A caustic perspective on India

03:09 pm - Bernanke makes you reflect on RBI

The appointment of Ben Bernanke in the US has focused a lot of attention on the core issues of monetary policy. The situation in India is quite bad, with (a) Tremendous conflicts of interest which hobble the RBI and (b) The lack of a coherent strategy of monetary policy.

One foreign economist who studies India, who shall remain nameless, says that RBI's idea of monetary policy is "If it moves, shoot it" (referring to RBI's chase from one market to another, trying to locate some price that moves, and trying to prevent the price from moving). This is not the systematic monetary policy from the textbooks, which gives us stabilisation. RBI violates the Taylor principle, so that the response to a shock in prices is less than 1. RBI violates `rules rather than discretion'. Private players have no idea where monetary policy is going.

12:00 pm - The struggle within the CPI(M)

West Bengal has a big problem on pension liabilities. But the trade union wing of the party, which controls EPFO and derives various benefits from controlling EPFO, does not want new kinds of pension institutions to come up in the country.

The New Pension System is a new proposal which will affect new recruits of GOI - none of whom are members of the trade unions that the CPI(M) controls.

So this has the makings of an interesting tension within the CPI(M). On one hand, the trade unionists can argue that strengthening pension provisions does damage to EPFO and the trade unions; that an effective New Pension System can (one day) lead to political pressure for reforms of EPFO and a removal of trade unions from their dominant role in the EPFO. On the other hand, the reformists within West Bengal can argue that it is more important for West Bengal to put it's public finance on a sound foundation, and that the new recruits into the civil service (which is where the new pension system will kick in) are not members of trade unions anyway.

There are some signs that the West Bengal wing of the party is winning. The proof of the pudding will lie in the eating; when the PFRDA Bill goes through in Parliament.

11:42 am - Participatory notes in the gunsights again

The Economic Times has a story saying that participatory notes may again come under attack. The claim is that government wants to ensure that only clean money through recognised banking channels is permitted in the securities market.

"Know your customer" is increasingly being used as a capital control against foreign participation in the equity market. My simple litmus test is like this: What do advanced market economies do? When we look at countries like the UK, there is no hint of using "clean money" issues to block foreigners from participating in the securities markets. Yes, there are problems with criminals and terrorists, and those are dealt with by the police. Financial regulators and central banks do not use these excuses to throw up capital controls - that only happens in Socialist India.

Banning P Notes is practically infeasible. A foreign entity does not have to tell an Indian regulator that it has written OTC derivatives involving India. All that will happen is that the more ethical firms will comply, and the business will shift to other firms who are fine with not talking about what they are doing. In any case, there are many shades of gray about positions and portfolios. So if GOI does go through with a ban on P Notes, it will become one more government rule that is repeatedly flouted and nobody has the capacity to enforce.

The whole enterprise of "Foreign Institutional Investors" in the Indian equity market has become a bit silly. It is time for India to just abandon the attempt at having such rules, and have unregulated participation by foreign investors.

12:29 am - The mud, the stars

Andy Mukherjee of Bloomberg has a gloomy piece about the IT sector being in the gunsights of politics, about India's risks of strangling the goose that lays golden eggs. He points out that software and BPO are now big on a macroeconomic scale, and hence can't be ignored like they traditionally used to.

I am not persuaded by his fundamentally gloomy spin. Certainly, the noises that Prakash Karat makes are partly a reflection of the intra-CPI(M) power struggle that is taking place, where Karat & Co. are pitted against Buddha. I am also skeptical about the extent to which unionisation can take place in any modern workplace. The pioneers who try to start a union will just get sacked. Firms that get hit at one location will relocate out of that city.

Bibek Debroy, writing in Business Standard reminds the reader that India's malaise is not the Left, but the Congress itself. This article is astonishing considering that Bibek Debroy works for a Congress think-tank.

He says that the years 1991-1996 were exceptionally effective in economic reform. I am actually skeptical about this claim. The reforms of that period pretty much ended by 1993. Some of the biggest things - e.g. telecom and roads and privatisation - got done in Yashwant Sinha's time.

But Bibek Debroy goes on to argue that India's growth is no longer adversely affected by socialism at the Centre. He says that simple demographics will power India's growth, particularly if some states are able to get going on improving local public goods. I hope he's right, but I can't help have a nagging feeling that serious trouble is brewing.

01:08 pm - Mistrust of markets

When the 2004 election results came out, the stock market dropped sharply, particularly on 17 May 2004. At the time, the left make noises claiming that this was a conspiracy on the part of the BJP and the BJP-supported stock brokers to embarass the new government. Such claims showed the acute mistrust and lack of knowledge about markets on the part of the loony left. I like to apply one test to such conspiracy theories: Can you show me how someone makes money out of the conspiracy?

When we look back, the stock market looks very smart. Valuations started dropping from April 2004, when it looked like the NDA would not make it. Valuations started cautiously going back up when the names of the PM and FM were announced. It is ironic to see that Manmohan Singh probably owes his job to India's active stock market, for if it had not served such a wake up call on 17 May 2004, then the decision about the prime ministership might have played out very differently.

From February 2004 onwards, the story that seems to have been at work on the stock market is high earnings growth. The market has not been particularly optimistic, i.e. P/E ratios have been relatively low. It is, actually, odd that the market has been completely unwilling to look beyond it's nose, and bid up prices ahead of the next quarter's earnings growth. The mood seems to be skittish; the market seems to be saying "show me the earnings and then I'll dole out the same old P/E for it".

Now, Jagdish Shettigar is displaying the same acute mistrust and lack of knowledge about markets on the part of the loony right. The loony left and the loony right are so alike in their ignorance about markets. (This is the person about whom Jagdish Bhagwati said "if he's an economist, then I'm a Bharat Natyam dancer"). Shettigar's views are:

"Uncertainty over continuation of reform process ever since UPA took over should have had negative influence on stock market instead of sky-rocketing the index," Shettigar said. Blaming UPA for making "compromises" for the sake of stability of the coalition government, he said the Centre has not been able to carry forward the required policy initiatives on disinvestment, foreign investment, pension reform, rationalisation of user charges and subsidies.

He is right, of course, in arguing that the UPA is asleep on economic policy, and more focused on self-preservation. But that does not change the fact that corporate earnings growth has been dramatic, so that with a stable P/E ratio, you get a huge rise in the index.

07:00 am - Solving India's problem of PSU banks

The UPA is an excellent reformist government. They seem to be systematically working to undermine PSU banks. In a normal world, this should help transfer market share to private and foreign banks. But unfortunately, in the Indian context, it may only mean more money being paid by taxpayers to keep PSU banks aloft.

I find this pattern fascinating. First, Mani Shankar Aiyar tried to contaminate board level appointments for PSU oil companies. Now this is being done with PSU banks. And a official of the Ministry of Finance seems to have told the journalist that things were as bad with the previous government. I guess the whole point of having PSUs is so the ruling party can steal from them.

08:23 am - Buddhadeb Bhattacharjee's choice

Buddadeb Bhattacharjee says that in the future, strikes will not affect the IT industry

1. And how does he propose to achieve this? Will he be able to use the police to enforce law and order against his own CPI(M) goondas? At least the Shiv Sena is honest enough to say that it will make no attempt to rein in it's goondas in Bombay.
2. Why should IT be given such privileged treatment? Does West Bengal need a few isolated IT firms, employing highly educated people, or does it need millions of jobs in trade-union-free textile factories?

Thus far, the press and the business community has given Mr. B.B. a free pass, being always willing to accept his claims that he is actually a modern person, unlike the "Bengali ogres" . But beyond a point, such protestations are wearing thin. If Mr. B.B. is serious about being a good neo-liberal, he will have to get out of the CPI(M).

08:17 am - The socialism that's in our DNA

The constitution is the closest you get to the `DNA' of a country, and our constitution contains the word "socialism" or "socialist". Generally, I used to think that these were mere pious phrases and didn't matter. Remarkably enough, this affected a recent decision of the supreme court. In other words, removing these phrases from the constitution is not just about superficial phrase-mongering. This stuff affects the real economy.

Shekhar Gupta has an excellent article about how in India, socialism means the business of using the State to steal from the poor and feed the rich. These attitudes run deep: they are in the constitution, and they are in the minds of millions of people.

11:11 am - When is a bank bankrupt?

Business Standard has an odd story about a bank. Janakalyan Bank (sounds like a cooperative bank) encountered a run on the bank.

It has net NPAs of 16.5% so it is, in fact, most likely quite bankrupt. Customers seem to be peeling away - deposits dropped from Rs.1309 crore in 2003-04 to Rs.1100 crore in 2004-05. I hadn't realised how big these things could be - generally cooperative banks are quite small.

In order to stop the run on the bank, the finance ministry and the RBI have stated, to the public, that the bank is solvent. I suppose that means unlimited deposit insurance is available on top for these depositors.

06:12 pm - We learn from history that we learn nothing from history

The "LPG crisis" is shaping up as a comic story, straight out of the 1970s.

The first ingredient is a wrong price for LPG. Nobody should be surprised if there is a huge growth of LPG consumption. People will substitute away from other fuels in order to use a subsidised fuel.

Then you have a "shortage". LPG cylinders are scarce, so dealers give them to their friends. And, theft of LPG has started, so the customer gets a substandard cylinder.

The government tosses around buzzwords like "hoarding" and "illegal use". Didn't these go out of fashion with Indira Gandhi? What can I say? Mani Shankar Aiyar is a socialist past age 20.

08:00 am - Lack of spine => weak reforms

To solve the problems of the terrible urban infrastructure in India, one of the ideas that has been kicked around is that of giving cities and states incentives for reform. The rough idea is that you bribe the local politician with money so that he'll do good things even though it goes against his first instinct. A more polite version is to say that money is available to fund transition costs involved in reform, assuming that the main game plan is reform.

Indian Express has a story saying that the conditionalities associated with the National Urban Renewal Mission (NURM) are likely to be diluted. So you can expect NURM to just turn into more money sent down dysfunctional institutions. Earlier, atleast the fig leaf was that NURM was paying money to overcome transition costs involved in reform. Now the "reform" isn't particularly in the picture.

A similar-but-different story is unfolding in banking. The Basle I rules require that banks have to have a little equity capital in order to grow. In India today, banks have equity capital which is 5% of assets, or roughly 20:1 leverage. This kind of leverage should make many hedge funds terrified. But atleast, the way things work, for a bank to have Rs.100 in assets, they have to cobble together Rs.5 in equity.

Some PSU banks are hitting constraints because in order to meet the requirements and continue to grow, they will have to issue fresh equity capital, which will lead to a decline in the government's shareholding, which is already at 51%. Apparently when the banks were nationalised, the law put in a clause that GOI's shareholding can't drop below 51%. So these PSU banks are in a jam.

The possible paths are: to force these banks to stagnate, or to send in new equity capital from the Ministry of Finance, or to weaken the definition of equity capital, or to amend the act to allow government holding to drop below 51%. Hindu Business Line says that RBI now plans to dilute the definition of Tier I capital so as to accomodate them. Banking in India is in bad enough shape as it is. Now it looks like even the minimal protection, of roughly 5% equity capital, will be diluted. This can't be the best solution!

11:04 pm - The people who're in charge

RBI deputy governer Rakesh Mohan says:

Highlighting the role of Central Bank, he said RBI continue to focus on price stability in order to curb the inflation but added the fluctuation in the foreign exchange rates is determined by market. However, RBI would intervene in the market whenever there is an excessive volatility in prices. ''We need exchange rate stability with normal fluctuation and not volatility.''

I sure hope the journalist misquoted him, else it looks like he doesn't know what `volatility' means.

Update: The foot in mouth appears to be real. Reuters has him saying: "We have to take concern about exchange rate instability, volatility. I am distinguishing between fluctuation on one hand, which is good, and volatility or instability which is bad at least from Reserve Bank's point of view,".

06:38 pm - Slow agricultural growth is quite fine

It is part of conventional politically correct groupthink to keep worrying about slow agricultural growth. But no country has become developed by emphasising agriculture.

High incomes can only be supported by industry and services. And, high growth in industry and services will suck people out of agriculture, thus increasing the land per capita (a.k.a. capital per person) in agriculture, thus delivering higher incomes in agriculture.

Agriculture is already down to 20% of GDP. Within perhaps a decade it will drop to 10%. So it will just not be a big deal for the economy. The finance minister should focus on getting high growth in industry and services.

Before someone steps in to say "but 60% of the people depend on agriculture", I should point out that this data is fairly broken. Nobody knows what is truly "rural" as opposed to "urban", and perhaps half of "rural" workers are in non-agricultural professions.

06:11 pm - How well do we measure the economy?

Noticed a discussion on measurement of growth at The Indian Economy blog. The question they ask is: To what extent are Indian growth rates a reflection of a process of the underground economy going overground? Earlier, there was a Bloomberg article on India's `dodgy' statistics. My understanding of the situation is:

• Some products, like steel or crude oil, are inherently easy to measure. If true India were growing much faster than the apparent statistics showed, then the growth rates of steel and crude oil would need to be higher. As an aside, some concerns about reported Chinese growth rates are based on the lack of coherence between Chinese growth data and Chinese electricity production data. Indeed, one very smart person that I know, who tracks both India and China, believes that both countries have a roughly-equal growth rate, with a bit of undercounting in the Indian case and a bit of exaggeration in the Chinese case.
• GDP statistics are not to be taken too seriously. They are useful for comparisons across countries and across years. If the same mistakes afflicted Indian data last year that are at work today, then the percentage GDP growth would be roughly okay. Across countries, things are more nasty. Richer countries tend to have smarter people working on the statistical system. In India, smart people do not opt to work in the statistical system. In addition, there is the issue of the black economy. So the Norway to India ratio is surely exaggerated by the official statistics. (This is over and beyond the `purchasing power parity' adjustment issue).
• The accounting data released by companies is pretty well done. There may be efforts at creative accounting, but there are surely not errors owing to incompetence. In many cases, it is possible to obtain independent information about the country by adding up sound information seen for thousands of firms. The picture obtained from there is broadly consistent with the growth rates seen in official statistics.
• One does see higher growth with these big firms, which reflects a decline in the informal sector. In this sense, the common preconception that "the dynamic sector of the economy is the small firms" is likely not correct. E.g. we know that in the software industry, the top 100 firms are really the dominant thing. There is a very long lower tail of small firms, but they add up to remarkably little output.

Some 2-3 years ago, the Index of Industrial Production data got a lot better because the procedure through which information was taken from factories was outsourced by the government to a private agency (CMIE). So today, we can trust this data better.

12:01 am - Fantasy: "The CPI(M) gets fined Rs.100 crore for the nationwide strike"

Not so long ago, the Supreme Court had fined the BJP and the Shiv Sena for the losses associated with a bandh called by them.

Will this happen once again with the damage to the economy caused by the bandh on thursday called by the left parties? One can hope.

One fine of Rs.1000 crore on the CPI(M) should put an end to such problems for life. After all, they are good businessmen and will understand the implications of a fine.

10:54 am - From one bad tax to another

A basic idea in tax policy is that the `correct' tax base is either income or value added. You do not tax transactions.

The market economy constantly organises and reorganises production. On one day, a firm may do activities X and Y under the same roof. On another day, it may produce till the X stage and then sell the intermediate product to another firm. If transactions are taxed, the latter structure is inefficient and tax policy will exert a bias against it. Taxing transactions introduces a huge set of distortionary responses on the part of companies and households who try to reorganise their lives to avoid taxes.

This government has introduced two bizarre taxes: the securities transaction tax (STT) and the cash withdrawal transaction tax.

The second strange thing going on is the idea of a "cess". A cess is an earmarked tax. It was okay in the case of the fuel cess, which was really just an implementation method for a user charge on highways. But it was totally wrong in the case of the education cess. Why should a citizen pay an additional 2% "to fund education"? Isn't spending, on fields such as education, the purpose for which all taxes are charged in the first place?

If the STT, the CTT and the Education cess were not bad enough, now Business Standard writes that a `Labour Cess' is on it's way. This will fund the horrible Unorganised Sector Workers Social Security Bill.

Few things in India today are as depressing as this. They start with an awful piece of law -- the Unorganised Sector Workers Social Security Bill -- which is riddled with every mistake in reasoning that you can find. And they want to fund it with a cess -- there could not be a worse way to finance it. Unsatisfied by merely doing damage to the economy by having a bad system, they want to do damage to the economy in how they fund it.

If you put all these together, there is a frightening set of "innovations" of the UPA:

• STT
• CTT
• Education cess
• Unorganised Sector Workers Social Security Bill
• A cess for the latter.

This is just five rotten things in one blog entry. I haven't even started counting all the other rotten things in the play.

10:12 pm - Creeping privatisation of banking, UPA style

Trade unions in India are high on life, knowing they have a sympathetic government, and that the CPI(M) controls the hot button. Apparently there will be a strike by many lefty trade unions on Thursday.

The HT article says: The strike had been called to highlight the Left-supported United Progressive Alliance government's "reckless" free-market reforms, said the union leader. "We are against the moves to privatise the public sector banks through divestment or sale of the government's equity and merger and acquisition among state-run banks," said Fernandez.

If the Left-supported UPA government has engaged in "free-market reforms", then I'm a Bharat Natyam dancer.

Hmm, but I guess he supports the most important aspect of privatisation - which is the shift of the industry to private providers. Customers of PSU banks who get inconvenienced on Thursday are more likely to switch to a private bank. The heart of the bank privatisation problem is : How to reduce the market share of PSU banks. The thursday strike will help. We should have more of these.

05:48 pm - Crumbling law & order

Robert Kaplan once wrote that underdevelopment is when the police are as dangerous as the criminals. India is very odd in that when the British left, we were underdeveloped but the law and order was rather good. Over the years, the drug of socialism has shifted the attention of the political system away from the core business of law and order to the pleasant task of doling out subsidies and welfare programs. This lack of focus on law and order, which is the core task of the government, has led to a steady deterioration in the police and in the judiciary. A friend of mine in a big city told me yesterday about appearing in court in a minor context, where a bribe was being openly demanded of him by the police, in court, while the judge was watching.

Today, we read about a policeman who kidnapped a schoolboy. And, we read about naxalites being good for tiger preservation.

There are great hopes about BPO on a gigantic scale in India. A defining issue there will be the sense of safety that makes it possible for women to work the night shift. That is a law and order issue. (It is also a labour law issue).

10:20 pm - Bizarre policy process (FDI in retail)

Business Standard has an article where the Great Hope of Reform in India, Buddhadeb Bhattacharjee, says that foreigners should not be allowed into the retail trade. What `expert' on this subject has he talked with? M. S. Swaminathan. Some choice quotes from the BS article:

The chief minister of West Bengal, Buddhadeb Bhattacharjee, told members of the National Council of the Confederation of Indian Industry (CII) that the Left was opposed to the presence of foreign players or entities backed by FDI in the retail sector, specially in agricultural products. In the agriculture segment, goods moved from the producer to the end-consumer through the hands of a series of intermediaries and middlemen who would be completely edged out if FDI-backed heavyweights were allowed to start up operations, he explained. The Left could not allow foreign capital to eliminate the livelihood of the many families who made a living by trading and dealing in agricultural products at the local level, he indicated. Foreign capital would also lead to the extinction of local markets and small mandis, he said.

In West Bengal, the Left Front government, in power since 1977, had set up agricultural produce marketing committees (APMCs) at the block and district levels in all districts, sources in the state government told Business Standard.

The state government would oppose any move that would harm this network built up over the years with government resources, he indicated. The APMCs in most districts were prosperous and operated warehouses and market yards of various capacities at the local level in association with local self-government (LSG) agencies at the panchayats, block and district (zilla) layers, the source added. Most of them had generated resources for development projects at the local level that included not just agriculture-relate infrastructure but also offices, guest houses and conference or meeting halls, the source added.

Ah, I see! You don't want FDI in retail because it interrupts your crony socialism, inefficiencies in the supply chain being used to feed CPI(M) people. Scary - he is supposed to be one of the better politicians on the landscape.

I often feel there is a sterile debate about whether a modern retail industry will yield more or less jobs. I think the point is to get more efficiency. That is roughly the same as having more capital and less labour being expended to get the job of retailing done. In other words, modernisation of retail should only be interesting if it gets India a retail sector which recruits fewer people.

The lefties are, of course, stupid in thinking that by blocking FDI in retail they can protect their APMCs and the associated rackets of CPI(M) workers. All that will happen is that instead of foreign companies accelerating the pace of change in Indian retail, the field will be dominated by Indian companies only. Blocking FDI in retail does not change too much: it slows down India's growth, it has adverse consequences for Indian exports, and it ensures fatter rates of return for Indian capitalists.

05:20 pm - Saffronisation of medical education

A few weeks ago, the British medical journal The Lancet had an article where they found that some "homeopathic" treatments were no better than placebos. This must have hurt the revenues of "homeopaths" all over the world.

In a normal country, a "homeopath" has a tenuous existence, because he's just a quack and cannot practice medicine. But in India, we have a loony government. Apparently, the government has written to The Lancet questioning the study. A government writing to a technical journal claiming to have better knowledge on a scientific question is as pathetic as Stalin's stooge, Lysenko, supporting Lamarckism (the claim that inherited traits are transmitted).

And now, they want to saffronise medical education, by making sure that it's not just the quacks who know quack medicine. This is yet another reminder of how important it is to get the universities out of the clutches of the government.