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Monday, January 24, 2022

Does financial and macro policy explain household investment in gold?

by Renuka Sane and Manish Kumar Singh.

Gold plays a significant role in the portfolio of Indian households. Several explanations have been offered: gold is an important source of credit, it matters for socio-cultural and political reasons, provides women with agency as women are likely to have more control over the gold they own relative to financial assets. Research has, however, not paid adequate attention to the performance of gold as an asset class. Investment in gold is often brushed aside as irrational based on the evidence that gold has delivered near zero real returns (in USD) over a 100 year period (Siegel, 2014). In a new working paper, Sane and Singh (2022): "Does financial and macro policy explain household investment in gold?" We argue that investments in gold have to be seen in the context of Indian financial markets. Gold is a a far more sensible investment that international research would suggest.

Indian financial markets

Household saving is a function of the financial environment within which the household operates. The following characteristics of Indian markets are worth noting:

  1. High inflation: India adopted a formal inflation target of 4 per cent within a band of +/- 2 per cent in August 2016. Before this, high levels and volatility of inflation had been a persistent problem in India. The average inflation in the four years prior to inflation targeting was around 7.26% - this dropped to 4.19% after the adoption of the framework (Patnaik & Pandey, 2020). When there is such high and persistent inflation, households will naturally look for instruments which are able to, at the very least, beat inflation, even if not provide a complete hedge.

  2. Interest rate management: India has consistently followed a policy of managing long-term interest rates on government borrowings. This has led to an environment of low interest rates for government borrowing, and has prevented long-term yields from rising. Interest rates on fixed deposits which are benchmarked to long-term government yield is also relatively low and have been consistently falling over the 1999-2021 period from an interest of 9-10% to about 4%.

  3. Volatility in equity markets: Emerging markets are generally more volatile than markets in OECD countries. The annualised 10 year standard deviation on the MSCI Emerging Markets Index was around 17%, while that of the MSCI World Index (based on large and mid cap representation across 23 Developed Markets (DM)) was around 13%. An asset that serves as a hedge assumes greater importance in emerging markets relative to developed markets.

  4. Capital controls: One way to hedge a portfolio is to diversify across different markets. However, this has been difficult in India, owing to a complex framework of restrictions on the current and capital account till the year 2000. In 2000, the current account was made fully convertible, and a modified framework for capital controls was put in place (Patnaik & Shah, 2012). There continue to be restrictions, on both the current and capital account, which differ depending on the type of investor, and the assets in question.

  5. Currency interventions: Patnaik & Sengupta (2021) study RBI interventions and find that when there has been pressure on the rupee to appreciate, the RBI has responded by intervening in the forex market and buying dollars. When, in the aftermath of the 2008 global financial crisis, there was pressure on the rupee to depreciate, the RBI allowed the rupee to fluctuate in this period. Indian investors, therefore, benefit from a larger depreciation of the rupee for those assets where the price is determined in international markets.

High inflation levels and volatility, low interest rates on account of financial repression, inability to invest in international markets until very recently, depreciation of the rupee have a bearing on the choices that are available to households. Financial repression changes the risk-return trade-off between fixed deposits and gold. Similarly in an environment where individuals are restricted from investing in overseas markets, gold offers a way for doing international diversification. These become important considerations as we evaluate the performance of gold vis-a-vis the Indian equity market.

How does gold fare?

We use data from June 1999-March 2021 and find that:

  1. In the last 20 years, real returns on gold have always been positive.

  2. Apart from a few years around 2018, gold has consistently beaten returns on fixed deposits.

  3. RBI interventions in the currency market changes the dynamics of gold return for Indian households. Our regression estimates suggest that if the Indian rupee depreciated against the U.S. dollar by 10% in a month, then the gold price in Indian rupees increased on average about 3.63%. While the exchange rate pass-through is far from complete, it implies that currency interventions by the Reserve Bank of India have implications for the gold price that is seen by Indian investors.

  4. Gold and NIFTY seem to have moved together till about 2008, after which NIFTY saw a sharp fall, while gold continued with its upward trajectory. The two asset classes moved together again till about 2014, and then from 2015 till early 2020. There seems to be a divergence in the series around 2014, when NIFTY was rising steadily while gold prices fell before rising again. Gold is a strong hedge against the NIFTY when measured in daily frequency. In the last 10 years, this relationship had become stronger.

  5. The global minimum variance portfolio which only includes gold and NIFTY suggests a 63% weight to gold for target annual return of about 13%. As the target return increases, we see that the weight allocated to gold drops to about 3%. When one does a similar optimisation exercise including the S&P 500 returns, the global minimum variance portfolio suggests a weight of 46.5% for gold, 31.3% for NIFTY and 22.2% for SPX. Once international diversification is possible, the weight of gold has fallen by almost 16 percentage points. The confidence intervals, however, on these estimates are wide given the paucity of longer time-series data on returns.


Gold has provided the means to Indian households to overcome the difficulties associated with high inflation in a financially repressed macroeconomic environment with capital controls. Given the performance of gold, fixed deposits and NIFTY, and the difficulties of international diversification households have not been entirely unreasonable to hold gold in their portfolios. If policy has to channel household savings to more productive uses, it has to confront the underlying issues in the macroeconomic environment which make gold a preferred investment choice.


Patnaik, I. & Pandey, R. (2020). Four years of the inflation targeting framework. NIPFP Working Paper Series, No 325.

Patnaik, I. & Sengupta, R. (2021). Analysing India's exchange rate regime. India Policy Forum (forthcoming).

Patnaik, I. & Shah, A. (2012). Did the Indian capital controls work as a tool of macroeconomic policy? IMF Economic Review, 60, 439-464.

Sane, R. & Singh, M. (2022). Does financial and macro policy explain household investment in gold?, Dvara Research Working Paper Series No. WP-2022-01.

Siegel, J. J. (2014). Stocks for the long run: The definitive guide to financial market returns and long-term investment strategies. McGraw Hill.

Renuka Sane is a researcher at NIPFP, New Delhi. Manish Kumar Singh is a researcher at IIT Roorkee.

Thursday, January 20, 2022

Review of "The Rise of the BJP: The Making of the World's Largest Political Party" by Bhupender Yadav and Ila Patnaik

by Ajay Shah.

The INC emerged as the dominant party after independence. A similar phenomenon was seen in other countries, e.g. the PRI in Mexico. With the 2014 and 2019 Lok Sabha election results, the BJP emerged as a dominant force in Indian politics. For everyone interested in India, we need to learn more about the sources of this success, and about the nature of the BJP as a political party and as an organisation. Many books about the BJP have been written. I found the new book insightful and thought provoking; it has many new ideas, it made me think in new ways, it changed the way I see the world.

Many simple stories are told about the rise of the BJP, e.g. around nationalism. I have been skeptical about the extent to which these can be at work. After all, `National' is the middle name of the INC, and after winning the war in Bangladesh in December 1971, Indira Gandhi's INC rapidly collapsed into a political crisis in 1973-1975. Perhaps we underestimate voters, perhaps we are too ready to impute base passions upon voters. We need to think more about the forces at work.

An insightful path for thinking about the world is to see the role of organisations, of teams of humans that come together to achieve complex tasks. To understand an organisation, we must understand the mechanisms of information, incentives and power that bind the group of people together, and generate actions by each person that are adequately consistent with the objectives of the organisation. This way of thinking yields insights about for-profit firms, into the large magnitudes of resources that are used by Indian state organisations which fail to deliver on their organisational objectives, and also into political parties. It encourages us to think about deeper forces rather than concepts like popularity of individuals or the passions of the street. In the book, I found new insights into the BJP as an organisation.

In this organisation-oriented approach to the evolution of Indian party politics, we would tell a story where in 1947, the INC was the only game in town. It had built a complex organisation under highly adverse conditions, of British rule, of a low probability of personnel achieving personal benefits from political activism, and of limited resourcing owing to the fear of rich people. The organisation design of the INC, that worked 1919-1962, broke down thereafter. The arrangement of information, incentives and power, that worked for the freedom movement and for the early decades after independence, were no longer optimal for the later period. In parallel with this decline of the INC as an organisation, the book tells the story of how the BJP built a more effective organisation design.

A major theme of the book is political mobilisation of the masses. A hundred years ago, Gandhiji got people to get involved, to march on streets, to turn the other cheek when faced with state violence. In a lost age, people walked many kilometres to catch a tiny glimpse of Nehru and hear a raspy voice crackling in loudspeakers. The precise recipes for mobilisation change over the years. When the people lost interest in listening to politicians, there was not enough fundamental thinking; many organisation people tried to cover up for the loss of interest through manufactured crowds. When I have been in political rallies in India, I have often seen listless people.

The BJP innovated with an array of process methods for political mobilisation. Whether it is a yatra or a divas, they have developed clear names and process methods for a continuous heartbeat of political mobilisation that is now taking place all across the country. Regardless of the extent to which there is a base that is ideologically motivated, a lot of people are attracted by the drum beat of activity and a sense of belonging to a club. The massive scale of mobilisation activity all around the country helps pull in enough voters who would otherwise be non-ideological, to get to the 37% vote share.

There is an ironic link between INC welfarism and BJP mobilisation. The Indian left and the INC focused the union government towards welfare, and built the UIDAI system. The BJP has built a remarkable system for reminding the recipient of welfare, all around the country, that the subsidy has come from Mr. Modi. We marvel at the complexity of information processing, in getting precise and personalised facts out to millions of party workers who talk with hundreds of millions of voters. These were unintended consequences of the emphasis in the Indian state upon subsidies and not public goods.

In understanding India, we need to think more about the BJP. We have to look beyond the `crests of foam that the waves of history carry on their strong backs'. Bhupender Yadav and Ila Patnaik have written a valuable book which helps us understand the phenomenon and direct our curiosity into a new set of questions.

Monday, January 10, 2022

A cooperative liquidity window for mutual funds: A debate

Harsh Vardhan vs. Josh Felman and Ajay Shah.

Problem statement

There is a mismatch between the growth of the mutual fund industry versus the maturation of the financial markets (Shah, 2018). This generated trouble after the IL&FS default of August 2018, and will likely make trouble in the future also. Mutual funds are in an awkward place, promising liquidity to their customers but lacking a liquid bond market. Some years ago, the exchanges were getting better, and there was a path to building the Bond-Currency-Derivatives Nexus, so we could hope that progress on both paths would come along and solve the problem of the mutual funds. Now, both elements (exchanges and bond market reform) have a weak outlook. Is there a way out of this conundrum? Can a liquidity window for mutual funds be created, through which the problem of the mutual funds can be solved?

Why we need this and how it can work, by Harsh Vardhan

Indian debt mutual funds have grown rapidly over the past few years. Debt funds got a strong push after demonetisation. Currently the total assets under management (AuM) of debt funds are ~ Rs 15 Trn. There are individual debt fund schemes with AuMs of over Rs 1 Trn.

Debt funds invest their corpus in debt securities. In India there are two main classes of debt securities – those issued by the government including central and state governments and those issued by companies. Both have very poor liquidity. In the case of government bonds, while there is a somewhat liquid interbank market, a large part of the liquidity is in a single ‘benchmark’ paper which is typically a 10 year bond. When a new 10 year bond is issued, the old one ceases to be the benchmark and its liquidity drops sharply. The lack of liquidity is even worse with corporate bonds.

Most debt mutual funds promise high liquidity to their investors. For liquid and short duration funds, redemption proceeds are credited to the investor on T+1 while for most other debt funds it is T+2. MFs suffer the agony of liquid liabilities and illiquid assets. They manage this challenge through two pathways: (a) holding cash (typically less than 5% of AuM) and (b) having credit lines from banks.

There is considerable systemic risk in the Indian financial system, and situations where these two pathways prove to be inadequate. As an example, Franklin Templeton shut down six debt schemes when redemptions were unusually large and the bond market was unusually illiquid. The redemption pressure that they faced had nothing to do with their money management; it was induced by an episode of systemic risk.

In the anatomy of these recurrent debt market crises, one interesting feature is market failure in the form of a negative externality. Purely at random, when large redemptions show up at any one door, the selling that this induces drives down prices (as the overall market is illiquid and impact cost is high), which adversely impacts the NAV of all other funds. For any rational economic agent that sees the first inkling of higher outflows (either by watching flows or by looking at NAV changes), it is rational to yank all debt investments. This creates a channel through which selling by one fund induces redemptions for others.

Another way to locate these problems in the framework of market failure is to see that market liquidity is a public good. As an example, the liquidity of Nifty futures is non-rival (your consumption of liquidity does not adversely impinge on my access to liquidity) and non-excludable (everyone can access the Nifty futures market). When we build liquid markets, we are creating a public good.

All market failure is ultimately a problem of coordination between economic agents. We should look for collective action through which some of the problems of debt mutual funds can be addressed.

There are two solutions going around, for this problem of bond market illiquidity, which just don’t make sense. One strategy is for regulators to demand that mutual funds hold more capital. Mutual funds are not balance-sheet based entities and the journey of trying to amplify their equity capital requirements is conceptually wrong. Another strategy is for the central bank or the government through any other agency, to run a liquidity window for mutual funds. When the full consequences of this play out for mutual funds, it is likely to leave them worse off.

Is there a way out of this jam? I believe we can establish a Cooperative Liquidity Window (CLW), built by mutual funds for mutual funds -- with a small involvement of the state -- which can help solve this problem. For the people who are too used to state leadership in such things, we should point out that the Bank of England played this kind of function -- liquidity support for distressed banks -- for centuries as a purely private organisation; it was only nationalised in 1946. During the great depression in the US in the 1930s, J P Morgan, founder owner of the eponymous bank, orchestrated a bail-out of the American banking system through co-operative efforts of larger, stronger banks. These experiences are food for thought, and the design proposed here draws on this history.

For such an emergency liquidity support mechanism, we should establish five conceptual objectives:

  • It should use no public money.
  • There should be an extremely low amount of state coercion involved, in getting some MFs to participate in the CLW, and no role for the state in terms of regulation, management, appointments, or rule-making of the CLW.
  • The governance of the mechanism should be within the AMCs that participate in it; it should operate as a self regulatory organisation.
  • The capital to set up and operate the mechanism should be provided by the participants; it should operate as a mutual co-operative; rules of access to the mechanism should be defined by the participants.
  • It should be only an emergency liquidity support system. The criteria for defining an emergency, and the extent of support that can be provided to individual entities, should be defined by members as the by-laws of the mechanism.

How would the proposed CLW work?

  1. The participating AMCs would create a vehicle by contributing to the equity of the vehicle. The vehicle could be set up as a trust or any other legal form that minimizes transaction costs.
  2. Some members would be coerced by SEBI (the largest firms adding up to perhaps 75% of the category AUM) and others would be voluntary participants (those who would like to benefit from its services even if not forced by SEBI). Apart from this, there would be no role for the state power in the CLW, in any fashion.
  3. The equity contribution of each MF should be determined by its debt fund corpus. For example, all MFs with debt fund AuM of over Rs 1 Trn might contribute Rs.5 Billion, those with an AuM of Rs 0.5 Trn to 1 Trn might contribute Rs. 3 Billion, and so on. The CLW governance must write the specific rules of equity contributions.
  4. The CLW would leverage up and create a corpus that supports a securities repurchase (repo) operation in the event of stress.
  5. When a member AMC faces severe redemption pressure (way beyond what is deemed normal by the members collectively as defined by the governance rule of the CLW) it would pledge its eligible debt securities to raise short term liquidity. This would be akin to a bank accessing the repo window in the event of a run.
  6. This window would also accept liquidity from members like a normal repo window.
  7. The rules regarding the extent of liquidity support provided, the tenure, the bid-ask spread, acceptable securities as collateral and hair cuts, etc. would all be defined by the members collectively.
  8. The CLW would operate as a not for profit entity or provide a modest return on equity to the member shareholders.

Currently there are ~45 AMCs in India. If we assume that 40 of them participate, each contributing an average of Rs 1 billion of equity capital, we would have Rs.40 billion of equity capital in hand. Assuming 4x leverage, the resources of the organisation would be Rs.160 billion. It is easy to go to much higher values.

The CLW should support participating MFs only in dealing with liquidity issues and not credit risk issues. This should be enshrined in the governance and operating rules of the CLW. Considering that the CLW will be managed by the AMCs themselves, who are all deeply informed players, it is reasonable to assume that they will be able to differentiate between liquidity and credit issues, Further, at a security level, the CLW will determine eligibility of securities and haircuts applicable. This will ensure that even in providing liquidity support, credit issues are not ignored. The rules of operation of the CLW should be well known, ex ante, so all the participating MFs face a predictable environment.

Let us simulate how the Franklin Templeton crisis might have played out, if this CLW was in place. The issues faced by Franklin Templeton’s shuttered debt funds schemes were purely liquidity issues: Over the last 18 months or so, they have returned upwards of 90% of the AUM at the time of shutting the schemes. Further, the return on these funds during the time was comparable with other funds in the same asset class. As the Franklin Templeton crisis was a liquidity crisis and not a credit crisis, the CLW would have been in play to support the liquidity crisis at Franklin Templeton. With illustrative assets of Rs.160 billion, it would have had the financial depth to deal with this situation, where all six affected funds put together had a total AUM of about Rs. 250 billion.

This design is not a substitute for a deep and developed bond market. A liquid market for securities is always the best solution to deal with any liquidity issues. But we face a problem today: We have a situation where the debt mutual funds corpus has grown very significantly and yet the bond market, especially the corporate bond market, remains very illiquid. The CLW is a mechanism where enlightened self interest can create a cooperative which helps the sector deal with a dangerous liquidity challenge.

In my proposal, there is only one use of state power: I feel SEBI should force large debt funds adding up to (say) 75% of the industry AUM to be members of the CLW, and force non-members to communicate this lack of membership in their customer-facing communications. The justification for this use of state power lies in the extent to which this would help reduce systemic risk (innocent bystanders being adversely affected in the next mutual fund crisis). This coercion addresses the free rider problem, where any one MF may derive benefits from the more stable mutual fund / bond market system, but try to be stingy in not paying for this stabilisation. Apart from this, I propose there should be no state involvement / control / regulation of the analysis, design, staffing, rule-making or operation of the CLW.

All members would have the self interest of making the facility work well -- as they are both owners and customers -- and they would thus exert governance. This is a problem where a cooperative solution works well. There is no market failure in the working of the CLW, and thus no role for regulation or any other involvement of the state.

There is one limitation in this design. The CLW will not be adequate if there is a full fledged financial crisis, such as what was experienced in 2008. In that case, the CLW would become one more element of the financial system that would have to be analysed in the crisis management at MOF.

There is no solution which can cover up for the lack of a bond market, by Josh Felman and Ajay Shah

Bond mutual funds are facing a serious dilemma. On the one hand, they promise investors liquidity, the ability to withdraw money at short notice. But on the other hand, they hold assets that are largely illiquid and difficult to sell. As a result, they face a mismatch between what they promise and what they can actually deliver.

Investors typically pay little attention to this mismatch, because most of the time it isn’t apparent. That’s because on most normal days, the investors who want to withdraw their money are more than counterbalanced by the many investors who are putting their money into the funds. It is only when this balance is disrupted, when a large proportion of investors “run” to take their money out, that mutual funds must sell their assets and the liquidity mismatch is revealed (Sane, Shah, Zaveri 2018).

Of course, banks face a similar mismatch problem. They, too, promise that depositors can withdraw funds easily, even as they hold assets (loans) that are even more illiquid than bonds. But in the case of banks there is a firewall against runs, namely the deposit insurance provided by the Deposit Insurance and Credit Guarantee Corporation. With this insurance, depositors know that their deposits are always safe. Accordingly, they have no incentive to rush to banks to withdraw their money, even if they find out that their bank’s loans have turned bad.

Could a Cooperative Liquidity Window (CLW) provide a similar firewall for debt mutual funds? At first blush, it seems like it would. After all, if the problem is that bonds are illiquid, then it seems logical to create a window that would allow funds to exchange bonds for cash. Moreover, the CLW proposal has some particularly attractive features. It would be a private initiative, involving no public money; and it would be employed only in emergencies, reducing the risk that it would distort financial markets. It avoids state failure by having no state involvement, apart from coercing large mutual funds (MFs) to become members.

But we see difficulties in translating this concept into a working liquidity facility. Consider the following problems with the proposal:

  • The illustrative corpus – Rs 160 billion – is relatively small, about the size of a single mutual fund group (such as Franklin Templeton). So, if several groups get into trouble at once, there won’t be enough liquidity to go around. In our thinking about the CLW proposal, we should think of something more like Rs.0.5 trillion of dry powder.
  • The proposal envisages that lenders will be willing to purchase Rs 120 billion of CLW debt. Would they really be willing to lend so much money to an unknown institution engaged in the risky activity of buying illiquid debt? And even if they did, what interest rate would they charge?
  • Assuming that lenders charge a relatively high rate of interest, how will the economics of every day operation of the CLW work out? In most years, its assets will simply be sitting in safe but low-yielding government securities, so it will suffer from a negative cost of carry. That means it will need to make compensating large profits on its occasional liquidity activities, by buying debt at very low prices and selling at high prices.

Let’s assume optimistically that these problems can somehow be overcome. We think the proposal still won’t work, because it has an important flaw: it is based on the premise that mutual funds facing runs are merely suffering from liquidity problems. But things are usually not this simple. Most runs involve credit risk issues, which means that there is a danger of defaults, which could saddle the CLW with large losses. And this makes all the difference. To be concrete: we don’t agree with Harsh’s relatively sanguine assessment of the Franklin Templeton story.

Runs on mutual funds follow a standard sequence. Initially, investors find out that a large bond-issuing firm is in serious trouble. In response, they start examining the portfolios of their mutual funds. And when they find the funds that are heavily exposed to the teetering firm, they run. This is precisely what happened in the case of Franklin Templeton. This firm invested aggressively in risky assets: even its “safe” Ultra Short mutual fund invested more than one quarter of its portfolio in assets rated A or below, rather than the AAA assets that such funds would normally hold. In addition, Templeton invested heavily in zero coupon bonds issued by Yes Bank. So when financial markets turned risk averse and Yes Bank ran into trouble, investors fled the Templeton funds.

In restrospect, it turns out these investors were correct: there was indeed credit risk. It is now almost two years since Templeton shut six of its funds, and the 300,000 investors in these funds still haven’t received all of their money back. Even if investors are reimbursed eventually for their full nominal amounts, they have suffered an opportunity cost. Inflation will have eaten away at the real value of their money, and they will have lost the opportunity to use the funds to meet last year’s expenses (such as Covid hospital bills) or make other investments. In particular, they were unable to place this money in the stock market, which has nearly doubled since withdrawals were frozen in April 2020.

The complexity of correlations and asymmetric information about credit and liquidity risk means that the proposed CLW will run into three problems:

  1. It could distort the incentives of mutual funds. Right now, mutual funds face market discipline. They know that if they invest in risky, illiquid bonds, they will get into trouble if investors panic and demand their money back. So most mutual funds – unlike Franklin Templeton – try to confine their purchases to safe, relatively liquid bonds. Precisely for this reason, most funds were able to survive the runs on Templeton largely unscathed.

  2. This discipline could disappear if a liquidity window is established. In this case, mutual funds will feel more free to buy risky, illiquid bonds. In fact, they might try to buy as many such bonds as possible. After all, risky bonds carry higher interest rates, so mutual funds that buy them will be able to advertise higher returns. And if things go wrong, these funds will always be able to pass the problem onto the CLW.

    Of course, they will not be able to transfer all their risk, since they have contributed to the equity capital of the CLW. For example, if they own 10 percent of the CLW, they would have to bear 10 percent of any losses faced by the CLW. Still, they might be able to pass on 90 percent of any potential losses. And this is enough to distort incentives.

    So, the CLW will try to stop such behavior, by limiting the types of debt they will buy. But this will not be easy.

  3. The CLW will find it difficult to use rules or discretion to determine what types of debt are eligible for the facility. If the CLW tries to use rules, that is to define the types of debt that they will buy, firms will employ ‘financial engineering’ to create debt that nominally conforms to the rules but in fact remains highly risky. This was how the US wound up in a financial crisis in the mid-2000s: because firms created synthetic bonds that were rated AAA but were actually highly risky. Closer to home, there are also examples of bonds that were deemed safe – like the AAA-rated bonds issued by ILFS – that nonetheless ended up defaulting.

  4. If the CLW consequently eschews rules and says instead that it will handle episodes using case-by-case discretion, users will fear that they cannot rely on the CLW, since such an approach would mean that other members could veto their attempt to unload their bonds to the facility.

    We request the reader to not envision peaceful times, when some trades are taking place and spreads are fine, but instead to think of times when spreads are high, recent trades have stale prices, and a pall of fear hangs over the market. Consider a situation like late 2008, when bond prices were plummeting. At that time, buying bonds was considered a foolhardy act, comparable to ‘catching a falling knife’. Would a consortium of mutual funds really have the courage to intervene in this situation?

    It is important to recall that the shareholders of the CLW are, themselves, bond market traders. They are the ones refusing to buy the bonds at any price on their own books – that is why the bonds are illiquid! So why would they allow their agent (the CLW) to do this? Consider the calculation of the other firms. If the CLW purchases the bonds, and the bonds default, the cost will have to be borne by the members of the cooperative. In contrast, if the CLW doesn’t purchase the bonds and the mutual fund is forced to shut down, the other firms might even benefit. Recall how the rest of the financial system `ganged up’ against LTCM in 1998, as they stood to gain from declining prices of LTCM’s positions.

  5. Even when the CLW is willing to purchase bonds, it will not be easy to agree on a price. When bonds are illiquid, their price is not known to anyone. The distressed mutual fund will plead for a high price – and it will have a say in the running of the CLW. But other shareholders would object, as they would not want to suffer losses. So the Board of the CLW will work themselves into a tizzy trying to agree on a sale price.

  6. Let’s assume the majority on the Board gets to decide the price.They will face an inherently difficult problem. Because the bonds are illiquid, the Board will need to guess the true value of the bonds on offer. And because the CLW would be running with an elevated leverage ratio, the consequences of guessing too high would be disastrous. At a 3:1 debt-equity ratio, a 30 percent fall in the price of the CLW’s assets would wipe out the entire equity capital. So, the CLW will need to offer a low price.

These three problems would haunt the CLW. It might freeze up with decision-making paralysis precisely at the times when decisive action is most required. Alternatively, it might proceed, but with excessive caution. It might purchase only select assets, meaning that many mutual funds facing runs would find the liquidity window closed. And even where the CLW was willing to purchase their assets, it is likely to offer a low price, which would prove ruinous to already-stressed MFs. These features interfere with the stated function of the CLW.

Many people remember stories from the Panic of 1907, where one person -- J.P. Morgan -- was the buyer of the last resort. This mechanism worked because Morgan was a self-interested profit-maximising individual who made a decision to use dry powder. He drove a hard bargain and purchased assets very cheaply, and turned a tremendous profit. He took enormous risk in the process, for he could have gone bankrupt himself. And, it could easily have been that the demand for liquidity insurance was bigger than his balance sheet, in which case his intervention would have gone badly wrong. For each J.P. Morgan who is celebrated for a 1907 event, there are many others who failed at various moments in history. We dream that a CLW will be able to think and act like J.P. Morgan, but its shareholders + board + management would find it impossible to have the entrepreneurial and risk-taking acumen of an individual. This is perhaps why we don’t see such a co-operative liquidity window in the world today.

A final point. We have stayed within the construct of no state intervention other than forcing MFs adding up to 75 percent of category AUM to become members. We fear, however, that when faced with the difficulties described above, the Indian state will not hold back even though there is no market failure. Once this happens, the familiar litany of state failure would commence.

We see this debate as a special case of a general principle. An economic policy strategy that addresses the surface symptoms is unlikely to work; the scope for financial engineering in public policy is very small. For a policy to succeed, it needs to engage in a root cause analysis, to address the underlying economic problem. If the problem is that investors are running from bond funds because they are inherently illiquid, then the only way to solve this problem is by reducing the mismatch between what these funds promise and what they can actually deliver. And that requires some fundamental financial reforms.

Hence, we would argue that the future of Indian finance remains along the strategy of the Financial Sector Legislative Reforms Commission (FSLRC). Once this is done, the need for a liquidity window will gradually fade away.


Mutual funds with feet of clay. Ajay Shah, Business Standard, 22 January 2018.

Runs on mutual funds. Renuka Sane, Ajay Shah, Bhargavi Zaveri. The Leap Blog, 12 October 2018.

Monday, December 20, 2021

The footprint of union government procurement in India

by Anjali Sharma and Susan Thomas.

Difficulties of government contracting are one important source of low state capacity. When capabilities in government contracting are low, problems that involve purchase from the private sector prove to be daunting (e.g. Covid-19 vaccines), and the decisions of make vs. buy are distorted (e.g. arms manufacture by the Indian state). This has motivated research in the field of government contracting. Along with a few other fields, government contracting constitutes a `horizontal' field which influences state capacity in all specialised domains such as defence, health, etc.

A foundational fact of this field is the magnitudes involved. A few researchers have worked on the problem of measuring the size of government procurement. In a recent paper, The footprint of union government procurement in India, we develop an estimation strategy based on public finance data that is available in the public domain, for the union government and for central public sector enterprises ("CPSEs").

We analyse the fiscal documents produced by the ministries and public sector enterprises of the union government: the `Detailed Demand for Grants' (DDG) submitted by various departments and ministries to the Ministry of Finance of the Union Government and the annual statement of accounts published by the Controller General of Accounts (CGA). Object head level data is collected from the DDGs, the heads that constitute public procurement are identified. and each expenditure is classified as procurement or non-procurement. Procurement expenses are further classified into procurement expenses of goods, services and works, and operating or revenue expenditure and capital expenditures. This results in an estimate for the total operating and capital procurement expenditure for a given ministry or department in a year.

This methodology generates estimates for :

  1. Total procurement in a year
  2. The magnitudes which are operating expenditures vs. capital expenditure.
  3. The procurement magnitudes in goods, services and works.

In this work, some records are not amenable to the approach used and are excluded from the analysis. This could contain procurement activity, which is missed out. Therefore, the resulting estimates are biased on the downward side.

The paper uses 2016-17 as an example where these methods are applied. The main findings for 2016-17 are:

  1. The total purchases of the union government are about Rs.3.9 trillion, and the CPSEs additionally purchase Rs.13.8 trillion. These add up to around 12% of GDP.
  2. Of the total purchases by the union government, Rs.2.2 trillion are capital goods and the remainder are operating expenses. The CPSEs added Rs.2.2 trillion of fixed assets. The remaining Rs.13.67 trillion were operating expenses. This indicates that a little over 13% of public procurement by union government and CPSEs are capital expenses.

This research fits into the emerging literature on government contracting. Obtaining a sense of the empirical magnitudes involved is a critical building block of this field. We build on, and enhance, the measurement of public procurement which includes the preface to the draft `Public Procurement Bill, 2012', work by the research group at Consumer Unity & Trust Society (CUTS, 2012), and research work based on the World Bank Global Public Procurement Database (Djankov et al 2016).

Alongside this (conservative) estimate of union government procurement activities at about 11% of GDP, there are purchases by state and city governments. Khan (2012) places this total at around 30% of GDP. The magnitudes involved underline the importance of this field, of measuring, diagnosing, and improving the capabilities of government in contracting.


CUTS (2012), International, Government Procurement in India Domestic Regulations and Trade Prospects, CUTS, October 2012.

Simeon Djankov, Asif Islam and Federica Saliola, How large is public procurement in developing countries?, Peterson Institute for International Economics blog, November 2016.

M. H. Khan, Public procurement issues with Government of India, Presentation at LBSNAA, March 2017. 

Anjali Sharma and Susan Thomas, The footprint of union government procurement in India, xKDR Working Paper 10, November 2021


Anjali Sharma is Head of Strategy and Regulatory Affairs at National E-Governance Services Ltd. Susan Thomas is Research Professor of Business at Jindal Global University and Researcher at xKDR Forum, Bombay.

Tuesday, December 14, 2021

Bringing gender equality in the Hindu Succession Act: An overdue reform

by Devendra Damle and Ajay Shah.

One element of the gender problem in India is the Hindu Succession Act, 1956 (HSA). This law governs intestate succession for Hindus, Buddhists, Jains and Sikhs (i.e. 80% of Indian citizens), and discriminates against women. Under the rules governing the devolution of property, the relatives of a woman's husband have a stronger claim to her property than her parents and siblings. This is not true of the property belonging to a man. This unequal treatment is inconsistent with equal treatment by the state as envisioned in Articles 14 and 15(1) of the Constitution of India.

This question has just come back into prominence. In an ongoing case — Kamal Anant Khopkar vs Union of India [WP(C) 1517/2018] — the Supreme Court of India issued an order on 7th December 2021 directing the Solicitor General to provide the Union Government's view on these discriminatory provisions (See: here). A brief by the Amicus Curiae — Meenakshi Arora — highlighting the discriminatory provisions prompted the Supreme Court to take this action. The bench noted that this discrimination has remained in the statute books for a long time. The Court also noted that a judicial and/or legislative intervention is necessary to remedy it.

The discriminatory provisions in the HSA have profoundly impacted many Hindu women. Some examples help us understand the unfairness in play:

  1. Consider an ongoing case in the High Court of Punjab and Haryana (See: here). One Devina Bhardwaj and her husband Chetan Bhardwaj jointly purchased a home in Gurgaon in 2014. Devina bore most of the expense. Both contracted COVID-19 in early 2021. Chetan died intestate in April 2021. As a result, his property devolved to Devina and his parents in equal parts. Shortly after that, Devina also died intestate. Devina's mother-in-law sought to gain access to Devina and Chetan's assets (estimated to be worth INR 2.7 crore), a significant portion of which were Devina's self-acquired property. The concerned revenue department officials declared her the sole-legal heir to Devina's assets. This is in line with the scheme of devolution under the HSA.
    Devina's mother has filed a petition in the High Court of Punjab and Haryana claiming her right to Devina's share of assets, and challenging the constitutional validity of the relevant provision of the HSA. The High Court has issued a notice to the Union Government seeking its reply. (See: here)

  2. The Supreme Court dealt with a similar issue in the landmark case Om Prakash v. Radhacharan [(2009) 15 SCC 66]. In this case, one Narayani Devi's husband died shortly after their marriage. Her in-laws banished her from the matrimonial home. She returned to her parents, who supported her and provided her with an education. She went on to amass a significant amount of property of her own, and died childless and intestate. Her mother and her late husband's nephews filed competing claims over her self-acquired property. The matter eventually reached the Supreme Court. The Supreme Court, relying on a plain reading of the HSA, granted all of Narayani's' property to her late husband's nephews, while her mother received nothing. The story would have been very different if Narayani had been a man.

In an NIPFP working paper, we describe how devolution schemes under the HSA differ for men and women. We describe how courts have interpreted these provisions, and their validity under Articles 14 and 15(1) of the Constitution of India. We describe the previous attempts at reform and where they have fallen short. We propose an amendment to the HSA to make it more gender-equitable. Several other authors have pointed out the disparity between how a man's and woman's property is treated under the HSA, and the consequences of this discrimination (See: here and here).

Devolution of property under HSA

The HSA prescribes different rules of devolution for property belonging to men and women. The devolution scheme for a man is governed by Section 8 of the HSA. It states that Class-I heirs — his mother, wife, and lineal descendants — have the first claim to his property. Class-II heirs — his father, siblings, lineal descendants of his siblings, and the siblings of his parents — have a claim if there are no surviving Class-I heirs. The Schedule to the Act contains a detailed list of heirs in each class and sub-class. All property belonging to the man devolves as per this scheme, and it largely keeps all the man's property within his natal family.

The devolution scheme for a woman's property is different. Section 15(2) applies to any property the woman inherited from her husband, her husband's family and her parents. Under Section 15(2)(a), if a widow dies childless, any property she inherited from her husband or his family returns to the heirs of the husband. 'Heirs of the husband' refers to the list of heirs given in Section 8. Section 15(1) gives a general devolution scheme, which applies to all other properties. Under Section 15(1), a woman's husband and children have the first claim to her property. The heirs of her husband are next in line, followed by her parents, followed by other heirs of her parents.

Under Section 15(1), if a widow dies childless, the heirs of the husband have a stronger claim than her parents and siblings over all her property that she did not inherit from her parents. This includes all self-acquired property, gifts, bequests through wills, and property inherited from siblings and other relatives. There are no reciprocal provisions in the devolution scheme for a male deceased's property. There is no scenario where a woman's family has a claim over the husband's property.

Constitutional challenge to Section 15 of the HSA

Article 14 of the Constitution of India guarantees all persons equal treatment under the law and Article 15(1) explicitly prohibits the state from discriminating between citizens solely based on religion, race, caste, sex, or place of birth. This means the state cannot make laws that treat citizens differently solely based on the aforementioned distinctions, except in specific circumstances. It appears clear that the provisions of the HSA — which are part of Hindu personal law — discriminate between men and women, but does this violate Article 14 and 15(1)?

In Mamta Dinesh Vakil v. Bansi S. Wadhwa [LNIND 2012 BOM 748] the Bombay High Court termed this unequal treatment unconstitutional. It concluded that the discrimination in HSA is solely based on sex and cannot plausibly be said to serve any other rational purpose. The Court, however, referred the question of constitutionality to a larger bench, which has yet to be constituted. While the question of constitutionality may not be settled, judgments such as Om Prakash v. Radhacharan highlight the fact that discrimination under HSA is, in the least, extremely unfair to women. Specifically, Hindu widows with no surviving children.

India's international commitments

The discrimination under HSA falls afoul of India's commitments under the United Nations Convention on the Elimination of All Forms of Discrimination Against Women (CEDAW). India became a signatory to the CEDAW in 1980, and the Parliament ratified it in 1993. Removing gender-based discrimination in property-related legislation is one of the core requirements of the CEDAW.

The Supreme Court has, in multiple cases, ruled that the legislature, administration and judiciary must give due regard to India's international commitments under treaties such as the CEDAW. In C Masilamani Mudaliar & Ors v Idol of Sri Swaminathaswami Thirukoil & Ors [(1996) 8 SCC 525], the Supreme Court ruled that the obligations under CEDAW to eliminate gender-based discrimination in legislation are binding on the government. The Supreme Court has made similar rulings in several other cases, such as Madhu Kishwar & Ors. v State of Bihar & Ors. [(1996) 5 SCC 125], and Githa Hariharan and Ors. v Reserve Bank of India and Ors. (MANU/SC/0117/1999).

Past attempts at reform

There have been some attempts at reform in the past, but so far, they have been piecemeal, limited in their scope, and unsuccessful. The Law Commission of India, in their 207th Report (2008) and their Consultation Paper on Family Law (2018), recognised the issue of disparity in the treatment of men's and women's self-acquired property and proposed amendments. However, instead of instituting a common devolution scheme, they proposed adding another subsection to Section 15 to govern the devolution of a woman's self-acquired property.

The Law Commission's proposal has three issues. First, it does not define self-acquired property. Second, it retains Section 15(2)(b), which requires the property that a woman has inherited from her husband to be passed to the husband's heirs if she dies childless. Third, it ignores the fact that the heirs of the husband will be preferred over the woman's natal family if she has inherited the property in question from relatives other than her parents, such as her siblings or grand-parents, since it will continue to be governed by Section 15(1).

Two private member's bills — the first introduced by Anurag Singh Thakur in 2013 and the second introduced by Dushyant Chautala in 2015 — also sought to resolve this issue. However, both these proposed amendments suffered from the same problems as the proposal of the Law Commission. What is necessary is a comprehensive reform of the devolution scheme in the HSA.

Better examples before us

There are two existing Indian succession laws that do far better than the HSA in terms of gender-equality. Devolution schemes in the Indian Succession Act, 1925 (ISA) and the Goa Succession, Special Notaries and Inventory Proceeding Act, 2012 (GSSNIP) are gender-neutral. ISA applies to Christians and Parsis, and GSSNIP applies to all persons domiciled in Goa. The British Colonial Government enacted the ISA in 1925. The progenitor of the GSSNIP — the Portuguese Civil Code — was enacted in Goa in 1870. The ISA is still on the statute books, and the GSSNIP replaced the Portuguese Civil Code in Goa in 2018.


The provisions of the HSA discriminate against Hindu women by prescribing different rules for the devolution of property held by men and women. These provisions unfairly prioritise the husband's family over the woman's own family, even when the woman has acquired the property in question through her skill or effort. The legislation is a product of an era when it was inconceivable for Indian women to own and acquire property. However, these biases continue to be perpetrated upon Hindu women in India today. This discrimination is probably ultra vires of Articles 14 and 15 of the Constitution of India. It violates India's commitments under the CEDAW. It is unfortunate that the Parliament has allowed this discrimination to persist despite knowing of the existence of more equitable laws such as the GSSNIP and ISA in our own country.

The Supreme Court's notice to the Union Government is an indication of India's evolving jurisprudence on questions of gender-equity. This is an opportunity for the Court and the Parliament to, once and for all, eliminate discrimination in a law that affects a majority of Indian women.


  1. Gender discrimination in devolution of property under Hindu Succession Act, 1956 (NIPFP Working Paper No 305), by Devendra Damle, Siddharth Srivastava, Tushar Anand, Viraj Joshi and Vishal Trehan, May 2020.
  2. Equal treatment for women on inheritance, by Ajay Shah, in Business Standard, 2020.
  3. A law that thwarts justice, by Prabha Sridevan, in The Hindu, 2011.
  4. Childless Hindu widow's death leads to flawed property succession: Supreme Court, in The Times of India, 2021.
  5. HC seeks Centre's reply on petition challenging validity of section 15 of Hindu Succession Act alleging gender discrimination, in LegitEye, Aug 2021.
  6. Proposal to amend Section 15 of the Hindu Succession Act, 1956 in case a female dies intestate leaving her self acquired property with no heirs (Report No 207), by Law Commission of India, 2008.
  7. Consultation Paper on Family Law, by Law Commission of India, 2018.
  8. Manju Narayan Nathan v. Union of India and another [CWP No. 14305 of 2021 (O&M)], High Court of Punjab and Haryana, August 2021.

Devendra Damle is researcher at the National Institute of Public Finance and Policy. Ajay Shah is researcher at xKDR Forum and Jindal Global University.

Thursday, December 09, 2021


Calling for applications: Post Graduate Programme in Public Policy at the Takshashila Institution

A pioneer in modern public policy education in India, the Takshashila Institution’s Post-Graduate Programme in Public Policy is designed for working professionals.It is targeted at dynamic individuals who wish to enter the growing professional sphere of policy, public affairs, governance and leadership, while pursuing their current occupations. The programme is academically rigorous and attuned to the current requirements of industry, media, social sector and politics. The PGP equips participants with a core set of skills in policy evaluation, economic reasoning, effective communication and public persuasion. Its emphasis is on how these skills can be applied to formulate and analyse policies in a variety of settings.

Submit your applications by 8th January