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Thursday, November 30, 2006

India's trend GDP growth rate : 9% or 7%?

A short while ago, I wrote a BS article and blog posting about the remarkable GDP growth numbers that have been coming out. This was discussed on the Indian Economy Blog at the time and then again recently. The subject is particularly topical because of today's data release showing a fantastic 9.2% GDP growth (WOW!).

What is at stake is the distinction between trend and cycle. All market economies experience a business cycle. Even though Chinese data shows virtually no business cycle fluctuations to speak of, I'm pretty sure that a globalised market economy like China experiences a business cycle; it's just not being captured in the data properly.

How do you define trend and how do you define cycle? There are many ways of separating trend from cycle. I like a simple heuristic: I call the average growth over the latest 10 years to be the "trend growth rate". Ten years is a long enough period that it averages over ups and downs. The deviation from this trend is what I call "cycle". There are other ways, and in my judgment the answers don't differ by too much.

Going by this definition of trend, we find that from 1979 till 2006, trend GDP growth ticked up slowly from 3.5% to a shade below 7%. This is a very impressive achievement. But it highlights one important fact. All the wonderful things at work from 1979 to 2006 generated an improvement of 3.5 percentage points over an aeon (27 years). And there were a host of wonderful things at work in this period. The savings rate went up. The size of the workforce rose nicely (the so called `demographic dividend'). Many improvements in the economic policy framework took place - I think it's fair to say that the policy environment is completely transformed between 1979 and 2006. All these wonderful changes added up to a gain in the trend rate of 3.5 percentage points over a 27 year period.

I am optimistic about further improvements in the savings rate. I am optimistic about further improvements in the quantity and quality of labour. I am cautiously optimistic about the possibility that the economic policy might actually get a bit better. I expect the trend GDP growth in India will accelerate beyond 7%. (See these materials if you are curious about the past and future acceleration of trend GDP growth). But even the most adventurous optimism in these regards does not support an expectation of a sudden escalation of trend growth. These things only change slowly. GDP is a massive enterprise pumping out Rs.30 trillion per year. That is a lot of money; it is a vast enterprise of a great deal of producers. It does not change quickly. If we add 100 to 200 basis points to trend growth over a decade, I would say it's a grand achievement.

Further, I do not treat a further escalation of trend GDP growth as inevitable destiny. The world economy could have a nasty downturn. Indian economics and politics could go awfully wrong. Many countries have done very well in short spells and then run afoul of problems and thus faced growth decelerations. Think about it - what if the UPA does something on reservation which ignites blood in the streets like the Mandal Commission period? We in India have lived in a great period, where trend growth has accelerated for 27 years, and it's been a great ride. But we should not expect a further acceleration of trend growth as inevitable destiny.

Some ask whether it's fair to talk about trend growth at 7% when the latest quarter has shown 9.2%. Is an estimate of trend growth of 7% sensible, when we've got one quarter growth of a full 2.2 percentage points above it? My response lies in `procyclical policies' that India is following. The way India works, capital flows do well when things are good, RBI cuts real interest rates when capital flows come in, the government spends more when things are good. All this acts as a stimulant and exaggerates the good times. I say this with great sadness because all these aspects will exaggerate the bad times when they inevitably come. India has a poor macro policy framework. What Indian macro policy does is to magnify the cycle, to exaggerate the fluctuations. This is part of why we see a one-quarter result of 9.2% at a time when the trend is more likely to be ~ 7%.

Some say that I shouldn't worry about the gloomy outlook for world GDP growth when India and China are doing so well - these countries can power the world economy. The data doesn't support that. China is 5% of the world's GDP and India is 2%. The numbers just aren't big enough to counteract sluggishness in the US, Japan and Eurozone, all three of which are likely to turn in anemic numbers in the next 12 quarters.

Update (2006-12-13): Akash Prakash has a main piece in Business Standard today on these issues.

Thursday, November 23, 2006

SEBI `disgorgement' order that isn't

SEBI has passed a `disgorgement' order against depositories and DPs in the `IPO scam'. For the background, my earlier blog entries on the `IPO scam' are here and here.

There are all kinds of slippery issues of language, on this issue, that require care. The IPO `scam' wasn't much of a scam, it was a mountain made out of a molehill caused by a wrong policy in the first place. And, this SEBI order fails to achieve `disgorgement' of unlawful gains - it merely inflicts fines upon parties who made no unlawful gains.

Jayanth Varma has an excellent blog entry on this order. An edit in Business Standard says:

However, several questions arise in the present case. First, the money to be paid to retail investors who lost out has to be taken from those who enjoyed unwarranted gains, i.e. those who `engorged' in the IPO scam. These are not the market intermediaries whom Sebi has focused on, namely the depositories and depository participants (DPs), who only got their regular fees and nothing more. These intermediaries may be guilty, as Sebi has already determined, of violating the `know your client' norms, but they are not the ones who `engorged' and who therefore should now be asked to disgorge. The `engorgement' was done by the dummy investors in whose names shares were allotted, and it should be possible to take those shares and sell them in the market, with the loss that has been calculated by retail investors being paid to them, and the balance returned to those who got the allotment. The logical flaw in Sebi's order is in mixing up a penalty for misconduct (which it can legitimately levy on market intermediaries who err) with disgorgement; both are a financial drain, but the logic of each is quite different.

The Rs 116-crore question is what happens to the disgorgement fund, since the money has been made payable to Sebi. In the US, the SEC set up the Fair Funds for Investors in 2002 to benefit investors who have lost money because of illegal practices of other investors or companies, and fair funds are now playing an increasing role in enforcement. But even in the US, the aggrieved parties have received little money despite a provision for the appointment of an administrator. The task of identifying the affected parties involves detailed work, but should not be shirked for that reason. The outcome to be avoided is Sebi pocketing the money - as the tax authorities do when they recover excise duties illegitimately collected from customers by companies. That would be very unjust engorgement.

The Economic Times editorial says:

Sebi’s final order on the case is still awaited. Its earlier order of April 27, 2006 is an interim one. Some respondents have gone on appeal against the findings and their appeals are pending at various stages. In such a scenario, to come down so heavily on intermediaries when they have not gained any monetary benefit defies logic.

Neither the depository nor the DPs have derived any ‘ill-gotten gains.’ That gain has been made by the scamsters. However, Sebi says, “it is expected the intermediaries will take prompt steps in their own interest to pursue other wrongdoers and perpetrators of the illegal actions and attempt to collect sums from such individuals/companies.” Given the nature of the legal system, that will be a Herculean task. Moreover, it is cumbersome to determine the identity of those who presumably lost out in the allotment process or to quantify the extent of loss.

Sebi’s order justifies its penalty by claiming that “each intermediary in the hierarchy of intermediaries contributed cumulatively to the market abuse”. But if CSDL and NSDL are guilty of failing to police the DPs, then Sebi as the regulator at the top of this hierarchy can also be accused of sleeping on the watch. Instead, it has chosen to gloss over its own culpability and that of the RBI, which as the banking regulator has constructive responsibility for the mistakes of bank DPs, and pinned the blame entirely on market intermediaries.

If disgorgement was the goal, careful detailed work is required in five steps:

  1. Reconstructing the orders placed in the IPO auctions,
  2. Identifying the people (the Roopalbens) who obtained unlawful gains,
  3. Identifying the people who would have won allocations in the auction if these unlawful bids were removed;
  4. Extracting money from the Roopalbens who obtained unlawful gains;
  5. Transferring this to the people who would have won allocations.

Each one of these steps is hard work, but it is the hard work that a regulator has to do if it aspires to achieve disgorgement. SEBI has not done any one of these fives steps. It has hence failed to achieve disgorgement of unlawful gains. Plucking a number out of thin air - a fine of Rs.45 crore - and inflicting it upon a conveniently accessible NSDL - does not achieve disgorgement.

Update: There was an ET debate on this, with two good pieces by Rajiv Luthra and Somasekhar Sundaresan.

Wednesday, November 22, 2006

Big picture speech of financial sector policy reform by Paulson

In recent weeks, Bloomberg & Schumer have talked about the loss of competitiveness of New York as a financial centre. I have also felt the centre of gravity shifting from New York to London in the post-2001 period. On 20th, Paulson did a great speech on these issues. It makes the obligatory claims that New York is still a great financial centre, while talking about the reforms agenda in a statesmanlike fashion. The Ministry of Finance in India doesn't write speeches of this quality. In what follows ahead, I have extracted the most informative paragraphs of his speech. The boilerplate:

Our capital markets are the deepest, most efficient, and most transparent in the world. We are the world's leader and innovator in mergers and acquisitions advice, venture capital, private equity, hedge funds, derivatives, securitization skills, and Exchange Traded Funds. This expertise has made our leading financial institutions, many of them headquartered right here in New York, leaders in Asia, Europe, and Latin America. U.S. commercial and investment banks contribute greatly to economic success all around the globe.
The problem:

Despite our strong economy and stock market, IPO dollar volume in the U.S. is well below the historical trend and below the trend and activity level in a number of foreign markets.

Moreover, existing public companies in the U.S. are deciding to forgo their public status – with its attendant regulatory requirements – and go private. This is occurring in record numbers, at record volumes, and, as a percentage of overall public company M&A activity, is approaching levels we have not seen in almost 20 years. This development is being facilitated by ever-growing private pools of capital.

A checklist of what could be at work:
  • The development of markets outside the U.S., particularly in London and Hong Kong – and the ability of U.S. investors to participate in these offerings;
  • A legal system in the U.S. that exposes market participants to significant litigation risk;
  • A complex and confusing regulatory structure and enforcement environment;
  • And new accounting and governance rules which, while necessary, are being implemented in a way that may be creating unnecessary costs and introducing new risks to our economy.
I was intrigued by the fact that when discussing the development of markets outside the US, he touched upon IFRS as a piece of successful principles-based regulation:

A number of foreign markets have developed excellent standards and protocols. In some parts of the world, particularly Europe, public companies adhere to the International Financial Reporting Standards – an accounting system that differs from ours.

One important feature of the IFRS accounting system is that it is principles-based, rather than rules-based. By "principles-based," I mean that the system is organized around a relatively small number of ideas or concepts that provide a framework for thinking about specific issues. The advantage of a principles-based system is that it is flexible and sensible in dealing with new or special situations. A rules-based system typically gives more specific guidance than a principles-based system, but it can be too rigid and may lead to a "tick-the-box" approach. I will be talking about the difference between principles-based and rules-based systems in a number of contexts today.

International companies that list in the United States must reconcile their IFRS statements with U.S. Generally Accepted Accounting Principles, or GAAP. We should recognize that the time and cost that go into reconciling and restating IFRS statements may not be a worthwhile expense for a foreign company considering the U.S. market. Because of progress being made in converging accounting standards, the U.S. and EU have developed a "roadmap," with the goal of allowing listings in the U.S. market on the basis of statements prepared using IFRS, and likewise continuing to permit listings in the EU on the basis of statements prepared according to GAAP. These efforts are encouraging.

The usual conservative, sensible call for reforms of the tort system:

A sophisticated legal structure – with property rights, contract law, mechanisms to resolve disputes, and a system for compensating injured parties – is necessary to protect investors, businesses, and consumers. But our legal system has gone beyond protection. In 2004, U.S. tort costs reached a record quarter-trillion dollars, which is approximately 2.2 percent of our GDP. This is twice the relative cost in Germany and Japan, and three times the level in the UK. The consulting firm Towers-Perrin found that the tort system is highly inefficient, with only 42 cents of every tort dollar going to compensate injured plaintiffs. The balance goes to administration, attorney's fees, and defense costs. Inefficient tort costs are effectively a tax paid by shareholders, employees, and consumers. Simply put, the broken tort system is an Achilles heel for our economy. This is not a political issue, it is a competitiveness issue and it must be addressed in a bipartisan fashion.

From an Indian perspective, a very interesting rumination on a messy financial architecture:

Another issue to consider in assessing the competitiveness of our financial markets is regulation. Over the course of our nation's history, we have added multiple regulators to respond to the issues of the day. Our regulatory system has adapted to the changing market by expanding, but perhaps not always by focusing on the broader objective of regulatory efficiency.

For example, while the business of banking has converged over time, we still have four separate banking regulators. We have a similar dynamic with the securities and commodities markets, and their related self-regulatory structures. Each of these organizations has different statutory responsibilities and a number have different regulatory philosophies. We also have a dual federal-state regulatory system in the banking and securities markets – and the degree of federal preemption over state law in these areas varies greatly. Another large and important part of our financial sector, insurance, is regulated solely at the state level.

A consequence of our regulatory structure is an ever-expanding rulebook in which multiple regulators impose rule upon rule upon rule. Unless we carefully consider the cost/benefit tradeoff implicit in these rules, there is a danger of creating a thicket of regulation that impedes competitiveness.

A very UK-style advocacy of principles-based regulation instead of rules based regulation:

Our rules-based regulatory system is prescriptive, and leads to a greater focus on compliance with specific rules. We should move toward a structure that gives regulators more flexibility to work with entities on compliance within the spirit of regulatory principles.

Rules by themselves cannot eliminate fraud. Wrongdoers will seek out loopholes or ways to circumvent the rules. For instance, in the recent business scandals, management at some companies remained technically within the rules while offering deceptive financial statements.

Some rules developed in the past have proved to be deficient in today's dynamic marketplace and some that are developed today are likely to be sub-optimal in a few years unless they are rooted in principles which will stand the test of time.

The problems of multiple inspectors from multiple regulators going after the industry:

At times, our legal system and regulatory structure produce unintended consequences. Consider the area of enforcement. Over the last several years different regulators at the state and federal level have been focused on finding and prosecuting wrongdoing – a worthy, necessary, and successful effort. But when multiple jurisdictions and entities are involved, each with their own objectives and approaches, the enforcement environment can become inefficient and, to the regulated, can appear confusing and threatening.

On SOX, the Republicans don't seem to have an appetite for legislative solutions; they want to only improve the administration of the Act:

At this time, I do not believe we need new legislation to amend Sarbanes-Oxley. Instead, we need to implement the law in ways that better balance the benefits of the legislation with the very significant costs that it imposes, especially on small businesses.

By far the single biggest challenge with Sarbanes-Oxley is section 404, which requires management to assess the effectiveness of a company's internal controls and requires an auditor's attestation of that assessment. Companies should invest in strong internal controls and shareholders welcome this development because it is in their best interest. However, section 404 should be implemented in a more efficient and cost effective manner. It seems clear that a significant portion of the time, energy, and expense associated with implementing section 404 might have been better focused on direct business matters that create jobs and reward shareholders.

Businesses around the world are eager to see how we address this issue. The Chairman of the SEC, Chris Cox, recognizes the severity of this problem and is providing strong leadership to address it. He understands that it will take an aggressive forward-leaning approach to change the implementation of Section 404 and make it more efficient.

Mark Olson, the Chairman of the Public Company Accounting Oversight Board, shares Chris Cox's viewpoint. Collectively, they have responsibility for providing guidance on implementing Section 404. The SEC will soon seek comments on a new and much improved auditing standard aimed at ensuring that the internal control audit is top down, risk based, and focused on what truly matters to the integrity of a company's financial statements. This new guidance for both companies and their auditors should encourage common sense reliance on past work, and on the work of others. Moreover, the SEC and the PCAOB are going to provide tailored guidance for small companies that recognizes their specific characteristics and needs.

A paean on principles as opposed to rules; adhering to principles is harder than checkboxes on rules done by a clever compliance person!

We should remember that we cannot legislate or rule-make our way to ethical behavior, whether it be in the business world or any other endeavor. Proper corporate governance processes increase the likelihood that well-intentioned people will do the right thing. But they do not guarantee such an outcome – and they certainly do not guarantee that unethical people will do the right thing. In my judgment, we must rise above a rules-based mindset that asks, "Is this legal?" and adopt a more principles-based approach that asks, "Is this right?"

Several weeks ago, Warren Buffett offered a warning to his leadership team at Berkshire Hathaway when he wrote, "The five most dangerous words in business may be `Everybody else is doing it.'" As usual, Warren Buffett was right. The ability to avoid these pitfalls takes moral leadership, starting right at the top.

Concerns about accounting:

  • Given the importance of accounting to our financial system, is there enough competition?
  • Will our reformed accounting system produce the high-quality audits and attract the talented auditors we need?
  • Do auditors seek detailed rules in order to focus on technical compliance rather than using professional judgment that could be second-guessed by the PCAOB or private litigants?

Importance of principles-based system for accounting:

A common theme in my remarks today is the desirability, where practical, of moving toward a principles-based system. Nowhere is this issue more relevant than in the accounting system. Added complexity and more rules are not the answer for a system that needs to provide accurate and timely information to investors in a world where best of class companies are continually readjusting their business models to remain competitive.

Last year, approximately 1,200 publicly listed companies in the United States restated their financials. As of September 30 of this year, the number is more than 1,000. Some of these companies were involved in the business scandals. Many others were well-intentioned companies struggling to cope with a redefinition of rules in a complex system. These restatements draw time and attention away from other value-enhancing activities – and they represent an added cost to shareholders. Businesses and auditors are searching for something that doesn't exist in today's constantly changing world – a rules-based safe haven that still provides investors with an accurate portrayal of a company's financial performance.

Auditors should be able to focus on one fundamental objective – ensuring the integrity and economic substance of management's financial statements. To get there, we must recognize that accounting is not a science. It is a profession, requiring judgments that cannot be prescribed in a one-size-fits-all manner that undermines the usefulness of financial statements to investors.

They seem to have an interesting "President's Working Group on Financial Markets". One feels so much safer when the head of Goldman Sachs has to make decisions about hedge funds:

And the President's Working Group on Financial Markets – comprised of the Treasury Secretary and the Chairmen of the Federal Reserve Board, the SEC, and the CFTC – continues to review and monitor markets, assess issues related to the performance of derivatives, and study the activities of hedge funds in three broad areas: investor protection, operational risk, and potential for systemic risk. We have begun a series of educational meetings with a broad array of participants in the hedge fund community to gain insight as we move forward with our deliberations.


  • First, it is necessary to take a global view. We don't operate in isolation, so it is very important to consider how changes we make affect the ability of our companies to compete globally and how these changes affect our interaction with markets and regulators around the world.
  • Second, our regulatory structure should be more agile and responsive to changes in today's marketplace.
  • Third, to stand the test of time, rules should be embedded in sound principles.
  • Fourth, regulators should take a risk-based approach to regulation, weighing the cost to shareholders against the benefits.
  • Fifth, our enforcement regime should punish and deter wrongdoing and encourage good behavior without hindering responsible risk-taking and innovation.
  • And, lastly, the best way our business leaders can protect the integrity and competitiveness of our markets is to exert moral leadership, where the threshold question is, "Is this right?" not "Do the rules allow us to do this?"
  • Our capital markets remain strong and competitive, but they face some significant challenges that do not lend themselves to easy answers or quick fixes. The Treasury Department plans to host a Conference on Capital Markets and Economic Competitiveness early next year. We will invite participants with a wide range of perspectives, particularly the investor perspective. The Conference will cover the three primary areas I have discussed today – our regulatory structure, our accounting system, and our legal system – all of which impact our capital markets and are critical to the overall economic competitiveness of our nation. Our objective will be to stimulate bipartisan discussion and to lay the groundwork for a long-term strategic examination of these issues.

Saturday, November 18, 2006

Global warming aspects of the Indo-US nuclear deal

The major focus about the Indian nuclear deal has been on proliferation issues. However, CO2 emissions is also an important dimension of the deal [link]. Ila Patnaik has two articles on nuclear energy [one, two] and one on global warming [link].

In the weeks leading up to the vote at the US Senate, David G. Victor of Stanford has done a document The India Nuclear Deal: Implications for Global Climate Change:Testimony before the U.S. Senate Committee on Energy and Natural Resources. The abstract reads:

The nuclear deal probably will lead India to emit substantially less CO2 than it would if the country were not able to build such a large commercial nuclear fleet. The annual reductions by the year 2020 alone will be on the scale of all of the European Union's efforts to meet its Kyoto Protocol commitments. In addition, if this arrangement is successful it will offer a model framework for a more effective way to engage developing countries in the global effort to manage the problem of climate change. No arrangement to manage climate change can be adequately successful without these countries' participation; to date the existing schemes for encouraging these countries to make an effort have failed; a better approach is urgently needed.

You can access the PDF file via `' (free registration required): link.

Article on the equity derivatives market in `Business World'

Mobis Philipose has written an interesting article in Business World on the equity derivatives market titled Needed: New wine, new bottle. It is related to, and adds value on, many of the issues on equity derivatives that have figured on this blog. It is on the web (free registration required), but the BW website does not give out permalinks. When that link stops working, use part 1, part 2.

How not to "control" inflation

India is a fascinating country on attitudes to inflation. On one hand, there is a deeply ingrained belief that inflation hurts the poor most, and politicians are hawkish about inflation. But concern about inflation has not manifested itself in good measurement of inflation. Inflation measurement is bad - and has been bad for the longest time without any effort at fixing it. And, in the short run, there is lassitude in doing anything about inflation. The `Taylor Principle' is not understood, and there is little by way of institutional mechanism or institutional commitment to control inflation.

When inflation does spike up, the first response in socialist India is to look for ways in which government can manipulate prices of a few products.

Suppose there are N commodities that go into an inflation measure. There are two sets of N numbers: the price rise p_i for all commodities and their weights in the index w_i. There will always be a distribution of different price rises; i.e. all values p_i will not be the same. So if you sort p_i you will always be able to identify 10 commodities with the highest price rise. And if you sort p_i*w_i, you will always be able to identify the 10 commodities which have `contributed the most to inflation'. Statements then get made of the form `there is no real problem of inflation; it's just that there are just 10 weird commodities which account for xx% of the overall inflation; we have to solve these localised problems and we're fine'.

In socialist India, the government would then go after these 10 commodities with price controls, imports, release of inventory from government warehouses, ban on futures trading, etc.

There is a need to completely shift away from this mentality. Data processing, as described above, delivers no insight into where inflation is coming from. It is just an arithmetic fact that some commodities will have higher price rises than others. The economy suffers greatly from distortions when the government goes after the top 10 commodities every now and then in this fashion.

Ila Patnaik had a great article in Indian Express on 11th November where she argues that in a market economy, inflation should be seen as a phenomenon of macroeconomics, requiring a response from macro policy; arguing that it is time for the government to get out of manipulating prices of individual commodities.

This is an important part of the case for an inflation targeting central bank in India. Monetary policy based on inflation targeting is good in its own right; it is monetary policy which stabilises the boom and bust of GDP growth. But in India, it will address the goal of politicians who like low inflation, and remove the pressures that come up from time to time for government to get hands-on with manipulation of prices of specific commodities.

Update (10 Feb 2007): Indian Express has an editorial on difficulties of inflation measurement.

Wednesday, November 15, 2006

Pension guarantees considered subtle

The negotiations about the PFRDA Bill, which are presently underway, are reportedly discussing guarantees gifted by the government to NPS participants.

Many years ago, when US-64 was fresh on our minds, I used to think that keeping government out of such obligations was a no-brainer. It is too easy for a political process to come up with a plausible-sounding guarantee, which is actually horribly expensive a few years down the line. The best example of this is the European DB pension systems.

In 2001 and 2002, when the early work on translating the Project OASIS report into the NPS was being done at DEA, Robert Palacios anticipated that discussions about pension guarantees would surely come up, and that a thorough analysis of guarantees needs to be done well ahead of time. He pushed me into thinking about the subject. I used this off-the-shelf knowledge to write an article titled Pension Guarantees are Subtle in Business Standard today.

The EPW article I talk about is: Investment risk in the Indian pension sector and the role for pension guarantees, EPW, 2003, pdf. In addition, I have worked further on the tools for analysing pension guarantees link.

Coincidentally, Gautam Bhardwaj is also in Business Standard today, in a debate about pension fund investment into the stock market. The other side is by a M. K. Pandhe, who seems to have the bulk of his facts wrong.

Saturday, November 11, 2006

Separation between commodity futures and mainstream finance

One of the (many) strange things that India does in the financial sector is a separation between commodity derivatives and mainstream finance. Everywhere in the world, it is well understood that there is only one business called the securities industry, which involves organised trading of all manner of spot and derivatives products, including derivatives on physical commodities. But in India, we have a piece of legacy legislation dating back to the 1950s which places commodity futures with the Department of Consumer Affairs, and places regulatory functions with the Forward Markets Commission. Through this, the people who do consumer protection - e.g. issues like weights and measures - are tasked with thinking about safety + soundness of clearing corporations.

If commodity futures could be merged back into mainstream finance, there would be more rapid development, by tapping into the skills, regulations and legal structure which has been created for derivatives. In addition, in the existing situation, there is a loss of economies of scale, economies of scope and competition associated with cutting up finance into separate pieces.

When you wander in the streets of India, you see boards of firms saying "Member NSE, BSE, NCDEX, MCX", which reminds you every day of the de-facto convergence of the two worlds. The customers are the same; the brokerage firms are the same. The artificial separation is caused by a piece of legislation going back a half century, done at a time when none of this was understood.

Today two developments took place which illuminate these issues. First, SEBI seems to have removed the last barriers to the trading of Exchange Traded Funds on gold. This will be done by "financial" mutual funds, traded on "financial" exchanges, and regulated by SEBI. It serves to highlight the lack of a distance between commodities and finance.

In parallel, there were some newspaper stories about the possible use of the Securities Appellate Tribunal (which was created in the SEBI context) for handling appeals against the FMC. This also makes a lot of sense, and underlines the unity of commodity futures in mainstream finance.

By international standards, separating out commodity futures into a separate market is a fairly perverse thing to do. I have no doubt that at some point, some prime minister is going to sign off on the merger of these two worlds into a single competitive market.

The US is the only country where a somewhat wonky arrangement is in place (though not as wonky as what we have in India). In the US, the CFTC is a separate regulator for all derivatives markets. They do better than India in placing all derivatives together, i.e. commodity derivatives are not separated out. The CFTC is an old agency, and its continued separation from the SEC reflects complacence, and a lack of political will, in the US. When you are the world's biggest financial system in the world's biggest economy, it's easy to get complacent with what is in place (witness the sluggish movement towards electronic trading at exchanges in the US). But here also, international competition is bringing in a new level of stress; the UK integration of all financial regulation into the FSA is increasingly leading to a shift of business to the UK. A recent article in Forbes talks about some interest in convergence.

What google earth can do for illegal land development

Ubiquitous access to Google Earth has many interesting implications for the land market.

I have seen many signs where obscure little real estate brokers, by the road side, offer to show you properties through Google Earth.

Nancy Sajben sent me a pointer to a blog entry talking about how land acquisition for an SEZ was influenced by Google Earth: farmers were able to argue their position more clearly by utilising this information.

In cities like Bombay and Delhi, I sometimes think the resolution of Google Earth pictures are so high that one can even identify illegal construction where a house spills into the road. The puzzle is: who will do this?

I have long been highly conscious about illegal land development on the boundaries of national parks by developers who chip away, one acre at a time. I don't know the legal foundations surrounding Borivli National Park, but the amount of construction taking place at the edges of the park seems very, very suspicious to me. And this is Bombay - anywhere outside Bombay I'm sure the dangers of encroachment are much worse.

It would be wonderful if an environmental activist group would engage in the following steps:

  1. Utilise the public records to make a .kmz file of the boundary of all the national parks in India,
  2. Setup software which watches google earth, and throws up an alert when it looks like there is some habitation in what ought to be park land.
Update: I just noticed some work in South America which sounds like this.

Saturday, November 04, 2006

A little off topic: Noticed a great photoblog on India.

Syed Rashed Ahmad runs a great blog "indianglory" where he puts out roughly two photographs a day. I find them stunning; a great reason to start using an RSS feed reader even if you don't do so already. Go look at the blog; Get his RSS feed. I just wish the pictures were bigger.

Wednesday, November 01, 2006

Reddy & Bernanke

I wrote an article Reddy & Bernanke in Business Standard today, in reaction to the RBI rate hike, and placing it in the context of developments outside India.

The outstanding fact of Indian macro in recent times is the acceleration of CPI inflation, which rose from 3% in late 2003 to between 6% and 7% today. Further, the inadequate response of monetary policy in this episode generates expectations on the part of households and firms that in the future, a rise in inflation will be persistent. Mature market economies have stable inflation and unstable exchange rates; in the third world it is upside down.

I argue that India continues to need tight monetary policy, so as to get CPI inflation back to the 3% which had been achieved in late 2003. The situation in the US is much more cloudy - if a recession sets in within a few months, the Fed might be cutting rates. This underlines the idea that India is a large economy which requires a monetary policy based on the domestic business cycle, and the use of US monetary policy (by running a pegged exchange rate) is not optimal for India.

Hmm, while on this note, it was interesting to then see Chidambaram using the phrase `inflationary expectations' in this speech. Maybe caring deeply about inflation persistence and the expectations of households & firms isn't a disease of economists only :-)