Responses to the Budget announcements

• Ila Patnaik
• Jahangir Aziz
• Monika Halan

Interesting features of the budget speech

Financial stability, regulatory coordination, financial reforms

So far, in India, regulatory coordination was based on the HLCC. This has not been a particularly good experience. The HLCC was not statutory and there was no defined mechanism through which decisions would be obtained. Many inter-regulatory difficulties simply languished. One peculiar aspect of the HLCC was that it was chaired by the RBI governor, while RBI was at the centre of many inter-regulatory disputes. It was awkward, having one of the competing views on a question being the chair.

On these questions, the Raghuram Rajan report had said:

A Financial Sector Oversight Agency (FSOA) should be set up by statute. The FSOA's focus will be both macro-prudential as well as supervisory; the FSOA will develop periodic assessments of macroeconomic risks, risk concentrations, as well as risk exposures in the economy; it will monitor the functioning of large, systemically important, financial conglomerates; anticipating potential risks, it will initiate balanced supervisory action by the concerned regulators to address those risks; it will address and defuse inter-regulatory conflicts, and look out for the build-up of systemic risks. 

The FSOA should be comprised of chiefs of the regulatory bodies (with a chair, typically the senior-most regulator, appointed from amongst them by the government), and should also include the Finance Secretary as a permanent invitee. The FSOA should have a permanent secretariat comprised of staff including those on deputation from the various regulators. There should be a prescribed minimum frequency of meetings of the FSOA. All issues of regulatory co-ordination, and supervision of systemically important financial conglomerates and financial institutions will be taken up by the FSOA. 

The discussions of the FSOA with the management of systemically important institutions will be principles-based, and ts will initiatete the process of gradually implementing more principles-based regulation throughout the system. It will be important that the FSOA add value by substituting for some existing processes instead of adding another layer, while bringing collective regulatory views to bear. It is not our intent that the FSOA be a super-regulator displacing existing regulators. Instead it provides needed coordination and fills gaps that current structures have proved inadequate for. 

In addition, there is merit in setting up a Working Group on Financial Sector Reforms with the Finance Minister as the Chairman. The main focus of this working group would be to monitor progress on financial sector reforms (such as the proposals of the Patil, Parekh, Mistry, and this committee), and to initiate needed action. The working group's membership would include the regulators, as well as ministries on as-needed basis. The working group would be supported by a secretariat inside the Finance Ministry.

There was a contrasting view. After the global financial crisis, we got a strong campaign by RBI, based on the proposition of financial stability. It was claimed that now that financial stability is important, the original role and structure of RBI (as envisaged in the 1934 legislation) is the right one, so all reform proposals should now be shelved. Suggestions were made that the financial stability function should be handed over to RBI, which could ultimately lead to RBI becoming the super-regulator of finance, with the power to give instructions to other regulators such as SEBI based on financial stability considerations. Every bureaucracy likes to stave off change, and to grow its turf, so the arguments put forward by RBI were less than persuasive given its self-interest.

I have been skeptical about the idea of placing financial stability functions at RBI, for a few reasons:

• Crisis management involves utilisation of taxpayer resources, which can only be authorised by the treasury. Indeed, if a banking regulator is given a stability function, he will be inclined to cover up for the failures of banking supervision by utilisation of taxpayer money.
  There is a similar problem when a banking regulator who is also a central bank is inclined to cover up for the failures of banking supervision by giving `short-term liquidity support'. This problem is already with us in India. We should not make matters worse.
• The essence of financial stability thinking is to break out of India's silo system, and look at the overall financial system. The inhabitants of any one silo in India are likely to be ill equipped to think about the overall financial system.
• Financial stability thinking repeatedly involves asking any one regulatory agency to question its existing way of thinking. If an existing agency doing a lot of financial regulation is asked to do financial stability, this will not come about. Worse, there is the danger of `regulatory capture' where every regulatory agency tends to adopt the world view and maximisation of its firms. If RBI is asked to do financial stability work, we run the risk that these new levers of power will be used to favour banks at the expense of other kinds of financial firms.
• It is hard to obtain sensible notions of transparency and accountability in the nascent field of financial stability. There is much merit in a principal-agent problem approach in designing the block diagrams of government. When a clear document can be written down specifying a job that has to be done, then it is better for government to contract that out to an external agency, since the clarity of mandate makes possible accountability. But for the things where a clear contract cannot be written down, contracting-out to an external agency is hard, and it is better to in-source these functions.
• New work that we initiate in India should not interfere with our long term goals of establishing a proper central bank.

I am quite comfortable with the two interesting models out there. In the US, there are many financial regulators, and stability functions are being placed in a council of regulators. That makes sense. And in the UK, the Bank of England does no financial regulation, and it has been asked to do stability work. That also makes sense since the BoE takes an outsiders view of the work of the FSA. The staff quality of the Bank of England also encourages confidence that this will be in a technically sound way, without being imbued with an ideology of hostility to finance. In an Indian setting, both approaches make sense. One path would involve removing all financial regulation from RBI, turning it into a high quality central bank setup with staff quality matching that of the BoE, and then tasking it with the financial stability function. The other path is to place financial stability with a council of regulators.

This debate had simmered for some time. In the budget speech today, the Finance Minister announced the decision taken by government on how this should be handled:

37. The financial crisis of 2008-09 has fundamentally changed the structure of banking and financial markets the world over. With a view to strengthen and institutionalise the mechanism for maintaining financial stability, Government has decided to setup an apex-level Financial Stability and Development Council. Without prejudice to the autonomy of regulators, this Council would monitor macro prudential supervision of the economy, including the functioning of large financial conglomerates, and address inter-regulatory coordination issues. It will also focus on financial literacy and financial inclusion.

This seems to be some kind of fusion between the Raghuram Rajan proposals of the FSOA and the Working Group on Financial Sector Reforms. More details are awaited from DEA on how they want to play this.

Financial Sector Legislative Reforms Commission

The four major committee reports on Indian finance -- Patil, Mistry, Rajan and Aziz -- have all emphasised a comprehensive overhaul of outdated laws. The laws of 1934, 1952, 1956, etc. are quite out of touch with the India of today. And this job is complicated by the fact that one amendment to the laws at a time does not cut it. You might like to see my article in Pragati magazine in August 2009, where I argue that changing the laws is the essence of financial reform in India today.
In today's budget speech, the FM said:

101. Most of our legislations governing the financial sector are very old. Large number of amendments to these Acts made at different points of time has also increased ambiguity and complexity. The Government proposes to set up a Financial Sector Legislative Reforms Commission to rewrite and clean up the financial sector laws to bring them in line with the requirements of the sector.

Large complex IT-intensive projects

Stepping away from new laws, economic reform in India is critically about big and complex IT systems. These present unique challenges of public administration, when compared with the traditional ways of working of government in India. A new process manual is required through which these big complex IT-intensive projects can be rolled out and run.

In today's budget speech, the FM said:

104. An effective tax administration and financial governance system calls for creation of IT projects which are reliable, secure and efficient. IT projects like Tax Information Network, New Pension Scheme, National Treasury Management Agency, Expenditure Information Network, Goods and Service Tax, are in different stages of roll out. To look into various technological and systemic issues, I propose to set up a Technology Advisory Group for Unique Projects under the Chairmanship of Shri Nandan Nilekani.

Co-contribution for unorganised sector in NPS

There is an increasing sense that a government should help grow the participation of the informal sector in a defined-contribution individual account pension system by having co-contribution. In today's budget speech, the FM said:

90. To encourage the people from the unorganised sector to voluntarily save for their retirement and to lower the cost of operations of the New Pension Scheme (NPS) for such subscribers, Government will contribute Rs.1,000 per year to each NPS account opened in the year 2010-11. This initiative, "Swavalamban" will be available for persons who join NPS, with a minimum contribution of Rs.1,000 and a maximum contribution of Rs.12,000 per annum during the financial year 2010-11. The scheme will be available for another three years. Accordingly, I am making an allocation of Rs.100 crore for the year 2010-11. It will benefit about 10 lakh NPS subscribers of the unorganised sector. The scheme will be managed by the interim Pension Fund Regulatory and Development Authority. 

91. I also appeal to the State Governments to contribute a similar amount to the scheme and participate in providing social security to the vulnerable sections of the society.

A coherent vision for pension reforms is not yet in place: right alongside this, the government talks about a National Social Security Fund for unorganised sector workers with Rs.1000 crore.

Entry barriers in banking

One of the key mistakes in Indian banking has been the entry barriers: until recently, the rules inhibited placement of ATMs, placement of branches, new private banks, branches by foreign banks, money market mutual funds. There has been some progress on placement of ATMs and branches in recent months. A next step was announced in the budget speech:

38. The Indian banking system has emerged unscathed from the crisis. We need to ensure that the banking system grows in size and sophistication to meet the needs of a modern economy. Besides, there is a need to extend the geographic coverage of banks and improve access to banking services. In this context, I am happy to inform the Honourable Members that the RBI is considering giving some additional banking licenses to private sector players. Non Banking Financial Companies could also be considered, if they meet the RBI's eligibility criteria.

A coherent vision for banking policy is not yet in place: right alongside this, the government promises to put Rs.16,500 crore or roughly 0.3% of GDP to increase the equity capital of PSU banks.

Micro foundations of inclusive growth - from Economic Survey

Even if you don't usually read the Economic Survey, this year, the chapter titled Micro foundations of inclusive growth is well worth reading.

The Right to Education Act

Raghuram Rajan and Abhijit Banerjee in Indian Express on the flaws in the Right to Education Act.

Illiberal India

Did you know that when someone wants to visit India to attend a conference, the person has to:

obtain Conference Visa from the Indian Mission concerned on production of either the invitation letter from the organiser, event clearance from the Ministry of Home Affairs, administrative approval of the nodal ministry, political clearance from the Ministry of External Affairs or clearance from the State Government/UT concerned.

Or am I mis-reading this, and all that's required is an invitation letter from the organiser?

Implications of ETF on the Hang Seng index that's traded in India

I have a column in Financial Express today on this subject.

Talk at R/Rmetrics Singapore Conference 2010 on measurement of the exchange rate regime

Anmol Sethy will do a talk on our work on testing, dating and monitoring exchange rate regimes at the R/Rmetrics Singapore Conference 2010, including some recent progress on parallel computation. For background, see this paper, which talks about the ideas, and the open source R package fxregime. This is now fairly mature work: many of the papers at the NIPFP DEA Program website have utilised the ideas and code. The 6th meeting of the NIPFP-DEA Research Program (9 and 10 March) is going to have interesting new work in this field.

Come work for us

Come work for the NIPFP-DEA Research Program:

We are looking for people with a Masters or a Ph.D. with an economics / econometrics / statistics background with an interest in the fields visible in the above URL. Computer programming skills, ideally in R or matlab, are desirable.

Please send your resume to Anurodh Sharma : anurodh54 at gmail dot com.

Interesting readings

• Read this interview in the Times of India with Steve Coll, and this Congressional testimony of his. If you haven't yet read Ghost Wars, you should.
• Vijay Kelkar's recent speech on privatisation.
• The comments on this blog post are worth reading.
• Sanjeev Sanyal, in Business Standard, summarises our public policy problem: we need to build a strong (i.e. capable) State with a limited mission.
• Joe Leahy, in the Financial Times, has an article titled India: A nation develops about global quality R&D taking place in India. I'm pleased that researchers are being paid salaries large enough to make it easy to relocate to India. Also see David Brooks in the New York Times on Israel's achievements in this.
• Tamal Bandyopadhyay in Mint on the woes of foreign banks in India.
• Pratip Kar in Business Standard on competition between stock exchanges in India.
• Parth Shah debates Vinod Raina in the Business Standard on private schools.
• Nitin Pai has a response to Barbara Crossette's diatribe.
• Vikas Bajaj in the New York Times on the literature festival in Jaipur. How civilised. I have long felt that a genuine life of the mind in India is 25 years or more into the future. Maybe that's being too pessimistic.
• Olivier Coibion and Yuriy Gorodnichenko remind us that we are in the Great Moderation.
• Shai Bernstein, Josh Lerner, Morten Sorensen and Per Stroemberg have an NBER working paper titled Private Equity and Industry Performance . They find that industries where PE funds have invested in the past five years have grown more quickly in productivity and employment.
• Michael Slackman in the New York Times, taking stock of Dubai.
• One of the best blogs that I know of, from India, is `Wanderer's Eye', by Aniruddha Dhamorikar. E.g. see his latest post, on a mother wasp. Also see: a great collection of pictures on India.
• In the Hall of Shame of the 25 dirtiest cities of the world, by Forbes magazine, Bombay is at rank 7 and Delhi is at rank 24.
• Watch me talk about the recent RBI credit policy announcement -- part 1, part 2.
• Raghuram Rajan has a careful response to the Obama's proposals, which illuminates my recent writings on this.
• Scott McNealy has a beautiful goodbye note to Sun.
• Chris Anderson has an amazing story in Wired magazine about the new world of `small batch' manufacturing.
• Miles Corwin has an inspiring story for everyone who wants to be a writer or a journalist. And, for anyone engaged in deep thinking about the media, do not miss this lecture by Alan Rusbridger.

What could go wrong if petroleum product prices are decontrolled?

I have an article in Financial Express on this today.

Mumbai as an international financial centre

Three fascinating new takes on Mumbai as an international financial centre:

• Mukul Asher and Azad Singh Bali in DNA a few weeks ago.
• In the February 2010 issue of Pragati released yesterday, there are two articles on this: by Percy Mistry himself, and by V. Anantha Nageswaran.

A while ago, I had a blog post - http://tinyurl.com/mistry - which collected together the MIFC report and the immense outpouring of responses to it at the time.

How do I think we are faring? Pretty much as expected:

• India has not yet moved towards a deeper rewriting of the core financial laws, and redefinition of the role and function of government agencies in finance. But there is an increasing acceptance that this task is high on the TODO list of policy-makers, after the Patil, Mistry, Rajan and Aziz reports.
• Some incremental change has come about, such as currency futures. SEBI is making good progress on strengthening the capital markets which will be the foundation of India's play in the world of international financial services.
• Bombay is making a little progress (or maybe not ). See my recent blog post: Two paths to good cities.
• Participation in IFS production through BPO is continuing to grow rapidly. There is real capability building up in the labour market.
• India's de facto integration into the world economy took a knock in the crisis. The gross flows in and out of the country (across capital and current accounts) achieved a peak value of $211 billion in the September 2008 quarter.
  From that peak, there was a drop to $152 billion in the March 2009 quarter - this took India back to a value similar to that seen in September 2007.
  From that bottom, growth has begun again, and in the latest data (September 2009) this number is back up to $175 billion (which is bigger than the value seen in the December 2007 quarter but not yet the March 2007 quarter).
• In the crisis, we have better understood that small countries like Iceland find it difficult to be a big international financial centre given the lack of a commensurate fiscal backstop. This improves India's competitive positioning when compared with Singapore, Dubai or Qatar.