Will NBFC liquidity squeeze snowball into a crisis? Financial Express 30th October 2018

NBFCs carrying higher risk perception and 11 banks under PCA; Will NBFC liquidity squeeze snowball into a crisis?

By: Madan Sabnavis | Updated: October 30, 2018 4:19 AM

A liquidity issue has surfaced in the financial market given the challenge faced by NBFCs in raising funds.

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The question, however, is whether or not banks are willing to lend to specific NBFCs? Besides, this will hold only till December and isn’t a permanent measure.

A liquidity issue has surfaced in the financial market given the challenge faced by NBFCs in raising funds. There are three questions here. Firstly, whether or not it is serious. Secondly, whether this can be addressed by the system. Thirdly, whether this will affect the growth path.

It is necessary to understand the concept of liquidity which is being talking about. There is one path endogenous to the system where money flows to various financial intermediaries in the normal course of activity. The flow of funds comes in the form of bank deposits, mutual funds, insurance, provident and pension funds at the retail end.

At the wholesale side, it is money put in bonds and some money market instruments. The latter is limited as it is more a channelling of funds in the secondary stage as investments in bonds and CPs is done from the funds collected at the retail end which can also have some bulk deposits.

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Here it can be seen that growth in bank deposits for the first half of the year at `3.7 lakh crore is more than double that of what was there last year at `1.6 lakh crore. Bank credit increment this year is, however, at `3.6 lakh crore and investments are at `1.3 lakh crore, leading to a liquidity issue with banks which has been supported through the LAF window where there are around `1.3-1.5 lakh crore in net repos (overnight and term). Add to this the exogenous impact of RBI coming in with periodic OMOs and liquidity to the banking system is well balanced.

Bond issuances have been lower, but it is hard to find out whether it is a supply issue or demand one. Mutual funds flows have increased, while small savings could have gone up given the higher rates being offered. The listed insurance companies and EPFOs show higher inflows.

Put together, this indicates that flows are steady. It looks like investors and lenders have become more discerning.
Now, when it comes to NBFCs, sentiment has changed. Funds normally flow from banks and bonds for long-term purposes and banks, CBLO and CPs for short-term requirements. If there is a slower flow of funds then it is more a case of willingness to lend by the concerned lenders/investors in these instruments. The problem as stated by RBI is actually not acute across the industry but more specific to a handful of these entities.

Institutions like insurance companies or provident and pension funds do have funds to invest as there is data to suggest that the investible corpus has increased for insurance companies as well as EPFO. While it is possible that any increase in small savings would have gone to GSecs, the others have the option of investing in bonds issued by these NBFCs. How about banks? RBI data on sectoral distribution of credit suggests that, up to August, there was a fall in outstanding loans to NBFCs.

Here, it may be conjectured that this component could have come down further in the following two months. There are two issues here. Firstly, banks have been eager to expand on their retail loan book and hence may choose not to lend to NBFCs as there is a higher risk perception. Secondly, with 11 banks under PCA, the overall ability of banks to lend has come down. Hence, while these banks continue to receive deposits, they tend to get invested in GSecs as narrow banking takes over.

Two announcements have been made which can alleviate the situation to an extent. The first is by RBI, where it has allowed another 0.5% of NDTL, which is held under SLR of 19.5%, to be permitted for calculation of high quality liquidity assets under LCR within the category of FALL (facility to avail liquidity for LCR) to the extent of incremental lending to NBFCs.

The question, however, is whether or not banks are willing to lend to specific NBFCs? Besides, this will hold only till December and isn’t a permanent measure. Therefore, banks may be cautious to extend lending.

The second is statements made by some banks that are willing to buy some of the loans of NBFCs. But this will only mean the churning of existing funds as a purchase of, say, an auto loan book from a NBFC will result in banks probably lending less directly to customers on their own account. For the financial system as a whole, this may not matter.

A way out could be to do what the Fed did with QE wherein it purchased commercial loans and generated liquidity. This is an option which has been vetoed by RBI which does not believe this problem is pervasive to opening a window for NBFCs, although the reference is more like allowing NBFCs to join the repo window and offer their holdings of GSecs (which they are already using at the CBLO market). Therefore, there would be no assistance coming from RBI as of now.

It has been suggested that RBI should dilute the PCA principles so that these banks can lend more, but this would mean going back to the old days of compromise which should be eschewed. Therefore, this does not make too much sense. Another piece of advice has been to make RBI announce the lowering of risk-weighted norms for reckoning capital on loans to NBFCs. This will be imprudent and is not something which one can recommend to enable easier flow of credit to this sector.

Will the ongoing problems come in the way of growth? If the supply of funds to NBFCs has been hindered on account of unwillingness of banks to lend due to risk-profile issues, then there would be a movement for those borrowers of NBFCs to the banking system. Here, the SMEs, automobiles, tractors, real estate and housing industries would be the affected parties. They would have to either look for better funded NBFCs to source loans or the banking sector. Such a transition would be visible when data on bank lending is released for the months of September and October.

However, to the extent that lending is hindered because of the inability of the financial system, RBI has been proactive with OMOs as well as relaxing of the norms for reckoning the liquidity coverage ratio under Basel III to ensure that the funding power of banks is enhanced.
Therefore, while there definitely is an issue on the liquidity front, it is localised to a specific segment and not pervasive. To the extent that there is a shortfall, it is being addressed by RBI through some fine tuning. But, if liquidity is not forthcoming due to risk perception issues, then the specific segment would be impacted.

However, it is not expected that this will snowball into a crisis-like situation as substitutions in funding can take place over time. Presently, one can confidently be agnostic in the view of the situation’s impact on economic growth, but monitoring the developments would still be advisable.

Book review: The Aadhaar Effect by NS Ramnath, Charles Assisi Financial Express October 28 2018

it is quite appropriate for a book on Aadhaar to come out at a time when the courts also have taken a view on its authenticity with the accompanying caveats. What started off as giving an identity to every individual has now become an integral part of policy formulation and implementation at various levels, which, in turn, has also raised security issues, as well as concerns on violation of privacy.

NS Ramnath and Charles Assisi, in their book The Aadhaar Effect, have done a fairly good job in giving us a glimpse of the history of the concept, from how it all started to where it is today. In fact, the original idea was to have a smart card that finally got diluted to a strip of glazed paper. There were several people involved in bringing this scheme to fruition, and while the name associated with it is Nandan Nilekani, the success was due to a team effort. The authors take us through the thought processes behind this scheme and how the two governments supported the concept with the usual hiccups. The conflicts between the home ministry and Planning Commission, followed by Niti Aayog, are quite interesting.

Aadhaar has been a clear case of PPP, where governments have supported the concept being driven essentially by private enterprise. The team, set up by Nilekani, had elements of both the sectors and, hence, the characteristics were a blend of advantages and disadvantages that come with such a combo. Evidently, the authors have had detailed discussions with several of those involved in this enterprise, which created this winning combination.

The project had its critics from the day of inception and which had to be addressed by Nilekani and company. In the process, Nilekani may have gotten carried away, as he changed track depending on the audience. It, hence, was made to look like a cure for everything, which was not the case. Giving an identity to every citizen is one thing, which is similar to a passport, ration card or voter card—there could be no argument against such identification—but the use of Aadhaar was projected as a policy panacea, which attracted its share of naysayers. If one looks at an Aadhaar card, it just tells the person of his or her existence and does not reveal anything more. There is no mention of background or income and, hence, from a policy perspective, can’t go beyond identification. As Aadhaar has gotten linked to bank accounts, it does serve the purpose of better targeting of benefits in the form of cash transfers. But it does not solve the problem of whether the person deserves the benefit, especially when a distinction has to be made between the poor and not-so-poor.

Here, the authors also present the story of how well it has worked in terms of the schemes that were linked with Aadhaar. The reader can’t be blamed if she feels that the book is sponsored by the creators of the concept, as it reads like positive propaganda. However, towards the end, they have separate sections on the critiques of the concept spread over various dimensions. This, sort of, balances the presentation, which otherwise reads too one-sided.

The authors treat the implementation of Aadhaar as a game consisting of Lego blocks being put together. These include UPI, eSign, eKYC, DigiLocker, etc, together with the other infrastructure that the country has built, especially GSTN, which, the authors feel, has far-reaching effects. Therefore, in their opinion, one should view the story as the creation of a new superstructure that will put the blocks together to improve interconnectivity between different economic programmes, government expenditure and income, thus leading to a superior solution.

While the larger part of the presentation is in praise of Aadhaar, let us look at the opposite view, which is also presented. There have been cases of fraud (which has come in terms of incorrect identities), as well as manipulation of the biometrics. Once given and linked to government programmes, Aadhaar has meant exclusion of the millions who do not have this identification. Also, the fact that delivery of services is linked to this number means that in the absence of biometric matching or absence of electricity or internet connection, benefits are not received. Creating a superstructure without infrastructure in place is a valid criticism, which, however, does not diminish the power of using this system for delivery of benefits. Another criticism is that the government claims to have saved a lot of money, which is not substantiated. But again, this can’t be made out as a case against Aadhaar.

Aadhaar was supposed to also identify fake PAN cards and duplicates by presenting a unique identity to everyone. However, it was found that the proportion of fake PAN cards taken out of the system was just 0.47%. Further, duplicates removed from the system were even more minuscule than the fake ones. This then begs the question of whether the exercise was worth the cost given the existence of several alternative identity documents in the system. The question of security is probably more serious, and the fact that there has been no breach so far is not assurance that it will not happen in the future.

On the whole, it is a fair presentation of the scheme with a tilt towards eulogising it. As the book gets into details of the building of the team and creating a structure, there are several names involved and their views presented. This could be a drag when reading, as is the case with any biography of a concept, where only those in the job would identify with the characters. The book could have been better knit by reducing the noise on personalities and focusing on the issues, as this results in some bit of meandering that can distract the reader.

s there space for more commodity exchanges? Financial Express 20th October 2018

Traders would prefer to trade on a single exchange as this lowers the bid-ask spread and impact costs, making the existence of another exchange unviable.

Is there space for more commodity exchanges? This is a pertinent question because it is accepted theoretically that more competition can bring about better solutions in any market. But in case of commodity derivatives trading in India, the story has been one of diminishing number of exchanges over the last decade and a half ever since commodity futures trading was resurrected. In fact, even traded volumes have come down from previous peaks and, presently, the impression is that they are just about stable.

The two leading stock exchanges, NSE and BSE, have now also brought commodity derivatives onto their trading platform and this adds an interesting dimension to the market. It has been observed across the globe that liquidity tends to get concentrated in trading in specific commodities on specific exchanges and it is here the early mover advantage lies. Intuitively, trading members would like to trade on the exchange which has the largest volumes and number of trades as this lowers the bid-ask spread or the impact cost. The adage ‘liquidity begets liquidity’ very much holds here. Hence, for traders who are not hedgers but more of day traders or speculators, it may not make sense to trade on different exchanges. They would prefer to concentrate their business on a single exchange. And wherever a second platform is an option, it is used for arbitraging to the extent that there are micro price differences.

In India, if one looks at vibrant trading in commodity derivatives, NCDEX has advantage in cotton, sugar, soybean, mustard, chana, guar and spices. While it started off with a wider array of products, today it is recognised more as an efficient exchange for farm products. MCX is a clear leader in gold, silver, energy products, metals and mentha. MCX has, over time, evolved to hold some can of a monopolistic position in these commodities. In a way, things have gotten compartmentalised over time. The third force in the form of a merged ICEX-NMCE would have some advantage in rubber from the latter and diamonds for the former. Total volumes traded on these exchanges have been stable in the last two years. For MCX, it was about Rs 54 lakh crore in FY18 and about Rs 6 lakh crore for NCDEX. The merged ICEX had volumes of Rs 0.36 lakh crore.

The new entrants will be looking more at bullion as they are easier to launch compared with farm products. This is where the challenge lies. Bullion trading is already concentrated in MCX and weaning away members to a new platform is difficult. Three points need to be made here. Firstly, anecdotally, it should be pointed out that when futures trading was in its infancy, NCDEX was dominant in silver and MCX in gold. But over time, MCX had taken over as the dominant player and today all trading takes place here. NCDEX has not been able to make inroads notwithstanding several products being launched to gain market interest. Secondly, today, arbitraging takes place across exchanges in different countries and therefore existing players would have to be open to a new opportunity of arbitraging across two domestic exchanges which they have chosen not to do so far. It is not certain whether they would be up to it in the absence of any incentive.

Thirdly, in the days when commodity markets had a separate regulator, FMC, equity brokers perforce had to open a subsidiary to do commodity trading to separate the risk of equity trading from this arm. Today, this is no longer an issue with SEBI being the unified regulator and hence there will be few players who have been held back on this score.

The new comexes have to, hence, address the requirements of a new set of traders who have not been active in this segment. Therefore, for the new exchanges to be successful, the approach has to be different. Brokers operating on the equity platform must be encouraged to trade in commodity exchanges too. BSE and NSE, hence, have an advantage of a committed member group. But still, moving members from MCX to NSE or NCDEX will be difficult just as it has been seen that the differentials in volumes of trading between BSE and NSE have been maintained over the years.

Gold and silver are definitely easier commodities to understand as they do not get messy like agricultural commodities which have delivery, quality and accompanying penalty issues. To begin with, some kind of incentives can be given to get equity traders to deal with commodity derivatives. This is not easy as it requires a different kind of understanding of the subject which may be a deterrent for newcomers. Besides, in order to ensure an even playing field, the regulator has to permit the same for other existing exchanges too.

Also, the sheen in commodity markets has worn off to some extent in the last few years. This is on account of a limited basket of commodities being traded and the fear of bans still being present. Alternatively, some kind of market making should be permitted here, but then it has to apply to other exchanges too and if this is done, it may negate this effect.

Interestingly, commodity derivative trading has a fairly unique history with there being several regional exchanges when futures trading was revived in 2002. But all the existing exchanges have closed down. Further attempts have been made by new entrants, too, which have not been sustainable. ACE and Universal Commodity Exchange were two new exchanges that were operational but had to close down due to non-viability.

Against this background, the new platforms could be starting from a position of disadvantage, though the existing support of the equity platform and the franchise built by BSE and NSE would be the main driving factor for this business.

A curious question that can be raised here is that, if stock exchanges have been allowed to have separate trading platforms for commodities, by the same logic, the existing commodity exchanges, like NCDEX, should be allowed to deal with shares. MCX already has this through the Metropolitan Exchange route. For an exchange like NCDEX, or even the merged ICEX, this will make sense given the barriers in commodity trading where a modicum of stagnation has set. Allowing equities, and also currency derivatives and interest rate futures, could open new lines of business. And, curiously, NSE has a stake in NCDEX and is now operating its trading platform. By similar logic, NCDEX offering the same products as NSE would be an interesting regulatory proposition even though the probability of success would be uncertain.

Why banks don’t need to worry about deposits despite ostensibly higher post office small saving rates: Financial Express 16th October 2018

With digitisation catching on and the India Post possibly becoming a successful payments bank, the concept of small savings may narrow down to those which exclude deposits.

The increase in interest rates in some small savings schemes has expectedly raised the question on whether or not the demand for bank deposits would come down in case banks do not increase their interest rates. The recent hikes in interest rates, which are based on the movements in market rates of GSecs, have ostensibly made such deposits more attractive. In this regard, it is interesting to gauge the importance of this category of savings.

Small savings come in three forms: Deposits with post offices, certificates and PPF. There are different motivations for going to a post office for opening such accounts. Deposits with post offices are similar to those offered by banks and appeal more to the lower income groups. Certificates are virtually discounted bonds which give a fixed return on maturity and are similar to bearer bonds with certain KYC caveats attached. PPF are long-term deposits with tax benefits which have very rigid rules when it comes to withdrawal. It is a niche product as people use it for tax savings where one gets tax benefits on the deposits made as well as on the returns. However, there is an upper limit on such deposits which is Rs 1.5 lakh per annum. Bank deposits, on the other hand, are quite singular in scope but offer a basket of other facilities once an account is opened that are not available with post office deposits.

Presently, the interest rate disparity is significant in some buckets when returns on bank deposits and post office deposits are juxtaposed. A savings account with a post office gives 4% against 3.5% for most banks, while some offer higher rates of 6%. The difference in interest rates between term deposits in the two schemes could be as much as 50 bps for 1 year, 30 bps for 2 years, 50-55 bps for 3 years and 45-50 bps for 5 years (a sample of five leading banks in terms of size has been used here). Hence, broadly, the difference can be in the range of 50 bps.

Interestingly, within commercial banks, too, there is a similar disparity in interest rates which does not cause customers to switch from one bank to another as these rates are dynamic and the differential can change at various points of time. Besides, once a relationship is built with a bank branch, rarely does one change the destination for deposits on this score. This explains why customers do not move from one bank to another even when new branches of other banks are opened.

This can also explain why the small savings avenues have never been too attractive for customers even though, on an average basis, the returns have been better here. The attached graphic provides information on outstanding small savings and bank deposits for the last 6 years ending FY17.

The graphic shows that the share of small savings in the deposits pool of the public has been coming down and is in the range of 6.5-7%. Therefore, there does not really appear to be a significant threat to bank deposits per se. This can be due to several factors.

Firstly, post office deposits are always considered to be more distant and hence less accessible. Secondly, these deposits have been more popular amongst the lower income groups where the savings power is limited. The users of small savings hence tend to be quite niche. Thirdly, banks offer other facilities like cards, remittance facilities, loans, transfers, and third party products, etc, which make it a one-stop shop for all financial requirements. This is not possible when it comes to post offices. And lastly, as said earlier, funds do not move from one structure to another merely because of rate differentials. This is because of inertia on the part of the customer as well as the fact that, given the changes in interest rates by banks, it is not possible to keep switching deposits across these alternatives. The most glaring case is of the savings deposit rate offered by some private banks which is substantially more than that given by the rest of the banks. Yet, every bank has its own clientele and there is rarely a diversion of deposits.

Also, within small savings, interestingly, the share of certificates has come down over the years from around 35% to 27% between 2011-12 and 2016-17. The share of all deposits has increased from 59-60% to 64% while PPF has gone up from 5-6% to 9%. Within small savings, the schemes oriented towards senior citizens and girl children have become popular and have contributed to the growth in such savings.

Prima facie, it does not appear that banks have to worry much about interest rates of small savings being increased as it is unlikely to affect the flow except at the margin. The bigger challenge will be the competition from within i.e., the payments bank of India Post. It offers a savings deposit account with all the frills of a normal bank account and pays an interest rate of 4%. This holds for individuals, merchants and postmen. Add to this the availability of the DBT facility and it would directly impact the business of small savings as whole. Savings accounts of post offices will now compete with those offered by India Post Payments Bank and there can be some cannibalisation. Here, there is a possibility of savers moving their accounts over to the new platform.

With digitisation catching on, commercial banks having Jan Dhan accounts firmly entrenched and the India Post possibly becoming a successful payments bank, the concept of small savings may narrow down to those which exclude deposits. This is something which the system must be prepared for and just like how several postal services are less important in the age of mobile phones and WhatsApp, the same would be the case with this avenue of services of post offices. This would be good for the government which, today, has to pay a higher cost of small savings compared to that of regular market borrowings. The future surely will be interesting for this range of small savings schemes.

Can’t compare this Re shock with 2013: Business Line October 15, 2018

The fundamentals are better this time round. Even if extraneous factors pull the rupee down, oil prices are likely to stabilise

The rupee’s relentless slide in recent weeks has naturally led to comparisons with the situation that prevailed in 2013.

The fact that the RBI remained silent on the currency management issue in the credit policy and focused on inflation exclusively has given a signal that the rupee will have to find its own level.

The currency crisis this time has been caused ostensibly by the oil economics going awry driven largely by the US sanctions on Iran. The escalation in the US-China trade war with the former is calling the shots, and the strengthening dollar has only made matters worse. .

In the previous episode, while oil had sky-rocketed to $140/barrel (it is less than $ 90 today), the price rise was caused by a combination of the US Fed’s ‘taper tantrum’, signalling the winding up of quantitative easing (QE) and hardening of policy rates, as well as severe demand-supply mismatches of oil.

Low investment in the past had reflected in higher prices which were then corrected by US shale oil subsequently. This time it is largely politics that is causing the distortion making it more difficult to find a solution.

How does India stand today? While it sounds tempting to draw parallels with 2013 and also call for similar solutions, the Indian situation is actually quite different in 2018. In fact, interestingly it is stronger than before. The table (attached) gives some important macro indicators in these two episodes which are quite conclusive of this belief.

 

The data reveal that the position in 2018 is far more comfortable in almost all the parameters except foreign portfolio investment (FPI). FPI flows have been negative in both the episodes, and this has got to do more with the Federal Reserve driving such actions.

In 2013, the talk of QE being rolled back had an adverse impact on these funds, as there was a reversal of existing stocks as well as a slowdown in fresh flows as less liquidity was available.

In 2018 too, the continuous increase in interest rates by the Federal Reserve is the main reason for the FPI flows to turn negative. So the RBI was expected to increase rates this time to even out the interest rate differential between the two regimes.

The other parameters like the CAD, import cover, FDI and real sector indices look healthier than before which gives a great deal of confidence to the policy makers.

A critical point for India would be November when the oil story will play out and the direction of the currency will be known.

The political element

In the present environment it is hard to speculate on how the politics will play out and whether India will be able to strike a deal with Iran within the US overall framework of sanctions. This combined with the OPEC reaction to lesser oil from Iran will determine the direction of oil prices.

If the political temperatures cool down then oil prices should return to less than $80/barrel. However, if there is a stalemate and the US is not able to supplement supplies with its own shale reserves, then the price could go up further, which will call for some solutions from the government. The US-China trade war will continue to keep the dollar stronger and make the rupee wobbly. But the primary factor of oil would be addressed by this point of time.

If the rupee continues to fall, it would be tricky for the government. The government has announced measures to make ECBs easier and FPIs more attractive. At the same time import tariffs on several goods have been increased to lower the growth in imports. The measures, which have been tried out already, have not had much of an impact on capital flows or containing imports, though these measures could take at least six months to work out. Given that the quota system went out of vogue after the WTO was set up, there aren’t too many other steps that can be taken to improve the CAD. The last option would be to go in for sovereign bonds.

Reserves cover

Currently with forex reserves at around $400 billion, import cover is comfortable. In fact the decline in reserves of around $25 billion this year can be attributed mainly to the RBI selling dollars of around $15-16 billion to stem the rupee’s fall. It is here that it is necessary to distinguish between the fundamentals that are driving the rupee and the extraneous factors over which we have no control — trade wars, Federal Reserve actions and the oil conundrum.

The RBI and the government have worked well to address the fundamentals including getting the oil marketing companies (OMCs) to raise foreign funds of up to $10 billion to ease pressure in the forex market.

A sovereign bond or NRI bond or a swap would be the last resort. While it would be prudent to have such a scheme as a standby, the government needs to work out critical triggers which would lead to exercising this option. Such bonds are expensive and given that the ECBs and OMC borrowings are now being allowed without hedging requirements, the future risk also needs to be weighed appropriately.

Why the ideas of Nobel prize winners Nordhaus and Romer are relevant for India: Financial Express October 9 2018

Nordhaus’ work is more on the ‘negative spillover’ of emissions and damage to the environment as a result of growth. Romer’s is on the ‘positive spillovers’ of knowledge and technology.

The Nobel Memorial Prize in Economic Sciences is now 50 years old and, interestingly, the average age of the recipient is 67 years. The age has ranged from 51-90 years, with Kenneth Arrow being the youngest to be bestowed with this honour. The Nobel Prize for this year has been awarded to two economists in two different fields, but both relating their work with economic growth. William Nordhaus, aged 77 years, has worked on climate change and economic growth, and Paul Romer (of the World Bank), aged 63 years, had worked on innovation and growth. Interestingly, the focus is on growth for both of them. Nordhaus’ work is more on the ‘negative spillover’ of emissions and damage to the environment as a result of growth. Romer’s work is on the ‘positive spillovers’ of knowledge and technology.

It is now accepted that in order to get higher standard of living it is necessary to have accelerated growth. This is the only way in which jobs can be created such that people are able to improve their standard of living. Here the two winners have different perspectives. Nordhaus says that as we strive to bring about high growth, we tend to damage our environment, which, in turn, comes back to haunt us and retard future growth. Therefore, all growth policies have to keep this in mind from the point of view of a long-term perspective, as a damaged environment will affect our lives. This has already been seen in terms of land, which gets less fertile due to excessive use of fertilisers and overgrazing, carbon emissions which affect health, aircraft which damage the ozone layer, erratic rainfall, ocean life, etc.

Nordhaus hence spoke of ‘DICE’ as the way forward—the ‘Dynamic Integrated model for Climate and Economy’. The obvious solution is a carbon tax, which is now quite popular in the world, whereby one discourages emissions or makes entities use better technologies that lower such emissions. The important thing is that there has to be government intervention here, as the market system will not ensure such a solution.

The problem here really is that countries, at times, make such compromises for short-term gains, especially when they want to get out of a low-equilibrium trap. Also, often, the externalities caused by damaging the environment, which affects everyone, are assumed to be everyone’s problem and not just that of the nation.

Instead, there should ideally be ban on the use of certain material or technology that damages nature, and which should be agreed upon by all the countries. Carbon tax is a softer option that only increases the cost of damaging the environment (which will be passed to the consumer), but does not really bring an end to the polluting process. In India, for example, a simple thing like a ban on plastic bags has been difficult to implement due to various lobbies. Outright bans are the only way out.

Now, Romer talks of a positive stimulus to growth, which is based on knowledge or technology. This is logical because if one looks across growth patterns of various countries and compared the strategies pursued for higher growth, technology is the differentiating factor. That is why African countries remain slow-movers, while the East Asian economies were able to gallop on the back of innovation.

This story has played out historically, with the advent of the Industrial Revolution in the mid-19th century in Britain, through the years to the new technology revolution that started in the 1980s and has only been reinforced in the last four decades or so. In fact, a lot of progress in India can be attributed to innovation—the Green Revolution in agriculture or the IT revolution that changed the balance of payments dynamics.

An interesting observation by Romer is that when technology brings about growth, it is non-exclusive because the benefits do percolate to other companies and countries—though there could be litigation of all dimensions in terms of copyrights and IPR (Intellectual Property Rights) in both industrial as well as pharmaceutical worlds. He, therefore, spoke about the need for R&D subsidy to be given by governments to ensure that this spiral is maintained. The power of new ideas is hence quite supreme and cannot be contested. Here one can leave it to the market to drive such innovation, as it is intrinsic to the business models that focus on growth.

But two interesting questions can be raised here, when looking at the works of the two winners. The first is the link between technology and climate change. If new ideas based on innovation, a la Schumpeter, had to succeed—which is what the modest steam engine did, to begin with—it is not possible to ensure that such technology is consistent with sustainable growth. For example, the technology of mobile phones has brought in a broader debate of radiation emissions where the tenets of Nordhaus and Romer would collide. There has to be intervention by the government.

Second, when technology becomes labour-displacing, can it really lead to meaningful higher growth per se? This is important especially in labour-surplus economies, where the concept of technology has to be redefined, because in several countries in Africa and South Asia, where there is shortage of power, can innovations in the laboratory be practically viable? While this issue may have been discussed in Romer’s work over the years, the point to note is that innovation must be tailor-made to suit local requirements so that it does not disturb the ecosystem. The advent of artificial intelligence (AI) is relevant because such innovations are not yet tested, but could render several jobs redundant in countries like India where we have adjusted to the computer after almost three decades!

For India, the ideas of both these economists are very relevant. When talking of inclusive growth and creation of jobs, the focus has to be on using innovation in a stylised manner so that the large labour force is gainfully employed. The retail boom witnessed in India is a good example of how new ideas have made a difference.

The climate change issue is more challenging because, currently, while India may be meeting the global standards in terms of carbon emissions, there need to be internal rules to ensure that we protect the environment. The changing climate forces have created volatility in the monsoon patterns and global warming has already made its imprints as witnessed by the significantly higher temperatures in some parts of the country. Laws need to be in place that ensure there is a proper marriage of technology with carbon emissions before unbridled growth spoils the story in the near future.

‘Lying for Money: How Legendary Frauds Reveal the Workings of Our World’ Financial express 30th September 2018

We keep reading about scams in the financial world, though fraudulent practices are pervasive in every walk of economic life. Scams in resource allocation and frauds in banks and companies are making headlines in India especially, so a lot of what one reads in Dan Davies’ book Lying for Money would not be very novel.

The author presents a view of the various kinds of frauds that have been committed across the world that can actually be a guide on how to cheat in the white-collared world. He is careful, however, to warn the reader that people rarely manage not to get caught and, therefore, one should not try out such means, howsoever tempting they may be.

The LIBOR scandal is well known where respectable bankers gave low quotations in the polling process as the idea was to trick the market into believing that the banks were strong. If they had provided the right rates, which were actually higher, then the prevalent fear psychosis would have taken over, given the deep suspicions that were harboured against banks post the financial crisis. Barclays was the big name that was involved in this fraud.

Starting from this example, Davies goes across various kinds of frauds that have been perpetrated, right from raising money for central banks of countries that never existed to the more well-known cases of Ponzi or Madoff. His belief is that fraudsters play on the weaknesses in the system of checks and balances and the audit processes that are meant to supplement the environment of trust. And it is hard to catch these people because crooked businessmen employ the services of crooked auditors, accountants, lawyers and even bankers so that there is a strong circle of fraudulent parties in the ring, which is hard to dislodge.

Based on the series of episodes of fraud perpetrated in the commercial world, the author brings the characterisation of them to four groups. The first is what he calls a ‘long firm’, which runs up a lot of credit from the vendors with the intention of never paying them. Dealers often have to sell on credit or else they will not be able to manage inventory. These long firms look honest and prima facie one can never find out that there is no intent to repay.

The second kind of fraud is plain ‘counterfeiting’, where false documents or claims are made that go beyond making counterfeit goods. This can hold for products as well as people. To become a long firm, one may present fraudulent documents to gain trust and the rest becomes easy for the fraudster.

Third is what he calls a ‘control fraud’ wherein the classic principal-agent problem is leveraged as the owner may not be able to control what goes on in the company. This happened in the financial crisis where incorrect decisions were taken, the boards misled and high bonuses earned by the management. Nick Lesson was another example of how systems were dodged or misused to earn large salaries and bonuses. When the bubble bursts, the company’s name gets tarnished, and even collapses, but the perpetrator(s) could just get away with it, or even if found, cannot compensate for the losses. That was what happened to Barings Bank. The same becomes a distributed control fraud when there is a mechanism that is set in place where high risks are taken and fake profits reported.

The last kind of fraud comes under— what are termed as—market frauds where the victim is the market. Cartels best exemplify this phenomenon. Another example put forward is of toxic dumping, which several companies do and which never gets detected because of the strong chains built to ensure that any nit is not reported by the authorities.

Given the trend of a large number of frauds involving some of the best names in the field of accounting, there are some interesting insights provided by Davies. As all firms seek business, it is easy for companies to force the accounting and auditing firms to agree to what they would like to show. The author believes that all auditors are honest and competent. But they need to have a spine, which is never revealed as the fees are more important and a persistent and overbearing CEO can have his or her way.

One can also get very good stock market valuation by making incorrect projections based on numbers that have been cooked up by the accountants. By rigging the due diligence process, one can continue to keep bringing out deceitful statements. Stock market experts can be paid to move up the price and tempt investors to buy into these stocks. Here, he takes us through various kinds of accounting frauds, which include fake sales, incorrect recognition of revenues, delayed recognition of costs, fake assets, and unreported debt. Several conglomerates have multiple subsidiaries that are floated, especially as special-purpose vehicles or what Enron had called ‘off-balance sheet vehicles’, where the idea is to conceal the true debt of the entity. Even when revelations are complete, they would normally go into the fine print in notes to the accounts, which very few would ultimately see.

He argues that there is a fraud triangle, which can be found in every such episode. The need to commit fraud is always linked with earning more than one can by honest means. This can work, provided there is opportunity, which involves complete understanding of the system to spot the loopholes for exploitation. Last, there has to be rationalisation of the deed—often corporate frauds are rationalised as being done for a temporary period, which then gets institutionalised.

And finally, cheating the government is something all of us are familiar with, which happens through both tax avoidance, as well as tax management. This is where almost all companies hire the best heads to ensure that tax payments are not always commensurate with growth in profits.

This is a very interesting book and for those who work in the corporate world, it will be easier to identify with various techniques that are used on real-time basis to cheat the system. It would be hard to come across companies where these practices are absent, as it does appear that the crux of doing business is to make money by any means—and if it cannot be found out, “‘tis even better”.