Arrow, India and elections: Impossibility of solving the Impossibility theorem: Financial Express 13th March 2017

Having all sections participate in governing the country leading to policy formulation sounds fair enough, though at the end of the way there are other factors at work which make governments pay more obeisance to these forces like globalisation, fiscal prudence, etc

Kenneth Arrow’s famous impossibility theorem is compelling not just from the point of view of working out the math involved, in the lecture theatre of Delhi School of Economics, but because the contemporary developments in the world today make this theory relevant. It has a lot of applicability in our framework of political choices and economic decisions, where we always feel that the final result of any system of selection is never close to what one can call a collective view.

Arrow’s theorem basically says that when we have a system of voting to arrive at a collective social choice, we can rarely have one which satisfies five basic tenets. These are first, a situation where everyone has the chance to rank all the preferences that are offered. The second is transitivity in the ranking where if A>B and B>C, then A>C always holds. Third, the solution is Pareto efficient in so far as if every citizen prefers an option to another, then it is socially the best one. Fourth, there is definitely the absence of a dictator who overrules and decides what is good for the citizens, and last, decisions taken are independent of irrelevant alternatives.

One of the conditions put here is that we must have at least three alternatives rather than a referendum variety where the choice is between a ‘yes’ and ‘no’. Curiously, the Brexit had its share of critics. It was argued that a decision taken by a majority vote which was defined as being marginally over 50% though reflecting the ‘majority’ could still not be ideal. It was argued that higher ratios like 67% or 75% must be used. But if the 51% rule is not used and a higher cutoff is pitched for, then there will rarely be any mCloser to home the UP elections can be a good illustration of Arrow’s impossibility theorem. How about the other axioms? People surely did have their choices or preferences between the BJP, Congress-SP and BSP. If these parties are denoted by N,C and B, respectively, in general it could be argued that N>C based on what happened in the elections at the centre. Further, it may be assumed for the sake of argument that if C>B, then N>B must hold. But this will not be so as people in society have different ways of reacting to parties and persons as well as the perceived dogmas. Therefore, transitivity cannot be taken for granted in this case.

This conclusion will come out sharply in case one of the parties does not field a candidate. Let C not be in a constituency. Will all their votes go to N which should be the case if rational behaviour held? Unlikely again, and it is just possible that all the votes for C could go to B. This is why when multi parties contest the elections those which win may not need to get more than 30-35% of the votes and only have to ensure that the rest get a lower share of the votes. This is the condition of ‘irrelevant alternatives’ skewing the show while N is preferred to C which is better than B, when C steps out, B could emerge the winner. This has invariably been the case when it is a three or four cornered contest.

The same can be taken into the world of economy policy making where we assume that since there is a government that has been elected by the majority rule–which as discussed above could flout the logical way of social choices being expressed, now has the power over policy formulation. A look at the budgetary options can illustrate this point.

Let us assume that there are three options for allocation of funds which address the concerns of different segments of society. These are infra spending, subsidies and salaries. The rich talk of infrastructure as they would like to have swankier airports and highways where they can drive their BMWs. The poor will be happier with more subsidies as this affects them the most and this class which is not bothered about the wastages or leakages as long as they get something. The middle class is happier with salaries being increased because at the end of the day they need to run their households with a decent level of comfort.

In this situation too one can never reach a transitive state, as the rich will prefer infra to everything else with subsidies being the third preference. The poor will have an order of subsidies, infra and salaries while the middle class would have salary at the top of the list and could toss between the two. However, if the subsidy part is deemed irrelevant when going for a vote, then salaries may be preferred to infra creating an anomaly. Hence, if social choice is to be decided by logical ranking of all preferences based on numbers, the scales may tilt to subsidies as most people would like it and infra could be the last.

This is where the dictator plays the part which could be the PM or FM or FS where it is decided that society needs infra the most followed by salaries and subsidies and hence a decision is reached. Hence, the final outcome of any policy will never be the view of the majority and is invariably that of the elites which have been elected by the people to serve them.

This deduction is interesting because it can take one back to the theory of social contract where Jean Jacques Rousseau questioned whether there can be a legitimate political authority. By having such systems which Arrow spoke about, it may appear that at times people may be better off in isolation. When people in a democracy elect a government, which as can be seen may not be consistent, then individuals surrender their freedom to this government which then decides what is good for all. The policies which go beyond the Budget as was explained earlier would again tend to wean towards the elites and may not lead to an optimal social decision.

Is there a solution to this conundrum? Not really as there can never be a system where all ends meet. Having all sections participate in governing the country leading to policy formulation sounds fair enough, though at the end of the way there are other factors at work which make governments pay more obeisance to these forces like globalisation, fiscal prudence, etc. But quite ironically people still get swayed by slogans and not express themselves differently the next time at the ballot box.ajority decision which can be arrived at.

The Wealth Wallahs: : Book Review in Financial Express March 5, 2017

BIOGRAPHIES ARE quite common these days, with the author narrating the story of the protagonist. In The Wealth Wallahs, Shreyasi Singh talks about first-generation entrepreneurs who have made a mark for themselves in the world of business. These persons are in the age group of 40-60 years. By tracing their backgrounds and business lives, and based on their outlook, Singh has been able to draw some patterns, helping draw some generalisations. This is what makes it so refreshing, as the book is developed around a theme and the characters fit in unlike other books, where authors choose the character and then fill in the story. It makes a difference to the reader who is better able to appreciate the value created by these people.

The Wealth Wallahs is broadly divided into two parts, where the first focuses on how first-time rich people approach business, which is quite distinct and different from conventional and well-established business houses. This theme is developed quite well by the author, where perspectives are also provided on our attitude to wealth and the inequality that goes with it—this has become a big issue, especially after Thomas Piketty wrote his epic book focusing on the problem. The second part of the book is focused more on wealth management, with emphasis on a single company, IIFL Wealth, and the stalwarts there who have created value not just in terms of ‘company valuation’, but also in terms of clients.

An interesting point made by Singh is that first-generation entrepreneurs have a certain idealistic goal of creating ‘value’ rather than ‘money’—the examples of Raghav Bahl and the entire IIFL Wealth set-up point to this. Unlike the progeny of successful businessmen—the author doesn’t take names, but the indication is clear—this class of people is different in terms of lifestyle and approach to business. While they are wealthy, they are not ostentatious and this makes a huge difference. There is humility not just in speech, but also in living. Hence, having a good house in an upmarket locale isn’t flaunted. The values inculcated at home are also simple. Here, Singh draws a comparison with Chinese entrepreneurs who live an ostentatious life and love to show off.

The author also points out the views of these new-age entrepreneurs when it comes to philanthropy and this makes interesting reading. While all businessmen talk about it, this generation means it and does so silently.

A large part of the book is devoted to wealth managers and this is where IIFL Wealth takes over. There are lots of stories about several persons, where the names might not be too familiar to the reader, but make interesting reading nonetheless. Perfunctory remarks have been made about IIFL founders Nirmal Jain and R Venkatraman, the faces of the organisation. However, there are also several other wealth managers who are covered in this book. The strategies that have been adopted by them when approaching clients, as well as while deploying funds to maximise returns have been elaborated in the book.

There are several tips given on how to approach a client and do business. The trick is to balance aggression with restraint. While one should be client-centric, it should not come down to servility, says the author. There is, hence, considerable maturity required when dealing with clients.

There are definitely some takeaways for entrepreneurs looking to get into this field, as the book provides a roadmap for them to pursue. It talks about values, which should not be lost and provides a clue on what not to do when running a business. Chasing value creation should be the goal, which results in wealth, but an untrammelled quest for wealth might have pitfalls in terms of compromise in principles, governance and value creation. These are some points that can be drawn from Singh’s work.

GDP growth: New estimates have put CSO in the news again: Financial Express March 3, 2017

The new intellectual inputs that went into the computation of the new series of GDP with terms like basic prices and distinction between product and production taxes being thrown in, has added to the level of confusion when interpreting these numbers. Nobody can pin point as to what is amiss in the methodology, and hence it must be right. But every time the estimates come out, there is scepticism as the numbers do not quite gel with the ground reality. The Q3 results add to this debate as it demonetisation did not quite matter in terms of impact on growth—the number is really good at 7%. No agency or economist expected such a positive scenario.

To be fair, the CSO numbers do tell us that compared with FY16 when growth was 7.9%, FY17 would be inferior at 7.1% which means that 0.8% has been shaved off due to demonetisation as there was nothing else amiss in the economy. Q3 and Q4 were to be the leading quarters, and hence it is possible to argue that at 7% in Q3, growth would have been higher in case there was no demonetisation. In fact, at the start of the year, it was assumed that growth would be around 7.6% and with a bit of luck could touch 8%. Hence, the economy has definitely come lower this year.

Further, the segments that were affected quite sharply were real estate, consumer goods and construction, which is what the Q3 growth numbers do reveal. Consumer goods, however, remain an enigma as manufacturing has grown at a high rate of 8.3%.

Two issues need to be addressed by the CSO. First, it is essential to create a series for the earlier years prior to FY12, so that one can benchmark these growth rates. The present series which keeps GDP growth broadly in the range of 6.5-7.5% for the last 5 years or so, may have had much higher numbers in the good pre-2011 years when the FY05 base year yielded growth rates in the region of 8-9%. A conjecture could be that this could be 9-10%, in which case it is possible to position the growth rates of 7% in the present context.

The other is to match growth in physical numbers with value added, which holds especially in industry where there are clear corresponding numbers available. For instance, value added in mining, manufacturing, electricity and construction grew by 7.5%, 8.3%, 6.8% and 2.7%, respectively in Q3-FY17. In physical terms, IIP shows that growth rates were 5.2%, 0.20%, 5.25% for the three major segments, and steel (12.5%), cement (-0.85%) which are taken to be synonymous with construction. The difference for the three leading sectors is 2.3%, 8.78% and 1.5%, respectively. So, low production lead to high value addition. The argument that manufacturing is producing more high value items which even on low physical production numbers yields high value addition no longer holds as this would be the case for all the years and does not reflect a single year phenomenon as the base for comparison would be progressively higher. As value addition is sum of profits and salaries, does this mean that while jobs have not increased, value addition has and led to disproportionate gains for owners of capital? This would be of interest to Thomas Piketty.

Another area which has to be addressed is the case of constant revisions to GDP estimates, which has become a norm. The FY17 numbers released in February 2017 would be different from those in May 2017 when the first annual estimate is provided which will then further undergo a change when the first advance estimates for FY18 come in January 2018 with revised FY17 numbers.

For FY17, the GVA numbers for the first two quarters have been revised downwards by up to 0.4%, while GDP growth numbers have improved. In FY16, the variation in GVA between the first set of estimates and the ones provided this time was as high as 0.9% in Q2, while GDP strayed by 0.6% during this period. Such deviations are serious as they could change the judgement from being good to ordinary or the other way round. Based on such experiences, it could be possible to work on the assumption that there could be up to 0.5% change in the number when the final estimates arrive.

The issue to be debated is whether or not the CSO should be in a hurry to bring out high frequency data which is susceptible to wide swings. The counter argument would be that having some indicative numbers is better than not having any such guidance and if all operators work on the principle of ‘plus/minus 0.5%’, things will still be manageable.

The major challenge for the CSO is the existence of a very large unorganised sector. Agriculture is tough because even the ministry works on guesses all the time as a large part of the output never enters the market as the marketable surplus is lower and has to be estimated. Further, all sales transactions are not recorded which makes it difficult to arrive at the output numbers. Satellite imaging helps because there is no alten both manufacturing and services, unorganised sector is large. SMEs do not have reporting statements. This also holds for unorganised retail, transport, professionals, hospitality, where there could be under-reporting. Monetising the economy is a way out and introduction of GST should make things more transparent.

There are evidently no easy solutions as the economy is complex and largely unorganised. Getting in the National Agricultural Market and GST which involves online recording will help to diminish the noise elements in the data. The push given to e-filing is also useful. The local bodies especially the panchayats need to be involved aggressively and harness technology to improve the systems of reporting. This surely will be a long process, but should be expedited with a time frame kept in mind while bringing all levels of the government on the same platform.rnative.

NPAs woes: Bad bank idea will promote risky loan culture; here’s why: Financial Express 28th February 2017

The issue of resolution of NPAs (non-performing assets) is back on the discussion board given its magnitude. In fact the problem was always there, but we have tended to push things under a cover of camouflage for quite some time now, under what was euphemistically called restructured assets. One fine day it was decided that we must come clean and banks have started recognising these in a uniform manner. They also made provisions thereof leading to drop in profits which coexist with high NPA ratios. The banks are supposed to cleanse their books by March 2017; but one cannot be too sure as a large number of them had given assurances that this would be done by March 2016, which was not the case.

Now, there are talks of having a bad bank which can resolve the problem of NPAs. Simply put, the bad bank buys up all the bad assets of banks and pays them partly in cash with the rest in securities, and then takes on the job of collecting and resolving the same, analogous to what a recovery agent does for retail loans. The bank is freed of such assets and continues with business, while the bad bank resolves and pays back the bank based on the success of the recovery.

As we are seriously talking of such a bad bank being created, there are ten questions that should be kept in mind which cover all aspects of this grand design and simultaneously highlight what can go wrong, so that we are better prepared.

First, how many such bad banks (BB) should there be? Is a single entity effective or should there be multiple BBs so as to make it more manageable? After all we are talking of a potential number of R7 lakh crore of loans which are classified as bad assets which have to be taken over. On the face of it, a single entity could get bogged down by the number and having regional BBs could be a better idea.

Second, what should be the ownership pattern of a BB? As the ARCs which have operated so far have had limited success, the onus of creating such a platform is on the government, and ideally the centre has to form such an institution. But a government owned BB tackling issues of NPA resolution, of probably PSBs, can run into bureaucratic speed breakers or interference making it a non-starter. Asking the private sector to do so will not be different from the ARCs, and hence a combination can be considered, though the possibility of falling back cannot be ruled out.

Third, whether the BB buys bad assets of only public sector banks or all banks? Ideally, it should be the latter as the idea is to cleanse the toxic assets which afflict the system though the magnitude is assuredly smaller for private banks. But they must be treated on par with public sector banks when the purchases are being made.

Fourth, which assets should be bought by the BB? NPAs are well spread across sectors and a call has to be taken whether it should be looking at only industry or cover retail, services and agriculture. This is important because farm loans, too, are important and susceptible to weather conditions that affect ability to service debt. By taking them off the books, the issue of loan waivers can be addressed. Hence, there is need to have a formal pecking order that forms a priority list of the sectors to be sequentially cleaned up.

Linked to the sectors to be covered, the fifth question pertains to the size of loans that have to be bought. While prima facie, taking off the larger loans makes sense, from the point of view of resolution, the smaller tickets could be the low hanging fruits. Therefore, it may make sense to have allocations across the loan size segments so that the BB ends up with an eclectic mix of bad assets.

The sixth question for the BB is funding. At the end of the day, the BB requires money to pay upfront to the selling bank and administer the recovery process. If we are talking of large numbers, then it is essential for them to be well capitalised. The BB would also have to borrow funds in the market (hopefully not from banks!) to ensure that they have funds to expand their operations. The latter can be difficult; and would be possible only after a minimum level of maturity is achieved in their operations. If this is so then then the government has to allocate funds from the Budget or get the public financial institutions to contribute to the capital.

Seventh, at what price should the loans be bought? This has been a sticky point in terms of valuation. Public sector bankers, in particular, would be petrified to sell at a low price, and hence there has to be a standardised way of determining this value so that bankers come forward. There have been many instances of bankers being pursued well after their tenure for loan failures, and unless the formula is fixed from above, there would be little enthusiasm shown by banks.

The eighth question that has to be answered in advance is whether or not we are sure that such assets can be sold. For example, a loan asset may be secured by a steel mill. Can the BB be sure of selling this mill? Also, while often the BB would be getting in fresh investors who could be looking at only the better layers of assets. This will also be the problem with the securities that are to be issued where the market has to be deep.

GDP outcome - A vindication of currency purge? Business Standard 1st March 2017

The major takeaway from the gross domestic product (GDP) numbers that has been released is that the demonetisation impact on growth has been extremely muted, with minimum impact on various sectors. The third quarter was to reflect any shortfall in output on account of this move, and the picture is hence, satisfying with growth at seven per cent. The two sectors that have been impacted were construction and the financial segment, where growth rates were low with growth of 2.7 per cent and 3.1 per cent, respectively. As was expected, the real estate sector was affected the most, on account of the non-availability of cash, which gets reflected here.

The government has been very active in this quarter to ensure that growth has been on the right path with this segment showing growth of 11.9 per cent, which is in line with the higher infra spending by the government, as revealed in the Revised Estimates for the year in the Budget that was presented. The surprise elements have been high growth in gross value added in manufacturing, which has always been an enigma, considering there is a disconnect between Index of Industrial Production growth and this number, which is actually value added in the corporate sector, which has been buoyant based on the third quarter (Q3) results announced so far. Hence, the Q3 growth number is a vindication of the government’s stance that demonetisation would not affect growth significantly.

For this year too, the Central Statistics Office (CSO) is looking at 7.1 per cent growth, which though lower than 7.9 per cent of last year, is still fairly impressive and comes well over the other private forecasts. The sectoral break-up shows that the good performance is being driven by the government, agriculture and manufacturing. It does appear that compared with the beginning of the year where growth estimates at the official level were in the range of 7.5-8 per cent, we would have lost around half a percentage point in growth in GDP, which could be attributable to demonetisation.

The picture on capital formation remains disappointing and the CSO does not expect there will be any improvement this year, with the gross capital formation rate coming down from 29.2 per cent in FY16 to 26.9 per cent in FY17. Private investment is the clue to a reversal here, as the government does have some limitation in driving capital formation, given that the central government capex is just about two per cent of GDP at current prices and would not be able to drive the economy in the absence of private investment.

The way forward is positive because there are already signs that the volume of currency in the system is picking up, which means economic activity will mean revert with a hiatus of not more than two quarters i.e., July 2017 onwards. A growth rate of above 7.5 per cent for FY18 cannot be ruled out, if inflation remains under control. Also, such a growth rate will support the projections made in the Union Budget and the revenue targets would be easier to meet.  But in order to ensure that jobs are created, the focus has to be on ensuring that physical production, especially in industry, keeps pace with the growth in value addition. This will probably be the focus of attention in the coming year for the government.

Business as usual: Financial Express Feb 26, 2017

WHEN ONE picks up a book with a title like Riding the Tiger: How to Execute Business Strategy in India, a sense of wariness is not unnatural, as there are several books on how one should steer a company in a ‘VUCA’—volatile, uncertain, complex and ambiguous—environment to remain successful. Biographies of companies are common when authors try to tell you what to do. Wilfried Aulbur and Amit Kapoor’s book, however, comes as a breath of fresh air, even though the word ‘tiger’ is quite a cliché now, as is the action of riding this carnivorous animal.

Riding the Tiger provides insight into what some firms have done, from sectors as varied as engineering and consumer products, handling the current volatile environment. Some companies that feature in the book include Hindustan Unilever, Maruti Suzuki, Adani Group, Godrej Consumer Products, Siemens, Bosch, Bajaj Auto and HDFC Life. Then there are companies like Vaatsalya Healthcare, IndiGo and JSW Steel, which are great names, but rarely sketched when authors write about successful companies. Aulbur and Kapoor use a different approach, wherein they embed the case study of a company in the attribute that they consider important for success. This makes the characters fit into the narrative, making the book interesting.

The authors’ argument is that when one is the CEO, one can’t give excuses. While issues like consumer requirement and technology have to be addressed, a factor that can really be an insurmountable challenge is regulation, which can change at any time owing to a Supreme Court decision or political whim. Finally, it’s the CEO who will be held responsible. Hence, he/she should be thinking ahead. This is the main problem with most companies, where CEOs are so obsessed with day-to-day operations that theLet us look at some of the attributes that deserve attention. Operational expertise is one factor that can distinguish companies and products, and normally falls under what can be called ‘internal controls’. The way one cuts cost and enhances quality with competitive pricing is a necessary condition for success. Maruti Suzuki focuses on every detail to cut costs, while the IndiGo model is based on high ‘on-time’ performance. Many flyers praise the airline for always being on time, a tenet the brand has been built around.y fail to see the big picture. This can be dangerous, say the a

Let us look at some of the attributes that deserve attention. Operational expertise is one factor that can distinguish companies and products, and normally falls under what can be called ‘internal controls’. The way one cuts cost and enhances quality with competitive pricing is a necessary condition for success. Maruti Suzuki focuses on every detail to cut costs, while the IndiGo model is based on high ‘on-time’ performance. Many flyers praise the airline for always being on time, a tenet the brand has been built around.

Another crucial factor is innovation. The compulsion of innovation is, in fact, necessary even in financial services, with HDFC Life Insurance excelling in online delivery.

Third, companies should know what they stand for and operate within these confines to present their value propositions to the market. A firm like Bharat Forge is known for metallurgy, while Samvardhana Motherson is known for auto ancillary products. These companies know their strengths and stay away from unrelated diversification, which is the tendency for some companies. Within the organisation, the value proposition should be known to all, so that everyone can work towards the goal. JSW Steel, for instance, made it a point to engage with local communities and so got their support in times of need.

Leadership, of course, is the most important, as the entire framework has to be conceived by the leader. He/she has to ensure that the company stays committed to its roots. When the environment changes radically, the leader has to define new choices and activity systems. Mahindra Rural Housing Finance’s approach to improving the lives of the rural populace through tailormade lending products has had a positive impact while remaining an attractive business opportunity.

The authors simultaneously argue that leaders must show agility and courage. Vaatsalya Healthcare, for instance, started several pilot hospitals and then adopted the model that worked best. Godrej is another example. It leverages its products in Argentina and Indonesia, and then improves on products that work well there for the Indian market. Similarly, HDFC Life moved from a market share approach to a profit-focused model due to regulatory pressures and adapted well.

Towards the end of the book, the authors tabulate what various companies have done in these areas. Let us sample IndiGo’s case. Operational excellence at the company is through fast turnaround times, high volumes, low maintenance and fuel efficiency. Innovation is typified by continuous small changes, like in-flight cleaning and boarding ramp, which keep it ahead of competition. The choices and tradeoffs are based on its preference for on-time and low-cost courteous travel experience. Leadership has taken the airline to new international destinations.

Riding the Tiger is a book worth reading and keeping on the shelf. CEOs can pick some points from stories of companies covered here. The book provides good clues on how to survive in an uncertain and volatile market. The message is that there are no short cuts when it comes to planning for the future.