Lehman actually was the 'fall guy' as it came to epitomise everything that can go wrong in a capitalist world, which was personified by what the cinematic character Gordon Gekko said: "Greed, for the lack of a better word, is good." One may feel sorry for Lehman as the government and the Federal Reserve had helped bail out Bear Stearns before Lehman fell, and later AIG after Lehman collapsed. But a helping hand was not offered to Lehman. With the global financial order being restored after going through another upheaval of sovereign debt crisis in Europe, it is time to look back and reminisce over the last six years. The Federal Reserve has been drawing back on its quantitative easing programme and the indication is that, by 2015, the amount will be nil and that interest rates will be increased. It is more a sign of saying that the crisis is over and it is back to business. What have we learnt along the way? First, the crisis caught everyone off the guard and, therefore, the response was dissimilar. There was always the question of growing a moral hazard where, if the authorities bailed out one institution, others would also be tempted to go down under. Being the first of its kind, central banks were not quite sure of what they were doing. Even today there are no easy answers to whether distressed institutions should be bailed out or let to die, as the implications are severe for the system. Unlike a company where the shareholders are the losers, in case of banks, there is public money involved, which is often protected by the government. Second, as a corollary, the support provided to these institutions was not to prop up the company or the shareholders, but the financial system. Given that securitisation helped disperse risks, they had permeated a wide cross-section, and allowing these assets to fail would have sent the system crashing as various banks funded by deposits had exposures here. Therefore, even in future, one cannot allow such banks to fail. Third, the focus has shifted to more regulation and better supervision, and central banks across the world are more particular about their systems. Basel has moved to the third version and, after focusing a lot on capital in the second version, has now turned to liquidity as finally it is cash that matters in crunch time. Fourth, regulation has also pervaded the credit rating space, which till then had no oversight. There have been several changes in this area too, with new agencies such as ARC Ratings coming up as there has been a call for having more competition in this segment. To the credit of the Big Three CRAs, they have resurrected quite well after the double blow from the financial and sovereign debt crisis and today it is possible to say that they are better placed under the umbrella of supervision. Fifth, central banks started lowering interest rates to revive their economies under the stimulus programmes which combined higher fiscal imbalances. However, the impact was limited as banks were still not confident about dealing in the market. The crisis was about the loss of trust and credibility and this is why it has taken time to get up. A financial system in which players do not trust one another is bound to run into trouble as activity comes to an end since no one knows how good or bad the counter-party is. This means conventional tools do not work in exceptional circumstances. Sixth, following from the above, governments got their central banks to use desperate measures to revive their economies. Therefore, quantitative easing was necessary to restore liquidity into the system so that institutions could get cash from the Federal Reserve or the Bank of England or the ECB by either selling bonds or offering them as security depending on the comfort of the central bank. The theoretical issue raised was whether such surpluses would lead to inflation, a concern in the West. However, with low growth conditions, excess liquidity did not quite put pressure on prices. There were other problems, however. Seventh, with globalisation and the so-called bifurcation of the world economy, these funds have not been used within these geographies, and investors have had the tendency to borrow cheap from these central banks and invest in the emerging markets, thus fostering 'carry trade'. While this has spooked asset prices in the EMs, it has generated liquidity issues and called for monetary policy action in these countries as inflationary pressures have built up. Simultaneously, exchange rate adjustment has put pressure to correct the external balances as well as domestic liquidity. This has become an unintended consequence on both sidesfunds moving out of the developed countries and into emerging markets and creating policy problems therein. Eighth, with excess liquidity in the system, there is again a fear of the build-up of another asset bubble. Currently, it is hard to point towards any asset class that is under such a threat, but the fact that there is surplus cheap liquidity is a precondition for such a situation. Ninth, surplus liquidity and low interest rates have failed to bring about the desired level of change in the growth prospects of these economies. This is a conundrum which Keynes had spoken ofthe famous liquidity trap where even if you lower rates or increase liquidity, spending does not increase. The solution is to increase government spending, but with several constraints on this end, countries are not in a position to spend. The US also had a hard time to get through the Senate and faced the fiscal cliff and debt ceiling challenges. European countries cannot spend as it is a part of the deal to get finance from the ECB. Therefore, progress has been slow. Ten, notwithstanding all that has happened, economies still veer towards capitalism and the good part of the story is that countries have not quite turned protectionist or even leftist looking. This is important because capitalism is an evolutionary process which Schumpeter said involved creative destruction where one cannot move forward without letting the old order burn down. Only then do innovations come about. If CDO and CDS were the innovations of the pre-financial crises years, the QE model as a cure for stagnation is the highlight of the post-crises years.

Raghuram Rajan’s first year at RBI - Making a difference to continuity Financial Express September 4, 2014

The last change of guard at RBI took place on September 4, 2013, at a time when there was a crisis-like situation on the external front. With Raghuram Rajan taking over as Governor, there was a fresh set of expectationssome irrational, as one followed the speech made that evening. The speech was, in a way, an agenda to accomplish. Quite naturally, when one has to evaluate the course taken by the central bank, this would be the reference template. The significant part of the path followed has been one of continuity. The difference has been the pace. Most of the points stressed by the Governor have been on the to-do list of RBI earlier and have been reiterated in various policies, but the change really brought about was that the approach has been action-oriented, with committees being set up, policy papers being put up for discussion and notifications being issued. In a way just like the Modi government, RBI has been nimble-footed in getting things done based on a time-line. Four major achievements are noteworthy. First, there was a frontal counterattack on currency depreciation, and while the path followed all through was defensive in terms of controlling the outflow of dollars and using the LAF to curb speculative activity, Governor Rajan brought in the swap facility to get over $30 billion. This was unique because while there was discussion on the issuing of a sovereign bond, this move got in the dollars that were required without the government entering the market either directly or indirectly. The second was on the monetary policy front. The market expected him to lower rates to propel growth. This is where Governor Rajan did not deviate and showed continuity in policy. He continued the aggressive stance on inflation and went ahead and had an expert committee lay the path of inflation targeting. We now have inflation targets set through the CPI, and while one can still contest this stance, it does surely lay to rest any uncertainty. What the committee has done is to lay down the rules of the game, and the market has accepted it. Curiously, the same stance taken by his predecessor had come in for vitriolic criticism from industry and critics. Therefore, this achievement is commendable. In fact, the FM is also on the same wavelength now. Third, there has been a lot of talk on inclusive banking. Keeping in line with the then objectives of the UPA government, which has been reiterated by the NDA government now, the committee has made recommendations and we are on the path of spreading banking through different formsconventional or payments bank and correspondent banking model. Once again, a definite shape has put in place by RBI. Fourth, there has been talk of new banking licences for long. We have had several applications and controversies with the withdrawal of some entities, as well as the elections coming in the way with the process being within the confines of 'propriety'. Yet, we have had two licences dispensed, and while this has been a conservative and relatively non-controversial start, one may expect more players once these two entities become operational given that they are to be provided on tap. There have been two areas which have proved to be mixed bags as far as the financial markets are concerned. The first relates to the inflation-indexed bonds that have been brought, under the National Savings Securities scheme. These have not quite taken off, with the structuring not being quite attractive, given that the base return of 1.5% carries a downside risk in case inflation comes down. Also, their non-marketability has kept investors away as these securities have to be held to maturity. The other is in the area of interest rate futures (IRFs) on 10-year bonds. IRFs have had a checkered story so far, and the 10-year bond does reasonable business of around R1,000 crore a day (the 2023 and 2024 bonds). But such experimentation, though not very buoyant, is still a major improvement over the past escapades with the 364-day T-bills. All such endeavours have with them an unfinished agenda, and there are three issues that would have to be addressed. The first is more of a theoretical concept, spoken of by Rajan when he visualised the internationalisation of the rupee. This seems to be a long way off at the moment. But the other two issues, relating to SLR and NPAs, are nagging ones. There was a reference made to lazy banking and the fact that banks were heavily investing in GSecs. But how does one stop banks from overinvesting in GSecs? Today, they hold on to almost 4-5% of excess SLR as this helps in reckoning capital to comply with Basel II norms, eschewing NPAs and earning a reasonable return. In fact, at a time when NPAs are rising, the central bank should take comfort especially when weaker banks plough their funds into GSecs. The question really is whether or not RBI can stipulate a maximum SLR. This will be a bold move if RBI is serious about banks not holding excess government paper. Any such move will also mean that the LAF has to be revisited or else the reverse repo window will find queues even at 7%. The other challenge is NPAs. The Governor had spoken about promoters not having the 'divine right' not to pay back their loans. Here again, with several controversies already in the news, can RBI actually blacklist wilful defaulters and bar them from further finance? At present, while such information is available, banks still lend hoping that the projects/promoters become profitable in course of time as all finance is based on taking risk. This probably looks like an effective way to blacklist borrowersit happens for individuals who default on credit card payments for a couple of thousands of rupees. Why not for big companies? The past one year has been exciting for the banking sector, with Governor Rajan taking several measures to make things happen. As a central banker, there are certain things that can be done and others that cannot. There has been a lot of debate generated, which is good but continuity has been the theme. The Governor had quoted Rudyard Kipling in his inaugural speech: If you can trust yourself when all men doubt you, but make allowance for their doubting too. After one year, Shakespeare sounds appropriate: All the world's a stage, and all the men and women merely players. They have their exits and their entrances; and one man, in his time, plays many parts. The Governor surely has his part right.

Does monetary policy really matter? Financial Express 28th August 2014

Does the interest rate really matter today, or for that matter, even monetary policy? A lot of focus is on RBI and its monetary policy which holds the reins on the repo rate, considered to be the signaling rate for the financial system. There has been intense debate on whether or not interest rate action can bring about growth or lower inflation. If you are a monetarist, you would argue that monetary policy can attack inflation. If you support Keynes, then the growth potential of interest rates would dominate your set of arguments. As is the case with any argument in economics, there are two sides to the story, and one is never sure which one is right as there are compelling arguments on both sides. But the Indian situation is quite unique and does not go with both these schools. Let us look at growth's relationship with interest rates. Industry always argues that lower interest rates are a necessary condition for growth to take off. Theoretically, it is right because when rates are lowered, the investor is better placed to juxtapose the internal rate of return with a lower interest rate for taking a decision. The question then to be asked is as to which level of interest rate will really get industry to invest more money today? Investment decisions are based not just on current interest rates but expectations of the same in the future. If they are expected to come down further, then decisions would be postponed as locking into an interest today may not be ideal. Therefore, while one can argue on whether RBI needs to lower rates by 50 bps or 100 bps, the precise amount that will spur investment is not clear and will depend on other conditions. Now, let's look at the capacity utilisation rate in industry today. It was around 75% in March, which means that industry has surplus capacity. If output needs to be scaled up, it can be done within the existing capacity. What is important is the demand for the product. This has been the Achilles heel for us, where demand has lagged and has created a disincentive to invest. In fact, the inventories-to-sales ratio was 17% (going by RBI data for March 2014), which indicates that companies could offload their finished goods first if demand increased and still have spare capacity to leverage for meeting final demand. Hence, by lowering interest rates, RBI may not actually have industry going in for large doses of investment unless we see commensurate traction in consumer demand. Curiously, when interest rates were increased in FY11 and FY12the repo rate went up from 5% to 8.5% (on a point-to-point basis)capital formation in current prices continued to increase by 17.1% and 18.9%, respectively, indicating that interest rates were not a limiting factor. During these two years, GDP growth was 8.9% and 6.7%, respectively. Subsequently, while rates have come down and then increased to 7.5% in FY13 and 8% in FY14 (especially after May 2014), growth in capital formation slowed down to 7.3% and 4.6%. This means that if growth is buoyant, interest rates do not matter, and when growth is low, investment will not take place as demand is low. Interest rates act further as a deterrent. Therefore, the takeaway is that merely lowering interest rates and assuming that the transmission is smooth through bank lending rates, borrowing will not necessarily pick up. Demand has been hampered due to inflation. Food inflation, particularly, has impacted the purchasing power of households which have had to cut back on both consumption of manufactured products, especially durable goods, and financial savings. Consumer goods growth has been low, a negative 12.6% in FY14 over growth rates of 2.6% in FY12 and 2% in FY13. Such demand cannot be revived by lowering interest rates, as an inflationary environment does create consternation in the minds of households who have to plan for the future based on such expectations. Therefore, the issue comes back to inflation control as a factor influencing consumer demand. Can monetary policy influence inflation? Again, the answer appears to be a shrug, coupled with absence of optimism, when we look at the CPI figures. If one looks at the weights of the components, the following picture emerges. Food has weight of 49.7%, fuel 9.49%, clothing 4.7%, and 9.8% for housing. Few components here would be based on credit for most households. Then, there is 7.6% for transport and communications, 3.4% for education and 5.7% for medical expenses, where a very small part is addressed through credit. But to the extent that credit is used for purposes like education or medical purposes, interest rates would not be a limiting factor as these are necessities. Therefore, by linking monetary policy to CPI inflation, we are starting on a shaky note as interest rates have little bearing on most components. It could just mean that we are chasing a crooked, never-ending shadow. When monetary policy targeted the WPI number, it looked more feasible as it was a producer's index which was largely met through leverage and hence impacted investment decisions. However, today by targeting an index which may not be impacted by the policy tool, the objective of inflation control may not be realised. In fact, monetary policy may be viewed more as a reaction policy to the phenomenon of inflation. A better way to read the policy will be to say that the policy will be aggressive to retain positive real interest rates and adjust nominal rates to inflation. This means that the use of the traditional trade-off between growth and inflation, something which has been spoken of by textbooks and assiduously pursued by monetary authorities, may not really hold. Taking this a step forward, it goes beyond the rational expectations theory which says that monetary policy cannot affect growth, but also contests monetarism by saying that the best it can do is to adapt to inflation, when it cannot control it. The crux really is that when we have a situation of supply-driven inflation and low-demand led growth, working on the production side and going in for pump-priming a la Keynes could work. At any rate, monetary policy may not really matter.

Think the big changes through: Financial Express 25th August 2014

Two interesting developments are being discussed in terms of organisational changes at the government level. The first one relates to the Planning Commission and the second is of an internal restructuring exercise at RBI. The former is a case of an organisation being closed down or restructured while the latter has struck controversy as it requires a change in RBI Act. Critics argue that institutions such as the Planning Commission or the PM's Economic Advisory Council (PMEAC) may not be needed when there is the office of the Chief Economic Advisor (CEA) under the ministry of finance. The less charitable attribute the creation of such institutions as a way of dispensing favours. The counter argument is that when the PM is the head of the PMO or the Planning Commission, then, logically, he has to appoint the members as it is a prerogative bestowed on the office. Therefore, entry will be restricted and not based on the UPSC style of appointments. Hence, while recruitment cannot be questioned, the value added by these institutions can be debated. Few will argue in favour of retaining the Planning Commission, with planning losing relevance with as the socialist school withered. With the overlap of its powers with those of the Finance Commission, which determines how resources are to flow to states, the plan panel is not required. The share of the public sector is roughly half of what is projected for the economy and most activity is carried out through the federal structure, which obviates a meaningful role for the Commission. As there are annual vision documents and long-term vision documents brought out, the five-year perspective can be skipped without any major loss of information or insight. Do we then require institutions such as Planning Commission or the PMEAC? In fact, both serve as advisory boards and present a view which is largely in consonance with that of the government. There are also economists at different levels with various ministries who provide views with a sector-specific focus. While a plethora of views is useful, they tend to asymptotically converge with the government's opinion and are seldom critical. Therefore, when we talk of an independent think-tank, one is not sure about its true contribution. Instead the CEA and his/her team can do the same job. The issue of what to do with the staff of the plan panel can be addressed by transfers to the ministries. There are 109 officials who deal with various sectors who could be assigned relevant roles in the concerned ministry. The ministry of statistics and programme implementation can be provided a bigger role than just bringing out data, especially concerning the assessment of programmes and their impact. The other issue relates to appointments, which has also come up in the context of RBI expanding its echelon of deputy governors. The debate is on the selection criteria for the creation of the post of COO with the rank of deputy governor. This case is unique as, so far, there has been continuity in selection procedures. At the moment, two deputy governors are selected from within RBI's staff and the system has worked well as it rewards a combination of merit and experience. Two other deputy governors are selected as qualified economists and commercial bankers, based on a predefined recruitment process. Interestingly, RBI allows its own staff to work outside in the private sector and then allows them to return without affecting their tenure. But lateral induction into RBI is not common except for the two deputy governor posts. Therefore, an issue which should have been an internal one has come up in public forum. It may be argued that the COO should be selected from within RBI as there are experts who have experience on both sidesas the regulator and the regulated. It is felt that people having worked with the central bank for years are best suited to be elevated. In fact, it would be hard to find an outsider who has the same years of experience. However, the other side of the debate argues that taking in an outsider would add new dimensions to RBI thinking and, as the post would be a new one, it would not impinge on the existing structures with only the protocol being changed. Besides, the argument goes that if two DGs are being appointed from outside, adding another one should not make a difference. There are also examples of central banks in other countries taking in experts from outside. The Bank of England recruited Canadian Mark Carney as its Governor. Therefore, there are no fixed templates. This decision is important as it will serve as a precedent for future recruitment. Presently, public sector banks do recruit specialists at senior levels on a contract basis with market-linked compensation. The system has come to accept such appointments even though there is substantial variation in pay structures. The same can apply to RBI, too, though changes have to be made to the RBI Act to enable the same. While thinking of the usefulness of an institution, one needs to tread cautiously and define the agenda. Or else, we could end up closing down institutions to create similar ones. If the new structures go beyond the pedantic, they could work. Also, when it comes to restructuring the central bank, what needs to be thought through more is the value added with the new structure rather than how the position is filled.

The magnificent seven: Financial Express August 24, 2014: Review of Fewer, Bigger Bolder: Sanjay Khosla Mohanbir Sawhney

Fewer, Bigger, Bolder advises companies to follow its ‘seven-point path’ for success

Fewer, Bigger, Bolder
Sanjay Khosla & Mohanbir Sawhney
Penguin
R699
Pp 260
THE RISE of the ‘corporate’ as an integral part of the growth process in any economy has also brought with it stylised solutions as to how one should move forward. Companies always look for growth, or unbridled growth, as a solution to increasing shareholder value and keep looking for acquisitions, more products, brands, geographies, etc. This is where authors Sanjay Khosla and Mohanbir Sawhney advise that one should pause, think and reflect on the future path and get more focused.
In their book titled, Fewer, Bigger, Bolder, the authors try and chart a way for companies to strategise based on their own experiences, which draw heavily from how they worked with Kraft and brought about a transformation. Their view is that companies should work on the 5-10-10 principle, which, simply put, means that they should focus on five categories, 10 brands and 10 markets. This is quite the opposite of going in for mindless expansion, which is not sustainable. Often, we confuse quantity for quality and lose the plot.
They go a step ahead and also propagate an ‘upside-down principle’, where they turn business on its head. Instead of acquiring more customers, they say we should ‘fire’ customers who are not profitable. Further, we should ‘kill products’ that do not produce revenue and profit, and instead of proliferating brands, we should put our weight behind select brands. Last, instead of looking at more markets, we should focus on select ones where we can dominate and win.
They discuss at length the concept of complexity and arrive at a thumb rule to measure the same. We should multiply the number of products we produce with the customers, markets and operations entities, and divide the same by the revenue. If this number keeps falling, then we are getting less efficient, which is the result of increasing complexity.
Therefore, there are four questions that we should ask: first is ‘what’, meaning the offerings of the company. Second is ‘who’, which is customers. Third is ‘where’, or the markets we are looking at, and the last is ‘how’, meaning operations. By answering these four questions, we can actually resolve the issue of complexity of a business.  
The authors argue that ultimately it’s a matter of staying focused and not spreading the company vision everywhere. They propound a seven-point path that has to be followed sequentially in spirit.
First is what they call ‘discovery’, which is turning initiatives into opportunities. Leadership has to get aligned to these initiatives. Here, they talk of holding workshops, where there is free flow of arguments and thoughts, so that we can zero in on the goals. Their view is that bosses should be muted, so that others can express freely, and there should be lateral thinkers or those who can keep finding fault along the way, so that all possible hurdles are well-understood before finalisation of plans. More importantly, leaders should stand aside and let the teams drive the discovery process. 
Next, they talk of ‘strategy’, where these insights have to be prioritised and synthesised. This covers all products, markets, platforms, customer segments, etc, and the way forward is finalised at this stage. Here, the ‘what, who, where and how’ are actually put on paper for execution. There are several lenses that should be looked through: offerings, brands, customers, channels, markets, monetisation and processes. We need to choose among these lenses to get the right focus and then work on three criteria, which the authors club under momentum, margin and materiality. 
Third, we need to have a ‘rallying cry’, where it has to be taken to the boardroom, factories, markets, customers, etc. The strategy has to be communicated well to all these stakeholders. Here, they say the rallying cry can be a phrase, colour, number or symbol that brings the strategy alive for everyone in the organisation. 
Fourth, we need to have the right ‘people’ to take things forward. They need to be involved and feel passionately about what they are doing. Here, the organisation has to choose the right leaders who have the passion and zest to take the team along. We have to distort resources by taking them away from non-priority areas and channel them to high-priority ones. We may have to give a blank cheque to the team that will show the way, which means an open hand to do anything to achieve the goals.
Fifth, the most difficult part is to ‘execute’, as strategy and goals cannot be attained unless we are able to execute well. Cutting costs and fuelling growth both go with this move. Here, the authors talk of delegation, better use of resources by not doing marginal stuff, cutting bureaucracy and, more importantly, ‘start small but scale fast’.
Sixth, the authors call for ‘organisation’, which is basically creating organised networks that collaborate. Here, we need to have a ‘glocal’ look, which combines both domestic and global markets. Their tip is not to restructure and reorganise the company just for the sake of doing it. The need is to build collaborative structures that can deliver. 
Last, we need to have metrics for measuring our performance, which has to be monitored relative to the goals set for the company. Three pieces of advice here are that before embarking on this process, we need to have it clear, as to what is it that we want to achieve. Second, we need to be balanced and strike a good fit between what they call rear-view mirror and windshield metrics. Last, the simpler the metric, the better it is for us. 
Will all this lead the company turn around? The authors think this is the way for companies, but there should be constant review and we need to create a virtuous cycle and keep doing this periodically, as conditions change around us. 
The insights are interesting, but the problem with most books on management and strategy is that while they are prescriptive and talk of the ideal, they do not address the issue on why companies do not follow them. In fact, several points advocated are sheet common-sense, which companies fail to observe. 
Most companies are egotistic and run by the management based on their subjective perspective with a large degree of insecurity when it comes to taking people along, something that these stylised chapters rarely work on. Goals are almost always amorphous and strategies are rarely communicated down the line. And there is a tendency for a top-down approach in a large number of companies. Probably, this could be the next research subject for the authors, as to why companies do not follow these rudimentary rules. 

Other side of the great fall: Financial express 17th August 2014: Book review of Inside the banking crisis: The untold story: Hugh Pym

Inside the Banking Crisis brings out the financial meltdown as it unfolded in the UK—a refreshing change from the tomes available in the market focusing on the US
Inside the Banking Crisis: The Untold Story
Hugh Pym
Bloomsbury
R599
Pp 222

THE FINANCIAL crisis, which is over seven years old, is still referred to as a contemporary economic incident or catastrophe because several policies being pursued by central banks even today are trails of the crisis. In a way, the shadow cast is much longer than the event.
Hugh Pym’s book, Inside the Banking Crisis, brings out the crisis as it unfolded in the UK. The previous books on the crisis have generally been US-centric, as that was the epicentre of the financial earthquake that left several institutions and ideologies shattered. Therefore, one is more familiar with Lehman and the Federal Reserve than with what happened in other countries in Europe during that time.
Some crises in the UK were more on the global map, like Northern Rock Bank’s crumbling, but other stories are not on top-of-the-mind recall. This is where Pym’s book makes a difference, as it narrates UK’s untold story.
Pym, a member of the BBC team that covered the crisis, chronicles in a detailed manner the developments that took place covering four major stories: Northern Rock Bank, Halifax Bank of Scotland (HBOS), Royal Bank of Scotland (RBS) and Bradford and Bingley. Other players who come into the picture are Lloyds, Santander and the likes on one side and the government, chancellor of exchequer and the Bank of England on the other. Some of the protagonists were Mervyn King (of Bank of England), Alistair Darling (chancellor of the exchequer), Gordon Brown (the prime minister), Eric Daniels (of Lloyds), James Crosby (of HBOS) and Matt Ridley (of Northern Rock Bank), among others.
The book becomes interesting when it describes the discussions that took place to alleviate the situation and the strong ideologies that came in the way. The reaction time, hence, appeared to be longer than it was in the US or, for that matter, the European Central Bank (ECB). The end result, though, was to agree to save the financial system with the help of infusion of capital, as well as quantitative easing programmes.
The story revolved around three pillars: identification of the problem, realisation of it and the remedial action taken. Each one had its own problems in terms of interpretation, with certain ideological issues always coming in. The major question was who should provide the bailout? King was of the view that it was not the central bank’s concern, as its mandate was to conduct the monetary policy. As a corollary, the responsibility was that of the Financial Services Authority (FSA). The FSA, on its part, argued that the crisis was not in its domain because a banking crisis meant that the central bank had to play the role of lender as the last resort. Therefore, it was back to the Bank of England. The government had to contend on whether nationalisation was the best option, but that would have meant that its fiscal would be strained. Given these differences, different solutions were applied for failed banks, even as the search continued for a buyer.
Northern Rock Bank had a model of borrowing short and lending long, which was directed at the mortgage segment. The problem emerged when financing channels stopped after the crisis began in the US. The result was a run on the bank, as deposit holders feared that their funds were in jeopardy. The Bank of England, unlike its counterparts in the US and Europe, was not in favour of quantitative easing to begin with. Also, King took the issue of moral hazard seriously, which meant that if one bank was rescued then others would also line up for similar resuscitation packages.
The delay in action led to long queues of depositors at the banks. Coincidentally, the IT systems also crashed, as customers tried to offload their accounts online. This exacerbated the panic, as everyone wanted to cash out. Getting other banks to buy Northern Rock was not possible, as all major suitors were busy with the ABN deal (which finally went to RBS). The bank went down after the central bank had to reluctantly guarantee and pay deposit holders while taking on the assets.
HBOS was an enlarged model of Northern Rock with high levels of short-term borrowings—the difference was that there was greater dependence on foreign markets. Here, the parleys went on with Lloyds, which bought the bank. Scarcely had the government and the central bank found a solution here that the RBS was knocking at the door for a bailout. Finance had to be provided by the Bank of England. Here, the solution was for the government to take a large stake of 82%, but keep it on the stock market, thus eschewing the title of nationalisation. Santander took over Bradford and Bingley in the course of time.
The book gets into the details of how the discussions proceeded and the thought processes in the central bank over the entire time period. King was fairly obstinate and preferred to go by the rulebook, while others felt that the bank should be accommodating. Eventually, with government intervention, the deals went through, though a large number of payments were made in a clandestine manner to ensure that word did not get out that the Bank of England was supporting these institutions through infusion of funds.
Also, the Bank of England had its own quantitative easing, where it either bought back securities from banks to provide liquidity or exchanged mortgage-backed securities with government securities that could, in turn, be sold in the market. The crux was that banks cannot be allowed to fail, as it hits deposit holders whose interests cannot be ignored. Banks were also sliced into good and bad banks with the good ones being sold and the bad ones nationalised.
Almost five years down the line, things have stabilised. The good and bad banks concept has worked. The government took on the bad part of Northern Rock, while the retail side went to Virgin Money. The branches of Bradford and Bingley went to Santander, while the bad assets were combined with those of Northern Rock to form the UK asset resolution agency. Lloyds is back on the stock market after the HBOS episode. RBS, too, carries on today, but is still to recover from the crisis.
It is clear that the major lesson is that central banks have to be alert and prepared to take remedial action before a crisis escalates. Crises never erupt suddenly, as the conditions that create them take time to build up. Often, they are associated with bubbles, which are mistaken as signs of strength rather than weaknesses. It is only when the cracks become fissures that a crisis is recognised and by that time it is too late. Further, the issue of moral hazard always comes up for discussion as to whether central banks should intervene or not. And if they have to, how should it be timed. The author concludes by saying that the story of the crisis has no end. While future generations will be grateful to politicians, regulators and advisors for preventing a cataclysm, they will not thank them for leaving debts and liabilities, which could take decades to settle.
On a lighter note, when the British government mooted an idea to tax the bonuses of bank executives associated with the crisis at a higher rate as a kind of punishment, bankers felt that they deserved these bonuses and were unfairly targeted, as they had helped the system weather the crisis!

Equity gains need not be exempt from tax any more: Economic Times August 13, 2014

Financial inclusion and equity markets are two sacred shibboleths that are hard to dislodge, and questioning them is blasphemy. The first is an indicator that someone cares while the other is held sacrosanct as it represents everything that success all about. It is against this background that one can review the issue of tax arbitrage which has been in the spotlight in the Budget.

Investors preferred to save in FMPs as the capital gains tax was applied at a lower rate of 10 per cent or 20 per cent compared with bank deposits, which were taxed at the income tax slab rate. This was a tax anomaly, which put bank deposits at a disadvantage and was corrected by putting debt funds gains on par with interest on deposits.
The exception now is that debt-based growth schemes would qualify for capital gains tax at 20% if kept for more than three years. Using this logic one can question the sense in still exempting equity gains from any tax if held for more than one year.
First, what is the justification for giving special treatment to equity? Fresh equity helps in capital formation and hence there is a priori justification for giving exemption. But does this hold for secondary market transactions?
Here there is only transfer of money from one buyer to seller and the company does not get money. But high secondary market activity provides a boost to companies to raise more equity and hence indirectly helps investment.
Besides, such exemptions are a reward for risk-taking unlike debt, where returns are known before investment. But there is a counter argument here. While primary purchase of equity and subsequent sale after an acceptable period of time can be tax-exempt, a secondary market deal is speculative.
There is no value created for anyone except shareholders who could reap high rewards. When the company value goes up, existing shareholders enjoy the benefit even though the company is not going in for additional investment. Therefore, such gains have to be taxed.
 
In fact, using Piketty's logic, it could be said that the principle of not taxing such gains is a clear case of capitalist advocacy influencing policy making. It is a measure of growing affluence, which needs to be taxed to lower policy-induced inequality.
The argument of risk-taking cannot be justified here as the decision is based on personal choice and does not lead to the Keynesian animal spirits leading to investment.
There is little anecdotal evidence to formation increases. In fact it has been coming down in the past few years even as the market has done well. Investment decisions are based on demand, interest rates and overall economic conditions. Curiously, money invested by debt funds and bank deposits qualify better for tax benefits.
Bank deposits are diverted directly to lending according to government dictats through priority sector lending, or into government securities through SLR stipulation, and hence meet national goals.
Investments made by debt funds go into corporate bonds, CDs and CPs — all used for productive purposes. Therefore, there is justification to argue that there is direct link with productive activity. How can the issue be resolved? We need to see if there is a link between secondary market activity and primary equity issuances as also the tendency of companies to prefer equity to debt. Equity issuances in the past 10 years have crossed `40,000 crore only once and have been less than Rs10,000 crore in the past three years. Corporate debt raised has averaged Rs3.3 lakh crore in this period — corporates prefer debt to equity as source of finance.
The stock market has increased by almost two-thirds during this otherwise dismal period while it has soared by a multiple of four times over a decade. Quite clearly, equity issuances have not increased even as the secondary market has boomed.
The boom in the secondary market has often been linked with foreign institutional investor funds and the accompanying sentiment and has been divorced from economic fundamentals.
This being the case there is reason for revisiting the tax benefits provided to gains on equity to bring about financial parity. In fact the existence of this tax arbitrage will channel more money into this higher risk alternative. The way out is really to put all savings on a similar plane. Small savings too would be under the scanner.
But there are limits on investment that can be made here and they are locked in for a longer period of time. This lock-in concept should now be extended to other instruments as well. Hence, if a three year lock-in is required for debt growth schemes to qualify for capital gains, the same should apply for bank deposits as well as equity.
Risk cannot be accorded any tax benefit except for the entrepreneur, which is available through tax holidays. According special status to equity gains hence may not seem convincing.
While this may sound heretic in today's world where stock market indices have become the barometer of sentiment and confidence, such a step would be a very bold one, considering no one would like to disrupt this equilibrium, which may have a proclivity to the rich. But, if we are talking of correcting tax arbitrage, extension to equity may be argued as being a corollary.
 

On second thought: Financial Express: August 10 2014: Book review of Think Like a freak

Think Like a Freak is not based on hypothesis, but on facts vetted through experimentation, and offers a new look at conventional thinking

Think Like a Freak: How to Think Smarter about Almost Everything
Steven D Levitt & Stephen J Dubner
Penguin
R499
Pp 268
WHEN ONE picks up a book by Steven D Levitt and Stephen J Dubner, which has the word ‘freak’ in the title, one knows what to expect. Think Like A Freak is the third book in the trilogy and encourages us to think out of the box, or think like a freak. Often, we prefer to go along the trodden path, which is okay, but thinking like a contrarian may help differentiate ourselves and, more importantly, can make a difference to our working lives. If we go by what the authors believe, thinking like a freak often provides better solutions.
The book is 211-pages-long, with over 40 pages of notes, which include discussions with various people and the experiments carried out to prove their point. Therefore, it is not based on hypothesis, but on facts vetted through experimentation. This, in fact, is one of the areas that the authors talk a lot about—why is it that the three most difficult words to say are: I don’t know? Starting from the point where there are no clear answers (like the question on who caused the 26/11 Mumbai blasts, for which answers would be different for people in different geographies), they go on to attack the group of economic and business forecasters.
The authors believe that no one can tell the future and all the predictions made by various forecasters in the market resemble a ‘chimp throwing darts’. The probability of going wrong is high, but normally these errors don’t matter because no one remembers them. This makes one think that all the prizes and accolades won by various luminaries could have been just due to chance. Here, they single out Thomas Sargent, who won the Nobel Prize in economics. Sargent said ‘I don’t know’ when asked about how CD rates would behave in the future. All of us fall into a trap, something that’s called ‘ultracrepidarianism’, which means that we all think we are experts on everything, including things we do not know. One is not sure how brokers, investment bankers and fund managers will react to this conclusion, as they spend most of their time making forecasts and compelling investors to believe in them.
The authors also talk about advertising, asking as to how can one be sure if a campaign has worked. They give examples to show that even when there is no advertising, sales are not really affected. This may sound blasphemous to advertising executives, but companies are still hesitant to end advertising, as it has become a tradition to advertise notwithstanding the uncertainty of the results. Similarly, their story on wine tasting is quite remarkable, where experiments carried out for wine tasters did not quite show that they rate the most expensive ones as the best wines. In fact, contrary to expectations, they put a higher price tag on lower-priced wines, which just goes on to show that most of these are just marketing gimmicks. Their conclusion is that we need to have experiments to prove or disprove any theory we have.
At another level, they also point out that often we do not know the problem and while we always think we have answers, we go the wrong way, as we don’t understand the problem. Here, they give the example of a hot dog bun contest, where the winner put his mind to the task and developed an innovative way to win the competition by eating more than 20 hot dog buns than the earlier record-holder by separating the bun and dog and dipping the former in hot water with oil to allow for easier transmission into the alimentary canal. This is what one would do if they thought like a freak.
By telling various stories the authors emphasise that we need to always ask questions and then search for the answers through experiments and not remain ‘dogmatic’, which is what we normally tend to be. The 40 pages of notes help drive home the point. While some stories are light, they also show that we need to get to the root of the problem. Here, they give the classic case of governments giving food to the poor, which does not quite alleviate poverty. We need to give them incomes and, for that, job creation is necessary. Here, we can juxtapose our own poverty alleviation pogrammes, which do not create value.
Let us look at some other cases of thinking like a freak. The authors urge us to think like children and look for easy answers. Here, they give the case of improving the performance of children in schools in China by merely providing spectacles to them, as it was found that most of the children had visual defects and hence were not able to study. Also, to improve savings in the US, their solution is that instead of over $60 billion being channelled through lotteries, such money should be put in banks, where a part of the interest on these savings is used as lottery and distributed. This would help the person preserve the capital value and also add to the savings of the economy.
On incentives, they tackle the problem of saving electricity and show how different approaches can get disparate responses. Surprisingly, the moral code comes first (save environment) followed by social (helps society), economic (saves money) and herd (others also do so).
Another interesting experiment was carried out by Brian Mullalay, who started the process of plastic surgery for children under the banner, Operation Smile, where the team went around performing free surgeries. When they realised that the demand was higher, they diverted funds to train doctors across the world to perform the operations, which helped save a lot of money. This is innovation used for better results.
The company Zappos has a unique way of dealing with new employees. They pay them wages as low as $11 an hour, but the employees still have a high level of satisfaction. In fact, when they join and are trained, they are offered $2,000 to leave if they want to. The idea is that they don’t like to keep an unhappy person who would strain their financial resources. This is again a way a ‘freak’ would look at the issue. In fact, they feel that all recruitment forms should be lengthy, so that only those who are genuinely interested apply. But companies are averse to doing such freaky things, as they will get fewer applications.
But there are repercussions to an incentive system, which was witnessed when the World Bank gave incentives for destroying environment strainers. China began a drive to claim these incentives, which were analogous to the ‘cobra effect’ during colonial India, where incentives were given for cobra skins—people started breeding them to claim the incentive.
Probably, the most intriguing freak-like story narrated here is of the legendary rock group Van Halen, where they had a 53-page rider that their organisers had to read to prepare for their show. One never figured out why the group was against M&M browns. A lot of discussions went into whether they were eccentric or had something against the product. It was revealed by their main singer, Lee Roth, later that this clause was put in the list as a test. If the browns appeared at the show, it meant the organisers had not read the rider properly.
Now this one is really good: the freakiness in thought comes out when the authors get into the mind of a football player who is taking a penalty kick. Normally, everyone kicks to the side, as this is where the goalkeeper dives by instinct. If you are a freak, then you should aim at the centre because no one expects it. But there is a risk, as if you fail, everyone will scream at you. Therefore, one tends to get ‘selfish’ and shoot at the corner.
Think Like A Freak is a pleasing book to read. It is more a collection of stories, where people think differently and hence it is in praise of the contrarian. Sure, there are pitfalls, as things do not always work. But then the authors feel that one should not feel hesitant to quit, as they had done when they thought of being golf players or musicians, but ended up writing books instead.

Leave the banks alone: Financial Express: 8th August 2014

The idea of waiving of loans sounds specious as it appears that we are not doing the right thing. But if we are espousing the ideology of financial inclusion, then loan-waivers may not look out of place as they can be justified as being an extension of the same concept. In fact, it is mandatory for banks to lend 18% of their total advances to the farm sector. There is also an interest rate subvention scheme for agriculture where the banks are compensated from the budgetary allocations for the difference. Therefore, the debate is about whether or not there is a contradiction in our stance on waivers when there are sops being provided through other channels even though, prima facie, it appears to be something that should be eschewed. The issue has surfaced again as the Andhra Pradesh and Telangana governments have spoken of waiving farm loans (which might total nearly R1.2 lakh crore), and RBI has voiced concern as this is not a prudent practice. The earlier government at the Centre had announced a major debt-waiver scheme in 2008 before the general elections which amounted to nearly R50,000 crore. The way the scheme worked was that banks and FIs would waive off loans of marginal farmers fully and partly for 'others' who repaid 75% of the loan on a one-time-settlement basis. The government then passes this amount on to the banks through budgetary allocations over a period of time. Writing off loans for farmers is popular, especially from the political standpoint, as it helps curry favour with the electorate. The rationale always given is that the farmers are not able to repay their loans on account of unfavorable monsoon and consequent poor yields; therefore, they need to be helped out. But then, shouldn't that hold for any borrower who cannot repay loans for certain genuine reasons? Normally, most defaults are due to economic conditions turning unfavorable if we leave aside the cases of mismanagement or business failure. The argument goes that if industry can be provided with options like restructuring since projects get affected due to extraneous reasons, farmers too should be entitled to some benefits, where waivers are one option. The counter argument then is that how does one tackle loans that cannot be repaid by SMEs, which also constitute a part of the priority-sector? These loans are too small to be restructured but also require affirmative action from the government. If this argument is acceptable, then where should we draw a line and stop giving relief? The argument against any kind of relief either in the form of restructuring or write-offs is that it impinges on the operations and credibility of the financial system. Bankers would be in a quandary on whether or not to lend and could also dilute their standards knowing well that there are options available to avoid classifying such defaults as NPAs. Therefore, RBI needs to ensure that this credibility is not diluted in any way. The problem with loan-waivers is that they invariably create a moral hazard of two varieties. The first concerns the farmer given there is an incentive to default with the hope of a waiver. It also, in a way, punishes those who repay their loans on time as they would never benefit from waivers and hence forces them to also become deviants. It becomes a risky game as there is a good reason to not repay as there is no retribution. In case of personal loans, any default on credit card or mortgage installment automatically gets recorded in the centralised registry which disqualifies one for future loans. This does not happen in case of farm loans. Hence, loan waivers should also carry a stick along with the carrot when invoked or else default can turn into a habit. The second is that once it becomes a political game, there will be competitive waivers, especially before elections. Usually such waivers come from the Centre but if states also indulge in such activity, then it will mess up the system. But once it is done, not promising or announcing such programmes could cause the electorate to look for alternative parties which promise the same. This is a credible fear as it has been felt that the present case of waivers from AP and Telangana may not be based on desperate circumstances such as drought but more on a political considerations. The CAG, in its audit of the 2008 loan-waiver scheme, found faults with the implementation which are now ubiquitous in the case of almost all state-sponsored schemes. The real beneficiaries tend to get left out and those who do not qualify for the same are provided the benefit. Very often, rich farmers, capable of repaying, are covered and small borrowers get left out. Also, waivers have been given to MFIs when they did not qualify for the same. Further, there are delays in the banks being paid by the government which affects their own liquidity. This becomes a problem as liquidity of banks is affected by such delays. Given that this is not a good practice as it makes light of the concept of appraisal processes which are the raison d'etre for financial intermediation, how can this be reconciled with financial inclusion? Today, banks, per force, have to lend to the agriculture sector a fixed proportion of their resources and charge a lower interest rate. Further, when these loans are not serviced there is a case for waiver which, though helpful for the borrowers, denudes the efficacy of banking. The concept of waiver should be done away with by the central bank and the government needs to look at other ways of compensating the borrowers in times of stress like providing jobs under NREGA so that they are ultimately able to service their debt. The major threat we have today is that there is too much focus on financial inclusion which actually clashes with the basic tenets of commerce where banks are being forced to lend in a desired direction. The fact that for the system, the targets are just about met and not exceeded indicates that on their own volition, it may not be the first choice for banks. With pressures on capital, quality of assets, inclusive banking on the savings side, banks are already faced with challenges. Governments should try and avoid bringing in politics through loan-waivers or else we will be vitiating the system.

Less for more: Financial Express 3rd August: Book review: Indians ina Globalizing World : Dilip Hiro

Indians in a Globalizing World, which says our economy has generated a large population of have-nots, leaves the reader with a sense of unease.

The impact of economic reforms in India has been a debated subject, with there being two sides to it. People like Jagdish Bhagwati, Arvind Panagariya and company have elaborated on the progress made because of private sector initiatives. The trickle-down theory has worked, as seen by the jobs created and the growth in consumerism. The solution is that the government should continue to provide such incentives to further the growth. Then there are people like Jean Dreze and Amartya Sen, who still feel that things are unequal and that there is a need for the government to take affirmative action to ensure that the poor are made less poor.
In between, there are a lot of statistics to show what all has happened despite the government being there, which has only added to the inefficiency wherever it is involved.
It is here that Dilip Hiro makes his contribution to the debate in his quite remarkable book, titled, Indians in a Globalizing World. His contention is more on the side of the antagonists of reforms, where he shows that, at the end of the day, the New Economic Policy (NEP), which was a part of the Washington Consensus followed after 1991, has aggrandised inequality. It has resulted in the rich being the main beneficiaries and the poor being left out or left just with illusions and tidbits in the form of the state spending money on social welfare programmes. In the process, we have created several success stories in a skewed economy tilted against agriculture, harnessed corruption of large magnitudes with the involvement of the government and the private sector, and generated a large population of have-nots, who, while being driven to the edge by the government-industry nexus, have fallen back on the support of terrorist outfits. This end result is far from being comfortable.
The way Hiro builds the case in the 10 chapters is interesting. The narrative starts with the township of Gurgaon, which is representative of everything that reforms and their consequences are about. There are several offices and residential complexes that have come up in Gurgaon, which show the affluence. The back-office call centres represent the globalisation and the absence of infrastructure displays the lacunae still in the system. The growth of slums and the disparity in incomes across these settlements and the super-affluent complexes tell us everything about what the new economic policies have achieved. More importantly, Hiro focuses on the call centres, which have created several jobs, but are low-paying and with a high degree of insecurity in tenure. This is what the NEP brought in.
India certainly has become global and made a name for itself in international circles. If one looks at the proliferation of Indians in the IT industry of the US and the growth of some Indian companies that have entered the world league, the story is one of bewilderment. Indian companies have made inroads into the UK too, with the Tata and Mittal groups going in for acquisitions of a scale that could never have been conceived before. Quite clearly, these achievements have been made possible because of the economic transformation in the country.
But our preoccupation with wealth creation (we can take pride in housing a growing number of billionaires) has made us concentrate our efforts on the richer segments of society in the name of supporting productive sectors. This has had two repercussions. The first is that the state of agriculture has been neglected and this is something we realise every time there is a delayed monsoon. We have actually lost out on the benefits of the green revolution and have left it to nature to address the issue of food supply. The case of farmer suicides due to their inability to repay debts is symptomatic of this malaise, which has crept through the various corners of our social fabric. In fact, Hiro is critical also of the present institutional framework, which is not fair to farmers when it comes to lending. This forces them to go to money lenders. It has led to farmers turning to other occupations, leading to large-scale migration to urban areas.
Second, the result has been creation of large slums in these areas, which has had a number of negative consequences in terms of the pressures on housing, urban infrastructure, unemployment and the wider social problem of crime. In fact, the author also points out that our public distribution schemes, such as PDS, are severely flawed and need to be revisited with a sense of urgency.
Alongside these developments, the author also talks a lot of the ‘sleaze’ that has entered our society with the quest for wealth being enormous. He exposes wide-scale corruption and the close nexus between politicians and beneficiaries, which is industry. Here, he talks about scams like 2G, CWG, coal, etc, and points out that these are not new and that even in the 1980s we had the Bofors and Howitzer deals. Further, corruption is quite deep-rooted in us and the entire model of decentralisation has only created more layers of corruption. He gives instances of both the main parties in Tamil Nadu, DMK and AIADMK, giving cash incentives to voters to vote for their parties.
The private sector is no less than the government. The methods used by brokers like Harshad Mehta and Ketan Parikh, and the transfer of money to politicians added to the sleaze. The irregularities, which have come to the forefront in the cases of Satyam and IPL, are manifestations of this malaise.
Putting these developments together, Hiro points out that we have created a new problem—the rise of Maoism. Here, he goes into the details of the growth of this movement in Chhattisgarh. The case here is quite clear. Public land has been sold by the government in return for rewards to industry. For the tribal population, who live on this land and who are promised rehabilitation, there is an absence of justice, as the promises have not been kept. They, in turn, seek justice from the Maoists whose answer to these questions ranges from driving out industry through kidnappings to killing politicians and the security forces. This is the new form of justice and war, which we cannot escape.
While one can argue about the rights or wrongs of the issue, at the end of the day, we have created this new movement, which, as per the author, works well for displaced people. While the government has taken stern action against the sympathisers, it’s not a solution. Therefore, this development can be treated as a consequence of the uneven distributive system that has been created by us, where policies have been geared only towards capitalists.
But things are changing and the author argues that the growth of the new civil movement against corruption and a call for greater transparency have helped to a large extent in creating greater awareness. Hopefully, things will change for the better.
By the time one finishes reading the book, there is a sense of unease. There are no clear answers here. The rich feel that a lot of good has come to the country because of these reforms and hence they have an air of superiority about them, as they are convinced that they have deserved it, going by the law of economic Darwinism. Those on the fringe, who see the goodies around them, feel that they can get something somewhere. But those in the interiors don’t feel that gung-ho about reforms because they are still waiting. There are no solutions to this situation, which is understandable, as they are not quite within the grasp of our thinking today.

Why we still need the APMC laws: Business Standard: August 1, 2014

States need to create alternative marketing structures for farm produce since middlemen also provide vital services that are otherwise unavailable to the farmer

One of the issues often raised in the context of high food inflation is the pressing need to change the Agricultural Produce Market Committees (APMC), the marketing boards established by state governments. The earlier United Progressive Alliance government had asked the Congress-ruled states to remove fruit and vegetables from the ambit of APMC. Curiously, there has been little progress and the argument here is that a solution cannot be found by merely taking out products from the APMC laws. That exercise must be aggressively supplemented with new structures. Also, though it is true that the existence of the APMC channels does inflate prices the basic cause of food inflation is supply shortages, which cannot be covered by dismantling these laws.

The APMC laws were drawn up to protect the farmer from middlemen. It was mandated that all farm produce must be sold in the state APMC where the farmer is located. After the primary sale, farmers could move out to the rest of the country. The idea was to ensure that the farmer got a fair deal and was not cheated since the mandis have facilities for auctions, weighing, storage, display, payments and receipts. The result was not really positive. There are auction platforms in two or three of the mandis while grading facilities are available for about a third of them. Cold storage provisions are available in less than 10 per cent. It is alleged that the buyers who are licensed middlemen work as a cartel and keep prices low. No new licences are issued because there is no space for more shops in this area.

There are 7,190 regulated mandis and another 22,505 periodic markets in the country. Given India's size, the average coverage is 115 sq km, whereas the ideal should be 80 sq km or a radius of five km. Therefore, access is quite difficult; it means farmers have to travel a long distance to sell their goods every day. If one tries to understand the system, it will become clear why the mandi system continues to be a preferred option.

The mandi is a known system for the farmer and the practices, though opaque, are accepted. The farmers know the adathiya or middleman and the latter is sure of a sale. If the farmer were to sell elsewhere, he would have a problem getting a better price and as well as finding someone who will buy his "size" of the commodity. A farmer bringing, say, one tonne of a food product would not be able to sell it across the counter in the absence of an institutional set-up. He has to sell his produce the same day because there are no facilities to store the product outside his farm. Therefore, even in a state like Bihar, which has abolished these laws, there has been no change in the pattern of sale.

Further, though we like to criticise the middleman for buying "low" and selling "high", he actually provides a service in stocking the good. Typically, most crops have one season, kharif or rabi. Rice and maize, though primarily kharif crops, also grow as rabi. The kharif crop is harvested between September and November, and has to be made available through the year. This job is done by these intermediaries. And under normal weather conditions, they keep prices stable through the year. But there are costs involved such as storage, packing, transporting and, finally, selling the good across the country. Therefore, though we do lament the high price differential between the farmer and consumer, a large part of the price difference can be explained by these costs that are due to a lack of organised systems. Despite these structures, wastage could go up to six per cent for cereals and pulses, 18 per cent for fruit and 12 per cent for vegetables, according to a report on marketing reforms brought out by the ministry of agriculture in 2012.

Given these practical problems, merely scrapping APMC laws will not quite work. We need a multi-pronged approach to create alternative systems, a point that has been made in the past but never with any perseverance. We need to provide competition to mandis so that they become more transparent. ITC e-chaupals had made a major impact in the soya bean market in Madhya Pradesh and we need to encourage such systems that bridge information symmetry and deliver superior solutions.

First, having electronic private mandis, like the one promoted by the National Commodity and Derivatives Exchange (NCDEX), is one solution. But access for farmers is still a problem since we need to have multiple centres for delivery and the farmer may not always be able to deal directly on the electronic platform.

Second, periodic bazaars (Rythu bazaar in Andhra Pradesh, Shetkari bazaar in Maharashtra, Apna Mandi in Punjab and so on) should be more widespread and the responsibility lies with the state government to create create the infrastructure. By allowing such free trading farmers would enjoy lower costs, such as 0.5-2 per cent mandi fees, commissions that can go up to eight per cent for horticulture products, weighing and handling charges and so on. This has to be subsidised through state budgets or else we will end up in the mandi-like situation.

Third, contract farming is a good idea. It is allowed in several states where the processor gets into contracts with timers for buyback. But anecdotal evidence suggests that often farmers renege on their contracts and it is not feasible for the corporate to take legal recourse.

Fourth, corporate farming should be permitted on a large scale so that large retail chains grow the crops they can sell in their stores and create the necessary infrastructure to do so.

The system of agricultural marketing is complex and we need solutions that fit the system. Farmers harvest and bring their produce periodically and have no holding power in terms of money or storage facilities. Unlimited buyers in the mandi with an electronic auction system will provide the best result. But we cannot get rid of the middlemen who carry the risk and store the product for an entire annual cycle. Somebody has to do it. That is why this system will remain until we create alternative structures over time.

A rate cut seems unlikely: Financial Express 31st July 2014

Indications are there should be an unchanged stance bordering on caution and a wait-and-watch approach

The concept of credit policy has evolved over the years with a metamorphosis in thought, content and direction. Traditionally, we have had two policies with a slack and busy season that coincided with the harvest, and festival season when there was more spending by consumers that, in turn, increased demand for funds by industry for production. This distinction was contested and done away with towards the end of the 1990s. RBI did reserve the right to intervene to correct markets and there was business for economists and treasury analysts as they tried to guess RBI action based on economic and monetary conditions.
A couple of years ago, RBI decided there would be eight policies to reduce the noise in the market and make things more predictive. But when there was the forex crisis last year, interventions brought in some correction. The latest stance is there will be six policies with the right to intervene when required. But the direction seems to be clearly on reducing uncertainty in the markets as when players start to guess every time, they tend to create distortions.
The content of policy has changed. There was a time when the policy document touched on every aspect of the financial system and there were sections on bank lending, prudential regulation, market development, ULBs, etc. It was a comprehensive review and way forward for the entire system. This has also been dispensed with as RBI has separated all reforms and financial sector issues from monetary policy. The credit policy is now just a call on monetary policy measures with other issues being flagged separately through discussion papers and draft and final reports. Thus, the content is to be focused on rates and measures to control the growth in credit and in the true sense is a monetary policy statement.
The approach to monetary policy has changed too. Going by the textbook, policy is to target a tradeoff between growth and inflation and economists have argued all their lives in favour of one of them. If you followed the classical economics doctrine, then inflation-targeting would be preferred. If the dogma was Keynesian, then the die would be cast in favour of growth. Monetarism would say that policies could only work on growth in the short run and inflation-targeting would be the right way to go. But if you were on the path of rational expectations, then what would matter is the surprise element. Otherwise we always say that the market has already buffered in the move which, in turn, means that it would not work. The present regime at RBI has had some surprises in the past.
RBI, quite rightly, never committed to any theory and kept options open, which is what it should be. But now, with the Urjit Patel Committee indicating inflation-targeting, with CPI inflation being the anchor, the market has assumed that lower inflation is a necessary condition for any rate action from RBI. The central bank evidently will not just go by the CPI number, though it would certainly play an important role on the chessboard.
What then are the possibilities this time? Both growth in credit and deposits are subdued. RBI data shows that between April and July 11, incremental deposits are higher than the sum of credit and investments, which means that liquidity is not quite an issue today. Growth in deposits at 3.8%, though lower than 4.6% last year, has covered demand from the government and private sector. Logically, there is no reason to lower CRR or even SLR. The SLR stands at 26.7%, higher than the mandated 22.5%. Thus, even a token cut in SLR will not really work, though it can only signal that the central bank is willing to ease up here. But even last time RBI lowered the SLR, which may not have mattered but had the market on the back-foot considering that the authority sounded cautious on inflation.
GSec yields took a different turn with the new benchmark being announced at 8.4% compared with the 8.65-8.7% range for the existing benchmark. The new benchmark should lower rates, though the primary direction will come from RBI’s monetary policy announcement. CPI inflation came below the 8% mark in June, though inflationary expectations are still not positive for a rate cut.
The monsoon does appear to be recovering, which can improve the situation, though one cannot be sure of the final kharif crop that will determine the direction in movement of prices. While we have buffers in rice, the same is not available for pulses, oilseeds, coarse cereals and sugarcane, and hence the element of uncertainty remains. In this situation, it appears unlikely that rates will be cut, and whatever has to happen on interest rates will be driven by the GSec market. The new benchmark will take time to evolve as there needs to be more than the present level of R7,000 crore to make it truly representative of the market conditions. The 8.83% security has stock of over R80,000 crore.
The monetary policy statement is anyway a short statement and the contours are fixed. There would be a call taken on expected growth in deposits and credit this year and any revision in the macro targets of GDP and inflation. The GDP growth range of 5-6% with mean of 5.5% is similar to what the ministry of finance has assumed in the Economic Survey and is unlikely to change as there are not really any fresh data points that have come in to justify any change in stance.
The view on inflation will be cautious and while the Iraq crisis has moved over, there is still some concern on the Israel-Palestine conflict. But the overwhelming factor will be the domestic developments relating to monsoon. Inflation in manufactured goods has shown upward tendencies though not serious enough to press the button. Therefore, all indications are that there should be an unchanged stance bordering more on caution and a ‘wait-and-watch’ approach.
The next review would definitely be at a time when the clouds would clear on the domestic economic developments to gauge the future movements and hence a call on rates. Until then, industry will have to carry on with the status quo.