A conference on Indian pension reform

IIEF Pension Policy and Business Conference, 2009.

Recent RBI moves in financial reform

I have an article in Financial Express today where I try to interpret recent RBI announcements in financial reforms.

Looking back at Indira Gandhi

Writing in Indian Express, Pratap Bhanu Mehta looks back at Indira Gandhi. He offers five lessons for today's Congress:

1. Leaders are more effective when they work through institutions rather than attempting to subvert them.
2. Sound economic policies are not a matter of simply projecting good intentions; they require a concerted understanding of the causal conditions that make for successful intervention.
3. Being personally secular is neither here nor there. The important thing is to fish in the treacherous waters of communal identification, from wherever it comes.
4. As the Punjab crisis demonstrated, when the state does not act impartially and in time, it sows the seeds of greater violence in the future.
5. Democracy is not just about the practice of popular authorisation. It is about a whole gamut of constitutional values that have to be zealously guarded.

India had a bad period from 1962 to 1977, of which the worst part was the Emergency. This period preceded Pakistan's worst years (Zia ul Haq's period, 1978-1988). Kamal A. Munir has an article in Financial Express about Pakistan where we see the sustained impact of those years.

India seems to have come out better from the dark period, partly because that period ended a long time ago and there has been more time for healing. In addition, in Pakistan's case, the Afghan wars and islamisation which began in Zia ul Haq's period have not yet ended. In some sense, Pakistan is not yet into the post-authoritarian post-conflict period of reconstruction of institutions, which began in India in 1977.

Regulation vs. micro-management

Writing in Business Standard, Somasekhar Sundaresan reminds us that SEBI has greater powers than US SEC. I'm curious: Does the US SEC have the power (if it should so decide) to control what time trading should start and stop at all exchanges?

How evil is insider trading?

I have long been a skeptic about State action against insider trading, which is believed to be widely prevalent in India. Writing in the Wall Street Journal yesterday, Donald J. Boudreaux has a nice scheme which can replace the existing policy framework.

New thinking on financial stability

I have an article in Financial Express today, where I discuss RBI's take on financial stability, which sums up to the rejection of all recent thinking in India on monetary and financial reform, in the light of recent thinking on this subject at the US Fed and the ECB.

Movement on corporate bonds

Shilpy Sinha and Swapnil Mayekar have a story in Business Standard offering some optimism about the corporate bond market. They point out that in the six months from April to September 2009, corporate bond turnover was Rs.1.6 trillion, when compared with Rs.0.5 trillion in the same period of the previous year.

SEBI has decided to force many market participants to do netting by novation at a clearing corporation when trading on the corporate bond market. From 1 December 2009 onwards, there will be two possibilities for a trading mechanism:

1. OTC trade, reported on one of the three trade-reporting systems, run by BSE, NSE and FIMMDA, or
2. Order book trade, run by BSE or NSE.

But regardless of how trading takes place, counterparty risk will be eliminated, and netting efficiency obtained, through the clearing corporations. This will be a big win compared with the awful settlement mechanism that's used today. It should reduce transaction costs on this market.

The deeper problems of corporate bonds remain:

1. The lack of a liquid GOI yield curve along with interest rate derivatives, so as to be able to layoff interest rate risk when holding a corporate bond portfolio,
2. The low values for loss-given-default, given the lack of a bankruptcy code and
3. The ban on credit derivatives.

The workaround for #2 is: to stick to trading in short dated bonds from issuers where the failure probability is very low. A workaround for #3 is: to utilise information about credit risk embedded in the stock price.

The right way to think about the corporate bond market is in the context of the Bond-Currency-Derivatives Nexus, which emphasises the interlinkages between the government bond market, interest rate derivatives, corporate bonds, credit derivatives, the currency spot and currency derivatives. All these markets have to achieve liquidity with active arbitrage. The key ingredient for getting there is unifying the regulation and supervision at SEBI. This should address the bulk of the problems of corporate bonds -- other than the problem of loss-given-default.

Interesting readings

• David Oakley reports on Brazil having made it to investment grade. This is their payoff to the immense progress that took place in the last decade in terms of fiscal, financial and monetary institution building. In many respects, India's starting conditions today are similar to where Brazil was before these reforms.
• Robert Shiller, in Financial Times defends financial innovation, and Robert Cryan, in New York Times worries that Canadian banks missed opportunities in this crisis.
• Chiraga Chakrabarty, in DNA, on the need for INR/EUR futures. Once INR/USD and INR/EUR futures are trading, futures on USD/EUR will close the currency triplet and ensure efficient pricing of all three.
• Raghuram Rajan in Financial Times on the neat idea of requiring banks to hold debt capital that will convert into equity when two triggers are met.
• Read about Larry Summers and the US economic policy process in New Yorker magazine.
• Anil Padmanabhan has an important column in Mint on the mess that is shaping up on the Goods and Services Tax.
• James Lamont describes the world's third largest producer of Gherkins: a firm named Global Green, out of Bangalore.
• On TV, Vivek Law takes on the mess found in fund management products sold by Indian insurance companies.
• Nell Minow in Financial Times with new thinking about corporate governance.
• Ila Patnaik on RBI's next moves. Also see The good news, analysed better and This is no time for a rate hike.
• Vimal B in Financial Express on the internationalisation of the Chinese yuan.
• Jayanth Varma is scathing about the SEC's efforts at being motherly towards fat fingers.
• India's New Capital Restrictions: What Are They, Why Were They Created, and Have They Been Effective? by Bryan J. Balin of The Johns Hopkins University School of Advanced International Studies (SAIS).
• Alan Blinder thinks that we should all be long India.
• Shubhashis Gangopadhyay pleads for the removal of capital controls against venture capital and private equity.
• Counterfactual history, by Ramachandra Guha: Episode 1: What if Subhas Chandra Bose had returned home sometime after WW-II ended?.
• How Sam Yin Chueh changed the world.
• We have serious problems with freedom of press in India.

Did we get a good IIP number today? No.

It seems that we got a good IIP number today? Here's what the year-on-year growth of IIP Manufacturing says:

Mar 2009	-0.30
Apr 2009	0.39
May 2009	1.84
Jun 2009	7.82
Jul 2009	7.41
Aug 2009	10.21

So it looks like a recovery is gaining traction, with yoy growth going up in each month from March 2009 till August 2009, other than a slight decline in July 2009?

No.

The year-on-year growth is, unfortunately, a highly misleading measure. Here's what we get when we look at the seasonally adjusted levels and the annualised growth of these:

	Seas.Adj.IIP	Ann.Growth
Mar 2009	296.64	1.62
Apr 2009	297.69	4.24
May 2009	299.08	5.59
Jun 2009	319.78	80.32
Jul 2009	320.81	3.84
Aug 2009	322.14	4.98

This shows a very different picture. It shows one big month -- June 2009 -- where seasonally adjusted IIP jumped from 299.09 to 319.78. This was an annualised growth rate of 80.32%. This was the month in which the recovery kicked in, where we jumped back from the low state to a better state.

After that, growth has dropped back to anaemic levels, with annualised growth of 3.84% in July and 4.98% in August. So today's data release was actually not so hot - it was just 4.98% growth (annualised) of seasonally adjusted IIP manufacturing.

Each value of the year-on-year growth rate is the moving average of the latest 12 values of the month-on-month growth. So this one big value of 80.32% is going to elevate each reading of yoy growth up, all the way until we calculate the yoy growth from May 2009 till May 2010. After that, we'll get to the yoy growth from June 2009 till June 2010 and this jump will go away.

You only get the true picture by looking at point-on-point changes of seasonally adjusted data.

Interpreting recent movements of the rupee-dollar rate

In recent weeks, there has been a lot of focus on the appreciation of the rupee against the dollar. In an opinion piece in Financial Express today, I point out that the US dollar has fluctuated considerably in the period after September 2008, and interpret the recent events on the Indian currency market. At first, in the `flight to safety' into US government bonds that came about after the Lehman shock, the US dollar gained ground. As the global financial system has gained confidence, the reversal of this `flight to safety' has meant a concomitant decline in the US dollar.

These ups and downs of the US dollar have important implications for our intuition in India about the rupee-dollar rate. If we think the US dollar is roughly fixed, then the pursuit of an inflexible rupee-dollar rate can be interpreted as some kind of `stability'. But if the US dollar itself is a fluctuating yardstick, it is hard to justify efforts at RBI to obtain inflexibility of the rupee-dollar rate. When the dollar declines in value, an attempt at holding on to a rigid rupee-dollar rate is tantamount to forcing a rupee depreciation, and vice versa.

Greater flexibility in the rupee dollar rate will free up monetary policy to pursue the more important goal of stabilising the domestic business cycle. But along the way, for firms to learn to live with greater flexibility of the rupee dollar rate, well functioning currency derivatives markets are required. RBI needs to first step away from the present strategy of banning most of these markets, so as to be able to move forward to greater flexibility of the rupee.

On the macroeconomic arguments about the long-term decline of the US dollar, see Wolfgang Munchau in the Financial Times today.

2009 Economics Nobel Prize

We'll soon get the announcement. Here are a few possibilities, computed by Thomson/Reuters, using citation analysis.

If I had to vote, it would be a Taylor/Woodford prize.  For a sense of this work, see: link, link. While inflation targeting was invented in New Zealand based on the intuition of cleanliness in public administration, Taylor and Woodford had a lot to do with being able to think straight about it.

It's interesting to wonder how publicly visible citation data can be used to predict the Nobel prize outcome. One would want some kind of model which consumes citation data and comes up with an estimate of the Pr(Nobel prize). E.g. if one strong idea suffices (example: James Heckman) then it suggests certain people who will get through (example: Paul Romer). If they want you to build a broad literature (example: Robert Lucas) then that yields a different profile of those who will get through. Hmm, I can't come up with an example of another Robert Lucas. Such a modelling effort will yield insights on the usefulness of summary statistics of citation data such as the h-index and the g-index. As an example, it's easy to test which of the h index or the g index have superior predictive power in a model of predicting the Nobel prize.

For an analogy, it's easy to take firm data and fit an ordered probit model which predicts the credit rating. Once this is done, you're holding a black box which is able to look at firms, and come up with a real valued measure of credit risk. In similar fashion, once a model is estimated, which maps citation data and generates a real number from 0 to 1 (e.g. the probit latent variable), then it can be applied to a full database of all economists, and yield a measure of how Nobel-like each person is. This can be easily layered into Google scholar.

Most people in India think of Raghuram Rajan as being the first Indian-born economist who became the chief economist of the IMF. What is not widely appreciated is that in the class of economists of Indian origin who are younger than Amartya Sen, Raghu is the best set of papers, as measured by citations.

Bharti/MTN transaction, and India's problem of capital controls

I have a piece in Financial Express today about the deeper linkages between the failed Bharti/MTN transaction and India's problem of capital controls.

The dual listing issue was, of course, not the only or even the main reason why the Bharti/MTN transaction failed. But it was an important impediment, and many interesting transaction structures could have been used if this constraint had been absent. And, the issues that I highlight in the article are applicable in a much broader range of situations. Unsigned reportage in Economic Times suggests that a few other people are also thinking similarly.

Also see reportage by Heather Timmons in the New York Times. Subhomoy Bhattacharjee in Financial Express has interesting views. Also see The legal aspects of dual listings, on the blog `Indian corporate law'.

For another story of Indian companies who are growing up, facing global competition, and hitting constraints of Indian public policy, see this story by Pallavi Aiyar about Jet Airways setting up their hub in Belgium.

The remarkable Indian automobile industry

The automobile industry is an oasis in the Indian economy in terms of having high quality data. Commercial vehicles are of particular interest given that CV sales is a component of investment demand in the economy. Hence, we can learn something about investment demand in particular, and business cycle conditions in general, by looking at what is going on with CVs. If you try to draw a graph of the time-series of CV sales, you will find that this is very noisy. And if you convert it to year-on-year growth, this is not useful since each value of the year-on-year growth is a moving average of the latest 12 one-month changes. You'll pickup what was happening in the last year, and not what is happening right now.

Swaminathan S. Anklesaria Aiyar has an article in Economic Times on India's remarkable emergence as an exporter of automobiles. Mahesh Vyas has an article in Business Standard on the recent rebound in automobile production and sales. And, here's the link to the CMIE website on cars.

Let's look at global conditions. It's interesting to look at (seasonally adjusted) US data for sales of automobiles. Possibly helped by the cash-for-clunkers program, this data shows a strong bounce, back to the levels seen in early 2009. Click on the graph to see it more clearly:

Giovanni Veronese emailed me a fascinating graph, with seasonally adjusted data for Indian commercial vehicles. Click on the graph to see it more clearly. This is not quite comparable with the above, since it pertains to commercial vehicles and not cars. And, Indian exports are unlikely to have benefited from the US cash-for-clunkers program. All the three lines on the graph are seasonally adjusted levels, indexed to 100 for the production of January 2005. The red line is for Indian exports. It shows a very high rate of growth - a roughly 50% rise over the period from 2005 to early 2008. This is the incredible rise of India as an automobile exporter, the story told by Swaminathan S. Anklesaria Aiyar. Unlike sales of cars in the US, this has not recovered to pre-crisis levels.

The green line is domestic sales. This shows a recovery similar to that seen in the US - back to the values much like those seen immediately before the crisis, but without a cash-for-clunkers program being run by the government.

The blue line is automobile production. It shows savage cuts in production executed by the industry when the financial crisis appeared. This was unlike the standard script for downturns as we know them, where firms generally build up inventory when sales slow down. This time around, working capital financing in order to hold inventory was hard to find. I also think that the headlines and television dramatisation of the early stages of the downturn, accompanied by sharp movements in the prices of securities, were useful as an early warning system. This triggered off action by CEOs well before the full bad news came out through sales. As a consequence, there was very little inventory in hand, and production bounced back nicely when sales came back.

If the three indexes had continued to grow as they had done pre-crisis, then all three would have been roughly at values like 200 today (i.e. one doubling ahead of the values of January 2005). Instead, we're back to the pre-crisis level or worse. Exports are just a bit more than half the pre-crisis high. In the case of production, we're at a value of 130, which is significantly behind the pre-crisis level of 150.

It is really important to do seasonal adjustment, and then eyeball time-series of seasonally adjusted levels, in order to understand what is going on with these series. We've been updating a set of series every Monday morning, and releasing these as a public good.