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Sunday, August 31, 2008

Consequence of reservation for women in elections

Reservation for women has been done at the Gram Panchayat level and is proposed at other levels of government. People who like empowerment of women, handed down by the State, generally think this is a good thing.

Reservation is implemented in various seats by rotation. One consequence of this is often the lack of interest of elected women in getting re-elected. A woman who won a seat that's reserved-for-women knows for sure that in the next election, there will be no reservation for that seat. As a consequence, the threat of elections fails to induce accountability. These women are often more focused on harvesting private benefits of office, and less on pleasing voters. It always sounded, to me, as another episode where a powerful urge to do good crowded out hard thinking.

In an article on VoxEU: Democracy and accountability: The perverse effects of term limits, Paola Conconi, Nicolas Sahuguet and Maurizio Zanardi examine a similar situation: the behaviour of a politician who can't run for elections once again owing to term limits.

Freedom of speech

We are proud of India as a liberal democracy, but what we have has shaky legal foundations. In a blog post by Harsh on

Compare this enunciation of free speech

Constitution of India, Article 19. Protection of certain rights regarding freedom of speech, etc.- (1) All citizens shall have the right- (a) to freedom of speech and expression; .... _15[(2) Nothing in sub-clause (a) of clause (1) shall affect the operation of any existing law, or prevent the State from making any law, in so far as such law imposes reasonable restrictions on the exercise of the right conferred by the said sub-clause in the interests of _16[the sovereignty and integrity of India,] the security of the State, friendly relations with foreign States, public order, decency or morality, or in relation

with this:

American Constitution, Amendment 1- Congress shall make no law abridging the freedom of speech, or of the press (no further caveats)

In the first case the constitution hands out rights and freedoms to individuals. In the second case the constitution assumes pre-existing rights and freedoms, and places limitations on the government instead.

In the first case, the state is supreme with practically no constitutional limits because of all the myriad caveats and exceptions. In the second case, the state is but a constitutionally restricted agent of the individual.

In the first case the onus is on the individual to show that he is within his rights to do something; in the second case the onus is on the government to show that it has constitutional authority to regulate something.

That is the difference between lip-service to freedom, and true freedom.

I have always been curious about the collision between freedom of speech and (a) government control of radio and TV and (b) restrictions against foreign media. It seems clear to me that if we believe in freedom of speech, these two elements do not belong. With a US-style constitution, would the courts have ruled against the government on these two fronts?

Saturday, August 30, 2008

Global Turbulence: Its Unfolding Trajectory and the Likely Implications for India

A lecture by Percy S. Mistry at ASCI, Hyderabad, on 26 August 2008.


Since mid-2007, the global economy has been unravelling in disconcerting fashion. That has taken governments and `aam aadmi' by surprise in most countries. The nature and speed of this `unravelling' has been discomfiting. It affects everyone: i.e. individuals, poor, middle-income, or rich, multinational and domestic firms, academics, governments or regulators.

Global turbulence is certainly affecting India. We can see that in sudden changes in our inflation rate, growth rate, exchange rate, and in our capital markets. We can see it in the stresses and strains it is putting on fiscal, monetary and social policy. But, by and large, the impact of global ructions has so far been less on India than on other energy importing countries. The continental dimensions of the Indian domestic market are now generating a powerful internal growth dynamic with rising domestic incomes. That provides India with some shelter from this global storm.

Energy exporters are, of course, booming. They cannot absorb the huge surge of funds that are flooding into their small economies. Energy exporters in the Middle East have built up incremental reserves of over $3 trillion in just the last five years. This huge imbalance in global financial flows and in rapidly accumulating financial stocks represents both a cost and an opportunity for India. But we risk exacerbating the cost and blowing the opportunity.

India is not as dependent as China is on the US and EU for manufactured exports. But that gives us little comfort. Our service exports are facing headwinds. Remittances may fall if the US and EU go into recession. But that may be offset by remittances from Gulf countries. Yet, paradoxically, India will weather this storm with less damage than the US, EU or Japan; and most developing or transition countries.

That is not just because of the size of its growing domestic market but because its trade, finance, industrial and agriculture sectors are not yet as integrated into the global economy as those of many other countries that are globally less significant than India has become. Some of us may take comfort from that and argue that we should insulate ourselves even more. But there are downsides to being insulated; especially for a country that has benefited so much from globalisation. That phenomenon has opened our access to labour and service export markets; which in turn India has done much to develop.

In any event, regardless of what is happening in the world, we are building up many problems of our own by default. We do not seem to have either the political consensus or the administrative capacity to address simultaneously that large number of urgent issues that confront us.

Our deficit on merchandise trade is approaching 10% of GDP. Despite export income from services and remittances we now have a current account deficit of 2.5 to 3% of GDP. We have a `real' fiscal deficit approaching if not exceeding 10% of GDP taking all off-budget items into account. These are not good signs; especially in an external environment that is not benign. But I'll come to that later.

We now have significantly lower growth than we thought we would -- from 9% to 7%. It is a reflection of how far we have come in the last five years that not just government and industry, but even aam aadmi, is now concerned about GDP growth falling to 7%. We face much greater economic and financial uncertainty. Our stock markets have lost 40% of their value in just six months. No one knows when we will get back to January 2008 levels.

Our inflation rate seems to have gone from 5% to 12.5% almost overnight! That seems to have come upon us suddenly and caught us all by surprise. We seem to be in denial about the extent to which our growth rate might be hit in the next 18 months. The ugly reality is that we are now being hit by three or four combined largely exogenous shockwaves of varying intensity and amplitude.

Four Globally Generated Shockwaves

  1. The Financial Shock triggering a Global Slowdown
  2. The Oil & Commodity (including Food) Price Shocks that have exacerbated the financial shock
  3. The Resulting Inflation Shock
  4. The Coming Stagflation Shock

The first phenomenon of concern is the systemic global financial shock triggered by the sub-prime crisis in the US a year ago. It spread instantly to Europe. It has since affected parts of the world more integrated than we are with the American financial system. These include places like Latin America and East Asia; especially in Korea, Japan, Taiwan, Hong Kong and Singapore. It has certainly affected China and, to a lesser extent, India as well.

What was a financial dislocation in the US is now slowly but surely making itself felt as a shockwave spreading through the global economy. In the US and EU a severe credit squeeze is on as banks and NBFC's retrench to stem `mark-to-market' value losses, despite a stance of relative monetary laxity on the part of central banks to revive growth. Small and medium sized firms that had committed credit lines are finding those suddenly closed. Banks are reducing their exposure not just to SMEs but to home financing, credit card and other consumer credit risk; e.g. for purchases of consumer durables and cars. Personal loans that were being marketed through the post have become extinct. NPA's and loan defaults are rising even as net credit extension is contracting. And this is happening despite monetary policy in the developed world being quite loose, while inflation is escalating. We run the risk that such an accommodating monetary stance, if prolonged in a vain attempt to revive growth, may cause global inflation to ignite and go out of control; reaching levels last seen in the late 1970s and early 1980s. It took a decade and a very tight monetary squeeze to wring inflation out and get growth going again.

What started in the US and EU, is now becoming a global credit squeeze as the largest and most influential global banks, as well as their smaller counterparts, focus on repairing broken balance sheets rather than on expanding global business. Their focus is firmly on improving credit quality. They are all slashing back on credit quantity. That could result in the financial shock translating itself into a real economy, output shock. In turn that may turn into an unemployment and income reduction shock.

When such a downward spiral starts it is difficult to arrest and reverse; especially if fiscal deficits are already too high and room for manoeuvre for fiscal or monetary stimulation is limited. Unfortunately, that is precisely the situation that most countries, including India, are now in. There are very few countries running fiscal surpluses or deficits so low that they can afford classic Keynesian stimulus. These are energy exporters or countries like China and Singapore.

The kind of credit squeeze we are now facing cannot be relieved by monetary accommodation alone. Pushing on a loose string does not get you very far. It needs more than that. Most of all it needs time to permit necessary adjustments of gross macro-imbalances in savings, investment and consumption to occur. But we do not know how much time that will take. Global policy stance is aimed at delaying those adjustments. That uncertainty threatens to prolong global misery and delay global recovery. It is now abundantly clear that all the talk about coupling or decoupling, and being insulated from global forces, is fundamentally oxymoronic. We are in a globalised world where we sink or swim together. Some countries may do better than others. Some may drown. But we are all getting wet.

The second shockwave is the oil price and related wider commodity price shock. It has been building up gradually for some time. But it gathered real force last year. Many people think it has peaked. I am not so sure. A variety of arguments have been trotted out ad nauseam to explain what happened and why; although I must confess that few really seem to understand what did happen. I certainly don't.

Financial speculation has been blamed for oil prices overshooting. But the evidence on that is mixed. In the kind of financial world we now live in, it is becoming almost impossible to tell the difference between: (a) the amount of liquidity that is needed from financial operators to keep commodity markets functioning smoothly under conditions of stress, and (b) the excess liquidity pumped into markets to influence short term prices that can legitimately be called speculation. Providers of market liquidity can often overshoot or undershoot in their own price expectations of what the future may hold. They adjust their positions in physical and derivative markets daily as new information emerges. That is NOT speculation. It is how the oil market works. Price discovery must respond to new information and changed expectations continuously if markets are to function. Nevertheless, the recent sharp fall in oil prices does support the view that speculative heat in the oil market may have gotten out of hand.

The third shock, resulting from the first two, is the more generalised inflation shock that is now running rampant through the world economy. What was obscured during the halcyon years was the extent to which China was absorbing global inflation in its quest to become the world's workshop. For the sake of market share, and to accumulate forex reserves, China sacrificed the interests, wages and living standards of its manufacturing workers. Their lives and living standards have improved dramatically within a generation. But that improvement has not occurred as fast as it should have, had global currency markets been better understood by China and been allowed to work properly.

To be ultra-competitive China kept wages and its exchange rate artificially low for too long. In doing so it transferred real income from Chinese manufacturing workers to global consumers. That approach -- sustained for 15 years -- prevented global adjustment from occurring as smoothly and as early as it should have. Global currency markets were not permitted to work in ironing out imbalances in global trade, current and capital accounts, in reserves, and the global circulation of investment and savings.

The artificial suppression of the CNY, for what the Chinese authorities defended as legitimate domestic reasons, delayed necessary global adjustment. It has now made the size of the adjustment that is needed now, much worse. In retrospect, it clearly made the world's central banks much too complacent about the global inflation shock that they would eventually have to cope with, once China's ability to absorb it came to an end. Since inflation was not showing up in their domestic consumer price indices -- although it was showing up in almost all asset prices -- they seemed to think they had conquered it decisively.

There is a lesson in that for India. We seem to have convinced ourselves, like the Chinese, that capital account opening and market determination of exchange rates to permit market equilibration of traded prices would be bad for us; that it would destroy our competitiveness and destabilise our financial system. I firmly believe that exactly the opposite is the case. If our competitiveness depends solely on the exchange rate then we are not really competitive at all. Our financial system would be stronger with more competition, innovation and openness. But it would need structural change. Moreover we need to make Indian producers and service providers more responsive to global price changes in all the big prices (whether for energy, money, etc.) without providing too many shock absorbers of the kind that in turn cripple our macro-economy.

The fourth shock, yet to be felt with full force, is the coming stagflation shock. That will occur as the combined impact of the first three shocks feeds more fully into the global economy and lowers output growth, but with prices remaining higher than they should. How long will that last? No one knows. While history invariably repeats itself, it never does so in exactly the same way. So while we may think we know the broad contours of what might happen, and what the consequences may be, we have no idea of exactly how things will unfold or evolve.

Eventually commodity prices, then wholesale producer prices, and last, consumer prices, will moderate with falling global demand. But the large remaining structural demand-supply imbalances in oil, gas and energy production, food production, metal/mineral production, that have become so evident over the last three years, will not disappear overnight. The investments now being made in expanding supply will not come on stream overnight. With continued growth in India, China and Asia even the supply responses that are presently on stream may not be enough to moderate prices to the extent we would like. With the oil price declining then rising again in the last two weeks (while the dollar has moved in the opposite direction) some pundits seem to think the worst is over. But is it? No one really knows.

Suddenly, our expectations about future global and Indian growth are lower. Our levels of uncertainty about the future are higher. Until yesterday we were convinced, along with China, that we would be masters of the 21st century universe in two decades. Now we are not so sure. Some of us are behaving as if we have gone from heroes to zeroes almost overnight.

This abrupt reversal has been particularly unpleasant and confidence-shaking. That is because we are realising in retrospect just how benign the previous period of nearly 15 years has been. We have had relatively high growth and low inflation in India and in the global economy since 1993 with a few blips in between. Of course all has not been sunny and bright everywhere. Let me explain to draw the backdrop of what may lie in store for India if lessons learnt elsewhere apply.

Since 1992, a country as large and significant for the global economy as Japan -- which we forget still accounts for over 10% of the global economy -- has been in a state of stagnation/deflation with dreadful demographics and legacy pension and healthcare liabilities that are staggering in size; along with a level of public debt that makes Italy look responsible. The UK and the EU were in virtual recession during the early 1990s but emerged from that to a prolonged period of low but positive growth between 1995 and 2007. Latin America has been recovering. But Africa has remained its non-performing self; except for a brief respite due to exploding commodity prices. Africa has been unable to capitalise on its mineral and natural wealth. Eastern and Central Europe have been doing well since coming out of the shadows of being Soviet satellites. The US, China and India have been doing well since 1993.

Since 1993 though we have had a number of local financial and economic crises; with disturbances like the Mexico crisis of 1994-95, the Asian crisis of 1997-99, financial crises in Russia, Turkey, Ecuador, Argentina, and so on. In that period we have seen the dot-com bubble burst in 2000, followed by the globalisation of terrorism since 9/11/2001. That has had a profound effect on the psyches of governments around the world; but most particularly in the US which has developed symptoms of acute paranoia, reflected in an embedded siege mentality. But despite these local and regional shocks, the global economy has prospered averaging a growth rate of nearly 5% with low inflation for 15 years.

Now the legacy of those 15 years of growth is at risk. We are caught, like rabbits in headlights, wondering what has happened, as well as why and how. Were our achievements so fragile and illusory that they could now be so imperilled? Were we building our houses, dreams and expectations on unrealistic foundations of sand? Are we now coping with entirely different realities that have come to the fore? When is the unravelling of value going to stop?

In India we tend to be a bit volatile in our reactions when things do not turn out as we expect or project in a state of euphoria. Our post-independence experience suggests that we are naturally inclined to pursue a national strategy that amounts to `meddle-and-muddle, but stay in the middle'. But our media and public commentators are given to extremes of hyperbole. One minute we are in the clouds and nothing can stop us. The next minute we are underground and nothing can save us. The truth as always lies in between. We are neither heroes nor zeroes. We are just typical Indians.

A Fifth -- Geo-Political -- Shockwave

I could go into much more detail about the four shocks that the world and India now face. But I will not do that. Reams have been written in India and around the world about all of them. Much of what has been written is suspect. But that is beside the point. I do not want to take up more time on the detailed nature of these shocks. What I would like to do instead is focus on another profound transition -- a fifth geopolitical shockwave if you will -- that is rapidly unfolding and that we are in the midst of feeling the effects of, without quite realising it or preparing ourselves properly to deal with it.

The last decade of the 20th century and the first decade of the 21st are registering significant subterranean movements in the geopolitical tectonic plates that support the world economy and determine the global balance of power. The centre of global economic gravity is shifting decisively away from the West to the East. In the next three decades, bilateral Indo-Chinese and Indo-Asean trade, indeed intra-Asian trade, will resemble the pattern of trans-Atlantic trade growth between the US and Europe, and then trans-Pacific trade growth between the US, Japan and East Asia through the first and second halves of the 20th century. The 21st century will see trans-Indian Ocean and trans-Himalayan trade grow in a similar way.

As the centre of global economic gravity shifts so will flows of trade, finance and investment as well as global movements of high and low-value labour. So will the weight of global consumption. For too long the world has bestowed on America the dubious honour of being the world's consumer of last resort. In the process, the world has also unwittingly made China the world's producer of first resort. In part that unintended consequence, and dysfunctional tendency, lies at the root of the economic problems that the world now faces. In order to fuel American consumption well beyond reasonable levels, the world in general, and China as well as energy exporters in particular, have provided the US with credit in its own currency that is now looking increasingly poor in quality.

The world has permitted America to borrow egregiously and excessively in its own currency without the kind of surveillance by the IMF and OECD that other countries are subjected to. And that has been grossly overdone. A major adjustment is now clearly needed in global consumption, savings and investment patterns. America needs to consume less, reduce its borrowing dramatically, and stop printing excess money to support its addiction to excess consumption. It needs to invest far more to replace its crumbling infrastructure and restore its manufacturing and service efficiency.

To an extent the same applies to Europe, although it does not exhibit the same egregious imbalances as the US; although the UK is heading in the same direction. What Europe has to accept is that its welfare state model is reaching the end of its sell-by date. It generates too many perverse social incentives with the state trying to mitigate all the risks that individuals must be allowed to bear some responsibility for. It is compromising on excellence, efficiency and effectiveness with an assertion of `equality' in a state-driven way that will ensure that true equality always remains elusive. In the process, public services are absorbing so large a proportion of the total economy that old Europe is becoming structurally uncompetitive. New Europe provides the only hope for dynamism in the European economy.

In Asia adjustment has to be of an opposite nature. China, in particular, must learn from the experience of Japan. It has to start consuming much more domestically and increasing imports rapidly, while saving, investing and exporting slightly less. China also has to move toward spreading markets throughout its entire economy rather than letting markets operate only in its export driven manufacturing sector. It has to open its capital account, let its currency float, and resolve the major problems its financial system confronts. It would be nice if China spent less on its military build-up (because it faces no real external threats) and switched such spending to domestic private consumption. Eventually China must face up to the contradiction between a market economy and an authoritarian polity that no longer believes in communism or socialism; but believes only in retaining the absolute power of the communist party. A free market in a free economy will eventually demand a free political system. Obdurate official opposition to that reality on the part of the Chinese authorities will only make China and the world a less safe place until reality asserts itself, which it inevitably and inexorably must.

For all this to happen, the geographic pattern of savings mobilisation and circulation will change dramatically. South and East Asia will become larger players in global finance than the US and Europe. Those changes will bring about profound changes in perceptions of global security needs and raise questions about who polices the world, what our stake is in ensuring that it is policed well, and how. The days of US hegemony in that domain are coming to an end. Those who wished for that outcome may suddenly find themselves regretting its premature arrival! We are simply unprepared for it.

Who or what replaces the US as the world's hegemon is unclear. China is making no secret of its ambitions to fill the vacuum that the US leaves. The rest of the world is making no secret of its concerns about that. That has profound implications for India, which are not being discussed at all; or certainly not being discussed openly. Even now the Indian Ocean is in danger of becoming Chinese as the China-Africa trade and investment axis grows at a pace that India hardly realises or is keeping pace with. It will soon be crowded with Chinese merchant ships and fishing fleets demanding protection by the Chinese navy.

So the fifth geopolitical shock that is unfolding slowly but building up in force has even greater implications for India that what is happening at present in the global economy.

The Implications of these Five Shockwaves for India

What are these implications? To me the answer is obvious. To others it is fanciful. To many wise commentators in government, the media and politics, the answer seems to be to become more introspective and protectionist; i.e. to hunker down, strengthen our protective fortifications and our policy umbrellas, and put on three or four more raincoats to protect ourselves from the global storm raging around us. My own feeling is that such an approach may stop us from getting wetter than we otherwise might. But it will also stop us from continuing along the path of progress and poverty alleviation through rapid growth that we have now irrevocably committed ourselves to.

The most obvious implications are for India to pursue second generation reforms aggressively on a number of fronts: i.e.:

  1. The Economic Front
  2. The Political Front
  3. The Judicial Front
  4. The Social Front

While I cannot on this occasion go into the depth I would like in all these four areas I will sketch out my glimpse of what we need to do to cope.

First, India must unleash a second round of deep and wide reforms in its economy beginning with its financial system, then its labour market, and spreading to its agricultural and urban economy. We have made progress in transforming productive competitiveness. We have done so by unshackling our private sector, and by improving the technological prowess and market reach of our industrial and services economy. But we still have far to go in becoming globally competitive across the board. We have failed so far to tackle our urgent labour market problems and financial system reforms that would make our real economy even more dynamic, more flexible and responsive to global market changes, and much more globally competitive. We are falling too far behind in addressing critical reforms in making overdue policy changes and much larger public and private investments in rural development and agriculture. While we have talked about them ad nauseam our infrastructure constraints are growing more acute by the day. We are simply failing to cope with very rapid rates of urbanisation resulting from accelerated rural-urban migration; and in our approach to avoiding future environmental and ecological damage.

To be fair one could at a stretch say that some reforms in these areas have begun. But they are barely discernible to the naked eye. We need to: (i) move more swiftly and boldly toward an open capital account and toward a much freer financial system that develops bond, currency and derivatives markets more swiftly and is regulated quite differently; (ii) focus RBI's attentions exclusively on monetary policy and inflation control and divest it of the responsibility for doing anything else; (iii) repair immediately our large and growing fiscal deficit, along with the size of rapidly burgeoning public debt, by divesting state-owned banks, companies and other assets -- we need to do this on financial and efficiency grounds and not on ideological grounds.

We need to move (iv) from an addiction to price subsidies to the provision of targeted income subsidies that are aimed at alleviating poverty rather than at destroying proper market functioning; and (v) more swiftly on creating essential infrastructure by replacing our endless talk with decisive action if we wish to prevent total gridlock in our economy. On the human capital front we need to (vi) privatise our academic establishments and upgrade dramatically our deteriorating capacity to develop human capital in all its diversity as rapidly as we need. It is not enough to have twenty islands of educational excellence in an ocean of mediocrity. Finally we need to (vii) universalise healthcare rapidly but learn carefully from the lessons of others and learn what we must try and avoid. We must not create the NHS that Britain is so proud of but that is totally dysfunctional in addressing genuine healthcare needs efficiently and cost-effectively.

In addition to all that we need badly to revamp our parliamentary and judicial systems so that they strengthen the processes of democracy rather than weaken and compromise them as well as compromising the integrity of the Indian state in that process. We desperately need a polity that is less fractured, fragmented and so devoid of principles, faith, belief, or economic and social philosophy, that blocks of votes and seats are available to the highest bidder to achieve any expedient, episodic outcome. I could do a lecture on each of those areas. But, this is neither the time, nor the place for that. Last year, P.C. Alexander made an excellent speech at ASCI on precisely this issue. Bimal Jalan has written about it openly as has Arun Shourie and other luminaries in Indian public life. Yet writing is not enough

It is not only our polity whose structure, process and behaviour that imperils development, growth and democracy in India. Our judiciary, legal system and our society as a whole are equally to blame. Perhaps the roots of the problems lie in the way our lawyers are trained. But the entire judiciary and legal system now seems preoccupied with technicalities, endless (but lucrative for lawyers) delays in the court proceedings, and an obsession with `undue' process at the expense of swift conflict resolution, substance and justice. Corruption has spread through the judicial system like rampant cancer. Yet the judiciary considers itself immune from public scrutiny, transparency or accountability. It refuses to employ management practices that would make the legal system more efficient, less time-consuming and less crippling in its cost for the average person to have recourse to. The same is true of our law enforcement agencies. They stand by and permit mayhem rather than acting decisively and forcefully to prevent it. They act only after irreparable damage is done and then in a reticent manner. They are quick to oppress the poor and indulge in daily petty corruption that is the bane of life in India.

Yet, at the end of the day, who is to blame for the continual erosion that has occurred so relentlessly in the authority, credibility, legitimacy and probity of our great institutions: i.e. the presidency, parliament, government, law enforcement and the judiciary? Ultimately we, as thinking Indians, have to blame ourselves for treating our precious democratic legacy and heritage so lightly. We concede too readily our political space to be dominated by the incompetent, the irrational, the prejudiced, the blindly traditional, the power-hungry, venal, corrupt and vainglorious. It is not public service that motivates candidates for election anymore. It is purely the pursuit of power for its own sake and material self-interest. Our anti-corruption laws are so ineffectual that they have become a standing joke. The way in which they are applied is even more hilarious. With a few notable exceptions, most of our politicians at national and state level are a source of acute embarrassment for India rather than of pride.

And still, the growing middle class in India cannot be bothered to turn out and vote. Nor does it voluntarily create public service NGOs that monitor and scrutinise the day-to-day behaviour of our elected and appointed officials. So it abdicates political space to the deprived and disempowered who vote quite rationally in the interests of what they believe at election time will be their own betterment; seduced every five years by grand rhetoric and false promises never delivered. Of course their betterment never results; because they vote for people they think are so representative of themselves but in reality lack their basic ethics and decency; i.e. they vote for those that are relatively uneducated, those to whom reason and rationality has not even passing familiarity, those who believe that their role as elected representatives is solely to push for the interests of their castes, tribes and co-linguals and subordinate entirely the wider interests of India as a nation, and those who believe that winning elections is the best short cut to the accumulation of personal wealth. One could of course go on endlessly in this vein, as many have. But it is counterproductive. Bemoaning our plight does not get us anywhere. Doing something about it might. And the great Indian middle class now needs to make itself felt forcefully in acting -- through voting and monitoring -- to raise standards in Indian public life.

Second, to cope with the geopolitical realities of tomorrow, India must develop and project a much clearer vision and strategy about what role it is going to play in the world as one of its two most populous countries representing a sixth of humanity; and one of its four largest economic blocs along with the US, the EU and China. With great power status -- which we will have to cope with, even if we do not want it -- will come even greater responsibility. We need to be able to handle it well.

We cannot sleepwalk or sweet-talk our way into the future on an issue by issue basis; which is the impression we seem to giving to the world now. It is profoundly disturbing that most countries in the world treat India and China so differently in their dealings with them. They treat China with deference and respect tinged with fear. They treat India with diffidence and occasional disdain, if with a great deal of affection tinged with a sense that India is just too undisciplined, and too `diffuse, difficult, disorganised and distracted' to ever get its act together. China is seen by the world and treated by it as a majestic tiger; India is more like a Labrador intent more on scratching its itches than on going anywhere.


I have spoken for too long. So let me summarise: To withstand this and other global shocks, to keep output growing at rates of above 8% annually, so that we can remove poverty even if it is through the bootstrap effect of increasing the size of our middle class relentlessly, and to ensure that India enters the world with confidence not diffidence, we need second generation reforms in spreading the benefits of market functioning throughout our economy. But that is not enough.

We also need to decide more clearly what role the state should play in our economy and our society. It is patently obvious that sarkar can no longer be maa and baap to everyone. It cannot own and operate commercial assets allegedly in the public interest. Experience suggests that the public interest is not served by the state doing so. Instead it is compromised. Our previous policies have kept India impoverished and only post 1992 reforms that had their roots in 1984 have changed that trajectory.

What government needs to do is govern and regulate properly, to ensure law and order, provide for personal and national security, enforce and respect property rights, and promote our economic and strategic interests in the world. It does not need to do what the private sector can do better. By doing what government should not be doing, it is not doing well what it should be doing; i.e. governing. We need to rethink our approach and strategy to facilitate the emergence of India as a major economic and strategic player on the global stage. And we need to improve our regulatory capacity across the board to make India more efficient, effective, competitive, dynamic and innovative in all that we do.

We must realise that our growth is being affected not just by what is happening in the world. It is also being affected by a dramatic slowdown in our own reform momentum. We cannot live off the fruits of post-1992 reforms forever. Their benefits are now embedded. At the margin they will yield less and less. Their incremental gains are gradually tapering off.

To keep our growth rate at 8% or more we need to move further and faster with reforms not just in our economy but in our society, our political system and judiciary. Events in J&K remind us that we are at increasing risk of losing control over the centrifugal and centripetal political forces that are continually bearing down upon us. We should not permit the celebration of our diversity and our multi-ethnicity, which we seem to revel in as a sub-continent, to damage our integrity, sovereignty, unity and sense of purpose as a nation.

I could say a lot more but I have already said enough with deliberate provocative intent. I would be happy to listen to your reactions and answer your questions.

Central Recordkeeping Agency of the New Pension System is up

I have written 35 blog posts on the subject of pensions. Day Zero of the New Pension System was 10 April 2007. It took 135 days to get to Day One, which was 24 August 2007. Now, on 29 August 2008, the Central Recordkeeping Agency is up and running, and hopefully the NPS will soon be open for business with individual accounts, multiple fund managers and multiple styles.

This is ten years and a month after Project OASIS began. The wheels grind slow, but they grind true. You might like to see this article by S. A. Dave (written in 2006) about the Indian pension reforms.

And, Mukul Asher has an article in Mint emphasising the four tasks of Indian pension reform.

Friday, August 29, 2008

Thursday, August 28, 2008

Public vs. private providers in higher education

Andre Beteille has an article in The Telegraph yesterday on the `lazy mental habits' that we're using in thinking about private vs. public providers for higher education.

Wednesday, August 27, 2008

Choosing a Nifty index fund

Here's a snapshot of what is going on with Nifty index funds in India. The annualised tracking error is computed using the one year of data ending 31 July 2008.

SchemeTracking error (%)Expenses (%)
Nifty BeES 0.19 0.50
Franklin India Index Fund - NSE Nifty Plan - Growth 0.42 1.00
Franklin India Index Tax Fund 0.58 1.50
UTI SUNDER 0.59 0.50
Tata Index Fund - Nifty Plan - Option A 0.63 1.50
UTI Nifty Fund - Growth 0.70 1.21
PRINCIPAL Index Fund - Growth 0.86 0.75
ICICI Prudential Index Fund 1.10 1.25
SBI Magnum Index Fund - Growth 1.26 1.50
Canara Robeco Nifty Index - Growth 1.45 ?
Birla Sun Life Index Fund - Growth 1.76 1.51
LIC MF Index Fund - Nifty Plan - Growth 1.99 1.50
HDFC Index Fund - Nifty Plan 2.55 1.50

The RBI governor question

Ila Patnaik had an article in Indian Express last month on the agenda at RBI, and Financial Express has an editorial today on recruiting an RBI governor.

Tuesday, August 26, 2008

What is wrong with India's expansion of public sector universities

Pratap Bhanu Mehta has a great article in Indian Express on what is wrong with the bureaucratic processes that are presently underway in increasing the size of India's public sector universities.

Saturday, August 23, 2008

Certifications, IT

In the early 1990s, if you had looked at the potential for an IT industry in India, the answer could easily have been: "Not possible, because there aren't enough decent colleges and universities around". Yet, the IT industry happened. I find the build up of the requisite human capital of this industry to be rather interesting. Going beyond IT, more generally, if you look at the tripling of India's GDP and the immense internationalisation in this period, it seems to have taken place against daunting odds given that higher education is dysfunctional. For almost all students in India, the knowledge they command when stepping into the labour market is not substantially different from the knowledge they had when finishing 12th grade; the undergrad / masters degrees add next to nothing. This could have held back India's growth. It didn't.

How do we explain the tripling of GDP? The bulk of human capital in India has been built by self-motivated people. This was largely learning-by-doing - as economists have always known - supported by a little timely training. This process can be speeded up through the use of high quality certification exams, that really challenge the exam-taker, and that push forward to international standards of quality. Both processes - learning by doing and certification - are largely independent of formal education.

I read a column by Robert Cringely which links up to these issues. He talks about a certification in computer networking : ``Cisco Certified Internetwork Expert'' (CCIE). As he says:

The CCIE is Cisco's top certification category and VERY hard to earn. Being a CCIE doesn't mean you have Len Bozack on speed dial, but it might as well. Cisco products dominate the Internet and CCIEs are Cisco gurus, so if you are serious about the Internet as a nation you'll have CCIEs hanging about, or that's the theory. Conversely, if you just talk a good game as a country with technological aspirations, maybe you won't have many CCIEs at all -- maybe none. It's one way to determine who the posers are.

Cisco publishes the number of CCIEs by country every quarter. Here's what it shows for India:

2000 4
2001 17
2002 39
2003 72
2004 102
2005 115
2006 144
2007 200
2008 410

It shows a nice exponential build-up, despite roughly zero progress on higher education in this period.

In the case of finance, I know that the headcount of FRM certification is a useful measure of the number of people in India who actually know some finance (does a time-series exist?). I don't know anything about the CCIE. Is it a very Cisco thing? If this is the case, fluctuations in the number of CCIE would partly merely reflect the success or failure of Cisco in India. My informal impression is that Cisco is much less important in price-sensitive-India than they are elsewhere in the world.

The Cisco data also has numbers for other countries. I'm curious what blog readers think about (a) The extent to which the headcount of CCIE can be interpreted as a measure of the presence of high quality skills in the country and (b) A common sensical interpretation about inter-country comparisons - e.g. China's count is 8x bigger than India but China hasn't made the same impression in the international software market.

Friday, August 22, 2008

Now, currency futures

In April 2007, I had written an opinion piece titled Currency futures now. Today, in Financial Express I have an opinion piece titled Now, currency futures. In some respects, we do make progress in India. Update: See this article by Rajarshi Singhal in Economic Times today (27th August).

I found a search for `currency futures' on this blog to be a mildly interesting review of the events from 2007 onwards in this space.

Thursday, August 21, 2008

Emphasise certifications as a means to building human capital

Given India's terrible elementary and higher education system (ponder the implications of this also), a greater emphasis on certification rather than education might make a lot of sense. Employers want to know that a person has the correct knowledge. An exam should give employers the confidence that this is indeed the case. In India, young people are very good at studying on their own for examinations. Once you start thinking like this, school is a low quality use of your time. I always tell young people in India: never let school come in the way of your education.

Think of the best 50,000 students at the IIT JEE. If they have a good certificate in their hands saying they are really top quality high school students by world standards, that's useful in signalling. And, this knowledge was largely picked up outside of the school system, which is calibrated to a much lower standard.

An excellent example of a certification mechanism which has helped remove entry barriers into the labour market is NSE's NCFM examination. I have met so many young people with weak educational backgrounds, who were able to jump this barrier and start off into successful careers in the financial sector, thanks to this certification exam. And, I have written about the GARP FRM before: it's an internationally recognised certification which delivers better knowledge than any MBA in India.

Tuesday, August 19, 2008

Optimism in the GDP forecast for 2008-09

CMIE has come out with their Monthly Review for August 2008 in which they give the rationale for their particularly optimistic forecast for GDP growth in 2008-09. One key element of their optimism is strong investment activity which (a) buoys demand and (b) generates fresh output through projects that will be commissioned in 2008-09. At page 62 they say that projects worth Rs.270,000 crore are likely to be commissioned in the remainder of this year.

The other key element of their optimism is measurement problems of the Index of Industrial Production (IIP). On page 45, they have a quarterly time-series where they compare quarterly sales growth (built bottom-up from firm level data) vs. the IIP. For the June 2008 quarter, there is an unprecedently large discrepency between the two: firm level data is saying 23.3% growth in real terms (a rollicking pace of growth) while IIP data is showing 5.6% growth. They say:

It is imperative that the credibility of the IIP is reestablished at the earliest to enable meaningful analysis. The recent fall in the reliability of the IIP is the result of a considerable deterioration in the quality of data used in the construction of the index. Response rates have fallen dramatically. This has compounded the usual problems of the IIP - archaic weights and methodology.

Difficulties with a call auction market

by 011, who prefers to remain anonymous.

I love hunting grossly undervalued small and micro cap stocks on the Belgrade Stock Exchange. For some of them I would be more then happy to pay double their last price. The stocks I have in mind are all extremely illiquid, trading by the single price auction usually less then ten times a year. But even in days when they trade, I have slim chances of buying them due to BELEX trading rules.

Belgrade Stock Exchange functions as an order driven market with no market makers. Essential for the Single Price Auction Method of the Unregulated Market, where over 1500 small and micro cap stocks trade, is this: Trading sessions, comprised of four trading phases (pre-opening, auction, trading, and at-the-close-trading) are held every working day from 9:30 to 12 a.m. Single price is determined as one of the greatest trading volume. If the greatest volume can be achieved at more than one price, a price closer to the reference price (single price of the previous trading) is determined as the single price. Daily price limits are +/- 20%.

Rare sellers of the above mentioned grossly undervalued stocks are mostly workers or pensioners of these companies, who hardly know anything about stock exchange, and nothing about how to value stocks. They received free shares during the process of privatization, and are sometimes under pressure from top management to sell them their shares at reference price. When a worker agrees to sell, a manager's buy market order is first entered into the trading system, and later on the worker's sell limit order, nearly always at reference price.

Buy limit orders, even with 20% higher price, not only don't get executed on these grossly undervalued stocks due to the priority of a market order, they don't even influence a new price. On the other hand, if an uninformed seller doesn't request a higher then reference price for his stock (most workers and pensioners don't even know they can), the price may never increase, even though there are buyers willing to pay much more for it.

Here is what happened to me. In May 2006, I concluded that a Masinoprojekt Kopring stock (MSPK) was grossly undervalued. Its price at that time was 2200 RSD. Just to show to prospective sellers that there is a buying interest at higher price, on 18th May I placed a small buy limit order for 20 shares at 2600 RSD for the duration of 30 days. Hoping that someone would place a sell limit order at the same, 18.2% higher then the last (reference) price, I was ready to quickly place then a market order to secure buying the shares.

Three days I was eagerly watching from 10 to 12 a.m. the BELEX.Info real time quotes, but there wasn't any sell order. On May 23, at first I saw someone's buy market order for 411 shares, and shortly afterwards a sell limit order at 2200 for the same number of shares. My 2600 buy order didn't get the shares that day, and was still active. Four trading days passed then without sell orders and buy market orders. On May 30, again firstly appeared a buy market order for 107 shares, and later on a sell limit order at 1900 for the same number of shares. Single price fell to 1900. Not only my 2600 buy order didn't get the shares that day, but from the next day on it wasn't active anymore, because it was outside the +/- 20% price limit. Before my order expired, there was one more trade, on June 8, for 182 shares, again at 1900 RSD and with the same Buy Market Order That Knows Exactly How Many Shares Will Be Offered and When scenario. Should I say, the days between were without sell orders.

It is now August 2008 and this scenario repeats again and again on MSPK and some other stocks as well. Lifting the 20% price limit on call auction would not solve the problem. Even if someone places a large buy limit order, say at a 50% higher price in a situation without price limit, a BMOTKEHMSWBOW would, under present BELEX rules of determining the single price when the greatest volume can be achieved at more than one price, take all the offered shares at reference price, because uninformed sellers don't request a higher price. There would be no price change.

Neither would a continuous market do better, due to lack of sell orders. Large shareholders already know their shares are worth at least double their current price and are not interested to sell. Workers and pensioners who don't know the shares are worth much more, sell them nearly always to top management (informing them in advance of their intentions to sell on a particular date) at the last price, sometimes even for less. A mighty BMOTKEHMSWBOW will then be placed shortly before that sell limit order.

Unjustified stock price stagnation, or even a 13.6% decline, as in the example above, is caused by the way BELEX determines single price, when the greatest volume (number one criteria) can be achieved at more than one price. Single price would better reflect forces of supply and demand if it is determined, as number two criteria, by the best not executed limit order, in case it is better then reference price. BELEX rule instead, chooses reference price, as criteria number two.

Reference price as number two criteria for single price determination, and existence of market order in an order driven market for illiquid stocks, may easily prevent market forces to act. When this happens, not only is it harmful to the best seller (who receives considerably less for his shares) and best buyer (who cannot even buy shares), but to the public as well (who gets a misleading information about market price for the stock).

I am always puzzled what justifies existence of market order in a call auction for illiquid stocks. It can not secure a faster execution, but it can block market forces, as the MSPK real world example shows.

Saturday, August 16, 2008


Michael Walton has a good opinion piece in Financial Express on the subject of inequality in India. He starts out with the eminent good sense on the subject:

Should we care about inequality? Many would see this as a dumb question. But there are two, opposing views on why it may be considered dumb. The first is that inequality is so obviously central an issue, so pervasive in Indian society that it is transparently the case that tackling inequality is central to the development process. Indeed, the long history of both rhetoric and action by the Indian state is, ostensibly, in line with this view.

A second view is that inequality is a big diversion. India is still a poor country. The first order question is sustaining growth, while ensuring the poor participate in that growth. (And, indeed, in most growth episodes, most of the time, the income of the poor grows more or less as fast as the average.)

Moving from Latin America to India a year ago (as I did) casts this question into relief. At first glance the contrast seems to support the view that inequality is a second order question here. Latin America is the region of inequality par excellence. Measured inequality in India (from the National Sample Survey) is way below the Latin American average, and even below the most equal society theretiny Uruguay, famed for its extensive social insurance system. It is also lower than in China, Malaysia and Thailand. Sustaining rapid growth looks much more important than any feasible redistribution, not least for the poor.

On the scale of decades, the only thing that matters for poor people is GDP growth. Every percentage point of the growth rate that is given up in the quest of reduced inequality today does permanent damage of the trajectory of consumption of poor people in coming decades. As an example, suppose a family starts out in poverty in India today earning Rs.1000 a month. Here is what 30 years of growth does at a few alternative growth rates:

2.5% 2,097

6% growth over the coming 30 years gets a family making Rs.1000 a month in India today up to Rs.5,744 a month. But if the growth rate gets up to 7%, then this same family gets up to Rs.7,612 per month. These large differences are induced by small improvements in the growth rate. And, if we sink into socialist stasis of 3.5% GDP growth which would yield 2.5% per capita growth, then this family gets up to Rs.2,097 a month in 30 years.

I think 30 years is the right horizon to think about these issues, for it corresponds to the change that a person sees from age 0 to age 30, and then again from age 30 to age 60. It is very important for poor people in a country to see such massive changes in their well being coming about within such timescales.

Policymakers who care about the consumption of poor people have to have a very short-sighted discount rate (in addition to certain kinds of preferences) in order to espouse policies that emphasise equity at the price of growth.

Manish Sabherwal has a piece in Economic Times today, where he points out the logical fallacies of simplistic beliefs about inequality using a natural experiment that recently took place in India:

India has become substantially more equal since January 8, 2008. About two hundred billionaires have turned into millionaires. The drop in stock market and real estate values means that the top 5% richest people may have lost about 40% of their wealth and making the rich poor increases equality. But does this exponential increase in equality help India’s poor? Do they even care?

Michael Walton then runs through the criticisms of this perspective. First, inequality off NSSO data is underestimated. I feel that inequality using household survey data is underestimated everywhere. It's as hard for an investigator in Mexico City filling out forms to get into one of the haciendas of the rich, or an investigator in New York City filling out forms to get into a penthouse in Manhattan, as it is for him to get into a prosperous home in Bombay.

Second, the really important thing is inequality of opportunity. I fully agree. Here, it is possible to obtain first best with reduced inequality of opportunity and higher GDP growth, by undertaking fundamental reform of education and health in India. This is a rare situation where policy makers with an interest in one kind of inequality can actually assist growth. But so far, the gigantic spending programs in health and elementary education (e.g. Sarva Shiksha Abhiyaan) have been dominated by the interests of their respective civil servants, and not the interests of the users of these services. Higher education is another great opportunity to make a difference to equality of opportunity, but so far in India, the policy framework is systematically designed to disadvantage a person born in a family with weak financial and human capital.

Third, he says that inequality is likely to get worse, and that this will have implications for the political system and society. I agree with this outlook. Inequality in India will get a lot worse before it gets better, given that the top decile is in the process of plugging into globalisation, and generating tremendous wealth in the process. Over time, the remaining nine deciles will handsomely reap the fruits of this transformation, but in the short term, inequality will worsen.

Vijay Kelkar has always emphasised that inequality matters because it influences the political foundations of liberal economic policies. I see this as shaping up to be a big challenge for Indian politicians over the coming 25 years. So far, the early indicators are bleak.

In her article The first globalization: Lessons from the French, Suzanne Berger emphasises one of the `great surprises in history' : despite the inequalities created by capitalism, no electorate has ever voted in free national elections to overturn it. She argues that while anti-capitalist political parties have been strong, they have never won the day.

I'm not so sure. Democracy does contain the possibility of the demos coming together and expropriating private property and trampling on individual freedoms - as Indira Gandhi did and as a number of `idiotic' regimes in the world have shown. Berger emphasises one element of what holds such dangers in check:

...the constitutional engineering of Madison and the founders of other liberal democratic societies did work to protect the rights of individuals and the functioning of a market economy. Institutions like the Bill of Rights, the Supreme Court, and federalism did in fact build dikes that protected property and markets against democratic majorities

To the extent that the `constitutional engineering of Madison' is important in throwing up these dikes, we are in trouble in India, given the extent to which constitutional engineering (and re-engineering) have systematically damaged the rights of individuals and the functioning of the market economy.

Rule of law and foreign venture capital funds

Economic Times has a news item by G. Ganpathy Subramaniam and Deepshikha Sikarwar, and an opinion piece by Richie Sancheti and Vikram Shroff on the functioning of foreign venture capital funds.

I am worried that there is a problem of rule of law here. What appears to be going on is that applications are not being cleared even though they are compatible with the existing policy framework. If the policy framework is a problem, it should be changed. But at all times, the letter of the law must define how government agencies operate. Similar problems seem to have arisen earlier with RBI's treatment of external commercial borrowing (ECB) also.

Running any system of capital controls, in the modern world, is messy. There will inevitably be a arms race where the bureaucrats will come up with new controls and the private sector will use technological and financial sophistication to evade these controls. Good countries wake up and understand that this spy vs. spy contest is pointless, and shift over to full convertibility. While we are in the process of getting there, the least we should aspire to is to not do violence to the idea of rule of law.

Tuesday, August 12, 2008

New clarity on capital account convertibility

See this article by Eswar Prasad and Raghuram Rajan on voxEU. Also see the approach towards capital controls of the Mistry and Rajan reports, which is broadly drawn from this same literature.

Monday, August 11, 2008

Working paper `Early warnings of inflation in India'

A new paper on this subject by Rudrani Bhattacharya, Ila Patnaik and myself has been released as a working paper by the Planning Commission and by NIPFP. The abstract reads: In India, year-on-year percentage changes of price indexes are widely used as the measure of inflation. In terms of monthly data, each observation of a one-year change in inflation is the sum of twelve one-month changes. This suggests that better information about inflationary pressures can be obtained using point-on-point monthly changes. This requires seasonal adjustment. We apply standard seasonal adjustment procedures in order to obtain a point-on-point seasonally adjusted monthly time-series of inflation in India. In three interesting high inflation episodes – 1994-95, 2007 and 2008 - we find that this data yields a faster and better understanding of inflationary pressures. A file with the key time-series data figuring in the paper has also been released for public download. Also see this article by Ila Patnaik in Indian Express which has a non-technical explanation of the paper.

Saturday, August 09, 2008

EPFO's procurement of fund managers

I had previously written about EPFO's successful auction-based procurement of fund managers. There are two good opinion pieces which place this in a larger perspective: by Vikas Dhoot yesterday in Indian Express, and by Manish Sabherwal in Financial Express today.

Friday, August 08, 2008

RBI report on interest rate futures

RBI has come out with a committee report. It fixes the ban on bank participation that snarled up interest rate futures trading all these years. For the rest, it's disappointing; years have been spent in writing something that a competent finance practitioner could have written (sans the mistakes) in an afternoon. Employees of the government are still doing product design, prescribing what hours trading should take place, tinkering with central planning about how participant of type X cannot engage in activity Y, etc. It is not imbued with the vision of the Bond-Currency-Derivatives Nexus. See the `Comment' by Susan Thomas towards the end of the report.

Thursday, August 07, 2008

The cost of the prevailing policy framework in finance

A recurring theme in the Mistry and Rajan reports is the lack of competition in Indian banking, and the deleterious consequences of capital controls through which it is attempted to cut off domestic finance from the rest of the world. Janmejaya Sinha has a ground level story in Financial Express which illustrates the incompetence and inefficiency of Indian finance.

Tuesday, August 05, 2008

Slowdown in China

On 11 May, I had written a blog post titled `Decoupling?' where I pointed out that China's exports growth to the US had dropped to 0% on a year-on-year basis. Today, the New York Times has an article by Keith Bradsher about the slowing Chinese economy. The CNY appreciation seems to have stalled as the growth lobby has become more influential than the PBOC. (Yes, China differs from India in this respect also). The best coverage of the action is at Michael Pettis' blog.

India is more internationalised than ever before. The global business cycle downturn matters more in thinking about the outlook for the Indian business cycle when compared with the way things were in previous decades. On this subject, you might like to see my article New issues in Indian Macro Policy.

Nifty futures: NSE vs. SGX

Mobis Philipose has an excellent article in Mint on this competition. It's an unequal battle, because international market participants trading on SGX have no restrictions while their participation on NSE is hamstrung by India's capital controls which include the FII framework, barriers against PNs, etc.

While on this subject, see the story of Nikkei 225 futures at what was then called SIMEX on page 107 of the MIFC report. Some years from now, books like the MIFC report will be carrying a story about how India gifted the Nifty futures market to SGX.

Five readings on currencies and monetary policy

Financial Express has an editorial on the outlook for the US dollar and for the rupee. In addition to their arguments, one needs to factor in the interest that policy makers ought to have in a strong rupee as a tool for combating inflation.

Martin Feldstein has a column on the outlook for the US dollar.

William Pesek has two good columns on Bloomberg: on Asian macro policy being out of whack, and on China's problems with inflation (which are a lot like ours).

Monday, August 04, 2008

Rupee appreciation and inflation

Writing in The Times of India, Swaminathan S Anklesaria Aiyar says:

What will the Congress do to improve its chances? I offer two predictions. First, the government will seek to strengthen the exchange rate of the rupee, making imports cheaper and thus, creating downward pressure on prices. Second, after having raised interest rates thrice in the last two months, it will raise them further soon, but then lower them shortly before the poll date. This strategy will aim to check inflation right now, while reducing the sting of high EMIs before the election.

Some people seem to think that fluctuations of the exchange rate reflect genuine market forces, given that the Indian rupee is supposed to be a `market determined exchange rate'. It is argued that INR depreciation was `caused' by weak capital inflows and the current account deficit. There is ample statistical evidence which tells us that this is not the case. While there is a rupee-dollar market, it is a manipulated market, and the player who commands market power there - the RBI - controls what happens on this market. We should not have illusions about the role of market forces in fluctuations of the rupee. In a month where RBI does not do trading, it is because the RBI chooses to not trade.

Assuming the government decides that INR appreciation is required, how might this be achieved?

  1. Reversing the capital controls of 2007 : against private equity in February, against external commercial borrowing in August and against participatory notes in October. This will make a small difference to conditions on the currency market, but eliminate the distortions caused by these controls and the transactions costs suffered by economic agents in bypassing these controls.
  2. Easing capital controls, e.g. by placing FII investments in rupee denominated bonds on par with FII investments in equities
  3. Selling reserves. E.g. see this article about South Korea selling reserves in order to combat inflation.

Friday, August 01, 2008

RBI transparency, continued

In a recent blog post, I pointed to three documents on RBI transparency -- a paper by Dincer & Eichengreen (March 2009), an an article by Helene K.Poirson (February 2008) and a paper by Crowe & Meade (July 2008).

Crowe & Meade have a followup article today where they talk about the consequences of improved central bank independence upon inflation performance. And Andy Mukherjee has a column on Bloomberg about the problems of RBI transparency.