reflections on free market

REFLECTIONS ON FREE MARKETECONOMY, CAPITAL MARKETS, BANKING,FOREX MARKETS AND GOVERNANCE

ICFAI Books

An Introduction

ICFAI BOOKS is the initiative of the ICFAI University Press to publish

a series of books in the areas of finance, management and allied

areas with a special focus on emerging and frontier areas. These

books seek to provide, at one place, a retrospective as well as

prospective view of the contemporary developments in the

environment, with emphasis on general and specialized branches of

knowledge and applications.

The articles are organized in a sequential and logical way that

makes reading continuous and helps the reader acquire a holistic

view of the subject. This helps in strengthening the understanding of

the subject better and also enables the readers stretch their thoughts

beyond the content of the book. The series is designed to meet the

requirements of executives, research scholars, academicians and

students of professional programs. The ICFAI University Press has

published over 750 books in this series. For full details, readers are

invited to visit our website: www.icfaipress.org/books.

REFLECTIONS ON FREE MARKETECONOMY, CAPITAL MARKETS, BANKING,

FOREX MARKETS AND GOVERNANCE

GRK Murty

ICFAI BOOKS

THE ICFAI UNIVERSITY PRESS

REFLECTIONS ON FREE MARKET – ECONOMY, CAPITAL MARKETS, BANKING,FOREX MARKETS AND GOVERNANCE

Author: GRK Murty

© 2006 The ICFAI University Press. All rights reserved.

Although every care has been taken to avoid errors and omissions, this publication is beingsold on the condition and understanding that the information given in this book is merely

for reference and must not be taken as having authority of or binding in any way on theauthors, editor, publishers or sellers.

Neither this book nor any part of it may be reproduced or transmitted in any formor by any means, electronic or mechanical, including photocopying, microfilming

and recording or by any information storage or retrieval system, without priorpermission in writing from the copyright holders.

Trademark notice: Product or corporate names may be trademarks or registeredtrademarks, and are used only for identification and explanation without

intent to infringe.

Only the publishers can export this book from India. Infringement of this conditionof sale will lead to civil and criminal prosecution.

First Edition: 2006

Printed in India

Published by

The ICFAI University Press52, Nagarjuna Hills, Punjagutta

Hyderabad, India–500 082Phone: (+91) (040) 23430 – 368, 369, 370, 372, 373, 374

Fax: (+91) (040) 23352521, 23435386E-mail: [email protected], [email protected], [email protected]

www.icfaipress.org/books

ICFAI Editorial Team:

Editorial Co-ordinator : K Krishna ChaitanyaEditors : R V Harnoor and C V Ramaswamy

Visualizer : S GaneshDesigners : S Hari Krishna Reddy and B Yugandhar

ISBN: 81-314-0387-4

ABOUT THE AUTHOR

GRK Murty, a postgraduate in Agricultural Sciences is currentlyworking for The ICFAI University Press, as Managing Editor.Earlier, he worked at AP Agricultural University, Hyderabad forsix years and later with Bank of India for 27 years. He has published45 papers in Science, Banking, Management and Insurancejournals. He has also presented papers on Banking and Insuranceat National and International seminars. He has authored two books– Soft Skills for Success and Currency Market Derivatives. He has tohis credit three edited books: Forex Markets: Exchange Rate Dynamics;Derivatives Markets – Vol. 1; and Infrastructure Projects – CurrentFinancing Trends. He is the Consulting Editor for The ICFAI Journalof Bank Management. He can be reached at [email protected],[email protected]

In reverence for my brotherDr. G Venkatramaiah, MS (Ortho)

my arch-educator.

CONTENTS

Foreword I

Preface V

SECTION I

ECONOMY

1. Growth: The other side 3

2. Reservations: Where are we heading? 7

3. Prof. Galbraith, the visionary 13

4. Budget 2006-07 17

5. Japan: Back to ‘Normal’? 21

6. Higher education: Why not private participation? 25

7. End of green (span) years for economy? 30

8. Must learn fast, and act faster 35

9. A true zentrepreneur! 39

10. Commodity price uncertainties: Role of derivatives 44

11. 100% FDI in real estate: Is it enough? 49

12. Can India stitch its textile industry in time? 53

13. Indian agriculture at crossroads 58

14. Flapping wings of a butterfly inChina make the world sneeze? 63

15. Sri Lankan economy: It has a lesson to teach us 67

16. We get petrol from the benevolenceof oil companies? 71

17. No stifling of growth, please! 75

18. FDI in insurance: That’s whatthe economy needs, baby! 79

19. Is ‘India shining’ amidst dark cloudsof fiscal profligacy? 83

20. FTA or no FTA, ‘industrial competitiveness’alone matters 87

21. ECBs or FIIs: Which is more good? 91

22. Cancun or globalization: Whose somersault is it? 95

23. Why poor LIC, why not post office? 99

24. Why & how macroeconomic policieswork and work on us? 103

25. Isn’t it ironic? 107

26. Walk the talk… Oh! “me?” no way 112

27. To disinvest or not to…. 116

28. Interest rates under deregulated regimeand market dichotomy 120

29. Why is gold still “good as gold”? 125

30. CRR ‘reduction-package’: Is it really all that? 129

SECTION II

CAPITAL MARKETS

31. Sense and sensex 135

32. It’s all politics of economics! 139

33. Thundering in the Indian skies? 143

34. Samvat 2062 146

35. Transaction tax: No more deals, please! 151

36. IPO’s rating: What for? 155

37. Imperfect information! Imperfect competition!Imperfect markets! 160

38. “No” contrarian fund: Only contrarianinvestors, please! 164

39. “Nothing will come of nothing” 168

40. Indian “hermeneutics of suspicion” 172

41. Investment sans trading “nirarthakam”? 176

42. ‘Clarity-driven’ regulatory interventionalone makes sense 180

43. Who is hedging who? 183

44. Socially responsible investing no more a fad 188

45. Stock market behaviour: A method in madness 193

SECTION III

BANKING

46. Recent rise in undesirable consumerism:‘Credit’ to credit cards? 201

47. Central banks’ trilemma 206

48. Here again PSBs are in the news, ofcourse for a good cause! 211

49. GTB fiasco: A new lesson for themarket economy? 216

50. Is RBI a big brother or a helping hand? 221

51. Shining NPAs: A reflection ofnational ‘character’? 226

52. Queering “flat pitch”/“curve” 231

53. Out, ‘lazy banking’ & in, ‘resilience’ 236

54. Reserve bank’s ‘duvidha’? 240

SECTION IV

FOREX MARKETS

55. Capital account convertibility:Is India ready for it? 247

56. Who is great: God or the economist? 252

57. Forex reserves and infrastructureinvestment: Strange bedfellows? 257

58. Forex reserves for domesticinvestment: A bold move 262

59. Wrestling to manage the “swamp of plenty”? 266

60. “Blossoms sadder than tears on grief’s eyelids” 271

61. Hail thee, Jalan and thy rustic wisdom! 276

62. What does an appreciating rupee mean? 279

63. Is rupee strong enough to go in for Euro-loans? 282

64. Do forex reserves serve those‘who only stand and wait’? 286

65. Mere expression of ‘exuberance’and ‘abundance’? 291

66. Can removal of regulationsbuild a market for swaps? 295

SECTION V

GOVERNANCE

67. Indo-US nuclear agreement: The road ahead 301

68. We all have to act on it! 306

69. Indo-US nuclear deal 311

70. Religion vs. ghastly acts of the ‘angry apes’… 316

71. Clause 49: A step towards ‘good governance’ 321

72. India Pharma Inc.: What is in store? 325

73. PV: The prime minister who “empowered”his colleagues to dissent 330

74. “Our ‘quarrels’ are ours, theirends none of our own” 335

75. Thank you, Anil Ambani! 339

76. Solving negotiation problems 344

77. ‘Self-regulation’, the obvious panacea… 347

78. “Silence of lambs”… 351

79. Individual interests vs. public good 355

80. “Anandame jeevita makarandam” 359

• Index 365

PREFACE

It is about four years ago that the Consulting Editor of PortfolioOrganizer mooted the idea of my writing a regular column forhis magazine. I just wondered at the suggestion and forgot, butnot the editor. He kept on reminding me and ultimately, beingcoerced into it, I was to ponder over it, of course with a lot oftrepidation. Ultimately, I stumbled on a template: to pick anevent from the market and analyze its dynamics – theantecedents, its impact, likely future scenario, and its theoreticalunderpinnings – in about 1200 to 1300 words. The exercise wasrepeated month after month in the two publications of the ICFAIUniversity Press – Portfolio Organizer and Treasury Management.

In short, that is the genesis of this book. Selection of columnsfor inclusion in the book is based on the philosophy that theycan ‘endure’, though dated. The selected articles are arrangedunder five heads: Economy, Capital Markets, Banking, ForexMarkets and Governance. None of them is edited afresh, withthe intention of retaining the originality of reaction to theevents considered. And to keep the readers’ interest alive,they are sequenced in a descending fashion in terms of monthand year.

VI

In analyzing these events I have very liberally drawn onthe wisdom of many intellectuals of the world as availablefrom books, magazines, periodicals, research papers,newspapers, etc. And it is very difficult to thank them allindividually, except to say that but for their wisdom the bookwould have not been what it is.

Many of my colleagues have helped me in bringing out thisbook. Notable among them are Prof. G Kumara Swamy Naidu,the then Consulting Editor of Portfolio Organizer and Prof. KSeethapathi, Consulting Editor, Treasury Management who havegently nudged me into this writing and I thank them for theirencouragement. I am grateful to my professor Dr. S S PrabhakarRao who has obliged me by going through some of themanuscripts. My sincere thanks are due to Sri R V Harnoor,for kindly going through the manuscript and offering hisexcellent inputs. I also thank Sri Koshy Verghese, Director,ICFAI Books and his team, particularly Sri K Krishna Chaitanyaand Sri C V Ramaswamy for their excellent co-operation inpublishing this book. I sincerely thank my colleague Sri S HariKrishna Reddy for his tireless patience in typing these articles.

I am highly thankful to Prof. B Ramesh Babu, AdjunctProfessor, The ICFAI School of Public Policy, Formerly, SirPherozeshah Mehta Professor of Civics and Politics, Universityof Bombay, who has graciously acceded to my request to writea foreword, by patiently going through the manuscript and thenpenning those beautiful words. I remain grateful to him.

Lastly, my sincere thanks are due to Sri N J Yasaswy,Founder Member and Member of Board of Governors, ICFAI,who has provided me space and encouragement to expressmyself, but for which this book would not have seen the lightof the day.

– GRK Murty

SECTION I

ECONOMY

A cursory glance at what the Indian corporates had accomplished in the fiscal 2004-05 reveals certain intriguing features, besides

reaffirming that India Incorporate had the tenacity, though itscompetitiveness was earlier constrained by governmental actions, toface global competition with élan and put up a bright show.

During fiscal 2004-05, the top 500 companies of India Inc notchedup an impressive combined net sales figure of Rs.12,78,159 crore –an increase of 19% over the previous year – testifying to the boomingeconomy. Not surprisingly, it was the old economy companies(interestingly, many of them are the Public Sector) that occupied thehigher echelons of the best 500 list. Oil Companies have contributedas high as 31.43 per cent to the total net sales of the top 500 companies,followed by sectors such as banking, IT, pharma, and automobileindustries. Though the performance in fiscal 2004-05 is quite in linewith the average annual growth rate of 6 per cent that we have beenwitnessing over the last 15 years, we cannot afford to be oblivious ofthe emerging ‘other side’ of the growth.

ONE

Growth: The other side

An economic growth rate of 8% is fine. Equitabledistribution of its fruits through well-targeted aid andgood governance is still finer!

4 REFLECTIONS ON FREE MARKET

Our growth is essentially of a ‘bi-polar’ nature. Even today we havearound 31% of population living on less than US $1 per day. Around81% of the population is living below US $2 per day as against 45% inChina, 22% in Brazil and 0% in Japan and the US. On the otherhand, according to a 2006 survey carried out by Barclays Capital, thewealth management firms will be holding or managing an estimated$256 billion for Indian clients, which incidentally is almost half theGDP of the country. The report also reveals that for the affluent class,China will be the largest market in Asia with an estimated $93 billion,followed by Korea and India with $50 billion each. The latest worldwealth report makes similar revelations: India has 70,000 high net-worth individuals, with financial assets of over $1 million. Interestingly,the number of the super-rich is growing in India at the rate of 14.6%which is twice the world average of 7.3%. The spread of wealth acrossthe country can be gauged from the fact that almost two million newtwo wheelers and one million four wheelers are sold every year.

All this only indicates how skewed our wealth distribution is. Amidstplenty, we have half of our population living in poverty. We are nodoubt a super-competitive country at least in sectors such as IT, whereour software companies are known to provide solutions to the best ofmultinationals. At the same time, we also have a great chunk ofpopulation reeling under illiteracy, poor healthcare, and under-nourishment. Accretion of wealth is thus highly uneven.

No wonder if all this makes India a country of contrasts. Thelousy infrastructure that we are living with is another example ofcontrasts. On the one hand, our software companies transmit complexdata of trillions of bytes via undersea cables at the click of the mousewhile on the other, it takes hours for a rider of a Maruti, Indica orBenz to inch forward on the choked roads of Mumbai, Bangalore orHyderabad. We have a national highway network of 1,24,000 miles

5Growth: The other side

as against 8,70,000 miles in China and most of it is of two lane, withpoor or no maintenance.

According to one estimate of Morgan Stanley, India hardly spendsaround $2.5 billion a year on building roads while China spendsmore than $25 billion a year. Owing to the poor port infrastructureand bureaucratic interventions such as customs, it is estimated that ittakes 6 to 12 weeks for the Indian goods to reach the US, while it ishardly 2 to 3 weeks from China. Similarly, the cost of power is muchhigher in India vis-à-vis China. All these constraints mean thatbusinesses in India pay more than what their competitors in Chinapay for producing goods, and that makes Indian goods that much lesscompetitive in the global market. The World Bank index of cost-of-doing-business places India at the 116th position in a list of 155countries. Indeed, one section of the world market still considers usas a country of licence raj.

With the advent of globalization, we have been experiencing aboom in the service industry, mainly arbitraging on our human capital.More and more countries are realizing the hard-working nature ofIndians as a means to cut their costs while being sure of productivityenhancement. Thus India became the hub for Business ProcessOutsourcing (BPO) and Knowledge Process Outsourcing (KPO).Incidentally, the outsourcing industry has become the major employerof the market. The availability of jobs in BPO and KPO segmentsresulted in higher consumption leading to increased demand for retailcredit which in turn fuelled further consumption. This whole virtuouscircle of jobs creating demand and demand creating jobs made aninteresting revelation: our source of competitive advantage in bothBPO and KPO is simply the availability of quality manpower in therequired quantities. Now, the threat is that this advantage may notlast long unless we maintain a minimum standard of education. Thecurriculum needs to be upgraded in line with the industry


requirements with professional training as mandatory under everycourse. The focus of education must be moved away from theoreticaldiscourse to implanting problem-solving analytical skills, team learningskills, team working skills, team decision-making skills, etc. Unlessthe country produces quality manpower we would not be able to moveup in the value chain. Indeed, we may not be able to face even theemerging competition from countries like China which are investingheavily in upgrading human skills. And all this calls for hugeinvestments in the educational sector.

If we have to sustain whatever growth our corporate world hasregistered, and at the same time keep the negative fallouts of the freemarket economy under check, we, taking a cue from the developedcountries like the US and Germany which are known to spendconsiderable share of their GDP on public expenditure, must makepolitical choices quickly. We must use the wealth created to providehealthcare, education and social security to the teeming population.We must create basic infrastructure that fuels growth further. As thePrime Minister stated at some conference, we have to make aninvestment of $150 billion in the infrastructure development in thenext seven to eight years. We must re-engineer our educational systemto churn out ‘employable graduates’ in the fast-changing technologicalworld of tomorrow.

Corporates too can—and need to—chip in in this whole exerciseof creating a “more inclusive brand of capitalism” by “incorporatingpreviously excluded voices” and simultaneously delivering “economic,social and environmental benefits,” all in one go.

——)0——

7Reservations: Where are we heading?

Everything in this world has an expiry date: aspirin of Bayer, VSNaipaul of literature, Ramanna of BARC, Dilip Kumar of

Bollywood, Lata Mangeshkar of the world of music, even communismin Russia, but not the ‘reservations’ of India. The recent announcementof the ministry of HRD proposing to create reservations for OtherBackward Classes (OBCs) to the extent of 27%, in Central educationalinstitutions including the Indian Institutes of Technology (IITs),Indian Institutes of Management (IIMs), Central Universities, etc.,and the consequent reactions of the society would corroborate thestatement. It is averred that the present proposal is an outcome of the93rd Constitutional Amendment Act, though it has only an enablingclause to offer such reservations; it is not mandatory. The impact ofthe proposal could be gauged from the fact that 4500 odd seats thatare on offer in the seven IITs under the ‘merit’ category, would nowstand reduced by a whopping 1200 seats.

May 2006.

TWO

Reservations: Where arewe heading?

The current move to increase reservations from 22.5%to 49.5% in IITs, IIMs etc., if viewed in the backdropof ‘globalization’, is sure to undermine nationalinterests.


It is further feared that the government may extend ‘quotas’ toprivate educational institutes, foreign universities operating from Indiaand even private businesses for employment. This has raked up afresh debate nationwide. Reacting to the proposals, Mr. Ratan Tata,Chairman of Tata Sons, as quoted in The Hindu, said: “Though I donot want to comment on it, it (reservation) is bad… In some way itwill tend to divide the country into different groups.” That aside, thecurrent move, unlike yesteryear’s propositions, merits criticalexamination from the perspective of the ongoing ‘globalization’process, which is an altogether different ball game of economic pursuitsthat the country is engaged in.

As Edward S Herman observed, globalization, as an ideology,connotes freedom and internationalism. It helps realize the benefits offree trade, and thus comparative advantage and division of labour. It issupposed to enhance efficiency and productivity. It is therefore both anopportunity and a risk. It is an opportunity when one can master thecraft of doing business at increased levels of ‘efficiency’. On the otherhand, if the economy is plagued with inefficiencies, there is no greaterrisk than globalization. It has ushered in the era of changing paradigms:a move away from financial capital to intellectual capital; horizontal/vertical to virtual and time-tested procedures to innovation.

In a globalized economy, businesses, while competing for a sharein the highly competitive markets, essentially look for qualifiedknowledge workers for improving their product differentiation. Thisautomatically calls for excellence in the educational system. Thefunction of the education system then becomes more of generating‘employable’ graduates, which means admission of students on ‘merit’rather than on any other ‘consideration’. Klein Lawrence, whileanalyzing the economic growth in China and India, identified the‘intervention of bureaucracy’ as the obstacle to India’s continuingeconomic expansion. He opined that in the highly competitive global


economy, slow reaction movement will hold back many potentialplayers, and India should reconsider the place of ‘class-society’ infuture development.

According to the Nasscom McKinsey Study 2005, India faces apotential shortage of skilled workers for IT and BPO industries inthe next decade. According to it, at present only about 25% of technicalgraduates and 10–15% of general college graduates are suitable foremployment in the off-shore IT and BPO industries respectively. Thatbeing the quality of students our educational system is turning outtoday, what the plight will be after the proposed regulations isanybody’s guess. The seriousness of the problem can be gauged fromwhat Nasscom has recommended: one, to set up focused-educationzones to improve the quality of higher education and to deregulatehigher education in stages over the next 5 to 7 years and shift to alargely demand-based funding system for colleges and universities,and two, for industry to pilot skill development programmes in over2000 colleges by 2010. That being the reality, it is needless to say thatthe present move to increase the reservations to 49% is sure tojeopardize national interests in the long run.

There is a gnawing fear that ‘reverse discrimination’ resulting fromreservation policies, which has all along been simmering under thelid, is likely to become open and vocal, in a knowledge economy. Thiswould only get further aggravated by the present move to increase the‘quotas’. Secondly, the denial of entry into an institute of excellenceowing to the increased ‘quotas’ despite the applicant’s credentials, thattoo, for an individual who is not responsible for what the lower casteshave been subjected to in the past, is being perceived as ‘unfair’ by thedeprived lot and is sure to cause intense resentment and this is sure toimpact economic pursuits of the society adversely.

IT is India’s unique competency in the global market. If we have toretain this lead and leverage on it for future growth, the industry can


hardly afford anything other than excellence in skills-profile of its workforce. Reservation policies which enable a less skilled person to walkover a competent person to grab a job, is bound to shrink thecompetency levels across the organizations making businesses lesscompetitive. This phenomenon, whether we like it or not and desirableor undesirable, is quite certain to challenge the current reservationpolicies as we march further into ‘globalization’. Indeed, this fact iswell reflected in what Mr. Azim Premji, Chairman of Wipro, said athis company’s annual meeting: “We appreciate the compulsions of thegovernment. But we are an organization which needs to select peopleon merit. We compete with global companies and are primarily in theservices business, which is highly people-dependent.”

Under the threat of being punished for inefficiencies in a globalizedeconomy, the businesses will go all out to attract talent from anycorner of the globe, and may even recruit non-Indians for leveragingon diversity while functioning at multi-locations. Such overseasrecruitments are sure to go up as a consequence of the current moveon reservations. This emerging reality has another dimension—placing together highly endowed and poorly skilled employees in ateam that is assigned the task of, say, development of a software package,simply derails it, for the highly talented individuals resent the presenceof the poorly skilled, considering them as a drag on the team’sperformance. Such poor ‘hygiene’ at work places pulls down theoverall efficiency of the businesses. Fearing this, businesses areresenting reservations as is reflected in the comments of Mr. RatanTata, Chairman of Tata Sons, and Mr. Rahul Bajaj, Chairman ofBajaj Auto Ltd.

There is of course a flip side to globalization: It widens the gapbetween the highly endowed sections and those who are sociallydisadvantaged. Over it, if businesses, which have of late become theprime employers, stay focused on ‘talent/merit’, the plight of weaker


sections is bound to worsen further. This may generate social unrestand may even threaten the very social fabric. And this cannot bearrested through mere reservations, for it caters to a minuscule ofpopulation. So, the state should activate “use of its power andresponsibility towards the ends of protecting citizens against economicadversities and ensuring a certain standard of prosperity to all.” Itshould work towards eliminating ‘discrimination’ and ‘reversediscrimination’ from the society. Such unison of energies is onlypossible when the government provides the means to acquire theessentials of life to the ‘less endowed’, which alone encourages themto ‘re-brand’ with newer skills for seeking employment. The stateshould create ‘trampolines’ that offer the cushion for all those whoget laid off by the businesses or fail to get employment for want ofnew skills. As a part of the proposed ‘trampoline architecture’, it mustalso create ‘community vocational training centres, that can retrainthose who lost their jobs and make them re-employable.

Psychologists have something different to say: cognitive skilldevelopment is influenced to a great extent by the quality of care thata child receives during its early phase of growth. Therefore, welldesigned intervention in terms of balanced nutrition, facilitatingmental hygiene, etc., launched in the early phase of child growthmatters more than ‘quotas’, later. The government shouldsimultaneously strengthen elementary education on priority. Todayit is said that the government spends around Rs.3000 per child peryear, by way of running a poor quality primary school system. Instead,why should it not encourage private initiatives to establish qualityschools and run them on a template that ensures infusion of analyticalskills? The government can even experiment issuing a voucher ofRs.3,000 in favour of parents to encourage them to choose a schoolof their choice, and thus make them accountable for their children’squality education. It is time we implemented the 1986 NationalEducational Policy without further loss of time.


Our schools and colleges must be made to allocate time and gradesto students in order to encourage them to undertake social work tobetter the lives of the less endowed, so that such interactions wouldbuild a right mindset at the right age among the youth for cultivatingthe concept of ‘social inclusiveness’, besides eliminating acrimonybetween the ‘haves’ and the ‘have-nots’. Similarly, companies mustvolunteer to let their employees go out and work for the welfare ofthe ‘less endowed’ for a specified period and the same must be takencognizance of while appraising their performance. It is time companieswalked beyond resenting reservations and exhibited a sense of socialresponsibility by undertaking various skill development activities forpeople in areas around their workplaces and made them employable.Thus, it is not ‘reservations’ that the government should aim at, butdevelop human capital in partnership with corporates.

——)0——

13Prof. Galbraith, the visionary

Prof. John Kenneth Galbraith, an iconoclastic economist, ateacher, a diplomat, above all a visionary who empathized with

mankind, died on April 29, at the ripe age of 97.

He was a Keynesian and a protagonist of political liberalism andprogressive politics of 20th century America. His faith in government’sability to build a welfare state reflects in many of his speeches, inwhich he forcefully hailed the role of government planning as opposedto economic freedom. It is his articulations such as, “The marketcannot reach forward to take great strides when these are called for…To trust to the market is to take an unacceptable risk that nothing, ortoo little, will happen” that surprisingly made the lanky and angularat 6 feet and 8 inches, yet imposing personality of an American–JKGalbraith – a darling of many young and old Indians of 60s. It’s adifferent matter that today many may accuse India of having not takenthat ‘risk’ of relying on market, and ending up as a “permit-license-quota-Raj”; but no one can deny the need for governments to create“safety-nets”, more so in today’s globalized economy.

May 2006.

THREE

Prof. Galbraith, the visionary

The most loved American of Indians and in his deathIndia lost a good friend.


Prof. Galbraith spent almost seven decades of public life – as abureaucrat, a diplomat, or as an adviser to many presidents or fearlesslyfiring cannons at Washington from Harvard as its Professor. Hispassion for and understanding of political liberalism can well begauged from what he said about Franklin D. Roosevelt: “A singularfeature of Franklin D. Roosevelt was his pragmatic accommodationto whatever needed to be done. If you ever hear a politician say, “I’mgoing to adhere strictly to principle”, then you should take shelterbecause you know that you are going to suffer”. His longing to befree from dogmatic ideologies and doctrinaire politics while researchingfor answers to political and economical questions is well reflected inhis statement: “Under capitalism, man exploits man. UnderCommunism it is just the opposite”.

Prof. Galbraith, true to his iconoclastic nature averred that classicaleconomic theory was true to the eras of ‘poverty’ but not to the present,when the economy has moved into an age of ‘affluence’ warranting acompletely new economic theory. He argued: “if the individual’s wantsare to be urgent they must be original with himself. They cannot beurgent if they must be contrived for him. And above all, they must notbe contrived by the process of production by which they are satisfied…one cannot defend production as satisfying wants if that productioncreates the wants.” Being disturbed by the widening gap between therichest and the poorest and fearing that it can one day threaten the veryeconomic stability of a country, Prof. Galbraith desired that the stateshould invest in parks, transportation, education, and such other publicamenities. He lamented the back seat taken by “education, literature orthe arts” in measuring the “human advance” vis-à-vis “production ofautomobiles including Sports Utility Vehicles.”

Prof. Galbraith abhorred war, for in his opinion it represents “thedecisive human failure.” He argued against the Vietnam and Iraqwars. He said: “wars are a major threat to civilized existence and a

15Prof. Galbraith, the visionary

corporate commitment to weapons procurement and use nurtures thisthreat.” His concern and empathy for mankind and his internationalvision are rightly reflected in what he wrote in the guardian two yearsbefore his death: “civilized life, as it is called is a great white towercelebrating human achievements, but at the top there is permanentlya large black cloud. Human progress dominated by cruelty and death.”

It is, perhaps, to drive away that “black cloud” farther and farther,he wrote more than 48 books spanning across politics, economics,memoirs and novels. His writings, to quote the New York Times, areknown for: “his customary clarity, eloquence, and humor” that “cutsto the heart of what economic stability means (and doesn’t mean) intoday’s world and lays bare the hazards of complacency abouteconomic inequality”. Here it would be educative for us to hear fromhim as to what writing means to him: “one extraordinary part of goodwriting is to avoid excess,… next is to be aware of the music, thesymphony of words, and to make written expression acceptable to theear. … Never to assume that your first draft is right… And it is onlyin the second and third and fourth drafts that you really escape theoriginal pain and have the opportunity to get it right.… I do not putthat note of spontaneity that my critics like into anything but thefifth draft.” That prodigious labor made him “one of the most giftedwriters… tumbling the tribal gods of both left and right”.

Prof. Galbraith is considered a great epigraphist – a sample ofwhich can run as: “money is a singular thing. It ranks with love asman’s greatest source of joy. And with death as his greatest source ofanxiety. Over all history it has oppressed nearly all people in one oftwo ways: Either it has been abundant and very unreliable, or reliableand very scarce.” This epitomizes his belief that “there are nopropositions in economics that can’t be stated in clear, plain language.There just aren’t.”


His unusual world vision can be safely traced to his student daysat University of California at Berkeley – “a hotbed of radicalism” –that awarded him Ph.D in Agricultural Economics, which, to quotehim, shaped a “certain tendency to question the official wisdom” thathe later termed “conventional wisdom”. Driven by a faith that “socialscience should be tested by its usefulness”, Prof. Galbraith pursuedthat stream of economic thought which Thorstein Veblen fromStanford labeled as “exoteric knowledge” – “knowledge related topractical application” – instead of the “esoteric knowledge” which ismore concerned with “mathematical expressions, econometricniceties”, etc., that have a tendency “to leave the real world alone”.

His immense faith in the power of the conscientious individual toact against the tyranny of the corporate power made him less of aneconomist and more of a mixture of sociologist, political scientist anda far-sighted writer. This side of Galbraith has no doubt attractedcriticism from the likes of Prof. Milton Friedman: Galbraith believesin the superiority of aristocracy and in its paternalistic authority, heproposes that consumer’s wants be decided by those with ‘higher minds’.Friedman asserts that many reformers are averse to a free market.

The great trilogy of widely read and highly influential books –American Capitalism that pointed out the loss of “perfectlycompetitive” model; The Affluent Society which contrasts the“affluence of the private sector with the squalor of public sector”;and The New Industrial State which accuses “The mature corporation”that enjoyed “the means for controlling the prices at which it sells aswell as those at which it buys” – penned by him, brilliantly profilingthe America of their time, are sure to keep the legacy of Prof. Galbraithalive for generations to come.

——)0——

17Budget 2006-07

T he way Indians, Indian businesses, India’s media, and itspoliticians reacted to the budget 2006-07 stands out as unique.

It simply made the budget a ‘non-event’. Is it a reflection of the maturitythat Indians and Indian democratic institutions have accomplishedin the last 50 odd years of independence? If so, nothing like it, for itreflects the ‘confidence’ Indians have in themselves and their faith intheir democratic institutions.

It only reaffirms that India has come of age – Indians are todaysilently but resolutely telling themselves: “we can manage ouraffairs”; “we no longer look at others – including the Government,to micro-manage our lives and its affairs”. It is now up to theleadership to not only take this new-found ‘confidence’ forward butalso use it as a platform to build a new India whose ‘atmospherics’permit every citizen to explore his full potential.

Now, coming to the budget per se, though the media acclaimed itas a budget that didn’t tinker with the ongoing economic growthprocess by doing any wrong, we must admit that Shri Chidambaram

March 2006.

FOUR

Budget 2006-07

It has, for good, become a ‘non-event’ though it hascertain interesting provisions.


did work for creating the right ‘atmospherics’, at least on two fronts:one, he made an attempt to exhibit a sense of commitment to fiscaldiscipline, and two, kept his budget “compassionate” despite “severefiscal constraints.”

As for his commitment to fiscal discipline, he projected a fiscaldeficit of 3.8% as against 4.1% of GDP for the current year. Thisperhaps augurs well for the nation to ultimately catch up with thetargeted fiscal deficit of 3% by 2008-09. However, the projected revenuedeficit of 2.1% as against the current 2.6% is not all that encouraging,though it must be admitted that it is on the right track. Looking atthe research findings of Smt. Indira Rajaraman, RBI Chair Professorat NIPFP, which reveal that the increment in fiscal and revenuedeficits in pre-election years over the last 30 years was found to liebetween 0.7- 0.9% of GDP, one cannot refrain from saying that theproposed reduction under revenue deficit sounds insufficient as inthe remaining two years the Government has to achieve a reductionof more than 1% if the Government were to catch up with the FRBMAct by 2008-09 which incidentally happens to be the pre-electionyear. But, for the time being, it sounds encouraging, particularlywhen we take note of the elections that are in the offing in a coupleof important states.

The other significant element of the budget is the allocation ofresources to certain key programmes such as rural employmentguarantee, rural health mission, rural roads, Sarva Shiksha Abhiyan,that signifies a major effort towards bettering the life of the commonman. Although the experiences with public expenditure under suchprogrammes has so far been quite bitter, allowances must be granted,for the present administration is aiming at increasing the accountabilityand efficiency of the delivery channels by focusing more on ‘programapproach’ than on project approach.

19Budget 2006-07

There is yet another interesting provision in the budget. After all,we cannot afford to forget that there are almost 700 million Indiansliving in 6,00,000 villages, for whom agriculture continues to be themainstay of life. Despite all the technological advancement that today’sIndia can gloat about, Indian agriculture is still dependent on thevagaries of monsoon. Besides irrigation, the other major constraintfor Indian agriculture is timely availability of ‘credit’, which eventoday continues to be a daunting task for every farmer. No civilizedIndian could afford to ignore the fact of erratic behaviour of themonsoon coupled with the burden of credit causing insurmountablewoes to the farming community as reflected in the suicides by farmersfrom time to time.

Against these ground realities, the budget proposal to makeshort-term credit available to the farmers at 7% per annum is a welcomefeature. The significance of this otherwise none-too-importantprovision in the budget gets manifested when one juxtaposes theprevailing interest rates of 10% and above on crop loans given to afarmer—who is known to trade on today’s grains by sowing them inopen fields for tomorrow’s more output—along with the interest ratesof around 7.5%-8.5% prevailing on car loans and other consumerloans given to the urban elite.

The Finance Minister’s idea of giving subvention to ensure itseffective implementation is again laudable. Well! The orthodox puristsmay on this score accuse the government of intervening in the interestrate administration mechanism. But the truth is, neither the presentprescribed interest rate of 7% under short-term crop loans, nor theintention of supporting its implementation through budgetaryprovision is not out of the market context. The prevailing interestrate on deposits up to two years in banks is hardly 4.5%. As againstthis cost of funds, a rate of 7% on crop loans is sure to take care ofbanks’ operating cost. So, whatever subvention the government has


proposed is perhaps meant for only bolstering banks’ profits. As againstthis, it is a well-known fact that banks have been heavily subsidizingcorporate loans during the last 3-4 years by fixing interest rates ondeposits at negatively returning rates.

There is yet another positive side to this provision: it goes wellwith the proposition of the Finance Minister’s reliance on ‘growth’for eradicating poverty. Ever since reforms were initiated, India didrealize commendable economic growth, but it was more of a ‘bipolar’nature which is likely to cause more resentment among those sectionsthat are left out of the ‘growth’. There is, thus, a great need for an“all inclusive” model of budgeting to ensure least resistance tomarket-driven economy and that precisely is what this provision hasaccomplished.

The cut in duties on small cars is another positive attempt whichmay generate more demand and, in the process, make India a hub forsmall car manufacturing, which if realized, is certain to create moresecondary employment opportunities that in turn can give a gentlepush to ‘consumption’. It is altogether a different matter that asimultaneous rise in the duties on cars other than small could havenot only further strengthened this argument but also paved the wayfor easing the congestion on the roads. Nevertheless, all this doesnot matter so long as the citizens are confident of managing themselvesand the Government refrains from micro-managing people’s affairsas it has done in this budget.

——)0——

21Japan: Back to ‘Normal’?

T he Sun is at last rising, albeit slowly, or so it appears. TheJapanese economy is slowly emerging out of its more-than-a-decade

old deflation — a deflation that was once considered a remote possibilityin a fiat-economy since there is a plethora of policy instruments availablefor Central Banks to support aggregate spending in a fashion that bestsuits its given context. Even Ben S Bernanke, the present Fed Chairman,in one of his presentations before the National Economists Club,Washington, DC, on November 21, 2002 said: “Under a fiat moneysystem, a government should always be able to generate increasednominal spending and inflation, even when the short-term nominalinterest rate is at zero… and hence positive inflation.”

That was the theoretical assumption. The reality proved otherwise.It all started way back in the 80s when an appreciating yen madeJapanese exports less price-competitive. It was to bail out the exportersthat the Bank of Japan (BoJ) initiated in 1986 an easy monetarypolicy by cutting the discount rate. Unwittingly, this resulted in realestate and share price bubble. To cool the markets, the BoJ was toreverse its easy monetary policy by raising the discount rate — thirteen

March 2006.

FIVE

Japan: Back to ‘Normal’?

A move of Bank of Japan from ‘Liquidity targeting’to ‘Interest rate targeting’ may unwittingly challengethe asset prices elsewhere in the global markets.


times between May 1989 and August 1990 – to 6%. But this resultedin the fall in the Nikkei by around 39% in 1990. This caused furtherproblems: the moneys said to have been lent recklessly by banks duringthe bubble period turned out to be bad loans, and this led banks notto undertake fresh lending. All this cumulatively resulted instagnation. The subsequent lack of demand triggered deflation – ageneral decline in prices.

By 1999, it became clear that the economy could not be kickedout of stagnation unless drastic monetary policies were adopted whichculminated into bringing down the overnight call rate to zero by theBoJ. But to everybody’s surprise, nothing could halt the fall in prices.In the year 2001 the BoJ initiated an unprecedented and untestedpolicy of “quantitative easing”. Under this policy the BoJ simply floodedthe system with more money – liquidity went up to ¥35000 bn whichwas almost six times the amount that was actually needed to push theovernight interest rates to zero. However, nothing positive happened:no discernible economic activity in terms of spending/investing couldbe traced. One reason cited for such dismal performance was thefailure of banks which were by then heavily loaded with non-performance loans, to pass it on as credit to the broader economy. Onhindsight, it appears that the failure of even “quantitative easing policy”in pushing Japan out of deflation was perhaps more due to “themassive financial problems that the Japanese banking and corporatesectors faced coupled with a large overhang of Government debt.”

Anxious to come out of this syndrome, the BoJ subsequentlyincreased its purchase of Government bonds massively from ¥400 bna month to ¥1200 bn. This was followed by another drastic step: in2002, to prop up the falling stock market, the BoJ purchased sharesin unnamed companies worth around ¥2000 bn, which of coursehelped the stock market revive.

All these measures at last helped the economy recover: the GDPgrew 2.8% in 2005 and 4.2%, year-on-year in the 4th quarter. There

23Japan: Back to ‘Normal’?

were indications of inflation returning. The stock market startedlooking up with corporates brimming with good order books postinggood profits. Every economic indicator has at last started pointingtowards the exit of deflation. Prompted by these developments, theBoJ announced on 9th March 2006 its scrapping of the existing“quantitative easing policy” and its desire to pursue a more normalmonetary policy henceforth.

This move, however, should not alter the Japanese economicscenario overnight. The BoJ has promised to maintain overnightinterest rates at zero percent during the transition. So long as theBoJ’s tightening remains behind the yield curve, the economy is sureto flourish leading to rising equity prices. On the other hand, if thetightening is too harsh, it may hit the economy very hard, that too,when people take time for their psychological shift from deflation toinflation which means poor spending during the transition. This inturn can hit corporate profits badly. The expectation of higher yieldson Japanese bonds is already causing the yen to become strong againstthe dollar. A stronger yen would only mean less ‘export-receivables’in terms of domestic currency which could eat into corporate profits.In any case, the full effect of BoJ’s decision to move into orthodoxmonetary policy will only be known in the country a few years hence.

Coming to the international scenario, one may be tempted to believethat Japan emerging out of deflation must sound pretty melodious.“Yes,” everyone is delighted to hear that Japan is out of deflation butnot BoJ’s announcement of ending its “quantitative easing” policy.Particularly, it is those who are engaged in ‘carry trade’ that are terriblydisturbed – indeed, must be shivering in their pants—by its intendedreturn to normal monetary practices. Even many Central Bankers mustbe wondering at the likely fallout of BoJ abandoning its “quantitativeeasing” policies on the world economy.

The easy money policy hitherto practised has indeed contributed agood deal to higher bond prices and the accompanying low long-term


interest rates in major global markets – all because of too much moneychasing too few assets. Against this backdrop, one likely scenario toemerge is: a grinding halt to “carry trade”, which means no longerborrowing Yen at no cost and buying assets elsewhere in the globaleconomy; Japanese investors would be encouraged to invest more inthe domestic assets for better returns than invest abroad; the resultantrise in yen value vis-à-vis foreign currencies, and fall in the price offoreign assets due to drop in demand. The other worst scenario, whichis of course a far-fetched one, could be: fall in “carry trade” resultingin lesser investment in American assets that in turn can lead to higheryields on the US Treasury bonds, which means expensive mortgageloans and falling house-prices—all leading to the much-feared prickingof the US housing bubble.

Whether or not such scenarios are a mere figment of a fertilebrain, one thing is certain: it is potential enough to rattle the globaleconomy. This jolt along with that of the mounting US trade andfiscal deficits and the Asian surpluses can collectively inflict severepain on world economy—at least for some time to come.

The only blessing in disguise is that the world has been expectingthese changes for quite some time and is thus not taken by surprise,which means the market players must be well preparing for all theeventualities. Secondly, Japan coming out of its decade-old deflationis in itself a good cause for the world economy to cheer about, for itcan fuel the world economic growth, should the US or Europefalter. In all probability, everything may come out all right sincethe process is supposed to be gradual, which incidentally allows formonetary loosening elsewhere. The only nagging fear, however, is:how BoJ will achieve the targeted 0-2% inflation for it is the fulcrumof global economy.

——)0——

25Higher education: Why not private participation?

Today, there is hardly any discussion under economics that is“globalization-free”. Its all pervasiveness is mostly attributed to

multilateral trade liberalization; success of the economic reforms indeveloping countries, particularly China and India; technologicaladvancement and convergence in communication and computationtechnologies, and the resulting blurred demarcation between whatcan and cannot be traded in the international trade. The net result ofthese developments is the emergence of new macroeconomicinterdependencies that transcend sovereign boundaries.

With the advent of globalization we have been witnessing many‘seismic changes’ in the world. One of them is the intense internationalcompetition that many businesses are today facing. This has led tocompanies outsourcing and offshoring of manufacturing activitiesand services to countries that are endowed with low-cost labor.McKinsey Global Institute predicts that by 2008, 160 million jobs inservices are likely to be performed away from the customer.

March 2006.

SIX

Higher education:Why not private participation?

The quest for knowledge workers in a globalizedeconomy compels India to hone its infrastructurefor higher education.


India has emerged as one of the prime beneficiaries of these globaldevelopments. During 2000-04, the offshore IT and BPO industriescontributed 90% of the absolute growth in foreign exchange inflowsunder service industries, said CMIE. According to Nasscom McKinseyStudy 2005, if we maintain the current global leadership level in ITand BPO industries, our off shoring industries could, by 2010, wellbecome one of the world’s great export industries. But to maintainthe growth momentum, the report says that “India will need a 2.3million strong IT and BPO workforce by 2010.”

The report, on the downside, warns that India will encounter apotential shortage of skilled workers in the next decade or so. Accordingto the report, it is only 25% of technical graduates and 10 to 15% ofgeneral college graduates who were suitable for employment in theoffshore IT and BPO industries respectively. To stay in the lead, thereport states that India needs to improve the quality and skills of itsworkforce. It recommends the establishment of focused education-zones to improve the quality of higher education; deregulation ofhigher education and a shift to a largely demand-based funding systemfor colleges and universities.

Higher education system in the country has, of course, come along way: the number of university level institutions has increasedfrom 18 in 1947 to 307 by the end of 2004. The student enrolmenthas also grown impressively from 2,28,804 in 1947 to 94,63,821 in2002-03. Despite such an impressive growth that is rated to be thesecond largest after the US, it hardly covers 7 percent of the populationwhich is lower than even that of developing countries such as Indonesia(11 percent), Brazil (12 percent), and Thailand (19 percent).

Physical infrastructure aside, there is nothing much to gloat overquality. According to Ramamurti committee report (1990): “Academicactivities (of universities) are at a low ebb and the academic calendar


itself gets seriously disrupted almost every year. The system of highereducation continues to encourage memorization of facts andregurgitation rather than creativity…We cannot ignore the fact thatwe do not have many colleges today which can pride themselves ofimparting under graduate education of the higher quality, comparableto some of the well known institutions in the world.” The findings ofthe report, though old, are as valid today as they were when reported.

As though its not enough, the government, in its anxiety to curtailfiscal deficit had drastically reduced financial outlay per student fromRs.7676/- at 93-94 price levels to Rs.5873/- in 2001-02 (budget estimates).That aside, we are continuing with the system of affiliation that wasstarted in 1857. Indeed, today it has become more complex because ofaffiliating an infinite number of colleges to a single university. As aresult, the already depleted financial resources are expended onadministration rather than on creating academic resources. Accordingto Andre Beteille, “Our universities are simply functioning as degreegiving institutions concentrating on conducting examinations ratherthan becoming a system that transmits, generates and interpretsknowledge.”

Against this backdrop, a need has arisen for encouraging privateparticipation in higher education – for reasons galore. One, creationof better infrastructure for quality higher education is a must forsustaining our current levels of economic growth. Two, World Bankin its report of 1994 observed that institutes of higher learning equipindividuals with advanced knowledge and skills to dischargeresponsibility in government, business and professions; produces newknowledge through research and serve as conduit for the transfer,adaptation and dissemination of knowledge generated elsewhere. But,the Government is no longer in the mood of investing in highereducation, for the ministry of finance opines that higher educationbenefits individuals more than the society. This is further corroborated


by the Birla Ambani report submitted to the Prime Minister suggestingthat government subsidies to higher education should be minimaland the funds thus saved should be invested in expanding facilities atthe primary and secondary stages of education. Three, according tothe census of 2001, the overall literacy rate in the country has goneup by 10 percent during the last 10 years. It is therefore possible thataround 8 to 10 percent of this freshly educated lot would seekadmission at college level in the next 8 to 10 years. As against thecurrent capacity of 8 million college seats created in the last 150years, we would be required to create an additional capacity of 8 to 10million college seats in the coming 8 to 10 years. Obviously, this is agigantic task that cannot be addressed by the government alone, norcan it ignore the surging demand for it.

Globalization is changing the structure of higher educationradically by moving the services across the boundaries, instead of thepeople moving across the borders as witnessed earlier. Such migrationof education to new locations in search of clients is necessitatinginstitutions of higher education in India to reorganize themselves towithstand the competition. In the light of these facts, investmentsfrom private bodies must be encouraged to freely flow into highereducation. Certain sections of academia however, harbor anapprehension that private universities may give a go by to quality.This argument sounds hollow since no institute can survive for longon poor quality product and education is no exception to this universaltruth. For that matter, no one can afford to ignore the contributionof private institutes such as NIIT, APTECH, and various other privatecomputer training institutes that have made India what it is today inthe field of IT. It is only by serving their intended cause throughquality programmes that institutes like Manipal Academy, ICFAI,Symbiosis etc. could survive thus far.


Even otherwise, the state can and should always ensure that theprivate universities once established, comply with the basic qualitystandards prescribed. All that is required to ensure the quality acrossthe board is to have a national level overseeing body that is teethedwith powers to grant permission to establish a university and also toderecognize an already established university if it fails to maintainthe prescribed standards. That aside, as the private universities, whichare to survive purely on fee income have to necessarily re-equipthemselves with newer programs from time to time, real academicautonomy becomes an essential prerequisite. For that matterirrespective of ownership, universities must not be strangled byexcessive bureaucracy, if education is to be bettered.

Private universities are to recover their cost by charging fee fromstudents proportionate to their expenses. Hence, such fee structuremay not always be within the reach of the common man. A need thusarises to fund such candidates. It is to be noted here that if Harvardor Stanford or MIT is being fed by a continuous stream of studentsand if these institutions are able to maintain such reputation forexcellence in education, it is only because there is an institutionalizedsupport available to the students to borrow money, pursue studiesand pay it back from their future earnings with no hassles attached.Although, the Indian banking system grants loans for highereducation, it is not as formalized, institutionalized and simplified asin the US. There is a need to urgently streamline and make loaningsystem student-friendly.

Aside of these conflicting demands, one thing is certain: all possiblethrust must be given to higher education for maintaining the currentgrowth-momentum.

——)0——


It’s not a year or two, five or ten; it is eighteen and a half long years, after which Alan Greenspan is going to retire from the Federal

Reserve as its Chairman. He has been showered with accolades fromacross the globe. He has been acclaimed as the “the greatest centralbanker who ever lived.” There are of course enough reasons foreveryone to praise his performance at Fed, for its impact is oftenfound influencing the rest of the global economy too. Secondly, hishandling of Fed policies has not only provided impetus to sustaingrowth in the US economy but also helped emerging economies suchas those of China, Russia, and India that were integrating themselvesinto global economies – either by design or by default.

Ever since he took over the reins of Fed from Paul Volcker, he haspursued the singular objective of ‘price stability’ and he did succeedin accomplishing it except for a blip or two in his long and eventfuljourney. He could also succeed in steering the American economy

February 2006.

SEVEN

End of green (span) years foreconomy?

Mr. Alan Greenspan – the most intently watchedcentral banker – has become the ‘missing variable’of economic predictions.

31End of green (span) years for economy?

through two major crises: the 1987 stock market crash that occurredimmediately after his taking over the reins of Fed and the bursting ofthe dotcom bubble in 2000-01. He provided a massive monetarystimulus for the strong growth of American economy for 10 years onthe trot. Fed maintained real interest rates negative for several yearsand even now real rates are notoriously low.

Inflation averaged at around 2.4% per year during Greenspan’sera as against 3.7% per year from the end of World War II to Volcker’stenure. This greater price stability can be described as his greatestcontribution to the economy, for it enabled enterprises to use theirresources more efficiently and steadily. This performance has obviouslymade Milton Friedman, the Nobel Laureate in Economics, say: “Thereis no other period of comparable length in which the Federal ReserveSystem has performed so well.” In accomplishing all this successGreenspan has not only demonstrated that it is possible for centralbanks to maintain stable prices but also set a standard for the othercentral banks around the world.

Every central banker is essentially judged for his performance byhow well he managed the value of the national currency and on thatscore, Mr. Greenspan did a better job than all his predecessors. Thefact that he did so by liberally supplying dollars to the world despitestrong criticism from a section of economists and the underlyingthreat of raising bubble in the stock market or real estate, is all themore remarkable. There is courage of conviction rather than a methodin madness of his pursuit of such monetary policies. Similarly, hishandling of financial markets deserves all praise. His tenure witnessedfewer bank failures despite two bouts of recession. His handling ofLTCM debacle in 1998, which was considered “potential enough toseize markets, inflict substantial damage on many market participantsincluding those not directly involved with the firm, impair the


economies of many nations, including that of the US”, is in itself atestimony to the understanding Mr. Greenspan had about the financialmarkets and his ability to manage financial crises with finesse.

Greenspan has shown to the world that central banks need todistrust any “ism” or rule. His innate ability not to get bogged downwith any particular economic ‘idea’ or ‘model’ but to quickly changethe gears whenever any performing model is found no longer working,has proved to be the bedrock of his success. For instance, in 2003,watching Japan sliding into deflation and stagnation, Greenspanmaintained US interest rates at 1% for almost a year until the economypicked up momentum keeping the threat of deflation at bay.

Mr. Greenspan, as aptly proclaimed by himself in many of hisspeeches, is a “Bayesian” – a person willing to make decisions basednot on the most probable outcome but on a range of likely outcomes.In other words, he preferred to manage the bigger risk, while lettingthe minor risks be taken care of by themselves. This trait alone enabledhim to do everything in his power to avoid a recession. In the processhe might have “inflated one asset price bubble (equities, housing,bonds) after another.” But he had clarity of his own about whateverhe did, as reflected in one of his statements, of course, made in adifferent context: “We do not have the choice of accepting the benefitsof the current system without costs.”

Greenspan left behind another amazing intellectual tool for thefuture central bankers to use: a method of enquiring for the “missingvariable” – the driving force behind the current market behaviour –that was not captured into the already known economic models.Whenever the behaviour of economy defied the existingunderstanding, he relentlessly searched for that “unidentified factor”to unearth the root cause so that he could effectively manage it. Inthe late ’90s he undertook one such search for a reason that can

33End of green (span) years for economy?

explain how both unemployment and inflation were together fallingas against the known norm of falling unemployment resulting in araise in wages leading to higher inflation. His passion for searchingfor new ‘understanding’ and ability to think unconventionally acrossthe boundaries can be traced to what he said in one of his late ’90spresentations: A missing variable is not an “observable phenomenon,but neither was the planet Pluto before 1930”. He went on to say“scientists figured out that there had to be something there, giventhe extent to which Uranus and Saturn were deviating from theirforecast orbits”. Having said that, he launched a massive researcheffort and finally his staff could come up with an explanation that itwas the information technology that had triggered a once-in-a-generation acceleration in productivity.

His understanding of the market mechanics is amazingly displayedin his statement: It is “noted that robust competition – includingfrom foreign producers… (which is) helping to contain cost andprime pressures”. This statement, though sounds bland at first sight,is pregnant with deep insights. The passionate enquiry that heundertook in 2003 to understand how high US trade deficits, whichare to be necessarily financed by external borrowings, could keepgoing without asserting any upward pressure on US interest ratesand downward pressure on the dollar, enabled him to conclude thatit is the indifference of the investors towards sovereign boundarieswhile deciding where to invest their money that has kept Americandeficits getting bridged with least turmoil. He could thus spot that itis the ‘globalization’ which has kept inflation and wage growth undercheck despite the rising employment rate and growth rate.

All these accomplishments lead to the question: Are Mr. Greenspanand the assorted strategies that he has used in managing the USmonetary affairs unquestionable? The answer is perhaps a certain“no”, for he left behind a record trade deficit, vanishing household


savings, raising real estate bubble, etc. His reputation in posterity,however, squarely rests on how these imbalances would be resolved.There is also a strong criticism of his indifference to arrest theemergence of bubbles in the economy – be it in the bond market,stock market or real estate. In his singular pursuit of arresting deflationand keep the economy on growth path, Mr. Greenspan perhaps becameindifferent to the bubbles, maybe overdriven by his belief that marketswill unwind these imbalances on their own but with a big ‘if’ – ofthere being no policy blunder.

True, the central banks of many Asian countries have so farexhibited enthusiasm in financing American deficits – maybe in theirown interest of holding their currencies from appreciating. But thereis a limit to such accumulation of dollars by these countries: Chinahas expressed its desire to spread its reserves across currencies tooptimize risk and return. Once they decide to diversify their reserves,the dollar is sure to fall. Should this happen, bond yields willautomatically rise as investors would demand higher compensationagainst the risk. Along with it if the real estate bubble bursts, consumerspending in the US will dry up. This automatically results in theeconomic slowdown. The obvious next question is: Will the Americaneconomy’s hard landing slow down the rest of the world economy?There is of course good news: the economies of Japan and Germanyare showing signs of ‘pick-up’ which may avert the crisis. Nevertheless,time alone will reveal the impact of what Greenspan left behind onworld economy.

In any case, as Greg Mankiw, the economist from HarvardUniversity, said “luck plays a large role in how history judges centralbankers.”

——)0——

35Must learn fast, and act faster

Thomas Friedman, ace columnist of The New York Times, in hisrecent bestseller, The World is Flat: A Great History of the 21st

Century, concluded that the “global web-enabled platform for multipleforms of sharing knowledge and work, irrespective of time, distance,and geography” has simply made the world flat. More than this, hemade a startling revelation in his address to the 12th annualconference of The Indus Entrepreneurs : American moms better telltheir children to do their homework; else, there are millions of Indianand Chinese kids waiting in the wings to take their jobs. Of course,to smoothen the ruffled feathers of the anxious listeners, he also saidthat “kids need to learn how to learn and learn fast!”

Apart from American moms, the Indian fiscal managers also needto pay heed to Friedman’s advice: Learn to learn fiscal managementfast and pool up gumption to act upon it. We all know that when thetotal expenditure of the government exceeds its total revenues, acountry ends up in fiscal deficit. In such situations, the governmenthas to compulsorily borrow from the market to bridge the gap between

June 2005.

EIGHT

Must learn fast, and act faster

IT has made the globe look not only flat but alsoideas to freely slide from one end to the other and it isonly the agile that can reach destiny without falling.


expenditure and revenues. Such borrowings from domestic marketsresult in ‘internal debt’ and, on the other hand, if borrowed fromexternal sources, increases external debt. Economists use the debt-to-the-GDP ratio as the key indicator of a sovereign’s solvency. It isoften the government’s fear that if the debt-to-the-GDP ratio is veryhigh, lenders may doubt the government’s ability to service debt andthereby shy away from investing in the government paper. Now thequestion is, what is the debt-to-the-GDP ratio that can be consideredhigh and hence to be corrected with no further loss of time.

The debt-to-the-GDP ratio, being only one of the indicators of thegovernment’s ability to repay loans, there is no single number that canbe quoted as an anchor. It is how one uses the other macroeconomicfundamentals and the inferences drawn therefrom that define the likelycrisis resulting from rising fiscal deficit. To have a better appreciationof this significant issue, let us first look at ‘internal debt’ and ‘externaldebt’ separately. If fiscal deficit is financed by external debt and if thecountry has no capital account convertibility, it is the exportperformance, management of real exchange rate, quantum of forexreserves and the maturity pattern of the debt that defines an impendingcrisis. As is currently being witnessed, as long as our export base isgrowing, we are more likely to have enough foreign exchange to servicedebt. Similarly, as long as the Reserve Bank does not allow the Rupeeto overvalue in real terms, there is no danger of Indian exports becomingless competitive in the global arena, and thus, there would be no threatto widening the export base; and as long as exports grow significantly,the country can be assured of foreign exchange earnings that can beused for servicing foreign debt. Secondly, when a country holdssubstantial foreign exchange reserves vis-à-vis its short-term debts, thereis no fear of credit risk of the lenders. Lastly, when the debt is essentiallyof a long-term nature, the overall risk for the flight of capital is minimal.Today, we are enjoying a firm ground on all these parameters and thus

37Must learn fast, and act faster

need not get scared by the theoretical threat under the high debt-to-the-GDP ratio as the risk of external payment crisis is pretty low.

On the other hand, if the fiscal deficit is to be financed internally,the government sells securities to the investing public with a promiseto pay a certain fixed interest on them. Most of such securities areusually bought in our country by banks and financial institutions.Banks are known to mop up small deposits from various savers acrossthe country and use them for investing partly in government securitiesand partly for lending to investors to earn interest in excess of whatthey pay to their depositors and stay liquid. However, as the debt-to-the-GDP ratio rises, investors in government securities may doubt thegovernment’s ability to pay the promised interest and retire the debtthrough ever increasing fiscal deficits. Once banks and financialinstitutes anticipate such a scope for default, they may withhold furtherinvestments in government paper. At such a turn of events, the onlyalternative for the government would be to mandate the banks to investtheir funds in government securities. However, that is fraught withrisk: The common depositors of the banks, fearing that banks are holdingworthless securities, may withdraw their deposits, forcing a bankingcrisis. In the event of such a crisis, the sovereign ratings will bedowngraded, leading to the exit of foreign investors. And as these peoplerush to the market to offload their investments and flee the country,the rupee may depreciate, precipitating the real crisis. However, herethe question is: Are we in such a predicament?

We must realize that today we are in a very strong position: Ourforeign exchange reserves stand at US$142 bn; our interest rates arecomparable to the rest of the world; the banking system is comfortablewith liquidity, and the economy is enjoying a stable growth rate ofabove 6% for the last couple of years.

It is time we learnt to free ourselves from the phobia of fiscaldeficit and built up courage to make use of debt financing — both


external and internal, to build essential infrastructure that takes careof generating additional resources to service future debt paymentobligations. As a first step in this direction, we may encourage FIIparticipation in the debt market by relaxing the existing restrictions.Such FII participation improves the depth and width, particularly ofthe bond market. Such a vibrant debt market enables midcap companiesand those companies that are sub-investment grade to mobilize capitalfor expansion, diversification or upgradation. The Indian debt marketcertainly needs a diversified investor base to improve its maturity level.

Today, FIIs are mere fringe players in the debt market. Evenotherwise, the average trading volume in the debt market hovers aroundRs.3,000 cr, and thus it is not a big deal for the market players toabsorb the FII outflows. In most of the developed markets, debt marketsare quite larger than equity markets, whereas our debt markets are stillsmaller than the equity markets. We should therefore allow foreigninstitutional investors to invest both in sovereign and corporate bonds,of course, with a caveat that they could invest only in securities havinga residual maturity of more than three years. Such participation willcertainly make markets more liquid, resulting in dependable pricediscovery while reducing borrowing costs in the medium term. If we,under the fear of rising fiscal deficit, do not learn the technique ofusing debt funds for creating world-class assets, the global capital maybypass us, as there are many other countries who are willing to welcomethem to augment their own production base. Time is now ripe for us toborrow from the global financial markets, of course, with built-inprudential protections, and use it for creating new assets.

Thomas Friedman is right. The world is getting flat, and unlesswe wake up to this momentous development and learn to mustercourage to explore every available means to raise capital and buildthe necessary competency to thrive in the global competition, we willsimply miss out on the tremendous upcoming opportunities.

——)0——

39A true zentrepreneur!

The recent ruling of the Insurance Regulatory and DevelopmentAuthority on the acquisition of Max India shares by Parkville

Holding and Ensley, two Mauritius-based entities, reminds us of whatCharles Darwin said in The Origin of Species: “If under changingconditions of life, organic beings present individual differences inalmost every part of their structure … causing an infinite diversity instructure, constitution and habits to be advantageous to them …. Ifvariations useful to any organic being ever do occur, assuredlyindividuals thus characterized will have the best chance of beingpreserved in the struggle for life…. This principle of preservation, orthe survival of the fittest, I have called Natural Selection.” His theoryof Natural Selection perhaps rests on the living beings’ power of“better adaptation in however slight a degree to the surroundingphysical conditions.”

Organizations being in no way different from man, the philosophyof “survival of the most adaptable” holds good for the survival ofcompanies too. Indeed, that is what reflects in the ruling of IRDA:

May 2005.

NINE

A true zentrepreneur!

Evolution is a means to overcome limitations, andentrepreneurs have to evolve to break the barriers tobetter the society.


Foreign equity held by entities other than foreign partners in aninsurance joint venture will not be counted while calculating the foreigninvestment cap of 26%. Theoretically, this could mean that thecumulative foreign holding in an insurance joint venture can nowcross even 50%, while of course the management control remains inIndian hands. This ruling has far-reaching consequences. It helps privateinsurance companies infuse additional capital into their companies; iteases the pressure on Indian promoters for capital infusion from theirown sources and allows Non-Resident Indians, overseas commercialbanks, etc., to invest in Indian insurance companies.

To better understand the spirit of ‘adaptability’ exhibited by IRDAto the emerging needs of the insurance industry, we need to take apeep into what the economic theory says about insurance and itsgrowth. Economists of different hues say that insurance plays acomplementary role in the production of goods and services byeliminating uncertainties that are otherwise associated with everybusiness activity. It plays a “stabilizing” role in trade and commerceby transferring the risk from one person to a group and by sharing oflosses on some equitable basis by all members of the group. Insurance,thus, makes many contribute to the losses of the unfortunate few inan organized fashion and in the process, everyone in the group isprovided with freedom from the burden of “uncertainty” embeddedin businesses. The insurance industry helps in the economic growthof a country in many ways. It promotes financial stability and reducesanxiety; it acts as a lubricant for trade and commerce; it enablesentrepreneurs to undertake such businesses as would not have beentaken up for the risks associated with them but for the availability ofinsurance; it mobilizes national household savings in a big way; itenhances financial intermediation and due to the long-term natureof liabilities, life insurance companies and pension funds could benatural investors in medium and long-term infrastructure projects.


Prudent investment by insurers fosters a most efficient allocation ofcountries’ capital. The significance of the insurance industry as astimulant of our economic growth can be gauged from the fact thatfor the financial year 2002-03 its investments in industry andinfrastructure stood at Rs.2,91,418.36 cr, which is 11.89% of theGDP. A sound and vibrant insurance industry is thus a must for theeconomic growth of a country in terms of employment generation,improvement in the standards of living and growth in investment inindustry and infrastructure.

Against this backdrop, insurance penetration in India is still at anabysmal low when compared with even some of the developing countries.Insurance premium as a percentage of our GDP in 2001 stood at 2.71as against 5.18, 17.97, 4.23 of Malaysia, South Africa and Chilerespectively. As against this, the Indian economy has been among thefastest growing economies of the world for well over a decade. Backedby such growth prospects, life premium in India is expected to grow atan annual rate of about 18 to 20% and the pensions at a rate of about 20to 30% up to the year 2009-10. Similarly, the growth prospect in thenon-life sector is reported to be quite rosy: estimated to grow fromRs.83.78 bn as of 1998-99 to Rs.386.3 bn by 2004-10.

There is, thus, a huge untapped potential in the Indian insurancemarket which needs to be harvested for the growth in the economy.Driven by these growth prospects, we opened our insurance marketto foreign participation in the late 1990s under the overall supervisionof the Insurance Regulatory and Development Authority, as the marketregulator. As a result, many new private companies have entered themarket, mostly as joint ventures with foreign collaboration. But,industry reports indicate that no new entrant into insurance businesshas so far succeeded in creating new insurance business except foreating into the existing market share of LIC or other public sectorundertakings. There is, thus, a need for penetration of insurance


business into newer markets, which calls for more players andadditional investments even from the existing players.

The need for additional capital arises on two counts: One, tocomply with the regulatory requirements under maintenance of“solvency margins” and two, it takes a minimum of five years for newinsurance companies to stabilize and break even and hence requiretheir own capital to service claims in between. But, the Indian partnersin joint ventures have been unable to bring in additional capital.Domestic investors may not be attracted to commit their funds toinsurance business, for it takes a long time to pay dividends. Thispredicament was well captured by the Finance Minister in his lastproposition for increasing FDI from the present 26 to 49%. FDI“has the potential to add a competitive edge” and “there is an urgentneed for infusing huge amounts of capital” into insurance business.

The move is of course opposed by some sections on two counts.One, it is believed that strategic sectors should not be in the controlof foreigners, and two, the possible “insensitivity” of MNCs to localneeds as they will be purely driven by profits. But, in today’s “globalizedeconomy”, it is not profitable for states to determine “who can dowhat and to whom”, instead, they should stay focused on monitoringthe businesses and ensure that they are carried out as per the templateprescribed. Having already opened the insurance sector to foreignparticipation, we stand exposed to no new sovereign risks merely byincreasing the cap from the present 26 to 49%. Secondly, marketreports indicate that in many of the new insurance companies thathave come up in the recent past with foreign collaboration, themanagement is already in the hands of the foreign partnering companysince many of the domestic partners lack the domain knowledge tomanage such companies profitably. In view of this reality, no newthreat is likely to arise out of the proposed hike in the cap on FDI.


Insurance business is after all a known capital guzzler. Domesticsavings are proved to be insufficient to finance the capital requirementsof the growing sectors of the economy. Indeed, it is already being feltby the insurance industry that the present levels of capital investmentsare quite insufficient to underwrite new businesses. If there is noinfusion of fresh capital into the already existing insurance companies,many may not be in a position to undertake new business. Yet, theproposal for increasing FDI participation remains an impasse.

Well, maybe, the government is in a stalemate. But the IRDA, havingimmense faith in the positive force of a pliant attitude, which allows one toadapt to circumstances and to attend to those things that can becontrolled, paved the way for otherwise capital-starved Indian insurersto mobilize capital from overseas investors by giving a positive rulingof the Max India case. A true Zentrepreneur!

——)0——


Traditionally, developing countries are known to rely heavily onexport of commodities for income generation. One study

estimates that primary commodities account for 68% of exports oflow-income developing countries while it is 44% in the case of high-income developing countries. Such dependency on a fewcommodities obviously exposes the traders and producers tocommodity price uncertainties. For instance, a trader who purchasedtobacco or coffee from local farmers with an intention to exportfaces enormous risk if the international prices collapse before hesells his stock of tobacco/coffee. In the absence of any protectionfrom the risk of fall in price, the traders work for large margins tokeep themselves secure. In other words, the price-risk is ultimatelytransferred to the original producer i.e. tobacco/coffee farmer.Uncertainty in commodity prices also affects the debt servicingcapacity of the traders as well as producer-farmers. This indirectly

TEN

Commodity price uncertainties:Role of derivatives

Market liberalization process has only weakenedtraditional commodity price stabilization measuresthat governments hitherto practiced exposing farmersto a greater price-risk.

May 2005.

45Commodity price uncertainties: Role of derivatives

makes the cost of their debt prohibitively high. Even the availabilityof credit may at times become difficult, particularly for farmers.

Theoretical analysis suggests that commodity prices will fall relativeto others because of the relatively inelastic demand. Thus, the realincome of the commodity producers falls because inelastic demandprevents them from offsetting price movements with volume changes.The prime reason for extra volatility in commodity prices is thepresence of natural shocks that are not predictable and mostly relateto the previous year’s production or consumption-decisions. A shock-producing reduction in supply will lead to a sharp increase in pricefollowed by a slow or rapid reduction, depending on the nature of thecommodity. Commodity price cycles are mostly of flat bottoms withoccasional sharp peaks.

There are four types of price problems: short-term fluctuations –common among the agriculture products, either within a year due toseasonal variations or from year to year because of normal weathervariations; medium-term changes – as seen often in oil or other mineralmarkets, responding to multi-year business cycles in the worldeconomy; permanent changes affecting one or a few countries – owingto technological changes or discovery of new technology which alterscompetitiveness; and long-term declining commodity prices. Normally,the behavior of commodity prices will be shorter periods of rises thanfalls and this asymmetric behavior tends to impose costs on any schememeant for balancing price fluctuations.

All this cumulatively exposes producers to the dual problem oflower returns and higher risks. Although commodity-price-riskproblems are common to both developed and developing countries,they are more serious in developing countries, since the extent oftheir dependence on commodity exports is critically high. Secondly,their specialization may remain restricted to one or a few commodities


and thus commodity price variations affect a much higher proportionof the developing countries’ economies. Thirdly, the share ofdeveloping countries in the world commodity markets often beingsmall, they stand additionally exposed to the risk of decisions of othercountries. Thus, commodity price risk is likely to raise the real capitalintensity of commodity production above the direct production cost.This adds extra burden to the already poor, particularly those engagedin production of agricultural commodities, where the producers arepoor even relative to the individual country’s average income.

The increased openness of countries, creation of global commoditymarkets, improved communications facilitating immediate knowledgeof competing prices across the globe and the resulting increased marketefficiency have only added further agony to the people exposed tocommodity price uncertainties. The impact of commodity pricechanges is thus greater in countries that are more than averagelydependent on commodity exports. Similarly, imports such as food,oil and gas of developing countries are known to be adversely impactedby global commodity price movement.

Developing countries are hitherto known to manage commodityprice risks essentially in three ways. One, governments implementdomestic and international price stabilization schemes; two, reservemanagement; and three, contingent finance. Domestic pricestabilization scheme involves purchase of commodities and creation ofbuffer stock when commodity prices fall below a certain pre-determinedprice and selling it when the prices recover. Some countries like Indiaare known to prescribe minimum support prices for various commoditiesproduced by farmers to protect them from the falling prices and therebyenable them to recover at least their cost of production.

It is, of course, a different matter that such practices have onlyincreased the need for a huge budget provision. Some other countries

47Commodity price uncertainties: Role of derivatives

maintain a ‘stabilization fund’ with an objective to compensateproducers when prices fall and accumulate reserves when pricesincrease. However, large commodity stabilization schemes are knownto demand large capital outlay. Secondly, they are often found to beineffective, during the periods of crisis. Thirdly, most of such schemesare found to be used more for achieving social objectives than forprice-stabilization. The net result is huge corruption and mis-management of the scarce capital. In view of these facts, and as asequel to the ongoing liberalization process, the governments areslowly withdrawing from commodity markets.

The slow withdrawal of government from market stabilizationactivities resulted in a search for new alternatives and thus enteredderivatives into commodity markets. Commodity derivative instrumentsaim at making commodity prices and/or revenues more predictablerather than stabilizing prices or revenues. They simply remove priceuncertainty for commercial transactions and thereby reduceuncertainty in revenues. They reduce the uncertainty regarding futurerevenues by enabling producers to lock in a price. Trading in derivativeinstruments exposes traders to market prices and to market expectationsof future prices. Dependence on market prices automatically allocatesthe resources to those sectors where market prices are likely to bemore favorable. Trading in commodity derivatives can also result intransfer of risk from domestic markets to global markets. Trading incommodity derivatives increases the creditworthiness of a borrowerby insuring his revenues from future price fluctuations.

India, being no exception to these global changes, initiated stepsin 2003 to create a market for commodity derivatives trading bywithdrawing all the existing restrictions on forward trading incommodities. Today, there are four national level commodityexchanges offering online futures trading facilities in agriculturalcommodities. They have also established terminals across the


country to create a national market for commodity derivatives.Despite the hype, trading volumes have not yet picked up andwhatever trading currently going on is mostly confined to traders. Torealize the full benefits of the market for price stabilization there isa need to encourage farmers to avail these facilities.

Farmers, at least, large farmers having commercial farms, can usederivatives – such as forwards and futures – to eliminate price uncertaintyby lock-in into a price for a future date delivery of agricultural produce,well before even sowing the crop. Such secured prices enable them tomake appropriate decisions about allocation of resources i.e. whichcrop to sow, how much to sow, etc. Similarly, exporters and importersalso can use derivative instruments for removing price uncertaintyassociated with their export/import transactions.

Compared with government-sponsored price stabilizationprograms, management of price risk through commodity derivativesmarket is considered to be less expensive to manage and operate; isconsistent with WTO directions; can provide producers with benefitscomparable to traditional program, and is market neutral, sincepremiums are determined by markets.

But the million dollar question is how to make derivatives tradingaccessible to Indian farmers. And a still bigger question is: How toeducate farmers to use commodity derivatives? Perhaps, that is onwhat government has to work through its extension wings, besidesmaking derivatives trading more user-friendly by legalizing warehousereceipts as negotiable instruments, duly accompanied by constructionof adequate warehousing capacity in the countryside.

——)0——

49100% FDI in real estate: Is it enough?

Common sense shows that the construction sector has a positivecorrelation with employment creation and income generation.

One estimate says that a 10% rise in construction project expenditureis likely to increase GDP by 3%. Such an increase in GDP has enoughpotential to create around 1.5 million jobs. Perhaps, driven by thisphilosophy, the cabinet committee on economic affairs has recentlycleared 100% FDI in all forms of housing, commercial premises,hotels, resorts, hospitals, educational institutions, recreationalfacilities, etc. It has also set pretty liberal norms for such participation:Minimum area to be developed under each project is 25 acres; aminimum built-up area is 50,000 sq. metres; minimum capitalinvestment for wholly-owned subsidiaries is $10 mn; capital investmentfor joint ventures is a minimum of $5 mn, and the “lock-in” period oforiginal investment is 3 years. To avoid speculative trading, thecommittee has of course barred sale of undeveloped land. The currentmove is expected to have a multiplier effect not only on employmentcreation, but also on building techniques and technology. It will also

April 2005.

ELEVEN

100% FDI in real estate:Is it enough?

Real estate is no longer made but can only be usedsensibly for bettering the lives.


have tremendous ripple effects on ancillary industries of construction.The net result: Market hype.

However, Niranjan Hiranandani, Managing Director ofHiranandani Constructions Ltd., a noted real estate tycoon fromMumbai, has something different to say, “100% FDI without scrappingthe Urban Land Ceiling and Regulation Act is like giving a half-blindman a pair of glasses without the frame.” True! If the current move hasto yield the desired result, the clearance must be supplemented by quitea few reforms in stamp duties, land records, land acquisition procedures,etc. More than anything else, the construction business must first befreed from the mafia. Simultaneously, the local urban developmentalauthorities have to reorient themselves in offering basic municipalfacilities to builders so that foreign investors do not end up constructingstate-of-the-art buildings with no takers.

Constraints aside, the current move will surely pave the way forintegration of our real estate business with that of the global marketwhere property commoditization is proceeding rapidly. This is likelyto bring in a new breed of players into our markets: Real estatesyndicates; real estate investment trusts, etc., who are said to be veryactive in western markets. Real estate syndication has become themeans to channel private savings into real estate investment in thewestern corporate world, particularly for financing purchase and saleof properties of high-end value. Syndication is nothing but a comingtogether of investors who pool capital for investment in real estate. Atypical syndication involves three phases: i) Origination—that consistsof planning for and acquiring property, getting it properly registered,etc.; ii) Operation—managing the syndicate as well as the propertyacquired; and iii) Liquidation—resale of the property. Syndication,besides offering professional management which is crucial for success,allows small-scale investors to own and operate a property that is farbeyond the reach of any single investor.

51100% FDI in real estate: Is it enough?

Real Estate Investment Trusts act as conduit for investingshareholder funds in real estate. The trusts make up a large amountby pooling funds from investors to invest in buying or constructingbuildings, developing real estate projects, etc., and then collect rentsfor distribution among shareholders. REITs are of three types: RealEstate Equity Trust, Real Estate Mortgage Trust and a combinationof these two. Equity trusts essentially own properties of a residential,commercial or an industrial nature and their main source of incomeis rent. They are prohibited by law from holding any property primarilyfor sale to customers and are entitled to claim depreciation. The equitytrust ultimately distributes a great chunk of its revenue on the propertyto shareholders. Mortgage trusts essentially invest in short-term andlong-term mortgages on real estates. They earn income by way ofinterest on mortgages and the same is distributed among shareholders.

The current move may even prompt domestic mutual funds tofloat real-estate related schemes for pooling capital from domesticinvestors and participate actively in the real estate business as a measureto fight inflation. Whether our mutual funds float real estate-linkedschemes or not, one thing is certain: the present move is bound tomake the market more sophisticated, with diverse market players andincreased transactions. As the domestic real estate market integrateswith global markets, the spectrum of risk associated with theconstruction business will simply widen, calling for critical analysis,constant measuring, monitoring and management.

As risks multiply, real estate valuers must assume the role of spectrumanalyzers. They must build up necessary acumen to analyze propertyrights, legal and regulatory frameworks, and value the propertytransparently, taking into account the value cycles of the market. Theymust build transnational networks to educate themselves about the marketbehaviour, both during booms and busts, and use the information tominimize similar future market shocks. It is also to be borne in mind thatthe fundamental starting-point for real estate risk analysis is the


independence of valuers. As real estate is becoming more and more acommodity, like gold futures or corporate bonds, the importance ofindependent, ethical and well-educated real estate valuers is increasing.

True, it is difficult to estimate the present value of a real estateproject as it essentially rests on projected rents, discount rates, anticipatedinflation, loss in value due to depreciation and vacancies due to thedevelopment of competing projects, etc. Moreover, data on buildingpermits, new construction contracts, rents, market prices and vacancyrates is often not readily available, and if available, is difficult to verify.This results in banks underestimating the risk of their heavy exposureto the real estate sector. This risk gets accentuated by the fact that BaselII proposed a higher capital adequacy ratio for high volatility commercialreal estate loans, which Indian banks that are currently active in homeloans market must keep in mind.

Once the primary market is well established, the secondary market inhousing loans, which is currently dormant in India, is likely to take off.There are of course certain essentials such as right legal, tax and regulatoryframework; robust primary market; a capital market that has the appetitefor mortgage-backed security bonds, and economic incentive to securitizehome loans that must be in place for the secondary market to take off.

As securitization picks up, the need for evaluating singletransactions loses significance, while it becomes essential for evaluatinga pool of loans. In other words, real estate valuers must move awayfrom being information gatherers to becoming information arbiters.This obviously calls for a new set of skills, and this in turn calls fornew market rating systems. To cater to these emerging needs, wemust nurture a team of professionals that includes accountants,brokers, engineers, lawyers and government regulators. In short, thevaluation profession must become an army of full spectrum analyzersof real estate-related risk, else the current move may remain as onemore attempt aimed merely at giving a boost to the construction sector.

——)0——

53Can India stitch its textile industry in time?

“Hoo… Hoo… Hoo… Amma! Cover me at least with your pallu!” said the half-naked boy shivering in biting cold.

“Beta! It’s pretty worn out! Can it provide warmth to you?” saidthe mother in a “poverty-laden” tone.

“Amma, isn’t it my Baba who weaves bedsheets and sarees? Howcome we don’t have any of them for our use?”

“Beta, we weave them for wages! We should have money to buythem.”

“Won’t we get money if Baba weaves clothes? Why doesn’t heweave them?”

“For want of buyers, bales and bales of cloth remain unsold. Whatis the gain in weaving more?”

March 2005.

TWELVE

Can India stitch its textileindustry in time?

Economics is all-pervasive, and yet someonesomewhere has to make a beginning to give it a desireddirection.


“Amma, are people so overstuffed with clothes that they havestopped buying? And we don’t have anything?”

“It’s not because of overstuffing but because there is no moneythat people are not buying clothes.”

“Without work nobody gets money, right?”

“Yes”

“With no money, no one can buy clothes, right?”

“Yes”

“When nobody buys, they remain stocked, right?”

“Yes”

“So long as they remain unsold, no new jobs, right?”

“Yes”

“No work means no money; no money means no buying of clothes;no buying of clothes means no work. No work means?”

“Time to be wise…”

“Amma! Hoo… Hoo… it is pretty cold down here…”

That is a touching Telugu story of Bollimuntha Sivaramakrishnawritten some four decades back, which still haunts every reader.

More haunting is the current state of our textile industry. Theworld textile trade was estimated at US $395 bn at the end of 2003, ofwhich textiles had a share of $169 bn as against $226 bn worth ofclothing business. The same is estimated to increase to $856 bn bythe year 2010. With the WTO-mandated lifting of quota restrictions


on textile exports of developing countries, more and biggeropportunities are likely to be thrown open. How prepared are we totake advantage of these global opportunities that are certain to emergepost-MFA scenario of global textile trade, is the big question thatsends a chill down the spine.

To get a fair answer, let us begin at the beginning. Our textileindustry is estimated to be worth $37 bn, of which exports are worthabout $13 bn. During the period 1990 to 2004, we could hardlyincrease our share in the textile and clothing export market from 2%to 4% and 1.66% to 8% respectively, as against 7% to 16% and 4% to23% respectively that China could accomplish.

It is true that we have been working on improving our industrybut certainly not with the requisite amount of speed. It is surprisinghow the textiles industry that was the key constituent of post-independent India’s industrial revolution could fall into such atechnological rut and remain indifferent to the “scale of economies”for this long.

Today, it is believed that we could be outsmarted by rivals such asChina and Bangladesh since we haven’t made the requisiteinvestments to catch up with the likely growth of 3% to 15% in ourshare of global export market by 2010. It is reported that an investmentof hardly $3 bn has been made in the textile industry despite variousrelaxations from the government: Incentives through TUF(Technology Upgradation Fund); cut in customs duties for importedmachinery; rationalization of domestic duties; dereservation of wovengarments; permitting 100% FDI (Foreign Direct Investment) throughthe automatic route, etc. This poor investment, when looked againstthe current trend of global buyers who want fewer clients and biggersuppliers, that too, from fewer locations, is certain to prove disastroustomorrow. We have simply failed to invest in creating “scales”.


The mistake may sound more fatal if we realize that our competitorshave been relentlessly expanding their capacities during the last 10years. China is reported to have invested around $30 bn during2000-04 in its textile industry. It is also reported to have establishedaround 150 professional colleges and 120 research institutionsexclusively for the apparel industry to make its textile workers moreefficient so that they could encash the market opportunities likely tobe thrown open post-MFA scenario. Even countries like Pakistan arereported to have invested substantial sums in building and steppingup capacities in the textile industry.

As against these global trends, we, even today, have labour-intensive small companies that account for 90% of our fabric weavingsegment. Even in the garment sector, we have fewer than 20 companieswith sales of more than $50 mn with little or no scope for improvingtheir productivity owing to inflexible labour laws. But the benefits of“barrier-free trading” can be grabbed only by those who have investedin creating larger capacities with matching technical and managerialskills that are essential to attract big orders from global clients.

The message is: “scale” is the decider of long-term relations withclients like Wal-Mart and other US retail outlets. So, the Indianproducers must get their act together. We have every physical advantageto encash on these opportunities: Availability of inputs like cotton,yarn and low-cost, skilled labour. All that we need to cultivate todayis “agility” and “zeal” to compete in product development, quality,service, and most important, to be proactive and innovative. Thealready well-established companies with a brand reputation of theirown in the global markets such as Aravind, Raymonds, MaduraGarments have to substantially invest to expand their manufacturingcapacities, if required, even by inviting FDI. It also makes great senseto invite FDI even in the form of technology or import of capitalgoods to manufacture quality apparel. It is equally essential to sensitize


the local designers with trends in global fashions so that our exportsremain constantly in tune with the global tastes. The export-orientedunits must even explore the scope to build diversity in their humanresources, particularly in their R&D wings, by hiring designers fromthose countries whose markets they want to capture, so that continuousinnovations in tune with the client country tastes can be captured intheir products.

It is time that the government and the industry joined hands increating global level scale of operations in the textile industry tocapitalize on the newer opportunities. During the transition, thestate should aim at creating “trampolines” across the country whichcan offer the cushion for all those who get laid off by the businessesor not getting employed. The state must also establish “communityvocational training centers” if not research institutes that Chinacreated, which can retrain those who lost their jobs and make themre-employable. These centers must design the curriculum and imparttraining in such a way that the citizens are helped to constantly re-equip themselves with new skills much before they become redundantin the job market.

Are there any takers for the government is not that hapless as themother of that half-naked shivering boy?

——)0——


Poor people face a variety of risks: labor market risk, health risk,earnings risk, etc. To enhance security for such poor people who

constitute around 36% of our population, we should reduce theirvulnerability to ill health and economic shocks. But their onlysignificant asset is their ‘labor’. So any attempt to improve their welfaremust first attempt to increase their employment opportunities andthe productivity of their ‘labor’. For a majority of population underthis category, even today agriculture is the main economic activity.As against this hard reality, the contribution of agriculture to GDP isdeclining from year to year, which currently stood at 26% of GDPwhile population growth is adding more numbers to the ‘unemployed’category in the country side.

It is a commonsensical knowledge that growth in employment isdirectly proportional to the ‘economic growth’. Today, globalizationis being advocated as the ultimate panacea for generating andsustaining increased ‘economic growth’. Though existing literaturesuggests that economic integration across borders enables every

THIRTEEN

Indian agriculture at crossroads

Post-WTO, Indian agriculture is likely to face gravechallenges and the State cannot afford to ignore itunder the illusion of an otherwise ‘shining’ India.

February 2005.

59Indian agriculture at crossroads

country to grow better than what it used to be earlier, it is doubtful ifit equally benefits all workers and businesses of a developing economysince they can lose out their markets to more efficient manufacturersof foreign origin competing with the local manufacturers, particularlyduring transition to modern technology. Such loss of markets for thedomestic businesses can result in further loss in employment andthereby hit the vulnerable sections of society more severely, resultingin major dislocations and loss of status. The worst sufferers will beurban poor and agricultural laborers, and marginal farmers, andwithin these two groups it is the latter who suffer most.

Over and above this, the four major elements of the World TradeAgreement namely – market access, domestic support, export subsidies,and trade related intellectual property rights under agriculture – posefurther threats of stiffer competition, greater uncertainties under thenew world order, and price fluctuations to Indian agriculture. This islikely to jolt the Indian farming community out of their ‘reverie’challenging them to adjust their operations to external stipulationsand adopt the new technological practices which enable them tomanage external threats and opportunities with minimal damage.The Government Procurement Agreement (GPA) which claims tooffer twin benefits – one, the benefit of transparency-driven competitionresulting in better value for money spent on government purchasesincluding agricultural commodities for public distribution and two,the scope for widening export markets for Indian agricultural productsas a result of purchases by governments of other member countries –is indeed likely to adversely impact the demand for agriculturalproducts within our market as developed countries are more likely toout-bid the domestic traders/agriculturists in the price war owing totheir technological superiority in agricultural production. The netresult could be falling employment opportunities and economic distressto all those who are dependent on agriculture, directly or indirectly.


These challenges demand that we rapidly modernize ouragricultural production and its marketing. And that is where the Stateenters the scene to undertake technological upgradation of agriculturalpractices, buildup institutional support for making capital availablein time at an affordable price, building rural infrastructure for freemovement of technical inputs and storage and marketing of outputand create ‘private-public partnerships’ in improving the overall ruralproductivity. In short, the State has a greater role to play in ‘securing’the livelihood for rural labor. But ironically, nothing substantial ishappening today under this head.

As a first step in this direction, the State should activate researchunder agriculture. There is, of course, a well-established network ofresearch laboratories across the country that are engaged in inventingnewer ways of farming for better results and, indeed, it is these verylaboratories that have once ushered in green revolution in the country.But, they appear to have lost their steam. What is therefore, urgentlyneeded is to make these institutes resilient once again, besides investingheavily in creating well equipped laboratories in the new fields ofscience – biotechnology, water management etc. The other importantinput that the State must make available to farmers is ‘capital’. Thebanking system is today more engaged in catering to the needs ofurban consumers than meeting the demand under farm loans. It isparadoxical that an urban consumer can today easily avail a loan forbuying a car at an interest rate of 7 to 8%, while a crop loan costsanywhere above 10% for a farmer. The need of the hour is low costfarm loans and insurance coverage for the agricultural produce.

That aside, it is everybody’s experience in India that many newinitiatives under agriculture launched by the government forimproving the economic lot of rural populace have often failedmiserably for obvious reasons. It is in this context that ‘ContractFarming’ popsup as the best alternative. It is essentially an agreement

61Indian agriculture at crossroads

between unequal parties: companies, government bodies or individualentrepreneurs on the one hand and economically weaker farmers onthe other. But it can contribute to both – increased income for farmersand higher profitability for sponsors. When efficiently organized andmanaged, contract farming is known to reduce the risk and theuncertainty for both the parties, as compared to buying and sellingof crops in the open market. It offers many advantages to farmers:sponsors often provide inputs and production services of high quality;access to timely credit through or from sponsors; sponsors often tendto introduce appropriate technology and also impart new skills tofarmers; farmer’s price risk is minimized as sponsors specify prices atthe time of entering into agreement; and access to reliable markets,which are, otherwise, out of reach of small farmers.

There is, of course, a flip side to contract farming. If the managementis not fair, it could lead to: increased risk, particularly, when growingnew crops, owing to both market failure and production problems;unsuitable technology and crop incompatibility; manipulation of quotasand quality specifications by the sponsor in such a way that all thecontracted for production is not purchased; domination of sponsorsowing to their monopolistic nature that can lead to exploitation,unreliability, and corruption; and indebtedness and over-reliance offarmers on advances because of production problems.

Contract farming, being a ‘win-win’ proposition, offers certainadvantages to the sponsors too. Although companies can have anumber of options to obtain raw materials for their processing andmarketing activities such as purchase from spot market or large-scaleestates, it is always advantageous to mobilize it from small and marginalfarmers, as it affords them greater political acceptability. Workingwith small farmers under contract farming enables them to overcomeland constraints and ensure production reliability and, to a greatextent, “shared risk” as production risks are totally faced by farmers.


At the same time, contract farming affords quality consistency asfarmers undertake cultivation of crops with the inputs provided bythe sponsors and that, too, under their technical guidance. It alsoenables the sponsors to market their own farm inputs.

Of course, there are also certain potential problems that sponsorsface: land availability constraints owing to legal lacunas resulting inlack of security of tenure and thus jeopardizing sustainable long-term operations; social and cultural constraints that come in the wayof farmers’ ability to produce in keeping with the expectations of thesponsors; farmers’ discontent resulting from the behavior of thesponsors’ employees in guiding them through the new technologiesand ensuring better returns from the investment; and farmersentertaining extra-contractual marketing for realizing better spotmarket prices or their diverting the inputs supplied by the sponsorsfrom the intended purposes can as well jeopardize their production/processing plans.

Ultimately, as in any other promotional activity, what matters undercontract farming too is integration of all the involved parties’ interestsfairly well. This can be achieved only when all the parties are awareof their interests and that’s what government agencies must facilitate,besides monitoring it.

It is time the government wake up to these challenges and draftedstrategies to secure the lives of the ‘less-endowed’ agricultural labourersand marginal farmers.

——)0——

63Flapping wings of a butterfly in China make the world sneeze?

After about nine years, China’s central bank has at last raised interest rates on one-year lending from 5.31% to 5.58%. It has

also hiked the interest rates on deposits by an amount equal to 27bps. Simultaneously, it has removed a host of lending restrictionsimposed earlier—particularly, the ceiling imposed on the interest ratesthat banks can charge on their loans. Intriguingly, this paltry raise of27 bps in interest rate has not only become global news, exciting thewhole clan of financial analysts the world over to churn out reams ofcomments on this grand move of China, but has also brought abouta sea-change in the very dynamics of global financial markets. Atleast, that is how the analysts are looking at China’s current movetowards market-determined interest rates.

The world’s reaction to this move is quite instantaneous. Aspectacular reaction was, however, noticed in oil prices which havedropped by almost $5 per barrel. The reason is simple: the present setof rate-hikes announced by the Chinese authorities is an indicator of

December 2004.

FOURTEEN

Flapping wings of a butterfly inChina make the world sneeze?

The globe has become small and truly round whereevery incident is impacting every other ‘happening’elsewhere.


their desire to cool the economy in an orderly fashion which in turnmeans a fall in demand for oil. The International Energy Agencyforecast the demand for oil from China to grow by 8,40,000 barrelsper day during the current year, which incidentally amounts to around35% of estimated growth in the global demand. At the same time, asAlan Greenspan stated, American economy entered a “soft patch”,which means a fall in demand for oil. With two of the world economygrowth engines thus heading to a soft patch and Japan’s economystill not coming out of its hibernation, the Organization of PetroleumExporting Countries and other oil-exporting countries are obviouslya worried lot. In the wake of these developments, any further rise inthe oil prices is certainly going to adversely affect the demand for oil.Perhaps these are good enough reasons for the market to greet theChinese central bank’s rate-hike announcement with a slide in theglobal oil prices.

This surprise move also ignited strong trading volumes in bondsand interest rate futures. Initially, the bond prices were reported tohave gone up by 15 bps. It is, of course, a different matter that thehike subsequently evened out. This paradoxical development of Asiancentral banks supporting the rising US interest rates can be explainedby the fact that it is the insatiable desire of these banks to hold backtheir currencies from further appreciation that compelled them tosupport the US paper. Next to Japan, the Chinese central bank isreported to be the biggest holder of American treasury bonds. Butthe current rate hike by China is all set to have a tremendous impacton American treasury bonds.

Coming to the impact of the Chinese central bank’s rate hike onthe international trade, it must be admitted that the demand forcommodities such as steel, aluminum, copper, will witness a steepfall which would mean a reduction in exports to China from otherAsian countries—including India, both in terms of volumes and price

65Flapping wings of a butterfly in China make the world sneeze?

realization. Dampening of the Chinese economy which, along withthe US, has become a global growth engine in the recent past, willpull down global oil prices. No doubt, the fall in oil and commodities’prices will be welcomed by Indian manufacturers as it improves theirmargins. It is also a welcome development from the consumer pointof view. But countries having export relations with China will be hithard. It is not yet clear if China follows the next logical step ofrevaluing its currency that has been pegged to the US dollar at 8.28yuan since 1995 despite a worldwide protest led by the US at theyuan being pretty undervalued. In any case, a higher interest ratedifferential between the dollar and the yuan that is to emerge fromthe current rate hike is likely to appreciate the yuan. If yuan appreciates,Indian exports to other countries, where we are in direct competitionwith China, are likely to improve further.

Amidst these calculations, the US Federal Reserve had gently nudgedits interest rates by a quarter percentage. The press release of the FederalOpen Market Committee said: “Output appears to be growing at amoderate pace despite the rise in energy prices, and labor marketconditions have improved.” With the current move, the credit cost goesup from the present level of 1.75% to 2.0%. Now, the question is whetherthis increase in the cost of capital will have any effect on the overalldemand for industrial output. One school of economists argue thatmounting American deficit may lead to international financialinstability. As America continues to borrow more and more from othersfor bridging the deficit, the real interest rates may rise. This is potentialenough to erode the world’s confidence in the US fiscal policy whichcan in turn weaken the dollar. If it happens, Europe and Asia will facea real crisis in their export performance. This vicious circle may finallyretard the growth of world economy.

Against these global developments, our interest rates, as usual,remained unresponsive. We have witnessed for almost one year interest


rates moving only southward. Now that interest rates, having reachedthe nadir, are they set to go up? But even when the inflation rate hasgone up to a record high in August, no bank felt it necessary to raiseits interest rates. It is a different matter that the poor depositors wereto be content with negative rate of return. The Reserve Bank of Indiawas perhaps obsessed with its twin goals of price stability and providingadequate credit to industry at competitive interest rates. The soft interestrate regime has only helped government and industry to borrow capitalat cheaper rates. It has also made retail loans available at hithertounheard of interest rate, encouraging undesirable consumerism inthe country. In the process, everyone appears to have been overtakenby a feeling that the “good times” are here forever.

While we are under the sway of “good times”, inflation has beenraising its ugly head all over the globe. It is difficult for Indianauthorities to be indifferent to these developments: Policy initiatives,though unpalatable, must be taken for staying agile. RBI hasultimately sent a signal about the likely direction of interest rates byraising the “Repo” rate by 25 bps. Today, all the banks are consideringraising their interest rates—both on deposits and loans. Now, thequestion is how far can the banks go in resetting their interest rateson deposits and loans? There is certainly a limit to raising interestrates on loans, for corporates of repute are enjoying varied sourcesfor raising capital today and that too, at a very competitive price. Atthe same time, they cannot be ignorant of their profit margins. So,the victim would perhaps again be the depositor. It will be interestingto watch how banks are going to balance these multiple demands.

But one thing that is certain in a globalized economy is that weneed to be doubly right in picking up the sounds of flapping wingsand be instantaneous in our policy responses to those global sounds(changes); else we may risk being left far behind in the race.

——)0——

67Sri Lankan economy: It has a lesson to teach us

Sri Lanka’s economy, like the island itself, is a small economy.Like India, it is a multi-ethnic, multi-cultural, and multi-religious

country. At the time of independence during 1948, Sri Lankaneconomy was wholly dependent on agriculture and was consideredvulnerable to external conditions. Against this backdrop, like anyother newly independent country in Asia and Latin America of thosedays, Sri Lanka too was attracted towards the then emerging economicphilosophy of ‘maximization of growth through capital accumulationand industrialization based on import substitution’. The belief thatthe ‘vicious circle’ of low savings and low growth prevailing in‘developing countries’ can be turned into a ‘virtuous circle’ of highsavings and high growth by government intervention, has becomethe Pole Star of its policy initiatives. Driven by this impetus,immediately after independence, Sri Lanka resorted to the exercise ofnational planning for achieving rapid economic growth.

December 2004.

FIFTEEN

Sri Lankan economy: It has alesson to teach us

Though Sri Lanka adopted economic planning, it,unlike India, didn’t stay stuck with any one modeland that has put its economy on growth curve despitecivic strife.


Intriguingly, planning in Sri Lanka passed through manyperplexities that emanated from shifting definitions of economicgrowth models and types of planning. The first document of CeylonNational Congress (CNC) – “A policy and program for the CNC—gave high priority to health and education, import substitution inagriculture, and establishment of local governing bodies with theactive participation of local communities that would assumeresponsibility for health, education, sanitation, agriculture andirrigation, etc.” Though the Congress manifesto of 1947 omittedexplicit reference to planning, the leadership expressed its implicitcommitment to some degree of planning for the future.

At the time of its independence the situation prevailing in Sri Lankadid not reveal its strong commitment to planning as much as theunequivocal commitment of its neighbour, India, to the planning anda mixed economy and its socialist bias. Perhaps that was one reasonwhy Sri Lanka could not infuse the required amount of clarity into theplanning exercise as much as the other developing economies such asIndia did. One good thing that happened to Sri Lankan planningexercise was the constant changing of models and its application todevelopment problems and the commitment of political rulers to theplanning exercise in tune with the changing governments.

A new era had, however, begun with the taking over of thegovernment by the left-oriented coalition parties led by the SLFPin the general elections of 1956. It expressed its firm commitmentto the formulation of a national plan by establishing the NationalPlanning Council by an Act of Parliament with the Prime Ministeras Chairman, the Minister of Finance as Deputy Chairman andeminent professionals drawn from different fields as members.The NPC, treating planning primarily as an intellectual andtechnical task, came up with a well-drafted 10-year plan fulfillingall the technical and professional requirements of a sound economicdevelopment plan. The plan articulated the need for ‘turning the

69Sri Lankan economy: It has a lesson to teach us

country’s existing export sector into the equivalent of a capital goodssector by the domestic production of consumer import substitutes’,so that external payments crisis would not impede industrial andagricultural growth.

The plan was acclaimed worldwide for its high professional content.Its implementation, however, suffered a setback with the assassinationof S.W.R.D. Bandaranaike, the prime minister. Nevertheless, the earlyseeds sown for active collaboration between public and privateinvestment giving a thrust to manufactured-goods-led-exports indeedpaved the way for its inviting foreign investment in to the countrymuch earlier to its neighbours. Here, it is worth recalling the statementof Sir John Kotelawala that clearly establishes the glaring differencebetween the Indian and Sri Lankan planning process: “Thegovernment and the private-sector are therefore like oarsmen in aboat. While they must row together, they must ensure that they rowin rhythm, for it is only in a spirit of cooperative endeavour that theycan reach the promised land of contentment and prosperity that willgive us confidence in ourselves as a nation.”

It is, however, a different matter that this well-intended planningexercise turned topsy-turvy during the ’60s and became worse by the’70s due to the oil crisis which ultimately made the two decades ofthe progressive policy stance that aimed at making the economy lessvulnerable to external conditions, simply a failure.

Driven by the philosophy that ‘nothing about development is pre-destined’, and economic growth depends on initial conditions, productdifferentiation amongst exporting economies and the speed and qualityof reforms, this time, the government was able to weather the crisisby adopting orthodox fiscal policy measures which, unlike in thepast, were duly supported by appropriate monetary policies. Theexchange rate policy was also used as a specific tool to reduce currentaccount deficit. There was also widespread support for the removal ofdomestic marketing restrictions, besides a favourable response from


the political circles to the opening up of the economy. The privatizationprogram helped to increase private sector participation, and improvedefficiencies, particularly in tea estates and telecommunications. Allthis cumulatively enabled the country to achieve an average annualgrowth rate of 5% for the next quarter century.

Export of manufacture goods went up from 0.9 percent of allexports during 1965 to 76 percent of exports by 2001, while primaryexports declined from 99 percent to 16.5 percent during the sameperiod. Manufactured exports from Sri Lanka are heavily tilted towardstextiles, clothing accounting for 52 percent of manufactured exports.With these changes, Sri Lanka has emerged as one of the only fourcountries outside East Asia that have achieved a clear policy shiftfrom import substitution to export-oriented industrialization. SriLanka indeed gained the reputation as the most aggressive pursuerof ‘privatization’ among the South Asian countries.

Whether or not Sri Lanka succeeded in accomplishing plannedeconomic growth through its various shifts from one model to theother during the last four decades is beside the point. What isimportant to learn here is the ease with which Sri Lanka could shiftfrom one model of economic development to the other with utmostease and despite civil disturbances, how it could metamorphose froman “inward-looking economic entity” to an “export-driven” economy.Its most noteworthy feature is that it has not mortgaged its economicgrowth to ‘public sector’. It could thus become the first country inSouth Asia to open its economy to foreign investment as early as1978. It enjoys the highest per capita income of $837 in South Asiaand has a literacy rate of 90 percent. But for the civil strife for almosttwo decades, it could have achieved a growth rate far higher thanwhat it is enjoying today.

Are there any takers in India?

——)0——

71We get petrol from the benevolence of oil companies?

More than 200 years ago, Adam Smith said: “It is not from the benevolence of the butcher, the brewer, or the baker, that

we expect our dinner, but from their regard to their own interest. Weaddress ourselves, not to their humanity but to their self-love, andnever talk to them of our necessities but of their advantages.” We, asa nation, have, however, been, trying to prove that Adam Smith andhis economic principles are wrong. This relentless pursuit of ourscontinues no matter economic reforms or no reforms. One can citeumpteen examples in support of this point.

Take, for instance, our oil companies. They, unlike Smith’sbutcher, the brewer, or the baker, are highly benevolent. They haveevery concern for us, the consumers. They are so benevolent thatthey are unmindful of their own costs. They are more concernedabout our affordability than their rising input costs and waning profitmargins. It is everybody’s knowledge that world oil prices are on flare.Crude oil prices have touched $55 per barrel. The input costs of oil

November 2004.

SIXTEEN

We get petrol from thebenevolence of oil companies?

In economics there are no free lunches! To beeconomical, every exchange must take place onmutually satisfying monetary terms.


companies are thus rising day by day. The intensity of heat can begauged from what the Chairman and Managing Director of ONGCsaid: The government’s refusal to allow domestic oil companies tohike retail prices of petroleum products was pushing them intobankruptcy. Perhaps, it is for the first time that any executive frompublic sector undertakings could muster courage, even to utter a fact.He said: “Whether you have an oil pool account or some othermechanism to subsidize the prices, at the end of the day, someone hasto pay.” Even the Chairman and Managing Director of Indian OilCorporation aired his anguish at the losses sustained by the firm dueto the current hike in the crude prices. Yet the government—the ownerof the majority of oil companies in the country—is not allowing themto pass on the increased input costs to consumers. If it is notbenevolence, what is it? Aren’t we defying the basic economicprinciples of production?

That apart, what now causes more anxiety is the reported move ofthe Oil Ministry directing the upstream companies; such as the Oiland Natural Gas Commission, Oil India Limited, and Gail; to sharethe subsidy burden since they have made windfall profits owing to thesurge in international prices of crude oil. The current subsidy burdenunder kerosene and LPG is estimated at Rs.4,200 cr, and of this, if thereports are true, these three upstream companies have to shell outabout one-third of Rs.4,200 cr while the rest comes from thegovernment. The investing public who have put in their savings in therecently launched Initial Public Offer of ONGC are the worst hit bythis move. Incidentally, this could be one of the concerns due to whichthe ONGC Chairman could have lamented his woes in public.

The irony of this will not stop at ONGC doorstep or at the IOC,HPCL, or BPCL. Tomorrow, if the government comes out with afresh bout of disinvestment of public sector enterprises, investorswould think twice about committing their savings since they cannotbe sure of the said company functioning on bare economic principles.

73We get petrol from the benevolence of oil companies?

If such awareness dawns on the investor community, the governmentwill have it. Of course, we cannot presume that the government isunaware of these basics, but then, why this? One reason could bethat the government expects that the current hike in the oil priceswould be a temporary phenomenon. If that be the case, let us examinewhat is happening on the world crude oil front.

It is reported that all the major oil-producing countries are alreadyoperating at full capacity. No one is sure when things in Iraq will getcleared. Uncertainties attributed to Iran, if true, are yet another causefor the world oil market to worry. On the other hand, winteracquisitions of western countries are in full spree. Any threat to thecurrent supply levels—be it in terms of escalations of clashes in Iraq,or political action such as the Russian government taking over oilgiants, will only make markets murkier. Over and above all this, pricesof any traded commodity are prone to jump up with the spread of badnews. One such bad news currently doing the rounds in the globaloil market is the threat of rebels fighting for sovereignty against oilfacilities in Nigeria. All this cumulatively leads to the belief that thecurrent uptrend in the crude prices is not likely to witness south-bound journey, at least in the foreseeable future.

Besides supply, the other element that gives a push to anycommodity’s price is the rising demand for it. Even on this front,there is no respite. On the one hand, consumption in China during2004 is reported to have gone up by about 9,00,000 barrels per day.Similarly, the consumption level in the other Asian countries too hasgone up. The rising world consumption patterns and fallingproduction levels including the spare capacities available with OPECcountries, has obviously resulted in a big gap between supply anddemand. In such a scenario, the possibility of a fall in crude prices isquite remote. Of course, it is possibile, if the US Fed Reserve withdrawsits support to the growth momentum witnessed in the economy inthe recent past. But, the current mood of the Fed Reserve does not


hint at this possibility. China is another country which can impactthe oil prices. But if it has to happen, China should either revalue itscurrency or hike domestic interest rates so that demand for oil slides.But this is more unlikely to happen. The net result is that there wouldbe no respite from the rising prices, at least in the immediate future.

As against these world developments, our crude oil imports arerising. It is reported that we have imported 51 million tonnes duringthe current fiscal 2005 and it is likely to grow about 11% over theprevious year. What is important to note here is that demand for oilhas gone up despite the rise in international prices. One of the reasonsfor this peculiar phenomenon could be the tariff cuts imposed by thegovernment to soften the impact of global price rise on retail domesticconsumers. It means price rise or no price rise, the consumptionpattern is certainly poised for constant growth. The current level ofcar production in the country is in itself a pointer towards theemerging reality. Secondly, it is also evident that the risingconsumerism, particularly in the high-end segment of the society, ismore out of the increased earnings that they are enjoying by virtue ofeconomic reforms and the opening up of the economy. This raisesthe obvious question: How long does the government want to subsidizethe consumers and for what reasons? One may argue here that raisingthe oil prices will have a cascading effect on the prices of allmanufactured goods whose production consumes oil. True, but whenthe cost of inputs goes up, the consumer has to bear the additionalcost or reduce his consumption proportionately. Unfortunately,neither of these is happening as the Sovereign is unwittinglyencouraging citizens to consume more by (1) reducing the tariffsand (2) not allowing the manufacturers to pass on their full costs tothe consumer. So, the result is benevolence. And let us enjoy as longas it lasts.

——)0——

75No stifling of growth, please!

The dragon is raising its head again: Inflation has surged to athree-and-a-half-year high of 7.61% for the week ended July 31.

The rising global oil prices and the increase in the prices of domesticcommodities such as steel, iron ore, edible oil, and other manufacturegoods, vegetables, fruits, since June this year are portrayed as the realculprits that have led to the current rise in inflation in the country.Another school of thought states that the present inflation is morebecause of money supply growing at a higher rate than desired, whichresulted from the accumulating foreign exchange reserves. Reasonsapart, the inflation has done what it is known to do: It has spookedthe market. The yield on ten-year benchmark government securityhas gone up from 5.06% in the first week of April to a high of 6.28%by the second week of August 2004. The sharp reaction of the marketis understandable since inflation, actual or expected, in a deregulatedmarket is technically bound to impact the bond rates. The hardeningbond yields are indeed causing anxiety to banks since they need tomake a huge provision against their portfolio of government securitiesthat is fast depreciating.

September 2004.

SEVENTEEN

No stifling of growth, please!

Inflation – whether it is cost-push or demand-pull –is inflation and needs to be handled with dexteritybut transparently.


The Finance Minister has of course ruled out “knee-jerk” reactionbut assured that the government would take action in a “measured”way on the fiscal side and the RBI on the monetary side, to tackleinflation. He also warned the manufacturers against hiking commodityprices. Understandably, the equity markets have reacted negatively tothe evolving scenario and the government’s reaction to the risinginflation by shedding 77 points in the 30-share BSE Sensex. The callmarket too is looking up though for a different reason. RBI’sintervention in the foreign exchange market is reported to have suckedout liquidity from the market. The only encouraging phenomenonamidst the current turmoil is the reported rise in credit off-take fromthe banking system.

What does all this mean? It simply means a general and progressiveincrease in prices. Under the pressure of inflation, “everything getsmore valuable except money”. In other words, what Rs.100 fetchedprior to the rise in inflation can no longer be acquired with the samesum; instead, one needs to spend more than Rs.100 to acquire thesame commodities. One school of economists strongly feels that thepresent rise in inflation is more of a ‘cost-push’ nature, which meansthe rise in price levels is the result of rising input costs. Theoretically,‘cost-push’ inflation is generated by three factors: One, rising wages;two, increase in corporate taxes, and three, imported inflation, whichmeans that the imported raw material or partly-finished goods becomemore expensive, often as a result of currency depreciation, etc.However, the current inflation that is rightly referred to as an ‘imported’inflation, is due to sky-rocketing oil prices in the global markets. Andeverybody is aware how rising oil prices adversely impact a largeproportion of the country’s production activities. It is still fresh inmemory how, even during the controlled price mechanism regimethat was expected to cushion consumers from the impact of risingprices, higher crude oil prices invariably pushed the general pricelevel in the country higher, adversely affecting the common man.

77No stifling of growth, please!

Indeed, it is a well-recorded phenomenon all over the globe that theprice rises resulting out of oil shocks, remained active for almost twosubsequent years.

What then needs to be done? The answer is simple: We must firstlearn to accept reality, for it is suicidal to deny the prevailing inflationarytrends in the economy as it is after all a disease that is potential enoughto destroy a society. And how can we say that the current rise inprices is not that threatening on the plea that it is only a ‘base-period’effect which merely made them look menacing on a year-on-year basis;i.e., the rise in current wholesale price index is not truly thatthreatening as it is made out to be by virtue of their comparison withlast year’s low inflation rate. It is nothing short of an illusion.

At one point of time, government agencies aired a feeling that theworst was over and the prices were likely to come down, more so withthe onset of the monsoon, although it was anybody’s guess that theglobal oil prices were not likely to cool down immediately. The crudeprices had in fact touched a high of $47 per barrel. Why this fooling?This brings to mind Milton Freidman, the Nobel laureate’s words:“The cure for inflation is simple to state but hard to implement. Theproblem is to have the political will to take the measures necessary”. Itis time we showed gumption to accept the reality and made citizensunderstand the government’s willingness to manage inflation mostjudiciously. If in the process people are required to put up withtransitional adversities, the government should prepare them to face itwith a promise that these hurdles are temporary and the citizens arecertainly wise enough to bear it, provided the government comes outclean and transparent. To be fair to the current crop of political leadershipwe must, of course, admit that this trend has indeed been exhibited bythe government and hope that it becomes a norm for the future.

Theory associated with cost-push inflation says that the standardmethods of fighting inflation using either monetary policy or fiscalpolicy to induce a recession are extremely expensive, since it can


raise unemployment to frightening levels, besides pulling down theexisting gross domestic product to far lower levels. As it is evidentthat the current inflation is an imported one, the normal monetaryresponses such as reducing monetary growth, rising interest rates,may not yield tangible results. On the other hand, such a move ismore prone to cripple the growth in the economy. Any positiveindicators that have emerged in the recent past about increased creditoff-take from the banking system towards fresh investments by thecorporates should not be choked by monetary policy initiatives, inour anxiety to arrest inflation. As the surging crude oil prices is aworld-wide phenomenon, the government must watch out for thereaction of the larger players in the market carefully and shape itspolicies accordingly.

Either way the current inflation calls for more of fiscal policyinitiatives than monetary policy measures. Against these theoreticalunderpinnings, the proposed move of the government to cut customsduty and excise duties on major petroleum products across the boardsounds appropriate to offset the inflationary impact resulting fromthe rise in crude oil prices. Of course, there is a flip side to it: Thegovernment revenue may come down. This may be true in the shortrun but in the long run, the reduction in the duties is sure to encouragegrowth which is otherwise choked by any monetary policy initiativeand thereby offset the revenue losses owing to reduction in rates byincreasing the very ‘collection-base’. What therefore matters mostnow is a quick and transparent proclamation by the government aboutits intended action for two reasons: One, it eliminates uncertaintyfrom the market, which is quite essential for orderliness in the marketand two, it enables the market players draft their own readjustmentmeasures so as to tide over the crisis with least ‘side-effects’. Let ushope the current dispensation in the North Block sets in motion anew but effective trend in the governance of the economy.

——)0——

79FDI in insurance: That’s what the economy needs, baby!

Each epoch, after all, will have its own passions and foibles. TheGovernment sometime back threw open the insurance market,

much like pulling down the Berlin wall, for private investment. Andas a natural sequel to this, the Finance Minister has now made abudgetary proposal to increase the Foreign Direct Investment cap ininsurance from the present 26% to 49% since FDI “has the potentialto add a competitive edge” and “there is an urgent need for infusinghuge amounts of capital” into “insurance”. This proposal, as anyonecould anticipate, has sparked opposition from several political parties.Without getting into the political compulsion of those who areopposing the current move, we shall make an attempt to objectivelyanalyze the dire need for infusion of huge capital into the insurancesector and how its infusion or no-infusion via FDI matters to theinsurance sector and to the economy at large.

Insurance is an important device designed to deal with risksthrough sharing. It has two fundamental characteristics: One,

September 2004.

EIGHTEEN

FDI in insurance: That’s whatthe economy needs, baby!

Prospects of insurance business – a known guzzlerof capital – cannot be insured without adequatecapital.


transferring the risk from one person to a group, and two, sharing oflosses on some equitable basis by all members of the group. To renderthis service, an insurance company basically undertakes three functionsviz. risk-taking – creates the counterpart of risk, which is security;asset management – undertakes sound investment of the premiumcollections to maximize returns; and servicing the customer by sellingpolicies and honouring claims.

Economists of different hues agree that as an economy develops,the contribution of the primary sector declines and that of the servicesector increases. Within the service sector, it is the insurance sectorthat plays an important role in the economic growth of a country.Insurance plays a complementary role in production of goods andservices by eliminating uncertainties that are otherwise associated withevery business activity. It plays a ‘stabilizing’ role in trade and commerce.

There is yet another important function that insurance performs:it stimulates economic growth as could be gauged from the fact thatfor the financial year 2002-03, its investments in industry andinfrastructure stood at Rs.291418.36 crore, which is 11.89 percent ofour GDP. A sound and vibrant insurance industry is thus a must forthe economic growth of a country. As against this, there is a hugeuntapped potential in the Indian insurance market which needs to beharvested for the growth in the economy.

Insurance is basically a business of accepting future risks for anupfront fee today. Ironically, at the time of accepting such risks, theinsurer has the least knowledge about the cost of the goods sold. Buthe only believes that the future value of the premium income willcompensate for the adverse risk selection or early occurrence of riskor any adverse investment climate at the time the claim under theproduct sold needs to be paid. Insurance business is thus saddledwith underwriting risk, timing risk and investment risk. As a part of

81FDI in insurance: That’s what the economy needs, baby!

proactive management, these risks call for maintenance of adequatecapital at all times. Thus, adequacy of capital to underwrite insurancehas simply become ‘critical’ for its very survival.

In order to protect the interests of the policy-holders the InsuranceRegulatory and Development Authority (IRDA) prescribed various“solvency margins” and monitors their compliance by the insurancecompanies. The IRDA (Assets, Liabilities and Solvency Margin ofInsurers) Regulations, 2000, requires all insurers to maintain anexcess of value of assets over liabilities, to the extent of not less thanRs.50 crore, or a sum equivalent based on the prescribed formulagiven in IRDA (Actuarial Report and Abstracts) Regulations, 2000.Similarly, in respect of general insurers, a minimum solvency marginof Rs.50 crore is required to be maintained or a sum equivalent basedon formula given in IRDA (Assets, Liabilities, and Solvency Marginof Insurers) Regulations, 2000. In addition, the registrationrequirements stipulate that all insurers are to maintain a solvencyratio of 1.5 times the normal requirement.

Besides, the newly established insurance companies will take aminimum of five years to stabilize and till then they need to fundtheir underwriting losses by infusing their own funds. The need forsuch infusion of additional funds from time to time for undertakingfresh business could as well be gauged from the report that ICICIPrudential increased its capital nine times since its inception inDecember 2000 from the minimum prescribed capital of Rs.100 croreto Rs.625 crore, Max New York to Rs.346 crore, HDFC StandardLife to Rs.218 crore, Birla Sun Life to Rs.230 crore, SBI Life toRs.175 crore, etc.

Insurance business is a known capital guzzler: it needs a constantinfusion of fresh capital which Indian partners are reported to beunable to bring in. Now the moot question is what is the alternative?


Press reports indicate that in view of this predicament, even IRDAsupported the industry’s demand for increasing the cap under FDI.Such a move alone can help these capital-starving new insurancecompanies raise additional capital through their foreign partners whoare ready with deep pockets.

But, there is opposition to increase the FDI on two counts: One,strategic concerns because of which a sector should not be in thecontrol of foreigners, and two, the ‘insensitivity’ of MNCs to localneeds as they are driven purely by profit goal. But, in today’s ‘globalizedeconomy’, it is not profitable for states to determine ‘who can dowhat and to whom’, instead they should stay focused on monitoringthe businesses and ensure that they are carried out as per the templateprescribed. Incidentally, the existing guidelines from IRDA directevery insurer without prejudice to Section 27 or Section 27A of theAct to invest and at all times keep invested his controlled fund in themanner prescribed by it. The IRDA also obtains compliance certificatefrom the insurer as per the prescribed format along with the investmentreturns on a quarterly basis. On any score there is thus little to beworried about FDI and its side-effects. Instead, we must learn to useFDI like China for our economic development.

——)0——

83Is ‘India shining’ amidst dark clouds of fiscal profligacy?

Jaswant Singh has shown a great sense of timing in announcinghis ‘giveaways’ at a time when growth in the economy is buoyant,

interest rates are low, foreign exchange reserves are at an all-timehigh and the industry is better composed to face global competition.He exhibited gumption in reducing the peak customs tariff rate from25% to 20%, abolishing special auxiliary duty of 4%, and loweringduties on items like computers, VCDs, DVDs, and coal. Thesereductions, which were termed by some as ‘pre-poll’ measures, areestimated to reduce revenue yield by Rs.8000 to 10,000 crore. Thepresent set of mini-reforms without any reference to the expenditureside led some to label them as “an opportunistic behaviour” but theindustry as a whole has welcomed it for, in its opinion, the economicbenefits stemming from these reductions far outweigh the revenue losses.

True, many in the past demanded a reduction in peak level tariffrates to Chinese levels so that India too could achieve a GDP growthrate of 8%. They have all along been arguing that if the duties are

February 2004.

NINETEEN

Is ‘India shining’ amidst darkclouds of fiscal profligacy?

Long-run fiscal deficits are sure to kill the economythough temporary relief can be enjoyed under theguise of technicalities.


reduced, corruption would decrease, output increase and, as a result,revenue collections too would increase. Indeed, the tax cuts offerednow in areas such as telecommunications, computerization,infrastructure development are more prone to generate a mood ofoverall confidence in the economy which in turn can encourageconsumers to consume and investors to invest. And that is what isrequired now to build the much-needed ‘economic tempo’ in thecountry. Secondly, they also set the tone for the post-election reformsto be launched by the new government. That they might also servethe political ambitions of the party in power is perhaps irrelevant.

Well, maybe, but economists have something else to lament:apocalyptic vision of “fiscal crisis.” Certainly, some economists arequite worried about the impact of these concessions on the alreadyburgeoning fiscal deficit. True, one of our major problems is largebudget deficit and the resulting high level of national debt. The budgetdeficit of the Central Government alone stands at around 6% of theGDP. It rises to about 10% of the GDP if the deficits of Stategovernments are included. It is a different matter that we are notalone in having a high fiscal deficit. France and Germany are noexception to this. Even the United States suffered a budget deficit ofaround 3.7% in 2003 which is projected to further rise to 4.3% bynext year. Japan’s fiscal deficit stands at 8% of the GDP. The averageratio of budget deficit to the GDP among the emerging marketeconomies is about 4%. This globally pervading phenomenonobviously posits a few questions: How does peacetime deficit matterfor the economy? Could any of the cuts proposed by the FinanceMinister be countered under the plea of fiscal deficit? Why worryabout a debt that is primarily supported by ‘domestic borrowings’?

To better appreciate these questions, let us first take a look at whatfiscal deficit is and the theoretical underpinnings of its impact on theeconomy. The budget deficit is traditionally defined as the differencebetween total government outlays, including the interest on the

85Is ‘India shining’ amidst dark clouds of fiscal profligacy?

national debt, and the government’s revenue receipts. Fiscal deficit isa consequence of a too self-indulgent conduct of the government,i.e., the government spends more than it collects in taxes. A budgetdeficit therefore means increased borrowing by the government. Ofcourse, here one may argue that as the GDP is also rising, the ratioof the national debt to the GDP will not increase. But this dependson whether the growth rate of national debt is more than the growthrate of the GDP. A continuously increasing ratio of debt to the GDP,as in India, runs the risk of its non-sustainability in the long run.

To better appreciate the drivers behind the growing ratio of debt tothe GDP, let us peep into what and how standard deficit and primarydeficit influence the fiscal crisis. The primary deficit is the standarddeficit minus the interest on the government debt. In other words,primary deficit is nothing but the government’s non-interest outlaysminus total revenues. Obviously, the existence of primary deficit and apositive difference between the interest rate on the national debt andthe growth rate of the GDP result in increased ratio of debt to theGDP. The very positive difference between the interest rate and thegrowth rate of the GDP means that the interest payments alone causethe debt to rise faster than the GDP. Therefore, to reduce the ratio ofdebt to the GDP, a country must either enjoy a primary surplus or itseconomy must grow faster than the rate of interest or both.

Experience around the world indicates that a rising ratio of debtto the GDP leads to higher interest rates and this in turn results inincreased growth in debt. It is in this context that economists arguethat a sound fiscal policy must ensure that the government revenueexceeds government’s non-interest outlays and the excess of revenueover non-interest outlays must be sufficient to finance enough of theinterest payments on the public debt. If not, they warn that the largefiscal deficits can hold back economic growth, lower real incomes,reduce national savings and capital formation and increase the risk


of financial and economic crises of the type countries of Asia andLatin America suffered in the recent past. Secondly, they also warnthat fiscal deficit can lead to higher inflation, despite the ReserveBank’s tight monetary policies. Experience the world over indicatesthat a country which runs fiscal deficit over a long period, exposesitself to poor capital accumulation, lower economic growth, lowerlevels of real income and the real standard of living. Suffice to saythat by any logic no one, including governments, can live on borrowedfunds forever.

This takes us back to square one: How can Singh’s mini-reformsthat are known to increase fiscal deficit be termed as ‘pro-growth?’A plausible argument in favour of Singh’s mini-budget could bethat the reduced tax rates would give a fillip to growth in the GDPand thus the overall debt to the GDP ratio will not rise, if not comedown immediately.

Secondly, the impact of growing debt to the GDP ratio may notbe felt immediately since the world today is passing through anastoundingly low interest rates phase. Even otherwise, the adverseeffects of budget deficits are rarely immediate and thus every politicalsystem, prefers, though unfortunately, to ignore budget deficits,and Singh is perhaps no exception to this temptation. That apart,the very nature of economic decisions, the results of which alwaysreveal themselves only in the future, affords the ministry the‘comfort’ of predicting a most favourable outcome for its decision.So, wait for time to reveal whether “India is shining” or living on“fiscal profligacy.”

——)0——

87FTA or no FTA, ‘industrial competitiveness’ alone matters

Indian foreign exchange reserves are inching towards the hundredbillion mark. The hoopla generated by the first ever appreciation

of the rupee in the recent past by almost 6% in a matter of a fewmonths and the resulting surge in foreign exchange reserves havealmost muted even such milestone events as the Free Trade Agreementthat India signed with Thailand and a few such other economiccooperation agreements that are in the offing.

Incidentally, it’s not only the FTAs that were drowned under thesurging foreign exchange reserves but also the warning aired by thenoted economist Jagdish Bhagwati, who said: “the world trading systemcomes to look like a spaghetti bowl of ever-more complicated tradebarriers, each depending on the supposed ‘nationality’ of products”.This warning raises many questions: “Are Preferential TradeAgreements (PTAs) so dubious?” “What really are PTAs?” “How dothey affect trade between countries?” “Are they good or bad?”

December 2003.

TWENTY

FTA or no FTA, ‘industrialcompetitiveness’ alone matters

More than free trade agreements, it is the quality-and price-competitiveness of the industrial outputthat generates international trade.


Let us now take a look at what these preferential trade agreementsmean and how they matter in the international trade, whichunderstanding alone can enable us to dispassionately evaluate thegood or bad of the recently signed trade agreements by India.Preferential trade agreements are of two types: Free trade agreementsand customs unions. Free trade agreements are defined by the WorldTrade Organization as “agreements among two or more parties inwhich reciprocal preferences are exchanged to cover a large spectrumof parties’ trade in goods”. Customs unions, on the other hand, arethe PTAs “with a common external tariff in addition to the exchangeof trade preferences”. Such agreements can be either bilateral orplurilateral.

It is reported that as at the end of the year 2000, there were about240 preferential trade agreements, of which 170 are already in force,while the rest are in various stages of negotiation. A major chunk ofthese PTAs are in the form of FTAs. The Euro-Mediterranean regionis known to have a high concentration of PTAs. However, in therecent past, a lot of PTA activity was witnessed in America and Asia.Indeed, it was after the failure of Cancun talks that both the EuropeanUnion and the US threatened the rest of the world to pursue“bilateralism” in world trade, perhaps giving a sweet burial to the“rule-based multilateral trading system” granted under the WTO. Tobetter appreciate the consequences of such a burial, it is desirable tolook at what the WTO does.

The WTO administers the trade agreements negotiated by itsmembers in the past, settles trade disputes and also acts as a forum fornegotiations for further trade agreements – all of which cumulativelyguarantee the smooth flow of trade within a rule-based trading system.Under the WTO, anti-dumping rules and subsidiary restrictions canbe enforced and thus it can, to some extent, control the unilateralactions of the major trading nations. Its dispute settlement mechanism

89FTA or no FTA, ‘industrial competitiveness’ alone matters

has also become very powerful vis-à-vis the mechanism to resolvedisputes under the bilateral agreements. There is of course an argumentin favour of bilateral negotiations under the plea that they can bebrought to a conclusion quickly because of limited participatingmembers than in talks under the WTO – a multilateral framework.The bilateral agreements are often found to result in a substantialimprovement in political relationships between the partner countries.

Without going deeper into the merits and demerits of bilateraland multilateral framework of trade agreements, let us take a quicklook at what economists have got to say about the FTAs. Historically,it is presumed that Free Trade Agreements expand markets andeconomic efficiency for they are necessarily meant for tradeliberalization. However, this traditional view was later challenged byeconomists like Jacob, Viner and James Meade. According to themPTAs exert two effects: “Trade creation” and “trade diversion”. Tradecreation under PTA occurs when a country’s domestic production isreplaced by lower cost imports from the partner country while tradediversion occurs when the low-cost imports from countries other thanthe PTA partner are replaced by higher cost imports from partnercountries, of course, owing to tariff preferences. Obviously, PTAscould enhance welfare only when their “trade creation effects”outweigh their “trade diversion effects”. They argue that emergenceof such a benefit rests on several factors and maybe that is the reasonwhy many trade economists are often found to be suspicious of thealleged benefits of PTAs.

Over and above that, free trade agreements or customs unions arenot only antithetical but also engender a lot of problems in terms ofdefining and policing rules of “origin of goods”. Such rules are quiteessential since tariff preferences are accorded only to goods actuallyproduced in the partner country but not to the goods from the rest ofthe world that make an entry via the partner country with the lowest


external tariff. For instance, Singapore, being a trade-dependenteconomy, maintains zero tariffs on almost all products. It also hasfree trade agreements with countries like South Korea and Japan. Inview of this, goods of Korea or Japan can enter India throughSingapore and thus warrant policing to arrest India’s losses that couldeither be in the form of a fall in customs revenue or eating into themarket share of domestic firm. Despite these disadvantages, FTAs aremushrooming all around, that too, more out of non-economicconsiderations. It would not be surprising if this trend gains furthermomentum owing to the failure of Cancun talks.

Against this backdrop, let us analyze what India has in store fromthe FTAs. The CII claims “FTAs will provide Indian companies theright platform to position themselves as global players. It sends theright signal to the global business fraternity that India is not aprotectionist economy”. But it is also equally true that the envisagedbenefits squarely rest on the details of the product lists, phasing,rules of origin etc. For instance, penetrating into the Thai’s alreadywell-established auto components market would call for a consistenteffort from Indian manufacturers in improving and sustaining qualityof their output that, too, over a number of years. Similarly, till ourtax structure, labour laws, energy costs, capital costs, infrastructurequality etc., match with those of Thailand, the FTA may in effect becounterproductive, though unintended, owing to which our productsare more prone to price-uncompetitive. In any case, FTA with Thailandcannot generate “trade creation gains” as much as an FTA with theUSA or the European Union can. The moral of the story is that, toreap full gains from any such trade liberalization agreements, weneed to build at once “industrial competitiveness” and in that context,the government and the industry should work together.

——)0——

91ECBs or FIIs: Which is more good?

Economics textbooks say that participants in the markettransactions must bear the full consequences of their decisions,

be it losses or gains. Obviously, market players go to considerablelengths to pocket the profits from the success of their businesses,while passing on the costs to others. But this simple logic is oftenlost sight of by the market regulators in their anxiety to put off anyemerging ‘instability’ in the market and the recent act of thegovernment in revising the policy guidelines under the ExternalCommercial Borrowings (ECBs) is an example of this phenomenon.

The Finance Ministry has recently tightened the norms for ECBs.According to the latest guidelines, companies can borrow foreigncurrency denominated loans of US $50 million and above frominternational financial markets only to finance infrastructure projectswhich involve foreign exchange needs, such as for importing capitalequipment and technology. The revised guidelines also prescribe acap on the interest rate: the maximum spread over the six-month

December 2003.

TWENTY ONE

ECBs or FIIs:Which is more good?

Cutting off the leg is not a cure for pain butadministration of a ‘cure’ certainly is.


‘Libor’ cannot exceed 150 basis points. It is also made mandatory forthe corporates to park their ECB proceeds abroad until they are utilizedfor the intended purposes. The immediate fallout of the current moveis quite obvious – all corporates cannot borrow from global financialmarkets and reap the benefit of the historically lowest interest ratesprevailing in the global financial markets.

Now the question is why this sudden change in the guidelinesunder the ECB programme? One immediate motive that strikes tomind is the pressure caused by the mounting foreign exchange reservesand its management to the Reserve Bank of India. Secondly, thegovernment might have thought that such restrictions on ECBs wouldautomatically drive many of the corporates to Indian banks for theircapital needs, so that banks can be helped to come out of their‘liquidity-overhang’.

True, the management of forex reserves that have crossed $93billion is certainly a matter of concern and any further inflows wouldonly make matters worse. This prompts us to take a look at theunderlying reasons for the current upsurge in forex reserves. Themajor culprit for the increased inflow of forex is the FIIs who arereported to have so far invested in the stock market around $6 billion.It is of course pretty encouraging to note that our capital marketscould attract the attention of global investors by offering goodvaluations, which reaffirms that India Inc. is doing well. But there isalso a bad news embedded in it: What if tomorrow the FIIs find thatanother market is offering a better return than ours? The answer issimple: Driven by the basic principle of economics, they would simplyunlock their positions in India and move on to the markets that offerbetter profit. In other words, their investments in the Indian marketare purely profit-driven and are therefore unstable. An extension ofthis argument makes it clear that surging forex reserves too arevulnerable to frequent changes.

93ECBs or FIIs: Which is more good?

Well! That’s not the end of the story since vulnerability of forexreserves to frequent changes means volatility in the market – both thestock and forex markets. Even otherwise, what purpose do these FIIfunds serve? These funds at best can only power the stock marketrally. They don’t add to any fresh investments in the country. Onemay at best argue that they would unlock the domestic funds fromthe existing investments and make them available for fresh investmentsbesides generating a ‘feel-good’ factor about India Inc. But that is notwhat is happening today and in any case the FII inflows cannot betreated as investments for they are simply ‘trades’.

Now, as against this, the ECBs are long-term borrowings andthus assume the status of investment meant for generating fresh‘wealth’. They facilitate availability of cheap funds to corporates eitherfor investment in new projects or to manage the existing businessesby making dirt-cheap working capital available. Secondly, funds beingavailable today at historically low prices of around 1.25% in the globalfinancial markets as against the prevailing PLR of about 10% in thedomestic market, the ECBs would simply bring down the cost ofoutput of businesses. Reduced cost of production automatically makesIndian exports price competitive in the international market. Secondly,with the opening up of markets and drastic reduction in tariffs in therecent past, Indian consumers are flooded with imported goods ataffordable prices, as a result of which even companies operating withinthe domestic market are required to offer competitive prices vis-à-visimported goods, which could be accomplished to a great extent byavailing loans under the ECB scheme at low interest rates.

Against these realities, imposition of restrictions on companiesfrom availing loans from global markets – all with the objective ofeasing the burden of managing the surging foreign exchange reservesby the RBI and giving a fillip, though misplaced, to credit off-takefrom Indian banks, does not sound logical.


There is of course another argument in favour of current guidelinesunder ECB: many of the corporates who have earlier borrowed underthe ECB program are found not managing their forex risk properlyeither due to lack of awareness or absence of proper risk managementpractices, which authorities regard as not a healthy practice for thesystem as a whole and hence the current restrictions. If this is true, itis nothing short of the government taking over upon itself thecorporates’ responsibility to manage their forex risk exposure. Thisimposed ‘macro measure’ for managing the ‘micro risk’ would onlywipe out the scope for ‘Pareto efficiencies’, if any. Instead, it wouldhave made greater impact had the government tinkered with guidelinesfor FIIs participation in capital markets as a measure to minimizefurther inflows of foreign exchange. But, logically speaking eventhat would have sent a wrong signal to the market players that, too,when we are making an attempt to integrate with the global economy.So, the obvious answer to all these problems is honing of our skills tomanage the forex reserves more optimally and for the government tostay focused on the ‘macro-economic management’ leaving ‘micro-management’ to the respective agencies for it is they who asentrepreneurs required to pocket gains and suffer losses as well.

——)0——

95Cancun or globalization: Whose somersault is it?

“Perestroika” and “glasnost” are not just two words in the Russian language but they are of tremendous historical significance.

They helped Germans pull down the Berlin Wall. They caused thecollapse of communist regime in East European countries. They havebeen instrumental for these countries in shedding off their faith in“central planning” and the “command and control” system of economicdecision-making. It led to their embracing the market-driven economy.Unashamedly, they have even sought Foreign Direct Investment forgiving a boost to their flagging economies. Ultimately, these wordshave achieved immortality by eclipsing the “cold-war” syndrome andlaunching the world on an altogether new “trajectory”.

The third world countries from Asia and Africa, too, have fallenin line. They have come out of their cocoons that had been wovenunder the guise of “self-reliance” and have started liberalizingthemselves slowly but steadily. It’s, of course, such countries as Taiwan,Hong Kong, South Korea and Singapore who were the first amongst

October 2003.

TWENTY TWO

Cancun or globalization:Whose somersault is it?

The wealthier nations must realize that “justice isthe main pillar that upholds the whole edifice” ofglobal trade.


the developing world to liberalize and join the international tradingregime. Subsequently, China joined the liberalization process,followed by India.

Cumulatively, “globalization” has become the buzzword.Globalization is understood as a process under which capital, people,goods, information, and culture move freely across the sovereignboundaries. It is argued that the “Market economy” will result in“convergence of living standards of rich and poor nations”. In supportof this argument the protagonists of globalization cite the example ofChina—a communist country where liberalization is said to havedoubled the grain production in five years. This phenomenon haddemonstrated the power of ‘market principles’ in no uncertain terms.

Though market economy appears to have triumphed, discordantnotes are not unheard of. With the spread of globalization,“international aid” that once flew from the first world nations to thethird world countries as a tool for their economic development, wasreplaced by Foreign Direct Investment. It is also reported that for amajority of the developing and transitional economies, the incomegaps have become greater today than before. Even within the countrieswherever high levels of aggregate growth is experienced as a sequelto their embracing “neo-liberal” economics, the additional wealthhas benefited only a select few. This obviously resulted in a stingingattack on the WTO and the IMF for the practices that they haveadvocated from a section of economists, notable among them beingthe Nobel laureate, George Stiglitz.

All this, of course, also explains why the Cancun talks failed.Nevertheless, it makes sense to examine afresh what happened atCancun. It is a simple burst-out of all the contradictions embeddedwithin the WTO: unequal rights and obligations, fear about shrinkingsovereign influence, and the hypocrisy of developed countries. To

97Cancun or globalization: Whose somersault is it?

better appreciate the frustration inflicted by the hypocrisy of thedeveloped countries, let us take a look at the recent episode relatingto the US multinational, Chiquita.

Chiquita is a leading international marketer, producer anddistributor of fresh and processed fruits and vegetable products fromthe US. When the European Union decided to award a quota of lessthan 10% of banana imports to Chiquita, the corporation made theUS government protest this restriction by lodging a complaint withthe WTO charging the EU with a “discriminatory” approach. TheUS administration even threatened to impose a new 100% duty onthe imports from the EU if it was not agreeable for a negotiatedsettlement on banana imports. Ultimately, when the EU refused tocomply with even the WTO order, the US did impose punitive dutieson EU imports. This story only highlights the bizarre willingness ofthe governments and even of the world bodies to oblige the corporatesand their greed for business growth.

Let us now juxtapose this episode with the recent responses ofthe US and other developed countries to a proposal that emanatedfrom some of the world’s poorest countries at the Cancun meet callingfor a level playing field in the global cotton markets. The West Africancountries, namely Chad, Mali, and Burkina Faso, are engaged incotton cultivation for export market. But their cotton exports have oflate been facing a major challenge from the US and EU cotton farmerswho, owing to a high level of subsidies extended by the governmentof the US and the European countries – $3 and $1 billion respectively– were found pulling down global cotton prices. Given the lack of alevel playing market, these countries asked the US and the EU toremove cotton subsidies. But, as the cotton growers of the US andEuropean countries warned their respective governments againstreducing subsidies, the US and the rest, instead of responding positivelyto the African proposal, unashamedly made a counter proposal.


That is the level of maturity exhibited by the leadership of thedeveloped countries: on the one hand, they advocate free trade forevery other country, but when it comes to them what matters is theirown interests and in the process, they do not mind flouting whatthey urge others to do. The buck doesn’t stop here: in order toovercome the impact of delayed decisions at WTO, the US is toyingwith the idea of striking bilateral deals wherever warranted. It doesn’tmatter to them though such bilateral deals go against the very basictenets of “globalization”. Similarly, the EU is reported to haveproposed to limit the negotiations at the WTO to a small bloc ofcountries depending on their share in the global trade – all to obviatesuch irritations as they encountered at Cancun. What does all thismean? Does it mean killing the “rule-based multilateral trading system,”or, does it mean a grinding halt for “globalization”?

It doesn’t matter which somersaulted – the Cancun meet or theprocess of “globalization.” But what matters more is the bizarreexhibition of vested interests by the US and the EU countries: theWest wants free access to the developing country markets butdeliberately slows down in reciprocating the same to the poorercountries where they enjoy a competitive advantage. They do notmind even seeking exemptions from the very principles and rulesthey urge on others. It is time they realized what Adam Smith said:“Society may subsist, though not in the most comfortable state,without beneficence; but the prevalence of injustice must utterlydestroy it… Justice is the main pillar that upholds the whole edifice”.

Doesn’t it apply to the whole world?

——)0——

99Why poor LIC, why not post office?

“India faces fiscal crisis.” So warns the World Bank. It has predicted that India’s fiscal deficit could swell up to 11.8% of the GDP

by 2006–07. It affirms: “India’s large fiscal imbalances pose a seriousthreat to sustained growth and development over the medium term….If this negative cycle continues, a full-fledged fiscal crisis cannot beruled out over the medium term”. Given the likely scenario, it desiresthat the centre and the states be proactive in reducing fiscal deficit,in shifting expenditures into more productive areas and in removingstructural impediments to higher private investment and productivity.Is this yet another “technocratic” prescription based more on ideologythan economics? Routine stuff to come from the IMF/World Bank?

Keeping that argument aside for a while, let us take a look at therecently launched “Varishta Pension Bima Yojana” by the Governmentof India for the benefit of senior citizens. The scheme, to beadministered by the LIC, offers an assured return of 9% per annumto the policyholder against a one-time payment of a minimum amount

August 2003.

TWENTY THREE

Why poor LIC, why notpost office?

Parenting does not mean making unfair demands onthe wards, that, too, when the turf is not the home.


of Rs.33,335 and a maximum of Rs.2,66,665. At the launchingceremony, the Finance Minister said that the declining interest rateshad reduced the income of senior citizens. To compensate them forthe loss, the minister observed that the Central Government haddevised the scheme by committing itself to fill the gap between thereturns earned by LIC on the premium collections and the assuredreturn of 9%. The scheme offering an assured return of 9%, particularlyin the current falling interest rate scenario, is no doubt a boon to thesenior citizens. But it also has its flip-side: What if tomorrow the interestrate rises to more than 9%, which possibility cannot be totally ruledout, that too, in a long lock-in period of 15 years? The objective ofstabilizing the net buying capacity of the senior citizens could havebeen fully achieved if the government had thought of a floating ratelinked to a base rate, like treasury bills with a floor of 9% per annum.

There is yet another dimension to this scheme. Assuming that theLIC, which administers the scheme, is able to deploy the funds insuch a way that it yields a 7% secure return, the Government willhave to bear a subsidy burden of 2% on the premium and this outgoworks out to around Rs.55.33 cr if one lakh senior citizens purchasethe policy for the maximum amount. Interestingly, as per the 1991census data, senior citizens constitute around 9.4% of the population.In other words, the pension scheme’s target clientele would be around10 cr. If even 5% of this target population subscribe to the policy atthe maximum amount, the government has to shell out Rs.2,800 cras subsidy. And this is what is already sending shivers down the spineof the fiscal managers of the country, more so in the light of the latestWorld Bank forecast about the imminent fiscal crisis.

That precisely is the reason why schemes of this nature do notsound that good for “experts” called “technocrats” from the IMF.But economic policies cannot always be “technocratic” for there arealways trade-offs that convey different values to different political

101Why poor LIC, why not post office?

doctrines. And quite often, the political choices do make economicsense, for after all there cannot always be an economic policy that is‘Paretian’. Nevertheless, technical analysis is capable of bettering theoutcome of political choices too, since it can facilitate promotion ofboth growth and equality. One such analysis questions the selectionof the LIC for administering the “Varishta Pension Bima Yojana” asit involves higher costs, in terms of both agency and portfoliomanagement cost. For instance, if the LIC has to earn a securedreturn from the premium collections sans credit risk, it has to obviouslyinvest the collection in government securities involving transactioncosts that ultimately raise the demand for subsidy.

Instead, the government should have chosen the post office as anodal agency to administer the scheme. India possesses one of themost extensive post office networks in the world with 1.55 lakh postoffices/outlets spread all over the country. Almost 90% of the postaloutlets are in the rural areas. The Indian postal system currentlyprovides 38 services, which can be broadly divided into three categoriesof activities, viz., communication, transportation, and other services.

The savings bank wing of the postal department is also offering anumber of financial services in collaboration with the private sector.Postal network also sells life insurance. It is currently managingaround 13,52,000 insurance policies. Such being its vast reach andexperience in offering financial services in the country, the postaldepartment could have been the ideal choice for administering thenew scheme at a less cost.

Unlike the LIC, the postal department can directly transfer thepremium collections to the Central Government. Similarly, theGovernment can as well reduce its dependence on marketborrowings. The net result would be less burden on the exchequer.There is an advantage to policyholders too: A post office being in


their very neighbourhood makes pension withdrawal pretty simple. Italso spares the LIC from the likely regulatory embarrassments. To thatextent it keeps the LIC in good stead to edge out the competition fromthe newly entered private insurers. Doesn’t it make the schemeeconomically more sensible?

——)0——

103Why & how macroeconomic policies work and work on us?

Aficionados of the Keynesian school of economic thought are quite familiar with the fiscal and monetary policies that are used as

effective tools for macroeconomic management by governments.However, with the advent of market-driven economics, governmentshave lost theoretical support for their active intervention policies.These pundits essentially perceive macroeconomy as a system ofinterlinked markets. They argue that disturbances in the economymay temporarily divert markets from equilibrium, but are predisposedto return to equilibrium without governmental intervention.

They, for instance, by equilibrium in labour markets, mean that allunemployment is voluntary as it is decided by worker’s offerings orwithdrawal from employment at different wage rates and hence in theabsence of government or labour union intervention, wages are morelikely to return to equilibrium. It is strongly prophesied that governmentintervention, however strongly it may intend to stimulate the economyor reduce unemployment, would only have a short-term effect since

June 2003.

TWENTY FOUR

Why & how macroeconomicpolicies work and work on us?

Globalization commands that we respect thewisdom of ancient economists like Adam Smith andJ M Keynes.


whatever illusion it can create through policy shifts becomesirrelevant or becomes relevant at a higher price level, once peopleand their expectations adapt to the new policy environment. Thusthey are advocating giving off of fiscal policy initiatives whilerestricting the implementation of monetary policy to the extent ofmaintaining price stability.

There is of course an obvious conflict in this argument with theground realities. To better appreciate this, let us test-check the advocacyof the market economists via an Indian example. A couple of yearsback, some of the Indian public sector banks were reported to haveincurred huge losses. In order to keep them afloat and arrest itscontagion risk, the Government injected fresh capital into them byway of budgetary grants. This averted their bankruptcy, besidesenabling them to successfully turn around and offer the much neededsuccour to the depositors. Instead, had the Government, being drivenby the market economy philosophy, chosen to remain a silent spectator,these banks would have had their natural death. Secondly, theresulting ‘contagion’ would have created a financial crisis in thecountry, subjecting millions of ordinary depositors to trauma.

True, the system might have returned to equilibrium at a laterdate even without governmental intervention, but at what cost? Theordinary citizens would have paid dearly if the banks had gone intoliquidation. This only reveals that some one or other has to pay theprice for the market crisis if it is to be put on the rails once again.But such “pay-outs” by a select few are certainly prone to make themacroeconomic policies less sustainable, for it cannot ensuredistributional equity in the system.

Plausibly, this could be one reason why no government worth itssalt is fully subscribing to the prescriptions advocated by the marketeconomists. And this stands vindicated by more than half a century

105Why & how macroeconomic policies work and work on us?

of world’s experience gained by implementing macroeconomic policiesprescribed under the Keynesian analysis that are believed to ensureeconomic stabilization by avoiding excessive inflation or recession;distributional equity; achievement of broad social goals such as incomesecurity, education, health care; and a stable platform for economicdevelopment.

It is hard to exaggerate here the benefit of the informed-government-intervention using fiscal or monetary policies as tools toset right the volatile markets that are often found to be socially andenvironmentally disruptive. It is also equally true that social goalscannot be achieved unless collective action is initiated via democraticinstitutions of governance. Government intervention thus becomesa must for not only achieving macroeconomic stability but also toaccomplishing the well-being of the common man that cannot beserviced or can only be inadequately serviced by the market.

Whether market economists are right or not is not what mattershere: it falls far short of what is needed to accomplish the “equity”that is even acknowledged by the World Bank as the central concernof the state. It is only the Keynesian theories that place great emphasison equitable distribution to build a stable society on which alone astable macroeconomic system can rest and grow.

This becomes imperative even from the perspective of the newlyemerging concern for ecological stability the world over. In theexpanding world of free-trade and globalization, the need to havecontrolled macroeconomic policies is gaining more importance asfree trade is supposed to have negative impact on environmental andsocial balances too. Secondly, the emerging global and regional freetrade regimes are potential enough to make sovereign control onmonetary and fiscal policies ineffective as is currently being felt inthe European Union, particularly with the launching of the Euro.


The cumulative result is plain enough: To ignore the potential ofmonetary and fiscal policies to ensure fair distribution, social equity,ecological sustainability and ultimately the very sustainability of macroeconomy, would be an even greater mistake. It is high time economictheorists came out with a theoretical prescription that permits only aminimal but effective governmental intervention in managing macroeconomy with high transparency and least surprises to the investingcommunity so that their long-range planning remains always in syncwith the macroeconomic policies being pursued, for that alone canbring a semblance of certainty into the otherwise uncertaintyassociated with the ‘future’. Secondly, such transparentmacroeconomic policy alone can pave the way for investments to takeplace in an orderly fashion and the economy to grow.

Well, not so fast: this may not be the end of the conflict. As theconcept of sustainable development is picking up momentum, manynew perspectives on economic theory, such as natural capital, currentand intergenerational equity, green accounting, green tax reform,growth and the environmental Kuznets curve debate have come intoexistence. Obviously, these introductions and the resulting overlapbetween environmental, social, and economic analysis will have aconsiderable impact on macroeconomic policies. However, very littleresearch has so far been done on these lines.

On the other hand, free market economy is bound to result inincreased international and intra-national economic inequality andincreased environmental destruction. Hence, to promote sustainabilityas well as efficiency, increased consumption and macroeconomicstability, environmental and social dimensions must also be wellintegrated into macroeconomic policies.

——)0——

107Isn’t it ironic?

Come February, Indians, wittingly or unwittingly, getswooped by the budget-fever. They indulge in all kinds of budget-

related conversations animatedly. Actually, there is nothing new: ithas been happening for the last five decades. Maybe, if one travelsfarther down the lane of history, one may trace such discussions toeven Chanakya’s period. Our ancient thinkers strongly advocated akind of taxation whose implementation is not felt by the people. Aking was ordained to take into account the ‘Yoga Kshema’ of thetaxpayers while levying taxes. He was expected to take into accountall the conditions considered necessary for ensuring the Yoga (stability)and Kshema (welfare) of the taxpayer.

It was said that a king, while collecting taxes from people, mustact like a gardener, and not like a charcoal-maker. He should be wiseenough to allow the growth of resources of the state before imposingtaxes on the people. Taxation should be equitable and reasonable –both the state and the people should feel that they have got a fair andreasonable return for their labours. It is also said that exemption of

April 2003.

TWENTY FIVE

Isn’t it ironic?

‘Giving with the right hand and taking away withthe left hand’ kind of budget leads the economy ‘thatis on the move’ to nowhere.


the un-affluent sections from tax burden and imposition of higherduties on luxurious goods was valued as a principle of ‘progression’.

Kautilya advocated that taxation should be imposed in proportionto the paying ability of the people, else “fiscal tyranny would lead topopular discontent.” The Jatakas also reveal that oppressive taxationsometimes forced the subjects to leave the kingdom and migrate toother places. This incidentally holds good even today but instead ofpeople, it is the capital that is migrating from a highly taxed countryto one which offers either scope to avoid tax altogether or imposesleast tax burden.

From the yin and yang of the past, let us now move onto thecurrent scenario. This is best accomplished by recalling theconcluding but interesting remarks of the finance minister’s budgetspeech: “This budget is of an India that is on the move. An India thatnow rapidly advances to prosperity. It is about an India that banishespoverty, and builds on its great resource base, the strength of itshuman capital and the immense reservoir of its knowledge.” Despitethe high inspirational value of these remarks, nobody appears to havepaid any attention to them. Or, is it that people are no longer movedby words, however inspiring they might be. Or, perhaps, they wantto make a point – Mere wishful thinking does not mean anything,particulary, when the reality is different.

The hard reality is that 70% of the population still live in thecountryside. During the current financial year, the country has beenafflicted with the severest drought witnessed in the recent past. As aresult, agricultural production is estimated to have fallen 3.1%. Asagainst these realities, precious little has been done to give a boost toagricultural production except announcing a scheme for high-techhorticulture and precision farming. On the other hand, the budgethas hiked fertilizer price while leaving subsidies under food,


LPG and kerosene distribution untouched though they are slated togo up.

Industry and services segments are reported to be growing at theimpressive rates of 6.1% to 7.1% respectively. The current budget hasoffered it a host of concessions: Excise duties on cars, pharmaceuticals,soft drinks and liquor have been cut, ostensibly to give a boost toconsumer demand. The concessions granted to the motor industryare particularly intriguing since the simultaneous rise in petrol anddiesel prices will offset whatever gain a consumer might get out ofthe price cut on cars. But in the hype generated by the rate cut in carprices, consumers tend to ignore the impact of price rise under petrol/diesel on their overall budget and likely to jump at acquisition ofcars. Or, there may not be any rise in demand and even if there is, itwill simply end up fanning undesirable consumerism.

There is yet another attempt at giving a boost to consumer demand:Direct taxes are tinkered with here and there; raising standarddeduction limit for salaried employees; elimination of surcharge forindividuals; raising the exemption limit under income from othersources; etc. Taxing dividends in the hands of shareholders has beenabolished. What is more, they can even enjoy these sops while sippingimported liquor at a much lesser cost than hitherto. As against thesecuts, the finance minister tried to suck in more out of the purses ofthe people by raising service tax from the current level of 5% to 8%.And this would mean increased expenses for various services likecatering, mobile phones, and banking services.

The finance minister in his anxiety to put money in the purse ofevery housewife did precious little to bring down the fiscal deficit, nomatter even if it continues to be the second highest consolidatedfiscal deficit in the whole world. The revenue deficit itself stood at awhopping Rs.1,12,000 crore testifying to the inability of the


government to effect any significant cut in non-plan expenditure.Secondly, there is no provision in the budget for the redemption ofUS 64 units in May, though the shortfall is estimated at Rs.6500. Itsimply defies the canons of prudence. The estimated fiscal deficit ofRs.1,53,637 or 5.6% of GDP relies more on the realisation ofadditional revenue of around Rs.3000 crore from service tax despitethe current fiscal’s revised estimates being short of the budget estimatesby more than Rs.1000 crore.

It is proposed to buy back old domestic debt from banks to capitaliseon the falling interest rates. Interestingly, government effected therate cut under small savings schemes administered by it, by 100 basispoints. Though the government argues that the real returns fromthese instruments would be around 6.3%, which is higher than whatwas offered during 1991-92 to 1995-96, one is not sure if this wouldhold good for long when the inflation rate has started climbing up inthe recent past. More so with the kind of push being given toconsumerism, savers may end up with lower real returns. This mayultimately affect national savings behaviour which in the ultimateanalysis is in nobody’s interest.

Budget proposals talk about giving a major thrust to infrastructure:Plan outlay under power, roads, and national highways is beingincreased 22%, 39% and 23% respectively. But, it is not clearwherefrom the funds would flow in for its accomplishment; that toowhen we lack the required political will to frame policy guidelinesthat are capable of sustaining uninterrupted flow of private investmentinto infrastructure development. The situation looks more grim if wetake cognizance of what a recent World Bank report observes: Growingfiscal deficit over the years “resulting in higher inflation” which can“push up interest rates, further crowd out private investment, weakenthe health of the financial system and increase vulnerability tomacroeconomic risks.”


Dumped in bewilderment? Wondering if India is really on themove? Guessing its potential to rapidly advance to prosperity?Wondering if it could ever banish its poverty?

Well! With the kind of “resource base, the strength of its humancapital and the immense reservoir of its knowledge” it is no wonder ifIndia achieves these goals but it certainly asks for a consummateleadership that is willing to take unpleasant decisions.

——)0——


The Federation of Indian Chambers of Commerce and Industry(FICCI) that was established in 1927 at the behest of the Father

of the Nation—Mahatma Gandhi—with the objective of garneringsupport for India’s independence and to further the interests of theIndian business community, recently celebrated its platinum jubilee.

The celebration, as claimed by the out-going President of FICCI,was indeed a historic event. The deliberations were true to the occasion.The thoughts aired, though not fresh, made an apt reflection of thecurrent scenario. They merit meditating for that may help the nationtranslate the thoughts into action.

Let us first recall what the prime minister said in his address tothe gathering of the captains of industry. He expressed his anguishat the persisting problems in fiscal consolidation both at the Centreand in the states: slow implementation of reforms in the power sectorand on the labour front; and the pace of infrastructure investments.

January 2003.

TWENTY SIX

Walk the talk…Oh! “me?” no way

If all the talk of leadership about prudence,governance, accountability etc., is only for others topractice, we may not succeed in the global arena.

113Walk the talk… Oh! “me?” no way

He said he was concerned that the systems, procedures, rules andregulations in the government had still not been sufficiently reformedto serve the needs of rapid economic growth. He called upon theindustrialists to somehow “increase the growth rate by a couple ofpercentages without any financial investments by carrying outnecessary governance reforms at various levels.”

What a profound statement! And how rightly it captured the illsfaced by the country! It makes one feel sick at the haplessness of thegovernment. And, mind it, these statements have come from no lessthan the Prime Minister of the country. Now the question is: Are weto stay content with our learned helplessness?

This bewilderment begets a battery of questions: who can ensurefiscal consolidation? Who has to hasten the reforms process in thepower sector and pave the way for private investment? Who has totake the initiative to increase the growth rate with no additionalinvestments? Who has and where from to start reforms in governance?Does all this mean that the Central and state governments do nothave the willingness to make things happen? Are they so moribundthat they cannot unshackle the nation from its inefficiency, wasteand diffidence?

It is not that we have lost everything: the very fact that the primeminister could so publicly air his anguish at the sluggish growth inreforms speaks volumes for our willingness to correct the things, toset the nation on the right course, that too perhaps through thechosen democratic process. And, in fact, that may be what the primeminister had at the back of his mind when he aired his displeasure atthe tardy growth the nation has been witnessing.

Let us now turn our attention to what the literature on fiscalpolicy and its influence on economic growth has to say. The neo-classical school states that fiscal deficits in a closed economy increase


aggregate consumption leading to reduction in national savingsresulting in higher real interest rates and this in turn, depressesinvestment and overall economic activity. In an open economy, higherfiscal deficits are reflected in higher capital flows and a realappreciation leading to lower net exports and again, a reduction inoverall activity. In either situation, the net result is, crowded-outinvestments and reduced activity. But, according to the Keynesianapproach, if the economy is operating at a less than full employment,expansionary fiscal policy is conducive to growth.

Against these theoretical underpinnings, let us take a look at whatis happening on our home front. In our anxiety to achieve fiscalconsolidation, we have sacrificed social sector expenditure comprisingmainly, education, medical facilities, public health, family welfareand sanitation. Similarly, the government has practically withdrawn totallyfrom incurring any capital expenditure on infrastructure build-up.

On the other hand, the OECD countries achieved fiscaladjustment during the ’90s, mostly by way of expenditure reductionsin areas such as wages, current transfers and interest payments ratherthan by tax increases. As against these cross-country experiences, weare today suffering from our inability to curtail revenue expenditures.The current expenditures are assuming a larger proportion of thegovernment expenditure, mainly driven by consumption expendituresand transfer payments viz., interest payments, and subsidies. Thedeterioration in the revenue/GDP ratio has obviously affected theinvestments in productive sectors. Nor has the anticipated investmentin the infrastructure come from the private sector. The net result isthe deceleration of the economy.

What this ‘reality’ calls for is anybody’s guess. It is time someoneinitiated the much-needed frontal assault on waste and inefficiencyin government and business. When wastage in government is

115Walk the talk… Oh! “me?” no way

rampant, taxes become small. Secondly, be it China, Europe or theUS, they all leveraged on their robust public institutions for growth.But our public institutes turned out to be ineffective, iniquitous,inefficient and a drain on the exchequer, all because of the lack ofpolitical will to keep these institutes at arm’s length from the politicalleadership.

Now, the moot question is, who has to energize these institutes toimprove their efficiency and effectiveness; and who would take theinitiative to reform the governance of the national resources. Thisreminds us of what the outgoing FICCI president said at thecelebrations: “You can’t build a reputation on what you’re going todo” but have to “walk the talk.” He then called for ‘accountability’ inthe system, pointing out that today “we have no way to provideredressal or disincentives, leave alone penalty, if the systems areinefficient, or they do not deliver the right goods”. The message isquite obvious: it is the government which has to take a bold decisionon creating conducive ‘atmospherics’ for private investment, bothfrom within and outside the country in the form of FDI, by puttinga ‘once-for-all’ framework in operation.

Intriguingly, at the end of the day’s celebrations, Sri Rajendra SLodha passed on the baton of presidentship of FICCI to Dr. ACMuthiah, Chairman, SPIC Ltd to steer it through the year 2002-03.

Utterly baffling?

——)0——


“To disinvest or not to”, has of late become, shall we say, the pastime of the intelligentsia in India. Look at any of the

newspapers or magazines – they are full of the ‘Whys’ and ‘Why nots’of disinvestment and sets of prescriptions from the elite for managingthe transition. The intelligentsia is arguing that the public sector is adrag on the Indian economy. Right from the former finance ministerto the coffee-shop gossipers, public sector-bashing has become afashion. How times have changed! These are the very same enterprisesthat were once referred to as ‘temples’ of modern India but appear tohave run their course.

One school of economists attributes all the ailments afflictingIndian economy today, to the inefficient functioning of the publicsector undertakings (PSUs). It is commonly perceived that PSUs arethe personal fiefdoms of politicians and bureaucrats. They stronglybelieve that Indian politicians are the most undesirable agency to beassigned with the responsibility of controlling the country’scommercial assets.

December 2002.

TWENTY SEVEN

To disinvest or not to….

Who owns the assets (PSUs) is less important thanwho manages them and how?

117To disinvest or not to….

Admittedly, it may all be well-founded, for politicians are knownto grab the earliest opportunity to appoint their cronies on the boardsof companies in their domain and use the assets of those companiesas their personal property. While the chief executive of a public sectorundertaking can be fired overnight for the failings of the unit, theminister concerned cannot be held accountable. Given the option,these politicians would not let go the various perks that they couldenjoy by being with PSUs and in the process make them less and lessbusiness-oriented and more and more accommodative in nature tothe whims and fancies of the political leadership.

That apart, over a time, one segment of the elite started labellingthe public sector as inefficient and is clamouring for its immediateprivatization. It is their firm belief that business is no business of thegovernment. These zealots are therefore arguing that privatization isthe only way to make the virtually defunct public sector units onceagain productive. In support of their argument they cite the exampleof China, whose competitiveness is claimed to have been enhancedby the large scale privatisation of State-Owned Enterprises andrationalisation of labour force that commenced sometime in 1995.But, it is pretty simplistic to think that everything relating to thepublic sector is bad.

It is equally naïve to think that the private sector is free from allthese ills. As argued, if private ownership guarantees performance,how does one account for the mounting NPAs under the corporatecredit that the banking system in India is saddled with? The slew ofscandals breaking in corporate America does not speak any differentlyabout private ownership. The accounting scandals in the US make itclear that when it comes to enriching themselves at the cost ofshareholders, industrialists and managers in the private sector are noangels. The managerial greed to amass wealth among the executivesof even reputed American corporates was reported to be of amonumental scale.


This being the truth of a market that is considered efficient andhighly transparent, being overseen by a powerful regulatorymechanism, it is hard to bite the thesis that private ownership inIndia will fare better. Even the existing literature on privatizationsuggests that wherever opportunities for ‘tunnelling’ exist, meretransfer of ownership into private hands is not going to make muchdifference. Worse still, where there is a scope for ‘siphoning of funds’,there would be no incentive for even the private management tomaximize shareholder value via improved performance of the company.

Interestingly, what emerges from these two sets of arguments isthat mere ‘ownership’ of assets does not make them productive but itis the ‘management efficiency’ that makes a corporate’s existencemeaningful to its shareholders. To put it differently, “efficientmanagement” is neither the property of private ownership nor ofpublic ownership. In fact, we have enough evidence from PSUsthemselves to support this argument. The spectacular success of PSUssuch as BHEL, IOC, ONGC, HPCL, which were headed by qualityleadership, is a testimony that ownership by itself cannot define thesuccess. Here, by “efficient management” we mean subjecting thecorporates to the discipline of capital market and making executivesaccountable to the shareholders; existence of a strong institutionalframework that evens out the ‘principal-agent’ conflicts inherent inthe companies’ management and surveillance of the market by apowerful regulatory agency backed by an equally tough lawenforcement mechanism.

It is, altogether a different thing that the US with suchinstitutional framework and acknowledged as an efficient market,functioning under the doctrine of capitalism, miserably failed to arrestthe expropriation of investor’s funds by unscrupulous managements.Nevertheless, this hard reality posits a baffling question—“What, then,is privatization for?” The answer would perhaps be more baffling for

119To disinvest or not to….

we do not know what skeletons would tumble down out of the Indiancorporate world if we had the same reverence for corporate governanceand powerful market regulators as the US had. Even otherwise, meretransfer of ownership of the already existing assets to private handsneither adds to the nation’s wealth nor anything substantial to theGDP.

There is yet another purpose for which disinvestment ofgovernment stake in PSUs is recommended – to use the proceeds fornarrowing our ever growing fiscal deficit. This recommendationsounds pretty suicidal. This only reminds us of what a 20th centuryAustrian economist, Ludwig von Mises, once said: “It may sometimesbe expedient for a man to heat the stove with his furniture. But heshould not delude himself by believing that he has discovered awonderful new method of heating his premises.” To rein in the fiscal-deficit the government should curtail its revenue expenditure forth-with but not sell the stake in PSBs or shy away from investing ininfrastructure development, education and healthcare.

Lo! we are back to square one: ‘disinvestment’ per se is not an endin itself. Whether ownership rests with the private or public, it hardlymakes any impact on “efficiency levels” unless the government doeswhat it alone can do, i.e., create conditions for growth through higherpublic investment in areas such as education, health, water supply,irrigation, infrastructure, and economy is made to learn and practisenot to tolerate “somnolence, sloth and non-conformity to generallyaccepted international norms and standards of macroeconomicmanagement, disclosure, transparency and financial accountability.”

——)0——


The recently announced mid-term review of monetary and creditpolicy has indeed brought cheers to bank borrowers but the

depositors have nothing to cheer about. The cut in the bank rate by25 basis points brought it to 6.25%, which is the lowest since 1973.This cut in the bank rate has set in motion the process of reductionin interest rates on bank deposits by more than 25 basis points.Ironically, the dividend paid today by some of the commercial banksis perhaps more than the interest rate of 6.5% being now offered ona deposit of three years maturity.

That apart, what is more intriguing here is the reliance of themonetary policy on the Wholesale Price Index (WPI) instead ofConsumer Price Index (CPI) for gauging inflation. True, inflationhas been declining sharply in the past couple of years: Inflation ratemeasured as point-to-point variation in the wholesale price index fellfrom above 5.0% during the first five months of 2001-02

December 2002.

TWENTY EIGHT

Interest rates under deregulatedregime and market dichotomy

The interest rate behaviour outside the bankingsystem is sure to frustrate the monetary policy inaccomplishing its objectives.

121Interest rates under deregulated regime and market dichotomy

(April-August) to touch 1.1% as on February, 2002, being the lowestin the last two decades. The rate of inflation during 2002-03 continuedto remain low and currently stands at 3.27% as compared to 5.5%during the corresponding period of 2001-02.

But, at the retail level, consumer prices diverged from WPI-basedinflation. The annual point-to-point variation in the Consumer PriceIndex for Industrial Workers (CPI-IW) rose to 5.5% in 2002-03 from2.5% in 2000-01. This difference between WPI-based inflation andCPI-IW compels one to suspect the present levels of inflation.Paradoxically, while the prices of luxuries have come down, those ofnecessities have not. Even if the official inflation rate is believed tobe correct, which is currently above 4%, one has to say that the realinterest rate of return has fallen sharply. Its impact on savings hardlyneeds to be stressed here.

So, what is the net impact of these measures? One thing is certain:It compels savers to scout for better avenues that pay them more thanwhat they can get from the banking system. Resultantly, savers maydivert their savings towards stock market. Incidentally, immediatelyfollowing the monetary policy announcement, BSE Sensex movedup by 1.8%. But, stock market behaviour being not rational alwaysand with the kind of losses the investors have suffered earlier, it’s nowonder if the present rise in Sensex is only an “announcement-effect”.If that is true, the savers may ultimately move towards eitherundesirable consumption or move away from the banking sector. Eitherof these two is potential enough to erode the savings rate, should thecurrent low interest rate regime remain unaltered in the medium-term. Once the savings rate comes down, there is every danger ofliquidity-crunch revisiting the system, making everything hot onceagain. How soon it would be, is the big question mark, but that iswhat really matters to risk managers in banks.


Worse yet, the RBI Governor’s statement on interest rate cutcategorically states that no useful purpose would be served by a furthercut in the interest rates. Nor are the corporates likely to grab creditsimply because interest rates have been reduced. Over and above this,the system is going to be replenished with additional funds to thetune of about Rs.2,500 cr by way of reduction in CRR.

As against the falling interest rate scenario in the banking system,the unorganized sector continues to function merrily with highinterest rates. Even in today’s scenario of a liquidity overhang in thebanking system, entrepreneurs from the unorganized sector, such asbus operators, building contractors, real estate developers, trade andcommerce, are borrowing funds from the market at an exorbitantrate of 2.5 to 3% per month.

Even small entrepreneurs are mobilizing funds at three or fourtimes the bank rate from private moneylenders. The real rate of returnearned from such investments is pretty mind-boggling vis-à-vis thereturn from the banking system. It is thus evident that we have twodistinct sub-systems within the financial system, operating under twosets of interest rates. Incidentally, entrepreneurs are known to visitboth the segments of the market for mobilizing funds to pursue theirbusiness interests, as the unorganized sector is almost functioning asa parallel economy under its own unwritten laws. Thus, it has thepotential to frustrate the monetary policy initiatives addressed to checkinflation and bring down interest rates.

To make the interest rate channel an effective conduit of monetarypolicy, all interest rates in the economy, including small savings rates,should respond to monetary policy directives. But, the ruling priceson small savings schemes hover around 9% for a maturity of sixyears. As the expert committee appointed under the chairmanship ofDr. Y. V. Reddy, the former Deputy Governor of Reserve Bank of

123Interest rates under deregulated regime and market dichotomy

India, on small savings schemes opined, that if the 9% is risk freerate, commercial banks should offer this risk-free rate plus riskpremium as their interest on deposits of similar maturity, if they haveto wean away the savers from the post-office. But today’s interest ratestructure of commercial banks indicates that they have simply giventhe go-by to this basic principle of market-driven economy. It is ofcourse a different matter – thanks to Indian savers! – that banks stillcontinue to attract fresh deposits defying all the canons of risk returntrade-off.

There is yet another angularity in the market: Pass-through isasymmetric, i.e., the loan rates react faster to tight policy initiativesthan they do when the policy is eased. The policy implications of thisslow “pass-through” are that a smaller change in the policy rate willachieve the desired change in the lending rates within a short periodand vice-versa. But what is desired is uniform ‘pass-through’ policysignals across the entire spectrum of interest rates. In such a market,proactive institutions are likely to either suffer or gain from theirinstantaneous reactions to the policy initiatives.

Lastly, inflation is another key macro economic variable that affectsthe rate of interest. The world over, the consumer price index isbeing used as a measure of inflation against our practice of relyingon WPI. There are obvious reservations about using WPI, as it restrictsthe scope for a proper comparison of the inflation rate of two nations.Some time ago, Dr. Y. V. Reddy, Deputy Governor of Reserve Bankof India, while reiterating the need for “a national consensus on theacceptable level of inflation,” called for a change in the weightagesof indices used in the calculation of inflation rates: “It is now obviousthat none of the existing measures provides a truly reliable gauge ofinflation at any point of time; the issues relating to base year, coverageand weights have to be resolved”. Although a move in this directionhas been initiated, nothing substantial has been accomplished. There


is also a criticism regarding non-inclusion of the service industry inthe computation of WPI, as its omission distorts the real inflationrate in the economy.

There is also no unanimity in the views on using the past orfuture inflation rate for measuring the real interest rate. Someeconomists are of the view that the future inflation rate should bededucted from the nominal interest rate for calculating the real interestrate. Similarly, the concept of core inflation has also been advocated.

Under these dichotomies God only save the banks!

——)0——

125Why gold is still “good as gold”?

Since time immemorial, gold has been one of the greatestweaknesses of mankind in general and Indians in particular. It

holds a queer fascination for everyone. A great deal has been spokenor written about it, yet all these discussions and writings have generatedonly heat and hardly thrown any light on its price behaviour as ishappening with its current bullish rally all over the globe.

In its glittering past, many have glorified the yellow metal as thebest-fit to play the monetary role. But Keynes and William Jenningshad castigated gold by describing it as a “barbaric relic of the past.”Despite what people say about it, gold continues to remain as theultimate hard asset that normally shines in times of financial turmoil.It often tends to take its traditional role as an asset of last resort as iscurrently happening, although it lost its monetary role long back.

Historically, gold functioned as money. Till the beginning of the19th century it was quite customary for the kings and queens of thecontinent to mint gold coins. They served as a medium of exchangenot only for domestic transactions but also in trade and paymentAugust 2002.

TWENTY NINE

Why is gold still “good as gold”?

Gold – the safest asset, particularly in times ofeconomic crisis – is still considered as one of theworld’s highly liquid assets.


transactions with other countries. The par values of currencies of thecountries in terms of gold standards were directly determined by theirrespective gold content. However, later this scene changed withcountries finding gold coins/bars quite inconvenient to carry aroundfor spending purposes and with governments issuing paper certificatesthat are redeemable in gold on presentation to the treasury or centralbanks. Subsequently, with the world gold production being foundinsufficient even in those days to meet the rising demand of goldcoinage, there was a move among certain countries to use silver as asupplement. This move towards bimetallism marked the first steptowards reducing the monetary role of gold.

In post-World War II, with the declining economic and politicalstrength of the UK, the USA emerged as the world’s greatest economicpower and as a result, many countries have preferred the US dollar togold and pegged their currencies to the US dollar. This was followedby other reasons such as declining gold component of world monetaryreserves, deflated monetary stocks being exposed to further drainduring speculative “gold rushes”, and the resulting move of centralbanks not to intervene in the private gold markets in the late 1960s.Creation of SDR in 1969 as a reserve asset, and the failure of monetarygold stocks of the central banks to arrest the spurt in the free marketprice of gold have ultimately stamped the gradual exit of gold fromglobal monetary role.

In the recent past, gold regained its lost lustre with the pricesshooting up from dollar 255 to 305 per ounce, its highest level innearly two years, in international markets. The plausible reasons forsuch a bullish rally are many: The ongoing global recessionaccompanied by worldwide stock markets melt-down; pessimistic outlookof Warren Buffet, a noted investor, on the world that is besieged byterrorism and his warning about the meagre returns from the stockmarkets over the next few years; shaky Japanese banking system that isplagued with uncertainties about their solvency, falling interest rates

127Why gold is still “good as gold”?

to as little as 0.02% per year, the trade-off between the ultra low interestrate and security and the recent withdrawal of government insuranceon savings have shaken the faith of the Japanese compelling them tolook for alternative secure places to put their money in and in theprocess gold became the Mecca of their investments contributing around10% to world gold sales; Chapter 11 bankruptcy filing by Enron andthe accompanying perception that there is no shortage of egregiousconduct elsewhere in the corporate world of the US; Argentina’s defaulton its sovereign debt; the September 11 terrorist attack on US; gradualdecline in gold production in the last three years etc., have allcumulatively resulted in loss of faith in fiat currency resulting in arush for gold. Secondly, analysts attribute the current rise in gold pricelargely to increased demand in the US where low interest rates havemade bond and money market yields unattractive and fears of war inthe Middle East have driven people towards safer investments.

Gold is perceived as “store of value” as it still meets the functionof money particularly in the context of free fall/collapse of currenciesas is seen in the case of former USSR. Second, it offers hedgingfacility against inflation akin to taking an insurance policy againstcalamities as its price is strongly correlated to inflation. Third, it isone of the safest assets, particularly in times of economic crisis. Fourth,it helps in diversifying an investor’s portfolio. Lastly, it being one ofthe world’s highly liquid assets, offers high liquidity. So, there is noescape from its lure whatsoever and people can’t but fall for it.

Historically, gold has been used as a safe haven by almost everyone who had access to it and could afford to own it. People own itbecause it has no risk unlike fiat currencies that could be wiped outshould the fiat monetary system collapse. It is to hedge their betsagainst economic instability that investors buy gold. There is, however,a hitch here—as long as gold continues to function as money, and isquoted in US dollars, it will continue to respond to any change inexchange rates just like any other currency such as yen, euro. So the


sustainability of its current price-rise depends much on the movementof the dollar exchange rate.

Currently, US economic growth is slowing down, inflation isrearing its ugly head and the Federal Reserve is increasing the moneysupply to fight off recession. In the process, the heyday of dollarappears to be over and if this really happens, investors having noother alternative for safe parking of their funds, more so when yenand euro are languishing for their own reasons, would obviouslyresort to buying gold. In short, if the current gold price rally is tosustain, one needs to see a weakening dollar against foreigncurrencies, else the rally may well be a short-lived one.

It’s amazing that even after its diminishing monetary role, goldcontinues to sway the emotions of people with its scintillating andrewarding appeal and value to those who come to grip with its pricebehaviour. Despite 8000 years of experience, why gold is good asgold remains an intriguing question. Many have attempted to explainit in many ways but none to the satisfaction of the commoner exceptof course the Egyptians who have aptly said that gold’s value is afunction of its physical characteristics and its scarcity.

Many of the physical attributes of gold are quite incredible: it’sthe most malleable of all metals; its ductility is amazing; itsresplendent lustre allows it to be designed into the most covetedand exquisite jewelry that befits queens and kings. Its scarcity ismore unbelievable than its physical characteristics for, the world’sholdings accumulated from time immemorial to the present are onlyaround 1,20,000 tonnes. As against this, banks can create dollarsand there are no physical limitations on the quantity that can becreated. Similarly, they can disappear as easily as they were createdwhile gold is almost indestructible. And that’s why gold continuesto lure mankind for good.

——)0——

129CRR ‘reduction-package’: Is it really all that?

It’s amazing. It is incredulous, for never in the past did any one from the country’s central bank ever attempt to reveal his or her

mind before pronouncing regulations, nor ever share with the intendedusers, their perceptions about the proposed changes in the regulations.That is exactly what Dr. Y. V. Reddy, the Deputy Governor of theReserve Bank of India, did in Chennai when he said, “the centralbank may consider announcing a one-time reduction in the cashreserve ratio from the present 5.5 percent to the statutorily prescribedminimum of 3 percent in one go.”

Elaborating on the package, the Deputy Governor said that thereduction in the CRR should be accompanied by several changes,such as change in the way banks at present maintain cash balance.He also opined, “as CRR gets lowered and repo-market develops,refinance facilities may have to be lowered or removed altogetherand the access to the non-collateralized call money market restricted

February 2002.

THIRTY

CRR ‘reduction-package’:Is it really all that?

The Deputy Governor’s revelation about the intendedreduction in the CRR from 5.5% to 3% is a radicaldeparture from the set practices of central banks.


with the objective of imparting greater efficacy to the conduct ofmonetary policy.”

This indeed is a great transformation in the mindset of regulators.Such loud thinking would no doubt go a long way in enabling themarket players to get ready with the strategies required to managethemselves under the proposed changes. Thus far it’s pretty good,but its timing is disquieting. In fact, the sharp rise in the prices ofgovernment bonds immediately following these statements vindicatesour anxiety about the injection of excess liquidity and its adverseimpact on the system.

This scenario gets worsen when one takes note of the fact that thecommercial banks’ credit growth during April-December 2001 fellsharply to Rs.37,256 crore from Rs.49,615 crore recorded for thecorresponding period in 2000. As of December 2001, the non-foodcredit grew 10.8 percent on a year-to-year basis as against 19.5 percentgrowth recorded the previous year. This poor credit off-take obviouslyforced banks to end up in having an average excess investment of 40percent under SLR securities as against the required 25 percent.

As ill-luck would have it, the Indian economy’s performanceduring the current fiscal is no better than the banks’ dismal performanceon the credit front. The government’s falling tax receipts, rising non-plan expenditure, bulging revenue and fiscal deficits are indeed quitedisturbing. There is nothing happening on the macro-economic levelthat encourages one to hope for an early upturn in the economy. Thefact that bond prices suddenly went up following the DeputyGovernor’s statement on RBI’s intention to reduce the CRR to 3percent, is perhaps a forewarning of the scenario that is likely tounfold once the cut becomes a reality.

Unless the government comes out with policy initiatives to give apush to economic activity that encourages private investment in

131CRR ‘reduction-package’: Is it really all that?

infrastructure, there may not be any appreciable demand for creditfrom corporates. Perhaps, the only alternative for banks then wouldbe to go all out for retail lending which again is not everybody’s ballgame. No wonder then, if PSBs, wittingly or unwittingly, once againend up in more SLR securities than what is statutorily required, andthere appears to be no dearth of securities as the government hasalready surpassed the net market borrowings proposed in the budgetby about Rs.3196 crore, while another Rs.7500 crore is to be borrowedto redeem the debt likely to mature during the current fiscal.

As the proverbial last nail in the coffin, the Deputy Governorstrongly desired that banks should use the call money window onlyto iron out their temporary mismatches in liquidity and not as a sourceof funding their normal requirements, that too on a sustained basis.Admittedly, it is a laudable objective. However, this kind of governancebased on external control is more prone to fail, for in the long run itis only self-control that survives. Moving to self-control is not only aprocess of advancing to maturity – not just among individuals but onthe part of organizations too – but it also helps regulators in reinforcingorderliness in the market.

The most surprising thing here is that on one occasion or theother, similar apprehensions have been aired by all concerned,including the regulators. For instance, the RBI has been consistentlypointing out that the monetary policy in terms of quick-fixes, likecutting interest rates, may not be very effective when the slowdown isquite structural in nature. The former governor of RBI, Mr. Rangarajan,once said, “Lowering of interest rates need not necessarily stimulateoutput.” Despite there being easy money available all around, creditoff-take has been languishing for the last one year. It is against thisbackdrop that the present proposal to reduce CRR from the ruling5.5 percent to 3 percent in the form of a package in one go makes it‘a riddle wrapped in a mystery inside an enigma.’


It is of course altogether different if the current articulation aboutthe cut in CRR is part of a bigger gameplan of RBI that intends toexperiment new ideas to promote economic revival and in the processobliquely suggest loosening of the controls on inflation to give agentle push to the growth rate. And this is quite plausible as the RBIhas been talking for quite some time about the adverse effects of theongoing deflationary trends on the economy.

To better appreciate the dichotomy of falling prices being not goodfor the GDP growth, it may not be a bad idea to spend a few minuteson inflation and deflation. Deflation is a situation where falling pricespersuade consumers to defer their purchases in anticipation of a furtherfall in prices in the future. This deferment of purchases by theconsumers results in a decline in demand leading to a further fall inprices and thus sets in motion the deflation cycle. This is what RBI,describes as bad for GDP growth and in its ‘Report on Currency andFinance 2000-2001’ suggests an optimum level of growth‘maximizing-inflation’ of around 5 to 6 percent a year. This line ofargument leads to the obvious question: Is the present talk of reducingCRR in one go to 3 percent a part of RBI’s overall strategy ofmanipulating monetary policy to push up inflation so that economycan be given a kick-start?

If this is true, the current articulation about cut in CRR by themonetary authority deserves to be complimented as proactive besidesof course being provocative, for there is every danger of these pro-inflationary measures going out of control owing to the infirmitiesinherent in our market. All this cumulatively makes monetarymanagement complex and necessitates a quick test checking of variousideas well before the deflation hijacks the growth in economy as hashappened in Japan and elsewhere.

Wow! It’s highly thoughtful of the RBI.

——)0——

Section II

Capital Markets

“Sensex nose-dived by 826 points”; “Meltdown: investors lose Rs.225681 crore”; “Largest fall in BSE’s 130 years” – thus

screamed the market players on Thursday, 18th May 2006. Comingto the details: The market suffered its biggest single day fall of 6.8%.As the benchmark index fell from an intra-day high of 12217.81 to11391.43, it wiped out a whopping Rs.2,00,000 crore of marketcapitalization – all in a matter of a day’s trading. No support waswitnessed even at 11400 levels, though; unlike on May 17th 2004 itdid not trigger circuit breakers.

‘Volatility’ is, of course, not new to stock markets, but what isdisturbing this time is its extreme reaction. And, what matters morehere is reaction to what? Market Pundits are, of course, ready withanswers, though on hindsight: it is the global meltdown that tankedSensex. Every market analyst sang in chorus that globalization is theprime cause for the current market crash. True, it is the globalizationthat has provided infinite liquidity in the form of FIIs that took theIndian stocks to dizzy heights. And it is the same globalization, whichhad knocked the Sensex off the cliff and crash-landed it in Chowpati.

May 2006.

THIRTY ONE

Sense and sensex

Are they strange bedfellows?


What more do you need to prove the force behind the crash than thefact that FIIs dumped Rs.2500 crore worth of stocks in one week?

But, then, is it all that sudden, or that unexpected? “No”, it’s nota storm on a clear sunny day, for it was only on Monday, May 15ththat the Sensex lost 463 points. For that matter, Dalal Street hasbeen witnessing ‘disturbances’ for the last two weeks. Nor did theturbulence felt in the global stock markets for the last one week makeany sense to the market. Despite the signals about the impedingturbulence being so pronounced, no one prepared to tighten the seatbelt; on the other hand, everyone preferred to cheer the sort of recoverynoticed in Sensex subsequently. And that is the influence of ‘hubris’?Or, sense and Sensex cannot be cosy bedfellows? And that could beone reason why Keynes would have said: “markets can be ‘irrational’for a lot longer than you can be solvent. The most egregious exampleis in recent times is the dollar and exchange rate: dollar rate risingfrom ¥99 to ¥147 in a matter of three years with little change ineconomic fundamentals”.

There is, of course, another story doing rounds as a cause for thehistorical crash. It runs thus: the CBDT issued a circular invitingcomments from the interested parties by May 25th on a circular whichwas issued by it on 31-8-1989 prescribing guidelines to distinguishbetween shares held as ‘investment’ by FIIs from ‘stock in trade’, andaccordingly, tax their returns, for it now wants to issue supplementaryinstructions on tax liabilities. “That is enough” is what analysts said,to make the market that is on a bull run to get tanked. And see the‘timing’ CBDT chose to attract the attention of players to tax-relatedissues! That, too, in a market where a handful of words uttered evenat a marriage party by those who are even remotely connected withregulatory establishments can count for so much. That being thereality, it doesn’t matter whether CBDT is aware of the likely impactof its action on the market, or not, it would and it did rock the market

137Sense and sensex

till at last the Finance minister dispelled the fears by clarifying theposition. But, once set in motion, the fall, in a bull market, as thetheory tells us, cannot but run for long and that’s what did happen.

And, of course, it is not for the first time; we did witness suchspooking by the government once in a while – albeit unintentionally.Similarly, global events impacting the Sensex is nothing new, for wehave been witnessing such falls ever since we have thrown open ourmarkets to FIIs. Reports are agog about the underlying reasons forthe current turbulence in the global markets: heightened fear aboutrising inflation rates, rising long-term global interest rates, fallingdollar, record US trade deficit, etc., are all contributing their mite.Yet, we don’t heed them.

We still want to call ourselves ‘rational’. But, when markets risewe cheer, and when they crash we all moan in chorus. Does it meanthat investors expect share prices to rise for ever? True, everyone isexpecting India to record the strongest economic growth in the worldthis year too. But, isn’t it a fact that our stock prices had risen toohigh, that, too, too fast? Can we afford to ignore the external andinternal developments of the recent past that can impact our growthadversely? Isn’t it true that for quite sometime everyone is talkingabout a ‘correction’? All this drives home a point: retail investorsmust keep watching stock valuations vis-à-vis economic fundamentals– both internal and external. For instance, the recent election resultsin states made analysts forecast that the present incumbent at thecentre may not deliver much under ‘reforms’. There are enoughreasons for the market to behave the way it did. Even otherwise, canwe forget the market dictum: “Risk and return go together”? But,what is more distressing is, that we refuse to change.

This reminds us of a dialogue that Bill Watterson wrote for Calvinand Hobbes cartoon. While careering through woods in their red wagon,Calvin turns to Hobbes and says: “it’s true, Hobbes, ignorance is bliss!


Once you know things, you start seeing problems everywhere. Andonce you see problems, you feel like you ought to try to fix them. Andfixing problems always seems to require personal change. And changemeans doing things that aren’t fun! I say phooey to that!”

In the meanwhile their wagon heading downhill picks up speed.Calvin turns to Hobbes and says, “but if you’re willfully stupid, youdon’t know any better, so you can keep doing whatever you like! Thesecret to happiness is short-term stupid self-interest!”

But Hobbes, peeping into the valley below utters in an anxiety-filled tone: “We are heading for that cliff!” Calvin putting his handsover his eyes says, “I don’t want to know about it.”

They fly over the cliff and crash-land. Hobbes then mutters, “I’mnot sure I can stand so much bliss.” Calvin responds, “Careful! Wedon’t want to learn anything from this.”

Any take-home from this? “Yes”, markets are changing everyday.Change could be triggered by any event: rising inflation rate in theUS and the consequent rise in interest rates can simply mop up thefree-flowing dollars from Asian markets, which means further fall inthe market. Volatility will haunt the market so long it is in a growthphase. Investors must therefore change their investment plans withagility, while regulators should realize the significance of changingtimes in which, pronouncements are prone to deliver unintendedresults unless timed properly. So, any takers for willingly becoming‘change managers’?

——)0——

139It’s all politics of economics!

Mr. Lakshmi Mittal, the India-born and London-settled richestindividual of Europe, has, by bidding for Arcelor, simply thrown

the continent into the blast furnace. How else can one explain theunprecedented reaction that emanated from Luxembourg and Franceto his offer to take over Arcelor that works out to Euro 28.21 bn – 25%in cash and the balance 75% by way of share swap in Mittal Steel,which Mr. Lakshmi Mittal justifies stating that “the offer provides avery attractive premium …a generous cash element.”

Mittal Steel, the world’s largest steel company in terms of crudesteel capacity and other related measures, made its grand vision forcreating a giant steel corporation with a capacity of over 100 milliontonnes by acquiring the world’s second largest steel company, Arcelor,so that the merged entity could be three times bigger than its closestrival, Nippon Steel of Japan. This move of Mittal, according to manyanalysts, is quite a departure from his known strategy of acquiringailing steel plants, and turn them around into success stories.

THIRTY TWO

It’s all politics of economics!

Europe has its own definition for ‘globalization’ andwhat is more, it longs to live with it.

April 2006.


That aside, the current move of Mittal to acquire Arcelor, is analtogether different story: Arcelor is one of the most profitable steelcompanies in the world and is an icon of Europe. Arcelor considersitself as the world leader in the steel industry in terms of high qualityproducts, technology, etc. It is after all the very steel industry of Spain,France, Belgium and Luxembourg. In the opinion of its management,Mittal can bring in no new technology to either improve its productquality or bring out niche products for catering to newer markets oraccess to key markets. All these countries in which Arcelor operatesconsider themselves having had a long history of steel-making andhence cannot stomach the fact of a relatively newcomer to the industrybuying their Arcelor. The net result is: a spat for Mittal not onlywith Dolle but also with the governments of Luxembourg and France.

The protests that are pouring out of Luxembourg and Paris caughtevery one by surprise. It is still understandable what Mr. Guy Dolle,CEO of Arcelor, said: “We produce perfumes, whereas Mittal makeseau de Cologne” but what is most wondrous is Mr. Jean-ClaudeJuneker, prime minister of Luxembourg which holds a 5.6 percentequity in Arcelor, rejecting the offer by saying that “the hostile bid byMittal Steel calls for a reaction that is as hostile”.

Nor could the President of France Jacques Chirac hold back hisstrong preferences when he said at the press conference in Delhi: “Itis purely financial. That is to say, without any industrial plan beingknown or conveyed and contrary to practice, without priorconsultations”.

The Finance Minister of France went a step farther when he saidthat as a stakeholder, his government cannot keep quiet when a hostileattempt is made to take over a company that is important to theircitizens. This is well reflected even in their other attempts to blockthe foreign bids for their companies, such as those emanating from

141It’s all politics of economics!

the US earlier and Italy now. But French companies ironically havea different story to tell: They made a record acquisition of foreigncompanies last year.

It’s of course nothing new – it was the same yesterday againstCNOOC Ltd. that bade for Unocal Corp. of the US; today it isagainst the DP World and in between Mittal and tomorrow it couldbe any other company. The story will be the same. It is the questionof acceptance. Today it is the businesses from an unknown corner ofthe globe that have suddenly emerged to take over the businessesironically, of the erstwhile trendsetters of cross-border acquisitions.And obviously, xenophobic reaction is the result.

Look! Here is a merger proposal which, according to manyanalysts, is well poised to offer certain strategic advantages. One,the merged entity by its sheer size can bargain for a better price foriron ore, coal, and other material that go into steel-making. Two,by virtue of its presence in all the segments of the steel industry andhaving plants in countries that are from both developed anddeveloping countries, the merged entity can better face the threat ofemerging economies flooding the markets with low-priced qualitygoods. Three, it can optimize on costs having multi-locationoperations which enables it to not only shuffle the product lineacross the centres but also to shut down the high-cost processingcentres without sacrificing the product range. Above all, the provenability of the Mittal group in managing widely disbursed steel plantsproducing all kinds of products with a focus on efficiency, costreduction etc., would be available for the management of Arcelor’splants too. Yet, it is the governments of Luxembourg, France, etc.,that are revolting against the offer.

Indeed, the market has greeted the merger announcement byjacking up Arcelor’s stock price 28% and Mittal Steel’s share prices


around 6%. Even the ‘sweet pill’ dividend of €1.20, an increase of85% over the previously declared dividend, announced by Arcelordidn’t make much difference to the markets. Incidentally, the dividendwas again raised from €1.20 to €1.80, perhaps vindicating the fact ofno effect of earlier announcement on the market.

Yet, the management of Arcelor does not mind accusing Mittal ofbringing political overtones to the deal, while the fact is that it is theLuxembourg and French governments that took the side of Arcelor.According to the International Herald Tribune, “Mittal represents achallenge to Europe that is profoundly new: the emerging marketnot as a front of cheap talent, but as a springboard for new businessmodels and new multinationals seeking to beat or buy Westerncompanies”. Isn’t it a sheer exhibition of “economic patriotism”?

Amazingly, these very countries do not mind preaching free tradeand globalization to every other country, but when it comes to them,what matters is simply their own interests and in the process, theydon’t mind flouting what they urge others to do. Isn’t it politicsdriven by economics?

——)0——

143Thundering in the Indian skies?

Indian aviation industry has at last come of age. First, it was theopening up of the Indian skies for private carriers. Then the

development of green field airports followed by modernization of Delhiand Mumbai airports through private participation.

The real thunder is, of course, Jet taking over its rival carrier, AirSahara, for $500 million. Mr. Naresh Goyal, Chairman of Jet Airways,said that it won’t take over Air Sahara’s liabilities, but merge Sahara’sbrand into its own. With this acquisition, he hopes, to increase Jet’smarket share to about 50 percent.

Mr. Goyal’s anxiety to take over Sahara is quite palpable: with theadvent of low-cost carriers, Jet has been experiencing stiff competition.Within two years of its operation, Air Deccan captured a market shareof 11%. The recently started Kingfisher too could muster a marketshare of 6%, while it is 5% in the case of Spice jet. The net result wasthat Jet was losing its market share. The only way then for Jet tosuccessfully face competition was to acquire ‘size’. And that preciselyis what it did.February 2006.

THIRTY THREE

Thundering in the Indian skies?

Mergers with little or no revelations on ‘pricing’ areof late causing much consternation to investors individing whether to stay put with the mergers or not.


That aside, the centre for Asia Pacific Aviation estimated the growthin Indian air travel industry at 50 million passengers by 2010. It alsostated that the industry would be requiring 450 to 500 commercialaircraft, 2000 to 2500 new pilots and supporting logistics at theairports. But the Indian airports are already choked up with airlinesgaping for parking lots, hangars etc. Analysts believe that theacquisition of Sahara will enhance Jet’s strength in every sense –financial, commercial, operational, technical, HR, and infrastructureperspective. According to one section of analysts, the resultingmonopoly in terms of parking lots in key metro airports like Mumbai,Delhi, and almost 50% share in the domestic market will simply enableit to price out many smaller players from the market. Against thisbackdrop, acquisition of Sahara by Jet makes great business sense: itgains just access to Sahara’s parking lots, ground crew, pilots, hangars,planes, and ultimately greater share in the domestic market.

There is of course a flip side to it: some analysts are labelling theprice of acquisition as ‘quite high’, given Sahara’s relatively smallmarket and not-so-efficient operations. Some analysts wonder howJet paid US$500 million for an airline that does not own a singleaircraft and whose market share is steadily falling. They are evenasking: “is it that Jet paid US$500 million to Sahara for its parkingbays, prime take-off and landing lots at major metros, hangars, pilots,other technical staff, etc.?” In fact, Sahara is burdened with lossestotalling Rs.145 crore. It is less profitable compared to Jet, as revealedby the net margins: Jet enjoyed a net margin of 9% during 2004-05as against 1.45% of Sahara. Sahara is over staffed. Even aircraftutilization is high in Jet vis-à-vis Sahara. Jet has, indeed, made aname for itself in maintaining service standards on a par withestablished international airlines. That being the reality, some thinkthat seamless integration of these two airlines may pose a challenge.

145Thundering in the Indian skies?

It is in this context that some analysts reckon that Jet, in its anxietyto turn Sahara’s loss-making operations around, may even getdistracted from ramping up international routes, which is a must forJet to ultimately become strong. In fact, it should acquire internationalroutes, particularly to the US, and operate to build strong brand,that, too, well before the other competing airlines become eligible tobid for international flights. It is of course another matter that itsapplication for rights to fly to the US has been pending for long.

That said let us now take a peep at two other associated issues.One, Asian companies are quite often found trading at a discount towestern companies. Many analysts believe that this is an outcome ofthe historical focus of Asian companies on ‘growth’ rather than on‘returns on capital’. According to them, growth, though essential,cannot automatically create sustained shareholder value. In theiropinion, what sustains the maximization of shareholders’ wealth isthe return on capital and nothing else. In that context, the cost ofgrowth tagged on to the price of an acquisition, as in the instantcase, therefore needs to be taken note of. Two, acquisitions are todayperceived by investors as causing consternation since they cannotmake an informed decision whether to stay invested or quit upon amerger announcement owing to paucity of information. The presentacquisition is no exception: Jet did not reveal how it valued itsacquisition nor do the investors know the market value of Saharasince it is a non-listed conglomerate.

Time alone can answer the question: is the acquisition of Saharaby Jet a thundering in the Indian skies or in the investors’ heart?

——)0——


Samvat 2061, the year that witnessed many records tumbling–the Sensex scaled the highest ever level of 8800, a record FII

inflow of $8.6 bn and a whopping Rs.6 lakh cr of wealth generation,has finally come to an end. It was a year that is to be cherished at leastfor some time to come.

Samvat 2062 thus began on an overall cheerful note. This positivemood was indeed vindicated by the happenings during Muhurattrading. The Sensex bounced back to 8000 on Muhurat trading butfinally settled down at 7944. The session ended with an ultimate riseof 52 points in the Sensex indicating profit booking immediatelyfollowed by the stronger move witnessed in the initial phase of trading.

The happenings at the Muhurat trading remind us of what hasbeen happening during the last five years: Every year the Sensex hasbeen rising followed by a fall, but the extent of the fall was found tobe very large, and very sharp—all in a couple of weeks. This cycle hasalmost repeated in the last five years but with a difference: Everybounce back in the Sensex has showcased a new set of stocks and a

December 2005.

THIRTY FOUR

Samvat 2062

The Indian capital market has certainly come of agebut it is the perseverant lot who can get paiddividends.

147Samvat 2062

new set of sectors as the leading stars. What then is the inference thatthe common investors must draw?

The underlying message is simple: Samvat 2062 will be like anyother previous year—the Sensex will rise, new set of stocks and newsectors will emerge pushing the Sensex forward while the rest of thestocks silently undercut these gains and suddenly pull down the mast.The investors therefore have to exercise utmost caution: theirinvestment must be driven by a sense of ‘vision’, a sense of ‘conviction’and tons of ‘patience’ rather than simply be carried away by the hypecreated by both the markets and its pundits.

Their ‘vision’ should enable them to foresee how macroeconomicfundamentals of the globe are behaving, what changes are likely tohappen and ultimately how these changes are likely to impact thebehaviour of domestic markets. And this is not a onetime affair:Markets, particularly stock markets which are in a constant phase ofchange, need to be analyzed repeatedly and strategies redrawn toshuffle the portfolios; otherwise yesterday’s portfolio might prove fatalfor today. For instance, till a couple of weeks prior to Muhurat trading,market pundits were saying that global liquidity was flowing intoemerging markets and hence the markets were in an upswing. It isestimated that over the last two years FIIs have pumped in around$140 bn into emerging markets. But when the markets started sliding,everyone started shouting in a chorus: FIIs are fleeing the country asinterest rates in America are poised for a rise.

True, such experiences are not that uncommon. During 1995,on account of a mere 2% points rise in the federal interest rate, theFIIs moved out of the emerging markets, lock, stock and barrel,plunging these markets in dark at one go. And such recurrences cannot be ruled out in the future. But such cyclical inflows and outflowsof FIIs’ capital in and out of emerging markets will have their own


underlying ‘reasons’, ‘pointers’ and ‘timings’ and anticipating themis what constitutes the ‘vision’.

At the time of Muhurat trading, analysts were saying that the USinterest rates will rise and with it FIIs will move their funds fromemerging markets back home. This move, they argue, will suck outliquidity as a result of which the Sensex is all set for a slide. Someanalysts have even argued that the current volatility in the crude oilmarket will only add fat to the fire. As against these predictions, theSensex surprisingly made a fastest ‘thousand-point recovery’. Nowthe moot question is what contributed to this reversal.

An interesting macroeconomic phenomenon is surfacing in theglobal economy: a glut in world savings. Among the Asian countriesitself the savings have reached a phenomenal height. Japanese forexreserves stood at $841.79 bn while China’s stood at $769 bn. Thecurrent savings rate of China is said to be 50% of its GDP, which isthe highest in its recorded history. Over and above this, it continuesto attract a good chunk of world’s FDI flows, which means moreaddition to its savings. Similarly, the soaring oil prices have catapultedRussian export earnings, resulting in a trade surplus of $113 bn.Owing to the booming commodity sales, even Brazil recorded a currentaccount surplus of $12.5 bn. So is the case with other Asian countriessuch as Taiwan, Korea, Singapore, and India. The net result is: Worldis flush with savings which are obviously searching for profitableinvestment avenues.

As against these requirements, world interest rates are ruling athistorically low levels. In fact, interest rates in the US are said to beyielding negative returns. Secondly, the returns on stocks in theadvanced countries are already enjoying a high price-earnings ratiowhich means limited scope for further appreciation. Thirdly, Europeis struggling to wriggle out of a poor growth rate which is more a

149Samvat 2062

result of its strengthening currency, while it is no different fromJapan’s plight. In such a scenario, the global savings are obviouslymoving towards other assets such as real estate and stocks in emergingmarkets for a better yield. This could be one of the prime reasonsbehind the quickest recovery of 1000 points that the Sensex couldmake in hardly 12 trading days. And if this is true, there is no reasonwhy the Sensex should not scale further heights.

And that is where the investors need to exhibit a sense of‘conviction’. They should pick companies that are sound in theiroperations and the macroeconomic fundamentals support them inachieving their sales volumes. Secondly, the investors must also beclear about the time span of their investment. Historically, it hasbeen established that investments made on a long-term perspectivehave not failed the investors in accomplishing their goals for the upsand downs of the stock market need to have time to average out andbless the investors with a ‘market plus’ return.

As a conviction, investors may also explore ‘contrarian investment’which is nothing but looking beyond the obvious. In other words, itmeans skipping the over-hyped sectors/stocks and staying focused on‘value-oriented’ investment. Experiences reveal that when the marketsentiment is upbeat, everyone craves to roam around index-stockswhile ignoring those companies which are undervalued by the marketbut enjoy bright prospects on a long-term perspective. Investors mustpick companies that are sound in their business as reflected in theirlow price-earnings ratios, price to book value, price to free cash flows,etc., with a courage of conviction. That is not enough. Once suchstocks are picked, an investor should exhibit lots of ‘patience’—patienceto wait for the executed ‘deal’ to deliver the results. Interestingly,Contrarian investment is more prone to deliver results when the bullrun is quite secular, which is indeed being witnessed by Indian marketscurrently.


To create wealth in Samvat 2062, investors should navigate withcaution that is prompted by a sense of ‘vision’, ‘conviction’ and‘patience’.

——)0——

151Transaction tax: No more deals, please!

“Reforms always come from below. No man with four aces asks for a new deal”. That was a point on which Irish Digest

once asked its readers to ponder over. Logically, the statement besidessounding true, appeals to everyone. But in reality, what one often seesis the opposite—the holders of aces are found calling shots and makingefforts to garner more ‘tricks’. The examples are not far to seek, for, weencounter such incidents everyday. Take, for instance, the current furorecreated by the stock-broking community demanding scrapping of theturnover tax imposed in the current budget. It is a strange situation!They have been spared the burden of the prevailing long-term capitalgains, and granted the benefit of reduction in short-term capital gainsby 10% but were asked to pay 0.15% transaction tax and they are onthe streets demanding withdrawal of turnover tax!

As against this, let us take a look at the plight of the Indian poor,who in the very words of the Finance Minister (FM) are in dire needof “basic education for their children, drinking water, basic healthcare,medicines at affordable prices and jobs for their children”. The FM,

August 2004.

THIRTY FIVE

Transaction tax:No more deals, please!

Is it always the well-fed that end up with carrots fromthe masters, though unfortunate?


of course, observed in his budget speech, “We shall ensure throughhigher and targeted investments that jobs are available to them”. Weare aware of what we have achieved so far under these heads and howdisproportionate the budgetary allocations are vis-à-vis the mammothtask on hand and what we contemplate to accomplish under thishead in the foreseeable future. Ironically, even in the current budget,except for allocating a greater part of his budget speech to agriculture,the FM hardly committed a plan outlay of 3% to agriculture andallied activities, which is inadequate to boost capital formation inagriculture. Intriguingly, these lesser mortals seldom took to the roadsdemanding fiscal support for ensuring that basic amenities are madeavailable to them. But, in the recent past, the farming communityhas resorted to suicides to express their haplessness. Does this realitynot make the statement—“No man with four aces asked for a newdeal” sound pretty hollow, at least in the Indian context?

To better appreciate the shallowness of the statement, let usscrutinize the turnover tax more deeply. The recent budget hasscrapped the existing long-term capital gains tax; reduced short-term capital gains tax to 10% and imposed a transaction tax of 15basis points on all transactions related to financial market securities.Reports indicate that the industry itself proposed such modifications.In the words of the FM, the transaction tax is efficient, neat, non-regressionary, eliminates tax avoidance and ensures that everybodycontributes to the exchequer. The reasons for its imposition arethus clear. Even otherwise, transaction tax is a very logical concept.It has proved to be successful in other developing countries such asKorea and Taiwan, which enjoy bigger market capitalization andhigher trading volumes compared to India, where it is currentlylevied at 0.30%. Of course, the said tax in these countries is leviedonly on cash market transactions. There is no turnover tax on debtand derivative market transactions and no short-term or long-termcapital gains tax.

153Transaction tax: No more deals, please!

Despite these experiences of other countries, the turnover taxproposal has shocked all those associated with financial markettransactions and drawn them to the roads. The brokers are protestingthe move under the plea that the trade volume on day traders’ accountwill be adversely affected. But the question is—what is the tradingvolume generated by these day traders even otherwise? They are well-known to play only on select scrips such as those having very limitedfree floating stock in the market, stocks of MNCs or stocks in whichFIIs are very active. In fact, they are known only to create volatility inthe market by virtue of their playing on a select few stocks. Hence,they cannot impact market liquidity significantly. Their othercomplaint about the turnover tax is that a levy of 15 basis points istoo much for investors. But if we recall the transaction costs associatedwith delivery as well as non-delivery-based trading through the erstwhilebadla trading mechanism, which were as high as 200 basis points(bps), the current imposition of 15 bps sounds pretty meagre. Secondly,for a long-term investor and that too after the removal of long-termcapital gains tax, 0.15% transaction tax does not sound hurting. Ofcourse, when it comes to the speculators from the non-institutionalsegment, such as day traders, the transaction cost may double withthe imposition of transaction tax but one has to choose between thelong-term interests of the market and self-serving protests from thespeculation-driven trading volumes/traders.

Another school of argument draws attention to the current globaltrends that have attached greater significance for cross-border portfolioflows, which are coming handy in implementing growth plans ofdeveloping countries. It argues that imposition of turnover tax onfinancial market transactions will hurt the flow of FII investmentsinto the country. This is certainly not a valid argument sincereplacement of long-term tax with transaction tax makes greatdifference to long-term investors such as FIIs who usually stay putwith investments for a long period to realize profits and hence, itwould be a welcome change for them. Similarly, it is easy for domestic


long-term investors to manage their tax compliances under thechanged set-up. They no longer need to bother about setting off thecapital gains against the losses incurred and will be freed from theassociated paperwork. There is a feeling in the markets that FIIs havenot been comfortable in investing in India because of relatively highlevel of taxation in terms of capital gains tax. Under the newdispensation, FIIs would feel more encouraged to invest in India.

There is, however, a need for the FM to re-examine the impositionof turnover tax on debt and derivative securities. It is a well-knownfact that our debt market is based mostly on government securitiesand secondary market transactions are carried out at wafer-thinmargins. Hence, imposition of tax on such transactions is more proneto kill the secondary debt market. Secondly, since traders under debtmarket are mostly government-owned banks whose profits are anywaytaxed at higher rates elsewhere, removal of transaction tax on debtsecurities does not really matter. Similarly, imposition of transactiontax on derivatives securities does not augur well because it will simplyincrease the cost of risk mitigation by an average of 10%. Derivativesecurities being mostly structured for a period of less than one year,the question of long-term capital gain does not arise and hence, anyprofit derived out of derivatives trading is treated as short-term capitalgain and taxed accordingly. It thus deserves to be kept outside thepurview of the transaction tax.

Lastly, citizens must recall that one of the biggest problems Indiafaces is that of ‘tax compliance’. It is a fact that hardly a quarter ofthose who should pay taxes, do actually pay. And, when it comes tocapital gains tax, the less said the better. Against this backdrop, theproposed transaction tax on equity shares would pave the way for‘efficiency’ that is glaringly absent in the Indian tax collection system.So, no more deals, and at any rate, how long will the governmentdangle carrots before the well-fed?

——)0——

155IPO’s rating: What for?

Once in a while, markets lure investors with a great businessopportunity. The media also goes all out to highlight such

opportunities as it happened during the time of the dot com era. Andinvestors will as usual rush to support it, of course, in the greed formaking more money. As the business opportunity is tantalizinglyattractive, many firms will attempt to exploit it. The net result ismore IPOs inviting public to subscribe to those shares. Each of theseshares entitles its holder to an equal share amount of profits besidesbeing entitled to a vote on matters of corporate governance. Of course,such shares represent a mere residual claim on assets of a corporation.In other words, if a company goes into liquidation and all its assetsare sold, shareholders are entitled to receive only that part of proceedswhich is left after meeting all the other liabilities of the company.

That apart, the subscribers to such an IPO get return on theinvestment from two sources. The first source is the ‘dividend’ paidin cash to the shareholder by the firm that issued the shares. Thisdividend payout is of course not mandatory like interest payment under

July 2004.

THIRTY SIX

IPO’s rating: What for?

The Asian currency crisis of late ’90s has provedbeyond doubt that ratings carry no meaning in anhour of crisis.


a debt but paid at the discretion of the firm’s board of directors. Thesecond source of return to the shareholder is any gain (or loss) that ashareholder can realize by virtue of appreciation (or depreciation) inthe market price of the share over the period it is held by the investor.This kind of return is commonly known as capital gain (or loss).Both these returns put together constitute the ultimate return to theshareholder on his equity investment. This return is squarelydependent on the ability of a firm to perform well, that too, consistentlyin the future. The scope for making money on an equity investmentalways rests in future. Hence, no investor can be certain of hisinvestment decisions in the equity markets and he has no choice exceptto run along with the herd into hot sectors that are promising goodreturns from time to time. It is no wonder, if over a period of time,the competition drives down returns of businesses that have comeinto existence under much hype as witnessed during the technologyboom, and many of the new entrants may even be forced out ofbusiness. The problem investors face in standing back from suchinvestments is that the cycle at times takes a long time to unfold.Whatever be the reason, the ultimate loser is the investor community.

Perhaps, being deeply concerned about such embedded risks thatinvestors face in equity markets, the Securities and Exchange Boardof India (SEBI) recently announced its intention to subject IPOs formandatory rating. The SEBI perhaps hopes that such mandatoryratings will help investors take “informed” decisions and therebyminimize the risks. Now, the moot question is: Can “ratings” mitigatenon-systemic risks arising from factors external to exchanges, trading,and settlement mechanisms? We know how corporates work: the legalnature and structure of a corporation tend to exempt both corporationand its management from accountability for many of the costs oftheir activities; actual shareholders have no voice in corporate affairsand the board of directors and executives are protected from financial


liability for their acts of negligence. The generous compensation oftop management seldom has any relation to actual performance, andthey are rarely prosecuted for the illegal acts of the corporation, whichacts, if performed by anybody else, would have attracted imprisonmentwhile corporates are allowed to get away with small fines.

Against this reality, we must bear in mind that ‘rating’ is not ageneral purpose evaluation of the issue, nor is it a one-time assessmentvalid for the future life of the security. Rating agencies are neitherauditors nor regulators and, hence, have to depend on whatever datahas been made available by the company. Ratings are either solicitedfor a fee by the company or ‘unsolicited’: Under a solicited form, thecompany gives the agency access to its top management and to non-public information; and when unsolicited, rating is free and basedonly on public information. Such a ‘rating’ either by CRISIL orICRA or, for that matter, any other rating agency can at best score acompany coming out with IPO on important parameters such asbusiness prospects, financial risks, governance, quality of reportingand management. How can a score of even four out of five on theseparameters tell an investor whether he can make money or not? Toquote the former chairman of SEBI, D. R. Mehta, “Investment inequity shares is risky and its magnitude cannot be defined.”Considering this, he observed that, “We (SEBI) have no plans tomake it compulsory for companies to go in for ratings before tappingthe market.”

True, credit rating has become a well accepted norm for predicting‘default risk’, simply because it only estimates the ability of an obligateto service a known repayment commitment or otherwise, which isessentially the worry of investors in the debt market. On the otherhand, every investor in equity market comes with his own expectationabout the money to be made based on the risk-perception of his owninvestment portfolio. But, it is impossible for anyone to rate the


prospect of investors making money in an IPO. Rating can at bestmake an academic discussion on risk and reward potential associatedwith an IPO. A rating that is based on company fundamentals cannotattempt to assess the valuations and hence it is meaningless to theinvestors for all fundamental analysis in equity market is essentially a“valuation” since the price performance depends on the perceiveddiscount to intrinsic value. So the obvious question is, “What then israting for?”

Let us analyze this analogy with an example. In the recent past,Biocon and PCS have come out with IPOs. As everyone knows, bothcompanies are into ‘hot sectors’ and their managements commandmarket respect as evidenced by investment of VCs, their track record,prudential management and sound business models. Obviously, bothIPOs were oversubscribed by almost 30 times. But PCS was listed onthe stock exchange at below IPO price while Biocon was listed atpremium. Now the moot question is why this difference? The answeris simple: It is the “market perception”. Biocon being intoBiotechnology, a segment that is currently the darling of the market,was perceived by the investors as having high potential for growthand was traded at a premium. On the other hand, PCS, whose growthprospects are linked to IT and associated services, came under thecloud of “outsourcing politics” that surfaced recently and theweakening dollar across the globe and the market has accordinglydiscounted its valuation. These evolving perceptions which areexternal to the company that define the valuation prospects of a scripare simply beyond the capacity of any rating exercise to capture andreflect upon. If these two were to be rated by an IPO and upon listingif they were tanked for similar sentiments, the investors would havesimply discredited the ratings. They might have even alleged thatthey were misled by the ratings.


There is yet another question to be answered: Who has to bear thecost of rating? Obviously, it is the issuing company and if so, what isso great about a rating that is solicited at a fee by the issuer for it canseldom be different from what the paying company desires to have, ashas been witnessed umpteen times in the past.

In a free market, every economic decision-maker must make hisown decision, being fully conscious of the fact that he and he alonehas to pocket the loss or gain out of it, if the markets are to remainefficient. What is then needed is not mandatory rating but a concertedeffort by SEBI to educate investors about the changed dynamics ofequity investments and, more importantly, ensuring that merchantbankers play their role with due diligence and integrity.

——)0——


Monday, May 17, 2004 is by now a pretty old date in the calendar.Yet, the events of the day are not that ordinary to forget so

quickly. It is the Black Monday on which the Sensex witnessed thelargest intraday fall of over 800 points in the 129-year history of BSE.It made investors poorer by Rs.1,33,602 cr by way of loss in marketcapitalization, despite the fact that trading was suspended for nearlythree hours in two separate cool-offs. Before locating the underlyinglessons, let us trace how the ‘bleeding’ took place.

It is by now a well-known fact that driven by Friday’s experience,many investors were in panic to sell their stocks. But, there were nobuyers in the market. With no buying support, the already panic-stricken investors started frenetically pressing the ‘sell’ button. Theresult was that with every share sold, the prices fell further. In themeanwhile, falling stock prices caused erosion in the value of thecollaterals and other forms of safety margins that brokers maintainwith stock exchanges as guarantee. This prompted exchanges to

July 2004.

THIRTY SEVEN

Imperfect information! Imperfectcompetition! Imperfect markets!

It’s not economics that matters in making a countryinvestment-worthy but its very fabric of culture –values, ethics, and morals.

161Imperfect information! Imperfect competition!...

demand additional security or increased cash margins, neither of whichcould be attempted by the brokers in a falling market scenario. Asimilar situation arose among a few banks that had lent money undermargin trading. The net outcome was that both exchanges and lendingbankers placed sell orders in the market. Obviously, this move onlyhastened the price-slide.

The market was so panic-stricken that most of the sell orders placedon Monday morning were reported to be at ‘market prices’. Whenthere were no buyers in the market, the market orders had simply, asthey should, dragged down the prices. To make things worse, hedgefunds and a few major FIIs were reported to have exiting the PSUstocks in a jiffy. As the news about bigger players selling stocks spread,the rest of the players rushed to the market to let loose anarchy uponthe world. There is no wonder if the program trades were also triggeredautomatically when the market was hitting ‘lows’ consistently. Thenet result is that investors were bled white in hardly a span of twotrading days. Today, it has raised a battery of questions: “What triggeredthis run?” “How does it affect the economy at large?” “What, therefore,needs to be done to arrest such incidents from recurring?” Let usexplore answers to these questions.

In a globalized market no one can afford to ignore the fact thatmoney moves in and out of markets with an exclusive concentrationon ‘profit’ and nothing else. To generate that profit, investors do nothesitate from shifting their savings from one locale to another. Theconvergence in telecom and computational technology only madethe job of real-time communication that much easier. In such ascenario, what matters in moving capital in and out of a locale is the‘better return’ that a market can offer with ‘least uncertainty’. Let usexamine this phenomenon in detail. As every one of us remembers,at one point of time PSU stocks were trading at steep discounts despitetheir being fundamentally sound. The reason was simple: Investors,


particularly FIIs, have no faith in the government’s ability to behaveas an economically rational owner. However, encouraged by theprevious government’s move for privatization as evidenced by thestrategic sale of ONGC, etc., via IPOs, hedge funds had taken hugepositions on PSU stocks. As the expectations rose about oil andbanking PSUs making good profits in the free market arena, tradingon PSUs picked up momentum, and indeed, over 40% of FII flowsduring the last 12 to 15 months were into PSUs. As against thismarket expectation, what have we done? The first big step inundermining this belief came in the form of left parties calling forhalting privatization. ‘Transition of power’ is in itself a big event forthe market to take a view on the future economic prospects. Againstthis reality, by talking against privatization, the politicians have onlystirred up a hornet’s nest. It hardly took two trading days for theinvestors to complete the rest of the job. The result was fall in marketcapitalization till LIC, GIC, banks etc., entered the market to re-enact their traditional role of bailing out the market. One cannot, ofcourse, rule out, if it is the usual rhetoric, that the ‘left’ has to rollout.Well, whether perfect or imperfect, it is nevertheless information andwe cannot blame the market that is ‘futuristic’ for its reaction.

The next question in line is, what is in it for the economy? Thefalling stock prices mean a fat lot worse for the economy. First,Monday’s mayhem had simply shaken the confidence of investorswho after a prolonged hiatus were just showing up. With the kindof losses they suffered in terms of erosion of their wealth, investorswill be pretty scared to revisit the market at least for some time tocome. The drop in stock prices forces investors to spend less. Itadversely impacts the flow of capital into start-ups, expansion/diversification projects, and there will be no fresh IPOs. It wouldnot be a wonder if it even results in less foreign capital inflow intothe country. It also means rising cost of capital for corporates. In

163Imperfect information! Imperfect competition!...

economic jargon, it ends up in ‘economic contraction’. Its impacton economic growth, particularly when we have moved out of‘planned-economy’ and entered ‘market-economy’, is mind-boggling.Secondly, stock markets, being a forward-looking forecaster of acountry’s economy, are good in allocating capital to various segmentsof the economy. With the flow of private capital into infrastructureprojects and other services, there is little reason to suspect its impact,more so when the government has almost withdrawn from suchinvestments. The moral is, having opened up our markets, we cannotadopt a ‘stop-go-stop’ approach, since it only results in ‘uncertainty’which is most despised by the investing fraternity. All this is simplynot a good indication for the economy.

That apart, ambiguity in the pursuit of reforms would only driveaway the investors from the market, for it generates uncertainty. Atthe cost of repetition, we must remember here that no investor visitsmarkets for the love of it but does so to make ‘more money’. Evenotherwise, our markets lack depth that was indeed felt on ‘BlackMonday’. True, in a descending market, nobody would be willing toextend buying support. But if we had long-term investors like pensionfunds they would have played the role of ‘market-stabilizers’ by stayinginvested in such scripts which are otherwise sound fundamentally.In the absence of such supporting systems, markets would obviouslyremain imperfect. As long as they remain imperfect, such runs as wehave witnessed on Black Monday would keep revisiting us.

Looking at the Black Monday’s happenings it sounds so true thatpolitical culture, norms and habits are important determinants of notonly the quality of social life, but also of economic progress and growth.

——)0——


What a transformation! Indians, too, can puff up their chests atthe way their economy is shaping up and merrily say goodbye

to 2003. As the year is inching towards its end, India’s foreign exchangereserves crossed the $100 bn mark. The healthy foreign exchangereserves, as the Finance Minister observed, can serve the country“economically, psychologically, and diplomatically.”

The old economy, too, has consolidated its position and is witnessinga tremendous resurgence in profitability and valuations. Projectionsfor the real economy are equally good for the coming year, too. Accordingto an estimate of analysts, fresh capital of around Rs.110000 cr iscommitted for investment either in expansion of existing units or innew projects in the coming two years.The Sensex is all set to end theyear at 5500 and the market capitalization of all the stocks traded acrossthe exchanges has almost crossed Rs.1225000 cr. Good days are hereagain for the ordinary investors who have been lamenting at theirshrinking wealth for the last 3-4 years. The global economy that ran

January 2004.

THIRTY EIGHT

“No” contrarian fund: Onlycontrarian investors, please!

Investors must be left to themselves to enjoy theprofits or losses out of their own decisions.

165“No” contrarian fund: Only contrarian investors, please!

through a blue patch for the last two years also started looking up.Everything looks good for the Indian economy.

Despite all this hunky-dory image, an average Indian is still hauntedby a nagging fear: Will the boom continue in 2004? Or, will we be backto where we were in 2002 by the end of 2004? These fears are not ill-founded. It is by now common knowledge that the rise in share pricesrecorded in the past six to seven months is mostly FIIs-driven. Thetotal inflow during 2003 is estimated to be well over $7.2 bn. Contraryto the commonly held belief that the FIIs stay away from the marketduring the year-end, the net inflows from the FIIs during December2003 are reported to be around $1.07 bn. The market turnover inDecember is a whopping Rs.18000 cr as against the average monthlyturnover of Rs.7000 to Rs.8000 cr for the past five years. India is reportedto have emerged as the third biggest recipient of the FII inflows in Asiaafter Taiwan and South Korea.

This very active role of the FIIs in the current bullish rally in theIndian capital market is perhaps causing concern on many counts.There is a widespread apprehension that under the garb of the FIIs,substantial non-institutional investments via promissory notes andhedge funds have entered the Indian market. Secondly, there areconcerns about the ‘herd mentality’ of the FIIs that can trigger theirexit at the slightest provocation such as easy opportunities elsewhere,profit booking, political developments within India or outside. Asagainst this fragile status, the Indian retail investors, institutionalinvestors and speculators are only known as momentum players.

Neither the market had the depth due to absence of such marketplayers as pension funds or hedge funds that are known to take a long-term view of the market. The prime concern hence is how to ensuremarket stability against the known potential of the FIIs to tanker themarket anytime. Even the market regulators appear to have been seizedby this fear, else the Securities and Exchange Board of India (SEBI)


would not have sought the government’s advice on the creation of a‘contrarian fund’ to counter the rising inflow of the FIIs funds.

The obvious question now is: “How does the contrarian fund helpus avert the market crisis?” It is apparent—buy the stock and help theFIIs exit the market at their best opportune time and in the process,perhaps, afford a semblance of ‘market stability’, which incidentallyis what the regulators are concerned about. The moot question nowis what does ‘contrarian’ mean? A contrarian is someone who is knownto take an altogether different view from that of the other players,mostly guided by long-term perspective. But it doesn’t, however, meanthat a contrarian would enter the market when it is under the siege of‘exuberance’, as our market is currently in, and be a buyer to thesellers who want to book profits.

Contrarians are known to play more on the extremes of the marketcontinuum. Incidentally, that is what the FIIs did at the beginningof 2003 when the Indian market was out of sheen. When the marketwas at its low, and there were no domestic buyers in the market, it wasthe FIIs who were the first to appreciate the underlying strength ofthe Indian real economy and buy the stock. They indeed took acontrarian view on the market and gave a tremendous push to thevaluations. It is they who brought the index to the current levelwhen the domestic institutional investors, retail investors andspeculators were shying away from the market. It is a different matteraltogether that some Indian institutional investors could encash, whilethe retail investors were, perhaps, watching the rally bewildered.

True, for every seller, there must be a corresponding buyer in themarket and it is in this context that a ‘contrarian view’ becomes amust for markets to be efficient. But it does not mean that thegovernment should establish a contrarian fund to keep the marketget going. Here it is worth recalling the experiences of central banksthat are commonly known for market intervention to deliberately

167“No” contrarian fund: Only contrarian investors, please!

establish a contrarian view on exchange rates. For instance, wheneverthe rupee appreciates beyond a point acceptable to the Reserve Bankof India (RBI), it is known to enter the market to mopup the excessdollars and thereby arrest the rupee’s appreciation and vice versa.But, such intervention has a known cost and a benefit, though limited.But with the globalization and the deregulations of markets, evencentral banks are less frequently resorting to such strategies, as quiteoften the accompanying costs have proved to be prohibitively costlyand secondly, the market proved to be bigger even to the centralbanks for influencing their behaviour. The question now is: Are weto replicate it in the stock markets, too?

Of course, public memory could be short, but we haven’t yetforgotten what kind of role the UTI used to play in the stock marketin the past. Whenever markets were falling, the UTI used to, of course,at the subtle directive from the government, exhibit a contrarian viewby willingly becoming a buyer to every seller in the market. We arealso aware of the cost the UTI had to ultimately pay for suchmisadventures. The moral of this story is that such buying neverallows the fund to cut its losses for it would be constantly averagingdown in a bear market.

Don’t we have anything to learn from the UTI episode? Shall wenot appreciate that the ‘contrarian investment’ means not buyingwhen others are selling, but buying when no other investor is buyingas such a class of investors driven by a long-term perspective, hold acontrarian view on the market? This ‘trait’ is what the regulatorsshould strive to cultivate in the market by encouraging long-termplayers to stay invested with due support in terms of loan againststock etc., as a matter of routine. In the ultimate analysis, what themarket expects from the regulators is not ‘contrarian fund’ butencouragement that breeds and nurses a tribe of ‘contrarian investors’.

——)0——


A globalized India has become a reality, at least in the context of capital markets. The 30-share BSE Sensex soared 120 points,

all in a day’s trading. During the past six months, the Indian stockmarket has risen quite dramatically. From a low of 2900, the Sensextouched 4907 at the close of trading on October 31st. The rise of over50% has taken every investor by surprise. It is indeed causing a lot ofdisquiet among all those concerned with the stock market, includingthe North Block, for reasons galore.

The current rally is mostly fuelled by the active participation ofthe FIIs. They account for nearly one-third of the delivery volumes.It is reported that today almost an amazing two-thirds of the freefloating stock in India’s leading quoted companies is held by foreigninstitutional investors. The current dramatic rise in the FII inflowsinto Indian markets is mostly attributed to the excess liquidity that issloshing round the rest of the globe. The persisting weakness in theUS economy, the falling interest rates all over the globe and thecommon perception that the Asian economies and currencies will

November 2003.

THIRTY NINE

“Nothing will come of nothing”

If one has to have more of something, he has tonecessarily give off something elsewhere.

169“Nothing will come of nothing”

strengthen further are the main driving forces behind the incredibleinflow of the FII funds.

The first time entry of the hedge funds into Indian markets hasonly added fat to the fire. Intriguingly, the hedge funds are the mostfeared investors across the globe for they are known to be the mostleveraged entities promising investors a pretty high return irrespectiveof the market movements. In their obvious greed for hefty returns,they are known to take high bets unmindful of the accompanyinghigh risks and move across the markets swiftly, once the greed issatiated. They are the potential source for inflicting “volatility” inthe market.

This is not the end of the story. Nearly 40% of the $5 bn portfolioinvestment made by the FIIs in the recent rally of Indian stock marketsis reported to have come from the Non-Resident Indians through theparticipatory notes. In a way, it amounts to a return flight of thecapital belonging to Indians and if it is really true, one may not getunduly alarmed about it for, it can sustain the current upswing inthe market for quite some time. On the other hand, if it turns out tobe otherwise, market fears would get vindicated.

That phobia apart, what matters most here is the fact that today“globalized India” is quite firmly linked to the global cycles, with theresult that whatever happens in New York, London, Tokyo, or Brazil,is potent enough to define the behaviour of the Indian markets asmuch as the domestic happenings do. Secondly, every decision relatingto the FIIs’ investment in the Indian bourses is not made based onthe domestic fundamentals but mostly on the happenings across theglobe: the global interest rates, business cycle conditions in theindustrialized countries, potential for making profit from differentregional equity markets, credit ratings of countries, exchange ratemovements, balance of payments position, etc. Market pundits also


aver that there is a co-movement between the FII flows and the rallyin the Indian stock market.

The net result of these developments is an undeclared fear aboutthe sustainability of the current rally. Everyone today is haunted bythe fear: “What if tomorrow the FIIs book profits, packup their bagsand move out of India lock, stock and barrel?” True, the key variablesdeciding their entry or exit being external in nature, there is nowonder if it becomes a reality. To avert such a crisis, some gurus areeven suggesting creation of a “contingent fund” generated throughdomestic banks’ contribution to it, so that even if the FIIs exit, marketstability can be ensured. Are the treasurers listening?

What a suicidal proposition! And how diligently we refuse to learnfrom the past! When will we accept the truth that “one can neverhave something for nothing”? Having chosen to open our markets toglobal players, should we not be prepared to pay for the accompanyinggains as well as the losses? The Indian banking system is alreadysaddled with a plethora of ills: endemic NPAs, directed lending,liquidity over-hang and poor off-take of credit, etc. As though thesewere not sufficient enough to topple the banking system, anotherdirected lending, that too, for stock market operations! Even assumingthat the banking system would chip in and inject fresh funds into thestock market, where is the guarantee that it can sustain the marketrally for, as feared by many, when it is fuelled mostly by fundamentalsother than the economic ones? Are we not then offering the bankingsystem at the altar for FIIs? And for what gain? Is it not true that,whether an FII or a trader, so long driven by the belief that ‘ambition’is a virtue and ‘accumulation of profit’ as the most important business,they will find out the way “over the mountains and under the graves”to satisfy their avarice and lust for profit?

171“Nothing will come of nothing”

What regulators are required to do therefore, is to educate theordinary investors about the changed market mechanics, create a senseof awareness among them about the new risks that are dawning onthe “globalized” Indian capital markets, and caution them to becognizant of the underlying fundamentals while committing theirfunds for investment, while allowing the market to sort out theoutcomes of the “rally” on its own. After all, every investor, be itFIIs, domestic mutual funds, high net-worth individuals or retailinvestors, must learn to be accountable to his decision. And as marketsgrow in size, no amount of contingent fund can hold a sinking markethigh. It is the market rally driven by the rationality of the investorsalone that can sustain stable growth and that’s what the system shouldproactively nurture.

——)0——


It is often aired that as a clan, we Indians have an uncanny ability to weave a web around us and then struggle to wriggle out of it.

We are also known to repeat it without learning from our ownmistakes. Maybe, we are genetically wired to be so, but at what cost?

Look at the current rally in the stock market: Sensex has gainedabout 66% from a six-month trough in late April; it once sprinted toa fresh 39-month high of 4900.92; Foreign Institutional Investors’(FIIs) trade is reported to have accounted for about 35% of NSEdelivery volumes; and in absolute numbers their trading volume hasrisen from Rs.9842 cr in April to Rs.19,066 cr in September.

Interestingly, it is the local mutual fund industry and such domesticfinancial institutions as LIC and GIC who have cashed in on thecurrent boom in the market. It is reported that in the current month,FIIs have been the net buyers of equity worth Rs.5385 cr, while thedomestic mutual funds are the net sellers to the tune of Rs.376 cr.More than these numericals, the current rally has certainly given a big

November 2003.

FORTY

Indian “hermeneutics ofsuspicion”

Free market and suspicion about market players donot gel well together.

173Indian “hermeneutics of suspicion”

boost to the ‘psyche’ of ordinary retail investor who has been languishingin an otherwise stagnant market for more than two years now.

Amidst this hunky-dory, the Securities and Exchange Board ofIndia (SEBI) is reported to have asked the FIIs to furnish the detailsof Participatory Notes’ (PNs) beneficiaries and clarify whether theyare from a hedge fund or a corporate or a pension fund, suspectingthat the PN beneficiaries are none other than the banned OverseasCorporate Bodies (OCBs). This makes an intriguing reading: theregulators appear to have stumbled upon certain information thatmade them infer that a slice of the current inflows from the FIIscould belong to Indians since “about 20 to 25 companies holdingPNs have Indian sounding names.”

Surprisingly, this suspicion has arisen not for the first time. Duringthe early part of this year, the market was rife with rumours that theSEBI was contemplating a ban on FIIs who have issued participatorynotes from market participation. As could be expected, these rumourshad adversely impacted the market prices of several stocks, especiallythose having high foreign holding. The most affected stocks werereported to be from the technology sector.

Yet, surprisingly, it was the FIIs and foreign brokerage firms whoprotested the move with a plea that SEBI did not have any jurisdictionover such instruments issued outside India. The SEBI was thenreported to have decided to amend its draft code of conduct governingmarket participants and allow the FIIs to participate in our markets,irrespective of their dealings in derivative instruments, such asparticipatory notes issued outside India against the underlying Indiansecurities, provided they disclose details of such instruments.

But, the contemplation to investigate the matter afresh only revealsthat we have not learnt anything from the past experiences. That


apart, what are these PNs that are causing so much consternation tothe market regulators? PNs are like contract notes issued by registeredFIIs to their clients located outside India, the underlying being Indiansecurities. These are obviously availed by institutions who do notwant to go through the hassles of various regulatory processes andmechanics prescribed for market participation by the SEBI but wantto have an exposure to Indian securities. Thus, PNs enable suchinstitutes as hedge funds to trade in Indian securities through theregistered FIIs.

The next obvious question is, “What if the Hedge Funds or OCBsparticipate in the market?” The OCBs were recently banned fromparticipating in the Indian markets, while Hedge Funds are the mostfeared players for they are often misconstrued as highly volatile—that they place large directional bets on stocks, currencies, etc., andhence the commotion. True, hedge funds are highly leveraged andare known to be high-risk takers in anticipation of high returns andin the process, keep shifting from market to market. But, the role ofhedge funds in the current rally in our market is well conceded bythe market pundits. Technically, FIIs cannot be wronged for issuingPNs. Secondly, having once opened our markets for overseasinvestment, we cannot, perhaps, be choosy about the participants.

We only need to put in place a robust control mechanism tomaintain market stability. Prudence dictates that we should not pokeour nose into market happenings at the slightest provocation, for ithas the potential to play a spoilsport in the market. There is alreadyan unstated fear among the domestic players—What if tomorrow theFIIs decide to pack off and shift their money to another market?Possibly it can tank our market, but the truth is they cannot leave us,at least in the short run, unless we drive them out; for no othermarket today is offering such returns as ours is. It is time we cameout of our den – “hermeneutics of suspicion” – and accepted the

175Indian “hermeneutics of suspicion”

reality that no investor will visit our market for sheer love of it. Andfrequent changes in the regulations that only makes foreigninstitutional investors scary of stay invested for long, which is not inthe interests of our markets in achieving depth and volumes.

Having expressed our desire to welcome foreign capital via reformsand get integrated with the global economy, we must nurture the traitof pursuing a chosen policy doggedly and work for sustainable growthin the economy, for knee-jerk reactions would only derail and delay thetransition. Or, does someone have a better idea?

——)0——


“The little house among the trees by the lakeFrom the roof smoke rises.Without itHow ‘Nirarthakam’ would beHouse, trees and lake”.

In this poem, the poet is very forthright in his assertion:Metaphorically he is implying that if there is no smoke, there is

no life and if there is no life, the serene lake, the lush-green treesthat circumscribe the lake, and the house are all “Nirarthakam”.How true it is! If there is no life, what difference does it make whetherthe trees are lush-green or denuded of leaves; lake is tranquil orturbulent; and it is a house or hutch. They acquire meaning, beautyand appreciation only when life is around. That is the worth of“life” and “living”.

Leaving the trees, lakes, and houses behind for a while, let usmove on to our stock markets. The stock market investors are of late

October 2003.

FORTY ONE

Investment sans trading“nirarthakam”?

Realized investments alone enable an investor to growand enjoy the fruits of investment.

177Investment sans trading “nirarthakam”?

reflecting quite a cheerful mood, for they are greeted by the risingSensex. There is buoyancy in the market. It is duly supported by theresponsible behaviour of individual companies. They have becomeconscious of costs. Companies have been divesting unprofitable units/divisions. They are diligently working towards ‘stripping-up’ of assetsto reduce their capital cost.

This new-found phenomenon is obviously getting reflected in therising index. Indeed, the Sensex is reinventing its lost glory, havingcrossed the 4000-mark. First, it was public sector banks, whose stockstole the limelight. It is now the turn of the manufacturing sector tosustain the overall market momentum. Almost every scrip has risenin its market valuation. Everyone has forgotten the past and is writingan altogether new script.

But all this “up-n-rise” in the stock market makes sense only tothose investors who trade actively and capitalize on the marketopportunities. This assertion of course raises a question: Why doubtinvestors’ desire to swap their scrips for a better price that the marketis offering today? Yes, there is a reason, for psychologists have adifferent story to tell. They say that most of the investors have a tendencyto place an extra value on scrips they already own. Think of a scripyou own, say, SBI: Would you swap it for the current market price,for it is three times more than your purchase price? The prospecttheorists say that you will, most probably, not, for you are clouded by“endowment effect”.

Daniel Kahnemal, who won the Nobel prize in Economics lastyear, says that due to psychological effects, individuals do not partwith their earlier possessions, however trivial they may be. Researchindicates that this strong desire to hold on to current possessions isequally prevalent among the stock market investors. And this factorcompels us to believe that the majority of investors really do not makeuse of market opportunities thrown open to swap their holdings with


a better price or swap cash for picking up a good stock even in abullish market, at least with the required speed.

This is obviously in stark contrast to what has been postulated bythe hitherto acclaimed ‘neoclassical’ thought that believes in peopleas rational economic agents, and hence states that preferences betweentwo goods are independent of an individual’s current entitlements.But, this theory has been directly refuted by the findings of theexperiments carried out by Daniel Kahneman et al. (1990), and IanBateman et al. (1997). This anomaly has been attributed to‘psychological effects’ and the same is termed ‘prospect theory’ byDaniel Kahneman and Amos Tversky (1979). George Loewensteinand Kahneman (1991) have reported that the main effect ofendowment is not to enhance appeal of the good one owns but ratherthe pain of giving it up. The study carried out by Knetsch (1989)examined the trading rates among Cornell undergraduate studentsand found that 89% of those originally endowed with a mug chooseto keep the mug, and 90% of those endowed with a chocolate bardecided to keep the chocolate bar.

Despite the existence of laboratory evidence favouring the prospecttheory, some economists still believe that the anomaly is merely theresult of a mistake made by inexperienced consumers, which theyargue would be overcome through the learning process and over aperiod of time, their behaviour will be on the lines of neoclassicalmodels’ predictions. It was to resolve this controversy between thebelievers of the neoclassical model and those of the prospect theoryand to unravel the truth behind these claims, that John A List, aneconomist from the University of Maryland, carried out three teststhat pit the neoclassical theory against the prospect theory in a naturallyoccurring market condition.

The experiments were conducted with 500 subjects consisting ofprofessional dealers as well as ordinary consumers so as to capture the

179Investment sans trading “nirarthakam”?

distinction between the behaviours of consumers having intense tradingexperience and those with less trading experience in a well functioningmarket. The findings established that the prospect theory had strongpredictive power for inexperienced consumers’ behaviour across boththe trading and auction treatments. Secondly, there is also strongevidence to say that experienced investors’ behaviour approaches theneoclassical prediction suggesting that agents with intense marketexperience have learned to part with entitlements. The study furthersuggests that attenuation of the anomaly appears to take place on thesell side of the market more quickly than on the buy side.

This would otherwise mean that the green investors are quite slowin appreciating the current boom in the market. And our stock marketis more endowed with such inexperienced retail investors. Secondly,it is commonly observed that the majority of Indian investors evenotherwise do not trade on the stock once acquired. Further, the veryfact that the current rise in the Sensex is driven mostly by FIIs and,to a certain extent, by the domestic institutional investors, itselfvindicates this phenomenon. So, the moral of the story is that unlessthe novice investors who spread across the country learn the trick ofthe game quickly, the current ‘up-n-rise’ in stock market remains“nirarthakam”. After all, who doesn’t need life?

——)0——


“W here would one place the bubble that burst in public sector banks last week?” That was the question raised by Business

Line, June 9, 2003. It also provided the answer: Investors who boughtpublic sector bank stocks on May 29, 2003 had lost around Rs.40 cr.True, it does not sound as big as the security scam of 1992, or themore recent K-related stock scam, but it once again confirms ourinability, in no uncertain terms, to arrest such recurrences. It hasperhaps become a national obsession to wake up after setting thehouse on fire and cry in chorus. As though to vindicate the growingbelief about our regulators’ knee-jerk reactions, particularly thosewho are made accountable to regulate the behaviour of our stockmarket players, it is reported that the Finance Minister directed SEBIto look into the abnormal movement of public sector bank stocks overthe past several weeks and submit a report. Interestingly, Mr. JaswantSingh, the Finance Minister, speaking at a function, true to hisprofession, made an observation: “The period between 1990 and 2003has seen many fractures in investor confidence… We have tried tomake the system as transparent as possible. I am disappointed at whathappened (in public sector bank stocks)”.

July 2003.

FORTY TWO

‘Clarity-driven’ regulatoryintervention alone makes sense

Intervention backed by ‘knowledge’ alone leads tocorrection of any event.

181‘Clarity-driven’ regulatory intervention alone makes sense

True to the élan of political leadership, the minister did not botherto elaborate whether he felt responsible for the contradictory statementsmade by his ministry officials, which was reported to be the maincause of the unusual fluctuation in prices of some of the bank stocks.If we recall the happenings right from early May, it becomes clearthat the share prices of most of the PSBs began to rally driven byreports that banks were likely to return a part of their capital to thegovernment at par. At this juncture, had any authority from anygovernment agency clarified the correct position about transfer ofcapital, this speculative rally could have been nipped in the bud.

Instead, it was reported that during the peak of the rally the financeministry’s spokesperson and the finance secretary made contradictorystatements at two different times. It was reported in newspapers thatfirst an official spokesperson in the ministry of finance said that thegovernment would accept return of capital from some of the banks atpar value. This obviously led to wild fluctuations in the stock pricesof some PSBs reaching unprecedented levels from late April to theend of May, all under the assumption that returning a part of equityto the government at par would automatically improve their earningsper share as also book values, which is what an investor is concernedabout. That is not the end of the story, for the finance secretary wasreported to have said on June 2nd that the government had no intentionof accepting the return of capital by PSU banks at par when themarket prices of those stocks were quoting well above par which indeedset the house on fire, and the prices have nose-dived.

This episode reminds us of a study carried out byPricewaterhouseCoopers Endowment by assembling a panel ofeconomists and researchers to study and develop a worldwide opacity-index and correlate it with the cost of capital. More than the findingsof the study, what matters here is how they defined opacity and thekey factors that determine it. The team defined opacity as the lack of


“clear, accurate, formal and widely accepted practices”. They haveidentified corruption, legal system, government macro economic andfiscal policies, accounting standards and practices (includingcorporate governance and information release) and regulatory regimeas the defining elements of the “O-Factor.”

The expert team had ab initio accepted the fact that no country islikely to earn a perfect score under all these heads since there is everypossibility of these elements deviating from the expected course suchas there may be corruption in government leading to bribery orfavouritism; economic policies may be vague or unpredictable; businessregulations may be unclear, inconsistent, or irregularly applied; andaccounting standards may be weak or un-enforced which makes itdifficult to obtain accurate financial information. The study furtherrevealed that a high opacity-index will adversely impact the cost aswell as the availability of capital in several different ways. Lack ofclear, consistent and reliable practices in the areas of legal disputes,regulation and national economic policy are certain to negativelyimpact the flow of overseas investments too. Particularly, internationalinvestors are prone to be reticent to invest in non-opaque countries.The net result of all this would mean a rise in the cost of doingbusiness and difficulty in mobilization of capital for investment. Alas,we do not know how many more such scams and studies we wouldneed to educate ourselves in effective management of the capital market.

The moral of this analysis is that unless regulators cultivate theart of proactive regulation driven by “clarity of purpose”, marketregulation is certain to remain a distant dream. This in turn makesthe need for political bosses to cultivate professionalism sufficientenough to display boldness in accepting the slip-ups and charting anew course to arrest the recurrence of scams, quite obvious. MayGod help us realize this dream soon!

——)0——

183Who is hedging who?

Derivatives trading that was launched in 2000 is viewed as a greathit in India: Trading has shot up from 21295 contracts per day

in 2001 to 50000 plus contracts by December 2002, which is said tobe the highest in the world. Further, analysts believe that in 2003 itis sure to witness growing volumes under futures and options trading;what is more, it would be driven mostly by retail investors.

This forecast about active participation of retail investors inderivatives trading is sure to cause anxiety, for there is a danger ofretail investors losing entire margin in one single day if they end upon the wrong side of a trade. That could be one reason why WarrenBuffett said: derivatives are financial weapons of mass destruction,carrying dangers that, while now latent, are potentially lethal. Itdoesn’t, however, mean that they are bad per se and hence to beshunned once for all, atleast that’s what one understand from whatDavid Bweinberger, Managing Director, Swiss Bank Corporationsaid: derivative instruments don’t create surprises; they help tominimize them. This, of course, calls for a thorough clarity about

March 2003.

FORTY THREE

Who is hedging who?

Risk and risk management through derivatives oftentend to mimic Shankaracharya’s ‘Maya’, unless oneis adept at their usage.


the risk that one is exposed to, the hedging strategy one needs toadopt for achieving the objectives.

The very word ‘risk’ evokes different meanings for different people.Yet, its basic concept is very simple: In financial terms, it is the potentialchange in the price of an asset or commodity. Risk denotes both theupside and downside of the price movement. But, we rarely considerthe upside movement as risk. In routine life we always use risk todenote the most “undesirable” and that is the “loss”.

Risk always rests in the future. It is all pervasive and has a profoundimpact on mankind. Certain risks are known to have only downsidebut no chance of gain. Certain risks are diversifiable while certainothers are not. But none of them are said to be extinguishable; atbest they can be transferred. Risk retains its fullness, no matter whotransfers to whom, who buys from whom or how much of it is boughtor sold, until at least it extinguishes on its own.

Risk is dynamic. It is an abstract parameter requiring a degree ofintellect to measure it. Yet, it cannot be measured directly. It canonly be calibrated for it is not a naturally occurring phenomenon.It requires the integration of at least two quantities viz—the chanceand the type of event. It is also said that risk cannot be forecastedprecisely for it is dynamic.

Risk is also not straightforward for there is another dimension toit: The risk of ‘opportunity loss’. This very complexity and dynamismof all pervasive risk has perhaps made life more interesting to live by.It eternally challenges one’s ability to fight it out, endurance towithstand it and ingenuity to circumvent it.

Risk analysis, has thus become a natural and an innatecharacteristic of human nature. True, everyday, we use informationto reduce our risks of perceived hazards by altering our style of living


such as regulating our eating habits, avoiding smoking, using smokealarms and so on for the purpose of reducing our risk of injury,disease or death. It is amazing how people take the best possibledecisions to deal with this kind of inescapable trade-offs in life.

In the equity market, volatility and risk are synonymous. Volatilityis a great concern for every player in the equity market. Volatility is notonly a concern of investors but also of regulators. In a way “arrival ofnew information” into market causes volatility. Market players reassessthe true value of the firm continuously based on fresh information thatflows in. In efficient markets, the price of the traded asset is prettyquickly adjusted to the fresh inflow of information and hence thevolatility. It is thus not bad. But, if the price movement is not connectedwith any new information, the resulting volatility is bad.

It is to minimize the exposure of a portfolio to this volatility/price risk, investors resort to ‘hedging’ – the act of minimizing theexposure to the risk. One reason for the current hedging-maniacould be our improved mental faculties and consequently the “know”of more. The more we know, the more evident risk is becoming.Indeed ‘risk’ has become repugnant term in that it makes anybodyshudder to think of what might happen. Verily, it has been an eternalstruggle to create an element of ‘certainty’ amidst ‘uncertainty’.

This resulted in the emergence of derivatives. In financial terms,hedging is said to basically aim at reducing the variability of thecorporate income/portfolio income. Another reason why companiesor investors go for hedging their exposure to financial price risk is toimprove or maintain their competitiveness in the market/ keep portfoliovalue intact.

Let us see how it works. Assume that the current portfolio of Ramconsists ACC stock whose price he expects to fall sharply in the near


future. To hedge from this fall in price and the consequent loss,assume Ram sold individual stock futures contract of NSE on ACCat Rs.162, expiry date being March 26, 2003 under the assumptionthat any fall in the price and the consequent erosion in the value ofACC stock that he is currently holding will be off-set by the gain hewill make under the futures contract on ACC that he sold. Now,Ram having achieved the objective of keeping his portfolio intact bygoing short on individual stock derivatives, believes that he has hedgedhis portfolio.

But Ram’s example posits quite a few disturbing questions: WhenRam anticipates a fall in ACC price, why has he not opted for theoutright sale of ACC stock? Or, is it that he is not quite sure of it? Isselling futures contract a speculative move, then? Another mostimportant question is, what prompted Ram’s buyer of the futurescontract, to buy it? Is he speculating that the price of ACC will rise?If so, what is he trying to hedge—his future acquisition of ACCstock? Remember, all these questions merit examination in the contextof what we have seen earlier: No business wants to suffer losses andso only goes for hedging.

Yet another question: Why has not Ram gone for a put option onACC? Why only futures contract? Is it because he has to shell downpremium upfront, if he had gone for option contract on ACC? Or, isit a replication of our love for ‘Budha’ - culture? In fact, if one watchesthe statistics pertaining to derivatives trading on Indian bourses, onegets wonderstruck as to why there is a big difference in the tradingvolumes under futures on index and individual stocks and withinindividual stocks between futures and options.

All this begets the next logical question: Is trading in derivatives aspeculative move? There is always a thin demarcation betweenspeculation and hedging. In fact, speculation is often disguised as a


trading for hedging for, after all, speculation is nothing but a bet onthe future direction of price movements. Of course, it combines highrisks with high potential rewards and thus the urge for speculation.And what speculation also needs is conviction of one’s view of theprice movement and lots of guts to spare and lose money, no matterborrowed or own.

We are back to where we started off—who is hedging whom? Andit is certainly pretty fuzzy! Or, is it that risk is in the mind of theperceiver as “beauty is altogether in the eye of the beholder”, drivingpeople crazy in different directions? One thing is, however, certain:Risk is increasingly becoming bad and in the game of riskmanagement, everything mimics Shankaracharya’s ‘Maya’ (illusion).

——)0——


In the world of “convergence,” it is increasingly being felt that we are for sure metamorphosing into a “learning society”. This appears

to be true as otherwise how else can one explain the suddenly acquiredsignificance for the words: “human-dignity”, “child labor”,“pollution”, “environment”, and “ecology”. It is slowly but certainlydawning that we, in the belief of having solved the “productionproblem”, have drifted far away from the ancient wisdom. Driven bythis new-found wisdom, western investors are becoming highlyconscious of not investing their hard-earned money in companiesthat damage environment, use innocent animals for research, rely ontobacco or booze, etc., to make big money.

This increased awareness among people has resulted in anunprecedented social change that brought Socially ResponsibleInvesting (SRI) to the forefront. As SRI took its baby-steps forward, itno longer remained a fad, instead, even larger institutions have startedincorporating screening policies to disassociate themselves from

July 2002.

FORTY FOUR

Socially responsibleinvesting no more a fad

“Whatever I dig from thee, O Earth, May that havequick growth again, O purifier, may we not injurethy vital or thy heart”.

189Socially responsible investing no more a fad

investments in companies that are not considered to be the followersof ethical practices.

Till AD 1500, the dominant world view was organic: People livedin small cohesive communities and experienced nature in terms oforganic relationships, characterized by the interdependence ofspiritual and natural phenomena and the subordination of individualneeds to those of the community. Ancient wisdom was anchored inreason and faith. This belief is well captured in the words of CarolynMerchant: “The image of the earth as a living organism and nurturingmother served as a cultural constraint restricting the actions of humanbeings. One does not readily slay a mother, dig into her entrails forgold, or mutilate her body …. As long as the earth was considered tobe alive and sensitive, it could be considered a breach of humanethical behavior to carry out destructive acts against it.”

They firmly believed that the whole of mankind’s actions and desiresare bound up with the existence of other human beings. A man’svalue to the society was judged from his feelings, thoughts and actionsthat were directed towards promoting the good of his fellow-beings.The health of society was considered to be dependent “quite as muchon the independence of the individuals composing it as on their closesocial cohesion.” To be ethical, it was believed that one’s behaviourshould essentially be based effectually on sympathy, education andsocial ties and needs. But unfortunately, these cultural constraintsdisappeared as the mechanization of science took place settingdecadence in motion.

This medieval outlook changed radically in the 16th and 17thcenturies. The notion of an organic, living and spiritual universewas replaced by that of the world as a machine and the “world-machine”became the dominant metaphor of the modern era. This replacedworld-view was primarily responsible for the industrial growth that


we are today witnessing and a significant manifestation of it is theemergence of corporations. The largest of them have transcendednational boundaries and become major global actors. The assets ofmany of these multinational corporates have far exceeded the grossnational product of many nations. Their economic and political powerhas surpassed that of even some national governments.

Competition, coercion and exploitation have become the core ofthe activities of giant corporates, all meant for indiscriminateexpansion. “Profit-maximization” has become the sole objective tothe exclusion of all other considerations. They undertake an intensesearch for natural sources, cheap labour, and new markets, unmindfulof environmental disasters and social tensions that have emerged asthe offshoots of this indifferent growth. In the process, many corporateshave lost their human face.

Lack of responsibility towards fellow beings and pride in whatone does, coupled with an insatiable greed for profit, have ledcorporates to pursue wasteful and unjustified production activities.Theodore Roszak has aptly captured this painful scene in the words:“Work that produces unnecessary consumer junk or weapons of waris wrong and wasteful. Work that is built upon false needs ofunbecoming appetites is wrong and wasteful. Work that deceives ormanipulates, that exploits or degrades is wrong and wasteful. Workthat wounds the environment or makes the world ugly is wrong andwasteful. There is no way to redeem such work by enriching it orrestructuring it, by socializing it or nationalizing it, by making it‘small’ or decentralized or democratic.”

It is the ecological shortsightedness and profit greed of thecorporates that is generating hazardous fumes. Corporations are knownto vigorously oppose environmental regulation as they enjoy matchingpolitical power to prevent stringent controls, at least in the developing

191Socially responsible investing no more a fad

countries. There are companies that simply dump polluting wasteproducts “somewhere else” rather than neutralizing them beforereleasing into environment, without caring that in a finite ecosystemthere is no such place as “somewhere else”.

Our obsession with economic growth and the value systemunderlying it have created a physical and mental environment in whichlife has become extremely unhealthy. Perhaps the most tragic aspect ofthis social dilemma is the fact that the health hazards created by theeconomic system are caused not only by the production process but bythe consumption of many of the goods produced and heavily advertisedto sustain their economic expansion. The more we study the socialproblems of our time, the more we realize that the mechanistic worldview and the value system associated with it had generated technologies,institutions and lifestyles that are profoundly unhealthy.

However, with the passage of time and having experienced the ill-effects of over-dependence on technology, a new vision of reality isslowly, emerging. The world has become aware of the interrelatednessand interdependence of all phenomena – physical, biological,psychological, social and cultural.

As environmental and human rights lobby groups mobilized publicopinion, the force behind their argument for the companies to behave,has started yielding results. They have succeeded in compellingcompanies and investors to take a clear stance on the issues relatingto sustainability of the eco-system. Environmental issues today haveassumed global perspective as the phenomena of green house effect,damage to the ozone layer and falling biodiversity are just showinghow vulnerable the world is. As the Buruntlant Commission 1987observed, meeting the needs of the present without compromisingthe ability of the future generations to meet their own needs shall bethe guiding post for the business pursuits to maintain sustainabilityand that is what the SRI movement is all about.


Being driven by this philosophy, the concept of socially responsibleinvestment has evolved as a tool to boycott the securities offered byobjectionable companies and thereby influence their behaviour. Nowthe moot question is, can mere avoidance of a company’s stock affectits behavior? It is too premature to say “yes”, but such avoidance of acompany for investment by a majority definitely increases its cost ofcapital and that is what is expected to wield influence on the behaviourof an erring company.

Shareholders have thus arrogated to themselves the role ofdirecting capital flows towards companies that are society-ecofriendlyand ethical in their disposition towards their employees and consumers.The protagonists of SRI have also encouraged “shareholder-activism”which in turn threatened companies with passing of resolutionscompelling a company to make decisions that promote theenvironment, the well-being of employees, safety of products and theultimate health of the end-users.

According to one study, during 1996 around 240 such social andenvironmental shareholders’ resolutions were passed in the USA.And that is how the concept of socially responsible investment hascome to stay and wield power on the corporate world.

——)0——

193Stock market behaviour: A method in madness

Imagine you are travelling by a train on a midsummer day. Thetrain is bursting with holiday-going school-children, brimming

with zest. The air is filled with the shrill voices of the kids, theirlaughter and merriment. Suddenly the train comes to a halt in thethick of a jungle. There are groups of monkeys in the nearby trees,quite restless, leaping from branch to branch. Children are amused atthe sight of female monkeys leaping and jumping from tree to treewith their children hanging upside down, clinging tightly to them asthey run. Some kids are running back to their mothers as monkeys,being attracted or perhaps distracted by everything, are trying to snatchaway their colourful playthings. “Grab and run” appears to be themotto of monkeys. Amidst this hustle and bustle, there is a fat monkeyfrozen in the act of eating an orange-like fruit held in her hand, whilethe many rinds of the fruits she has eaten lie strewn all around.

This scene might be taking you back to your childhood memoriesof those travels that you undertook during summer holidays. But

June 2002.

FORTY FIVE

Stock market behaviour:A method in madness

Is it that ‘rationality’ and ‘irrationality’ are intertwinedin mankind and so the wild swings in stock markets?


that’s not exactly what we are interested in right now. Does it depict“a pungent satire of life” or “eat the fruits, discard and scatter therinds” dictum or “a perfect allegory of a stock exchange pit.”

The orthodox financial theorists would obviously take an exceptionto this allegory for they strongly believe that investors, unlike monkeysthat are attracted or distracted by everything that is colourful, are saddledwith ‘rationality’. Economic models have all along been assuming thatpeople behave rationally, that each would act in accordance with hisvalues, make decisions that would take individual interests to furtherheights. Surprisingly, the “expected utility theory” survived all theseyears despite the society witnessing quite too often a wide range of“irrational” behaviour. For almost the last three decades, the disciplineof finance has been enthralled by the concept of random walk cumefficient market hypothesis.

However, the article “Prospect Theory and Analysis of DecisionUnder Risk” by Daniel Kahneman and Amos Tversky in Econometricapublished in 1979, rattled the financial theorists forcing them to seebeyond the financial horizon for explaining this “irrationality”. Theauthors challenged the basic tenets of the expected utility theory bystating that people underweight merely probable outcomes incomparison with outcomes that are certain; that decisions are madein terms of amounts to be gained or lost rather than differences intotal end positions and the negative value of a loss is two to threetimes the positive value of a dollar-equivalent gain.

This was followed by another path-breaking paper, “Does the StockMarket Overreact?” in which the authors, Werner De Bondt andRichered Thaler, challenged the efficient market theory. Thus emergedthe theory of behavioural finance.

During the last 20 years, behavioural finance, blending economicsand psychology, has indeed grown into a new discipline exploring


financial situations where emotional factors are often found to cloudreasoning, thereby making people behave foolishly, defying all therationality attributed under the efficient market hypothesis.

To answer the question – Why investors behave so foolishly? – Prof.Robert Shiller of Yale University has proposed four theories: prospecttheory, regret theory, anchoring and over- and under-reactions theory.

The Prospect theory says that people respond differently toequivalent situations depending on whether it is presented in thecontext of a loss or a gain. Typically, an investor gets highly distressedif he/she were to incur a loss of Rs.300, say, while selling Infosysscrip than he or she is made happy by an equal gain of Rs.300 in thesale of Wipro scrip. This typical aversion towards loss, behaviouralscientists point out, makes an investor willing to take more risk toavoid losses than to realize gains. A typical investor owning a scripwhose price is falling, continues to hold it despite the apparent losses,instead of cutting the loss and using the sale proceeds to buy anotherscrip that is more likely to give a better return. The “endowment-effect” of this theory explains why people set a higher price for anasset they own than they would be prepared to spend to acquire itfrom others. It is but natural that these individual idiosyncrasies ofthe investor group ultimately result in the incongruous marketbehaviour challenging the very efficient market hypothesis.

The “Regret theory” talks about the emotional reactions of investorstowards their judgments that turn out to be wrong, such as buying astock that has gone down in value or not buying the one which hassubsequently gone up in value. A category of investors, under thefear of being found wrong in their judgment, even refuse to sell thestocks that have gone down in value. To avoid the embarrassment ofreporting losses, investors have often been found to resort to suchbehaviour. Such investors tend to find it easy to follow the crowd in


buying a popular stock not because of its high intrinsic value butbecause it simply affords them an opportunity to excuse themselvesfrom the resulting losses if any and to rationalize the loss by sayingthat so many others have suffered it.

People driven by “anchoring” philosophy seldom care for historicalevidences but get carried away by the immediate past experiences. Theytend to extrapolate recent trends though they are at loggerheads withthe long-run averages and probabilities and hurriedly decide upon takinga position. How else can one explain the rise in the price of Infosysscrip immediately following the announcement of results for the thirdquarter of 2001-02, when the owners themselves forewarned theinvesting public about the likely dip in the earnings growth of thecompany. This kind of overreaction from the investor group to recentmarket happenings, that too at the cost of other data, obviously takesthe stock under question away from its intrinsic value which is nothingbut a la affront to the efficient market hypothesis. Their overconfidencegenerates more optimism when the market goes up, while its downfallgenerates more pessimism. Thus prices fall too sharply on bad newsand rise too steeply on good news.

It is to be admitted here that the modern finance theories areoften found wanting in explaining such sudden and steep rises andfalls in the stock prices. This is where behavioural finance theoristschip in. Daniel Kahneman and Amos Teversky have offered anexplanation to such irrational investor behaviours by citing twopsychological theories, viz., “representativeness-heuristic” and“conservatism”. The former principle says that investors tend to seepatterns in random sequences, while the latter says that people chasewhat they see as a trend and remain slow in changing their opinioneven after the emergence of new data that contradicts the currentview in no uncertain terms.


It’s not that only the general investing public is inflicted withirrational behaviour. Research has shown that professional analysts areremarkably bad in forecasting the earnings growth of individualcompanies. It is often observed that growth rate in earnings forecastedby all the research analysts is more prone to fall around a central point,for no analyst likes to stay away from the crowd. Analysts are also knownto favour well-known companies with good forecasts, for they stronglybelieve that even if such companies under-perform, they are less likelyto be fired. This herd behaviour is attributed to the fact that the analystsare often evaluated against their peers in deciding their pay structureand other perks and hence they do not want to be away from them.

Having said that about analysts, let us now turn to institutionalinvestors/fund managers. Evidence indicates that institutional investorsbehave differently. This could be so as being agents, they act on behalfof the ultimate investors. Agents are at times found to be reluctant totake risk, even when the chances strongly suggest that they shouldtake a particular position in their clients’ interests. Here the culpritis “fear”—the fear of being fired. Secondly, they tend to favourinvestments in companies that are well known and popular as theyare less likely to be fired even if they under-perform.

The behavioural finance is thus revealing “why we do what we dowith our money”, and there is a method in this madness which needsto be taken care of for better returns from the market.

——)0——

Section III

Banking

T ill a couple of decades back, wealth for Indians was verily ‘material’.Either one had it or hadn’t. It was there in solid form. Even the

less endowed used to see it, though from a distance. It was there inrock solid form to be seen, felt and of course craved for. Perhaps, bybeing there visibly in solid form, it motivated everyone to work towardsit, if not for it. It was mostly used to purchase the essentials of life.The exchanges were also all in solid forms: Both giving and takingwere in hard form. Whenever anyone thinks of such exchanges, whatimmediately comes to mind is the rustle of paper or the tinkle ofcoins. All this has, however, drastically changed with the spread ofbank branch networks across the length and breadth of the country.With the spread of bank branches even up to the village level, thesolid form of wealth simply metamorphosed into passbook entries.People slowly mastered the art of exercising their super-symbolic powerof money through their bank cheques and passbooks.

August 2005.

FORTY SIX

Recent rise in undesirableconsumerism: ‘Credit’ to

credit cards?

Living today on tomorrow’s likely earnings is assuicidal as playing with a tiger.


As against this scenario, look at what is happening in today’smarkets: You will find less of solid exchanges but more of lesseressentials. Today, under the new-found affluent conditions, most ofus are looking for a new level of needs. Even we, the new Indians, areslowly but steadily moving away from a system meant for materialsatisfaction to a system meant for delivering ‘psychic gratification’. Itis neither the manufactured goods nor even ordinary services that arelooked for; but more of pre-programmed ‘experiences’ that are soughtafter. Snow worlds, Ocean parks, Discotheques, etc., have thusbecome the centres of attraction as consumers are going out and outfor collecting ‘experiences’ as consciously and passionately as theyonce collected ‘things’. And at all these centres, it is mostly the youthsthat are seen. Symptomatic of this emerging trend are the plasticcards in the wallets that are tucked in the hip pockets of male andfemale urban consumers.

Money—the alter ego of men and women— is no longer peggedto that ‘guaranteed by the central government’ paper or coins. It isthe card —whether it is ATM card, Credit card or a smart Debitcard—that has become the link between money and the individual.Today, there are millions of cards that are being tossed out at retailoutlets to restaurants; petrol bunks to pubs; colleges to clubs; mallsto IMAXes and what not, as authentic media for exchange. A yearbefore launching of economic reforms in 1991, there were hardly afew flaunting plastic cards. But by the end of 2003 their numbershot up to 9 million. Venture Infotek, a consumer paymentprocessing company, estimates the total spends in the credit cardpayment industry in 2003-04 at US $5 bn at merchantestablishments. According to Electronic Payments International, theirgrowth is projected at 10-14 million cards for 2005. According toanother forecast put out by the Lafferty Group, India’s credit cardspending is estimated to grow 34% in 2005.

203Recent rise in undesirable consumerism: ‘Credit’ to credit cards?

It is no exaggeration to say that with the emergence of new paymentsystem, it is not only the very living style of the people that has radicallyaltered but also the ethics and value systems of the whole society. Goneare the days when people, like drones, meticulously accumulated moneyfirst to purchase an essential at a later date. As against this, the emergingphilosophy of life is: “Today’s gratification against tomorrow’s earnings”.The net result is buying of ‘experiences’ for the heck of it. What wasonce considered essential has become trivial or obsolete today. Whatwas never thought of as essential, except in poetic illusion or delusion,has today become the centre of attraction. And its pursuit has becomethat much easier with the advent of plastic money.

Credit cards are found to be inducers of compulsive buyingbehaviour—a behaviour that denotes chronic, repetitive purchasingas a primary response to negative events or feelings. Credit card issaid to be the offshoot of the culture of consumerism, under whichmany consumers “avidly desire, pursue, consume and display goodsand services that are valued for non-utilitarian reasons such as status,envy, provocation, and pleasure-seeking”. The easy access to ‘credit’through credit cards has simply acted as a catalyst to spread consumerculture in the Indian metros and towns. It is the people who areessentially driven by attitudes such as power, prestige, ‘keeping upwith Joneses’ and ‘anxiety’ that are highly prone to compulsive buyingbehaviour. People driven by the attitude of power, prestige are proneto use money as a tool to influence and impress others and as asymbol of success. To them money is power and status—it is a meansto buy control and domination. Such people do not look for real gainin satisfaction; they simply acquire goods just to flaunt them as statussymbol and in that context, credit card simply acts as a treadmill ofconsumption. The second group of people that are driven by an attitudeof ‘anxiety’ perceive money as a source of protection from anxiety.Such people perceive compulsive buying as a ‘quick fix’ for anxiety.


These two groups of people tend to treat compulsive buying as amechanism to increase their ability to match their subjectiveperceptions of socially desirable appearances. In fact, compulsive buyersoften use shopping and buying as a means of relieving stress and itsassociated anxiety and credit card use is found to stimulate suchspending. Compared with cash, credit cards are said to result in greaterimprudence. For instance, research studies reveal that the introductionof credit cards into fast-food restaurants resulted in more sales andtransactions that are 50 to 100% larger than cash transactions. Creditcards, by virtue of eliminating the immediate need for money to buysomething, accelerate the habit of compulsive spending. Researchstudies also indicate that credit cards fan their irrational usage. It isalso found that such irresponsible use of credit cards only results indisruptions in one’s personal finances.

Apropos of these societal transformations, the recent press releaseof the Reserve Bank of India about placing its draft guidelines oncredit cards in Public Domain is a well-thought-out move. Particularly,its advice to banks and all others concerned with the credit cardsbusiness not to issue credit cards to students unless they haveindependent financial means is praiseworthy. It is also good of theReserve Bank to make it mandatory for the card issuers to explain themost important terms and conditions such as fees and charges, interestfree period, over due interest charges, charges in case of default,recovery procedure in case of default, procedure for surrender of card,drawal limits, billings and method of payment etc. It is also proposedthat no bank should levy charge that was not explicitly indicated tothe credit card holder at the time of issue of the card and obtaininghis/her consent. Most importantly, card issuers were asked not toissue unsolicited cards and unilaterally upgrade credit cards andenhance credit limits. They were also advised to observe the extantinstructions on Fair Practice Code for lenders issued by RBI while

205Recent rise in undesirable consumerism: ‘Credit’ to credit cards?

recovering dues. Particular mention must be made of the directiveasking banks and their agents not to resort to intimidation orharassment of any kind, either verbal or physical, against any personin their debt collection efforts.

Indeed, these are the issues which the consumers should havethemselves demanded. Ironically, they have to put up with all theunethical practices such as issuing unsolicited cards, improper billing,collection of exorbitant charges/unspecified interest rates, etc. It is awonder that consumers don’t revolt against such abuse of therelationship? Is it their anxiety to hold the card that kept them silent?What is the root cause? Doesn’t ‘the credit’ for all this go toconsumerism?

——)0——


W hat a difference a month makes! The Foreign InstitutionalInvestors, the major drivers of our stock market for the last

two years, have suddenly become the net sellers. Market reports revealthat during the last two months, FIIs have become net sellers to theextent of more than Rs.2,300 cr. Thanks to the domestic mutualfunds, who, having mobilized huge amounts through Initial PublicOffers in the recent past, could pick up “sell-outs” of FIIs almost tothe extent of Rs.4824 cr but for which the market would have witnesseda sharp reaction. Even to imagine such a scenario would have beenshuddering. But it is commonsensical to say that if the present trendcontinues, mutual funds, as one market analyst has already said, cannotlend support to the market for a long time to come, which means afall in the sensex.

No wonder if such a predicament emerges, when we look at whatis happening all around the globe: oil prices are soaring, currentlybeing at $51.56 per barrel; sharp recovery that the dollar is witnessingagainst the Japanese yen and the euro; changing global investment

July 2005.

FORTY SEVEN

Central banks’ trilemma

In an uncertain future, working for certainty in allthe three dimensions is certainly non-achievable forthe RBI.

207Central banks’ trilemma

scenario, etc. All these are pointing to a disturbing future. Over andabove this, the impact of a clear “Nee” from the Dutch and the French“Non” to the European constitution treaty is already felt in the forexmarkets and it is anybody’s guess what it would mean to dollar further.

How does it matter to us? It matters to us a lot. The foreignexchange reserves have fallen from $142.5 bn to $139.6 bn – aclean dip of $2.9 bn, that too all in a span of three to four fortnights.When viewed against the inflow of $7 bn and $5 bn during Februaryand March respectively, the current fall sends a different signal.Obviously, everyone jumped at the conclusion that FIIs, being thenet sellers in the recent past, are the main culprits behind the currentfall in foreign exchange reserves. Here, one should also take note ofthe fact that during the last two months the Reserve Bank of Indiarefrained from intervening in the foreign currency market allowingthe rupee to appreciate, though marginally and that too might havehad its impact on the fall in reserves as we practice the principle of“mark to the market” of securities. Another market development thathas its own say on the reserves level is the appreciation of the dollar3 to 4% against other currencies of the reserves such as Japanese yen,euro and pound. All these facts have cumulatively resulted in thereserves plummeting by $3 bn, all within a month.

The story does not end there. The rupee tumbled and closed at43.78 against the US dollar. The immediate reason for such a fall istraced to the sustained heavy month-end demand for dollars. But awhopping slide of 18 paise in a day cannot just be attributed to thesole “month-end scramble”, virtually from all quarters, for dollars.There is more to it than meets the eye behind the current appreciation.The dollar has become stronger against major global rivals such aseuro; a slowdown in the FII inflows; apprehensions about dollarshortage in the futures market; rising global oil prices, etc., have alla role in depreciating the rupee by almost 26 paise in just two


consecutive trading sessions. Obviously, the market expects the rupeeto remain under pressure for some time to come unless huge dollarinflows are witnessed.

‘Yes’, these scenes have almost been recurring that, too, quiteoften ever since India put itself on the “reform trajectory”. Theliberalization of exchange regulations that permitted flow of capitalacross the borders, though in a limited way, is obviously the “drivingforce” behind these oft-repeated Forex market scenes. Such suddenshifts in currency prices despite there being no change inmacroeconomic fundamentals are only mocking at the underlyingtheories of exchange rate determination. This prompts us to believethat today what determines exchange rates is not trade deficit andeconomic growth that were once considered important determinantsof exchange rates, but “capital flows”. In other words, it is the marketequilibrium exchange rate—the one which balances demand andsupply of the currency in the absence of official intervention, whichis likely to define the exchange rates.

What, however, matters here is not the determinants of theexchange rates but it is the trepidation resulting from such volatilemarket scenes which is throwing businessmen as well as policy-makersout of gear. Such repeated quakes in the economy pose a question—is economic globalization as projected by its proponents really a “goldenstraitjacket”? The answer is probably “no”. The current scenariodemands that we take a deeper look at the recently aired theory:Central banks in open economies are certain to face a macro-economictrilemma. The uninterrupted inflow of foreign capital with intermittentbut sudden and huge outflows; the resulting exchange rate volatility;and the costs involved under sterilization programmes, etc., are allcumulatively nudging us to believe that irrespective of the limited orfree mobility of capital, trilemma is inevitable for a central bank solong as foreign capital is permitted to move in and out of the country.

209Central banks’ trilemma

Typically, a central bank in such a situation is confronted withthree essentially desirable and yet contradictory objectives: One, tostabilize the exchange rate; two, to enjoy free international capitalmobility; and three, to engage in a monetary policy oriented towardsdomestic goal.

This trilemma will of course get further accentuated if we adoptfull capital account convertibility. What trilemma means is that if weintroduce full capital account convertibility, we can maintain no morethan two of the following three conditions: one, a fixed rate of exchangebetween the rupee and other currencies; two, unregulatedconvertibility of our currency and foreign currencies; and three, anational monetary policy capable of achieving domesticmacroeconomic objectives.

For instance, if the Government and Reserve Bank desire to reduceunemployment in the country by raising aggregate demand for goodsand services, the RBI has to cut down the interest rates for domesticbusinesses so that the economy becomes highly productive and morecompetitive in the global trade. However, this is not feasible if theexchange rate is fixed and arbitrage is unimpeded. In such a situationthe Reserve Bank cannot reduce interest rates below those that areprevailing in the major global financial markets unless it gives up“unregulated convertibility of its currency and foreign currencies” byimposing direct controls over movements of funds across the exchanges.Alternatively, it may have to sacrifice the condition of “fixed rate ofexchange between its currency and other currencies”. The trilemmadrives us to conclude that exchange rate should matter only when itaffects domestic inflation. But, in reality what most central banks do issomething totally different from the theoretical optimum. The mostcommon exchange rate mechanism adopted by the majority of countriesis neither a currency board nor a free float – but only intermediary ofcrawling pegs, fixed rates within banks, managed floats with no


pre-announced path etc. So irrespective of the pure theoretical positionof a Currency Board or a free float, the external value of the rupeecontinues to be a matter of concern to businessmen and policy-makers,besides the ordinary man on the road, though the reason is morepsychological than real or more real than psychological. But one thingis certain: Nothing is certain in forex market.

——)0——

211Here again PSBs are in the news, of course for a good cause!

In today’s globalized economy it is becoming evident that the currentways of doing business are not good enough to stay competitive in

tomorrow’s market—organizations have to invent new ways ofcompeting. In the world of continuous redefinition of industryboundaries and commingling of the technologies, businesses have tostrive for ‘opportunity share’ in future markets. It thus becomesimperative to focus on new strategic management that fosters alongitudinal focus on processes rather than on static cross-sectionalanalysis with due attention to strategic choices, culture andorganizational learning. Suffice it to say that what is needed today isstrategic clarity based on established principles. Strategic decisionssuch as divestments, new product launches, acquisitions,consolidation, though in vogue for long, have become more relevanttoday than in the past for creating additional space for the existingfirms to claim additional pie in the ‘opportunity share’. Mergers andacquisitions have thus become universal tools to attain greater market

September 2004.

FORTY EIGHT

Here again PSBs are in the news,of course for a good cause!

Mergers as a part of business strategy may yieldresults but administration-driven mergers are certainto fail.


share, acquire additional brands, cannibalize competing brands, realizeimproved infrastructure, create new synergies, capitalize on efficienciesand economies of scale, globalize in shorter span of time, etc.

Against this world scenario, it is heartening to listen what theFinance Minister said: “Consolidation is the name of the game,which is happening in every sector. I am happy that banks have alsotaken an initiative in this regard.” He further said that “If two ormore banks come together, we will support them and we need world-class banks. We have to think global and act local.” His comments arejust in consonance with what theoreticians in finance have been oftensaying: Mergers and acquisitions are the best fit strategy for quickgrowth and in turn for maximization of shareholder’s wealth. Secondly,the timing of the announcement itself is pretty encouraging: Withthe opening up of the service sector under WTO agreements to globalcompetition, it is essential to accomplish ‘scale of economies’ in thebanking industry to compete with the global players and this is possibleonly through mergers.

Leaving aside the wishful thinking and coming to realities weencounter a question: Is the present move for consolidation ‘business-driven’ or ‘administration-driven’? If it is going to be business-driven,we need to leaf through the experiences of global players that considertwo cardinal issues in differentiating a successful acquisition fromthe unsuccessful: One, doing the homework to select the rightcompany and two, applying an effective and replicable integrationprocess once the deal is struck. It also calls for a match between thevision of the acquirer and of the acquired firms, as otherwise they areprone to be at loggerheads and thus the generation of quick resultsand long-term wins for the shareholders, employees, customers, andbusiness partners, remains a question mark. Experiences also indicatethat as high as 60% of the mergers and acquisitions concluded in1990s have failed to capture the expected value. This highlights the


fact that although mergers as a strategy sound theoretically prettygood, their success demands ample ingenuity in their execution. Asput by an analyst, “A larger part of what makes a deal successful afteryou complete it, is what you do before you complete it”.

Against these experiences, let us analyze the pros and cons of thepresent consolidation drive. Efficiency theories under mergers suggestthat mergers provide a mechanism by which capital can be used withmore efficiency and the productivity of the firm can be increasedthrough ‘economies of scale’. The ‘theory of differential efficiency’states that if the management of bank “A” is more efficient than themanagement of bank “B”, and if bank “A” acquires bank “B”, theefficiency of bank “B” is likely to be brought up to the level of bank“A”. According to this theory, the increased efficiency of bank “B” isconsidered the outcome of ‘merger’. So, if the proposed mergers areto be successful, there must be a set of well-managed banks whichhave the potential to upgrade the efficiency levels in the acquired/merged bank that is said to be inefficiently managed. Now the mootquestion is how and who differentiates the ‘well-managed’ from the‘ill-managed’. And the answer is anybody’s guess, particularly in theIndian PSBs.

Another most important theory of mergers is ‘synergy theory’,which states that when two banks combine they should be able toproduce a greater effect together than what the two operatingindependently could. It refers to the phenomenon of two plus twobecoming five. This synergy could be ‘financial synergy’ or ‘operatingsynergy’. The mergers in the Indian banking system are technicallybound to give ‘operating synergy’, if not ‘financial synergy’. But thereare a great many hurdles in the path to operating synergy. Today, allthe public sector banks have branches in all the major towns and arein fact operating at many places side by side. There is thus a need tomerge such branches if operational synergy is to be realized through


bank mergers and such numbers could be pretty high. Looking at thecurrent experiences, one wonders if such consolidation is feasible.Even if it is possible, that is not the end of the story. It leads toanother problem: What is to be done with the excess staff? Are themerged units empowered to retire the excess staff? Or, are they tooffer a Voluntary Retirement Scheme and if so, how to fund it? Is theacquirer to fund acquisition as well as the retirement scheme? Thismay be a tall demand on our present system, more so when we considerthe level of capital adequacy the merged units need to maintain,including under the Basel II proposals. Do we have such strength?Or is the government planning to foot the bill? The next problem isthe existence of Regional Rural Banks. They, having lost the veryobjective for which they were established, are serving no greaterpurpose as separate entities. Hence, they also need to be taken noteof in the current drive for consolidation.

That apart, every bank is after all unique defined by a bundle ofunique resources, relationships, and a set of management practices.These differences are glaringly visible between the banksheadquartered in Mumbai, Chennai, and Kolkata. When two suchbanks come together, the first conflict that needs to be resolved isthat of cultural integration. Secondly, these banks have been hithertofighting bitterly with each other for a share in the market and whensuch employees are brought together, it poses a great challenge toleadership to align their focus with the vision of the merged unit.This calls for professional leadership which has to necessarily flowfrom the board of directors.

Despite these hurdles, there is no escape from the mergers, since“What matters today most to run a business is neither capital norknowledge but the ability to form powerful partnerships”. Thiscomment of Peter Drucker unambiguously tells us that a partnershipbetween a strong market leader and a weakling makes more sense


than a partnership between equals. A merger of two should alwaysgive ‘five’ as no extra benefit accrues from becoming a ‘four’. Thisintuition innocently puts a question: Why not, as a first step towardsmergers, raise private participation in the banks? Let the major playerstest the waters and mobilize equity and having proved their strength,may then find it easy to acquire a bank, purely on ‘business-driven’lines, for that is more likely to succeed.

Mergers per se are good but to reap the full benefits the acquiringbanks/government, being the owner of the major banks, should firsteliminate the hurdles in the path of successful mergers. Else, mergersmay tend to end up with the proverbial farcical result.

——)0——


It was in the early hours of Monday, July 26. An anxious face peeped into my cabin, intermittently. Perhaps, noticing someone or other

sitting with me, she swiftly but reluctantly, withdrew. I could readthe ‘anxiety’ writ large on her face. Later, noticing me alone in thecabin, she hurriedly pushed herself forward and mumbled: “Sir, Iwant to ask you about Global Trust Bank”. “Why”, you had anydeposits with it? “Yes Sir, it’s a considerable sum”. “You need notworry about its safety but have to only wait till its merger etc., isdecided by the Reserve Bank of India,” said I. “You say, I will get mymoney back?” I made a sincere attempt to placate her: “Yes, Youwill”. Apparently, relieved of her tension, she started finding faultwith the male members of her family for her present plight. Shesquarely blamed her husband, who appeared to have all of a suddensaid: “It is your money, so you handle it as you like.” She lamentedthat but for her husband granting that freedom, she would not haveended up with GTB. I was taken aback: A woman, who is incidentally

August 2004.

FORTY NINE

GTB fiasco: A new lesson for themarket economy?

No matter whether you are a man or a woman, “howcomfortable it would be if only one could escape fromtaking decisions?”

217GTB fiasco: A new lesson for the market economy?

a holder of the highest academic qualification that a university canoffer, was accusing her husband for granting her freedom of decision.A true evidence for Erich Fromm’s “Escape from Freedom”?

More striking than this, however, has been the recent upsurge inthe failure of finance companies/cooperative banks and now the GlobalTrust Bank. Essentially, banks are considered as the “repositories ofnational wealth”, and the backbone of the Nation’s Payment System. Abank deposit is basically considered as ‘near money’ for a depositor isgiven to believe that on any given day he can tender a cheque andreceive the cash. As against these decades of belief, look, what theGlobal Trust Bank has inflicted on its hapless depositors: a moratoriumwhich means closure of normal operations of the bank—making/receiving deposits, except for a maximum withdrawal of Rs.10,000 fromsavings or current account and giving out loans till the regulator findsa solution to rejuvenate it. It is an altogether different matter that themoratorium is aimed at freezing the assets and liabilities of the bank soas to arrest its further deterioration but what essentially it did was tosubject the depositors to a trauma. No one knows how many depositorslike my colleague are passing through the pangs of ‘uncertainty’attached to their life’s savings put with GTB. The treachery is hard tolive with by all those who have reposed faith in GTB.

True, as Shakespeare said: “There’s no art/To find the mind’sconstruction in the face” but a regulator cannot get away with it.They are pretty aware that the GTB’s net worth was wiped away twoyears back. There were also reports to the effect that its indiscriminatelending to garment exporters, diamond traders, share brokers, etc.had resulted in accumulation of huge bad debts. Indeed, it was knownfor quite some time that all was not well with GTB: the Reserve Bankof India vindicated this by asking the main promoter to step downfrom executive positions three years ago. The bank’s accounting yearwas extended. Its auditors were changed twice in the recent past.


Its annual report for the year ended March 2002 was rechecked bynew external auditors, as the RBI annual inspection team found thereport incorrect. The proposals for injecting fresh equity have beentaking an unduly long time to fructify. Earlier, its interim chiefexecutive left the bank within a short period. All this speaks volumesfor what is in store at GTB.

That’s not the end of the story for, if we travel a little farther downmemory lane, we notice many grave irregularities that are ordinarilypotential enough to attract the regulator’s attention. Current reportsreveal an alarming feature of its very establishment: The promotersare reported to have taken finance from a trader for infusing equityinto bank by promising a minimum share price for the bank’s scrip.This, in itself, is a good enough reason for the regulator to declinethe banking licence. It is no wonder if such linkages have ultimatelyled the bank to get caught in the stock market scam. There were alsoreports about the involvement of GTB in price rigging of its shares,prior to its proposed merger with UTI Bank. All these happeningscompel one to conclude that GTB is a suspect player in the financialmarket. In fact, there were pretty good warning signals, at least to theregulators, if not to the depositors; who are supposed to be good atsmoke detection. These signals could have prompted the regulatoryauthority to initiate corrective action long back. Instead, the ReserveBank of India welcomed “the decision taken by the GTB and itsboard of directors to clean up the balance sheet” in its press release ofSeptember 30, 2003 but, imposed moratorium exactly 10 monthsafter the said press release. The outcry of the demonstrating depositorsis thus understandable.

Ironically, the principal promoter of the bank, “refuses to take theblame for Global Trust Bank’s failure” as reported in the BusinessStandard on July 27, “but holds his management style of totaldelegation of power to senior managers and his hands-off approach

219GTB fiasco: A new lesson for the market economy?

responsible for the bank’s collapse”. In the interview, he categoricallystated, “I am not a failure” but it is “my new management style—total delegation to senior management—failed”. What an assertion!

What matters most here is when we juxtapose the act of GTB’spromoter Ramesh Gelli transferring the responsibility down the linefor the failure of his bank, with that of my colleague’s attempt totransfer the blame for the uncertainty attached to her deposits withGTB and the consequent trauma that she had undergone to the actof her husband granting her freedom, it makes quite a revelation. Letus first take the case of my colleague for a detailed analysis: We cannot,though my colleague did, find fault with her husband’s act of grantingher freedom to decide how to invest her money for she did exercise it,presumably, happily too. But, it is only upon the decision turningsour, that she felt unfortunate that her husband, ‘all of a sudden’,left the decision of investing money to her. This entire episodeinterestingly reveals a lesson: Granting power with no prior trainingis dangerous, particularly to those who have not been allowed tohandle money matters independently. No wonder if the executives towhom Gelli is reported to have delegated powers, air similar feelingsif asked for the reasons for their failure in exercising the delegatedpower fruitfully.

Intriguingly, this analogy leads us to another revelation— eveninstitutions, for that matter, even ‘systems’, cannot handle ‘newness’of anything that is granted all of a sudden. They perhaps needsomeone to watch from behind and guide them to chart a new path,till at least they strike their own roots. This is a lesson worth learningby all those who are associated with the march of the country from aregulated regime to a market-driven economy. But the moot questionis—at what cost? Yes, innumerable depositors of GTB have alreadyundergone their life’s trauma but it is only to be hoped that suchincidents do not recur though no one can guarantee it since


economies in transition are vulnerable to such mishaps. This, however,imposes a tremendous responsibility on the market regulators tomonitor the system with a great degree of alacrity. Let us fondly hopethat the regulators act upon the lessons learnt, while the rest “learncaution from others’ misfortunes”.

——)0——

221Is RBI a big brother or a helping hand?

It is often said that the primary objective of banking sector reforms launched by the Reserve Bank of India in the recent past is to

essentially inject an element of market discipline into an otherwiselacklustre performance of the Indian banking system. In the process,the RBI has introduced many measures to make banks adopt prudentaccountancy policies. It has introduced new norms for classifyingloan accounts into bad debts. It has also stipulated stringentprovisioning requirements. To fall in line with the internationalstandards in maintaining risk-based capital, the RBI has alsoprescribed a capital adequacy norm. Banks are also advised to betransparent in their disclosures about operations and risks undertakenperiodically, hoping that such disclosures would increase the credibilityof the banks’ functioning by revealing their competency to measureand monitor the quantity and quality of their risk-exposure besides,enabling investors to assess a bank’s financial strengths andperformance more accurately. With this, it is expected that banks

May 2004.

FIFTY

Is RBI a big brother ora helping hand?

Certain systems find it inconvenient to change withthe changing times and adopt newer techniques andunfortunately it is the rest who get penalized for it.


visiting equity markets for capital would automatically be disciplinedby investors.

Even the Basel committee on banking supervision in its report onenhancing bank transparency opined that market discipline wouldfunction as a third pillar in the capital adequacy framework. It is alsobelieved that in a liberalized environment, market discipline reinforcesregulatory and supervisory efforts of the RBI and provides a strongincentive to banks to manage their business in a prudent and efficientmanner. It is also hoped that good corporate governance will prevailamong the banks paving the way for maximization of stakeholders’wealth. Cumulatively, it is hoped that with prudential supervisionand market discipline in place, the kind of financial crisis East Asiawitnessed in 1997 could for ever be averted in India.

Contrast these expectations with the recent directives issued by theRBI regarding dividend payout by commercial banks in India. The RBIhas recently issued a fiat prohibiting banks with net non-performingassets above 3% and capital adequacy ratio below 11% in the precedingtwo completed years, from paying dividend without its approval. Inaddition, their dividend payout ratio cannot exceed 33.33% of thecurrent year’s net profit. Based on the financial data for 2002-03, it isreported that only three of the 19 listed public sector banks and twoof the 18 listed private banks will qualify to declare dividend withoutseeking the RBI’s approval. Prima facie, the very need for the ReserveBank to issue such directives reveals that neither the banks, which inthe normal course of business, should determine how much dividendto declare to keep the investors happy while keeping the businessstrong, learnt to behave on their own, nor could the market disciplinethem as anticipated while launching financial reforms.

That however, is not the only problem. Investors in bank stockswould certainly be unhappy with these directives, for no investor commits


his funds to companies that do not pay dividend. During the last 12months, banks’ stocks were actively traded on the bourses and indeedwitnessed dream prices. This sudden move of the Reserve Bank willnot only force investors to stay away from bank stocks but is certain toplay prima donna with the plans of those banks which contemplatedtapping the capital market for fresh funds to augment their capitaladequacy. This in turn can derail the business plans of those bankswhose future growth is solely linked to build-up of additional capitaladequacy. The ultimate victim of all this is corporate governance.

Intriguingly, the brazen intrusion of RBI into banks’ right todeclare dividend posits two questions: one, is it the lack of confidencein bank managements’ ability to steer through the troubled waters,or two, is it the RBI’s penchant for micromanaging the banks thatprompted the current directives? The former question is moredisturbing for 80% of banks are under the control of the governmentand it is very difficult to digest the idea that the government hasabdicated its responsibility for supervising the managements. Of course,there is a discordant note among the analysts about the government’srole in managing banks. The government being anxious to bringdown its fiscal deficit by whatever means that are at its command andbeing the owner of major banks, may arm-twist the banks to declaredividend without minding its adverse impact on the health of theirbalance-sheets. Perhaps, looked in that context, the present move ofthe RBI may sound sensible.

Of course, many in industry are citing a number of reasons to justifythe current directives of the RBI. The analysts argue that unlike manyother corporates, banks being financial intermediaries are prone totypically function with an embedded mismatch between highly liquidliabilities on one side and less liquid, non-marketable assets on theother side of their balance-sheets, and the consequences of embeddedmismatch get further accentuated with the accompanying wide array of


risks like credit risk, market risk, and operational risk. Secondly, banksbeing highly leveraged, these inherent risks could result in catastrophiclosses unless managed effectively. The fact that banks today hold anincreasingly large proportion of assets and liabilities signifies the direneed for prudent and effective management. Failure of banks, besideschallenging the common man’s very perception of banks as repositoriesof national wealth, being highly contagious, may pull down the veryfinancial architecture of the country.

There is yet another argument in favour of the current move of theRBI. In a scenario where banks are known to have invested about 40%of their funds in government securities, any upward move in interestrates that, too, when analysts opine that interest rates have alreadybottomed out, can inflict huge capital losses on their investmentportfolios. Industry pundits argue that should such an eventuality arise,few banks would be in a position to tide over the crisis on their own;more so, if one were to believe the market reports that no bank has yetinitiated action on the advice of the RBI to create an investmentfluctuation reserve of 5% of their investment portfolio by 2006. Someothers argue that the present move may be aiming at preparing Indianbanks for the new Basel II Accord as less payout in terms of dividendhelps banks shore up their capital adequacy. By and large, everyonerelated to the banking industry in the country has thus hailed thecurrent move of the RBI as quite sensible and timely.

So far so good, but it certainly fails to silence the cynics, if youwish to call them so, from posing a barrage of questions: What wouldRBI do if banks approached it for permission to pay dividend? Whereis the guarantee that the RBI will not accede to such requests? And,if it accedes, what are the guidelines for exercising such discretion?Where is the guarantee that exercising such discretion will not defeatthe very purpose of these directives? More than anything, would such


a move not shift the onus of declaring dividend to the RBI from theshoulders of the real managers of a bank—the board of directors?

Apart from these questions, should the RBI as a supervisor of thebanking industry not appreciate the fact that issuing directives to honethe financial architecture of the country is one thing, and retainingthe power to use discretion under the same rules that, too, when suchexercising of discretion will amount to supplanting itself in the role ofboard of directors of respective banks, is quite another. It only reaffirms,though unfortunately, that even after a decade of financial reforms, thesystem has not transformed the bank managements from being tinytoddlers to professional managers, as devoutly wished for. The mootquestion is how long the RBI wishes to do hand-holding? Aren’t we yetready for independent managements that could prudently handle theiraffairs in such a way that it keeps their business healthy and investorshappy with market appreciation of their investments besides payingdividends? Against this backdrop, RBI’s intrusion into micro-management of banks sounds no good by any stretch of the imagination.

——)0——


Yes, there is a lot of ‘new-found confidence’ on display among theIndian companies. They have mustered enough energy to take

on globalization confidently. The rising demand for consumer creditfrom the banking sector is a sure pointer towards the growing demandin the country for industrial output. Current happenings give a feelthat corporates too are moving slowly but certainly away from their‘investment-shy’ posture to committing fresh investments for buildingnew capacities and improving productivity and quality of products byfine-tuning the ‘processes.’ They are even resorting to financialengineering: Today companies are enthusiastically moving forwardto cash in on the prevailing historically low interest rates by borrowingafresh to retire high-cost old loans. They are gung-ho on restructuringtheir debt portfolios with a mix of foreign currency- and rupee-denominated loans so as to reduce capital cost and stay competitivein the market.

April 2004.

FIFTY ONE

Shining NPAs: A reflection ofnational ‘character’?

It’s not only human beings that have character butalso corporates and it matters most in corporates forthey thrive on the capital of many.

227Shining NPAs: A reflection of national ‘character’?

That said, India has a lot to answer for. One such distressingphenomenon demanding explanation from the nation as a whole isthe Reserve Bank of India’s stern warning to banks against attemptingto “evergreen” their balance sheets for the financial year ending March31, 2004. Here evergreening means managing the balance-sheet throughmeans that do not violate banking laws in letter but breach them inspirit. Indeed, it is not for the first time that the Reserve Bank of Indiahas aired such displeasure at the attempted evergreening by the bankingsystem; doubts have been aired for quite some-time about bankscamouflaging their balance-sheets at every financial closure.

Controversies aside, let us examine why banks resort toevergreening at all. The need for evergreening has indeed arisen outof the stringent provisioning norms that the RBI introduced a decadeback and the mounting pressure on banks for reporting profits.According to the instant norms on provisioning, banks are to identifya loan as an NPA if the instalments fallen due or the interest that wascharged was overdue for two quarters or 180 days. One may wonderhere: “What is the big deal in it?” It does make a difference: too manybad debts hit a bank’s balance-sheet in two ways. One, it reduces thecurrent interest income and two, it demands provision from theearnings made elsewhere as a protection against the bad debts andboth cumulatively affect the bank’s profit. Secondly, a high percentageof NPAs erodes its market credibility.

It is to overcome these hurdles that banks are perhaps resorting toevergreening. Under this, bank “A” sanctions a loan to a firm whoseaccount with bank B is becoming bad for recovery to enable it to depositthe amount thus released in its loan account with bank “B” and thusarrest its slide into NPA. This helps “B” bank to report fewer NPAs andalso enhance its interest income. As a sequel to this, bank “B” sanctionsa loan to a customer of bank “A” whose account is likely to become anNPA, to enable him to deposit it in his account with bank “A”, thereby


avert its slide into an NPA. By resorting to such mutual help, banks areshowing NPAs at a lower level than what they really were. Some banksare reported to have invented yet another route to evergreen theirbalance-sheets. They disburse too many loans at the end of the financialyear in the hope that the credit portfolio thus inflated automaticallyreduces the NPAs in percentage terms.

There is more to this conundrum. From the next financial year,banks are likely to be directed to identify a debt as a non-performingasset, if either the instalment or the interest was overdue for onequarter or 90 days. This is what is really causing more consternationto the Reserve Bank of India: It apprehends that evergreening maymake deeper inroads. The RBI’s anxiety over the episode is thusobvious, though banks say its apprehensions are misplaced byclaiming that they are fully gearing up for the transition and relatedchallenges.

But the real tragedy behind the whole episode is that no one iswilling to look at the root cause of the NPAs. It is the failure of thebusinesses to generate anticipated cash flows as projected at the timeof committing fresh investment either for expansion of existing lineof business or creation of new capacities, to service the debt. Therecould of course be multiple reasons for such failures: lack ofentrepreneurship at the top in executing the project as envisaged;their undertaking ambitious projects in their anxiety to grab the earlybird advantage or to prevent others from entering the competitionthat too with no matching owned-funds or internal accruals to realizethe projected sales volume; unanticipated liquidity crisis owing toeither non-receipt of owned-funds in time or hiccups in the releaseof loan by banks; blatant misuse of funds meant for execution of theproject; deliberate default in repaying the debt and so on. Time alsoplays havoc with many projects: At times projects do not move at all;and on other occasions time flits away, like a wraith, as though the

229Shining NPAs: A reflection of national ‘character’?

owner was not there. The adverse impact of “time-overruns” is provedto be as tempestuous as “cost-overruns.”

There could also be instances where banks and financialinstitutions might have themselves contributed their mite, thoughunwittingly, towards NPA’s accretion. They might not have displayedmatching skills to assess the multivariate projects that have soughtfinances effectively, allowing the embedded risks to creep into theirbalance-sheets as NPAs. Or, it could be that banks have not exhibitedthe requisite resilience in locating the incipient weaknesses of projectswell in time and initiate appropriate action in terms of restructuringthe debt etc., that could have seen the project through with a little orno damage to the core.

In the fitness of things, we must also examine the role of “character”of all those involved in the episode. Be it individuals or corporates, alllive with reference to their “character.” It is the character that definesthe fate of a person or a corporate. Suffice it to say that ‘character’ and‘destiny’ are intimately welded together. Character as defined by its“leadership” is indeed the destiny of any company. It is the character ofa corporate which encourages unchecked greed for wealth resulting inirrational expansion of existing lines of activities or diversion into analtogether new line of business, that too with no matching intrinsicstrength. Such irrational commitment of investments to fresh projectscoupled with a lack of ‘sincerity of purpose’ obviously leads to failurein accomplishing the envisaged business objectives. Or, it is the verycharacter of the company that drives it either to deliberately misuse thecash flows or wilfully default from repaying the debt. All thisautomatically leads to the crystallization of the much-shuddered default-risk and accretion of NPAs in the banking industry.

In the final analysis, it is the “character” of the corporates thatdefines the level of NPAs in banks and the subsequent need for


evergreening of banks’ balance-sheets. So, there is no logic in blamingthe circumstances for all our ills. Remembering,

“The gods are just, and of our pleasant vicesMake instruments to plague us”,

are we to collectively pray for build-up of ‘character’ across thecorporate corridors that enhances productive function of real resourceswhich alone can mitigate NPAs and the associated problems?

——)0——

231Queering “flat pitch”/“curve”

Bowlers in cricket dread a “flat pitch”. It is dead and hence cannotassist the bowlers. Being placid, it neither offers cues nor supports

the bowlers for getting wickets. On the other hand, it calls for a lot ofingenuity from the bowlers. They need to be highly disciplined inbowling “wicket to wicket”. They cannot afford to drift even for awhile from “line and length”. Even a slight error of the bowler willbe punished mercilessly by his opponent. Simply put, bowling onflat pitches is nightmarish. And so is the case with a flat yield curve:it offers no insights to investors in designing their investmentstrategies. To better appreciate this analogy, let us begin at thebeginning.

A “yield curve” is a plotting of the interest rate yields on bondswith differing terms to maturity, but with the same risk, liquidity andtax consideration. Simply put, it is a description of the term structureof interest rates. Normally, yield curves are upward sloping whichmean the long-term interest rates are above short-term interest rates.

April 2004.

FIFTY TWO

Queering “flat pitch”/“curve”

Be it a cricket field or a financial market, flatness isalways shunned for there would be no challenge,which means no gains and in business sans gainsthere is no beauty.


Having said that, let us bear in mind that the yield curve could alsoslope downward or simply remain flat.

Now, the fundamental question is what determines its slope. Toanswer this, let us take a deeper look at the underlying theory of theyield curve known as expectations hypothesis of the term structure ofinterest rates. It states that the interest rate on a long-term bond willequal an average of short-term interest rates expected to occur overthe life of the long-term bond. This hypothesis is derived from theassumption that bonds of different maturities are perfect substitutes,as otherwise, the expected return from holding one period bonds willnot match with the expected return from holding the n-period bond.It otherwise states that the entire term structure at a given point intime reflects the market’s current expectations regarding the futureshort-term rates. For instance, a positively sloped yield curve impliesthat spot interest rates are expected to rise in future, while a negativelysloped yield curve implies the reverse. The expectation theory, however,is predicated on several assumptions of which the important one isthat the investors and issuers have complete maturity flexibility.

Historically, the slope of the yield curve has been one of the bestsingle leading indicators of the economy. It demonstrates the overalllevel of current interest rates. Most of the time, analysts draw theyield curve in terms of government securities, since they are risk-freeand thus eliminate all possible theoretical distortions in terms of credit-risk, etc. Its shape tells a lot about expectations of investors aboutfuture interest rate movements, which in turn will predict the rate ofeconomic growth. It is a multipurpose tool with many applications:input for monetary policy application, a tool to measure market risk,etc. The shape of the yield curve is normally classified into four groupsviz., normal yield curve, flat yield curve, inverted and steep yieldcurve, each conveying its own message.


A normal yield curve, as the name implies, is lower on the left,and higher on the right side, indicating that the short-term interestrates yield less than long-term interest rates. A flat yield curve isformed when both short-term and long-term maturities are nearlythe same giving approximately the same yield which indicates thatthe economy could potentially move into a pullback, contraction, oreven a recession.

An inversion of the yield curve results when investors rush topurchase long-term bonds shooting up their price of the bond anddecreasing the yield. It reflects expectations that the central bankcould be forced to decrease interest rates to provide liquidity to theslowing economy. The inverted yield curve is usually an accurateforecast of a slowdown or an economic recession. A steep yield curveis formed when an economy is moving from recession to growth. It isoften characterized by long-term rates well in excess of short-termrates. In the waning days of recession, short-term yields will remainlow, but long-term yields will begin to rise sharply in the expectationthat the central bank will be forced to raise interest rates to fight backinflation. A steep curve is often found at the end of a recession.

With this theoretical understanding, let us now take a look atwhat is happening to our yield curve: In the recent past, it has beenflattening. The spread between the overnight rate and the 10-yearsovereign yield has all along been declining. During 2003-04, itdeclined by 61 bps from 116 bps at the beginning of the fiscal. Theyield curve is currently around 130 bps. It is perhaps the flattestyield curve we have had in the recent past. Another distressingphenomenon is that the yield curve has already turned inverted atthe shorter end. This is perhaps obvious, for the 364 day T-billyield has been below the official repo rate. By global standards, ouryield curve is pretty flat. Intriguingly, the yield on ten-year G-sec isat 5.04%, almost in tune with the global average. But, the average


overnight rate of 2.84% and the official repo rate of 4.50% aresignificantly above the global average.

The answer to our flat yield curve is not far to seek. It is therigidity depicted by the Reserve Bank of India (RBI) in fixing reporate at the same level for long periods. Although the repo rate wasonce cut by 50 bps by the RBI, it could hardly make any dent on theyield curve since the fall in ten-year yields during the said period isover 110 bps. This rigidity exhibited by the RBI in fixing repo rate ismaking it incongruous with other short-term interest rates. Secondly,the present regulations prohibiting short selling of governmentsecurities are resulting in a “long-only-market”. A “long-only-market”does not afford an opportunity to market players to express their two-way views on the interest rates and thus the yield curve does notnecessarily reflect the market expectations. Derivatives too play a greatrole in defining yield curve. They facilitate short selling withoutbeing actually short in the underlying cash market. But we have anill-developed derivatives market. Similarly, skewed issuance ofgovernment securities towards the long end has shifted the secondarymarket activities towards securities with longer maturities. Theresulting low appetite for short-term papers created ill-liquidity callingfor factoring the liquidity risk premium into short-term rates. Theresulting higher yields at the shorter end and softer yields at thelonger end are automatically flattening the yield curve. Cumulatively,these factors are distorting the yield curve.

As a flat pitch is nightmarish for bowlers, the flattening yieldcurve is certainly a cause for concern for the markets. The USexperience teaches us something shuddering: its inverted yield curveof 2000 was followed by an extended period of economic downturnin the economy. Though the Fed Reserve has cut the interest rates 13times since then, its economy is still wriggling to come out of the


economic slowdown. Similarly, the inverted yield curve of Japan pointstowards an economic recession.

An yield curve is an important input for policy-makers. It providesinformation on market expectations on inflation and GDP growthembedded in it. As against this, a flat yield curve, like a “flat pitch”,provides no insights to the central bank on these two issues that areessential for drafting an effective monitory policy. There is of coursea caveat that one need to bear in mind here. In a very regulatedfinancial market, the informational content of a yield curve is relativelyless as the slope of the yield curve is partly determined by the deliberatepolicy of the central bank as it is indeed happening today in thestruggle of RBI for managing the surging foreign currency inflows.This in turn makes the flattening yield curve more nightmarish toinvestors and planners than a flat pitch does for bowlers.

——)0——


During 2003-04, banks are reported to have invested far more ingovernment securities than what has been disbursed as credit.

As per the latest release of weekly statistics by the Reserve Bank ofIndia, non-food credit of banks stood at Rs.55,125 cr, while theinvestment in government securities stood at Rs.97,197 cr. It otherwisemeans that, as against the stipulated investment of 25% of incrementalassets in Gilts, they have invested almost 66% during the currentyear. Of course, the reasons are obvious: it is pretty easy to dump theaccredited deposits in Gilts since it calls for an assessment of neithercredit worthiness nor the measurement and management of “defaultrisk”. Maybe, that is one of the reasons why some are labelling it as“lazy banking.”

But there is a glitch within this apparently good-lookinginvestment. This could perhaps run all right so long as the interestrates continue to move southwards, but what if tomorrow the trendreverses? The current view on market is that interest rates have

January 2004.

FIFTY THREE

Out, ‘lazy banking’ &in, ‘resilience’

Be it in business or in public life, in a globalizedeconomy, laziness is penalized and resilience isrewarded.

237Out, ‘lazy banking’ & in, ‘resilience’

bottomed out, and once the demand for credit picks up, interest rateswill only move northwards. It is expected that the prolonged span of“under-investment” will soon set the stage for a prolonged cyclicalexpansion. After all, it is capital expenditure alone that can fuel theemployment growth, which in turn can give a push to sustainedconsumption. Once growth in domestic consumption is sustainedover a long period, it not only reduces the dependence on the vagariesof demand from external markets, but also strengthens the exportcompetency of Indian companies. It is after all commonsensical thatmany of today’s multinationals have become global players only afterhaving established themselves as strong players in their respectivedomestic markets. It is indeed their strength in the domestic marketthat affords a kind of cushion for these corporates from external shocks,if any, and sustains their global spread.

It looks as if Indian firms were very much aware of thisphenomenon and hence are reorganizing themselves professionally.It is heartening to note that during the last couple of years, Indiancompanies have made use of the “recession” to strengthen theirbalance-sheets quite impressively. They are today in a better positionto make fresh investments out of their own funds. One set of analystsestimate the proposed commitment of Indian corporates towards thecreation of additional capacities at Rs.20,000 cr in the form of equityin the coming twelve to twenty months. It means that there would bea demand ten to twelve times the size of the credit from banks. Sucha development is bound to tighten the liquidity in the market and putupword pressure on interest rates.

What would happen then? Banks would face a double-edged sword:rising interest rates will, on the one hand, result in fall in theinvestment income, while on the other hand, it raises interestexpenditure on deposits. There is yet another danger lurking behindall this corporate “hoopla” of investment-revival. During such periodsof investor enthusiasm, it often so happens that companies that are


not quite fit enough, also join the bandwagon and make a demandfor credit from banks. Of course, by now, banks would have becomesmart enough to outsmart such entrants. Nevertheless, they need todisplay their competency to handle the risks embedded in creditdispensation more visibly so that it acts as a deterrent to the bad guysto tinker with the financial system.

The ground realities are, however, nowhere near these demands.It’s a pity that even after a decade of financial reforms, the centralbank has to advise banks to work out their PLR by factoring theiractual cost of funds, operating expenses, a minimum margin to coverthe provision requirement under the NPAs, dividend to be paid to theshareholders, and the required profit margin. Does this advice meanthat banks were hitherto announcing their PLR arbitrarily? Anotherequally alarming feature is that banks are reported to be currentlylending funds at the sub-PLR since they are drowned in liquidity thatresulted out of poor credit offtake. This contingency raises twoquestions—how then are banks covering their costs? And how arethey accounting for the costs associated with loans that have differentmaturities and the accompanied risks?

Probably one can answer the first question through the fact ofmarginal cost of deposits coming down substantially in the recentpast. But it is very difficult to find an answer to the second questionexcept to say that banks are ignoring the risks associated with longmaturing loans, provision experiences under different segments oflending, etc., however critical it may appear, from the point of viewof their profitability. This double bind only drives home the need forproduct-wise PLRs. Or otherwise, having worked out a benchmarkPLR banks should work out separate “risk premiums” to cover thecost of each risk such as maturity risk, product risk, portfolio risk,provision risk, capital risk, being entertained under different loans soas to ensure that every loan is properly charged to recover theunderlined costs fully.

239Out, ‘lazy banking’ & in, ‘resilience’

There is yet another challenge which is not far off. Oncereal-time gross settlement becomes functional by June, the “float”—which banks are today enjoying as interest-free deposit from theircustomers that comes handy for meeting banks’ daily paymentrequirements—will simply disappear. It means that transaction costsare going to be high for banks while they would become cheaper tocustomers. This emerging challenge demands from banks a new setof pricing strategies.

The sum and substance of these arguments is that banks can nolonger afford to be lazy, that too, when markets are fast becomingturbulent owing to a continuous change in interest rates. What istherefore needed is “strategic resilience” that can continuously helpbanks to redo their balance-sheets with more and more profit-generatingassets. It is time that banks cultivated resilience across the hierarchythat would enable them to continuously anticipate and adjust to theconstantly changing market scenario before the need for changebecomes desperately obvious.

But the moot question is how to nurse “resilience” in banks. Howto sell the idea that the business models that have proved to be moreor less immortal are no longer good for getting better? It is particularlydifficult to sell this idea to executives who have enjoyed a benignenvironment all along where everything was taken for granted.Resilience is not about having an inventory of best practices, butmore of a strategy of constant morphing that enables banks to beforever conforming to emerging opportunities and the underlyingtrends. The goal should therefore be not correcting the past deeds,but making its future. It is only resilience that can guarantee plentyof excitement sans trauma. Mistakes in identifying, measuring andmanaging risks cost money and so are the outlived strategies andlaziness in correcting the past. So resilience matters and it is for eachbank to choose a path for nurturing it in their organization.

——)0——


Come April and the season of speculation on Credit policy, onegets emboldened to believe that Robert Frost might have penned

those lines keeping economists in view.

Leaving it at that, let us look at the ongoing slide in interest rates.True, high interest rates deter industrialists to commit funds forinvestment in new businesses or expansion of capacities ordiversification. And so only the Reserve Bank of India reduces interestrates when the economy is on the downswing, to stimulate economicgrowth as also to ensure that deflation does not set in. Theoretically,such reduction in interest rates is supposed to assist new enterprises,at least temporarily, in getting cheaper credit to get started. But inthe long run, it does no good to the economy as whatever gain itgenerates is likely to be offset by the resulting inflationary pressureson the business cycle.

Apart from inflation, artificially synthesized low interest rates proveto be no good for the economy at yet another level. Common sensereveals that distorted prices lead to distorted use. Theoretically, cheap

May 2003.

FIFTY FOUR

Reserve bank’s ‘duvidha’?

“Most of the change we think we see in life is due totruths being in and out of favour.”

241Reserve bank’s ‘duvidha’?

credit is known to encourage people to waste capital by makingexcessive investments in plant and machinery, real estate, etc., withoutweighing the productive value of such investments. Of course, inour context, thank God, that is not happening as is confirmed by thepoor demand for credit from the industrial segment.

But in the meanwhile, a disturbing development has silently creptinto the system. Banks, in their anxiety to deploy their funds profitably,are aggressively enticing middle class employees to take personal loans.This is giving a giant push to consumerism. Intriguingly, a farmermay have to spend more time in getting a loan to purchase a tractorthan an employee for buying an air-conditioner or Maruti Esteem.More than that, a farmer has to pay higher interest on a tractor loanvis-à-vis an employee or a professional for a car loan. Time alone canreveal where this leveraged-consumerism would lead the economy.Having said that, one cannot but lament at the ‘short-termism’ thatcontinues to rule the roost.

There is yet another dimension to the fall in the interest rates. Ifthe central bank, in its anxiety to kick-start the economy, continuesto practice low-interest rate regime, then savers may loath to save.This trend is already surfacing: lowest ever growth rate of just 12% inbank term deposits in 30 years has indeed been reported for the fiscalended March 2003. The lurking danger behind this development isrestricted credit expansion, restricted investment in new enterprisesand finally little or no employment generation. Cumulatively, allthis means no rise in the purchasing power of the populace.

Apprehensions aside, as at the end of March 2003, inflation hastouched 6% which is almost 25 basis points higher than the interestrate offered at the shorter end by many PSBs today. It otherwise meansthat if one wants to maintain the present value of money intact, onehas to keep his money in a bank for at least one year. If RBI, which is


reported to be favouring a softer interest rate scenario, further reducesbank rate in the forthcoming credit policy, real returns to savers willsimply turn negative. Then, what is the incentive for the savers todefer their gratification and save the capital?. Such fall in savingsleads to poor capital formation domestically, which means non-availability of capital to meet the increased demand for freshinvestments at the other end of the business cycle.

Some economists are of course arguing that the present rise ininflation is not a ‘demand-pull’ but only a ‘cost-push’ phenomenon.They predict that once the Iraq war is over, crude prices will comedown and obviously the inflation. But if one factors the fall inagricultural production by as much as 3.1% during the last year, noone can dare expect a fall in prices of oilseeds, cotton etc. That apart,what if the monsoon turns out to be weak even during 2003, whichindeed is the prediction. Though one shudders to think of anotherbad-monsoon year, one thing is certain: it will result in a further fallin agricultural production. It means there is little chance for inflationto come down, if not shoot up further.

There is of course another closely related ‘concept’ that meritsour attention here: inflation might be good for growth. Empiricalstudies carried out by Fischer and Bruno and Easterly establish that“inflation is negatively correlated with growth – at least double-digitinflation rates”. On the other hand, studies carried out by Barro andSarel did not find any negative relationship between inflation below8% and growth in economy. This is supported by inferential evidence,i.e., “deflation is considered bad for growth”.

There is another important phenomenon that needs to be takennote of here. There is always a considerable delay between the ReserveBank effecting a change in interest rate – up or down – and thatchange affecting the demand in the economy. Studies reveal that it

243Reserve bank’s ‘duvidha’?

takes almost a year and a half for an interest rate shift affected by thecentral bank to impact the economy.

It would therefore be interesting to watch which truth – “theundesirable low-interest-rate- driven growth in consumerism” or “therising inflation rate and the need to curb it” or “the continuing lullin the industrial output and the resulting need to give it a pushthrough monetary initiation” – would be “in and out of favour” ofthe central bank.

——)0——

Section IV

Forex Markets

Every now and then, someone or other from India initiates adebate on Capital Account Convertibility (CAC). This time it

was the Prime Minister who said: “I have requested the FinanceMinister and the Reserve Bank of India to revisit the subject andcome out with a road map on CAC based on current realities.” Beforegetting deep into the debate let us first see what economists have tosay on CAC.

CAC simply means freedom to a resident to convert his local assets,physical or monetary, into foreign assets and vice versa at market-determined rates of exchange. Market-oriented economists putativelyadvocate CAC for a plethora of benefits: it maximizes the efficiency inthe use of capital across the world; it enlists macro-economic disciplineand thereby makes capital markets behave and respond to such policyshifts; compels governments to supervise financial systems and regulatethem well; eliminates discretionary powers of bureaucrats that in turn

April 2006.

FIFTY FIVE

Capital account convertibility:Is India ready for it?

Looking to China that is sitting pretty with forexreserves of $850 bn, no one should get tempted to saythat CAC is essential for attracting foreign capital.


can eradicate corruption from the corridors of financial system andfinally affords freedom to individuals to dispose of their income andwealth as they deem good in their interest.

But the South-East Asian financial crisis simply put the ‘CapitalAccount Convertibility’ on the backburner. It shifted the emphasisto caution. Critics, armed with the fall-outs of the Asian crisis, haveargued that capital control is the most wanted mechanism to mitigatevolatility in international capital markets and to maintain theautonomy/sovereignty, of national policy.

Admittedly, the economic profession knows a great deal aboutcurrent account liberalization, its desirability and effective ways ofliberalization but knows very little or nothing about capital accountliberalization. This school of thought is therefore asking for orderboth in thinking about and policy framing on capital account. It isalso argued in many quarters that capital account liberalization hasgot many costs embedded in it, the shocks of which are beyond thecapacity of the developing economies to absorb.

Professor Jagdish Bhagwati, the noted economist of ColumbiaUniversity, forcefully but persuasively warns the whole world not toequate the benefits that are likely to flow from free mobility of capitalwith the benefits arising from free trade, for they are not analogous.Obviously, all those benefits that flow to society from the principle of“comparative advantage” in production and exchange of goods donot readily translate into similar benefits from the exchange ofcurrencies. He drew the attention of the world to the fact of availabilityof enormous quantum of historical database to establish the flow ofbenefits from free trade while it is abysmally low with regard to freeflow of capital. Hence, he warns that the weight of evidence and theforce of logic point towards a policy that restrains capital flows ratherthan allows its free flow.

249Capital account convertibility: Is India ready for it?

It is a commonly held belief that CAC makes a developing country’seconomy highly vulnerable, i.e., when something goes wrong, thensuddenly a lot goes wrong, as it happened during the Asian crisis.Free flow of capital from international markets into a developingeconomy is usually guided by a “feel good or bad equilibrium” of aneconomy. The “good equilibrium” created by the high confidenceand growth in economy acts as a ‘pull-factor’ for capital inflows – asis currently happening with us – while a reverse of it results in outflowof capital. Indeed, this is what happened in South-East Asiancountries during 1997. Once the equilibrium is shifted from good tobad, owing to erosion of confidence in their pegged-rate currencysystem and fall in exports growth, nothing could stall the flight ofcapital from these countries.

Neo-classical economists of course counter it by arguing that CAC“is a welfare enhancing mechanism.” Their contention is that, in aliberalized environment, international financial markets allow residentsof different countries to pool various risks because of which a countrysuffering from a temporary recession or natural disaster can as wellborrow abroad. This is also considered to be a boon to the developingcountries which suffer from poor capital formation, as they can borrowfrom global markets to make investments and promote economic growth.In recent years, this neoclassical explanation is criticized on the groundthat global capital markets are victims of adverse selection and moralhazard. It is therefore very difficult to know precisely when outcomeswill switch from good equilibria of rapid growth fuelled by capitalinflows to bad ones with the accompanying wide spread capital flight,precipitating deep recessions. Thus, it raises the crucial question:Whether the longer run macro-economic benefits of “allocativeefficiency” outweigh the instability costs of capital account openness?

Even the findings of Sebastian Edwards and Geoffrey Garrett revealthat countries can only reap the efficiency benefits of capital account


liberalization without incurring its instability costs when they possessprudential financial sector institutions that establish regulations forcapital adequacy, reserve requirements and the like, monitor closelythe behaviour of actors in the financial sector, and are transparent tothe outside world. The study comments that this type of prudentialregulation has almost become a commonplace practice in the OECD,while it is woefully missing in the developing countries.

Against these theoretical underpinnings, the current level of foreignexchange reserves gives a feeling of adequacy and lots of comfort sincethey are, as stated by Lawrence Summers, Chairman, HarvardUniversity, in excess by 15% of our requirements, encouraging theidea of CAC. Secondly, India, as observed by the Prime Minister, havinghad free-trade agreements with SAARC, Singapore, Thailand, andASEAN and working on similar arrangements with Japan, China andKorea, wants to capitalize on the new growth avenues opened up bysimplifying regulatory and approval procedures and reducing transactioncosts. In such a scenario, it is expected that by CAC lots of foreigncapital can be attracted into the country which can be invested forimproving productive efficiencies. These improved productive gainsare expected to strengthen the Indian rupee, which in turn is expectedto result in attracting further capital inflows and thus creating a virtuouscircle of capital inflow.

But the ground realities have a different story to tell: it is not mereliberalization of capital account convertibility but the sovereign ratingsthat determine capital inflows into a country. In other words, even byliberalizing exchange regulations, Indian corporates cannot accessinternational capital at cheaper rates so long as its sovereign rating isbelow investment grade. Secondly, the economy should be strongenough to absorb the capital inflows once CACs is allowed, otherwise,it may distort the interest rate scenario in the country. For that to happenwith no hiccups, we should have a robust debt market. It must have the

251Capital account convertibility: Is India ready for it?

strength to absorb the increased inflows or outflows of capital (owingto free convertibility) without causing excessive volatility in the yieldcurve; otherwise monetary policy implementation will get a beating.Thirdly, for the rupee to become convertible, it is not enough for theRBI to declare it as convertible; there must be willing holders of therupee from outside India. There must be a demand for the rupee fromexternal sources for legitimate purposes, such as trading and investmenteither in India or in other countries.

Admittedly, full convertibility status brings India to the end ofglobalization but its success depends on the strength of domesticeconomy and the institutions that keep it orderly and robust. Thisreality now raises a question: why then are the Prime Minister and theFinance Minister making a proposition for full convertibility? Is itthat they want to use it as a platform to give an aggressive push tofurther reforms in the country? Logically, it looks so, for even the RBIholds an opinion that there are many other reforms that are to be putin place before going for full convertibility. For instance, fiscal deficitneeds immediate correction. And above all look at the share of vulnerableliabilities (FII inflows and FCNR deposits) in the reserves and thepast experiences thereunder! It does not offer the comfort one wishesto have while going convertible on capital account.

Indeed, a lot needs to be done on the fiscal and monetary frontsbefore we really open up for free flow of capital across the borders. Inthe meanwhile, it may make sense to use the excess reserves forinfrastructure development, as suggested by Lawrence Summers.

——)0——


We do not know if God really created the currency board, butthey certainly seem to be a godsend when we consider what

Sir John Hicks (1967) said, “On strict Ricardian principles, thereshould have been no need for central banks. A currency board, workingon a rule, should have been enough.” History tells us that the firstcurrency board was established in Mauritius in 1849, and by the1930s they spanned across the British colonies of Africa, Asia, theCaribbean and Pacific Islands. Intriguingly, a currency board wasestablished in North Russia on 11 November, 1918 and its architectwas none other than John Maynard Keynes.

History testifies to the fact that prior to the World Wars, growth inthe world economy was abysmally low, since it remained essentiallyprovincial. The cross-border flow of goods was minimal and capitalinvestments were mostly within sovereign boundaries. Obviously, thisresulted in orderliness in the management of money. But, this inflicted

July 2005.

FIFTY SIX

Who is great:God or the economist?

“In the beginning, God created the sterling and thefranc. On the second day, He created the currencyboard and, lo, money was well-managed.”

253Who is great: God or the economist?

silent suffering on those who were not endowed with natural resources.Yet, people have lived haplessly with whatever has befallen them…

“On the third day, God decidedthat man should have free willand so He created the budgetdeficit.

On the fourth day, however, Godlooked upon His work and wasdissatisfied. It was not enough.

So, on the fifth day, God createdthe central bank to validatethe sins of man.

On the sixth day, God completedHis work by creating man andgiving him dominion over all ofGod’s creatures.

Then, while God rested on theseventh day, man createdinflation and the balance-ofpayments problem.”*

Stricken by misfortune, man started questioning: How to make ‘growth’take place? Whether God allowed it or the constant search of man for abetter tool to achieve quicker growth enabled it is not certain, but onething did happen—man stumbled upon the ‘budget deficit’. Slowly butintelligently, he started realizing that budget deficits do not matter aslong as they create additional employment and wealth. Man gotemboldened by his experiences and theorized: As long as the return oninvestments through deficit is higher than the cost of borrowings, theeconomy can well-afford budget deficits. Man researched further and

* Peter B Kenen (1978) as quoted in “Currency Boards” by Steve H Hanke, Annals,AAPSS, 579, Jan ’02.


refined his theories: Persistent deficit in revenue accounts cannot beaccepted under the principle that as long as the cost of borrowing is lessthan the returns from investments, deficit is all right. In other words, thecost of borrowing matters in situations where deficit is revenue-driven, asit could become a major cause of future deficit by itself.

It is again not known if central banks were sent by God or mancreated them. They, however, gained significance—or notoriety—asfinanciers of ‘deficit.’ They were also pretty handy to governments inmanaging the maze of problems emanating from deficit financing.Central banks have slowly but firmly established themselves as ‘lendersof the last resort.’ A look at their balance-sheets gives a better pictureof this role.

The asset side of the balance-sheet of a central bank contains netdomestic assets and net foreign reserves. This enables the centralbanks to undertake a discretionary monetary policy by buying andselling domestic bonds and bills. This automatically changes themonetary basis—money circulation increases when a central bankbuys bonds and bills from the market and decreases when it sellsbonds and bills. As a part of their monetary role, central banks alsomanage exchange rate policy and thus emerges a conflict betweenexchange rate policies and monetary rate policies. For instance, whenforeign capital inflows are excessive, a monetary authority quite oftenneutralizes their effect by contracting the domestic component of themonetary base. Similarly, when capital outflow increases, the centralbank attempts to reverse the changes by increasing the domesticcomponent of the monetary base via purchase of gilt securities. Thisresults in a balance of payments problem.

It is these policy conflicts and the resulting problems that forcedman to search for a better alternative again. It ended in a revisit tothe ‘God-created’ currency boards. Currency boards are designed

255Who is great: God or the economist?

with no discretionary monetary powers to engage in the fiduciaryissue of money. Their sole function is to exchange domestic currencyfor an anchor currency at a fixed rate. Thus, the quantum of domesticmoney in circulation is being dictated by market forces, i.e., thedemand for domestic currency. They maintain reserves in the formof low-risk, interest-bearing bonds in the anchor currency, and aremandated to hold reserves equal to 100% or a little more of theirmonetary liabilities. Therefore, they cannot practice discretionarymonetary policy.

This rigid structure of the currency board has obviously generateda lot of opposition, although currency boards proved their efficiencyin realizing price stability, a respectable growth rate, and mostimportantly, fiscal discipline. In fact, currency boards fit well intoKarl Schiller’s definition of a sound monetary system: “Stability mightnot be everything, but without stability, everything is nothing.”Ironically, it is felt that “a currency board is unlikely to be successfulwithout the solid fundamentals of adequate reserves, fiscal disciplineand a strong and well-managed financial system, in addition to therule of law.” However, supporters propose currency boards to be anantidote to these very evils. Another strong argument against currencyboards is that they do not permit maintenance of competitivenessamong countries. The other most populist argument against them isthat they result in loss of monetary sovereignty.

That apart, another interesting development surfaced from theso-called intellectual debate on economic growth: the division of theworld into developed and developing countries. Developed countriesbelieve that the rule of law in developing countries is weak. Theyargue that a ‘principal-agent’ problem emerges because of theprincipals’ (voters) inability to exercise power on the ‘agents’(politicians), once elected. To rectify these problems, economists are


now prescribing currency boards to these countries so that their fiscalregime will be subordinated to the monetary regime.

The net outcome is: “He created the currency board,” but Westerneconomists prescribe it for the developing countries. Now, who isgreat: ‘He’ or the Economist? Perhaps whoever can dictate is great!

——)0——

257Forex reserves and infrastructure investment: Strange bedfellows?

Over the past four months or so, we have been listening to anationwide debate on whether or not to use the surging foreign

exchange reserves that are lying idle for infrastructure developmentin the country. One section of the economists led by the PlanningCommission believes that the current level of foreign exchangereserves that stood at $142.5 bn is pretty good to meet the importrequirements and all other external payment obligations of the countryfor more than normally accepted periods. Secondly, maintenance ofreserves of such magnitude is also costing the country dearly. On theother hand, it is becoming difficult for the Planning Commission tomobilize sufficient resources to propose a reasonable capital-outlayunder the Tenth Plan that can ensure enhanced economic growth. Itis also feared that any further rise in fiscal deficit would only increasedrawings from the private savings and thereby push the interest ratesnorthward which in effect means crowding out of private investmentwhich is currently already at its lowest. Amidst these contradictions,one section of economists led by the Planning Commission opines

April 2005.

FIFTY SEVEN

Forex reserves and infrastructureinvestment: Strange bedfellows?

When the chips are down, it is only the out-of-boxthinking that can take one out of the mess.


that usage of foreign exchange reserves to augment infrastructuredevelopment in the country is a viable alternative.

Of course, this move poses an obvious question: Are the reservesthe savings of India? The answer is an unequivocal “No” and soanother school of economists are airing apprehensions about itsprudence in using them for infrastructure development. Accordingto them, it is nothing but usage of short-term funds for long-termpurposes that too, for investments which do not ordinarily generateforeign exchange earnings. Such a move is considered potentialenough to create liquidity crisis should FIIs withdraw their investmentsfrom the capital market. As evidence to their argument, they drawour attention to what happened in East Asian countries during 1997.These countries borrowed short-term funds from internationalfinancial markets and invested in long-term non-foreign exchangeearning projects such as real estate development, as a consequence ofwhich they ended up in a liquidity crisis. They have another line ofargument: The current level of poor private investment ininfrastructure project is not due to lack of funds, it has more to dowith the lack of clarity in our policy initiatives. How else, they ask,can we explain the high inflows of private capital into sectors liketelecom while little or nothing has flowed into roads, powertransmission etc.

Probably, infrastructure sectors such as roads, power generationand transmission are not making business sense, either due to frequentshifts in our policy stances or the embedded social obligations ofthose projects, where non-enforceability of toll collection on all, freesupply of power to certain sections, etc., is in vogue. In other words,what is being argued is that it is not lack of funds, but the conducive“atmospherics” which is holding back private investments ininfrastructure projects. Accordingly, it is concluded that usage offoreign exchange reserves for creation of infrastructure is less prudent.


They have another question: What is the big difference betweencommitting fresh investment for infrastructure development throughdeficit financing and using forex reserves, for both are known toresult in increased money circulation in the system. And expansionof money supply is generally despised by institutes like IMF, WorldBank and monetarists, like Milton Friedman, who generalized thatany increase in money supply will eventually result in increased prices.Hence, they strongly argue that capital for investment has to comefrom real resources and therefore take a strong exception to the usageof forex reserves for encouraging investment in infrastructure.

This argument necessitates that we take a close look at what DavidHume once said based on his experiences in European countries. “Inevery kingdom into which money begins to flow in greater abundancethan formerly, every thing takes a new face: Labour and industry gainlife; the merchant becomes more enterprising; the manufacturer morediligent and skilful, and even the farmer follows his plough with greateralacrity and attention. This is not easily to be accounted for.” He is ofthe firm conviction that money supply stimulates industrial as welllabour activity as money integrates less monetized and less developedareas with more developed regions of the economy. He thereforeadvocated a policy of “keeping alive a spirit of industry and increasingstock of labour in which consists all real power and riches”. Hence, heconcludes: “Although the absolute quantity of money is a matter ofgreat indifference, there are only two circumstances of any importance—the gradual increase (of money supply), and its thorough concoctionand circulation through the state.”

Hume thus proposes that it is not the absolute quantity of moneyin circulation that matters, but its wide circulation throughout theeconomy that increases economic activity by bringing in a largerproportion of society into the exchange economy. In view of whatHume said it makes a great sense for the sovereign to stay focused in


ensuring wide circulation of money throughout the economy byeliminating the scope for its accumulation rather than gettingperplexed by the fear of excess money in circulation. If we juxtaposethe current move for using forex reserves for infrastructure investmentalong with the foregoing argument of Hume, one gets emboldenedto say that it is a right move for a right cause at a right time; more so,when we are attempting to move away from a developing stage to adeveloped state. It is the right time because we are endowed withmore reserves, better skilled labour, and a more robust economy thanwhat we had a decade back, and are thus in a better position toconsciously practice expansionary fiscal policies for sustainingimproved growth rate.

The one thing that all schools of economists have in commontoday is the idea that infrastructure in the country must be augmented.It is argued that such investments must be made immediately and thecountry simply cannot afford to wait for policy corrections that couldultimately encourage private investments in infrastructuredevelopment. The much-debated question today is: What will happenif we don’t augment our infrastructural facilities immediately? Theanswer is pretty obvious: As time passes, the infrastructure bottlenecksbecome so acute and powerful that they simply pull down the growthrate and there is no wonder if the spectre of inflation will rise andmake its dirty existence felt either through a cost pull or demandpush mechanism. Such a predicament is most undesirable when weare getting more and more integrated with world economy. Themessage therefore is to accelerate economic growth, reduce poverty,and bridge the gap between “haves” and “have nots” of the society byincreasing infrastructure investments immediately.

In the larger context, it doesn’t matter if the increasedinfrastructure investment by the government through borrowing isinflationary. It is simply a question of belief: All cholesterol is not


bad; it is only low-density lipid that is a bad cholesterol. Similarly, itis for what the deficit is used that makes an investment good or bad.“Yes”, if the deficit is for hiking government employees’ salaries, it isbad and should be avoided. But when it is meant for investing ininfrastructure development it doesn’t matter even if it leads totemporary price rise for ‘tomorrows’ will be brighter. Such a boldinitiative is bound to result in economic transformation of the society.Hence, it makes no sense to follow the much prescribed theology ofthe International Monetary Fund or that of the World Bank for fiscaldiscipline. Even otherwise, there is a substantial difference inaugmenting infrastructure through direct government borrowingsand borrowings against foreign exchange reserves through a specialpurpose vehicle, the former by virtue of becoming a part of budgetresults in monetization while the latter becomes a contingent liability.Secondly, as long as the borrowings against reserves are used forimport content of infrastructure development, there will be no increasein money supply and hence, no impact on domestic prices.

All things considered, it is time for the government to take boldinitiatives for improving infrastructure and thereby give a boost toeconomic growth which in turn can generate more employment andarrest the ills of poverty to a tolerable level of a civilized society. Arewe not entitled to leverage on the current strengths of the economy?

——)0——


The Prime Minister’s Office is reported to have instructed “Financeand Planning Secretaries to find ways to use the country’s foreign

exchange reserves to run up a current account deficit, instead of thecurrent account surplus that has been the status for the last fewquarters, and absorb a sizeable chunk of external savings to boostdomestic investment and growth.” Looking at the current rise ininflation that is partly attributed to excess money circulation resultingfrom Forex reserves, there appears to be no alternative for thegovernment. That aside, it is a good move: We have for once showngumption to use the accumulated forex reserves that stood at US$112 bn for the week ended by September 3, 2004, for the good ofthe Indian economy, instead of hoarding them abroad.

To better appreciate the current move, let us take a look at a fewbasic economic principles. International trade is essentially driven bythe principle of comparative advantage. It means countries exportgoods in whose manufacture they enjoy a relative advantage. Similarly,they import goods in whose manufacture they face certain

October 2004.

FIFTY EIGHT

Forex reserves for domesticinvestment: A bold move

The world is yet to know making of wealth withouttaking risk.

263Forex reserves for domestic investment: A bold move

disadvantages. Secondly, if a country has to accomplish faster growth,it has to essentially invest more than what it saves, which meansexternal borrowings. The counterpart of it is “trade deficit”.Technically speaking, a developing country like India, ideally, shouldhave a current account deficit of 2 to 3% of its GDP to grow fast.This is all the more important when our domestic savings are notsufficient to fund the investment requirements in proportion to thedesired growth rate. Instead, we have had a current account surplusof 1% of the GDP for the last couple of quarters. In other words, wehave been consuming fewer goods than what we have been producingand in the process lending our savings to outsiders. This is certainlyagainst our “growth” interests. And that is what the current move islikely to correct.

Economic principles aside, every central bank is driven by its ownconcerns in managing its foreign exchange reserves and the RBI isno exception. One such concern could be that RBI finds it difficultto allow the rupee to find its own value. It perhaps fears that suchinaction on its part exposes businesses to exchange rate risk—whichis the sensitivity of the real value of a firm’s assets, liabilities, operatingincome, expressed in its functional currency, to unanticipated changesin exchange rates that cause the loss. Secondly, an appreciating rupeemay make our exports less competitive in the international market,with the result the exports may fall. Thirdly, an appreciating rupeeequally impacts the future cash flows and profits of a firm that isoperating even within the domestic market. The economic risk isincreasingly becoming significant in the globalized economy wherethe ripple effects of economic changes in one corner of the globe arebeing felt everywhere else. There is of course a positive side too foran appreciating rupee—it makes imports less expensive in rupee terms.Secondly, an appreciating rupee makes imports a cost advantage forthose exporters whose imported raw material constitutes a sizablecomponent of their exports.


Perhaps, to obviate these risks, the present exchange rate policy ofthe RBI essentially aims at stabilizing the exchange rate throughmarket intervention. Hence, the RBI has been purchasing dollarsagainst rupees. This act obviously puts more domestic currency intothe market. So, to contain the money supply growth within theacceptable level of 16 to 17%, the RBI sucks out the excess rupees byselling its holding of government bonds. This act of RBI ensures thatreserve money does not grow at the rate at which the reserves offoreign exchange grow. However, many fundamentalists are of theopinion that the current level of reserves are more than adequate tomeet import liabilities of near future and hence argue that such reservesinvolve an opportunity cost. Indeed, the RBI sustained a loss ofRs.1,500 cr under this operation during 2002-03.

This cost is likely to go up with the hardening of domestic interestrates. So, the present exchange rate policy posits a battery of questions:Is it worth incurring cost to sterilize dollar inflows? What if inflowscontinue unabated and demand more MSBs to sterilize them? Is thatnot potential enough to push domestic interest rates furthernorthwards? Instead, why not use these reserves for domesticinvestment? The present move is a clear answer to some of thesequestions. Here again we need to understand the intricacies associatedwith the usage of foreign exchange reserves for domestic investment.There is a lurking fear that the foreign exchange reserves, which aremostly in the form of NRI deposits and FII investments, may moveout of the country at the slightest provocation. And no one is interestedin revisiting the 1991 crisis, for it is quite scary to think of the traumathat the country experienced then.

Against this background, the present move sounds brave and thuslaudable. But the route chosen to create “trade deficit”, i.e.,encouraging public sector enterprises to import capital goods, doesnot sound encouraging, for a variety of reasons. It is commonly

265Forex reserves for domestic investment: A bold move

perceived that public sector undertakings are treated as the personalfiefdoms of politicians and bureaucrats. It is also strongly believedthat politicians are the most undesirable agency to be assigned withthe responsibility of controlling the country’s commercial assets.

Essentially, what matters in businesses is “management efficiency”.It should make a corporate’s existence meaningful to the shareholders.To put it differently, “efficient management”— subjecting corporatesto the discipline of capital market and making executives accountableto the shareholders; existence of a strong institutional frameworkthat evens out the “principal-agent” conflicts that are inherent to thecompanies’ management and surveillance of the market by a powerfulregulatory agency backed by an equally tough law enforcementmechanism—is what is required to generate wealth. It is also essentialthat corporates learn not to tolerate “somnolence, sloth andnon-conformity to generally accepted international norms andstandards of macroeconomic management, disclosure, transparencyand financial accountability.” But all this is evident more by its absencethan presence in public sector enterprises.

Hence, it makes greater sense to float a Special Purpose Vehicle toborrow against the foreign exchange reserves under the aegis of aPublic Sector Bank and lend only to such corporates as are knownfor efficient management of assets to generate wealth quicklyirrespective of private or public ownership. Let us hope that the currentmove sees its logical end and the country stands benefited.

——)0——


During the British regime and even during our early independencedays, there was an axiom doing the rounds among the Indian

farmers that aptly captured the flight of Indian agriculture: Athivrishtiya Anavrishti which means either too much or too little of rainfallthat inflicted innumerable woes on Indian farmers. This syndromeappears to have now shifted to India’s foreign exchange reserves: Theyrose to $116.06 bn by April 9,2004 from a minuscule $5.83 bn as onMarch 1991. We have since travelled from a very precarious positionof defaulting on our external payment obligations to a most solventposition among the emerging economies. Indeed, the athivrishti ofdollars is so much that in a single week the dollar accretion is reportedto have been $3.70 bn.

The Reserve Bank of India (RBI), in its anxiety to arrest thedownpour of dollars in the Indian market, has further reduced theinterest rates on NRI term deposits and savings deposits so as to

May 2004.

FIFTY NINE

Wrestling to manage the“swamp of plenty”?

It doesn’t matter whether you are an individual oran institution the eternal challenge is to exercisechoice.

267Wrestling to manage the “swamp of plenty”?

eliminate the scope for arbitrage. But looking to the kind of inflowswe have witnessed in the recent past, it is doubtful if this measure isin any way going to influence the inflow of dollars. The latest week’sdata on balance of payments released by the RBI indicates that amajor chunk of inflows are in the form of FII investments and proceedsunder service exports. Secondly, if the rupee continues to appreciateat the same rate of 9% as witnessed during the last fiscal, it makesgreat sense for NRIs to maintain rupee deposits irrespective of interestrate offered as no investor would like to miss the opportunity to makea few dollars extra from the appreciating rupee in addition to whateverinterest rate these deposits offer, which incidentally are tax-free. Thus,there appears to be no readymade solution to the RBI’s problem ofdollars’ athivrishti. In fact, it is a challenge more to the businessacumen of Indian corporates that becomes obvious if one takes adeeper look at the “swamp of plenty”.

Of course, prima facie, the nightmare of surging dollars and theresulting strengthening of the rupee against the dollar, the euro, andthe pound sterling will haunt the RBI for some time to come or atleast till the Indian corporates, particularly exporters, come to termswith the ground realities and start doing their businesses with a new-found game plan. Encouragingly, this time around, the Indianexporters have of course not made much noise over the rising rupeeas in the past which is quite an encouraging phenomenon. One prooffor this courageous display of exporters could be that despite a risingrupee, exports have risen by 15% during the first 11 months of2003-04 and a staggering 35% during February, 2004 over thecorresponding month of the previous year. Of course, this could notbe taken as a final proof of the appreciating rupee having no impacton exports, for there is a valid argument to the effect that exchangerates affect trade flows with a lag of around 6-12 months.


Before examining why exporters are chary about the rising rupee,let us take a peep at how the currencies of those countries which areour traditional competitors in the export market are faring vis-à-vis theUS dollar. It is reported that between April 2002 and April 2004 theThai baht appreciated by almost the same percentage as the Indianrupee, the Korean won rose 13.5%, the Japanese yen 20.4%, the Britishpound 21.4% and the euro a whopping 27.1%. This phenomenon ofsimultaneous appreciation of competitors’ currencies vis-à-vis the dollarindicates that Indian exporters are no worse off than the exporters ofthese countries and if at all there is any fall in Indian exports, it mustbe for reasons other than adverse exchange rate—i.e., for reasons suchas differences in inflation, productivity and quality of goods. There is,however, a distinctive disadvantage for Indian businesses vis-à-vis thoseof China and Malaysia as these countries intelligently pegged theircurrencies to the dollar, which means these currencies move in tandemwith the dollar vis-à-vis other global currencies such as euro, yen andpound sterling, and thereby ensure that its price-competitiveness isintact in global markets. In view of this, China is likely to pose a threatto Indian exports, particularly in segments such as textiles and othermanufactured goods.

There is yet another dimension to the appreciating rupee whichneeds to be taken note of seriously. An appreciating rupee will enhancethe economic risk exposure of even those Indian companies whichare marketing their products in the domestic market. The appreciatingrupee simply makes imports cheaper thereby encouraging traders toimport goods from abroad to meet the local demand. To that extentthe demand for locally manufactured goods is adversely affected. In aglobalized economy, where tariffs on cross-border goods are fallingat a faster rate, this phenomenon poses a great threat to the localmarket players too. In such an evolving scenario, China poses a greatthreat to the Indian manufacturers in the domestic as well as in export

269Wrestling to manage the “swamp of plenty”?

markets. But ironically, today, nobody is paying the required attentionto this prospective ‘silent killer’.

As against these emerging threats, the macroeconomicfundamentals of India that are iced with over 8% GDP growth perannum are likely to attract more inflows of foreign exchange. As longas imports continue to remain as subdued as they are now, there shallbe no dearth of dollars flooding the Indian market. The net result ofall these factors would be an appreciating rupee. Of course, it isbeyond anyone’s comprehension as to by how much the rupee wouldappreciate. It all depends on supply of and demand for dollars andultimately the willingness of the RBI to purchase the dollars andsterilize the rupee-equivalent through sale of government securitiesor via the recently launched “market stabilization scheme”. But, thereis certainly a limit to market intervention of central banks as a measureto maintain the exchange rate at a desired level. And the RBI is noexception to this universal phenomenon, particularly when theeconomy is opening up at a faster rate and capital flows are swelling.The recent steep appreciation of the rupee owing to sudden withdrawalof the RBI from its dollar-purchasing activity is perhaps a pointertowards the likely future.

So, what then should Indian corporates do to wriggle out of thisswamp? There is of course no definite answer. Each company has toinvent its own strategy that keeps it on a competitive trajectory.Corporates, whether exporters or domestic players, must accept thefact that insulated-markets and stable exchange rates have beenfossilized, and hence be prepared for a continuous appreciation ofthe rupee with accompanying reduction in import tariffs by around5% per annum. Factoring these assumptions into their businessprocessing, they must build up appropriate competencies to cut downproduction expenses and ensure a return on capital greater than thecost of capital. And that is the only mantra by which corporates can


wriggle out of the impact of exchange rate volatilities of globalizedeconomy where sovereigns have almost lost influence on theireconomies. Athivrishti or Anavrishti (of either dollars or rain), it isonly the all-round “competency” that can steer us out successfully.

——)0——

271“Blossoms sadder than tears on grief’s eyelids”

At last, the Reserve Bank of India (RBI) could muster courage to issue operational guidelines to banks permitting them to sell

foreign currency to resident Indians to invest up to $25000 a year inthe international markets. The Finance Minister’s announcementhas indeed generated a lot of fanfare but, should we say, failed toenthuse instantaneous action from the RBI. In the meanwhile, manyeconomists, as usual, aired their feelings for and against the FinanceMinistry’s move. We do not know if the RBI too contemplated for awhile on the commonly held economic belief: “Large unsustainablefiscal deficits and open capital markets make uncomfortablebedfellows”, and lost in wilderness. Is the delay in operationalizingthe Minister’s declaration, a consequence of it?

One cannot perhaps brush it aside as one of those administrativeglitches. Interestingly, the RBI’s report on currency and finance statesthat “there is considerable merit in using a regulatory mechanism formoderating the ebb and flow in capital movements” to avert “highly

March 2004.

SIXTY

“Blossoms sadder thantears on grief’s eyelids”

In a boundaryless market, integrated approachvis-à-vis event-specific administration alone bettersthe scope for good results.


speculative or motivated attack on the currency”, as otherwise, it canlead to “destabilization of economy”. The report also observes that “thebeneficial effects of capital account liberalization on growth areambiguous”. It further affirms that “there is no evidence that countrieswithout capital controls have grown faster, invested more, or experiencedlower inflation”. The best example that one could cite in favour of thisargument is China that has no capital account convertibility nor currentaccount convertibility but could grow @ 8.6% per annum since 1990,accumulate whopping foreign exchange reserves of above US $420 bn,and attract Foreign Direct Investment (FDI) in double-digit billionsagainst India’s ability to attract an FDI of a paltry $2 bn per annum. Weare not sure if these ground realities have had anything to do in delayingthe framing of foolproof guidelines by the Reserve Bank foroperationalizing the announcement.

Arguments apart, let us take a peep into what the current capitalaccount liberalization means to individuals. It simply means thatIndian investors can now buy global assets by opening foreign currencyaccounts and remitting $25000 per year. As usual, it is Citibank andICICI Bank, who are the first to come forward offering short-termdeposits on quite a few global currencies iced with fancy LIBOR plusreturns. Given the ruling interest rate of 3.5% per annum on a 90-day rupee deposit with domestic banks, and returns on foreigncurrencies such as Australian dollars etc., being 6%, there is a hugetemptation for a wealthy and sportive Indian to jingle his savings indollars and cents. Indeed, quite a good response was reported to theseplain vanilla deposits, if press reports about Citibank mopping upone million on its very first day of offering the facility, are anyindication. Interestingly, in the recent past, the Australian dollar hasappreciated almost 9% against the Indian rupee. If this trend continuesfor another three months, a three-month Australian dollar depositcan earn an annualised return of more than 40%. Similarly, in the


past three months Sterling is reported to have appreciated more than12.5% and if it repeats the same in the coming three months, aresident depositor sloshing his savings in pounds at the ruling interestrate of around 4.3% can simply make a killing with an annualisedreturn of 50% plus.

Certainly, the opportunities thrown open by the Finance Ministerare attractive and exciting. Pretty blossoms! But, there is a flip side tothis opportunity: Risk. It is always probable that these foreigncurrencies instead of appreciating may actually depreciate, whichmeans realization of fewer rupees against the foreign currency deposit.Should that happen, even the higher interest rates offered on theseforeign currency deposits cannot save the investor from the possibilityof losing the principal. Now, the moot question is, should an Indianinvestor seize the opportunities thrown open? A simple answer tothis question is an effective ‘Yes’ and ‘No’ as well. If you have thewherewithal to constantly monitor deposits and move out from afalling currency vis-à-vis the Indian rupee and relodge in anappreciating currency, you can still make higher returns. But onething is certain: You cannot switch currencies as freely as a dealercan do, for your deposits have a maturity period. Even if bankstomorrow allow premature withdrawals and switching of currencies,the service charges thereon may be pretty discouraging. This argumentnaturally leads us to the “no” answer.

There is yet another dimension to this “no”: As usual, the currentreform too is “episodic”. The management of surging foreign exchangereserves that involved a huge stabilization-cost for the Reserve Bankperhaps prompted the Finance Ministry to liberalize capital accounttransactions. Being episodic, it has obviously not taken cognizanceof rules under the Foreign Exchange Management Act (FEMA) whichdo not permit a resident to hedge foreign exchange exposure arisingfrom financial investments. Till such time the rules under hedging


are liberalized, every investor in foreign currency sits like a lameduck fully exposed to the vagaries of volatility associated with globalcurrency markets. All this downside-related talk of course should notdampen the spirits but caution the investor in building a globallydiversified investment portfolio.

To overcome these risk-related hurdles, the investors could as wellseek the mutual fund route, as technically they are better equipped tohandle the risks thereof. Usually, to cater to such needs of globalinvestors, global fund managers often float what is known as “feederfunds”. A feeder fund conducts virtually all of its investing throughanother fund, called the master fund. This is similar to a fund offunds arrangement, except that the master fund manager is responsiblefor managing the underlying investments. However, as the currentregulations do not permit floating of such specialized funds in India,resident investors cannot avail this route too.

The latest banking business figures released by the RBI reveal thatcredit offtake has recorded a growth rate of 5.7% since December toFebruary 6th, as against 3.4% for the corresponding period of theprevious year. That apart, analysts project a private investment of aroundof Rs.20,000 cr under new projects in the coming 12 to 15 months andif this turns out true, the fresh demand for credit may be above tentimes of the proposed equity investment. All these estimates are likelyto mop up whatever liquidity-overhang the system is facing today, leadingto an upward push in interest rates. Should that happen, investors inglobal markets may have to bear a heavy opportunity cost.

Over and above all, the current liberalization in the capital accounttransactions is bound to adversely impact the availability of domesticsavings for investment purposes. Suppose, 400,000 investors comeforward to sell domestic currency and buy dollars for investment inoverseas markets, they would simply erase not only US $10 bn from


the foreign exchange reserves but also suck out liquidity from thedomestic money market by around Rs.450 bn. And India is certainlyricher than that number. Unless our very economic performanceimproves correspondingly, the current relaxations may end up as“blossoms sadder than tears on grief’s eyelids”, for the nation at large.

——)0——


Yes, as he desires Bimal Jalan, the outgoing Governor of the ReserveBank of India, will be remembered simply as Bimal Jalan, for in

the words of Narasimham, the former Governor of RBI, Jalan, hasbeen a great RBI Governor. It is reported that Narasimham in hisfarewell letter to Jalan wrote: “You have not merely been a successfulGovernor but, if I may say so, a great governor the likes of whom wehave not had over the last 50 years. I believe you will take your place inthe pantheon, along with the likes of James Taylor and C D Deshmukh.”

What more can one say to an outgoing central bank governorwho leaves behind a legacy of a record level foreign exchange reserves,a low rate of inflation, lowest ever interest rates, an appreciating rupeebesides a stable exchange rate and a money supply well within thedesired levels?

Apart from the present, there is much to talk about the past—what he did, and how he handled the monetary managementimmediately after taking over the reins of central bank. At the time of

September 2003.

SIXTY ONE

Hail thee, Jalan andthy rustic wisdom!

Taking decisions in the thick of battlefield is whatdistinguishes a leader from the rest.

277Hail thee, Jalan and thy rustic wisdom!

his assuming governorship, the rupee was on its free fall, havingreached a peak of Rs.39.30 to a dollar. On the other hand, theaftermath of East-Asian crisis was still holding back fresh FIIs flowsinto Indian stock markets. Nor was there scope to improve forex inflowseither through external commercial borrowings, as they were simplymade expensive by the East-Asian crisis, or via ADRs, GDRs, asemerging markets’ paper was then considered untouchable.

Amidst this chaos, Jalan is reported to have spent around $3 bn toarrest the fall of the rupee, without of course targeting maintenanceof a particular exchange rate. It was not that easy for a Governor tospend the meagre reserves of around $28 bn for defending an otherwisesliding currency, particularly, when the country was passing throughpolitical uncertainties. Nevertheless, this dare-devil act did halt thefall in the rupee rate temporarily.

But with the announcement of elections, the rupee reached 40 perdollar, pulling the rug from under the feet of the Governor. To combatthe market onslaught, he quickly hiked the bank rate by 2% makingrefinance from the central bank expensive on the one hand, andincreased the cash reserve ratio by 2% to suck out around Rs.2400 crfrom the market. He did not stop there. He reduced export refinanceand forced interest rates on rupee loans to climb up. With tight monetaryregulations, he made imports expensive and induced exporters torepatriate sale proceeds quickly. That’s not the end of the story. Hewent ahead with the decision to float Resurgent India Bonds offering amarket-related interest rate on the bonds to augment the flaggingexchange reserves. And all this when the world is yet to come out ofthe trauma inflicted by the East Asian crisis. Cumulatively, however,these acts have arrested the further slide in the rupee exchange rate.

Today, looking back at what has happened, armchair economistsmay dismiss them as mere textbook monetary prescriptions. But, totake a decision in real-time situation, and that too when the “chips


are down” and whatever one knows at the time of taking the decisionbeing a faint hope for a positive outcome, calls for ‘nerves’. And thatis leadership in action!

In Jalan we have seen a Governor who didn’t go by the “establishedfad of the day in terms of economic policy”. He was not overtaken by“all the talk about fixed exchange rate, flexible exchange rate,appreciating exchange rate, capital account convertibility and so on,”but stuck to his own decisions and, in the process, could generate a“feel-good” atmosphere in the financial markets with surging foreignexchange reserves of $85 bn plus.

As Jalan himself said: “As long as there is money, the centralbank’s agenda remains unfinished”. Having built the reserves, it isnow for his successor, Yaga Venugopal Reddy, to work out a strategyto use it profitably. He should not let the market be carried away bythe massive reserves but insist on prudent behaviour. Financial presshas begun reporting about the rise in imports describing it as welcomenews. It is a different matter if the imports are related to capital goods,which is likely to raise the production capacities leading to marketgrowth. But expending the arduously built reserves on the import ofconsumer durables, may not be in the best interest of the country.Instead, the reserves need to be used for creating additional capacitiesor for creating fresh markets for Indian exporters by way of grantingcredit lines to overseas buyers. At the same time, the cost of additionalreserves cannot be brushed aside easily. Anyway, all this is going topose a serious challenge to the incoming Governor.

Looking to the past and the future, one can’t but agree with Jalan’sassertion: “Isn’t this the right time to go?” “You are absolutely right”,Mr. Governor! As you move on to your new job, we salute you for notbeing carried away by “isms” and sticking to your native wisdom indelivering whatever is being acclaimed today by the nation as well done!

——)0——

279What does an appreciating rupee mean?

Exchange rate changes expose corporates to a variety of risks. In the financial context, ‘risk’ refers to the probability of loss. In

basic arithmetic terms, a company makes loss whenever its income isless than the expenditure incurred for generating that income. Solong as one records income and expenses in rupee terms, workingout profit or loss is no big task. But, if a business has receipts andpayments in two different currencies, profit or loss calculation getscomplicated. One way of overcoming this problem is to convert foreigncurrency receipts into rupees so that revenues can be compared withthe rupee cost of production and profit/loss can be arrived at. Andthat is where the exchange rate of the rupee against the foreigncurrency becomes a key variable in determining the profit or loss.

Therefore, one can say that changes in exchange rate can converta business unit’s profit to loss and vice versa. Interestingly, theselosses are not the outcome of operational inefficiencies ormanagement’s bad practices. These have purely emanated from change

July 2003.

SIXTY TWO

What does an appreciatingrupee mean?

Anything that appreciates not only becomes dear butalso makes all others associated with it dearer.


in exchange rates. It is the sensitivity of a firm’s operating income,expressed in its functional currency, to unanticipated changes inexchange rates that causes the loss. This probability of a businessincurring loss on account of changes in foreign exchange rates isknown as foreign exchange rate risk and that is what in effect Indianexporters are experiencing today with the rising rupee.

It is the IT sector which was the first to feel the pinch of risingrupee value. It is reported that Infosys is anticipating a fall in itsrevenues of around 0.5% for every 1% appreciation in the rupee. Itwould be worse in the case of textile exports as they are already workingon wafer-thin margins. One way of overcoming this risk is perhaps tobuy a forward cover but it is only a short-term measure. The realeffective alternative to beat the negative effects of rising currency is toimprove operating efficiencies and quality standards. Exporters haveto simply move up the value chain. The need to make exports“price-inelastic” appears to have already dawned on Indian exporters,for this time around the usual whimper from exporters that used toaccompany every episode of rising rupee is very much absent.

It’s not that the adverse impact of rising currency value isconfined just to exports. It would equally impact the future cashflows and profits of a firm that is operating even within the domesticmarket. It is commonly but wrongly perceived that companies havingno direct foreign currency exposure are not impacted by thechanging exchange rates. The truth, however, is that if competitorswithin or outside the country derive a profit opportunity on accountof movement of exchange rate, it is bound to influence a company’scash flows irrespective of its forex exposure. It is obvious that withthe domestic currency’s rising value, a domestic firm’s local saleswill decrease as its customers could buy foreign substitutes that areavailable at less price.

281What does an appreciating rupee mean?

The economic risk is increasingly becoming significant in theglobalized economy. Yet, its management is failing to draw the attentionof corporate mandarins to the extent desired. One plausibleexplanation could be that unlike in the context of exports, lossesunder economic risk are not distinctly visible. One report indicatesthat the overall corporate earnings growth would fall 10% in thecurrent fiscal if the rupee appreciates 5% against the dollar. Themore the competition from the global players the more would be theimpact on the sales of domestic companies.

True, exchange rates can move both ways and thus can lead toprofit as often as to losses. It is also true that the extent of profit orloss owing to exchange rate movement should average out over aperiod of time. But the danger with forex risk is it could result in aloss large enough to wipe out the business in one stroke, and thecompany may not have a second opportunity for the probability ofmaking an equally large profit.

The need has, therefore, arisen for the corporates to measureeconomic exposure by collecting historical data on how local saleswere affected in the past and using it to simulate future sales underdifferent exchange rate scenarios. Alternatively, a firm can assess itseconomic exposure to exchange rate movements by applyingregression analysis on the historical cash flows and exchange rates.Whilst on this, it is worth remembering what Alan Greenspan said,“There may be more forecasting of exchange rates, with less success,than almost any other economic variable”. Hence the game planshould be: “Become leaner and fitter”, and “improve the operatingefficiencies”, else the economy as a whole may end up in a big mess.

——)0——


Newspaper headlines such as “Emergence of Strong Rupee”; “Forward premiums at Life Lows” – “3-, 6- and 12-month

forward premiums stood at 0.25 0.48 and 0.36% respectively”; “Timefor Indian corporates to go in for Foreign Currency Loans”, have yetagain made Indian corporates wrinkle their foreheads or raise theireyebrows. To the passive corporates, these headlines may of coursesound like another shot at journalistic jingle, but to the active, it ismuch more, for there is a scope to harvest the full benefit of prevailingrock-bottom interest rates in the global financial markets, should theirmarket readings prove to be correct.

All this has put the CFOs, endowed with the responsibility ofmaking judgments that reflect the best interests of the company, in aquandary. They are struggling to wriggle out an acceptable answer tothe barrage of questions such as: Is the current swing in favour of therupee momentary or sustainable? How long will low forwardpremiums rule the market? Will forward premiums go up? Is it wise

June 2003.

SIXTY THREE

Is rupee strong enough to go infor Euro-loans?

It does not matter whether the rupee is strong orweak so long as one has a natural hedge.

283Is rupee strong enough to go in for Euro-loans?

to rely on predictions of newspapers when exchange rate behaviour isknown to defy all canons of predictability? What, after all, moves theexchange rates? Can a reliable prediction be made out of such aknowledge?

Theoreticians in exchange rate economics often proclaim with adash of confidence, that monetary fundamentals are the best meansto predict exchange rate behaviour. They propose three alternativefundamentals in predicting exchange rates: purchasing power parity,uncovered interest parity, and flexibility-price monetary model. Butthe survey of literature on the understanding of exchange ratesbehaviour tells a different story.

Meese and Rogoff showed that the exchange rates could not beforecast from monetary fundamentals. Mark and Sul say that even byusing modern sophisticated tools, such as econometric techniques,panel data, one can predict exchange rate movement at best over aperiod of 3-4 years. The literature on exchange rate forecasting hasshown that the amount of exchange rate variations forecasted bymonetary models is very insignificant, particularly for short periods.The net emerging wisdom out of the research is that exchange ratechanges cannot be forecast or cannot be forecast using macroeconomicfundamentals.

There is yet another important aspect worth bearing in mind here.A decade back, the total trading in the US dollar was just around 190billion, whereas today, it has reached an alarming level of US$1.3 tn.When the Bretton Woods system was in vogue, the international flowof capital was severely restricted. But when it broke in the early 1970s,capitalistic countries scrapped their capital controls with the resultthat larger sums of capital started moving across borders. This freeflow of capital across borders, that too not being backed by anymerchandize movement, is often believed to be the prime cause of the


growing financial markets instability. As long as there is no “world”interest rate, there cannot be a single global capital market, whichmeans the uncertainty associated with exchange rate movement is boundto be an eternal feature.

There is yet another proximate reason for foreign exchange crisis:Foreign exchange rates are not always determined in a free market.Central banks are often found intervening on a grand scale in orderto influence the price of their currencies. In the process, while losingsubstantial amounts, they have been successful in maintainingartificial exchange rates for substantial intervals. And suchinterventions are just beyond anybody’s guess or prediction.

A study carried out some time back by a research organization onhow currency-traders think their markets behave, revealed that mostdealers consider macroeconomic fundamentals irrelevant in intra-daytrading. Currency dealers today strongly believe that it’s the news,bandwagon effects, and speculative effects that move the intra-day market.It is the speculative forces which traders measure from the order-flowsthrough the market that are now considered to be highly responsible forintra-day and medium-term trading behaviour. Some currency tradershave gone further by asserting that it is now the behaviour of the tradersthat is moving the foreign exchange market.

That being the uncertainty associated with the exchange ratemovement and its prediction, no wonder that any gain made out oflow interest rates is wiped out by adverse exchange rate movement ata later date. Secondly, it is worth bearing in mind here thatinternational borrowings are usually governed by the floating interestrate mechanism. As the effective interest rate is periodically reset withreference to the base rate, there is no guarantee that the effective costof capital would remain low vis-à-vis domestic rates forever, that toowhen we know that there is no “world” interest rate.

285Is rupee strong enough to go in for Euro-loans?

So, get it all out and try to move on with the conventional wisdom:It makes a lot of sense for companies having “natural hedge” to borrowfrom international financial markets. Others must be cautious of availingforeign currency loans unless they have a thorough understanding ofidentifying, measuring, managing and monitoring foreign exchangerisk. Else, the risk may prove to be too costly to bear.

——)0——


Anxiety, emotional excitement, and extreme attitudes on all sides are what today surround the surging foreign exchange reserves

in quantities that had never been witnessed in the past. Market-watchersobserve that the system is awash with cash, and worry that it may leadto the risk of higher inflation and asset price bubble with pressure onbond yields and other market-determined interest rates. Hence, theyexpect that the Reserve Bank of India would continue to containliquidity and thereby limit the risk of asset bubbles by intervening inthe foreign exchange market. Some are very strongly advocatingreduction of the cash surplus in the system by sterilization of foreignexchange inflows, more so, in the light of the current annual inflationof around 6%.

As it ought to be, the Reserve Bank of India too is quite concernedabout the strong foreign exchange inflows and the associatedproblems. Being driven by this concern, it has indeed set up aworking group to identify new instruments for sterilization. Thecommittee proposed that the Government of India should issue

March 2003.

SIXTY FOUR

Do forex reserves serve those‘who only stand and wait’?

Savings as a whole lead to growth of the nation whilehoarding results in stagnation.

287Do forex reserves serve those ‘who only stand and wait’?

Market Stabilization Bonds (MSBs) to augment the RBI’s ability tosterilize foreign exchange inflows. It is also made abundantly clearthat the money borrowed by the Government of India under theMSBs would not be available for the government’s spending, but isto be used exclusively for sucking the liquidity out of the system.

Recent press reports indicate that the Reserve Bank of India intendsto issue MSBs worth around Rs.60,000 cr in the coming 12 monthsto suck out liquidity from the market resulting from the inflow offoreign exchange. Market pundits consider it a good move since theReserve Bank does need an effective tool to suck out the liquidityarising from strong foreign exchange inflows. Such a fund is alsoanticipated to offer the RBI a better leeway to shape “repo rate” as akey monetary signal to smoothen kinks at the short end of the yieldcurve. True, that is what in fact the Reserve Bank is doing today,albeit with its own funds. But its influence appears to be waning asthe excess cash in the system continues to distort the yield curve bymaking available overnight-unsecured inter-bank loans at less thanthe repo rate of 4.5%. So, it is argued that by issuing MSBs, theReserve Bank can effectively reduce liquidity, eliminating thesedistortions in the yield curve and thus make the repo rate a crediblesignal to the market.

Now, the moot question is what difference does it make whetherthe Reserve Bank sells its own securities or the Government of Indiasells the MSBs in terms of the “cost of sterilization” of foreignexchange inflows to the country at large. The immediate benefit thatthe Reserve Bank could gain by making the Government of India sellMSBs, instead of its own bonds, is the transfer of loss being sufferedby it today, under the ongoing sterilized intervention to thegovernment account directly. To better appreciate the other benefitsthat may accrue out of the proposed move, let us first take a look athow sterilization works.


Under sterilized intervention mechanism, the Reserve Bank buysthe foreign exchange inflows against the rupee. This obviouslyenhances the reserve money base. So, to contain the money supplygrowth within the acceptable level of 16 to 17%, the Reserve Banksucks out the excess rupees put into the system by selling its holdingof government bonds. It thus ensures that reserve money does notgrow at the rate at which the reserves of foreign exchange grow. But,over a period of time, as its holding of net foreign exchange reservesbecomes equal to the monetary base, the Reserve Bank could no longercontain the reserve money growth. It is in such a situation that MSBshelp the Reserve Bank suck rupees out of the economy without leavingany monetary impact since the government, instead of spending themoney so collected as under other borrowings, deposits with theReserve Bank of India. But, if the inflow of foreign capital continues,even this mechanism could prove pretty expensive.

Assume, for a while, that the foreign exchange inflows continueunabated. Then, the government, being in need of more funds forsterilization, has to obviously encourage the public to subscribe moreto MSBs by offering higher interest rates. This may ultimately pushmarket-determined interest rates upward which, in turn, canunwittingly, lead to more foreign capital inflow. Should that happen,the need for MSBs simply spirals up and so goes on the viciouscircle. There is yet another danger: If the Reserve Bank, under oneor the other monetary predicament, gives up this game-plan half way,it may send a wrong signal about its ability to sterilize inflows anylonger. Such an eventuality is fraught with the risk of “reversespeculative attack”. Either way, we are in for trouble.

And the trouble is more out of our hoarding the reserves thanfrom using them for further generation of wealth. To better appreciatethis subtle but distressing feature, let us first see how savings differfrom hoarding. According to John Stuart Mill, ‘savings’, does not

289Do forex reserves serve those ‘who only stand and wait’?

imply that what is saved is not consumed, nor even necessary that itsconsumption is deferred; but only that if consumed immediately, it isnot consumed by the person who saves it. On the other hand, hoarding,according to Mill, means savings laid out for future use; and whilehoarded, it is not consumed at all by anyone. It otherwise meanssavings never lie idle but are borrowed by one or the other in thesystem for consumption, while in the case of hoarding, the accumulatedmoney is not consumed at all. It thus reveals that the value of savingslies in their utilization whereas hoarding, like in the form of preciousmetals, results in opportunity costs. In other words, it is our inabilityto put the current inflows of foreign capital to domestic use that iscosting us pretty dearly. Our inability to use these foreign exchangereserves for giving a push to the growth of domestic economy getsreaffirmed by the permission granted by the Finance Ministry forresident Indians recently to invest US$25,000 per annum in overseassecurities without any questions being asked. Of course, this move isno doubt meant for reducing the pressure on RBI in managing theinflows as also the sterilization costs thereon.

There is of course yet another dimension to this conundrum of“swamping plenty”. A plausible reason that one could offer for thecurrent hoarding of foreign exchange reserves is that they are neitherour earnings nor savings. They, being the savings of others, are liableto be withdrawn any time. So, like our ancestors who in the anxietyof putting aside a buck or two for a rainy day, and there being nobanking facilities, used to hoard the current receipts under the earthin the form of coins or precious metals, we are today hoarding iteither in the US treasury bills or in the near money securities issuedby central banks of other developed countries, while those countriesare transforming them into their dynamic investments to give a pushto their economic growth. When are we to learn to practice thesesimple economic fundamentals?


In the ultimate analysis, it is not the huge Forex reserves that matterin accomplishing economic prosperity but the entrepreneurship of the“self confident” type that can and is willing to take risks. Indeed, thistrait should reflect more in the governance of the country than inindividual investors. Ironically, that is glaringly missing today. What istherefore needed is not to feel “shiny” about the swamping liquidity,but to invent newer ways of using these inflows for the growth ofdomestic economy, lest “India Shining” should remain ephemeral.

——)0——

291Mere expression of ‘exuberance’ and ‘abundance’?

The New Year has brought cheers for the investing clan—bothindividuals and corporates—in India. The Finance Minister

recently announced that individual investors and listed Indiancompanies would be permitted to invest in listed companies in overseasstock exchanges. Simultaneously, the Government has also doubledMutual Funds investment limit abroad to $1 bn, abolished retentionlimit on ADR/GDR proceeds, allowed firms to acquire immovableproperty overseas and abolished the cap of $20,000 for remittancesunder ESOPs.

There is of course a caveat for investing in overseas listedcompanies: Companies in which individuals, listed Indian companiesand mutual funds proposing to invest should each have a shareholdingof at least 10% in a listed Indian company as on January 1 of the yearof investment. Further, in the case of listed companies investingabroad, their investment should not exceed 25% of their net worth ason the date of the last-audited balance-sheet of the company. To cap

February 2003.

SIXTY FIVE

Mere expression of‘exuberance’ and ‘abundance’?

When one is suddenly flooded with fortunes, it isbut natural to lose, though momentarily, the senseof proportion.


it, the Government kept this window open for a six month time at theend of which it proposed to review the matter afresh.

Hype apart, what matters here is the caveat that accompanied theinvestment relaxations and secondly, their timing. Given the 10%investment requirement in the Indian companies by overseas-listedcompanies, how many foreign companies are eligible for investmentby Indians? This requirement would prune the eligibility list, moreso when close to 30 multinationals have had their stock delisted fromthe Indian bourses during the last two years and many others are ontheir way to get theirs delisted. The next question is: Are the relaxationsworkable in the present state of economy? These two put together raiseanother fundamental question: Why would anyone want to invest inan unknown market, that too when FIIs are rushing into Indiaconsidering it as the safest place to invest and earn a decent return?

Theoretically, investing internationally reduces the portfolio riskfor it enables building up of portfolios with low correlations to domesticholdings, resulting in lower volatility of the portfolio. It makes greatsense to invest in markets that behave differently, for different countriesgo through different economic cycles, so that even if one marketunderperforms, the other may provide a cushion.

But in the wake of globalization, the resultant convergence offinancial markets, and the movement of markets in tandem with eachother, one is not sure how long these theoretical underpinnings wouldhold good. Secondly, are the individual investors and corporates forwhom the core business and the accumulated experience is certainlysomething other than management of investments, competent enoughto invest in overseas markets and simultaneously manage the embeddedprices and currency risk thereof? If this is true, is it not right to saythat the present relaxation will only distract the corporates andindividuals from their main businesses?

293Mere expression of ‘exuberance’ and ‘abundance’?

Let us pause here for a while and guess what then has really beenaimed at by the fresh bout of relaxations. Are they meant to triggerprivate demand for dollars and encourage individuals and corporatesto manage the surging forex reserves that have recently crossed US$70 bn, by investing in the overseas stock markets, so that the RBI’sjob of liquidity management is made less strenuous?

But it begets two arguments. One, given the ruling LIBOR of1.4% and the forward premiums of 3.0 to 3.5%, it still makes sense tointernational players to borrow funds from the global markets andremit the same to India where interest rates are ruling around 6.0 to7.0% to pocket a neat arbitrage gain of 2.0 to 2.5%. This wouldsimply mean that forex reserves are likely to grow till at least marketsreturn to equilibrium. Two, presuming that, as assumed by theGovernment, the individuals and corporates being carried away bythe hype generated by the announcement, ignore the ground realitiesof the economic conditions in the West which is under prolongedrecession that is currently further endangered by the impending Iraqwar and India where the economy is set to be doing well with a GDPof around 5.5%, invest in overseas stocks and hopefully earn goodreturn. But this hype may not last long for the returns on suchinvestments are greatly influenced by the currency rate fluctuations.If the rupee continues to appreciate vis-à-vis the dollar—that of coursecannot be ruled out looking at the current trend of the dollar fallingprecipitously against the Euro and even the Rupee, the future returnsfrom the overseas investments are more likely to fall in rupee terms.This automatically drives away the prospective customers from suchoverseas investments. The net of these two arguments would be: risein forex reserves and no growth in overseas investments.

So, we are back to square one. There is of course a redeemingfeature—relaxations are subject to review after six months. Thisshall facilitate a watch on how inflation behaves, for so long it


remains below 2% whereby the rupee continues to appreciate unlessof course RBI tinkers with it—unlikely in the present context as itwould cost it dearly—there is a chance of enjoying continuous inflowof foreign exchange. But the moment inflation raises its ugly head,which would not be surprising with the unabated growth in fiscaldeficit and the resultant debt trap, capital flight from the country islikely to be triggered.

Secondly, much of our forex reserves being borrowed money, it ishighly mobile. As CMIE puts the ratio of “vulnerable liabilities tothe total forex reserves as on March 31, 2002, at as high as 92%”,there is hardly any wonder if any minor deviation in the marketparameters triggers capital flight. And that is the real danger lurkingbehind the current relaxations. Of course, it is a different matter:Looking at the past investment behaviour of mutual funds underearlier relaxations, no one is expecting any investment worthmentioning under the current relaxations too. Thus far it is good.Does it then mean that all this is a mere expression of exuberancefrom a feel of abundance? Let us fondly hope: “It’s that!”

——)0——

295Can removal of regulations build a market for swaps?

The Reserve Bank of India has once again allowed AuthorizedDealers in foreign exchange to offer Rupee-Foreign Currency

swaps without its prior approval. It has also allowed banks to undertakeswaps on an unmatched basis upto US$25 mn, of course with a rider.Some treasurers have acclaimed these relaxations as “partial restorationof what banks have been doing a year back.” Some others havecommented that it is yet another proactive step towards the fullconvertibility of rupee.

As the market reactions are dying down, the same old issues thatbothered the treasurers when the Foreign Currency swaps wereintroduced for the first time in 1997 are once again emerging as a bigquestion mark. No doubt, the present product relaxations have simplifiedthe corporate’s access to this derivative product. It is, however, still notclear how the corporates are going to surmount the hurdles that indeeddidn’t allow the market to take off in the past. This old question – “Is itjust by removing the regulations that the markets will evolve for foreign

January 2002.

SIXTY SIX

Can removal of regulationsbuild a market for swaps?

Without a well developed ‘yield curve’ it is suicidalfor market makers to take proprietary positionsunder swaps.


currency/rupee swaps, or are there any underlying factors which needto be addressed before making the policies” – is still haunting thetreasurers. In order to arrive at the right answer to this question, let usfirst examine how a currency swap works, who the parties are, whatneeds they have, how their needs are met by swaps and what factors themarket players, market makers and regulators need to collectively workat to reap the full benefits of the product.

It simply involves the exchange of interest obligation or foreigncurrency exposure or a combination of both by two or more corporatesor a corporate and a bank. It may not necessarily involve the legalswapping of actual debt but an agreement is made to exchange cashflows under a particular loan. Swaps enable a corporate treasurer tomanage currency exposure by switching over liabilities from onecurrency into a fully hedged liability in another currency. Secondly,special facilities available to a particular borrower but not to all canbe arbitraged upon for further gains. Thirdly, it can obviate the scarcityvalue resulted in the market by too many floatations. Fourthly, swapsbeing instruments that allow the user to hedge, i.e., to offset risks,are also used by the speculators to take risks deliberately in the hopeof making a profit. Finally and importantly, swaps can also be used toreduce the cost of loans.

Banks, being authorized dealers and as market makers, arrangethe swap and ultimately take swap exposures in their books. A bankwould enter into a swap transaction with a corporate and then enterthe market to find another party with a matching opposite requirementso as to hedge itself against any market fluctuations. Swaps havebasically zero value. The two cash flows exchanged under a swap willhave to be identical in their discounted present values if the bank hasto remain unaffected by the transaction. The swap rate thus arrived atis appropriately modified to quote bid-offer rate to the customer sothat at the end of the day it gets paid for arranging the swap.

297Can removal of regulations build a market for swaps?

It is the pricing of the swap that is very critical in the entiretransaction. A bank takes into consideration many factors likeprevailing market conditions, i.e., term structure of interest rates,structure/duration of the swaps, current position of the company,ready availability of off-setting swap, credit quality of the counterparty,regulatory constraints like risk capital requirements etc.

So, what really matters here is the scope to foresee interest ratemovement, exchange rate movements, the inflationary behaviour indomestic as well as key trading partner countries and transact withmarket players having a sound understanding of derivatives. A wellestablished legal structure that makes enforcement of contracts easyand a standard accounting system that affords transparency are theother two important requirements for sound operations in the market.

Now the moot question is, are we having these comforts to makethe foreign currency rupee swaps to take off? Let us examine eachone of them in detail for a rational answer. Interest rates are forecastedlooking at the “Yield Curve” of the long-term bonds and the macroeconomic variables like inflation, fiscal deficit, government’s non-plan expenditure etc. Against this requirement, it is safe to say wehave no term money market of any worth where two-way quotes areavailable. Unless there is an active term money market that integratesmoney, capital and forex markets, it is difficult to plot a yield curve.This obviously makes estimation of long-term interest rate on rupee afar cry and to that extent swap pricing becomes a mere hunch.

Secondly, the parties need to have a ‘view’ on the movement of theexchange rate. In a free market, exchange rate movement is defined byinterest rate differentials of the currency pair involved. But in our marketwhere, regulations still control inward and outward flows, exchangerate movement does not strictly obey the principle of interest ratedifferentials defining the exchange rates. Secondly, the RBI is known


to frequently intervene in the market to regulate the price volatility. Insuch a market, it is the supply and demand position of the foreigncurrency that defines the exchange rate movement. In this scenario, itis difficult to take a firm view on the likely exchange rate movement inthe near future and to that extent it weakens the swap pricing.

The interest rate movement and in turn the exchange rate movementultimately rest on the economic fundamentals of the country as reflectedin the prevailing inflation rates. Despite this economic truth, interestrates in our markets are far away from the idealistic situation. Althoughwe are inching in that direction, our interest rates continue to bearbitrarily fixed. Secondly, our inflation rates are calculated based onthe wholesale price indices. It thus always leaves a scope for poorrelationship between the inflation and interest rates. It is evident fromthe foregoing that the existing gaps in the system cannot facilitatedetermination of a dependable swap cost.

The market players, market makers and regulators have to thereforefirst work collectively to fill these gaps in the system. There is anurgent need for the market to develop “Yield Curve”. Till such time,it would be venturesome for any market maker to strike a swap dealeven under the lure of momentary high spreads. It would be suicidalto take open position with so many inadequacies all around thoughregulations permit.

——)0——

Section V

Governance

After nightlong hectic parleys leading to the signing of the much- longed-for nuclear cooperation pact, both Prime Minister

Manmohan Singh and President Bush walked into the gardens ofHyderabad House to address a joint press conference. It was 12.20p.m. Prime Minister Singh asked: “Shall I start?” and President Bush(said), “Please”. Then Prime Minister Singh said: “We have madehistory today”, while President Bush preferred to say, “We haveconcluded an historic agreement today.” The statements were greetedwith rapturous applause.

As the details trickled down, it became clear that India had offeredto separate 14 of its 22 reactors as civilian and place them under theinternational safeguards perpetually. The Fast Breeder Test Reactorand the Prototype Fast Breeder Reactor, and Bhabha Atomic ResearchCentre are out of safeguards; CIRUS reactor shall be retired by 2010,against which the US will ensure supply of natural uranium from

April 2006.

SIXTY SEVEN

Indo-US nuclear agreement:The road ahead

Clinching a nuclear deal with the US in businessstyle is one thing and carrying it forward for the goodof the nation is another. It calls for ‘statesmanship’.


outside by amending its own laws thereunder and also making otherNuclear Supply Group countries fall in line. Robert Blackwill, theformer US Ambassador to India, aptly captured the significance ofthe deal when he said: “It is a historic day for Indo-US relations”.

Rhetoric apart, no one can better describe the significance of March3rd agreement between Mr. Bush and Mr. Singh than what PrimeMinister Singh himself said to Parliament: “As India strives to raiseits annual GDP growth rate from the present 7-8% to over 10%, theenergy deficit will only worsen. This may not only retard growth, itcould also impose an additional burden in terms of the increased costof importing oil and natural gas, in a scenario of sharply risinghydrocarbon prices. While we have substantial reserves of coal,excessive dependence on coal-based energy has its own implicationsfor our environment. Nuclear technology provides a plentiful andnon-polluting source of power to meet our energy needs. However,to increase the share of nuclear power in our energy mix, we need tobreak out of the confines imposed by inadequate reserves of naturaluranium, and by international embargos that have constrained ournuclear program for over three decades.”

As the prime minister put it so emphatically, the deal, if it getsthrough the US Congress, can simply “dismantle internationalrestrictions, which when achieved, could unleash our scientific talent”by enabling our scientists to interact with research institutions andscientists engaged in advanced research on various facets of nuclearpower generation such as fast reactors being developed based onconcepts such as gas-cooled fast reactor, molten salt reactor, andsuperficial water-cooled reactor. Acceptance of India into the NuclearGroup shall also enable our scientists to participate in the InternationalThermonuclear Experimental Reactor being set up by the US, EU,Japan, South Korea, Russia and China which in itself will be a richlearning experience in the cutting-edge technology besides keeping

303Indo-US nuclear agreement: The road ahead

them abreast of the global technological developments. All this shalljust increase our “commercial potential in the nuclear power andrelated sectors.”

The significance of this agreement can be gauged from the factthat no sooner it was inked than the US Department of Energy-funded Fermi Labs, Chicago, reported to be convincing India to takea big lead in designing and building the International Linear Collidor,a project that would cost around $8 billion. As Dr. Amit Roy, Directorof the Inter-University Accelerator Centre, New Delhi, stated, “Thecountry can be a key player in this challenging sector wheretechnology is guarded.” Such exposures not only remove the isolationIndian scientists have been in since 1974 but also boost theirconfidence to think big and use the knowledge so acquired infurthering the cause of the institutions they represent, more so whenthe largest accelerator in India is the pocket-sized 172 meter Indus atIndore Lab.

There are of course many Indians who watched the joint pressstatement on TV with a scowl on their face fulminating against theUS interest in the scheme. They are perhaps haunted by a barrage ofquestions: why is America so much interested in the deal? Is thereanything that America wants to take away from us? Is there any benefitthat they are deceitfully aiming at? In international relations and, forthat matter, even in the life of an individual, “nothing comes out ofnothing”. For a nation or for an individual, what matters is “what isthere in it for me?”. It is, however, to be remembered that in thisworld of connectivity, if one has to have more of something, one hasto necessarily give up something elsewhere, proportionately.

The President himself cited many reasons for their interest inthe deal: “It is in our (American) economic interests that India hasa Civilian Nuclear Power Industry to help take the pressure off the


global demand for energy… And so, to the extent that we can reducethe demand for fossil fuels, it will help the American consumer.”Secondly, as Alyssa Ayres and Sumit Ganguly from the Universityof Pennsylvania and Indiana University respectively, observed inthe Wall Street Journal, “Civil nuclear cooperation with India willadvance the long-term strategic goals of the US rather than threatenthe global order. It offers an opportunity to re-address inequitieswithin the global nuclear regime…offers an unprecedentedopportunity to get on to the right side of history.” That, at leastapparently, is what America is aiming at.

Now, coming to our strategic needs, critics say that keeping thefast-breeder reactors under military control, without inspections,would allow India to develop far more nuclear arms, and more quickly,than it has in the past. The same feasibility is amply decipherablefrom what Robert J Einhorn, a senior adviser at the Centre forStrategic and International Studies in Washington, said: “It’s notmeaningful to talk about 14 of the 22 reactors being placed undersafeguards. What’s meaningful is what the Indians can do at the unsafe-guarded reactor, which vastly increases their production of fissilematerial for nuclear weapons.” Even otherwise, what is the safestockpiling that deters others from quarrelling with us is anybody’sguess. Hence it needs least attention.

Prime Minister Singh has once again proved his ability to launchIndia on a new trajectory: He opened up a new opportunity to ournuclear scientists by plucking them out of nuclear quarantine, tointegrate themselves with the major global players and gain scope topush forward their technical competence in ensuring energy securityfor the country. Now it is a question of how we carry it forward andutilize it for the best interests of the country. It is not going to beeasy: the new-found status throws many challenges in handling ourrelations with neighbours, far and near.

305Indo-US nuclear agreement: The road ahead

The first thing that we must learn is not to repeat mistakes. Forinstance, we committed the blunder of not stockpiling nuclear fuelbefore exploding a nuclear device in 1974, the consequences of whichare haunting us till date. We must stop reinventing the wheel underthe folly of ‘self-reliance’, and instead grab the technology availablein the market immediately and build the nuclear power plants withleast cost and time overruns that were once synonymous of our reactorbuilding. Once the technology available globally is imbibed, it couldbe used as a platform to probe newer domains of science, particularlytake forward the fast breeder program that ultimately leads to usingour abundant thorium deposits.

Thanks to our exclusion from the global nuclear club, our cost ofnuclear power production remained pretty high. To beat it, we nowneed to capitalize on the new opportunity to import reactors fromabroad. Now, the question is: where is the capital? Encouraged bywhat Mr. Ratan Tata said the other day, the Government may explorethe scope for private participation in nuclear power production. Oncethe reactors are kept under international safeguards, it does not matterwhether the power plants are under public or private management.

In this endeavour, our behaviour should exhibit, needless to sayhonestly, that we are not crazy about stockpiling nuclear weapons,for there is already a lot of dissonance going around, both in andout of the country, against the deal, and any let-up may derail thewhole prospect.

In today’s context ‘national interest’ is the only guiding post andeverything else becomes secondary to it and the sooner we practice it,the better it would be. God alone save us, if we do not know what is inour interest!

—)0——


It was like any other late-night drive to the workplace. At least, that was what the 24-year-old Pratibha Srikant Murthy—an employee

of Hewlett Packard Global Delivery Application Services inBangalore—might have thought while leaving the house for work ina replacement vehicle driven by a new driver around 2 a.m. on thatfateful night. No one in the BPO industry had ever imagined thatsuch a fate awaited her. Even Pratibha, for sure, didn’t suspect anyfoul play when she called her colleague Pavan to the office to confirmthat she was on her way to log in at the scheduled time of 3.30 a.m.But fate willed otherwise: Pratibha was raped and murdered by thecab-driver.

Only a couple of days back, the Nasscom-McKinsey reportannounced that the Indian ITeS sector had grown from $4 bn in2002 to $17 bn by 2005. The report cheered everyone in the industryby stating that offshore IT and BPO exports had tripled over the lastfive years. The industry is agog with predictions that India will soonbecome the preferred destination for global BPO and jobs will growfrom one million to 10 million. All those connected with the BPO

February 2006.

SIXTY EIGHT

We all have to act on it!

The fear of being caught in the public acts as apowerful deterrent even to a beastly personality.

307We all have to act on it!

industry in one way or the other were indeed getting ready to capitalizeon the prospects.

Amidst such high spirits, the news of the rape and gruesomemurder of Pratibha by the taxi driver was least expected. It sent achill wave across the country. It aroused loud protests, and of course,rightly. Call centre employees took to the streets protesting againstthe horror inflicted on the sanity of the nation. They all demandedadequate measures for security, particularly for women employees who,incidentally, are said to constitute around 40% of the total BPOemployment. Accusations and counter-accusations were galore.Employers alleged that the police were lax in their night patrolling.The police countered saying that it was the responsibility of theemployers to check the antecedents of the drivers before hiring themfor such sensitive jobs. Indeed the DCP of South Bangalorecommented on Pratibha’s murder: “It was a clear security lapse by thecompany.” In the maze of these accusations, what distinctly surfacedwas that the reaction of our society at large is not in proportion to theheinous crime inflicted on the fair face of humanity. To be honest,we must admit that a majority of us received the news as passively aswe do any other bad news of the day. And this is very unfortunate ofa society in which its members are known to greet each other withNamaskar which implies “God in me welcomes the God in you”—aphysical, mental, and intellectual surrender to the Supreme Being—and it certainly does not even economically augur well for a countrywhich wants to come to grips with itself.

Having said that, let us see how the families whose childrenworking in BPOs are reacting. Many parents whose daughters aretoday venturing out in the nights for a decent earning are whispering/questioning themselves: “Is it wise for women to work in BPOs?”Every concerned citizen of the country is wondering: “How safe areour cities for women to go out at night?” And there could be many


other whispers that might have been drowned in silence. In the entireaftermath, the real need of the hour is lost sight of. It is time werealized that policing alone cannot annihilate such bestial intentionsof mankind. It is only an ardent effort towards civilizing the societyby proper education that citizens can be made to respect each other’spersonal space and esteem. And policing can only supplement suchsocietal initiatives in arresting the recurrence of such brutal acts.

True, it is not an easy path, nor a quick provider of relief. Sucheducation needs right ‘atmospherics’ for bearing fruit. It is certainlya giant task. But it can be addressed by all of us collectively. To beginwith, let us first see what families can do. In this whole exercise,there is a greater responsibility thrust on the parents. They alone canbetter police their wards by educating them about human values rightfrom early childhood and insisting on their adherence to these basicvalues in their behaviour. It is not only a social responsibility that isthrust on them but also essential in their own interest, for everyfamily in the society today houses a potential ‘Pratibha’ and a potential‘transgressor of human dignity’.

We are today passing through a kind of ‘cultural transition’ wheremen and women are moving away from their native habits andembracing the western lifestyle in terms and speed that were neverexperienced in the past. It is, of course, certainly heartening to seetoday’s youth—the freely intermingling male and female—marchingforward with ease and confidence as though to build a new India thatis distinctly different from the colonial past. But the events such asthose reported from Gurgoan and Bangalore not only shatter thishope but also pose a battery of questions: Is all this ‘modernism’witnessed at today’s workplaces only ephemeral? Or, is it that whathas changed is only our attire and not our respect for the fellowfemale traveller? Is it that our mental make-up about the femininegender never changes? But then what does all this mean to the society?

309We all have to act on it!

It only means that women must be sensitized not to get carried awayby the so called ‘modernism’ witnessed in Malls and call centres andto be on their guard. That is where socially active groups can chip inand supplement parental efforts in not only civilizing the society, butalso guarding it from insanity till sanity prevails on its own.

Let us now turn our attention to what employers in the BPO industrycan do. It is indeed heartening to note that for the first time in thecountry, an industry–level response to counter such challenges hascome immediately after the incident. The Nascom has responded tothe event by offering to broaden the scope of the National EmployeeRegistry to include vendor employees as well, hoping that it will helpcall centre companies to make verification checks on the employees oftransport and security agencies they hire. Yes, such quick responses doprovide the much-needed succour to the wounded feelings of theemployees immediately, but are not a long-term solution to the problem.

Now, the question is: Is there anything that the BPO industry cando to obviate these problems on a long-term basis? One that immediatelycomes to mind here is what Roger Noll—a Professor from StanfordCenter for International Development, said: If India wants the benefitsof ongoing reforms to spread across the country, each State shouldestablish facilities for development of business enterprises in more thanone city. As rightly said, it may be the time for the BPO industry tomove out to our 2nd- or 3rd-tier cities/towns to reap advantages. One,such a spread of BPO units across the geography eases the pressure onthe already inadequate infrastructure—in terms of housing, roads,transportation security etc.,—of the metros. Two, their spread to lessdensely populated towns affords scope for BPOs to house themselvesamidst centres of human habitation. This eliminates travel on longstretches of roads that are sparsely populated besides minimizing traveltime. Cumulatively, it acts as deterrent to the prospective offenders ofhuman dignity. Three, small towns, by virtue of affording greater scope


for the neighbours to know each other well, do not breed the syndromeof ‘strange familiars’ that a metro does. That sense of identity with thecommunity in turn lessens the scope for crimes as everyone fears toappear immoral in the eyes of the neighbour. The very fear of beingcaught by the neighbours while doing a ‘wrong’ deed is a great deterrentto such crimes and this is more possible in close-knit communities ofsmall towns than in metros. Four, policing of such narrow confinescan afford even greater security against erring beings. More thananything else, such dispersal of growth centres across the geographyminimizes migration of people from their known neighbourhoods,which is again a great deterrent to evil deeds. Finally, such distributionof growth centres across the country ensures regional equity in thedistribution of wealth and in turn generates better ‘atmospherics’ forsocial consciousness to emerge. And all this at no extra cost; indeed itreduces the operating costs of BPOs substantially.

Then, what are we waiting for: Let us together act at once to makeour country more civilized!

——)0——

311Indo-US nuclear deal

T he debate on the Indo-US nuclear deal of July 18th, 2005 hasreached its zenith with a group of former ambassadors urging

the government “to share with the people of India all that they arelegitimately entitled to know” about it. Given the heated discussionsit has generated, the deal merits businesses’ attention.

Under the deal, the US will “work to achieve full civil nuclearenergy cooperation with India as it realizes its goals of promotingnuclear power and achieving energy security.” The US Presidentwould seek agreement from Congress to adjust domestic laws andpolicies, and it will work with allies to adjust international regimes toengage in full civilian nuclear cooperation and trade with India,including, but not limited to, expeditious consideration of fuel suppliesfor safeguarding nuclear reactors at Tarapur.

On its part, India agreed to identify and separate civilian andmilitary nuclear facilities and programs in a phased manner and filea declaration regarding its civilian facilities with the InternationalAtomic Energy Agency (IAEA); take a decision to place voluntarily

February 2006.

SIXTY NINE

Indo-US nuclear deal

From the Known to the Unknown: when an‘unanticipated good’ happens, even countries findit difficult to swallow it.


its civilian nuclear facilities under the IAEA safeguards; sign andadhere to an additional protocol with respect to civilian nuclearfacilities; continue its unilateral moratorium on nuclear testing; workwith the United States for the conclusion of a multilateral FissileMaterial Cut Off Treaty; refrain from transfer of enrichment andreprocessing technologies to states that do not have them and supportinternational efforts to limit their spread; and ensure that the necessarysteps have been taken to secure nuclear materials and technologythrough comprehensive export control legislation and throughharmonization and adherence to Missile Technology Control Regimeand Nuclear Suppliers Group guidelines.

Some have hailed the deal as India’s ‘nuclear triumph’ since itconfers on it a nuclear weapons power status, besides enabling it toprocure advanced nuclear technology, machinery and, mostimportantly, uranium supplies. The civilian collaboration is expectedto offer energy security to India. There is a flip side to the deal: Someallege that it compromises with India’s strategic nuclear autonomy, asthough it was once independent of external assistance. Even theAmerican elite have voiced their concern against the deal. StrobeTall bott—President, Brookings Institution and former US specialenvoy to South Asia, cautioned that the decision to recognize Indiaas a legitimate nuclear power does not bode well for world security.He also said that the Indo-US agreement effectively granted Indianuclear legitimacy—with little in return—that will completelyundermine the global non-proliferation regime, while some othershailed it as a reflection of what US Secretary of State CondoleezzaRice argued in one of her articles during the 2000 election campaignthat the US should regard India as a strategic counterweight to China.

But this apparently good-looking deal ran into a barrage of criticismduring its implementation. It is alleged that the US repudiated thevery core of the deal – that India would “assume the same responsibilities


and practices and acquire the same benefits and advantages as otherleading countries with advanced nuclear technologies, such as the US.”Secondly, although “identification and separation of civilian and militarynuclear facilities and programs in a phased manner” is at India’s volition,the US is reported to have insisted that such separation “plan” be“credible”, “transparent”, and “defensible”. Thirdly, though the deal isof a reciprocal nature, the State Department appears to have madeIndia’s act of ‘separating’ its nuclear establishments into civilian andmilitary as a condition precedent for the US to seek approval from theCongress for changing laws.

The controversies aside, it is worth recalling here what our Ministerof Defence said at the Carnegie Endowment for International Peaceon June 27, 2005: “India is a heavily energy-deficient country. Energyscarcity is the most serious hindrance for India’s economic progress.With the anticipated growth rate of 8% under GDP per year, thegrowth of oil demand is projected to be 6% per annum, which meansoil imports could rise to 85% over the next two decades. If, indeed,India is to realize its economic potential, it needs alternative sourcesof energy. Though it has indigenously developed technologies fornuclear energy, it faced serious impediments in accessing materialsand components and easing of these constraints will impact favourablyon our economic prospects over the next two to three decades.” Thereis yet another interesting observation that merits our attention here:George Perkovich, Vice President for Studies at the CarnegieEndowment for International Peace, said that “…the issue is not oneof (India) succumbing to outside pressure (for separating civil nuclearprograms including fast-breeder programs); it is one of paying to getsomething in return”.

Even otherwise, if we peep into the history of our NuclearEstablishment, it becomes evident that though we established theAtomic Energy Commission in 1948 to indigenously harness atomicenergy we could, as observed by Zia Mian and M V Ramana elsewhere,


accomplish no progress till theUK assisted us to design and buildthe first reactor Apsara that wentcritical with the enrichedUranium fuel supplied by it.Similarly, the CIRUS reactor wassupplied by Canada and heavywater by the US. As stated byPerkovich elsewhere, around 1100Indian scientists were trained atvarious US facilities. That is howwe began our journey into theNuclear Fuel Cycle, but of courseprogressed well within the givenmonetary and technologicalconstraints till at least we wereostracized from the global nucleargroup of countries after weexploded a civilian nuclear devicein 1974.

Thereafter we could not ofcourse carry forward the nation’senergy security and self-reliancepolicy that was drafted by HomiBhabha way back in 1950 whichconstituted a “three-stage nuclearpower program” to use ournatural uranium and thoriumresources to establish a totallyindigenous technology base.There are of course reasonsgalore: To accomplish the vision

Nuclear Fuel Cycle

Recoveryfrom ore as Uranium

oxide/Yellow cake

Conversioninto Uranium hexaflouoride

U-235 is 0.7%

Enrichmentfed through gas centrifuges

to increase the proportion ofU-235 to 3.5% for use in reactor

Fuel FabricationEnriched U-235 is converted

to U.dioxide powder andinserted into tubes

ReactorU-235 isotape splits in the

core of the reactor producingheat which is used togenerate Electricity

Storagespent fuel stored in ponds

to decrease temperature andradioactivity

Reprocessingreprocessed to recover unspenturanium which can reenter the

cycle at conversion stage orPlutonium can be blended

with enriched uraniumat fabrication stage

Storage and DisposalLeft out is sealed in

corrosion-resistant material andburied deep under stable rocks

Wea

pons

Wea

pons


of Bhabha we were required to build a sufficient number of PressurizedHeavy Water Reactors first to produce adequate Plutonium so that wecould migrate to the second stage breeder program. But due to shortageof natural uranium we could not even fuel the existing PHWRs. Norhave we any encouraging news from the mining front: The knownuranium sources in Jaduguda mines are depleting fast while localopposition held up uranium mining in Domiasiat in the North-Eastand Nalgonda in A.P. The net result is that we are cumulatively farbehind the projections under nuclear power generation.

Though in terms of what Mujid Kazimi of the MassachusettsInstitute of Technology said: “Everything they (Indians) have reported(on their research about fast-breeder reactions) to date indicates theyare on course”, we appear to be making inroads into this new field,we still could not make the technology available for commercialexploitation, due more to our isolation from the NSG countries. It isthus increasingly becoming evident that “unhindered access to nuclearmaterial, equipment, technology and fuel from international sources,”is a must for our further progress.

The current electricity projections put the country’s need at400000 MW by 2025. Given the scenario and from what Dr. AnilKakodkar, Chairman, Atomic Energy Commission, said, “Thegrowth constraint would, by and large, be removed for civiliannuclear power if the agreement goes through as we have envisaged”,the deal per se assumes importance, for it considerably eases thenuclear fuel supply for newer plants. If what George Perkovich said“India is running out of fuel, the need for electricity cannot be metby the nuclear program, especially if there is no internationalcooperation”, is true, which, of course, the government alone knows,it becomes all the more essential to work towards implementing thedeal for a ‘win-win’ outcome.

——)0——


Thursday, July 7. “It was 8.40 a.m. when I boarded the train towork at Finsbury Park. The train was so full that I had to walk to

the first carriage. It was absolutely packed. Even more people got inat Kings Cross. It felt like the most crowded train ever. Then, as weleft Kings Cross, at 8.55 a.m., there was an almighty bang. Everythingturned totally black and clouds of choking smoke filled the carriage.It was so dark that nobody could see anything. I thought I was aboutto die, or was dead. I was choking from the smoke and felt like I wasdrowning.

Air started to flood in through the smashed glass and the emergencylighting helped us see a bit. We were OK. A terrible screamingfollowed the initial silence. There was screaming and groaning allaround. God alone knows how, but we somehow calmed each otherand tried to listen to the driver. He told us that he was going to takethe train forward a little so he could get us out, after he had madesure the track wasn’t live. We all passed the message into the darknessbehind us, down the train.

August 2005.

SEVENTY

Religion vs. ghastly acts of the‘angry apes’…

“Culturally organized anger” accomplishesmilitaristic perfection in its violent lifestyle.

317Religion vs. ghastly acts of the ‘angry apes’…

After about 20 minutes, we escaped from the smashed carriage.We walked carefully through the semi-darkness, wondering if thetracks were live. We walked in a single file to Russell Square Station,where we were lifted off the tracks to safety. My mouth was so dry. Mylungs felt full of choking dirt. I suddenly became aware of a hugebleeding gash full of glass in my wrist. I could see the naked bone inmy arm. I staggered about outside the tube and no one, least of allme seemed to know what to do. I knew others behind me were somuch worse off than I was.

I was so very lucky!”

These were the outpourings of a victim of the series of terroristattacks in the London Tube. That ghastly act of “angry apes” hadonce again brought religion to the centre-stage. The thinking mindsof the world were agitated with a battery of questions: What is thisreligion? Is religion meant for maintaining a semblance of orderlinessin societal function or is it meant to destroy the social fabric? Is itmeant for living in harmony with each other or to create/perpetratehell for the neighbour? Is it meant for indoctrinating minds withhatred against outsiders or for filling them with warmth for everyone?Does religion mean being human or devilish? Yesterday, it was 9/11.Today, it is 7/7. And in between it was Madrid. What will it betomorrow? What is this religion? What is it aiming at?

Etymology says that the word religion is derived from religio in‘Romance’ language. Does romance mean killing one another? Hatingone another? Or living together? Incidentally, the true etymology ofthis word connects it with relegere — to recollect, to recall, and toreflect; all with a shade of concentration and anxiety. The currentetymology, however, seeks to relate religion with religare — to bind,join, unite, though philologically inexact, but this certainly enjoysthe benefit of expressing far more vividly the actual and the living


meaning of the word. Morris Jastrow summed up the definition ofreligion proposed by his predecessors thus: “Religion consists of threeelements: One, the natural recognition of a Power or Powers beyondour control; two, the feeling of dependence upon this Power or Powers;and three, entering into relations with this Power or Powers.”

“Uniting these elements into a single proposition, religion maybe defined as the natural belief in a ‘Power’ or ‘Powers’ beyond ourcontrol, and upon whom we feel ourselves dependent; which beliefand feeling of dependence prompt (1) to organization, (2) to specificacts, and (3) to the regulation of conduct, with a view to establishingfavourable relations among ourselves and the Power or Powers inquestion.” This synthesis sounds like a pretty good description, butnonetheless, it has a serious defect: It does not bring out theimportance of the transcendent quality of all religions.

Is this missing of ‘transcendence’ in any way responsible for whatis happening today in the name of religion or for the sake of religion?What if religion is perceived like what Huxley said: “Reverence andLove for the Ethical Ideal and the desire to realize that ideal in Life”?Would that reverence and love for the ethical ideal in the name ofreligion have made any difference in practising the religion as a toolfor sublime living? That is perhaps what Kant meant when he said:Religion “consists in our recognizing all one’s duties as divinecommands.” Doesn’t it then want us to realize that religion is thesum total of beliefs, sentiments, and practices—individual or social—which have for their object a power which man recognizes as supreme,on which he depends, and with which he can enter into a relationship.

Yet, man, “like an angry ape, plays such fantastic tricks beforehigh heaven; As makes the angels weep.” Does it mean that religion,by itself, is no good unless it encourages its practice in reverence tomoral rights of a man and others. Most of all, it is about whose

319Religion vs. ghastly acts of the ‘angry apes’…

commands we are following: Is it the commands of that divine poweror the commands of the powerful mortals? Only religion isvociferously yelling to stop this insane behaviour of man against man.

Elders in the families should now undertake this teaching. Theyshould teach everyone in their families how shameful it is to inflictinjury on others—that, too, wantonly. And they must practice itrelentlessly, because in today’s world, money has emerged as the visibleGodhead of modernism, ‘transforming all human and natural qualitiesinto their opposites’. Unless they strive for this noble teaching as alife-long pursuit, and deliver it, nothing substantial can be achievedor changed.

It has to be borne in mind here that, however anxious a man maybe to get at the right thought, “he can only understand it by bringingit into relation with his own mind; and this is not an empty mind,but a mind already stuffed with personal categories and a content ofits own, and disposed therefore to look at things in a particular way.He must of necessity, therefore, read this mental character into anynew facts that are brought before him, estimate them by its canons,appropriate and assimilate them, turning them round, as it were, tillhe can see them in the light of his own habitual modes of thought.”

This assertion poses a big challenge to all those religious leaderswho are sincere about correcting the digression that religion has takenfrom the divine path by landing into the lap of powerful mortals inthe recent past. It is a big challenge! But there is no escape from it ifwe believe that we all are the subordinates of that absolute Power andwe have no ethical ground to supplant the Power. Everyone who hasfaith in the future of mankind should denounce anyone who,knowingly or unknowingly, indulges in any act of destruction. It isnot only necessary to put them to shame, but also to make themunderstand that the whole society shames them.


Therefore, what is needed is not sectarians with axes to grind, butrationalists of moderate temper and perfect good faith who can analyzereligious facts and interpret them on rationalistic lines, and accordinglyeducate the society to remain decent to themselves by being decent toothers. So, elders and pontiffs have a responsibility, that of educatingthe society through rightly and ardently practising religion.

——)0——

321Clause 49: A step towards ‘good governance’

Corporates usually have an apex policy-making body known asBoard of Directors (BoD). The members of the board exercise

their authority collectively. Hence, the professional credentials andcommitment of members have an extensive impact on the fortunes ofbusinesses. Yet, the Indian Companies Act does not offer a definitionof “Board of Directors”. Even the designation “Director” has a blanddefinition: “It includes any person occupying the position of director,by whatever name called” [Section 2(13)]. Of course, from this, onemay infer that the BoD is a group of individuals, each of whom islabelled a “Director”. In much the same way, the Act does not tellwhat a BoD is supposed to do. Here again, we have to infer from thedefinitions given under Section 2 of the Act, as also Sections 291-93,that a BoD is expected to perform the role of overseeing the runningof the enterprise by its Chief Executive. The majority opinion is thatthe BoD must ‘direct’ the affairs of the company and not ‘manage’them. That being the law, it is no wonder that many Indian boardsnormally have a CMD, and two directors, i.e., a husband, a wife, and

May 2005.

SEVENTY ONE

Clause 49: A step towards‘good governance’

It’s not only a constant endeavour that is essential fornurturing good governance but also an assertion for it.


a daughter. On top of it, the real problem is the one of non-involvement of the board in the affairs of the companies. No wonderthen that it is the CEO or the promoters who choose the directorsand get them elected, not because of their knowledge specific to thecompany, but because of their ‘compatibility’.

As against this, today’s market economy elsewhere is strongly workingtowards fixing of the problem of ‘governance’ by inducting moreindependent directors on board. With the enactment of the Sarbanes-Oxley Act of 2002, the erstwhile near monarchical status of CEOswithin the corporations is getting rattled, and for good. With increasednumber of independent directors on the boards, they are flexing theirmuscles to assert their right to democratize the corporations, wherehitherto the writ of the CEO alone ran unquestioned. In the recentpast, boards in the US sought the ouster of even such legendary CEOsas Michael Eisner of Walt Disney and Maurice Greenberg of AIG—an act which was unthinkable even a couple of years ago. Now thequestion is, can Indian boards ever emulate such assertion?

The trend is perhaps catching up with us too—at least indiscussions, if not in actions. Today, lenders and investors who havebecome global, are looking for less ‘governance risks’. Indeed, withthe increased capital inflows into our stock markets, we too havebecome conscious of the need for good governance. The regulatorshave appointed committees to suggest a suitable template of governancethat matches with the best practices elsewhere. The need forindependent directors who could ask critical questions, throw in newperspectives in risk management and business strategy andmetamorphose board meetings into brain-storming sessions that addvalue to the companies is multiplying. In fact, it is common knowledgethat good corporate governance ensures better ratings, higher growthand higher valuations for a company. Perhaps, prompted by theserequirements, Sebi has recently directed exchanges to amend the listingagreement with the revised Clause 49.

323Clause 49: A step towards ‘good governance’

According to the clause, companies where the chairman of theboard is a non-executive director must ensure that at least one-third ofits board comprises independent directors, and in case he is an executivedirector, at least half the board should comprise independent directors.But the problem is that whenever ethics and consensus are sought tobe enforced by law, that too in businesses, it will be followed just asother laws are followed to the letter and not in the spirit. And obviously,the compliance could be only to the extent to which one could getaway with. So, the first compliance from the corporate world with theamended Clause 49 is the request for deferring its implementationunder the plea that “we do not have the requisite reservoir of independentdirectors”. True to our tradition, the regulators have deferred theimplementation and the obvious victim is ‘governance’.

The whole episode compels us to recall what ChhandogyaUpanishad (1.1.10) ordains us: Yadeva Vidyaya Karoti,/ Sraddhaya,Upanisada,/tadeva Viryavattaram Bhavati (whatever work is donewith knowledge,/Through faith and backed by meditation,/that alonebecomes most effective). The stanza states that Vidya—knowledge ofwork, the theoretical and conceptual clarity of subject—is theprimordial requirement for efficiency in work.

Knowledge sans Sraddha—faith, remains static, remains as a merepossession. Sraddha evinced by the seeker alone energizes Vidya andensures its transformation into Karma, i.e., action. Swami Vivekanandaonce said, “What makes the difference between man and man is thedifference in this Sraddha and nothing else. He who thinks himselfweak, will become weak.” Sraddha simply generates the ‘belief’; andbelief in one’s knowledge-power alone makes things happen. “SraddhaSraddhamayoyam purso yo yat Sraddha na eva sah”—(whatever bethe measure of his Sraddha, that will be the measure of his life aswell), says the Gita. Therefore, one needs to acquire Sraddha—deepfaith in the self, so that one may develop into a dynamic character.


Knowledge can be imparted but no training can impart Sraddha.Sraddha has to be captured by oneself. Sraddha is more of a spiritualvalue. It moves a man from within. It is simply a reflection of therichness of the personality of the Board of Director or a simple worker.It imparts an artistic quality to one’s life and work. Faith in oneself, inthe divine within, is the greatest source of enrichment of a personality.Such a person works out of the fullness of one’s heart.

This Sraddha (faith) however, needs to be properly channelised.Upanishad (calm meditation) helps in properly directing anddisciplining one’s knowledge. It makes one’s actions meaningful,Sarvopakari (good for everyone). This flow of energy from faith, Sraddhathrough knowledge, Vidya to Karma is the basis of efficiency. But thisflow is prone to suffer shutdowns due to the ups and downs in theemotional life of the worker. Inner disintegration or want of integrationresults in outer disorganization. This automatically lowers the efficiency.Upanishad helps in arresting these disturbances. Meditation gathersthe mind into itself. When the mind takes leave of the body, thought isthe best. Upanishad fortifies the worker and his work. That fortificationspreads fearlessness, love and peace all round. It simply unites‘philanthropic efficiency with philosophic calm’. That alone makes the‘governance’ a Sarvahit (omni-benevolence).

A ‘governance’ that is driven by these values of Vidya, Sraddhaand Upanishad can simply excel in its effect, efficiency andacceptability. It otherwise means that before accepting a responsibility,we need to question ourselves if we have these qualities, otherwise,we should not. This personal longing for ‘deserving a desire’ aloneensures ethical conduct in any walk of life. It alone can result in‘good governance’, even better than by law.

What a blessed insight! But, are there any takers?

——)0——

325India Pharma Inc.: What is in store?

It is heartening to note that in the recent past, our pharmaceutical companies are trying to assert their presence in the global markets.

Quite a few Indian pharma companies have made overseas acquisitions:Wockhardt acquired CP Pharmaceuticals in the UK; Ranbaxy acquiredRPG Aventis in France; and Zydus Cadila has finalized its acquisitionplans for acquiring Alpharma SAS of France, etc. On the other hand,we also see many major pharma multinationals looking at India forstriking profitable partnerships with Indian companies in researchand drug development. As we inch forward towards post-WTO (WorldTrade Organization) scenario, it is feared that many drastic changesare likely to occur.

Ernst & Young, in its Global Pharma Report 2004, observed that“Indian pharma companies topped drug filings with USFDA for2003.” We have filed a total of 126 DMFs, accounting for 20% of alldrugs coming into the US market. This phenomenal accomplishment

March 2005.

SEVENTY TWO

India Pharma Inc.:What is in store?

Today’s success cannot guarantee tomorrow’sperformance unless the pharma industry wakes upto the emerging demands and reconfigures itself atthe earliest.


of Indian companies made several MNCs to recognize the capabilitiesof Indian firms in the ‘process chemistry’ and compelled them tomove close to India for their bulk requirements. Many of them havealready outsourced their manufacturing – that, too, of complex anddifficult to make molecules to Indian companies.

The mindset of Indian pharma industry has in the recent past changeddrastically. Encouraged by the approval accorded by the US FDA forIndian manufacturing facilities, drug majors have been looking at globalmarkets backed by cutting edge technology and cost-effective excellencein drug manufacturing. However, post-2005, domestic drug majorswill be facing great challenges from product patent regulations as theresearch and development facilities owned by these companies areinsignificant vis-à-vis those of the multinationals. The drug discoveryand development being a very expensive preposition, it is only themajor multinationals who are in this business for a long time andprocess formidable size, scale and experience at their command, thatare going to rule the roost in the future.

In such an emerging scenario, research and development will bethe backbone of the growth. This obviously calls for huge investmentsin R&D. But none of our existing players is in a position to makesuch huge investments. Even our major players cannot do much inthis area as they are constrained by lack of investment capabilities.There is however, a ray of hope: the success in discovery of newdrugs need not necessarily be associated with ‘bigness’ of theorganization. Indian chemists are well known for their researchcapabilities. They are occupying leading positions in global researchcenters of various multinational pharma companies. Although theyare working outside India, their knowledge could still be tapped bythe domestic pharma companies provided they know how to accessand harness such knowledge. It is the entrepreneurship of domesticfirms and the speed with which they address the issue of discovering


new drugs that defines their success. As a part of this new game plan,Indian companies must strive to strike collaboration among the majordomestic players, particularly in areas of research and developmentof new drugs as it enables them to fill the gaps in individual company’sstrategies with speed and in a cost effective manner.

In the intervening period, to sustain their growth, domestic firmsmay have to position themselves as leading bulk drug and genericplayers. Many of them have to mold themselves into specialized playersoffering customized pharmaceutical services to global players such as‘contract research’; ‘custom chemical syntheses’; ‘clinical researchtrails’, etc. Such an involvement not only generates and sustainscash flows during the transition but also offers them enoughexperience that is necessary to build their own competencies to discovernew drugs and compete on equal terms in the global markets.

The spread of ‘convergence’ across various sectors in the recentpast has only intensified the need for partnerships and alliances inmanufacturing industries too. The rising global competition, andthe resulting downsizing have only intensified the necessisity forcollaborative arrangements. Hamel, Doz & Prahalad have prescribed‘Collaboration’ for improving a firm’s competitive profile since itstrengthens both the companies against outsiders and creates valuefor them as ‘leader, rule setter, and capability builder’.

Collaboration is indeed competition but in a different form.Collaborating parties enter alliances with clear strategic objectives.They understand well how partners’ objectives will affect their success.Learning from partners is of paramount importance: they need toview each alliance as a window on their partners’ broad capabilities;use the alliance to build skills in areas outside the formal agreementand systematically diffuse new knowledge throughout theirorganization. Harmony is however not the most important measure


of success: occasional conflict may be the best evidence of mutuallybeneficial collaboration; few alliances remain as win-win undertakingsforever; a partner may be content even as it unknowingly surrenderscore skills or one may pursue independent path once it built upcompetency to sustain on its own in the market.

Of course, collaboration has its own limitations: it must bedefended against competitive compromise; involves a constantlyevolving bargain; must keep employees at all levels well informedabout what skills and technologies are off-limits to the partner andmonitor what the partner requests and receives. Collaboration is wellsuited for activities such as new product development; improving aproduct design for manufacturability using competencies withinsupply chain network; reducing time to market for new productintroduction; reducing the manufacturing cycle time for designatedpartners; improving logistics costs across supply chain network, etc.Managing and improving time and capital involvement to developand bring a new product on to the shelf is a critical constituent ofpharmaceutical industry, and it is to overcome these hurdles‘collaboration’ among the competing businesses comes quite handy.

Post-WTO, our pharma industry will witness a tough competitionfrom multinationals in offering new drugs to consumers. Thisobviously demand thorough professionals to man diverse operationssuch as research, development of new drugs, conducting clinical trials,their synthesis through complex processes, and marketing – all callfor thorough professionalism. This can only be ensured by hiringright pharmaceutical researchers with sound professionalqualifications. Even that is not enough – they need to be constantlyretrained to keep them abreast with current developments in theindustry. It is only such thorough professionalism and its constantupgradation that can sustain competency in the organization.


Secondly, to stay ahead in the competition pharma companiesmust inspire its professionals to innovate – to innovate new processesfor cost effective manufacturing of existing drugs, innovate newmolecules, new drugs, etc. In fact, innovation should become thevery culture of the organization. But innovation calls for many things:finance, professional education, training, retraining and anorganizational environment that nurtures innovation. Innovationflourishes in organizations only when funds are plentiful and areliberally available. Along with plentiful funds, there must also beavailability of professionals who had the backing of requisite education,intelligence and zeal to innovate. It makes great sense for the industryto enter into collaboration agreement with some of the nation’s leadingeducational institutes for offering courses in pharmacy, chemicalengineering and biotechnology with a curriculum that best caters tothe current as well as prospective demands of the industry. Similarly,they may even strike collaborative agreements with universitylaboratories for undertaking drug discovery related research.

No doubt, Indian pharma industry has come of age, but post-WTO it will find it difficult to maintain profit margins, unless theyinvent new drugs for which they have to gear up. There is no time;they have to literally gallop!

——)0——


“A courageous and wise statesman who put India on the path of reform” is what PV – Pamulaparti Venkata Narasimha Rao

– was in the words of Lee Hsien Loong, the Prime Minister ofSingapore. For Goh Chok Tong, the former Prime Minister ofSingapore, Rao was “an international statesman, a quiet but visionaryleader of India” and “India is blooming today because of the foundationhe laid”. In the words of Rao himself, as stated in his book, TheInsider, he “climbed ladders and more ladders… feeling all the whilethat he was on level ground… from patvari to Prime Minister: Along journey from a small Indian village to the capital with nocelebration at any stage”. And thus remained “a modest man”, maybe consciously believing that he “has much to be modest about.”

It is destiny that he, a semi-retired politician, was all of a suddencatapulted to the PM’s seat as well as made the president of the

February 2005.

SEVENTY THREE

PV: The prime minister who“empowered” his colleagues

to dissent

A leader’s strength reflects more in his ability toabsorb the critics and march forward than insilencing them under the threat of power.

331PV: The prime minister who “empowered” his colleagues...

Congress Party by the power centres led by Sonia Gandhi, of coursenot without a reason: His sobriety and the perceived “no threat” fromhim to the people who were already in commanding positions. Oncein the saddle, he proved to be a great commander having a soundgrip on the task of steering the country through turbulent times,despite inheriting a nation that was facing great threats frominsurgents in Punjab and Jammu & Kashmir and which, economically,was on the brink of bankruptcy.

As Deng Xiaoping steered China away from the Maoist policies tomarket economy during the early 1980s, Rao mustered courage to gentlypush India away from Nehruvian economics to a path of liberalizationthat freed India from the shackles of socialist ideology-driven ‘inward-looking’ growth path. The reform process that was launched underhim made far-reaching changes: Foreign trade, foreign investment andexchange rate regimes were all redefined. The financial sector wastotally overhauled. Of all these reforms, the devaluation of the rupeeand the shift in the very exchange rate regime were the fundamentalones, which could not have been achieved but for the wholeheartedsupport from Rao. In the words of C Rangarajan, the then Governorof Reserve Bank of India, Rao stood solidly behind the Finance Ministerextending all political support needed for putting India on the righteconomic course. As the ex-Governor observed, he was not a reluctantreformer although he didn’t sound that enthusiastic while thesepath-breaking reforms were successfully executed.

He did just what he was supposed to do—watching theirimplementation from a distance without poking his nose, simply as anelderly statesman. Unlike the common ilk of politicians, he didn’t maketoo much noise in implementing these reforms attracting the otherwiseavoidable resentment from the staunch followers of the erstwhile regime.He had thrown open the door to Foreign Institutional Investors toinvest in Indian capital markets and Foreign Direct Investments in


many sectors despite strong opposition from powerful industrial housesto such initiatives. The Colas and the likes of IBM who had beenbanished from India earlier were welcomed back. Being fully convincedhimself about the need for fundamental economic changes, he stoodlike a rock behind the various reforms that were launched and executed.

Rao reformed the country in such a way that he could finallyreconfigure the “Hindu growth rate” and, to the surprise of everybody,leapfrogged GDP to 8% plus. He accomplished all this in a prettysubdued way, and yet, lost his job. To quote him: “I lost one job tryingto implement a socialistic program” (Chief Ministership of AndhraPradesh while implementing land reforms in the early 1970s) and “asif to balance it, I have also lost another job trying to liberalize what hadtended to become insensitive somehow after the socialist process, thoughnot because of it,” and that was the irony which even statesmen of yorecould not escape from.

This side of PV’s personality is well-known to everyone for thatwas what often prized in public or private. But what our youngergeneration, which is attempting to whisk out of the colonialmoorings, should know about PV is the “other side” of him whichis unfortunately spoken of less, be it in public or private. To appreciateit better, let us first take a look at what the Congress party is knownas, or for that matter, the predominant tilt we as Indians have towards“mai-baap” culture, where everyone is afraid to air his feelings freely.While intervening in the debate on the resolution moved by MorarjiDesai on purity and strengthening the organization at the CongressSubjects Committee meeting at Satyamurty Nagar, Avadi on January20, 1955, and the suggestion by Algurai Shastri that the resolutionshould not publicize the malpractices that had crept into theCongress since self-criticism in public simply would put the nooseround the necks of Congressmen which other people might use todrag them with, Nehru said: “I have been president of the Congress

333PV: The prime minister who “empowered” his colleagues...

and I know from personal experience that there is a lot of impurityin the Congress and even some of the biggest Congressmen are aparty to it. Why should we hide these things? Are we to live behindpurdah and wear a veil? Algurai Shastri has himself talked to meseveral times about these impure trends in the Congress andexpressed his regret about them. If any member wants to suggest anamendment to the resolution, by all means he can do it, but wemust face our weaknesses and drawbacks and the impure trends thathave crept in, truthfully and honestly.”

No one would perhaps disagree if I said that Nehru’s lamentationremained all along a distant dream, till at least PV landed on thePrime Ministerial gaddi. It is not known if it was to compensate forhis act of nudging India away from Nehruvian economic policies thatRao wanted to push the Congressmen gently towards what Nehrudesired to happen, but he did grant allowances to his detractors to airtheir feelings, views contrary to the party’s stance and, for that matter,even criticize the leadership without fear and hang-ups. Else, theTiwaris, Singhs, et al., would not have had the courage to openlyquestion the wisdom of Rao or criticize his acts from public platforms.PV’s grace simply radiates from the fact of his maintaining silenceover such criticisms. We, however, do not know if this empoweringof his colleagues to freely air their opinions which could be quiteembarrassing to the power centres and maintaining stoic silence overthem was by design, believing in Machiavelli’s principles: “Scornand abuse arouse hatred against those who indulge in them withoutbringing them any advantage” and “Prudent Princes and Republicsshould be content with victory, for, when they are not content withit, they usually lose”, or by default. Nevertheless, he did reform themindset of Indians. He simply emboldened the people to questionthe “authority” and seek answers. Whether this reform has takenroots as firmly as the economic reforms or not is a different question.


What matters here is, a beginning had been made and Rao walkedaway with that credit. As though a testimony to that grand beginningof Rao, we witness today even the executives of public enterprisesairing their candid opinions, though contrary to the establishedpositions, on national issues. We must salute Rao for watering Nehru’slongings to germinate at least after 40 years. And that is whatmetamorphosed PV, a politician, into a “wise statesman”.

——)0——

335“Our ‘quarrels’ are ours, their ends none of our own”

Curtains were raised. Act I began. The King entered the stage and stated: “There are ‘ownership issues’ but they are in private

domain. Since Reliance is a professionally well managed company noone, two or three individuals including myself can make any differenceto Reliance,” said Mukesh. Act II: On return from the US, MukeshAmbani, the Chairman and Managing Director of Reliance IndustriesLimited, clarified that what he had said earlier had been taken out ofcontext and thus wrongly interpreted. According to him, what heactually meant was that ownership issues are only “future-initiatives-centric” and had little to do with the existing units since Dhirubhaihad settled them before his journey to the heavenly abode. He furtherasserted his authority over the group by mailing the message to groupemployees: “There is no ambiguity in his (Dhirubhai’s) legacy that theCMD (Mukesh) is the final authority on all matters concerning RIL”.In between these two acts, the poor audience had the trauma of theirlifetime: There was a hectic day of frenzied selling of Reliance Group’sshares in the stock market. On a single day of trading, RIL lost 3.4% of

January 2005.

SEVENTY FOUR

“Our ‘quarrels’ are ours, theirends none of our own”

Even one is enough to build world-class assets but twoare a must for any quarrel.


its price; Reliance Energy fell by 1.2% and Reliance Capital by 5.9%.Act III: Anil Ambani’s (Vice-Chairman and Managing Director ofReliance Industries) e-mail sent to the Chairman and ManagingDirector (his elder brother) of RIL informing him about his “firmview that RIL should abide by the highest standards of corporategovernance, and this should first be reflected at the proceedings of ourboard of directors” has been made public.

The current battle Royal (Reliance!) is not confined to the twobrothers but involves a bigger cast—ambitious advisers and spindoctors, battling bahus and a mother struggling to bring togetherher two sons to make them see reason. Interestingly, after the deathof Dhirubhai Ambani, Mukesh said: “Anil is like my son”. How sadit is today to see that relationship being driven as though by intrigueand visceral hatred! The evolving rivalry between the brothers, dulyaccompanied by a host of advisers on either side, is drawing us closerto Shakespearean drama: “Friends now fast sworn,/Whose doublebosoms seem to wear one heart… Break out/To bitter enmity”. Allthis smell of lingering dispute over ownership between the brothersis bound to impact the performance of RIL. Reliance is India’s biggestprivate sector enterprise. It is the very embodiment of the confidenceof Indian industry. It has all along reflected a spirit of “can do” amidstan otherwise sulking Indian entrepreneurship. Being dynamic, it hadso far tasted only success. And any feud between the brothers is notconfined to Reliance alone: It simply impacts the very future of Indianstock market and also affects a major chunk of government revenues,besides the fate of around 80,000 employees and their families. Thoughtheir quarrel is their own, its ends are not just theirs; it pervades abigger canvas. The fall-out of the quarrel is bound to shake the veryfaith of investing public in family businesses of India.

The IPO market is almost dead except for a couple of issues in therecent past. The recent annual report of the Reserve Bank of India

337“Our ‘quarrels’ are ours, their ends none of our own”

brings out another alarming feature to light: Investment of householdsavings in shares and debentures has slid to 1.4% of total savings in2003-04 from 7.7% recorded in 1999-2000. It is quite intriguing tonote such a fall even when the interest rate scenario in the countryhas not been that encouraging for the last two years. Universally, it isbelieved that when bond rates are low, investments largely move intostock markets. Contrary to this generally held belief, retail investorsin the country are shying away from the stock market. The reasonsare of course not far to seek: Frequent scams in the stock market,price manipulation by vested interests, poor corporate governance,pursuit of personal agenda of promoters at the cost of company, etc.,have become some of the common experiences of retail investors.The survey carried out by the Society for Capital Market Researchand Development during 2002 revealed that almost 40% of the sampleinvestors cited volatility and price manipulation as the most disturbingphenomenon of the Indian stock market. As against these groundrealities, a healthy capital market craves for a large number of individualinvestors with active participation since that alone can facilitate betterprice discovery. Secondly, active participation of retail investors instock market operations can act as a counterweight for institutionalinvestors such as FIIs, who are known to swing the market in tandemwith their desires.

Given such a scenario in India, feuds of Reliance’s nature are theleast expected. It is time Indian businesses and their leaders bore inmind and be guided by what Shakespeare made the player-king inHamlet say: “Our thoughts are ours, their ends none of our own.”“Ends” are the real issues of thoughts that human beings entertain.While pursuing their ideas, people often unwittingly tend to strikeinto the existing order of things. As seen in many of the Shakespeareantragedies, people in search of power become pawns to the designs ofothers and fight blindly in the dark. They act freely, but in the endget tied down to its consequences irrespective of their thoughts being


noble or ignoble. Lady Macbeth, driven by the courage and force ofwill, fancied that she can “dash the brains out” from even a sucklingbaby, finally finds herself hounded to death by the smell of a stranger’sblood. Othello, being driven crazy by “motiveless” malignity of ascheming friend, and assuming that he is executing solemn justice,strangles love. Brutus, in the interest of his country, felt right inasking for Caesar’s life, but engineers misery to his country and deathto himself. To gain the crown, Macbeth killed the king whom herevered so much till then, and finds that the crown had only broughthim all the horrors of life. In this tragic world, man’s thought,translated into act, often finds itself transformed into the opposite.Whatever one may dream of doing, one finally achieves the oppositeof what one yearns for. All this may suggest that men are helpless.But, that is not true, since man is often found to be the cause of hisown undoing. That is what is to be essentially remembered here: It isthe human action that becomes the ultimate cause of the catastrophe.And this critical action is quite often found to be bad or wrong.These thoughts are worth being meditated upon by every leader ofpublic or private governance.

Coming back to Reliance, it must be stated that after a point,Dhirubhai certainly did not work for amassing wealth, but to actualizehis potential— potential to build world-class assets in a country thatis plagued with all sorts of constraints. He built the assets simply tobuild them. How could his progeny be different then? Wouldsomebody please tell the warring brothers that their feud is makingReliance fall apart – fall apart not only that which had been built soassiduously by Dhirubhai, of course, in association with four otherhands, but also the newfound “can-do” spirit among the buddingentrepreneurs of India?

——)0——

339Thank you, Anil Ambani!

Ever since civilization dawned, words like “governance” and“government” have been engaging the best of minds in the

world. History’s greatest personalities like Kautilya, Aristotle, andConfucius have eloquently theorized “governance” and “government”but all that appeared to have been lost in oblivion till at last theWorld Bank evinced an interest in “governance”. During the early1980s, of course, in its frustration about handling the problemsassociated with the execution of projects financed by it in Africancountries, the World Bank revived “governance” by defining it asnothing but “exercising of political power—a kind of power that solidlyrests on a strong legal foundation, maintenance of a non-distortionarypolicy environment with macroeconomic stability, investment in basicsocial services and infrastructure, protecting the vulnerable, andprotecting the environment to manage a nation’s affairs.”

Over a period of time, this convergence of mega trends inadministration brought out by the World Bank began to take shapeas the form of governance which envisages participation of all thosewho have a stake in decision-making, transparency in whatever isdone, accountability for every action undertaken, and an appreciation

December 2004.

SEVENTY FIVE

Thank you, Anil Ambani!

At times, quarrels too prove to be beneficial, at leastfor the rest at large.


of human rights. However, with the advent of globalization, the debateinitiated by the World Bank has slowly become the catchword of thecorporate world, not because of their love for “participation”,“transparency”, “accountability”, or “human rights” but because ofissues specifically relating to the economic aspect of governance thathave come to the fore.

This debate got further accentuated in the western corporate worldwith the submission of Cadbury Committee recommendations. Thecommittee was constituted in the UK in 1991 to address and reportthe financial aspects of corporate governance by the FinancialReporting Council and London Stock Exchange. The committeemade far-reaching recommendations and as a result corporate governancehas become much broader to include fair, efficient and transparentadministration to achieve certain well-defined objectives. Over a period,it has become synonymous with a system of structuring, operating andcontrolling a company in such a way that it can achieve long-termstrategic goals that satisfy shareholders, creditors, employees, customersand suppliers while complying with the legal and regulatory requirementsand caring for environmental and local community needs.

Today, corporate governance simply means making a corporateboth a powerful economic entity and an important social institutionthat uses its economic power to add value to society generally, and topeople’s lives individually. It simply ordains an open decision-makingprocess involving boards and shareholders as that alone can result instability besides lessening the likelihood of convulsive decisions andcontentious changes. It is strongly believed that such an approach todecision-making will create healthier, more self-renewing and moreflexible corporations. This new moral contract between the corporate,the individual and the society is basically aimed at transformingcorporates into value-creating institutions.


That was the story of “corporate governance” and its evolution.India too had its own share of committees drafting corporate governanceguidelines and its own moves for adopting it across the corporate world.That is perhaps what Anil Ambani, in his letter of November 27,attempted to remind his brother— Mukesh Ambani, Chairman andManaging Director of Reliance Industries, the flagship company ofthe group whose collective shareholder wealth is estimated to be inexcess of Rs.85, 000 cr—by saying: “It is my firm view that RIL shouldabide by the highest standards of corporate governance, and this shouldfirst be reflected at the proceedings of our board of directors.”

To better appreciate these cravings of the younger Ambani forcorporate governance, let us begin at the beginning. It is reportedthat Ambanis hold around 46% of equity in Reliance Industries whichin turn holds around 45% in Reliance Infocomm, around 35.5% inReliance Energy and a similar holding pattern in other subsidiarieslike Reliance Capital and Reliance Infrastructure. However, the directholding of the brothers in RIL is reported to be hardly 5.13%, whilethe family-managed Petroleum Trust holds another 7.5%. The rest isreported to be held by a motley of investment companies. Andintriguingly, the market knows little about the ownership of theseinvestment companies. But one thing is certain: Whoever controlsthese investment companies would automatically own RelianceIndustries. So, the million-dollar question is: Who is it that had hishand securely on these investments/front-companies? That aside, whatis shocking to note here is that even after a decade of market reformswe are still to come out of our old habits. This incidentally remindsus of a pathetic admission of ignorance by a former cabinet minister,made a couple of months back, about the ownership of a companythat operates in the Indian skies. And, that is perhaps what“transparency” meant for India Inc.


That is only the tip of the iceberg: Even a cursory glance at Anil’sletter throws more light on how our boards govern the affairs of acompany. To quote Anil fully, he said that “Item No.17 (of agenda ofBoard meeting dated July 27, 2004) was introduced as a supplementaryagenda without my (Anil Ambani’s—VC&MD of RIL) knowledgeand/or consent, and keeping me completely in the dark. He said:“This is contrary to all past practice, whereby supplementary agendaitems, like the main agenda, have always been pre-circulated,pre-discussed and pre-agreed between the two managing directors,before any board meeting. This is all the more surprising, as I havesubsequently learnt that some of the other RIL directors, and severalRIL employees, had been taken into confidence on the supplementaryagenda, and the contents and objectives of the same, while I, asVC&MD, was not even informed of the same!”

He goes on to say, “The clubbing together of a very substantiveproposal on redefinition of the powers of the managing directors,etc., with this unrelated subject of the HSE committee, obscured thereal purpose of the agenda item, and prevented a proper appreciationof the consequences thereof. Specifically, the proposed redefinitionof powers of the managing directors reflected a substantial and materialvariation of the equation as has existed in RIL for the past more thantwo decades, and this clearly required intensive discussion andconsideration of the board of directors, based on full facts andcircumstances being presented to the board. None of this hashappened. The incorrectness of the minutes is evident from the factthat even I am supposed to have voted in favour of the proposedresolution. Clearly, I, as VC and MD, would not vote for theprejudicial variation of my existing authorities and powers!”

That is how, if Anil is to be believed, our boards function. Theyare quite often found not doing what they are supposed to do anddoing what they are not supposed to do. All that corporate governance


asks for is that “nothing important is missed and nothing trivialincluded” in the board agenda and the directors appreciating theirdual role—the role of respecting the gravity of issues put forward bythe management and deliberating upon them with sraddha andrequisite jnana of the issues and discharging their responsibilitiestowards the company’s shareholders and creditors by taking “non-convulsive” decisions that ensure healthy sustenance of the company.It is only a governance that is driven by the values of vidya, sraddhaand upanishad that can excel in its effect, efficiency and acceptabilitybesides being sarvopakari—good for everyone.

As against this, what has been quoted by Anil Ambani is only anantithesis of corporate governance. If this is the plight of a Fortune500 company which is also considered as one of the best managedcorporate institutions in India, one can as well visualize what scantregard we Indians have for corporate governance. In this context, theinvesting public of India must thank Anil Ambani for having made the“sordid governance” public and thereby sensitizing everyone for agovernance, that is, as quoted in Chhandogya Upanishad, sarvopakari.

——)0——


Remember childhood? The time when you were crazy about getting a Camlin watercolours box, the agonizing negotiations,

the deals and counter deals, perceived and real that you had withyour dad or mum and the accompanying trauma for its acquisition?And how special you felt once you pocketed it? Any parallel with therecent acquisition of L&T’s cement division by Grasim?

Whatever may be the twists and turns that Grasim and L&T’sdeal had undergone, its ultimate success had certainly signified thecentrality of the “art of negotiation” in today’s inorganic growth ofcorporates. It is not that corporate executives are not aware of thebasic tenets of negotiation: Many a time, even experienced negotiatorsend up in a deadlock as it initially happened in the Grasim case,damaging relationships and in the process allow conflicts to spiral,leaving sour feelings among even those who are in no way directlyrelated with the deal. However adept the executives may be atnegotiation, they often fall prey to petty mistakes, observes James KSebenius. A sense of awareness about one’s propensity to fall prey tosuch mistakes is therefore essential for every corporate negotiator.

August 2003.

SEVENTY SIX

Solving negotiation problems

Every exchange calls for a payment and everypayment demands a fair exchange.

345Solving negotiation problems

Let us now take a look at the basic tenets of negotiation. It is aprocess involving two or more people of either equal or unequal powermeeting to discuss shared and/or opposed interests in relation to aparticular area of mutual concern. It is essentially a process of comingto terms with and, in so doing, getting the best deal possible. It involvesfour steps: Determining objectives of negotiation; preparing for thenegotiation; conducting the negotiation, and reviewing thenegotiation. All these four steps are in turn influenced by thesituational as well as institutional views as applicable to the issueunder negotiation. It is very essential to get at least the institutionalviews under these heads clearly articulated before going to thenegotiating table.

Such a prior articulation makes it abundantly clear as to whatcould be expected from the negotiation process and to that extent itpaves a smooth way for its ‘success’. True, in any negotiation, eachparty can ultimately choose only one option from the available two:accepting the deal or staying put with the best no-deal option, i.e.,the course of action it would have taken had there been no ‘deal’.Despite this hard reality, every negotiator tends to advance his or herfull set of interests. Indeed, he or she would persuade the other partyto say ‘yes’ to a proposal that best fits into his scheme of things betterthan the best no-deal option does.

Now the moot question is “why should the other party say yes?” Itis often forgotten at the negotiating table that the ‘best’ one partywants to have has to come from the other party who, incidentally,besides controlling it, had different ‘wants’ of his own. It is thus self-evident that every negotiating executive must not only review hisown wants and expectations from the other side but also understandwhat the other side wants to have from the deal, for in it lies the keyto create and sustain the ‘value outcome’ from a negotiation. Hence,the pursuit of one’s own ‘best-fit’ from a negotiation is a blunder.


Sebenius further observes that even experienced negotiators makesix common mistakes: Neglecting the other side’s problem, lettingthe price bulldoze other interests, letting the positions drive outinterests, searching too hard for the common ground, neglectingBATNAs, and failing to correct the skewed vision that keeps themaway from the solution to the problem.

Amongst these, “neglecting the other side’s problem” is the mostcritical. At the least, one should understand the problem from theother side’s perspective, since that makes it easy to work out a solutionfor the other side’s problem as a means of solving one’s own problem.But, social psychologists point out that it is very difficult for mostpeople to understand the other side’s perspective. Sometimes, thenegotiators may see the other side’s concerns and yet dismiss them as‘their’ problem. They say, “let them handle their problem, while welook after our own problems”. This ‘self-centred tendency’ will alwaysundercut the ability of the negotiator to effectively influence how thecounterpart sees its problem. If one wants to change the mind of theother party, one should first know where his mind is. One can thentry to build the bridge to cross over the gulf between where thecounterpart is right now and his desired end point. Such a movealone makes sense and contributes to the success of a negotiationthan trying to jostle the other side from where he is to where youwant him to be.

No matter whether you are a kid or a seasoned negotiator fromGrasim or any other corporate, to succeed in a negotiation, knowingwhat the other party wants to have from the deal, though not easy, isa must. And if you want to have more of ‘something’, you must beprepared to sacrifice more ‘elsewhere’.

——)0——

347‘Self-regulation’, the obvious panacea…

Is our world capricious, arbitrary, unpredictable, irrepressibly mad?“No”, not necessarily, but it is certainly a complex one. Its

complexity is all due to its connectedness. It is this connectednessthat makes prediction so difficult. Greater the connectedness, widerthe spread of ‘cause-and-effect’ relationship over both space and timeand lesser is its predictability. This gets further complicated sincepeople endowed with multiple, different, competing, or simply vagueobjectives are intrinsically part of all these events.

But, if you pose the question of ‘unpredictability’ to stock marketpundits, they will simply chuckle at you and of course they have areason too. They posit that ‘financial transparency,’ which meanstimely, meaningful and reliable disclosure about a company’s financialperformance, enables investors to make informed investment decisions.To put it differently, the availability of reliable information about theperformance of a company makes prediction of its market price feasible.

November 2002.

SEVENTY SEVEN

‘Self-regulation’, the obviouspanacea…

Exogenous rules are only complied with whileendogenous rules are simply lived.


Stock market pundits have yet another theory to gloat about – the‘Theory of market efficiency’ which, in the words of Fama, means“a market where there are a large number of rational profit maximizersactively competing, with each trying to predict future market valuesof individual securities, and where important current information isalmost freely available to all participants.”

This definition has two critical components: One—“a largenumber of rational profit maximizers” and two—“availability ofimportant current information almost freely to all participants”. It isthe availability of important current information to every participantthat enables evaluation of a stock’s intrinsic value, where intrinsicvalue is defined as the present value of all the cash flows shareholdersexpect to receive, with the expectation of these cash flows being formedon the basis of all the available information, and thereby predict itsmarket price. This hypothesis begs a very critical and pertinent question:What is the level and quality of information needed for such predictionand against which, what is available to the ordinary investor today?To be honest, the answer is very obvious, particularly in the light ofwhat has happened at Enron and the mind-numbing frauds and scandalsthat are of late pouring out of the western corporate world.

The studies carried out by Prof. Leuz, Prof. Dhananjay Nandaand Prof. Peter Wysocki of Wharton Business school, Fuqua Schoolof Business and Sloan School of Management respectively, revealthat many more firms outside the US suffer from accountingirregularities and minority shareholders are reported to be always atthe receiving end in many of these countries. “Earnings management”and “number manipulation” are reported to be common in Europeancountries like Austria, Italy, Germany, and South-East Asian countrieslike South Korea and Taiwan.

All this means, existence of asymmetry of information in more thanone way. First whatever information being made available to the public

349‘Self-regulation’, the obvious panacea…

is what the owner or CEO of a company felt right to communicatewith the rest of the world and, secondly, whatever is being made availableneed not necessarily be always true, as was witnessed in the recent past.

Worse yet, the question is not so much “Why asymmetry ofinformation?”, it is more like “why the hell all those concerned didn’tdo something to correct it?” If that is what is happening, is it not theduty of the directors and auditors to muster courage and confidenceto ask for explanations or express dissent? The directors or auditorscannot simply delegate the clarity of disclosure to the managementdown the line and wash of their hands. It is that simple, yet it appearsto have been forgotten quite often.

It is also not uncommon for many to lament at a naïve question:“How to figure out what is going on inside an executive’s head”?The answer is simple: “No way”. No regulation on earth can hackthe mind of the owner of a company and read it, nor can it regulatea CEO’s thinking. It is perhaps an eternal chasm that no oneshareholder exactly knows what a company is up to better than itsowners and examples are plenty—no one, for that matter even itsbiggest shareholder, the Government of India, knew what Tatasintended to do with the cash reserves of VSNL till they announcedtheir plans for investing it in Tata Tele Services. And so only the jobof the Board of Directors and Auditors assumes greater significance.They must raise their hands and demand an explanation for thingsthey did not understand. They should exhibit courage to go beneaththe rules and unearth the truth to ensure transparency.

So, what is needed now is not regulation to punish the erringCEOs, but to determine how to get more transparency—a transparencythat is true but not overloading an investor with more data. Thisbecomes feasible, if only the corporate sector feels responsible andaccountable. Companies should cultivate the habit of disclosing right


information. They should regulate themselves, for no amount ofoutside regulation is capable of honing one’s ethical practices.

In this context, CEOs, being privy to inside information, have apivotal role in accomplishing honest disclosure. True, sometimes,their wants and desires to succeed and produce the best price fortheir company’s ‘issue’ or ‘profit margin’ get in the way of their ethicalstanding. Secondly, they are likely to be challenged by the question“Why the hell should I be an honest disclosurer, while I am not sureof what others are up to?” Despite such temptations, they must notget carried away by their own “take-homes”, instead exhibit self-regulation and abide by the need for fair transparency, lest “Whatelse in the long run can maintain the‘homoeostasis’ of the market—a market that is a pretty open system where a tinkering ‘here’ is likelyto pop up as a problem ‘elsewhere’?”

Of course, so long as the investors, as in India, remain passiveand are content with whatever is doled out to them by themanagements, the question of “Market-punishment” may not arise atall, and the managements will jolly well carry on with their presentsoppy “governance.”

——)0——

351“Silence of lambs”…

It is often said that money is at the centre of problems. And throughout the recorded history of mankind, many were

confounded with its insufficiency. Its perpetual insufficiency is vyingfor the “mind-share” of everyone—right from ministers to mutual fundmanagers, CEOs of corporates to ordinary citizens on the road,presidents of nations to destitutes in the sub-Saharan jungles. Its pursuithas driven many crazy. Even love didn’t make that many fools of men.

There are scant signs that wisdom evolving out of the enlightenedgovernance of even the twenty-first century will help counter this. Infact, it has transformed into an “infectious greed” of giant proportions,as never before witnessed in the civilized history. This slide is bestillustrated by the corporate scandals that are being reported from theUS in which shareholders are reported to have lost trillions of dollars,while the corporate bosses have walked away with huge cash paymentsand stock options. Every one, right from the Board of Directors,CEOs, auditing firms to shareholders, has contributed his mite tothis increasing rot in the corporate world.

October 2002.

SEVENTY EIGHT

“Silence of lambs”…

Ownership doesn’t matter; it is only those who carefor and assert their rights that get paid.


For many, inclusion of shareholders in the list of the accused forthe present sorry state of affairs in the corporate world of the US maysound unfair, but that can’t be helped. Anyway, putting this aside fora while, let us take a deeper look at the otherwise expected role of theshareholders in protecting their own investment interests.

No one can deny that investors are capable of influencing managersto create value for the firm’s shareholders. If not individuals, certainly,institutional shareholders are fully armed to ensure managerial disciplineby significantly influencing corporate management, for today theycontrol over half of the stock in the US market. It doesn’t mean theyhave to take a confrontational posture. A behind-the-scene cooperativeapproach could have been launched by them to resolve issues that arein direct conflict with the interests of managers and shareholders, suchas executive compensation, stock options, expansion or diversificationof business. They should have taken the managements that are“stonewalling” shareholders’ interests to task.

Another thing that these investors could have done to counterthe corporate dishonesty was to act as “whistle blowers”. They couldhave drawn the attention of the regulators to the suspected corporatemalpractices. Instead, during the whole of the last decade, Americanshareholders being entranced by their surging wealth, spent timeand energy in deifying companies and their chief executives. In chorus,they have been singing the praises of the CEOs for the kind of growththey could record and market valuation they could offer. Amazingly,they remained content with the kind of market valuations they couldenjoy—all in the greed for making quick money. Swayed by “irrationalexuberance”, they willingly ignored their own long-term interestsvis-à-vis short-term gains.

The sway was so strong that even the burst of the dotcoms or ofthe stock market bubble could not shake the investors out of their

353“Silence of lambs”…

quiescence. They were so overwhelmed by their greed and the apparentscope to make money in the market that they never bothered aboutthe kind of compensations being demanded by the executives fromtime to time nor did they have time to foresee the impact of stockoptions etc., on the ultimate behaviour of the executives or theirpropensity to manipulate these provisions for their personalaggrandizement.

Today, however, having lost trillions of dollars, the investors havesuddenly become vociferous in decrying the role of CEOs, board ofdirectors, auditors, regulators etc. Such an outcry can at best only, helpbetter the future. Nevertheless, it has changed the very mood ofinvestors. All of them have become remorseful and to that extenteveryone in the market has become wise.

This newly-dawned wisdom prompts us to recall what AdamSmith once said: “It is not from the benevolence of the butcher, thebrewer, or the baker, that we expect our dinner, but from theirregard to their own interest.” Smith was very categorical in sayingthat the individual “intends only his own gain.” Ironically, the presentepisode stands as proof to Smith’s proclamation. In the instant case,the corporate executives could articulate their “own gains” by seekingall kinds of remunerations and pursuing them to the hilt withoutbeing mindful of the means of their execution, while the poorshareholders who, by abdicating their responsibilities towards theirown interests, lost all their wealth.

The obvious revelation is that it is not just the corporate managerswho need to be honest about their performance, even investors needto be more dispassionate in taking a view about what they have beentold by the corporate bosses. As America’s Securities and ExchangeCommission had advised, they need to view the pro-forma earningsreports of companies “with appropriate and healthy scepticism” asthey are generated for a variety of purposes.


True, in good times, these ambitious projections could be achieved.But in an economic downturn, these out-of-reach targets can luresome managers to fudge the figures and get away with it, unlessshareholders are watchful of such misdeeds. At least, the institutionalinvestors must be active in picking up such cues from the “whistleblowers”, hailing particularly from inside the companies and pursuethem to their logical end. For example, it is reported that at Enron,some staff did express their concern about the accounting practicesbeing adopted by it much before it spiralled into bankruptcy. It is justnot enough to merely pick up the signals from such “whistle blowers”;they must also encourage and protect such employees’ interests ascompanies are reportedly treating them as “alien-class”, thoughregrettably. Now moving back to the alleged contribution ofshareholders to the present corporate sham, it becomes obvious thatunless shareholders pursue their own interests rationally anddynamically, nothing can counterbalance the corporate managers’pursuit of their own interests.

Doesn’t it mean that it is not silence but the activism of shareholderswhich matters in ensuring personal as well as public good?

——)0——

355Individual interests vs. public good

Long ago Adam Smith said: “Every individual endeavours to employ his capital so that its produce may be of the greatest

value. He generally neither intends to promote the public interest,nor knows how much he is promoting it. He intends only his ownsecurity, only his own gain. And he is in this led by an invisible handto promote an end, which was no part of his intention. By pursuinghis own interest he frequently promotes that of the society moreeffectually than he really intends to promote it.”

True, companies work towards creating shareholder value byidentifying and undertaking investments that generate returns far greaterthan the firm’s cost of raising money and in so doing they do a favourto the society—the favour of facilitating allocation of capital to thebest of the projects. Similarly, an individual’s investment in a project,though for personal gain, produces the maximum public good thatcaters to the felt needs of the individuals. This is perhaps what AdamSmith meant by the “invisible hand” at work in the capital market.

September 2002.

SEVENTY NINE

Individual interests vs.public good

Personalized interests that confine to naturalboundaries can alone result in public good.


But the current string of scandals pouring out of America’s mosthigh-flying corporates—Enron, Xerox, Tyco, Global Crossing andmost recently, WorldCom—are challenging this belief, for investor’sportfolios have shrunk in value while the CEO’s pockets have puffedup. Worse, the much-talked-about USGAP and the regulatoryinstitutions— the so called beckon lights of capitalism—have all beenfound wanting while corporate bosses were busy “cooking the books,shading the truth and breaking the laws.”

Furthermore, even the outside directors and auditors have failed todetect the growing corporate malfeasance. Responsible CEOs havecontinued to collect huge bonus packages while the value of theircompanies dramatically declined, resulting in a move towards filingfor bankruptcy. Indeed, most of the Americans and their media todayare squarely blaming the executive pay and granting of stock options asthe root cause of all the bad that has happened. In certain quarters,there is a strong argument that it is the huge amount of stock optionsdished out to executives that encouraged the bosses to behave despicably.

Since the venerated corporate bosses were exposed as fraudulenthucksters, the whole world has been gunning for their heads. EvenPresident George Bush has lamented that faith in the integrity ofAmerican business leaders was being undermined by executives“breaching trust and abusing power”. The American agony over thecorporate happenings is well captured in the statement of thePresident—“the business pages of American newspapers should notread like a scandal sheet.”

These misdeeds have only swelled up public anger and in theprocess, much abuse is being heaped upon the business executiveswho as a class are being condemned as untrustworthy and venal.The anguish generated by these outpourings from the citizens overthe business executives is indeed making the likes of Intel Chief feel“class alien”.

357Individual interests vs. public good

Set against this long list of American corporate failings, one is illat ease in appreciating Adam Smith’s “invisible hand” and its supposedrole in promoting public good. That apart, the present focused pursuitof personal interests by the corporate executives of Enron, etc., endedup eroding the value of real stake-holders. Amidst this mess, “Whereis the prophesied public good?” remained a moot question.

Hang on, for there are reasons for optimism. There is anotherside to the history of American corporate world that is equallyinteresting. The corporate landscape of the USA is equally swampedby philanthropic deeds of the corporate barons who poured theirindividual fortunes made out of their personal investments into greatuniversities, art galleries and medical schools. As recently as last year,Gordon Moore of Intel is reported to have donated US$5.8 bn totheir family foundation and another US$300 mn to CaliforniaInstitute of Technology. It is an acclaimed fact that the richer theAmericans become, the higher the amounts they contribute tocharities. And Americans have, of course, amply rewarded thecorporate executives by simply deifying them till yesterday.

The American business system, besides being highly creative, hasvirtues as well as vices. And there is nothing surprising if theAmericans had alternately deified and demonized the corporate bosses.That aside, what now matters most is, “What has this history ofphilanthropy exhibited by the business barons got to say about theongoing ruckus over corporate malfeasance?”

This conflicting exhibition of virtues and vices perhaps revealsthat pursuit of personal interests purely driven by “infectious greed”is less likely to do any public good. The “invisible hand” becomesvisible if only the individuals or corporates pursue their interests withhonesty of purpose and integrity of approach. Any deviation from thecommonly expected rational, cool-headed and law-abiding behaviour


is more prone to belittle Adam Smith’s proclamation. In the ultimateanalysis, who knows, if it won’t do any good even to the pursuer ofchicanery for he is likely to be haunted by the law-enforcing agenciescompelling him to cough-up the ill-gotten money. Even jail-termscannot be ruled out as is currently being contemplated by the politicalbosses. Such a reaction from the society for reversing these alarmingtrends when there is still time, hopefully will put the system back onrails enabling it to contribute its expected mite to the public good.And who knows if this mechanism is a part of the “whole” thatconstitutes Adam Smith’s invisible hand working silently towardspublic good. If that is true, it is time for the eminent public-spiritedbusinessmen of integrity to come forward and take the lead in devisingmeasures to combat this metastasising malignancy. Else, there is everydanger of political bosses, in their anxiety to prove their commitmentto sanitize the system, enacting stifling legislation that may ultimatelyprove to be more harmful than the disease itself.

Whether such a movement would restore the role of the corporatesin contributing to the public good as contemplated by the greatphilosopher and economist, Adam Smith, way back in 1776 or not isfor the corporate world and its leaders to decide.

——)0——

359“Anandame jeevita makarandam”

One summer evening, a song – “anandame jeevita makarandam”(bliss is the nectar of life) wafted along from a distance. It was

like notes of bells, sounds of musical instruments, the ordinary noiseof wind or rain on window panels – all in gay abandon. Walkingalong with it was like an unquenched thirst suddenly gettingmiraculously fulfilled.

As the time ticked, the fading song posed a question: “where tofind ananda and how to possess it?” Search for ananda has beeneternally haunting man. This eternal search could have promptedErich Fromm to say: “man is the only animal for whom his own lifeis a problem which he has to solve”. And the greatest hurdle that iscoming in the way of finding a solution is the very thinking processthat we apply and the set of values that we have evolved to guide ourreasoning. Is it our over-emphasis on finding a single solutionexclusive of all others that is defeating our very purpose of pursuit ofhappiness and ananda?

May 2006.

EIGHTY

“Anandame jeevita makarandam”

“Beauty is truth, truth beauty,” – that is all Ye knowon earth, and all ye need to know. That’s all whatone needs to know even to be in ananda.


As the world is increasingly moving towards industrialization,the Western protagonists of capitalism perceived economic progressas the lynchpin of happiness. It’s their belief that economic progressbuilds a fairer and better ordered society. It is supposed to facilitate asensible and decent living. But it has not turned out to be so norwould it in the future. The capitalism-driven search for ‘excellence’and ‘efficiency’ in every walk of life has only divided the society into‘haves’ and ‘have-nots.’ They have positioned pursuit of ‘efficiency’and ‘economic growth’ on a high pedestal that has resulted in pricingevery work either very highly or simply at zero. Is it not what echoesfrom what Thoreau once said: the silent poor who built the pyramidsto be the tombs of the Pharaohs were fed on garlic, and it may also bethat they were not decently buried themselves? Does it mean that thisdifference between the ‘haves’ and ‘have-nots’ is the only constant toremain eternally unchanged amidst Epicures’ eternal ‘change’?

This singular pursuit for economic excellence to the exclusion ofall else which was the hallmark of laissez-faire capitalism could havemade John Maynard Keynes to lament: “There must be no mercy orprotection for those who embark their capital or their labour in thewrong direction. It is a method of bringing the most successful profit-makers to the top by a ruthless struggle for survival, which selects themost efficient. It does not count the cost of struggle, but looks onlyto the benefits of the final result which are assumed to be lasting andpermanent, once it has been attained. The object of life being to cropthe leaves off the branches up to the greatest possible height, thelikeliest way of achieving this end is to leave the giraffes with thelongest necks to starve out those whose necks are shorter.”

Aside from these economic thoughts, there are wide-eyed poetswho had something else to romanticize on happiness. There is JohnOldham, England’s favorite satirist of 17th century, who wrote:“Music’s the cordial of a troubled breast,/The softest remedy that grief


can find/The gentle spell that charms our care to rest/And calms theraffled passions of the mind.” “I feel physically refreshed andstrengthened by it”, said Coleridge about music. Even Goethe saidthat music made him unfold “like the fingers of a threatening fistwhich straighten, amicable.” A. E. Housman had a different poem(that captures the mood of industrial revolution well): “And maltdoes more than Milton can/To justify God’s ways to man/Ale, man,ale’s the stuff to drink/For fellows whom it hurts to think.” There isthat saint-composer from South India, Thyagaraja, for whom the‘economics of happiness’ is centered on his commune with his Godthrough his kritis— “Marugelara Oh! Raghava”—why concealment,Oh! God, and such other 500 and odd compositions. A noted Telugupoet of 20th century, Sri Sri, poured-out his longing for a ‘poetic-relationship’ in his exquisite lyricism: “love you for what you are/andsay ‘here I am’ to pop tear-filled eyes for thee/that alone is wealth/thatalone is swarg.”

So, we had economists on one side who said “economic progress”leads to happiness and, on the other side, we had poets for whomright from ‘music’ to ‘tear-filled’ eyes to ‘relationships’, to ‘malt’, isthe source of happiness. These conflicts relating to happiness madepeople to aver: “there is more to human happiness than can beencompassed in terms of economic measures alone.” This could nothowever last longer, for with the advancement in the tools foreconomic studies, a new breed of economists engaged themselves inexamining the empirical determinants of happiness. Intriguingly,today, there is a copious literature on ‘economics of happiness’.

David G Blanchflower of Dartmouth College, Hanover andAndrew J Oswald of Warwick University have taken it to further(bizarre?) heights by attempting to estimate econometric happiness,factoring ‘sexual activity’ as an independent variable. Here, theyconceptualized ‘happiness’ relying on the definition given byVeenhoven: “the degree to which an individual judges the overall


quality of his or her life as favorable”, while ignoring the psychologist’sunderstanding of happiness in terms of ‘context-free happiness’ –well-being from life as a whole, and ‘context-specific happiness’ –well-being associated with a single area of life. Their conceptualizationof ‘happiness’ indeed has the support of literature which reveals thatself-reported happiness is a mere reflection of four factors:circumstances, aspirations, comparisons with others, and a person’sbaseline happiness or disposition outlook. Interestingly, much of theliterature suggests (redicules?) that one “should think of people asgetting utility from a comparison of themselves with others.” Theytook off from this platform to construct an econometric happinessequation with sexual activity as independent variable to find out thelinks between money, sex, and happiness. The study revealed a positiveassociation between frequency of sexual activity and happiness. Indeed,“it was statistically well-determined, monotonic and large.”

That is the ever-mounting conflict between happiness and itsattainment! Let us for a while look at it from an ancient Indianperspective: Nanda in Sanskrit means “that which can reduce inquantity”. Ananda means that which cannot reduce in quantity.Simply put, ananda means bliss! Ananda is not joy, for it comeswithout a reason. It just is or is not, while joy is something that wefeel through senses and hence we need to have an external objectsuch as ‘sex’ in the case of econometric happiness or ‘music’ or‘relationship’ as in the case of poets. When one feels joy withoutthese external objects/sensory inputs, it becomes bliss. Ananda simplycomes from within and thus is independent unlike the ‘happiness’ inthe econometric equation of David and Andrew. It otherwise meansthat the very living becomes a bliss when it is not attached to‘externalities’. It is by stopping to seek that one finds bliss, and, ifthat is accepted and cultivated, every other economic good becomesirrelevant for being happy – for being in bliss.


This raises a new question: How is it that some retain that intrinsiccapacity to be happy, to be in bliss; while others lament its absence?The answer perhaps lies in the axiom: “a man is nothing but hismind; if that be out of order, all’s amiss and if that be well, the rest isat ease.” Mind can be in order when there is coherence in our thoughtprocess. Our knowledge of happiness and ananda, as Paul Thagardobserved elsewhere, is not like a house that sits on a foundation ofsolid stones, but is more like a raft that floats on the sea while all thepieces of the raft fit together and support one another. A belief cannotbe justified merely because it is indubitable, but because it cohereswell with other beliefs and support one another. As Rawls said, wemust adjust our whole set of beliefs, practices, and principles untilwe reach a coherent state called ‘reflective equilibrium’.

Now the question is how to achieve it? We all know that frommusic to rainbow, beautiful objects produce pleasure and happinesswhich means ‘beauty’ has a large emotional component. But as manyphilosophers observed, it also has a large component of ‘coherence’.“Beauty is the unity or coherence of the imaginary object; uglinessits lack of unity, its incoherence”, said R.G. Collingwood. The humanmind, by configuring such coherence amongst its various beliefs,values, and expectations can generate beautiful experiences, whichmeans happiness, which means ananda. For that matter, the veryknowledge of it, as an ancient Indian seer said, is ananda.

No wonder, in that configuration, you hum those undying lines,all in gay abandon – Andame anandam/anandame jeevithamakarandam* (Beauty is bliss and bliss is the elixir of life).

——)0——

* from a lyric of Samudrala (1958).

Index

A

A E Housman, 361Acceptable Level of Inflation, 123Accountability, 18, 112, 115, 119,

156, 265, 339, 340Accumulation of Profit, 170Acquisition, 39, 50, 73, 109, 141,

143-145, 186, 211, 212, 214,325, 344

Adam Smith, 71, 98, 103, 353,355, 357, 358

Adaptability, 40Administration-Driven, 211, 212Affluence, 14, 16Affluent Class, 4Air Sahara, 143Aircraft Utilization, 144Alan Greenspan, 30, 64, 281Algurai Shastri, 332, 333Alien-class, 354Allocative Efficiency, 249Alpharma SAS of France, 325Alyssa Ayres, 304American Economy, 30, 31, 34,

64Amos Tversky, 178, 194Ananda, 359, 362, 363Anavrishti, 266, 370Anchor Currency, 255

Anchoring, 195, 196Andrew J Oswald, 361Angry Apes, 316, 317Anil Ambani, 336, 339, 341-343Announcement-Effect, 121Anti-Dumping, 88Apsara, 314Arcelor, 139-142Art of Negotiation, 344Asian Markets, 138Asian Surpluses, 24Asset Price Bubble, 32, 286Asymmetry of Information, 348,

349Atmospherics, 17, 18, 115, 258,

308, 310Atomic Energy Commission, 313,

315Aviation Industry, 143Azim Premji, 10

B

Bad Cholesterol, 261Bad Equilibrium, 249Badla, 153Balance of Payments Problem,

253, 254Balanced Nutrition, 11Bankruptcy, 72, 104, 127, 331,

354, 356


Barclays Capital, 4Barrier-Free Trading, 56Basel Committee, 222Basel II Accord, 224Base-Period, 77Bayesian, 32Ben S Bernake, 21Berlin Wall, 79, 95Best-fit, 125, 345Bhabha Atomic Research Centre,

301Bilateralism, 88Bill Watterson, 137Bimal Jalan, 276Biocon, 158Biotechnology, 60, 158, 329Bi-Polar, 4Birla Ambani Report, 28Black Monday, 160, 163Bond Market, 34, 38Bond Yields, 34, 75, 286BPO, 5, 9, 26, 306, 307, 309, 310Breaching Trust, 356Bretton Woods System, 283Brookings Institution, 312Budget Deficit, 84-86, 253Bureaucratic Interventions, 5Buruntlant Commission, 191Business Cycle Conditions, 169Business Opportunity, 155Business Prospects, 157Business-Driven, 212, 215

C

C Rangarajan, 331Cadbury Committee, 340California Institute of

Technology, 357Calvin and Hobbes Cartoon, 137Cannibalize Competing Brands,

212Capability Builder, 327Capital Account Convertibility,

36, 209, 247, 248, 250, 272,278

Capital Adequacy, 52, 214,221-224, 250

Capital Flight, 249, 294Capital Flows, 114, 192, 208, 248,

269Capital Formation, 85, 152, 242,

249Capital Gain, 151-154, 156Capital Guzzler, 43, 81Capital Market, 52, 92, 94, 118,

133, 146, 165, 168, 171, 182,223, 247-249, 258, 265, 271,284, 331, 337, 355

Capital Risk, 238Capitalism, 6, 14, 16, 118, 356,

359, 360Carnegie Endowment for

International Peace, 313Carolyn Merchant, 189Carry Trade, 23, 24

367Index

Central Planning, 95Centre for Asia Pacific Aviation,

144Centre for Strategic and

International Studies inWashington, 304

Ceylon National Congress, 68Change Managers, 138Chhandogya Upanishad, 323, 343Chief Executive, 117, 218, 321,

352Child Labor, 188Chiquita, 97CIRUS Reactor, 301, 314Civic Strife, 67Civilian Nuclear Power Industry,

303Clarity of Purpose, 182Class Alien, 356Classical Economic Theory, 14Clause 49, 321-323Clinical Research Trails, 327CMIE, 26, 294CNOOC Ltd, 141Coal-based Energy, 302Cognitive Skill, 11Colas, 332Cold-War, 95Coleridge, 361Collaboration, 41, 42, 60, 101,

312, 327-329Collection-base, 78Commercial Potential, 303

Commodity DerivativeInstruments, 47

Commodity Prices, 44-47, 76Common Investors, 147Communism, 7, 14Community Vocational Training

Centers, 57Compatibility, 61, 322Competitive Edge, 42, 79Complementary Role, 40, 80Compulsive Buying, 203, 204Condoleezza Rice, 312Confucius, 339Congress Party, 331, 332Consumer Price Index, 120-123Consumerism, 66, 74, 109, 110,

201, 203, 205, 241, 243Context-free Happiness, 361Contract Farming, 60-62Contract Research, 327Contrarian Fund, 164, 166, 167Contrarian Investment, 149, 167Contrarian View, 166, 167Conventional Wisdom, 16, 285Convergence, 25, 96, 161, 188,

292, 327, 339Convergence in Communication

and Computation, 25Cooking the Books, 356Cornell, 178Corporate Governance, 119, 155,

182, 222, 223, 322, 336, 337,340-343


Correction, 137, 180, 251, 260Cost Effective, 326, 327, 329Cost of Sterilization, 287Cost Push, 75-77, 242Country of Contrasts, 4CP Pharmaceuticals, 325Crawling Pegs, 209Credible, 128, 169, 287, 313Cross-Border Acquisitions, 141Cross-Border Portfolio Flows, 153Crowding, 257CRR (Cash Reserve Ratio), 122,

129-132, 277Cultural Transition, 308Currency Board, 209, 210, 252-256Currency-Traders, 284Current Account Deficit, 69, 262,

263Custom Chemical Syntheses, 327Cutting-edge Technology, 302Cyclical Expansion, 237Cyclical Inflows, 147

D

D R Mehta, 157Daniel Kahnemal, 177David Bweinberger, 183David G Blanchflower, 361David Hume, 259Debt –

– Financing, 37– Market, 38, 154, 157, 250– Payment, 38

– Servicing Capacity, 44– to-the-GDP Ratio, 36

Default Risk, 157, 236Deficit Financing, 254, 259Deflation, 3, 21-24, 34, 132, 240,

242Delivery Application Services, 306Demand-Pull, 75, 242Deng Xiaoping, 331Depreciate, 37, 273Deregulations, 167Derivative Market, 152Derivative Securities, 154Derivatives, 44, 47, 48, 154, 183,

186Derivatives Trading, 47, 48, 154,

183, 186Destabilization of Economy, 272Dhirubhai Ambani, 336Discretionary Monetary Policy,

254, 255Discriminatory Approach, 97Disinvestment, 72, 116, 119Diversification, 38, 162, 240DMFs, 325Doctrinaire Politics, 14Domestic –

– Assets, 24, 254– Borrowings, 84– Mutual Funds, 51, 171,

172, 206– Prices, 261– Support, 59

369Index

Dotcom Era, 155DP World, 141Dr. Anil Kakodkar, 315Dr. Y. V. Reddy, 122

E

Earnings Management, 348Earnings Risk, 58East-Asian Crisis, 277Easy Monetary Policy, 21Ecological Stability, 105Ecology, 188Econometric Happiness, 361, 362Economic –

– Contraction, 163– Exposure, 281– Freedom, 13– Fundamentals, 36, 136,

137, 147, 149, 208, 269,283, 284, 289, 298

– Inequality, 15, 106– Models, 32, 194– Patriotism, 142– Planning, 67– Reforms, 25, 71, 74, 202,

333– Risk Exposure, 268– Risk, 110, 263, 268, 281– Stability, 14, 15, 105, 106,

339– Theory, 14, 40, 106– Variable, 123, 281, 297

Economically Rational Owner, 268

Economics of Happiness, 361Economies of Scale, 212, 213Education Zones, 9Efficient Management, 118, 265Elementary Education, 11Embedded Risks, 156, 229Emerging Economies, 30, 141,

266Employable Graduates, 6, 8Endowment Effect, 177Enron, 127, 348, 354, 356, 357Environment, 6, 104-106, 188,

190-192, 222, 239, 249, 302,329, 339, 340

Epigraphist, 15Equity Investments, 159Erich Fromm, 217, 359Ernst & Young, 325Escape from Freedom, 217Evergreening, 227, 228Exchange Economy, 259Exchange Rate Risk, 263, 280Excluded Voices, 6Exit of Foreign Investors, 37Exoteric Knowledge, 16Expansion, 8, 38, 114, 162, 164,

190, 191, 228, 229, 237, 240,241, 259, 260, 352

Expected Utility Theory, 194Export Subsidies, 59Export-Driven, 70Exporting Countries, 64External Commercial

Borrowings, 91, 227


External Debt, 36External Payment Crisis, 37Externalities, 362Exuberance, 166, 291, 294, 352

F

Falling Unemployment, 33Farming Community, 19, 59, 152Fast Breeder Test Reactor, 301Fast Reactors, 302Feeder Funds, 274Fiat Money System, 21FICCI, 112, 115FII Inflows, 93, 165, 169, 207, 251Financial –

– Crises, 32– Intermediation, 40– Reporting Council, 340– Risks, 157– Synergy, 213– Transparency, 347

Fiscal –– Constraints, 18– Crisis, 84, 85, 99, 100– Deficit, 18, 24, 27, 35-38,

83-86, 99, 109, 110, 113,114, 119, 130, 223, 251,257, 271, 294, 297

– Discipline, 18, 255, 261– Material Cut off Treaty, 312– Material, 304, 312

Fixed Exchange Rate, 278Flat Pitch, 231, 234, 235

Flat Yield Curve, 231-235Flattening Yield Curve, 234, 235Flexibility-Price Monetary Model,

283Flexible Exchange Rate, 278Float, 51, 100, 209, 210, 239, 265,

274, 277, 284, 363Foreign –

– Direct Investment, 55, 79,95, 96, 272, 331

– Exchange Reserves, 36, 37,75, 83, 87, 92, 164, 207,250, 257, 258, 261-266,272, 273, 275, 276, 278,286, 288, 289

– Institutional Investors, 38,168, 172, 175, 206, 331

Forex Reserves, 36, 92-94, 148,247, 257, 259, 260, 262, 286,290, 293, 294

France, 84, 139-141, 325FRBM, 18Free –

– Float, 153, 168, 209, 210– Flowing Dollars, 138– Floating Stock, 153, 168– Market, 6, 16, 126, 159,

162, 172, 297– Trade, 105, 250– Trade Agreement, 87-90,

250Functional Currency, 263, 280

371Index

Future-initiatives-centric, 335Futures Contract, 186

G

Gail, 72Gas-cooled Fast Reactor, 302Generic Players, 327Geoffrey Garrett, 249George Loewenstein, 178George Perkovich, 313, 315George Stiglitz, 96GIC, 162, 172Gilt Securities, 254Glasnost, 95Global –

– Capital, 38, 249, 284– Interest Rates, 137, 169– Pharma Report 2004, 325– Trends, 56, 153

Globalization, 5, 7, 8, 10, 25, 28,33, 58, 95-98, 103, 105, 135,139, 142, 167, 208, 226, 251,292, 340

Globalization-Free, 25Globalized Economy, 8, 10, 13,

25, 42, 66, 82, 211, 236, 263,268, 270, 281

Globalized India, 168, 169, 171Goethe, 361Goh Chok Tong, 330Gold Rushes, 126Good Equilibrium, 249Gordon Moore, 357

Governance, 3, 78, 105, 112, 113,115, 119, 131, 155, 157, 182,222, 223, 290, 299, 321-324,336-343, 350, 351

Governance Risks, 322Government Procurement

Agreement, 59Government Securities, 37, 75,

101, 154, 224, 232, 234, 236,269

Government-owned Banks, 154Grasim, 344, 346Green Field Airports, 143

Greg Mankiw, 34Ground Crew, 144Growth Path, 34, 331Guy Dolle, 140Guzzler of Capital, 79

H

Hamel, Doz & Prahalad, 327Hamlet, 337Hangars, 144Happiness, 138, 359-363Health Risk, 58Hedge Funds, 161, 162, 165, 169,

174Hedging, 127, 183-187, 273Herd Mentality, 165High Net-Worth Individuals, 171High Price-earnings Ratio, 148High-cost Processing Centers, 141Hindu Growth Rate, 332


Homi Bhabha, 314Homoeostasis, 350Hubris, 136Human –

– Advance, 14– Capital, 5, 12, 108, 111– Dignity, 188, 308, 309– Progress, 15– Rights, 191, 340

I

IBM, 332Ideologies, 14Illiteracy, 4Ill-Liquidity, 234Import Substitution, 67, 68, 70Imported Inflation, 76Inclusive Brand of Capitalism, 6Incredible Inflow, 169Independent Directors, 322, 323Index-Stocks, 149Indian Air Travel Industry, 144Indian Banking System, 29, 170,

213, 221Indian Oil Corporation, 72Indiana University, 304Indira Rajaraman, 18Infectious Greed, 351, 357Insurance Penetration, 41Insurance Regulatory and

Development Authority, 39,41, 81

Internal Debt, 36

International –– Atomic Energy Agency

(IAEA), 311, 312– Energy Agency, 64– Herald Tribune, 142– Linear Collidor, 302– Statesman, 330– Thermonuclear

Experimental Reactor, 302– Trade, 25, 64, 87, 88, 262

Inter-University AcceleratorCentre, 303

Intrinsic Value, 158, 196, 348Inversion of the Yield, 233Inverted, 232-235Investment-Shy, 226Investor Community, 73, 156Investors’ Heart, 145Invisible Hand, 355, 357, 358Inward-looking, 70IPOs, 155, 156, 158, 162Irish Digest, 151Irrational, 136, 193, 194, 196,

197, 204, 229, 352Irrational Behaviour, 194, 197Irrational Exuberance, 352Irrationality, 193, 194

J

Jacques Chirac, 140Jaduguda, 315Jagdish Bhagwati, 87, 248James K Sebenius, 344

373Index

James Meade, 89Japanese Forex Reserves, 148Japanese Yen, 206, 207, 268Jean-Claude Juneker, 140Jet Airways, 143Jnana, 343John Maynard Keynes, 252, 360John Oldham, 360John Stuart Mill, 288

K

Kahneman, 178, 194, 196Kant, 318Karl Schiller, 255Karma, 323, 324Kautilya, 108, 339Keynesian, 13, 103, 105, 114Keynesian Theories, 105Kings Cross, 316Klein Lawrence, 8Knetsch, 178Korean Won, 268Kuznets Curve, 106

L

L&T, 344Labor Market Risk, 58Lady Macbeth, 338Lakshmi Mittal, 139Lawrence Summers, 250, 251Lazy Banking, 236Leadership, 17, 26, 68, 77, 98,

111, 112, 115, 117, 118, 181,214, 229, 278, 333

Learning Society, 188Least Uncertainty, 161Lee Hsien Loong, 330Lenders of the Last Resort, 254Less Endowed, 11, 12, 62, 201Less Monetized, 259Leveraging on Diversity, 10LIC, 41, 99-102, 162, 172

Licence Raj, 5Liquidity, 21, 22, 37, 76, 92, 121,

122, 127, 130, 131, 135, 147,148, 153, 168, 170, 228, 231,233, 234, 237, 238, 258, 274,275, 286, 287, 290, 293

Liquidity Crisis, 228, 258

Liquidity-Overhang, 92, 274London Stock Exchange, 340London Tube, 317Long-Only-Market, 234Long-term –

– Capital Gains, 151-153– Capital Gains Tax, 152, 153– Interests, 153, 352

– Investor, 153, 154, 163Loss-making, 145Low Price-earnings Ratios, 149Low-density, 261Low-priced Quality Goods, 141LTCM, 31Ludwig von Mises, 119

Luxembourg, 139-142


M

M V Ramana, 313Macbeth, 338Machiavelli, 333Macroeconomic Fundamentals,

36, 147, 149, 208, 269, 283,284

MacroeconomicInterdependencies, 25

Macro-Economic Management,94

Macroeconomic Phenomenon,148

Madrid, 317Mahatma Gandhi, 112Malls, 202, 309Malt, 361Managed Floats, 209Management Efficiency, 118, 265Mandatory Rating, 156, 159Manmohan Singh, 301Mark to the Market, 207Market –

– Access, 59– Capitalization, 135, 152,

160, 162, 164– Economy, 6, 96, 104, 106,

163, 216, 322, 331– Makers, 295, 296, 298– Mechanics, 33, 171– Neutral, 48– Perception, 158

– Plus Return, 149– Prices, 47, 52, 62, 161,

173, 181– Sentiment, 149– Stabilization Bonds, 286– Stabilization Scheme, 269– Turnover, 165– Economy, 163– Punishment, 350– Stabilizers, 163

Massachusetts Institute ofTechnology, 315

Maturity Pattern, 36

Maturity Risk, 238Maurice Greenberg, 322

Max India, 39, 43Maximizing-Inflation, 132McKinsey Global Institute, 25

Mental Hygiene, 11Mergers and Acquisitions, 211,

212Michael Eisner, 322Micro-Manage, 17

Micro-Management, 94, 225Midcap Companies, 38

Milton Friedman, 16, 31, 259Mind-share, 351Minor Risks, 32

Missile Technology ControlRegime, 312

Missing Variable, 30, 32, 33Mittal Steel, 139-141

375Index

Modernization, 143Modest Man, 330Molten Salt Reactor, 302

Momentum Players, 165Monetarists, 259

Monetary –– Basis Money Circulation,

254

– Fronts, 251– Policy, 21, 23, 77, 78, 104,

120-122, 130-132, 209, 232,251, 254, 255

– Powers, 255– Sovereignty, 255– Stimulus, 31

Monetization, 261Money Supply, 75, 128, 259, 261,

264, 276, 288Month-end Scramble, 207Monthly Turnover, 165Morarji Desai, 332Moratorium, 217, 218, 312Morris Jastrow, 318Mortgage-Backed Security Bonds,

52MSBs, 264, 287, 288Muhurat Trading, 146-148Mujid Kazimi, 315Mukesh Ambani, 335, 341Multi-location Operations, 141Mutual Funds, 51, 171, 172, 206,

291, 294

N

Nalgonda, 315Namaskar, 307Naresh Goyal, 143Nascom, 309Nasscom McKinsey Study 2005,

9, 26Nation’s Payment System, 217National –

– Hedge, 282, 285– Employee Registry, 309– Interest, 7, 9, 305– Savings, 85, 110, 114– Uranium, 301, 302, 314,

315Near Money, 217, 289Negative Returns, 148Nehruvian Economics, 331Neoclassical, 113, 178, 179, 249Neo-Liberal, 96New York, 15, 35, 81, 169New-Found Confidence, 226Nippon Steel of Japan, 139Niranjan Hiranandani, 50Nirarthakam, 176, 177, 179Nominal Interest Rate, 21, 124Non –

– Convulsive, 343– Delivery-based Trading,

153– Event, 17– Executive Director, 323


– Institutional Segment, 153– Listed Conglomerate, 145– Plan Expenditure, 110– Polluting, 302– Proliferation, 312– Regressionary, 152– Resident Indians, 40, 169– Systemic Risks, 156

Normal Yield Curve, 232, 233North-East, 315NPAs, 117, 170, 226-230, 238Nuclear –

– Autonomy, 312– Fuel Cycle, 314– Quarantine, 304– Suppliers Group

Guidelines, 312– Supply Group, 302– Technology, 302, 312– Triumph, 312

Number Manipulation, 348

O

OECD, 114, 250O-Factor, 182Off-Setting Swap, 297Oil India Limited, 72One-Time Assessment, 157ONGC, 72, 118, 162Opacity-Index, 182Open Capital Markets, 271Open Market Committee, 65

Operating Efficiencies, 280, 281Operating Synergy, 213Opportunistic Behaviour, 83Opportunity Loss, 184Opportunity Share, 211Option Contract, 186Organization of Petroleum, 64Organizational Learning, 211Origin of Goods, 89Orthodox Purists, 19Othello, 338Outflows, 38, 147, 208, 251Outsourcing Politics, 158Over- and Under-Reactions

Theory, 195Over-Hyped Sectors/Stocks, 149Overseas Corporate Bodies, 173

P

Pareto Efficiencies, 94Parking Lots, 144Parkville Holding, 39Participatory Notes, 169, 173Pass-through, 123Pass-through Policy, 123Paternalistic Authority, 16Paul Volcker, 30PCS, 158Pension Funds, 40, 163, 165Perestroika, 95Peter Drucker, 214Pharaohs, 360

377Index

Philanthropic Efficiency, 324Philosophic Calm, 324PHWRs, 315Planned-Economy, 163Planning Commission, 257PLR, 93, 238Plutonium, 314, 315Political –

– Culture, 163– Liberalism, 13, 14– Overtones, 142– Power, 190, 339

Pollution, 188Poor Growth Rate, 148Portfolio Risk, 238, 292Positive Inflation, 21Postal Network, 101Post-MFA Scenario, 55, 56Poverty, 4, 14, 20, 53, 108, 111,

260, 261Power Transmission, 258Powerful Partnerships, 214President Bush, 301Pressurized Heavy Water

Reactors, 315Price Rigging, 218Price Stability, 30, 31, 66, 104,

255Price-Inelastic, 280Primary Commodities, 44Primary Market, 52Principal-Agent Conflicts, 118,

265

Private Participation, 27, 143, 215,305

Product Risk, 236Production Problem, 61, 188Prof. Peter Wysocki, 348Profit Booking, 146, 165Profitable Investment Avenues,

148Profit-Maximization, 190Progressive Politics, 13Project Approach, 18Promissory Notes, 165Prospect Theory, 178, 179, 194,

195Protectionist Economy, 90Prototype Fast Breeder Reactor,

301Provision Risk, 238Prudent Investment, 41Prudent Princes, 333Prudential Protections, 38PSU Banks, 181Psychic Gratification, 202Psychological Effects, 177, 178PTAs, 87-89Public Amenities, 14Pull-Factor, 249Purchasing Power Parity, 283

Q

Quality of Reporting, 157Quantitative Easing, 22, 23


R

R G Collingwood, 363R&D, 57, 326Rahul Bajaj, 10Ratan Tata, 8, 10, 305Rating Agencies, 157Ratings, 37, 155-158, 169, 250,

322Ratio of Debt-to-the-GDP, 85Rational, 55, 106, 108, 117, 121,

136, 137, 144, 162, 171, 178,193-197, 204, 213, 224, 229,271, 272, 279, 297, 320, 348,352, 354, 357

Rationality, 171, 193-195Real Estate –

– Equity Trust, 51– Investment Trusts, 50, 51– Mortgage Trust, 51– Syndicates, 50

Real Resources, 230, 259Real-Time Gross Settlement, 239Recession, 31, 32, 77, 105, 126,

128, 233, 235, 237, 249, 293Re-Employable, 11, 57Reflective Equilibrium, 363Reform Trajectory, 208Regret Theory, 195Regulators, 52, 91, 119, 130, 131,

138, 157, 165,-167, 171, 173,174, 180, 182, 185, 218, 220,296, 298, 322, 323, 352, 353

Relegere, 317Reliance, 20, 61, 95, 120, 305,

314, 335-338, 341Reliance –

– Capital, 36, 341– Energy, 336, 341– Infocomm, 341– Infrastructure, 341

Religare, 317Religio, 67, 317-320Repo Rate, 66, 233, 234, 287Repositories of National Wealth,

217, 224Representativeness-Heuristic, 196Reservation Policies, 9, 10Reserve Bank of India (RBI), 5, 18,

52, 66, 76, 83, 93, 122, 123,129-132, 135, 167, 186, 204-207, 209, 215-218, 221-225,227, 228, 234, 235, 236, 238,240, 241, 247, 251, 263, 264,266, 267, 269, 271, 274, 276,286-289, 293-298, 336, 337,347

Resilience, 229, 236, 239Resurgent India Bonds, 277Retail Investors, 137, 165, 166,

171, 179, 183, 337Returns on Capital, 145Revenue Deficits, 18Revenue/GDP, 114Reverse Discrimination, 9, 11

379Index

Reverse Speculative Attack, 288Richered Thaler, 194Rising Inflation, 76, 137, 138, 243Risk –

– Analysis, 51, 184– and Return, 34, 137

– Based Capital, 221– Perception, 157

– Premiums, 238

Robert –– Blackwill, 302

– Frost, 240

– J Einhorn, 304– Shiller, 195

Roger Noll, 309

Rule Setter, 327Rupee-Foreign Currency Swaps,

295

S

S.W.R.D. Bandaranaike, 69

SAARC, 250

Safety-Nets, 13Sarbanes-Oxley Act of 2002, 322

Sarvahit, 324

Sarvopakari, 324, 343Scale of Economies, 55, 212

Scientific Talent, 302

SDR, 126, 165, 212Sebastian Edwards, 249

Secondary Debt Market, 154

Seismic Changes, 25

Self-centred Tendency, 346Self-reliance, 95, 305, 314

Self-serving, 153

Sell-outs, 206Sense of ‘Conviction’, 147, 149

Sensex, 76, 121, 135 -137 ,146-149, 160, 164, 168, 172,177, 179, 206

Services Business, 10Shakespearean Drama, 336Shareholder-Activism, 192Silent Killer, 269Siphoning of Funds, 118Sir John Hicks, 252Sir John Kotelawala, 69Skewed, 4, 234, 346SLR, 130, 131Social Fabric, 11, 317Social Inclusiveness, 12Social Science, 16Socialistic Program, 332Socially Responsible Investing

(SRI), 188, 191, 192Solvency Margins, 42Sordid Governance, 343South-East Asian Countries, 249,

348Sovereign Ratings, 37, 250Special Purpose Vehicle, 261, 265Spectrum Analyzers, 51, 52Speculation-Driven Trading, 153Speculators, 153, 165, 166, 296


Spooking, 137

Sraddha, 323, 324, 343

Stabilizing, 40, 47, 80, 100, 264Stagnation, 22, 32, 286

Stanford Center for International

Development, 309Start-ups, 162

State-Owned Enterprises, 117

Statesman, 301, 330, 331, 334Steep Yield Curve, 232, 233

Stock in Trade, 136

Stock-Broking, 151Stonewalling, 352

Store of Value, 127

Strange Familiars, 310Strategic Clarity, 211

Strategic Counterweight to China,

312Strategic Resilience, 239

Strobe Tall Bott, 312

Sub-Investment Grade, 38Sub-PLR, 238

Sub-Saharan Jungles, 351

Subvention, 19Sumit Ganguly, 304

Superficial Water-cooled Reactor,

302Super-Rich, 4

Supply Chain Network, 328

Sustained Shareholder Value, 145Swami Vivekananda, 323

Sweet Pill, 142Symphony of Words, 15

Synergy Theory, 213

System of Affiliation, 27

T

Targeted Investments, 152

Tata Tele Services, 349Tatas, 349

Tax Compliance, 154

Technology Upgradation Fund,55

Theoretical Optimum, 209

Theoretical Threat, 37Theory of Market Efficiency, 348

Thomas Friedman, 38

Thoreau, 360Thorstein Veblen, 16

Three-stage Nuclear Power

Program, 314Tons of ‘Patience’, 147

Trade –

– Agreements, 87-90, 250– Creation, 89, 90

– Deficit, 33, 137, 208, 263,

264– Diversion, 89

Trampoline Architecture, 11

Trampolines, 11, 57Transaction Tax, 15, 152-154

Transcendence, 318

381Index

Transition of Power, 162Transparency, 59, 106, 119, 222,

265, 297, 339-341, 347, 349,

350Transparent, 51, 75, 77, 78, 106,

118, 221, 250, 313, 340

Tribal Gods of Both Left and Right,15

Tricks, 151, 318

Tunnelling, 118Turnover Tax, 151-154

U

Uncertainty, 40, 44, 47, 48, 61,78, 106, 161, 163, 185, 217,

219, 284

Uncovered Interest Parity, 283Under-Investment, 237

Under-Nourishment, 4

Unidentified Factor, 32University of Maryland, 178

University of Pennsylvania, 304

Unocal Corp, 141Unsolicited, 157, 204, 205

Urban Land Ceiling and

Regulation Act, 50US Federal Reserve, 65

US Housing Bubble, 24

US Trade and Fiscal Deficits, 24USFDA, 325

USGAP, 326

V

Valuation, 52, 92, 137, 157, 158,164, 166, 177, 322, 331, 348,352

Value Outcome, 345Value-creating Institutions, 340Varishta Pension Bima Yojana, 99,

101Vidya, 323, 324, 343Virtuous Circle of Jobs, 5Viryavattaram Bhavati, 323Vision, 16, 84, 139, 147, 148,

150, 191, 212, 214, 314, 346Volatility, 45, 52, 93, 135, 138,

148, 153, 169, 185, 208, 248,251, 274, 292, 298, 337

VSNL, 349Vulnerable Liabilities, 251, 294

W

Warren Buffett, 183Warwick University, 361Wealth Distribution, 4Wealth Generation, 146Welfare State, 13Werner De Bondt, 194Wharton Business School, 348Whistle Blowers, 352, 354Wholesale Price Index, 77, 120William Jennings, 125Wockhardt, 325


World Bank, 5, 27, 99, 100, 105,110, 259, 261, 339, 340

World Bank Index, 5World Interest Rate, 148, 284World Trade Agreement, 59World Trade Organization, 88, 325WorldCom, 356World-Machine, 189

X

Xenophobic Reaction, 141

Y

Yield Curve, 23, 231-235, 251,287, 295, 297

Z

Zero Value, 296Zia Mian, 313Zydus Cadila, 325

reflections on free market

Documents