Rebooting India – Realizing a Billion Aspirations book review: Reboot, please! Book Review Financial Express Nov 22, 2015

Rebooting India: Realizing a Billion Aspirations
Nandan Nilekani & Viral Shah
Penguin
Pp 337
R799
A LOT has been said about how technology can change the way we conduct our lives. The fact that we can do so many things online today is testimony to this advancement. This is the crux of Rebooting India: Realizing a Billion Aspirations. However, the title is a misnomer, as the book tells us more about how technology has already rebooted the country in certain respects rather than what could happen in the future—especially in terms of government and governance—which was posited at the beginning.
Nandan Nilekani and Viral Shah, both renowned names, hence disappoint by not giving too many ideas for the future, and by instead carrying out a descriptive discourse on the past. However, if we consider this book as one that tells us where all we have rebooted at the rudimentary level in the country, it is fairly comprehensive.
The authors do tend to go overboard with Aadhaar, which, though a success in terms of coverage, has its limitations. True, a verified unique identification (UID) number can be used for several purposes that involve sifting through data on citizens for various purposes. However, constant self-eulogies could put off the reader. The authors do admit that UID is not mandatory, but say it’s useful not just from the point of view of giving one an identity, but also in channelling welfare programmes such as Mahatma Gandhi National Rural Employment Gurantee Act (MGNREGA) and subsidies. All this is possible because a bank account can be opened on the strength of the Aadhaar card, after which transfers can be made. Models for new kinds of banks, too, will depend more on technology and less on human interface.
So technology certainly has made things more transparent when it comes to government services. It will also be a critical part of the effectiveness of GST, which has been put forward as the next big thing for the country. Once accepted, its implementation will depend on how technology is able to steer the loose ends so as to bring about an optimal solution.
The authors also talk of events like elections, which have now been technology-enabled, both in terms of voting and counting, cutting down on time and costs, besides bringing in transparency. The authors argue that elections should incorporate UID as well, so that people can vote for candidates of their constituency from anywhere in the country.
In fact, this might be just a couple of years away—the next elections could probably accommodate this requirement, which is growing significantly, given the migratory nature of labour in rural areas. Social media—using which candidates have been able to get closer to the electorate—being used for elections is another example of the success story of technology. In the 2014 general elections, this was an effective way for candidates to get into households and influence voting patterns. While one cannot judge the success of a candidate who chooses this medium over physical tours, it is a fact that social media has definitely enhanced his/her reach.
The authors also explain how technology can enhance efficiency seamlessly and ensure that things move faster. The electronic toll collection option at toll roads is another example of how technology has made life easier. The authors extend the argument to the legal and medical fields as well, which open up a plethora of opportunities for not just providers of these services, but also tech companies. Education is another area that has been touched upon, which, the authors say, can be transformed through technology. However, we still have a long way to go here, given our predilection for specific colleges and institutions.
Clearly, technology is the way forward, as it is a great enabler, as well as an equaliser in terms of being non-exclusive. The fact that the government has latched on to this theme is interesting and it is here that the authors could have elaborated on how the mindset should change. In fact, the progressive use of technology, which is labour-displacing, is a major issue for countries that are labour-surplus and face the challenge of providing employment. Every time a new technology displacement happens, a segment of employment is affected. A discussion on this, along with a perspective on how the new skillsets are matched with technology, would have made the book infinitely more interesting. But Rebooting India is readable, as it explains how technology processes work for implementing various schemes.
At times, the authors quote numbers that should have been cross-checked, like central subsidies accounting for 4% of the GDP. Or, for that matter, several conjectures on savings from various technology-based actions, which would have been more convincing had the basis for arriving at these numbers been explained. However, coming from persons with a non-economic background, this can be ignored.
The authors do state at the beginning of the book that if we identify 10 major issues, we can put 100 competent persons to have the jobs executed. This may be trivialisation—just like the single-window clearance that we talk about—given the complexity of the system in which we operate, which involves not just the central government, but states and local governments as well. However, they do speak of 12 such issues, of which some have been implemented like UID and others that are yet to be implemented. But, these solutions may not be transformational, as technology is more an enabler than a driver of the economy. We cannot simplify solutions to serious problems like
unemployment and poverty to single factors.

The irrationality of stock limits: Financial Express , Nov 9, 2015

Whenever the price of any agricultural commodity increases sharply, the standard response is to trace the problem to hoarding. It happened for sugar, tur, urad, soybean earlier, and more recently for onions in 2013 and once again for pulses in 2015.
The Essential Commodities Act is a tool that is invoked by the government periodically to impose stock limits on various holdings of commodities. This applies at the wholesaler and retailer ends, which can then also include exporters or importers to ensure that the scope for hoarding is reduced, which, in turn, brings down prices. Any violation can lead to seizure of the product beyond the prescribed limit and possible judicial action.
The government has invoked the stock limits for pulses and it has been claimed that by the release of such stocks, supplies have been augmented and prices have come down. A fundamental issue is the opacity of the concept of hoarding. Normally most crops have a single season harvest. Rice, maize, urad, moong, groundnut have two harvests but are primarily kharif crops. Wheat, chana, mustard are exclusively rabi, while soybean is only kharif. Once the harvest comes in, we have to wait for the next season before the fresh arrivals are available for consumption.
Therefore, the product has to be made available throughout the year across the country. For most of these crops except rice and wheat where the Food Corporation of India (FCI) has a procurement and storage system, there are virtually no carry-over stocks with imports being used to balance the requirement.
Now the fundamental question is that with the crop being harvested once and the requirement being throughout the year, it is but natural that someone has to hold on to the stock. Farmers do not have the holding power and sell at the time of the harvest. It is then the intermediates who get into action and move the goods through the country, dealing with wholesalers along the way, finally moving to the retailer.
Intuitively, the stocks are being carried by players who have to provide for warehousing, transportation, regular fumigation, insurance, etc, which, in turn, requires funding. Hence, while the intermediates are presented in an exploitative light in these conditions, the fact is that someone has to do these jobs.
Under normal conditions, the processes of stocking and releasing the product are seamless with minimum price variations through the year. However, once there is news of a bad crop—which is the case of tur, moong and urad this time—prices start moving up in advance and the dealers, who are also stockholders, take advantage of the situation and push up prices. Are they actually hoarding the product in a significant manner to increase prices or is this happening due to the normal market forces is a matter of debate. Hence, the distinction between regular stocking and hoarding is blurred, and every time there are expectations of lower production, the stock holding is interpreted as hoarding, which becomes illegal with penal action being taken.
Once the act of storing is treated as hoarding, then there is a major risk in the commodity futures market. A commodity futures market runs on the basis of credibility in price discovery, which, in turn, is enhanced by delivery.
While deliveries do not normally take place as it is inefficient being a high-cost affair, in India NCDEX has witnessed increased deliveries, which actually add weight to the price discovery process. In case of products like oilseeds (soybean and mustard) and pulses (chana), deliveries have been increasing with several mills using this platform effectively. If transactions take place based on price expectations, and deliveries are reckoned on the same, then the decisions taken are genuine and not based on pure speculative or day-trading forces.
With the government now coming down on hoarding, this market would be on weak grounds.
There is already news that some of the warehouses which stock commodities that are dealt with on futures exchanges have been raided and the stocks impounded. This is detrimental as genuine transactions involving hedgers would be set back. Stocks kept in the warehouses are being delivered and are a part of legitimate trading being in a transparent system.
The issue with imposing stock limits is that it gives rise to harassment of dealers and warehouses, which distorts the markets. It should be pointed out that no one stores a product just for the sake of it, and finally given the limited period where a product can be stocked, there are limits to which one can exploit a perverse benefit in these conditions. We need to use our judgement and differentiate between prices increasing on account of ‘hoarding’ and ‘genuine stocking’, which has an upside when the future is bearish for output. While profiteering will happen at the margin, other solutions like price ceiling can be a solution where the MRP can be fixed at the consumer end. The MRP can always be calculated backwards, as the procurement price in the previous season is known as well as the cost of carrying the stocks on a monthly basis, though admittedly given the plethora of qualities that exist for each product, a range looks more feasible.
At another level, there is a need to debate on the wisdom in having the FCI carry large stocks of rice and wheat with its open-ended procurement scheme, which has often triggered puzzles in the system where market prices increase due to low availability of wheat even while the country produces a high quantity, as most of it gets locked up with this agency. This anomaly has not really been highlighted, as typically the price of these two products should be stable to the extent of the MSP. But given that often millers complain of shortage in supplies, the culprit in hoarding happens to be the government itself. This needs to be corrected.
A run on hoarding is aggressive when prices are moving up sharply and affecting consumers. But, as has always been witnessed, such actions only cool prices to a certain extent, with the decline being in the region of 10-15% depending on the region concerned. In addition, the quantities seized have rarely been substantial to decisively increase supplies in the market. Therefore, attention should be more on augmenting supplies through production and right timing of imports and building buffers in all vulnerable commodities. The FCI can do this by having effective policies for releasing excess rice and wheat in its warehouses.

Doing business’ rankings don’t seem right: Business Line : November 5, 2015

Some countries have jumped up on the World Bank scale by tweaking a couple of parameters. Is the improvement for real?

The advancement in India’s rank in the World Bank’s ‘ease of doing business’ ratings does reflect the Centre’s efforts to improve matters . The progress made seems all the more impressive in view of our improved ranking in the Global Competitiveness Report of WEF, from 71 to 55. Surely, there is a lot happening in the business environment which may not have translated into actual investment, which is affected by other considerations.

The World Bank has revised the methodology for calculating the rankings; it has introduced quality parameters too, which puts us at 130 in a set of 189 countries compared with 134 last year. However, the new methodology does raise a few doubts.

Some improvements

India’s improvement has been marked in two of the 10 variables that go into this ranking. The first is on starting business where both the number of procedures involved and time taken have come down. This has also lowered the cost of starting business. There is scope here for further improvement, though there is need for initiatives from State governments, too.

The other variable that’s seen improvement is accessing electricity, where the number of procedures has come down from seven to five and the time from 106 to 90 days. Here again, there is scope for improvement. But there have been no changes in the other eight parameters such as credit, taxes, trading, insolvency, protecting minority interests, enforcement of contracts and so on.

If this picture is juxtaposed with the earlier World Bank report, the solution becomes clear: States need to work harder. None of the States had crossed the threshold of meeting 75 per cent of the desirable elements required for enabling business; seven States achieved between 50-75 per cent.

The other factors relating to insolvency or taxation would lie more with the Centre, which is still trying to grapple with issues of debt recovery. Here the problems seem to be entrenched and solutions have not yet been found. On taxation, hopefully the GST will make us move up the ranking table; the existing multi-layered system is a major hindrance to business.

Questionable approach

However, this particular report of the World Bank does raise questions about the overall approach. The change in ranking of countries has tended to be very drastic in a large number of cases. It is hard to believe that the situation could have changed so perceptibly over a short span oftime. Uganda, for instance, has improved its rank from 135 to 122 with one element on obtaining credit showing an improvement in rank from 128 to 42. Here again, the element of depth of credit information index jumped from 0 to 7 which enabled the rank to go up.

With virtual status quo on other scores, such a sharp movement casts some doubts on the final result. Similarly, for Kenya, the sharp improvement in rank was due to the electricity connection factor where the number of days involved came down from 145 to 110 and the related cost from 1081 per cent of per capita income to 1011 per cent, which by itself is very high. The rank improved by 14 positions.

These scores at times seem less than convincing. Too much seems to have changed in just a year, going by these assessments. Further, a lot of these objective scores are based on what governments state in their policies or manuals. At the operational level it could be different, which is hard to capture on a global scale.

The World Bank’s concept is certainly novel as there is no other such benchmark for comparing countries. However, wide swings in ranking do raise a red flag. To appear really convincing, the improvements should be able to sustain themselves over time.

India deserves better S&P rating: Financial Express October 22, 2015

The decision taken by ratings agency Standard & Poor’s (S&P) not to upgrade India or change the outlook to positive is disappointing. It has also been stated that it is unlikely to happen next year, which means that 2017 would be the earliest date that one can hope for a change. The rating for India has always been on the precipice of investment-grade bordering on junk status, with innuendos of a downgrade made whenever there is an impasse in Parliament. How is one to view this?
The challenge for most emerging markets is that once they start from a low rating, it becomes hard to move upwards, and the preconceived notion of ‘economic stratification’, analogous to the social hierarchies in Indian society, comes in the way. Hence, while there can be very strong arguments to support the fact that India should be in at least the ‘A’ category, once in the ‘BBB’ grade, movement upwards is hindered by the rating’s stickiness.
A country rating has to be looked at from the point of view of how the country performs over a period of time on various parameters. India’s economic growth has shown resilience over the last three years and notwithstanding the decline in the investment rate, the barriers that came in the way of growth have been resolved to the extent that there were policy decisions to be taken. Inflation has come down, and RBI has geared its policy towards targeting the CPI number. The balance of payments looks much healthier today with a net accretion of foreign currency with capital flows dominating this accretion. But, more importantly, one can confidently say that the worst is behind us and that there can only be improvement from hereon.
While investment could be a dark spot in our performance, it is also true that such spending has slowed down in almost all countries as the global economy is on the downward path and hence it is a universal phenomenon. The fact that the Indian economy is still sharp in comparison hence becomes important furthering the argument for an upgrade.
This leads to another way of looking at a country rating, which is a peer comparison made with other emerging markets or even developed countries. Now, going by the IMF or World Bank or UNCTAD reports, India appears to be fastest-growing economy, reckoned on the basis of the GDP calculation now common to all. A number of above 7% is impressive and the forecasts too are in a higher range from 2016 onwards. This also supports the hypothesis earlier that things will only look up from now.
If one looks at the way in which the economy has withstood shocks that emanated from extraneous forces starting from the tapering programme of the US Fed to the yuan depreciation, the rupee turned out to be one of the best-performing currencies. No doubt, the astute policies of both the finance ministry and RBI helped in restoring stability almost immediately after the shock. In fact with the help of other factors, such as low commodity prices, India’s external account looks very strong and resilient. Hence, compared globally, there can be a strong argument for an upgrade based on past, current and future perspectives.
One of the best ways to judge the perception held of any country is foreign investment. The Financial Times recently reported that India was the largest draw for FDI; this is significant not because of the numbers, but because the flow of such investment continues to be in the region of $35-45 billion on an annual basis. This also means that investors who are putting in their money in any country do so irrespective of the country rating and they do not find India less exciting because of the BBB grade. Opening up of sectors like defence and railway equipment or the relaxed limits for investment shows that the country is also eager to get more foreign investment. The WEF’s Global Competitiveness Report also reflects the country’s increased competitiveness with its rank improving to 55 from 77 in one year—this should definitely show somewhere in the country rating. Going by the theory of revealed preference, India does gain favour of foreign investors.
On the domestic-side, a lot has happened beyond the GDP-growth number. The government, over the years, has shown the determination to move along the fiscal responsibility path and contain fiscal deficit. Further, subsidies (food and fuel) have been rationalised and the impasse in telecom and coal cleared. This has been supplemented with a plethora of reforms in labour, banking, monetary policy target agenda, etc. While it is true that GST and land reforms remain part of the unfinished agenda, surely this cannot come in the way of an upgrade given that every country would have issues that may be red-flags from the pint of view of a ratings agency, but have to pass through the democratic processes.
Interestingly, the three issues flagged often: capitalisation of public sector banks, losses of SEBs and fiscal deficit are all inter-related as the onus falls on the government to maximise this function. So far, it has been done within the fiscal space afforded by both the central and state governments to ensure that the FRBM path is not violated in any way. While it is argued that the debt level is high, at around 70%, it should be remembered that it is largely in rupees and hence does not pose any threat. But even other higher-rated countries have issues on the fiscal side, with spending on healthcare, for instance, that put their accounts under pressure.
Does the rating matter for the country, considering that there is no national borrowing in the global space? It affects companies that seek to raise funds overseas as the sovereign rating becomes a barrier.  Second, as we are looking to internationalise the rupee, the country rating would be a consideration, especially if, say, a rupee bond is being raised in the euro market. Third, the country rating has become a prestige issue; rating classifications have now assumed the same significance as “third world/first world”, etc. Last, it does affect some investment decisions where calls on the destination of such funds are based on the country rating. Hence, while we do get in a lot of foreign investment, it would be better in case we moved up the alphabet.
But, at the ideological level, the process of assigning sovereign ratings should be reviewed and not be intransigent when it comes to emerging markets.

The Silo Effect book review: Breaking barriers: Financial Express 18 October 2015

The Silo Effect
Gillian Tett
Hachette
Pp 290
R599
WE ALL know that every organisation has several departments with each having some degree of specialisation. This structure is considered necessary. However, what’s also true is that sometimes these parts tend to work in isolation, irrespective of the grand strategic plans that every company talks about.
And this leads to what Gillian Tett calls ‘silos’—different parts of a system that do not communicate with one another—within an organisation. These silos could result in fairly catastrophic consequences for companies, exacerbated by the high degree of competition between them. In fact, this competition could result in employees becoming reluctant to share information with each other as well.
The Silo Effect is an excellent book. It takes readers through several examples of companies—Sony, JP Morgan, Bank of England, etc—which ran into trouble on account of these silos. The author, with a background in anthropology, cogently shows how silos and their impact can be translated in the context of societies, companies, regulators, hospitals, police departments, etc.
Talking about the financial world and, more specifically, the downturn, the way the cards came tumbling down during the crisis was largely due to the absence of conversation between various arms of the same organisation. One stark example of this is UBS. The Swiss financial services company had a small derivative desk, which took on large exposures sitting in the US. And no one monitored this. Hence, when the crisis struck, it was cataclysmic. The New York office was ‘long’ in the market, while the London bank was ‘shorting’ housing risk. The issue here was that the two offices did not speak to one another. The traders of London should have asked the financiers of New York questions and then corrected their position. But this did not happen. Hence, the chief risk officer of the investment bank was not aware of the collateralised debt obligations (CDOs) being built in the New York investment warehouse.
The rest, as they say, is history.
The Silo Effect is all about avoiding silos. The author not only provides examples of companies that bore the brunt of having such cultures, but also companies that overcame this problem by recognising its perils. In fact, there are some companies that actually took advantage of it and profited. The story of hedge fund BlueMountain Capital Management is relevant here. The CEO and chief investment officer Andrew Feldstein—who had earlier worked with JP Morgan—was aware of the perverse incentives that existed in the ‘silo’ system. By analysing these incentives and their impact on prices, BlueMountain exploited these and profited. For instance, Feldstein studied how Wall Street organised its activities into rigid teams and trading flows, which distorted markets and prices. He exploited this by buying low and selling high. They would sell some pieces of debt or create CDOs to create demand. Once Wall Street followed, as it was programmed to do, the prices would go up and they would sell at a higher price. The trick was to break down the artificial buckets, or classification, created by Wall Street when trading. This is a case of taking advantage of the shortcomings in the ‘classification system’.
However, the most glaring example of a company that ran into trouble because of silos is of Sony’s. In the 1990s, the company was well-known for launching multiple products in the same domain at the same time—Memory Stick, Walkman, Vaio Music Clip and Network Walkman were all launched in 1999. While it might sound impressive, this is exactly what brought about the decline of the company. Different departments at Sony would develop their own digital music devices with proprietary technology, which wouldn’t be compatible with another department’s. These parts, or silos, worked in isolation driven by their own departmental goals, which led to Sony’s decline.
Silos take a toll at the regulatory level as well. Take, for instance, Bank of England’s case. At the time of the financial crisis, the economists at the bank were aware of what was happening, but were more immersed with modelling, which had become a fad in the bank. It was assumed that the Financial Services Authority (FSA), the market regulator, would address the issues, as this wasn’t the job of economists. The then Bank of England governor Mervyn King felt the bank did not have the tools to curb any bubble. In this process, the spiralling problem of lending to ‘other financial corporations’ did not catch anyone’s attention and it was only when the crisis struck that they realised that there was a problem.
Interestingly, Tett doesn’t just stop at corporates in the book. She also gives examples of public services—like the fire department in New York—whose departments don’t share databases with each other. A simple thing like putting together data of all buildings along with their ages, the kind of people who live there, income levels, etc, would lower the perimeter of scrutiny for the fire department, which could then work towards focusing only on the more vulnerable buildings.
There are other examples provided, too, like how a computer geek in Chicago, US, changed careers and made the police department cross the silo barrier. In this case, the departments in the police force rarely shared information.
Here, the silos were broken down by mapping information of all departments and putting them in a centralised system, which helped track and predict crime.
The example given about Facebook in the book is the opposite of Sony’s. Here, the staff developed an internal silo-busting experiment by keeping boundaries of its teams flexible and fluid, enhanced by rotating staff between departments.
Silos, as per Tett, are an anthropological phenomenon. They arise because groups and organisations have created conventions on how they classify the world. While they do have their benefits, companies need to get out of silos whenever collaboration is required.
Some lessons that may be drawn from the book are that we need better coordination to overcome silos since they can’t be completely abolished. Job rotation and constant interaction between different departments of an organisation are necessary. Also, pay structures need to be rethought. The ‘eat what you kill’ approach of investment banks creates perverse incentive and must be avoided. Flow of information is a must across all departments to ensure that everyone knows what’s going on. The taxonomy, or classification system, must be reimagined—the case of Bank of England economists failing to see the leverage building in the system is a good example of what should be avoided.
The Silo Effect is an easy to read and entertaining book, as it gives several examples that aren’t just in the esoteric domain of the financial world. The reader will be able to relate to the book both at the general, as well as the specific level. At the general level, we always say different arms of the government work at cross purposes and that the left hand does not know what the right is doing. But even at the organisation level, departments are always competing and holding back information from one another. While managements try and foster competition, often the lure for rewards tightens these silos. And this can have disastrous consequences if and when a meltdown occurs. This is something that all companies should work towards avoiding.

RBI could create a fund as a counter-cyclical currency buffer: Economic Times, 14th October 2015

The draft framework on ECBs is encouraging as it seeks to provide greater access to companies while minimising risks for the system. The significant changes are in the areas of widening the categories of lenders that could be on board, longterm borrowing and overall cost.
ECBs prima facie are attractive as long as international interest rates are low and their differential with domestic rates high. Typically one would borrow from the global market at an interest rate that would depend on the rating of the company and country, to which must be added the CDS cost. Libor for six months is around 50 bps and the CDS would vary from 150-250 bps, depending on the timing and the company.
The RBI has lowered the all-in-cost to 300 bps above Libor for ECB between three and five years and 450 bps for above five years. This would exclude several companies that now have to borrow at lower rates. If one were to currently borrow in the domestic market, with a base rate of around 10%, only the best companies could do. It could go up to 14-15% for others depending on the risk perception. The ECB route certainly looks alluring in comparison.
However, a major risk which is often not considered is currency; the rupee has become very volatile. This is a global phenomenon and not linked necessarily with our fundamentals. For companies that have a natural hedge in terms of exports or other dealings that earn foreign currency, this would not be a problem. But for others, this risk can be significant Companies today operate on the premise that the rupee will be stable and that the RBI will not let it depreciate too much. But, what is the right rate of depreciation that we are talking of ?
In a longer time frame, which is say, a decade, one can say the rupee will depreciate by 3-4% per annum (see table). But then the interim period can be one of movement in either direction and of differing magnitude, and given that the ECBs have tenure of above three years, the interest payments as well as the principal amounts would be susceptible to risk. This is where companies carry a high degree of risk on their books.
The solution is to hedge the forex risk by taking forward cover. However, today with the annualised forward cover being in the range of 6.5-7%, which is almost the same on the NSE forex derivative segment, the cost when added to the limit set by the RBI would be closer to 12%, with the benefit from borrowing in the global market being eroded considerably.
It is probably this factor that has caused the RBI to recommend lowering of the all-in-cost ceiling. It now appears that the domestic interest rates will be moving in the downward direction. On the other hand, global interest rates will tend to increase starting in the US and spreading to other developed nations in course of time.
In such a case, the cost of ECBs would increase and simultaneously, the spread between domestic and global rates will reduce. This becomes important in our context, because ECBs have been chiefly responsible for the increase in our external debt.
In 2014-15, external debt increased from $446.3 billion to $ 475.8 billion, implying an increase of $ 29.5 billion. ECBs in net terms increased by $ 32.4 billion, which was almost 110% of the increase in overall debt. Further, ECBs account for around 38% of the outstanding external debt. Quite clearly, the RBI’s proposed guidelines would like to reduce the differential between the two markets.
However, it is true that several companies are not hedging their forex risk given the cost involved and are relying heavily on the RBI to ensure that the rupee remains stable.
The assumption is that the rupee will in general not fall more than the forward rate. If interest rates are to move in only the downward direction, then the forward rate will come down proportionately and probably encourage companies to hedge.
An issue that may be thrown up for discussion is whether the RBI can insist that all foreign borrowings should be backed by partial forward cover. A ballpark number can be that if the loan is for five years, onefifth of the sum should be hedged every year, which will lower the blow in case the rupee falls sharply. If it is for 10 years, then one-tenth has to be covered every year and so on. Hence the cost of 7% would be lowered proportionately.
Alternatively, the RBI can, through say State Bank of India, create and maintain a fund, where all borrowers have to deposit a certain proportion of the money borrowed, which could be 1% or 1/2% of their borrowings. This in turn should be made available to the contributing companies, which face stress when the rupee falls drastically and payments have to be made at a concession.
It would be a kind of counter-cyclical buffer created on dollars to maintain stability in the system. While RBI provided this cover to the FCNR (B) deposits raised in 2014 by banks, for private players, a solution has to be from within. The RBI can only be the facilitator.

Nobel for Angus Deaton – Hail Amartya Sen? Financial Express October 14, 2015

Given that economists today are sceptical about capitalism, the economics Nobel Prize this year going to an economist focused on poverty and welfare doesn’t come as a suprise. Angus Deaton has been recognised for his work on consumption, welfare and poverty, having worked in India and other developing countries on these issues.
With the Nobel for Deaton, the now-dated but infamous altercation between economists Amartya Sen and Jagdish Bhagwati should see the scales of global opinion tilt in favour of Sen—Deaton’s premise is that mere growth numbers mean nothing if the lower income segments do not see a commensurate flow of benefits. From a business perspective—and not just a humanitarian one—this large section must have enough consuming power because consumption growth led by the higher-income group alone can never be self-sustaining.
The Indian growth model since 1991 has had a top-down approach, with direct intervention chastised as being imprudent. Deaton would say that for an economy to flourish, we have to focus on consumption, not income. ‘Saturation in consumption’ has made developed countries turn to developing nations for furthering investment and production. In India, too, we have seen growth being stunted when low income groups did not have enough purchasing power.
This, as per Deaton, would be the pressure point for an economy like India—it must have greater equality and must increase the purchasing power of lower income groups to sustain development. The government should measure consumption in addition to income. Profiling for consumption through income-stratification would reveal whether or not consumption levels have gone up, and, by implication, welfare. Instead of GDP, we must look at gross domestic consumption (GDC) and its distribution across various income groups.
The National Sample Survey provides, by far, the most comprehensive data over time, and it is such extrapolations across income groups that should serve as the basis for future policy action. Deaton would very much approve of the calorie-based approach to measuring poverty—in retrospect, the approach of the Planning Commission was right. We need to improve the calorie intake of these sections by enhancing their access to consumption of other goods, too. In this context, the approach of the Food Security Act would stand vindicated as it is only when we reach out to this segment would the topline growth numbers make sense.
Deaton starts with the micro-level on consumption—how we allocate our income towards consumption. Price could be one factor determining how much of a good we consumer. But other considerations, too, are factored in, viz. alternatives, necessities, quality, etc. Hence, consumption builds at the economy-level based on decisions taken by myriad people at the micro-level.
Two implications emerge. First, Deaton observes that consumption changes very smoothly, unlike income that can change sharply. Consider a situation where rural incomes do not increase significantly and consumption for essentials remains stable. Then, with high inflation, there is less money left for buying other consumer goods. This scene has been playing out in India where demand has been affected for the last 3 years and industrial growth has been impacted.
The second is that if income levels of the poor or their consumption doesn’t increase, there will be issues for savings.
If consumption is fixed, savings would tautologically be just residual. Hence, trying to improve savings through incentives will not work down the line and the only way out is to increase their income of the households, with focus on households at the lower income levels.
This has some interesting implications for banking, which focuses a lot on financial inclusion (for instance, the Jan Dhan programme), including payments- and small-banks. All eye a greater share of the poor man’s wallet, in the form of deposits. But if the incomes of the poor do not increase, they will not be able to save.
At the macro-level, too, efforts to increase savings to fund investment must be made and this is where Deaton becomes important. His Nobel is a sort of confirmation of what Sen has long been arguing. We need affirmative policies to ensure that the poor are taken along in the growth process. It is not a favour, but a necessity, given that even though our population is large, we need to have a large consuming class; this is not possible unless we have such measures that take the majority along. Programmes like the the MGNREGS or loan waivers would find favour under this dispensation. Even India Inc will be looking keenly at this segment, as this is where great spending potential lies. Every October, there is an expectation that rural demand will pick and urban spending will increase, due to the festival season. But when more is being spent on food under conditions of unchanged income levels, there would be less money left for non-food expenditure.
At a broader level, Deaton’s recommendation would also move towards taxation policy and its impact on consumption. Policy makers and analysts have always argued for reduction of subsidies, and linking fuel prices to the market. An increase in crude prices, if not subsidised by the government, will affect prices of all goods, including food, as transport costs go up. This is where we need to use our judgment because the market system does not distinguish between the people and charges everyone the same price, which is not ideal in this situation. The repercussions go across consumption, production, savings, investment and growth. Angus Deaton’s contribution and the recognition of his work should, hopefully, strike the right cord with governments in all developing nations.
Relying less on the market and lowering our obsession with plain growth numbers will help us to focus and do right.

The Success Sutra: Myth and meaning: Book Review Financial Express: October 4, 2015

The Success Sutra: An Indian Approach
to Wealth
Devdutt Pattanaik
Aleph Book Company
Pp 147
Rs399
EVERYONE WHO is familiar with the Ramayana will be aware of the famous Lakshman Rekha sequence, where Ravan disguised as a hermit requests Sita for food and she has to decide whether or not to step across the line. In the Mahabharata, Krishna asks the Pandavas to burn down the forest, Khandavaprastha, which they are loathe to do until told that if it’s not done, they wouldn’t be able to build an empire. In another story from the Ramayana, King Dashrath requires sage Rishyashring to perform a yagna for him. But Rishyashring can’t perform it unless he is married. So princess Shanta is sent to seduce him and, eventually, he falls for her charms. In another tale, Queen Kaikeyi gets two boons from King Dashrath. She uses one for banishing Ram and tries to install her son Bharat as king of Ayodhya. However, her son refuses to become king.
These stories may sound moralistic, but Devdutt Pattanaik in his book, The Success Sutra, uses such tales to exhibit the four secrets of success for any business. If one were to relate these four stories (there are several more in the book) to sound business principles, they would be ‘decision taking’, ‘violence’, ‘seduction’ and ‘churning’, respectively. The book discusses these from different angles. If you are convinced with these analogies, you will enjoy reading this book. Else, it could get a bit taxing.
In this book, Pattanaik interprets corporate and business actions and structures through Indian mythology. While the idea is very novel, it tends to feel a bit forced at times, especially when a comparison doesn’t hold. However, his four points for success are certainly appealing.
Let us look at decision taking, an integral part of any organisation. Often, it’s the hardest thing, as there is always a chance of decisions going wrong. So how far do we go in taking such chances, provided we conduct preliminary analysis before reaching our decision? More importantly, once we go ahead with a decision, retracting it becomes difficult, if not impossible. Also, often people do not want to take responsibility for what they do, especially when the consequences of the investment are unknown.
Here, some of the aphorisms that Pattanaik comes up with are: decisions are good or bad only in hindsight and hence are rationalised in hindsight. And, more importantly, the person taking the decision is responsible fully for bad decisions, but also exclusively becomes the beneficiary of a good decision. One is, however, not sure if it really works this way in most organisations.
The author’s take on ‘violence’ is also interesting. His view is that without violence there can be no nourishment and any physical growth involves consumption of others. If there is development, it has to be at the cost of something else—more housing complexes mean less open space and so on. Violence is culturally acceptable in a society where we ‘take’ when no one ‘gives’. But it’s not acceptable in case the concept of ‘taking’ is not accompanied by ‘giving’. Hence, in an example given by the author, while giving away a child to repay debt is not right, violation of a patent, say, for a drug in the larger interest of society would be acceptable even if it’s moralistically incorrect.
The analogies get perplexing when he tries to put Shiva’s drinking of poison during the churning of the ocean in context of present business activity. The churning was done to obtain the nectar of immortality, but it released a number of things in the process, the deadly poison being one of them. By consuming it, Shiva protected humanity.
However, some of Pattanaik’s analogies do make a lot of sense. For example, his likening of ‘seduction’ of mythological figures to seduction of consumers will find many takers, as this is what all companies try to do. They reach out to customers to increase their top-lines. Further, when we talk of employee retention and rewards, the story also revolves around seduction. But such seduction, Pattanaik warns, could be a trick, a trap or even manipulation. It could, however, also be an expression of genuine affection. Given that almost all CEOs today are constantly urging their employees to work towards customer satisfaction, one would tend to think it is genuine, even if it is forced affection. The two, however, are inseparable.
The last sutra is ‘churning’ and since an organisation has several forces—ranging from production to accounting, research and sales—every organ plays a dominant role at some point of the business chain. The others have to submit when one dominates. When there is stringency, for example, accounts become more important than sales or marketing.
The author further stretches the reader’s imagination to relate Vishnu’s tools with different ideas: ‘conch shell’ for communication, ‘wheel’ for repetition and review, ‘lotus’ for appreciation and praise, and ‘club’ for reprimand. It is the author’s interpretation of these tools as symbols of expression and could easily have been interpreted as something else as well. A writer’s prerogative, perhaps?
Pattanaik also talks of the need to balance everything in life. Again, with examples from mythology, he shows how strategy and tactic represent force and counterforce, respectively—‘creativity and the process’, ‘ambition and contentment’, ‘hindsight and foresight’, etc.
Pattanaik concludes by saying modern management is all about chasing a target, but if we chase Lakshmi, the goddess of wealth, it creates conflict. At the heart, we have to have a fair exchange, that is, give so that we can get. Every component of an organisation is important and we need to keep everyone satisfied. This would be the route to success.
The book could get a bit difficult to read, as one has to think hard to relate the examples from mythology with the business world. The stories as stand-alones are quite interesting, but at times do not gel well with the advice being given. To the credit of the author, it should be said drawing such parallels, even though stretched at times, does require remarkable skills.

Interpreting the 50 bps cut in rates: Financial Express: October 1, 2015

The efficiency of monetary policy, as a rule, gets enhanced if there is a surprise element. If everyone expects the expected, then the impact is less distinct as the market has buffered in the same. The monetary policy announced on September 29 took the market by surprise with a bold and aggressive reduction in interest rate by 50 bps. This step can be called bold because we are assuming a certain inflation path to fructify while it is aggressive as the rate cut is of a higher order and a deviation from the 25 bps approach pursued so far.
Interestingly, if one goes back to the August statement, the rationale provided for not lowering rates holds even today. Inflation, though down, is expected to increase given that the ministry of agriculture has projected lower kharif production this season. Thus, ‘inflationary expectations’, which were the crux of the August argument, actually remain high. But as RBI is still looking at a number of close to 6% by January 2016, it was reasonable to assume that we are on the right path. The uncertainty regarding the Fed interest rate hike remains today with the added worry of funds moving out once lower rates in India are juxtaposed with higher rates overseas. FPI investments have been negative in the last two months. Yet RBI has decided to toss for growth and lowered rates. This should assuage industry, which has made it a habit of asking for interest rate cuts every time there is a policy. But will it work?
Let us look at the position of banks in terms of extreme cases. Deposits were around Rs 90 lakh crore as of September, of which Rs 82 lakh crore were time deposits. Assuming growth of, say, 15% from here on, incremental deposits would be Rs 12.3 lakh crore. Every 25 bps reduction in interest rates would benefit the system as a whole by Rs 3,075 crore as outstanding deposits would be on contracted rates and not be subjected to new lower interest rates.
Outstanding credit was Rs 67 lakh crore and assuming 10% growth in credit, the amount would be Rs 6.7 lakh crore. On the lending side, virtually 90% of loans get repriced almost immediately. So, of the total credit of, say, Rs 73.7 lakh crore, 25 bps reduction in rates would be a decline in interest income by Rs 16,580 crore. Hence, if both deposit rates and lending rates are lowered to the same extent at the same point of time, then there would be a loss suffered by banks. This is the conundrum of the ‘impossibility of proportionate transmission’ across banking business.
This is one reason why banks are quick to lower deposit rates, which will lower the cost for them immediately, while the lending portfolio would react with a lag by a smaller magnitude. In fact, to attain a closer to equilibrium net gain, banks would have to lower deposit rates by 125 bps to match the loss on loans on account of 25 bps reduction in rates (see table 1).
While one may complain about the transmission mechanism being tardy, the numbers presented show the practical difficulty in doing so. Add to this the high NPAs that banks have and the interest rate spreads tend to be very high relative to those in other economies.
With RBI and the government deciding that banks would be convinced to lower interest rates, which some have already done, the next question is whether this will really help in reviving investment in the economy. Would bank credit pick up merely because interest rates are lowered?
This is important because the ultimate goal of lower interest rates is to make borrowing cheaper. Ironically, on the day of the monetary policy, the RBI report on capacity utilisation shows that the average for industry had actually come down in Q1 of FY16 to 71.5%. This certainly does not indicate that industry will be in a rush to invest, unless there is a turnaround in demand conditions. Even in the past, lowering of interest rates has not always resulted in a higher offtake in credit.

Table 2 juxtaposes growth in bank credit with the repo rate for the last five years. There is evidently no clear pattern in the movement in repo rate and growth in credit over the years. The highest growth rate in credit was witnessed in 2010-11 when the repo rate was increased by 175 bps.
How then can this rate cut be interpreted? First, the aggression in the quantum could be interpreted as compensation for a partial decrease in retrospect for August when similar economic conditions and concerns made RBI think otherwise. Therefore, in effect, it is a case of 225 bps reduction in the rate. Second, as it has been overtly stated that the government will speak to the banks and have them lower their rates, one could expect the same. We could expect between 25-50 bps cut in base rates going ahead. Third, while rates will be cut and there could be some uptick in growth in credit in the third and fourth quarters, the impact on growth would be muted in FY16, which is also supported by the fact that RBI has toned down its forecast for GDP growth, albeit marginally from 7.6% to 7.4%, without mentioning any positive growth stimulus. Fourth, as a corollary, RBI has prepared the setting for the next investment cycle by working towards bringing down interest rates when companies actually borrow.
Last, as table 2 shows, interest rate has an important but not a decisive role to play in investment decisions as no one invests just because rates are low. Demand conditions, infra bottlenecks, supply of raw material, land and environment issues also influence such decisions. Therefore, we must be abstemious in terms of expectations on final outcomes.

FMC and SEBI: Finally in step: Buisness Line October 1, 2015

The merger bodes well for the commodity futures market in India, now that it has matured. But patience is called for

The merger of the Forward Markets Commission (FMC) with the Securities and Exchange Board of India (SEBI) is a major milestone for the commodity futures market in India. This idea is not new; it was floated seriously at least 12 years back when the commodity market was revived and three national level exchanges were in the field. At that time it was felt the FMC should remain a separate entity, given the unique nature of this market.

The commodity market came under the regulation of the FMC and was guided by the FCRA of 1952 with the FMC being a division of the ministry of consumer affairs (MCA). The argument put forward was that the market was young and needed attention and expertise. It could not be treated as a financial instrument since it involved the physical delivery of goods which in turn had a bearing on spot markets and prices. Therefore, the MCA would have oversight of this market. The spot markets are regulated by the APMC Acts which fall within the jurisdiction of State governments.

Over the years, the market has matured. In between there was a dent to the credibility of commodity markets with the NSEL failure, but the futures markets have carried on through this turmoil and emerged more resilient.

There have also been controversies regarding their links with inflation which has led to the banning of futures trading in specific commodities. Conditions have stabilised since, and there is evidently a need to take this market to a different level.

Good news

One way of looking at commodity derivatives is like any other financial instrument as is the case in several markets, including the US. Since India has separate regulatory structures — the FCRA and SCRA Acts dealing with commodities and securities — integration would be required. The first step taken earlier was to bring the commodity futures market under the ministry of finance and, as an extension, merge the FMC with SEBI.

What would this mean for the market? Commodity derivatives can now be looked upon as a financial instrument analogous to equity or debt. This will bring all derivatives under a single regulator just like in the US where the CFTC controls and regulates them.

This will be good news for brokers if there is integration of the two trading platforms. There will be some housekeeping to be done as all brokers need to register with SEBI. Exchanges too have to comply with the networth norms.

It is not known if the stock exchanges will be allowed to deal with commodities and vice versa for commodity exchanges. If permitted, there would be further competition in both markets, leading to consolidation at some point of time, which is always the case for financial infrastructure. The major consideration is to ensure that risk from one market does not spill into the other. This was the primary reason for commodities being separated from securities.

The consequence, however, was that the same broker firm would open a commodity outfit and then trade from the same office space under two banners. With a single regulator now for both the markets, and hence also for the exchanges, this issue needs to be resolved: whether or not there is need to have separate companies trading in two segments with separate risk capital.

The existing exchanges will definitely see a shakeout as stock exchanges venture into this space. It is unlikely, however, that in the absence of consolidation they can make a useful dent in the business of existing players. This is so because historically it has been observed that exchanges tend to get specialised in specific products and generate liquidity to the extent that it is difficult to wean away business. Hence MCX retains primacy in bullion and energy while NCDEX dominates the agricultural spectrum. New exchanges have come and barely survived, and more often than not been marginalised by market forces.

Therefore, it is not expected that things will be different if stock exchanges open these platforms. However, one never can tell.

High expectations

There are several expectations from the commodity market. The FCRA permits trading only in tangibles and hence indices were kept out of the ambit. This becomes pertinent now as weather indices could be useful for farmers, provided they understand the product. With such an index in place they can take insurance against rainfall through a market-oriented product.

Further, the FCRA does not allow trading in options, and with this market coming under SEBI there is expectation that then same will be enabled.

However, one must not overstate the business to be generated from options as globally options clock just 10 per cent of total business. In fact, from the top 20 contracts traded in farm and energy products, soyabean and corn feature on CBOT and crude oil on ICE.

But options would be useful again for farmers as they would resemble an MSP of the government, though in this case it will be options on futures.

Education will be important to ensure that they work for that community. However, it is expected that such options will enhance the use of futures and, in these uncertain times for farm output, would be useful tools.

Bigger field

An area that can see some momentum, even though SEBI has moderated expectations for the first year, is enlarging the field of players. Today, banks are not allowed to trade as banking regulation does not permit it.

Banks can play a role as aggregators for farmers and also cover themselves for the credit risk in lending to farmers once backed by a futures contract. Similarly, while direct trading may not be advisable now, at a later date it could be considered just like equity exposures under their investment limits.

Another area includes capital market participants such as mutual funds and FIIs which can add depth. Mutual funds can add value by diversifying their portfolios.

Today, it is debt, equity and hybrid products. Now with SEBI allowing such investments over time, there can be a sea change for the retail investor. However, given that delivery issues exist, there have to be exit routes to ensure that they do not get loaded with delivery.

Maybe special contract of non-deliverables can be considered. The same holds for FIIs where similar contracts have to be designed, since delivery can lead to challenges on the export-import front as well as stocking when there are shortfalls in production of commodities.

On the whole we can expect exciting times, but the market needs to be patient because SEBI will roll out reforms gradually, after consolidation takes place at the regulatory level.

Advantage small banks: Financial Express: 23rd September 2015

Small banks are the last bricks in the wall of financial inclusion that has been cemented by the Reserve Bank of India (RBI) and comes close on the permission to entities to set up payments banks. Small banks are a concept where the entity is allowed to collect deposits and use the funds for specific purposes with a focus on priority sector lending.
RBI has maintained a minimum paid-up capital of Rs 100 crore. Surprisingly, as of March 2014, there were 10 banks in the public and private sector that had capital of less than this level, which includes four associate banks of SBI, Lakshmi Vilas Bank, Nainital Bank, City Union Bank, J&K Bank, Catholic Syrian and Tamilnad Mercantile Bank. Hence, in terms of size, these small banks could compare well with the existing banks.
Further, assuming that the small bank starts with a capital of Rs 100 crore, the equivalent amount for an existing bank in FY14 would be Karur Vysya Bank, which had a balance sheet size of around Rs 51,000 crore, of which total advances were Rs 34,000 crore. Intuitively, one can visualise the potential scale that can be built on this size of capital over a period of time.
The basic concept involves a certain matrix in terms of lending. In fact, 75% of adjusted bank credit has to be for the priority sector that includes small farmers, micro units, etc. Further, there is a clause which says that 50% of total loans should be going to borrowers where credit is up to Rs 25 lakh. In addition, the prudential norms of CRR and SLR have to be met. Hence, for every Rs 100 of deposits collected, Rs 25.5 would be set aside for pre-emptions. Of the Rs 74.5 left, Rs 56 has to be to the priority sector (assuming adjusted bank credit is the base). Further, Rs 37.25 of total loans has to be less than Rs 25 lakh.
A look at the structure of credit in the banking system, as of 2014, shows that loans of size of up to Rs 25 lakh totalled Rs 16.71 lakh crore, out of a sum of Rs 62.8 lakh crore, with a share of slightly more than 25%. However, in terms of number of accounts, there were 137.1 million accounts with loans of each less than Rs 25 lakh, out of a total of 138.7 million accounts—share of 99%. Quite clearly, there is a large market in terms of number of accounts that can be targeted by these new banks. Intuitively, these banks can focus also on rural home loans to retail segment that would qualify under these stipulations.
The concept is again novel and with 10 applications being given an in-principle nod, there would be another ring of players in the market. The approvals are to eight microfinance institutions (MFIs), and one Local Area Bank (LAB) and Non-Banking Financial Company (NBFC). They are well distributed across the country with only two entities based in Chennai. They would be allowed to operate across the country with no restrictions. This appears to be a good enough experiment which is being tested before other players are allowed to join the fray.
The interesting thing about these small banks is that all of them are already in the financial business and hence do not have to start afresh. There are CRR and SLR norms to adhere to, which becomes important to ring-fence them from the risk associated with priority sector lending. However, the issue really is that priority sector loans tend to become vulnerable to becoming non-performing assets (NPAs) with the propensity being higher for them. In the past, the NPA ratio for priority sector loans has ranged from 4-5% while that of non-priority sector has been around 3%, with the number increasing to 4% in 2014 due to the problems in the infrastructure space.
The challenge would be to control NPAs here, as an unfavourable monsoon would have an impact on farm loans. Similarly, any slowdown in the industrial sector is first felt on the small and medium-sized enterprises (SMEs), which have payments problems. Therefore, on both scores, they would be at a disadvantage compared with the commercial banking system. Banks are able to diversify their portfolio by lending to all sectors which includes retail, services and manufacturing, while these banks would be left with dealing with the smaller ones only. Besides, given that these accounts would be small and well dispersed, the cost of monitoring would also be higher for them.
To the advantage of the licensees, their experience on this front would help them overcome this challenge as they already have relationships with customers in this area and only have to scale up. The rules allow them to open branches across geographies, though they have to be in unbanked areas. While this is an opportunity, the accompanying risk of focusing on the hitherto unbanked section would be a challenge. On the positive side, they would be able to garner deposits from the public, which will help the system to bring in more deposit holders as well as provide funding to these banks.
Two questions that come up are the following. The first is whether these banks will be able to add a ‘delta’ to the overall level of lending? This is pertinent here because these organisations already exist and are involved in lending. This portfolio, which hitherto was not part of the system, would get added to the bank credit level. But for the system as a whole, the incremental growth would be important.
The second question is whether these banks would also be treated like commercial banks in terms of having access to the money market and the RBI repo window. With them being subjected to the CRR and SLR stipulations, they should be part of the banking system and also be allowed to do treasury operations to manage their balance sheets.
While the concept of both payments banks and small banks will be tested over time, the small banks, being already in the business of lending, would have a distinct certainty in their operations. However, the fact that they will now be regulated and have to lend to the more vulnerable sections will ensure that they have to constantly be on guard when balancing their loan portfolios.

Capitalism at crossroads: Book review Financial Express September 20, 2015

Capitalism’s Toxic Assumptions: Redefining Next Generation Economics  
Eve Poole
Bloomsbury
Pp 187
Rs 499




AFTER THE financial crisis, there has been a tendency to highlight capitalist greed. A part of the critique has to do with the unethical nature of the system, which helps the rich get richer at the expense of society. But have we ever stopped to consider whether the capitalist system per se is faulty or whether the way it has evolved has made it less than perfect?
This is important because it’s largely believed that the market mechanism is the most efficient one and does not show partiality. This is where Eve Poole brings in her contribution by questioning the basic assumptions of capitalism in her book Capitalism’s Toxic Assumptions. We have all learnt that there are some fundamental principles of capitalism based on assumptions such as the ubiquitous invisible hand, market pricing, self-interest and so on. And in economics, as long as we have assumptions, the logical fallouts cannot be questioned. This, as per the author, is where we are completely wrong.
Poole argues that there are seven tenets on the foundations of which capitalism stands. However, these assumptions actually do not hold and are flawed. The first idea is competition. We are taught that in this system there is perfect competition. Here, Poole puts forward two arguments. One is from the point of view of math, where the assumption of large number of sellers and buyers competing independently to produce an optimal solution never exists. Game theory dominates the way business is conducted in real life and strategic behaviour moves on the basis of cooperation rather than competition. If we view the airlines loyalty scheme, the OPEC cartel, clearing houses and systems in markets, etc, the approach is one of collaboration.
The other argument put forward here is, interestingly, a biological observation, which involves greater participation of women in the system, which, in turn, guides the way business is done. Men typically respond through the ‘fight or flight mode’, which is competitive, but women follow the policy to ‘tend and befriend’, which is a collaborative approach. The greater participation of women has changed or modified the overall approach to compete. Poole’s corollary argument is that if this female mode of response had pervaded boardrooms during the financial crisis, it would have been resolved faster. This line of thought definitely sounds novel and is worth pursuing.
The second assumption relates to the existence of an invisible hand. This presumption, as per the author, though convenient for everyone, does not exist in the manner in which it was conceived by Adam Smith. The dominant players justify their unequal power by saying it’s the result of the invisible hand, even though they manipulate the markets to stay on top. The government accepts the invisible hand theory, so that it does not have to do much. The actual working of the market shows that it is never fair, is heavily loaded towards the rich and never delivers the theoretical benevolent outcomes. An example given is how the ‘invisible hand’ is loaded against developing countries—they have to open their markets to the West, but the western markets remain closed, with huge farm subsidies given to domestic markets to eschew free movement of goods.
The third assumption relates to utility or the premise that we work on the basis of self-interest. In practical life, however, we are not rational and don’t choose an optimal solution. Further, as we cannot read the future, we end up making the wrong choices, which models cannot capture. So the assumption that we are rational is an exception rather than a rule. The fact that we can be wooed by advertising to purchase goods defies rational behaviour. Another rudimentary example of how we end up not behaving rationally relates to how doctors are influenced by pharma companies when prescribing medication.
The fourth assumption of capitalism of the Smithsonian variety talks of the agency problem, where the management has to align itself with the interest of shareholders to take care of the principal-agent relationship. While we have a board of directors to guard the shareholders, they have no real interest. Does the board really guard the interest of the owners is a question that’s being asked today. The McGregor theory of motivation has been used by the author to explain why it’s necessary to turn Theory X workers (who have to be coerced to work and need supervision) into Theory Y workers (who are self-driven and address the issue of principal-agent). Giving stock options helps to align the management with owners, but drives a wedge with those in the lower-income echelons.
Next, capitalism assumes that market pricing is just. Do demand and supply always match? And second, is price always based on cost plus margin? Dan Ariely had shown that demand is driven by supply—as his experiment with shampoo showed that the ‘shampoo-rinse-and-repeat’ formula actually doubled demand—which then justifies a higher price. Further, the fact that the cost of tea varies in various locations such as cafes, hotels, etc, explains why the pricing is not perfect. Again, for goods where money is the basis of valuation, prices are no longer linked to costs. Here, examples of designer labels are given, where externalities, which are the order of the day, hold. Therefore, this assumption of price being determined by an invisible hand through market forces of demand and supply rarely holds.
The sixth assumption is the supremacy of the shareholder. This is whimsical and never really holds in practice, though all statements refer to working for the shareholder. This assumption has ended up fuelling an exponential rise in boardroom pay and encouraged a narrow view of corporate performance. These shareholders are actually elusive and cannot be identified. And often, all appeals made are actually for the well-being of the management. This has led to short-termism and a narrow definition of responsibilities.
Last, the assumption of the legitimacy of the limited liability model has been questioned by Poole. This makes shareholders bother more about gains than losses because their risk is limited. This makes them encourage aggressive risk strategies supported by incentive packages to maximise their returns. This means that both shareholders and senior management are aligned with share price maximisation with all accompanying dangers of the ‘get-rich’ strategy.
Poole is definitely not against capitalism, but only goes about proving that the classic system, as envisaged by Smith, does not exist. It has deteriorated to one, where the management works around the system, while the demand-supply mechanics are distorted, thus bringing about sub-optimal solutions—the breeding grounds for crises. This balanced view from another side certainly adds a fresh dimension to economic thinking on capitalism.
 

Enhancing doing business in states: The race begins now: Financial Express September 17, 2015

The report on an assessment of the implementation of business reforms by various states—brought out by DIPP along with World Bank, CII and KPMG—is interesting as it is probably the first of its kind. While analysing the extent to which states have achieved success when targeting 98 action plans, we get a fair idea of how states stand on a common scale. This is a starting point and, going forward, if this exercise is done on an annual basis, we will get a clear idea of the progress made intertemporally. Given the stark differences across states, there would be an incentive for those lower down the echelon to improve on the pace of business reforms, enabling faster growth.
India’s overall rank of doing business is low, at 142, in a list of 189 countries, and in only two parameters—on credit access and investor protection—we come in the first 100. The implication here is that we do well when it comes to regulation—where credit goes to RBI and Sebi—but falter when it comes to processes where there is human interface. Besides, most laws that have to be adhered to are localised and fall under the domain of the state or the specific town or city where activity is undertaken. Hence, a state analysis is more compelling to pinpoint the areas that need improvement, as often these stress areas are not under the purview of the Centre.
Potential investors look at the comparative environment provided by states before taking decisions. It matters more when the decision to invest is not based on the availability of something specific to a state—like minerals—when there are fewer options.


The results of this study are revealing. First, no state has complied with above 75% implementation of the 98-point action plan and hence there are no ‘leaders’ as per the report. The other three categories classified in terms of implementation performance are ‘aspiring leaders’ (50-75%), ‘acceleration required’ (35-50%) and ‘jump-start needed’ (0-25%). The bands have been kept quite wide, and the aspiring leaders are Gujarat, Andhra Pradesh, Jharkhand, Chhattisgarh, Madhya Pradesh, Rajasthan and Odisha. Some of these names do come as a surprise as they are not associated with high growth. The opportunities for mining, for example, in states like Jharkhand, Odisha and MP could be accelerating factors for the states.
On the other side, states like Maharashtra, Karnataka, Tamil Nadu, West Bengal, Delhi and Punjab, which come across as the more advanced states, are in the ‘acceleration required’ category. There are 10 states that need a jump-start, and eight of the set of 16 states have a rate of less than 10% with six of them being states of the Northeast. While these states have traditionally been neglected, the state governments should start becoming more involved in the growth process and create an enabling environment.
The study points out that there is little relationship between high level of implementation and per capita income or investment, though the trend line moves downwards for the former and upwards for the latter.
The table gives the share of states in the total number of Industrial Entrepreneurs Memorandum (IEMs) filed from 2010 to July 2015 in terms of number and value. It shows that six of the seven states in the ‘aspiring leaders’ category are in the top 10 states witnessing filing of IEMs. States like Maharashtra, Tamil Nadu and West Bengal are the others on this list, which has a lot of interest from industry notwithstanding the limited set of reforms that have been implemented.
Some conclusions can be drawn. One, while doing business may be difficult, it may not be a deterrent, provided there is opportunity. Highly industrialising states will still get higher doses of investment, notwithstanding the challenges.
Two, as a corollary, it can be said that if there is improvement in implementation of business reforms, there would be probably more investment flowing in these states. Therefore, these governments cannot sit back and have to work on improving these scores. Three, the relatively new states of Jharkhand and Chhattisgarh have done better, probably due to the mineral wealth and interest of investors. But Uttarakhand lags and falls in the ‘jump-start needed’ category. Normally, new states starting afresh would be better positioned and enthusiastic to make investment easier. Clearly, this has not happened here. In fact, even Telangana is in the acceleration required category, and hopefully will see a major change when the review is done the next time.
The report indicates the area where there has been maximum progress in terms of states implementing reforms is taxation—VAT, CST. This involves doing away with manual intervention with e-filing. The hint here is that, as the country introduces GST, there will be a lot of convenience for companies which will make doing business that much easier.
On the other side, wherever manual intervention is involved, reforms are harder to come by. Here the report talks of inspection in areas like labour, wages, bonus, shops and establishment, etc, where a lot needs to be done. Similarly, the idea of electronic courts at the district level has been covered relating to e-summons and e-filing of cases. Also, in the area of enforcement of contracts, conditions are pitifully slow across the country and would be a deterrent to investors.
Cross-comparison of states in terms of achieving these 98 action points is classified under eight categories. The table lists top five states on the scale in each of these areas along with the national average and highest score achieved by the leading state.
There is concentration in the performance of states, and it is members of the same group that dominate these lists.
When juxtaposed with regional disparities that exist across countries, it is a wakeup call for those governments where investment does not take place, so special effort has to be put in case these states have to advance. Those which are doing well but are low on implementation have to take corrective action, as there would be migration of investment to other states that are more hospitable to the same.

No Ordinary Disruption: The sign of four: Financial Express September 13, 2015

No Ordinary Disruption: The Four Global Forces Breaking All the Trends
Richard Dobbs,
James Manyika & Jonathan Woetzel
Public Affairs
Pp 277
Rs 799
TWO SUBJECTS that still get more authors than the financial crisis are ‘change’ and ‘leadership’. Both lead to several suggestions on how companies should plan the future and strategise for a better tomorrow. The book, No Ordinary Disruption, is written by three McKinsey Global Institute directors and, hence, was expected to provide several insights on what is happening in the world around us. The book does not disappoint and while it may not say anything different from what various management experts have been saying, it reiterates quite cogently the current waves that are sweeping us, which should help companies gear up for the challenge.
Let us see how the authors go about putting these ideas together. They point out that there are four major disruptions taking place in the world today, which have positive implications, but also have the ability to shock. The word ‘disruption’ is used from the point of view of major changes taking place rather than being barriers to growth. At the same time, not responding to these changes could make these phenomena impediments.
The first is that the fulcrum of economic and business activity is shifting away from developed countries to emerging markets—China leads the way here, with other emerging markets like India, Brazil, etc. The authors point out, quite interestingly, that the new power centres are no longer countries or regions, but new cities that have been growing. And these will dominate the global scene in the years ahead. This rapid pace of urbanisation, which is inherent in the transformation process, is the game-changer and will keep generating demand for various products at a progressive rate, providing new opportunities for everybody.
The second is technological change, which goes beyond what happened during the industrial revolution in the 19th century. Few would have expected the hydraulic fracturing and shale energy discoveries disrupting the oil economy, which we can see today—oil prices have crashed with this new oil coming in. Robotics is another field that is fast catching up, with autonomous vehicles without human drivers set to be the next big thing. The takeaway is that companies must keep thinking of ways to rejuvenate their business by leveraging technology.
Third, the demographic changes taking place are quite distinct, with a rapidly ageing population in the West. This trend is normally interpreted as being a burden for governments, wherein they have to provide social security benefits. Alternatively, it is looked upon as a blessing when dealing with the trait of demographic dividend for countries like India. But from a business perspective, two features stand out. The requirements and demands of the ageing group of people are quite different from the lower age groups, and the way forward is that companies should gear their product processes towards this population. The other is a mirror reflection of this phenomenon: the working population has been affected with the replacement demand not being met due to the non-availability of skill sets. This will be a challenge going ahead. A common development in all countries is that people who started working, say, 20-30 years back, have been through a phase, where their skill set became redundant, forcing them to reorient their professional course. This will continue.
The fourth disruption is greater connection through globalisation, which has brought people and countries closer. The two major areas, which have enabled free flow of goods across countries have traditionally been trade and finance. Growth in trade in goods and services has been hastened across the world with new agreements, bringing about considerable integration between countries. Finance has become universal with the proliferation of markets, resulting in easy access. The financial crisis in the US clearly showed how integrated the global financial system was, encompassing several countries. The authors conclude that smart planning, willingness to change and openness to new ways of conducting business will be attributes in harnessing the power of global flows.
However, the suggestions made for corporates are more practical. The authors say corporates need to think of new opportunities in terms of cities and urban clusters. Products have to be customised to meet local tastes and they need to build lower-cost supply chains and innovative models to become competitive. One has to design and control multi-channel routes to the market, and rethink brand and marketing strategies. Organisation structures and talent strategies have to be returned to this new setting. Here, the authors give examples of how some companies have been adaptive: Frito-Lay has captured 40% of the branded snacks market in India. Instead of tailor-making their products to local requirements, they created Kurkure, inspired by traditional street-side food. Tingyi in China became the leading food and beverage vendor by redesigning instant noodles just like Wrigley’s in the gum market.
Besides these four changes or disruptions, the authors also examine three other significant challenges for countries. The first is resource management. Here, the challenge is not just in the use of resources, but also in discovering new ways of doing things. A proactive stance needs to be taken, the authors say. For this, they put forward themes like recycling, efficiency and conservation. These lead to competitive advantage when resource prices become volatile, as efficiency efforts become the distinguishing factor.
Second, the authors highlight the uncertain nature of the cost of capital. The Federal Reserve’s moves to lower rates (or go in for quantitative easing), withdraw easing programmes and increase interest rates can impact the cost of capital across the world. Various actions have been suggested by the authors—which, on second thoughts, are no-brainers. The first is to improve the productivity of capital followed by exploration of new sources, where sovereign wealth funds find special mention. Next, risk has to be addressed through appropriate mitigating measures, as new commercial opportunities are exploited.
Finally, governments have an important role to play in terms of creating the right policy framework. This will evidently vary across nations and will be the differentiating factor for the future performance of companies.
The authors put forward the McKinsey view of how things are looking and are likely to proceed with a fair degree of competence. While their suggestions may not be entirely new, the fact that the authors are practitioners from McKinsey, which has great experience in reshaping companies and countries, leads us to believe that the suggestions can be taken as a refresher course for CEOs.

Can anything beat the allure of gold: Buisness LIne September 11, 2015

The gold monetisation schemes are laudable, but they are up against Indians’ craving for the yellow metal

At present, the demand for gold is down and the current account deficit very comfortable. But we can never be sure how Indians will behave when it comes to gold. It is for this reason that the government has been working on devising alternative instruments that would deliver the same benefits to holders and potential buyers of the metal. This could further reduce the physical import of gold.

The gold bond and monetisation schemes are progressive steps taken by the government in this regard. Both assume that the potential client is not strongly inclined to have physical gold in possession and that by providing similar rewards, this inclination will only decrease.

Good for government

The Gold Bond Scheme is an excellent one from the point of view of the government. Here, households buy a bond that is linked to the weight of gold in rupee terms. The bond is for 5 to 7 years, which means there is a good investment tenor for the same. The government may pay a nominal interest rate, say 1 per cent, and take over the price risk as it has chosen not to hedge the same. The amount is put in a fund, which can be used to cover the increase in price in future.

The way this gold reserve fund operates is important. If the money lies idle, it will be useful in taking liquidity out of the system when these bonds are purchased. If the fund invests in other assets, then there could be a return for the government.

In fact, such funds could be lent to the State governments with the interest cost being used to cover the price risk. The amount is to be a part of the fiscal deficit, which does not matter as it would only be an accounting entry with no money being spent if kept in the locker, with the nominal interest rate paid being the only cost.

Why buy?

Why should an investor buy this bond? A conventional investor who values gold would not like such an option, as it is better to have physical gold in the locker where it would not earn any money, but there would be a guarantee that it exists. Besides, buying a bond involves adhering to all the KYC norms, and hence if gold is to be used to escape the taxman, this is not a very attractive option. But if capital gains are indexed or exempted, then it could be a jolly good option.

There would not be too many long-term investors here who would like to keep a gold bond for 5 years. Those dealing in the short term would be using the commodity derivatives market and trade on, say, NCDEX where one can take a call on short term movements. Locking in for 5 years may hence, not be very appealing, especially as there is no option of redemption in gold.

But assuming that some people do opt for a lock-in, there would be two options for them. One is that they keep rolling over the bond. This is of advantage for the government and works well where there are taxes to be collected on such appreciation. But if everybody wants to redeem the same, then the outflow from the government would be to that extent. However, by making it a pure monetary transaction, the physical demand for gold would be eschewed.

Hence, this is an excellent scheme for the government, though the investor would come from a very niche segment that sees value here. If it works, it would add to the entire basket of financial instruments available today for savers.

The second scheme

The gold monetisation scheme is trickier. Here the individual deposits physical gold with the government (through the agents) and can ask for the gold back at the time of redemption in case it is short term of up to 3 years. For medium and long term, it is to be only in cash, which can make it equivalent to the gold bond and hence would be interchangeable in concept. There would be few people who would like to give up their gold for cash and also make themselves known to the taxman! While the cost here is higher for the government as it has to reimburse for the conversion, assaying and storage charges, the main problem would arise when there is demand for physical gold. As long as the deposit is renewed, it serves the government well. But if there is large scale redemption, then there would be the need to import gold from the market. This can be avoided, provided there are fresh deposits coming in every year, just like bank deposits. But any specific positive or negative event can cause an adverse movement and demand for gold. Given that part of the gold would have been lent to the jewellers, there could be a mismatch between the supplies and demand.

The government has done a commendable job in trying to mimic the purchase of physical gold with these two new schemes. But one is never sure how individuals will behave especially when it comes to physical gold. The gold futures contract or even the spot contract which are offered on commodity exchanges (where one can demand gold anytime when traded on an exchange at the time of expiration) has not quite lowered the physical appetite for gold. The fact that the KYC norms cannot be dodged can be a major deterrent for the investor as most of the gold transactions escape the organised network.

It would be the investor community which is not savvy enough to go to the exchanges that will find these instruments attractive. The monetisation scheme is quite restrictive as it expects people to give up gold and not ask for it if held beyond 3 years. This can be a weak point to start with.

Worries only on policy front : Asian Age: August 30 2015

Indian investors watch stock prices fall in BSE

Based on the experiences from the past, global economic developments were always going to be important in shaping the future of policy formulation in the country. The guess of late was however restricted more to the Federal Reserve and its stance on interest rates. However, the dynamics have changed in the last couple of weeks on two fronts. The first is the devaluation of the Yuan by China which came unexpectedly, followed by the shakeout in the stock market which has had reverberations across all global markets. Both of them indicate an expected palpable slowdown in the Chinese economy. What does this mean for us?

The most important factor that would guide the future is the permanency of what is happening around us. Will the Yuan depreciate further or will it stabilise? Will the Chinese economy continue moving downwards or will growth stabilise soon? There are evidently no easy answers here as the stock market crash came just after the devaluation. In fact China has followed it up by cutting interest rates too which means that the government does recognize that the economy is slipping and that it would work on all fronts to restore growth through export advantage and domestic demand.

To answer the questions put forth earlier, the currency decline could be considered to be more transient as the Yuan has been around 6.40 to a dollar which was the expected target rate to begin with. However the lower growth puzzle for the country will be deeper and it will take time to reverse the same. It may be expected that the 7 plus growth rate would take between one and two years to achieve on a sustained basis.

A Chinese slowdown is negative for all countries which have strong trade relations with the nation as imports will slow down thus affecting exports of countries especially in Latin America and East Asia which are dependent on this market. At the same time low growth in China will affect its own imports and demand for commodities and the cycle will remain in the downward direction for another year for sure. China is the largest consumer of metals and the declining prices have affected the profitability of all companies across the worlds which have confronted declining incomes. India has not been immune to this phenomenon.

Putting these facts together, the feeling one gets is that the Chinese slowdown will retard growth in the world economy especially in export oriented countries and given that other regions are tied to growth in this geography or have their own problems like the Euro region, all eyes will be on the US to be the engine to growth and hence the Fed to take a call on interest rates. The picture today is positive though there are few signs to show any kind of acceleration is in place.

India is relatively a more domestic oriented economy where growth emanates from within the country and exports are more of a secondary support. However, the economy will not be insulated as it will get affected in two ways. The first is the exchange rate route where the rupee has also been falling continuously to new lows. The second is the interest rate action of the Fed will also have a bearing on RBI’s decision on interest rates.

The rupee depreciation this time is different from the 2013 episode as the earlier one was based on the combination of an external shock and weak fundamentals. This time, the balance of payments looks robust and the only shock is external. Ironically there are limited policy options for the RBI which will have to think of direct intervention to bring about any correction. The fact that we have reserves of $ 355 billion is a comfort here. Therefore a lot will depend on the stance taken by the central bank and its level of comfort. More importantly the RBI will be observing if the current round of depreciation in the rupee is temporary or of a permanent nature. Also given that there has been a call by the market to allow the rupee to depreciate before this event took place, the central bank may probably be comfortable with the present turn of events.

But from the monetary policy standpoint, the rupee depreciation and volatility may not be too satisfactory. It has been agreed that the RBI will target inflation, but a weak rupee will have a tendency to increase imported inflation which will become a monetary concern. Presently inflation is low and the concern is only the kharif crop. With the rupee falling by almost 5% in the last month, there will be some upward pressure on prices. At another level, with the rupee being where it is, the RBI may have a strong reason not to touch interest rates at this point because the window for FPI in debt should be kept open at a time when the trade balance is already shaky and the rupee weakening.

In fact there is a strong reason for the Fed to defer its rate hike as it would be keen to ensure that US does not lose its export competitive edge by letting the Yuan fall. With inflation being marginally positive and its own target at 2 per cent, the US is far from an inflationary situation to warrant a rate hike. This can be another factor supporting a deferment of rate cut by the RBI.

To conclude it can be said that the Chinese devaluation and stock market crash has had repercussions on these two markets all over the world. India has not escaped this contagion as these two markets are well interconnected globally given the preponderance of foreign investors in the stock markets and the rupee being linked to the dollar. Therefore, adjustments by the central bank are inescapable. The comfort however lies in the fact that the economy is growing positively and is more dependent on domestic demand. In fact growth in exports is in the negative territory and yet, GDP growth looks quite positive. Hence while we would be concerned on these developments from the policy standpoint, we can feel somewhat reassured on growth and employment to a large extent.