Kick Off Interim Budget With Cut in Income Tax

AH, IT’S time for Indians to indulge in their four-year itch again. It’s once again time for that great, once-in-four-years festival called “general elections”. Some starryeyed call it a celebration of democracy, some see it as an opportunity to escape the long arm of the law and gain respectability, some see it as a time to forge new alliances, and then some see it as an opportunity to extract some fresh commitments from politicians when they are at their most vulnerable.

While in this high season of corporate governance, the government-in-power’s balance of achievements and failures is expected to come under close scrutiny. But, the one other balance sheet of greater importance will escape inspection. The elections have given the government an escape route — it will now have to present only an interim budget, which is a vote-on-account asking Parliament for funds to tide over all the must-spend expenses till the next government takes over and presents a full budget. So, this government can only use the VOA opportunity to tom-tom its achievements, advertise its success with the economy (before the current downturn upset all their plans) and make some noises about how it cares for the poor, the farmers, the marginalised (in all its forms — gender, religion and caste). With the Election Commissioner watching hawk-eyed, it cannot actually implement new taxes, though it can announce new economic measures. While presenting the interim budget in 1991, former finance minister Yashwant Sinha (as part of the Chandrashekhar government) had, for the first time in Indian economic history, announced the government’s intention of divesting its equity in public sector units.

This government probably doesn’t need to do much about indirect taxes since it has already implemented some tax cuts through its two stimulus packages. But, surely, the finance minister should be allowed to make some course corrections where gross anomalies exist. Here is the Mocha Master’s list.

The government has loaded one cess after another on the income tax paid by individuals. This is taxation through the backdoor, using a surreptitious route to milk the most under-represented political class. This also exhibits how the government, unable to stem the rot in its finances, is passing on its burden to the salaried class. The education cess, for instance, is the government’s admission that it is squandering away the tax-payer’s contributions and needs more funds to fulfil its basic duties. In the debate over stimulus packages in the US, some economists feel that tax cuts might achieve much more in reviving the economy than throwing money into one project after another. The Indian government could examine the option of removing the cesses as one of the viable alternatives for firing up the economy.

Some sanity might also be required in the levy of service taxes. No one is complaining about the basic concept of service tax. If excise duty can be levied on manufacture of goods, then service tax is also logical, especially when services contribute to a good 50% of GDP. But, just like small-scale units enjoy tax breaks, there should be some service tax relief for home offices, to nurture entrepreneurship. In these times of economic upheaval, the government will have to devise some strategy that encourages entrepreneurship, especially one that supports people who have been either laid off from their jobs or those who opt to work from their homes. And, service tax breaks for small-officehome-office can be a great booster shot, even if they are for a limited period.

The time has also come to think of a maximum retail price for some services. Just like there is MRP for a wide variety of goods, which restricts the exploitation of the consumer in the hands of the manufacturerwholesaler-retailer nexus, some kind of a similar arrangement is required for services also. For instance, take the airline industry. Although many of the private airlines are advertising low fares, these are deceptive. For instance, if a private airline advertises a Rs 2,500-fare for Mumbai-Bangalore, the actual money paid by the passenger works out to Rs 5,500.

Out of the hidden difference of Rs 3,000, a major component is scooped up by the airlines as something called “fuel surcharge”, which was imposed when oil prices had shot up. Now that the prices are down, the airlines are reluctant to pass on the benefits to passengers.

Utilities, especially power suppliers, too have hidden costs. Today your power consumption might be just worth, say, Rs 2,800. But, your total bill might end up being as high as Rs 4,500 on account of various cesses, and cross-subsidies loaded on you. For instance, a typical Mumbai electricity bill includes the following items, over and above the “energy charges” which is based on your consumption of electricity — standby charges, cost of expensive power, fixed charges, fuel adjustment charges, electricity duty and tax on sale of electricity.

If the government is serious about reviving the economy, the time might be right to review some of the hidden taxes, charges, levies that turn the economy into a highcost island. The start could be made with some of the cesses on income.

Courtesy: The Economic Times

Jai Ho! It’s Time for Bollywood to Globalise

Danny Boyle’s Slumdog Millionaire seems to have left Bollywood redfaced and indignant. At least, that’s the impression one gets after hearing all the noises emerging from this sprawling, and largely unorganised, industry. But seen in the broader perspective of India’s journey into globalisation, it somehow seems to make some sense. And, seems somewhat predictable too.

Marque voices and some leading purse managers in the industry have been grudging in their praise of the movie, particularly after it swept the gongs at two global film award ceremonies, the Critics’ Choice Awards and the Golden Globe Awards, and looks well on its way to sweeping many other honours. The carping is about how the movie exploits Mumbai’s slum life and its squalor. This complaint is not new. Bollywood has often taken exception to renowned Indian film directors winning awards overseas for depicting real Indian life, as distinct from the reel life that launched many spurious dreams.

Broaden the debate a bit and it has an uncanny similarity to the voices one heard when India embarked on its economic reforms and liberalisation programme. Home-grown Indian companies, till then cocooned and sheltered by the governments’ protective policies, initially formed informal clubs to lobby for a continuation of the old policies or for special preferential treatment to Indian companies. Later, when that didn’t help, they pooh-poohed the chances of any foreign investor succeeding in the Indian market. Their common refrain: they do not understand the Indian market, they do not understand the granularity of different cultural strands that together make up the complicated Indian tapestry, or worse, they did not understand the “environment”. The last one is obviously a euphemism — what it meant was that the multinational corporations didn’t know how to finesse the Indian political-bureaucratic nexus to their own advantage, thus giving the Indian companies an inherent edge.

How wrong all those assumptions have been. First, many smart Indian promoters sold away their brands and companies to MNCs as soon as the gates were flung open, thus inviting criticism from some of the more patriotic industrialists. Then, most of the foreign investors found willing joint venture partners among Indian companies, eager to lend their names for a onetime fee. These “invading” companies also were able to “understand” the Indian market better by hiring the relevant local talent, at times by offering salaries and working conditions far better than the Indian companies. The same tactic was also used for massaging the environment.

All this is also symptomatic of Corporate India’s reluctant acceptance of the phenomenon known as globalisation. In the end, though, parts of India Inc have come out smiling. That’s because the inherently strong companies realised competition is a way of life and greasing palms cannot become an organisation’s core competence. In fact, many Indian companies also took advantage of globalisation to acquire brands, companies and markets overseas.

Cut to Bollywood, which also seems to be in the early phases of denial. Slumdog Millionaire probably represents, in some ways, the initial stages of the entertainment industry’s globalisation pangs. But, globalise it must, whether it is kicking or screaming. Bollywood is suffering from a valuation crisis, especially after the market meltdown. Many home-grown studios — which opted for a corporate structure to facilitate access to cash and to leverage the euphoric bull run — have now become easy pickings for foreign studios. Most of these studios had earlier promised foreign studios either joint projects, or even joint ventures with substantial stakes. Unable to wriggle out of these commitments, many of these studios are bound to lament - somewhat true to form — the erosion of Indian cultures, ethos and values.

Slumdog Millionaire also represents a different way of doing things, in sharp contrast to Bollywood’s entrenched practices. Take casting. The film crew scoured countries and cities to search for the right faces; the boy, in fact, is a non-resident and the girl is a totally new face. The film producers and director even auditioned the young boy and girl together to see if they had the right chemistry on screen. In Bollywood, the leading man is decided mostly on a whim and a fancy, long before the screenplay is finalised. If it’s a big budget film from a well-known studio, the lead role is then usually reserved for the son of the studio promoter. In many cases, the leading man also dictates the choice of the female lead, script be damned.

In this case too, as was the case with Indian industry, the foreign studio has found Indian talent and financiers willing to risk their gifts and their finances on Danny Boyle because he comes with a past, a successful track record of having directed some very cutting edge cinema. Danny Boyle’s nationality — or his lack of Indian roots — never made any difference. What mattered was his craft.

There are many Indian companies which are happy to cater to only a market niche and do not desire global markets, but are eager to run their companies on global best practices. Likewise, there will be cinema that will cater primarily to Indian audiences but will be produced by implementing global best practices. And, that’s going to make all the difference.

Courtesy: The Economic Times

Spot A Corporate Scam

FOR some it’s clearly winter, for those spoiling for a fight with neighbouring countries it’s a time for bellicosity and for many it’s a period of abstinence and renouncement. But, for Corporate India, this is, undeniably, a season for corporate governance. The nice-sounding, and sanctimonious, phrase moves from conference halls to board rooms this month as Satyam occupies business mindspace, boggles the popular imagination and becomes the new “shock-and-awe” item of the season.

The term ‘corporate governance’ tends to make an appearance and leave a strong impression mostly during times of market crashes and slow economic activity. During go-go times, no one cares. Even the Satyam skeletons would have stayed firmly locked up, rattling some consciences occasionally.

But, this time, long faces are discussing the issue seriously on television channels, equity analysts are saying they knew all along that India Inc was seriously in deficit and many company promoters are looking over their shoulders every so often.

Does this end here? Hopefully. But, if one is to hear all the doomsday artists and professional corporate watchers, this could just be the beginning of a long procession of companies waiting to be outed. So, here’s a favourite parlour game: how to spot and detect the next wrong ones. Look out for these traits:

* This one is a sure give-away. Be suspicious of companies suddenly launching on unrelated diversifications with great gusto. For instance, a chemicals processing company starting a floriculture project is a sure sign that it is planning some land-related scam or is using up shareholder’s money for a hare-brained project to be launched by the promoter’s son.

* Beware of companies which have huge related-party transactions. This is one old (and successful) model of siphoning off cash from the company. It is also a not-sosubtle way of ‘inflating’ sales. About 50% of one large, and listed, real estate company’s sales are to a group company (which stays resolutely private), but the money to be received from the same company somehow does not jive with the sales number. In this way, the listed company uses public money to build projects, sells them to the private company, shows pumped-up sales, but the buyer (the private company) is over time shown as incapable of paying up, the receivable is written off from the listed company and when the sales eventually happens, the shareholders of the private company gain the most. Cost is borne by the public, but profits stay with only the promoters.

* Keep your antennae up for companies which suddenly change their accounting policies. Many companies suddenly change either their depreciation policy or even their revenue recognition policy. A change in the depreciation policy allows many companies to either reduce their actual losses or helps balloon profits. Many corporates also suddenly change how they acknowledge revenue accretion. In many cases, this helps show a sudden increase in sales, resulting in better valuation on the stock markets.

* Another red flag: Companies that suddenly show a dramatic jump in sales, when nothing extraordinary has happened in the economic environment to justify the spurt in growth. One media company which went public a few years ago, showed a spectacular jump in its total revenue a couple of months before filing its prospectus. Recently, another technology company showed a 900% jump in sales over just six quarters ended September 2008! People should be beating a path to this company’s door for some clues on how to locate undiscovered multitudes of buyers.

* Many companies, during good times, entered into some exotic foreign exchange derivative contracts, hoping to punt on the movement of currencies they had no clue about, such as the Swiss franc. In good times, all’s acceptable. But, come crunch time and all these derivative contracts have now shrunk in value. But, the companies that bought these fancy products are yet to recognise the forex losses on their profit and loss accounts. It’s a bit like a time bomb ticking away in the accounts. Some companies have disclosed their exposure, but are refusing to provide for it, hoping it will go away one day like a bad dream.

* Ditto is the case with many companies which had loaded up on forex debt, like a famished urchin landing up at a free, five-star buffet. Today, they are shying away from showing the losses on these debts, especially since the rupee-dollar has moved adversely from the time they had contracted the debt. Expect to hear more about a fancy term called Accounting Standard 30 in the coming days.

So, what’s the lesson from this time? Sorry to sound cynical, but as long as the system stays what it is, there might be just a few more revelations, and then it’s back to business as usual. C’mon, we’re all forgetting the basics. Can you ask people to keep a tight rein on greed in a market that’s asking everybody to buy that fancy yacht, or that bejewelled watch, in the space of a heart-beat? Perhaps, it’s better for all of us if we were to accept this silver-tongued beast as an irrefutable part of our lives.

Another to-do list for politicos in New Year

RESOLUTIONS, promises, to-do lists. January always finds human beings indulging in some temporary exercise of will power, a willful abandonment of hedonism and a self-imposed regime of restraint. Some soldier on with their resolve, but most dump their long lists of self-imposed asceticism in a couple of months. That’s the beauty of these pledges—it’s like emerging from a crash purgatory course, all cleansed, radiant and beaming. In contrast, politicians take important vows only once in five years, and don’t even need to make any pretences of keeping up with them. But, they should see January 2009 differently.

A lot of expectations have been built up this year and the political class would do well to heed them. This year, in keeping with the season’s overdose of optimism and goodwill, might also just be that inflection point when the first strains of change become visible. Barack Obama’s “YW-C” call-to-arms seems to have had some impact in India as well. If politicians don’t want to be swept aside by a historical tide of anger washing up against their indefensible citadel, now is the time for them to draw up their own list of undertakings, thing to do over the year, in addition to their normal duty (which is, governing, eradicating poverty or strengthening the economy). Here are a few items from that list.

* Get the municipal corporations back in order. If necessary, legislate or amend existing legislation. It all begins here, whether it’s the citizen’s disenchantment with the system or the seeds of corruption, which then flower elsewhere. Most voters think at two levels — his immediate environment and then policies at the national level. The evolved ones may squeeze in a state-level tier. But, unhappiness with the immediate civic administration usually also gets expressed at the state level, as Sheila Dixit understood so well and Vilasrao Deshmukh refused to countenance. Look at the mess in the country’s richest and probably the best civic bodies (which is not saying much, given the abysmal state of all of them), Brihanmumbai Municipal Corporation. The muni has suddenly woken up to the prospect that the city’s water requirements is far higher than what can be supplied. The reason? Lack of co-ordination between the department that sanctions construction of new buildings and the one that’s in charge of water supplies.

* End the illegal trade in arms. It is true that, since 1990, this country has moved towards a liberal economic regime that puts great store by free markets. The shift in policies was spearheaded by the current PM, who was the FM then. But that doesn’t mean that we also believe in the laissez faire powers of an unfettered arms bazaar. It is common knowledge that firearms of any make, with matching ammunition, is available to anybody willing to shell out the cash. And, the hardware is available everywhere — Bihar, UP, Bangalore, Punjab, Maharashtra. Plus, corruption in the ordnance factories that allows leakage of ammo has been reported extensively. It’s time we ceased talking of Peshawar’s arms bazaar when our politicians and the police have been turning a blind eye to the thriving underground trade in armaments.

* There’s another business model crying out for state intervention. It’s called forced abductions, or kidnappings, which usually finds closure with the payment of a ransom. This is routinely practised by powerful thugs and patronised by politicians (in some cases by powerful ministers) and given free rein by the police force. Some times, in certain states, if the kidnapped person’s family is willing to pay the police a handsome percentage of the ransom amount, or the abductor fails to pay adequate commissions, then the kidnapped person might be rescued earlier than expected. This has turned into a perfect fund-raising exercise for political parties in the heartland and doesn’t require killing hapless PWD engineers. Surprising, Harvard or Wharton are yet to write a case study on this.

* Implement the National Police commission’s report at the earliest. The speed with which 26/11 has spurred the political class to rush through legislation (such as the National Investigation Agency or the UPAA amendment) or to create new wings of the police force (such as Maharashtra government’s decision to create an NSG-lookalike at the state level) invests the populace with a scepticism and a cynicism borne from years of misguided policies and corruption. Everybody is keeping his fingers crossed, hoping that these decisions do not become another opportunity for kickbacks or authoritarianism. There is a feeling that even if half the commission’s report is implemented, many of the problems bedevilling the police force could be sorted out. But, first, the police appointments have to be depoliticisied. A former home minister of Maharashtra was known to have opened a small time business in transfers - a literal version of the pay-as-you-go model. This arbitrary power needs to be taken away from ministers and vested with an all-party committee, probably headed by the CM.

Rx: Start With Consumption, Start Small

The trick to jump-starting the economy might lie in creating demand for basic goods, besides increasing liquidity and other revival measures

IN THE movie Batman & Robin, arch-villain Freeze gate-crashes into an antiquities exhibition and announces: “In this universe, there is only one absolute. Everything…freezes.” Credit markets across the world have frozen over, and though there’s no nasty piece of work yet (at least not on the scale of Freeze), there are no early signs of thawing. Spring may still be far away, but attempts by regulators and governments from across the world to end the economic chill don’t seem to be working. In India too, the government and the central bank, Reserve Bank of India, seem to be working hard to loosen winter’s cold grip over the Indian economy, but with little success.

The RBI has been infusing the economy regularly with large doses of liquidity ever since the system was beset with worries of money drying up. The RBI tried everything in the book — cut cash reserve ratio, freed up part of the statutory liquidity ratio, opened a special lending facility for banks to on-lend to NBFCs, housing finance companies and mutual funds, created a special refinance window from where banks could borrow without providing any collateral. Additional liquidity was pumped in by buying back bonds issued under the market stabilisation scheme. In all, since mid-September, the RBI pumped in Rs 300,000 crore through the sluice gates.

But, even that did not help hydrate the financial system. When banks were swamped with liquidity, they took the cash and dumped it with the RBI for a 6% return, even when lending it to prime borrowers might have fetched better returns. The central bank even cut its benchmark repo rate by 150 basis points (bps) to 7.5% on October 19 in an attempt to get some of that money moving out of the bank vaults. Still no go.

The RBI recently turned up the thermostat once more, this time to prod banks to start lending at reduced interest rates. It cut its benchmark repo and reverse rate by 100 bps. But, again, there’s hardly any movement. The banks are still carting their surplus cash over to the RBI and dumping it there for safe-keeping, for even as a low a return as 5%. Take a look at the money being tipped over at the RBI window.

For the first five days of the month, till the RBI cut the rates, banks plonked Rs 243,310 crore with the Reserve Bank, for a return of only 6%. Then on December 6 — a Saturday — it cut rates again. Over the next three working days, banks again deposited Rs 84,635 crore with the central bank, for a return of just 5%. The total — for just eight days — works out to over Rs 327,000 crore! In fact, the RBI was forced to comment, while announcing the new rate cuts, that the liquidity adjustment facility operated by the central bank, “has largely been in an absorption mode.”

In effect, this means banks are still wary of lending to corporates, despite the sea of liquidity and rate cuts unleashed by the central bank. This also then conveys how banks are still uncertain about the future and that they are doubtful about the ability of their corporate clients to pay up in time. In short, the vital glue of financial system — trust — seems to be missing and the authorities designing the various economic packages are unable to supply it in sufficient quantities.

Here's an example — a public sector unit was able to issue five-year bonds to banks with a coupon of 9.33%. Around the same time, one of the Top five India Inc companies also borrowed three-year money, but at 10.10%. Clearly, banks are willing to take a risk on the government, even if it is a subsumed sovereign guarantee, but not on even AAA-rated private companies. Banks have not forgotten the nightmares of the early 1990s, when bank NPAs ruled around 10-14%. This time, despite the prodding from the government and the central bank, they are unwilling to stick their necks out. The RBI has allowed banks to restructure loans — a euphemism for looking the other way when a loan turns bad — that might in ordinary times have been called for stricter treatment. But, the banks are still not biting.

The problem also seems to be in the system’s liquidity absorption capacity. Whatever steps the government takes at the moment — such as, providing cheap cash to corporates through a variety of refinance windows — not only are banks reluctant to lend, even corporates are loath to load up their balance sheets with fresh debt. Many of them are drawing down their existing credit lines with banks — emboldened somewhat by the new restructuring space — to finish existing projects but are unwilling to bet on new projects. With aggregate demand having fallen, India Inc is also contending with reduced topline and bottom line projections. In such a scenario, they may not be in a mood to pile up additional debt.

Therefore, the key to the current economic impasse might lie on the demand side. The government has tried addressing the issue by spending on infrastructure and by cutting taxes to boost demand. These are also not without their associated problems. Any investment in infrastructure will yield results only after a long lag, and the nature of improved technology does not allow for the higher employment generation that one saw a few years ago. Plus, to get an infrastructure project started is also time-consuming — financial closure in these days of clammy credit markets is a tough call.

Some economists say that the production orientation of the economy has changed in favour of expensive consumer products, a sector that might be slow off the blocks in reviving. In such a situation, reviving demand for wage goods might just do the trick. Even this hypothesis needs to be tested. The occasion might present itself soon — with experts forecasting a better-than-average winter crop, the government should facilitate hassle-free movement of the harvest to the markets and consumables to centres where the ensuing agricultural income can be spent. This may sound simplistic, but sorting the physical, infrastructural infirmities could be one of the first achievable steps on the long road to recovery.

Published as an Op-Ed in The Economic Times (December 15, 2008)

New Bretton Woods Or Globocops?

A new multilateral regulatory structure seems unlikely now, given that the Fed and some central banks would not like to be told what to do. But, there is bound to be greater global coordination between central banks

A FEW days ago, the US Federal Reserve opened swap lines of $120 billion with four countries — Brazil, Mexico, Singapore and South Korea — to keep international liquidity pipelines unclogged. A few days before that, the European Central Bank entered into foreign currency swaps with Iceland and Switzerland, even though they are not part of the Eurozone. A $12-billion swap line was also established with Denmark. ECB also offered Hungary a $6.4-billion loan to tide over its temporary liquidity shortage. The objective of these swap lines is the same — to ensure that the global financial system, especially the countries that are “systemically” important to the US and European economies, do not suffer from a temporary shortage of dollars or euros, leading to a further deepening of the global credit crisis.

Traditionally, this job should have gone to the International Monetary Fund. Conspiracy theory proponents will undoubtedly detect a dishonourable political design here — with developing countries demanding a more egalitarian shareholding structure in the multilateral institute, this is the only way in which both the US and Europe can maintain their sway over the global financial system. But, such extreme hypotheses apart, the IMF normally takes some time to design restructuring packages for distressed economies, while the Fed and ECB are more concerned with overnight and short-term liquidity issues. Plus, here’s the biggest difference — central banks can print money, while IMF has to depend on shareholders’ largesse. So, given the severity of the global financial crisis, both the Fed and the ECB are not leaving anything to chance, or to the IMF’s time-consuming methods.

They are now stepping into a role that is not specified in their mandate. For instance, ECB’s twin-edged mandate is to maintain price stability in the euro command area and to support the general economic policies of the European Community. The Fed’s conventional role, on the other hand, was to ensure full employment, but the oil shock of the 1970s saw US lawmakers adding inflation combat to that traditional mandate. With the current global financial blowout, both the Fed and ECB are now trying to broaden their usual role into some form of “global lenders of last resort”. They are now ready to provide liquidity to liquidity-starved nations in exchange for marketable and non-marketable instruments, even though such paper may be below the normally accepted credit-rating threshold.

This marks a sharp change from the way these central banks have operated over the years and may even provide some clues about how they will conduct their business in the future. The question that arises immediately, therefore, is: are central banks world-over going to morph into something different?

One thing is definite: henceforth, the Fed is sure to get responsibility for ensuring “stability in the financial system”. The Fed’s hands-off policy with regard to Wall Street and its high jinks has not gone down well with millions of US taxpayers who feel burdened with the responsibility of having to bail out errant banks and financial institutions. Academic and quasi-academic literature over the past few weeks is full of references to how central banks must now build efficient radar systems that can detect incipient trends of financial turmoil and head them off before they can grow in size. However, that’s easier said then done. Experts agree unanimously that it’s also very difficult to pinpoint asset-price bubbles early on in the game. Yet, the political impact of the recent experiences is likely to see lawmakers foisting central banks with some accountability.

As a corollary, central banks the world over will now find it difficult to keep monetary policy and bank supervision separate. There are already rumblings that central banks should have oversight over all components of the financial system, especially when recent experiences have shown that it takes no time for the contagion to spread from one segment to the other.

At a recent conference in Chile, Sveriges Riksbank’s deputy governor Lars Nyberg said: “I want to emphasise that monetary policy is perhaps not the most efficient instrument for preventing crises from happening. Even though a too loose monetary policy may contribute to the build-up of a bubble, it is less clear to what extent monetary policy can prevent such a build-up. It is quite likely that substantial interest rate increases, that central banks would find it hard to implement, would be required to achieve this. More moderate rate increases may, of course, still have an effect at the margin, not least as a signal from the central bank that there are certain concerns linked to prevailing developments. But a more capable line of defence to prevent financial crises is to have proper rules and effective supervision in place.”

Transparency is another word that is likely to be heard with increasing frequency in coming months. The demand that central banks lift the veil from their operations is being heeded in degrees, some with a greater extent of openness than some others. And then there are some which operate in a completely secretive environment. Add to this the fact that most financial markets are still opaque and you have a lethal combo. The extreme opacity in the way financial markets created and traded financial instruments is a major reason behind the current crisis. In the days ahead, lawmakers are certain to demand a greater measure of transparency from both central banks (since many commentators have also blamed central banks’ easy money policy for the turmoil) and financial markets.

Finally, will there be new Bretton Woods institutions, responsible for global financial governance, or will central banks become the new globocops? A new multilateral regulatory, institutional structure seems unlikely now, given that some central banks — especially the Fed — would not like to be told what to do. But, there is bound to be greater global coordination and a higher volume of data exchange between central banks. For instance, jointly, both the RBI and Fed should now be able to wring more data out of financial institutions on the sources behind participatory notes.

Published as Op-Ed in The Economic Times (November 14, 2008)

Recapitalising Public Sector Banks

Despite finance minister P Chidambaram’s assertions that all our banks are well capitalised and regulated, the only way to grow in the tough times that lie ahead is to provide banks with additional capital

LAST autumn, when finance minister P Chidambaram was visiting USA with his senior officials, he was apparently invited to lunch by treasury secretary Henry “Hank” Paulson. At the meeting, Paulson reportedly held forth on the benefits of an open financial system and the need for India to loosen its controls. Much as this might sound apocryphal, a news wire also recently carried a dispatch from Beijing, detailing how Paulson harangued the audience at Shanghai Futures Exchange 18 months ago about how “an open, competitive and liberalised financial market” was far more efficient than “governmental intervention”.

Cut to the present. The US government’s attempts to staunch the flow of red ink from its financial sector by stitching together a $700-billion bailout plan has brought its role as a champion of open markets, with minimum “government intervention”, into some question. It has also made the US administration the target for a fair bit of ridicule. But, irrespective of whether the package — called the Troubled Assets Relief Programme, or TARP — is right or not, there are broadly three developments in the US that are worth noting.

* Ban on short selling: Governments across the world, irrespective of their ideological shades or origins, try and influence market outcomes through interventionist policies. Sometimes it works, but its toxic after-effects are felt long after the deed is done. The desire to train markets to deliver what, governments erroneously believe, is beneficial to all market participants is dangerous and essentially short term in nature. These follies include stabs at banning short selling in stock markets. The Indian government has attempted this in the past and the US market regulator is among the latest to succumb to this peculiar affliction.
   The Securities and Exchange Commission, followed by regulators in some other countries, has decided to ban short selling in stocks of financial companies, principally to minimise opportunists (read hedge funds) from aggravating the misfortune of defenceless finance companies. However, the move has instead driven out liquidity from the market and, given the shortage of long-only investors, has turned the markets more volatile. Regulators also do not realise that shorts uncover problems long before they are made public and when they’re past any redemption.

* Return to Keynes?: TARP is probably the Fed and treasury’s way of acknowledging that monetary measures can go only a limited distance in solving some of the endemic problems confronting the US banking sector. The Fed has over the past 12 months tried to keep the financial catastrophe at bay by reducing interest rates and by pumping in huge amounts of liquidity. While this did help the banks somewhat initially, it subsequently failed in averting the bankruptcies and the destruction of balance sheets in other financial institutions outside the Fed’s jurisdiction, such as insurance companies and investment banks. Consequently, the fire-fighters cobbled together TARP, probably encouraged and emboldened by the outcome of the past packages put together during the Depression, or the savings and loan bailout.

TARP, in a sense, can be viewed as a surrogate recapitalisation programme for financial institutions and banks that do not have adequate capital to make up for their damaged assets. So far, so good. But two questions arise here. One, what does this do to USA’s burgeoning budget deficit and will it have the desired effect of providing the kind of fiscal stimulus that the administration hopes for? Two, what happens when a host of other personal loan categories — such as credit card, auto and education loans — also goes toxic, as has been feared for some time now? Will that lead to another bailout deal?

* Sea of liquidity: On Monday, just hours before Republicans in the House of Representatives torpedoed TARP, the Fed decided to flood the global financial system with $630 billion in cash — by increasing its existing currency swaps with other central banks in the world (such as European Central Bank, Bank of England and Bank of Japan, among others) by $330 billion and by enhancing its emergency lending programme by $300 billion. This is over and above all the other rehydrating programmes initiated by the Fed in the past.

While TARP does not technically lead to a flood of fresh liquidity into the system, the additional $630 billion is aimed at de-clogging the credit pipelines and reinstating confidence in the system. But it is also like a time-bomb ticking away in the global financial system whose aftermath will be felt much later. Long after the damage is controlled, this cash is likely to stay around and, much like the legacy Alan Greenspan left behind, impact asset prices across the globe. 

All these have enormous implications for the Indian economy. The biggest danger is that Indian policymakers might also be tempted to pursue wrong policies, primarily out of a misplaced sense of having always pursued the right policies and a desire to thumb one’s nose at all the free market votaries. There is a bit of schadenfreude at work here also. India has its unique set of problems and the only way to really unleash the productive energies of the economy is to keep reforming the different markets. Investors are already expressing their disappointment about the five years wasted by this government without implementing crucial reforms in either labour, or agricultural or infrastructure sectors.

Two critical issues arise here. One, the US government’s $700-billion TARP doesn’t automatically give India the licence to be complacent about its ballooning budget deficit, a large part of which is buried under the illiquid oil and fertiliser bonds. Also, India has to quickly move to recapitalise its public sector banks. Despite finance minister P Chidambaram’s assertions that “all our banks are well capitalised and well regulated”, the only way to grow in the tough times that lie ahead is to provide banks with additional capital. As the global, and the Indian, economy slows down, many Indian banks will need to revisit their capital levels. A solution exists — the government has to dilute part of its holdings in these banks. Supply of quality paper can also provide the market with a booster dose in comatose times.

Published as an Op-Ed in The Economic Times (October 3, 2008)

RBI’s Priorities And Concerns

The pressure on the RBI to cut rates will intensify now because of two immediate reasons — G8 central banks are re-hydrating their economies to keep the credit lines lubricated and China has cut its rates

IN LESS than a week of taking over his new assignment, Reserve Bank governor Duvvuri Subbarao decided to hold a press conference and talk about some macro issues. This is unusual. Typically, a central banker takes some time to settle down before speaking out about the problems of the day. But, given that he chose to address the media so soon after taking over, it is perhaps an indication of the troubled times we live in. Or, perhaps, it’s symptomatic of the confusion roiling the asset markets, making them swing between the two extremes of heightened expectations and mounting uncertainties.

There are signs of ambiguity everywhere — whether it’s in the inflation numbers or growth impulses, whether it’s in the drag effect of a global slowdown or the intense volatility experienced by the markets. Therefore, it was a welcome sign that Subbarao decided to break with convention and spelt out his priorities. While Subbarao has taken to his new role (and its obligatory nuanced statements) with surprising agility, he did outline, rather pointedly, some of the RBI’s concerns and priorities.

But many other concerns remain unspoken and there are any number of surprises (“known unknowns”, as Subbarao calls them) strewn along the central bank’s path to attaining economic growth with price stability. The global sell-off arising out of the collapse of three Wall Street icons — Lehman Brothers, Merrill Lynch and AIG — are the latest “known unknowns”. Much of the advice dished out for the governor so far focuses on obvious concerns, some unfinished agenda and a few minor issues. The obvious ones are: unease over the rate of inflation and speculation over the future course of monetary tightening. The incomplete tasks include financial sector reforms and addressing the capital deficit in PSU banks. The minor issues involve tinkering with products and processes in the currency and interest rate markets. But, Subbarao still has to keep his guard up for a host of wide-ranging issues, including the aftermath of the global credit squeeze.

Elections are round the corner and the governor is bound to be inundated with demands to loosen the monetary taps, some of which were quite presciently tightened by his predecessor. With crude prices having now dipped below $100, the requests to ease interest rates have acquired a new force. Add to that the latest WPI numbers — which dropped to 12.1% for the week ended August 30, from 12.34% the week before — and the clamours for an interest rate cut are already getting louder. Subbarao needs to watch out. Crude prices are still higher than the prices charged by oil marketing companies. But, more importantly, Opec recently decided to undertake a production cut. Although this has so far failed to rattle markets — primarily because of the global economic slowdown — the danger of further production cuts or sudden disruptions in oil production cannot be ruled out.

Also, the slowing down of the inflation rate might be slightly misleading. For one, the inflation index is still growing above the RBI’s comfort levels. But, beyond that, on a disaggregated basis, there are some essential products and manufactured items that are still showing rising prices. There are also two other factors that can’t be overlooked — the base effect might be finally wearing off and, therefore, it is important to look at the week-on-week growth in the index, which clocked 0.2% for August 30, after rising marginally in the previous week. In fact, the September 12 report by the Goldman Sachs Asia economics research team forecasts inflation peaking to 13.5% by November before beginning to cool off. Plus, the rupee’s continuous depreciation against the dollar over the past few days, despite the RBI’s attempts at intervention, could complicate attempts to tamp down inflationary expectations. The rupee will continue to be under pressure as foreign investors rush to sell their equity holdings and buy dollars.

The pressure to cut rates will also intensify now because of two immediate reasons — G-8 central banks are re-hydrating their economies to keep the credit lines lubricated and China has cut its rates. But, developed country banks are caught in an asset blow-out and need additional liquidity to keep their heads above water which Indian banks, thankfully, don’t. Export-driven China, on the other hand, sees large parts of its economy affected by the US developments and has therefore opted to chase growth. India has a strong domestic market and even the consensus growth forecast of 7-7.5% is pretty good by international standards.

The monetary tightening was conducted to squeeze out excess demand, a partial reason for the build-up of inflationary expectations. This is what Subbarao said at his maiden press conference: “The current high level of domestic inflation reflects a combination of supply-side pressures as well as demand-side factors… Though demand is not the main problem, in the absence of further flexibility on the supply side, demand management has to be part of the solution. Dampening demand and anchoring inflation expectations has been the logic behind Reserve Bank’s monetary stance.” One of the methods used was increasing cash reserve ratio (CRR) and the repo rate. This was to ensure a slowdown in the runaway growth in bank credit. Former governor Y V Reddy pressed the panic buttons when credit-deposit ratio crossed 80%, indicating that banks were borrowing short term to finance long-term assets.

Subbarao’s observation about systemic rigidities — “absence of further flexibility…” — is unlikely to be set right any time soon. Plus, as the RBI’s annual report points out, the fisc is expected to come under increasing stress from, among other things, implementation of the sixth pay commission, lower petro-product duties, higher fertiliser subsidies and farm debt waivers. Therefore, perforce, demand-side management will have to remain the focus of the RBI’s strategy. But, the expectations of monetary easing are also unlikely to fade away soon. The market will be looking at the governor pretty closely — to see whether he can indeed walk the lonely path reserved for central bank governors, insulated from the influence of markets and, most importantly, from the fiscal side across the fence.

Publilshed as an Op-Ed in The Economic Times (September 17, 2008)

Good Intention, Bad Outcome

Overseas M&As are providing Indian companies with a new competitive edge. The Competition Act, instead of adding teeth to this new-found competitive advantage, might end up debilitating Indian industry

JUST when you thought India Inc had acquired the muscle to play the global sweepstakes, Indian lawmakers have struck back with attempts to rein in the corporate sector’s worldly ambitions. Prima facie, it seems to be the handiwork of a bunch of people who were nourished on the economic rent built into the licence raj system and are now desperate to restore their cash flows to the pre-reforms era.

They may have just hit upon the perfect system. The new Competition Act — first passed by Parliament in 2002, then amended in 2007 after going through a parliamentary standing committee on finance, but yet to be notified — might be their ticket to the gravy train. As things stand, once the amended Competition Act is notified, industry is scared that this will signal a return to the nightmarish days of Monopolies and Restrictive Trade Practices Act, which required every company, industrial group, entrepreneur to seek approval for every step they took, every move they made. In some ways, it was the MRTP Act of yore which not only stifled competition but also gave birth to the unholy industry-politician-bureaucrat nexus and provided India with a high-ranking berth in the global corruption league tables.

The intentions of the Competition Act are actually honourable. The Act aims to protect citizens from the ill-effects of concentration of power in any company or industrial group and their ability to influence market outcomes, through pricing muscle or market domination. The Act’s opening lines are: “An Act to provide…for the establishment of a Commission to prevent practices having adverse effect on competition, to promote and sustain competition in markets, to protect the interests of consumers and to ensure freedom of trade carried on by other participants in markets, in India…” Every developed country has a similar legislation in some form or the other. But, it is the design and the purport of this Act that promises to incapacitate industry. Here’s an example: had the Act been notified, the Idea-Spice telecom deal might still be languishing in bureaucratic muddle.

The Act has several grey areas, and the purpose behind leaving these gaps in the drafting is anybody’s guess. Given the country’s abysmal judicial and regulatory infrastructure, the first question that arises is whether the country is ready for it. The Competition Commission of India (CCI), a quasi-judicial body entrusted with enforcing the Competition Act, has no wherewithal to adjudicate on any of its mandates. It has a paltry budget, skeletal staff, a crummy office and none of the knowledge base that’s de rigueur for any regulator.

Let’s look at some of the trip-wires left in the Act. First, any M&A deal has to mandatorily notify the CCI. Then, under the Act, CCI gets 210 days to give its assent — a rather long period in today’s competitive environment. Assume the commission feels the deal is not inimical to any of its stated objectives and gives it a green signal. Now comes the fun part — any person can go on appeal to the Appellate Tribunal, which does not have any mandatory time limits. Imagine the scope for mischief. The Act states: “The appeal filed before the Appellate Tribunal…shall be dealt with by it as expeditiously as possible and endeavour shall be made by it to dispose of the appeal within six months from the date of receipt of the appeal.” What if the “endeavour” does not result in a verdict in six months? The Act is silent on the issue. But, that’s not the end. Even if the tribunal overturns the appeal, the appellant can still approach the Supreme Court which will then, in keeping with the tenets of natural justice, need to hear all sides before reaching a verdict. Which M&A deal can wait for so long?

The amended Act also requires all Indian companies bidding for overseas acquisitions to obtain a pre-deal approval first. In fact, all sellers will henceforth require that bidders get all their approvals in place first even before considering their bids. However, many sellers might not be willing to keep the deal in abeyance for 210 days. In addition, there is the issue of confidentiality. Government offices are notorious for leaks — not only to the media but even to business rivals. In comparison, many Indian companies which acquired European targets in the recent past, including some marquee names, not only obtained a pre-deal approval in less than 30 days, but also claim that not a word leaked from the European competition authorities.

Then, there is the threshold level of assets or turnover which is used to decide whether the Act should be made applicable to any company entering into an M&A deal, whether in India or abroad (it will also include two foreign companies merging overseas, if they have operations in India, subject to a threshold level as well). Section 20(3) of the Act requires the government to increase or reduce the threshold levels every two years, on the basis of either the wholesale price index or the foreign exchange rate.

There is a whole range of other contentious issues that is exercising industry, such as the large tracts of ambiguous drafting or the powers granted to the government. For instance, the government has reserved for itself the right of exemption: “The central government may, by notification, exempt from the application of this Act... (a) any class of enterprises if such exemption is necessary in the interest of security of the state or public interest…” While it is strange that the commission, as regulator, has been deprived of this power, the Act also does not include any provisions for exempting “any class of acquisition”, such as creeping acquisitions.

Of the three issues that the Act is expected to tackle, we have touched upon only one here, namely M&As. The other two — preventing cartelisation and abuse of dominant position — also contain enough landmines to trigger off a raft of disputes. But, all this raises one fundamental issue. Overseas M&As were providing Indian companies with a new competitive edge. Legislation, instead of adding teeth to this new-found competitive advantage, might end up debilitating Indian industry.

Published as as an Op-Ed in The Economic Times (August 20, 2008)

Agriculture, The Engine Of Growth

The structural deficiency of the agricultural economy as a whole and the slipover impact from the rise of crude prices on fertiliser prices as well as on transport costs for ferrying food items need to be tackled urgently

THE meeting of heads of state from G-8 and eight other economically important nations (which included Indian Prime Minister Manmohan Singh) in Japan this week got headlines in the Indian media for all the wrong reasons. While the PM’s presence there provided the focal point of all political action in Delhi, the conclave wound up on Wednesday without reaching any meaningful action plan on the two most contentious issues: combating climate change and controlling global inflation caused by rising food and fuel prices. Preoccupied as he might be with all the political drama, Manmohan Singh should also be worried about food security. Especially, since Maharashtra faces a drought-like situation this year.

The greatest disappointment of the G-8 meeting, however, seemed to be the failure of global leaders to come up with a concrete plan to tackle the food crisis. News agency Reuters filed this report: “The G-8 leaders also acknowledged the economic threat from surging oil and food prices…but came up with no fresh initiatives to tackle what they said were complex problems requiring long-term solutions.” What’s strange is the absence of any acknowledgement from the G-8 leaders that the major reason for the rise in food prices is increasing bio-fuels production in the US and, to some extent, in Europe. The rich countries made no promises to remedy this structural issue, which promises to pull another 100 million people below the poverty line this year, but shifted the responsibility to other big emerging countries. Reuters also filed this report: “The G-8…called for countries with sufficient food stocks to make available a part of their surplus for countries in need.”

The World Bank says this upfront in a position paper (Rising Food Prices — Policy Options and World Bank Response): “Concern over oil prices, energy security and climate change have prompted governments to take a more proactive stance towards encouraging production and use of bio-fuels. The has led to increased demand for bio-fuel raw materials, such as wheat, soy, maize and palm oil, and increased competition for cropland…Other developments, such as drought in Australia and poor crops in the EU and Ukraine in 2006 and 2007, were largely offset by good crops and increased exports in other countries and would not, on their own, have had a significant impact on prices. Only a relatively small share of the increase in food production prices (around 15%) is due directly to higher energy and fertiliser costs.” On a more pessimistic note, the World Bank’s note prepared for the G-8 meeting — Double Jeopardy: Responding to High Food and Fuel Prices — states clearly that food prices are likely to remain above the 2004 levels till at least 2015.

All this raises worries about India’s food situation, particularly since repeated studies have shown that any rise in food prices, rather than fuel prices, is seen to have a greater impact on the common man’s inflationary expectations. This assumes greater importance in the case of the urban poor and the rural landless workers, where food has the lion’s share of the total consumption basket, compared to fuel which is either subsidised or almost free. What is likely to exacerbate the situation is the structural deficiency of the agricultural economy as a whole and the slip-over impact from the rise of crude prices on both fertiliser prices as well as on transport costs for ferrying food items from production centres to consumption hubs. Here are some of the urgent issues that need tackling immediately.

THE first anomaly lies at the macro level. Over 60% of the country’s population is today dependent on agriculture, which contributes to only 20% of GDP. This translates into low income per rural family, which then makes most of them vulnerable to debt traps and pushes them into distress every time there is an exogenous shock. The need is to wean away part of each family into skills-based training, without necessarily alienating the entire family from its agricultural roots. The solution is not to provide them with only urban-based jobs, but to create a talent pool for rural industry, whether it is manufacturing or services-based. Such an industrial base, through linkages, has the potential of bringing about qualitative changes in agriculture as well.

• As a result of so many people depending on agriculture for income, land holdings are exceedingly fragmented, leading to falling crop productivity. According to official statistics, close to 60% of all land holdings in the country are marginal holdings (where land ownership is less than 1 hectare). Consequently, the average size of operational holdings is not even half a hectare, or about 1 acre. Average foodgrain yields, therefore, have been almost stagnant.

• Diversion of crop land into non-agricultural use is growing and could be another cause for worry in the long run. New ways should be found of converting non-agricultural land into agricultural land (without actually reducing the forest cover) and employing technology to increase the productivity of these tracts. Antiquated legislation regulating sale and purchase of agricultural land also needs to be updated, with adequate safeguards, to allow for consolidation of farmland.

• A solution for improving the income and the yields would be to introduce contract farming in a big way. This allows a large corporate to tie up with a large number of farmers with contiguous plots. Both win: while the farmer does not lose his homestead and is assured of an income at the end of the harvest, the corporate is ensured a steady supply of output, which takes some of the uncertainties out of his supply chain.

• Finally, the government has no choice but to rise above petty vote-bank politics and take a hard look at all the handouts (such as loan waivers or cheap credit) and the subsidy structure. According to the World Development Report, 2008, 75% of India’s agricultural budget is spent on such private goods, instead of investing in public goods (such as rural roads, or increasing outlays for agricultural R&D).

In short, agriculture has the potential to become the engine for future growth in the economy, but only if the right cards are played now.

Published as an Op-Ed in The Economic Times (July 11, 2008)