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.