You Say Off-shoring, I Say Outsourcing

Both the Indian economy and the India Inc brand name owe a lot to "outsourcing" as the key to their global recognition and success stories. But, as the recent HSBC scandal demonstrates, the magic of Indian outsourcing seems to be fading away faster than you can say N R Narayana Murthy! What's happening?

The key to the outsourcing trend lies in some of India's strengths built during the 1960s and 1970s -- solid engineering institutions and a knowledge of English. Many global corporations, starting with General Electric and Texas Instruments, realised that some of their grunt work could be outsourced to India. They could use the vast reservoir of Indian engineers to do in India some of the quotidian work they were doing in USA. The prime motivation: saving costs.

This then caught the popular imagination as telecom infrastructure improved during the 90s and made communications -- both data and voice -- cheaper and better. Companies rushed to set up outsourcing centres in India -- shops that basically made sales calls to customers across the English-speaking world, to tackling after sales service issues, to even writing software code.

Another word was added to the business lexicon: "off-shoring". Global companies started spreading their work around the globe, basically to take advantage of cheaper skilled labour pools elsewhere. This also included another phenomenon: transfer pricing, which basically incorporated strategies at the global HQ level of reaping tax advantages by incurring costs in high tax geographies and shifting profits to low tax regimes.

But, since the basic premise behind the entire exercise was cutting costs, there were incentives for inventive managers to keep doing the same thing at lower costs. And, then came the financial crisis. With profits plunging to subterranean depths, companies starting sacrificing well-established risk measures and processes to gain that extra bit of business.

The same applies to banks which had "off-shored" their operations, compliance and risk processes to overseas locations. Ideally, the off-shore location, far removed (geographically, at least) from the business origination centres, were supposed to be neutral and free from any influence. In reality, there's hell to pay if managers in these off-shore centres said "no" to 2-3 consecutive proposals, even if the proposals did not meet the risk matrix guidelines. The pressure to get business is so intense and so acute that anybody saying "no", irrespective of the provenance of the funds, is viewed as an enemy of the institution.

We don't know what happened in HSBC exactly. The bank had an off-shore compliance centre in India to ensure that funds flow met the rules regarding anti-money laundering and terrorist funding. But, what we do know is that  a probe by the US Senate's Permanent Sub-Committee on Investigations found that the Indian compliance office was inadequately staffed, their quality of work was deficient and their monitoring procedures in internal control systems was weak (read full story here and here).

This is not the first time that India off-shore centres have been pulled up for the reasons cited above. In the mad rush to cut costs and stay competitive, many companies are sacrificing critical business processes, making compromises with sacrosanct quality standards. But, the worst culprit seems to be the practice of hiring sub-standard staff, shoring up revenues by skimping on training and telecom facilities and pushing employees to go beyond their call of duty to bring in revenues. This then creates a fertile breeding ground for suspect motives and dodgy ethics.

You can teach all the ehtics you want in B-schools (which, by the way, is another story for another day) but at the end of the day you would need an organisational culture --starting from the Board of Directors to the CEO to even the HR guys -- to implement it. Are we expecting too much from the modern-day corporation?

Turkish Coffee -I

My Istanbul flight timings made sure Monday Mocha gave way to Turkish Coffee on Tuesday. So here are some initial impressions from the land of doner kebaps and koftes.

First, all compliments to the new management at the Mumbai International airport. No more sweaty queues to get into the airport terminal or to get the luggage screened. Smiles all around, courtesies extended and no more desperate crowding. Probably it’s because the air-conditioning was working. But, on a more serious note, the change now makes the flying out of Mumbai a pleasurable exercise.

And then to Istanbul. Somewhere I had been expecting a bleak city, with emotions ruling between the grey and the black, the burden of history weighing heavy on the ordinary Istanbullus’ shoulders. Maybe that’s what happens when you try to see the world through the eyes of Orhan Pamuk. According to him, there is a common leitmotif running through the city’s intricately intertwined genetic lattice – melancholy, or huzun, as a predominant cultural identity. But, on the surface, that somehow seems absent. The city looks bright and colourful, with the people eager to succeed, though the strains of balancing the plethora of competing cultural strands that make up modern-day Istanbul do break through the surface sometimes. But then, this is just a superficial impression gained from spending just one day in this great city. More later. Some pictures too coming up soon.

Inflation Still Stands Between RBI & A Rate Cut

Dark clouds of the metaphorical variety have invaded the Indian airspace at a time when the Indian economy is desperately praying for the real thing. The monsoon deficit, which seems to be aggravating with every passing day, is now well on course to affecting crop sowing and causing a shortfall in agricultural production (read about it here and here). There are other portentous clouds on the horizon too.

Industrial production is limping along: the May numbers show a growth of slightly over 2%. But, mass-scale scepticism underlines this number because the April growth numbers have now been revised down to (-)0.9%. This is ominous: this means that industry produced less (in absolute numbers) in April this year than it did in April last year.



Courtesy: Reuters

Inflation seems out of control, though there is one proverbial lining here. The wholesale price index surged up by 7.25% in June 2012 over June 2011. While this is below the 7.55% rise in May, and also considerably below the Street consensus call of over 7.6%, it’s still way above the Reserve Bank’s comfort zone. Bad news continues to emerge from data revisions – inflation data for April has now been revised upwards to 7.5% from 7.23% announced initially. Consumer inflation for May 2012 remains highly elevated at 10.36%. But, there is still a glimmer of good news in all this: given data volatility and unreliability, RBI tracks core inflation data (or non-food manufacturing inflation) which is currently steady around 5%.


In the midst of all this, the Reserve Bank of India is expected to meet on July 31 to conduct its mid-quarter review of monetary policy. The markets don’t know what to expect: a majority wants rates to be cut, because it associates the slowdown directly with rate hikes in the past. Therefore, it holds to logic (in their minds, at least) that rate cuts will lead to a growth uptick. In addition, many central banks around the world -- China, Europe, Taiwan, South Korea and Brazil -- have cut rates recently and the RBI Governor will be under pressure to emulate them. However, most economists and analysts feel that it might be a bit premature to take the shears to interest rates.

So, how will Duvvuri Subbarao chose to act? While it is a mug’s game trying to predict RBI’s actions (and many a well-known face has ended up with egg on it), this blog will rise above the humdrum and deign to advise the central bank.

This blog feels that the Reserve Bank should hold interest rates at the moment. Although this same blog had argued for a rate cut in February, it is arguing against it now. There are two key reasons. One is, of course, the singular impact that such rate signalling can have on sentiments, which at that point of time sorely needed some encouragement from the authorities. But, the more important reason is the way the opportunity to climb out of the slowdown hole has been squandered. There is no visible action on a number of fronts – either on expenditure management or on implementing major policy reforms. If the rate cut then had been combined with some policy actions from the centre (as was expected then), the situation could have been ripe for another rate cut now.

There are other compelling reasons to press for a pause now. Lower agri production is likely to result in higher food prices, especially for pulses, vegetables and fruits. Simultaneously, it is also expected to translate into lower rural incomes. This will mean lower demand for a broad spectrum of goods and services (think Hero Honda motorcycles or cement for rural housing). On a macro level, this means continuing with a period of slow industrial production. On top of all this, with inflation and inflationary expectations continuing to remain high, with global volatility continuing to put pressure on capital flows and the rupee (thereby creating another distinct source of inflation for the economy), and with the government yet to put its money where its mouth is, it probably makes no sense to cut rates now.

However, the central bank is under tremendous pressure. If it decides to cut rates at all, core inflation at 5% could be a strong reason. It is worth the wait to see how the policy shapes up and trying to figure out what has influenced the eventual outcome.

IIT Entrance Exams: Through The Wrong End of the Telescope!

Courtesy: Wikipedia

Education minister Kapil Sibal’s plans to revamp the system of entrance examination to the IITs has stirred up a fair bit of criticism, debate and an unfortunate display of emotions. It is quite possible that minister Sibal might just be barking up the wrong tree. But, even if you grant that, it is also true that the armies of the aggrieved are possibly looking down the wrong end of the telescope.

Minister Sibal has proposed that marks/grades obtained at the entrance exams should not be the only qualifying criterion for students aspiring admission into IITs. The Institutes should also take into account school performance, because while a particular student might have shown consistently good academic results in school, she could just be having a bad time on the day of the entrance exam.

Fair enough. But, that invites its own set of problems. A bulk of India’s school-going students attend institutions which report to their respective state education boards and the grading pattern, thereby, differs vastly across states. While some state boards are lenient with grading, some are exceedingly tight-fisted. This writer should know: the West Bengal state education board mistakenly believes (or, used to believe) that low marking was a virtuous sign of quality education. Therefore, there is a felt need to regularise grades across states.

The ostensible reason behind minister Sibal's exercise is to stem the growing informal industry of coaching classes, which help students focus – through boot camps – exclusively on cracking the entrance exam. This, it’s felt, is diluting the quality of students entering IITs and, thereby, the quality of engineers entering the job market.

This whole process has stirred up a hornet’s nest. The IIT faculty and alumni have voiced their outrage: they feel that the new system will not only harm the IIT cache but also spawn a new breed of coaching classes that will focus on fetching superlative grades at the school level. IIT alumni members are all influential members of society and therefore this has triggered off a different kind of power politics.

It is true that Kapil Sibal might need to revisit his proposal because if the quality of students is an issue, then the rot starts at the school level, especially the government schools. There is an article written by Ravish Tiwari on this in The Indian Express (read it here). Also, will incorporating the school-leaving academic records stem the rot in the system? Unlikely. In fact, it runs the danger of even breeding an entirely new breed of elitists, who will be selected by IITs for reasons that might be only borderline meritorious but sneakingly subjective. But, undoubtedly, something needs to be done.

Even the IIT faculty and alumni need to introspect. The Express article mentions that the faculty and administration did indeed start debating the quality of students they were taking in every year. How do you change that? One unavoidable option is to overhaul the entrance exam. For instance, should the entrance exams include a separate paper on English? Also, if the quality of engineers graduating is a concern, then the faculty should also take equal responsibility. These students spend four very critical, and impressionable, years of their life in an IIT campus. It is therefore up to the faculty to re-engineer (sorry, that was an unintended) the syllabus, the mix of courses and the pedagogy.

Now, for the other end of the telescope. One reason for the mad rush to get into IITs is the assurance of a pot of gold at the end of the rainbow. And, here the pot of gold are the IIMs, or the Indian Institutes of Management. These premier institutes also have a common entrance exam that is contentious. The structure of the exam shows that it’s weighted towards engineering students – or, it helps you score marks if you are an engineer. Also, given the tag of premier management institutes, students graduating here have a shot at the best jobs – make that the best-paying jobs – in the employment market. Therefore, the rush to get into IIT since admission in this hallowed institution is a guarantee of sorts. It definitely smoothens the path into IIM. Or, so is the perception.

It is this end of the telescope that Kapil Sibal and all education experts need to be tackling. Because the end is justifying the means.

Spooked: The BIS Annual Report 2011-12

The Bank for International Settlements, or BIS, the central bank of all central banks, has come out with its annual report (read here) for 2011-12 (BIS follows a April-March year).

The report contains some general observations, many of which are applicable to India. Sample some of the paragraphs:

1. The extraordinary persistence of loose monetary policy is largely the result of insufficient action by governments in addressing structural problems. Simply put: central banks are being cornered into prolonging monetary stimulus as governments drag their feet and adjustment is delayed...any positive effects of such central bank efforts may be shrinking, whereas the negative side effects may be growing.

Although this is with reference to the western economies with nominal interest rates ruling near zero and central bank balance sheets expanding, this paragraph could even apply to India. And, even though RBI has reeled its loose monetary policy back, on getting early warning signals of inflation and inflationary expectations during October-December 2009 (though some economists did blame RBI for delayed action), we do see the government failing to make the difficults adjustments or take the tough calls. Instead, they are relying on RBI to provide all the stimulus to the system and deliver growth.

So, here is the prognosis from BIS: central banks face the risk that, once the time comes to tighten monetary policy, the sheer size and scale of their unconventional measures will prevent a timely exit from monetary stimulus, thereby jeopardising price stability. The result would be a decisive loss of central bank credibility and possibly even independence. The last part is the scary bit.

2. Here is another relevant, though somewhat chilling, paragraph: Measures of debt service cost also suggest that high debt levels could be a problem. The fraction of GDP that households and firms in Brazil, China, India and Turkey are allocating to debt service stands at its highest level since the late 1990s, or close to it. Debt tends to accumulate on private sector balance sheets when interest rates are low. When rates eventually rise, higher debt service costs can trigger a painful deleveraging.

With the economy and industrial growth slowing down, commercial banks have been hit on two fronts: a deceleration in the build-up of commercial assets as well as retail lending slowing down. This means ;lower earnings and reduced bottomlines. However, banks are increasingly staring down the barrel of another risk: defaults. If that comes to pass, since high debt servicing becomes untenable in a low growth environment, bank balance sheets will be drenched in red ink.

For an interesting and different view of private sector debt, read former journalist and banker Haseeb Drabu's weekly column today (available here).

3. While the growth of banks from advanced economies has slowed, banks headquartered in emerging markets have been gaining in importance. Reporting steadily rising common equity, the average emerging market bank in a sample of large institutions worldwide is on a par with its US counterpart in terms of loan volumes; it has also substantially increased its securities investments. Chinese and Indian banks in particular expanded their balance sheets by roughly 75% between 2008 and 2011.

Only one point here: Remember this balance sheet growth took place during a period of economic stimulus which focused on consumption and not on capacity creation or expansion.With growth slowing down as expected, and rates continuing to remain high, this could force some banks to shrink their balance sheet sizes. We are seeing that happen already.

4. Countries such as Russia or India could experience considerable headwinds if growth slows as expected in their trading partners (Ukraine and Turkey for Russia, Middle East markets for India) during 2011–15. These headwinds could also be significant for most European countries, which trade heavily with each other and where growth forecasts have been sharply cut back.

So much bally-hoo was generated after June-July 2011 by the former Commerce Secretary about India diversifying its export markets, as well as its basket of export goods. Suddenly, we don't hear so much noise about it at all.